Waterstone Financial, Inc. 10-Q

Item 2. Management’s Discussion and Analysis of Financial Condition and Results of Operations Forward-Looking Information This Quarterly Report on Form 10-Q may contain various forward-looking statements, which can be identified by the use of words such as “estimate,” “project,” “believe,” “intend,” “anticipate,” “plan,” “seek,” “expect” and similar expressions and verbs in the future tense. These forward-looking statements include, but are not limited to: ● Statements of our goals, intentions and expectations; ● Statements regarding our business plans, prospects, growth and operating strategies; ● Statements regarding the quality of our loan and investment portfolio; and ● Estimates of our risks and future costs and benefits. These forward-looking statements are based on current beliefs and expectations of our management and are inherently subject to significant business, economic and competitive uncertainties and contingencies, many of which are beyond our control. In addition, these forward-looking statements are subject to assumptions with respect to future business strategies and decisions that are subject to change. The following factors, among others, could cause actual results to differ materially from the anticipated results or other expectations expressed in the forward-looking statements: ● general economic conditions, either nationally or in our market area, including employment prospects, that are different than expected; ● the effects of any pandemic, including COVID-19, and related government actions; ● competition among depository and other financial institutions; ● inflation and changes in the interest rate environment that reduce our margins and yields, our mortgage banking revenues, the fair value of financial instruments or the origination levels in our lending business, or increase the level of defaults, losses or prepayments on loans we have made and make whether held in portfolio or sold in the secondary markets; ● adverse changes in the securities or secondary mortgage markets; ● changes in laws or government regulations or policies affecting financial institutions, including changes in regulatory fees and capital requirements; ● changes in monetary or fiscal policies of the U.S. Government, including policies of the U.S. Treasury and the Federal Reserve Board; ● our ability to manage market risk, credit risk and operational risk in the current economic conditions; ● our ability to enter new markets successfully and capitalize on growth opportunities; ● our ability to successfully integrate acquired entities; ● decreased demand for our products and services; ● changes in tax policies or assessment policies; ● the inability of third-party providers to perform their obligations to us; ● changes in consumer demand, spending, borrowing and savings habits; ● changes in accounting policies and practices, as may be adopted by the bank regulatory agencies, the Financial Accounting Standards Board, the Securities and Exchange Commission or the Public Company Accounting Oversight Board; ● our ability to retain key employees; ● cyber attacks, computer viruses and other technological risks that may breach the security of our websites or other systems to obtain unauthorized access to confidential information and destroy data or disable our systems; ● technological changes that may be more difficult or expensive than expected; ● the ability of third-party providers to perform their obligations to us; ● the effects of any federal government shutdown; ● the ability of the U.S. Government to manage federal debt limits; ● significant increases in our loan losses; and ● changes in the financial condition, results of operations or future prospects of issuers of securities that we own. 38 See also the factors referred to in reports filed by the Company with the Securities and Exchange Commission (particularly those under the caption “Risk Factors” in Item 1A of the Company’s Annual Report on Form 10-K for the year ended December 31, 2020). The risks included here are not exhaustive. Other sections of this report may include additional factors which could adversely affect our business and financial performance. New risks emerge from time to time and it is not possible for management to predict all such risks, nor can it assess the impact of all such risks on our business or the extent to which any risk, or combination of risks, may cause actual results to differ materially from those contained in any forward-looking statements. Given these risks and uncertainties, investors should not place undue reliance on forward-looking statements as a prediction of actual results. Overview The following discussion and analysis is presented to assist the reader in understanding and evaluating the Company’s financial condition and results of operations. It is intended to complement the 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 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: community banking and mortgage banking. The community banking segment provides consumer and business banking products and services to customers primarily within Southeastern Wisconsin. Consumer products include loan products, deposit products, and personal investment services. Business banking products include loans for working capital, inventory and general corporate use, commercial real estate construction loans, and deposit accounts. The mortgage banking segment, which is conducted by offices in 21 states through Waterstone Mortgage Corporation, consists of originating residential mortgage loans primarily for sale in the secondary market. Our community banking segment generates the significant majority of our consolidated net interest income and requires the significant majority of our provision for loan losses. Our mortgage banking segment generates the significant majority of our noninterest income and a majority of our noninterest expenses. We have provided below a discussion of the material results of operations for each segment on a separate basis for the 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 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 The COVID-19 pandemic has caused economic and social disruption on an unprecedented scale. While some industries have been impacted more severely than others, all businesses have been impacted to some degree. 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. The goal of the CARES Act is to prevent a severe economic downturn through various measures, including direct financial aid to American families and economic stimulus to significantly impacted industry sectors. 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 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. 39 • The CARES Act allowed for a temporary delay in the adoption of accounting guidance under Accounting Standards Codification Topic 326, “Financial Instruments – Credit Losses (“CECL”) until the earlier of December 31, 2020 or after the end of the COVID-19 national emergency. During the quarter ended March 31, 2020, pursuant to the CARES Act and guidance from the Securities and Exchange Commission (“SEC”) and Financial Accounting Standards Board (“FASB”), we elected to delay adoption of CECL. On December 27, 2020, the Consolidated Appropriations Act, 2021 was signed into law. Among other provisions, this Act extended the temporary delay on the adoption of CECL until January 1, 2022. 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 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 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. • The CARES Act authorized the Small Business Administration (“SBA”) to temporarily guarantee loans under a new loan program call the Paycheck Protection Program (“PPP”). As a qualified SBA lender, we were automatically authorized to originate PPP loans. 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; and (c) principal and interest payments deferred for six months from the date of disbursement. The SBA will guarantee 100% of the PPP loans made to eligible borrowers. 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. 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 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. We maintain access to multiple sources of liquidity. Wholesale funding markets have remained open to us, but rates for short term funding have recently been volatile. If funding costs are elevated for an extended period of time, it could have an adverse effect on our net interest margin. 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 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 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 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. 40 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 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. The gross margin on loans originated and sold contraction reflects decreased industry demand due to the increased competition from mortgage orginators. We sell loans on both a servicing-released and a servicing-retained basis. Waterstone Mortgage Corporation has contracted with a third party to service the loans for which we retain servicing. Additionally, 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). Conventional loans include loans that conform to Fannie Mae and Freddie Mac standards, whereas governmental loans are those loans guaranteed by the federal government, such as a Federal Housing Authority or U.S. Department of Agriculture loan. 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 $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 September 30, 2021 2020 (Dollars in Thousands, except per share amounts) Net income $ 19,000 26,293 Earnings per share - basic 0.80 1.08 Earnings per share - diluted 0.79 1.08 Annualized return on average assets 3.38 % 4.78 % Annualized return on average equity 17.25 % 26.30 % 41 Net Interest Income Average Balance Sheets, Interest and Yields/Costs The following tables set forth average balance sheets, annualized average yields and costs, and certain other information for the periods indicated. Non-accrual loans are included in the computation of the average balances of loans receivable and held for sale. The yields set forth below include the effect of deferred fees, discounts and premiums that are amortized or accreted to interest income or expense. Yields on interest-earning assets are computed on a fully tax-equivalent yield, where applicable. Three months ended September 30, 2021 2020 Average Balance Interest Yield/Cost Average Balance Interest Yield/Cost (Dollars in Thousands) Assets Interest-earning assets: Loans receivable and held for sale (1) $ $1,573,194 $ $16,131 4.07 % $ $1,766,715 $ $18,224 4.10 % Mortgage related securities (2) 108,743 471 1.72 % 96,529 588 2.42 % Debt securities, federal funds sold and short-term investments (2)(3) 409,559 967 0.94 % 166,160 801 1.92 % Total interest-earning assets 2,091,496 17,569 3.33 % 2,029,404 19,613 3.84 % Noninterest-earning assets 137,454 160,526 Total assets $ $2,228,950 $ $2,189,930 Liabilities and equity Interest-bearing liabilities: Demand accounts $ $68,478 13 0.08 % $ $50,590 11 0.09 % Money market, savings, and escrow accounts 391,599 233 0.24 % 282,349 473 0.67 % Time deposits 663,343 701 0.42 % 741,265 3,011 1.62 % Total interest-bearing deposits 1,123,420 947 0.33 % 1,074,204 3,495 1.29 % Borrowings 475,000 2,445 2.04 % 531,588 2,640 1.98 % Total interest-bearing liabilities 1,598,420 3,392 0.84 % 1,605,792 6,135 1.52 % Noninterest-bearing liabilities Noninterest-bearing deposits 153,436 129,911 Other noninterest-bearing liabilities 40,148 56,451 Total noninterest-bearing liabilities 193,584 186,362 Total liabilities 1,792,004 1,792,154 Equity 436,946 397,776 Total liabilities and equity $ $2,228,950 $ $2,189,930 Net interest income / Net interest rate spread (4) 14,177 2.49 % 13,478 2.32 % Less: taxable equivalent adjustment 63 0.01 % 69 0.01 % Net interest income / Net interest rate spread, as reported $ $14,114 2.48 % $ $13,409 2.31 % Net interest-earning assets (5) $ $493,076 $ $423,612 Net interest margin (6) 2.68 % 2.63 % Tax equivalent effect 0.01 % 0.01 % Net interest margin on a fully tax equivalent basis (6) 2.69 % 2.64 % Average interest-earning assets to average interest-bearing liabilities 130.85 % 126.38 % __________ (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 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. (5) Net interest-earning assets represent total interest-earning assets less total interest-bearing liabilities. (6) Net interest margin represents net interest income divided by average total interest-earning assets. 42 Rate/Volume Analysis The following table sets forth the effects of changing rates and volumes on our net interest income for the periods indicated. The rate column shows the effects attributable to changes in rate (changes in rate multiplied by prior volume). The volume column shows the effects attributable to changes in volume (changes in volume multiplied by prior rate). The net column represents the sum of the prior columns. For purposes of this table, changes attributable to changes in both rate and volume that cannot be segregated have been allocated proportionately based on the changes due to rate and the changes due to volume. Three months ended September 30, 2021 versus 2020 Increase (Decrease) due to Volume Rate Net (In Thousands) Interest income: Loans receivable and held for sale (1)(2) $ (1,958 ) $ (135 ) $ (2,093 ) Mortgage related securities (3) 67 (184 ) (117 ) Debt securities, federal funds sold and short-term investments (3)(4) 727 (561 ) 166 Total interest-earning assets (1,164 ) (880 ) (2,044 ) Interest expense: Demand accounts 3 (1 ) 2 Money market, savings, and escrow accounts 363 (603 ) (240 ) Time deposits (287 ) (2,023 ) (2,310 ) Total interest-earning deposits 79 (2,627 ) (2,548 ) Borrowings (273 ) 78 (195 ) Total interest-bearing liabilities (194 ) (2,549 ) (2,743 ) Net change in net interest income $ (970 ) $ 1,669 $ 699 ______________ (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. (3) Includes available for sale securities. Average balance of available for sale securities is based on amortized historical cost. (4) Interest income from tax exempt securities is computed on a taxable equivalent basis using a tax rate of 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 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 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. Additionally, the average balance of time deposits decreased $77.9 million compared to the prior year period. ● Interest expense on money market, savings, and escrow accounts decreased $240,000, or 50.7%, due primarily to a 43 basis point decrease in average cost of money market, savings, and escrow accounts. Partially offsetting the decrease in average cost, the average balance increased $109.3 million. 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 $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. 43 Provision for Loan Losses The Company delayed adoption of ASC Topic 326 as permited under the CARES Act and subsequently under the Consolidated Appropriations Act. The Company calculated the current quarter allowance using the incurred loss model. 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. 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. 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. See further discussion regarding the allowance for loan losses in the "Asset Quality" section for an analysis of charge-offs, nonperforming assets, specific reserves and additional provisions and the "Allowance for Loan Loss" section. Noninterest Income Three months ended September 30, 2021 2020 $ Change % Change (Dollars in Thousands) Service charges on loans and deposits $ 1,136 $ 672 $ 464 69.0 % Increase in cash surrender value of life insurance 312 714 (402 ) (56.3 )% Mortgage banking income 46,547 72,112 (25,565 ) (35.5 )% Other 4,941 2,265 2,676 118.1 % Total noninterest income $ 52,936 $ 75,763 $ (22,827 ) (30.1 )% 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 $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 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. 44 Noninterest Expenses Three months ended September 30, 2021 2020 $ Change % Change (Dollars in Thousands) Compensation, payroll taxes, and other employee benefits $ 34,229 $ 39,405 $ (5,176 ) (13.1 )% Occupancy, office furniture and equipment 2,488 2,469 19 0.8 % Advertising 835 861 (26 ) (3.0 )% Data processing 986 922 64 6.9 % Communications 331 339 (8 ) (2.4 )% Professional fees 550 4,738 (4,188 ) (88.4 )% Real estate owned 1 11 (10 ) (90.9 )% Loan processing expense 1,135 1,336 (201 ) (15.0 )% Other 2,768 2,920 (152 ) (5.2 )% Total noninterest expenses $ 43,323 $ 53,001 $ (9,678 ) (18.3 )% 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. 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. ● 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. 45 Income Taxes 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. 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. The Company calculated the current year allowance using the incurred loss model. 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 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 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 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. We sell loans on both a servicing-released and a servicing-retained basis. Waterstone Mortgage Corporation has contracted with a third party to service the loans for which we retain servicing. Additionally, 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). Conventional loans include loans that conform to Fannie Mae and Freddie Mac standards, whereas governmental loans are those loans guaranteed by the federal government, such as a Federal Housing Authority or U.S. Department of Agriculture loan. Our origination efforts continue to be focused on loans made for the purpose of residential purchases, as opposed to mortgage refinance. The percentage of origination volume related to purchase activity increased to 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. 46 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. 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. Other noninterest expense decreased 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 the decreases, the amortization of mortgage servicing rights increased as the value of the servicing portfolio has increased in 2021 compared to 2020. Consolidated Waterstone Financial, Inc. Results of Operations Nine months ended September 30, 2021 2020 (Dollars in Thousands, except per share amounts) Net income $ 58,238 $ $53,310 Earnings per share - basic 2.45 2.16 Earnings per share - diluted 2.43 2.15 Annualized return on average assets 3.54 % 3.35 % Annualized return on average equity 18.08 % 18.02 % 47 Net Interest Income Average Balance Sheets, Interest and Yields/Costs The following tables set forth average balance sheets, annualized average yields and costs, and certain other information for the periods indicated. Non-accrual loans are included in the computation of the average balances of loans receivable and held for sale. The yields set forth below include the effect of deferred fees, discounts and premiums that are amortized or accreted to interest income or expense. Yields on interest-earning assets are computed on a fully tax-equivalent yield, where applicable. Nine months ended September 30, 2021 2020 Average Balance Interest Yield/Cost Average Balance Interest Yield/Cost (Dollars in Thousands) Assets Interest-earning assets: Loans receivable and held for sale (1) $ $1,627,793 $ $49,214 4.04 % $ $1,696,493 $ $54,404 4.28 % Mortgage related securities (2) 99,819 1,448 1.94 % 104,752 1,960 2.50 % Debt securities, federal funds sold and short-term investments (2)(3) 331,028 2,840 1.15 % 178,775 2,703 2.02 % Total interest-earning assets 2,058,640 53,502 3.47 % 1,980,020 59,067 3.98 % Noninterest-earning assets 142,822 146,959 Total assets $ $2,201,462 $ $2,126,979 Liabilities and equity Interest-bearing liabilities: Demand accounts $ $62,594 22 0.05 % $ $45,275 27 0.08 % Money market, savings, and escrow accounts 352,378 452 0.17 % 251,377 1,364 0.72 % Time deposits 686,262 3,068 0.60 % 735,350 10,369 1.88 % Total interest-bearing deposits 1,101,234 3,542 0.43 % 1,032,002 11,760 1.52 % Borrowings 478,349 7,414 2.07 % 545,631 7,913 1.94 % Total interest-bearing liabilities 1,579,583 10,956 0.93 % 1,577,633 19,673 1.67 % Noninterest-bearing liabilities Noninterest-bearing deposits 144,565 112,777 Other noninterest-bearing liabilities 46,657 41,502 Total noninterest-bearing liabilities 191,222 154,279 Total liabilities 1,770,805 1,731,912 Equity 430,657 395,067 Total liabilities and equity $ $2,201,462 $ $2,126,979 Net interest income / Net interest rate spread (4) 42,546 2.54 % 39,394 2.31 % Less: taxable equivalent adjustment 203 0.01 % 210 0.01 % Net interest income / Net interest rate spread, as reported $ $42,343 2.53 % $ $39,184 2.30 % Net interest-earning assets (5) $ $479,057 $ $402,387 Net interest margin (6) 2.75 % 2.64 % Tax equivalent effect 0.01 % 0.02 % Net interest margin on a fully tax equivalent basis (6) 2.76 % 2.66 % Average interest-earning assets to average interest-bearing liabilities 130.33 % 125.51 % __________ (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 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. (4) Net interest rate spread represents the difference between the yield on average interest-earning assets and the cost of average interest-bearing liabilities and is presented on a fully tax equivalent basis. (5) Net interest-earning assets represent total interest-earning assets less total interest-bearing liabilities. (6) Net interest margin represents net interest income divided by average total interest-earning assets. 48 Rate/Volume Analysis The following table sets forth the effects of changing rates and volumes on our net interest income for the periods indicated. The rate column shows the effects attributable to changes in rate (changes in rate multiplied by prior volume). The volume column shows the effects attributable to changes in volume (changes in volume multiplied by prior rate). The net column represents the sum of the prior columns. For purposes of this table, changes attributable to changes in both rate and volume that cannot be segregated have been allocated proportionately based on the changes due to rate and the changes due to volume. Nine months ended September 30, 2021 versus 2020 Increase (Decrease) due to Volume Rate Net (In Thousands) Interest income: Loans receivable and held for sale (1)(2) $ (2,384 ) $ (2,806 ) $ (5,190 ) Mortgage related securities (3) (97 ) (415 ) (512 ) Debt securities, federal funds sold and short-term investments (3) (4) 1,641 (1,504 ) 137 Total interest-earning assets (840 ) (4,725 ) (5,565 ) Interest expense: Demand accounts 8 (13 ) (5 ) Money market, savings, and escrow accounts 1,010 (1,922 ) (912 ) Time deposits (652 ) (6,649 ) (7,301 ) Total interest-earning deposits 366 (8,584 ) (8,218 ) Borrowings (1,093 ) 594 (499 ) Total interest-bearing liabilities (727 ) (7,990 ) (8,717 ) Net change in net interest income $ (113 ) $ 3,265 $ 3,152 ______________ (1) 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. (3) Includes available for sale securities. Average balance of available for sale securities is based on amortized historical cost. (4) Interest income from tax exempt securities is computed on a taxable equivalent basis using a tax rate of 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. The decrease in average loan balance was driven by a decrease of $108.2 million, or 7.6%, in the average balance of loans held in portfolio offset by a $39.5 million, or 14.0%, increase in the average balance of loans held for sale. ● Interest income from mortgage related securities decreased $512,000 primarily as the yield decreased 56 basis points. 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) 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. Additionally, the average balance of time deposits decreased $49.1 million compared to the prior year period. ● Interest expense on money market, savings, and escrow accounts decreased $912,000, or 66.9%, due primarily to a 55 basis point decrease in average cost of money market, savings, and escrow accounts offset by an increase in average balance of $101.0 million. 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 $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. 49 Provision for Loan Losses The Company delayed adoption of ASC Topic 326 as permited under the CARES Act and subsequently under the Consolidated Appropriations Act. The Company calculated the current quarter allowance using the incurred loss model. 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. 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 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 $487,000 for the nine 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. See further discussion regarding the allowance for loan losses in the "Asset Quality" section for an analysis of charge-offs, nonperforming assets, specific reserves and additional provisions and the "Allowance for Loan Losses" section. Noninterest Income Nine months ended September 30, 2021 2020 $ Change % Change (Dollars in Thousands) Service charges on loans and deposits $ 2,483 $ 3,384 $ (901 ) (26.6 )% Increase in cash surrender value of life insurance 1,297 1,587 (290 ) (18.3 )% Mortgage banking income 150,587 166,292 (15,705 ) (9.4 )% Other 6,812 2,868 3,944 137.5 % Total noninterest income $ 161,179 $ 174,131 $ (12,952 ) (7.4 )% 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. Gross margin on loans originated and sold decreased 7.7% at the mortgage banking segment. 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. 50 Noninterest Expenses Nine months ended September 30, 2021 2020 $ Change % Change (Dollars in Thousands) Compensation, payroll taxes, and other employee benefits $ $102,278 $ 100,695 $ 1,583 1.6 % Occupancy, office furniture and equipment 7,346 7,744 (398 ) (5.1 )% Advertising 2,570 2,625 (55 ) (2.1 )% Data processing 2,871 3,023 (152 ) (5.0 )% Communications 988 994 (6 ) (0.6 )% Professional fees 804 7,647 (6,843 ) (89.5 )% Real estate owned (11 ) 55 (66 ) (120.0 )% Loan processing expense 3,670 3,620 50 1.4 % Other 9,104 9,495 (391 ) (4.1 )% Total noninterest expenses $ $129,620 $ 135,898 $ (6,278 ) (4.6 )% 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. 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. ● 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 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 $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 $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 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. 51 Income Taxes 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 $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 $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. For the Nine months ended September 30, 2021 2020 Real estate loans originated for investment: Residential One- to four-family $ 43,137 $ 90,290 Multi-family 81,722 133,027 Home equity 4,736 4,914 Construction and land 23,358 41,418 Commercial real estate 33,552 26,637 Total real estate loans originated for investment 186,505 296,286 Consumer loans originated for investment 23 275 Commercial business loans originated for investment 19,922 41,944 Total loans originated for investment $ 206,450 $ 338,505 52 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, 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 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 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 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 $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. The Company receives payments from borrowers for their real estate taxes during the course of the calendar year until real estate tax obligations are paid in the fourth quarter. At the time at which the disbursements are made, the outstanding checks are classified as other liabilities in the statements of financial condition. These amounts remain classified as other liabilities until settled. 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 $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. Partially offsetting the increases, there were decreases due to the declaration of dividends, a decrease in the fair value of the security portfolio, and the repurchase of stock. 53 ASSET QUALITY NONPERFORMING ASSETS At September 30, At December 31, 2021 2020 (Dollars in Thousands) Non-accrual loans: Residential One- to four-family $ 3,797 $ 5,072 Multi-family 129 341 Home equity 46 63 Construction and land - 43 Commercial real estate - 41 Commercial - - Consumer - - Total non-accrual loans 3,972 5,560 Real estate owned One- to four-family - - Multi-family - - Construction and land 148 322 Commercial real estate - - Total real estate owned 148 322 Total nonperforming assets $ 4,120 $ 5,882 Total non-accrual loans to total loans 0.32 % 0.40 % Total non-accrual loans to total assets 0.18 % 0.25 % Total nonperforming assets to total assets 0.18 % 0.27 % All loans that are 90 days or more past due with respect to principal and interest are recognized as non-accrual. Troubled debt restructurings that are non-accrual, either due to being past due greater than 90 days or which have not yet performed under the modified terms for a reasonable period of time, are included in the table above. In addition, loans that are past due less than 90 days are evaluated to determine the likelihood of collectability given other credit risk factors such as early stage delinquency, the nature of the collateral or the results of a borrower review. When the collection of all contractual principal and interest is determined to be unlikely, the loan is moved to non-accrual status and an updated appraisal of the underlying collateral is ordered. This process generally takes place when a loan is contractually past due between 60 and 89 days. Upon determining the updated estimated value of the collateral, a loan loss provision is recorded to establish a specific reserve to the extent that the outstanding principal balance exceeds the updated estimated net realizable value of the collateral. When a loan is determined to be uncollectible, typically coinciding with the initiation of foreclosure action, the specific reserve is reviewed for adequacy, adjusted if necessary, and charged-off. 54 The following table sets forth activity in our non-accrual loans for the periods indicated. At or for Nine Months Ended September 30, 2021 2020 (In Thousands) Balance at beginning of period $ 5,560 $ 7,025 Additions 1,320 2,327 Transfers to real estate owned - (369 ) Charge-offs (12 ) (3 ) Returned to accrual status (1,544 ) (1,563 ) Principal paydowns and other (1,352 ) (1,376 ) Balance at end of period $ 3,972 $ 6,041 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 $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 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 September 30, 2021 totaled $2.2 million, which represents 55.8% 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 September 30, 2021. Interest payments received are treated as interest income on a cash basis as long as the remaining book value of the loan (i.e., after charge-off of all identified losses) is deemed to be fully collectible. If the remaining book value is not deemed to be fully collectible, all payments received are applied to unpaid principal. 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 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. The Bank received full payoff of the loan subsequent to December 31, 2020. 55 TROUBLED DEBT RESTRUCTURINGS The following table summarizes information with respect to the accrual status of our troubled debt restructurings: As of September 30, 2021 Accruing Non-accruing Total (In Thousands) One- to four-family $ 1,153 $ 1,695 $ 2,848 Commercial real estate 1,222 - 1,222 Commercial 1,097 - 1,097 $ 3,472 $ 1,695 $ 5,167 As of December 31, 2020 Accruing Non-accruing Total (In Thousands) One- to four-family $ 2,733 $ 532 $ 3,265 Commercial real estate 7,207 - 7,207 Commercial 1,097 - 1,097 $ 11,037 $ 532 $ 11,569 All troubled debt restructurings are considered to be impaired, are risk rated as either substandard or watch and are included in the internal risk rating tables disclosed in the notes to the unaudited consolidated financial statements. Specific reserves have been established to the extent that collateral-based impairment analyses indicate that a collateral shortfall exists. We do not participate in government-sponsored troubled debt restructuring programs. Our troubled debt restructurings are short-term modifications. Typical initial restructured terms include six to twelve months of principal forbearance, a reduction in interest rate or both. Restructured terms do not include a reduction of the outstanding principal balance unless mandated by a bankruptcy court. Troubled debt restructuring terms may be renewed or further modified at the end of the initial term for an additional period if performance has been acceptable and the short-term borrower difficulty persists. If a restructured loan is current in all respects and a minimum of six consecutive restructured payments have been received, it can be considered for return to accrual status. After a restructured loan that is current in all respects reverts to contractual/market terms, if a credit department review indicates no evidence of elevated market risk, the loan is removed from the troubled debt restructuring classification. We modified loans for borrowers that were not considered troubled debt restructings under the CARES Act. 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 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. 56 LOAN DELINQUENCY The following table summarizes loan delinquency in total dollars and as a percentage of the total loan portfolio: At September 30, At December 31, 2021 2020 (Dollars in Thousands) Loans past due less than 90 days $ 7,854 $ 3,938 Loans past due 90 days or more 3,378 3,958 Total loans past due $ 11,232 $ 7,896 Total loans past due to total loans receivable 0.92 % 0.57 % 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 $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 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. During the period of time in which we are awaiting receipt of an updated appraisal, loans evaluated for impairment based upon collateral value are measured by the following: ● Applying an updated adjustment factor (as described previously) to an existing appraisal; ● Confirming that the physical condition of the real estate has not significantly changed since the last valuation date; ● Comparing the estimated current value of the collateral to that of updated sales values experienced on similar collateral; ● Comparing the estimated current value of the collateral to that of updated values seen on current appraisals of similar collateral; and ● Comparing the estimated current value to that of updated listed sales prices on our real estate owned and that of similar properties (not owned by the Company). Virtually all habitable real estate owned (both residential and commercial properties) is managed with the intent of attracting a lessee to generate revenue. Foreclosed properties are recorded at the lower of carrying value or fair value, less costs to sell, with charge-offs, if any, charged to the allowance for loan losses upon transfer to real estate owned within 90 days of being transferred. Subsequent write-downs to reflect current fair market value, as well as gains and losses upon disposition and revenue and expenses incurred in maintaining such properties, are treated as period costs and included in real estate owned in the consolidated statements of income. The fair value is primarily based upon updated appraisals in addition to an analysis of current real estate market conditions. 57 ALLOWANCE FOR LOAN LOSSES At or for Nine Months Ended September 30, 2021 2020 (Dollars in Thousands) Balance at beginning of period $ 18,823 $ 12,387 Provision (credit) for loan losses (2,520 ) 6,310 Charge-offs: Mortgage One- to four-family 105 9 Multi-family - 5 Home equity - 13 Commercial real estate 10 - Construction and land 13 - Consumer 10 10 Commercial - - Total charge-offs 138 37 Recoveries: Mortgage One- to four-family 522 132 Multi-family 36 17 Home equity 12 22 Commercial real estate 3 11 Construction and land 52 2 Consumer - - Commercial - - Total recoveries 625 184 Net recoveries (487 ) (147 ) Allowance at end of period $ 16,790 $ 18,844 Ratios: Allowance for loan losses to non-accrual loans at end of period 422.71 % 311.94 % Allowance for loan losses to loans receivable at end of period 1.37 % 1.31 % Net recoveries to average loans outstanding (annualized) (0.05 )% (0.01 )% (Provision) credit for loan losses to net recoveries 517.45 % (4,292.52 )% Net recoveries to beginning of the period allowance (annualized) (3.46 )% (1.59 )% 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 $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. Credit quality is assured only when the estimated value of the collateral is objectively determined and is not subject to significant fluctuation. The allowance for loan losses has been determined in accordance with GAAP. We are responsible for the timely and periodic determination of the amount of the allowance required. Any future provisions for loan losses will continue to be based upon our assessment of the overall loan portfolio and the underlying collateral, trends in non-performing loans, current economic conditions and other relevant factors. To the best of management’s knowledge, all probable losses have been provided for in the allowance for loan losses. 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 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. This estimate is subject to change based on continuing refinement and validation of the model and methodologies. 58 The establishment of the amount of the loan loss allowance inherently involves judgments by management as to the appropriateness of the allowance, which ultimately may or may not be correct. Higher than anticipated rates of loan default would likely result in a need to increase provisions in future years. Liquidity and Capital Resources We maintain liquid assets at levels we consider adequate to meet our liquidity needs. We adjust our liquidity levels to fund loan commitments, repay our borrowings, fund deposit outflows and pay real estate taxes on mortgage loans. We also adjust liquidity as appropriate to meet asset and liability management objectives. The level of our liquidity position at any point in time is dependent upon the judgment of the senior management as supported by the Asset/Liability Committee. Liquidity is monitored on a daily, weekly and monthly basis using a variety of measurement tools and indicators. Our primary sources of liquidity are deposits, amortization and repayment of loans, sales of loans held for sale, maturities of investment securities and other short-term investments, and earnings and funds provided from operations. While scheduled principal repayments on loans are a relatively predictable source of funds, deposit flows and loan repayments are greatly influenced by market interest rates, economic conditions, and rates offered by our competitors. We set the interest rates on our deposits to maintain a desired level of total deposits. In addition, we invest excess funds in short-term, interest-earning assets, which provide liquidity to meet lending requirements. Additional sources of liquidity used for the purpose of managing long- and short-term cash flows include advances from the FHLB. 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 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 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. Our primary sources of cash are principal repayments on loans, proceeds from the calls and maturities of debt and mortgage-related securities, increases in deposit accounts, advances from the FHLB, and repurchase agreements from other institutions. Liquidity management is both a daily and longer-term function of business management. If we require funds beyond our ability to generate them internally, borrowing agreements exist with the FHLB which provide an additional source of funds. At 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. There are eight advances that have contractual maturities in 2028. Two of the 2028 advance maturities have quarterly call options which began in June 2020 and September 2020. There are four advances with contractual maturities in 2029. Three advances have quarterly call options currently available and the other advance has an option beginning in May 2022. 59 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. In the event a significant portion of our deposits is not retained by us, we will have to utilize other funding sources, such as FHLB advances, in order to maintain our level of assets. However, we cannot assure that such borrowings would be available on attractive terms, or at all, if and when needed. Alternatively, we could reduce our level of liquid assets, such as our cash and cash equivalents and securities available-for-sale in order to meet funding needs. In addition, the cost of such deposits may be significantly higher if market interest rates are higher or there is an increased amount of competition for deposits in our market area at the time of renewal. • Waterstone Financial, Inc. is a separate legal entity from WaterStone Bank and must provide for its own liquidity to pay dividends to its shareholders, repurchase shares of its common stock, and for other corporate purposes. The primary source of liquidity for Waterstone Financial, Inc. is dividend payments from WaterStone Bank. The ability of WaterStone Bank to pay dividends is subject to regulatory restrictions. At September 30, 2021 , Waterstone Financial, Inc. (on an unconsolidated basis) had liquid assets totaling $46.8 million. Capital 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. Partially offsetting the increases, there were decreases due to the declaration of dividends, a decrease in the fair value of the security portfolio, and the repurchase of stock. The Company's Board of Directors authorized a stock repurchase program in the third quarter of 2020. 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 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.” 60 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 September 30, 2021 and the respective maturity dates. More than More than One Year Three Years Over One Year Through Through Five Total or Less Three Years Five Years Years (In Thousands) Demand deposits (3) $ 217,078 $ $217,078 $ - $ - $ - Money market and savings deposits (3) 371,719 371,719 - - - Time deposit (3) 657,767 576,578 79,238 1,951 - Federal Home Loan Bank advances (1) 475,000 5,000 - - 470,000 Operating leases (2) 7,453 2,582 3,249 793 829 $ 1,729,017 $ $1,172,957 $ $82,487 $ $2,744 $ $470,829 (1) Secured under a blanket security agreement on qualifying assets, principally, mortgage loans. Excludes interest which will accrue on the advances. See call provisions in Note 7 - Borrowings. (2) Represents non-cancelable operating leases for offices and equipment. (3) Excludes interest. See Note 10 - Commitments, Off-Balance Sheet Arrangements, and Contingent Liabilities of the notes to unaudited consolidated financial statements for additional information. Off-Balance Sheet Commitments The following table details the amounts and expected maturities of significant off-balance sheet commitments as of September 30, 2021. More than More than One Year Three Years Over One Year Through Through Five Total or Less Three Years Five Years Years (In Thousands) Real estate loan commitments (1) $ 44,643 $ 44,643 $ - $ - $ - Unused portion of home equity lines of credit (2) 13,218 13,218 - - - Unused portion of construction loans (3) 69,198 69,198 - - - Unused portion of business lines of credit 19,864 19,864 - - - Standby letters of credit 954 954 - - - Total Other Commitments $ 147,877 $ 147,877 $ - $ - $ - General: Commitments to extend credit are agreements to lend to a customer as long as there is no violation of any condition established in the contract and generally have fixed expiration dates or other termination clauses. (1) Commitments for loans are extended to customers for up to 90 days after which they expire. (2) Unused portions of home equity loans are available to the borrower for up to 10 years. (3) Unused portions of construction loans are available to the borrower for up to one year. 61