UNITED STATES
SECURITIES AND EXCHANGE COMMISSION
Washington, D.C. 20549
Form 10-K
[x] |
ANNUAL REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES EXCHANGE ACT OF 1934 |
For the fiscal year ended December 31, 20 16
OR
[ ] |
TRANSITION REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES EXCHANGE ACT OF 1934 |
For the transition period from _____ to ______.
Commission file number : 0-24100.
HMN FINANCIAL, INC.
(Exact name of registrant as specified in its charter)
Delaware |
41-1777397 |
(State or other jurisdiction of incorporation or organization) |
(I.R.S. Employer Identification No.) |
1016 Civic Center Drive Northwest |
55901 |
Rochester , Minnesota |
(Zip Code) |
(Address of principal executive offices) |
|
(507) 535-1200 |
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Registrant ’s telephone number, including area code |
Securities registered pursuant to Section 12(b) of the Act:
Title of each class |
Name of each exchange on which registered |
|
Common Stock, par value $.01 per share |
NASDAQ Global Market |
Securities registered pursuant to section 12(g) of the Act:
None | ||||
(Title of class) |
Indicate by check mark if the registrant is a well-known seasoned issuer, as defined in Rule 405 of the Securities Act.
YES [ ] NO [ X ]
Indicate by check mark if the registrant is not required to file report s pursuant to Section 13 or Section 15(d) of the Exchange Act.
YES [ ] NO [ X ]
Indicate by check mark whether the registrant (1) has filed all reports required to be filed by Section 13 or 15(d) of the Securities Exchange Act of 1934 during the preceding 12 months (or for such shorter period that the registrant was required to file such reports), and (2) has been subject to such requirements for the past 90 days.
YES [ X ] NO [ ]
Indicate by check mark whether the registrant has submitted electronically and posted on its corporate Web site, if any, every Interactive Data File required to be submitted and posted pursuant to Rule 405 of Regulation S-T (§229.405 of this chapter) during the preceding 12 months (or for such shorter period that the registrant was required to submit and post such files).
YES [ X ] NO [ ]
Indicate by check mark if disclosure of delinquent filers pursuant to Item 405 of Regulation S-K (§232.405 of this chapter) is not contained herein, and will not be contained, to the best of registrant’s knowledge, in definitive proxy or information statements incorporated by reference in Part III of this Form 10-K or any amendment to this Form 10-K. [ X ]
Indicate by check mark whether the registrant is a large accelerated filer, an accelerated filer, a non-accelerated filer, or a smaller reporting company. See the definitions of “large accelerated filer”, “accelerated filer” and “smaller reporting company” in Rule 12b-2 of the Exchange Act.
Large accelerated filer [ ] Accelerated filer [ ]
Non-accelerated filer [ ] Smaller reporting company [ X ]
(Do not check if a smaller reporting company)
Indicate by check mark whether the registrant is a shell company (as defined in Rule 12b-2 of the Exchange Act).
YES [ ] NO [ X ]
As of June 30 , 2016, the aggregate market value of the registrant’s common stock held by non-affiliates of the registrant was $46.8 million based on the closing stock price of $13.58 on such date as reported on the NASDAQ Global Market.
As of February 28, 2017, the number of outstanding shares of common stock of the registrant was 4,495,258.
DOCUMENTS INCORPORATED BY REFERENCE
Portions of the registrant’s annual report to stockholders for the year ended December 31, 2016 (Annual Report), are incorporated by reference in Parts I and II of this Form 10-K. Portions of the registrant’s definitive proxy statement to be filed with the Securities and Exchange Commission pursuant to Regulation 14A not later than 120 days after the close of the registrant’s fiscal year ended December 31, 2016 are incorporated by reference in Part III of this Form 10- K.
TABLE OF CONTENTS
PART I |
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Page |
Item 1. |
Business |
5 |
Item 1A. |
Risk Factors |
31 |
Item 1B. |
Unresolved Staff Comments |
41 |
Item 2. |
Properties |
41 |
Item 3. |
Legal Proceedings |
41 |
Item 4. |
Mine Safety Disclosures |
41 |
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PART II |
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Item 5. |
Market for Registrant ’ s Common Equity, Related Stockholder Matters and Issuer Purchases of Equity Securities |
41 |
Item 6. |
Selected Financial Data |
41 |
Item 7. |
Management’ s Discussion and Analysis of Financial Condition and Results of Operations |
41 |
Item 7A. |
Q uantitative and Qualitative Disclosures About Market Risk |
42 |
Item 8. |
Financial Statements and Supplementary Data |
42 |
Item 9. |
Changes in and Disagreements With Accountants on Accounting and Financial Disclosure |
42 |
Item 9A. |
Controls and Procedures |
42 |
Item 9B. |
Other Information |
43 |
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PART III |
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Item 10. |
Directors, Executive Officers and Corporate Governance |
43 |
Item 11. |
Executive Compensation |
43 |
Item 12. |
Security Ownership of Certain Beneficial Owners and Management and Related Stockholder Matters |
43 |
Item 13. |
Certain Relationships and Related Transactions, and Director Independence |
43 |
Item 14. |
Principal Accounting Fees and Services |
44 |
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PART IV |
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Item 15. |
Exhibits, Financial Statement Schedules |
44 |
Item 16. |
Form 10-K Summary |
44 |
Signatures |
45 |
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Index to Exhibits |
46 |
Forward-Looking Statements
The information presented or incorporated by reference in this Form 10-K contains forward-looking statements within the meaning of Section 21E of the Securities Exchange Act of 1934. These statements are often identified by such forward-looking terminology as “expect,” “intend,” “look,” “believe,” “anticipate,” “estimate,” “project,” “seek,” “may,” “will,” “would,” “could,” “should,” “trend,” “target,” and “goal” or similar statements or variations of such terms and include, but are not limited to, those relating to growing our core deposit relationships and loan balances, enhancing the financial performance of our core banking operations, improving credit quality, reducing non-performing assets, and generating improved financial results (including profitability); the adequacy and amount of available liquidity and capital resources to the Bank; the Company’s liquidity and capital requirements; our expectations for core capital and our strategies and potential strategies for maintenance thereof; improvements in loan production; changes in the size of the Bank’s loan portfolio; the amount of the Bank’s non-performing assets and the appropriateness of the allowance therefor; our ability to integrate acquired operations; anticipated future levels of the provision for loan losses; future losses on non-performing assets; the amount and composition of interest-earning assets; the amount and composition of interest-bearing liabilities; the availability of alternate funding sources; the payment of dividends by HMN; the future outlook for the Company; the amount of deposits that will be withdrawn from checking and money market accounts and how the withdrawn deposits will be replaced; the projected changes in net interest income based on rate shocks; the range that interest rates may fluctuate over the next twelve months; the net market risk of interest rate shocks; the future outlook for the issuer trust preferred securities held by the Bank; the ability of the Bank to pay dividends to HMN; the ability of HMN to pay the principal and interest payments on its third party note payable; and compliance by the Bank with regulatory standards generally (including the Bank’s status as well-capitalized) and other supervisory directives or requirements to which the Company or the Bank are or may become expressly subject, specifically, and possible responses of the Office of the Comptroller of the Currency (OCC), Board of Governors of the Federal Reserve System (FRB), the Bank, and the Company to any failure to comply with any such regulatory standard, directive or requirement.
A number of factors could cause actual results to differ materially from the Company ’s assumptions and expectations. These include but are not limited to the adequacy and marketability of real estate and other collateral securing loans to borrowers; federal and state regulation and enforcement; possible legislative and regulatory changes, including additional changes to regulatory capital rules; the ability of the Bank to comply with other applicable regulatory capital requirements; enforcement activity of the OCC and FRB in the event of our non-compliance with any applicable regulatory standard or requirement; adverse economic, business and competitive developments such as shrinking interest margins, reduced collateral values, deposit outflows, changes in credit or other risks posed by the Company’s loan and investment portfolios; changes in costs associated with alternate funding sources, including changes in collateral advance rates and policies of the Federal Home Loan Bank (FHLB); technological, computer-related or operational difficulties; results of litigation; reduced demand for financial services and loan products; changes in accounting policies and guidelines, or monetary and fiscal policies of the federal government or tax laws; international economic developments; the Company’s access to and adverse changes in securities markets; the market for credit related assets; the future operating results, financial condition, cash flow requirements and capital spending priorities of the Company and the Bank; the availability of internal and, as required, external sources of funding; acquisition integration costs; our ability to attract and retain employees; or other significant uncertainties. Additional factors that may cause actual results to differ from the Company’s assumptions and expectations include those set forth in the Company’s most recent filing on Forms 10-K and 10-Q with the Securities and Exchange Commission. All forward-looking statements are qualified by, and should be considered in conjunction with, such cautionary statements. For additional discussion of the risks and uncertainties applicable to the Company, see the “Risk Factors” sections of this Form 10-K. All forward-looking statements are qualified by, and should be considered in conjunction with, such cautionary statements.
PART I
ITEM 1. BUSINESS
General
HMN Financial, Inc. (HMN and, together with its subsidiaries, the Company) is a stock savings bank holding company that owns 100 percent of Home Federal Savings Bank (the Bank). The Bank has a community banking philosophy and operates retail banking and loan production facilities in Minnesota, Iowa, and Wisconsin. The Bank has two wholly owned subsidiaries, Osterud Insurance Agency, Inc. (OIA), which does business as Home Federal Investment Services and offers financial planning products and services, and HFSB Property Holdings, LLC (HPH), which was inactive in 2016, but has acted as an intermediary for the Bank in holding and operating certain foreclosed properties. HMN was incorporated in Delaware in 1994.
As a community-oriented financial institution, the Company seeks to serve the financial needs of communities in its market area. The Company’s business involves attracting deposits from the general public and businesses and using such deposits to originate or purchase single family residential, commercial real estate, and multi-family mortgage loans as well as consumer, construction, and commercial business loans. The Company also invests in mortgage-backed and related securities, U.S. government agency obligations and other permissible investments. The executive offices of the Company are located at 1016 Civic Center Drive Northwest, Rochester, Minnesota 55901. Its telephone number at that address is (507) 535-1200. The Company’s website is www.hmnf.com. Information contained on the Company’s website is expressly not incorporated by reference into this Form 10-K.
Market Area
The Company serves the southern Minnesota counties of Dodge, Fillmore, Freeborn, Houston, Mower, Olmsted and Winona and portions of Steele, Goodhue and Wabasha through its corporate office located in Rochester, Minnesota and its eleven branch offices located in Albert Lea, Austin, Kasson (2), La Crescent, Rochester (4), Spring Valley and Winona, Minnesota. The portion of the Company’s southern Minnesota market area consisting of Rochester and the contiguous communities is composed of primarily urban and suburban communities, while the balance of the Company's southern Minnesota market area consists primarily of rural areas and small towns. Primary industries in the Company's southern Minnesota market area include manufacturing, agriculture, health care, wholesale and retail trade, service industries and education. Major employers include the Mayo Clinic, Hormel Foods (a food processing company), and IBM. The Company's market area is also the home of Winona State University, Rochester Community and Technical College, University of Minnesota - Rochester, Winona State University - Rochester Center and Austin’s Riverland Community College.
The Company serves Dakota County, in the southern portion of the Minneapolis and St. Paul metropolitan area, from its office located in Eagan, Minnesota. Major employers in this market area include Delta Airlines, CHS Cooperative, Flint Hills Resources LP (oil refinery), Unisys Corp (computer software), Blue Cross Blue Shield of Minnesota, and West Group, a Thomson Reuters business (legal research).
The Company serves the Iowa county of Marshall through its branch office located in Marshalltown, Iowa. Major employers in the area include Swift & Company (pork processors), Fisher Controls International (valve and regulator manufacturing), Lennox Industries (furnace and air conditioner manufacturing), Iowa Veterans Home (hospital care), Marshall Community School District (education), and Marshall Medical & Surgical Center (hospital care).
Based upon information obtained from the U.S. Census Bureau for 201 5 (the last year for which information is available), the population of the seven primary counties in the Company’s southern Minnesota market area was estimated as follows: Dodge – 20,634; Fillmore – 20,834; Freeborn – 30,613; Houston – 18,773; Mower – 39,116; Olmsted – 151,436; and Winona – 50,885. For these same seven counties, the median household income from the U.S. Census Bureau for 2011-2015 ranged from $47,105 to $68,116. The population of Dakota County was 414,686 and the median household income was $75,567. With respect to Iowa, the population of Marshall County was 40,746 and the median household income was $53,351.
Lending Activities
General. Historically, the Company has originated 15 and 30 year fixed rate mortgage loans secured by single family residences for its loan portfolio. Over the past 15 years, the Company has focused on managing interest rate risk and increasing interest income by increasing its investment in shorter term and generally higher yielding commercial real estate, commercial business and construction loans, while reducing its investment in longer term single family real estate loans. The Company continues to originate 15 and 30 year fixed rate mortgage loans and some shorter term fixed rate loans. The shorter term fixed rate loans and adjustable rate loans are generally placed into portfolio, while the majority of the 15 and 30 year fixed rate mortgage loans are sold in the secondary mortgage market. Mortgage interest rates continued to be at relatively low levels in 2016 and very few 15 and 30 year loans were placed into portfolio as most were sold into the secondary market in order to manage the Company’s interest rate risk position. The Company also offers an array of consumer loan products that include both open and closed end home equity loans. Home equity lines of credit have adjustable interest rates based upon the prime rate, as published in the Wall Street Journal, plus a margin. Refer to “ Note 5 Loans Receivable, Net ” and “ Note 6 Allowance for Loan Losses and Credit Quality Information ” in the Notes to Consolidated Financial Statements in the Annual Report for more information on the loan portfolio (incorporated by reference in Item 8 of Part II of this Form 10-K).
The following table shows the composition of the Company's loan portfolio by fixed and adjustable rate loans as of December 31:
20 16 |
20 15 |
20 14 |
20 13 |
20 12 |
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(Dollars in thousands) |
Amount |
Percent |
Amount |
Percent |
Amount |
Percent |
Amount |
Percent |
Amount |
Percent |
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Fixed rate Loans |
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Real e state: |
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Single family |
$ | 55,143 | 9.83 |
% |
$ | 55,226 | 11.68 |
% |
$ | 46,288 | 12.39 |
% |
$ | 47,377 | 11.96 |
% |
$ | 57,463 | 12.08 |
% |
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Multi-family |
29,171 | 5.20 | 8,045 | 1.70 | 10,919 | 2.92 | 7,687 | 1.94 | 9,608 | 2.02 | ||||||||||||||||||||||||||||||
Commercial |
159,195 | 28.38 | 117,790 | 24.91 | 104,178 | 27.89 | 109,387 | 27.62 | 115,519 | 24.28 | ||||||||||||||||||||||||||||||
Construction |
13,438 | 2.40 | 27,381 | 5.79 | 7,361 | 1.97 | 2,645 | 0.67 | 8,430 | 1.77 | ||||||||||||||||||||||||||||||
Total real estate loans |
256,947 | 45.81 | 208,442 | 44.08 | 168,746 | 45.17 | 167,096 | 42.19 | 191,020 | 40.15 | ||||||||||||||||||||||||||||||
Consumer loans: |
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Automobile |
3,036 | 0.54 | 2,885 | 0.61 | 1,124 | 0.30 | 971 | 0.25 | 623 | 0.13 | ||||||||||||||||||||||||||||||
Home equity |
9,744 | 1.74 | 10,231 | 2.16 | 10,711 | 2.87 | 11,629 | 2.94 | 11,390 | 2.39 | ||||||||||||||||||||||||||||||
Recreational vehicle |
7,553 | 1.35 | 2,650 | 0.56 | 0 | 0.00 | 0 | 0.00 | 0 | 0.00 | ||||||||||||||||||||||||||||||
Other |
5,447 | 0.97 | 4,635 | 0.99 | 4,091 | 1.09 | 4,174 | 1.05 | 4,827 | 1.02 | ||||||||||||||||||||||||||||||
Total consumer loans |
25,780 | 4.60 | 20,401 | 4.32 | 15,926 | 4.26 | 16,774 | 4.24 | 16,840 | 3.54 | ||||||||||||||||||||||||||||||
Commercial business loans |
53,019 | 9.46 | 39,197 | 8.29 | 32,147 | 8.61 | 40,122 | 10.13 | 32,769 | 6.89 | ||||||||||||||||||||||||||||||
Total non-real estate loans |
78,799 | 14.06 | 59,598 | 12.61 | 48,073 | 12.87 | 56,896 | 14.37 | 49,609 | 10.43 | ||||||||||||||||||||||||||||||
Total fixed rate loans |
335,746 | 59.87 | 268,040 | 56.69 | 216,819 | 58.04 | 223,992 | 56.56 | 240,629 | 50.58 | ||||||||||||||||||||||||||||||
Adjustable rate Loans |
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Real estate: |
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Single family |
48,112 | 8.58 | 35,719 | 7.55 | 23,553 | 6.31 | 29,090 | 7.34 | 39,574 | 8.32 | ||||||||||||||||||||||||||||||
Multi-family |
7,606 | 1.36 | 4,279 | 0.90 | 4,781 | 1.28 | 426 | 0.11 | 2,148 | 0.45 | ||||||||||||||||||||||||||||||
Commercial |
71,760 | 12.80 | 79,136 | 16.74 | 59,187 | 15.84 | 69,099 | 17.45 | 105,202 | 22.11 | ||||||||||||||||||||||||||||||
Construction |
17,910 | 3.19 | 10,722 | 2.27 | 5,242 | 1.40 | 5,206 | 1.31 | 4,000 | 0.84 | ||||||||||||||||||||||||||||||
Total real estate loans |
145,388 | 25.93 | 129,856 | 27.46 | 92,763 | 24.83 | 103,821 | 26.21 | 150,924 | 31.72 | ||||||||||||||||||||||||||||||
Consumer: |
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Home equity line |
40,476 | 7.22 | 38,561 | 8.16 | 36,832 | 9.86 | 36,178 | 9.13 | 36,521 | 7.68 | ||||||||||||||||||||||||||||||
Home equity |
6,558 | 1.17 | 4,970 | 1.05 | 1,709 | 0.46 | 0 | 0.00 | 0 | 0.00 | ||||||||||||||||||||||||||||||
Other |
469 | 0.08 | 483 | 0.10 | 458 | 0.12 | 471 | 0.12 | 614 | 0.12 | ||||||||||||||||||||||||||||||
Total consumer loans |
47,503 | 8.47 | 44,014 | 9.31 | 38,999 | 10.44 | 36,649 | 9.25 | 37,135 | 7.80 | ||||||||||||||||||||||||||||||
Commercial business loans |
32,157 | 5.73 | 30,909 | 6.54 | 24,975 | 6.69 | 31,587 | 7.98 | 47,085 | 9.90 | ||||||||||||||||||||||||||||||
Total non-real estate loans |
79,660 | 14.20 | 74,923 | 15.85 | 63,974 | 17.13 | 68,236 | 17.23 | 84,220 | 17.70 | ||||||||||||||||||||||||||||||
Total adjustable rate loans |
225,048 | 40.13 | 204,779 | 43.31 | 156,737 | 41.96 | 172,057 | 43.44 | 235,144 | 49.42 | ||||||||||||||||||||||||||||||
Total loans |
560,794 | 100.00 |
% |
472,819 | 100.00 |
% |
373,556 | 100.00 |
% |
396,049 | 100.00 |
% |
475,773 | 100.00 |
% |
|||||||||||||||||||||||||
Less |
||||||||||||||||||||||||||||||||||||||||
Unamortized discounts |
20 | 16 | 14 | 33 | 33 | |||||||||||||||||||||||||||||||||||
Net deferred loan (costs) fees |
(300 | ) | (91 | ) | 97 | 0 | 87 | |||||||||||||||||||||||||||||||||
Allowance for losses on loans |
9,903 | 9,709 | 8,332 | 11,401 | 21,608 | |||||||||||||||||||||||||||||||||||
Total loans receivable, net |
$ | 551,171 | $ | 463,185 | $ | 365,113 | $ | 384,615 | $ | 454,045 |
The following table illustrates the interest rate maturities of the Company's loan portfolio at December 31, 20 16. Loans which have adjustable or renegotiable interest rates are shown as maturing in the period during which the contract is due. Scheduled repayments of principal are reflected in the year in which they are scheduled to be paid. The schedule does not reflect the effects of possible prepayments or enforcement of due-on-sale clauses.
Real Estate |
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(Dollars in thousands) |
Single family |
Multi-family and Commercial |
Construction |
Consumer |
Commercial Business |
Total |
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Due During Years Ending December 31, |
Amount |
Weighted Average Rate |
Amount |
Weighted Average Rate |
Amount |
Weighted Average Rate |
Amount |
Weighted Average Rate |
Amount |
Weighted Average Rate |
Amount |
Weighted Average Rate |
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2017 (1) | $ | 9,427 | 4.05 |
% |
$ | 30,638 | 4.96 |
% |
$ | 20,944 | 3.56 |
% |
$ | 7,930 | 5.68 |
% |
$ | 46,793 | 4.35 |
% |
$ | 115,732 | 4.44 |
% |
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20 18 |
7,925 | 4.01 | 49,068 | 4.44 | 731 | 4.37 | 5,030 | 5.49 | 11,714 | 4.66 | 74,468 | 4.50 | |||||||||||||||||||||||||||||||||||||
201 9 |
9,482 | 4.21 | 30,274 | 4.43 | 640 | 4.35 | 4,674 | 5.67 | 6,684 | 4.47 | 51,754 | 4.51 | |||||||||||||||||||||||||||||||||||||
2020 through 2021 |
18,893 | 4.12 | 78,556 | 4.44 | 2,604 | 4.19 | 6,365 | 5.32 | 17,127 | 4.24 | 123,545 | 4.40 | |||||||||||||||||||||||||||||||||||||
2022 through 2026 |
24,194 | 3.88 | 68,084 | 4.39 | 6,429 | 3.82 | 9,384 | 5.36 | 2,788 | 5.51 | 110,879 | 4.36 | |||||||||||||||||||||||||||||||||||||
202 7 through 2041 |
29,008 | 3.93 | 11,089 | 5.03 | 0 | 0.00 | 39,900 | 4.22 | 15 | 4.50 | 80,012 | 4.23 | |||||||||||||||||||||||||||||||||||||
204 2 and thereafter |
4,326 | 3.75 | 23 | 4.50 | 0 | 0.00 | 0 | 0.00 | 55 | 0.00 | 4,404 | 3.71 | |||||||||||||||||||||||||||||||||||||
$ | 103,255 | $ | 267,732 | $ | 31,348 | $ | 73,283 | $ | 85,176 | $ | 560,794 |
(1) |
Includes demand loans, loans having no stated maturity and overdraft loans. |
Th e total amount of loans due after December 31, 2017 which have predetermined interest rates is $273.5 million, while the total amount of loans due after such date which have floating or adjustable interest rates is $171.5 million. Construction or development loans, at December 31, 2016, were $21.9 million for single family dwellings, $2.6 million for multi-family and $6.8 million for nonresidential.
The aggregate amount of loans and extensions of credit that the Bank is permitted to make to any one borrower is generally limited to 15% of unimpaired capital and surplus. In addition to the 15% limit, the Bank is permitted to lend an additional amount equal to 10% of unimpaired capital and surplus if the additional amount is fully secured by “readily marketable collateral” having a current market value of at least 100% of the loan or extension of credit. Similarly, the Bank is permitted to lend additional amounts equal to the lesser of 30% of unimpaired capital and surplus, or $30 million, for certain residential development loans. Applicable law establishes a number of rules for combining loans to separate borrowers. Loans or extensions of credit to one person may be attributed to other persons if: (i) the proceeds of a loan or extension of credit are used for the direct benefit of the other person; or (ii) a common enterprise is deemed to exist between persons. At December 31, 2016, based upon the 15% limitation, the Bank's regulatory limit for loans to one borrower was approximately $12.5 million and no loans to any one borrower exceeded this amount. At December 31, 2016, the Bank’s largest aggregate amount of loans to one borrower totaled $11.7 million. All of the loans for the largest borrower were performing in accordance with their terms as of December 31, 2016 and the borrower had no affiliation with the Bank other than its relationship as a borrower.
All of the Bank's lending is subject to its written underwriting standards and to loan origination procedures. Decisions on loan requests are made on the basis of detailed applications and property valuations determined by an independent appraiser. The loan applications are designed primarily to determine the borrower's ability to repay. The more significant items on the application are verified through the use of credit reports, financial statements, tax returns, or confirmations.
Single family loans are originated either for inclusion in the loan portfolio under the Bank ’s Portfolio First loan program or for sale in the secondary market to the Federal National Mortgage Association (FNMA) on a servicing retained basis or to other third party investors on a servicing released basis. The limit for retail mortgages originated for sale on the secondary market was $417,000 for both 2016 and 2015 and these loans require the approval of a designated secondary market underwriter. Three levels of approval authority have been established for loans originated under the Portfolio First loan program. The three levels of authority include Approved Portfolio First Lenders, Market Presidents, and Credit Administration positions with Portfolio First approval authority. Approved Portfolio First Lenders are select mortgage loan officers recommended for the Portfolio First program approval authority by their Market President and are approved by the Chief Operating Officer. The Credit Administration positions with Portfolio First approval authority include the Rochester Market President, Director of Retail Lending and Loan Servicing, Vice President of Credit Administration, Chief Credit Officer, and the Chief Operating Officer. Loans less than $350,000 require the approval of the Portfolio First Lender, the Market President, and one Credit Administration individual with Portfolio First approval authority. Loans over $350,000 require the approval of the Portfolio First Lender, the Market President, and two Credit Administration individuals with Portfolio First approval authority. Loans where the total aggregate amount of all loan obligations owed or guaranteed to the Bank, plus the new obligation is greater than $2.0 million, require the approval of a majority of the Senior Loan Committee, which is comprised of the Bank’s most experienced lending staff.
The Bank generally requires title insurance on its mortgage loans , as well as fire and extended coverage casualty insurance in amounts at least equal to the principal amount of the loan or the value of improvements on the property. The Bank also requires flood insurance to protect the property securing its interest when the property is located in a flood plain.
Single Family Residential Real Estate Lending . At December 31, 2016, the Company's single family real estate loans, consisting of both fixed rate and adjustable rate loans, totaled $103.3 million, an increase of $12.4 million, from $90.9 million at December 31, 2015. The increase in the single family loans in 2016 is the result of additional mortgage lending staff originating more loans with an increased emphasis on originating shorter term fixed rate and adjustable rate mortgage loans that were placed into the portfolio during 2016. The majority of the longer term loans that were originated during the year continued to be sold into the secondary market in order to manage the Company’s interest rate risk position.
The Company offers conventional fixed rate single family loans that have maximum terms of 30 years. In order to manage interest rate risk, the Company typically sells the majority of fixed rate loan originations with terms to maturity of 15 years or greater that are eligible for sale in the secondary market. The interest rates charged on the fixed rate loan products are based on the secondary market delivery rates, as well as other competitive factors. The Company also originates fixed rate loans with terms up to 30 years that are insured by the Federal Housing Authority (FHA), Veteran’s Administration (VA), Minnesota Housing Finance Agency, Iowa Finance Authority, or United States Department of Agriculture-Guaranteed Housing.
The Company also offers one-year adjustable rate mortgages (ARMs) at a margin (generally 350 to 450 basis points) over the yield on the Average Weekly One Year U.S. Treasury Constant Maturity Index for terms of up to 30 years. The ARMs offered by the Company allow the borrower to select (subject to pricing) an initial period of one year, three years, or five years between the loan origination and the date the first interest rate change occurs. The ARMs generally have a 200 basis point annual interest rate change cap and a lifetime cap of 600 basis points over or under the initial rate. The Company’s originated ARMs do not permit negative amortization of principal, generally do not contain prepayment penalties and are not convertible into fixed rate loans. Because of the low interest rate environment that has existed over the last few years, a limited number of ARM loans have been originated as consumers have generally opted for the longer term fixed rate loans.
In underwriting single family residential real estate loans, the Company evaluates the borrower's credit history, ability to make principal, interest and escrow payments, the value of the property that will secure the loan, and debt to income ratios. Properties securing single family residential real estate loans made by the Company are appraised by independent appraisers. The Company originates residential mortgage loans with loan-to-value ratios up to 100% for owner-occupied homes and up to 85% for non-owner-occupied homes; however, private mortgage insurance is generally required to reduce the Company's exposure to 80% or less of the value on most loans. The Company generally seeks to underwrite its loans in accordance with secondary market, FHA or VA standards. However, the Company does originate shorter term fixed rate and adjustable rate single family loans for its portfolio that do not meet certain secondary market guidelines.
The Company's residential mortgage loans customarily include due-on-sale clauses giving it the right to declare the loan immediately due and payable in the event that, among other things, the borrower sells or otherwise disposes of the property subject to the mortgage.
At December 31, 201 6, $0.9 million of the single family residential loan portfolio was non-performing compared to $1.7 million at December 31, 2015.
Commercial Real Estate and Multi-Family Lending . The Company originates permanent commercial real estate and multi-family loans secured by properties located primarily in its market area. It also purchases a limited amount of participations in commercial real estate and multi-family loans originated by third parties. The commercial real estate and multi-family loan portfolio includes loans secured by motels, hotels, apartment buildings, churches, manufacturing plants, land developments, office buildings, business facilities, shopping malls, nursing homes, golf courses, restaurants, warehouses, convenience stores, and other non-residential building properties primarily located in the upper Midwestern portion of the United States. At December 31, 2016, the Company’s commercial and multi-family real estate loans totaled $267.7 million, an increase of $58.4 million, from $209.3 million at December 31, 2015.
Permanent commercial real estate and multi-family loans are generally originated for a maximum term of 1 0 years and may have longer amortization periods with balloon maturity features. The interest rates may be fixed for the term of the loan or have adjustable features that are tied to the prime rate or another published index. Commercial real estate and multi-family loans are generally written in amounts up to 80% of the lesser of the appraised value of the property or the purchase price and generally have a debt service coverage ratio of at least 120%. The debt service coverage ratio is the ratio of net cash from operations to debt service payments. The Company may originate construction loans secured by commercial or multi-family real estate, or may purchase participation interests in third party originated construction loans secured by commercial or multi-family real estate.
Appraisals on commercial real estate and multi-family real estate properties are performed by independent appraisers prior to the time the loan is made. For transactions less than $250,000, the Company may use an internal valuation. All appraisals on commercial and multi-family real estate are reviewed and approved by a qualified third party or credit department employee. The Bank's underwriting procedures require verification of the borrower's credit history, income and financial statements, banking relationships, and income projections for the property. The commercial loan policy generally requires personal guarantees from the proposed borrowers. An initial on-site inspection is generally required for all collateral properties for loans with balances in excess of $250,000. Independent annual reviews are performed for aggregate commercial lending relationships that exceed $500,000. The reviews cover financial performance, documentation completeness, and accuracy of loan risk ratings.
Multi-family and commercial real estate loans generally present a higher level of risk than loans secured by single family residences. This greater risk is due to several factors, including the concentration of principal in a limited number of loans and borrowers, the effects of general economic conditions on income producing properties and the increased difficulty of evaluating and monitoring these types of loans. Furthermore, the repayment of loans secured by multi-family and commercial real estate is typically dependent upon the successful operation of the related real estate project. If the cash flow from the project is reduced (for example, if leases are not obtained or renewed), the borrower's ability to repay the loan may be impaired. At December 31, 2016, $1.3 million of loans in the commercial real estate portfolio were non-performing, compared to $0.3 million at December 31, 2015. The largest non-performing lending relationship in this category as of December 31, 2016 is a $1.2 million loan secured by a manufacturing facility located in the Bank’s primary market area.
Construction Lending. The Company makes construction loans to individuals for the construction of their residences and to builders for the construction of single family residences. It also makes a limited number of loans to builders for houses built on speculation. Construction loans also include commercial real estate loans.
Almost all loans to individuals for the construction of their residences are structured as permanent loans. These loans are made on the same terms as residential loans, except that during the construction phase, which typically lasts up to twelve months, the borrower pays interest only. Generally, the borrower also pays a construction fee at the time of origination plus other costs associated with processing the loan. Residential construction loans are underwritten pursuant to the same guidelines used for originating residential loans on existing properties.
Construction loans to builders or developers of single family residences generally carry terms of one year or less.
Construction loans to owner occupants are generally made in amounts up to 95% of the lesser of cost or appr aised value, but no more than 90% of the loan proceeds can be disbursed until the building is completed. The Company generally limits the loan-to-value ratios on loans to builders to 80%. Prior to making a commitment to fund a construction loan, the Company requires a valuation of the property, financial data, and verification of the borrower's income. The Company obtains personal guarantees for substantially all of its construction loans to builders. Personal financial statements of guarantors are also obtained as part of the loan underwriting process. Construction loans are generally located in the Company's market area.
Construction loans are obtained principally through continued business from builders and developers who have previously borrowed from the Bank, as well as referrals from existing clients and walk-in clients. The application process includes a submission to the Bank of accurate plans, specifications and costs of the project to be constructed. These items are one factor utilized in the determination of the appraised value of the subject property to be built.
At December 31, 2016, construction loans totaled $31.3 million, a decrease of $6.8 million from $38.1 million at December 31, 2015. Total construction loans included $21.9 million and $15.1 million of single family residential, $2.6 million and $18.9 million of multi-family residential, and $6.8 million and $4.1 million of commercial real estate loans at December 31, 2016 and December 31, 2015, respectively. The nature of construction loans makes them more difficult to evaluate and monitor than loans on existing buildings. The risk of loss on a construction loan is dependent largely upon the accuracy of the initial estimate of the property's value upon completion of the project, experience of the builder, and the estimated cost (including interest) of the project. If the estimate of value proves to be inaccurate, the Company may be confronted, at or prior to the maturity of the loan, with a project having a value that is insufficient to assure full repayment or the possibility of having to make substantial investments to complete and sell the project. Because defaults in repayment may not occur during the construction period, it may be difficult to identify problem loans at an early stage. In these cases, the Company may be required to modify the terms of the loan. At December 31, 2016, $0.1 million of construction loans in the commercial real estate portfolio were non-performing compared to $1.4 million at December 31, 2015. The non-performing construction loans are loans to parties related through common ownership to construct model homes that when sold, or have a purchase agreement, are converted to performing loans and the interest is recognized.
Consumer Lending. The Company originates a variety of consumer loans, including home equity loans (open-end and closed-end), automobile, recreational vehicles, mobile home, lot loans, loans secured by deposit accounts and other loans for household and personal purposes. At December 31, 2016, the Company’s consumer loans totaled $73.3 million, an increase of $8.9 million from $64.4 million at December 31, 2015.
Consumer loan terms vary according to the type and value of collateral, length of contract and creditworthiness of the borrower. The Company's consumer loans are made at fixed or adjustable interest rates, with terms up to 20 years for secured loans and up to five years for unsecured loans.
The Company's home equity loans are written so that the total commitment amount, when combined with the balance of any other outstanding mortgage liens, generally does not exceed 90% of the appraised value of the property or an internally established market value. Internal market values are established using current market data, including recent sales data, and are typically lower than third party appraised values. The closed-end home equity loans are written with fixed or adjustable rates with terms up to 15 years. The open-end home equity lines are written with an adjustable rate and a 2- or 10-year draw period that requires interest only payments followed by a 10-year repayment period that fully amortizes the outstanding balance. The consumer may access the open-end home equity line by making a withdrawal at the Bank, transferring funds through our online or mobile banking products, or writing a check on the home equity line of credit account. Open and closed-end equity loans, which are generally secured by second mortgages on the borrower’s principal residence, represented 77.5% of the Company’s consumer loan portfolio at December 31, 2016.
The underwriting standards employed by the Company for consumer loans include a determination of the applicant's payment history on other debts and their ability to meet existing obligations and payments on the proposed loan. Although creditworthiness of the applicant is of primary consideration, the underwriting process also includes a comparison of the value of the security, if any, in relation to the proposed loan amount. Consumer loans may entail greater credit risk than do residential mortgage loans, particularly in the case of consumer loans that are unsecured or are secured by rapidly depreciable assets, such as automobiles, recreational vehicles, or mobile homes. In these cases, any repossessed collateral for a defaulted consumer loan may not provide an adequate source of repayment of the outstanding loan balance as a result of the greater likelihood of damage, loss or depreciation. In addition, consumer loan collections are dependent on the borrower's continuing financial stability, and thus are more likely to be affected by adverse personal circumstances. Furthermore, the application of various federal and state laws, including bankruptcy and insolvency laws, may limit the amount that can be recovered on such loans. At December 31, 2016, $0.6 million of the consumer loan portfolio was non-performing, compared to $0.8 million at December 31, 2015.
Commercial Business Lending. The Company maintains a portfolio of commercial business loans to borrowers associated with the real estate industry as well as to retail, manufacturing operations, and professional firms. The Company's commercial business loans generally have terms ranging from six months to five years and may have either fixed or variable interest rates. The Company's commercial business loans generally include personal guarantees and are usually, but not always, secured by business assets such as inventory, equipment, leasehold interests in equipment, fixtures, real estate and accounts receivable. The underwriting process for commercial business loans includes consideration of the borrower's financial statements, tax returns, projections of future business operations, and inspection of the subject collateral, if any. The Company also purchases participation interests in commercial business loans originated outside of the Company’s market area from third party originators. These loans generally have underlying collateral of inventory or equipment and repayment periods of less than ten years. At December 31, 2016, the Company’s commercial business loans totaled $85.2 million, an increase of $15.1 million, from $70.1 million at December 31, 2015.
Unlike residential mortgage loans, which generally are made on the basis of the borrower's ability to make repayment from his or her income, and which are secured by real property with more easily ascertainable value, commercial business loans are of higher risk and typically are made on the basis of the borrower's ability to make repayment from the cash flow of the borrower's business. As a result, the availability of funds for the repayment of commercial business loans may be substantially dependent on the success of the business itself. Furthermore, the collateral securing the loans may depreciate over time, may be difficult to appraise, and may fluctuate in value based on the success of the business. At December 31, 2016, $0.4 million of loans in the commercial business loan portfolio were non-performing, compared to $0.1 million at December 31, 2015.
Originations, Purchases and Sales of Loans and Mortgage-Backed and Related Securities
Real estate loans are generally originated by the Company's salaried loan officers. Mortgage and consumer loan officers may also receive a commission in addition to their base salary for meeting production and other branch goals. Loan applications are taken in all branch and loan production offices.
The Company originates both fixed and adjustable rate loans, however, its ability to originate loans is dependent upon the relative client demand for loans in its markets. Demand for adjustable rate loans is affected by the interest rate environment. The number of adjustable rate loans remained low in 2016 due to the low long term fixed mortgage rates that existed during the year. The Company originated for its portfolio $18.4 million of single family adjustable rate loans during 2016, an increase of $6.3 million, from $12.1 million in 2015. The Company also originated for its portfolio $26.9 million of fixed rate single family loans during 2016, a decrease of $0.7 million, from $27.6 million for 2015. The changes in the fixed and adjustable rate single family loans that were placed into the loan portfolio in 2016 are the result of the Bank offering more adjustable and short term fixed rate loan options to borrowers that did not meet certain secondary market criteria but did meet internal underwriting guidelines. This increased the total amount of loans that were originated and placed into the Bank’s portfolio.
During the past several years, the Company has focused its portfolio loan origination efforts on commercial real estate , commercial business and consumer loans because these loans have terms to maturity and adjustable interest rate characteristics that are generally more beneficial to the Company in managing interest rate risk than traditional single family fixed rate conventional loans. The Company originated $140.5 million of multi-family and commercial real estate, commercial business and consumer loans (which excludes commercial real estate loans for construction or development) during 2016, a decrease of $0.6 million, from originations of $141.1 million for 2015. The slight decrease in originations primarily reflects the $12.0 million and $7.3 million decrease in commercial real estate loans and commercial business loans, respectively, in 2016 compared to 2015. Consumer loan origination also increased $1.4 million between the periods, while multi-family loan origination increased $17.3 million.
In order to supplement loan demand in the Company's market area and geographically diversify its loan portfolio, the Company, from time to time, purchases participations in real estate loans from selected sellers, with yields based upon then-current market rates. The Company reviews and underwrites all loans purchased to ensure that they meet the Company's underwriting standards and the seller generally continues to service the loans. The Company has generally not experienced higher losses or credit quality issues with purchased participations than other loans originated by the Company. The Company purchased $16.3 million of loans during 2016, a decrease of $2.1 million, from $18.4 million during 2015. The commercial real estate and commercial business loans that were purchased have terms and interest rates that are similar in nature to the Company's originated commercial and business portfolio. See “ Note 5 Loans Receivable, Net ” and “Note 6 Allowance for Loan Losses and Credit Quality Information” in the Notes to Consolidated Financial Statements in the Annual Report for more information on purchased loans (incorporated by reference in Item 8 of Part II of this Form 10-K).
The Company also acquired loans totaling $ 12.0 million in an acquisition that occurred in the second quarter of 2016 and $24.1 million in an acquisition that was completed in the third quarter of 2015.
The Company has some mortgage-backed and related securities that are held, based on investment intent, in the "available for sale" portfolio. The Company did not acquire any mortgage-backed securities in 2016 but did acquire $5.5 million of mortgage backed securities in 2015 in connection with an acquisition. No mortgage-backed securities were purchased in 2016 or 2015, other than those obtained in the acquisition, because debt instruments issued by federal agencies, such as FNMA and FHLMC, continued to be more appealing to purchase due to their shorter duration given the low interest rate environment that continued to exist in 2016. In 2016 and 2015, the Company sold $30,000 and $4.2 million of mortgage-backed securities, respectively, that were acquired in the 2015 acquisition. The securities were sold due primarily to the small lot size of the individual securities. See “Investment Activities” below.
The following table shows the loan and mortgage-backed and related securities origination, purchase, acquisition, sale and repayment activities of the Company for the periods indicated.
LOANS HELD FOR INVESTMENT |
||||||||||||
Year Ended December 31, |
||||||||||||
(Dollars in thousands) |
20 16 |
20 15 |
20 14 |
|||||||||
Originations by type: |
||||||||||||
Adjustable rate: |
||||||||||||
Real estate - |
||||||||||||
- single family |
$ | 18,442 | 12,111 | 2,009 | ||||||||
- multi-family |
9,246 | 0 | 4,400 | |||||||||
- commercial |
14,591 | 21,489 | 28,181 | |||||||||
- construction or development |
40,132 | 19,920 | 9,812 | |||||||||
Non-real estate - |
||||||||||||
- consumer |
15,481 | 18,852 | 10,487 | |||||||||
- commercial business |
10,353 | 19,538 | 8,123 | |||||||||
Total adjustable rate |
108,245 | 91,910 | 63,012 | |||||||||
Fixed rate: |
||||||||||||
Real estate - |
||||||||||||
- single family |
26,948 | 27,612 | 11,550 | |||||||||
- multi-family |
12,107 | 4,042 | 5,576 | |||||||||
- commercial |
42,176 | 47,306 | 23,316 | |||||||||
- construction or development |
19,181 | 38,299 | 39,274 | |||||||||
Non-real estate - |
||||||||||||
- consumer |
16,335 | 11,610 | 8,331 | |||||||||
- commercial business |
20,196 | 18,281 | 12,130 | |||||||||
Total fixed rate |
136,943 | 147,150 | 100,177 | |||||||||
Total loans originated |
245,188 | 239,060 | 163,189 | |||||||||
Purchases: |
||||||||||||
Real estate - |
||||||||||||
- single family |
0 | 2,800 | 0 | |||||||||
- multi-family |
750 | 0 | 0 | |||||||||
- commercial |
1,130 | 7,501 | 6,003 | |||||||||
- construction or development |
2,500 | 5,500 | 0 | |||||||||
Non-real estate - |
||||||||||||
- commercial business |
11,949 | 2,600 | 5,196 | |||||||||
Total loans purchased |
16,329 | 18,401 | 11,199 | |||||||||
Acquisition : |
||||||||||||
Real estate - |
||||||||||||
- single family |
146 | 4,985 | 0 | |||||||||
- multi-family |
0 | 100 | 0 | |||||||||
- commercial |
5,808 | 7,712 | 0 | |||||||||
Non-real estate - |
||||||||||||
- consumer |
3,536 | 5,226 | 0 | |||||||||
- commercial business |
2,546 | 6,037 | 0 | |||||||||
Total loans acquired |
12,036 | 24,060 | 0 | |||||||||
Sales, participations and repayments : |
||||||||||||
Real estate - |
||||||||||||
- multi-family |
4,500 | 0 | 0 | |||||||||
- commercial |
9,002 | 4,504 | 22,098 | |||||||||
- construction or development |
13,765 | 14,602 | 19,796 | |||||||||
Non-real estate - |
||||||||||||
- consumer |
719 | 516 | 982 | |||||||||
- commercial business |
634 | 154 | 2,201 | |||||||||
Total sales |
28,620 | 19,776 | 45,077 | |||||||||
Transfers to loans sold |
15,002 | 8,125 | 13,243 | |||||||||
Principal repayments |
140,944 | 154,054 | 137,205 | |||||||||
Total reductions |
184,566 | 181,955 | 195,525 | |||||||||
Decrease in other items, net |
(1,012 | ) | (303 | ) | (1,356 | ) | ||||||
Net increase (decrease) |
$ | 87,975 | 99,263 | (22,493 | ) |
LOANS HELD FOR SALE |
||||||||||||
Year Ended December 31, |
||||||||||||
(Dollars in thousands) |
2016 |
2015 |
2014 |
|||||||||
Originations by type : |
||||||||||||
Adjustable rate: |
||||||||||||
Real estate - |
||||||||||||
- single family |
$ | 0 | 0 | 0 | ||||||||
Total adjustable rate |
0 | 0 | 0 | |||||||||
Fixed rate: |
||||||||||||
Real estate - |
||||||||||||
- single family |
79,783 | 69,941 | 41,557 | |||||||||
Total fixed rate |
79,783 | 69,941 | 41,557 | |||||||||
Total loans originated |
79,783 | 69,941 | 41,557 | |||||||||
Sales and repayments : |
||||||||||||
Real estate - |
||||||||||||
- single family |
88,355 | 71,992 | 41,533 | |||||||||
Total sales |
88,355 | 71,992 | 41,533 | |||||||||
Transfers from loans held for investment |
(6,822 | ) | (3,778 | ) | (557 | ) | ||||||
Principal repayments |
20 | 24 | 7 | |||||||||
Total reductions |
81,553 | 68,238 | 40,983 | |||||||||
Net (decrease) increase |
$ | (1,770 | ) | 1,703 | 574 |
MORTGAGE-BACKED AND RELATED SECURITIES |
||||||||||||
Year Ended December 31, |
||||||||||||
(Dollars in thousands) |
2016 |
2015 |
2014 |
|||||||||
Purchases : |
||||||||||||
Fixed rate mortgage-backed securities |
$ | 0 | 2,343 | 0 | ||||||||
CMOs and REMICs (1) |
0 | 3,116 | 0 | |||||||||
Total purchases |
0 | 5,459 | 0 | |||||||||
Sales : |
||||||||||||
Fixed rate mortgage-backed securities |
0 | 2,174 | 0 | |||||||||
CMOs and REMICs |
30 | 2,021 | 0 | |||||||||
Total sales |
30 | 4,195 | 0 | |||||||||
Principal repayments |
(1,247 | ) | (1,890 | ) | (2,304 | ) | ||||||
Net decrease |
$ | (1,277 | ) | (626 | ) | (2,304 | ) |
(1) Collateralized mortgage obligations and real estate mortgage investment conduits
Classified Assets and Delinquencies
Classification of Assets . Federal regulations require that each savings institution evaluate and classify its assets on a regular basis. In addition, in connection with examinations of savings institutions, the Office of the Comptroller of the Currency (OCC) and the Federal Deposit Insurance Corporation (FDIC) examiners may identify problem assets and, if appropriate, require them to be classified with an adverse rating. There are three adverse classifications: substandard, doubtful, and loss. Assets classified as substandard have one or more defined weaknesses and are characterized by the distinct possibility that the Bank will sustain some loss if the deficiencies are not corrected. Assets classified as doubtful have the weaknesses of those classified as substandard, with additional characteristics that make collection in full on the basis of currently existing facts, conditions and values questionable, and there is a high possibility of loss. An asset classified as loss is considered uncollectible and of such little value that continuance as an asset on the balance sheet of the institution is not warranted. Assets classified as substandard or doubtful require the institution to establish prudent specific allowances for loan losses. If an asset, or portion thereof, is classified as a loss, the institution charges off such amount. If an institution does not agree with an OCC or FDIC examiner's classification of an asset, it may appeal the determination to the OCC District Director or the appropriate FDIC personnel. On the basis of management's review of its assets, at December 31, 2016, the Bank classified a total of $21.1 million of its loans and real estate as follows:
(Dollars in thousands) |
Single Family |
Real Estate Construction or Development |
Commercial and Multi-family |
Consumer |
Commercial Business |
Real Estate |
Total |
|||||||||||||||||||||
Substandard |
$ | 2,130 | 66 | 10,277 | 531 | 6,981 | 628 | 20,613 | ||||||||||||||||||||
Doubtful |
74 | 0 | 0 | 110 | 0 | 0 | 184 | |||||||||||||||||||||
Loss |
0 | 0 | 0 | 299 | 0 | 0 | 299 | |||||||||||||||||||||
Total |
$ | 2,204 | 66 | 10,277 | 940 | 6,981 | 628 | 21,096 |
The Bank's classified assets consist of non-performing loans and loans and other assets of concern discussed in Management’s Discussion and Analysis of Financial Condition and Results of Operations (incorporated by reference in Item 7 of Part II of this Form 10-K). See “ Note 6 Allowance for Loan Losses and Credit Quality Information” in the Notes to Consolidated Financial Statements in the Annual Report (incorporated by reference in Item 8 of Part II of this Form 10-K) for more information on classified assets. At December 31, 2016, these asset classifications were materially consistent with those of the OCC and FDIC.
Delinquency Procedures. Generally, the following procedures apply to delinquent single family real estate loans. When a borrower fails to make a required payment on a loan, the Company attempts to cure the delinquency by contacting the borrower. A late notice is sent on all loans over 16 days delinquent. Additional written and verbal contacts are made with the borrower between 30 and 60 days after the due date. If the loan is contractually delinquent 90 days, the Company sends a 30-day demand letter to the borrower and after the loan is contractually delinquent 120 days, institutes appropriate action to foreclose on the property. If foreclosed, the property is sold at a sheriff’s sale and may be purchased by the Company. Delinquent commercial real estate and commercial business loans are generally handled in a similar manner. The Company's procedures for repossession and sale of consumer collateral are subject to various requirements under state consumer protection laws.
Real estate acquired by the Company as a result of foreclosure is typically classified as real estate in judgment for six to twelve months and thereafter as real estate owned until it is sold. When property is acquired by foreclosure or deed in lieu of foreclosure, it is recorded as real estate owned at the estimated fair value less the estimated cost of disposition. After acquisition, all costs incurred in maintaining the property are expensed. Costs relating to the development and improvement of the property, however, are capitalized to the extent of fair value less disposition cost.
The following table sets forth the Company's loan delinquencies by loan type, amount and percentage of type at December 31, 20 16 for loans past due 60 days or more.
Loans Delinquent For: |
Total Delinquent |
|||||||||||||||||||||||||||||||||||
60-89 Days |
90 Days and Over |
Loans |
||||||||||||||||||||||||||||||||||
(Dollars in thousands) |
Number |
Amount |
Percent of Loan Category |
Number |
Amount |
Percent of Loan Category |
Number |
Amount |
Percent of Loan Category |
|||||||||||||||||||||||||||
Single family real estate |
4 | $ | 158 | 0.15 |
% |
7 | $ | 179 | 0.17 |
% |
11 | $ | 336 | 0.32 |
% |
|||||||||||||||||||||
Consumer |
5 | 117 | 0.16 | 4 | 140 | 0.19 | 9 | 258 | 0.35 | |||||||||||||||||||||||||||
Commercial business |
0 | 0 | 0.00 | 3 | 274 | 0.32 | 3 | 274 | 0.32 | |||||||||||||||||||||||||||
Total |
9 | $ | 275 | 0.05 |
% |
14 | $ | 593 | 0.11 |
% |
23 | $ | 868 | 0.15 |
% |
Loans delinquent for 90 days and over are generally non-accruing and are included in the Company’s non-performing asset total at December 31, 2016.
Investment Activities
The Company utilizes the available for sale securities portfolio in virtually all aspects of asset/liability management. In making investment decisions, the Investment-Asset/Liability Committee considers, among other things, the yield and interest rate objectives, the credit risk position, and the Bank's liquidity and projected cash flow requirements.
Securities. Federally chartered savings institutions have the authority to invest in various types of liquid assets, including United States Treasury obligations, securities of various federal agencies, certain certificates of deposit of insured banks and savings institutions, certain bankers' acceptances, repurchase agreements and federal funds. Subject to various restrictions, the holding company of a federally chartered savings institution may also invest its assets in commercial paper, investment grade corporate debt securities and mutual funds whose assets conform to the investments that a federally chartered savings institution is otherwise authorized to make directly.
The investment strategy of the Company has been directed toward a mix of high-quality assets (primarily government callable agency obligations) with steps and short and intermediate terms to maturity. At December 31, 2016, the Company did not own any investment securities of a single issuer that exceeded 10% of the Company's stockholders’ equity other than U.S. government agency obligations.
The Bank invests a portion of its liquid assets in interest-earning overnight deposits of the Federal Home Loan Bank (FHLB) of Des Moines and the Federal Reserve Bank of Minneapolis. Other investments include high grade municipal bonds, corporate preferred stock, corporate equity securities, and medium-term (up to five years) federal agency notes. HMN invests in the same type of investment securities as the Bank. See “ Note 4 Securities Available For Sale” in the Notes to Consolidated Financial Statements in the Annual Report for additional information regarding the Company's securities portfolio (incorporated by reference in Item 8 of Part II of this Form 10-K).
The following table set s forth the composition of the Company's securities portfolio, excluding mortgage-backed and related securities, at the dates indicated.
December 31, 20 16 |
December 31, 20 15 |
December 31, 20 14 |
||||||||||||||||||||||||||||||||||||||||||||||
(Dollars in thousands) |
Amort ized |
Adjusted |
Fair |
% of |
Amort ized |
Adjusted |
Fair |
% of |
Amort ized |
Adjusted |
Fair |
% of |
||||||||||||||||||||||||||||||||||||
Cost | To | Value | Total | Cost | To | Value | Total | Cost | To | Value |
Total |
|||||||||||||||||||||||||||||||||||||
Securities available for sale: |
||||||||||||||||||||||||||||||||||||||||||||||||
U.S. Government agency obligations |
$ | 74,979 | (1,063 | ) | 73,916 | 72.2 |
% |
$ | 105,003 | (61 | ) | 104,942 | 71.4 |
% |
$ | 135,014 | (570 | ) | 134,444 | 75.1 |
% |
|||||||||||||||||||||||||||
Municipal obligations |
2,819 | (20 | ) | 2,799 | 2.7 | 3,991 | 11 | 4,002 | 2.8 | |||||||||||||||||||||||||||||||||||||||
Corporate obligations |
290 | 2 | 292 | 0.3 | 340 | (6 | ) | 334 | 0.2 | |||||||||||||||||||||||||||||||||||||||
Corporate preferred stock |
700 | (350 | ) | 350 | 0.3 | 700 | (350 | ) | 350 | 0.2 | 700 | (280 | ) | 420 | 0.2 | |||||||||||||||||||||||||||||||||
Corporate equity (1) |
58 | 57 | 115 | 0.1 | 58 | 5 | 63 | 0.0 | 58 | 3 | 61 | 0.0 | ||||||||||||||||||||||||||||||||||||
Subtotal |
78,846 | 77,472 | 75.6 | 110,092 | 109,691 | 74.6 | 135,772 | 134,925 | 75.3 | |||||||||||||||||||||||||||||||||||||||
Federal Home Loan Bank stock (1) |
770 | 770 | 0.8 | 691 | 691 | 0.5 | 777 | 777 | 0.4 | |||||||||||||||||||||||||||||||||||||||
Total investment securities and Federal Home Loan Bank stock |
79,616 | 78,242 | 76.4 | 110,783 | 110,382 | 75.1 | 136,549 | 135,702 | 75.7 | |||||||||||||||||||||||||||||||||||||||
Average remaining life of investment securities excluding Federal Home Loan Bank stock (in years) |
2.52 | 1.48 | 1.77 | |||||||||||||||||||||||||||||||||||||||||||||
Other interest earning assets: |
||||||||||||||||||||||||||||||||||||||||||||||||
Cash equivalents |
$ | 24,140 | 24,140 | 23.6 | $ | 36,570 | 36,570 | 24.9 | $ | 43,455 | 43,455 | 24.3 | ||||||||||||||||||||||||||||||||||||
Total |
$ | 103,756 | 102,382 | 100.0 |
% |
$ | 147,353 | 146,952 | 100.0 |
% |
$ | 180,004 | 179,157 | 100.0 |
% |
|||||||||||||||||||||||||||||||||
Average remaining life or term to repricing of investment securities and other interest earning assets, excluding Federal Home Loan Bank stock (in years) |
1.72 | 1.11 | 1.34 |
(1) Average life assigned to corporate equity holdings is five years.
The composition and maturities of the investment securities portfolio, excluding F HLB stock, mortgage-backed and related securities, are indicated in the following table.
(1) Callable U.S. government agency securities maturity date based on first available call date that the security is anticipated to be called.
December 31, 201 6 |
||||||||||||||||||||||||||||||||
1 Year or Less |
After 1 through 5 Years |
After 5 through 10 Years |
Over 10 Years |
No stated maturity |
Total Securities |
|||||||||||||||||||||||||||
(Dollars in thousands) |
Amortized Cost |
Amortized Cost |
Amortized Cost |
Amortized Cost |
Amortized Cost |
Amortized Cost |
Adjusted To |
Fair Value |
||||||||||||||||||||||||
Securities available for sale: |
||||||||||||||||||||||||||||||||
U.S. government agency securities (1) securities |
$ | 15,005 | 59,974 | 0 | 0 | 0 | 74,979 | (1,063 | ) | 73,916 | ||||||||||||||||||||||
Municipal obligations |
102 | 2,560 | 157 | 0 | 0 | 2,819 | (20 | ) | 2,799 | |||||||||||||||||||||||
Corporate obligations |
0 | 290 | 0 | 0 | 0 | 290 | 2 | 292 | ||||||||||||||||||||||||
Corporate preferred stock |
0 | 0 | 0 | 700 | 0 | 700 | (350 | ) | 350 | |||||||||||||||||||||||
Corporate equity |
0 | 0 | 0 | 0 | 58 | 58 | 57 | 115 | ||||||||||||||||||||||||
Total |
$ | 15,107 | 62,824 | 157 | 700 | 58 | 78,846 | (1,374 | ) | 77,472 | ||||||||||||||||||||||
Weighted average yield (2) |
1.14 |
% |
1.35 |
% |
1.85 |
% |
5.02 |
% |
1.80 |
% |
1.34 |
% |
(1) Callable U.S. government agency securities maturity date based on first available call date that the security is anticipated to be called.
( 2 ) Yields are computed on a tax equivalent basis.
Mortgage-Backed and Related Securities . In order to supplement loan production and achieve its asset/liability management goals, the Company invests in mortgage-backed and related securities. All of the mortgage-backed and related securities owned by the Company are issued, insured or guaranteed either directly or indirectly by a U.S. Government Agency and are considered to be investment grade securities. The Company had $1.0 million of mortgage-backed and related securities classified as available for sale at December 31, 2016, compared to $2.3 million at December 31, 2015. The decrease in mortgage-backed securities in 2016 and 2015 is the result of fewer purchases by the Company and normal repayments. No mortgage-backed securities were purchased in 2016, and none were purchased in 2015 other than those acquired in the Kasson State Bank acquisition. Fewer mortgage-backed securities were purchased because debt instruments issued by federal agencies, such as FNMA and FHLMC, continued to be more appealing to purchase due to their shorter duration given the low interest rate environment that existed in 2016 and 2015.
The contractual maturities of the mortgage-backed and related securities portfolio without any prepayment assumptions at Dec ember 31, 2016 are as follows:
Dec. 31, 20 16 |
||||||||||||||||||||
(Dollars in thousands) |
5 Years or Less |
5 to 10 Years |
10 to 20 Years |
Over 20 Years |
Balance Outstanding |
|||||||||||||||
Securities available for sale: |
||||||||||||||||||||
Federal Home Loan Mortgage Corporation |
$ | 337 | 0 | 0 | 0 | 337 | ||||||||||||||
Federal National Mortgage Association |
302 | 0 | 0 | 0 | 302 | |||||||||||||||
Collateralized Mortgage Obligations |
0 | 0 | 104 | 262 | 366 | |||||||||||||||
Total |
$ | 639 | 0 | 104 | 262 | 1,005 | ||||||||||||||
Weighted average yield |
4.39 |
% |
0.00 |
% |
4.00 |
% |
2.00 |
% |
3.69 |
% |
At December 31, 2016, the Company did not have any non-agency mortgage-backed or related securities in excess of 10% of its stockholders' equity.
Mortgage-backed and related securities can serve as collateral for borrowings and, through sales and repayments, as a source of liquidity. In addition, mortgage-backed and related securities available for sale can be sold to respond to changes in economic conditions.
Sources of Funds
General. The Bank's primary sources of funds are retail, commercial, internet and brokered deposits, payments of loan principal, interest earned on loans and securities, repayments and maturities of securities, borrowings, and other funds provided from operations.
Deposits. The Bank offers a variety of deposit accounts to retail and commercial clients having a wide range of interest rates and terms. The Bank's deposits consist of savings, negotiable order of withdrawal (NOW), non-interest bearing checking, money market, and certificate accounts (including individual retirement accounts). The Bank relies primarily on competitive pricing policies and client service to attract and retain these deposits.
The variety of deposit accounts offered by the Bank has allowed it to be competitive in obtaining funds and to respond with flexibility to changes in consumer demand. As clients have become more interest rate conscious, the Bank has become more susceptible to short-term fluctuations in deposit flows. The Bank manages the pricing of its deposits in keeping with its asset/liability management, profitability and growth objectives. Based on its experience, the Bank believes that its savings and NOW accounts are relatively stable sources of deposits. However, the ability of the Bank to attract and maintain certificates of deposit and money market accounts, and the rates paid on these deposits, has been and will continue to be significantly affected by market conditions. The increase in deposits in 2016 relates to commercial deposits from clients in the alternative fuels industry. Deposits in 2016 also increased $19.0 million as a result of a branch acquisition that occurred in the second quarter of 2016. The increase in deposits in 2015 relates primarily to the $47.3 million in deposits that were acquired in an acquisition in the third quarter of 2015. The changes in deposits in 2014 are primarily the result of changes in the commercial deposits from clients in the ethanol industry.
The following table sets forth the savings flows at the Bank during the periods indicated.
Year Ended December 31, |
||||||||||||
(Dollars in thousands) |
201 6 |
201 5 |
201 4 |
|||||||||
Opening balance |
$ | 559,387 | 496,750 | 553,930 | ||||||||
Deposits |
4,323,445 | 4,084,845 | 4,825,616 | |||||||||
Deposits acquired in acquisitions |
18,977 | 47,280 | 0 | |||||||||
Withdrawals |
(4,309,719 | ) | (4,070,087 | ) | (4,883,860 | ) | ||||||
Interest credited |
721 | 599 | 1,064 | |||||||||
Ending balance |
592,811 | 559,387 | 496,750 | |||||||||
Net increase (decrease) |
$ | 33,424 | 62,637 | (57,180 | ) | |||||||
Percent increase (decrease) |
5.98 |
% |
12.61 |
% |
(10.32 |
%) |
T he following table sets forth the dollar amount of deposits in the various types of deposit products offered by the Bank as of December 31:
(Dollars in thousands) |
20 16 |
20 15 |
20 14 |
|||||||||||||||||||||
Transaction and Savings Deposits (1) : |
Amount |
Percent of Total |
Amount |
Percent of Total |
Amount |
Percent of Total |
||||||||||||||||||
Noninterest checking |
$ | 158,024 | 26.7 |
% |
$ | 151,737 | 27.1 |
% |
$ | 118,073 | 23.8 |
% |
||||||||||||
NOW – 0.07% (2) |
92,670 | 15.6 | 82,425 | 14.7 | 75,553 | 15.2 | ||||||||||||||||||
Savings – 0.08% (3) |
74,238 | 12.5 | 66,421 | 11.9 | 46,672 | 9.4 | ||||||||||||||||||
Money market – 0.25% (4) |
165,179 | 27.9 | 159,959 | 28.6 | 158,798 | 32.0 | ||||||||||||||||||
Total n on-certificates |
$ | 490,111 | 82.7 |
% |
$ | 460,542 | 82.3 |
% |
$ | 399,096 | 80.4 |
% |
||||||||||||
Certificates : |
||||||||||||||||||||||||
0.00 - 0.99% |
$ | 79,628 | 13.4 |
% |
$ | 85,391 | 15.3 |
% |
$ | 81,197 | 16.3 |
% |
||||||||||||
1.00 - 1.99% |
22,958 | 3.9 | 12,611 | 2.3 | 13,629 | 2.7 | ||||||||||||||||||
2.00 - 2.99% |
0 | 0.0 | 733 | 0.1 | 2,721 | 0.6 | ||||||||||||||||||
3.00 - 3.99% |
114 | 0.0 | 110 | 0.0 | 107 | 0.0 | ||||||||||||||||||
Total Certificates |
102,700 | 17.3 |
% |
98,845 | 17.7 |
% |
97,654 | 19.6 |
% |
|||||||||||||||
Total Deposits |
$ | 592,811 | 100.0 |
% |
$ | 559,387 | 100.0 |
% |
$ | 496,750 | 100.0 |
% |
(1) |
Reflects weighted average rates paid on transaction and savings deposits at December 31, 2016. |
(2) |
The weighted average rate on NOW Accounts for 2015 was 0.04% and for 2014 was 0.02%. |
(3) |
The weighted average rate on Savings Accounts for 2015 was 0.09% and for 2014 was 0.07%. |
(4) |
The weighted average rate on Money Market Accounts for 2015 was 0.22% and for 2014 was 0.25%. |
The following table shows rate and maturity information for the Bank ’s certificates of deposit as of December 31, 2016.
(Dollars in thousands) |
0.00- 0.99% |
1.00- 1.99% |
2.00- 2.99% |
3.00- 3.99% |
Total |
Percent of Total |
||||||||||||||||||
Certificate accounts maturing in quarter ending: |
||||||||||||||||||||||||
March 31, 201 7 |
$ | 14,955 | 980 | 0 | 0 | 15,935 | 15.51 |
% |
||||||||||||||||
June 30, 2017 |
16,075 | 408 | 0 | 0 | 16,483 | 16.04 | ||||||||||||||||||
September 30, 201 7 |
12,138 | 852 | 0 | 0 | 12,990 | 12.65 | ||||||||||||||||||
December 31, 2017 |
12,047 | 387 | 0 | 0 | 12,434 | 12.11 | ||||||||||||||||||
March 31, 2018 |
3,711 | 1,278 | 0 | 0 | 4,989 | 4.86 | ||||||||||||||||||
June 30, 2018 |
4,758 | 1,377 | 0 | 0 | 6,135 | 5.97 | ||||||||||||||||||
September 30, 201 8 |
4,886 | 994 | 0 | 0 | 5,880 | 5.73 | ||||||||||||||||||
December 31, 2018 |
2,807 | 2,244 | 0 | 0 | 5,051 | 4.92 | ||||||||||||||||||
March 31, 2019 |
2,086 | 949 | 0 | 0 | 3,035 | 2.96 | ||||||||||||||||||
June 30, 2019 |
2,389 | 1,436 | 0 | 0 | 3,825 | 3.72 | ||||||||||||||||||
September 30, 201 9 |
1,463 | 2,420 | 0 | 0 | 3,883 | 3.78 | ||||||||||||||||||
December 31, 2019 |
1,068 | 2,131 | 0 | 114 | 3,313 | 3.23 | ||||||||||||||||||
Thereafter |
1,245 | 7,502 | 0 | 0 | 8,747 | 8.52 | ||||||||||||||||||
Total |
$ | 79,628 | 22,958 | 0 | 114 | 102,700 | 100.00 | % | ||||||||||||||||
Percent of total |
77.54 |
% |
22.35 |
% |
0.00 | % | 0.11 | % | 100.00 | % |
The following table indicates the amount of the Bank's certificates of deposit and other deposits by time remaining until m aturity as of December 31, 2016.
Maturity |
||||||||||||||||||||
(Dollars in thousands) |
3 Months or Less |
Over 3 to 6 Months |
Over 6 to 12 Months |
Over 12 M onths |
Total |
|||||||||||||||
Certi ficates of deposit less than $250,000 |
$ | 13,910 | 14,368 | 21,259 | 43,299 | 92,836 | ||||||||||||||
Certificates of deposit of $25 0,000 or more |
255 | 751 | 1,007 | 1,551 | 3,564 | |||||||||||||||
Public funds less than $25 0,000 (1) |
217 | 161 | 58 | 8 | 444 | |||||||||||||||
Public funds of $25 0,000 or more (1) |
1,553 | 1,203 | 3,100 | 0 | 5,856 | |||||||||||||||
Total certificates of deposit |
$ | 15,935 | 16,483 | 25,424 | 44,858 | 102,700 | ||||||||||||||
Checking and savings accounts of $250,000 or more |
$ | 163,214 | 0 | 0 | 0 | 163,214 | ||||||||||||||
Accounts of $25 0,000 or more |
$ | 165,022 | 1,954 | 4,107 | 1,551 | 172,634 |
_______________
(1) Deposits from governmental and other public entities.
For additional information regarding the composition of the Bank's deposits, see “ Note 1 1 Deposits” in the Notes to Consolidated Financial Statements in the Annual Report (incorporated by reference in Item 8 of Part II of this Form 10-K). For additional information on certificate maturities and the impact on the Company's liquidity see “Management’s Discussion and Analysis of Financial Condition and Results of Operations - Liquidity and Capital Resources” of the Annual Report (incorporated by reference in Item 7 of Part II of this Form 10-K).
Borrowings. The Bank's other available sources of funds include advances from the FHLB and borrowings from the Federal Reserve Bank of Minneapolis. As a member of the FHLB of Des Moines, the Bank is required to own capital stock in the FHLB and is authorized to apply for advances. Each FHLB credit program has its own interest rate, which may be fixed or variable, and range of maturities. The FHLB may prescribe the acceptable uses for these advances, as well as limitations on the size of the advances and repayment provisions. Consistent with its asset/liability management strategy, the Bank has utilized FHLB advances from time to time to fund loan demand and extend the term to maturity of its liabilities. The Bank may also use short-term FHLB and Federal Reserve Bank borrowings to offset short term cash needs due to deposit outflows or loan fundings. At December 31, 2016, the Bank had no FHLB advances and no Federal Reserve Bank borrowings outstanding. On such date, the Bank had a collateral pledge arrangement with the FHLB pursuant to which the Bank may borrow up to $104.7 million for liquidity purposes, subject to approval from the FHLB. The Bank also had the ability to borrow $85.8 million from the Federal Reserve Bank based upon the loans that were pledged as collateral at December 31, 2016. On December 15, 2014, the Company entered into a Loan Agreement with an unrelated third party, providing for a term loan of up to $10.0 million that was evidenced by a promissory note with an interest rate of 6.50% per annum. On February 17, 2015 the Company took a one time advance on the note of $10.0 million and used the proceeds to retire the final $10.0 million of Preferred Stock. The outstanding loan balance on the third party note payable was $7.0 million at December 31, 2016.
Refer to the information on pages 20 and 21 under the caption “Management’s Discussion and Analysis of Financial Condition and Results of Operations - Liquidity and Capital Resources” in the Annual Report and “ Note 1 2 FHLB Advances and Other Borrowings” in the Notes to Consolidated Financial Statements in the Annual Report for more information on FHLB advances and other borrowings (incorporated by reference in Items 7 and 8 of Part II of this Form 10-K).
S ervice Corporations of the Bank
As a federally chartered savings bank, the Bank is permitted by OCC regulations to invest up to 2% of its assets in the stock of, or loans to, service corporation subsidiaries, and may invest an additional 1% of its assets in service corporations where these additional funds are used for inner-city or community development purposes. In addition to investments in service corporations, federal institutions are permitted to invest an unlimited amount in operating subsidiaries engaged solely in activities in which a federal savings bank may engage directly.
OIA is one of two subsidiaries of the Bank. OIA is a Minnesota corporation that was organized in 1983 and operated as an insurance agency until 1986 when its assets were sold. OIA remained inactive until 1993 when it began offering credit life insurance, annuity and mutual fund products to the Bank's clients and others. OIA currently offers a variety of financial planning products and services. HPH is the Bank’s other subsidiary and was organized as a limited liability company in Minnesota in 2013. It was inactive in 2016 but has operated as an intermediary for the Bank in holding and operating certain foreclosed properties.
Competition
The Bank faces strong competition both in originating real estate, commercial and consumer loans and in attracting deposits. Competition in originating loans comes primarily from mortgage bankers, commercial banks, credit unions and other savings institutions which have offices in the Bank's market area and those that operate through Internet banking operations throughout the United States. The Bank competes for loans principally on the basis of the interest rates and loan fees it charges, the types of loans it originates , and the quality of services it provides to borrowers.
Competition for deposits is pr incipally from mutual funds, securities firms, commercial banks, credit unions and other savings institutions located in the same communities and those that operate through Internet banking operations throughout the United States. The ability of the Bank to attract and retain deposits depends on its ability to provide an investment opportunity that satisfies the requirements of investors as to rate of return, liquidity, risk, convenience and other factors. The Bank competes for these deposits by offering a variety of deposit accounts at competitive rates, convenient business hours and a client oriented staff.
Other Corporations Owned by the Company
The Bank was HMN ’s sole direct subsidiary at December 31, 2016.
Employees
A t December 31, 2016, the Company had a total of 209 employees, which equated to 200 full-time equivalent employees. None of the employees of the Company are represented by any collective bargaining unit. Management considers its employee relations to be good.
Regulation and Supervision
The banking industry is highly regulated. As a savings and loan holding company (SLHC), HMN is subject to regulation, supervision and examination by the FRB. The Bank, a federally-chartered savings association, is also subject to extensive regulation, supervision and examination by the OCC, which is the Bank’s primary federal regulator. The FDIC also has authority to regulate the Bank. Subsidiaries of HMN and the Bank may also be subject to state regulation and/or licensing in connection with certain insurance and investment activities. The Company is subject to numerous laws and regulations. These laws and regulations impose restrictions on activities, set minimum capital requirements, impose lending and deposit restrictions and establish other restrictions. References in this section to applicable statutes and regulations are brief and incomplete summaries only. You should consult the statutes, regulations and related policies and interpretive guidance for a full understanding of the details of their operation. Changes in statutes, regulation or regulatory policies applicable to the Company, including interpretation or implementation thereof, could have a material effect on the Company’s business.
The Dodd-Frank Wall Street Reform and Consumer Protection Act
The Dodd-Frank Wall Street Reform and Consumer Protection Act of 2010 (Dodd-Frank Act) significantly changed the regulatory structure for financial institutions and their holding companies, including with respect to lending, deposit, investment, trading and operating activities. Federal banking regulators and other agencies including, among others, the FRB, the OCC and the Consumer Financial Protection Bureau (CFPB), have been engaged in extensive rule-making efforts under the Dodd-Frank Act. The future of these regulatory efforts is unclear.
Holding Company Regulation
In accordance with the Dodd-Frank Act, the OTS was integrated into the OCC in 2011 and the primary banking regulator for HMN became the FRB. The Dodd-Frank Act extended the “source of strength” doctrine to savings and loan holding companies. The Federal Reserve Board has promulgated regulations implementing the “source of strength” policy that require holding companies to act as a source of strength to their subsidiary depository institutions by providing capital, liquidity, and other support in times of financial stress.
Acquisitions by Savings and Loan Holding Companies. Acquisition of a savings association or a savings and loan holding company is generally subject to FRB approval and the public must have an opportunity to comment on the proposed acquisition. Without prior approval from the FRB, HMN may not acquire, directly or indirectly, control of another savings association.
Examination and Reporting. Under the Home Owners’ Loan Act (HOLA) and FRB regulations, HMN, as a SLHC, must file periodic reports with the FRB. In addition, HMN must comply with FRB record keeping requirements and is subject to holding company supervision and examination by the FRB. The FRB may take enforcement action if the activities of a SLHC constitute a risk to the financial safety, soundness or stability of a subsidiary savings association.
Affiliate Transactions. The Bank, as a holding company subsidiary that is a depository institution, is subject to both qualitative and quantitative limitations on transactions with the Company. See “Bank Regulation - Transactions with Affiliates and Insiders” below.
Capital Adequacy. The Bank is subject to various capital requirements, which, effective since January 1, 2015, have been modified under rules promulgated by the FRB and the OCC implementing the Dodd-Frank Act and the Basel III reforms of the Basel Committee on Banking Supervision of the Bank for International Settlements (Basel III Rules).
Under the Basel III Rules, certain SLHCs for the first time in 2015 became subject to formal regulatory capital requirements. In the second quarter of 2015, the FRB amended its Small Bank Holding Company Policy Statement (Policy Statement), which exempted small bank holding companies from the above capital requirements, by raising the asset size threshold for determining applicability from $500 million to $1 billion. The Policy Statement was also expanded to include savings and loan holding companies that meet the Policy Statement’s qualitative requirements for exemption. The Company meets the qualitative exemption requirements, and therefore, is exempt from the Basel III holding company capital requirements.
See
“Bank Regulation – Capital Requirements and Prompt Corrective Action Requirements; Basel III Rules”
below.
Dividends. Federal law also limits the ability of a savings and loan holding company, such as HMN, to pay dividends or make other capital distributions. FRB guidance applicable to holding companies sets out factors that should be taken into account when considering dividends or distributions, including, among other things, current and prospective earnings and liquidity, and the holding company’s ability to serve as an ongoing source of financial and managerial strength to insured depository institution subsidiaries such as the Bank.
B ank Regulation
As a federally-chartered savings association, the Bank is subject to regulation and supervision by the OCC. Federal law authorizes the Bank, as a federal savings association, to conduct, subject to various conditions and limitations, business activities that include: accepting deposits and paying interest on them; making and buying loans secured by residential and other real estate; making a limited amount of consumer loans; making a limited amount of commercial loans; investing in corporate obligations, government debt securities, and other securities; and offering various banking, trust, securities and insurance agency services to its clients.
Savings associations are expected to conduct lending activities in a prudent, safe and sound manner. The OCC regulates the safety and soundness of the Bank by enforcing statutory limits on the Bank ’s lending and investment powers. OCC regulations set aggregate limits on certain types of loans including commercial business, commercial real estate, and consumer loans. OCC regulations also establish limits on loans to a single borrower. As of December 31, 2016, the Bank’s lending limit to one borrower was approximately $12.5 million.
A federal savings association generally may not invest in noninvestment-grade debt securities. A federal savings association may establish subsidiaries to conduct any activity the association is authorized to conduct and may establish service corporation subsidiaries for limited preapproved activities.
Qualified Thrift Lender Test. Savings associations, including the Bank, must be qualified thrift lenders (QTLs). A savings association generally satisfies the QTL requirement if at least 65% of a specified asset base consists of assets such as loans to small businesses and loans to purchase or improve domestic residential real estate. Savings associations may qualify as QTLs in other ways. Savings associations that do not qualify as QTLs are subject to significant restrictions on their operations. If the Bank fails to meet QTL requirements, the Company would face certain limitations, including potential enforcement action by the OCC and, as a result of the Dodd-Frank Act, a statutory bar to the payment by the Bank of dividends except under prescribed conditions including approval by the OCC. As of December 31, 2016, the Bank met the QTL test.
OCC Assessments. The OCC is authorized by statute to charge assessments to cover the costs of examining the financial institutions it regulates and to fund its operations. The Bank’s OCC assessments for the year ended December 31, 2016 were approximately $171,000. While all SLHCs, including HMN, were subject to examination fees imposed by the OTS, the FRB has not assessed fees for its examination function.
Transactions with Affiliates and Insiders. Savings associations, like banks, are subject to affiliate and insider transaction restrictions. The restrictions prohibit or limit a savings association from extending credit to, or entering into certain covered transactions with affiliates, principal stockholders, directors and executive officers of the savings association and its affiliates. The term “affiliate” generally includes a holding company, such as HMN, and any company under common control with the savings association. Federal law limits covered transactions between the Bank and any one affiliate to 10% of the Bank’s capital and surplus and with all affiliates in the aggregate to 20%. In addition, the federal law governing unitary savings and loan holding companies prohibits the Bank from making any loan to any affiliate whose activity is not permitted for a subsidiary of a bank holding company. This law also prohibits the Bank from making any equity investment in any affiliate that is not its subsidiary. The Bank is currently in compliance with these requirements. The Dodd-Frank Act expanded the limitations on transactions with affiliates to cover transactions that create credit risk. Covered transactions now include derivatives and the borrowing and lending of securities. Repurchase agreements with affiliates are now subject to collateralization requirements.
Dividend Restrictions. Federal law limits the ability of a depository institution, such as the Bank, to pay dividends or make other capital distributions. The Bank, as a subsidiary of a savings and loan holding company, must file a notice with the FRB before payment of a dividend or approval of a proposed capital distribution by its board of directors and must obtain prior approval from the FRB if it fails to meet certain regulatory conditions.
During 201 6, the Bank paid dividends to HMN of $3.0 million to pay the principal and interest on the third party note payable and fund the ongoing operating expenses of the Company. HMN did not declare or distribute any dividends to its common shareholders in 2016.
Deposit Insurance. The FDIC insures the deposits of the Bank through the Deposit Insurance Fund (DIF). The DIF is funded by assessments of FDIC members such as the Bank. The FDIC applies a risk-based system for setting deposit insurance assessments. Under the risk-based assessment system, an institution’s insurance assessments vary according to the level of capital the institution holds and the degree to which it is the subject of supervisory concern.
The Dodd-Frank Act instituted significant changes that modified the way that the DIF is managed by the FDIC and is capitalized. The Dodd-Frank Act altered the assessment base for deposit insurance assessments from a deposit to an asset base. It also increased the DIF reserve ratio from 1.15% to 1.35%. The Dodd Frank Act also requires that FDIC assessments be set in a manner that offsets the cost of the assessment increases for institutions with consolidated assets of less than $10 billion (meaning that assessments on larger institutions will be responsible for the 20 basis point increase). During 2016, the Bank was assessed approximately $313,000 for the DIF. The Dodd-Frank Act also permanently increased deposit insurance coverage from $100,000 per account ownership type to $250,000.
In addition to deposit insurance assessments, the FDIC is authorized to collect assessments against insured deposits to be paid to the Financing Corporation (FICO) to service the FICO debt incurred in the 1980 ’s. The FICO assessment rate is adjusted quarterly. In 2016, the Bank paid a FICO assessment of approximately $32,000.
Capital Requirements and Prompt Corrective Action Requirements; Basel III Rules. The Bank is subject to various regulatory capital requirements administered by the federal banking agencies. Failure to meet minimum capital requirements can initiate certain mandatory and possibly additional discretionary actions by regulators that, if undertaken, could have a direct material effect on the Company’s financial statements. Under capital adequacy guidelines and the regulatory framework for prompt corrective action, the Bank must meet specific capital guidelines that involve quantitative measures of the Bank’s assets, liabilities and certain off-balance sheet items as calculated under regulatory accounting practices. Quantitative measures established by regulations to ensure capital adequacy required the Bank to maintain minimum amounts and ratios of Common Tier 1 Risk-based capital, Total Tier 1 capital (Tier 1 leverage ratio), Tier 1 capital to Risk-based assets, and Risk-based capital to total assets (in each case as defined in the regulations). The Bank’s capital amounts and classification are also subject to qualitative judgments by the regulators about components, risk weightings and other factors.
The Federal Deposit Insurance Corporation Improvement Act of 1991 (FDICIA) established five capital categories: 1) well capitalized; 2) adequately capitalized; 3) undercapitalized; 4) significantly undercapitalized; and 5) critically undercapitalized. The activities in which a depository institution may engage and regulatory responsibilities of federal bank regulatory agencies vary depending upon whether an institution is well-capitalized, adequately capitalized or undercapitalized. Undercapitalized institutions are subject to various restrictions such as limitations on dividends and growth. A depository institution’s prompt corrective action capital category depends upon where its capital levels are in relation to relevant capital measures, which include risk-based capital measures and certain other factors.
In addition to the capital categories, the Basel III Rules established a “capital conservation buffer” of 2.5% above the minimum capital ratios otherwise required by the prompt corrective action framework. The capital conservation buffer requirement is being phased in beginning in January 2016 at 0.625% of risk-weighted assets and will increase each year until fully implemented in January 2019. An institution will be subject to limitations on paying dividends, engaging in share repurchases, and paying discretionary bonuses if its capital level falls below the buffer amount.
At December 31, 2016, the Bank’s capital amounts and ratios are presented for (a) actual capital and (b) required capital and ratios under the Prompt Corrective Actions regulations to which the Bank is currently subject:
Prompt Corrective Action Regulations |
||||||||||||||||||||||||
Actual |
Required to be Adequately Capitalized |
Required to be Well Capitalized |
||||||||||||||||||||||
(Dollars in thousands) |
Amount |
Percent of Assets (1) |
Amount |
Percent of Assets (1) |
Amount |
Percent of Assets (1) |
||||||||||||||||||
December 31, 2016 |
||||||||||||||||||||||||
Common equity tier 1 capital |
$ | 77,634 | 13.42 |
% |
$ | 26,032 | 4.50 |
% |
$ | 37,601 | 6.50 |
% |
||||||||||||
Tier 1 leverage |
77,634 | 11.55 | 26,876 | 4.00 | 33,595 | 5.00 | ||||||||||||||||||
Tier 1 risk-based capital |
77,634 | 13.42 | 34,709 | 6.00 | 46,278 | 8.00 | ||||||||||||||||||
Total risk-based capital |
84,900 | 14.68 | 46,278 | 8.00 | 57,848 | 10.00 |
(1) |
Based upon the Bank ’s adjusted total assets for the purpose of the Tier 1 or core capital ratios and risk-weighted assets for the purpose of the risk-based capital ratios. |
Management believes that, as of December 31, 2016, the Bank’s capital ratios were in excess of those quantitative capital ratio standards set forth under the prompt corrective action regulations described above and was “well capitalized” within the meaning of those prompt corrective action regulations. However, there can be no assurance that the Bank will continue to maintain such status in the future. In addition, the OCC has extensive discretion in its supervisory and enforcement activities, including the ability to downgrade the Bank’s prompt corrective action capital category by one level under certain conditions.
Under applicable banking regulations, the failure to comply with capital rules or other applicable requirements as they arise, could subject HMN, the Bank and their directors and officers to such restrictions, legal actions or sanctions as the FRB or the OCC considers appropriate. Possible sanctions include among others (i) the imposition of one or more cease and desist orders requiring corrective action, which are enforceable directives that may address any aspect of the Company management, operations or capital, including requirements to change management, raise equity capital, dispose of assets or effect a change of control; (ii) civil money penalties; and (iii) downgrades in the capital adequacy status of the Bank. These regulatory actions may significantly restrict the ability of the Company to take operating and strategic actions that may be in the best interests of stockholders or compel the Company to take operating and strategic actions that are not potentially in the best interests of stockholders.
Other Regulations and Examination Authority. The FDIC has adopted regulations to protect the DIF and depositors, including regulations governing the deposit insurance of various forms of accounts. Federal regulation of depository institutions is intended for the protection of depositors, and not for the protection of stockholders or other creditors. In addition, federal law requires that in any liquidation or other resolution of any FDIC-insured depository institution, claims for administrative expenses of the receiver and for deposits in U.S. branches (including claims of the FDIC as subrogee of the insured institution) shall have priority over the claims of general unsecured creditors.
The OCC may sanction any OCC-regulated bank that does not operate in accordance with OCC regulations, policies and directives. The FDIC has additional authority to terminate insurance of accounts, after notice and hearing, upon a finding that the insured institution is or has engaged in any unsafe or unsound practice that has not been corrected, is operating in an unsafe or unsound condition, or has violated any applicable law, regulation, rule, or order of or condition imposed by the FDIC.
Federal Home Loan Bank (FHLB) System. The Bank is a member of the FHLB of Des Moines, which is one of the 11 regional Federal Home Loan Banks (FHBs). The primary purpose of the FHBs is to provide funding to their saving association members in support of the home financing credit function of the members. Each FHB serves as a reserve or central bank for its members within its assigned region. FHBs are funded primarily from proceeds derived from the sale of consolidated obligations of the FHLB System. FHBs make loans or advances to members in accordance with policies and procedures established by the board of directors of the FHB. These policies and procedures are subject to the regulation and oversight of the Federal Housing Financing Board. All advances from a FHB are required to be fully secured by sufficient collateral as determined by the FHB. Long-term advances are required to be used for residential home financing and small business and agricultural loans.
As a member, the Bank is required to purchase and maintain stock in the FHLB of Des Moines. As of December 31, 2016, the Bank had $0.8 million in FHLB stock, which was in compliance with this requirement. The Bank receives dividends on its FHLB stock. The FHLB’s dividend philosophy is to differentiate dividend rates between membership and activity-based capital stock. Based on the FHLB’s most recent quarterly filing on Form 10-Q for the nine months ended September 30, 2016, the effective combined annualized dividend rate paid on both subclasses of its capital stock during the nine months ended September 30, 2016 and 2015 was 4.25% and 2.92%, respectively.
Other Regulation. Under FRB regulations, the Bank is required to maintain reserves against transaction accounts (primarily interest-bearing and noninterest-bearing checking accounts). Historically, reserves generally have been maintained in cash or in noninterest-bearing accounts, thereby effectively increasing an institution’s cost of funds. These regulations generally require that the Bank maintain reserves against net transaction accounts. The reserve levels are subject to adjustment by the FRB and prior to October 6, 2008, the policy was to not pay interest on reserves. The FRB now pays interest and utilizes the rate of interest paid on reserves to conduct monetary policy. A savings association, like other depository institutions maintaining reservable accounts, may, under certain conditions, borrow from the Federal Reserve Bank discount window.
Numerous other regulations promulgated by the FRB, the OCC, the CFPB and other agencies and other governmental authorities affect the business operations of the Bank. These include but are not limited to regulations relating to privacy, equal credit access, mortgage lending and foreclosure practices, electronic fund transfers, collection of checks, lending and savings disclosures, and availability of funds. The CFPB has broad authority to develop new rules and interpretations with respect to consumer financial products and services, even though its examination and enforcement authority currently do not extend to the Bank.
The CFPB ’s rule-making activities include, among other things, the issuance in January 2013 of final rules implementing the Dodd-Frank Act mortgage lending requirements, including the “ability-to-repay” requirement for mortgage lending together with certain safe harbors and rebuttable presumptions of compliance associated with “qualified mortgages.”
Community Reinvestment Act. The Community Reinvestment Act (CRA) requires financial institutions regulated by the federal financial supervisory agencies to ascertain and help meet the credit needs of their delineated communities, including low to moderate income neighborhoods within those communities, while maintaining safe and sound banking practices. The regulatory agency assigns one of four possible ratings to an institution’s CRA performance and is required to make public an institution’s rating and written evaluation. The four possible ratings of meeting community credit needs are outstanding, satisfactory, needs improvement and substantial noncompliance. Under regulations that apply to all current CRA performance evaluations, many factors play a role in assessing a financial institution’s CRA performance. The institution’s regulator must consider its financial capacity and size, legal impediments, local economic conditions and demographics, including the competitive environment in which it operates. The evaluation does not rely on absolute standards, and the institutions are not required to perform specific activities or to provide specific amounts or types of credit. The Bank maintains a CRA statement for public viewing, as well as an annual CRA highlights document. These documents describe the Bank’s credit programs and services, community outreach activities, public comments and other efforts to meet community credit needs. The Bank’s last CRA exam was July 29, 2013 and the Bank received a “satisfactory” rating under the Intermediate Small Savings Association criteria. An exam has been performed in January 2017 covering the period from the previous exam in July 2013 to December 31, 2015. No results of this exam have been received as of the filing of this report.
Bank Secrecy Act. The Bank Secrecy Act (BSA) requires financial institutions to verify the identity of clients, keep records and file reports that are determined to have a high degree of usefulness in criminal, tax and regulatory matters, and to implement anti-money laundering programs and compliance procedures. The impact on Bank operations from the BSA depends on the types of clients served by the Bank.
Troubled Asset Relief Program – Capital Purchase Program
On October 3, 2008, the federal government enacted the Emergency Economic Stabilization Act of 2008 (EESA). EESA was enacted to provide liquidity to the U.S. financial system and lessen the impact of accelerating economic problems. The EESA included broad authority. The centerpiece of the EESA was the Troubled Asset Relief Program (TARP). The EESA’s broad authority was interpreted to allow the Treasury to purchase equity interests in both healthy and troubled financial institutions. The equity purchase program is commonly referred to as the Capital Purchase Program (CPP). The Company elected to participate in the CPP and sold shares of its Fixed Rate Cumulative Perpetual Preferred Stock, Series A (the Preferred Stock) to the Treasury in December 2008, along with a warrant to purchase 833,333 shares of HMN common stock at $4.68 per share (the Warrants).
On February 8, 2013, the Treasury sold the Preferred Stock to unaffiliated third party investors in a private transaction for $18.8 million. The Company received no proceeds from the sale and it had no effect on the Company’s capital, financial condition, or results of operations. The Company has redeemed all of the outstanding Preferred Stock with the final $10 million being redeemed on February 17, 2015.
On May 21, 2015, the Treasury sold the Warrant s at an exercise price of $4.68 per share to three unaffiliated third party investors for an aggregate purchase price of $5.7 million. Two of the investors received a Warrant to purchase 277,777.67 shares and one investor received a Warrant to purchase 277,777.66 shares. All of the Warrants may be exercised at any time prior to their expiration date of December 23, 2018. The Company received no proceeds from this transaction and it had no effect on the Company’s capital, financial condition or results of operations.
Executive Officers of the registrant
Officers are chosen by and serve at the discretion of the Board of Directors of HMN and the Bank. There are no family relationships among any of the directors or officers of HMN and the Bank. The business experience of each executive officer of both HMN and the Bank is set forth below.
Bradley C. Krehbiel , age 5 8 . Mr. Krehbiel has been a director of HMN and President of the Bank since 2009, President of HMN since 2010, and Chief Executive Officer of HMN and the Bank since 2012. Prior to that, he had been the Executive Vice President of the Bank since 2004. Mr. Krehbiel joined the Bank as Vice President of Business Banking in 1998. Prior to his employment at the Bank, Mr. Krehbiel held several positions in the financial services industry.
Jon J. Eberle , age 51 . Mr. Eberle is Chief Financial Officer, Senior Vice President and Treasurer of HMN and the Chief Financial Officer, Executive Vice President and Treasurer of the Bank. Mr. Eberle has held the Chief Financial Officer and Treasurer positions since 2003 and the Executive Vice President position since 2012. Prior to that he served as a Vice President since 2000 and as the Controller since 1998. From 1994 to 1998, he served as the Director of Internal Audit for HMN and the Bank. Prior to his employment at the Bank, Mr. Eberle worked for six years as a certified public accountant with a national accounting firm.
Lawrence D. McGraw , age 5 3 . Mr. McGraw has served as the Chief Operating Officer and Executive Vice President of the Bank since 2012. Prior to that he served as Chief Credit Officer and Senior Vice President since 2010. Prior to his employment at the Bank, Mr. McGraw served as Regional President and Chief Banking Officer of a Minnesota community bank from 2005 until 2010. From 2001 to 2005 he served as the President and Chief Executive Officer of a branch location of the same community bank. Prior to his tenure at the Minnesota community bank, Mr. McGraw held various positions at two other community banks and the FDIC.
Susan K. Kolling , age 6 5 . Ms. Kolling has served as Senior Vice President of the Bank and HMN since 1995. From 2001 to 2013, when she reached established board term limits, she also served as a Director of HMN and the Bank. Ms. Kolling served as a Vice President of the Bank from 1992 to 1994.
Available Information
The Company ’s website is www.hmnf.com. The Company makes available, free of charge, through its website its annual report on Form 10-K, quarterly reports on Form 10-Q, current reports on Form 8-K and amendments to those reports filed or furnished pursuant to Section 13(a) of the Securities Exchange Act of 1934, as soon as reasonably practicable after it electronically files these materials with, or furnishes them to, the Securities and Exchange Commission (the SEC). Information contained on the Company’s website is expressly not incorporated by reference into this Form 10-K.
ITEM 1A. RISK FACTORS
Like all financial companies, the Company ’s business and results of operations are subject to a number of risks, many of which are outside of the Company’s control. In addition to the other information in this report, readers should carefully consider that the following important factors, among others, could materially impact the Company’s business and future results of operations.
Risks Related to our Business
Our capital may not be adequate to meet all our needs and requirements in the future and we may need to take steps to meet our capital needs. These actions may reduce our base of earning assets and core deposits and may dilute our shareholders or result in a change of control of the Company or the Bank. There can be no assurance that we will satisfactorily meet our required future capital needs.
We are required by federal regulatory authorities to maintain adequate levels of capital to support our operations and protect depositors of the Bank. Depending upon the operating performance of the Bank and our other liquidity and capital needs, we may find it prudent , subject to prevailing market conditions and other factors, to raise additional capital through the issuance of additional shares of our common stock or other equity securities. Additional capital would potentially permit the Company to repay the existing third party note payable and allow the Bank to grow its assets more aggressively. Depending on circumstances, if we were to raise capital, we may deploy it to the Bank for general banking purposes, or may retain some or all of such capital for use by the Company.
If the Company were to raise capital through the issuance of additional shares of common stock or other equity securities, it would dilute the ownership interests of existing stockholders, dilute the Company’s earnings per share, and, if issued at a price less than the Company’s book value, dilute the per share book value of our common stock, and could result in a change in control of the Company and the Bank. New investors may also have rights, preferences and privileges senior to our current stockholders which may adversely impact our current stockholders. Our ability to raise additional capital through the issuance of equity securities, if deemed prudent, would depend on conditions in the capital markets at that time, which are outside of our control, and on our financial performance. A significant investment by a person or group may also necessitate an amendment to our Certificate of Incorporation, which would require stockholder approval. Accordingly, we may not be able to raise additional capital, if needed, at all, on favorable economic terms, or other terms acceptable to us.
The Bank may not be able to meet its cash flow needs on a timely basis at a reasonable cost, and its cost of funds for banking operations may significantly increase as a result of general economic conditions, interest rates and competitive pressures . HMN , on an unconsolidated basis , has limited capital resources and liquidity to assist the Bank with its liquidity and capital requirements.
Liquidity is the ability to meet cash flow needs on a timely basis and at a reasonable cost. The liquidity of the Bank is used to pay expenses, make loans and to repay deposit and borrowing liabilities as they become due or are demanded by clients and creditors. Many factors affect the Bank’s ability to meet liquidity needs, including variations in the markets served by its network of offices, its composition of assets and liabilities, reputation and standing in the marketplace and general economic conditions.
The Bank ’s primary source of funding is retail deposits, gathered through its network of thirteen banking offices. Wholesale funding sources principally consist of borrowing lines from the FHLB of Des Moines and the Federal Reserve Bank of Minneapolis and brokered and internet certificates of deposit obtained from the national market. Borrowings from the FHLB are subject to the FHLB’s credit policies and procedures relating to the valuation of the loans securing advances as well as the amount of funds the FHLB will loan to the Bank. The current collateral pledged to secure advances may become unacceptable, the formulas for determining the excess pledged collateral may change or the Bank’s credit rating with the FHLB could decrease. In these cases, the Bank may not have sufficient collateral to pledge or have the borrowing capacity to meet its funding needs and may be required to rely upon alternate funding sources, such as the Federal Reserve Bank, which bear higher borrowing costs. The Bank’s securities and loan portfolios also provide a source of contingent liquidity that could be accessed in a reasonable time period through sales.
Significant changes in general economic conditions, market interest rates, competitive pressures or otherwise, could cause the Bank ’s deposits to decrease relative to overall banking operations, and it would have to rely more heavily on brokered deposits or borrowings in the future, which are typically more expensive than retail deposits.
The Bank actively manages its liquidity position and monitors it using cash flow forecasts. Changes in economic conditions, including consumer savings habits and availability or access to borrowed funds and the brokered and Internet deposit markets could potentially have a significant impact on the Company’s liquidity position, which in turn could materially impact its financial condition, results of operations and cash flows.
HMN ’s primary source of cash is dividends from the Bank, and the Bank is restricted from paying dividends to HMN unless certain conditions are met under bank regulatory requirements. At December 31, 2016, HMN had $3.3 million in cash and other assets that could readily be turned into cash. Primarily, HMN requires cash for the payment of holding company level expenses, including interest and principal payments on its third party note payable, director and management fees, legal expenses and regulatory costs. HMN does not anticipate that it will have on a stand-alone basis adequate liquid resources to make all of the required cash payments for these items in the future. To meet these payment requirements or other potential HMN liquidity or capital needs would require dividends from the Bank or external capital. Failure to meet regulatory requirements for any future dividends from the Bank to HMN, or to receive dividends in amounts deemed satisfactory by HMN, could cause HMN to require other sources of liquidity for its needs in 2017 and beyond. Further information about HMN’s liquidity position is available on page 20 in the “Management’s Discussion and Analysis of Financial Condition and Results of Operations – Liquidity and Capital Resources” section of the Annual Report incorporated by reference in Part II, Item 7 of this Form 10-K.
Our allowance for loan losses may prove to be insufficient to absorb losses or appropriately reflect , at any given time , the inherent risk of loss in our loan portfolio.
Our non-performing assets were at $3.9 million, or 0.57% of total assets at December 31, 2016. Classified loans at December 31, 2016 were $28.2 million, or 5.0% of total loans. Classified loans represent special mention, performing substandard, and non-performing loans. The level of our classified loans was primarily due to the moderate economic recovery we are experiencing and the continued slow recovery of real estate values in some of the markets we serve. If the economic recovery does not continue and/or the real estate markets do not continue to improve, these assets may not perform according to their terms and the value of the collateral may be insufficient to pay any remaining loan balance. If this occurs, we may experience losses or an increased risk of loss in our loan portfolio, which could have a negative effect on our results of operations. Like all financial institutions, we maintain an allowance for loan losses to provide for loans in our portfolio that may not be repaid in their entirety. Our allowance for loan losses may not be sufficient to cover actual loan losses or the inherent risk of loss in our loan portfolio, and future provision for loan losses could materially adversely affect our operating results.
In evaluating the appropriateness of our allowance for loan losses, we consider numerous factors, including but not limited to, specific occurrences of loan impairment, our historical charge-off experience, actual and anticipated changes in the size of the portfolios, national and regional economic conditions such as unemployment data, loan delinquencies, local economic conditions, demand for single-family homes, demand for commercial real estate and building lots, loan portfolio composition and historical loss experience and observations made by the Company's ongoing internal audit and regulatory exam processes. In addition, we use information about specific borrower situations, including their financial position and estimated collateral values, to estimate the risk and amount of loss for those borrowers. Our estimates of the risk of loss and amount of loss on any loan are complicated by the significant uncertainties surrounding our borrowers’ abilities to successfully execute their business models through changing economic environments, competitive challenges and other factors. Because of the degree of uncertainty and susceptibility of these factors to change, our actual losses and estimates of risk of loss inherent in our loan portfolio have varied and are likely to continue to vary from our current estimates. Such variances may materially and adversely affect our financial condition and results of operations.
Federal regulators, as an integral part of their examination process, periodically review our allowance for loan losses and may require us to increase our allowance for loan losses by recognizing additional provisions for loan losses charged to expense, or to decrease our allowance for loan losses by recognizing loan charge-offs. Any such additional provisions for loan losses or charge-offs, as required by these regulatory agencies, could have a material adverse effect on our financial condition and results of operations.
The Company has concentrations in commercial business and commercial real estate loans, increasing the risk in its loan portfolio.
In order to enhance the yield and shorten the term-to-maturity of its loan portfolio, the Company has expanded its commercial business and commercial real estate lending and these categories of loans represented over 50% of the total loans receivable in each of the past five years. Some of the Company’s commercial real estate portfolio is in land development loans, while many of the Company’s commercial business loans were made to borrowers associated with the real estate industry. Commercial business and commercial real estate loans generally, and land development loans in particular, present a higher level of risk than loans secured by single family residences. This greater risk is due to several factors, including the concentration of principal in a limited number of loans and borrowers, the effects of general economic conditions on income producing properties and the increased difficulty of evaluating and monitoring these types of loans.
Furthermore, the repayment of loans secured by commercial real estate is typically dependent upon the successful operation of the related real estate project. If the cash flow from the project is reduced (for example, if leases are not obtained or renewed or properties intended for resale are not developed and sold), the borrower’s ability to repay the loan and the underlying collateral may be impaired. Commercial business loans to businesses that are dependent on the cash flow generated by the sale or leasing of real estate are similarly impacted. The Company’s commercial business and commercial real estate loan portfolios have experienced difficulties in the past, which has adversely affected the Company’s results of operations and financial condition. At December 31, 2016, the Company classified $3.3 million of loans as non-performing, of which $1.8 million related to commercial business and commercial real estate loans. At December 31, 2016, total classified loans included $24.6 million of commercial business and commercial real estate loans. The Company may experience actual losses in respect of these classified loans and further increases in the level of classified loans in our loan portfolio that may require further increases in our provision for loan losses.
Regional economic changes in the Company ’s markets have in the past adversely impacted, and may in the future adversely impact, results from operations.
Like all financial institutions, the Company is subject to the effects of any economic downturn, and in particular a significant decline in home values and reduced commercial development in the Company ’s markets has had a negative effect on results of operations in the past. The Company’s success depends primarily on the general economic conditions in the counties in which the Company conducts business, and in the southern Minnesota and northern Iowa areas in general. Unlike larger financial institutions that are more geographically diversified, the Company provides banking and financial services to clients primarily in the southern Minnesota counties of Dodge, Fillmore, Freeborn, Houston, Mower, Olmsted and Winona and portions of Steele, Goodhue and Wabasha counties, as well as Marshall county in Iowa. The local economic conditions in these market areas have a significant impact on the Company’s ability to originate loans, the ability of the borrowers to repay these loans and the value of the collateral securing these loans. A significant decline in the general economic conditions caused by inflation, recession, unemployment or other factors beyond the Company’s control can affect and has in the past affected these local economic conditions and can adversely affect and has in the past adversely affected the Company’s financial condition and results of operations. The Company has a significant amount of commercial business and commercial real estate loans and decreases in tenant occupancy and development home sales can have, and in the past have had, a negative effect on the ability of many of the Company’s borrowers to make timely repayments of their loans and the value of the collateral held as security for these loans, which can have, and in the past has had, an adverse impact on the Company’s earnings.
Because of the asset size of the Company, adverse performance affecting a few large loans or lending relationships can cause significant volatility in earnings.
Due to the Company ’s asset size, the provision for loan losses or charge offs associated with individual loans can be large relative to the Company’s earnings for a particular period. If one or a few relatively large loans become non-performing in a period and the Company is required to increase its loss reserves, or to write off principal or interest relative to such loans, the operating results for that period could be significantly adversely affected. The effect on results of operations for any given period from a change in the performance of a small number of loans may be disproportionately larger than the impact of such loans on the quality of the Company’s overall loan portfolio. The Company’s current internal lending limit is $7.5 million and the regulatory lending limit was $12.5 million at December 31, 2016. The Bank’s largest borrowing relationship had outstanding loans totaling $11.7 million and was performing at December 31, 2016.
The Company operate s in a highly regulated environment and may be adversely affected by changes in federal and state laws and regulations.
The Company is and will continue to be subject to extensive examination, supervision and comprehensive regulation by federal bank regulatory agencies. Banking regulations are primarily intended to protect depositors’ funds, federal deposit insurance funds, and the banking system and the financial system as a whole, and not holders of our common stock. These regulations affect our lending practices, capital structure, investment practices, dividend policy, and growth, among other things. See Item 1 “Business – Regulation and Supervision” of this Form 10-K for information regarding regulation affecting the Company.
The Dodd-Frank Act continue s to change the bank regulatory structure and to affect the lending, deposit, investment, trading and operating activities of financial institutions and their holding companies, including the Company. The Dodd-Frank Act requires various federal agencies, including the FRB, the OCC and the CFPB, to adopt a broad range of new implementing rules and regulations. The federal agencies were given significant discretion in drafting the implementing rules and regulations, and many of the requirements called for in the Dodd-Frank Act are being implemented over the course of several years. The full impact of changes resulting from the Dodd-Frank Act on our operations is ongoing. These changes and other changes in the regulatory landscape may significantly impact the profitability of business activities, require material changes to certain business practices, impose more stringent capital, liquidity and leverage requirements or otherwise adversely affect our business.
The FRB assess es the condition, performance and activities of savings and loan holding companies in a manner that is consistent with its established risk-based approach regarding bank holding company supervision to ensure that savings and loan holding companies are effectively supervised and can serve as a source of strength for, and do not threaten the soundness of, subsidiary depository institutions such as the Bank.
The CFPB, has broad authority to develop new rules and interpretations with respect to consumer financial products and services even though its examination and enforcement authority do not currently extend to the Bank.
Congress and federal regulatory agencies continually review banking laws, regulations, and policies for possible changes. Changes to statutes, regulations, or regulatory policies, including changes in interpretation or implementation of statutes, regulations, or policies, could affect us in substantial and unpredictable ways. Such changes could subject us to additional costs, limit the types of financial services and products we may offer, restrict mergers and acquisitions, investments, access to capital, the location of banking offices, or increase the ability of non-banks to offer competing financial services and products, among other things. Failure, or alleged failure, to comply with laws, regulations or policies could result in sanctions by regulatory agencies, civil or criminal penalties or money damages in connection with actions or proceedings on behalf of regulators or consumers, and/or reputational damage, any of which could have a material adverse effect on our business, financial condition and results of operations. While we have policies and procedures designed to prevent any such violations and to reduce the likelihood of such actions or proceedings, there can be no assurance that such violations will not occur or that such actions or proceedings will not be brought.
Changes to laws and regulations, including changes in interpretation or implementation, may also limit the Bank ’s flexibility on financial products and fees which could result in additional operational costs and a reduction in our non-interest income.
Further, our regulators have significant discretion and authority to prevent or remedy unsafe or unsound practices or violations of laws by financial institutions and holding companies in the performance of their supervisory and enforcement duties. Examples include limits on payment of dividends by banks and regulations governing compensation. Regulation of dividends may limit the liquidity of the Company and restrictions on compensation may adversely affect our ability to attract and retain employees.
We are subject to the CRA and fair lending laws, and failure to comply with these laws could lead to material penalties.
The CRA and fair lending laws and regulations impose nondiscriminatory lending requirements on financial institutions. The Department of Justice and other federal agencies are responsible for enforcing these laws and regulations. A successful challenge to an institution’s performance under the CRA or fair lending laws and regulations could result in a wide variety of sanctions, including the required payment of damages and civil money penalties, injunctive relief, imposition of restrictions on mergers and acquisitions activity, and restrictions on expansion activity. Private parties may also have the ability to challenge an institution’s performance under fair lending laws in private class action litigation. The Bank has implemented policies and procedures designed to ensure compliance with such laws and regulations, but any noncompliance could lead to regulatory actions that could result in material penalties or sanctions.
The USA Patriot Act and Bank Secrecy Act may subject us to large fines for non-compliance.
The USA Patriot and Bank Secrecy Acts require financial institutions to develop programs to prevent financial institutions from being used for money laundering and terrorist activities. If these activities are detected, financial institutions are obligated to file suspicious activity reports with the U.S. Treasury Department ’s Office of Financial Crimes Enforcement Network. These rules require financial institutions to establish procedures for identifying and verifying the identity of clients seeking to open new financial accounts. Failure to comply with these regulations could result in fines or sanctions. In recent years, several banking institutions have received large fines for non-compliance with these laws and regulations. Although the Bank has developed policies and procedures designed to ensure compliance, regulators may take enforcement action against the Bank in the event of noncompliance.
Changes in interest rates could negatively impact the Company ’s results of operations.
The earnings of the Company are primarily dependent on net interest income, which is the difference between interest earned on loans and investments and interest paid on interest-bearing liabilities such as deposits and borrowings. Interest rates are highly sensitive to many factors, including government monetary and fiscal policies and domestic and international economic and political conditions. Conditions such as inflation, recession, unemployment, money supply, government borrowing and other factors beyond management’s control may also affect interest rates. If the Company’s interest-earning assets mature, reprice or prepay more quickly than interest-bearing liabilities in a given period, a decrease in market interest rates could adversely affect net interest income. Likewise, if interest-bearing liabilities mature or reprice, or, in the case of deposits, are withdrawn by the accountholder, more quickly than interest-earning assets in a given period, an increase in market interest rates could adversely affect net interest income. Given the Company’s assets and liability composition as of December 31, 2016, a falling interest rate environment would negatively impact the Company’s results of operations. The effect on our deposits of decreases in interest rates generally lags the effect on our assets. The lagging effect of deposit rate changes is primarily due to the Bank’s deposits that are in the form of certificates of deposit, which do not re-price immediately when the federal funds rate changes.
Fixed rate loans increase the Company ’s exposure to interest rate risk in a rising rate environment because interest-bearing liabilities would be subject to repricing before assets become subject to repricing. Adjustable rate loans decrease the risks to a lender associated with changes in interest rates but involve other risks. As interest rates rise, the payment by the borrower rises to the extent permitted by the terms of the loan, and the increased payment increases the potential for default. At the same time, for secured loans, the marketability of the underlying collateral may be adversely affected by higher interest rates. In a declining interest rate environment, there is likely to be an increase in prepayment activity on loans as the borrowers refinance their loans at lower interest rates. Under these circumstances, the Company’s results of operations could be negatively impacted.
Changes in interest rates also can affect the value of loans, investments and other interest-rate sensitive assets including mortgage servicing rights, and the Company ’s ability to realize gains on the sale or resolution of assets. This type of income can vary significantly from quarter-to-quarter and year-to-year based on a number of different factors, including the interest rate environment. An increase in interest rates that adversely affects the ability of borrowers to pay the principal or interest on loans may lead to an increase in non-performing assets and increased loan loss reserve requirements that could have a material adverse effect on the Company’s results of operations.
Changes in interest rates or prepayment speeds could negatively impact the value of capitalized mortgage servicing rights.
The capitalization, amortization and impairment of mortgage servicing rights are subject to significant estimates. These estimates are based upon loan types, note rates and prepayment speed assumptions. Changes in interest rates or prepayment speeds may have a material effect on the net carrying value of mortgage servicing rights. In a declining interest rate environment, prepayment speed assumptions will increase and result in an acceleration in the amortization of the mortgage servicing rights as the assumed underlying portfolio declines and also may result in impairment as the value of the mortgage servicing rights declines.
The extended disruption or compromise of vital infrastructure, including the Company ’s technology systems, could negatively impact the Company’s results of operations and financial condition.
The Company ’s business depends on its ability to process, record and monitor a large number of transactions. The Company’s technological and physical infrastructures, which include its financial, accounting and other data processing systems, are vital to its operation. Extended disruption or compromise of its vital infrastructure by fire, power loss, natural disaster, telecommunications failure, computer hacking and viruses, terrorist activity or the domestic and foreign response to such activity, or other events outside of the Company’s control, could cause the Company to suffer regulatory consequences, reputational damage and financial losses, any of which, could have a material adverse effect either on the financial services industry as a whole, or on the Company’s business, financial condition and results of operations.
The Company faces cybersecurity and other external data security risks that could adversely affect the reputation of the Company and that could have a material adverse effect on the Company ’s financial condition and results of operations.
The Company’s business is dependent upon the transmission and storage of confidential information in digital technologies, computer and email systems, software, and networks. The Company has security systems in place and regularly monitors its computer systems and network infrastructure. The Company does not believe that it has experienced a material cybersecurity breach, but it has experienced immaterial threats to its data and systems, including computer virus and malware attacks and other attempted unauthorized access to our systems.
Cyber threats are rapidly evolving and the Company may not be able to anticipate or prevent all future attacks. Other financial institutions have been, and continue to be, the target of various evolving and adaptive cyberattacks, including malware and denial of service, as part of an effort to disrupt the operations of financial institutions, potentially test their cybersecurity capabilities, or obtain confidential, proprietary, or other information. As cybersecurity threats continue to evolve, the Company may incur increasing costs in an effort to minimize these risks. In addition, the Company could be held liable for, and could suffer reputational damage as a result of, any security breach or loss, which could have a material adverse effect on the Company’s financial condition and results of operations.
Third parties with which the Company does business or that facilitate its business activities, including vendors and retailers, could also be sources of operational and information security risk to the Company. There have been increasingly sophisticated and large-scale efforts on the part of third parties to breach data security with respect to financial transactions, including intercepting account information at locations where clients make purchases, as well as the use of social engineering schemes such as “phishing.” For example, large retailers have reported data breaches resulting in the loss of client information. In the event that third parties are able to misappropriate financial information of the Bank’s clients, even if such breaches take place due to weaknesses in other parties' internal data security procedures, the Company could suffer reputational or financial losses which could have a material adverse effect on its financial condition and results of operations.
Strong competition within the Company ’s market area may limit profitability or generate losses.
The Company faces significant competition both in attracting deposits and in the origination of loans. Mortgage bankers, commercial banks, credit unions and other savings institutions, which have offices in the Bank ’s market area have historically provided most of the Company’s competition for deposits and loans; however, the Company also competes with financial institutions that operate through Internet banking operations throughout the United States. In addition, and particularly in times of high interest rates, the Company faces additional and significant competition for funds from money market and mutual funds, and securities firms located in the same communities and those that operate through Internet banking operations throughout the United States. Many competitors have substantially greater financial and other resources than the Company. Finally, credit unions do not pay federal or state income taxes and are subject to fewer regulatory constraints than savings banks and as a result, they may enjoy a competitive advantage over the Company. The Bank competes for loans principally on the basis of the interest rates and loan fees it charges, the types of loans it originates and the quality of services it provides to borrowers. This competitive strategy places significant competitive pressure on the prices of loans and deposits.
Loss of large checking and money market deposit client s could increase cost of funds and have a negative effect on results of operations.
The Company has a number of large deposit clients that maintain balances in checking and money market accounts at the Bank. At December 31, 2016, there were $61.9 million in checking and money market accounts of clients in the ethanol and other industries that have relationship balances greater than $5 million. The ability to attract and retain these types of deposits has a positive effect on the Company’s net interest margin as they provide a relatively low cost of funds to the Company compared to certificates of deposits or advances. If these depositors were to withdraw these funds and the Bank was not able to replace them with similar types of deposits, the Banks cost of funds would increase and the Company’s results of operation would be negatively impacted.
We may decide to continue to grow our business through acquisitions, which may disrupt or harm our business and dilute stockholder value.
The Company completed acquisitions in the second quarter of 2016 and the third quarter of 2015. The Company continues to regularly monitor acquisition opportunities and conducts due diligence activities related to possible transactions with banks and other financial institutions. Negotiations may take place and future acquisitions may occur at any time. Our ability to grow through acquisitions will depend, in part, on the availability of suitable acquisition targets at acceptable prices, terms, and conditions; our ability to compete effectively for these acquisition candidates; and the availability of capital and personnel to complete such acquisitions and run the acquired business effectively. These risks could be heightened if we complete a large acquisition or multiple acquisitions within a relatively short period of time.
The benefits of an acquisition may take more time than expected to develop or integrate into our operations and we cannot guarantee that any acquisition will ultimately produce any benefits. Acquiring other banks, businesses, or branches involves various risks, such as potential disruption of the Company ’s business, including diversion of management’s attention; difficulty in valuing the target company; potential exposure to undisclosed, contingent, or other liabilities or problems, unanticipated costs associated with an acquisition, and an inability to recover or manage such liabilities and costs; exposure to potential asset quality issues of the target company; volatility in reported income as goodwill and other impairment losses could occur irregularly and in varying amounts; difficulty and expense of integrating the operations and personnel of the target company or in realizing projected efficiencies, revenue increases, costs savings, increased market presence, or other projected benefits; potential loss of key employees or clients of the Company or the target company; dilution to existing stockholders if securities are issued as part of transaction consideration or to fund transaction consideration; and potential changes in banking or tax laws or regulations that may affect the target company. Any of the foregoing factors could have a material adverse effect on the Company’s financial condition and results of operations.
Risks related to our Common Stock
The price of our common stock has been volatile and could continue to fluctuate in the future.
During the year ended December 31, 201 6, the closing price of our common stock on The NASDAQ Global Market ranged from $10.90 to $18.50 per share, and over the period from January 1, 2013 to December 31, 2016 it has ranged from $2.99 to $18.50. Our closing sale price on December 31, 2016 was $17.50 per share and on February 17, 2017 it was $18.50 per share. Our stock generally trades in relatively low volumes and its price may fluctuate in response to a number of events and factors, including, but not limited to, variations in operating results, litigation or governmental and regulatory proceedings, market perceptions of our financial reporting, changes in financial estimates and recommendations by securities analysts, the operating and stock price performance of other companies that investors may deem comparable to us, and news reports relating to trends in our markets or general economic conditions.
We may issue additional stock, or reissue shares of treasury stock, without shareholder consent.
We have authorized 16,000,000 shares of common stock . As of December 31, 2016, 9,128,662 shares were issued and outstanding (including 4,639,739 shares that were held as treasury stock), and 6,871,338 shares were unissued. Of the unissued shares of common stock 833,333 were reserved for issuance pursuant to outstanding warrants, 49,229 shares were reserved for issuance pursuant to outstanding options and 54,876 shares were reserved for issuance pursuant to our equity incentive plans. The board of directors has authority, without action or vote of the stockholders, to issue all or part of the authorized but unissued shares and to reissue all of the treasury shares. Additional shares may be issued, or treasury shares reissued, in connection with future financing, acquisitions, employee stock plans, or otherwise. Any such issuance, or reissuance, will dilute the percentage ownership of existing stockholders. We are also currently authorized to issue up to 500,000 shares of preferred stock and as of December 31, 2016, there were no preferred stock shares issued and outstanding. Under our certificate of incorporation, our board of directors can issue additional preferred stock in one or more series and fix the terms of such stock without shareholder approval. Preferred stock may include the right to vote as a series on particular matters, preferences as to dividends and liquidation, conversion and redemption rights and sinking fund provisions. The issuance of preferred stock could adversely affect the rights of the holders of common stock and reduce the value of the common stock. In addition, specific rights granted to holders of preferred stock could be used to restrict our ability to merge with or sell our assets to a third party.
Future sale of shares of our common stock in the public market upon exercise of the outstanding warrant s could depress our stock price.
Shares issuable upon exercise of the outstanding warrants represented beneficial ownership of approximately 16% of our common stock as of December 31, 2016. The warrants, or shares issuable upon exercise of the warrants may be eligible for sale publicly under Rule 144 under the Securities Act of 1933 in certain circumstances. Sales of substantial amounts of our common stock, whether upon exercise of the warrants or otherwise, or the perception that those sales could occur may adversely affect the market price of our common stock.
Our ability to pay dividends on or repurchase our common stock is significantly restricted . W e have not paid a dividend on our common stock during the last eight years and our current financial condition and results of operations and ongoing expenses, including the interest and principal payments due on our third party note payable , make payment of any such dividend unlikely in the foreseeable future.
We are a stock savings bank holding company and our operations are conducted primarily by the Bank. Since we receive substantially all of our revenue from dividends from the Bank, our ability to pay dividends on our common stock depends on our receipt of dividends from the Bank. Dividend payments from the Bank are subject to legal and regulatory limitations. The ability of the Bank to pay dividends to us is also subject to its profitability, financial condition, capital needs and other cash flow requirements. There is no assurance that the Bank will be able to pay dividends to us in the future or that we will generate adequate cash flow to pay dividends in the future. The inability to receive dividends from the Bank could have an adverse effect on our business and financial condition.
At December 31, 201 6, the Company had an outstanding balance of $7.0 million on a note to an unrelated third party with an interest rate of 6.50% per annum. The principal balance of the loan is payable in consecutive equal annual installments of $1.0 million on each anniversary of the date of the Loan Agreement, commencing on December 15, 2015, with the balance due on December 15, 2021. The Company may prepay the note in whole or in part without penalty.
The required payments on the note make the payment of any common stock dividend or distribution unlikely in the foreseeable future.
Provisions of our certificate of incorporation and bylaws, as well as Delaware and federal law, may discourage, delay or prevent an acquisition of control of us, even in situations that may be viewed as desirable by our stockholders.
Provisions included in our certificate of incorporation and bylaws, as well as provisions of the Delaware General Corporation Law and federal law (including banking regulations), may discourage, delay or prevent potential acquisitions of control of us, particularly when attempted in a transaction that is not negotiated directly with and approved by our board of directors, despite perceived short-term benefits to our stockholders (such as an increase in the trading price of our common stock).
Specifically, our certificate of incorporation and bylaws include provisions that:
• |
limit the voting power of shares held by a stockholder beneficially owning in excess of 10% of the outstanding shares of our common stock; |
• |
require that, with limited exceptions, business combinations between us and a stockholder beneficially owning in excess of 10% of the voting power of the outstanding shares of our stock entitled to vote in the election of directors, be approved by at least 80% of the total number of our outstanding voting shares; |
• |
require that prior to acquiring shares from a stockholder that owns 5% or more of our publicly traded voting stock, with limited exception, holders of 80% or more of our voting stock outstanding, other than shares held by the selling stockholder, must approve the transaction; |
• |
divide our board of directors, other than directors who may be elected by a class or series of preferred stock, into three classes serving staggered three-year terms and provide that a director may only be removed prior to the expiration of a term for cause by the affirmative vote of the holders of at least 80% of the voting power of all of the outstanding shares of capital stock entitled to vote in an election of directors; |
• |
require that a special meeting of stockholders be called pursuant to a resolution adopted by a majority of our board of directors; |
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require advance notice of nominations of directors to be made, or business to be brought, by stockholders at our annual meetings; |
• |
authorize the issuance of preferred stock with such designations, rights and preferences as may be determined from time to time by our board of directors; and |
• |
require that amendments to (i) our certificate of incorporation be approved by a two-thirds vote of our board of directors and by a majority of the outstanding shares of our voting stock or, with respect to the amendment of certain provisions (regarding, among other things, provisions relating to number, classification, election and removal of directors, amendment of the bylaws, call of special stockholder meetings, acquisitions of control, director liability, and certain business combinations), by 80% of the outstanding shares of our voting stock, and (ii) our bylaws be approved by a majority vote of our board of directors or the affirmative vote of at least 80% of the total votes eligible to be voted at a duly constituted meeting of stockholders. |
We are subject to the provisions of Section 203 of the Delaware General Corporation Law, which prohibits a publicly-held Delaware corporation from engaging in a “business combination” with an “interested stockholder” for a period of three years after the date of the transaction in which the person became an interested stockholder, unless the business combination is approved in a prescribed manner. For purposes of Section 203, a “business combination” includes a merger, asset sale or other transaction resulting in a financial benefit to the interested stockholder, and an “interested stockholder” is a person who, either alone or together with affiliates and associates, owns (or within the past three years, did own) 15% or more of the corporation ’s voting stock. For purposes of Section 203, “voting stock” means stock of any class or series entitled to vote generally in the election of directors. Furthermore, federal law requires FRB or OCC approval prior to any direct or indirect acquisition of control (as defined in regulations) of HMN or the Bank, respectively, including, with respect to the Bank, any indirect acquisition of control through an acquisition of control of HMN.
ITEM 1B. UNRESOLVED STAFF COMMENTS
None.
ITEM 2. PROPERTIES
The Company leases its corporate office in Rochester, Minnesota and owns the buildings and land for 10 of its 13 full service branches. The remaining three full service branches and four loan origination offices are leased. These leased branches are located at 1016 Civic Center Drive NW, Rochester, Minnesota; 100 1 st Ave Bldg., Suite 200, Rochester, Minnesota; and 2805 Dodd Road, Suite 160, Eagan, Minnesota. The leased loan origination offices are located at 50 14 th Avenue East, Suite 100, Sartell, Minnesota; 1850 Austin Road, Suite 103, Owatonna, Minnesota; 3960 Hillside Drive, Suite 206, Delafield, Wisconsin; and 100 Warren Street, Suite 300, Mankato, Minnesota. The Bank uses all properties and they are all located in Minnesota, except for one full service branch located in Iowa and one loan origination office located in Wisconsin.
I TEM 3. LEGAL PROCEEDINGS
From time to time, the Company is party to legal proceedings arising out of its lending and deposit operations. The Company is, and expects to become, engaged in a number of foreclosure proceedings and other collection actions as part of its collection activities. Based on our current understanding of these pending legal proceedings, management does not believe that judgments or settlements arising from pending or threatened litigation matters, individually or in the aggregate, would have a material adverse effect on the consolidated financial position, operating results or cash flows of the Company. Litigation is often unpredictable and the actual results of litigation cannot be determined with any certainty.
ITEM 4. M INE SAFETY DISCLOSURES
Not applicable.
PART II
ITEM 5. MARKET FOR REGISTRANT'S COMMON EQUITY, RELATED STOCKHOLDER MATTERS AND ISSUER PURCHASES OF EQUITY SECURITIES
The information on page 22 under the caption “Dividends”, “ Note 16 Stockholders’ Equity ” of the Notes to Consolidated Financial Statements, on page 56, page 68 under the caption “Common Stock Information” and the inside back cover page of the Annual Report is incorporated herein by reference.
ITEM 6. SELECTED FINANCIAL DATA
The information on page 5 under the caption “Five Year Consolidated Financial Highlights” of the Annual Report is incorporated herein by reference.
ITEM 7. MANAGEMENT ’S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS OF OPERATIONS
The table on page 8 and the tables regarding investment maturities on page 20 of Part 1 Item 1 of this Form 10-K, as well as the information on pages 6 through 26 under the caption “Management Discussion and Analysis” (other than the section captioned “Market Risk”) of the Annual Report is incorporated herein by reference.
ITEM 7A. QUANTITATIVE AND QUALITATIVE DISCLOSURE S ABOUT MARKET RISK
Not applicable.
ITEM 8. FINANCIAL STATEMENTS AND SUPPLEMENTARY DATA
The financial statements (including the Notes to Consolidated Financial Statements) on pages 27 through 63 of the Annual Report, are incorporated herein by reference.
ITEM 9. CHANGES IN AND DISAGREEMENTS WITH ACCOUNTANTS ON ACCOUNTING AND FINANCIAL DISCLOSURE
None .
ITEM 9A. CONTROLS AND PROCEDURES
Evaluation of disclosure controls and procedures. An evaluation was carried out under the supervision and with the participation of the Company’s management, including the Bank’s President (our Principal Executive Officer) and our Chief Financial Officer (our Principal Financial Officer) of the effectiveness of the design and operation of the Company’s disclosure controls and procedures (as defined in Rule 13a-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 that evaluation, the Principal Executive Officer and Principal Financial Officer have concluded that the Company’s disclosure controls and procedures are effective to ensure that information required to be disclosed by the Company in reports that it files or submits under the Exchange Act is recorded, processed, summarized and reported within the time periods specified in SEC rules and forms.
Management's Annual Report on Internal Control over Financial Reporting. The Company’s management is responsible for establishing and maintaining adequate internal control over financial reporting, as such term is defined in Exchange Act Rule 13a-15(f). Internal control over financial reporting is a process designed to provide reasonable assurance regarding the reliability of financial reporting and the preparation of financial statements for external purposes in accordance with generally accepted accounting principles.
Internal control over financial reporting includes those policies and procedures that pertain to the maintenance of records that in reasonable detail accurately and fairly reflect the transactions and dispositions of the assets of the Company; provide reasonable assurance that transactions are recorded as necessary to permit preparation of financial statements in accordance with generally accepted accounting principles, and that receipts and expenditures of the Company are only being made in accordance with authorizations of management and directors of the Company; and provide reasonable assurance regarding prevention or timely detection of unauthorized acquisition, use, or disposition of the Company ’s assets that could have a material effect on the financial statements.
Any control system, no matter how well conceived and operated, can provide only reasonable, not absolute, assurance that the objectives of the control system are met. The design of a control system inherently has limitations, and the benefits of controls must be weighed against their costs. Additionally, controls can be circumvented by the individual acts of some persons by collusion of two or more people, or by management override of the control. Therefore, no assessment of a cost-effective system of internal controls can provide absolute assurance that all control issues and instances of fraud, if any, will be detected.
Under the supervision and with the participation of management, including the Principal Executive Officer and Principal Financial Officer, the Company conducted an evaluation of the effectiveness of its internal control over financial reporting based on the framework in the 2013 Internal Control-Integrated Framework issued by the Committee of Sponsoring Organizations of the Treadway Commission. Based on the Company’s evaluation under this framework, the Company’s management concluded that the Company’s internal control over financial reporting was effective as of December 31, 2016. The Company has not included an attestation report of our independent registered public accounting firm regarding internal control over financial reporting. Our independent registered public accounting firm is not required to attest to management's report pursuant to Item 308(b) of Regulation S-K because the Company is not an accelerated filer or large accelerated filer.
Changes in internal controls. No change in the Company’s internal control over financial reporting was identified in connection with the evaluation required by Rule 13a-15(d) of the Exchange Act that occurred during the period covered by this report and that has materially affected, or is reasonably likely to materially affect, the Company’s internal control over financial reporting.
ITEM 9b. OTHER INFORMATION
None.
PART III
ITEM 10. DIRECTORS, EXECUTIVE OFFICERS AND CORPORATE GOVERNANCE
The information required by this Item is incorporated by reference from the information under the caption “Executive Officers of the Registrant” in Part I , Item 1, of this report and under the captions “Proposal 1 – Election of Directors - Board of Directors,” “Corporate Governance - Committees of the Board of Directors” and “Section 16(a) Beneficial Ownership Reporting Compliance” in the Company’s definitive proxy statement to be filed with the Securities and Exchange Commission pursuant to Regulation 14A not later than 120 days after the close of the Company’s fiscal year ended December 31, 2016 (the 2017 Proxy Statement).
The Company has adopted a Code of Ethics that applies to its principal executive officer, principal financial and accounting officer, controller and other persons performing similar functions. The Company has posted the Code of Ethics on its website located at www.hmnf.com. The Company intends to post on its website any amendment to , or a waiver from, a provision of the Code of Ethics that applies to its principal executive officer, principal financial and accounting officer, controller or other persons performing similar functions within four business days following the date of such amendment or waiver.
ITEM 11. EXECUTIVE COMPENSATION
The information required by this Item is incorporated by reference from the information under the caption “201 6 Executive Compensation” and “2016 Director Compensation” in the 2017 Proxy Statement.
ITEM 12. SECURITY OWNERSHIP OF CERTAIN BENEFICIA L OWNERS AND MANAGEMENT AND RELATED STOCKHOLDER MATTERS
The information required by this Item is incorporated by reference from the information under the captions “Security Ownership of Management and Certain Beneficial Owners” and “Other Equity Compensation Plan Information” in the 2017 Proxy Statement.
ITEM 13. CERTAIN RELATIONSHIPS AND RELATED TRANSACTIONS, AND DIRECTOR INDEPENDENCE
The information required by this Item is incorporated by reference from the information under the captions “Corporate Governance – Committees of the Board of Directors; - Director Independence; - Related Person Transaction Approval Policy; and - Certain Transactions” in the 2017 Proxy Statement.
ITEM 14. PRINCIPAL ACCOUNT ing FEES AND SERVICES
The information required by this Item is incorporated by reference from the information under the captions “Corporate Governance - Independent Registered Public Accounting Firm Fees” and “ -Approval of Independent Registered Public Accounting Firm Services and Fees” in the 2017 Proxy Statement.
PART IV
ITEM 15. EXHIBITS , FINANCIAL STATEMENT SCHEDULES
1. Financial Statements
The following financial statements appearing in the Company's Annual Report, are incorporated herein by reference.
|
|
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Pages in |
Annual Report Section |
2016 Annual Report |
Consolidated Balance Sheets -- |
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December 31, 2016 and 2015 |
27 |
|
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Consolidated Statements of Comprehensive Income -- |
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Each of the Years in the Three-Year Period Ended December 31, 2016 |
28 |
|
|
Consolidated Statements of Stockholders’ Equity -- |
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Each of the Years in the Three-Year Period Ended December 31, 2016 |
29 |
|
|
Consolidated Statements of Cash Flows -- |
|
Each of the Years in the Three-Year Period Ended December 31, 2016 |
30 |
|
|
Notes to Consolidated Financial Statements |
31 |
|
|
Report of Independent Registered Public Accounting Firm |
64 |
2. Financial Statement Schedules
All financial statement schedules have been omitted as this information is not required under the related instructions, is not applicable or has been included in the Notes to Consolidated Financial Statements.
3. Exhibits
The exhibits filed with this report are set forth on the Index of Exhibits filed as part of this report immediately following the signatures.
ITEM 1 6. FORM 10-K SUMMARY
None.
SIGNATURES
Pursuant 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 by the undersigned, thereunto duly authorized.
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HMN FINANCIAL, INC. |
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Date: March 10, 2017 |
By: |
/s/Bradley Krehbiel |
|
|
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Bradley Krehbiel, |
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|
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President and CEO |
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Each of the undersigned hereby appoints Hugh Smith and Jon Eberle, and each of them (with full power to act alone), as attorneys and agents for the undersigned, with full power of substitution, for and in the name, place and stead of the undersigned, to sign and file with the Securities and Exchange Commission under the Securities Act of 1934, as amended, any and all amendments and exhibits to this Form 10-K and any and all applications, instruments, and other documents to be filed with the Securities and Exchange Commission pertaining to this Form 10-K or any amendments thereto, with full power and authority to do and perform any and all acts and things whatsoever requisite and necessary or desirable. Pursuant to the requirements of the Securities Exchange Act of 1934, this report has been signed by the following persons on behalf of the registrant and in the capacities indicated on March 10, 2017.
Name |
Title |
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/s/ Bradley Krehbiel |
President and CEO |
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Bradley Krehbiel |
(Principal Executive Officer) |
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/s/ Jon. Eberle |
Senior Vice President, Chief Financial Officer and Treasurer |
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Jon Eberle |
(Principal Financial and Accounting Officer) |
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/s/ Hugh Smith |
Chairman of the Board |
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Hugh Smith |
||
/s/ Allen Berning |
Director |
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Allen Berning |
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/ s / M ichael B ue |
Director |
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Michael Bue |
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/s/ Bernard Nigon |
Director |
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Bernard Nigon |
||
/s/ Wendy Shannon |
Director |
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Wendy Shannon |
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/s/ Patricia Simmons |
Director |
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Patricia Simmons |
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/ s / M ark U tz |
Director |
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Marl Utz |
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/ s / H ans Z ietlow |
Director |
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Hans Zietlow |
INDEX TO EXHIBITS
1 |
Incorporated by reference to Exhibit 3.1 to the Company’s Quarterly Report on Form 10-Q for the period ended September 30, 2015 (File No. 000-24100). |
2 |
Incorporated by reference to Exhibit 3.1 to the Company’s Current Report on Form 8-K, dated March 5, 2012 (File No. 000-24100). |
3 |
Incorporated by reference to the same numbered exhibit to the Company’s Registration Statement on Form S-1 dated April 1, 1994 (File No. 33-77212). |
4 |
Incorporated by reference to Exhibit 4.1 to the Company’s Current Report on Form 8-K dated December 19, 2008, filed on December 23, 2008 (File No. 000-24100). |
5 |
Incorporated by reference to Exhibit 10.1 to the Company’s Current Report on Form 8-K dated May 27, 2014, filed on June 2, 2014 (File No. 000-24100). |
6 |
Incorporated by reference to the same numbered exhibit to the Company’s Annual Report on Form 10-K for the period ended December 31, 1994 (File No. 000-24100). |
7 |
Incorporated by reference to Exhibit 10.1 to the Company’s Quarterly Report on Form 10-Q for the period ended March 31, 2015 (File No. 000-24100). |
8 |
Incorporated by reference to Exhibit 10.2 to the Company’s Quarterly Report on Form 10-Q for the period ended March 31, 2015 (File No. 000-24100). |
9 | Incorporated by reference to Exhibit 10. 5 to the Company’s Annual Report on Form 10-K for the period ended December 31, 2015 (File No. 000-24100). |
10 | Incorporated by reference to Exhibit A to the Company’s Proxy Statement for its Annual Meeting of Stockholders held on April 28, 2009 (File No. 000-24100). |
11 |
Incorporated by reference to Exhibit 99.1 to the Company’s Current Report on Form 8-K dated May 6, 2009, filed on May 12, 2009 (File No. 000-24100). |
12 |
Incorporated by reference to Exhibit 10.8 to the Company’s Annual Report on Form 10-K for the period ended December 31, 2015 (File No. 000-24100). |
13 |
Incorporated by reference to Exhibit 10.9 to the Company’s Annual Report on Form 10-K for the period ended December 31, 2015 (File No. 000-24100). |
14 |
Incorporated by reference to Exhibit 99.3 to the Company’s Current Report on Form 8-K dated May 6, 2009, filed on May 12, 2009 (File No. 000-24100). |
15 |
Incorporated by reference to Exhibit 10.12 to the Company’s Annual Report on Form 10-K for the period ended December 31, 2015 (File No. 000-24100). |
47
Exhibit 10.11 |
HMN FINANCIAL, INC.
Executive
Management Incentive Plan
(amended
and restated through January 31
, 2017)
This document sets forth the HMN Financial Executive Management Incentive Plan (the “Plan”), including the Plan objectives, design, participation/eligibility, performance metrics and administration. Compensation provided pursuant to the Plan may be provided directly by HMN Financial, Inc. or any of its subsidiaries, including its wholly-owned banking subsidiary, Home Federal Savings Bank (the “Bank”).
1. |
PLAN OBJECTIVES |
The Plan is intended to advance the interests of the Company (as defined in Section 9) and its stockholders by enabling the Company and its subsidiaries to attract and retain executives who have the skills, experience and work ethic required to effectively achieve the Company’s goals and objectives, and to align executives’ interests with the creation and maintenance of long-term stockholder value. The Plan is prospective in design, utilizing a defined payout formula that is based upon the achievement, over the course of each annual performance period, of a combination of pre-determined company, subsidiary, departmental and/or individual performance objectives.
2. |
PLAN DESIGN |
T he Plan design incorporates incentive award payout levels that are linked to the achievement of pre-defined performance objectives, and payment of earned amounts in a mixture of cash and equity awards. The payout levels (defined as a percentage of salary) for each Plan participant are designed to provide market competitive payouts for the achievement of performance objectives. An individual participant may earn less or more than the targeted incentive payout level based on performance during the applicable performance period. The Compensation Committee of the Board (the “Committee”) will review and approve for each performance period the Plan participants, award opportunity levels (as a percent of salary), and specific performance objectives and weightings. The specific objectives, weightings, and award opportunity levels will be provided in a scorecard to be delivered to each plan participant as soon as practicable after the Committee approves the specific terms and conditions to which Plan awards for a performance period will be subject.
3. |
PERFORMANCE PERIOD |
Each Plan performance period shall be one calendar year (January 1 st to December 31 st ).
4. |
PARTICIPATION/ELIGIBILITY |
For e ach performance period, the Committee will determine the employees (or employee groups) who will participate in the Plan for that performance period. Each Plan participant shall be notified of his or her selection for participation in the Plan and provided with an individual scorecard for the applicable performance period.
Eligibility to participate in the Plan or to receive a payout following completion of a performance period shall be subject to the following conditions:
(a) |
Any new employee must be employed by June 1 st in any calendar year performance period to be eligible to receive a Plan award for that performance period. |
(b) |
An employee who commences employment after a calendar year performance period has begun but on or before June 1 of that performance period will be eligible to receive a Plan award whose payout will be pro-rated to reflect the portion of the performance period during which the individual was employed. |
(c) |
An employee who commences employment after June 1 st in any calendar year performance period will not be eligible to participate in the Plan during that performance period, but may be eligible to participate in the Plan during the next annual performance period. |
(d) |
A Plan participant must receive a minimum individual performance rating of “meets expectations” or better for a performance period in order to be eligible for any payout under a Plan award for that performance period. |
(e) |
Except as provided in paragraph 4(f) below, a Plan participant must be an active employee of the Company or one of its subsidiaries as of the award payout date in order to receive payment of a Plan award for a completed performance period. |
(f) |
A Plan participant who terminates employment during a performance period due to death or Disability (as the latter term is defined in Section 9) may, in the Committee’s discretion, receive a pro rata payout of a Plan award otherwise earned during the performance period based on the percentage of days the participant was actively employed during the performance period. A Plan participant who terminates employment for one of the foregoing reasons after a performance period has been completed but before the applicable award payout date will be entitled to be paid the full earned amount of his or her Plan award for that performance period. |
5.
PERFORMANCE OBJECTIVES
The payment of a Plan award will be contingent upon the degree of attainment over the applicable performance period of one or more performance objectives that are based on performance criteria approved by the Committee, such as net income, credit quality, return on equity, return on assets and performance against strategic initiatives. Any performance objective utilized may be expressed in absolute amounts, on a per share basis (basic or diluted), as a growth rate or change from preceding periods, as a comparison to the performance of specified companies or other external indices or measures, or as a comparison between or ratio of any approved performance criteria, and may relate to one or any combination of Company, subsidiary, department or individual performance. For any performance period, the Committee will select the applicable performance criteria, specify the relevant performance objectives based on those performance criteria, and specify in terms of a formula or standard the method for calculating the amount payable to a participant if and to the degree the performance objectives are satisfied, all prior to or as soon as possible following the commencement of the performance period.
6. AWARD CALCULATION AND PAYMENT
(a) A participant’s target award opportunity under the Plan for any performance period will be set by the Committee as a percentage of the participant’s eligible salary, defined as the actual amount of salary earned by the participant during the applicable performance period. The Committee will correspondingly establish threshold and maximum award opportunities for each Plan participant similarly expressed as percentages of the participant’s eligible salary.
(b) Incentive awards under the Plan may be earned during each performance period depending on whether and the degree to which the applicable performance objectives for that performance period have been achieved. In determining whether and to what degree Plan awards have been earned during a performance period, the Committee will apply both “Level 1” and “Level 2” performance objectives, as follows:
(1) The Company must achieve a Level 1 minimum net income objective specified by the Committee for the performance period before any payout may be made to any Plan participant for that performance period.
(2) The Company must achieve a Level 1 minimum credit quality objective specified by the Committee for the performance period in addition to the Level 1 minimum net income objective referenced in paragraph 6(b)(1) above before any payout may be made to any Plan participant for that performance period with respect to any Company Level 2 performance objectives.
(3) If the Level 1 minimum net income goal of paragraph 6(b)(1), but not the Level 1 minimum credit quality goal of paragraph 6(b)(2), is achieved for the performance period, Plan participants will remain eligible to receive payouts based on the achievement of Level 2 subsidiary, departmental or individual performance objectives.
(4) Assuming satisfaction of the Level 1 minimum net income objective and potentially also the Level 1 minimum credit quality objective, actual Plan award payout amounts earned will be calculated using a ratable approach, where payout amounts are calculated based on the degree to which specified Level 2 threshold, target and maximum performance levels associated with separate payout amounts have been achieved.
(c) A total payout amount will be calculated for each Plan participant for a performance period, taking into account the achievement of Level 1 objectives, the degree of achievement of Level 2 objectives, the relative weighting of the Level 2 objectives, the participant’s eligible salary and any applicable pro rata adjustments. The payout amount will be paid in a combination of cash and an equity award granted pursuant to the Company’s 2009 Equity Incentive Plan (or such successor equity incentive plan as may be adopted by the Board and approved by the Company’s shareholders) (the “2009 Plan”), with the ratio between the cash and equity portions to be determined annually by the Committee, subject to section 6(d) below.
(1) The cash portion will be paid no later than March 15 of the year following the performance period, contingent only upon a participant’s continued employment with the Company or one of its subsidiaries through the date of payment.
(2) The equity award may be in the form of a restricted stock award, a stock option award or any other form of award authorized under the 2009 Plan, in the discretion of the Committee. The number of shares subject to any such equity award will be determined by dividing the dollar amount of the equity portion of a participant’s total payout amount by the grant date fair value of the award per share of HMN common stock subject to the award. Each such equity award will be subject to the terms and conditions summarized in section 7.
(d) In its discretion, the Committee may permit the Plan participants to elect to receive an equity award for any performance period that represents a greater percentage of the total payout amount for that performance period than had been determined by the Committee (the difference between the ratio determined by the Committee and the higher percentage elected by the participant being the “Additional Equity Portion”), with a corresponding reduction in the percentage of the total payout to be made in cash. The Committee may establish such limits on the percentage to be received in the form of an equity award as it sees fit. Any election by a Plan participant to receive a greater percentage of the total payout in the form of an equity award shall be made on such form as may be approved by the Committee and must be received by the Company no later than the deadline established by the Committee.
7. EQUITY AWARD TERMS AND CONDITIONS
Each equity award granted as part of a payout under the Plan will have a time-based vesting schedule of between one-to-five years, as determined by the Committee, assuming continued employment of the participant by the Company or one of its subsidiaries; provided that any Additional Equity Portion of an equity award be immediately vested upon grant. If a participant terminates employment during the applicable vesting period, the participant will forfeit any unvested portion of any such equity award unless termination occurs due to death or Disability, in which case, the equity award will vest (and become exercisable or be settled, as applicable) in full immediately upon such termination. In addition, if a Change in Control (as defined in Section 9) occurs during the vesting period of an equity award granted as part of a total annual payout under the Plan, such equity award will vest (and become exercisable or be settled, as applicable) in full as of the occurrence of the Change in Control. Notwithstanding the foregoing, if such an equity award is in the form of a stock option or stock appreciation right, the Committee shall retain the discretion to take action as provided in Sections 13(a)(1), 13(a)(2) and 13(a)(5) of the 2009 Plan. A Plan participant will also receive any regular cash dividends declared and paid with respect to unvested restricted shares subject to any restricted stock award granted as part of a payout under the Plan. Equity awards granted as part of a total annual payout under the Plan will be subject to such additional terms and conditions as may be contained in a form of award agreement approved by the Committee and to the applicable terms of the Company’s 2009 Plan.
8. PLAN ADMINISTRATION
(a) The Committee shall administer this Plan and have the power, subject to the terms of this Plan, to determine when and to whom Plan awards will be granted, and the form, amount and other terms and conditions of each such award. The Committee shall have the authority to interpret this Plan and any award made under this Plan, to establish, amend, waive and rescind any rules and regulations relating to the administration of this Plan, and to make all other determinations necessary or advisable for the administration of this Plan. The Committee may correct any defect, supply any omission or reconcile any inconsistency in this Plan or in any award in the manner and to the extent it shall deem necessary or desirable. The determinations of the Committee in the administration of this Plan, as described herein, shall be final, binding and conclusive on all parties.
(b) The Committee may delegate all or any portion of its authority under the Plan to any one or more of its members or, as to Plan awards to participants who are not executive officers of the Company, to the CEO of the Company. The Committee may also delegate non-discretionary administrative responsibilities in connection with the Plan to the human resources department of the Company or the Bank or to such other persons as it deems advisable.
(c) The Board or the Committee may at any time terminate, suspend or modify the Plan and the terms and conditions of any Plan award which has not been paid.
(d) The Committee shall have the authority to provide for the modification of a performance period and/or an adjustment to or waiver of the achievement of any performance objective as determined to be appropriate and equitable by the Committee to prevent dilution or enlargement of the rights of Plan participants with respect to outstanding Plan awards upon the occurrence of certain events, such as a Change of Control, a recapitalization, a change in accounting principles or practices, or other unusual, extraordinary or non-recurring events occurring during the performance period.
(e) The CEO of the Company will provide recommendations to the Committee as to the individuals to be included as participants in the Plan for each performance period, the incentive award opportunity levels for each participant and the Level 1 and Level 2 performance objectives for each performance period.
9. DEFINITIONS
When the following terms are used with capital letters in the Plan, they will have the meanings indicated:
(a) “Board” means the Board of Directors of the Company.
(b) “Cause” has the same meaning given to the term in the Company’s 2009 Equity Incentive Plan.
(c) “Change in Control” means a Change in Control as defined in the Company’s 2009 Plan or a transaction described in clause (i) or clause (ii) of the definition of “Corporate Transaction” in the Company’s 2009 Plan.
(d) |
“Company” means HMN or any successor thereto. |
( e) “Disability” has the same meaning given to the term in the Company’s 2009 Equity Incentive Plan.
10. COMPENSATION RECOVERY
Each award and the compensation associated therewith shall be subject to potential forfeiture to or recovery by the Company in accordance with any compensation recovery policy currently in place or hereafter adopted by the Board.
1 1 . OTHER PROVISION S
(a) Nothing in the Plan shall confer upon any participant the right to continue in the employment of the Company or any of its subsidiaries or affect any right which the Company or any of its subsidiaries may have to terminate the employment of a participant with or without cause.
(b) The Company or any applicable subsidiary shall have the right to withhold from cash payments under the Plan to a participant or other person an amount sufficient to cover any required withholding taxes.
(c) The Plan shall be unfunded, and neither the Company nor any of its subsidiaries shall be required to segregate any assets that may at any time be represented by awards under the Plan. No participant shall, by virtue of this Plan, have any interest in any specific assets of the Company or any of its subsidiaries.
(d) The adoption of the Plan by the Committee shall not be construed as creating any limitation on the power of the Board or Committee to adopt such other incentive arrangements as it may deem appropriate.
(e) Payments received by a participant under an award made pursuant to the Plan shall not be deemed a part of a participant’s regular recurring compensation for purposes of the termination, indemnity or severance pay law of any state and shall not be included in, nor have any effect on, the determination of benefits under any other employee benefit plan, contract or similar arrangement provided by the Company or any of its subsidiaries unless expressly so provided by such other plan, contract or arrangement, or unless the Committee expressly determines otherwise. For these purposes, an amount determined to be payable to a participant hereunder for a performance period, including the portion payable in the form of an equity award, shall be deemed an annual cash incentive bonus and a participant’s target award opportunity for a performance period hereunder shall be deemed that participant’s target annual cash incentive bonus.
( f) To the extent that federal laws do not otherwise control, the Plan and all determinations made and actions taken pursuant to the Plan shall be governed by the laws of the State of Minnesota and construed accordingly.
( g) Participants and beneficiaries shall not have the right to assign, pledge or otherwise dispose of any part of an award under this Plan.
( h) Any payment or benefit to be made or provided to any participant pursuant to this Plan shall be subject to and conditioned upon compliance with 12 CFR Part 359, “Golden Parachute and Indemnification Payments.”
Page 5
Exhibit 13
Financial Highlights |
1 |
Letter to Shareholders and Clients |
2 |
Board of Directors |
4 |
Five-year Consolidated Financial Highlights |
5 |
Management Discussion and Analysis |
6 |
Consolidated Financial Statements |
27 |
Notes to Consolidated Financial Statements |
31 |
Report of Independent Registered Public Accounting Firm |
66 |
Other Financial Data |
64 |
Selected Quarterly Financial Data |
66 |
Common Stock Information |
68 |
Corporate and Shareholder Information |
Inside Back Cover |
Directors and Officers |
Inside Back Cover |
HMN Financial, Inc. and Home Federal Savings Bank are headquartered in Rochester, Minnesota. Home Federal Savings Bank operates twelve full service offices in Minnesota located in Albert Lea, Austin, Eagan, Kasson (2), La Crescent, Rochester (4), Spring Valley and Winona; one full service office in Marshalltown, Iowa; and three loan origination offices in Minnesota located in Sartell, Owatonna, and Mankato and one loan origination office in Delafield, Wisconsin.
FINANCIAL HIGHLIGHTS
At or For the Year Ended |
||||||||||||
Operating Results: |
December 31, |
Percentage |
||||||||||
(Dollars in thousands, except per share data) |
2016 |
201 5 |
Change |
|||||||||
Total interest income |
$ | 27,349 | 21,453 | 27.5 |
% |
|||||||
Total interest expense |
1,593 | 1,507 | 5.7 | |||||||||
Net interest income |
25,756 | 19,946 | 29.1 | |||||||||
Provision for loan losses |
(645 | ) | (164 | ) | (293.3 | ) | ||||||
Net interest income after provision for loan losses |
26,401 | 20,110 | 31.3 | |||||||||
Fees and service charges |
3,427 | 3,316 | 3.3 | |||||||||
Loan servicing fees |
1,108 | 1,046 | 5.9 | |||||||||
Gain on sales of loans |
2,618 | 1,964 | 33.3 | |||||||||
Other non-interest income |
1,048 | 1,327 | (21.0 | ) | ||||||||
Total non-interest income |
8,201 | 7,653 | 7.2 | |||||||||
Total non-interest expense |
24,130 | 23,196 | 4.0 | |||||||||
Income before income tax expense |
10,472 | 4,567 | 129.3 | |||||||||
Income tax expense |
4,122 | 1,611 | 155.9 | |||||||||
Net income |
6,350 | 2,956 | 114.8 | |||||||||
Preferred stock dividends |
0 | (108 | ) | 100.0 | ||||||||
Net income available to common shareholders |
$ | 6,350 | 2,848 | 123.0 | ||||||||
Per Common Share Information: |
||||||||||||
Earnings per common share and common share equivalents |
||||||||||||
Basic |
$ | 1.52 | 0.69 | |||||||||
Diluted |
1.34 | 0.61 | ||||||||||
Stock price (for the year) |
||||||||||||
High |
$ | 18.55 | 12.92 | |||||||||
Low |
10.81 | 10.18 | ||||||||||
Close |
17.50 | 11.55 | ||||||||||
Book value per common share |
16.91 | 15.54 | ||||||||||
Closing price to book value |
103.49 |
% |
74.32 |
% |
||||||||
Financial Ratios: |
||||||||||||
Return on average assets |
0.96 |
% |
0.50 |
% |
92.0 |
% |
||||||
Return on average stockholders' equity |
8.71 | 4.27 | 104.0 | |||||||||
Net interest margin |
4.11 | 3.56 | 15.4 | |||||||||
Operating expenses to average assets |
3.66 | 3.92 | (6.6 | ) | ||||||||
Average stockholders ’ equity to average assets |
11.07 | 11.70 | (5.4 | ) | ||||||||
Stockholders ’ equity to total assets at year end |
11.13 | 10.83 | 2.8 | |||||||||
Non-performing assets to total assets |
0.57 | 0.97 | (41.2 | ) | ||||||||
Efficiency ratio |
71.06 | 84.05 | (15.5 | ) |
Balance Sheet Data: |
December 31, |
Percentage |
||||||||||
(Dollars in thousands) |
2016 |
201 5 |
Change |
|||||||||
Total assets |
$ | 682,023 | 643,161 | 6.0 |
% |
|||||||
Securities available for sale |
78,477 | 111,974 | (29.9 | ) | ||||||||
Loans held for sale |
2,009 | 3,779 | (46.8 | ) | ||||||||
Loans receivable, net |
551,171 | 463,185 | 19.0 | |||||||||
Deposits |
592,811 | 559,387 | 6.0 | |||||||||
Federal Home Loan Bank advances and other borrowings |
7,000 | 9,000 | (22.2 | ) | ||||||||
Stockholders ’ equity |
75,919 | 69,645 | 9.0 | |||||||||
Home Federal Savings Bank regulatory capital ratios: |
||||||||||||
Common equity tier 1 capital |
13.42 |
% |
14.08 |
% |
(4.7 |
)% |
||||||
Tier 1 leverage |
11.55 | 11.46 | 0.8 | |||||||||
Tier 1 risk-based capital |
13.42 | 14.08 | (4.7 | ) | ||||||||
Total risk-based capital |
14.68 | 15.35 | (4.4 | ) | ||||||||
Letter to Shareholders and Clients
I am very proud to present you with our 2016 Annual Report. It reflects the hard work of a very dedicated group of employees and the patronage shown by our many loyal clients.
Net income for the year was $6.4 million and the return on stockholders' equity was 8.71%. While I am pleased with these bottom line results, I am especially pleased with the significant changes our balance sheet has undergone throughout the year, which I believe has positioned us to become a more profitable bank in the years to come.
While our total assets grew $39 million, or 6.1% during the year, our gross loan portfolio grew over $87 million, or 18.5%, during the same period. Most importantly, we grew in all four of the major loan categories – single family residential, commercial real estate, commercial business, and consumer, for the first time in over eight years. This growth was funded in part by a corresponding reduction in our lower-yielding investment portfolio. The asset growth and composition changes resulted in a $5.8 million increase in net interest income from the prior year.
Growth in deposits was another bright spot as the overall average deposits grew over $62 million in 2016 with all deposit account types showing growth during the year. Almost $43 million of the average deposit growth was related to the acquisitions we made during the past eighteen months, with the remaining growth related to organic deposit growth at our existing branches.
In April of 2016, we acquired certain assets and liabilities of the Albert Lea branch of Deerwood Bank. We were fortunate to find a branch in one of our existing markets that we could purchase without incurring significant increases in our overhead expense. The integration of client portfolios went very smoothly and the transition to servicing these deposits out of our existing branch facility helped make this office one of the largest community banks in that market.
2016 also marked the first full year of operation of the branches we acquired in Kasson, Minnesota in August of the prior year. This purchase has proven to be well timed and a very good fit for our Bank. Our new Kasson employees have done a remarkable job of transitioning their client base to Home Federal.
Other divisions of our Bank reported strong operating results as well. Our residential mortgage lending operation generated sales into the secondary market of $89.1 million in 2016 and recognized $2.1 million in gains on the sale of these loans. Our Small Business Administration (SBA) and United States Department of Agriculture (USDA) lenders also sold over $7.5 million in loans during the year recognizing a gain on sale of $0.5 million. Finally, Home Federal Investments Services, our wholly owned Bank subsidiary that offers our clients investment products and advice, reported record revenues and income for the year as well.
These results are due in large part to a major staffing upgrade we embarked on over the past three years. Our surveys of businesses and individuals in the markets we serve found that a growing number of prospective clients are disappointed with what they view as a general decline in the experience and authority levels of management at their local bank. For them, access to an experienced local manager, who has been given the authority to make a decision, is an important factor in determining where they choose to bank. We responded by training our local managers to offer all types and categories of Bank products while recruiting and retaining new talent where needed. While this staffing structure might be more expensive than the more common centralized approach, we are confident that it is an important point of differentiation in today ’s competitive marketplace.
At HMN, we believe our Company and our employees have a responsibility to give back to the local communities we serve. To that end, our employees collectively donated over 5,000 hours to local community service projects and nonprofits in 2016. Furthermore, Home Federal Savings Bank contributed almost $200,000 to various community projects, non-profits, and charities during the year.
I believe that our work in 2016 has positioned HMN to continue to grow and prosper in the coming years. Thank you for your support in making that happen.
Best Regards,
Brad Krehbiel
President/CEO
Board of Directors
|
|
||
Dr. Hugh Smith Chairman of the Board |
Bradley Krehbiel President and CEO |
||
|
|
|
|
Allen Berning |
Michael Bue |
Bernard Nigon |
Dr. Wendy Shannon |
|
|
|
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Dr. Patricia Simmon s |
Mark Utz |
Hans Zietlow |
FIVE-YEAR CONSOLIDATED FINANCIAL HIGHLIGHTS
Selected Operations Data: |
Year Ended December 31, |
|||||||||||||||||||
(Dollars in thousands, except per share data) |
2016 |
2015 |
2014 |
2013 |
2012 |
|||||||||||||||
Total interest income |
$ | 27,349 | 21,453 | 20,613 | 22,983 | 30,816 | ||||||||||||||
Total interest expense |
1,593 | 1,507 | 1,211 | 3,289 | 7,139 | |||||||||||||||
Net interest income |
25,756 | 19,946 | 19,402 | 19,694 | 23,677 | |||||||||||||||
Provision for loan losses |
(645 | ) | (164 | ) | (6,998 | ) | (7,881 | ) | 2,544 | |||||||||||
Net interest income after provision for loan losses |
26,401 | 20,110 | 26,400 | 27,575 | 21,133 | |||||||||||||||
Fees and service charges |
3,427 | 3,316 | 3,458 | 3,513 | 3,325 | |||||||||||||||
Loan servicing fees |
1,108 | 1,046 | 1,058 | 1,029 | 964 | |||||||||||||||
Gain on sales of loans |
2,618 | 1,964 | 1,828 | 2,102 | 3,574 | |||||||||||||||
Other non-interest income |
1,048 | 1,327 | 940 | 668 | 1,127 | |||||||||||||||
Total non-interest income |
8,201 | 7,653 | 7,284 | 7,312 | 8,990 | |||||||||||||||
Total non-interest expense |
24,130 | 23,196 | 21,403 | 22,623 | 24,670 | |||||||||||||||
Income before income tax expense |
10,472 | 4,567 | 12,281 | 12,264 | 5,453 | |||||||||||||||
Income tax expense (benefit) |
4,122 | 1,611 | 4,902 | (14,406 | ) (1) | 132 | ||||||||||||||
Net income |
6,350 | 2,956 | 7,379 | 26,670 | 5,321 | |||||||||||||||
Preferred stock dividends and discount |
0 | (108 | ) | (1,710 | ) | (2,068 | ) | (1,861 | ) | |||||||||||
Net income available to common shareholders |
$ | 6,350 | 2,848 | 5,669 | 24,602 | 3,460 | ||||||||||||||
Basic earnings per common share |
$ | 1.52 | 0.69 | 1.40 | 6.15 | 0.88 | ||||||||||||||
Diluted earnings per common share |
1.34 | 0.61 | 1.23 | 5.71 | 0.86 | |||||||||||||||
(1) Relates to the elimination of the deferred tax asset valuation reserve at December 31, 2013. |
Selected Financial Condition Data: |
December 31, |
|||||||||||||||||||
(Dollars in thousands, except per share data) |
2016 |
2015 |
2014 |
2013 |
2012 |
|||||||||||||||
Total assets |
$ | 682,023 | 643,161 | 577,426 | 648,622 | 653,327 | ||||||||||||||
Securities available for sale |
78,477 | 111,974 | 137,834 | 107,956 | 85,891 | |||||||||||||||
Loans held for sale |
2,009 | 3,779 | 2,076 | 1,502 | 2,584 | |||||||||||||||
Loans receivable, net |
551,171 | 463,185 | 365,113 | 384,615 | 454,045 | |||||||||||||||
Deposits |
592,811 | 559,387 | 496,750 | 553,930 | 514,951 | |||||||||||||||
FHLB advances and other borrowings |
7,000 | 9,000 | 0 | 0 | 70,000 | |||||||||||||||
Stockholders ’ equity |
75,919 | 69,645 | 76,013 | 85,675 | 60,834 | |||||||||||||||
Book value per common share |
16.91 | 15.54 | 14.77 | 13.49 | 8.02 | |||||||||||||||
Number of full service offices |
13 | 13 | 11 | 11 | 12 | |||||||||||||||
Number of loan origination offices (2 ) |
3 | 3 | 2 | 1 | 1 | |||||||||||||||
Key Ratios : (3 ) |
||||||||||||||||||||
Stockholders ’ equity to total assets at year end |
11.13 |
% |
10.83 |
% |
13.16 |
% |
13.21 |
% |
9.31 |
% |
||||||||||
Average stockholders ’ equity to average assets |
11.07 | 11.70 | 13.25 | 10.77 | 8.81 | |||||||||||||||
Return on stockholders ’ equity |
||||||||||||||||||||
(ratio of net income to average equity) |
8.71 | 4.27 | 9.12 | 42.22 | 8.94 | |||||||||||||||
Return on assets |
||||||||||||||||||||
(ratio of net income to average assets) |
0.96 | 0.50 | 1.21 | 4.55 | 0.79 |
(2) The Company opened a 4 th loan origination office in Mankato, Minnesota on January 1, 2017. (3 ) Average balances were calculated based upon amortized cost without the market value impact of ASC 320. |
See accompanying notes to consolidated financial statements. |
This Annual Report, other reports filed by the Company with the Securities and Exchange Commission, and the Company ’s proxy statement may contain forward-looking statements within the meaning of the safe harbor provisions of the Private Securities Litigation Reform Act of 1995. These statements are often identified by such forward-looking terminology as “expect,” “intend,” “look,” “believe,” “anticipate,” “estimate,” “project,” “seek,” “may,” “will,” “would,” “could,” “should,” “trend,” “target,” and “goal” or similar statements or variations of such terms and include, but are not limited to, those relating to growing our core deposit relationships and loan balances, enhancing the financial performance and profitability of our core banking operations, improving credit quality, reducing non-performing assets, and generating improved financial results (including profitability); the adequacy and amount of available liquidity and capital resources to the Bank; the Company’s liquidity and capital requirements; our expectations for core capital and our strategies and potential strategies for maintenance thereof; improvements in loan production; changes in the size of the Bank’s loan portfolio; the amount of the Bank’s non-performing assets and the appropriateness of the allowance therefor; anticipated future levels of the provision for loan losses; future losses on non-performing assets; the amount and composition of interest-earning assets; the amount and composition of interest-bearing liabilities; the availability of alternate funding sources; the payment of dividends by HMN; the future outlook for the Company; the amount of deposits that will be withdrawn from checking and money market accounts and how the withdrawn deposits will be replaced; the projected changes in net interest income based on rate shocks; the range that interest rates may fluctuate over the next twelve months; the net market risk of interest rate shocks; the future outlook for the issuer trust preferred securities held by the Bank; the ability of the Bank to pay dividends to HMN; the ability of HMN to pay the principal and interest payments on its third party note payable; the ability to remain well capitalized; and compliance by the Bank with regulatory standards generally (including the Bank’s status as “well-capitalized”) and other supervisory directives or requirements to which the Company or the Bank are or may become expressly subject, specifically, and possible responses of the Office of the Comptroller of the Currency (OCC), Board of Governors of the Federal Reserve System (FRB), the Bank, and the Company to any failure to comply with any such regulatory standard, directive or requirement.
A number of factors could cause actual results to differ materially from the Company ’s assumptions and expectations. These include but are not limited to the adequacy and marketability of real estate and other collateral securing loans to borrowers; federal and state regulation and enforcement; possible legislative and regulatory changes, including additional changes to regulatory capital rules; the ability of the Bank to comply with other applicable regulatory capital requirements; enforcement activity of the OCC and FRB in the event of our non-compliance with any applicable regulatory standard or requirement; adverse economic, business and competitive developments such as shrinking interest margins, reduced collateral values, deposit outflows, changes in credit or other risks posed by the Company’s loan and investment portfolios; changes in costs associated with alternate funding sources, including changes in collateral advance rates and policies of the Federal Home Loan Bank ( FHLB ) ; technological, computer-related or operational difficulties; results of litigation; reduced demand for financial services and loan products; changes in accounting policies and guidelines, or monetary and fiscal policies of the federal government or tax laws; international economic developments; the Company’s access to and adverse changes in securities markets; the market for credit related assets; the future operating results, financial condition, cash flow requirements and capital spending priorities of the Company and the Bank; the availability of internal and, as required, external sources of funding; acquisition integration costs; our ability to attract and retain employees; or other significant uncertainties. Additional factors that may cause actual results to differ from the Company’s assumptions and expectations include those set forth in the Company’s most recent filing on Forms 10-K and 10-Q with the Securities and Exchange Commission. All forward-looking statements are qualified by, and should be considered in conjunction with, such cautionary statements. For additional discussion of the risks and uncertainties applicable to the Company, see the “Risk Factors” sections of the Company’s Annual Report on Form 10-K for the year ended December 31, 201 6 .
All statements in this Annual Report, including forward-looking statements, speak only as of the date hereof, and we undertake no duty to update any of the forward-looking statements after the date of this Annual Report.
Overview
HMN Financial, Inc. (HMN or the Company) is the stock savings bank holding company for Home Federal Savings Bank (the Bank), which operates community banking and loan production offices in Minnesota, Iowa and Wisconsin. The earnings of the Company are primarily dependent on the Bank's net interest income, which is the difference between interest earned on loans and investments, and the interest paid on interest-bearing liabilities such as deposits and other borrowings. The difference between the average rate of interest earned on assets and the average rate paid on liabilities is the "interest rate spread". Net interest income is produced when interest-earning assets equal or exceed interest-bearing liabilities and there is a positive interest rate spread. Net interest income and net interest rate spread are affected by changes in interest rates, the volume and composition of interest-earning assets and interest-bearing liabilities, and the level of non-performing assets. The Company's net earnings are also affected by the generation of non-interest income, which consists primarily of gains from the sale of loans and real estate owned, fees for servicing loans, commissions on the sale of uninsured investment products, and service charges on deposit accounts. The Bank incurs expenses in addition to interest expense in the form of salaries and benefits, occupancy expenses, provisions for loan losses, deposit insurance, amortization expense on mortgage servicing assets, data processing costs and income taxes. The earnings of financial institutions, such as the Bank, are also significantly affected by prevailing economic and competitive conditions, particularly changes in interest rates, government monetary and fiscal policies, and regulations of various regulatory authorities. Lending activities are influenced by the demand for and supply of business credit, single-family and commercial properties, competition among lenders, the level of interest rates and the availability of funds. Deposit flows and costs of deposits are influenced by prevailing market rates of interest on competing investments, account maturities and the levels of personal income and savings.
Critical Accounting Estimates
Critical accounting policies are those policies that the Company's management believes are the most important to understanding the Company ’s financial condition and operating results. These critical accounting policies often involve estimates and assumptions that could have a material impact on the Company’s financial statements. The Company has identified the following critical accounting policies that management believes involve the most difficult, subjective, and/or complex judgments that are inherently uncertain. Therefore, actual financial results could differ significantly depending upon the estimates, assumptions and other factors used.
Allowance for Loan Losses and Related Provision
The allowance for loan losses is based on periodic analysis of the loan portfolio and is maintained at an amount considered to be appropriate by management to provide for probable losses inherent in the loan portfolio as of the balance sheet dates. In this analysis, management considers factors including, but not limited to, specific occurrences of loan impairment, actual and anticipated changes in the size of the portfolios, national and regional economic conditions such as unemployment data, loan delinquencies, local economic conditions, demand for single-family homes, demand for commercial real estate and building lots, loan portfolio composition and historical loss experience and observations made by the Company's ongoing internal audit and regulatory exam processes. Loans are charged off to the extent they are deemed to be uncollectible. The Company has established separate processes to determine the appropriateness of the loan loss allowance for its homogeneous single-family and consumer loan portfolios and its non-homogeneous loan portfolios. The determination of the allowance on the homogeneous single-family and consumer loan portfolios is calculated on a pooled basis with individual determination of the allowance for all non-performing loans. The determination of the allowance for the non-homogeneous commercial, commercial real estate and multi-family loan portfolios involves assigning standardized risk ratings and loss factors that are periodically reviewed. The loss factors are estimated based on the Company's own loss experience and are assigned to all loans without identified credit weaknesses. For each non-performing loan, the Company also performs an individual analysis of impairment that is based on the expected cash flows or the value of the assets collateralizing the loans and establishes any necessary reserves or charges off all loans, or portions thereof, that are deemed uncollectible.
The appropriateness of the allowance for loan losses is dependent upon management ’s estimates of variables affecting valuation, appraisals of collateral, evaluations of performance and status, and the amounts and timing of future cash flows expected to be received on impaired loans. Such estimates, appraisals, evaluations and cash flows may be subject to adjustments due to changing economic prospects of borrowers or properties. The fair market value of collateral dependent loans are typically based on the appraised value of the property less estimated selling costs. The estimates are reviewed periodically and adjustments, if any, are recorded in the provision for loan losses in the periods in which the adjustments become known. Because of the size of some loans, changes in estimates can have a significant impact on the loan loss provision. The allowance is allocated to individual loan categories based upon the relative risk characteristics of the loan portfolios and the actual loss experience. The Company increases its allowance for loan losses by charging the provision for loan losses against income and by receiving recoveries of previously charged off loans. The Company decreases its allowance by crediting the provision for loan losses. The current year activity in the allowance resulted in a credit to the loan loss provision. The methodology for establishing the allowance for loan losses takes into consideration probable losses that have been identified in connection with specific loans as well as losses in the loan portfolio that have not been specifically identified. Although management believes that based on current conditions the allowance for loan losses is maintained at an appropriate amount to provide for probable loan losses inherent in the portfolio as of the balance sheet dates, future conditions may differ substantially from those anticipated in determining the allowance for loan losses and adjustments may be required in the future.
Income Taxes
Deferred tax assets and liabilities are recognized for the future tax consequences attributable to temporary differences between the financial statement carrying amounts of existing assets and liabilities and their respective tax basis. Deferred tax assets and liabilities are measured using enacted tax rates expected to apply to taxable income in the years in which those temporary differences are expected to be recovered or settled. The effect on deferred tax assets and liabilities of a change in tax rates is recognized in income in the period that includes the enactment date. These calculations are based on many complex factors including estimates of the timing of reversals of temporary differences, the interpretation of federal and state income tax laws, and a determination of the differences between the tax and the financial reporting basis of assets and liabilities. Actual results could differ significantly from the estimates and interpretations used in determining the current and deferred income tax assets and liabilities.
The Company maintains significant net deferred tax assets for deductible temporary differenc es, the largest of which relate to the allowance for loan and real estate losses and state net operating loss carryforwards. For income tax purposes, only net charge-offs are deductible, not the entire provision for loan losses. Under generally accepted accounting principles, a valuation allowance is required to be recognized if it is “more likely than not” that the deferred tax asset will not be realized. The determination of the realizability of the deferred tax assets is highly subjective and dependent upon management’s judgment and evaluation of both positive and negative evidence, including the forecasts of future income, tax planning strategies, and assessments of the current and future economic and business conditions. The Company considers both positive and negative evidence regarding the ultimate realizability of deferred tax assets. Positive evidence includes the Company’s cumulative net income in the prior three year period, the ability to implement tax planning strategies to accelerate taxable income recognition, and the probability that taxable income will be generated in future periods. The Company could not currently identify any negative evidence. It is possible that future conditions may differ substantially from those anticipated in determining that no valuation allowance was required on deferred tax assets and adjustments may be required in the future.
Determining the ultimate settlement of any tax position requires significant estimates and judgments in arriving at the amount of tax benefits to be recognized in the financial statements. It is possible that the tax benefits realized upon the ultimate resolution of a tax position may result in tax benefits that are significantly different from those estimated.
Accounting for Loans Acquired in a Business Combination
Loans acquired in a business combination are initially recorded at their acquisition date fair values. The fair value s of the purchased loans are based on the present value of the expected cash flows, including principal, interest and prepayments. Periodic principal and interest cash flows are adjusted for expected losses and prepayments, then discounted to determine the present value and summed to arrive at the estimated fair value. Fair value estimates involve assumptions and judgments as to credit risk, interest rate risk, prepayment risk, liquidity risk, default rates, loss severity, payment speeds, collateral values and discount rate. Purchased loans are divided into loans with evidence of credit quality deterioration, which are accounted for under Accounting Standards Codification (ASC) topic 310-30 (purchased credit impaired (PCI)) and loans that do not meet this criteria, which are accounted for under ASC topic 310-20 (performing). PCI loans have experienced a deterioration of credit quality from origination to acquisition for which it is probable that the Bank will not be able to collect all principal and interest payments on the loan. In the assessment of credit quality, numerous assumptions, interpretations and judgments must be made, based on internal and third-party credit quality information and ultimately the determination as to the probability that all contractual cash flows will not be able to be collected. This is a point in time assessment and inherently subjective due to the nature of the available information and judgment involved.
Subsequent to the acquisition date, the Bank continues to estimate the amount and timing of cash flows expected to be collected on PCI loans. The present value of any decreases in expected cash flows after the acquisition date will generally result in an impairment charge recorded as a provision for loan losses, resulting in an increase to the allowance for loan losses. Increases in expected cash flows will generally result in a recovery of any previously recorded allowance for loan losses, to the extent applicable, and/or a reclassification from the nonaccretable difference to accretable yield, which will be recognized prospectively. For acquired performing loans, the difference between the acquisition date fair value and the contractual amounts due at the acquisition date represents the fair value adjustment. Fair value adjustments may be discounts or premiums to a loan's cost basis and are accreted or amortized into interest income over the loan's remaining life using the level yield method.
Subsequent to the acquisition date, the methods utilized to estimate the required allowance for loan losses for these loans is similar to originated loans. See “Note 2 Acquisitions” and “Note 6 Allowance for Loan Losses and Credit Quality Information” in the Notes to Consolidated Financial Statements for more information regarding acquired loans.
Results of Operations
Comparison of 201 6 with 201 5
Net income was $6.4 million for 2016, an increase of $3.4 million compared to net income of $3.0 million for 2015. Net income available to common shareholders was $6.4 million for 20 16, an increase of $3.6 million compared to net income available to common shareholders of $2.8 million for 2015. Diluted earnings per share for the year ended December 31, 2016 was $1.34, an increase of $0.73 per share compared to diluted earnings per share of $0.61 for the year ended December 31, 2015. The increase in net income for 2016 is due primarily to a $5.9 million increase in interest income as a result of an increase in the average interest-earning assets and a change in the composition of the average interest-earning assets held between the periods. Gain on sales of loans increased $0.7 million due to an increase in single family mortgage loan production and sales between the periods. The provision for loan losses decreased $0.5 million between the periods due to improvements in the credit quality of the commercial loan portfolio. These increases in income were partially offset by a $1.0 million increase in compensation expense due to annual increases in compensation and an increase in the number of employees related to the increased loan production. Income tax expense increased $2.5 million because of the increase in pre-tax income between the periods.
Net Interest Income
Net interest income was $25.8 million for 2016, an increase of $5.9 million, or 29.1%, from $19.9 million for 2015. Interest income was $27.3 million for 2016, an increase of $5.8 million, or 27.5%, from $21.5 million for 2015. Interest income increased between the periods because of an increase in the average interest-earning assets and a change in the composition of the average interest-earning assets held, which resulted in an increase in the average yields earned between the periods. While the average interest-earning assets increased $67.3 million between the periods, the average interest-earning assets held in higher yielding loans increased $120.4 million and the amount of average interest-earning assets held in lower yielding cash and investments decreased $53.1 million between the periods. The yield on average interest-earning assets was also enhanced by $2.2 million, or 30 basis points, due to loan prepayment penalties, yield adjustments recognized on purchased loans, and interest payments received on non-accruing and previously charged off loans during 2016. Due to the decreasing amounts of interest payments receive on previously charged off loans that are available for recapture, the yield adjustments to interest income are anticipated to decrease significantly in 2017 from those experienced in 2016. The increase in the average outstanding loans between the periods was primarily the result of an increase in the commercial loan portfolio, which occurred because of an increase in loan originations and a reduction in loan payoffs between the periods. Average outstanding loans also increased $18.6 million between the periods as a result of the acquisitions that occurred in the third quarter of 2015 and the second quarter of 2016. The average yield earned on interest-earning assets was 4.36% for 2016, an increase of 53 basis points from 3.83% for 2015.
Interest expense was $1.6 million for 2016 , an increase of $0.1 million, or 5.7%, compared to $1.5 million for 2015. Interest expense increased because of an increase in the average outstanding interest-bearing liabilities. The average rate paid on interest-bearing liabilities decreased 1 basis point between the periods because of the change in the composition of the average interest-bearing liabilities. While the average interest-bearing liabilities increased $62.9 million between the periods, the average amount held in lower rate checking and money market accounts increased $58.0 million and the average amount held in higher rate certificates of deposits and other borrowings increased $4.9 million between the periods. The increase in the average outstanding deposits between the periods was primarily due to the $42.9 million increase that occurred as a result of the acquisitions that occurred in the third quarter of 2015 and the second quarter of 2016. The average interest rate paid on interest-bearing liabilities was 0.28% for 2016 compared to 0.29% for 2015. Net interest margin (net interest income divided by average interest-earning assets) for 2016 was 4.11%, an increase of 55 basis points compared to 3.56% for 2015.
The following table presents the total dollar amount of interest income from average interest-earning assets and the resultant yields, as well as the interest expense on average interest-bearing liabilities, expressed both in dollars and rates. Non-accruing loans have been included in the average outstanding loan balance in the table as loans carrying a zero yield.
Year Ended December 31, |
||||||||||||||||||||||||||||||||||||
201 6 |
201 5 |
201 4 |
||||||||||||||||||||||||||||||||||
(Dollars in thousands) |
Average Outstanding Balance |
Interest Earned/ Paid |
Average Yield/ Rate |
Average Outstanding Balance |
Interest Earned/ Paid |
Average Yield/ Rate |
Average Outstanding Balance |
Interest Earned/ Paid |
Average Yield/ Rate |
|||||||||||||||||||||||||||
Interest-earning assets : |
||||||||||||||||||||||||||||||||||||
Securities available for sale: |
||||||||||||||||||||||||||||||||||||
Mortgage-backed and related securities |
$ | 1,631 | 58 | 3.56 |
% |
$ | 3,274 | 116 | 3.54 |
% |
$ | 3,726 | 164 | 4.40 |
% |
|||||||||||||||||||||
Other marketable securities |
84,528 | 1,289 | 1.52 | 130,806 | 1,881 | 1.44 | 119,484 | 1,269 | 1.06 | |||||||||||||||||||||||||||
Loans held for sale |
3,046 | 126 | 4.14 | 2,507 | 87 | 3.47 | 1,557 | 58 | 3.73 | |||||||||||||||||||||||||||
Loans receivable, net (1) (2) |
513,974 | 25,774 | 5.01 | 394,086 | 19,302 | 4.90 | 369,571 | 18,929 | 5.12 | |||||||||||||||||||||||||||
FHLB stock |
770 | 6 | 0.78 | 734 | 4 | 0.54 | 778 | 4 | 0.51 | |||||||||||||||||||||||||||
Other, including cash equivalents |
23,337 | 96 | 0.41 | 28,544 | 63 | 0.22 | 79,373 | 189 | 0.24 | |||||||||||||||||||||||||||
Total interest-earning assets |
$ | 627,286 | 27,349 | 4.36 | $ | 559,951 | 21,453 | 3.83 | $ | 574,489 | 20,613 | 3.59 | ||||||||||||||||||||||||
Interest-bearing liabilities: |
||||||||||||||||||||||||||||||||||||
NOW accounts |
$ | 85,440 | 50 | 0.06 |
% |
$ | 76,136 | 17 | 0.02 |
% |
$ | 71,666 | 14 | 0.02 |
% |
|||||||||||||||||||||
Passbooks |
71,728 | 62 | 0.09 | 55,273 | 42 | 0.08 | 47,200 | 32 | 0.07 | |||||||||||||||||||||||||||
Money market accounts |
164,522 | 366 | 0.22 | 153,441 | 347 | 0.23 | 162,207 | 414 | 0.26 | |||||||||||||||||||||||||||
Certificate accounts |
100,942 | 524 | 0.52 | 96,600 | 528 | 0.55 | 110,256 | 739 | 0.67 | |||||||||||||||||||||||||||
Brokered deposits |
0 | 0 | 0.00 | 0 | 0 | 0.00 | 830 | 12 | 1.45 | |||||||||||||||||||||||||||
FHLB advances and other borrowings |
9,374 | 591 | 6.30 | 9,225 | 573 | 6.21 | 0 | 0 | 0.00 | |||||||||||||||||||||||||||
Total interest-bearing liabilities |
$ | 432,006 | $ | 390,675 | $ | 392,159 | ||||||||||||||||||||||||||||||
Noninterest checking |
145,450 | 124,342 | 125,767 | |||||||||||||||||||||||||||||||||
Other non-interest-bearing liabilities |
1,434 | 985 | 924 | |||||||||||||||||||||||||||||||||
Total interest-bearing liabilities and noninterest-bearing deposits |
$ | 578,890 | 1,593 | 0.28 |
% |
$ | 516,002 | 1,507 | 0.29 |
% |
$ | 518,850 | 1,211 | 0.23 |
% |
|||||||||||||||||||||
Net interest income |
25,756 | 19,946 | 19,402 | |||||||||||||||||||||||||||||||||
Net interest rate spread |
4.08 |
% |
3.54 |
% |
3.35 |
% |
||||||||||||||||||||||||||||||
Net earning assets |
$ | 48,396 | $ | 43,949 | $ | 55,639 | ||||||||||||||||||||||||||||||
Net interest margin |
4.11 |
% |
3.56 |
% |
3.38 |
% |
||||||||||||||||||||||||||||||
Average interest-earning assets to average interest-bearing liabilities and noninterest-bearing deposits |
108.36 |
% |
108.52 |
% |
110.72 |
% |
(1 ) Tax exempt income was not significant; therefore, the yield was not presented on a tax equivalent basis for any of the years presented. (2) Calculated net of deferred loan fees, loan discounts, loans in process and loss reserves. |
Net interest margin increased to 4.11% in 2016 from 3.56% in 2015 primarily because of a change in the composition of average interest-earning assets held, which resulted in an increase in the average yields earned between the periods. The increases in the average yields earned was due to having larger average balances of higher earning loans and smaller average balances of lower earning cash and investments during 2016 when compared to 2015. The yield on average interest-earning assets was also enhanced $2.2 million, or 30 basis points, in 2016 due to loan prepayment penalties, yield adjustments recognized on purchased loans, and interest payments received on non-accruing and previously charged off loans. Average net earning assets increased from $43.9 million in 2015 to $48.4 million in 2016. The $4.5 million increase in net earning assets is due primarily to the net income earned in 2016.
The following table presents the dollar amount of changes in interest income and interest expense for major components of interest-earning assets and interest-bearing liabilities. It quantifies the changes in interest income and interest expense related to changes in the average outstanding balances (volume) and those changes caused by fluctuating interest rates. For each category of interest-earning assets and interest-bearing liabilities, information is provided on changes attributable to (i) changes in volume (i.e., changes in volume multiplied by old rate) and (ii) changes in rate (i.e., changes in rate multiplied by current volume).
Year Ended December 31, |
|||||||||||||||||||||||||
2016 vs. 201 5 |
201 5 vs. 2014 |
||||||||||||||||||||||||
Increase (Decrease) Due to |
Increase (Decrease) Due to |
||||||||||||||||||||||||
(Dollars in thousands) |
Volume (1) |
Rate (1) |
Total Increase (Decrease) |
Volume (1) |
Rate (1) |
Total Increase (Decrease) |
|||||||||||||||||||
Interest-earning assets: |
|||||||||||||||||||||||||
Securities available for sale: |
|||||||||||||||||||||||||
Mortgage-backed and related securities |
$ | (58 | ) | 0 | (58 | ) | (20 | ) | (28 | ) | (48 | ) | |||||||||||||
Other marketable securities |
(665 | ) | 73 | (592 | ) | 120 | 492 | 612 | |||||||||||||||||
Loans held for sale |
19 | 20 | 39 | 36 | (7 | ) | 29 | ||||||||||||||||||
Loans receivable, net |
5,824 | 648 | 6,472 | 1,175 | (802 | ) | 373 | ||||||||||||||||||
Cash equivalents |
(12 | ) | 45 | 33 | (121 | ) | (5 | ) | (126 | ) | |||||||||||||||
FHLB stock |
0 | 2 | 2 | 0 | 0 | 0 | |||||||||||||||||||
Total interest-earning assets |
$ | 5,108 | 788 | 5,896 | 1,190 | (350 | ) | 840 | |||||||||||||||||
Interest-bearing liabilities: |
|||||||||||||||||||||||||
NOW accounts |
$ | 1 | 32 | 33 | 1 | 1 | 2 | ||||||||||||||||||
Passbooks |
12 | 8 | 20 | 5 | 5 | 10 | |||||||||||||||||||
Money market accounts |
18 | 1 | 19 | 20 | (86 | ) | (66 | ) | |||||||||||||||||
Certificates of deposit |
26 | (30 | ) | (4 | ) | (104 | ) | (107 | ) | (211 | ) | ||||||||||||||
Brokered deposits |
0 | 0 | 0 | (12 | ) | 0 | (12 | ) | |||||||||||||||||
FHLB advances and other borrowings |
16 | 2 | 18 | 0 | 573 | 573 | |||||||||||||||||||
Total interest-bearing liabilities |
73 | 13 | 86 | (90 | ) | 386 | 296 | ||||||||||||||||||
Increase (d ecrease) in net interest income |
$ | 5,035 | 775 | 5,810 | 1,280 | (736 | ) | 544 |
(1) For purposes of this table, changes attributable to both rate and volume which cannot be segregated have been allocated proportionately to the change due to volume and the change due to rate.
|
The following table sets forth the weighted average yields on the Company's interest-earning assets, the weighted average interest rates on interest-bearing liabilities and the interest rate spread between the weighted average yields and rates as of the date indicated. Non-accruing loans have been included in the average outstanding loan balances in the table as loans carrying a zero yield.
At December 31, 201 6 |
||||||||||
Weighted average yield on: |
Weighted average rate on: |
|||||||||
Securities available for sale: |
||||||||||
Mortgage-backed and related securities |
3.51 |
% |
NOW accounts |
0.07 |
% |
|||||
Other marketable securities |
1.34 |
Passbooks |
0.08 | |||||||
Loans held for sale |
4.65 |
Money market accounts |
0.24 | |||||||
Loans receivable, net |
4.69 |
ICS/CDARS |
0.28 | |||||||
Federal Home Loan Bank stock |
0.50 |
Certificates of deposit |
0.61 | |||||||
Other interest-earnings assets |
0.75 |
Federal Home Loan Bank advances and other borrowings |
6.50 | |||||||
Combined weighted average yield on interest-earning assets |
4.14 |
Combined weighted average rate on interest-bearing liabilities |
0.27 | |||||||
Interest rate spread |
3.87 | |||||||||
Provision for Loan Losses
The provision for loan losses was ($0.6) million for the year ended December 31, 2016, a decrease of $0.4 million, from ($0.2) million for the year ended December 31, 2015. The provision for loan losses decreased between the periods primarily because of the decrease in the reserve percentages applied to certain risk rated loan categories as a result of an internal analysis performed. Total non-performing assets were $3.9 million at December 31, 2016, a decrease of $2.3 million, or 37.4%, from $6.2 million at December 31, 2015. Non-performing loans decreased $0.9 million and foreclosed and repossessed assets decreased $1.4 million during 2016.
A reconciliation of the allowance for loan losses for 201 6 and 2015 is summarized as follows:
( Dollars in thousands) |
2016 |
2015 |
||||||
Balance at January 1 |
$ | 9,709 | 8,332 | |||||
Provision |
(645 | ) | (164 | ) | ||||
Charge offs: |
||||||||
Commercial |
(180 | ) | (69 | ) | ||||
Commercial real estate |
(67 | ) | 0 | |||||
Consumer |
(108 | ) | (105 | ) | ||||
Single- family |
(66 | ) | (19 | ) | ||||
Recoveries |
1,260 | 1,734 | ||||||
Balance at December 31 |
$ | 9,903 | 9,709 | |||||
Specific allowance |
$ | 988 | 1,009 | |||||
General allowance |
8,915 | 8,700 | ||||||
$ | 9,903 | 9,709 | ||||||
The allowance for loan losses increased in 201 6 when compared to 2015 primarily because of the increase in the loan portfolio between the periods.
Non-Interest Income
Non-interest income was $8.2 million for the year ended December 31, 2016, an increase of $0.5 million from $7.7 million for the year ended December 31, 2015 .
The following table presents the components of non-interest income:
Year ended December 31, |
Percentage Increase (Decrease) |
|||||||||||||||||||
(Dollars in thousands) |
2016 |
2015 |
2014 |
2016/2015 |
2015/2014 |
|||||||||||||||
Fees and service charges |
$ | 3,427 | 3,316 | 3,458 | 3.3 |
% |
(4.1 |
)% |
||||||||||||
Loan servicing fees |
1,108 | 1,046 | 1,058 | 5.9 | (1.1 | ) | ||||||||||||||
Gain on sales of loans |
2,618 | 1,964 | 1,828 | 33.3 | 7.4 | |||||||||||||||
Other non-interest income |
1,048 | 1,327 | 940 | (21.0 | ) | 41.2 | ||||||||||||||
Total non-interest income |
$ | 8,201 | 7,653 | 7,284 | 7.2 | 5.1 | ||||||||||||||
The increase in non-interest income is primarily related to the $0.7 million increase in the gain on sales of loans due to an increase in single family loan originations and sales between the periods. Fees and service charges increased $0.1 million between the periods due primarily to an increase in debit card income. Loan servicing fees increased $0.1 million due to an increase in the loans serviced for others between the periods. These increases were partially offset by a $0.3 million decrease in other non-interest income because of a decrease in the gains realized on acquisitions between the periods.
Non-Interest Expense
Non-interest expense was $24.1 million for the year ended December 31, 2016, an increase of $0.9 million from $23.2 million for the year ended December 31, 2015. The following table presents the components of non-interest expense:
Year ended December 31, |
Percentage Increase (Decrease) |
|||||||||||||||||||
(Dollars in thousands) |
2016 |
2015 |
2014 |
2016/2015 |
2015/2014 |
|||||||||||||||
Compensation and benefits |
$ | 14,764 | 13,733 | 13,332 | 7.5 |
% |
3.0 |
% |
||||||||||||
(G ains) losses on real estate owned |
(596 | ) | 218 | (1,194 | ) | (373.4 | ) | 118.3 | ||||||||||||
Occupancy and equipment |
4,041 | 3,722 | 3,691 | 8.6 | 0.8 | |||||||||||||||
Data processing |
1,161 | 1,020 | 1,011 | 13.8 | 0.9 | |||||||||||||||
Professional services |
1,257 | 1,108 | 1,216 | 13.4 | (8.9 | ) | ||||||||||||||
Other |
3,503 | 3,395 | 3,347 | 3.2 | 1.4 | |||||||||||||||
Total non-interest expense |
$ | 24,130 | 23,196 | 21,403 | 4.0 | 8.4 | ||||||||||||||
Compensation expense increased $1.0 million between the periods due to annual increases in compensation and an increase in the number of employees between the periods because of the increased loan production. Occupancy and equipment expense increased $0.3 million because of increased software and equipment expenses. Other non-interest expense increased $0.1 million due primarily to an increase in loan related expenses as a result of the increase in loans originated between the periods. Data processing expense increased $0.1 million between the periods due to increased mobile and on-line banking costs. Other professional expenses increased $0.1 million primarily due to expenses related to the acquisition that occurred in the second quarter of 2016. These increases in non-interest expenses were partially offset by a $0.8 million increase in the gains on real estate owned between the periods primarily because of the gains that were recognized on the sale of two commercial properties during 2016.
Income Taxes
The Company considers the calculation of current and deferred income taxes to be a critical accounting policy that is subject to significant estimates , as previously discussed. Income tax expense was $4.1 million for the year ended December 31, 2016, an increase of $2.5 million, from $1.6 million for the year ended December 31, 2015. The increase in income tax expense between the periods is primarily related to the increase in pre-tax income in 2016 when compared to 2015.
Net Income Available to Common Shareholders
Net income available to common shareholders was $6.4 million for 2016, an increase of $3.6 million from the $2.8 million net income available to common shareholders for 2015. Basic earnings per common share for the year ended December 31, 2016 was $1.52, an increase of $0.83 from the basic earnings per common share of $0.69 for the year ended December 31, 2015. Diluted earnings per common share for the year ended December 31, 2016 was $1.34, an increase of $0.73 from diluted earnings per common share of $0.61 for the year ended December 31, 2015. Net income available to common shareholders and the basic and diluted earnings per common share increased primarily because of the increase in net income and a reduction in the dividends required to be paid on the outstanding Fixed Rate Cumulative Perpetual Preferred Stock Series A (the “Preferred Stock”) between the periods. On February 17, 2015 the Company redeemed the final 10,000 shares of its outstanding Preferred Stock and, as a result, no dividends were required to be paid on the Preferred Stock after that date.
Comparison of 2015 with 2014
Net income was $3.0 million for 2015, a decrease of $4.4 million, from $7.4 million for 2014. Net income available to common shareholders was $2.8 million for the year ended December 31, 2015, a decrease of $2.9 million, from net income available to common shareholders of $5.7 million for 2014. Diluted earnings per common share for the year ended December 31, 2015 was $0.61, a decrease of $0.62 compared to the diluted earnings per common share of $1.23 for the year ended December 31, 2014. The decrease in net income in 2015 is due primarily to a $6.8 million decrease in the credit provision for loan losses between the periods. The decrease in the credit provision was primarily because there was more commercial loan growth and fewer recoveries of previously charged off loans in 2015 when compared to 2014. Net income also decreased $1.4 million due to the change in the losses recognized on real estate owned between the periods. The increased losses in 2015 as compared to 2014 were primarily due to a large gain realized on the sale of a commercial property in 2014. These decreases in net income were partially offset by a $0.5 million increase in net interest income due to increases in outstanding loan balances and a $3.3 million decrease in income tax expense as a result of the decreased pre-tax income between the periods.
N et interest income was $19.9 million for 2015, an increase of $0.5 million, or 2.8%, from $19.4 million for 2014. Interest income was $21.5 million for 2015, an increase of $0.9 million, or 4.1%, from $20.6 million for 2014. Interest income increased between the periods primarily because of a change in the composition of average interest-earning assets held, which resulted in an increase in the average yields earned between the periods. While the average interest-earning assets decreased $14.5 million between the periods, the average interest-earning assets held in higher yielding loans increased $25.5 million and the amount held in lower yielding cash and investments decreased $40.0 million between the periods. The increase in the average outstanding loans between the periods was primarily the result of an increase in the commercial loan portfolio, which occurred primarily because of an increase in loan originations and a reduction in loan payoffs between the periods. The Company also acquired $24.1 million of loans through an acquisition that occurred in the third quarter of 2015. The average yield earned on interest-earning assets was 3.83% for 2015, an increase of 24 basis points from 3.59% for 2014.
Interest expense was $1.5 million for the year ended December 31, 2015, an increase of $0.3 million, or 24.4%, from $1.2 million for 2014. Interest expense increased primarily because of the change in the composition of the average interest-bearing liabilities held, which resulted in an increase in the average rate paid between the periods. While the average interest-bearing liabilities decreased $2.8 million between the periods, the average amount held in higher rate advances and other borrowings increased $9.3 million, the average amount held in higher rate certificates of deposit decreased $14.5 million, and the average amount held in other lower rate checking and money market deposits increased $2.4 million between the periods. The increase in the average rates paid was primarily due to the $10.0 million holding company note payable that was funded in the first quarter of 2015 in connection with the redemption of all of the remaining Preferred Stock. Interest expense increases related to borrowing costs were partially offset by the lower interest rates paid on deposit accounts between the periods as a result of the low interest rate environment that continued to exist in 2015. The average interest rate paid on interest-bearing liabilities was 0.29% for 2015, an increase of 6 basis points from the 0.23% average interest rate paid in 2014. Net interest margin (net interest income divided by average interest-earning assets) for 2015 was 3.56%, an increase of 18 basis points, compared to 3.38% for 2014.
Net interest margin increased to 3.56% in 2015 from 3.38% in 2014 primarily because of a change in the composition of the average interest-earning assets held, which resulted in an increase in the average yields earned between the periods. The increases in the average yields earned due to having larger average balances of higher earning loans and smaller average balances of lower earning cash and investments was partially offset by an increase in the average rates paid on the average interest-bearing liabilities held between the periods. The increase in the average rates paid was primarily due to the $10.0 million holding company note payable that was funded in the first quarter of 2015 in connection with the redemption of all of the remaining Preferred Stock. Average net earning assets decreased $11.7 million to $43.9 million in 2015 compared to $55.6 million for 2014 primarily because the proceeds of the $10.0 million note payable that was funded in the first quarter of 2015 were used to redeem outstanding Preferred Stock.
The provision for loan losses was ($0.2 million) for the year ended December 31, 2015, an increase of $6.8 million, from ($7.0 million) for the year ended December 31, 2014. The credit provision for loan losses decreased primarily because there was more commercial loan growth, fewer credit rating upgrades, and fewer recoveries of previously charged off loans in 2015 when compared to 2014. The decrease in non-performing loans relates primarily to a commercial real estate development relationship that was upgraded to performing status during 2015 due to the improved financial performance of the project as a result of increased lot sales.
The allowance for loan losses increased in 2015 when compared to 2014 primarily because of the $ 99.3 million increase in the loan portfolio between the periods.
Non-interest income was $7.7 million for the year ended December 31, 2015, an increase of $0.4 million, compared to $7.3 million for the year ended December 31, 2014. The increase is primarily related to a gain of $0.3 million that was recognized on an acquisition that occurred in the third quarter of 2015. Gain on sales of loans increased $0.1 million, or 7.4%, between the periods primarily b ecause of an increase in single-family loan originations and sales. Other non-interest income increased $0.1 million primarily due to an increase in income related to the sale of non-insured investment products. These increases in non-interest income were partially offset by a $0.1 million decrease in fees and service charges primarily because of a decrease in retail and commercial overdraft fees between the periods.
Non-interest expense was $23.2 million for the year ended December 31, 2015, an increase of $1.8 million, or 8.4%, from $21.4 million for the same period in 2014. Losses on real estate owned increased $1.4 million between the periods primarily because of a $1.0 million gain that was recognized on the sale of a single commercial property in 2014. Compensation expense increased $0.4 million between the periods primarily because of an increase in the expenses related to restricted stock awards and increased incentive accruals due to increased loan production. These increases in non-interest expense were partially offset by a decrease of $0.1 million in deposit insurance costs due primarily to a decrease in insurance rates between the periods.
The Company considers the calculation of current and deferred income taxes to be a critical accounting policy that is subject to significant estimates. Actual results could differ significantly from the estimates and interpretations used in determining the current and deferred income tax assets and liabilities . Income tax expense was $1.6 million for the year ended December 31, 2015, a decrease of $3.3 million from $4.9 million for the same period in 2014. The decrease in income tax expense between the periods is primarily related to the decrease in pre-tax income in 2015 when compared to 2014.
Net income available to common shareholders was $2.8 million for 2015, a decrease of $2.9 million from the $5.7 million net income available to common shareholders in 2014. Basic earnings per common share for the year ended December 31, 2015 was $0.69, a decrease of $0.71 from the basic earnings per common share of $1.40 for the year ended December 31, 2014. Diluted earnings per common share for the year ended December 31, 2015 was $0.61, a decrease of $0.62 from diluted earnings per common share of $1.23 for the year ended December 31, 2014. The net income available to common shareholders and the basic and diluted earnings per common share decreased primarily because of the decrease in net income between the periods that was partially offset by a reduction in the dividends paid on the outstanding Preferred Stock. On February 17, 2015 the Company redeemed the final 10,000 shares of its outstanding Preferred Stock and, as a result, no dividends were required to be paid on the Preferred Stock after that date.
Financial Condition
Loans Receivable, Net
The following table sets forth the information on the Company's loan portfolio in dollar amounts and percentages before deductions for deferred fees and discounts and allowances for losses as of the dates indicated:
December 31, | ||||||||||||||||||||||||||||||||||||||||
201 6 |
201 5 |
201 4 |
201 3 |
201 2 |
||||||||||||||||||||||||||||||||||||
(Dollars in thousands) |
Amount |
Percent |
Amount |
Percent |
Amount |
Percent |
Amount |
Percent |
Amount |
Percent |
||||||||||||||||||||||||||||||
Real Estate Loans: |
||||||||||||||||||||||||||||||||||||||||
One-to-four family |
$ | 103,255 | 18.41 |
% |
$ | 90,945 | 19.24 |
% |
$ | 69,841 | 18.70 |
% |
$ | 76,467 | 19.31 |
% |
$ | 97,037 | 20.40 |
% |
||||||||||||||||||||
Multi-family |
36,777 | 6.56 | 12,324 | 2.61 | 15,700 | 4.20 | 8,113 | 2.05 | 11,756 | 2.47 | ||||||||||||||||||||||||||||||
Commercial |
230,955 | 41.18 | 196,926 | 41.65 | 163,365 | 43.73 | 178,486 | 45.06 | 220,721 | 46.39 | ||||||||||||||||||||||||||||||
Construction or development |
31,348 | 5.59 | 38,103 | 8.05 | 12,603 | 3.37 | 7,851 | 1.98 | 12,430 | 2.61 | ||||||||||||||||||||||||||||||
Total real estate loans |
402,335 | 71.74 | 338,298 | 71.55 | 261,509 | 70.00 | 270,917 | 68.40 | 341,944 | 71.87 | ||||||||||||||||||||||||||||||
Other Loans: |
||||||||||||||||||||||||||||||||||||||||
Consumer Loans: |
||||||||||||||||||||||||||||||||||||||||
Automobile |
3,036 | 0.54 | 2,885 | 0.61 | 1,124 | 0.30 | 971 | 0.25 | 623 | 0.13 | ||||||||||||||||||||||||||||||
Home equity line |
40,476 | 7.22 | 38,980 | 8.24 | 36,832 | 9.86 | 36,178 | 9.13 | 36,521 | 7.68 | ||||||||||||||||||||||||||||||
Home equity |
16,302 | 2.91 | 14,782 | 3.13 | 12,420 | 3.33 | 11,629 | 2.94 | 11,390 | 2.39 | ||||||||||||||||||||||||||||||
Recreational vehicle s |
7,553 | 1.35 | 2,650 | 0.56 | 0 | 0.00 | 0 | 0.00 | 0 | 0.00 | ||||||||||||||||||||||||||||||
Other |
5,916 | 1.05 | 5,118 | 1.08 | 4,549 | 1.22 | 4,645 | 1.17 | 5,441 | 1.15 | ||||||||||||||||||||||||||||||
Total consumer loans |
73,283 | 13.07 | 64,415 | 13.62 | 54,925 | 14.71 | 53,423 | 13.49 | 53,975 | 11.35 | ||||||||||||||||||||||||||||||
Commercial business loans |
85,176 | 15.19 | 70,106 | 14.83 | 57,122 | 15.29 | 71,709 | 18.11 | 79,854 | 16.78 | ||||||||||||||||||||||||||||||
Total other loans |
158,459 | 28.26 | 134,521 | 28.45 | 112,047 | 30.00 | 125,132 | 31.60 | 133,829 | 28.13 | ||||||||||||||||||||||||||||||
Total loans |
560,794 | 100.00 |
% |
472,819 | 100.00 |
% |
373,556 | 100.00 |
% |
396,049 | 100.00 |
% |
475,773 | 100.00 |
% |
|||||||||||||||||||||||||
Less: |
||||||||||||||||||||||||||||||||||||||||
Unamortized discounts |
20 | 16 | 14 | 33 | 33 | |||||||||||||||||||||||||||||||||||
Net deferred loan (costs) fees |
(300 | ) | (91 | ) | 97 | 0 | 87 | |||||||||||||||||||||||||||||||||
Allowance for losses |
9,903 | 9,709 | 8,332 | 11,401 | 21,608 | |||||||||||||||||||||||||||||||||||
Total loans receivable, net |
$ | 551,171 | $ | 463,185 | $ | 365,113 | $ | 384,615 | $ | 454,045 | ||||||||||||||||||||||||||||||
In 201 6, the Company’s loan portfolio increased because of an increase in the loan originations as a result of an improving economy and an increase in lending staff. The loan portfolio also increased $6.0 million as a result of the acquisition that occurred in the second quarter of 2016. Because of the enhanced lending staff and the improving economic conditions projected, it is anticipated that the size of our overall loan portfolio will continue to increase in 2017.
Single family real estate loans were $103.3 million at December 31, 2016, an increase of $12.4 million, compared to $90.9 million at December 31, 2015. Mortgage loan originations increased in 2016 as a result of additional mortgage lending staff and an increased emphasis on originating shorter term and adjustable rate mortgage loans that were placed into the portfolio. The majority of the longer term mortgage loans that were originated during the year continued to be sold into the secondary market and were not placed in the loan portfolio in order to manage the Company’s interest rate risk position. The increased origination of loans placed into the loan portfolio was the primary reason for the increase in the single family loan portfolio during 2016.
Multi-family real estate loans were $36.8 million at December 31, 2016, an increase of $24.5 million, compared to $12.3 million at December 31, 2015. The increase in multi-family real estate loans in 2016 is primarily the result of the $16.6 million in multi-family construction loans where the construction phase was completed and the loan was reclassified as a multi-family real estate loan. The origination of multi-family loans also increased between the periods.
Commercial real estate loans were $231.0 million at December 31, 2016, an increase of $34.1 million, compared to $196.9 million at December 31, 2015. Commercial business loans were $85.2 million at December 31, 2016, an increase of $15.1 million, compared to $70.1 million at December 31, 2015. Increased commercial loan production as a result of increased demand for commercial loans resulted in an increase in the commercial business and commercial real estate loan portfolios in 2016.
Construction or development loans were $31.3 million at December 31, 2016, a decrease of $6.8 million, compared to $38.1 million at December 31, 2015. The decrease was the net result of the following activity during 2016: $26.0 million in new construction loans originated, $2.7 million in advances on existing loans, $5.8 million in loans paid-off, and $29.7 million in loans moved to a permanent loan classification because the construction phase was completed.
Home equity lines of credit were $40.5 million at December 31, 2016, an increase of $1.5 million, compared to $39.0 million at December 31, 2015. The open-end home equity lines are generally written with an adjustable rate and a 10 year draw period which requires interest only payments followed by a 10 year repayment period which fully amortizes the outstanding balance. Closed-end home equity loans are written with fixed or adjustable rates with terms up to 15 years. Home equity loans were $16.3 million at December 31, 2016, an increase of $1.5 million, compared to $14.8 million at December 31, 2015. The increase in the open-end equity lines and closed-end equity loans is related primarily to an increase in originations between the periods.
Recreational vehicle loans were $7.6 million at December 31, 2016, an increase of $4.9 million, compared to $2.7 million at December 31, 201 5. These loans have been made primarily to finance the recreational vehicle sales of a single dealer within the Bank’s market area and the increase in balances between the periods is due to an increase in originations.
Allowance for Loan Losses
The determination of the allowance for loan losses and the related provision is a critical accounting policy of the Company that is subject to significant estimates, as previously discussed. The current level of the allowance for loan losses is a result of management ’s assessment of the risks within the portfolio based on the information obtained through the credit evaluation process. The Company utilizes a risk-rating system on non-homogenous commercial real estate and commercial business loans that includes regular credit reviews to identify and quantify the risk in the commercial portfolio. Management conducts quarterly reviews of the entire loan portfolio and evaluates the need to adjust the allowance balance on the basis of these reviews.
Management actively monitors asset quality and, when appropriate, charges off loans against the allowance for loan losses. Although management believes it uses the best information available to make determinations with respect to the allowance for loan losses, future adjustments may be necessary if economic conditions differ substantially from the economic conditions in the assumptions used to determine the size of the allowance for loan losses.
The allowance for loan losses was $ 9.9 million, or 1.77% of gross loans at December 31, 2016, compared to $9.7 million, or 2.05% of gross loans at December 31, 2015. The allowance for loan losses increased primarily due to an $88.0 million increase in the loan portfolio between the periods. The increase in the allowance due to loan growth was partially offset by a decrease in the allowance due to lower reserve percentages being used for certain risk rated commercial loans between the periods as a result of an internal analysis of the most recent charge-off history that was performed during the year. The decrease in the allowance as a percentage of outstanding loans, from 2.05% of gross loans at December 31, 2015 to 1.77% of gross loans at December 31, 2016, reflects the improved credit quality of the loan portfolio between the periods.
The following table reflects the activity in the allowance for loan losses and selected statistics:
December 31, |
||||||||||||||||||||
(Dollars in thousands) |
201 6 |
201 5 |
201 4 |
201 3 |
201 2 |
|||||||||||||||
Balance at beginning of year |
$ | 9,709 | 8,332 | 11,401 | 21,608 | 23,888 | ||||||||||||||
Provision for losses |
(645 | ) | (164 | ) | (6,998 | ) | (7,881 | ) | 2,544 | |||||||||||
Charge-offs: |
||||||||||||||||||||
Single family |
(66 | ) | (19 | ) | (92 | ) | (200 | ) | (63 | ) | ||||||||||
Consumer |
(108 | ) | (105 | ) | (131 | ) | (484 | ) | (1,071 | ) | ||||||||||
Commercial business |
(180 | ) | (69 | ) | (55 | ) | (651 | ) | (2,464 | ) | ||||||||||
Commercial real estate |
(67 | ) | 0 | (936 | ) | (3,711 | ) | (5,719 | ) | |||||||||||
Recoveries |
1,260 | 1,734 | 5,143 | 2,720 | 4,493 | |||||||||||||||
Net recoveries (charge-offs) |
839 | 1,541 | 3,929 | (2,326 | ) | (4,824 | ) | |||||||||||||
Balance at end of year |
$ | 9,903 | 9,709 | 8,332 | 11,401 | 21,608 | ||||||||||||||
Year-end allowance for loan losses as a percent of year end gross loan balance |
1.77 |
% |
2.05 |
% |
2.23 |
% |
2.88 |
% |
4.54 |
% |
||||||||||
Ratio of net loan (recoveries) charge-offs to average loans outstanding |
(0.16 | ) | (0.36 | ) | (1.02 | ) | 0.53 | 0.91 |
The following table reflects the allocation of the allowance for loan losses:
December 31, |
||||||||||||||||||||||||||||||||||||||||
201 6 |
201 5 |
201 4 |
201 3 |
201 2 |
||||||||||||||||||||||||||||||||||||
Allocated Allowance as a % of Loan Category |
Percent of Loans in Each Category to Total Loans |
Allocated Allowance as a % of Loan Category |
Percent of Loans in Each Category to Total Loans |
Allocated Allowance as a % of Loan Category |
Percent of Loans in Each Category to Total Loans |
Allocated Allowance as a % of Loan Category |
Percent of Loans in Each Category to Total Loans |
Allocated Allowance as a % of Loan Category |
Percent of Loans in Each Category to Total Loans |
|||||||||||||||||||||||||||||||
Single family |
1.15 |
% |
18.41 |
% |
1.09 |
% |
19.24 |
% |
1.57 |
% |
18.70 |
% |
2.13 |
% |
19.31 |
% |
2.91 |
% |
20.40 |
% |
||||||||||||||||||||
Commercial real estate |
1.66 | 53.33 | 2.46 | 52.31 | 2.62 | 51.30 | 3.32 | 49.09 | 5.55 | 51.47 | ||||||||||||||||||||||||||||||
Consumer |
2.20 | 13.07 | 1.86 | 13.62 | 1.84 | 14.71 | 2.07 | 13.49 | 2.12 | 11.35 | ||||||||||||||||||||||||||||||
Commercial business |
2.53 | 15.19 | 2.05 | 14.83 | 2.11 | 15.29 | 3.08 | 18.11 | 5.08 | 16.78 | ||||||||||||||||||||||||||||||
Total |
1.77 | 100.00 |
% |
2.05 | 100.00 |
% |
2.23 | 100.00 |
% |
2.88 | 100.00 |
% |
4.54 | 100.00 |
% |
|||||||||||||||||||||||||
The allocated reserve percentages for commercial real estate decreased in 2016 due to the general improvement in the credit quality of the commercial real estate portfolio. The allocation of the allowance for loan losses for single family, commercial, and consumer loans increased due to an increase in the outstanding balances and changes in the types of loans held in these categories between the periods.
Allowance for Real Estate Losses
Real estate properties acquired or expected to be acquired through loan foreclosures are initially recorded at fair value less estimated selling costs. Management periodically performs valuations and an allowance for losses is established if the carrying value of a property exceeds its fair value less estimated selling costs. The balance in the allowance for real estate losses was $0.7 million at December 31, 2016 and $0.8 million at December 31, 2015.
Non-performing Assets
Loans are reviewed at least quarterly and if the collectability of any loan is doubtful, it is placed on non-accrual status. Loans are placed on non-accrual status when either principal or interest is 90 days or more past due, unless, in the judgment of management, the loan is well collateralized and in the process of collection. Interest accrued and unpaid at the time a loan is placed on non-accrual status is charged against interest income. Subsequent payments are either applied to the outstanding principal balance or recorded as interest income, depending on the assessment of the ultimate collectability of the loan. Restructured loans include the Bank's troubled debt restructurings (TDRs) that involved forgiving a portion of interest or principal or making a loan at a rate materially less than the market rate to borrowers whose financial condition has deteriorated. Foreclosed and repossessed assets include assets acquired in settlement of loans. Total non-performing assets were $3.9 million at December 31, 2016, a decrease of $2.3 million, or 37.4%, from $6.2 million at December 31, 2015. Non-performing loans decreased $0.9 million and foreclosed and repossessed assets decreased $1.4 million during 2016. The following table sets forth the amounts and categories of non-performing assets (non-accrual loans and foreclosed and repossessed assets) in the Company’s portfolio:
December 31, |
||||||||||||||||||||
(Dollars in thousands) |
2016 |
2015 |
2014 |
2013 |
2012 |
|||||||||||||||
Non-performing loans: | ||||||||||||||||||||
Single family |
$ | 916 | 1,655 | 1,564 | 1,602 | 2,492 | ||||||||||||||
Commercial real estate |
1,384 | 1,694 | 8,750 | 14,549 | 25,543 | |||||||||||||||
Consumer |
630 | 786 | 486 | 737 | 300 | |||||||||||||||
Commercial business |
343 | 46 | 120 | 608 | 1,640 | |||||||||||||||
Total |
3,273 | 4,181 | 10,920 | 17,496 | 29,975 | |||||||||||||||
Foreclosed and repossessed assets: |
||||||||||||||||||||
Single family |
0 | 48 | 50 | 0 | 1,595 | |||||||||||||||
Commercial real estate |
611 | 1,997 | 3,053 | 6,898 | 9,000 | |||||||||||||||
Consumer |
16 | 0 | 0 | 0 | 0 | |||||||||||||||
Total |
627 | 2,045 | 3,103 | 6,898 | 10,595 | |||||||||||||||
Total non-performing assets |
$ | 3,900 | $ | 6,226 | $ | 14,023 | $ | 24,394 | $ | 40,570 | ||||||||||
Total as a percentage of total assets |
0.57 |
% |
0.97 |
% |
2.43 |
% |
3.76 |
% |
6.21 |
% |
||||||||||
Total non-performing loans |
$ | 3,273 | $ | 4,181 | $ | 10,920 | $ | 17,496 | $ | 29,975 | ||||||||||
Total as a percentage of total loans receivable, net |
0.59 |
% |
0.90 |
% |
2.99 |
% |
4.55 |
% |
6.60 |
% |
||||||||||
Allowance for loan losses to non-performing loans |
302.56 |
% |
232.22 |
% |
76.30 |
% |
65.17 |
% |
72.09 |
% |
||||||||||
Gross interest income which would have been recorded had the non-accruing loans been current in accordance with their original terms amounted to $0.6 million for 2016, $0.4 million for 2015, and $0.9 million for 2014. The amounts that were included in interest income on a cash basis for these loans were $0.4 million, $0.2 million, and $0.2 million, respectively.
At December 31, 2016, 2015 and 2014, there were loans included in loans receivable, net, with terms that had been modified in a TDR totaling $3.3 million, $2.5 million, and $9.4 million, respectively. Had the loans performed in accordance with their original terms throughout 2016, 2015, and 2014, the Company would have record ed gross interest income of $0.6 million, $0.4 million, and $0.9 million, respectively. During 2016, 2015 and 2014 the Company recorded gross interest income of $0.4 million, $0.2 million, and $0.3 million, respectively.
For the loans that were modified in 2016 , $0.2 million were unclassified and performing, and $1.7 million were non-performing at December 31, 2016. The increase in TDRs in 2016 relates primarily to one commercial relationship totaling $1.3 million that was downgraded from performing to non-performing status and was restructured during the year. Of the loans that were modified in 2016 and outstanding at December 31, 2016, $1.3 million related to loans secured by commercial real estate and $0.4 million related to first or second mortgages on single family property, and the remaining modifications related to other consumer or commercial business loans.
For the loans that were modified in 2015, $0.5 million were unclassified and performing, and $0.7 million were non-performing at December 31, 2015. The decrease in TDRs in 2015 relates primarily to a group of commercial development loans totaling $6.0 million that were upgraded to performing status and met the criteria to be removed from TDR classification during the year. Of the loans that were modified in 2015 and outstanding at December 31, 2015, $0.8 million related to loans secured by first or second mortgages on single family properties, and the remaining modifications related to other consumer or commercial business loans.
For the loans that had been modified in 2014, $0.1 million were unclassified and performing and $0.1 million were non-performing at December 31, 2014. The decrease in TDRs in 2014 relates primarily to two related commercial development loans totaling $3.5 million that were charged down to $2.5 million and paid off during the year. TDRs also decreased during the year by $1.4 million due to the paydown of six loans in an unrelated commercial development, as well as $1.0 million due to the payoff of a loan for another unrelated commercial development. Of the loans that were modified in 2014 and outstanding at December 31, 2014, $0.2 million related to loans secured by first or second mortgages on single family properties, and the remaining modifications related to other consumer loans.
The following table sets forth the amount of TDRs in the Company ’s portfolio:
December 31, |
||||||||||||||||||||
(Dollars in thousands) |
2016 |
2015 |
2014 |
2013 |
2012 |
|||||||||||||||
Single family |
$ | 448 | 647 | 368 | 840 | 3,540 | ||||||||||||||
Commercial real estate |
1,774 | 725 | 7,956 | 14,781 | 24,702 | |||||||||||||||
Consumer |
709 | 732 | 571 | 697 | 1,814 | |||||||||||||||
Commercial business |
369 | 415 | 555 | 1,074 | 1,614 | |||||||||||||||
Total TDRs |
3,300 | 2,519 | 9,450 | 17,392 | 31,670 | |||||||||||||||
TDRs on accrual status |
1,297 | 1,618 | 7,414 | 3,780 | 7,125 | |||||||||||||||
TDRs on non-accrual status |
2,003 | 901 | 2,036 | 13,612 | 24,545 | |||||||||||||||
Total |
$ | 3,300 | 2,519 | 9,450 | 17,392 | 31,670 | ||||||||||||||
In addition to the TDRs and the non-performing loans set forth in the table above of all non-performing assets, the Company may identify other potential problem loans. Potential problem loans are loans that are not in non-performing status, however, there are circumstances present to create doubt as to the ability of the borrower to comply with present repayment terms. The decision of management to include performing loans in potential problem loans does not necessarily mean that the Company expects losses to occur but that management recognized a higher degree of risk associated with these loans. The level of potential problem loans is another predominant factor in determining the relative level of the allowance for loan losses. There were no potential problem loans identified by the Company as of December 31, 2016. The four loan relationships that are reported as potential problem loans at December 31, 2015 were $6.0 million in loans to two unrelated trucking companies and $0.5 million in loans secured by agricultural assets to two unrelated individuals. The three loan relationships reported as potential problem loans at December 31, 2014 were a $3.8 million loan to an educational institution, a $0.6 million loan to a small manufacturing business, and three loans totaling $0.3 million to a golf course.
Liquidity and Capital Resources
The Company attempts to manage its liquidity position so that the funding needs of borrowers and depositors are met timely and in a cost effective manner. Asset liquidity is the ability to convert assets to cash through the maturity or sale of the asset. Liability liquidity is the ability of the Bank to obtain retail, internet, or brokered deposits or to borrow funds from third parties such as the FHLB or the Federal Reserve Bank of Minneapolis.
The primary investing activities are the origination of loans and the purchase of securities. Principal and interest payments on loans and securities , along with the proceeds from the sale of loans held for sale, are the primary sources of cash for the Bank. Additional cash can be obtained by selling securities from the available for sale portfolio or by selling loans or mortgage servicing rights. Unpledged securities could also be pledged and used as collateral for additional borrowings with the FHLB or Federal Reserve Bank of Minneapolis to generate additional cash.
The primary financing activity is the attraction of retail and internet deposits. The Bank has the ability to borrow additional funds from the FHLB or Federal Reserve Bank of Minneapolis by pledging additional securities or loans, subject to applicable borrowing base and collateral requirements. See “Note 1 2 Federal Home Loan Bank (FHLB) Advances and Other Borrowings” in the Notes to Consolidated Financial Statements for more information on additional advances that could be drawn based upon existing collateral levels with the FHLB and the Federal Reserve Bank of Minneapolis.
The Bank's most liquid assets are cash and cash equivalents, which consist of short-term highly liquid investments with original maturities of less than three months that are readily convertible to known amounts of cash and interest-bearing deposits. The level of these assets is dependent on the operating, financing and investing activities during any given period.
The Bank has certificates of deposits from customers with outstanding balances of $57.8 million that mature during 2017. Based upon past experience, management anticipates that the majority of the deposits will renew for another term. The Company believes that deposits that do not renew will be replaced with deposits from other customers or FHLB advances. Proceeds from the sale of securities could also be used to fund unanticipated outflows of deposits.
The Bank has deposits of $61.9 million in checking and money market accounts of four customers that have individual relationship balances greater than $5.0 million. These funds may be withdrawn at any time, however, management anticipates that the majority of these deposits will remain on deposit with the Bank over the next twelve months. If these deposits are withdrawn, it is anticipated that they would be funded with available cash or replaced with deposits from other customers or FHLB advances. Proceeds from the sale of securities could also be used to fund unanticipated outflows of deposits.
Dividends from the Bank have been the Company ’s primary source of cash. The Bank is restricted under applicable federal banking law from paying dividends to the Company without prior notice to and non-objection of the applicable regulator. During 2016, the Bank paid dividends to the Company of $3.0 million and at December 31, 2016, the Company had $3.3 million in cash and other assets that could readily be turned into cash.
On February 17, 2015, the Company redeemed the final 10,000 shares of outstanding Preferred Stock. The Preferred Stock redemption was funded through a $10.0 million term loan to HMN from an unrelated third party that was evidenced by a promissory note. The interest payments on the note are due quarterly. The principal balance of the note bears interest at a rate of 6.50% and is payable in consecutive annual installments of $1.0 million on each December 15, beginning December 15, 2015, with the balance due on December 15, 2021.
T he Company’s primary use of cash is the payment of principal and interest on the third party note payable and holding company level expenses, including the payment of director and management fees, legal expenses, and other regulatory costs. The Company does not anticipate that it will have on a stand-alone basis adequate liquid resources to make future interest and principal payments on its third party note payable and fund the Company-level expenses. The Company plans to continue to fund its liquidity needs through dividends from the Bank or by obtaining external capital. Provided that no default or event of default has occurred and is continuing, the Company may also, at its option, elect to defer payment of one installment of principal on the third party note payable otherwise due prior to the maturity date, in which event such installment will become due and payable on the maturity date.
Contractual Obligations and Commercial Commitments
The Company has certain obligations and commitments to make future payments under existing contracts. At December 31, 2016, the aggregate contractual obligations (excluding bank deposits) and commercial commitments were as follows:
Payments Due by Period |
||||||||||||||||||||
(Dollars in thousands) |
Total |
Less than 1 Year |
1-3 Years |
4-5 Years |
More than 5 Years |
|||||||||||||||
Contractual Obligations: |
||||||||||||||||||||
Total borrowings |
$ | 7,000 | 1,000 | 2,000 | 4,000 | 0 | ||||||||||||||
Annual rental commitments under non- cancellable operating leases |
5,856 | 843 | 1,452 | 1,380 | 2,181 | |||||||||||||||
Total contractual obligations |
$ | 12,856 | 1,843 | 3,452 | 5,380 | 2,181 |
Amount of Commitments Expiring by Period |
||||||||||||||||||||
Other Commercial Commitments: |
||||||||||||||||||||
Commercial lines of credit |
$ | 50,229 | 26,523 | 9,282 | 9,414 | 5,010 | ||||||||||||||
Commitments to lend |
31,831 | 9,797 | 4,736 | 7,220 | 10,078 | |||||||||||||||
Standby letters of credit |
1,902 | 1,575 | 327 | 0 | 0 | |||||||||||||||
Total other commercial commitments |
$ | 83,962 | 37,895 | 14,345 | 16,634 | 15,088 | ||||||||||||||
Regulatory Capital Requirements
Effective January 1, 2015 the capital requirements of the Company and the Bank were changed to implement the regulatory requirements of the Basel III capital reforms. The Basel III requirements, among other things, (i) apply a strengthened set of capital requirements to the Bank (the Company is exempt, pursuant to the Small Bank Holding Company Policy Statement (Policy Statement) described below), including requirements relating to common equity as a component of core capital, (ii) implement a “capital conservation buffer” against risk and a higher minimum tier 1 capital requirement, and (iii) revise the rules for calculating risk-weighted assets for purposes of such requirements. The rules made corresponding revisions to the prompt corrective action framework and include the capital ratios and buffer requirements which will be phased in incrementally, with full implementation scheduled for January 1, 2019. Failure by the Bank to meet minimum capital requirements can initiate certain mandatory and possibly additional discretionary actions by regulators that, if undertaken, could have a direct material effect on the Company's financial statements. Under capital adequacy guidelines and the regulatory framework for prompt corrective action, both the Company and the Bank must meet specific capital guidelines that involve quantitative measures of their assets, liabilities and certain off-balance sheet items as calculated under regulatory accounting practices. The capital amounts and classification are also subject to qualitative judgments by the regulators about components, risk weightings and other factors. Management believes that, as of December 31, 2016, the Bank’s capital ratios were in excess of those quantitative capital ratio standards set forth under the prompt corrective action regulations. However, there can be no assurance that the Bank will continue to maintain such status in the future. The OCC has extensive discretion in its supervisory and enforcement activities, and can further adjust the requirement to be “well-capitalized” in the future. See “Note 1 7 Regulatory Capital” of the Notes to Consolidated Financial Statements for a table which reflects the Bank’s capital compared to these capital requirements.
In the second quarter of 2015, the FRB amended its Policy Statement, which exempted small bank holding companies from the above capital requirements, by raising the asset size threshold for determining applicability from $500 million to $1 billion. The Policy Statement was also expanded to include savings and loan holding companies that meet the Policy Statement’s qualitative requirements for exemption. The Company met the qualitative exemption requirements, and therefore, is exempt from the above capital requirements.
The Company also serves as a source of capital, liquidity and financial support to the Bank. Depending upon the operating performance of the Bank and the Company ’s other liquidity and capital needs, including potential Company-level expenses and the payment of principal and interest payments on the third party note payable, the Company may find it prudent, subject to prevailing capital market conditions and other factors, to raise additional capital through issuance of its common stock or other equity securities. Additional capital would potentially permit the Company to implement a strategy of growing Bank assets. Depending on the circumstances, if it were to raise capital, the Company may deploy it to the Bank for general banking purposes, or may retain some or all of it for use by the Company.
If the Company raises capital through the issuance of additional shares of common stock or other equity securities, it would dilute the ownership interests of existing stockholders and, if issued at less than the Company ’s book value would dilute the per share book value of the Company’s common stock, dilute the Company’s earnings per share, and could result in a change of control of the Company and the Bank. New investors may also have rights, preferences and privileges senior to the Company’s current stockholders, which may adversely impact the Company’s current stockholders. The Company’s ability to raise additional capital through the issuance of equity securities, if deemed prudent, will depend on, among other factors, conditions in the capital markets at that time, which are outside of its control, and on the Company’s financial performance and plans. Accordingly, the Company may not be able to raise additional capital, if deemed prudent, on favorable economic terms, or other terms acceptable to it. If the Bank cannot satisfactorily address its capital needs as they arise, the Bank’s ability to maintain or expand its operations, maintain compliance with the regulatory capital requirements, to operate without additional regulatory or other restrictions, and its operating results, could be materially adversely affected.
Dividends
The declaration of dividends is subject to, among other things, the Company's financial condition and results of operations, the Bank's compliance with regulatory capital requirements and other regulatory restrictions, tax considerations, industry standards, economic conditions, general business practices and other factors. The Company has not made any dividend payments to common stockholders during the three year period ending December 31, 2016.
Under applicable federal banking laws and regulations, no dividends can be declared or paid by the Bank to the Company without notice to and non-objection from the applicable banking regulator. There is no assurance that the Bank and the Company would satisfy the applicable regulatory requirements necessary to effect any such dividends. The payment of dividends by the Company is dependent upon the Company having adequate cash or other assets that can be converted to cash to pay dividends to its stockholders. Further, any determination as to whether, when and in what amount to declare and pay any such dividends would be subject to the discretion of the boards of directors of the Bank and the Company and would depend on numerous factors including the results of operations, financial conditions, growth plans, and cash flow requirements of the Company and the Bank.
Impact of Inflation and Changing Prices
The impact of inflation is reflected in the increased cost of operations. Unlike most industrial companies, nearly all of the assets and liabilities of the Company are monetary in nature. As a result, interest rates have a greater impact on the Company's performance than do the effects of general levels of inflation. Interest rates do not necessarily move in the same direction or to the same extent as the prices of goods and services.
New Accounting Pronouncements
In January 2016, the FASB issued ASU 2016-01, Financial Instruments – Overall (Subtopic 825-10) Recognition and Measurement of Financial Assets and Financial Liabilities. The amendments in this ASU require, among other things, equity investments to be measured at fair value with changes in fair value recognized in net income and that public business entities use the exit price notion when measuring the fair value of financial instruments for disclosure purposes. The amendments also require an entity to present separately in other comprehensive income the portion of the total change in the fair value of a liability resulting from a change in the instrument-specific credit risk when the entity has elected to measure the liability at fair value in accordance with the fair value option for financial instruments. In addition, the amendments also eliminate the requirement for public business entities to disclose the method(s) and significant assumptions used to estimate the fair value that is required to be disclosed for financial instruments measured at amortized cost on the balance sheet. The ASU is intended to reduce diversity in practice and is effective for public business entities for fiscal years beginning after December 15, 2017, including interim periods within those fiscal years. The amendments should be applied by means of a cumulative-effect adjustment to the balance sheet as of the beginning of the fiscal year of adoption. The adoption of this ASU in the first quarter of 2018 is not anticipated to have a material impact on the Company’s consolidated financial statements.
In February 2016, the FASB issued ASU 2016-02, Leases (Topic 842). The amendments in the ASU create Topic 842, Leases , and supersede the lease requirements in Topic 840, Leases . The objective of this ASU is to establish the principles that lessees and lessors shall apply to report useful information to users of financial statements about the amount, timing, and uncertainty of cash flows arising from a lease. The main difference between previous GAAP and this ASU is the recognition of lease assets and lease liabilities by lessees for those leases classified as operating leases under previous GAAP. The amendment requires a lessee to recognize in the statement of financial position a liability to make lease payments (the lease liability) and the right-of-use asset representing its right to use the underlying asset for the lease term. The accounting applied by a lessor is largely unchanged from that applied under previous GAAP. In transition, lessees and lessors are required to recognize and measure leases at the beginning of the earliest period presented using a modified retrospective approach. The modified retrospective approach includes a number of optional practical expedients that entities may elect to apply that will, in effect, continue to account for leases that commence before the effective date in accordance with previous GAAP unless the lease is modified. The amendments in the ASU, for public business entities that are U. S. Securities and Exchange Commission (SEC) filers, are effective for fiscal years beginning after December 15, 2018, including interim periods within those fiscal years. The adoption of this ASU in the first quarter of 2019 is not anticipated to have a material impact on the Company’s consolidated financial statements.
In March 2016, the FASB issued ASU 2016-09, Compensation – Stock Compensation (Topic 718). The amendments in this ASU affect all entities that issue share-based payment awards to their employees. The amendments are intended to simplify the accounting for share-based payment transactions including the income tax consequences, classification of awards as either equity or liabilities, and classification on the statement of cash flows. The amendments in this ASU, for public business entities, are effective for fiscal years beginning after December 15, 2016, including interim periods within those annual periods. Amendments should be applied using a modified retrospective transition method by means of a cumulative-effect adjustment to equity as of the beginning of the period in which the guidance is adopted. The adoption of this ASU in the first quarter of 2017 is not anticipated to have a material impact on the Company’s consolidated financial statements.
In June 2016, the FASB issued ASU 2016-13, Financial Instruments-Credit Losses (Topic 326): Measurement of Credit Losses on Financial Instruments. The amendments in this ASU affect all entities that measure credit losses on financial instruments including loans, debt securities, trade receivables, net investments in leases, off-balance sheet credit exposures, reinsurance receivables, and any other financial asset that has a contractual right to receive cash that is not specifically excluded. The main objective of this ASU is to provide financial statement users with more decision-useful information about the expected credit losses on financial instruments and other commitments to extend credit held by a reporting entity at each reporting date. To achieve this objective, the amendments in this ASU replace the incurred loss impairment methodology required in current GAAP with a methodology that reflects expected credit losses that requires consideration of a broader range of reasonable and supportable information to estimate credit losses. The amendments in this ASU will affect entities to varying degrees depending on the credit quality of the assets held by the entity, the duration of the assets held, and how the entity applies the current incurred loss methodology. The amendments in this ASU, for public business entities that are U. S. Securities and Exchange Commission (SEC) filers, are effective for fiscal years beginning after December 15, 2019, including interim periods within those annual periods. All entities may adopt the amendments in the ASU early as of the fiscal years beginning after December 15, 2018, including interim periods within those fiscal years. Amendments should be applied using a modified retrospective transition method by means of a cumulative-effect adjustment to equity as of the beginning of the period in which the guidance is adopted. Management is in the process of evaluating the impact that the adoption of this ASU in the first quarter of 2020 will have on the Company’s consolidated financial statements.
In August 2016, the FASB issued ASU 2016-15, Statement of Cash Flows (Topic 230): Classification of Certain Cash Receipts and Cash Payments. The amendments in this ASU affect all entities that are required to present a statement of cash flows under Topic 230 and address the following eight specific cash flow issues: debt prepayment or debt extinguishment costs; settlement of zero-coupon debt instruments or other debt instruments with coupon interest rates that are insignificant in relation to the effective interest rate of the borrowing; contingent consideration payments made after a business combination; proceeds from the settlement of insurance claims; proceeds from the settlement of corporate-owned life insurance policies; distributions received from equity method investees; beneficial interest in securitization transactions; and separately identifiable cash flows and application of the predominance principle. This ASU is intended to reduce diversity in practice and is effective for public business entities that are U. S. Securities and Exchange Commission (SEC) filers for fiscal years beginning after December 15, 2017, and interim periods within those fiscal years with early adoption permitted. Upon adoption, the amendments should be applied using a retrospective transition method to each period presented. The adoption of this ASU in the first quarter of 2018 is not anticipated to have a material impact on the Company’s consolidated financial statements.
Market Risk
Market risk is the risk of loss from adverse changes in market prices and rates. The Company's market risk arises primarily from interest rate risk inherent in its investing, lending and deposit taking activities. Management actively monitors and manages its interest rate risk exposure.
The Company's profitability is affected by fluctuations in interest rates. A sudden and substantial change in interest rates may adversely impact the Company's earnings to the extent that the interest rates borne by assets and liabilities do not change at the same speed, to the same extent, or on the same basis. The Company monitors the projected changes in net interest income that occur if interest rates were to suddenly change up or down. The Rate Shock Table located in the following Asset/Liability Management section of this Management’s Discussion and Analysis discloses the Company's projected changes in net interest income based upon immediate interest rate changes called rate shocks.
The Company utilizes a model that uses the discounted cash flows from its interest-earning assets and its interest-bearing liabilities to calculate the current market value of those assets and liabilities. The model also calculates the changes in market value of the interest-earning assets and interest-bearing liabilities under different interest rate changes.
The following table discloses the projected changes in market value to the Company ’s interest-earning assets and interest-bearing liabilities based upon incremental 100 basis point changes in interest rates from interest rates in effect on December 31, 2016.
Market Value |
||||||||||||||||
(Dollars in thousands) | ||||||||||||||||
Basis point change in interest rates |
-100 | 0 |
+100 |
+200 |
||||||||||||
Total market-risk sensitive assets |
$ | 686,536 | 673,175 | 660,259 | 647,134 | |||||||||||
Total market-risk sensitive liabilities |
582,820 | 541,354 | 503,943 | 471,842 | ||||||||||||
Off-balance sheet financial instruments |
(256 | ) | 0 | (16 | ) | 15 | ||||||||||
Net market risk |
$ | 103,972 | 131,821 | 156,332 | 175,277 | |||||||||||
Percentage change from current market value |
(21.13 |
%) |
0.00 |
% |
18.59 |
% |
32.97 |
% |
||||||||
The preceding table was prepared utilizing the following assumptions (the Model Assumptions) regarding prepayment and decay ratios that were determined by management based upon their review of historical prepayment speeds and decay rates. Fixed rate loans were assumed to prepay at annual rates of between 2% and 40%, depending on the note rate and the period to maturity. Adjustable rate mortgages (ARMs) were assumed to prepay at annual rates of between 7% and 53%, depending on the note rate and the period to maturity. Mortgage-backed securities were projected to have prepayments based upon the underlying collateral securing the instrument. All loan prepayments vary based on the note rate and period to maturity of the individual loans. Certificate accounts were assumed not to be withdrawn until maturity. Passbook and money market accounts were assumed to decay at annual rates of 19% and 7%, respectively. Non-interest checking and NOW accounts were assumed to decay at annual rates of 4% and 14%, respectively. Commercial non-interest checking and NOW accounts were assumed to decay at annual rates of 17% and 9%, respectively. Commercial MMDA accounts were assumed to decay at annual rates of 23%.
Certain shortcomings are inherent in the method of analysis presented in the foregoing table. The interest rates on certain types of assets and liabilities may fluctuate in advance of changes in market interest rates, while interest rates on other types of assets and liabilities may lag behind changes in market interest rates. The model assumes that the difference between the current interest rate being earned or paid compared to a treasury instrument or other interest index with a similar term to maturity (the interest spread) will remain constant over the interest changes disclosed in the table. Changes in interest spread could impact projected market value changes. Certain assets, such as ARMs, have features that restrict changes in interest rates on a short-term basis and over the life of the assets. The market value of the interest-bearing assets that are approaching their lifetime interest rate caps or floors could be different from the values calculated in the table. Certain liabilities, such as certificates of deposit, have fixed rates that restrict interest rate changes until maturity. In the event of a change in interest rates, prepayment and early withdrawal levels may deviate significantly from those assumed in calculating the foregoing table. The ability of many borrowers to service their debt may also decrease in the event of a substantial sustained increase in interest rates.
Asset/Liability Management
The Company's management reviews the impact that changing interest rates will have on the net interest income projected for the twelve months following December 31, 201 6 to determine if its current level of interest rate risk is acceptable. The following table projects the estimated impact on net interest income during the 12 month period ending December 31, 2017 of immediate interest rate changes called rate shocks:
(Dollars in thousands) |
|||||||||
Rate Shock in Basis Points |
Net Interest Change |
Percent Change |
|||||||
+200 |
$ | 2,859 | 11.15 |
% |
|||||
+100 |
1,408 | 5.49 | |||||||
0 | 0 | 0.00 | |||||||
-100 | (1,441 | ) | (5.62 | ) |
The preceding table was prepared utilizing the Model Assumptions. Certain shortcomings are inherent in the method of analysis presented in the foregoing table. In the event of a change in interest rates, prepayment and early withdrawal levels would likely deviate significantly from those assumed in calculating the foregoing table. The ability of many borrowers to service their debt may decrease in the event of a substantial increase in interest rates and could impact net interest income. The increase in interest income in a rising rate environment is because there are more adjustable rate loans that would re-price to higher interest rates in the next twelve months than there are deposits that would re-price.
In an attempt to manage its exposure to changes in interest rates, management closely monitors interest rate risk. The Company has an Asset/Liability Committee that meets frequently to discuss changes in the interest rate risk position and projected profitability. The Committee makes adjustments to the asset-liability position of the Bank that are reviewed by the Board of Directors of the Bank. This Committee also reviews the Bank's portfolio, formulates investment strategies and oversees the timing and implementation of transactions as intended to assure attainment of the Bank's objectives in an effective manner. In addition, the Board reviews, on a quarterly basis, the Bank's asset/liability position, including simulations of the effect on the Bank's capital of various interest rate scenarios.
In managing its asset/liability mix, the Bank may, at times, depending on the relationship between long and short-term interest rates, market conditions and consumer preference, place more emphasis on managing net interest margin than on better matching the interest rate sensitivity of its assets and liabilities in an effort to enhance net interest income. Management believes that the increased net interest income resulting from a mismatch in the maturity of its asset and liability portfolios can, in certain situations, provide high enough returns to justify the increased exposure to sudden and unexpected changes in interest rates.
To the extent consistent with its interest rate spread objectives, the Bank attempts to manage its interest rate risk and has taken a number of steps to restructure its balance sheet in order to better match the maturities of its assets and liabilities. In the past, more long term fixed rate loans were placed into the single family loan portfolio. In recent years, the Bank has focus ed its 30 year fixed rate single family residential lending program on loans that are saleable to third parties and generally places only adjustable rate or shorter term fixed rate loans that meet certain risk characteristics into its loan portfolio. In addition, a significant portion of the Bank’s commercial loan production continues to be in adjustable rate loans that re-price every one, two, or three years.
Off-Balance Sheet Arrangements
The Company has no off-balance sheet arrangements other than commitments to originate and sell loans in the ordinary course of business . See “Note 1 8 Financial Instruments with Off-Balance S heet Risk” in the Notes to Consolidated Financial Statements for additional information. Management believes that the Company has sufficient liquidity to satisfy its off-balance sheet obligations.
CONSOLIDATED BALANCE SHEETS
(Dollars in thousands) |
December 31, 2016 |
December 31, 20 15 |
||||||
ASSETS |
||||||||
Cash and cash equivalents |
$ | 27,561 | 39,782 | |||||
Securities available for sale: |
||||||||
Mortgage-backed and related securities (amortized cost $993 and $2,237) |
1,005 | 2,283 | ||||||
Other marketable securities (amortized cost $78,846 and $110,092) |
77,472 | 109,691 | ||||||
78,477 | 111,974 | |||||||
Loans held for sale |
2,009 | 3,779 | ||||||
Loans receivable, net |
551,171 | 463,185 | ||||||
Accrued interest receivable |
2,626 | 2,254 | ||||||
Real estate, net |
611 | 2,045 | ||||||
Federal Home Loan Bank stock, at cost |
770 | 691 | ||||||
Mortgage servicing rights, net |
1,604 | 1,499 | ||||||
Premises and equipment, net |
8,223 | 7,469 | ||||||
Goodwill |
802 | 0 | ||||||
Core deposit intangible, net |
454 | 393 | ||||||
Prepaid expenses and other assets |
1,768 | 1,417 | ||||||
Deferred tax asset, net |
5,947 | 8,673 | ||||||
Total assets |
$ | 682,023 | 643,161 | |||||
LIABILITIES AND STOCKHOLDERS ’ EQUITY |
||||||||
Deposits |
$ | 592,811 | 559,387 | |||||
Other borrowings |
7,000 | 9,000 | ||||||
Accrued interest payable |
236 | 242 | ||||||
Customer escrows |
1,011 | 830 | ||||||
Accrued expenses and other liabilities |
5,046 | 4,057 | ||||||
Total liabilities |
606,104 | 573,516 | ||||||
Commitments and contingencies |
||||||||
Stockholders ’ equity: |
||||||||
Serial-preferred stock: ($.01 par value) authorized 500,000 shares; issued shares 0 |
0 | 0 | ||||||
Common stock ($.01 par value): authorized 16,000,000; issued shares 9,128,662 |
91 | 91 | ||||||
Additional paid-in capital |
50,566 | 50,388 | ||||||
Retained earnings, subject to certain restrictions |
86,886 | 80,536 | ||||||
Accumulated other comprehensive loss |
(820 | ) | (214 | ) | ||||
Unearned employee stock ownership plan shares |
(2,223 | ) | (2,417 | ) | ||||
Treasury stock, at cost 4,639,739 and 4,645,769 shares |
(58,581 | ) | (58,739 | ) | ||||
Total stockholders’ equity |
75,919 | 69,645 | ||||||
Total liabilities and stockholders ’ equity |
$ | 682,023 | 643,161 |
See accompanying notes to consolidated financial statements.
Consolidated S tatements of COMPREHENSIVE INCOME
Years ended December 31 ( Dollars in thousands, except per share amounts) |
2016 |
201 5 |
201 4 |
|||||||||
Interest income: |
||||||||||||
Loans receivable |
$ | 25,900 | 19,389 | 18,987 | ||||||||
Securities available for sale: |
||||||||||||
Mortgage-backed and related |
58 | 116 | 164 | |||||||||
Other marketable |
1,289 | 1,881 | 1,269 | |||||||||
Cash equivalents |
96 | 63 | 189 | |||||||||
Other |
6 | 4 | 4 | |||||||||
Total interest income |
27,349 | 21,453 | 20,613 | |||||||||
Interest expense: |
||||||||||||
Deposits |
1,002 | 934 | 1,211 | |||||||||
Federal Home Loan Bank advances and other borrowings |
591 | 573 | 0 | |||||||||
Total interest expense |
1,593 | 1,507 | 1,211 | |||||||||
Net interest income |
25,756 | 19,946 | 19,402 | |||||||||
Provision for loan losses |
(645 | ) | (164 | ) | (6,998 | ) | ||||||
Net interest income after provision for loan losses |
26,401 | 20,110 | 26,400 | |||||||||
Non-interest income: |
||||||||||||
Fees and service charges |
3,427 | 3,316 | 3,458 | |||||||||
Loan servicing fees |
1,108 | 1,046 | 1,058 | |||||||||
Gain on sales of loans |
2,618 | 1,964 | 1,828 | |||||||||
Other |
1,048 | 1,327 | 940 | |||||||||
Total non-interest income |
8,201 | 7,653 | 7,284 | |||||||||
Non-interest expense: |
||||||||||||
Compensation and benefits |
14,764 | 13,733 | 13,332 | |||||||||
(Gains) losses on real estate owned |
(596 | ) | 218 | (1,194 | ) | |||||||
Occupancy and equipment |
4,041 | 3,722 | 3,691 | |||||||||
Data processing |
1,161 | 1,020 | 1,011 | |||||||||
Professional services |
1,257 | 1,108 | 1,216 | |||||||||
Other |
3,503 | 3,395 | 3,347 | |||||||||
Total non-interest expense |
24,130 | 23,196 | 21,403 | |||||||||
Income before income tax expense |
10,472 | 4,567 | 12,281 | |||||||||
Income tax expense |
4,122 | 1,611 | 4,902 | |||||||||
Net income |
6,350 | 2,956 | 7,379 | |||||||||
Preferred stock dividends |
0 | (108 | ) | (1,710 | ) | |||||||
Net income available to common shareholders |
$ | 6,350 | 2,848 | 5,669 | ||||||||
Other comprehensive (loss) income, net of tax |
(606 | ) | 204 | 256 | ||||||||
Comprehensive income available to common shareholders |
$ | 5,744 | 3,052 | 5,925 | ||||||||
Basic earnings per common share |
$ | 1.52 | 0.69 | 1.40 | ||||||||
Diluted earnings per common share |
$ | 1.34 | 0.61 | 1.23 |
See accompanying notes to consolidated financial statements.
Consolidated Statements of Stockholders ’ Equity
Accumulated |
Unearned |
|||||||||||||||||||||||||||||||
Other |
Employee |
Total |
||||||||||||||||||||||||||||||
Additional |
Comprehensive |
Stock |
Stock- |
|||||||||||||||||||||||||||||
Preferred |
Common |
Paid-in |
Retained |
Income |
Ownership |
Treasury |
holders ’ |
|||||||||||||||||||||||||
( D ollars in thousands) |
Stock |
Stock |
Capital |
Earnings |
(Loss) |
Plan |
Stock |
Equity |
||||||||||||||||||||||||
Balance, December 31, 2013 |
$ | 26,000 | 91 | 51,175 | 72,211 | (674 | ) | (2,804 | ) | (60,324 | ) | 85,675 | ||||||||||||||||||||
Net income |
7,379 | 7,379 | ||||||||||||||||||||||||||||||
Other comprehensive income |
256 | 256 | ||||||||||||||||||||||||||||||
Redemption of preferred stock |
(16,000 | ) | (16,000 | ) | ||||||||||||||||||||||||||||
Stock compensation tax benefits |
1 | 1 | ||||||||||||||||||||||||||||||
Restricted stock awards |
(1,262 | ) | 1,262 | 0 | ||||||||||||||||||||||||||||
Amortization of restricted stock awards |
240 | 240 | ||||||||||||||||||||||||||||||
Preferred stock dividends |
(1,785 | ) | (1,785 | ) | ||||||||||||||||||||||||||||
Earned employee stock ownership plan shares |
53 | 194 | 247 | |||||||||||||||||||||||||||||
Balance, December 31, 2014 |
$ | 10,000 | 91 | 50,207 | 77,805 | (418 | ) | (2,610 | ) | (59,062 | ) | 76,013 | ||||||||||||||||||||
Net income |
2,956 | 2,956 | ||||||||||||||||||||||||||||||
Other comprehensive income |
204 | 204 | ||||||||||||||||||||||||||||||
Redemption of preferred stock |
(10,000 | ) | (10,000 | ) | ||||||||||||||||||||||||||||
Restricted stock awards |
(332 | ) | 332 | 0 | ||||||||||||||||||||||||||||
Restricted stock awards forfeiture |
9 | (9 | ) | 0 | ||||||||||||||||||||||||||||
Amortization of restricted stock awards |
447 | 447 | ||||||||||||||||||||||||||||||
Preferred stock dividends |
(225 | ) | (225 | ) | ||||||||||||||||||||||||||||
Earned employee stock ownership plan shares |
57 | 193 | 250 | |||||||||||||||||||||||||||||
Balance, December 31, 201 5 |
$ | 0 | 91 | 50,388 | 80,536 | (214 | ) | (2,417 | ) | (58,739 | ) | 69,645 | ||||||||||||||||||||
Net income |
6,350 | 6,350 | ||||||||||||||||||||||||||||||
Other comprehensive loss |
(606 | ) | (606 | ) | ||||||||||||||||||||||||||||
Stock compensation expense |
79 | 79 | ||||||||||||||||||||||||||||||
Restricted stock awards |
(158 | ) | 158 | 0 | ||||||||||||||||||||||||||||
Amortization of restricted stock awards |
177 | 177 | ||||||||||||||||||||||||||||||
Earned employee stock ownership plan shares |
80 | 194 | 274 | |||||||||||||||||||||||||||||
Balance, December 31, 201 6 |
$ | 0 | 91 | 50,566 | 86,886 | (820 | ) | (2,223 | ) | (58,581 | ) | 75,919 |
See accompanying notes to consolidated financial statements.
CONSOLIDATED STATEMENTS OF CASH FLOWS
Years ended December 31 (Dollars in thousands) |
2016 |
2015 |
2014 |
|||||||||
Cash flows from operating activities: |
||||||||||||
Net income |
$ | 6,350 | 2,956 | 7,379 | ||||||||
Adjustments to reconcile net income to cash provided by operating activities: |
||||||||||||
Provision for loan losses |
(645 | ) | (164 | ) | (6,998 | ) | ||||||
Depreciation |
850 | 706 | 576 | |||||||||
Amortization of premiums (discounts), net |
47 | (3 | ) | 18 | ||||||||
Amortization of deferred loan fees |
(1,011 | ) | (964 | ) | (340 | ) | ||||||
Amortization of core deposit intangible |
92 | 28 | 0 | |||||||||
Amortization of purchased loan fair value adjustments |
(529 | ) | (657 | ) | 0 | |||||||
Amortization of mortgage servicing rights |
601 | 555 | 517 | |||||||||
Capitalized mortgage servicing rights |
(706 | ) | (547 | ) | (316 | ) | ||||||
Deferred income tax expense |
3,128 | 1,722 | 4,566 | |||||||||
Securities losses (gains), net |
10 | (6 | ) | 0 | ||||||||
(Gains) losses on sales of real estate and premises |
(596 | ) | 218 | (1,194 | ) | |||||||
Gain on sales of loans |
(2,618 | ) | (1,964 | ) | (1,828 | ) | ||||||
Proceeds from sales of loans held for sale |
99,121 | 78,278 | 56,040 | |||||||||
Disbursements on loans held for sale |
(79,783 | ) | (69,941 | ) | (41,557 | ) | ||||||
Amortization of restricted stock awards |
177 | 447 | 240 | |||||||||
Amortization of unearned ESOP shares |
194 | 193 | 194 | |||||||||
Earned ESOP shares priced above original cost |
80 | 57 | 53 | |||||||||
Stock option compensation expense |
79 | 0 | 1 | |||||||||
(Increase) decrease in accrued interest receivable |
(265 | ) | (346 | ) | 240 | |||||||
(Decrease) increase in accrued interest payable |
(9 | ) | 137 | (53 | ) | |||||||
Increase in other assets |
(323 | ) | (239 | ) | (444 | ) | ||||||
Increase (decrease) in other liabilities |
999 | 302 | (265 | ) | ||||||||
Other, net |
270 | 52 | 515 | |||||||||
Net cash provided by operating activities |
25,513 | 10,820 | 17,344 | |||||||||
Cash flows from investing activities: |
||||||||||||
Proceeds from sales of securities available for sale |
20 | 10,951 | 0 | |||||||||
Principal collected on securities available for sale |
1,245 | 1,694 | 2,148 | |||||||||
Proceeds collected on maturity of securities available for sale |
136,145 | 175,070 | 125,000 | |||||||||
Purchases of securities available for sale |
(104,968 | ) | (144,069 | ) | (157,004 | ) | ||||||
Purchase of Federal Home Loan Bank stock |
(1,879 | ) | (2,152 | ) | 0 |
Redemption of Federal Home Loan Bank stock |
1,800 | 2,238 | 7 | |||||||||
Proceeds from sales of real estate and premises |
2,369 | 1,127 | 4,816 | |||||||||
Net (increase) decrease in loans receivable |
(89,570 | ) | (80,447 | ) | 13,455 | |||||||
Gain on acquisition |
0 | (289 | ) | 0 | ||||||||
Acquisition payment (net of cash acquired) |
6,080 | 4,816 | 0 | |||||||||
Purchases of premises and equipment |
(1,607 | ) | (803 | ) | (847 | ) | ||||||
Net cash used by investing activities |
(50,365 | ) | (31,864 | ) | (12,425 | ) | ||||||
Cash flows from financing activities: |
||||||||||||
Increase (decrease) in deposits |
14,468 | 15,375 | (57,182 | ) | ||||||||
Redemption of preferred stock |
0 | (10,000 | ) | (16,000 | ) | |||||||
Dividends paid to preferred stockholders |
0 | (225 | ) | (5,964 | ) | |||||||
Proceeds from borrowings |
45,000 | 65,000 | 0 | |||||||||
Repayment of borrowings |
(47,000 | ) | (56,000 | ) | 0 | |||||||
Increase in customer escrows |
163 | 42 | 175 | |||||||||
Net cash provided (used) by financing activities |
12,631 | 14,192 | (78,971 | ) | ||||||||
Decrease in cash and cash equivalents |
(12,221 | ) | (6,852 | ) | (74,052 | ) | ||||||
Cash and cash equivalents, beginning of year |
39,782 | 46,634 | 120,686 | |||||||||
Cash and cash equivalents, end of year |
$ | 27,561 | 39,782 | 46,634 | ||||||||
Supplemental cash flow disclosures: |
||||||||||||
Cash paid for interest |
$ | 1,599 | 1,358 | 1,264 | ||||||||
Cash paid for income taxes |
436 | 191 | 0 | |||||||||
Supplemental noncash flow disclosures: |
||||||||||||
Loans transferred to loans held for sale |
15,002 | 8,125 | 13,243 | |||||||||
Transfer of loans to real estate |
591 | 110 | 142 |
See accompanying notes to consolidated financial statements.
Notes to Consolidated Financial Statements
December 31, 2016, 2015 and 2014
NOTE 1 Description of the Business and Summary of Significant Accounting Policies
HMN Financial, Inc. (HMN or the Company) is a stock savings bank holding company that owns 100 percent of Home Federal Savings Bank (the Bank). The Bank has a community banking philosophy and operates retail banking and loan production facilities in Minnesota, Iowa, and Wisconsin. The Bank has two wholly owned subsidiaries, Osterud Insurance Agency, Inc. (OIA), which does business as Home Federal Investment Services and offers financial planning products and services, and HFSB Property Holdings, LLC (HPH), which is currently inactive, but has acted in the past as an intermediary for the Bank in holding and operating certain foreclosed properties.
The consolidated financial statements included herein are for HMN, the Bank, OIA, and HPH. All significant intercompany accounts and transactions have been eliminated in consolidation .
The Company evaluated subsequent events through the filing date of our annual 10-K with the Securities and Exchange Commission on March 10, 2017.
Use of Estimates
In preparing the consolidated financial statements, management is required to make estimates and assumptions that affect the reported amounts of assets and liabilities as of the date of the balance sheet and revenues and expenses for the period. Actual results could differ from those estimates.
An estimate that is particularly susceptible to change relates to the determination of the allowance for loan losses. Management believes that the allowance for loan losses is appropriate to cover probable losses inherent in the portfolio at the date of the balance sheet. While management uses available information to recognize losses on loans, future additions to the allowance may be necessary based on changes in economic conditions and other factors. In addition, various regulatory agencies, as an integral part of their examination process, periodically review the allowance for loan losses. Such agencies may require changes to the allowance based on their judgment about information available to them at the time of their examination.
Cash and Cash Equivalents
The Company considers highly liquid investments with original maturities of three months or less to be cash equivalents.
Securities
Securities are accounted for according to their purpose and holding period. The Company classifies its debt and equity securities in one of three categories:
Trading Securities
Securities held principally for resale in the near term are classified as trading securities and are recorded at their fair values. Unrealized gains and losses on trading securities are included in other income.
Securities Held to Maturity
Securities that the Company has the positive intent and ability to hold to maturity are reported at cost and adjusted for premiums and discounts that are recognized in interest income using the interest method over the period to maturity. Unrealized losses on securities held to maturity reflecting a decline in value judged to be other than temporary are charged to income and a new cost basis is established.
Securities Available for Sale
Securities available for sale consist of securities not classified as trading securities or as securities held to maturity. They include securities that management intends to use as part of its asset/liability strategy or that may be sold in response to changes in interest rates, changes in prepayment risk, or similar factors. Unrealized gains and losses, net of income taxes, are reported as a separate component of stockholders ’ equity until realized. Gains and losses on the sale of securities available for sale are determined using the specific identification method and recognized on the trade date. Premiums and discounts are recognized in interest income using the interest method over the period to maturity. Unrealized losses on securities available for sale reflecting a decline in value judged to be other than temporary are charged to income and a new cost basis is established.
Management monitors the investment security portfolio for impairment on an individual security basis and has a process in place to identify securities that could potentially have a credit impairment that is other than temporary. This process involves analyzing the length of time and extent to which t he fair value has been less than the amortized cost basis, the market liquidity for the security, the financial condition and near-term prospects of the issuer, expected cash flows, and the Company's intent and ability to hold the investment for a period of time sufficient to recover the temporary loss, including determining whether it is more-likely-than-not that the Company will be required to sell the security prior to recovery. To the extent it is determined that a security is deemed to be other-than-temporarily impaired, an impairment loss is recognized.
Loans Held for Sale
Mortgage loans originated or purchased which are intended for sale in the secondary market are carried at the lower of cost or estimated market value in the aggregate. Net fees and costs associated with acquiring or originating loans held for sale are deferred and included in the basis of the loan in determining the gain or loss on the sale of the loans. Gains on the sale of loans are recognized on the settlement date. Net unrealized losses are recognized through a valuation allowance by charges to income.
Loans Receivable, net
Loans receivable, net, are carried at amortized cost. Loan origination fees received, net of certain loan origination costs, are deferred as an adjustment to the carrying value of the related loans, and are amortized into income using the interest method over the estimated life of the loans.
Premiums and discounts on purchased participation loans are amortized into interest income using the interest method over the period to contractual maturity, adjusted for estimated prepayments.
The allowance for loan losses is based on a periodic analysis of the loan portfolio and is maintained at an amount considered to be appropriate by management to provide for probable losses inherent in the loan portfolio as of the balance sheet dates. In this analysis, management considers factors including, but not limited to, specific occurrences of loan impairment, actual and anticipated changes in the size of the portfolios, national and regional economic conditions (such as unemployment data, loan delinquencies, local economic conditions, demand for single-family homes, demand for commercial real estate and building lots), loan portfolio composition, historical loss experience, and observations made by the Company's ongoing internal audit and regulatory exam processes. In connection with the determination of the allowance for loan losses, management obtains independent appraisals for significant properties or other collateral securing classified loans. Appraisals on collateral dependent commercial real estate and commercial business loans are obtained when it is determined that the borrower’s risk profile has deteriorated and the loan is classified as impaired. Subsequent new third party appraisals of properties securing impaired commercial real estate and commercial business loans are prepared at least every two years. For all land development loan types, a new third party appraisal is prepared on an annual basis where current activity is not consistent with the assumptions made in the most recent third party appraisal. Non-performing residential and consumer home equity loans and home equity lines may have a third party appraisal or an internal evaluation completed depending on the size of the loan and location of the property. These appraisals, or internal valuations, are generally completed when a residential or consumer home equity loan or home equity line of credit becomes 120 days past due and are typically updated after possession of the property is obtained. Valuations are reviewed on a quarterly basis and adjustments are made to the allowance for loan losses for temporary impairments and charge-offs are taken when the impairment is determined to be permanent. The fair market value of the properties for all loan types are adjusted for estimated selling costs in order to determine the net realizable value of the properties. The allowance for loan losses is established for known problem loans, as well as for loans which are not currently known to require an allowance. Loans are charged off to the extent they are deemed to be uncollectible. The appropriateness of the allowance for loan losses is dependent upon management’s estimates of variables affecting valuation, appraisals of collateral, evaluations of performance and status, and the amounts and timing of future cash flows expected to be received on impaired loans. Such estimates, appraisals, evaluations and cash flows may be subject to adjustments due to changing economic prospects of borrowers or properties. The fair market value of collateral dependent loans are typically based on the appraised value of the property less estimated selling costs. The estimates are reviewed periodically and adjustments, if any, are recorded in the provision for loan losses in the periods in which the adjustments become known. The allowance is allocated to individual loan categories based upon the relative risk characteristics of the loan portfolios and the actual loss experience. The Company increases its allowance for loan losses by charging the provision for loan losses against income and decreases its allowance by crediting the provision for loan losses. The methodology for establishing the allowance for loan losses takes into consideration probable losses that have been identified in connection with specific loans as well as losses in the loan portfolio that have not been specifically identified.
Interest income is recognized on an accrual basis except when collectability is in doubt. When loans are placed on a non-accrual basis, generally when the loan is 90 days past due, previously accrued but unpaid interest is reversed from income. If the ultimate collectability of a loan is in doubt and the loan is placed in nonaccrual status, the cost recovery method is used and cash collected is applied to first reduce the principal outstanding. Generally, the Company returns a loan to accrual status when all delinquent interest and principal becomes current under the terms of the loan agreement and collectability of remaining principal and interest is no longer doubtful. Previously collected interest payments that were applied to principal when the loan was classified as non-accrual are recorded as interest income using the effective yield method over the estimated life of the loan, including expected renewal terms.
All impaired loans are valued at the present value of expected future cash flows discounted at the loan's initial effective interest rate. The fair value of the collateral of an impaired collateral-dependent loan or an observable market price, if one exists, may be used as an alternative to discounting. If the value of the impaired loan is less than the recorded investment in the loan, the impaired amount is charged off. A loan is considered impaired when, based on current information and events, it is probable that the Company will be unable to collect all amounts due according to the contractual terms of the loan agreement. Impaired loans include all loans which are on non-accrual, delinquent as to principal and interest for 90 days or greater, or restructured in a troubled debt restructuring (TDR) involving a modification of terms. All non-accruing loans are reviewed for impairment on an individual basis.
Included in loans receivable, net, are certain loans that have been modified in order to maximize collection of the loan balances. The Company evaluates all loan modifications and if the Company, for legal or economic reasons related to the borrower's financial difficulties, grants a concession compared to the original terms and conditions of the loan that the Company would not otherwise consider, the modified loan is considered a TDR and is classified as an impaired loan. If the TDR loan was performing (accruing) prior to the modification, it typically will remain accruing after the modification as long as it continues to perform according to the modified terms. If the TDR loan was non-performing (non-accruing) prior to the modification, it will remain non-accruing after the modification for a minimum of six months. If the loan performs according to the modified terms for a minimum of six months, it typically will be returned to accruing status. In general, there are two conditions in which a TDR loan is no longer considered to be a TDR and potentially not classified as impaired. The first condition is whether the loan is refinanced with terms that reflect normal market terms for the type of credit involved. The second condition is whether the loan is repaid or charged off.
Purchased Loans Acquired Through Business Combinations
Purchased loans acquired in a business combination , including loans that have evidence of deterioration of credit quality since origination and for which it is probable, at acquisition, that the Company will be unable to collect all contractually required payments, are initially recorded at fair value as determined by the present value of expected future cash flows with no valuation allowance. The difference between the undiscounted cash flows expected at acquisition and the investment in the loan is an accretable yield adjustment and is recognized as interest income using the effective yield method over the life of the loan. Contractually required payments for principal and interest that exceed the undiscounted cash flows expected at acquisition is a nonaccretable difference and is not recognized as a yield adjustment, loss accrual, or a valuation allowance. Increases in expected cash flows subsequent to the initial investment are recognized prospectively through an adjustment of the yield on the loan over its remaining life. Decreases in expected cash flows after the loan is acquired are recognized as an impairment and charged to the provision for loan losses.
Transfers of Financial Assets and Participating Interests
Transfers of an entire financial asset or a participating interest in an entire financial asset are accounted for as sales when control over the assets has been surrendered. Control over transferred assets is deemed to be surrendered when (1) the assets have been isolated from the Company, (2) the transferee obtains the right (free of conditions that constrain it from taking advantage of that right) to pledge or exchange the transferred assets, and (3) the Company does not maintain effective control over the transferred assets through an agreement to repurchase them before their maturity.
The transfer of a participating interest in an entire financial asset must also meet the definition of a participating interest. A participating interest in a financial asset has all of the following characteristics: (1) from the date of transfer, it must represent a proportionate (pro rata) ownership interest in the financial asset, (2) from the date of transfer, all cash flows received, except any cash flows allocated as any compensation for servicing or other services performed, must be divided proportionately among participating interest holders in the amount equal to their share ownership, (3) the rights of each participating interest holder must have the same priority, and (4) no party has the right to pledge or exchange the entire financial asset unless all participating interest holders agree to do so.
Real Estate, net
Real estate acquired through loan foreclosure or deed in lieu of foreclosure, is initially recorded at its fair value less estimated selling costs. Third party appraisals are obtained as soon as practical after obtaining possession of the property. Valuations are reviewed quarterly by management and an allowance for losses is established if the carrying value of a property exceeds its fair value less estimated selling costs.
Mortgage Servicing Rights , net
Mortgage servicing rights are capitalized at fair value and amortized in proportion to, and over the period of, estimated net servicing income. The Company evaluates its capitalized mortgage servicing rights for impairment each quarter. Loan type and note rate are the predominant risk characteristics of the underlying loans used to stratify capitalized mortgage servicing rights for purposes of measuring impairment. Any impairment is recognized through a valuation allowance.
Premises and Equipment , net
Land is carried at cost. Office buildings, improvements, furniture and equipment are carried at cost less accumulated depreciation. Depreciation is computed on a straight-line basis over estimated useful lives of 5 to 40 years for office buildings and improvements and 3 to 10 years for furniture and equipment.
Goodwill
The Company records goodwill for acquisition amounts paid in excess of the net assets purchased. Goodwill is not amortized, but is tested for impairment at least annually or more frequently if there are indications of impairment.
Core Deposit Intangible , net
The Company records t he estimated fair value of the deposit base acquired in an acquisition as a core deposit intangible asset. The recorded amount is amortized on a straight line basis over the estimated life of the deposits acquired.
Impairment of Long-Lived Assets and for Long-Lived Assets to Be Disposed Of
The Company reviews long-lived assets and certain identifiable intangibles for impairment whenever events or changes in circumstances indicate that the carrying amount of an asset may not be recoverable.
Stock Based Compensation
The Company recognizes the grant-date fair value of stock option and restricted stock awards issued as compensation expense, amortized over the vesting period.
Employee Stock Ownership Plan (ESOP)
The Company has an ESOP that borrowed funds from the Company and purchased shares of HMN common stock. The Company makes quarterly principal and interest payments on the ESOP loan. As the debt is repaid, ESOP shares that were pledged as collateral for the debt are released from collateral based on the proportion of debt service paid in the yea r and then allocated to eligible employees. The Company accounts for its ESOP in accordance with ASC 718, Employers' Accounting for Employee Stock Ownership Plans . Accordingly, the shares pledged as collateral are reported as unearned ESOP shares in stockholders' equity. As shares are determined to be ratably released from collateral, the Company reports compensation expense equal to the current market price of the shares, and the shares become outstanding for earnings per share computations.
Income Taxes
Deferred tax assets and li abilities are recognized for future tax consequences attributable to temporary differences between the financial statement carrying amounts of existing assets and liabilities and their respective tax basis. Deferred tax assets and liabilities are measured using enacted tax rates expected to apply to taxable income in the years in which those temporary differences are expected to be recovered or settled. The effect of a change in tax rates on deferred tax assets and liabilities is recognized in income in the period that includes the enactment date. A valuation allowance is required to be recognized if it is “more likely than not” that the deferred tax asset will not be realized. The determination of the realizability of the deferred tax asset is subjective and dependent upon judgment concerning management’s evaluation of both positive and negative evidence regarding the ultimate realizability of deferred tax assets.
Earnings per Common Share
Basic earnings per common share excludes dilution and is computed by dividing the income available to common stockholders by the weighted-average number of common shares outstanding for the period. Diluted earnings per common share reflects the potential dilution that could occur if securities or other contracts to issue common stock were exercised or converted into common stock or resulted in the issuance of common stock that shared in the earnings of the entity.
Comprehensive Income
Comprehensive income is defined as the change in equity during a period from transactions and other events from non -owner sources. Comprehensive income is the total of net income and other comprehensive income (loss), which for the Company is comprised of unrealized gains and losses on securities available for sale.
Segment Information
The amount of each segment item reported is the measure reported to the chief operating decision maker for purposes of making decisions about allocating resources to the segment and assessing its performance. Adjustments and eliminations made in preparing an enterprise ’s general-purpose financial statements and allocations of revenues, expenses and gains or losses are included in determining reported segment profit or loss if they are included in the measure of the segment’s profit or loss that is used by the chief operating decision maker. Similarly, only those assets that are included in the measure of the segment’s assets that are used by the chief operating decision maker are reported for that segment.
New Accounting Pronouncements
In January 2016, the FASB issued ASU 2016-01, Financial Instruments – Overall (Subtopic 825-10) Recognition and Measurement of Financial Assets and Financial Liabilities. The amendments in this ASU require, among other things, equity investments to be measured at fair value with changes in fair value recognized in net income and that public business entities use the exit price notion when measuring the fair value of financial instruments for disclosure purposes. The amendments also require an entity to present separately in other comprehensive income the portion of the total change in the fair value of a liability resulting from a change in the instrument-specific credit risk when the entity has elected to measure the liability at fair value in accordance with the fair value option for financial instruments. In addition, the amendments also eliminate the requirement for public business entities to disclose the method(s) and significant assumptions used to estimate the fair value that is required to be disclosed for financial instruments measured at amortized cost on the balance sheet. The ASU is intended to reduce diversity in practice and is effective for public business entities for fiscal years beginning after December 15, 2017, including interim periods within those fiscal years. The amendments should be applied by means of a cumulative-effect adjustment to the balance sheet as of the beginning of the fiscal year of adoption. The adoption of this ASU in the first quarter of 2018 is not anticipated to have a material impact on the Company’s consolidated financial statements.
In February 2016, the FASB issued ASU 2016-02, Leases (Topic 842). The amendments in the ASU create Topic 842, Leases , and supersede the lease requirements in Topic 840, Leases . The objective of this ASU is to establish the principles that lessees and lessors shall apply to report useful information to users of financial statements about the amount, timing, and uncertainty of cash flows arising from a lease. The main difference between previous GAAP and this ASU is the recognition of lease assets and lease liabilities by lessees for those leases classified as operating leases under previous GAAP. The amendment requires a lessee to recognize in the statement of financial position a liability to make lease payments (the lease liability) and the right-of-use asset representing its right to use the underlying asset for the lease term. The accounting applied by a lessor is largely unchanged from that applied under previous GAAP. In transition, lessees and lessors are required to recognize and measure leases at the beginning of the earliest period presented using a modified retrospective approach. The modified retrospective approach includes a number of optional practical expedients that entities may elect to apply that will, in effect, continue to account for leases that commence before the effective date in accordance with previous GAAP unless the lease is modified. The amendments in the ASU, for public business entities that are U. S. Securities and Exchange Commission (SEC) filers, are effective for fiscal years beginning after December 15, 2018, including interim periods within those fiscal years. The adoption of this ASU in the first quarter of 2019 is not anticipated to have a material impact on the Company’s consolidated financial statements.
In March 2016, the FASB issued ASU 2016-09, Compensation – Stock Compensation (Topic 718). The amendments in this ASU affect all entities that issue share-based payment awards to their employees. The amendments are intended to simplify the accounting for share-based payment transactions including the income tax consequences, classification of awards as either equity or liabilities, and classification on the statement of cash flows. The amendments in this ASU, for public business entities, are effective for fiscal years beginning after December 15, 2016, including interim periods within those annual periods. Amendments should be applied using a modified retrospective transition method by means of a cumulative-effect adjustment to equity as of the beginning of the period in which the guidance is adopted. The adoption of this ASU in the first quarter of 2017 is not anticipated to have a material impact on the Company’s consolidated financial statements.
In June 2016, the FASB issued ASU 2016-13, Financial Instruments-Credit Losses (Topic 326): Measurement of Credit Losses on Financial Instruments. The amendments in this ASU affect all entities that measure credit losses on financial instruments including loans, debt securities, trade receivables, net investments in leases, off-balance sheet credit exposures, reinsurance receivables, and any other financial asset that has a contractual right to receive cash that is not specifically excluded. The main objective of this ASU is to provide financial statement users with more decision-useful information about the expected credit losses on financial instruments and other commitments to extend credit held by a reporting entity at each reporting date. To achieve this objective, the amendments in this ASU replace the incurred loss impairment methodology required in current GAAP with a methodology that reflects expected credit losses that requires consideration of a broader range of reasonable and supportable information to estimate credit losses. The amendments in this ASU will affect entities to varying degrees depending on the credit quality of the assets held by the entity, the duration of the assets held, and how the entity applies the current incurred loss methodology. The amendments in this ASU, for public business entities that are U. S. Securities and Exchange Commission (SEC) filers, are effective for fiscal years beginning after December 15, 2019, including interim periods within those annual periods. All entities may adopt the amendments in the ASU early as of the fiscal years beginning after December 15, 2018, including interim periods within those fiscal years. Amendments should be applied using a modified retrospective transition method by means of a cumulative-effect adjustment to equity as of the beginning of the period in which the guidance is adopted. Management is in the process of evaluating the impact that the adoption of this ASU in the first quarter of 2020 will have on the Company’s consolidated financial statements.
In August 2016, the FASB issued ASU 2016-15, Statement of Cash Flows (Topic 230): Classification of Certain Cash Receipts and Cash Payments. The amendments in this ASU affect all entities that are required to present a statement of cash flows under Topic 230 and address the following eight specific cash flow issues: debt prepayment or debt extinguishment costs; settlement of zero-coupon debt instruments or other debt instruments with coupon interest rates that are insignificant in relation to the effective interest rate of the borrowing; contingent consideration payments made after a business combination; proceeds from the settlement of insurance claims; proceeds from the settlement of corporate-owned life insurance policies; distributions received from equity method investees; beneficial interest in securitization transactions; and separately identifiable cash flows and application of the predominance principle. This ASU is intended to reduce diversity in practice and is effective for public business entities that are U. S. Securities and Exchange Commission (SEC) filers for fiscal years beginning after December 15, 2017, and interim periods within those fiscal years with early adoption permitted. Upon adoption, the amendments should be applied using a retrospective transition method to each period presented. The adoption of this ASU in the first quarter of 2018 is not anticipated to have a material impact on the Company’s consolidated financial statements.
Derivative Financial Instruments
The Company uses derivative financial instruments in order to manage the interest rate risk on residential loans held for sale and its commitments to extend credit for residential loans. The Company may also from time to time use interest rate swaps to manage interest rate risk. Derivative financial instruments include commitments to extend credit and forward mortgage loan sales commitments.
Reclassifications
Certain amounts in the consolidated financial statements for the prior years have been reclassified to conform to the current year presentation.
NOTE 2 Acquisitions
The Company records purchased assets and liabilities at their fair market value at the time of purchase in accordance with the requirements of ASU 805 - Business Combinations . On April 8, 2016, the Bank completed the acquisition of loans and assumption of liabilities of the Deerwood Bank branch in Albert Lea, Minnesota. The transaction increased the Bank’s assets by $19.0 million, including increases in loans, cash, goodwill, and core deposit intangible of $11.9 million, $6.1 million, $0.8 million, and $0.2 million, respectively. The Bank also assumed deposit liabilities of $19.0 million. The acquired loans and deposits are being serviced from Home Federal’s existing branch location at 143 West Clark Street, Albert Lea, Minnesota.
On August 14, 2015, the Bank completed the acquisition of certain assets and assumption of certain liabilities of Kasson State Bank. The transaction increased the Bank ’s total assets by $52.8 million including increases in loans of $24.1 million, investments of $17.5 million, cash of $10.0 million, core deposit intangible of $0.4 million and other assets of $0.8 million. The Bank also assumed liabilities of $49.3 million, including $47.3 million of deposits and $2.0 million in other liabilities. Consideration paid was $3.2 million and a gain on the transaction of $0.3 million was recorded. The Bank continues to operate both of the former Kasson State Bank locations in Kasson, Minnesota acquired in the transaction as branches of Home Federal Savings Bank.
Determining the estimated fair value of the acquired assets and assumed liabilities required the Bank to estimate cash flows expected to result from those assets and liabilities and to discount those cash flows at appropriate rates of interest. The most significant of those determinations related to the fair valuation of the loans acquired, which management considers to be a critical accounting estimate that involves significant estimates and assumptions. The fair value of the loans purchased was based on the present value of the expected cash flows. Periodic principal and interest cash flows were adjusted for expected losses and prepayments, then discounted to determine the present value and summed to arrive at the estimated fair value. For such loans, the excess of cash flows expected at acquisition over the estimated fair value is recognized as interest income over the remaining lives of the loans. The difference between contractually required payments at acquisition and the cash flows expected to be collected at acquisition reflects the impact of estimated credit losses and other factors, such as prepayments. In accordance with GAAP, there was no carry-over of previously established allowance s for loan losses established on the seller’s records. As a result, standard industry coverage ratios with regard to the allowance for credit losses are less meaningful after the acquisitions. The purchased loans were divided into loans with evidence of credit quality deterioration, which are accounted for under ASC topic 310-30 (purchased credit impaired (PCI)) and loans that do not meet this criteria, which are accounted for under ASC topic 310-20 (performing). PCI loans have experienced a deterioration of credit quality from origination to acquisition for which it is probable that the Bank will not be able to collect all contractually required principal and interest payments on the loan. Subsequent decreases in the expected cash flows require the Bank to evaluate the need for additions to the allowance for credit losses. Subsequent improvements in expected cash flows generally result in a reduction of previously established allowance for credit losses or the recognition of additional interest income over the remaining lives of the loans.
NOTE 3 Other Comprehensive (Loss) Income
The components of other comprehensive (loss) income and the related tax effects were as follows:
For the years ended December 31, |
||||||||||||||||||||||||||||||||||||
2016 |
2015 |
2014 |
||||||||||||||||||||||||||||||||||
(Dollars in thousands ) |
Before Tax |
Tax Effect |
Net of Tax |
Before Tax |
Tax Effect |
Net of Tax |
Before Tax |
Tax Effect |
Net of Tax |
|||||||||||||||||||||||||||
Securities available for sale: | ||||||||||||||||||||||||||||||||||||
Gross unrealized (losses) gains arising during the period. |
$ | (1,016 | ) | (404 | ) | (612 | ) | 344 | 137 | 207 | 38 | (218 | ) | 256 | ||||||||||||||||||||||
Less reclassification of net (losses) gains included in net income |
(10 | ) | (4 | ) | (6 | ) | 6 | 3 | 3 | 0 | 0 | 0 | ||||||||||||||||||||||||
Net unrealized (losses) gains arising during the period |
(1,006 | ) | (400 | ) | (606 | ) | 338 | 134 | 204 | 38 | (218 | ) | 256 | |||||||||||||||||||||||
Other comprehensive (loss) income |
$ | (1,006 | ) | (400 | ) | (606 | ) | 338 | 134 | 204 | 38 | (218 | ) | 256 | ||||||||||||||||||||||
The tax effect in 2014 includes the impact of the reversal of certain deferred tax asset valuation reserve components that reversed in 2014 as a result of the changes that occurred in the investment portfolio during the year.
NOTE 4 Securities Available for Sale
A summary of securities available for sale at December 31, 201 6 and 2015 is as follows:
(Dollars in thousands) |
Amortized cost |
Gross unrealized gains |
Gross unrealized losses |
Fair value |
||||||||||||
December 31, 201 6 |
||||||||||||||||
Mortgage-backed securities: |
||||||||||||||||
Federal Home Loan Mortgage Corporation (FHLMC) |
$ | 327 | 10 | 0 | 337 | |||||||||||
Federal National Mortgage Association (FNMA) |
295 | 7 | 0 | 302 | ||||||||||||
Collateralized mortgage obligations: |
||||||||||||||||
FHLMC |
371 | 0 | (5 | ) | 366 | |||||||||||
993 | 17 | (5 | ) | 1,005 | ||||||||||||
Other marketable securities: |
||||||||||||||||
U.S. Government agency obligations |
74,979 | 16 | (1,079 | ) | 73,916 | |||||||||||
Municipal obligations |
2,819 | 0 | (20 | ) | 2,799 | |||||||||||
Corporate obligations |
290 | 2 | 0 | 292 | ||||||||||||
Corporate preferred stock |
700 | 0 | (350 | ) | 350 | |||||||||||
Corporate equity |
58 | 57 | 0 | 115 | ||||||||||||
78,846 | 75 | (1,449 | ) | 77,472 | ||||||||||||
$ | 79,839 | 92 | (1,454 | ) | 78,477 | |||||||||||
December 31, 2015 |
||||||||||||||||
Mortgage-backed securities: |
||||||||||||||||
FHLMC |
$ | 728 | 31 | 0 | 759 | |||||||||||
FNMA |
725 | 22 | 0 | 747 | ||||||||||||
Collateralized mortgage obligations: |
||||||||||||||||
FHLMC |
742 | 2 | (1 | ) | 743 | |||||||||||
Other |
42 | 0 | (8 | ) | 34 | |||||||||||
2,237 | 55 | (9 | ) | 2,283 | ||||||||||||
Other marketable securities: |
||||||||||||||||
U.S. Government agency obligations |
105,003 | 68 | (129 | ) | 104,942 | |||||||||||
Municipal obligations |
3,991 | 18 | (7 | ) | 4,002 | |||||||||||
Corporate obligations |
340 | 0 | (6 | ) | 334 | |||||||||||
Corporate preferred stock |
700 | 0 | (350 | ) | 350 | |||||||||||
Corporate equity |
58 | 5 | 0 | 63 | ||||||||||||
110,092 | 91 | (492 | ) | 109,691 | ||||||||||||
$ | 112,329 | 146 | (501 | ) | 111,974 | |||||||||||
I n 2016, the Company sold $20,000 of available for sale securities and recognized a loss of $10,000 on the sales.
In 2015, the Company sold $11.0 million of available for sale securities and recognized a gain of $6,000 on the sales. The Company did not sell any available for sale securities and did not recognize any gains or losses on investments in 2014.
The following table presents the amortized cost and estimated fair value of securities available for sale at December 31, 2016, based upon contractual maturity adjusted for scheduled repayments of principal and projected prepayments of principal based upon current economic conditions and interest rates. Actual maturities may differ from the maturities in the following table because obligors may have the right to call or prepay obligations with or without call or prepayment penalties:
(Dollars in thousands) |
Amortized Cost |
Fair Value |
||||||
Due one year or less |
$ | 15,561 | 15,358 | |||||
Due after one year through five years |
63,144 | 62,282 | ||||||
Due after five years through ten years |
263 | 261 | ||||||
Due after ten years |
813 | 461 | ||||||
No stated maturity |
58 | 115 | ||||||
Total |
$ | 79,839 | 78,477 | |||||
The allocation of mortgage-backed securities in the table above is based upon the anticipated future cash flow of the securities using estimated mortgage prepayment speeds.
The following table shows the gross unrealized losses and fair values for the securities available for sale portfolio aggregated by investment category and length of time that individual securities have been in a continuous unrealized loss position at December 31, 201 6 and 2015:
Less Than Twelve Months |
Twelve Months or More |
Total |
||||||||||||||||||||||||||||||
(Dollars in thousands) |
# of Investments |
Fair Value |
Unrealized Losses |
# of Investments |
Fair Value |
Unrealized Losses |
Fair Value |
Unrealized Losses |
||||||||||||||||||||||||
December 31, 201 6 |
||||||||||||||||||||||||||||||||
Collateralized mortgage obligations: |
||||||||||||||||||||||||||||||||
FNMA |
1 | $ | 262 | (3 | ) | 1 | $ | 104 | (2 | ) | $ | 366 | (5 | ) | ||||||||||||||||||
Other marketable securities: |
||||||||||||||||||||||||||||||||
U.S. Government agency obligations |
13 | 63,896 | (1,079 | ) | 0 | 0 | 0 | 63,896 | (1,079 | ) | ||||||||||||||||||||||
Municipal obligations |
14 | 2,327 | (19 | ) | 2 | 214 | (1 | ) | 2,541 | (20 | ) | |||||||||||||||||||||
Corporate preferred stock |
0 | 0 | 0 | 1 | 350 | (350 | ) | 350 | (350 | ) | ||||||||||||||||||||||
Total temporarily impaired securities |
28 | $ | 66,485 | (1,101 | ) | 4 | $ | 668 | (353 | ) | $ | 67,153 | (1,454 | ) | ||||||||||||||||||
December 31, 2015 |
||||||||||||||||||||||||||||||||
Collateralized mortgage obligations: |
||||||||||||||||||||||||||||||||
FNMA |
1 | $ | 346 | (1 | ) | 0 | $ | 0 | 0 | $ | 346 | (1 | ) | |||||||||||||||||||
Other |
2 | 34 | (8 | ) | 0 | 0 | 0 | 34 | (8 | ) | ||||||||||||||||||||||
Other marketable securities: |
||||||||||||||||||||||||||||||||
U.S. Government agen cy obligations |
9 | 44,878 | (129 | ) | 0 | 0 | 0 | 44,878 | (129 | ) | ||||||||||||||||||||||
Municipal obligations |
12 | 2,010 | (7 | ) | 0 | 0 | 0 | 2,010 | (7 | ) | ||||||||||||||||||||||
Corporate obligations |
1 | 334 | (6 | ) | 0 | 0 | 0 | 334 | (6 | ) | ||||||||||||||||||||||
Corporate preferred stock |
0 | 0 | 0 | 1 | 350 | (350 | ) | 350 | (350 | ) | ||||||||||||||||||||||
Total temporarily impaired securities |
25 | $ | 47,602 | (151 | ) | 1 | $ | 350 | (350 | ) | $ | 47,952 | (501 | ) | ||||||||||||||||||
We review our investment portfolio on a quarterly basis for indications of impairment. This review includes analyzing the length of time and the extent to which the fair value has been lower than the cost, the market liquidity for the investment, the financial condition and near-term prospects of the issuer, including any specific events which may influence the operations of the issuer, and our intent and ability to hold the investment for a period of time sufficient to recover the temporary loss. The unrealized losses on U.S. Government agency obligations are the result of changes in interest rates. The unrealized losses reported for the corporate preferred stock at December 31, 2016 relates to a single trust preferred security that was issued by the holding company of a small community bank. Typical of most trust preferred issuances, the issuer has the ability to defer interest payments for up to five years with interest payable on the deferred balance. In September 2014, the issuer paid all deferred interest that was due and all payments were current as of September 30, 2014. Since January 2015, the issuer has deferred its scheduled interest payments as allowed by the terms of the security agreement. The issuer’s subsidiary bank has generated modest net income amounts over the past several years and met the regulatory requirements to be considered “well capitalized” based on its most recent regulatory filing. Based on a review of the issuer, it was determined that the trust preferred security was not other-than-temporarily impaired at December 31, 2016. The Company does not intend to sell the preferred stock and has the intent and ability to hold it for a period of time sufficient to recover the temporary loss. Management believes that the Company will receive all principal and interest payments contractually due on the security and that the decrease in the market value is primarily due to a lack of liquidity in the market for trust preferred securities. Management will continue to monitor the credit risk of the issuer and may be required to recognize other-than-temporary impairment charges on this security in future periods.
NOTE 5 Loans Receivable, Net
A summary of loans receivable at December 31, 2016 and 2015, is as follows:
(Dollars in thousands) |
201 6 |
201 5 |
||||||
Residential real estate loans: |
||||||||
Single family conventional |
$ | 103,125 | 90,587 | |||||
Single family FHA |
92 | 206 | ||||||
Single family VA |
38 | 152 | ||||||
103,255 | 90,945 | |||||||
Commercial real estate: |
||||||||
Lodging |
43,285 | 27,428 | ||||||
Retail/office |
53,935 | 45,097 | ||||||
Nursing home/health care |
8,185 | 9,183 | ||||||
Land developments |
24,240 | 21,272 | ||||||
Golf courses |
1,560 | 4,163 | ||||||
Restaurant/bar/café |
5,851 | 5,854 | ||||||
Alternative fuel plants |
0 | 2,205 | ||||||
Warehouse |
26,630 | 18,337 | ||||||
Construction: |
||||||||
Single family builder |
21,944 | 15,152 | ||||||
Multi-family |
2,610 | 18,865 | ||||||
Commercial real estate |
6,794 | 4,086 | ||||||
Manufacturing |
15,743 | 11,585 | ||||||
Churches/community service |
10,199 | 8,195 | ||||||
Multi-family |
36,777 | 12,324 | ||||||
Other |
41,327 | 43,607 | ||||||
299,080 | 247,353 | |||||||
Consumer: |
||||||||
Autos |
3,036 | 2,885 | ||||||
Home equity line |
40,476 | 38,980 | ||||||
Home equity |
16,302 | 14,782 | ||||||
Other – secured |
2,048 | 2,031 | ||||||
Recreational vehicles |
7,553 | 2,650 | ||||||
Land/lot s |
2,362 | 1,144 | ||||||
Other – unsecured |
1,506 | 1,943 | ||||||
73,283 | 64,415 | |||||||
Commercial business |
85,176 | 70,106 | ||||||
Total loans |
560,794 | 472,819 | ||||||
Less: |
||||||||
Unamortized discounts |
20 | 16 | ||||||
Net deferred loan costs |
(300 | ) | (91 | ) | ||||
Allowance for loan losses |
9,903 | 9,709 | ||||||
Total loans receivable, net |
$ | 551,171 | 463,185 | |||||
Commitments to originate or purchase loans |
$ | 47,220 | 27,184 | |||||
Commitments to deliver loans to secondary market |
$ | 9,595 | 8,071 | |||||
Weighted average contractual rate of loans in portfolio |
4.45 |
% |
4.54 |
% |
||||
Included in total commitments to originate or purchase loans are fixed rate loans aggregating $29.6 million and $22.3 million as of December 31, 2016 and 2015, respectively. The interest rates on these loan commitments ranged from 2.75% to 5.125% at December 31, 2016 and from 3.00% to 5.49% at December 31, 2015.
The aggregate amount of loans to executive officers and directors of the Company was $0.2 million, $2.7 million and $2.8 million at December 31, 2016, 2015 and 2014, respectively. During 2016, there was no activity on loans to executive officers and directors other than the $2.5 million in loans that were reclassified during the period due to a change in borrower classification. During 2015, repayments on loans to executive officers and directors were $0.1 million, new loans to executive officers and directors totaled $0.2 million, and loans closed or paid off were $0.2 million. During 2014, repayments on loans to executive officers and directors were $0.1 million, new loans to executive officers and directors totaled $0.2 million, sales of executive officer and director loans were $0.2 million, and loans reclassified were $0.2 million. All loans were made in the ordinary course of business on normal credit terms, including interest rates and collateral, as those prevailing at the time for comparable transactions with unrelated parties.
At December 31, 2016, 2015 and 2014, the Company was servicing loans for others with aggregate unpaid principal balances of approximately $425.5 million, $391.9 million and $379.7 million, respectively.
The Company originates residential, commercial real estate and other loans primarily in Minnesota, Wisconsin, and Iowa. At December 31, 2016 and 2015, the Company had in its portfolio single-family residential loans located in the following states:
At December 31, 201 6 and 2015, the Company had in its portfolio commercial real estate loans located in the following states:
NOTE 6 Allowance for Loan Losses and Credit Quality Information
The allowance for loan losses is summarized as follows:
(Dollars in thousands) |
Single Family |
Commercial Real Estate |
Consumer |
Commercial Business |
Total |
|||||||||||||||
Balance, December 31, 2013 |
$ | 1,628 | 6,458 | 1,106 | 2,209 | 11,401 | ||||||||||||||
Provision for losses |
$ | (440 | ) | (3,518 | ) | (4 | ) | (3,036 | ) | (6,998 | ) | |||||||||
Charge-offs |
(92 | ) | (936 | ) | (131 | ) | (55 | ) | (1,214 | ) | ||||||||||
Recoveries |
0 | 3,020 | 38 | 2,085 | 5,143 | |||||||||||||||
Balance, December 31, 2014 |
$ | 1,096 | 5,024 | 1,009 | 1,203 | 8,332 | ||||||||||||||
Provision for losses |
$ | (105 | ) | (427 | ) | 254 | 114 | (164 | ) | |||||||||||
Charge-offs |
(19 | ) | 0 | (105 | ) | (69 | ) | (193 | ) | |||||||||||
Recoveries |
18 | 1,481 | 42 | 193 | 1,734 | |||||||||||||||
Balance, December 31, 2015 |
$ | 990 | 6,078 | 1,200 | 1,441 | 9,709 | ||||||||||||||
Provision for losses |
$ | 262 | (1,788 | ) | 481 | 400 | (645 | ) | ||||||||||||
Charge-offs |
(66 | ) | (67 | ) | (108 | ) | (180 | ) | (421 | ) | ||||||||||
Recoveries |
0 | 730 | 40 | 490 | 1,260 | |||||||||||||||
Balance, December 31, 2016 |
$ | 1,186 | 4,953 | 1,613 | 2,151 | 9,903 | ||||||||||||||
Allocated to: |
||||||||||||||||||||
Specific reserves |
$ | 223 | 296 | 370 | 120 | 1,009 | ||||||||||||||
General reserves |
767 | 5,782 | 830 | 1,321 | 8,700 | |||||||||||||||
Balance, December 31, 2015 |
$ | 990 | 6,078 | 1,200 | 1,441 | 9,709 | ||||||||||||||
Allocated to: |
||||||||||||||||||||
Specific reserves |
$ | 235 | 248 | 434 | 71 | 988 | ||||||||||||||
General reserves |
951 | 4,705 | 1,179 | 2,080 | 8,915 | |||||||||||||||
Balance, December 31, 2016 |
$ | 1,186 | 4,953 | 1,613 | 2,151 | 9,903 | ||||||||||||||
Loans receivable at December 31, 2015: |
||||||||||||||||||||
Individually reviewed for impairment |
$ | 2,203 | 2,204 | 977 | 415 | 5,799 | ||||||||||||||
Collectively reviewed for impairment |
88,742 | 245,149 | 63,438 | 69,691 | 467,020 | |||||||||||||||
Ending balance |
$ | 90,945 | 247,353 | 64,415 | 70,106 | 472,819 | ||||||||||||||
Loans receivable at December 31, 2016: |
||||||||||||||||||||
Individually reviewed for impairment |
$ | 1,107 | 1,880 | 940 | 643 | 4,570 | ||||||||||||||
Collectively reviewed for impairment |
102,148 | 297,200 | 72,343 | 84,533 | 556,224 | |||||||||||||||
Ending balance |
$ | 103,255 | 299,080 | 73,283 | 85,176 | 560,794 | ||||||||||||||
The following table summarizes the amount of classified and unclassified loans at December 31, 2016 and 2015:
December 31, 2016 |
||||||||||||||||||||||||||||
Classified |
Unclassified |
|||||||||||||||||||||||||||
(Dollars in thousands) |
Special Mention |
Substandard |
Doubtful |
Loss |
Total |
Total |
Total Loans |
|||||||||||||||||||||
Single family |
$ | 457 | 2,130 | 74 | 0 | 2,661 | 100,594 | 103,255 | ||||||||||||||||||||
Commercial real estate: |
||||||||||||||||||||||||||||
Real estate rental and leasing |
1,577 | 3,156 | 0 | 0 | 4,733 | 148,610 | 153,343 | |||||||||||||||||||||
Other |
1,702 | 7,187 | 0 | 0 | 8,889 | 136,848 | 145,737 | |||||||||||||||||||||
Consumer |
0 | 531 | 110 | 299 | 940 | 72,343 | 73,283 | |||||||||||||||||||||
Commercial business: |
||||||||||||||||||||||||||||
Transportation industry |
0 | 4,065 | 0 | 0 | 4,065 | 6,444 | 10,509 | |||||||||||||||||||||
Other |
3,973 | 2,916 | 0 | 0 | 6,889 | 67,778 | 74,667 | |||||||||||||||||||||
$ | 7,709 | 19,985 | 184 | 299 | 28,177 | 532,617 | 560,794 | |||||||||||||||||||||
December 31, 2015 |
||||||||||||||||||||||||||||
Classified |
Unclassified |
|||||||||||||||||||||||||||
(Dollars in thousands) |
Special Mention |
Substandard |
Doubtful |
Loss |
Total |
Total |
Total Loans |
|||||||||||||||||||||
Single family |
$ | 189 | 2,889 | 55 | 0 | 3,133 | 87,812 | 90,945 | ||||||||||||||||||||
Commercial real estate: |
||||||||||||||||||||||||||||
Real estate rental and leasing |
1,910 | 4,827 | 0 | 0 | 6,737 | 118,639 | 125,376 | |||||||||||||||||||||
Other |
917 | 9,473 | 0 | 0 | 10,390 | 111,587 | 121,977 | |||||||||||||||||||||
Consumer |
0 | 639 | 52 | 286 | 977 | 63,438 | 64,415 | |||||||||||||||||||||
Commercial business: |
||||||||||||||||||||||||||||
Transportation industry |
4,082 | 18 | 0 | 0 | 4,100 | 5,249 | 9,349 | |||||||||||||||||||||
Other |
841 | 1,515 | 0 | 0 | 2,356 | 58,401 | 60,757 | |||||||||||||||||||||
$ | 7,939 | 19,361 | 107 | 286 | 27,693 | 445,126 | 472,819 | |||||||||||||||||||||
Classified loans represent special mention, performing substandard, and non-performing loans categorized as substandard, doubtful and loss. Loans classified as special mention are loans that have potential weaknesses that, if left uncorrected, may result in deterioration of the repayment prospects for the asset or in the Bank ’s credit position at some future date. Loans classified as substandard are loans that are generally inadequately protected by the current net worth and paying capacity of the obligor, or by the collateral pledged, if any. Loans classified as substandard have a well-defined weakness or weaknesses that jeopardize the liquidation of the debt. Substandard loans are characterized by the distinct possibility that the Bank will sustain some loss if the deficiencies are not corrected. Loans classified as doubtful have the weaknesses of those classified as substandard, with additional characteristics that make collection in full on the basis of currently existing facts, conditions and values questionable, and there is a high possibility of loss. A loan classified as loss is considered uncollectible and of such little value that continuance as an asset on the balance sheet is not warranted. Loans classified as substandard or doubtful require the Bank to perform an analysis of the individual loan and charge off any loans, or portion thereof, that are deemed uncollectible.
The aging of past due loans at December 31, 2016 and 2015 is summarized as follows:
(Dollars in thousands) |
30-59 Days Past Due |
60-89 Days Past Due |
90 Days or More Past Due |
Total Past Due |
Current Loans |
Total Loans |
Loans 90 Days or More Past Due and Still Accruing |
|||||||||||||||||||||
2016 |
||||||||||||||||||||||||||||
Single family |
$ | 342 | 158 | 179 | 679 | 102,576 | 103,255 | 0 | ||||||||||||||||||||
Commercial real estate: |
||||||||||||||||||||||||||||
Real estate rental and leasing |
0 | 0 | 0 | 0 | 153,343 | 153,343 | 0 | |||||||||||||||||||||
Other |
0 | 0 | 0 | 0 | 145,737 | 145,737 | 0 | |||||||||||||||||||||
Consumer |
412 | 117 | 140 | 669 | 72,614 | 73,283 | 0 | |||||||||||||||||||||
Commercial business: |
||||||||||||||||||||||||||||
Transportation industry |
0 | 0 | 0 | 0 | 10,509 | 10,509 | 0 | |||||||||||||||||||||
Other |
85 | 0 | 274 | 359 | 74,308 | 74,667 | 0 | |||||||||||||||||||||
$ | 839 | 275 | 593 | 1,707 | 559,087 | 560,794 | 0 | |||||||||||||||||||||
2015 |
||||||||||||||||||||||||||||
Single family |
$ | 490 | 130 | 799 | 1,419 | 89,526 | 90,945 | 0 | ||||||||||||||||||||
Commercial real estate: |
||||||||||||||||||||||||||||
Real estate rental and leasing |
0 | 0 | 0 | 0 | 125,376 | 125,376 | 0 | |||||||||||||||||||||
Other |
0 | 289 | 0 | 289 | 121,688 | 121,977 | 0 | |||||||||||||||||||||
Consumer |
330 | 262 | 119 | 711 | 63,704 | 64,415 | 0 | |||||||||||||||||||||
Commercial business: |
||||||||||||||||||||||||||||
Transportation industry |
0 | 0 | 0 | 0 | 9,349 | 9,349 | 0 | |||||||||||||||||||||
Other |
45 | 0 | 0 | 45 | 60,712 | 60,757 | 0 | |||||||||||||||||||||
$ | 865 | 681 | 918 | 2,464 | 470,355 | 472,819 | 0 | |||||||||||||||||||||
Impaired loans include loans that are non-performing (non-accruing) and loans that have been modified in a TDR. The following table summarizes impaired loans and related allowances for the years ended December 31, 2016 and 2015:
December 31, 2016 |
||||||||||||||||||||
(Dollars in thousands) |
Recorded Investment |
Unpaid Principal Balance |
Related Allowance |
Average Recorded Investment |
Interest Income Recognized |
|||||||||||||||
Loans with no related allowance recorded: |
||||||||||||||||||||
Single family |
$ | 217 | 217 | 0 | 567 | 15 | ||||||||||||||
Commercial real estate: |
||||||||||||||||||||
Real estate rental and leasing |
40 | 122 | 0 | 40 | 0 | |||||||||||||||
Other |
26 | 1,771 | 0 | 29 | 97 | |||||||||||||||
Consumer |
312 | 312 | 0 | 449 | 13 | |||||||||||||||
Commercial business: |
||||||||||||||||||||
Other |
274 | 356 | 0 | 81 | 18 | |||||||||||||||
Loans with an allowance recorded: |
||||||||||||||||||||
Single family |
890 | 890 | 235 | 1,022 | 17 | |||||||||||||||
Commercial real estate: |
||||||||||||||||||||
Real estate rental and leasing |
0 | 0 | 0 | 389 | 0 | |||||||||||||||
Other |
1,814 | 1,814 | 248 | 1,856 | 229 | |||||||||||||||
Consumer |
628 | 644 | 434 | 553 | 13 | |||||||||||||||
Commercial business: |
||||||||||||||||||||
Other |
369 | 921 | 71 | 423 | 57 | |||||||||||||||
Total: |
||||||||||||||||||||
Single family |
1,107 | 1,107 | 235 | 1,589 | 32 | |||||||||||||||
Commercial real estate: |
||||||||||||||||||||
Real estate rental and leasing |
40 | 122 | 0 | 429 | 0 | |||||||||||||||
Other |
1,840 | 3,585 | 248 | 1,885 | 326 | |||||||||||||||
Consumer |
940 | 956 | 434 | 1,002 | 26 | |||||||||||||||
Commercial business: |
||||||||||||||||||||
Other |
643 | 1,277 | 71 | 504 | 75 | |||||||||||||||
$ | 4,570 | 7,047 | 988 | 5,409 | 459 |
December 31, 2015 |
||||||||||||||||||||
(Dollars in thousands) |
Recorded Investment |
Unpaid Principal Balance |
Related Allowance |
Average Recorded Investment |
Interest Income Recognized |
|||||||||||||||
Loans with no related allowance recorded: |
||||||||||||||||||||
Single family |
$ | 1,251 | 1,251 | 0 | 943 | 60 | ||||||||||||||
Commercial real estate: |
||||||||||||||||||||
Real estate rental and leasing |
44 | 184 | 0 | 46 | 7 | |||||||||||||||
Other |
25 | 1,706 | 0 | 5,462 | 96 | |||||||||||||||
Consumer |
475 | 476 | 0 | 387 | 10 | |||||||||||||||
Commercial business: |
||||||||||||||||||||
Other |
0 | 79 | 0 | 36 | 0 | |||||||||||||||
Loans with an allowance recorded: |
||||||||||||||||||||
Single family |
952 | 952 | 223 | 1,045 | 14 | |||||||||||||||
Commercial real estate: |
||||||||||||||||||||
Real estate rental and leasing |
0 | 0 | 0 | 3 | 0 | |||||||||||||||
Other |
2,135 | 2,135 | 296 | 1,920 | 32 | |||||||||||||||
Consumer |
502 | 519 | 370 | 448 | 20 | |||||||||||||||
Commercial business: |
||||||||||||||||||||
Other |
415 | 967 | 120 | 429 | 20 | |||||||||||||||
Total: |
||||||||||||||||||||
Single family |
2,203 | 2,203 | 223 | 1,988 | 74 | |||||||||||||||
Commercial real estate: |
||||||||||||||||||||
Real estate rental and leasing |
44 | 184 | 0 | 49 | 7 | |||||||||||||||
Other |
2,160 | 3,841 | 296 | 7,382 | 128 | |||||||||||||||
Consumer |
977 | 995 | 370 | 835 | 30 | |||||||||||||||
Commercial business: |
||||||||||||||||||||
Other |
415 | 1,046 | 120 | 465 | 20 | |||||||||||||||
$ | 5,799 | 8,269 | 1,009 | 10,719 | 259 | |||||||||||||||
At December 31, 2016, 2015 and 2014, non-accruing loans totaled $3.3 million, $4.2 million and $10.9 million, respectively, for which the related allowance for loan losses was $0.8 million, $0.7 million and $0.8 million, respectively. Non-accruing loans for which no specific allowance has been recorded because management determined that the value of the collateral was sufficient to repay the loan totaled $0.7 million, $1.4 million and $8.0 million at December 31, 2016, 2015, and 2014, respectively. Had the loans performed in accordance with their original terms, the Company would have recorded gross interest income on the loans of $0.6 million, $0.5 million and $0.9 million in 2016, 2015 and 2014, respectively. For the years ended December 31, 2016, 2015, and 2014, the Company recognized interest income on these loans of $0.4 million, $0.3 million and $0.2 million, respectively. All of the interest income that was recognized for non-accruing loans was recognized using the cash basis method of income recognition. Non-accrual loans also include some of the loans that have had terms modified in a TDR.
The following table summarizes non-accrual loans at December 31, 2016 and 2015:
Dollars in thousands) |
2016 |
2015 |
||||||
Single family |
$ | 916 | 1,655 | |||||
Commercial real estate: |
||||||||
Real estate rental and leasing |
41 | 44 | ||||||
Other |
1,343 | 1,650 | ||||||
Consumer |
630 | 786 | ||||||
Commercial business: |
||||||||
Other |
343 | 46 | ||||||
$ | 3,273 | 4,181 | ||||||
Included in loans receivable, net, are certain loans that have been modified in order to maximize collection of loan balances. If the Company, for legal or economic reasons related to the borrower ’s financial difficulties, grants a concession compared to the original terms and conditions of the loan, the modified loan is considered a troubled debt restructuring (TDR).
At December 31, 2016, 2015 and 2014, there were loans included in loans receivable, net, with terms that had been modified in a TDR totaling $3.3 million, $2.5 million and $9.4 million, respectively. Had these loans been performing in accordance with their original terms throughout 2016, 2015, and 2014, the Company would have recorded gross interest income of $0.6 million, $0.4 million and $0.9 million, respectively. During 2016, 2015 and 2014, the Company recognized interest income of $0.4 million, $0.2 million and $0.3 million, respectively, on these loans. For the loans that were modified in 2016, $0.2 million were classified and performing, and $1.7 million were non-performing at December 31, 2016.
The following table summarizes TDRs at December 31, 2016 and 2015:
(Dollars in thousands) |
2016 |
2015 |
||||||
Single family |
$ | 448 | 647 | |||||
Commercial real estate: |
||||||||
Other |
1,774 | 725 | ||||||
Consumer |
709 | 732 | ||||||
Commercial business: |
||||||||
Other |
369 | 415 | ||||||
$ | 3,300 | 2,519 | ||||||
As of December 31, 2016, the Bank had commitments to lend an additional $ 0.4 million to a borrower who has TDR and non-accrual loans. These additional funds are for the construction of single family homes with a maximum loan-to-value ratio of 75%. These loans are secured by the home under construction. There were commitments to lend additional funds of $1.5 million to this same borrower at December 31, 2015.
TDR concessions can include reduction of interest rates, extension of maturity dates, forgiveness of principal and/or interest due, or acceptance of real estate or other assets in full or partial satisfaction of the debt. Loan modifications are not reported as TDRs after 12 months if the loan was modified at a market rate of interest for comparable risk loans, and the loan is performing in accordance with the terms of the restructured agreement. All loans classified as TDRs are considered to be impaired.
When a loan is modified as a TDR, there may be a direct, material impact on the loans within the Consolidated Balance Sheets, as principal balances may be partially forgiven. The financial effects of TDRs are presented in the following table and represent the difference between the outstanding recorded balance pre-modification and post-modification, for the periods ending December 31, 2016 and 2015:
Year ended December 31, 2016 |
Year ended December 31, 2015 |
|||||||||||||||||||||||
(Dollars in thousands) |
Number of Contracts |
Pre- modification Outstanding Recorded Investment |
Post-modification Outstanding Recorded Investment |
Number of Contracts |
Pre- modification Outstanding Recorded Investment |
Post- modification Outstanding Recorded Investment |
||||||||||||||||||
Troubled debt restructurings: |
||||||||||||||||||||||||
Single family |
4 | $ | 251 | 263 | 4 | $ | 476 | 478 | ||||||||||||||||
Commercial real estate: |
||||||||||||||||||||||||
Other |
1 | 1,274 | 1,274 | 1 | 209 | 209 | ||||||||||||||||||
Consumer |
18 | 382 | 384 | 21 | 527 | 530 | ||||||||||||||||||
Commercial business: |
||||||||||||||||||||||||
Other |
2 | 257 | 201 | 1 | 44 | 44 | ||||||||||||||||||
Total |
25 | $ | 2,164 | 2,122 | 27 | $ | 1,256 | 1,261 | ||||||||||||||||
Loans that were restructured within the 12 months preceding December 31, 2016 and 2015 and defaulted during the year are presented in the table below:
Year ended December 31, 2016 |
Year ended December 31, 2015 |
|||||||||||||||
(Dollars in thousands) |
Number of Contracts |
Outstanding Recorded Investment |
Number of Contracts |
Outstanding Recorded Investment |
||||||||||||
Troubled debt restructurings that subsequently defaulted: |
||||||||||||||||
Commercial real estate: |
||||||||||||||||
Other |
1 | $ | 183 | 0 | $ | 0 | ||||||||||
Consumer |
1 | 4 | 0 | 0 | ||||||||||||
Total |
2 | $ | 187 | 0 | $ | 0 | ||||||||||
The Company considers a loan to have defaulted when it becomes 90 or more days past due under the modified terms, when it is placed in non-accrual status, when it becomes other real estate owned, or when it becomes non-compliant with some other material requirement of the modification agreement.
Loans that were non-accrual prior to modification remain non-accrual for at least six months following modification. Non-accrual TDR loans that have performed according to the modified terms for six months may be returned to accruing status. Loans that were accruing prior to modification remain on accrual status after the modification as long as the loan continues to perform under the new terms.
TDRs are reviewed for impairment following the same methodology as other impaired loans. For loans that are collateral dependent, the value of the collateral is reviewed and additional reserves may be added as needed. Loans that are not collateral dependent may have additional reserves established if deemed necessary. The allocated allowance for TDRs was $0.6 million, or 6.2%, of the total $9.9 million in allowance for loan losses at December 31, 2016, and $0.5 million, or 5.2%, of the total $9.7 million in allowance for loan losses at December 31, 2015.
Loans acquired in a business combination are segregated into two types: purchased performing loans with a discount attributable at least in part to credit quality and PCI loans with evidence of significant credit deterioration. Purchased performing loans are accounted for in accordance with ASC 310-20 “Nonrefundable Fees and Other Costs” as these loans do not have evidence of credit deterioration since origination. PCI loans are accounted for in accordance with ASC 310-30 “Receivables – Loans and Debt Securities Acquired with Deteriorated Credit Quality” as they display significant credit deterioration since origination. In accordance with ASC 310-30, for PCI loans, the difference between contractually required payments at acquisition and the cash flows expected to be collected is referred to as the non-accretable difference. This amount is not recognized as a yield adjustment or as a loss accrual or a valuation allowance. Furthermore, any excess of cash flows expected at acquisition over the estimated fair value is referred to as the accretable yield and is recognized into interest income over the remaining life of the loans when there is a reasonable expectation about the amount and timing of such cash flows. Increases in expected cash flows subsequent to the initial investment are recognized prospectively through an adjustment of the yield on the loan over its remaining estimated life. Decreases in expected cash flows are recognized immediately as an impairment through the provision for loan losses.
The following is additional information with respect to loans acquired through acquistions:
(Dollars in thousands) |
Contractual Principal Receivable |
Accretable Difference |
Carrying Amount |
|||||||||
Purchased Performing Loans: |
||||||||||||
Balance at December 31, 2015 |
$ | 18,539 | (459 | ) | 18,080 | |||||||
Loans acquired during the period |
11,772 | (211 | ) | 11,561 | ||||||||
Change due to payments/refinances |
(13,413 | ) | 340 | (13,073 | ) | |||||||
Change due to loan charge-off |
(156 | ) | (2 | ) | (158 | ) | ||||||
Balance at December 31, 2016 |
$ | 16,742 | (332 | ) | 16,410 | |||||||
(Dollars in thousands) |
Contractual Principal Receivable |
Non-Accretable Difference |
Carrying Amount |
|||||||||
Purchased Credit Impaired Loans: |
||||||||||||
Balance at December 31, 2015 |
$ | 555 | (162 | ) | 393 | |||||||
Loans acquired during the period |
329 | (37 | ) | 292 | ||||||||
Change due to payments/refinances |
(449 | ) | 147 | (302 | ) | |||||||
Balance at December 31, 2016 |
$ | 435 | (52 | ) | 383 | |||||||
As a result of acquisitions, the Company has PCI loans for which there was, at acquisition, evidence of deterioration of credit quality since origination and for which it was probable at acquisition that all contractually required payments would not be collected. The carrying amount of those loans as of December 31, 2016 was $0.4 million.
No material provision for loan losses was recognized during the period ended December 31, 2016 related to acquired loans as there was no significant change to the credit quality of the loans.
NOTE 7 Accrued Interest Receivable
Accrued interest receivable at December 31 is summarized as follows:
(Dollars in thousands) |
2016 |
2015 |
||||||
Securities available for sale |
$ | 400 | 422 | |||||
Loans receivable |
2,226 | 1,832 | ||||||
$ | 2,626 | 2,254 | ||||||
NOTE 8 Intangible Assets
The Company’ s intangible assets consist of core deposit intangibles, goodwill, and mortgage servicing rights. A summary of mortgage servicing rights activity for 2016 and 2015 is as follows:
(Dollars in thousands) |
2016 |
2015 |
||||||
Mortgage servicing rights: |
||||||||
Balance, beginning of year |
$ | 1,499 | 1,507 | |||||
Originations |
706 | 547 | ||||||
Amortization |
(601 | ) | (555 | ) | ||||
Balance, end of year |
1,604 | 1,499 | ||||||
Valuation reserve |
0 | 0 | ||||||
Mortgage servicing rights, net |
$ | 1,604 | 1,499 | |||||
Fair value of mortgage servicing rights |
$ | 2,952 | 2,590 | |||||
All of the single family loans sold where the Company continues to service the loans are serviced for Federal National Mortgage Association (FNMA) under the individual loan sale program. The following is a summary of the risk characteristics of the loans being serviced for FNMA at December 31, 2016:
(Dollars in thousands) |
Loan Principal Balance |
Weighted Av erage Interest Rate |
Weighted Average Remaining Term (months) |
Number of Loans |
||||||||||||
Original term: |
||||||||||||||||
30 year fixed rate |
$ | 235,933 | 4.07 |
% |
305 | 1,953 | ||||||||||
15 year fixed rate |
110,377 | 3.12 | 140 | 1,163 | ||||||||||||
Adjustable rate |
57 | 2.75 | 293 | 2 |
The gross carrying amount of intangible assets and the associated accumulated amortization at December 31, 2016 and 2015 are presented in the following table. Amortization expense for intangible assets was $0.7 million, $0.6 million, and $0.5 million for the years ended December 31, 2016, 2015, and 2014, respectively.
Gross |
Unamortized |
|||||||||||
Carrying |
Accumulated |
Intangible |
||||||||||
(Dollars in thousands) |
Amount |
Amortization |
Assets |
|||||||||
December 31, 2016 |
||||||||||||
Mortgage servicing rights |
$ | 3,954 | (2,350 | ) | 1,604 | |||||||
Core deposit intangible |
574 | (120 | ) | 454 | ||||||||
Goodwill |
802 | 0 | 802 | |||||||||
Total |
$ | 5,330 | (2,470 | ) | 2,860 | |||||||
December 31, 2015 |
||||||||||||
Mortgage servicing rights |
$ | 3,739 | (2,240 | ) | 1,499 | |||||||
Core deposit intangible |
421 | (28 | ) | 393 | ||||||||
Total |
$ | 4,160 | (2,268 | ) | 1,892 | |||||||
The following table indicates the estimated future amortization expense for amortizing intangible assets:
(Dollars in thousands) |
Mortgage Servicing Rights |
Core Deposit Intangible |
Total
Intangible Assets |
|||||||||
Year ended December 31, |
||||||||||||
2017 |
$ | 440 | 99 | 539 | ||||||||
2018 |
350 | 99 | 449 | |||||||||
2019 |
297 | 99 | 396 | |||||||||
2020 |
215 | 99 | 314 | |||||||||
2021 |
162 | 47 | 209 | |||||||||
Thereafter |
140 | 11 | 151 | |||||||||
$ | 1,604 | 454 | 2,058 | |||||||||
No amortization expense relating to goodwill is recorded as generally accepted accounting principles do not allow goodwill to be amortized, but require that it be tested for impairment at least annually, or sooner, if there are indications that impairment may exist.
Projections of amortization are based on asset balances and the interest rate environment that existed at December 31, 2016. The Company®€™ s actual experience may be significantly different depending upon changes in mortgage interest rates and other market conditions.
NOTE 9 Real Estate
A summary of real estate at December 31, 2016 and 2015 is as follows:
2016 |
2015 |
|||||||||||||||||||||||
(Dollars in thousands) |
Residential |
Commercial & Other |
Total |
Residential |
Commercial & Other |
Total |
||||||||||||||||||
Real estate in judgment subject to redemption |
$ | 0 | 0 | 0 | 110 | 0 | 110 | |||||||||||||||||
Real estate acquired through foreclosure |
0 | 1,245 | 1,245 | 0 | 2,269 | 2,269 | ||||||||||||||||||
Real estate acquired through deed in lieu of foreclosure |
0 | 28 | 28 | 0 | 465 | 465 | ||||||||||||||||||
0 | 1,273 | 1,273 | 110 | 2,734 | 2,844 | |||||||||||||||||||
Allowance for losses |
0 | (662 | ) | (662 | ) | (62 | ) | (737 | ) | (799 | ) | |||||||||||||
$ | 0 | 611 | 611 | 48 | 1,997 | 2,045 | ||||||||||||||||||
NOTE 10 Premises and Equipment
A summary of premises and equipment at December 31, 2016 and 2015 is as follows:
(Dollars in thousands) |
2016 |
2015 |
||||||
Land |
$ | 2,021 | 2,021 | |||||
Office buildings and improvements |
9,666 | 8,930 | ||||||
Furniture and equipment |
12,478 | 12,714 | ||||||
24,165 | 23,665 | |||||||
Accumulated depreciation |
(15,942 | ) | (16,196 | ) | ||||
$ | 8,223 | 7,469 | ||||||
NOTE 11 Deposits
Deposits and their weighted average interest rates at December 31, 2016 and 2015 are summarized as follows:
2016 |
2015 |
|||||||||||||||||||||||||
(Dollars in thousands) |
Weighted Average Rate |
Amount |
Percent of Total |
Weighted Average Rate |
Amount |
Percent of Total |
||||||||||||||||||||
Noninterest checking |
0.00 |
% |
$ | 158,024 | 26.7 |
% |
0.00 |
% |
$ | 151,737 | 27.1 |
% |
||||||||||||||
NOW accounts |
0.07 | 92,670 | 15.6 | 0.04 | 82,425 | 14.7 | ||||||||||||||||||||
Savings accounts |
0.08 | 74,238 | 12.5 | 0.09 | 66,421 | 11.9 | ||||||||||||||||||||
Money market accounts |
0.25 | 165,179 | 27.9 | 0.22 | 159,959 | 28.6 | ||||||||||||||||||||
490,111 | 82.7 | 460,542 | 82.3 | |||||||||||||||||||||||
Certificates by rate: |
||||||||||||||||||||||||||
0 | - | 0.99% | 79,628 | 13.4 | 85,391 | 15.3 | ||||||||||||||||||||
1 | 1.99% | 22,958 | 3.9 | 12,611 | 2.3 | |||||||||||||||||||||
2 | - | 2.99% | 0 | 0.0 | 733 | 0.1 | ||||||||||||||||||||
3 | - | 3.99% | 114 | 0.0 | 110 | 0.0 | ||||||||||||||||||||
Total certificates |
0.61 | 102,700 | 17.3 | 0.53 | 98,845 | 17.7 | ||||||||||||||||||||
Total deposits |
0.20 | $ | 592,811 | 100.0 |
% |
0.17 | $ | 559,387 | 100.0 |
% |
||||||||||||||||
At December 31, 2016 and 2015, the Company had $172.6 million and $183.0 million, respectively, of deposit accounts with balances of $250,000 or more. At December 31, 2016 an d 2015, the Company had no certificate accounts that had been acquired through a broker.
Certificates had the following maturities at December 31, 2016 and 2015:
At December 31, 2016 and 2015, the Company had pledged mortgage loans and mortgage-backed and related securities with an amortized cost of approximately $17.4 million and $28.0 million, respectively, as collateral for certain deposits. An additional $1.0 million of letters of credit from the Federal Home Loan Bank (FHLB) were pledged at December 31, 2016 and 2015 as collateral on certain Bank deposits.
Interest expense on deposits is summarized as follows for the years ended December 31, 2016, 2015 and 20 14:
Dollars in thousands) |
2016 |
2015 |
2014 |
|||||||||
NOW accounts |
$ | 50 | 17 | 14 | ||||||||
Savings accounts |
62 | 42 | 32 | |||||||||
Money market accounts |
366 | 347 | 414 | |||||||||
Certificates |
524 | 528 | 751 | |||||||||
$ | 1,002 | 934 | 1,211 | |||||||||
NOTE 12 FHLB Advances and Other Borrowings
The Bank had no outstanding advances from the FHLB or borrowings from the Federal Reserve Bank of Minneapolis as of December 31, 2016 or December 31, 2015. At December 31, 2016 it had collateral pledged to the FHLB consisting of FHLB stock, mortgage loans, and investments with a borrowing capacity of approximately $105.7 million. The Bank had the ability to draw additional borrowings of $104.7 million from the FHLB, based upon the mortgage loans and securities that were pledged at December 31, 2016, subject to a requirement to purchase FHLB stock. The Bank also had the ability to draw additional borrowings of $85.8 million from the Federal Reserve Bank of Minneapolis, based upon the loans that were pledged to them as of December 31, 2016, subject to approval from the Board of Governors of the Federal Reserve System (FRB).
At December 31, 2015 the Bank had collateral pledged to the FHLB consisting of FHLB stock, mortgag e loans, and investments with a borrowing capacity of approximately $96.3 million. The Bank had the ability to draw additional borrowings of $95.3 million from the FHLB, based upon the mortgage loans and securities that were pledged as of December 31, 2015, subject to a requirement to purchase FHLB stock. The Bank also had the ability to draw additional borrowings of $73.5 million from the Federal Reserve Bank of Minneapolis, based upon the loans that were pledged to them as of December 31, 2015, subject to approval from the FRB.
On December 15, 2014, the Company entered into a Loan Agreement with an unrelated third party, providing for a term loan of up to $10.0 million that was evidenced by a promissory note (the Note) with an interest rate of 6.50% per annum. The principal balance of the Note is payable in consecutive equal annual installments of $1.0 million on each anniversary of the date of the Loan Agreement, commencing on December 15, 2015, with the balance due on December 15, 2021. Provided that no default or event of default has occurred and is continuing, the Company may, at its option, elect to defer the payment of one installment of principal on the Note otherwise due prior to the maturity date, in which event such installment will become due and payable on the maturity date. The Company may voluntarily prepay the Note in whole or in part without penalty and the Company has prepaid $1.0 million of principal on the Note in addition to the required annual payments. The outstanding loan balance was $7.0 million at December 31, 2016 and $9.0 million at December 31, 2015.
NOTE 13 Income Taxes
Income tax expense for the years ended December 31, 2016, 2015 and 2014 is as follows:
(Dollars in thousands) |
2016 |
2015 |
2014 |
|||||||||
Current: |
||||||||||||
Federal |
$ | 939 | (87 | ) | 262 | |||||||
State |
55 | (24 | ) | 74 | ||||||||
Total current |
994 | (111 | ) | 336 | ||||||||
Deferred: |
||||||||||||
Federal |
2,322 | 1,393 | 3,753 | |||||||||
State |
806 | 329 | 813 | |||||||||
Total deferred |
3,128 | 1,722 | 4,566 | |||||||||
Income tax expense |
$ | 4,122 | 1,611 | 4,902 | ||||||||
The reasons for the difference between the expected income tax expense utilizing the federal corporate tax rate of 34% and the actual income tax expense are as follows:
(Dollars in thousands) |
2016 |
2015 |
2014 |
|||||||||
Expected federal income tax expense |
$ | 3,560 | 1,553 | 4,176 | ||||||||
Items affecting federal income tax: |
||||||||||||
State income taxes, net of federal income tax deduction |
622 | 259 | 698 | |||||||||
Tax exempt interest |
(16 | ) | (44 | ) | (45 | ) | ||||||
Other, net |
(44 | ) | (157 | ) | 73 | |||||||
Income tax expense |
$ | 4,122 | 1,611 | 4,902 | ||||||||
The tax effects of temporary differences that give rise to the deferred tax assets and deferred tax liabilities are as follows at December 31:
Dollars in thousands) |
2016 |
2015 |
||||||
Deferred tax assets: |
||||||||
Allowances for loan and real estate losses |
$ | 4,186 | 4,169 | |||||
Deferred compensation costs |
262 | 235 | ||||||
Deferred ESOP loan asset |
704 | 710 | ||||||
Nonaccruing loan interest |
313 | 361 | ||||||
Federal net operating loss carryforward |
0 | 1,805 | ||||||
State net operating loss carryforward |
1,366 | 2,255 | ||||||
Alternative minimum tax credit carryforward |
118 | 500 | ||||||
Capitalized other real estate owned expenses |
56 | 530 | ||||||
Net unrealized loss on securities available for sale |
542 | 142 | ||||||
Other |
91 | 155 | ||||||
Total gross deferred tax assets |
7,638 | 10,862 | ||||||
Deferred tax liabilities: |
||||||||
Deferred loan fees |
100 | 247 | ||||||
Premises and equipment basis difference |
126 | 139 | ||||||
Originated mortgage servicing rights |
636 | 594 | ||||||
Federal tax liability on state net operating loss carryforwards |
676 | 779 | ||||||
Core deposit intangible |
74 | 105 | ||||||
Other |
79 | 325 | ||||||
Total gross deferred tax liabilities |
1,691 | 2,189 | ||||||
Net deferred tax assets |
$ | 5,947 | 8,673 |
The Company has no federal net operating loss carryforwards and $14.3 million of state net operating loss carryforwards at December 31, 2016 that expire beginning in 2023.
Retained earnings at December 31, 2016 included approximately $8.8 million for which no provision for income taxes was made. This amount represents allocations of income to bad debt deductions for tax purposes. Reduction of amounts so allocated for purposes other than absorbing losses will create income for tax purposes, which will be subject to the then-current corporate income tax rate.
The Company considers the determination of the deferred tax asset amount and the need for any valuation reserve to be a critical accounting policy that requires significant judgment. The Company has, in its judgment, made reasonable assumptions and considered both positive and negative evidence relating to the ultimate realization of deferred tax assets. Positive evidence includes the cumulative net income generated over the prior three year period and the probability that taxable income will be generated in future periods. Negative evidence includes the current general business and economic environments. Based upon this evaluation, the Company determined that no valuation allowance was required with respect to the net deferred tax assets at December 31, 2016 and 2015.
NOTE 14 Employee Benefits
A ll eligible full-time employees of the Bank that were hired prior to 2002 were included in a noncontributory retirement plan sponsored by the Financial Institutions Retirement Fund (FIRF). The Home Federal Savings Bank (Employer #8006) plan participates in the Pentegra Defined Benefit Plan for Financial Institutions (the Pentegra DB Plan). The Pentegra DB Plan ’ s Employer Identification Number is 13-5645888 and the Plan number is 333. The Pentegra DB Plan operates as a multi-employer plan for accounting purposes under the Employee Retirement Income Security Act of 1974, as amended (ERISA), and the Internal Revenue Code. There are no collective bargaining agreements in place that require contributions to the Pentegra DB Plan.
The Pentegra DB Plan is a sing le plan under Internal Revenue Code Section 413(c) and, as a result, all of the assets stand behind all of the liabilities. Accordingly, under the Pentegra DB Plan, contributions made by a participating employer may be used to provide benefits to participants of other participating employers.
Effective September 1, 2002, the accrual of benefits for existing participants was frozen and no new enrollments were permitted into the plan. The actuarial present value of accumulated plan benefits and net assets available for benefits relating to the Bank's employees was not available at December 31, 2016 because such information is not accumulated for each participating institution. As of June 30, 2016, the Pentegra DB Plan valuation report reflected that the Bank was obligated to make a contribution totaling $0.2 million which was expensed in 2016 and paid in the first quarter of 2017.
Funded status (market value of plan assets divided by funding target) as of July 1 for the 2016, 2015 , and 2014 plan years were 97.09%, 96.01%, and 97.98%, respectively. Market value of plan assets reflects contributions received through June 30, 2016.
Total employer contributions made to the Pentegra DB Plan, as reported on Form 5500, equal $163.1 mil lion, $190.8 million, and $136.5 million for the plan years ended June 30, 2015, 2014 and 2013, respectively. The Bank®€™s contributions to the Pentegra DB Plan are not more than 5% of the total contributions to the Pentegra DB Plan. There is no funding improvement plan or rehabilitation plan as part of this multi-employer plan.
The following contributions were paid by the Bank during the fiscal years ending December 31:
(Dollars in thousands) | ||||||||||||||
2016 | 2015 | 2014 | ||||||||||||
Date Paid |
Amount |
Date Paid |
Amount |
Date Paid |
Amount |
|||||||||
10/15/16 |
$ | 33 | * |
10/15/2015 |
$ | 42 |
10/15/2014 |
$ | 46 | |||||
12/30/2015 |
151 |
12/30/2014 |
164 | |||||||||||
Total |
$ | 33 | $ | 193 | $ | 210 | ||||||||
*- An additional contribution of $119,000 was accrued at December 31, 2016 and paid in the first quarter of 2017.
The Company has a qualified, tax-exempt savings plan with a deferred feature qualifying under Section 401(k) of the Internal Revenue Code (the 401(k) Plan). All employees who have attained 18 years of age are eligible to participate in the 401(k) Plan. Participants are permitted to make contributions to the 401(k) Plan equal to the lesser of 50% of their annual salary or the maximum allowed by law, which was $18,000 for 2016 and 2015 and $17,500 for 2014. The Company matches 25% of each participant®€™s contributions up to a maximum of 8% of their annual salary. Participant contributions and earnings are fully and immediately vested. The Company ’ s contributions are vested on a three year cliff basis, are expensed annually, and were $0.2 million in 2016 and 2015 and $0.1 million in 2014.
The Company has adopted an Employee Stock Ownership Plan (the ESOP) that meets the requirements of Section 4975(e)(7) of the Internal Revenue Code and Section 407(d)(6) of ERISA and, as such, the ESOP is empowered to borrow in order to finance purchases of the common stock of HMN. The ESOP borrowed $6.1 million from the Company to purchase 912,866 shares of common stock in the initial public offering of HMN in 1994. As a result of a merger with Marshalltown Financial Corporation (MFC), the ESOP borrowed $1.5 million in 1998 to purchase an additional 76,933 shares of HMN common stock to account for the additional employees and avoid dilution of the benefit provided by the ESOP. The ESOP debt requires quarterly payments of principal plus interest at 7.52%. The Company has committed to make quarterly contributions to the ESOP necessary to repay the loans including interest. The Company contributed $0.5 million in 2016, 2015, and 2014.
As the debt is repaid, ESOP shares that were pledged as collateral for the debt are released from collateral based on the proportion of debt servic e paid in the year and then allocated to eligible employees. The Company accounts for its ESOP in accordance with ASU 718, Employers' Accounting for Employee Stock Ownership Plans . Accordingly, the shares pledged as collateral are reported as unearned ESOP shares in stockholders' equity. As shares are determined to be ratably released from collateral, the Company reports compensation expense equal to the current market price of the shares, and the shares become outstanding for earnings per common share computations. ESOP compensation expense was $0.3 million for each of the years ending December 31, 2016, 2015 and 2014.
All employees of the Bank are eligible to participate in the ESOP after they attain age 18 and complete one year of service during which they worked at least 1,000 hours. A summary of the ESOP share allocation is as follows for the years ended December 31:
2016 |
2015 |
2014 |
||||||||||
Shares held by participants beginning of the year |
334,277 | 336,024 | 347,887 | |||||||||
Shares allocated to participants |
24,377 | 24,317 | 24,317 | |||||||||
Shares distributed to participants |
(18,784 | ) | (26,064 | ) | (36,180 | ) | ||||||
Shares held by participants end of year |
339,870 | 334,277 | 336,024 | |||||||||
Unreleased shares beginning of the year |
304,123 | 328,440 | 352,757 | |||||||||
Shares released during year |
(24,377 | ) | (24,317 | ) | (24,317 | ) | ||||||
Unreleased shares end of year |
279,746 | 304,123 | 328,440 | |||||||||
Total ESOP shares end of year |
619,616 | 638,400 | 664,464 | |||||||||
Fair value of unreleased shares at December 31 |
$ | 4,895,555 | 3,512,621 | 4,072,656 | ||||||||
In March 2001, the HMN Financial, Inc. 2001 Omnibus Stock Plan (2001 Plan) was adopted by the Company. In April 2009, this plan was superseded by the HMN Financial, Inc. 2009 Equity and Incentive Plan (2009 Plan) and options or restricted shares were no longer awarded from the 2001 Plan. As of December 31, 2016, all outstanding options issued under the 2001 Plan have expired.
The purpose of the 2009 Plan is to provide key personnel and advisors with an opportunity to acquire a proprietary interest in the Company. The opportunity to acquire a proprietary interest in the Company is intended to aid in attracting, motivating and retaining key personnel and advisors, including non-employee directors, and to align their interests with those of the Company ’ s stockholders. 350,000 shares of HMN common stock were initially available for distribution under the 2009 Plan in either restricted stock or stock options, subject to adjustment for future stock splits, stock dividends and similar changes to the capitalization of the Company. Additionally, shares of restricted stock that are awarded are counted as 1.2 shares for purposes of determining the total shares available for issuance under the 2009 Plan. As of December 31, 2016, there were 15,000 vested and 34,229 unvested options under the 2009 Plan that remain unexercised. These options expire 10 years from the date of grant and have a weighted average exercise price of $9.25.
A summary of activities under all plans for the past th ree years is as follows:
Unvested options |
||||||||||||||||||||||||||||
Shares Available For Grant |
Unvested Restricted Shares Outstanding |
Options Outstanding |
Award Value/ Weighted Average Exercise Price |
Number |
Weighted Average Grant Date Fair Value |
Vesting Period (in years) |
||||||||||||||||||||||
2001 Plan |
||||||||||||||||||||||||||||
December 31, 2013 |
0 | 0 | 45,540 | $ | 28.21 | 0 | ||||||||||||||||||||||
Forfeited/expired |
0 | 0 | (30,540 | ) | 27.33 | 0 | ||||||||||||||||||||||
December 31, 2014 |
0 | 0 | 15,000 | 30.00 | 0 | |||||||||||||||||||||||
Forfeited/expired |
0 | 0 | (15,000 | ) | 30.00 | 0 | ||||||||||||||||||||||
December 31, 2015 |
0 | 0 | 0 | 0.00 | 0 | |||||||||||||||||||||||
December 31, 2016 |
0 | 0 | 0 | 0.00 | 0 | |||||||||||||||||||||||
2009 Plan |
||||||||||||||||||||||||||||
December 31, 2013 |
121,053 | 101,806 | 15,000 | $ | 4.77 | 3,000 | $ | 4.41 | ||||||||||||||||||||
Granted January 7, 2014 |
(28,627 | ) | 23,856 | 0 | N/A | 0 | 3 | |||||||||||||||||||||
Granted May 27, 2014 |
(26,561 | ) | 22,134 | 0 | N/A | 0 | 3 | |||||||||||||||||||||
Forfeited/expired |
30,540 | 0 | 0 | 0 | ||||||||||||||||||||||||
Vested |
0 | (62,938 | ) | 0 | (3,000 | ) | 4.41 | |||||||||||||||||||||
December 31, 2014 |
96,405 | 84,858 | 15,000 | 4.77 | 0 | |||||||||||||||||||||||
Granted January 27, 2015 |
(11,903 | ) | 9,919 | 0 | N/A | 0 | 3 | |||||||||||||||||||||
Granted April 28, 2015 |
(3,158 | ) | 2,632 | 0 | N/A | 0 | 1 | |||||||||||||||||||||
Granted June 8, 2015 |
(398 | ) | 332 | 0 | N/A | 0 | 1 | |||||||||||||||||||||
Forfeited/expired |
395 | (329 | ) | 0 | 0 | |||||||||||||||||||||||
Forfeited/expired |
15,000 | 0 | 0 | 0 | ||||||||||||||||||||||||
Vested |
0 | (58,526 | ) | 0 | 0 | |||||||||||||||||||||||
December 31, 2015 |
96,341 | 38,886 | 15,000 | 4.77 | 0 | |||||||||||||||||||||||
Granted January 26, 2016 |
(4,087 | ) | 3,406 | 0 | N/A | 0 | 3 | |||||||||||||||||||||
Granted January 26, 2016 |
(34,229 | ) | 0 | 34,229 | 11.21 | 34,229 | 4.04 | 3 | ||||||||||||||||||||
Granted April 26, 2016 |
(3,149 | ) | 2,624 | 0 | N/A | 0 | 1 | |||||||||||||||||||||
Vested |
0 | (24,320 | ) | 0 | 0 | |||||||||||||||||||||||
December 31, 2016 |
54,876 | 20,596 | 49,229 | 9.25 | 34,229 | 4.04 | ||||||||||||||||||||||
Total all plans |
54,876 | 20,596 | 49,229 | $ | 9.25 | 34,229 | $ | 4.04 |
The following table summarizes information about stock options outstanding at December 31, 2016:
Date of Grant |
Exercise Price |
Number Outstanding |
Weighted Average Remaining Contractual Life in Years |
Number Exercisable |
Number Unexercisable |
Unrecognized Compensation Expense |
Weighted Average Years Over Which Unrecognized Compensation will be Recognized |
|||||||||||||||||||||
May 6, 2009 |
$ | 4.77 | 15,000 | 2.4 | 15,000 | 0 | $ | 0 | N/A | |||||||||||||||||||
January 26, 2016 |
$ | 11.21 | 34,229 | 9.1 | 0 | 34,229 | 59,528 | 2.1 | ||||||||||||||||||||
49,229 | 15,000 | 34,229 | $ | 59,528 | ||||||||||||||||||||||||
The Company will issue shares from treasury stock upon the exercise of outstanding options.
In accordance with ASC 718, the Company recognized compensation expense relating to the stock options granted in 2016 over the vesting period. The amount of the expense was determined under the fai r value method. There were no options granted in 2015 or 2014.
The fair value for each option grant is estimated on the date of the grant using a Black Scholes option valuation model. The assumptions used in determining the fair value of the options gran ted during 2016 are as follows:
2016 |
||||
Risk-free interest rate |
2.10 | % | ||
Expected life (in years) |
10 | |||
Expected volatility |
22.83 | % | ||
Expected dividends |
0.00 | % |
NOTE 15 Earnings per Common Share
The following table reconciles the weighted average shares outstanding and net income for basic and diluted earnings per common share:
Year ended December 31, |
||||||||||||
(Dollars in thousands, except per share data) |
2016 |
2015 |
2014 |
|||||||||
Weighted average number of common shares outstanding used in basic earnings per common share calculation |
4,180,994 | 4,127,453 | 4,060,404 | |||||||||
Net dilutive effect of : |
||||||||||||
Options and warrants |
553,386 | 513,505 | 507,856 | |||||||||
Restricted stock awards |
13,367 | 34,959 | 55,783 | |||||||||
Weighted average number of common shares outstanding adjusted for effect of dilutive securities |
4,747,747 | 4,675,917 | 4,624,043 | |||||||||
Net income |
$ | 6,350 | 2,956 | 7,379 | ||||||||
Dividends on preferred stock |
0 | (108 | ) | (1,710 | ) | |||||||
Net income available to common shareholders |
$ | 6,350 | 2,848 | 5,669 | ||||||||
Basic earnings per common share |
$ | 1.52 | 0.69 | 1.40 | ||||||||
Diluted earnings per common share |
$ | 1.34 | 0.61 | 1.23 | ||||||||
NOTE 16 Stockholders' Equity
The Company did not repurchase any shares of its common stock or pay any dividends on its common stock during 2016, 2015 or 2014.
The Company's certificate of incorporation authorizes the issuance of up to 500,000 shares of preferred stock, and on De cember 23, 2008, the Company completed the sale of 26,000 shares of Fixed Rate Cumulative Perpetual Preferred Stock, Series A (Preferred Stock) to the United Stated Department of Treasury (Treasury). The Preferred Stock had a liquidation value of $1,000 per share and a related warrant was also issued to purchase 833,333 shares of HMN common stock at an exercise price of $4.68 per share (the Warrant). The transaction was part of the Treasury®€™s Capital Purchase Program under the Emergency Economic Stabilization Act of 2008.
On February 17, 2015, the Company redeemed the final 10,000 shares of the outstanding Preferred Stock. On May 21, 2015, the Treasury sold the Warrant at an exercise price of $4.68 to three unaffiliated third party investors for an ag gregate purchase price of $5.7 million. Two of the investors received a warrant to purchase 277,777.67 shares and one investor received a warrant to purchase 277,777.66 shares. All of the warrants were still outstanding as of December 31, 2016 and may be exercised at any time prior to their expiration date of December 23, 2018. The Company received no proceeds from this transaction and it had no effect on the Company®€™s capital, financial condition or results of operations.
In order to grant a priority to eligible accountholders in the event of future liquidation, the Bank, at the time of conversion to a stock savings bank, established a liquidation account equal to its regulatory capital as of September 30, 1993. In the event of future liquidation of the Bank, an eligible accountholder who continues to maintain their deposit account shall be entitled to receive a distribution from the liquidation account. The total amount of the liquidation account will decrease as the balance of eligible accountholders is reduced subsequent to the conversion, based on an annual determination of such balance.
NOTE 17 Regulatory Capital
Effective January 1, 2015 the capital requirements of the Company and the Bank were changed to implement the regulatory requirements of the Basel III capital reforms. The Basel III requirements, among other things, (i) apply a strengthened set of capital requirements to the Bank (the Company is exempt, pursuant to the Small Bank Holding Company Policy Statement (Policy Statement) described below), including requirements relating to common equity as a component of core capital, (ii) implement a “capital conservation buffer” against risk and a higher minimum tier 1 capital requirement, and (iii) revise the rules for calculating risk-weighted assets for purposes of such requirements. The rules made corresponding revisions to the prompt corrective action framework and include the new capital ratios and buffer requirements which will be phased in incrementally, with full implementation scheduled for January 1, 2019. Failure to meet minimum capital requirements can initiate certain mandatory and possibly additional discretionary actions by regulators that, if undertaken, could have a direct material effect on the Company's financial statements. Under capital adequacy guidelines and the regulatory framework for prompt corrective action, the Bank must meet specific capital guidelines that involve quantitative measures of their assets, liabilities and certain off-balance sheet items as calculated under regulatory accounting practices. The capital amounts and classification are also subject to qualitative judgments by the regulators about components, risk weightings and other factors.
The FRB amended its Policy Statemen t, to exempt small bank holding companies from the above capital requirements, by raising the asset size threshold for determining applicability from $500 million to $1 billion. The Policy Statement was also expanded to include savings and loan holding companies that meet the Policy Statement ’ s qualitative requirements for exemption. The Company met the qualitative exemption requirements, and therefore, is exempt from the above capital requirements.
Quantitative measures established by regulations to ensure capital adequacy require the Bank to maintain minimum amounts and ratios (set forth in the following table and defined in the regulation) of Common Equity Tier 1 capital to risk weighted assets, Tier 1 capital to adjusted total assets, Tier 1 capital to risk weighted assets, and total capital to risk weighted assets.
At December 31, 2016 and 2015, the Bank's capital amounts and ratios are presented for actual capital, required capital and excess capital including amounts and ratios in order to qualify as being well capitalized under the prompt corrective action regulations:
Actual |
Required to be Adequately Capitalized |
Excess Capital |
To Be Well Capitalized Under Prompt Corrective Action Provisions |
|||||||||||||||||||||||||||||
(Dollars in thousands) |
Amount |
Percent of Assets (1) |
Amount |
Percent of Assets (1) |
Amount |
Percent of Assets (1) |
Amount |
Percent of Assets (1) |
||||||||||||||||||||||||
December 31, 2016 |
||||||||||||||||||||||||||||||||
Common equity tier 1 capital |
$ | 77,634 | 13.42 |
% |
$ | 26,032 | 4.50 |
% |
$ | 51,602 | 8.92 |
% |
$ | 37,601 | 6.50 |
% |
||||||||||||||||
Tier 1 leverage |
77,634 | 11.55 | 26,876 | 4.00 | 50,758 | 7.55 | 33,595 | 5.00 | ||||||||||||||||||||||||
Tier 1 risk-based capital |
77,634 | 13.42 | 34,709 | 6.00 | 42,925 | 7.42 | 46,278 | 8.00 | ||||||||||||||||||||||||
Total risk-based capital |
84,900 | 14.68 | 46,278 | 8.00 | 38,622 | 6.68 | 57,848 | 10.00 | ||||||||||||||||||||||||
December 31, 2015 |
||||||||||||||||||||||||||||||||
Common equity tier 1 capital |
$ | 71,520 | 14.08 |
% |
$ | 22,854 | 4.50 |
% |
$ | 48,666 | 9.58 |
% |
$ | 33,012 | 6.50 |
% |
||||||||||||||||
Tier 1 leverage |
71,520 | 11.46 | 24,971 | 4.00 | 46,549 | 7.46 | 31,213 | 5.00 | ||||||||||||||||||||||||
Tier 1 risk-based capital |
71,520 | 14.08 | 30,473 | 6.00 | 41,047 | 8.08 | 40,630 | 8.00 | ||||||||||||||||||||||||
Total risk-based capital |
77,934 | 15.35 | 40,630 | 8.00 | 37,304 | 7.35 | 50,788 | 10.00 |
(1) Based upon the Bank's adjusted total assets for the purpose of the Tier 1 leverage capital ratio and risk-weighted assets for the purpose of the risk-based capital ratios.
|
Beginning in 2016, the Bank must maintain a capital conservation buffer composed of common equity tier 1 capital above its minimum risk-based capital requirements in order to avoid limitations on capital distributions, including dividend payments and certain discretionary bonus payments to executive officers. For 2016, the capital conservation buffer is 0.625%. The buffer amount will increase incrementally each year until 2019 when the entire 2.50% capital conservation buffer will be fully phased in.
Management believes that, as of December 31, 2016, the Bank’ s capital ratios were in excess of those quantitative capital ratio standards applicable on that date, set forth under the prompt corrective action regulations, including the capital conservation buffer described above. However, there can be no assurance that the Bank will continue to maintain such status in the future. The Office of the Comptroller of the Currency has extensive discretion in its supervisory and enforcement activities, and can further adjust the requirement to be well-capitalized in the future.
NOTE 18 Financial Instruments with Off-Balance Sheet Risk
The Company is a party to financial instruments with off-balance sheet risk in the normal course of business to meet the financing needs of its customers. These financial instruments include commitments to extend credit. These commitments involve, to varying degrees, elements of credit and interest rate risk in excess of the amounts recognized in the balance sheet. The contract amounts of these instruments reflect the extent of involvement by the Company.
The Company's exposure to credit loss in the event of nonperformance by the other party to the financial instrument for commitments to extend credit is represented by the contract amount of these commitments. The Company uses the same credit policies in making commitments as it does for on-balance sheet instruments.
December 31, Contract Amount |
||||||||
(Dollars in thousands) |
2016 |
2015 |
||||||
Financial instruments whose contract amount represents credit risk: |
||||||||
Commitments to originate, fund or purchase loans: |
||||||||
Single family mortgages |
$ | 7,587 | 4,292 | |||||
Commercial real estate mortgages |
33,953 | 18,834 | ||||||
Non-real estate commercial loans |
420 | 1,310 | ||||||
Undisbursed balance of loans closed |
39,841 | 44,082 | ||||||
Unused lines of credit |
100,893 | 96,354 | ||||||
Letters of credit |
1,902 | 1,077 | ||||||
Total commitments to extend credit |
$ | 184,596 | 165,949 | |||||
Forward commitments |
$ | 9,595 | 8,071 |
Commitments to extend credit are agreements to lend to a customer, at the customer ’ s request, as long as there is no violation of any condition established in the contract. Commitments generally have fixed expiration dates or other termination clauses and may require payment of a fee. Since a portion of the commitments are expected to expire without being drawn upon, the total commitment amounts do not necessarily represent future cash requirements. The Bank evaluates each customer's creditworthiness on a case-by-case basis. The amount of collateral obtained, if deemed necessary by the Bank upon extension of credit, is based on the loan type and on management's credit evaluation of the borrower. Collateral consists primarily of residential and commercial real estate and personal property.
Forward commitments represent commitments to sell loans to a third party following the closing of the loan and are entered into in the normal course of business by the Bank.
The Bank issued standby letters of credit which guarantee the performance of customers to third parties. The standby letters of credit outstanding expire over the next 26 months and totaled $1.9 million at December 31, 2016 and $1.0 million at December 31, 2015. The letters of credit are collateralized primarily with commercial real estate mortgages. Draws on standby letters of credit would be initiated by the secured party under the terms of the underlying obligation. Since the conditions under which the Bank is required to fund the standby letters of credit may not materialize, the cash requirements are expected to be less than the total outstanding commitments.
The Company has certain obligations and commitments to make future payments under existing contracts. At December 31, 2016, the aggregate contractual obligations (excluding bank deposits) and commercial commitments were as follows:
Amount of Commitments Expiring by Period |
||||||||||||||||||||
Other Commercial Commitments: |
||||||||||||||||||||
Commercial lines of credit |
$ | 50,229 | 26,523 | 9,282 | 9,414 | 5,010 | ||||||||||||||
Commitments to lend |
31,831 | 9,797 | 4,736 | 7,220 | 10,078 | |||||||||||||||
Standby letters of credit |
1,902 | 1,575 | 327 | 0 | 0 | |||||||||||||||
$ | 83,962 | 37,895 | 14,345 | 16,634 | 15,088 | |||||||||||||||
NOTE 19 Derivative Instruments and Hedging Activities
The Company originates single-family residential loans for sale into the secondary market and enters into commitments to sell those loans in order to mitigate the interest rate risk associated with holding the loans until they are sold. The Company accoun ts for its commitments in accordance with ASC 815, Accounting for Derivative Instruments and Hedging Activities .
The Company had commitments outstanding to extend credit to future borrowers that had not closed prior to the end of the year, which is refer red to as its mortgage pipeline. As commitments to originate loans enter the mortgage pipeline, the Company generally enters into commitments to sell the loans into the secondary market. The commitments to originate and sell loans are derivatives that are recorded at fair value. As a result of marking these derivatives to fair value for the period ended December 31, 2016, the Company recorded an increase in other liabilities of $11,000, an increase in other assets of $30,000 and a net gain on the sale of loans of $19,000. As a result of marking these derivatives to fair value for the period ended December 31, 2015, the Company recorded a decrease in other liabilities of $7,000, an increase in other assets of $20,000 and a net gain on the sale of loans of $27,000.
As of December 31, 2016 and 2015, the current commitments to sell loans held for sale are derivatives that do not qualify for hedge accounting. The loans held for sale that are not hedged are recorded at the lower of cost or market. As a result of marking these loans for the period ended December 31, 2016, the Company recorded a decrease in other liabilities of $14,000 and a net gain on the sale of loans of $14,000. As a result of marking these loans for the period ended December 31, 2015, the Company recorded an increase in other liabilities of $3,000, and a net loss on the sales of loans of $3,000.
NOTE 20 Fair Value Measurement
ASC 820, Fair Value Measurements , establishes a framework for measuring the fair value of assets and liabilities using a hierarchy system consisting of three levels, based on the markets in which the assets and liabilities are traded and the reliability of the assumptions used to determine fair value. These levels are:
Level 1 — Valuation is based upon quoted prices for identical instruments traded in active markets that the Company has the ability to access.
Level 2 — Valuation is based upon quoted prices for similar instruments in active markets, quoted prices for identical or similar instruments in markets that are not active, and model-based valuation techniques for which significant assumptions are observable in the market.
Level 3 — Valuation is generated from model-based techniques that use significant assumptions not observable in the market and are used only to the extent that observable inputs are not available. These unobservable assumptions reflect our own estimates of assumptions that market participants would use in pricing the asset or liability. Valuation techniques include use of option pricing models, discounted cash flow models and similar techniques.
The following table summarizes the assets of the Company for which fair values are determined on a recurring basis as of December 31, 2016 and 2015.
Carrying Value at December 31, 2016 |
||||||||||||||||
(Dollars in thousands) |
Total |
Level 1 |
Level 2 |
Level 3 |
||||||||||||
Securities available for sale |
$ | 78,477 | 0 | 78,477 | 0 | |||||||||||
Mortgage loan commitments |
66 | 0 | 66 | 0 | ||||||||||||
Total |
$ | 78,543 | 0 | 78,543 | 0 | |||||||||||
Carrying Value at December 31, 2015 |
||||||||||||||||
(Dollars in thousands) |
Total |
Level 1 |
Level 2 |
Level 3 |
||||||||||||
Securities available for sale |
$ | 111,974 | 0 | 111,974 | 0 | |||||||||||
Mortgage loan commitments |
36 | 0 | 36 | 0 | ||||||||||||
Total |
$ | 112,010 | 0 | 112,010 | 0 | |||||||||||
The Company may also be required, from time to time, to measure certain other financial assets at fair value on a nonrecurring basis in accordance with generally accepted accounting principles. These adjustments to fair value usually result from the application of the lower-of-cost-or-market accounting or write downs of individual assets. For assets measured at fair value on a nonrecurring basis in 2016 and 2015 that were still held at December 31, the following table provides the level of valuation assumptions used to determine each adjustment and the carrying value of the related individual assets or portfolios at December 31, 2016 and 2015.
Carrying Value at December 31, 2016 |
||||||||||||||||||||
(Dollars in thousands) |
Total |
Level 1 |
Level 2 |
Level 3 |
Year Ended December 31, 2016 Total gains (losses) |
|||||||||||||||
Loans held for sale |
$ | 2,009 | 0 | 2,009 | 0 | 14 | ||||||||||||||
Mortgage servicing rights, net |
1,604 | 0 | 1,604 | 0 | 0 | |||||||||||||||
Loans (1) |
3,582 | 0 | 3,582 | 0 | (380 | ) | ||||||||||||||
Real estate, net (2) |
611 | 0 | 611 | 0 | (197 | ) | ||||||||||||||
Total |
$ | 7,806 | 0 | 7,806 | 0 | (563 | ) | |||||||||||||
Carrying Value at December 31, 2015 |
||||||||||||||||||||
(Dollars in thousands) |
Total |
Level 1 |
Level 2 |
Level 3 |
Year Ended December 31, 2015 Total gains (losses) |
|||||||||||||||
Loans held for sale |
$ | 3,779 | 0 | 3,779 | 0 | (3 | ) | |||||||||||||
Mortgage servicing rights, net |
1,499 | 0 | 1,499 | 0 | 0 | |||||||||||||||
Loans (1) |
4,790 | 0 | 4,790 | 0 | (373 | ) | ||||||||||||||
Real estate, net (2) |
2,045 | 0 | 2,045 | 0 | (262 | ) | ||||||||||||||
Total |
$ | 12,113 | 0 | 12,113 | 0 | (638 | ) |
(1) Represents carrying value and related specific reserves on loans for which adjustments are based on the appraised value of the collateral. The carrying value of loans fully charged-off is zero. (2) Represents the fair value and related losses on foreclosed real estate and other collateral owned that were measured at fair value subsequent to their initial classification as foreclosed assets. |
NOTE 21 Fair Value of Financial Instruments
ASC 825, Disclosures about Fair Values of Financial Instruments , requires disclosure of the estimated fair values of the Company's financial instruments, including assets, liabilities and off-balance sheet items for which it is practicable to estimate fair value. The fair value estimates are made as of December 31, 2016 and 2015 based upon relevant market information, if available, and upon the characteristics of the financial instruments themselves. Because no market exists for a significant portion of the Company's financial instruments, fair value estimates are based upon judgments regarding future expected loss experience, current economic conditions, risk characteristics of various financial instruments, and other factors. The estimates are subjective in nature and involve uncertainties and matters of significant judgment and therefore cannot be determined with precision. Changes in assumptions could significantly affect the estimates.
Fair value estimates ar e based only on existing financial instruments without attempting to estimate the value of anticipated future business or the value of assets and liabilities that are not considered financial instruments. In addition, the tax ramifications related to the realization of the unrealized gains and losses can have a significant effect on the fair value estimates and have not been considered in any of the estimates.
The estimated fair value of the Company's financial instruments are shown below. Following the t able, there is an explanation of the methods and assumptions used to estimate the fair value of each class of financial instruments.
December 31, 2016 | December 31, 2015 | |||||||||||||||||||||||||||||||||||
Fair value hierarchy | ||||||||||||||||||||||||||||||||||||
(Dollars in thousands) |
Carrying amount |
Estimated fair value |
Level 1 |
Level 2 |
Level 3 |
Contract amount |
Carrying Amount |
Estimated fair value |
Contract amount |
|||||||||||||||||||||||||||
Financial assets: |
||||||||||||||||||||||||||||||||||||
Cash and cash equivalents |
$ | 27,561 | 27,561 | 27,561 | 39,782 | 39,782 | ||||||||||||||||||||||||||||||
Securities available for sale |
78,477 | 78,477 | 78,477 | 111,974 | 111,974 | |||||||||||||||||||||||||||||||
Loans held for sale |
2,009 | 2,009 | 2,009 | 3,779 | 3,779 | |||||||||||||||||||||||||||||||
Loans receivable, net |
551,171 | 552,395 | 552,395 | 463,185 | 458,539 | |||||||||||||||||||||||||||||||
FHLB stock |
770 | 770 | 770 | 691 | 691 | |||||||||||||||||||||||||||||||
Accrued interest receivable |
2,626 | 2,626 | 2,626 | 2,254 | 2,254 | |||||||||||||||||||||||||||||||
Financial liabilities: |
||||||||||||||||||||||||||||||||||||
Deposits |
592,811 | 593,297 | 593,297 | 559,387 | 558,731 | |||||||||||||||||||||||||||||||
FHLB advances and other
|
7,000 | 7,018 | 7,018 | 9,000 | 9,000 | |||||||||||||||||||||||||||||||
Accrued interest payable |
236 | 236 | 236 | 242 | 242 | |||||||||||||||||||||||||||||||
Off-balance sheet financial
instruments: |
||||||||||||||||||||||||||||||||||||
Commitments to extend credit |
66 | 66 | 184,596 | 36 | 36 | 165,949 | ||||||||||||||||||||||||||||||
Commitments to sell loans |
(22 | ) | (22 | ) | 9,595 | (26 | ) | (26 | ) | 8,071 |
Cash and Cash Equivalents
The carrying amount of cash and cash equivalents approximates their fair value.
Securities Available for Sale
The fair values of securities were based upon quoted market prices.
Loans Held for Sale
The fair values of loans held for sale were based upon quoted market prices for loans with similar interest rates and terms to maturity.
Loans Receivable
The fair values of loans receivable were estimated for groups of loans with similar characteristics. The fair value of the loan portfo lio, with the exception of the adjustable rate portfolio, was calculated by discounting the scheduled cash flows through the estimated maturity using anticipated prepayment speeds and using discount rates that reflect the credit and interest rate risk inherent in each loan portfolio. The fair value of the adjustable loan portfolio was estimated by grouping the loans with similar characteristics and comparing the characteristics of each group to the prices quoted for similar types of loans in the secondary market.
FHLB Stock
The carrying amount of FHLB stock approximates its fair value.
Accrued Interest Receivable
The carrying amount of accrued interest receivable approximates its fair value since it is short-term in nature and does not present unantici pated credit concerns.
Deposits
The fair value of demand deposits, savings accounts and certain money market account deposits is the amount payable on demand at the reporting date. The fair value of fixed maturity certificates of deposit is estimated usi ng the rates currently offered for deposits of similar remaining maturities.
The fair value estimate for deposits does not include the benefit that results from the low cost funding provided by the Company's existing deposits and long-term customer relationships compared to the cost of obtaining different sources of funding. This benefit is commonly referred to as the core deposit intangible.
FHLB Advances and Other Borrowings
The fair values of advances and borrowings with fixed maturities are est imated based on discounted cash flow analysis using as discount rates the interest rates charged by the FHLB for borrowings of similar remaining maturities.
Accrued Interest Payable
The carrying amount of accrued interest payable approximates its fair va lue since it is short-term in nature.
Commitments to Extend Credit
The fair values of commitments to extend credit are estimated using the fees normally charged to enter into similar agreements, taking into account the remaining terms of the agreements a nd the present creditworthiness of the counter parties.
Commitments to Sell Loans
The fair values of commitments to sell loans are estimated using the quoted market prices for loans with similar interest rates and terms to maturity.
NOTE 22 HMN Financial, Inc. Financial Information (Parent Company Only)
The following are the condensed financial statements for the parent company only as of December 31, 2016 and 2015 and for the years ended December 31, 2016, 2015 and 2014.
Dollars in thousands) |
2016 |
2015 |
2014 |
|||||||||
Condensed Balance Sheets |
||||||||||||
Assets: |
||||||||||||
Cash and cash equivalents |
$ | 3,314 | 2,564 | |||||||||
Investment in subsidiaries |
78,108 | 74,565 | ||||||||||
Prepaid expenses and other assets |
44 | 33 | ||||||||||
Deferred tax asset, net |
756 | 1,000 | ||||||||||
Total assets |
$ | 82,222 | 78,162 | |||||||||
Liabilities and Stockholders' Equity: |
||||||||||||
Other borrowed money |
$ | 7,000 | 9,000 | |||||||||
Accrued expenses and other liabilities |
(697 | ) | (483 | ) | ||||||||
Total liabilities |
6,303 | 8,517 | ||||||||||
Common stock |
91 | 91 | ||||||||||
Additional paid-in capital |
50,566 | 50,388 | ||||||||||
Retained earnings |
86,886 | 80,536 | ||||||||||
Net unrealized losses on securities available for sale |
(820 | ) | (214 | ) | ||||||||
Unearned employee stock ownership plan shares |
(2,223 | ) | (2,417 | ) | ||||||||
Treasury stock, at cost, 4,639,739 and 4,645,769 shares |
(58,581 | ) | (58,739 | ) | ||||||||
Total stockholders' equity |
75,919 | 69,645 | ||||||||||
Total liabilities and stockholders' equity |
$ | 82,222 | 78,162 | |||||||||
Condensed Statements of Income |
||||||||||||
Interest income |
$ | 0 | 1 | 1 | ||||||||
Interest expense |
(589 | ) | (571 | ) | 0 | |||||||
Equity income of subsidiaries |
7,148 | 3,629 | 7,644 | |||||||||
Compensation and benefits |
(264 | ) | (269 | ) | (233 | ) | ||||||
Occupancy |
(30 | ) | (30 | ) | (24 | ) | ||||||
Data processing |
(6 | ) | (6 | ) | (6 | ) | ||||||
Professional services |
(138 | ) | (119 | ) | (165 | ) | ||||||
Other |
(329 | ) | (216 | ) | (374 | ) | ||||||
Income before income tax benefit |
5,792 | 2,419 | 6,843 | |||||||||
Income tax benefit |
(558 | ) | (537 | ) | (536 | ) | ||||||
Net income |
$ | 6,350 | 2,956 | 7,379 | ||||||||
Condensed Statements of Cash Flows |
||||||||||||
Cash flows from operating activities: |
||||||||||||
Net income |
$ | 6,350 | 2,956 | 7,379 | ||||||||
Adjustments to reconcile net income to cash used by operating activities: |
||||||||||||
Equity income of subsidiaries |
(7,148 | ) | (3,629 | ) | (7,644 | ) | ||||||
Deferred income tax benefit (expense) |
244 | 22 | (92 | ) | ||||||||
Earned employee stock ownership shares priced above original cost |
80 | 57 | 53 | |||||||||
Stock option compensation |
79 | 0 | 1 | |||||||||
Amortization of restricted stock awards |
177 | 447 | 240 | |||||||||
Decrease in unearned ESOP shares |
194 | 193 | 194 | |||||||||
Decrease (increase) in other assets |
(11 | ) | (23 | ) | 69 | |||||||
Decrease in other liabilities |
(214 | ) | (692 | ) | (420 | ) | ||||||
Other, net |
(1 | ) | 1 | 0 | ||||||||
Net cash used by operating activities |
(250 | ) | (668 | ) | (220 | ) | ||||||
Cash flows from investing activities: |
||||||||||||
Decrease in loans receivable, net |
0 | 900 | 100 | |||||||||
Net cash provided by investing activities |
0 | 900 | 100 | |||||||||
Cash flows from financing activities: |
||||||||||||
Redemption of preferred stock |
0 | (10,000 | ) | (16,000 | ) | |||||||
Dividends to preferred stockholders |
0 | (225 | ) | (5,964 | ) | |||||||
Proceeds from borrowings |
0 | 10,000 | 0 | |||||||||
Repayments of borrowings |
(2,000 | ) | (1,000 | ) | 0 | |||||||
Dividends received from Bank |
3,000 | 3,000 | 22,500 | |||||||||
Net cash provided by financing activities |
1,000 | 1,775 | 536 | |||||||||
Increase in cash and cash equivalents |
750 | 2,007 | 416 | |||||||||
Cash and cash equivalents, beginning of year |
2,564 | 557 | 141 | |||||||||
Cash and cash equivalents, end of year |
$ | 3,314 | 2,564 | 557 |
NOTE 23 Business Segments
The Bank has been identified as a reportable operating segment in accordance with the provisions of ASC 280. HMN, the holding company, did not meet the quantitative thresholds for a reportable segment and therefore is included in the “Other” category. The Company evaluates performance and allocates resources based on the segment ’ s net income, return on average assets, and return on average equity. Each corporation is managed separately with its own officers and board of directors.
The following table sets forth certain information about the reconciliations of reported net income and assets for each of the Company’ s reportable segments.
(Dollars in thousands) |
Home Federal Savings Bank |
Other |
Eliminations |
Consolidated Total |
||||||||||||
At or for the year ended December 31, 2016: |
||||||||||||||||
Interest income – external customers |
$ | 27,349 | 0 | 0 | 27,349 | |||||||||||
Non-interest income – external customers |
8,201 | 0 | 0 | 8,201 | ||||||||||||
Intersegment interest income |
0 | 1 | (1 | ) | 0 | |||||||||||
Intersegment non-interest income |
210 | 7,148 | (7,358 | ) | 0 | |||||||||||
Interest expense |
1,004 | 589 | 0 | 1,593 | ||||||||||||
Non-interest expense |
23,572 | 768 | (210 | ) | 24,130 | |||||||||||
Income tax expense (benefit) |
4,680 | (558 | ) | 0 | 4,122 | |||||||||||
Net income |
7,148 | 6,350 | (7,148 | ) | 6,350 | |||||||||||
Total assets |
681,257 | 82,222 | (81,456 | ) | 682,023 | |||||||||||
At or for the year ended December 31, 2015: |
||||||||||||||||
Interest income – external customers |
$ | 21,453 | 0 | 0 | 21,453 | |||||||||||
Non-interest income – external customers |
7,653 | 0 | 0 | 7,653 | ||||||||||||
Intersegment interest income |
0 | 1 | (1 | ) | 0 | |||||||||||
Intersegment non-interest income |
204 | 3,629 | (3,833 | ) | 0 | |||||||||||
Interest expense |
937 | 571 | (1 | ) | 1,507 | |||||||||||
Non-interest expense |
22,760 | 640 | (204 | ) | 23,196 | |||||||||||
Income tax expense (benefit) |
2,148 | (537 | ) | 0 | 1,611 | |||||||||||
Net income |
3,629 | 2,956 | (3,629 | ) | 2,956 | |||||||||||
Total assets |
642,151 | 78,162 | (77,152 | ) | 643,161 | |||||||||||
At or for the year ended December 31, 2014: |
||||||||||||||||
Interest income – external customers |
$ | 20,613 | 0 | 0 | 20,613 | |||||||||||
Non-interest income – external customers |
7,284 | 0 | 0 | 7,284 | ||||||||||||
Intersegment interest income |
0 | 2 | (2 | ) | 0 | |||||||||||
Intersegment non-interest income |
180 | 7,644 | (7,824 | ) | 0 | |||||||||||
Interest expense |
1,213 | 0 | (2 | ) | 1,211 | |||||||||||
Non-interest expense |
20,781 | 802 | (180 | ) | 21,403 | |||||||||||
Income tax expense (benefit) |
5,438 | (536 | ) | 0 | 4,902 | |||||||||||
Net income |
7,644 | 7,379 | (7,644 | ) | 7,379 | |||||||||||
Total assets |
576,397 | 76,221 | (75,192 | ) | 577,426 | |||||||||||
|
OTHER FINANCIAL DATA
The following tables set forth certain information as to the Bank ’s Federal Home Loan Bank (FHLB) advances.
Year Ended December 31, |
||||||||||||
(Dollars in thousands) |
2016 |
2015 |
2014 |
|||||||||
Maximum Balance: |
||||||||||||
FHLB advances |
$ | 15,500 | 16,000 | 0 | ||||||||
FHLB short-term advances |
15,500 | 16,000 | 0 | |||||||||
Average Balance: |
||||||||||||
FHLB advances |
468 | 551 | 0 | |||||||||
FHLB short-term advances |
468 | 551 | 0 | |||||||||
See “Note 12 Federal Home Loan Bank (FHLB) Advances and Other Borrowings” in the Notes to Consolidated Financial Statements for more information on the Bank’s FHLB advances and other borrowings.
SELECTED QUARTERLY FINANCIAL DATA
(Dollars in thousands, except per share data) |
December 31, 2016 |
September 30, 2016 |
June 30, 2016 |
|||||||||
Selected Operations Data (3 months ended): | ||||||||||||
Interest income |
$ | 6,711 | 6,954 | 7,159 | ||||||||
Interest expense |
420 | 404 | 395 | |||||||||
Net interest income |
6,291 | 6,550 | 6,764 | |||||||||
Provision for loan losses |
(374 |
) |
80 | 381 | ||||||||
Net interest income after provision for loan losses |
6,665 | 6,470 | 6,383 | |||||||||
Non-interest income: |
||||||||||||
Fees and service charges |
874 | 901 | 873 | |||||||||
Loan servicing fees |
296 | 280 | 271 | |||||||||
Gain on sales of loans |
770 | 656 | 705 | |||||||||
Other |
257 | 310 | 253 | |||||||||
Total non-interest income |
2,197 | 2,147 | 2,102 | |||||||||
Non-interest expense: |
||||||||||||
Compensation and benefits |
3,748 | 3,723 | 3,598 | |||||||||
(Gains) losses on real estate owned |
(161 |
) |
(11 |
) |
(75 |
) |
||||||
Occupancy and equipment |
1,047 | 998 | 1,006 | |||||||||
Data processing |
308 | 299 | 281 | |||||||||
Professional services |
386 | 252 | 368 | |||||||||
Other |
877 | 940 | 855 | |||||||||
Total non-interest expense |
6,205 | 6,201 | 6,033 | |||||||||
Income before income tax expense |
2,657 | 2,416 | 2,452 | |||||||||
Income tax expense |
973 | 1,002 | 974 | |||||||||
Net income |
1,684 | 1,414 | 1,478 | |||||||||
Preferred stock dividends |
0 | 0 | 0 | |||||||||
Net income available to common stockholders |
$ | 1,684 | 1,414 | 1,478 | ||||||||
Basic earnings per common share |
$ | 0.40 | 0.34 | 0.35 | ||||||||
Diluted earnings per common share |
$ | 0.35 | 0.30 | 0.31 | ||||||||
Financial Ratios: |
||||||||||||
Return on average assets (1) |
0.99 |
% |
0.84 |
% |
0.91 |
% |
||||||
Return on average common equity (1) |
8.93 | 7.55 | 8.23 | |||||||||
Average equity to average assets |
11.07 | 11.10 | 11.07 | |||||||||
Net interest margin (1)(2) |
3.89 | 4.10 | 4.36 |
(1) Annualized
(2) Net interest income divided by average interest-earning assets
March 31, 2016 |
December 31, 2015 |
September 30, 2015 |
June 30, 2015 |
March 31, 2015 |
|||||||||||||
6,525 | 6,109 | 5,390 | 5,070 | 4,884 | |||||||||||||
374 | 393 | 397 | 391 | 326 | |||||||||||||
6,151 | 5,716 | 4,993 | 4,679 | 4,558 | |||||||||||||
(732 | ) | 75 | (56 | ) | (183 | ) | 0 | ||||||||||
6,883 | 5,641 | 5,049 | 4,862 | 4,558 | |||||||||||||
779 | 827 | 863 | 844 | 782 | |||||||||||||
261 | 268 | 262 | 257 | 261 | |||||||||||||
487 | 536 | 613 | 530 | 285 | |||||||||||||
228 | 330 | 493 | 236 | 268 | |||||||||||||
1,755 | 1,961 | 2,231 | 1,867 | 1,596 | |||||||||||||
3,695 | 3,448 | 3,299 | 3,540 | 3,448 | |||||||||||||
(349 | ) | 97 | 168 | 65 | (112 | ) | |||||||||||
990 | 981 | 936 | 926 | 879 | |||||||||||||
273 | 267 | 254 | 268 | 231 | |||||||||||||
251 | 325 | 273 | 293 | 217 | |||||||||||||
831 | 878 | 1,039 | 708 | 770 | |||||||||||||
5,691 | 5,996 | 5,969 | 5,800 | 5,433 | |||||||||||||
2,947 | 1,606 | 1,311 | 929 | 721 | |||||||||||||
1,173 | 516 | 491 | 344 | 260 | |||||||||||||
1,774 | 1,090 | 820 | 585 | 461 | |||||||||||||
0 | 0 | 0 | 0 | (108 | ) | ||||||||||||
1,774 | 1,090 | 820 | 585 | 353 | |||||||||||||
0.43 | 0.26 | 0.20 | 0.14 | 0.09 | |||||||||||||
0.38 | 0.23 | 0.18 | 0.13 | 0.08 | |||||||||||||
1.12 |
% |
0.69 |
% |
0.53 |
% |
0.42 |
% |
0.33 |
% |
||||||||
10.12 | 6.19 | 4.77 | 3.50 | 2.60 | |||||||||||||
11.11 | 11.70 | 11.91 | 12.30 | 12.62 | |||||||||||||
4.09 | 3.80 | 3.44 | 3.56 | 3.42 | |||||||||||||
638,156 | 643,161 | 618,917 | 564,001 | 565,487 | |||||||||||||
1,984 | 2,283 | 7,080 | 2,115 | 2,471 | |||||||||||||
103,844 | 109,691 | 138,258 | 123,326 | 151,674 | |||||||||||||
4,467 | 3,779 | 5,153 | 5,968 | 2,663 | |||||||||||||
490,260 | 463,185 | 432,174 | 368,110 | 360,370 | |||||||||||||
551,506 | 559,387 | 531,586 | 481,476 | 483,323 | |||||||||||||
9,000 | 9,000 | 10,000 | 10,000 | 10,000 | |||||||||||||
71,687 | 69,645 | 68,710 | 67,494 | 66,775 |
COMMON STOCK INFORMATION
The common stock of the Company is listed on the Nasdaq Stock Market (Nasdaq) under the symbol HMNF. As of December 31, 2016, the Company had 9,128,662 shares of common stock issued and 4,639,739 shares in treasury stock. As of December 31, 2016, there were 572 stockholders of record and 1,036 estimated beneficial stockholders. The following table presents the stock price information for the Company as furnished by Nasdaq for each quarter for the last two fiscal years. On February 13, 2017, the last reported sale price of shares of our common stock on the Nasdaq was $18.50 per share. The Company has not paid a dividend on its common stock during the two year period ending December 31, 2016 and no common stock dividends are anticipated to be paid in 2017. See “Liquidity and Capital Resources – Dividends” in the “Management Discussion and Analysis” section of this annual report for a description of restrictions on the ability of the Company and the Bank to pay dividends.
For the Quarter Ended | ||||||||||||||||||||||||||||||||
December 31, 2016 |
September 30, 2016 |
June 30, 2016 |
March 31, 2016 |
December 31, 2015 |
September 30, 2015 |
June 30, 2015 |
March 31, 2015 |
|||||||||||||||||||||||||
HIGH |
$ | 18.55 | 15.00 | 14.44 | 11.80 | 12.06 | 12.06 | 12.61 | 12.92 | |||||||||||||||||||||||
LOW |
13.58 | 13.25 | 11.25 | 10.81 | 11.06 | 10.88 | 10.18 | 11.46 | ||||||||||||||||||||||||
CLOSE |
17.50 | 14.16 | 13.58 | 11.26 | 11.55 | 11.51 | 11.79 | 12.10 |
The following graph and table compares the total cumulative stockholders ’ return on the Company’s common stock to the NASDAQ U.S. Stock Index (“NASDAQ Composite”), which includes all NASDAQ traded stocks of U.S. companies, and the SNL Bank NASDAQ Index. The graph and table assume that $100 was invested on December 31, 2011 and that all dividends were reinvested.
Index |
12/31/11 |
12/31/12 |
12/31/13 |
12/31/14 |
12/31/15 |
12/31/16 |
||||||||||||||||||
HMN Financial, Inc. |
100.00 | 179.30 | 545.97 | 640.50 | 596.59 | 903.93 | ||||||||||||||||||
NASDAQ Composite |
100.00 | 117.45 | 164.57 | 188.84 | 201.98 | 219.89 | ||||||||||||||||||
SNL Bank NASDAQ Index |
100.00 | 119.19 | 171.31 | 177.42 | 191.53 | 265.56 |
HMN Financial, Inc. 1016 Civic Center Drive NW Rochester, MN 55901 (507) 535-1200
Annual Meeting The annual meeting of shareholders will be held on Tuesday, April 25, 2017 at 10:00 a.m. (Central Time) at the Roches ter Golf and Country Club, 3100 West Country Club Road, Rochester, Minnesota.
Legal Counsel Faegre Baker Daniels LLP 2200 Wells Fargo Center 90 South Seventh Street Minneapolis, MN 55402-3901
Independent Registered Public Accounting Firm CliftonLarsonAllen LLP 220 South Sixth Street, Suite 300 Minneapolis, MN 55402-1436
Investor Information and Form 10-K HMN ’s Form 10-K, filed with the Securities and Exchange Commission, is available without charge upon written request from: HMN Financia l, Inc. Attn: Cindy Hamlin, Investor Relations 1016 Civic Center Drive NW Rochester, MN 55901 or at www.hmnf.com
Transfer Agent and Registrar Inquiries regarding change of address, transfer requirements, and lost certificates should be directed to HMN ’s transfer agent: Wells Fargo Bank, N.A. Shareowner Services 1110 Centre Pointe Curve, Suite 101 MAC N9173-010 Mendota Heights, MN 55120 www.wellsfargo.com/shareownerservices (800) 468-9716
Directors Dr. Hugh C. Smith Chairman of the Board HMN and Home Federal Savings Bank Retired Professor of Medicine, Mayo Clinic College of Medicine and Consultant in Cardiovascular Division, Mayo Clinic
Allen J. Berning Chief Executive Officer Ambient Clinical Analytics
Michael A. Bue Retired Presi dent and Chief Executive Officer Security State Bank of Lewiston |
Bradley C. Krehbiel President and Chief Executive Officer HMN and Home Federal Savings Bank
Bernard R. Nigon Retired Audit Partner with RSM US LLP (formerly McGladrey & Pullen, LLP)
Dr. Wendy S. Shannon
Assistant Professor, Winona State University
Retired Professor of Pediatric and Adolescent Medicine, Mayo Clinic College of Medicine
Mark E. Utz Attorney at law, Wendland Utz, Ltd.
Hans K. Zietlow Director of Real Estate for Kwik Trip, Inc.
Executive Officers Who Are Not Directors Jon J. Eberle Senior Vice President, Chief Financial Officer and Treasurer of HMN and Executive Vice President, Chief Financial Officer and Treasurer of Home Federal Savings Bank
Susan K. Kolling Senior Vice President HMN and Home Federal Savings Bank
Lawrence D. McGraw Executive Vice President and Chief Operating Officer Home Federal Savings Bank
Branch Offices of Bank Albert Lea 143 West Clark Street Albert Lea, MN 56007 (507) 379-2551
Austin 201 Oakland Avenue West Austin, MN 55912 (507) 434-2500
Eagan 2805 Dodd Road, Suite 160 Eagan, MN 55121 (651) 405-2000
Kasson
203 West Main
(507) 634-7022
(507) 634-4141
La Crescent 208 South Walnut La Crescent, MN 55947 (507) 895-9200 |
Marshalltown 303 West Main Street Marshalltown, IA 50158 (641) 754-6198
Rochester 1201 South Broadway Rochester, MN 55901 (507) 536-2416
1016 Civic Center Drive NW Rochester, MN 55901 (507) 535-1309
100 1 st Avenue Bldg., Suite 200 Rochester, MN 55902 (507) 280-7256
2048 Superior Drive NW, Suite 400 Rochester, MN 55901 (507) 226-0800
Spring Valley 715 North Broadway Spring Valley, MN 55975 (507) 346-9709
Winona 175 Center Street Winona, MN 55987 (507) 453-6460
Loan Production Offices Sartell
50 14
th
Ave E, Suite 100
(320) 654-4020
Owatonna 1850 Austin Road, Suite 103
Owatonna, MN 55060
Mankato
100 Warren Street, Suite 300
(507) 455-0174
Delafield
3960 Hillside Drive, Suite 206
(262) 337-9511 |
EXHIBIT 21
Subsidiaries of Registrant |
|
Name & Address |
Year & State Inc. |
Home Federal Savings Bank 1016 Civic Center Drive NW Rochester , MN 55901 |
1934 Federal Charter |
Osterud Insurance Agency, Inc. DBA Home Federal Investment Svcs. 1016 Civic Center Drive NW Rochester, MN 55901 |
1983 MN |
HF
SB Property Holdings, LLC
|
2013
|
EXHIBIT 23.1
EXHIBIT 31.1
CERTIFICATIONS
I, Bradley Krehbiel , certify that:
1. I have reviewed this annual report on Form 10-K of HMN 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(s) and I are responsible for establishing and maintaining disclosure controls and procedures (as defined in Exchange Act Rules 13a-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 ensure that 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, to provide reasonable assurance regarding the reliability of financial reporting and the preparation of financial statements for external purposes in accordance 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 of the disclosure controls and procedures, as of the end of the period covered by this report based on such evaluation; and
(d) Disclosed in this report any change in the registrant’s internal control over financial reporting that occurred during the registrant’s most recent fiscal quarter (the registrant’s fourth quarter in the case of an annual report) that has materially affected, or is reasonably likely to materially affect, the registrant’s internal control over financial reporting; and
5. The registrant’s other certifying officer(s) and I have disclosed, based on our most recent evaluation of internal control over financial reporting, to the registrant’s auditors 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 to adversely affect the registrant’s ability to record, process, summarize and report financial information; and
(b) Any fraud, whether or not material, that involves management or other employees who have a significant role in the registrant’s internal control over financial reporting.
Date: March 10, 2017 | By: | /s/ Bradley Krehbiel | |
Bradley Krehbiel | |||
President and Chief Executive Officer | |||
(Principal Executive Officer) |
EXHIBIT 31.2
CERTIFICATIONS
I, Jon J. Eberle, certify that:
1 . I have reviewed this annual report on Form 10-K of HMN 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(s) and I are responsible for establishing and maintaining disclosure controls and procedures (as defined in Exchange Act Rules 13a-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 ensure that 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, to provide reasonable assurance regarding the reliability of financial reporting and the preparation of financial statements for external purposes in accordance 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 of the disclosure controls and procedures, as of the end of the period covered by this report based on such evaluation; and
(d) Disclosed in this report any change in the registrant’s internal control over financial reporting that occurred during the registrant’s most recent fiscal quarter (the registrant’s fourth quarter in the case of an annual report) that has materially affected, or is reasonably likely to materially affect, the registrant’s internal control over financial reporting; and
5. The registrant’s other certifying officer(s) and I have disclosed, based on our most recent evaluation of internal control over financial reporting, to the registrant’s auditors 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 to adversely affect the registrant’s ability to record, process, summarize and report financial information; and
(b) Any fraud, whether or not material, that involves management or other employees who have a significant role in the registrant’s internal control over financial reporting.
Date: March 10, 2017 | By: | /s/Jon J. Eberle | |
Jon J. Eberle | |||
Senior Vice President, Chief Financial Officer and Treasurer | |||
(Principal Financial Officer) |
Exhibit 32
HMN FINANCIAL, INC.
CERTIFICATION PURSUANT TO 18 U.S.C. SECTION 1350,
AS ADOPTED PURSUANT TO
SECTION 906 OF THE SARBANES-OXLEY ACT OF 2002
In connection with the Annual Report of HMN Financial, Inc. (the "Company") on Form 10-K for the period ending December 31, 2016 as filed with the Securities and Exchange Commission on the date hereof (the "Report"), we, Bradley Krehbiel, President and Chief Executive Officer of HMN Financial, Inc. (the “Company”) (Principal Executive Officer of the Company), and Jon Eberle, Senior Vice President, Chief Financial Officer and Treasurer of the Company (Principal 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:
(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.
Date: March 10, 2017 |
|
/s/ Bradley Krehbiel |
|
|
|
Bradley Krehbiel |
|
|
|
President and Chief Executive Officer |
|
(Principal Executive Officer) | |||
/s/Jon Eberle | |||
Jon Eberle | |||
Senior Vice President/Chief Financial Officer | |||
and Treasurer | |||
(Principal Financial Officer) |