TEB BANCORP: Management report and analysis of the financial situation and operating results (form 10-K)
This discussion and analysis reflects our consolidated financial statements and other relevant statistical data, and is intended to enhance your understanding of our financial condition and results of operations. The information in this section has been derived from the consolidated financial statements, which appear elsewhere in this annual report. You should read the information in this section in conjunction with the other business and financial information provided in this annual report.
Total assets increased
$10.2 million, or 3.3%, to $315.7 millionat June 30, 2021from $305.5 millionat June 30, 2020, primarily reflecting increases in cash and cash equivalents and available for sale securities offset by decreases in loans held for investment and loans held for sale. Total deposits increased $13.8 million, or 5.4%, to $269.9 millionat June 30, 2021from $256.1 millionat June 30, 2020. This resulted from an increase in interest-bearing savings and NOW accounts, which increased $12.8 million, or 16.9%, to $88.2 millionat June 30, 2021from $75.4 millionat June 30, 2020, and an increase in demand deposits, which increased $15.4 million, or 16.4%, to $109.0 millionat June 30, 2021from $93.6 millionat June 30, 2020. Borrowed funds, consisting solely of Federal Home Loan Bank of Chicago("FHLB") advances, decreased $4.0 million, or 44.4%, to $5.0 millionat June 30, 2021from $9.0 millionat June 30, 2020. Increased levels of deposits and cash during the year reduced our reliance on borrowed funds. Net income was $6.4 millionfor the year ended June 30, 2021, compared to $1.1 millionfor the year ended June 30, 2020. The increase in income was due to an increase in non-interest income during the year ended June 30, 2021, offset by a decrease in net interest income and an increase in non-interest expense. Net interest income after provision for loan losses decreased $454,000, or 4.8%, to $9.1 millionfor the year ended June 30, 2021from $9.5 millionfor the year ended June 30, 2020, primarily as a result of a lower average balance of loans. Non-interest income increased by $7.0 million, or 111.7%, to $13.2 millionfor the year ended June 30, 2021from $6.2 millionfor the year ended June 30, 2020, primarily resulting from a $6.9 million, or 135.0%, increase in gain on sales of mortgage loans. Non-interest expenses increased $1.2 million, or 8.4%, to $15.9 millionfor the year ended June 30, 2021compared to $14.7 millionfor the year ended June 30, 2020. The increase in non-interest expenses was due to an increase in compensation and benefits expense during the year ended June 30, 2021. Change in Fiscal Year
Summary of significant accounting policies
The discussion and analysis of the financial condition and results of operations are based on our financial statements, which are prepared in conformity with accounting principles generally accepted in
the United States of America(" U.S.GAAP"). The preparation of these financial statements requires management to make estimates and assumptions affecting the reported amounts of assets and liabilities, disclosure of contingent assets and liabilities, and the reported amounts of income and expenses. We consider the accounting policies discussed below to be significant accounting policies. The estimates and assumptions that we use are based on historical experience and various other factors and are believed to be reasonable under the circumstances. Actual results may differ from these estimates under different assumptions or conditions, resulting in a change that could have a material impact on the carrying value of our assets and liabilities and our results of operations. The JOBS Act contains provisions that, among other things, reduce certain reporting requirements for qualifying public companies. As an "emerging growth company" we may delay adoption of new or revised accounting pronouncements applicable to public companies until such pronouncements are made applicable to private companies. We determined to take advantage of the benefits of this extended transition period. Accordingly, our financial statements may not be comparable to companies that comply with such new or revised accounting standards. 39
The following are our main accounting policies:
Allowance for Loan Losses. The allowance for loan losses is established as losses are estimated to have occurred through a provision for loan losses charged to operations. Loan losses are charged against the allowance when management believes the uncollectability of a loan balance is confirmed. Subsequent recoveries, if any, are credited to the allowance for loan losses. The allowance for loan losses consists of specific reserves on certain impaired loans from analyses developed through specific credit allocations for individual loans. The specific reserve relates to all loans for which the allowance for loan losses is estimated on a loan by loan basis using either the present value of expected future cash flows discounted at the loan's effective interest rate, the loan's obtainable market price, or the fair value of the collateral if the loan is collateral dependent. The general reserve is based on our historical loss experience along with consideration of certain qualitative factors such as (i) changes in the nature, volume and terms of loans, (ii) changes in lending personnel, (iii) changes in the quality of the loan review function, (iv) changes in nature and volume of past-due, non-accrual and/or classified loans, (v) changes in concentration of credit risk, (vi) changes in economic and industry conditions, (vii) changes in legal and regulatory requirements, (viii) unemployment and inflation statistics, and (ix) changes in underlying collateral values. There are many factors affecting the allowance for loan losses, some are quantitative while others require qualitative judgment. The allowance for loan losses reflects management's best estimate of the probable and inherent losses on loans. The adequacy of the allowance for loan losses is reviewed and approved by our board of directors. Allocations of the allowance for loan losses may be made for specific loans, but the entire allowance for loan losses is available for any loan that, in management's judgment, should be charged-off. As an integral part of their examination process, various regulatory agencies review the allowance for loan losses as well. Such agencies may require that changes in the allowance for loan losses be recognized when such regulatory credit evaluations differ from those of management based on information available to the regulators at the time of their examinations. Income Taxes. Deferred tax assets and liabilities are recognized for the estimated future tax consequences attributable to 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 in effect for the year 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. Deferred tax assets are reduced by a valuation allowance when, in the opinion of management, it is more likely than not that some portion or all of the deferred tax assets will not be realized. We recognize the tax effects from an uncertain tax position in the consolidated financial statements only if the position is more likely than not to be sustained on audit, based on the technical merits of the position. We recognize the financial statement benefit of a tax position only after determining that the relevant tax authority would more likely than not sustain the position following an audit. For tax positions meeting the more-likely-than-not threshold, the amount recognized in the consolidated financial statements is the largest benefit that has a greater than 50% likelihood of being realized, upon ultimate settlement with the relevant tax authority. We recognize interest and penalties accrued or released related to uncertain tax positions in current income tax expense or benefit.
December 2019, a coronavirus (COVID-19) was reported in China, and, in March 2020was declared a national emergency in the United States. The COVID-19 pandemic has caused significant economic dislocation in the United Statesas many state and local governments ordered non-essential businesses to close and residents to shelter in place at home. Certain industries have been particularly hard-hit, including the travel and hospitality industry, the restaurant industry, and the retail industry. The following table shows the Company's exposure within these hard-hit industries. 40
Table of Contents Commercial Loan Type June 30, 2021 Percentage of Portfolio Loans Restaurant, food service, bar
$ 1,572,4570.73 % Retail 2,255,298 1.04 % Hospitality and tourism - - % $ 3,827,7551.77 % The Company's allowance for loan losses increased $59,000to $1.4 millionat June 30, 2021compared to $1.4 millionat June 30, 2020. Provisions were booked totaling $150,000during the year ended June 30, 2021, compared to $135,000during the year ended June 30, 2020. At June 30, 2021and June 30, 2020, the allowance for loan losses represented 0.65% and 0.57% of total loans, respectively. In determining its allowance for loan loss level at June 30, 2021, the Company considered the health and composition of its loan portfolio going into the COVID-19. At June 30, 2021, approximately 98.8% of the Company's loan portfolio was collateralized by real estate. Approximately 1.8% of the Company's loan portfolio is to borrowers in the more particularly hard-hit industries (including the restaurant and food service industries, retail industry, and hospitality and tourism industries) and the Company has no international exposure. Given the ongoing and dynamic nature of the circumstances, it is difficult to predict the full impact of the COVID-19 outbreak on our business. The extent of such impact will depend on future developments, which are highly uncertain, including when the coronavirus can be controlled and abated and when and how the economy continues to reopen. As the result of the COVID-19 pandemic and the related adverse local and national economic consequences, we could be subject to any of the following risks, any of which could have a material, adverse effect on our business, financial condition, liquidity, and results of operations:
? demand for our products and services may decrease, making it difficult to grow
assets and income;
if the economy is unable to continue to reopen, and / or high levels of
? return to unemployment, loan delinquencies, problematic assets and foreclosures can
increase, resulting in increased expenses and decreased income;
? loan guarantees, especially real estate, may lose value, which could
increase loan losses;
our allowance for loan losses may need to be increased if borrowers
? financial difficulties beyond the abstention periods, which will negatively affect
our net income;
? the equity and liquidity of loan guarantors may decline, compromising their
ability to honor commitments to us;
as a result of the drop in
? funds close to 0%, the return on our assets could fall further
that the decrease in our cost of interest-bearing debt, reducing our
interest margin and spread and reduction in net income;
? our uninsured investment income may decline as a result of continuing market turmoil;
? our cybersecurity risks are increased due to an increase in the
number of employees working remotely;
we rely on third-party providers for certain services and the unavailability of a
? critical service due to the COVID-19 outbreak could have a negative effect on
incurs additional resolution costs.
Moreover, our future success and profitability substantially depends on the management skills of our executive officers and directors, many of whom have held officer and director positions with us for many years. The unanticipated loss or unavailability of key employees due to the outbreak could harm our ability to operate our business or execute our 41
business strategy. We may not be able to find and integrate suitable successors in the event of loss or unavailability of key employees.
Any or a combination of the factors identified above could have a negative impact on our business, financial condition, results of operations and prospects.
June 30, 2021, the Company originated 26 PPP loans totaling $1.8 millionand generated approximately $76,000from the processing fees. All PPP loan originations occurred before the end of the June 30, 2021reporting period. As of June 30, 2021, 18 PPP loans totaling $1.1 millionhave been forgiven. As of June 30, 2021, the Company had modified 88 loans aggregating $22.9 million, primarily consisting of the deferral of principal and interest payments and the extension of the maturity date. Of these modifications, $22.8 million, or 99.5%, were performing in accordance with the accounting treatment under Section 4013 of the CARES Act and therefore did not qualify as TDRs. As of June 30, 2021, all of these modifications have resumed monthly loan payments and no modifications remain in a deferred status. Three loans totaling $294,000that were modified did not qualify for the favorable accounting treatment under Section 4013 of the CARES Act and therefore each loan was reported as a TDR; however, one of the loans was transferred out of TDR status after receiving six consecutive monthly payments after the end of the deferral period. Management has evaluated the loans and determined that based on the liquidation value of the collateral, no specific reserve is necessary. As of June 30, 2021 Payments Resumed Payments Deferred Loan Classification Number of Loans Balance Number of Loans Balance Construction, land, development 2 $ 113,324- $ - 1-4 family owner occupied 50 6,928,668 - - 1-4 family non-owner occupied 16 2,255,510 - - Multifamily 13 10,716,179 - - Commercial owner occupied 2 1,419,056 - - Commercial non-owner occupied 2 1,408,571 - - Consumer and installment loans 3 40,655 - - Total loan modification requests 88 $ 22,881,963- $ -
Comparison of financial position to
Total assets increased
$10.2 million, or 3.3%, to $315.7 millionat June 30, 2021from $305.5 millionat June 30, 2020, primarily reflecting increases in cash and cash equivalents and available for sale securities offset by decreases in loans held for investment and loans held for sale. Cash and cash equivalents increased $36.3 million, or 276.8%, to $49.4 millionat June 30, 2021from $13.1 millionat June 30, 2020due to the increased balance in deposit accounts and decrease in total loans outstanding during the year. Available-for-sale securities increased $12.6 million, or 61.9%, to $32.9 millionat June 30, 2021from $20.3 millionat June 30, 2020, due to utilizing excess cash to purchase securities totaling $16.9 million, offset by maturities and calls of $4.3 million. Loans held for investment decreased $21.8 million, or 9.1%, to $216.8 millionat June 30, 2021from $238.7 millionat June 30, 2020, primarily reflecting a decrease in one- to four-family owner occupied loans of $28.5 million, or 28.4%, to $72.0 millionat June 30, 2021from $100.5 millionat June 30, 2020. The decrease in one- to four-family owner occupied loans resulted from increased refinances and loan paydowns. These decreases were partially offset by an increase in multifamily loans of $15.4 million, or 20.2%, to $91.9 millionat June 30, 2021from $76.4 millionat June 30, 2020, as we continue to focus on originating this type of loan. 42
Loans held for sale decreased
$11.8 million, or 63.3%, to $6.9 millionat June 30, 2021from $18.7 millionat June 30, 2020. We currently sell a majority of the fixed-rate one- to four-family residential real estate loans that we originate. The balances at any month end vary based on the timing and volume of loan originations and sales. The decrease in mortgage interest rates due to COVID-19 resulted in a greater volume of loans originated and sold in the last quarter of the fiscal year ended June 30, 2020. Total deposits increased $13.8 million, or 5.4%, to $269.9 millionat June 30, 2021from $256.1 millionat June 30, 2020. The increase was due to increases in demand deposits of $15.4 million, or 16.4%, to $109.0 millionat June 30, 2021, from $93.6 millionat June 30, 2020and interest-bearing savings and NOW accounts of $12.8 million, or 16.9%, to $88.2 millionat June 30, 2021from $75.4 millionat June 30, 2020, offset by a decrease in certificates of deposit of $14.3 million, or 16.4%, to $72.7 millionat June 30, 2021from $87.0 millionat June 30, 2020. These increases are largely due to increased economic stimulus payments with decreases in certificates of deposit balances resulting from decreases in interest rates offered. Borrowed funds, consisting solely of FHLB advances, decreased $4.0 million, or 44.4%, to $5.0 millionat June 30, 2021from $9.0 millionat June 30, 2020. During the year, deposits increased and assets decreased, which allowed us to pay down borrowings. Total equity increased $9.6 million, or 40.9%, to $33.1 millionat June 30, 2021from $23.5 millionat June 30, 2020as a result of net income for the year. Accumulated other comprehensive loss decreased as a result of higher yields on our pension investments, resulting in a net positive funded status as of June 30, 2021. Average Balance Sheet The following table sets forth average balance sheets, average yields and costs, and certain other information at and for the periods indicated. No tax-equivalent yield adjustments have been made, as the effects would be immaterial. All average balances are daily average balances. Non-accrual loans were included in the computation of average balances. 43
The yields set forth below include the effect of deferred fees, discounts, and premiums that are amortized or accreted to interest income or interest expense. Loan balances exclude loans held for sale. For the Year Ended June 30, 2021 For the Year Ended June 30, 2020 Average Average Outstanding Average Outstanding Average Balance Interest Yield/Rate Balance Interest Yield/Rate (Dollars in thousands) Interest-earning assets: Loans
$ 229,258 $ 9,8794.31 % $ 249,657 $ 11,1734.48 % Securities 21,867 577 2.64 % 21,719 604 2.78 % Federal Home Loan Bank of Chicagostock 1,116 30 2.69 % 1,288 53 4.12 % Other 19,602 3 0.01 % 4,688 49 1.05 % Total interest-earning assets 271,843 10,489
3.86 % 277,352 11,879 4.28 % Non-interest-earning assets 30,707 25,971 Total assets
$ 302,550 $ 303,323Interest-bearing liabilities: Demand deposits $ 61,44237 0.06 % $ 49,83729 0.06 % Savings and NOW deposits 82,191 69 0.08 % 74,453 62 0.08 % Certificates of deposit 78,629 1,158 1.47 % 94,481 1,733 1.84 % Total interest-bearing deposits 222,262 1,264 0.57 % 218,771 1,824 0.83 % Borrowings 5,215 7 0.14 % 23,300 398 1.71 % Total interest-bearing liabilities 227,477 1,271
0.56% 242,071 2,222 0.92% Non-interest bearing debts 48,249
35,852 Total liabilities 275,726 277,923 Total equity 26,824 25,400 Total liabilities and equity
$ 302,550 $ 303,323Net interest income $ 9,218 $ 9,657Net interest rate spread (1) 3.30 % 3.36 % Net interest-earning assets (2) $ 44,366 $ 35,281Net interest margin (3) 3.39 % 3.48 % Average interest-earning assets to interest-bearing liabilities 119.50 %
The net interest rate differential represents the difference between the weighted average return (1) on interest-bearing assets and the weighted average rate of
interest bearing liabilities.
(2) Net interest-bearing assets represent the total of interest-bearing assets less
total interest-bearing liabilities.
(3) The net interest margin represents the net interest income divided by the average total
interest-earning assets. Rate/Volume Analysis The following table presents the effects of changing rates and volumes on our net interest income for the years indicated. The rate column shows the effects attributable to changes in rate (changes in rate multiplied by prior volume). The volume column shows the effects attributable to changes in volume (changes in volume multiplied by prior rate). The total column represents the sum of the prior columns. For purposes of this table, changes attributable to both rate and volume, which cannot be segregated, have been allocated proportionately based on the changes due to rate and the changes due to volume. 44
Table of Contents Year Ended June 30, 2021 vs. Year Ended June 30, 2020 vs. 2020 2019 Increase (Decrease) Total Increase (Decrease) Total Due to Increase Due to Increase Volume Rate (Decrease) Volume Rate (Decrease) (In thousands) Interest-earning assets: Loans
$ (879) $ (415) $ (1,294) $ (508) $ (81) $ (589)Securities 4 (30) (26) 20 (7) 13 Federal Home Loan Bankof Chicago stock (5) (18) (23) (38) (31) (69) Other 2 (49) (47) 22 (28) (6) Total interest-earning assets (878) (512) (1,390) (504) (147) (651) Interest-bearing liabilities: Demand deposits 7 1 8 2 (1) 1 Savings and NOW deposits 6 1 7 (6) 2 (4) Certificates of deposit (233) (342) (575) 73 254 327 Total interest-bearing deposits (220) (340) (560) 69 255 324 Borrowings (25) (366) (391) (415) (360) (775) Total interest-bearing liabilities (245) (706) (951) (346) (105) (451) Change in net interest income $ (633) $ 194 $ (439) $ (158) $ (42) $ (200)
Comparison of operating results for the years ended
General. Net income was
$6.4 millionfor the year ended June 30, 2021, compared to $1.1 millionfor year ended June 30, 2020. The increase in income was due to an increase in non-interest income offset by a decrease in net interest income and an increase in non-interest expense, described in more detail below. Interest Income. Interest income decreased $1.4 million, or 11.7%, to $10.5 millionfor the year ended June 30, 2021compared to $11.9 millionfor the year ended June 30, 2020. Interest income on loans, which is our primary source of interest income, decreased $1.3 million, or 11.6%, to $9.9 millionfor the year ended June 30, 2021compared to $11.2 millionfor the year ended June 30, 2020. Our average yield on loans decreased 17 basis points to 4.31% for the year ended June 30, 2021from 4.48% for the year ended June 30, 2020, reflecting recent decreases in market interest rates. The average balance of loans also decreased by $20.4 million, or 8.2%, to $229.3 millionfor the year ended June 30, 2021from $249.7 millionfor the year ended June 30, 2020. Interest Expense. Interest expense decreased $951,000, or 42.8%, to $1.3 millionfor the year ended June 30, 2021compared to $2.2 millionfor the year ended June 30, 2020, due to decreases in interest expense on borrowings and decreases in interest rates paid on deposits. Interest expense on borrowings decreased $391,000to $7,000for the year ended June 30, 2021from $398,000for the year ended June 30, 2020. This decrease resulted from the decreases in both the average balance of borrowings and the average rate we paid on borrowings. The average balance of borrowings decreased $18.1 millionto $5.2 millionfor the year ended June 30, 2021from $23.3 millionfor the year ended June 30, 2020, and the annualized average rate we paid on borrowings decreased 157 basis points to 0.14% for the year ended June 30, 2021, from 1.71% for the year ended June 30, 2020. As described above, increased levels of deposits and cash during the year ended June 30, 2021reduced our reliance on borrowed funds. The decrease in rates paid on borrowings reflects recent decreases in market interest rates. Interest expense on deposits decreased $560,000, or 30.7%, to $1.3 millionfor the year ended June 30, 2021from $1.8 millionfor the year ended June 30, 2020. Specifically, interest expense on certificates of deposit decreased $575,000, or 33.2%, to $1.2 millionfor the year ended June 30, 2021from $1.7 millionfor the year ended June 30, 2020. This decrease resulted from an decrease in the annualized average rate we paid on certificates of deposit, which decreased 37 45
basis points at 1.47% for the year ended
Net Interest Income. Net interest income decreased
$454,000, or 4.8%, to $9.1 millionfor the year ended June 30, 2021from $9.5 millionfor the year ended June 30, 2020, primarily as a result of the decreased interest income from loans. Our net interest rate spread decreased by six basis points to 3.30% for the year ended June 30, 2021from 3.36% for the year ended June 30, 2020, and our net interest margin decreased by nine basis points to 3.39% for the year ended June 30, 2021from 3.48% for the year ended June 30, 2020. Provision for Loan Losses. Provisions for loan losses are charged to operations to establish an allowance for loan losses at a level necessary to absorb known and inherent losses in our loan portfolio that are both probable and reasonably estimable at the date of the financial statements. In evaluating the level of the allowance for loan losses, management analyzes several qualitative loan portfolio risk factors including, but not limited to, management's ongoing review and grading of loans, facts and issues related to specific loans, historical loan loss and delinquency experience, trends in past due and non-accrual loans, existing risk characteristics of specific loans or loan pools, changes in the nature, volume and terms of loans, the fair value of underlying collateral, changes in lending personnel, current economic conditions and other qualitative and quantitative factors which could affect potential credit losses. See "-Summary of Significant Accounting Policies" for additional information. After an evaluation of these factors, we recorded a $150,000provision for the year ended June 30, 2021and $135,000for the year ended June 30, 2020. Our allowance for loan losses increased $59,000, or 4.4%, to $1.4 millionat June 30, 2021from $1.4 millionat June 30, 2020. The allowance for loan losses to total loans increased to 0.65% at June 30, 2021from 0.57% at June 30, 2020, and the allowance for loan losses to non-performing loans increased to 178.09% at June 30, 2021from 100.91% at June 30, 2020. To the best of our knowledge, we have recorded all loan losses that are both probable and reasonable to estimate at June 30, 2021. However, future changes in the factors described above, including, but not limited to, actual loss experience with respect to our loan portfolio, could result in material increases in our provision for loan losses. In addition, the WDFI and the Federal Deposit Insurance Corporation, as an integral part of their examination process, will periodically review our allowance for loan losses, and as a result of such reviews, we may have to adjust our allowance for loan losses.
Income other than interest. Information on non-interest income is as follows.
Year Ended June 30, Change 2021 2020 Amount Percent (Dollars in thousands) Service fees on deposits
$ 409 $ 430 $ (21)(4.9) % Service fees on loans 224 238 (14) (5.9) Gain on sale of mortgage loans 12,033 5,120 6,913 135.0 Income on sale of uninsured products 503 321 182 56.7 Gain (loss) on sale of other real estate owned 33 118 (85) (72.0) Other 25 20 5 25.0 Total non-interest income $ 13,227 $ 6,247 $ 6,980111.7 % Gain on sale of mortgage loans (consisting solely of one- to four-family residential real estate loans) increased as we earned a higher servicing release premium in addition to selling $496.5 millionof mortgage loans during the year ended June 30, 2021compared to $334.9 millionof such sales during the year ended June 30, 2020. Gain on sale of other real estate owned decreased as we made one sale of other real estate during the year eneded June 30, 2021in excess of the principal balance and four sales of other real estate during the year ended June 30, 2020in excess of the principal balance. 46
Non-interest charges. Information on non-interest charges is as follows.
Year Ended June 30, Change 2021 2020 Amount Percent (Dollars in thousands) Compensation and benefits
$ 10,000 $ 8,503 $ 1,49717.6 % Occupancy 2,121 1,969 152 7.7 Advertising 164 227 (63) (27.8) Data processing services 1,067 1,096 (29) (2.6) FDIC assessment 90 112 (22) (19.6) Cost of operations of other real estate owned 174 1,047 (873) (83.4) Insurance 116 156 (40) (25.6) Professional Fees 525 489 36 7.4 Other 1,652 1,078 574 53.2 Total non-interest income $ 15,909 $ 14,677 $ 1,2328.4 % Compensation and benefits expense increased primarily as a result of the increased commissions from greater loan volume. Advertising expenses decreased due to the large volume of applications received without the need to advertise. FDICassessments decreased due to improved financial condition. Cost of operations of other real estate owned decreased due to a large write off on other real estate loans during the year ending June 30, 2020. Insurance expenses decreased as we were able to renegotiate our contract and lock in a multi-year term. Other expenses increased due the increase in sold loan commsion fees offset due to the increased volume in loans sold, which are offset within compensation and benefits once the loans are sold. Income Tax Expense. We recognized no income tax expense or benefit for the years ended June 30, 2021and June 30, 2020due to a full valuation allowance being recorded against the Company's deferred tax assets.
Market risk management
General. Our most significant form of market risk is interest rate risk because, as a financial institution, the majority of our assets and liabilities are sensitive to changes in interest rates. Therefore, a principal part of our operations is to manage interest rate risk and limit the exposure of our financial condition and results of operations to changes in market interest rates. Our Asset/Liability Management Committee, consisting of members of our senior management, is responsible for evaluating the interest rate risk inherent in our assets and liabilities, for determining the level of risk that is appropriate, given our business strategy, operating environment, capital, liquidity and performance objectives, and for managing this risk consistent with the policy and guidelines approved by our board of directors. The board of directors receives a monthly report from the Asset/Liability Management Committee. We currently utilize a third-party modeling program, prepared on a quarterly basis, to evaluate our sensitivity to changes in interest rates.
We have sought to manage our interest rate risk in order to minimize the exposure of our earnings and capital to changes in interest rates. The following are our main strategies for managing our interest rate risk:
? sell the majority of our long-term fixed rate secondary loans
? limit our dependence on non-core / wholesale funding sources;
? increase our volume of transaction deposit accounts; and
? diversify our loan portfolio by adding more commercial loans, which
typically have shorter maturities and/or balloon payments. 47
By following these strategies, we believe we are in a better position to respond to increases in market interest rates.
We do not engage in hedging activities, such as futures, options or swaps, or investing in high-risk mortgage derivatives, such as residual interest on guaranteed mortgage bonds, residual interest of real estate mortgage investment conduits or dismembered mortgage-backed securities.
Net Interest Income. We analyze our sensitivity to changes in interest rates through a net interest income model. Net interest income is the difference between the interest income we earn on our interest-earning assets, such as loans and securities, and the interest we pay on our interest-bearing liabilities, such as deposits and borrowings. We estimate what our net interest income would be for a 12-month period. We then calculate what the net interest income would be for the same period under the assumptions that
the United States Treasuryyield curve increases or decreases instantaneously by 200 and 400 basis point increments, with changes in interest rates representing immediate and permanent, parallel shifts in the yield curve. A basis point equals one-hundredth of one percent, and 100 basis points equals one percent. An increase in interest rates from 3% to 4% would mean, for example, a 100 basis point increase in the "Change in Interest Rates" column below.
The tables below show, as of
June 30, 2021 Change in Interest Rates Net Interest Income Year 1 Change (basis points) (1) Year 1 Forecast from Level (Dollars in thousands) +400 $ 11,198 25.97 % +200 10,160 14.29 % Level 8,889 - % -200 8,284 (6.81) % -400 8,052 (9.42) %
(1) Assumes an immediate uniform change in interest rates at all maturities.
The table above indicates that at
June 30, 2021, in the event of an instantaneous parallel 200 basis point increase in interest rates, we would have experienced a 14.29% increase in net interest income, and in the event of an instantaneous 200 basis point decrease in interest rates, we would have experienced an 6.81% decrease in net interest income. At June 30, 2020in the event of an instantaneous parallel 200 basis point increase in interest rates, we would have experienced a 7.33% increase in net interest income, and in the event of an instantaneous 200 basis point decrease in interest rates, we would have experienced a 4.69% decrease in net interest income. Net Economic Value. We also compute amounts by which the net present value of our assets and liabilities (net economic value or "NEV") would change in the event of a range of assumed changes in market interest rates. This model uses a discounted cash flow analysis and an option-based pricing approach to measure the interest rate sensitivity of net portfolio value. The model estimates the economic value of each type of asset, liability and off-balance sheet contract under the assumptions that the United States Treasury yield curve increases or decreases instantaneously by 200 and 400 basis point increments, with changes in interest rates representing immediate and permanent, parallel shifts in the yield curve. 48
The tables below show, as of
At June 30, 2021 NEV as a Percentage of Present Value of Assets (3) Change in Rates (basis Estimated Increase (Decrease) in Increase Interest points) Estimated NEV NEV (Decrease) (1) NEV (2) Amount Percent Ratio (4) (basis points) (Dollars in thousands) +400
$ 54,555$ 6,557 13.66 % 19.11 % 407 +200 53,122 5,124 10.68 % 17.58 % 254 - 47,998 - - % 15.04 % - -200 38,872 (9,126) (19.01) % 11.64 % (340) -400 44,460 (3,538) (7.37) % 13.00 % (204)
(1) Assumes an immediate uniform change in interest rates at all maturities.
(2) NEV is the present value of the expected cash flows of the assets,
liabilities and off-balance sheet contracts.
(3) The present value of the assets represents the present present value of the entries
cash flow from interest-bearing assets.
(4) The NEV ratio represents the NEV divided by the present value of the assets.
The table above indicates that at
June 30, 2021, in the event of an instantaneous parallel 200 basis point increase in interest rates, we would have experienced a 10.68% increase in net economic value, and in the event of an instantaneous 200 basis point decrease in interest rates, we would have experienced a 19.01% decrease in net economic value. At June 30, 2020in the event of an instantaneous parallel 200 basis point increase in interest rates, we would have experienced a 14.97% increase in net economic value, and in the event of an instantaneous 200 basis point decrease in interest rates, we would have experienced a 6.41% decrease in net economic value. Certain shortcomings are inherent in the methodologies used in the above interest rate risk measurements. Modeling changes require making certain assumptions that may or may not reflect the manner in which actual yields and costs respond to changes in market interest rates. In this regard, the net interest income and net economic value tables presented assume that the composition of our interest-sensitive assets and liabilities existing at the beginning of a period remains constant over the period being measured and assumes that a particular change in interest rates is reflected uniformly across the yield curve regardless of the duration or repricing of specific assets and liabilities. Accordingly, although the net interest income and NEV tables provide an indication of our interest rate risk exposure at a particular point in time, such measurements are not intended to and do not provide a precise forecast of the effect of changes in market interest rates on net interest income and NEV and will differ from actual results. Furthermore, although certain assets and liabilities may have similar maturities or periods to repricing, they may react in different degrees to changes in market interest rates. Additionally, certain assets, such as adjustable-rate loans, have features that restrict changes in interest rates both on a short-term basis and over the life of the asset.
Calculations of interest rate risk may also not reflect the fair value of financial instruments. For example, decreases in market interest rates can increase the fair value of our loans, deposits and borrowings.
Liquidity and capital resources
Liquidity describes our ability to meet the financial obligations that arise in the ordinary course of business. Liquidity is primarily needed to meet the borrowing and deposit withdrawal requirements of our customers and to fund current and planned expenditures. Our primary sources of funds are deposits, principal and interest payments on loans and securities, proceeds from the sale of loans, and proceeds from maturities of securities. We also have the ability to borrow from the FHLB and from
U.S. Bank. At June 30, 2021, we had a $121.4 millionline of credit with the FHLB, and had $5.0 millionof borrowings outstanding as of that date, and we also had a $5.0 millionline of credit with U.S. Bank, with no borrowings outstanding as of that date. 49
While maturities and scheduled amortization of loans and securities are predictable sources of funds, deposit flows and loan prepayments are greatly influenced by general interest rates, economic conditions, and competition. Our most liquid assets are cash and short-term investments including interest-bearing demand deposits. The levels of these assets are dependent on our operating, financing, lending, and investing activities during any given period. Our cash flows are comprised of three primary classifications: cash flows from operating activities, investing activities, and financing activities. Net cash provided by (used in) operating activities was
$12.4 millionand ($4.7) millionfor the year ended June 30, 2021and the year ended June 30, 2020. Net cash provided by investing activities, which consists primarily of disbursements for loan originations and the purchase of securities, offset by principal collections on loans, and proceeds from maturing securities and pay downs on securities, was $13.5 millionand $26.2 millionfor the year ended June 30, 2021, and the year ended June 30, 2020. Net cash provided by (used in) financing activities, consisting of activity in deposit accounts, borrowings, and advance payments by borrowers for property taxes and insurance, was $10.4 millionand ($14.0) millionfor the year ended June 30, 2021and the year ended June 30, 2020. We are committed to maintaining a strong liquidity position. We monitor our liquidity position on a daily basis. We anticipate that we will have sufficient funds to meet our current funding commitments. Based on our deposit retention experience, current pricing strategy and regulatory restrictions, we anticipate that a substantial portion of maturing time deposits will be retained, and that we can supplement our funding with borrowings in the event that we allow these deposits to run off at maturity. At June 30, 2021, we exceeded all of our regulatory capital requirements, and we were categorized as well capitalized at June 30, 2021. Management is not aware of any conditions or events since the most recent notification that would change our category.
Off-balance sheet arrangements and global contractual obligations
Commitments. As a financial services provider, we routinely are a party to various financial instruments with off-balance-sheet risks, such as commitments to extend credit and unused lines of credit. While these contractual obligations represent our future cash requirements, a significant portion of commitments to extend credit may expire without being drawn upon. Such commitments are subject to the same credit policies and approval process accorded to loans we make. At
June 30, 2021, we had outstanding commitments to originate loans of $20.9 million, and outstanding commitments to sell loans of $41.0 million. We anticipate that we will have sufficient funds available to meet our current lending commitments. Time deposits that are scheduled to mature in one year or less from June 30, 2021totaled $32.1 million. Management expects that a substantial portion of the maturing time deposits will be renewed. However, if a substantial portion of these deposits is not retained, we may utilize FHLB advances or other borrowings to offset projected portfolio loan production. Contractual Obligations. In the ordinary course of our operations, we enter into certain contractual obligations. Such obligations include data processing services, operating leases for premises and equipment, agreements with respect to borrowed funds and deposit liabilities.
Recent accounting positions
Please refer to Note 1 to the Financial Statements included as Item 8 in this Annual Report for a description of recent accounting pronouncements that may affect our financial condition and results of operations.
Impact of inflation and price changes
The financial statements and related data presented herein have been prepared in accordance with
U.S.GAAP, which requires the measurement of financial position and operating results in terms of historical dollars without considering changes in the relative purchasing power of money over time due to inflation. The primary impact of inflation on our operations is reflected in increased operating costs. Unlike most industrial companies, virtually all of the assets and liabilities of a financial institution are monetary in nature. As a result, interest rates, generally, have a more significant 50
impact on a financial institution's performance than does inflation. Interest rates do not necessarily move in the same direction or to the same extent as the prices of goods and services.
ARTICLE 7A. Quantitative and qualitative information on market risk
For more information on market risk, see section 7. Management report and analysis of the financial position and results of operations.
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