What changed in this filing

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Item 2. Management’s Discussion and Analysis

2021-11-09 compared with 2021-08-03 · 236 added, 249 removed, 523 unchanged (48% of the section changed)

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general economic conditions, either nationally or in our market area, including employment prospects, that are different than expected;

the effect of any pandemic;

including COVID-19;

the effects of any pandemic, including COVID-19, and related government actions;

competition among depository and other financial institutions;

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It is intended to complement the unaudited consolidated financial statements, footnotes, and supplemental financial data appearing elsewhere in this Quarterly Report on Form 10-Q and should be read in conjunction therewith.

The detailed discussion in the sections below focuses on the results of operations for the three and six months ended June 30, 2021 and 2020 and the financial condition as of June 30, 2021 compared to the financial condition as of December 31, 2020.

The detailed discussion in the sections below focuses on the results of operations for the three and nine months ended September 30, 2021 and 2020 and the financial condition as of September 30, 2021 compared to the financial condition as of December 31, 2020.

As described in the notes to the unaudited consolidated financial statements, we have two reportable segments:

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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 three and six months ended June 30, 2021 and 2020, which focuses on noninterest income and noninterest expenses.

We have provided below a discussion of the material results of operations for each segment on a separate basis for the three and nine months ended September 30, 2021 and 2020, which focuses on noninterest income and noninterest expenses.

We have also provided a discussion of the consolidated operations of the Company, which includes the consolidated operations of the Bank and Waterstone Mortgage Corporation, for the same periods.

Significant Items

Earnings comparisons for the three and six months ended June 30, 2021 and 2020 were impacted by the significant items summarized below.

Earnings comparisons for the three and nine months ended September 30, 2021 and 2020 were impacted by the significant items summarized below.

COVID-19, the CARES Act, the Consolidated Appropriations Act, and the American Rescue Plan Act

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While some industries have been impacted more severely than others, all businesses have been impacted to some degree.

This disruption resulted in the shuttering of businesses across the country, significant job loss, and aggressive measures by the federal government.

This disruption has resulted in the shuttering of businesses across the country, significant job loss, and aggressive measures by the federal government.

In March 2020, the Coronavirus Aid, Relief and Economic Security (“CARES”) Act was signed into law as a $2 trillion legislative package.

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The package also includes extensive emergency funding for hospitals and providers.

In March 2021, the American Rescue Plan Act of 2021 (the "American Rescue Plan Act") was signed into law and provides approximately $1.9 trillion in spending to address the continued impact of COVID-19.

In March 2021, the American Rescue Plan Act of 2021 (the American Rescue Plan Act) was signed into law which provides $1.9 trillion in spending to address the continued impact of COVID-19.

While it is not possible to know the full universe or extent of these impacts as of the date this filing, we are disclosing potentially material items of which we are aware.

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The financial statements included in this Quarterly Report on Form 10-Q include an allowance for loan losses that was prepared under the existing incurred loss methodology.

Under the CARES Act, loans less than 30 days past due as of December 31, 2019 and COVID-19 modifications are considered current.

A financial institution suspended the requirements under accounting principles generally accepted in the United States (US GAAP) for loan modifications related to COVID-19 that would otherwise be categorized as a troubled debt restructuring (“TDR”).

Under the CARES Act, loans less than 30 days past due as of December 31, 2019 and subject to COVID-19 modifications are considered current.

A financial institution may suspend the requirements under accounting principles generally accepted in the United States (US GAAP) for loan modifications related to COVID-19 that would otherwise be categorized as a troubled debt restructuring (“TDR”).

This includes a suspension of the requirement to determine impairment of these modifications for accounting purposes.

In keeping with regulatory guidance to work with borrowers during this unprecedented situation, the Company has executed a payment deferral program for our lending clients that are adversely affected by the pandemic.

As of June 30, 2021, the Company had three modified loans totaling $559,000 consisting of principal deferrals or principal and interest deferrals.

As of September 30, 2021, the Company had three modified loans totaling $559,000 subject to principal deferrals or principal and interest deferrals.

These short-term deferrals are not considered troubled debt restructurings.

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As a qualified SBA lender, we were automatically authorized to originate PPP loans.

The Company is actively participating in assisting our customers with applications for resources through the program.

The Company participated in assisting our customers with applications for resources through the program.

PPP loans have:

(a) an interest rate of 1.0%, (b) a five-year loan term to maturity for loans made on or after June 5, 2020 (loans made prior to June 5, 2020 have a two-year term, however borrowers and lenders may mutually agree to extend the maturity for such loans to five years);

(a) an interest rate of 1.0%, (b) a five-year loan term to maturity for loans made on or after June 5, 2020;

and (c) principal and interest payments deferred for six months from the date of disbursement.

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The entire principal amount of the borrower’s PPP loan, including any accrued interest, is eligible to be reduced by the loan forgiveness amount under the PPP.

As of June 30, 2021, we have funded 449 loans totaling $44.6 million.

During the six months ended June 30, 2021, the Company originated a total of $14.5 million in PPP loans for customers and recognized $640,000 in fees received from the SBA.

As of June 30, 2021, we have PPP loans outstanding totaling $16.9 million.

Our fee income could be reduced due to COVID-19.

In keeping with guidance from regulators, we are working with COVID-19 affected customers to waive fees from a variety of sources, such as, but not limited to, insufficient funds and overdraft fees, ATM fees, account maintenance fees, etc.

These reductions in fees are thought, at this time, to be temporary in conjunction with the length of the COVID-19 emergency.

At this time, we are unable to project the materiality of such an impact, but recognize that the breadth of the economic impact is likely to impact our fee income in future periods.

Our interest income could be reduced due to COVID-19.

In keeping with guidance from regulators, we are actively working with COVID-19 affected borrowers to defer their payments, interest, and fees.

While interest and fees will still accrue to income, through normal GAAP accounting, should eventual credit losses on these deferred payments emerge, interest income and fees accrued would need to be reversed.

In such a scenario, interest income in future periods could be negatively impacted.

At this time, we are unable to project the materiality of such an impact, but recognize that the breadth of the economic impact may affect our borrowers’ ability to repay in future periods.

During the nine months ended September 30, 2021, the Company originated a total of $14.5 million in PPP loans for customers and recognized $1.1 million in fees received from the SBA.

As of September 30, 2021, we had PPP loans outstanding totaling $4.1 million.

Capital and liquidity

As of June 30, 2021 , all of our capital ratios, and our subsidiary bank’s capital ratios, were in excess of all regulatory requirements.

As of September 30, 2021 , all of our capital ratios, and our subsidiary bank’s capital ratios, were in excess of all regulatory requirements.

While we believe that we have sufficient capital to withstand an extended economic recession brought about by COVID-19, our reported and regulatory capital ratios could be adversely impacted by further credit losses.

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If an extended recession caused large numbers of our deposit customers to withdraw their funds, we might become more reliant on volatile or more expensive sources of funding.

Comparison of Community Banking Segment Results of Operations for the Three Months Ended June 30, 2021 and 2020

Net income totaled $7.5 million for the three months ended June 30, 2021 compared to $4.1 million for the three months ended June 30, 2020.

Net interest income increased $816,000 to $14.5 million for the three months ended June 30, 2021 compared to $13.7 million for the three months ended June 30, 2020.

Comparison of Community Banking Segment Results of Operations for the Three Months Ended September 30, 2021 and 2020

Net income totaled $6.8 million for the three months ended September 30, 2021 compared to $6.2 million for the three months ended September 30, 2020.

Net interest income increased $629,000 to $14.1 million for the three months ended September 30, 2021 compared to $13.5 million for the three months ended September 30, 2020.

Interest expense decreased as funding rates decreased.

Offsetting the decrease in interest expense, interest income on loans and mortgage-related securities categories decreased as replacement rates and average balances were lower than in the prior year.

The Company delayed adoption of ASC Topic 326 as permited under the CARES Act, as amended.

Offsetting the decrease in interest expense, interest income on loans decreased as replacement rates and average balances were lower than in the prior year and interest on mortgage-related securities decreased as yields continue to decrease with lower replacement rates.

The Company delayed adoption of ASC Topic 326 as permited under the CARES Act.

The Company calculated the current quarter allowance using the incurred loss model.

There was a negative provision for loan losses of $750,000 for the three months ended June 30, 2021 compared to a $4.3 million provision for loan losses for the three months ended June 30, 2020.

During the three months ended June 30, 2021, we made adjustments to our qualitative factors, primarily to account for the improvement in certain economic factors along with a decrease in loan balance.

Additionally, we recorded a significant recovery as a loan payoff was received.

Total noninterest income decreased $1.3 million due primarily to a decrease in loan prepayment fees.

Service charges on loans decreased due to fees earned on swaps in 2020.

Compensation, payroll taxes, and other employee benefits expense decreased $32,000 to $4.9 million primarily due to a decrease in variable compensation offset by increases in health insurance and employee stock ownership plan expenses.

Data processing expense decreased $212,000 due to the implementation of a new digital banking platform in 2020.

Other noninterest expense decreased $71,000 as certain loan-related expenses decreased offset by a decrease of credits received for FDIC premiums in 2020 but not in 2021.

Comparison of Mortgage Banking Segment Results of Operations for the Three Months Ended June 30, 2021 and 2020

Net income totaled $10.4 million for the three months ended June 30, 2021 compared to $16.8 million for the three months ended June 30, 2020.

We originated $1.07 billion in mortgage loans held for sale (including sales to the community banking segment) during the three months ended June 30, 2021, which represents a decrease of $77.5 million, or 6.8%, from the $1.14 billion originated during the three months ended June 30, 2020.

There was a negative provision for loan losses of $750,000 for the three months ended September 30, 2021 compared to a $1.0 million provision for loan losses for the three months ended September 30, 2020.

During the three months ended September 30, 2021, we made adjustments to our qualitative factors, primarily to account for the improvement in certain economic factors along with a decrease in loan balance.

Additionally, we continued to have net recoveries for the quarter.

Total noninterest income decreased $1.4 million due primarily to a decrease in gains from death benefits received on two bank owned life insurance policies during the three months ended September 30, 2020.

Compensation, payroll taxes, and other employee benefits expense increased $360,000 to $5.4 million primarily due to an increase in health insurance expense and Employee Stock Ownership Plan expense as the average stock price increased compared to the quarter ending September 30, 2020.

Other noninterest expense decreased $396,000 as certain loan-related expenses decreased.

Comparison of Mortgage Banking Segment Results of Operations for the Three Months Ended September 30, 2021 and 2020

Net income totaled $12.3 million for the three months ended September 30, 2021 compared to $20.1 million for the three months ended September 30, 2020.

We originated $1.06 billion in mortgage loans held for sale (including sales to the community banking segment) during the three months ended September 30, 2021, which represents a decrease of $241.2 million, or 18.6%, from the $1.30 billion originated during the three months ended September 30, 2020.

The decrease in loan production volume was driven by a $189.0 million, or 40.6%, decrease in refinance products as mortgage rates have increased.

Mortgage purchase products increased $168.9 million, or 26.6%, due to the high demand for single family homes and fixed-rate mortgages.

Total mortgage banking noninterest income decreased $13.7 million, or 21.3%, to $50.6 million during the three months ended June 30, 2021 compared to $64.2 million during the three months ended June 30, 2020.

The decrease in mortgage banking noninterest income was related to a 6.8% decrease in volume and an 11.8% decrease in gross margin on loans originated and sold for the three months ended June 30, 2021 compared to June 30, 2020.

Mortgage purchase products decreased $52.2 million, or 6.3%, due to inventory constraints in the market.

Total mortgage banking noninterest income decreased $21.9 million, or 29.9%, to $51.3 million during the three months ended September 30, 2021 compared to $73.1 million during the three months ended September 30, 2020.

The decrease in mortgage banking noninterest income was related to an 18.6% decrease in volume and a 16.4% decrease in gross margin on loans originated and sold for the three months ended September 30, 2021 compared to September 30, 2020.

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.

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Waterstone Mortgage Corporation has contracted with a third party to service the loans for which we retain servicing.

Additionally, there was a $4.0 million gain on sale of mortgage servicing rights during the three months ended September 30, 2021 compared to none during the three months ended September 30, 2020.

Additionally, our overall margin can be affected by the mix of both loan type (conventional loans versus governmental) and loan purpose (purchase versus refinance).

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Department of Agriculture loan.

Loans originated for the purchase of a residential property, which generally yield a higher margin than loans originated for refinancing existing loans, comprised 75.4% of total originations during the three months ended June 30, 2021, compared to 55.5% of total originations during the three months ended June 30, 2020, respectively, as refinance demand decelerated as interest rates increased over the past year.

The mix of loan type trended towards less conventional loans and more governmental loans;

with conventional loans and governmental loans comprising 75.3% and 24.7% of all loan originations, respectively, during the three months ended June 30, 2021, compared to 75.8% and 24.2% of all loan originations, respectively, during the three months ended June 30, 2020.

Total compensation, payroll taxes and other employee benefits decreased $3.0 million, or 9.2%, to $29.2 million for the three months ended June 30, 2021 compared to $32.1 million for the three months ended June 30, 2020.

Loans originated for the purchase of a residential property, which generally yield a higher margin than loans originated for refinancing existing loans, comprised 73.8% of total originations during the three months ended September 30, 2021, compared to 64.1% of total originations during the three months ended September 30, 2020, respectively, as refinance demand decelerated due to an increase in interest rates over the past year.

The mix of loan type trended towards more conventional loans and less governmental loans, with conventional loans and governmental loans comprising 76.1% and 23.9% of all loan originations, respectively, during the three months ended September 30, 2021, compared to 75.6% and 24.4% of all loan originations, respectively, during the three months ended September 30, 2020.

Total compensation, payroll taxes and other employee benefits decreased $5.6 million, or 16.1%, to $29.0 million for the three months ended September 30, 2021 compared to $34.6 million for the three months ended September 30, 2020.

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.

Professional fees decreased $489,000 to $361,000 during the quarter ended June 30, 2021 compared to $850,000 of expense during the quarter ended June 30, 2020.

The decrease related to a decrease in litigation costs compared to the prior year, as the Herrington settlement was resolved in 2020.

Occupancy, office furniture, and equipment decreased $262,000 due to lower rent and depreciation expenses.

Other noninterest expense decreased $561,000 to $2.7 million during the quarter ended June 30, 2021 compared to $3.2 million during the quarter ended June 30, 2020.

The decrease related to a decrease in the provision for losses on loans sold to the secondary market that results from both early payoff and early default provisions with investors.

The decreased provision was driven by both a decrease in the number and volume of loans sold, as well as actual default activity resulting from COVID-19 pandemic being lower than expected.

Offsetting the decrease, amortization of mortgage servicing rights increased as the size of the servicing portfolio has increased in 2021 compared to 2020.

Professional fees decreased $4.0 million to $421,000 during the quarter ended September 30, 2021 compared to $4.5 million of expense during the quarter ended September 30, 2020.

The decrease related to a decrease in litigation costs compared to the prior year, as the Herrington settlement was resolved during the quarter ended September 30, 2020.

Other noninterest expense decreased $174,000 to $2.3 million during the quarter ended September 30, 2021 compared to $2.4 million during the quarter ended September 30, 2020.

The decrease related to a decrease in the servicing fees on mortgage servicing rights due to the sale during the quarter ended September 30, 2021.

Consolidated Waterstone Financial, Inc.

Results of Operations

Three months ended June 30,

Three months ended September 30,

(Dollars in Thousands, except per share amounts)

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Yields on interest-earning assets are computed on a fully tax-equivalent yield, where applicable.

Three months ended June 30,

Three months ended September 30,

Average Balance

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Average interest-earning assets to average interest-bearing liabilities

(1) Interest income includes net deferred loan fee amortization income o f $494,000 and $428,000 for the three months ended June 30, 2021 and 2020, respectively.

(1) Interest income includes net deferred loan fee amortization income o f $644,000 and $349,000 for the three months ended September 30, 2021 and 2020, respectively.

(2) Average balance of mortgage related and debt securities are based on amortized historical cost.

(3) Interest income from tax-exempt securities is computed on a taxable equivalent basis using a tax rate of 21% for the three months ended June 30, 2021 and 2020.

The yields on debt securities, federal funds sold and short-term investments before tax-equivalent adjustments were 1.12 % and 1.71% fo r the three months ended June 30, 2021 and 2020, respectively.

(3) Interest income from tax-exempt securities is computed on a taxable equivalent basis using a tax rate of 21% for the three months ended September 30, 2021 and 2020.

The yields on debt securities, federal funds sold and short-term investments before tax-equivalent adjustments were 0.88 % and 1.75% fo r the three months ended September 30, 2021 and 2020, 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.

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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.

Three months ended June 30,

Three months ended September 30,

2021 versus 2020

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______________

(1) Interest income includes net deferred loan fee amortization income of $494,000 and $428,000 for the three months ended June 30, 2021 and 2020, respectively.

(1) Interest income includes net deferred loan fee amortization income of $644,000 and $349,000 for the three months ended September 30, 2021 and 2020, respectively.

(2) Non-accrual loans have been included in average loans receivable balance.

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Average balance of available for sale securities is based on amortized historical cost.

(4) Interest income from tax exempt securities is computed on a taxable equivalent basis using a tax rate of 21% for the three months ended June 30, 2021 and June 30, 2020.

Net interest income increased $1.0 million, or 7.8%, to $14.3 million during the three months ended June 30, 2021 compared to $13.2 million during the three months ended June 30, 2020.

Interest income on loans decreased $2.0 million due primarily to a 24 basis point decrease in average yield on loans as London Interbank Offered Rate ("LIBOR") and U.S.

(4) Interest income from tax exempt securities is computed on a taxable equivalent basis using a tax rate of 21% for the three months ended September 30, 2021 and September 30, 2020.

Net interest income increased $705,000, or 5.3%, to $14.1 million during the three months ended September 30, 2021 compared to $13.4 million during the three months ended September 30, 2020.

Interest income on loans decreased $2.1 million due primarily to a three basis point decrease in average yield on loans as London Interbank Offered Rate (LIBOR) and U.S.

Treasury rates continued to decrease and a $193.5 million, or 11.0%, decrease in average loans as payoffs continue to outpace originations.

The decrease in average loan balance was driven by a decrease of $101.6 million, or 7.2%, in the average balance of loans held in portfolio along with a $3.3 million, or 1.0%, decrease in the average balance of loans held for sale.

Interest income from mortgage-related securities decreased $184,000 as the yield decreased 60 basis points and the average balance decreased $5.7 million.

The decrease in average loan balance was driven by an decrease of $174.0 million, or 12.2%, in the average balance of loans held in portfolio along with a $19.6 million, or 5.8%, decrease in the average balance of loans held for sale.

Interest income from mortgage-related securities decreased $117,000 as the yield decreased 70 basis points offset by a $12.2 million increase in the average balance.

Interest income from other interest-earning assets (comprised of debt securities, federal funds sold and short-term investments) increased $172,000 due primarily to a $243.4 million increase in the average balance as cash balances were greater.

The increase in average cash balances resulted fron the growth in deposits along with paydowns on loans.

Offsetting the increase in average balance, the yield decreased 59 basis points as higher rate securities matured and were placed in cash.

The increase in average cash balances resulted from the growth in average deposits along with paydowns decreasing average loans.

Offsetting the increase in average balance, the yield decreased 87 basis points as higher rate securities matured and were held in cash.

Interest expense on time deposits decreased $2.3 million, or 76.7%, primarily due to a 120 basis point decrease in average cost of time deposits.

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Money market accounts continue to be a focus and the Company agressively marketed new and existing customers through various new offerings.

Interest expense on borrowings decreased $196,000, or 7.4%, due to a $129.8 million decrease in the average balance of borrowings during the three months ended June 30, 2021 compared to the three months ended June 30, 2020 as additional short-term funding was needed in 2020.

Offsetting the decrease in average balance, the cost of borrowings increased 30 basis points to 2.06% during the three months ended June 30, 2021, compared to 1.76% million during the three months ended June 30, 2020 as the lower rate short-term FHLB borrowings utilized uring 2020 were not necessary during 2021 due to our excess liquidity position.

Interest expense on borrowings decreased $195,000, or 7.4%, due to a $56.6 million decrease in the average balance of borrowings during the three months ended September 30, 2021 compared to the three months ended September 30, 2020 as additional short-term funding was needed in 2020.

Offsetting the decrease in average balance, the cost of borrowings increased six basis points to 2.04% during the three months ended September 30, 2021, compared to 1.98% during the three months ended September 30, 2020 as the lower rate short-term FHLB borrowings utilized during 2020 were not necessary during 2021 due to our excess liquidity position.

Provision for Loan Losses

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The Company calculated the current quarter allowance using the incurred loss model.

The negative provision for loan losses was $750,000 for the three months ended June 30, 2021 compared to $4.5 million of provision for loan losses for the three months ended June 30, 2020.

During the three months ended June 30, 2020, we made adjustments to our qualitative factors, primarily to account for the improvement in certain economic factors along with a decrease in loan balance.

Additionally, we recorded a significant recovery as a loan payoff was received.

We had a negative provision for loan losses of $750,000 at the community banking segment and no provision for loan losses for the mortgage banking segment.

Net recoveries were $378,000 for the three months ended June 30, 2021.

The negative provision for loan losses was $700,000 for the three months ended September 30, 2021 compared to $1.0 million of provision for loan losses for the three months ended September 30, 2020.

Additionally, we continued to have net recoveries for the quarter.

We had a negative provision for loan losses of $750,000 at the community banking segment and a $50,000 provision for loan losses for the mortgage banking segment.

Net recoveries were $100,000 for the three months ended September 30, 2021.

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 loan losses for the period.

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Noninterest Income

Three months ended June 30,

Three months ended September 30,

(Dollars in Thousands)

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Total noninterest income

Total noninterest income decreased $14.9 million, or 22.2%, to $52.0 million during the three months ended June 30, 2021 compared to $66.9 million during the three months ended June 30, 2020.

The decrease resulted primarily from a decrease in mortgage banking noninterest income along with a decrease in service charges on loan and deposits.

Total noninterest income decreased $22.8 million, or 30.1%, to $52.9 million during the three months ended September 30, 2021 compared to $75.8 million during the three months ended September 30, 2020.

The decrease resulted primarily from an decrease in mortgage banking noninterest income along with a decrease in cash surrender value of life insurance.

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 $52.2 million, or 4.7%, to $1.06 billion during the three months ended June 30, 2021 compared to $1.11 billion during the three months ended June 30, 2020.

Total loan origination volume on a consolidated basis decreased $220.0 million, or 17.3%, to $1.05 billion during the three months ended September 30, 2021 compared to $1.27 billion during the three months ended September 30, 2020.

Gross margin on loans originated and sold decreased 16.4% at the mortgage banking segment.

See "Comparison of Mortgage Banking Segment Results of Operations for the Three Months Ended June 30, 2021 and 2020" above for additional discussion of the increase in mortgage banking income.

Service charges on loans and deposits decreased primarily due to a decrease in fees earned on loan swaps originated.

The increase in cash surrender value of life insurance was due primarily to an increase in dividends due to the timing of the annual dividend.

The increase in other noninterest income was due primarily to increases in mortgage servicing fee income and wealth management revenue.

Mortgage servicing fee income increased as loans sold with servicing rights retained increased due to market conditions.

See "Comparison of Mortgage Banking Segment Results of Operations for the Three Months Ended September 30, 2021 and 2020" above for additional discussion of the decrease in mortgage banking income.

Service charges on loans and deposits increased primarily due to an increase in loan prepayment fees.

The decrease in cash surrender value of life insurance was due primarily to a decrease in balance as death benefit proceeds were received on two policies in the prior year.

The increase in other noninterest income was due primarily to a gain on sale of mortgage servicing rights and increases in mortgage servicing fee income, and wealth management revenue.

During the quarter ended September 30, 2021, the Company sold mortgage servicing rights related to $1.24 billion in loans serviced for third parties.

The sale generated $12.4 million in net proceeds and a $4.0 million gain.

There was no comparable sale during the quarter ended September 30, 2020.

As of September 30, 2021, the Company maintained servicing rights related to $160.8 million in loans previously sold to third parties.

Offsetting the increases, there was a $1.5 million decrease in gains from death benefit received on two bank owned life insurance policies during the three months ended September 30, 2020 compared to none during the three months ended September 30, 2021.

Noninterest Expenses

Three months ended June 30,

Three months ended September 30,

(Dollars in Thousands)

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Total noninterest expenses

Total noninterest expenses decreased $4.4 million, or 9.2%, to $43.3 million during the three months ended June 30, 2021 compared to $47.7 million during the three months ended June 30, 2020.

Compensation, payroll taxes and other employee benefits expense at our mortgage banking segment decreased $3.0 million, or 9.2%, to $29.2 million during the three months ended June 30, 2021.

Total noninterest expenses decreased $9.7 million, or 18.3%, to $43.3 million during the three months ended September 30, 2021 compared to $53.0 million during the three months ended September 30, 2020.

Compensation, payroll taxes and other employee benefits expense at our mortgage banking segment decreased $5.6 million, or 16.1%, to $29.0 million during the three months ended September 30, 2021.

Compensation, payroll taxes and other employee benefits expense at the community banking segment decreased $32,000, or 0.7%, to $4.9 million during the three months ended June 30, 2021.

The decrease was due primarily to a decrease in variable compensation offset by increases in health insurance and employee stock ownership plan expenses.

Occupancy, office furniture and equipment expense at the mortgage banking segment decreased $262,000 to $1.4 million during the three months ended June 30, 2021, primarily resulting from lower rent and depreciation expense.

Occupancy, office furniture and equipment expense at the community banking segment increased $32,000 to $887,000 during the three months ended June 30, 2021.

The increase was due primarily to increased snow removal expense.

Advertising expense increased $47,000, or 5.4%, to $911,000 during the three months ended June 30, 2021.

This was primarily due to marketing increases at the mortgage banking segment to attract customers as rates are higher than in the prior year.

Advertising at the community banking segment decreased as customer promotion slowed.

Data processing expense decreased $181,000, or 16.5%, to $914,000 during the three months ended June 30, 2021.

This was primarily due to decreased data conversion expenses as the new ditigal banking platform rollout at the community banking segment occured during the three months ended June 30, 2020.

Professional fees decreased $508,000 to $569,000 of income during the three months ended June 30, 2021.

The decrease related to a decrease in litigation costs compared to the prior year, as the Herrington settlement was resolved in 2020.

Other noninterest expense decreased $514,000, or 14.0%, to $3.2 million during the three months ended June 30, 2021.

The decrease at the mortgage banking segment related to a decrease in the provision for losses on loans sold as the secondary market that results from both early payoff and early default provisions with investors.

The decreased provision is driven by both a decrease in the number and volume of loans sold, as well as actual default activity resulting from the COVID-19 pandemic was lower than expected .

Offsetting the decrease at the mortgage banking segment, amortization of mortgage servicing rights increased as the size of the servicing portfolio has increased in 2021 compared to 2020.

Additionally, other noninterest expenses decreased at the community banking segment as certain loan expenses decreased offset by a decrease of credits received for FDIC premiums in 2020 but not in 2021.

Income tax expense totaled $5.9 million for the three months ended June 30, 2021 compared to $7.0 million during the three months ended June 30, 2020.

Income tax expense was recognized on the statement of income during the three months ended June 30, 2021 at an effective rate of 24.7% of pretax income compared to 25.1% during the three months ended June 30, 2020.

The decrease in rate is primarily due to lower pretax income, relative to permanent deductions.

Comparison of Community Banking Segment for the Six Months Ended June 30, 2021 and 2020

Net income increased $6.7 million for the six months ended June 30, 2021 to $14.9 million compared to net income of $8.2 million for the six months ended June 30, 2020.

Net interest income increased $2.2 million to $28.8 million for the six months ended June 30, 2021 compared to $26.6 million for the six months ended June 30, 2020.

Compensation, payroll taxes and other employee benefits expense at the community banking segment increased $360,000, or 7.2%, to $5.4 million during the three months ended September 30, 2021.

The decrease was primarily due to an increase in health insurance expense and Employee Stock Ownership Plan expense as the average stock price increased compared to the quarter ending September 30, 2020.

Occupancy, office furniture and equipment expense at the mortgage banking segment decreased $16,000 to $1.6 million during the three months ended September 30, 2021, primarily resulting from lower depreciation expense.

Occupancy, office furniture and equipment expense at the community banking segment increased $35,000 to $909,000 during the three months ended September 30, 2021.

The increase was due primarily to increased computer supplies expense.

Advertising expense decreased $26,000, or 3.0%, to $835,000 during the three months ended September 30, 2021.

This was primarily due to a decrease at the community banking segment as customer promotions slowed.

Data processing expense increased $64,000, or 6.9%, to $986,000 during the three months ended September 30, 2021.

This was primarily due to increases at the community banking and mortgage banking segments for continued investments in technology.

Professional fees decreased $4.2 million to $550,000 during the three months ended September 30, 2021.

The decrease related to a decrease in litigation costs compared to the prior year, as the Herrington settlement was resolved during the quarter ended September 30, 2020.

Other noninterest expense decreased $152,000, or 5.2%, to $2.8 million during the three months ended September 30, 2021.

The decrease related to a decrease in the servicing fees on mortgage servicing rights due to the sale during the quarter ended September 30, 2021.

Additionally, other noninterest expenses decreased at the community banking segment as certain loan expenses decreased during the three months ended September 30, 2021 compared to the three months ended September 30, 2020.

Income tax expense totaled $5.4 million for the three months ended September 30, 2021 compared to $8.9 million during the three months ended September 30, 2020.

Income tax expense was recognized on the statement of income during the three months ended September 30, 2021 at an effective rate of 22.2% of pretax income compared to 25.2% during the three months ended September 30, 2020.

During the three months ended September 30, 2021, the Company recorded a $949,000 return to provision income tax adjustment to reflect actual state tax apportionment based on the final 2020 tax returns.

There was no return to provision adjustment during the three months ended September 30, 2020.

Comparison of Community Banking Segment for the Nine Months Ended September 30, 2021 and 2020

Net income increased $7.3 million for the nine months ended September 30, 2021 to $21.6 million compared to net income of $14.4 million for the nine months ended September 30, 2020.

Net interest income increased $2.8 million to $42.9 million for the nine months ended September 30, 2021 compared to $40.1 million for the nine months ended September 30, 2020.

Interest expense decreased as deposit funding rates decreased.

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The Company calculated the current year allowance using the incurred loss model.

There was a negative provision for loan losses of $1.9 million for the six months ended June 30, 2021 compared to a $5.1 million provision for loan losses for the six months ended June 30, 2020.

During the six months ended June 30, 2021, we made adjustments to our qualitative factors, primarily to account for the improvement in certain economic factors along with a decrease in loan balance.

Additionally, we recorded a significant recovery as a loan payoff was received.

There was a negative provision for loan losses of $2.6 million for the nine months ended September 30, 2021 compared to a $6.1 million provision for loan losses for the nine months ended September 30, 2020.

During the nine months ended September 30, 2021, we made adjustments to our qualitative factors, primarily to account for the improvement in certain economic factors along with a decrease in loan balance.

Additionally, we recorded net recoveries of $487,000 during the nine months ended September 30, 2021.

Total noninterest income decreased $2.5 million due primarily to a decrease in loan fees.

Service charges on loans decreased due to fees earned on loan swap originations in 2020.

Compensation, payroll taxes, and other employee benefits expense decreased $225,000 to $9.8 million primarily due to a decrease in variable compensation, health insurance, and salaries offset by an increase in employee stock ownership plan expense.

Service charges on loans decreased due to fees earned on loan swap originations in 2020 and a decrease in gains from death benefit received on two bank owned life insurance policies during the nine months ended September 30, 2020.

Compensation, payroll taxes, and other employee benefits expense increased $135,000 to $15.2 million primarily due to an increase in employee stock ownership plan expenses offset by a decrease in salaries.

Data processing expense decreased $265,000 due to the implementation of a new digital banking platform in 2020.

Other noninterest expense decreased $607,000 as certain loan-related expenses decreased offset by a decrease of credits received for FDIC premiums in 2020 but not in 2021.

Comparison of Mortgage Banking Segment Operations for the Six Months Ended June 30, 2021 and 2020

Net income totaled $24.4 million for the six months ended June 30, 2021 compared to $18.7 million for the six months ended June 30, 2020.

We originated $2.18 billion in mortgage loans held for sale (including sales to the community banking segment) during the six months ended June 30, 2021, which represents an increase of $328.7 million, or 17.8%, from the $1.85 billion originated during the six months ended June 30, 2020.

Comparison of Mortgage Banking Segment Operations for the Nine Months Ended September 30, 2021 and 2020

Net income totaled $36.6 million for the nine months ended September 30, 2021 compared to $38.9 million for the nine months ended September 30, 2020.

We originated $3.24 billion in mortgage loans held for sale (including sales to the community banking segment) during the nine months ended September 30, 2021, which represents an increase of $87.5 million, or 2.8%, from the $3.15 billion originated during the nine months ended September 30, 2020.

The increase in loan production volume was driven by a $258.1 million, or 13.2%, increase in purchase products as housing demand remains high.

Mortgage refinance products increased $18.4 million, or 2.5% due to the current low interest rate environment.

Total mortgage banking noninterest income increased $10.6 million, or 11.1%, to $105.6 million during the six months ended June 30, 2021 compared to $95.0 million during the six months ended June 30, 2020.

The increase in mortgage banking noninterest income was related to a 27.8% increase in volume offset by a 1.8% decrease in gross margin on loans originated and sold for the six months ended June 30, 2021 compared to June 30, 2020.

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.

Mortgage refinance products decreased $170.6 million, or 14.2%, due to interest rates increasing over the past year.

Total mortgage banking noninterest income decreased $11.3 million, or 6.7%, to $156.9 million during the nine months ended September 30, 2021 compared to $168.2 million during the nine months ended September 30, 2020.

The decrease in mortgage banking noninterest income was related to a 7.7% decrease in gross margin on loans originated and sold offset by a 2.8% increase in loan production volume for the nine months ended September 30, 2021 compared to the 2020 period.

Gross margin on loans originated is the ratio of mortgage banking income (excluding the change in interest rate lock fair value) divided by total loan originations.

The decrease in gross margin on loans originated and sold reflects pricing competition in the industry to gain market share.

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Waterstone Mortgage Corporation has contracted with a third party to service the loans for which we retain servicing.

Additionally, there was a $4.0 million gain on sale of mortgage servicing rights during the nine months ended September 30, 2021 compared to none during the nine months ended September 30, 2020.

Additionally, our overall margin can be affected by the mix of both loan type (conventional loans versus governmental) and loan purpose (purchase versus refinance).

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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 65.5% from 60.4% of total originations for the six months ended June 30, 2021 and 2020, respectively, as refinance demand decelerated as interest rates increased over the past year.

The mix of loan type trended towards more conventional loans and less governmental loans;

with conventional loans and governmental loans comprising 77.2% and 22.8% of all loan originations, respectively, during the six months ended June 30, 2021, compared to 74.1% and 25.9% of all originations, respectively, during the six months ended June 30, 2020.

Total compensation, payroll taxes and other employee benefits increased $6.9 million, or 13.4%, to $58.4 million for the six months ended June 30, 2021 compared to $51.5 million for the six months ended June 30, 2020.

primarily a result of an increase in salaries to meet loan demand, commission expense as fundings increased, and branch manager pay increased as branches were more profitable.

The percentage of origination volume related to purchase activity increased to 68.2% from 61.9% of total originations for the nine months ended September 30, 2021 and 2020, respectively, as refinance demand decelerated due to an increase in interest rates over the past year.

The mix of loan type trended towards more conventional loans and less governmental loans, with conventional loans and governmental loans comprising 76.9% and 23.1% of all loan originations, respectively, during the nine months ended September 30, 2021, compared to 74.7% and 25.3% of all originations, respectively, during the nine months ended September 30, 2020.

Total compensation, payroll taxes and other employee benefits increased $1.3 million, or 1.5%, to $87.4 million for the nine months ended September 30, 2021 compared to $86.1 million for the nine months ended September 30, 2020.

The increase was primarily due to an increase in salaries to meet loan demand offset by a decrease in commission expense and branch manager pay decreased as gross margin pressure reduced branch profitability.

Occupancy, office furniture, and equipment expense decreased primarily resulting from lower rent and depreciation expense.

Advertising expense increased primarily due to marketing increases at the mortgage banking segment to attract customers as rates are higher than in the prior year.

Loan processing expenses increased for the six months ended June 30, 2021 as loan costs increased due to loan application volume.

Professional fees decreased $6.7 million primarily related to receiving a legal settlement in 2021 and lower litigation costs compared to the prior year as the Herrington settlement was resolved in 2020.

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Results of Operations

Six months ended June 30,

Nine months ended September 30,

(Dollars in Thousands, except per share amounts)

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Yields on interest-earning assets are computed on a fully tax-equivalent yield, where applicable.

Six months ended June 30,

Nine months ended September 30,

Average Balance

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Average interest-earning assets to average interest-bearing liabilities

(1) Interest income includes net deferred loan fee amortization income of $1.1 million and $599,000 f or the six months ended June 30, 2021 and 2020, respectively.

(1) Interest income includes net deferred loan fee amortization income of $1.7 million and $948,000 f or the nine months ended September 30, 2021 and 2020, respectively.

(2) Average balance of mortgage related and debt securities are based on amortized historical cost.

(3) Interest income from tax exempt securities is computed on a taxable equivalent basis using a tax rate of 21% for the six months ended June 30, 2021 and 2020.

The yields on debt securities, federal funds sold and short-term investments before tax-equivalent adjustments were 1.20 % and 1.91% f or the six months ended June 30, 2021 and 2020, respectively.

(3) Interest income from tax exempt securities is computed on a taxable equivalent basis using a tax rate of 21% for the nine months ended September 30, 2021 and 2020.

The yields on debt securities, federal funds sold and short-term investments before tax-equivalent adjustments were 1.07 % and 1.86% f or the nine months ended September 30, 2021 and 2020, respectively.

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Six months ended June 30,

Nine months ended September 30,

2021 versus 2020

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______________

Interest income includes net deferred loan fee amortization income of $1.1 million and $599,000 fo r the six months ended June 30, 2021 and 2020, respectively.

Interest income includes net deferred loan fee amortization income of $1.7 million and $948,000 fo r the nine months ended September 30, 2021 and 2020, respectively.

(2) Non-accrual loans have been included in average loans receivable balance.

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Average balance of available for sale securities is based on amortized historical cost.

(4) Interest income from tax exempt securities is computed on a taxable equivalent basis using a tax rate of 21% for the six months ended June 30, 2021 and 2020.

Net interest income increased $2.5 million, or 9.5%, to $28.2 million during the six months ended June 30, 2021 compared to $25.8 million during the six months ended June 30, 2020.

Interest income on loans decreased $3.1 million due primarily to a 35 basis point decrease in average yield on loans as London Interbank Offered Rate (LIBOR) and U.S.

(4) Interest income from tax exempt securities is computed on a taxable equivalent basis using a tax rate of 21% for the nine months ended September 30, 2021 and 2020.

Net interest income increased $3.2 million, or 8.1%, to $42.3 million during the nine months ended September 30, 2021 compared to $39.2 million during the nine months ended September 30, 2020.

Interest income on loans decreased $5.2 million due primarily to a 24 basis point decrease in average yield on loans as LIBOR and U.S.

Treasury rates continued to decrease and a $68.7 million, or 4.0%, decrease in average loans as payoffs continue to outpace originations.

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Additionally, the average balance decreased $4.9 million.

Interest income from other interest-earning assets (comprised of debt securities, federal funds sold and short-term investments) decreased $28,000 due to a 71 basis point decrease in the average yield.

The decrease in average yield was primarily driven by the decrease in federal funds rate over the past year and as higher yielding securities have matured.

Offsetting those decreases, the average balance of other interest-earning assets increased $105.7 million along with an increase in FHLB dividends.

Interest income from other interest-earning assets (comprised of debt securities, federal funds sold and short-term investments) increased $144,000 due to a $152.3 million increase in average balance of other interest-earning assets basis point decrease in the average yield.

The increase in average cash balances resulted fron the growth in average deposits along with paydowns decreasing average loans.

Offsetting the increase in average balance, the yield decreased 79 basis points as higher rate securities matured and were placed in cash.

Interest expense on time deposits decreased $7.3 million, or 70.4%, primarily due to a 128 basis point decrease in average cost of time deposits.

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Money market accounts have been a focus over the year and the Company has aggressively marketed new customers through various new offerings and new branches that opened within the past 12 months.

Interest expense on borrowings decreased $304,000, or 5.8%, due to a decrease of $71.4 million to $481.4 million in average borrowing volume during the six months ended June 30, 2021.

The decrease was primarily due to additional short-term funding was needed in 2020.

Offsetting the decrease in volume, the average cost of borrowings increased 16 basis points to 2.08% during the six months ended June 30, 2021, compared to 1.92% during the six months ended June 30, 2020 as the lower rate short-term FHLB borrowings utilized during 2020 were not necessary during 2021 due to our excess liquidity position.

Interest expense on borrowings decreased $499,000, or 6.3%, due to a decrease of $67.3 million to $478.3 million in average borrowing volume during the nine months ended September 30, 2021.

The decrease was primarily due to additional short-term funding needed in 2020.

Offsetting the decrease in volume, the average cost of borrowings increased 13 basis points to 2.07% during the nine months ended September 30, 2021, compared to 1.94% during the nine months ended September 30, 2020 as the lower rate short-term FHLB borrowings utilized during 2020 were not necessary during 2021 due to our excess liquidity position.

Provision for Loan Losses

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The Company calculated the current quarter allowance using the incurred loss model.

The negative provision for loan losses was $1.8 million for the six months ended June 30, 2021 compared to a provision for loan losses of $5.3 million for the six months ended June 30, 2020.

During the six months ended June 30, 2021, we made adjustments to our qualitative factors, primarily to account for the improvement in certain economic factors along with a decrease in loan balance.

The negative provision for loan losses was $2.5 million for the nine months ended September 30, 2021 compared to a provision for loan losses of $6.3 million for the nine months ended September 30, 2020.

Additionally, we recorded a significant recovery as a loan payoff was received.

We had a negative provision for loan losses of $2.6 million at the community banking segment and $80,000 in provision for loan losses for the mortgage banking segment.

Net recoveries were $407,000 for the six months ended June 30, 2021.

Net recoveries were $487,000 for the nine months ended September 30, 2021.

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Noninterest Income

Six months ended June 30,

Nine months ended September 30,

(Dollars in Thousands)

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Total noninterest income

Total noninterest income increased $9.9 million, or 10.0%, to $108.2 million during the six months ended June 30, 2021 compared to $98.4 million during the six months ended June 30, 2020.

The increase resulted primarily from an increase in mortgage banking income along with increases in all noninterest income categories.

The increase in mortgage banking income was primarily the result of an increase in loan origination volume offset by a decrease in gross margin on loans originated and sold.

Total noninterest income decreased $13.0 million, or 7.4%, to $161.2 million during the nine months ended September 30, 2021 compared to $174.1 million during the nine months ended September 30, 2020.

The increase resulted primarily from an decrease in mortgage banking income along with decreases in service charges on loans and deposits and increase in cash surrender value of life insurance.

The decrease in mortgage banking income was primarily the result of a decrease in gross margin on loans originated and sold offset by a decrease in loan origination volume.

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 increased $369.1 million, or 20.6%, to $2.16 billion during the six months ended June 30, 2021 compared to $1.80 billion during the six months ended June 30, 2020.

Gross margin on loans originated and sold decreased 7.7% at the mortgage banking segment.

See "Comparison of Mortgage Banking Segment Results of Operations for the Six Months Ended June 30, 2021 and 2020" above for additional discussion of the increase in mortgage banking income.

Service charges on loans and deposits decreased primarily due to loan fees primarily due to loan prepayment fees.

Service charges on loans decreased due to fees earned on loan swap originations in 2020.

The increase in cash surrender value of life insurance was due primarily to timing of the annual dividend earned on policyholders.

The increase in other noninterest income was due primarily to increases in mortgage servicing fee income and wealth management revenue.

Mortgage servicing fee income increased as loans sold with servicing rights retained increased due to market conditions.

Total loan origination volume on a consolidated basis increased $149.1 million, or 4.9%, to $3.21 billion during the nine months ended September 30, 2021 compared to $3.06 billion during the nine months ended September 30, 2020.

See "Comparison of Mortgage Banking Segment Results of Operations for the Nine Months Ended September 30, 2021 and 2020" above for additional discussion of the decrease in mortgage banking income.

Service charges on loans and deposits decreased primarily due to fees earned on loan swap originations in 2020.

The decrease in cash surrender value of life insurance was due primarily to decrease in balance as two death benefits were received on bank owned life insurance policies during the nine months ended September 30, 2020.

The increase in other noninterest income was due primarily to a $4.0 million gain on sale of mortgage servicing rights during the nine months ended September 30, 2021 compared to none during the nine months ended September 30, 2020.

Additionally, mortgage servicing fee income increased as loans sold with servicing rights retained increased (before the sale) due to market conditions.

Offsetting the increases, other income decreased primarily from a decrease in gains from death benefits received on two bank owned life insurance policies that occured during the nine months ended September 30, 2020.

Noninterest Expenses

Six months ended June 30,

Nine months ended September 30,

(Dollars in Thousands)

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Total noninterest expenses

Total noninterest expenses increased $3.4 million, or 4.1%, to $86.3 million during the six months ended June 30, 2021 compared to $82.9 million during the six months ended June 30, 2020.

Compensation, payroll taxes and other employee benefit expense at our mortgage banking segment increased $6.9 million, or 13.4%, to $58.4 million for the six months ended June 30, 2021.

The increase in compensation expense was primarily a result of an increase in salaries to meet loan demand, commission expense as fundings increased, and branch manager pay increased as branches were more profitable.

Compensation, payroll taxes and other employee benefits expense at the community banking segment decreased $225,000, or 2.2%, to $9.8 million during the six months ended June 30, 2021.

The decrease was primarily due to a decrease in variable compensation, health insurance, and salaries offset by an increase in employee stock ownership plan expense.

Occupancy, office furniture and equipment expense at the mortgage banking segment decreased $449,000 to $2.9 million during the six months ended June 30, 2021, resulting from lower rent and depreciation expense.

Occupancy, office furniture and equipment expense at the community banking segment increased $32,000 to $1.9 million during the six months ended June 30, 2021.

The increase was due primarily to snow plowing expense.

Total noninterest expenses decreased $6.3 million, or 4.6%, to $129.6 million during the nine months ended September 30, 2021 compared to $135.9 million during the nine months ended September 30, 2020.

Compensation, payroll taxes and other employee benefit expense at our mortgage banking segment increased $1.3 million, or 1.5%, to $87.4 million for the nine months ended September 30, 2021.

Compensation, payroll taxes and other employee benefits expense at the community banking segment increased $135,000, or 0.9%, to $15.2 million during the nine months ended September 30, 2021.

The increase was primarily due to an increase in employee stock ownership plan expenses offset by a decrease in salaries.

Occupancy, office furniture and equipment expense at the mortgage banking segment decreased $465,000 to $4.5 million during the nine months ended September 30, 2021, resulting from lower rent and depreciation expense.

Occupancy, office furniture and equipment expense at the community banking segment increased $67,000 to $2.8 million during the nine months ended September 30, 2021.

The increase was due primarily to snow plowing and computer supplies expenses.

Advertising expense decreased $95,000 at the community banking segment as customer promotional offers decreased.

Offsetting the decrease at the community banking segment, advertising increased $47,000 at the mortgage banking segment to attract customers in a competitive mortgage environment.

Data processing expense decreased $216,000, or 10.3%, to $1.9 million during the six months ended June 30, 2021.

This was primarily due to decreased data conversion expenses as the new ditigal banking platform rollout at the community banking segment occured during the six months ended June 30, 2020.

Offsetting the decrease at the community banking segment, advertising expense increased $40,000 at the mortgage banking segment to attract customers in a competitive mortgage environment.

Data processing expense decreased $152,000, or 5.0%, to $2.9 million during the nine months ended September 30, 2021.

This was primarily due to decreased data conversion expenses as the new ditigal banking platform rollout at the community banking segment occured during the nine months ended September 30, 2020 offset by other technology investments at both the community banking and mortgage banking segments.

Professional fees expense decreased $6.8 million to $804,000 primarily as a result of a decrease in legal fees at the mortgage banking segment primarily related to receiving a legal settlement in 2021 and lower litigation costs compared to the prior year as the Herrington settlement was resolved in 2020.

Loan processing expense increased $251,000 to $2.5 million during the six months ended June 30, 2021.

Loan processing expense increased $50,000 to $3.7 million during the nine months ended September 30, 2021.

This was primarily due to an increase in loan costs associated with the application volumes.

Other noninterest expense decreased $239,000 for the six months ended June 30, 2021 due to a decrease at the mortgage banking segment.

Other noninterest expense decreased $391,000 for the nine months ended September 30, 2021 due to decreases at the mortgage banking and community banking segments.

The decrease at the mortgage banking segment was primarily due to decreased provision for loan sale losses as there was additional uncertainity in the prior year regarding selling loans to third party investors from COVID-19 pandemic challenges.

Offsetting theses decreases, amortization expense of mortgage servicing rights increased as the value of the servicing portfolio has increased in 2021 compared to 2020.

Other noninterest expenses decreased at the community banking segment due primarily to a decrease in certain loan-related expenses decreased offset by a decrease of credits received for FDIC premiums in 2020 but not in 2021.

Income tax expense totaled $12.8 million for the six months ended June 30, 2021 compared to $8.9 million during the six months ended June 30, 2020.

Income tax expense was recognized on the statement of income during the six months ended June 30, 2021 at an effective rate of 24.5% of pretax income compared to 24.9% during the six months ended June 30, 2020.

Comparison of Financial Condition at June 30, 2021 and December 31, 2020

Total Assets – Total assets increased by $17.4 million, or 0.8%, to $2.20 billion at June 30, 2021 from $2.18 billion at December 31, 2020.

The increase in total assets primarily reflects an increase in cash and cash equivalents, and prepaid expenses and securities available for sale, partially offset by a decrease in loans receivable and loans held for sale.

The total assets increase reflects liability increases in deposits and advance payments by borrowers for taxes.

Cash and Cash Equivalents – Cash and cash equivalents increased $134.0 million, or 141.4%, to $228.7 million at June 30, 2021, compared to $94.8 million at December 31, 2020.

Offsetting these decreases, amortization expense of mortgage servicing rights increased as the value of the servicing portfolio has increased in 2021 compared to 2020.

Other noninterest expenses decreased at the community banking segment due primarily to a decrease in certain loan-related expenses offset by a decrease of credits received for FDIC premiums in 2020 but not in 2021.

Income tax expense totaled $18.2 million for the nine months ended September 30, 2021 compared to $17.8 million during the nine months ended September 30, 2020.

Income tax expense was recognized on the statement of income during the nine months ended September 30, 2021 at an effective rate of 23.8% of pretax income compared to 25.0% during the nine months ended September 30, 2020.

During the nine months ended September 30, 2021, the Company recorded a $949,000 return to provision income tax adjustment to reflect actual state tax apportionment based on the final 2020 tax returns.

Comparison of Financial Condition at September 30, 2021 and December 31, 2020

Total Assets – Total assets increased by $49.5 million, or 2.3%, to $2.23 billion at September 30, 2021 from $2.18 billion at December 31, 2020.

The increase in total assets primarily reflects an increase in cash and cash equivalents and securities available for sale, partially offset by a decrease in loans receivable and loans held for sale.

The total assets increase reflects liability increases in deposits and advance payments by borrowers for taxes along with net income.

Cash and Cash Equivalents – Cash and cash equivalents increased $263.8 million, or 278.4%, to $358.6 million at September 30, 2021, compared to $94.8 million at December 31, 2020.

The increase in cash and cash equivalents primarily reflects the additional source of funds through an increase in deposits and advance payments by borrowers for taxes, as well as paydowns of loans receivable and loans held for sale.

Securities Available for Sale – Securities available for sale increased $12.6 million to $172.2 million at June 30, 2021.

Securities Available for Sale – Securities available for sale increased $15.2 million to $174.8 million at September 30, 2021.

The increase was primarily due to purchases of mortgage-related securities exceeding security paydowns for the year and maturities of debt securities.

Loans Held for Sale - Loans held for sale decreased $49.4 million to $352.6 million at June 30, 2021 due to the decrease of refinancing activity resulting from the increase in mortgage rates.

Loans Receivable - Loans receivable held for investment decreased $78.7 million to $1.30 billion at June 30, 2021.

The decrease in total loans receivable was attributable to decreases in each of the one- to four-family, multi-family, commercial real estate, construction and land, home equity, commercial, and consumer loan categories.

Loans Held for Sale - Loans held for sale decreased $76.0 million to $326.0 million at September 30, 2021 due to the decrease of refinancing activity resulting from the increase in mortgage rates.

Loans Receivable - Loans receivable held for investment decreased $148.3 million to $1.23 billion at September 30, 2021.

The decrease in total loans receivable was attributable to decreases in each of the one- to four-family, multi-family, construction and land, home equity, commercial, and consumer loan categories.

The following table shows loan originations during the periods indicated.

Six months ended June 30,

Nine months ended September 30,

Real estate loans originated for investment:

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Total loans originated for investment

Allowance for Loan Losses - The allowance for loan losses decreased $1.4 million to $17.4 million at June 30, 2021.

Allowance for Loan Losses - The allowance for loan losses decreased $2.0 million to $16.8 million at September 30, 2021.

The decrease resulted from a negative provision due to improvement in certain economic factors, decreasing the required allowance related to the loans collectively reviewed.

The overall decrease was primarily related to each of the one- to four-family, home equity, construction and land, and consumer categories.

See Note 3 for further discussion on the allowance for loan losses.

Real Estate Owned – Total real estate owned decreased $172,000 to $150,000 at June 30, 2021.

During the six months ended June 30, 2021, no loans were transferred from loans receivable to real estate owned upon completion of foreclosure.

The overall decrease was primarily related to each of the one- to four-family, home equity, construction and land, commercial real estate, and consumer categories.

See Note 3 of the notes to unaudited consolidated financial statements for further discussion on the allowance for loan losses.

Real Estate Owned – Total real estate owned decreased $174,000 to $148,000 at September 30, 2021.

During the nine months ended September 30, 2021, no loans were transferred from loans receivable to real estate owned upon completion of foreclosure.

During the same period, sales of real estate owned totaled $172,000.

There were no writedowns during the six months ended June 30, 2021.

Prepaid expenses and other assets – Total prepaid expenses and other assets decreased $2.8 million to $54.7 million at June 30, 2021.

The decrease was primarily due to decreases in hedging receivables, deferred tax assets, and unrealized gain on loan swaps.

Deposits – Total deposits increased $46.2 million to $1.23 billion at June 30, 2021.

There was $2,000 in other activity applied to the balance and no writedowns during the nine months ended September 30, 2021.

Prepaid expenses and other assets – Total prepaid expenses and other assets decreased $5.2 million to $52.4 million at September 30, 2021.

The decrease was primarily due to the sale of mortgage servicing rights along with decreases in derivative assets and unrealized gain on loan swaps offset by an increase in funding receivable on loans sold.

Deposits – Total deposits increased $61.7 million to $1.25 billion at September 30, 2021.

The increase was driven by an increase of $76.4 million in money market and savings deposits and $28.9 million in demand deposits offset by a decrease of $43.6 million in time deposits.

Borrowings – Total borrowings decreased $33.1 million, or 6.5%, to $475.0 million at June 30, 2021.

Borrowings – Total borrowings decreased $33.1 million, or 6.5%, to $475.0 million at September 30, 2021.

The community banking segment paid off $24.0 million in short-term FHLB borrowings.

External short-term borrowings at the mortgage banking segment decreased a total of $9.1 million at June 30, 2021 from December 31, 2020.

Advance Payments by Borrowers for Taxes - Advance payments by borrowers for taxes increased $14.1 million to $17.7 million at June 30, 2021.

External short-term borrowings at the mortgage banking segment decreased a total of $9.1 million at September 30, 2021 from December 31, 2020.

Advance Payments by Borrowers for Taxes - Advance payments by borrowers for taxes increased $21.8 million to $25.3 million at September 30, 2021.

The increase was the result of payments received from borrowers for their real estate taxes and is seasonally normal, as balances increase during the course of the calendar year until real estate tax obligations are paid in the fourth quarter.

Other Liabilities - Other liabilities decreased $28.5 million to $46.5 million at June 30, 2021 compared to December 31, 2020.

Other Liabilities - Other liabilities decreased $30.3 million to $44.7 million at September 30, 2021 compared to December 31, 2020.

Other liabilities decreased primarily due to a seasonal decrease in outstanding checks related to advance payments by borrowers for taxes.

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Additionally, other liabilities decreased due to the payment of the legal settlement and a decrease in the liability related to forward commitments to sell loans at the mortgage banking segment.

Shareholders’ Equity – Shareholders' equity increased $18.6 million to $431.7 million at June 30, 2021 from December 31, 2020.

Shareholders’ Equity – Shareholders' equity increased $29.5 million to $442.6 million at September 30, 2021 from December 31, 2020.

Shareholders' equity increased primarily due to net income, additional paid-in capital as stock options were exercised and equity awards vested, and unearned ESOP shares vesting.

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NONPERFORMING ASSETS

At September 30,

At December 31,

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The following table sets forth activity in our non-accrual loans for the periods indicated.

At or for the Six Months

Ended June 30,

At or for Nine Months

Ended September 30,

(In Thousands)

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Balance at end of period

Total non-accrual loans decreased by $1.2 million, or 21.7%, to $4.4 million as of June 30, 2021 compared to $5.6 million as of December 31, 2020.

The ratio of non-accrual loans to total loans receivable was 0.34% at June 30, 2021 compared to 0.40% at December 31, 2020.

During the six months ended June 30, 2021, $997,000 in loans were placed on non-accrual status.

Offsetting this activity, $1.3 million returned to accrual status and $846,000 in principal payments were received during the six months ended June 30, 2021.

Of the $4.4 million in total non-accrual loans as of June 30, 2021, $3.5 million in loans have been specifically reviewed to assess whether a specific valuation allowance is necessary.

Total non-accrual loans decreased by $1.6 million, or 28.6%, to $4.0 million as of September 30, 2021 compared to $5.6 million as of December 31, 2020.

The ratio of non-accrual loans to total loans receivable was 0.32% at September 30, 2021 compared to 0.40% at December 31, 2020.

During the nine months ended September 30, 2021, $1.3 million in loans were placed on non-accrual status.

Offsetting this activity, $1.5 million returned to accrual status and $1.4 million in principal payments were received during the nine months ended September 30, 2021.

Of the $4.0 million in total non-accrual loans as of September 30, 2021, $3.2 million in loans have been specifically reviewed to assess whether a specific valuation allowance is necessary.

A specific valuation allowance is established for an amount equal to the impairment when the carrying value of the loan exceeds the present value of expected future cash flows, discounted at the loan's original effective interest rate or the fair value of the underlying collateral with an adjustment made for costs to dispose of the asset.

Based upon these specific reviews, a total of $90,000 in cumulative partial net charge-offs have been recorded over the life of these loans as of June 30, 2021.

Based upon these specific reviews, a total of $81,000 in cumulative partial net charge-offs have been recorded over the life of these loans as of September 30, 2021.

Partially charged-off loans measured for impairment based upon net realizable collateral value are maintained in a "non-performing" status and are disclosed as impaired loans.

There were no specific reserves as of June 30, 2021.

The remaining $864,000 of non-accrual loans were reviewed on an aggregate basis and $173,000 in general valuation allowance was deemed appropriate related to those loans as of June 30, 2021.

There were no specific reserves as of September 30, 2021.

The remaining $797,000 of non-accrual loans were reviewed on an aggregate basis and $120,000 in general valuation allowance was deemed appropriate related to those loans as of September 30, 2021.

The $120,000 in valuation allowance is based upon a migration analysis performed with respect to similar non-accrual loans in prior periods.

The outstanding principal balance of our five largest non-accrual loans as of June 30, 2021 totaled $2.2 million, which represents 50.9% of total non-accrual loans as of that date.

These five loans have not had any cumulative life-to-date net charge-offs and no specific specific reserve was deemed necessary based on net realizable collateral value with respect to these five loans as of June 30, 2021.

The outstanding principal balance of our five largest non-accrual loans as of September 30, 2021 totaled $2.2 million, which represents 55.8% of total non-accrual loans as of that date.

Interest payments received are treated as interest income on a cash basis as long as the remaining book value of the loan (i.e., after charge-off of all identified losses) is deemed to be fully collectible.

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Determination as to the ultimate collectability of the remaining book value is supported by an updated credit department evaluation of the borrower's financial condition and prospects for repayment, including consideration of the borrower's sustained historical repayment performance and other relevant factors.

As of June 30, 2021, there were no loans 90 or more days past due and still accruing interest.

As of September 30, 2021, there were no loans 90 or more days past due and still accruing interest.

As of December 31, 2020, there was a $586,000 loan that was 90 or more days past due and still accruing interest.

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The following table summarizes information with respect to the accrual status of our troubled debt restructurings:

As of June 30, 2021

As of September 30, 2021

(In Thousands)

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Loans less than 30 days past due as of December 31, 2019 were allowed for modifications if the borrower experienced a COVID-19 hardship.

As of June 30, 2021, the Company had $559,000 of one-to four-family loans consisting of the deferral of principal and interest.

As of September 30, 2021, the Company had $559,000 of one- to four-family loans subject to the deferral of principal and interest.

In accordance with the CARES Act, these short term deferrals are not considered troubled debt restructurings.

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The following table summarizes loan delinquency in total dollars and as a percentage of the total loan portfolio:

At September 30,

At December 31,

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Total loans past due to total loans receivable

Past due loans decreased by $992,000, or 12.6%, to $6.9 million at June 30, 2021 from $7.9 million at December 31, 2020.

Loans past due 90 days or more decreased by $783,000, or 19.8%, primarily in the one- to four-family loan category during the six months ended June 30, 2021.

Loans past due less than 90 days decreased by $209,000, or 5.3%, primarily in the one- to four-family loan category.

Past due loans increased by $3.3 million, or 42.2%, to $11.2 million at September 30, 2021 from $7.9 million at December 31, 2020.

Loans past due less than 90 days increased by $3.9 million, or 99.4%, primarily in the multifamily loan category offset by a decrease in the one- to four-family loan category during the nine months ended September 30, 2021.

Loans past due 90 days or more decreased by $580,000, or 14.7%, primarily in the one- to four-family loan category.

REAL ESTATE OWNED

Total real estate owned decreased by $172,000 to $150,000 at June 30, 2021, compared to $322,000 at December 31, 2020.

During the six months ended June 30, 2021, no loans were transferred to real estate owned upon completion of foreclosure.

Total real estate owned decreased by $174,000 to $148,000 at September 30, 2021, compared to $322,000 at December 31, 2020.

During the nine months ended September 30, 2021, no loans were transferred to real estate owned upon completion of foreclosure.

During the same period, sales of real estate owned totaled $172,000.

There were no write downs during the six months ended June 30, 2021.

There was $2,000 in other activity applied to the balance and were no write downs during the nine months ended September 30, 2021.

New appraisals received on real estate owned and collateral dependent impaired loans are based upon an “as is value” assumption.

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ALLOWANCE FOR LOAN LOSSES

At or for the Six Months

Ended June 30,

At or for Nine Months

Ended September 30,

(Dollars in Thousands)

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Net recoveries to beginning of the period allowance (annualized)

The allowance for loan losses decreased $1.4 million to $17.4 million at June 30, 2021, compared to $18.8 million at December 31, 2020.

The allowance for loan losses decreased $2.0 million to $16.8 million at September 30, 2021, compared to $18.8 million at December 31, 2020.

The decrease in allowance for loan losses reflects the $2.5 million negative provision for loan losses.

The negative provision recorded during the current year reflects adjustments to our qualitative factors, primarily to account for the slight improvement in certain economic factors along with a decrease in loan balance.

We had net recoveries of $407,000, or 0.06% of average loans annualized, for the six months ended June 30, 2021, compared to net recoveries of $62,000, or less than 0.01% of average loans annualized, for the six months ended June 30, 2020.

Of the $407,000 in recoveries during the six months ended June 30, 2021, the majority of the activity related to loans secured by one- to four-family residential, construction and land, and multi-family loan categories.

We had net recoveries of $487,000, or 0.05% of average loans annualized, for the nine months ended September 30, 2021, compared to net recoveries of $147,000, or less than 0.01% of average loans annualized, for the nine months ended September 30, 2020.

Of the $487,000 in recoveries during the nine months ended September 30, 2021, the majority of the activity related to loans secured by one- to four-family residential, construction and land, and multi-family loan categories.

Our underwriting policies and procedures emphasize that credit decisions must rely on both the credit quality of the borrower and the estimated value of the underlying collateral.

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Management is validating the CECL model and methodologies;

however we expect the change in the allowance for credit loss, including reserves for unfunded commitments, not to exceed 115% of the June 30, 2021 allowance based on a parallel computation.

however we expect the change in the allowance for credit loss, including reserves for unfunded commitments, not to exceed 110% of the September 30, 2021 allowance based on a parallel computation.

When finalized, this one-time increase as a result of the adoption of CECL will be recorded, net of tax, as an adjustment to retained earnings effective on the earlier of the fiscal year beginning after the termination date of the national emergency declaration by the President or January 1, 2022.

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Additional sources of liquidity used for the purpose of managing long- and short-term cash flows include advances from the FHLB.

During the six months ended June 30, 2021, primary uses of cash and cash equivalents included:

$2.16 billion in funding loans held for sale, $39.9 million for purchases of mortgage related securities, $33.1 million for short-term borrowings, $21.5 million for cash dividends paid, and $4.3 million to pay a legal settlement.

During the six months ended June 30, 2021 , primary sources of cash and cash equivalents included:

During the nine months ended September 30, 2021, primary uses of cash and cash equivalents included:

$3.21 billion in funding loans held for sale, $55.3 million for purchases of mortgage related securities, $33.1 million for short-term borrowings, $26.3 million for cash dividends paid, $4.7 million for purchases of our common stock, and $4.3 million to pay a legal settlement.

During the nine months ended September 30, 2021 , primary sources of cash and cash equivalents included:

$3.44 billion in proceeds from the sale of loans held for sale, $148.8 million for net loan receivables decrease, $61.7 million from an increase in deposits, $30.8 million in principal repayments on mortgage related securities, $6.4 million in maturies of debt securities, and $58.2 million in net income.

During the six months ended June 30, 2020, primary uses of cash and cash equivalents included:

$1.80 billion in funding loans held for sale, $46.0 million for funding of loans receivable, $20.4 million in purchases of our common stock, $18.8 million for cash dividends paid, $5.6 million for purchases of FHLB stock, $4.5 million forpurchases of mortgage related securities, and $2.5 million for purchases of debt securities.

During the six months ended June 30, 2020, primary sources of cash and cash equivalents included:

$1.73 billion in proceeds from the sale of loans held for sale, $104.0 million in proceeds from short-term FHLB borrowings, $11.5 million in proceeds from additional short-term borrowings, $89.9 million from an increase in deposits, $20.8 million in principal repayments on mortgage related securities, $3.4 million in maturities of debt securities, $27.0 million in net income, and a $4.7 million increase in advance payments by borrowers for taxes.

During the nine months ended September 30, 2020, primary uses of cash and cash equivalents included:

$3.06 billion in funding loans held for sale, $46.3 million for funding of loans receivable, $32.7 million in purchases of our common stock, $21.7 million for cash dividends paid, $5.6 million for purchases of FHLB stock, $4.5 million for purchases of mortgage related securities, and $5.0 million for purchases of debt securities.

During the nine months ended September 30, 2020, primary sources of cash and cash equivalents included:

$3.07 billion in proceeds from the sale of loans held for sale, $34.0 million in proceeds from short-term FHLB borrowings, $34.6 million in proceeds from additional short-term borrowings, $116.9 million from an increase in deposits, $33.6 million in principal repayments on mortgage related securities, $3.8 million in maturities of debt securities, $53.3 million in net income, $9.6 million in proceeds from death benefits on bank owned life insurance, and a $9.9 million increase in advance payments by borrowers for taxes.

A portion of our liquidity consists of cash and cash equivalents, which are a product of our operating, investing and financing activities.

At June 30, 2021 and 2020, respectively, $228.7 million and $76.9 million of our assets were invested in cash and cash equivalents.

At June 30, 2021, cash and cash equivalents were comprised of the following:

At September 30, 2021 and 2020, respectively, $358.6 million and $76.9 million of our assets were invested in cash and cash equivalents.

At September 30, 2021, cash and cash equivalents were comprised of the following:

$327.3 million in cash held at the Federal Reserve Bank and other depository institutions and $31.3 million in federal funds sold and short-term investments.

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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 June 30, 2021, we had $470.0 million in long term advances from the FHLB with contractual maturity dates in 2027, 2028, and 2029.

At September 30, 2021, we had $470.0 million in long term advances from the FHLB with contractual maturity dates in 2027, 2028, and 2029.

The 2027 advance has a contractual maturity date in December 2027.

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There are four advances with contractual maturities in 2029.

Two advances have quarterly call options currently available and the other two have options beginning in August 2021 and beginning in May 2022.

At June 30, 2021, we had outstanding commitments to originate loans receivable of $55.6 million.

In addition, at June 30, 2021, we had unfunded commitments under construction loans of $57.5 million, unfunded commitments under business lines of credit of $14.4 million and unfunded commitments under home equity lines of credit and standby letters of credit of $14.2 million.

At June 30, 2021, certificates of deposit scheduled to mature in one year or less totaled $564.2 million.

Three advances have quarterly call options currently available and the other advance has an option beginning in May 2022.

At September 30, 2021, we had outstanding commitments to originate loans receivable of $44.6 million.

In addition, at September 30, 2021, we had unfunded commitments under construction loans of $69.2 million, unfunded commitments under business lines of credit of $19.9 million and unfunded commitments under home equity lines of credit and standby letters of credit of $14.2 million.

At September 30, 2021, certificates of deposit scheduled to mature in one year or less totaled $576.6 million.

Based on prior experience, management believes that, subject to the Bank’s funding needs, a significant portion of such deposits will remain with us, although there can be no assurance that this will be the case.

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The ability of WaterStone Bank to pay dividends is subject to regulatory restrictions.

At June 30, 2021 , Waterstone Financial, Inc.

At September 30, 2021 , Waterstone Financial, Inc.

(on an unconsolidated basis) had liquid assets totaling $46.8 million.

Shareholders' equity increased $18.6 million to $431.7 million at June 30, 2021 from December 31, 2020.

Shareholders' equity increased $29.5 million to $442.6 million at September 30, 2021 from December 31, 2020.

Shareholders' equity increased primarily due to net income, additional paid-in capital as stock options were exercised and equity awards vested, and unearned ESOP shares vesting.

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The Company's Board of Directors authorized a stock repurchase program in the third quarter of 2020.

As of June 30, 2021, the Company had repurchased 10.8 million shares at an average price of $14.42 under previously approved stock repurchase plans.

As of September 30, 2021, the Company had repurchased 11.0 million shares at an average price of $14.51 under previously approved stock repurchase plans.

WaterStone Bank is 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 June 30, 2021 , WaterStone Bank exceeded all regulatory capital requirements and is considered “well capitalized” under regulatory guidelines.

At September 30, 2021, WaterStone Bank exceeded all regulatory capital requirements and is considered “well capitalized” under regulatory guidelines.

See “Notes to Unaudited Consolidated Financial Statements - Note 8 - Regulatory Capital.”

Contractual Obligations, Commitments, Contingent Liabilities, and Off-balance Sheet Arrangements

The following tables present information indicating various contractual obligations and commitments of the Company as of June 30, 2021 and the respective maturity dates.

The following tables present information indicating various contractual obligations and commitments of the Company as of September 30, 2021 and the respective maturity dates.

(In Thousands)

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Off-Balance Sheet Commitments

The following table details the amounts and expected maturities of significant off-balance sheet commitments as of June 30, 2021.

The following table details the amounts and expected maturities of significant off-balance sheet commitments as of September 30, 2021.

(In Thousands)

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Compared sentence by sentence after normalising whitespace, quotation marks, case and digits, so re-formatting and restated figures do not read as changed language. Wording changes appear as one removal and one addition. The current filing and the prior one are authoritative.

What changed 10-Q

Item 2. Management’s Discussion and Analysis