Item 7. Management’s Discussion and Analysis
Item 7. Management's Discussion and Analysis of Financial Condition and Results of Operations
Overview
The following discussion and analysis is presented to assist the reader in understanding and evaluating the Company's financial condition and results of operations. It is intended to complement the consolidated financial statements, footnotes, and supplemental financial data appearing elsewhere in this Annual Report on Form 10-K and should be read in conjunction therewith. The detailed discussion in the sections below focuses on the results of operations for the year ended December 31, 2023, compared to the year ended December 2022, and the financial condition as of December 31, 2023 compared to the financial condition as of December 31, 2022.
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As described in the notes to consolidated financial statements, we have two reportable segments: community banking and mortgage banking. The community banking segment provides consumer and business banking products and services to customers. Consumer products include loan products, deposit products, and personal investment services. Business banking products include loans for working capital, inventory and general corporate use, commercial real estate construction loans, and deposit accounts. The mortgage banking segment, which is conducted through Waterstone Mortgage Corporation, consists of originating residential mortgage loans primarily for sale in the secondary market.
Our community banking segment generates the significant majority of our consolidated net interest income and requires the significant majority of our provision for credit losses. Our mortgage banking segment generates the significant majority of our noninterest income and a majority of our noninterest expenses. We have provided below a discussion of the material results of operations for each segment on a separate basis for the year ended December 31, 2023, compared the year ended December 31, 2022, which focuses on noninterest income and noninterest expenses. We have also provided a discussion of the consolidated operations of Waterstone Financial, which includes the consolidated operations of WaterStone Bank and Waterstone Mortgage Corporation, for the same periods.
For a discussion of our results of operations for the year ended December 31, 2022 compared to the year ended December 31, 2021, see “Part II, Item 7: Management’s Discussion and Analysis of Financial Condition and Results of Operations” Discussion of Results of Operations included in our 2022 Form 10-K, filed with the SEC on February 28, 2023.
Significant Items
There were no Significant Items for the years ended December 31, 2023 and 2022.
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Critical Accounting Policies
Our consolidated financial statements are prepared in accordance with GAAP and follow general practices within the banking industry. Application of these principles requires management to make complex and subjective estimates and judgments that affect the amounts reported in the consolidated financial statements and accompanying notes. We base our estimates on historical experience and on various other assumptions that we believe to be reasonable and appropriate under current circumstances. These assumptions form the basis for our judgments about the carrying values of assets and liabilities that are not readily available from independent, objective sources. We evaluate our estimates on an ongoing basis. Use of alternative assumptions may have resulted in significantly different estimates. Actual results may differ from these estimates.
Accounting policies are an integral part of our financial statements. A thorough understanding of these accounting policies is essential when reviewing our reported results of operations and our financial position. We believe that the critical accounting policies and estimates discussed below involve a heightened level of management judgment due to the complexity, subjectivity and sensitivity involved in their application.
See Note 1 - Summary of Significant Accounting Policies to the consolidated financial statements contains a further discussion of our significant accounting policies.
Critical accounting policies are those that involve significant judgments and assumptions by management and that have, or could have, a material impact on our income or the carrying value of our assets.
Allowance for Credit Losses. The ACL represents management's estimate of current expected credit losses, or the amount of amortized cost basis not expected to be collected, on our loan portfolio and the amount of credit loss impairment on our AFS securities portfolio. Determining the amount of the ACL is considered a critical accounting estimate because of its complexity and because it requires extensive judgment and estimation. Estimates that are particularly susceptible to change that may have a material impact on the amount of the ACL include:
●
Our evaluation of current conditions;
●
Our assessment that the physical condition of the real estate has not significantly changed since the last valuation date;
●
Our determination of a reasonable and supportable economic forecast and selection of the reasonable and supportable forecast period;
●
Our evaluation of historical loss experience;
●
Our evaluation of changes in composition and characteristics of the loan portfolio, including internal risk ratings;
●
Our estimate of expected prepayments;
●
Our selection of models and modeling techniques may also have a material impact on the estimate;
●
The value of underlying collateral, which may impact loss severity and certain cash flow assumptions for collateral-dependent, criticized and classified loans;
●
Our selection and evaluation of qualitative factors; and
●
Our estimate of expected cash flows on AFS debt securities in unrealized loss positions.
The appropriateness of the allowance for credit losses is reviewed and approved quarterly by the WaterStone Bank Board of Directors. The allowance reflects management’s best estimate of the amount needed to provide for the future losses over the life of the loan portfolio, and is based on a loss model using a forecast and historical losses developed and implemented by management and approved by the WaterStone Bank Board of Directors.
Actual results could differ from this estimate, and future additions to the allowance may be necessary based on unforeseen changes in loan quality and economic conditions. More specifically, if our future charge-off experience increases substantially from our past experience, or if the value of underlying loan collateral, in our case mostly real estate, declines in value by a substantial amount, or if unemployment in our primary market area increases significantly, our allowance for credit losses may be inadequate and we will incur higher provisions for loan losses and lower net income in the future.
See Note 1 - Summary of Significant Accounting Policies to the consolidated financial statements describes the methodology used to determine the ACL.
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In addition, state and federal regulators periodically review the WaterStone Bank allowance for credit losses. Such regulators have the authority to require WaterStone Bank to recognize additions to the allowance at the time of their examination.
Income Taxes. The Company and its subsidiaries file consolidated federal, combined state income tax, and separate state income tax returns. The provision for income taxes is based upon income in the consolidated financial statements, rather than amounts reported on the income tax return. Deferred tax assets and liabilities are recognized for the future tax consequences attributable to differences between the financial statement carrying amounts of existing assets and liabilities and their respective tax bases as well as for net operating loss carry forwards. Deferred tax assets and liabilities are measured using enacted tax rates expected 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 as income or expense in the period that includes the enactment date.
Under generally accepted accounting principles, a valuation allowance is required to be recognized if it is “more likely than not” that a deferred tax asset will not be realized. The determination of the realizability of deferred tax assets is highly subjective and dependent upon judgment concerning management's evaluation of both positive and negative evidence, the forecasts of future income, applicable tax planning strategies, and assessments of current and future economic and business conditions. Examples of positive evidence may include the existence of taxes paid in available carry-back years as well as the probability that taxable income will be generated in future periods. Examples of negative evidence may include cumulative losses in a current year and prior two years and general business and economic trends.
Positions taken in the Company’s tax returns are subject to challenge by the taxing authorities upon examination. The benefit of uncertain tax positions are initially recognized in the financial statements only when it is more likely than not that the position will be sustained upon examination by the tax authorities. Such tax positions are both initially and subsequently measured as the largest amount of tax benefit that has a greater than 50% likelihood of being realized upon settlement with the tax authority, assuming full knowledge of the position and all relevant facts. Interest and penalties on income tax uncertainties are classified within income tax expense in the consolidated statements of operations.
Fair Value Measurements. The Company determines the fair value of its assets and liabilities in accordance with ASC 820. ASC 820 establishes a standard framework for measuring and disclosing fair value under generally accepted accounting principles. A number of valuation techniques are used to determine the fair value of assets and liabilities in the Company’s financial statements. The valuation techniques include quoted market prices for investment securities, appraisals of real estate from independent licensed appraisers and other valuation techniques. Fair value measurements for assets and liabilities where limited or no observable market data exists are based primarily upon estimates, and are often calculated based on the economic and competitive environment, the characteristics of the asset or liability and other factors. Therefore, the valuation results cannot be determined with precision and may not be realized in an actual sale or immediate settlement of the asset or liability. Additionally, there are inherent weaknesses in any calculation technique, and changes in the underlying assumptions used, including discount rates and estimates of future cash flows, could significantly affect the results of current or future values. Significant changes in the aggregate fair value of assets and liabilities required to be measured at fair value or for impairment are recognized in the consolidated statements of operations under the framework established by generally accepted accounting principles.
Recent Accounting Pronouncements.
Refer to Note 1- Summary of Significant Accounting Policies of our consolidated financial statements for a description of recent accounting pronouncements including the respective dates of adoption and effects on results of operations and financial condition.
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Selected Financial Data
The summary financial information presented below is derived in part from the Company’s audited financial statements, although the table itself is not audited.
At or for the Year Ended December 31,
2023
2022
2021
(In Thousands, except per share amounts)
Selected Financial Condition Data:
Total assets
$
2,213,389
$
2,031,672
$
2,215,858
Cash and cash equivalents
36,421
46,642
376,722
Securities available for sale
204,907
196,588
179,016
Loans held for sale
164,993
131,188
312,738
Loans receivable
1,664,215
1,510,178
1,205,785
Allowance for credit losses (1)
18,549
17,757
15,778
Loans receivable, net
1,645,666
1,492,421
1,190,007
Real estate owned, net
254
145
148
Deposits
1,190,624
1,199,012
1,233,386
Borrowings
611,054
386,784
477,127
Total shareholders' equity
344,056
370,486
432,773
Selected Operating Data:
Interest income
$
99,208
$
70,245
$
69,883
Interest expense
48,993
13,291
14,368
Net interest income
50,215
56,954
55,515
Provision (credit) for credit losses (1)
656
968
(3,990
)
Net interest income after provision for credit losses (1)
49,559
55,986
59,505
Noninterest income
81,185
105,555
203,195
Noninterest expense
119,712
137,062
170,594
Income before income taxes
11,032
24,479
92,106
Provision for income taxes
1,657
4,992
21,315
Net income
$
9,375
$
19,487
$
70,791
Per common share:
Income per share - basic
$
0.47
$
0.89
$
2.98
Income per share - diluted
$
0.46
$
0.89
$
2.96
Book value
$
16.94
$
16.71
$
17.45
Dividends declared
$
0.70
$
0.80
$
1.80
(1) The Company adopted ASU 2016-13 as of January 1, 2022. The prior year amounts presented are calculated under the prior accounting standard.
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At or for the Year Ended December 31,
2023
2022
2021
Selected Financial Ratios and Other Data:
Performance Ratios:
Return on average assets
0.44
%
0.96
%
3.20
%
Return on average equity
2.62
4.91
16.38
Interest rate spread (1)
1.83
2.76
2.47
Net interest margin (2)
2.46
3.00
2.68
Noninterest expense to average assets
5.56
6.79
7.71
Efficiency ratio (3)
91.11
84.34
65.94
Average interest-earing assets to average interest-bearing liabilities
126.10
134.23
130.76
Dividend payout ratio (4)
148.94
146.07
43.62
Capital Ratios:
Waterstone Financial, Inc.:
Equity to total assets at end of period
15.54
%
18.24
%
19.53
%
Average equity to average assets
16.64
19.66
19.53
Total capital to risk-weighted assets
21.50
24.36
29.01
Tier 1 capital to risk-weighted assets
20.39
23.29
27.99
Common equity tier 1 capital to risk-weighted assets
20.39
23.29
27.99
Tier 1 capital to average assets
16.77
19.45
19.29
WaterStone Bank:
Total capital to risk-weighted assets
20.10
21.52
25.52
Tier 1 capital to risk-weighted assets
18.99
20.46
24.50
Common equity tier 1 capital to risk-weighted assets
18.99
20.46
24.50
Tier 1 capital to average assets
15.62
17.08
16.88
Asset Quality Ratios:
Allowance for credit losses - loans as a percent of total loans (5)
1.11
%
1.18
%
1.31
%
Allowance for credit losses - loans as a percent of non-performing loans (5)
385.79
412.28
283.06
Net chargeoffs (recoveries) to average outstanding loans during the period
0.01
(0.04
)
(0.07
)
Non-performing loans as a percent of total loans
0.29
0.29
0.46
Non-performing assets as a percent of total assets
0.23
0.22
0.26
Other Data:
Number of full-service banking offices
14
14
14
Number of full-time equivalent employees
698
742
870
(1) Represents the difference between the weighted average yield on average interest-earning assets and the weighted average cost of interest-bearing liabilities.
(2) Represents net interest income as a percent of average interest-earning assets.
(3) Represents noninterest expense divided by the sum of net interest income and noninterest income.
(4) Represents dividends paid per share divided by basic earnings per share.
(5) The Company adopted ASU 2016-13 as of January 1, 2022. The 2021 amounts presented are calculated under the prior accounting standard.
Comparison of Consolidated Waterstone Financial, Inc. Financial Condition at December 31, 2023 and at December 31, 2022
Total Assets. Total assets increased by $181.7 million, or 8.9%, to $2.21 billion at December 31, 2023 from $2.03 billion at December 31, 2022. The increase in total assets primarily reflects increases in loans held for investment and loans held for sale, partially offset by decreases cash and cash equivalents, office properties and equipment, and other assets. The increase in total assets also reflects liability increases in borrowings.
Cash and Cash Equivalents. Cash and cash equivalents decreased $10.2 million to $36.4 million at December 31, 2023 from $46.6 million at December 31, 2022. The decrease in cash and cash equivalents primarily reflects the funding of loans held for sale, loans held for investment, and securities available for sale as well as the decrease of funding sources from deposits.
Securities Available for Sale . Securities available for sale increased by $8.3 million to $204.9 million at December 31, 2023 from $196.6 million at December 31, 2022. The increase was primarily due to purchases of mortgage-related securities to take advantage of the increase in interest rates. The increase was also driven by a decrease in unrealized losses as the values of securities increased due to a decrease in long term interest rates. Purchases for the year exceeded the combination of security paydowns and maturities of debt securities.
Loans Held for Sale . Loans held for sale increased $33.8 million, or 25.8%, to $165.0 million at December 31, 2023 from $131.2 million at December 31, 2022 due to a decrease in mortgage rates at the end of the year.
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Loans Receivable . Loans receivable held for investment increased $154.0 million, or 10.2%, to $1.66 billion at December 31, 2023 from $1.51 billion at December 31, 2022. The increase in total loans receivable was attributable to increases in each of the one- to four-family, multi-family, commercial, and commercial real estate loan categories.
Allowance for Credit Losses. The allowance for credit losses increased $792,000 to $18.5 million at December 31, 2023 from $17.8 million at December 31, 2022. The increase primarily resulted from the increase in the total loan balances. Net charge-offs totaled $135,000 for the year ended December 31, 2023. During the year ended December 31, 2023, we made adjustments to our qualitative factors, primarily to account for the changes in internal metrics and external risk factors. See Note 3 - Loans Receivable of the notes to consolidated financial statements for further discussion on the allowance for credit losses. The forecast factor remained unchanged as we monitor the economic environment going forward.
Prepaid Expenses and Other Assets. Total prepaid expenses and other assets decreased $7.4 million to $52.4 million at December 31, 2023 from $59.8 million at December 31, 2022. The decrease was primarily due to a decrease in the fair value mark on derivatives as interest rates decreased and deferred taxes decreased as unrealized losses on available for sale securities decreased due to falling long-term interest rates.
Deposits. Deposits decreased by $8.4 million to $1.19 billion at December 31, 2023, from $1.20 billion at December 31, 2022. The decrease was driven by a decrease of $52.9 million in money market and savings deposits and a decrease of $43.5 million in demand deposits. The decrease was partially offset by an increase of $88.0 million in time deposits as customers sought higher rates in the current interest rate environment.
Borrowings. Total borrowings increased $224.3 million to $611.1 million at December 31, 2023, from $386.8 million at December 31, 2022. The community banking segment increased its short-term FHLB borrowings by $123.3 million offset by a decrease of its long-term FHLB borrowings by $45.0 million. In addition, we borrowed $145.0 million from the Federal Reserve Bank, all of which was incremental to 2022. External short-term borrowings at the mortgage banking segment increased a total of $1.0 million to $2.1 million at December 31, 2023 from $1.1 million at December 31, 2022. The increase in borrowings was used to fund the increase in loans held for investment.
Other Liabilities. Other liabilities decreased $9.0 million to $61.0 million at December 31, 2023 compared to $70.1 million at December 31, 2022. Other liabilities decreased primarily due to a decrease of the fair value mark on derivative liabilities related to the loans held for sale and the back-to-back swaps decreased with the decrease in interest rates and a decrease in dividends payable as fourth-quarter dividends per share decreased to $0.15 in 2023 from $0.20 in 2022.
Shareholders ’ Equity. Shareholders’ equity decreased by $26.4 million, or 7.1%, to $344.1 million at December 31, 2023 from $370.5 million at December 31, 2022. Shareholders' equity decreased primarily due to the declaration of dividends and the repurchase of stock. Partially offsetting the decreases, there were increases due to the net income, additional paid-in capital as stock options were exercised and equity awards vested, increases in the values of securities available for sale, and unearned ESOP shares vesting.
Comparison of Community Banking Segment Operations for the Years Ended December 31, 2023 and 2022
Net income from our community banking segment for the year ended December 31, 2023 totaled $18.6 million compared to $22.8 million for the year ended December 31, 2022. Net interest income decreased $4.9 million to $51.7 million for the year ended December 31, 2023 compared to $56.6 million for the year ended December 31, 2022. Interest income on loans increased as replacement rates and average loans held for investment balances were higher than in the prior year and interest income on mortgage-related securities and debt securities, federal funds sold and short-term investments increased due to the increase in the average balance and replacement rates. Offsetting the increases in interest income, interest expense on deposits and borrowings increased as replacement rates and average balances increased.
There was a provision for credit losses of $441,000 for the year ended December 31, 2023 compared to a provision for credit losses of $677,000 for the year ended December 31, 2022. The provision for credit losses consisted of a $712,000 provision related to loans due to loan growth and a $271,000 of negative provision related to unfunded commitments as the loan pipeline balance decreased for the year ended December 31, 2023. The provision for credit losses related to loans increased primarily due to loan growth in the portfolio. During the year ended December 31, 2023, we made adjustments to our qualitative factors, primarily to account for the changes in internal metrics and external risk factors. The forecast factor remained unchanged as we monitor the economic environment going forward.
Noninterest income decreased $834,000 for the year ended December 31, 2023 due primarily to a decrease in prepayment penalties on loans and gain from death benefit received on one bank-owned life insurance policy during 2022.
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Compensation, payroll taxes, and other employee benefits expense increased $853,000 to $19.9 million during the year ended December 31, 2023 primarily due to an increase in salaries due to annual raises that took place at the beginning of the year and an increase in full-time equivalents due to fewer open positions. Other noninterest expense decreased $1.7 million to $3.9 million as certain loan-related expenses paid to the mortgage banking segment for the purchase of single-family adjustable rate mortgage loans decreased compared to the prior year. These fees are eliminated in the consolidated statements of income.
Comparison of Mortgage Banking Segment Operations for the Years Ended December 31, 2023 and 2022
Net loss totaled $9.6 million for the year ended December 31, 2023 compared to net loss of $3.4 million for the year ended December 31, 2022. We originated $2.12 billion in mortgage loans held for sale (including sales to the community banking segment) during the year ended December 31, 2023, which represents a decrease of $641.8 million, or 23.2%, from the $2.76 billion originated during the year ended December 31, 2022. The decrease in loan production volume was driven by a $424.9 million, or 17.3%, decrease in home purchase volume due to inventory constraints in the market, housing affordability, and as interest rates have increased. Total mortgage banking noninterest income decreased $25.6 million, or 24.6%, to $78.5 million during the year ended December 31, 2023 compared to $104.1 million during the year ended December 31, 2022. The decrease in mortgage banking noninterest income was related to a 23.2% decrease in volume and a 2.6% decrease in gross margin on loans originated and sold for the year ended December 31, 2023 compared to December 31, 2022. Gross margin on loans originated and sold is the ratio of mortgage banking income (excluding the change in interest rate lock fair value) divided by total loan originations. The gross margin on loans originated and sold contraction reflects decreased industry demand due to the increased competition from mortgage originators. We sell loans on both a servicing-released and a servicing-retained basis. Waterstone Mortgage Corporation has contracted with a third party to service the loans for which we retain servicing.
Additionally, our overall margin can be affected by the mix of both loan type (conventional loans versus governmental) and loan purpose (purchase versus refinance). Conventional loans include loans that conform to Fannie Mae and Freddie Mac standards, whereas governmental loans are those loans guaranteed by the federal government, such as a Federal Housing Authority or U.S. Department of Agriculture loan. Our origination efforts continue to be focused on loans made for the purpose of residential purchases, as opposed to mortgage refinance. The percentage of origination volume related to purchase activity increased to 96.0% from 89.1% of total originations for the year ended December 31, 2023 and 2022, respectively, as refinance demand decelerated due to an increase in interest rates over the past year. The mix of loan type trended towards more governmental loans and less conventional loans, with governmental loans and conventional loans comprising 41.0% and 59.0%, respectively of all loan originations, respectively, during the year ended December 31, 2023, compared to 29.3% and 70.7% of all originations, respectively, during the year ended December 31, 2022.
During the year ended December 31, 2023, the Company sold mortgage servicing rights related to $318.4 million in loans serviced for third parties. The sale generated $3.5 million in net proceeds and a $583,000 gain. During the year ended December 31, 2022, there were no sales of mortgage servicing rights.
Total compensation, payroll taxes and other employee benefits decreased $15.9 million, or 19.6%, to $65.1 million for the year ended December 31, 2023 compared to $81.0 million for the year ended December 31, 2022. The decrease in compensation expense was primarily related to decreased commission expense and branch manager compensation driven by decreased loan origination volume and branch profitability as gross margins decreased. Additionally, salaries expense decreased due a reduction in headcount during the year ended December 31, 2023 compared to the year ended December 31, 2022.
Comparison of Consolidated Waterstone Financial, Inc. Results of Operations for the Years Ended December 31, 2023 and 2022
Years Ended December 31,
2023
2022
(Dollars In Thousands, except per share amounts)
Net income
$
9,375
$
19,487
Earnings per share - basic
0.47
0.89
Earnings per share - diluted
0.46
0.89
Return on average assets
0.44
%
0.96
%
Return on average equity
2.62
%
4.91
%
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Average Balance Sheets, Interest and Yields/Costs
The following table set forth average balance sheets, average yields and costs, and certain other information for the periods indicated. Non-accrual loans were included in the computation of the average balances of loans receivable and held for sale. The yields set forth below include the effect of deferred fees, discounts and premiums that are amortized or accreted to interest income or expense. Yields on interest-earning assets are computed on a fully tax-equivalent yield, where applicable.
Years Ended December 31,
2023
2022
2021
Average Balance
Interest
Average Rate
Average Balance
Interest
Average Rate
Average Balance
Interest
Average Rate
(Dollars in Thousands)
Assets
Interest-earning assets:
Loans receivable and held for sale (1)
$
1,752,806
90,148
5.14
%
$
1,467,306
62,935
4.29
%
$
1,600,115
64,366
4.02
%
Mortgage related securities (2)
172,318
4,053
2.35
%
162,584
3,241
1.99
%
103,324
1,954
1.89
%
Debt securities, federal funds sold and short-term investments (2)(3)
119,650
5,201
4.35
%
269,171
4,271
1.59
%
366,949
3,827
1.04
%
Total interest-earning assets
2,044,774
99,402
4.86
%
1,899,061
70,447
3.71
%
2,070,388
70,147
3.39
%
Noninterest-earning assets
106,532
120,744
142,040
Total assets
$
2,151,306
$
2,019,805
$
2,212,428
Liabilities and equity
Interest-bearing liabilities:
Demand accounts
$
80,143
82
0.10
%
72,751
61
0.08
%
64,653
50
0.08
%
Money market and savings accounts
309,119
4,529
1.47
%
391,170
1,201
0.31
%
363,930
904
0.25
%
Certificates of deposit
700,034
21,127
3.02
%
602,332
3,601
0.60
%
675,495
3,466
0.51
%
Total interest-bearing deposits
1,089,296
25,738
2.36
%
1,066,253
4,863
0.46
%
1,104,078
4,420
0.40
%
Borrowings
532,248
23,255
4.37
%
348,482
8,428
2.42
%
479,262
9,948
2.08
%
Total interest-bearing liabilities
1,621,544
48,993
3.02
%
1,414,735
13,291
0.94
%
1,583,340
14,368
0.91
%
Noninterest-bearing liabilities
Non interest-bearing deposits
120,321
159,495
146,767
Other noninterest-bearing liabilities
51,439
48,500
50,140
Total noninterest-bearing liabilities
171,760
207,995
196,907
Total liabilities
1,793,304
1,622,730
1,780,247
Equity
358,002
397,075
432,181
Total liabilities and equity
$
2,151,306
$
2,019,805
$
2,212,428
Net interest income / Net interest rate spread (4)
50,409
1.84
%
57,156
2.77
%
55,779
2.48
%
Less: taxable equivalent adjustment
194
0.01
%
202
0.01
%
264
0.01
%
Net interest income, as reported
50,215
1.83
%
56,954
2.76
%
55,515
2.47
%
Net interest-earning assets (5)
$
423,230
$
484,326
$
487,048
Net interest margin (6)
2.46
%
3.00
%
2.68
%
Tax equivalent effect
0.01
%
0.01
%
0.01
%
Net interest margin on a fully tax equivalent basis
2.47
%
3.01
%
2.69
%
Average interest-earning assets to average interest-bearing liabilities
126.10
%
134.23
%
130.76
%
(1) Includes net deferred loan fee amortization income of $643,000, $684,000 and $2.1 million for the years ended December 31, 2023, 2022, and 2021, respectively.
(2) Includes available for sale securities.
(3) Interest income from tax exempt securities is computed on a taxable equivalent basis using a tax rate of 21% for the years ended December 31, 2023, 2022, and 2021. The yields on debt securities, federal funds sold and short-term investments before tax-equivalent adjustments were 4.18%, 1.51%, and 0.97% for the years ended December 31, 2023, 2022, and 2021, respectively.
(4) Net interest rate spread represents the difference between the yield on average interest-earning assets and the cost of average interest-bearing liabilities and is presented on a fully tax equivalent basis.
(5) Net interest-earning assets represent total interest-earning assets less total interest-bearing liabilities.
(6) Net interest margin represents net interest income divided by average total interest-earning assets.
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Rate/Volume Analysis
The following table sets forth the effects of changing rates and volumes on our net interest income for the periods 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 net column represents the sum of the prior columns. For purposes of this table, changes attributable to changes in both rate and volume that cannot be segregated have been allocated proportionately based on the changes due to rate and the changes due to volume. There were no out-of-period items or adjustments for any of the years presented.
Years Ended December 31,
Years Ended December 31,
2023 versus 2022
2022 versus 2021
Increase (Decrease) due to
Increase (Decrease) due to
Volume
Rate
Net
Volume
Rate
Net
(In Thousands)
Interest and dividend income:
Loans receivable and held for sale (1)(2)
$
13,483
$
13,730
$
27,213
$
(5,567
)
$
4,136
$
(1,431
)
Mortgage related securities (3)
202
610
812
1,190
97
1,287
Other interest-earning assets (3)(4)
(3,376
)
4,306
930
(1,204
)
1,648
444
Total interest-earning assets
10,309
18,646
28,955
(5,581
)
5,881
300
Interest expense:
Demand accounts
6
15
21
11
-
11
Money market and savings accounts
(305
)
3,633
3,328
71
226
297
Certificates of deposit
677
16,849
17,526
(214
)
349
135
Total interest-bearing deposits
378
20,497
20,875
(132
)
575
443
Borrowings
5,865
8,962
14,827
(3,790
)
2,270
(1,520
)
Total interest-bearing liabilities
6,243
29,459
35,702
(3,922
)
2,845
(1,077
)
Net change in net interest income
$
4,066
$
(10,813
)
$
(6,747
)
$
(1,659
)
$
3,036
$
1,377
(1)
Includes net deferred loan fee amortization income of $643,000, $684,000 and $2.1 million for the years ended December 31, 2023, 2022, and 2021, respectively.
(2)
Non-accrual loans have been included in average loans receivable balance.
(3)
Includes available for sale securities.
(4)
Interest income from tax exempt securities is computed on a taxable equivalent basis using a tax rate of 21% for the years ended December 31, 2023, 2022, and 2021.
Net Interest Income
Net interest income decreased $6.7 million, or 11.8%, to $50.2 million during the year ended December 31, 2023 compared to $57.0 million during the year ended December 31, 2022.
•
Interest income on loans increased $27.2 million, or 43.2%, to $90.1 million during the year ended December 31, 2023 compared to $62.9 million during the year ended December 31, 2022 due primarily to an 85 basis point increase in average yield on loans as interest rates continued to increase over the past year and an increase in average loan balance as loans held for investment increased. The increase in average loan balance was driven by an increase of a $307.2 million, or 23.7%, in the average balance of loans held for investment offset by a decrease of $21.7 million, or 12.6%, in average loans held for sale.
•
Interest income from mortgage related securities increased $812,000, or 25.1%, primarily as the average balance increased $9.7 million and the yield increased by 36 basis points.
•
Interest income from debt securities increased $938,000, or 23.1%, to $5.0 million, due primarily to a 267 basis point increase in yield. The increased yield was partially offset by a decrease of $149.5 million in average balance.
•
Interest expense on time deposits increased $17.5 million, or 486.7%, primarily due to a 242 basis point increase in average cost of time deposits. Additionally, the average balance of time deposits increased $97.7 million compared to the prior year period.
•
Interest expense on money market, savings, and escrow accounts increased $3.3 million, or 277.1%, due primarily to a 116 basis point increase in average cost of money market, savings, and escrow accounts as offering rates increased to match the Federal Funds Rate. Partially offsetting the increase in average cost, the average balance decreased $82.1 million as more money moved to time deposits.
•
Interest expense on borrowings increased $14.8 million, or 175.9%, to $23.3 million due to a 195 basis point increase in the cost of borrowings during the year ended December 31, 2023 compared to the year ended December 31, 2022 as the federal funds rate increased over the past year. Additionally, the average balance increased $183.8 million to $532.2 million during the year ended December 31, 2023, compared to $348.5 million during the year ended December 31, 2022.
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Provision for Credit Losses
There was a provision for credit losses of $656,000 during the year ended December 31, 2023 compared to a $968,000 provision for loan losses for the year ended December 31, 2022. The $656,000 provision for credit losses consisted of a $927,000 provision related to loans and $271,000 of negative provision related to unfunded commitments for the year ended December 31, 2023. The increase in the loan portfolio provision is due to the increase in loan balance and the decrease on the unfunded commitments is due to the decrease in the loan pipeline. During the year ended December 31, 2023, we made adjustments to our qualitative factors, primarily to account for the changes in internal metrics and external risk factors. The forecast factor remained unchanged as we monitor the economic environment going forward.
The provision is primarily a function of the Company's reserving methodology and assessments of certain quantitative and qualitative factors which are used to determine an appropriate allowance for credit losses for the period. See further discussion regarding the allowance for loan losses in the "Asset Quality" section for an analysis of charge-offs, nonperforming assets, specific reserves and additional provisions and the "Allowance for Credit Loss" section.
Noninterest Income
Years Ended December 31,
2023
2022
$ Change
% Change
(Dollars in Thousands)
Service charges on loans and deposits
$
1,819
$
2,202
$
(383
)
(17.4
%)
Increase in cash surrender value of life insurance
1,710
1,738
(28
)
(1.6
%)
Mortgage banking income
75,686
99,560
(23,874
)
(24.0
%)
Other
1,970
2,055
(85
)
(4.1
%)
Total noninterest income
$
81,185
$
105,555
$
(24,370
)
(23.1
%)
Total noninterest income decreased $24.4 million, or 23.1%, to $81.2 million during the year ended December 31, 2023 compared to $105.6 million during the year ended December 31, 2022.
•
The decrease in mortgage banking income was primarily the result of a decrease in loan origination volume and gross margin on loans originated and sold. Gross margin on loans originated and sold is the ratio of mortgage banking income (excluding the change in interest rate lock fair value) divided by total loan originations. Total loan origination volume on a consolidated basis decreased $525.9 million, or 20.6%, to $2.02 billion during the year ended December 31, 2023 compared to $2.55 billion during the year ended December 31, 2022. Gross margin on loans originated and sold decreased 2.6% at the mortgage banking segment. Gross margin on loans originated and sold is the ratio of mortgage banking income (excluding the change in interest rate lock fair value) divided by total loan originations. See "Comparison of Mortgage Banking Segment Results of Operations for the Year December 31, 2023 and 2022" above, for additional discussion of the increase in mortgage banking income.
•
Service charges on loans and deposits decreased primarily due to a decrease in loan prepayment fees and other loan fees.
•
The decrease in other noninterest income was due primarily to an decrease in mortgage servicing fee income and gain from death benefit decreased as there was a gain recorded on one bank owned life insurance policy during the year ended December 31, 2022 compared to none during the year ended December 31, 2023. Offsetting the decreases, the Company sold mortgage servicing rights related to $318.4 million in loans serviced for third parties during the year ended December 31, 2023. The sale generated $3.5 million in net proceeds on a mortgage servicing rights book value of $2.9 million and resulted in a $583,000 gain. There were no comparable sales during the year ended December 31, 2022. As of December 31, 2023 and December 31, 2022, the Company maintained servicing rights related to $238.7 million and $409.6 million, respectively, in loans previously sold to third parties.
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Noninterest Expenses
Years Ended December 31,
2023
2022
$ Change
% Change
(Dollars in Thousands)
Compensation, payroll taxes, and other employee benefits
$
84,096
$
99,565
$
(15,469
)
(15.5
%)
Occupancy, office furniture, and equipment
8,323
8,706
(383
)
(4.4
%)
Advertising
3,779
3,976
(197
)
(5.0
%)
Data processing
4,653
4,470
183
4.1
%
Communications
988
1,189
(201
)
(16.9
%)
Professional fees
2,686
1,815
871
48.0
%
Real estate owned
4
19
(15
)
(78.9
%)
Loan processing expense
3,428
4,744
(1,316
)
(27.7
%)
Other
11,755
12,578
(823
)
(6.5
%)
Total noninterest expenses
$
119,712
$
137,062
$
(17,350
)
(12.7
%)
Total noninterest expenses decreased $17.4 million, or 12.7%, to $119.7 million during the year ended December 31, 2023 compared to $137.1 million during the year ended December 31, 2022.
•
Compensation, payroll taxes and other employee benefit expense at our mortgage banking segment decreased $15.9 million, or 19.6%, to $65.1 million for the year ended December 31, 2023. The decrease in compensation expense was primarily related to commission expense and branch manager compensation driven by decreased loan origination volume and branch profitability as gross margins decreased. Additionally, salaries expense decreased due a reduction in headcount during the year ended December 31, 2023 compared to the year ended December 31, 2022.
•
Compensation, payroll taxes and other employee benefits expense at the community banking segment increased $853,000 or 4.5%, to $19.9 million during the year ended December 31, 2023. The increase was primarily due to an increase in variable compensation and overall salary expense due to annual raises and an increase in full-time equivalents due to open positions being filled.
•
Occupancy, office furniture and equipment expense at the mortgage banking segment decreased $410,000 to $4.7 million during the year ended December 31, 2023 primarily resulting from lower equipment lease, maintenance, computer, and depreciation expenses.
•
Occupancy, office furniture and equipment expense at the community banking segment increased $27,000 to $3.7 million during the year ended December 31, 2023 compared to the prior year. The decrease was due primarily to increased building maintenance/repair costs.
•
Advertising expense decreased $197,000, or 5.0%, to $3.8 million during the year ended December 31, 2023. This was primarily due to a decrease at the mortgage banking segment in an effort to control costs.
•
Data processing expense increased $183,000, or 4.1% to $4.7 million during the year ended December 31, 2023. This was primarily due to increases at the community banking and mortgage banking segments for continued investments in technology and security.
•
Professional fees increased $871,000, or 48.0%, to $2.7 million during the year ended December 31, 2023. The increase was due to receiving a countersuit settlement related to a previously closed legal matter at the mortgage banking segment during the year ended December 31, 2022. Additionally, legal costs increased at the mortgage banking segment due to ongoing legal matters.
•
Other noninterest expense decreased $823,000, or 6.5%, to $11.8 million during the year ended December 31, 2023. The decrease at the mortgage banking segment related to a decrease in corporate meeting expenses, travel expenses, meals expense, and mortgage servicing rights amortization as the there was a bulk sale in the first quarter of 2023 and none during 2022. Offsetting the decreases, other noninterest expenses increased at the community banking segment as FDIC premiums increased starting in 2023
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Income Taxes
Income tax expense decreased $3.3 million to $1.7 million during the year ended December 31, 2023, compared to $5.0 million during the year ended December 31, 2022 as pretax income decreased $13.4 million. Income tax expense was recognized during the year ended December 31, 2023 at an effective rate of 15.0% compared to an effective rate of 20.4% during the year ended December 31, 2022. The decrease in the effective rate was primarily due to the permanent deductions being a greater percentage of pretax income as pretax income continued to decrease compared to the prior year.
On July 1, 2023, Wisconsin’s Governor signed the State Budget, retroactive to January 1, 2023, which included language that provides financial institutions with an exemption from state taxable income for interest, fees, and penalties earned on business or agriculture purpose loans where the borrower resides, or is located, in the state of Wisconsin and that are $5 million or less. The Company is not able to calculate a reasonable estimate of the impact of this law until further information regarding the criteria is published from the Wisconsin Department of Revenue. If we are allowed to exclude current taxable income, we would expect to decrease our 2023 effective income tax rate and potentially reduce our deferred tax asset with a one-time charge to income tax expense to reflect the reduction in state income taxes. The Company will calculate an estimate once more details are provided.
Liquidity and Capital Resources
We maintain liquid assets at levels we consider adequate to meet our liquidity needs. The liquidity ratio is equal to average daily cash and cash equivalents for the period divided by average total assets. We adjust our liquidity levels to fund loan commitments, repay our borrowings, fund deposit outflows and pay real estate taxes on mortgage loans. We also adjust liquidity as appropriate to meet asset and liability management objectives. The operational adequacy of our liquidity position at any point in time is dependent upon the judgment of the Chief Financial Officer as supported by the Asset/Liability Committee. Liquidity is monitored on a daily, weekly and monthly basis using a variety of measurement tools and indicators. Regulatory liquidity, as required by the WDFI, is based on current liquid assets as a percentage of the prior month’s average deposits and short-term borrowings. Minimum primary liquidity is equal to 4.0% of deposits and short-term borrowings and minimum total regulatory liquidity is equal to 8.0% of deposits and short-term borrowings.
Our primary sources of liquidity are deposits, amortization and repayment of loans, sales of loans held for sale, maturities of investment securities and other short-term investments, and earnings and funds provided from operations. While scheduled principal repayments on loans are a relatively predictable source of funds, deposit flows and loan repayments are greatly influenced by market interest rates, economic conditions, and rates offered by our competitors. We set the interest rates on our deposits to maintain a desired level of total deposits. In addition, we invest excess funds in short-term, interest-earning assets, which provide liquidity to meet lending requirements. Additional sources of liquidity used to manage long- and short-term cash flows include advances from the FHLB.
A portion of our liquidity consists of cash and cash equivalents, which are a product of our operating, investing and financing activities. At December 31, 2023 and 2022, $36.4 million and $46.6 million, respectively, of our assets were invested in cash and cash equivalents. Our primary sources of cash are principal repayments on loans, proceeds from the calls and maturities of debt and mortgage related securities, increases in deposit accounts, Federal funds purchased and advances from the FHLB.
Our cash flows are derived from operating activities, investing activities and financing activities as reported in our Consolidated Statements of Cash Flows included in our Consolidated Financial Statements.
During the years ended December 31, 2023, and 2022, we originated on a consolidated basis $2.02 billion and $2.55 billion in loans for sale and sold loans on a consolidated basis of $2.06 billion and $2.81 billion. During the years ended December 2023 and 2022, loan originations net of loan repayments resulted in a negative cash flows of $154.2 million and $303.9 million. Cash received from the principal repayments of debt and mortgage related securities and maturity and calls of debt securities totaled $24.9 million and $50.7 million for the years ended December 31, 2023 and 2022, respectively. We purchased $29.5 million and $90.0 million in debt securities and mortgage related securities classified as available for sale during the years ended December 31, 2023 and 2022, respectively. The net decreases in deposits were $8.4 million and $34.4 for the year ending December 31, 2023 and 2022. We received a $1.2 million death benefit on a bank owned life insurance policy in 2022. There was an increase in net borrowings of $224.3 million for the year ended December 31, 2023 and a net decrease in borrowings of $90.3 million for the year ended December 31, 2022. During the years ended December 31, 2023 and 2022, we repurchased common stock of $26.0 million and $47.8 million, respectively. During the years ended December 31, 2023 and 2022, we paid cash dividends on common stock of $15.4 million and $30.3 million, respectively.
Deposits decreased by $8.4 million from December 31, 2022 to December 31, 2023. The decrease was driven by a $96.4 million decrease in total transaction accounts, offset by an $88.0 million increase in time deposits. Deposit flows are generally affected by the level of interest rates, market conditions, products offered by local competitors, and other factors.
Liquidity management is both a daily and longer-term function of business management. If we require funds beyond our ability to generate them internally, borrowing agreements exist with the FHLB which provide an additional source of funds. At December 31, 2023, we had $159.0 million in long term advances from the FHLB with contractual maturity dates in 2025, 2027, and 2028. See Note 6 - Borrowings of the notes to audited consolidated financial statements for additional information about the remaining call option details of our FHLB long-term debt.
The Company had approximately $287.9 million of uninsured deposits for approximately 1,209 customers as of December 31, 2023. Uninsured deposit amounts are estimated based on the portions of customer account balances that exceed the FDIC insurance limits.
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At December 31, 2023, we had outstanding commitments to originate loans receivable of $9.8 million. In addition, at December 31, 2023, we had unfunded commitments under construction loans of $76.7 million, unfunded commitments under business lines of credit of $15.4 million and unfunded commitments under home equity lines of credit and standby letters of credit of $12.2 million. At December 31, 2023, certificates of deposit scheduled to mature in less than one year totaled $622.4 million. Based on prior experience, management believes that a significant portion of such deposits will remain with us, although there can be no assurance that this will be the case. In the event a significant portion of our deposits are not retained by us, we will have to utilize other funding sources, such as Federal Home Loan Bank of Chicago advances, Federal Reserve Discount Window or brokered deposits to maintain our level of assets. However, such borrowings may not be available on attractive terms, or at all, if and when needed. Alternatively, we would reduce our level of liquid assets, such as our cash and cash equivalents and securities available for sale in order to meet funding needs. In addition, the cost of such deposits may be significantly higher if market interest rates are higher or there is an increased amount of competition for deposits in our market area at the time of renewal.
Capital
Shareholders’ equity decreased by $26.4 million, or 7.1%, to $344.1 million at December 31, 2023 from $370.5 million at December 31, 2022. Shareholders' equity decreased primarily due to the declaration of dividends and the repurchase of stock. Partially offsetting the decreases, there were increases due to the net income, additional paid-in capital as stock options were exercised and equity awards vested, increases in the values of securities available for sale, and unearned ESOP shares vesting.
The Company's Board of Directors authorized a 2,000,000 share stock repurchase program in the second quarter of 2023. As of December 31, 2023, the Company had repurchased 15.9 million shares at an average price of $15.04 under previously approved stock repurchase plans.
Waterstone Financial, Inc. and WaterStone Bank are subject to various regulatory capital requirements, including a risk-based capital measure. The risk-based capital guidelines include both a definition of capital and a framework for calculating risk-weighted assets by assigning assets and off-balance sheet items to broad risk categories. At December 31, 2023, Waterstone Financial, Inc. and WaterStone Bank exceeded all regulatory capital requirements and are considered “well capitalized” under regulatory guidelines. See “Supervision and Regulation—Capital Requirements” and Note 9 - Regulatory Capital of the notes to the consolidated financial statements.
Contractual Obligations, Commitments, Contingent Liabilities, and Off-balance Sheet Arrangements
During the year ended December 31, 2023, our FHLB short-term debt increased by $123.3 million and we repaid $304.0 million in FHLB long-term debt and borrowed $259.0 million of new FHLB long-term debt. In addition, we borrowed $145.0 in short-term debt from the Federal Reserve Bank.
See Note 8 - Borrowings of the notes to the consolidated financial statements for additional information about the remaining maturities of our FHLB long-term debt.
See Note 14 - Commitments, Off-Balance Sheet Arrangements, and Contingent Liabilities of the notes to the consolidated financial statements for additional information.
WaterStone Bank has various financial obligations, including contractual obligations and commitments that may require future cash payments. The following tables present information indicating various non-deposit contractual obligations and commitments of WaterStone Bank as of December 31, 2023 and the respective maturity dates.
Impact of Inflation and Changing Prices
The financial statements and accompanying notes have been prepared in accordance with GAAP. GAAP generally requires the measurement of financial position and operating results in terms of historical dollars without consideration for changes in the relative purchasing power of money over time due to inflation. The impact of inflation is reflected in the increased cost of our operations. Unlike industrial companies, our assets and liabilities are primarily monetary in nature. As a result, changes in market interest rates have a greater impact on performance than do the effects of inflation.
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