Waterstone Financial, Inc. 10-K

SECURITIES AND EXCHANGE COMMISSION Washington, D.C. 20549 F O R M 10-K [X] ANNUAL REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES EXCHANGE ACT OF 1934 For the fiscal year ended December 31, 2021 Commission file number: 001-36271 WATERSTONE FINANCIAL, INC. (Exact name of registrant as specified in its charter) Maryland 90-1026709 (State or other jurisdiction of incorporation or organization) (I.R.S. Employer Identification No.) 11200 W Plank Ct , Wauwatosa , Wisconsin 53226 (Address of principal executive offices) (Zip Code) ( 414 ) 761-1000 Registrant's telephone number, including area code: Securities registered pursuant to Section 12(b) of the Act: Title of each class Trading Symbol Name of each exchange on which registered Common Stock, $0.01 Par Value WSBF The NASDAQ Stock Market LLC Securities registered pursuant to Section 12(g) of the Act: NONE Indicate by check mark whether the registrant is a well-known seasoned issuer (as defined in Rule 405 of the 1933 Act). Yes □ No T Indicate by check mark whether the registrant is not required to file reports pursuant to Section 13 or Section 15(d) of the 1934 Act. Yes □ No T Indicate by check mark whether the registrant (1) has filed all reports required to be filed by Section 13 or 15(d) of the Securities Exchange Act of 1934 during the preceding 12 months (or for such shorter period that the registrant was required to file such reports), and (2) has been subject to such filing requirements for the past 90 days. Yes T No □ Indicate by check mark whether the registrant has submitted electronically every Interactive Data File required to be submitted pursuant to Rule 405 of Regulation S-T during the preceding 12 months (or for such shorter period that the registrant was required to submit such files) Yes T No □ Indicate by check mark whether the registrant is a large accelerated filer, an accelerated filer, a non-accelerated filer, a smaller reporting company, or an emerging growth company. See definitions of “large accelerated filer,” “accelerated filer,” “smaller reporting company,” and "emerging growth company" in Rule 12b-2 of the Exchange Act. Large accelerated filer ☐ Accelerated filer ☒ Non-accelerated filer ☐ Smaller Reporting Company ☐ Emerging growth company ☐ If an emerging growth company, indicate by check mark if the registrant has elected not to use the extended transition period for complying with any new or revised financial accounting standards provided pursuant to Section 13(a) of the Exchange Act. o Indicate by check mark whether the registrant has filed a report on and attestation to its management’s assessment of the effectiveness of its internal control over financial reporting under Section 404(b) of the Sarbanes-Oxley Act (15 U.S.C. 7262(b)) by the registered public accounting firm that prepared or issued its audit report. ☒ Indicate by check mark whether the registrant is a shell company (as defined in Rule 12b-2 under the Exchange Act). Yes ☐ No T The aggregate market value of the voting and non-voting common equity held by non-affiliates of the Registrant, computed by reference to the price at which the common equity was last sold on June 30, 2021 as reported by the NASDAQ Global Select Market®, was approximately $ 495.7 million. As of February 25, 2022, 24,230,968 shares of the Registrant’s Common Stock were issued and outstanding. DOCUMENTS INCORPORATED BY REFERENCE Part of Form 10-K Into Which Document Portions of Document are Incorporated Proxy Statement for Annual Meeting of Part III Shareholders on May 17, 2022 WATERSTONE FINANCIAL, INC. FORM 10-K ANNUAL REPORT TO THE SECURITIES AND EXCHANGE COMMISSION FOR THE YEAR ENDED DECEMBER 31, 2021 TABLE OF CONTENTS ITEM PAGE PART I 1. Business 3-29 1A. Risk Factors 29-37 1B. Unresolved Staff Comments 37 2. Properties 38 3. Legal Proceedings 38 4. Mine Safety Disclosures 38 PART II 5. Market for Registrant's Common Equity, Related Stockholders Matters and Issuer Purchases of Equity Securities 39-40 6. [Reserved] 40 7. Management's Discussion and Analysis of Financial Condition and Results of Operations 40-54 7A. Quantitative and Qualitative Disclosures About Market Risk 55 8. Financial Statements and Supplementary Data 56-102 9. Changes in and Disagreements with Accountants on Accounting and Financial Disclosure 103 9A. Controls and Procedures 103 9B. Other Information 104 9C. Disclosure Regarding Foreign Jurisdictions that Prevent Inspections 104 PART III 10. Directors, Executive Officers and Corporate Governance 104 11. Executive Compensation 104 12. Security Ownership of Certain Beneficial Owners and Management and Related Stockholder Matters 104 13. Certain Relationships and Related Transactions, and Director Independence 105 14. Principal Accountant Fees and Services 105 PART IV 15. Exhibits and Financial Statement Schedules 105-107 16. Form 10-K Summary 105 Signatures 107-108 PART 1 Item 1. Business Forward-Looking Statements This Annual Report on Form 10-K may contain or incorporate by reference 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; • 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 effect of any pandemic; including COVID-19; • 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 or reduce the fair value of financial instruments or reduce 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; • 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 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. See also the factors regarding future operations discussed in "Management's Discussion and Analysis of Financial Condition and Results of Operations" and "Risk Factors" below. Waterstone Financial, Inc. Waterstone Financial, Inc., a Maryland corporation (“New Waterstone”), was organized in 2013. Upon completion of the mutual-to-stock conversion of Lamplighter Financial, MHC in 2014, New Waterstone became the holding company of WaterStone Bank SSB and succeeded to all of the business and operations of Waterstone Financial, Inc., a Federal corporation (“Waterstone-Federal”) and each of Waterstone-Federal and Lamplighter Financial, MHC ceased to exist. In this report, we refer to WaterStone Bank SSB, our wholly owned subsidiary, both before and after the reorganization, as “WaterStone Bank” or the “Bank.” Waterstone Financial, Inc. and its subsidiaries, including WaterStone Bank, are referred to herein as the “Company,” “Waterstone Financial,” or “we.” The Company maintains a website at www.wsbonline.com . We make available through that website, free of charge, copies of our Annual Reports on Form 10-K, Quarterly Reports on Form 10-Q, Current Reports on Form 8-K, amendments to those reports and proxy materials as soon as is reasonably practical after the Company electronically files those materials with, or furnishes them to, the Securities and Exchange Commission. You may access those reports by following the links under “Investor Relations” at the Company’s website. Information on this website is not and should not be considered a part of this document. Waterstone Financial’s executive offices are located at 11200 West Plank Court, Wauwatosa, Wisconsin 53226, and its telephone number at this address is (414) 761-1000. - 3 - BUSINESS OF WATERSTONE BANK General WaterStone Bank is a community bank that has served the banking needs of its customers since 1921. WaterStone Bank also has an active mortgage banking subsidiary, Waterstone Mortgage Corporat ion , which had 61 offices in 23 states as of December 31, 2021. WaterStone Bank conducts its community banking business from 14 banking offices located in Milwaukee, Washington and Waukesha counties, Wisconsin. WaterStone Bank’s principal lending activity is originating one- to four-family, multi-family residential, and commercial real estate loans for retention in its portfolio. At December 31, 2021, such loans comprised 24.92%, 44.62%, and 20.79%, respectively, of WaterStone Bank’s loan portfolio. WaterStone Bank also offers home equity loans and lines of credit, construction and land loans, commercial business loans, and consumer loans. WaterStone Bank funds its loan production primarily with retail deposits and Federal Home Loan Bank advances. Our deposit offerings include certificates of deposit, money market savings accounts, transaction deposit accounts, noninterest bearing demand accounts and individual retirement accounts. Our investment securities portfolio is comprised principally of mortgage-backed securities, collateralized mortgage obligations, government-sponsored enterprise bonds, private-label enterprise bonds, municipal obligations, and other debt securities. WaterStone Bank is subject to comprehensive regulation and examination by the Wisconsin Department of Financial Institutions (the "WDFI") and the Federal Deposit Insurance Corporation (the "FDIC"). WaterStone Bank’s executive offices are located at 11200 West Plank Court, Wauwatosa, Wisconsin 53226, and its telephone number is (414) 761-1000. Its website address is www.wsbonline.com . Information on this website is not and should not be considered a part of this document. WaterStone Bank’s mortgage banking operations are conducted through its wholly-owned subsidiary, Waterstone Mortgage Corporation. Waterstone Mortgage Corporation originates single-family residential real estate loans for sale into the secondary market. Waterstone Mortgage Corporation utilizes lines of credit provided by WaterStone Bank as a primary source of funds, and also utilizes a line of credit with another financial institution as needed. On a consolidated basis, Waterstone Mortgage Corporation originated $4.20 billion in mortgage loans held for sale during the year ended December 31, 2021 , which excludes the loans originated from Waterstone Mortgage Corporation and purchased by WaterStone Bank. Subsidiary Activities Waterstone Financial currently has one wholly-owned subsidiary, WaterStone Bank, which in turn has three wholly-owned subsidiaries. Wauwatosa Investments, Inc., which holds and manages our investment portfolio, is located and incorporated in Nevada. Waterstone Mortgage Corporation is a mortgage banking business incorporated in Wisconsin. Main Street Real Estate Holdings, LLC is a Wisconsin limited liability corporation and previously owned WaterStone Bank office facilities and held WaterStone Bank office facility leases. Wauwatosa Investments, Inc. Established in 1998, Wauwatosa Investments, Inc. operates in Nevada as WaterStone Bank’s investment subsidiary. This wholly-owned subsidiary owns and manages the majority of the consolidated investment portfolio. It has its own board of directors currently comprised of its President, the WaterStone Bank Chief Financial Officer, Treasury Officer and the Chairman of Waterstone Financial’s board of directors. Waterstone Mortgage Corporation. Acquired in 2006, Waterstone Mortgage Corporation is a mortgage banking business with offices in 23 states. It has its own board of directors currently comprised of its President, its Chief Financial Officer, the WaterStone Bank Chief Executive Officer, President, Chief Financial Officer and Chief Credit Officer. Main Street Real Estate Holdings, LLC. Established in 2002, Main Street Real Estate Holdings, LLC was established to acquire and hold WaterStone Bank office and retail facilities, both owned and leased. Main Street Real Estate Holdings, LLC currently conducts real estate broker activities limited to real estate owned. Market Area WaterStone Bank. WaterStone Bank’s market area is broadly defined as the Milwaukee, Wisconsin metropolitan market, which is geographically located in the southeast corner of the state. WaterStone Bank’s primary market area is Milwaukee and Waukesha counties and the five surrounding counties of Ozaukee, Washington, Jefferson, Walworth and Racine. We have nine branch offices in Milwaukee County, four branch offices in Waukesha County and one branch office in Washington County. At June 30, 2021 (the latest date for which information was publicly available), 49.1% of deposits in the State of Wisconsin were located in the seven-county Milwaukee metropolitan market and 42.0% of deposits in the State of Wisconsin were located in the three counties in which the Bank has a branch office. WaterStone Bank’s primary market area for deposits includes the communities in which we maintain our banking office locations. Our primary lending market area is broader than our primary deposit market area and includes all of the primary market area noted above but extends further west to the Madison, Wisconsin market and further north to the Appleton and Green Bay, Wisconsin markets. Waterstone Mortgage Corporation. As of December 31, 2021, Waterstone Mortgage Corporation had 11 offices in New Mexico, nine offices in Florida, seven offices in Wisconsin, three offices in each of Arizona, Colorado, Illinois, Oklahoma, and Texas, two offices in each of Idaho, Minnesota, Ohio, and Pennsylvania, and one office in each of Alabama, Arkansas, California, Georgia, Indiana, Iowa, Maryland, Michigan, New Hampshire, Tennessee, and Virginia. - 4 - Competition WaterStone Bank . WaterStone Bank faces competition within our market area both in making real estate loans and attracting deposits. The Milwaukee-Waukesha metropolitan statistical area has a high concentration of financial institutions, including large commercial banks, community banks and credit unions. As of June 30, 2021, based on the FDIC annual Summary of Deposits Report, we had the 10th largest market share in our metropolitan statistical area out of 46 financial institutions, representing 1.5% of all deposits. Our competition for loans and deposits comes principally from commercial banks, savings institutions, mortgage banking firms and credit unions. We face additional competition for deposits from money market funds, brokerage firms, and mutual funds. Some of our competitors offer products and services that we do not offer, such as trust services and private banking. Our primary focus is to build and develop profitable consumer and commercial customer relationships while maintaining our role as a community bank. Waterstone Mortgage Corporation. Waterstone Mortgage Corporation faces competition for originating loans both directly within the markets in which it operates and from entities that provide services throughout the United States through internet services. Waterstone Mortgage Corporation’s competition comes principally from other mortgage banking firms, as well as from commercial banks, savings institutions and credit unions. Lending Activities The scope of the discussion included under “Lending Activities” is limited to lending operations related to loans originated for investment. A discussion of the lending activities related to loans originated for sale is included under “Mortgage Banking Activities.” Historically, our principal lending activity has been originating mortgage loans for the purchase or refinancing of residential and commercial real estate. Generally, we retain the loans that we originate, which we refer to as loans originated for investment. One- to four-family residential mortgage loans represented $$300.5 million, or 24.9%, of our total loan portfolio at December 31, 2021. Multi-family residential mortgage loans represented $$538.0 million, or 44.6%, of our total loan portfolio at December 31, 2021. Commercial real estate loans represented $$250.7 million, or 20.8%, of our total loan portfolio at December 31, 2021. We also offer construction and land loans, home equity lines of credit and commercial loans. At December 31, 2021, commercial business loans, home equity loans, and construction and land loans totaled $$22.3 million, $$11.0 million and $$82.6 million, respectively. The largest exposure to one borrower or group of related borrowers was $40.1 million in the multi-family category. The borrower represented a total of 3.3% of the total loan portfolio as of December 31, 2021. Loan Portfolio Composition. The following table sets forth the composition of our loan portfolio in dollar amounts and as a percentage of the total portfolio at the dates indicated. At December 31, 2021 2020 2019 2018 2017 Amount Percent Amount Percent Amount Percent Amount Percent Amount Percent (Dollars in Thousands) Mortgage loans: Residential real estate: One- to four-family $ $300,523 24.92 % $ $426,792 31.04 % $ $480,280 34.60 % $ $489,979 35.53 % $ $439,597 34.03 % Multi-family 537,956 44.62 % 571,948 41.59 % 584,859 42.14 % 597,087 43.29 % 578,440 44.77 % Home equity 11,012 0.91 % 14,820 1.08 % 18,071 1.30 % 19,956 1.45 % 21,124 1.64 % Construction and land 82,588 6.85 % 77,080 5.61 % 37,033 2.67 % 13,361 0.97 % 19,859 1.54 % Commercial real estate 250,676 20.79 % 238,375 17.33 % 236,703 17.05 % 225,522 16.35 % 195,842 15.16 % Commercial loans 22,298 1.85 % 45,386 3.30 % 30,253 2.18 % 32,810 2.38 % 36,697 2.84 % Consumer 732 0.06 % 736 0.05 % 832 0.06 % 433 0.03 % 255 0.02 % Total loans 1,205,785 100.00 % 1,375,137 100.00 % 1,388,031 100.00 % 1,379,148 100.00 % 1,291,814 100.00 % Allowance for loan losses (15,778 ) (18,823 ) (12,387 ) (13,249 ) (14,077 ) Loans, net $ $1,190,007 $ $1,356,314 $ $1,375,644 $ $1,365,899 $ $1,277,737 - 5 - Loan Portfolio Maturities and Yields. The following table summarizes the final maturities of our loan portfolio at December 31, 2021 . Maturities are based upon the final contractual payment dates and do not reflect the impact of prepayments and scheduled monthly payments that will occur. One- to four-family Multi-family Home Equity Construction and Land Maturing in the year ended Weighted Weighted Weighted Weighted December 31, Amount Average Rate Amount Average Rate Amount Average Rate Amount Average Rate (Dollars in Thousands) One year or less $ $20,287 3.98 % $ $38,526 4.09 % $ $1,083 4.99 % $ $25,350 2.64 % More than one year through five years 39,207 4.45 % 284,727 3.72 % 5,665 4.96 % 24,228 3.37 % More than five years through 15 years 73,753 4.59 % 213,175 3.42 % 4,223 3.77 % 33,010 3.99 % More than 15 years 167,276 4.02 % 1,528 4.25 % 41 4.88 % - 0.00 % Total $ $300,523 4.21 % $ $537,956 3.63 % $ $11,012 4.50 % $ $82,588 3.40 % Commercial Real Estate Commercial Consumer Total Maturing the year ended Weighted Weighted Weighted Weighted December 31, Amount Average Rate Amount Average Rate Amount Average Rate Amount Average Rate (Dollars in Thousands) One year or less $ $24,807 4.35 % $ $6,018 3.84 % $ $725 7.98 % $ $116,796 3.83 % More than one year through five years 132,844 4.11 % 6,517 3.39 % 7 7.69 % 493,195 3.88 % More than five years through 15 years 93,025 3.54 % 3,904 4.28 % - 0.00 % 421,090 3.61 % More than 15 years - 0.00 % 5,859 6.74 % - 0.00 % 174,704 4.11 % Total $ $250,676 3.92 % $ $22,298 4.55 % $ $732 7.97 % $ $1,205,785 3.81 % The following table sets forth the scheduled repayments of fixed and adjustable rate loans at December 31, 2021 that are contractually due after December 31, 2022. Due After December 31, 2022 Fixed Adjustable Total (In Thousands) Mortgage loans Real estate loans: One- to four-family $ $23,557 $ $256,679 $ $280,236 Multi-family 237,081 262,349 499,430 Home equity 1,959 7,970 9,929 Construction and land 31,204 26,034 57,238 Commercial 152,336 73,533 225,869 Commercial 13,864 2,416 16,280 Consumer 7 - 7 Total loans $ $460,008 $ $628,981 $ $1,088,989 One- to Four-Family Residential Mortgage Loans. One- to four-family residential mortgage loans totaled $$300.5 million, or 24.9% of total loans at December 31, 2021. Our one- to four-family residential mortgage loans have fixed or adjustable rates. Our single family adjustable-rate mortgage loans generally provide for maximum annual rate adjustments of 200 basis points, with a lifetime maximum adjustment of 600 basis points. Our adjustable-rate mortgage loans typically amortize over terms of up to 30 years, and are indexed to the 12-month LIBOR rate. Single family adjustable rate mortgage loans are originated at both our community banking segment and our mortgage banking segment. We do not offer and have never offered residential mortgage loans specifically designed for borrowers with sub-prime credit scores, including Alt-A and negative amortization loans. Adjustable rate mortgage loans can decrease the interest rate risk associated with changes in market interest rates by periodically repricing, but involve other risks because, as interest rates increase, the loan payments by the borrower increase, thus increasing the potential for default by the borrower. At the same time, the marketability of the underlying collateral may be adversely affected by higher interest rates. Upward adjustment of the contractual interest rate is also limited by the maximum periodic and lifetime interest rate adjustments permitted by our loan documents and, therefore, the effectiveness of adjustable rate mortgage loans in decreasing the risk associated with changes in interest rates may be limited during periods of rapidly rising interest rates. Moreover, during periods of rapidly declining interest rates the interest income received from the adjustable rate loans can be significantly reduced, thereby adversely affecting interest income. - 6 - All residential mortgage loans that we originate include “due-on-sale” clauses, which give us the right to declare a loan immediately due and payable in the event that, among other things, the borrower sells or otherwise transfers the real property subject to the mortgage and the loan is not repaid. We also require homeowner’s insurance and where circumstances warrant, flood insurance, on properties securing real estate loans. The average one- to four-family first mortgage loan balance was approximately $210,000 on December 31, 2021, and the largest outstanding balance on that date was $6.0 million, which is a consolidation loan that is collateralized by 86 single family properties. A total of 56.2% of our one- to four-family loans are collateralized by properties in the state of Wisconsin. Multi-family Real Estate Loans. Multi-family loans totaled $$538.0 million, or 44.6% of total loans at December 31, 2021 . These loans are generally secured by properties located in our primary market area. Our multi-family real estate underwriting policies generally provide that such real estate loans may be made in amounts of up to 80% of the appraised value of the property provided the loan complies with our current loans-to-one borrower limit. Multi-family real estate loans are offered with interest rates that are fixed for periods of up to five years or are variable and either adjust based on a market index or at our discretion. Contractual maturities do not exceed 10 years while principal and interest payments are typically based on a 30-year amortization period. In reaching a decision whether to make a multi-family real estate loan, we consider gross revenues and the net operating income of the property, the borrower’s expertise and credit history, global cash flows, and the appraised value of the underlying property. We will also consider the terms and conditions of the leases and the credit quality of the tenants. We generally require that the properties securing these real estate loans have debt service coverage ratios (the ratio of earnings before interest, income taxes, depreciation and amortization divided by interest expense and current maturities of long term debt) of at least 1.15 times. Generally, multi-family loans made to corporations, partnerships and other business entities require personal guarantees from the principals and by the owners of 20% or more of the borrower. A multi-family borrower’s financial information is monitored on an ongoing basis by requiring periodic financial statement updates, payment history reviews and periodic face-to-face meetings with the borrower. We generally require borrowers with aggregate outstanding balances exceeding $1.0 million to provide updated financial statements and federal tax returns annually. These requirements also apply to most guarantors on these loans. We also require borrowers with rental investment property to provide an annual report of income and expenses for the property, including a tenant list and copies of leases, as applicable. The average outstanding multi-family mortgage loan balance was approximately $1.1 million on December 31, 2021, with the largest outstanding balance at $11.5 million. Loans secured by multi-family real estate generally involve larger principal amounts than owner-occupied, one- to four-family residential mortgage loans. Because payments on loans secured by multi-family properties often depend on the successful operation or management of the properties, repayment of such loans may be affected by adverse conditions in the real estate market or the economy. Home Equity Loans and Lines of Credit . We also offer home equity loans and home equity lines of credit, both of which are secured by owner-occupied and non-owner occupied one- to four-family residences. At December 31, 2021, outstanding home equity loans and equity lines of credit totaled $$11.0 million, or 0.9% of total loans outstanding. At December 31, 2021, the unadvanced portion of home equity lines of credit totaled $12.0 million. The underwriting standards utilized for home equity loans and home equity lines of credit include a determination of the applicant’s credit history, an assessment of the applicant’s ability to meet existing obligations and payments on the proposed loan, and the value of the collateral securing the loan. Home equity loans are offered with adjustable rates of interest and with terms up to seven years. The loan-to-value ratio for our home equity loans and our lines of credit is generally limited to 90% when combined with the first security lien, if applicable. Our home equity lines of credit have ten-year terms and adjustable rates of interest, subject to a contractual floor, which are indexed to the prime rate, as reported in The Wall Street Journal . Interest rates on home equity lines of credit are generally limited to a maximum rate of 18%. The average outstanding home equity loan balance was approximately $41,000 at December 31, 2021, with the largest outstanding balance at that date of $291,000. Construction and Land Loans. We originate construction loans for the acquisition of land and the construction of single-family residences, multi-family residences, and commercial real estate buildings. At December 31, 2021, construction and land loans totaled $$82.6 million, or 6.9% of total loans. A total of $50.3 million had yet to be advanced as of December 31, 2021. Our construction mortgage loans generally provide for the payment of interest only during the construction phase, which is typically up to nine months for single-family residences although our policy is to consider construction periods as long as three years for multi-family residences and commercial buildings. At the end of the construction phase, the construction loan converts to a longer-term mortgage loan upon stabilization. Construction loans can be made with a maximum loan-to-value ratio of 90%, provided that the borrower obtains private mortgage insurance if the owner-occupied residential loan balance exceeds 80% of the lesser of the appraised value or acquisition cost of the secured property. The average outstanding construction loan balance totaled approximately $3.8 million on December 31, 2021 , with the largest outstanding balance at $11.1 million. The average outstanding land loan balance was approximately $150,000 on December 31, 2021 , and the largest outstanding balance on that date was $627,000. Before making a commitment to fund a construction loan, we require an appraisal of the property by an independent licensed appraiser. We also review and inspect each property before disbursement of funds during the term of the construction loan. Loan proceeds are disbursed after inspection based on either the percentage of completion method or the actual cost of the completed work. Construction financing is generally considered to involve a higher degree of credit risk than longer-term financing on improved, owner-occupied real estate. Risk of loss on a construction loan depends largely upon the accuracy of the initial estimate of the value of the property at completion of construction compared to the estimated cost (including interest) of construction and other assumptions. If the estimate of construction cost is inaccurate, we may be required to advance funds beyond the amount originally committed in order to protect the value of the property. Additionally, if the estimate of value is inaccurate, we may be confronted with a project, when completed, with a value that is insufficient to ensure full repayment of the loan. - 7 - Commercial Real Estate Loans. Commercial real estate loans totaled $$250.7 million at December 31, 2021, or 20.8% of total loans, and are made up of loans secured by office and retail buildings, industrial buildings, churches, restaurants, other retail properties and mixed use properties. These loans are generally secured by property located in our primary market area. Our commercial real estate underwriting policies provide that such real estate loans may be made in amounts of up to 80% of the appraised value of the property. Commercial real estate loans are offered with interest rates that are fixed up to five years or are variable and either adjust based on a market index or at our discretion. Contractual maturities do not exceed 10 years while principal and interest payments are typically based on a 20 to 25-year amortization period. In reaching a decision whether to make a commercial real estate loan, we consider gross revenues and the net operating income of the property, the borrower’s expertise and credit history, business and global cash flow, and the appraised value of the underlying property. In addition, we will also consider the terms and conditions of the leases and the credit quality of the tenants, if applicable. We generally require that the properties securing these real estate loans have debt service coverage ratios (the ratio of earnings before interest, income taxes, depreciation and amortization divided by interest expense and current maturities of long term debt) of at least 1.15 times. Environmental surveys are required for commercial real estate loans when environmental risks are identified. Generally, commercial real estate loans made to corporations, partnerships and other business entities require personal guarantees by the principals and by the owners of 20% or more of the borrower. A commercial real estate borrower’s financial information is monitored on an ongoing basis by requiring periodic financial statement updates, payment history reviews and periodic face-to-face meetings with the borrower. We generally require borrowers with aggregate outstanding balances exceeding $1.0 million to provide annual updated financial statements and federal tax returns. These requirements also apply to all guarantors on these loans. We also require borrowers to provide an annual report of income and expenses for the property, including a tenant list and copies of leases, as applicable. The average commercial real estate loan in our portfolio at December 31, 2021 was approximately $946,000, and the largest outstanding balance at that date was $12.7 million. Commercial Loans. Commercial loans totaled $$22.3 million at December 31, 2021, or 1.85% of total loans, and are made up of loans secured by accounts receivable, inventory, equipment and real estate. Included in commercial loans are the Paycheck Protection Program (PPP) loans, which totaled $1.8 million at December 31, 2021. As a qualified SBA lender, we were automatically authorized to originate PPP loans. 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); 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. Our commercial loans are generally made to borrowers that are located in our primary market area. Working capital lines of credit are granted for the purpose of carrying inventory and accounts receivable or purchasing equipment. These lines require that certain collateral levels must be maintained and are monitored on a monthly or quarterly basis. Working capital lines of credit are short-term loans of 12 months or less with variable interest rates. At December 31, 2021, the unadvanced portion of working capital lines of credit totaled $17.9 million. Outstanding balances fluctuate up to the maximum commitment amount based on fluctuations in the balance of the underlying collateral. Personal property loans secured by equipment are considered commercial business loans and are generally made for terms of up to 84 months and for up to 80% of the value of the underlying collateral. Interest rates on equipment loans may be either fixed or variable. Commercial business loans are generally variable rate loans with initial fixed rate periods of up to five years. A commercial business borrower’s financial information is monitored on an ongoing basis by requiring periodic financial statement updates, usually quarterly, payment history reviews and periodic face-to-face meetings with the borrower. Excluding the PPP loan balance, the average outstanding commercial loan at December 31, 2021 was $248,000 and the largest outstanding balance on that date was $5.9 million. Origination and Servicing of Loans. All loans originated for investment are underwritten pursuant to internally developed policies and procedures. While we generally underwrite owner-occupied residential mortgage loans to Freddie Mac and Fannie Mae standards, due to several unique characteristics, our loans originated prior to 2008 do not conform to the secondary market standards. The unique features of these loans include interest payments in advance of the month in which they are earned and discretionary rate adjustments that are not tied to an independent index. Exclusive of our mortgage banking operations, we retain in our portfolio all of the loans that we originate. At December 31, 2021, WaterStone Bank was not servicing any loan it originated and subsequently sold to unrelated third parties. Loan servicing includes collecting and remitting loan payments, accounting for principal and interest, contacting delinquent mortgagors, supervising foreclosures and property dispositions in the event of unremedied defaults, making certain insurance and tax payments on behalf of the borrowers and generally administering the loans. - 8 - Loan Approval Procedures and Authority . WaterStone Bank’s lending activities follow written, non-discriminatory, underwriting standards and loan origination procedures established by WaterStone Bank’s board of directors. The loan approval process is intended to assess the borrower’s ability to repay the loan, the viability of the loan and the adequacy of the value of the property that will secure the loan, if applicable. To assess the borrower’s ability to repay, we review the employment and credit history and information on the historical and projected income and expenses of borrowers. Loan officers, with concurrence from independent credit officers and underwriters, are authorized to approve and close any loan that qualifies under WaterStone Bank underwriting guidelines within the following lending limits: ● Any secured mortgage loan up to $500,000 for a borrower with total outstanding loans from us of less than $1.0 million that is independently underwritten can be approved by the Chief Credit Officer or select lending personnel. ● Any secured mortgage loan up to $1.0 million can be approved jointly the Chief Executive Officer. ● Any secured mortgage loan ranging from $500,001 to $3.0 million or any new loan to a borrower with outstanding loans from us exceeding $1.0 million must be approved by the Officer Loan Committee. ● Any non-real estate loan up to $250,000 for a borrower with total outstanding loans from us of less than $250,000 that is independently underwritten can be approved by select lending personnel. ● Any non-real estate loan up to $500,000 for a borrower with total outstanding loans from us of less than $500,000 that is independently underwritten can be approved by the Chief Executive Officer or Business Banking Manager. ● Any non-real estate loan ranging from $500,001 to $3.0 million or any new non-real estate loan to a borrower with outstanding loans exceeding $500,000 must be approved by the Officer Loan Committee. ● Any new loan over $3.0 million must be approved by the Officer Loan Committee and the board of directors prior to closing. Any new loan to a borrower with outstanding loans from us exceeding $10.0 million must be reviewed by the board of directors. Asset Quality When a loan becomes more than 30 days delinquent, WaterStone Bank sends a letter advising the borrower of the delinquency. The borrower is given a specific date by which delinquent payments must be made or by which they must contact WaterStone Bank to make arrangements to bring the loan current over a longer period of time. If the borrower fails to bring the loan current within the specified time period or to make arrangements to cure the delinquency over a longer period of time, the matter is referred to legal counsel and foreclosure or other collection proceedings are considered. All loans are reviewed on a regular basis, and loans are placed on non-accrual status when they become 90 or more days delinquent. When loans are placed on non-accrual status, unpaid accrued interest is reversed, and further income is recognized only to the extent received when collection of the remaining principal balance is reasonably assured. Non-Performing Assets. Non-performing assets consist of non-accrual loans and other real estate owned. Loans are generally placed on non-accrual status when contractually past due 90 days or more as to interest or principal payments. Additionally, whenever management becomes aware of facts or circumstances that may adversely impact the collectability of principal or interest on loans, management may place such loans on non-accrual status immediately, rather than waiting until the loan becomes 90 days past due. At the time a loan is placed on non-accrual status, previously accrued and uncollected interest on such loans is reversed and additional income is recorded only to the extent that payments are received and the collection of principal is reasonably assured. Generally, loans are restored to accrual status when the obligation is brought current, has performed in accordance with the contractual terms for a reasonable period of time, and the ultimate collectability of the total contractual principal and interest is no longer in doubt. - 9 - The table below sets forth the amounts and categories of our non-accrual loans and real estate owned at the dates indicated. At December 31, 2021 2020 2019 2018 2017 (Dollars in Thousands) Non-accrual loans: Residential One- to four-family $ $5,420 $ $5,072 $ $5,985 $ $4,902 $ $4,677 Multi-family 128 341 667 1,309 1,007 Home equity 26 63 70 201 107 Construction and land - 43 - - - Commercial real estate - 41 303 125 251 Commercial - - - 18 26 Consumer - - - - - Total non-accrual loans 5,574 5,560 7,025 6,555 6,068 Real estate owned One- to four-family - - 46 163 1,330 Multi-family - - - - - Construction and land 148 322 1,256 3,327 4,582 Commercial real estate - - - 300 300 Total real estate owned 148 322 1,302 3,790 6,212 Valuation allowance at end of period - - (554 ) (1,638 ) (1,654 ) Total real estate owned, net 148 322 748 2,152 4,558 Total non-performing assets $ $5,722 $ $5,882 $ $7,773 $ $8,707 $ $10,626 Total non-accrual loans to total loans, net 0.46 % 0.40 % 0.51 % 0.48 % 0.47 % Total non-accrual loans to total assets 0.25 % 0.25 % 0.35 % 0.34 % 0.34 % Total non-performing assets to total assets 0.26 % 0.27 % 0.39 % 0.45 % 0.59 % All loans that meet or exceed 90 days with respect to past due principal and interest are recognized as non-accrual. Troubled debt restructurings which are still on non-accrual status either due to being past due 90 days or greater, 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 which 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 fiscal 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 between 60 and 90 days past contractual due dates. 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, generally coinciding with the initiation of foreclosure action, the specific reserve is reviewed for adequacy, adjusted if necessary, and charged-off. The following table sets forth activity in our non-accrual loans for the years indicated. At and for the Year Ended December 31, 2021 2020 2019 2018 2017 (Dollars in Thousands) Balance at beginning of year $ $5,560 $ $7,025 $ $6,555 $ $6,068 $ $9,857 Additions 3,374 3,356 3,716 3,147 3,149 Transfers to real estate owned - (637 ) (1,052 ) (545 ) (2,171 ) Charge-offs (12 ) (11 ) (31 ) (6 ) (766 ) Returned to accrual status (1,792 ) (2,501 ) (650 ) (777 ) (2,716 ) Principal paydowns (1,556 ) (1,672 ) (1,513 ) (1,332 ) (1,285 ) Balance at end of year $ $5,574 $ $5,560 $ $7,025 $ $6,555 $ $6,068 - 10 - Total non-accrual loans increased by $14,000 to $$5.6 million as of December 31, 2021 compared to December 31, 2020. The ratio of non-accrual loans to total loans receivable was 0.46% at December 31, 2021 compared to 0.40% at December 31, 2020. During the year ended December 31, 2021, no loans transferred to real estate owned, $$12,000 in loan principal was charged off, $$1.6 million in principal payments were received and $$1.8 million in loans were returned to accrual status. Offsetting this activity, $$3.4 million in loans were placed on non-accrual status during the year ended December 31, 2021. Of the $$5.6 million in total non-accrual loans as of December 31, 2021, $4.2 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 $30,000 in partial charge-offs have been recorded with respect to these loans as of December 31, 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 reserve as of December 31, 2021. The remaining $1.4 million of non-accrual loans were reviewed on an aggregate basis and $210,000 in general valuation allowance was deemed necessary related to those loans as of December 31, 2021. The $210,000 in general 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 December 31, 2021 totaled $3.5 million, which represents 62.7% of total non-accrual loans as of that date. These five loans did not have any charge-offs or require any specific valuation allowances as of December 31, 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. There were no accruing loans past due 90 days or more during the years ended December 31, 2021 or 2019. There was one accruing loan with a balance of $586,000 past due 90 days or more during the year ended December 31, 2020. The Company received full payment shortly after December 31, 2020. Troubled Debt Restructurings. The following table summarizes troubled debt restructurings by the Company’s internal risk rating. At December 31, 2021 2020 2019 2018 2017 (Dollars in Thousands) Troubled debt restructurings Substandard $ $3,989 $ $9,249 $ $4,018 $ $4,256 $ $5,035 Watch - 2,320 - 2,476 47 Total troubled debt restructurings $ $3,989 $ $11,569 $ $4,018 $ $6,732 $ $5,082 Troubled debt restructurings totaled $$4.0 million at December 31, 2021, compared to $$11.6 million at December 31, 2020. At December 31, 2021, all of the troubled debt restructurings were performing in accordance with their restructured terms. All troubled debt restructurings are considered to be impaired and are risk rated as either substandard or watch and are included in the internal risk rating tables disclosed in the notes to the consolidated financial statements. Specific reserves have been established to the extent that the collateral-based impairment analyses indicate that a collateral shortfall exists or to the extent that a discounted cash flow analysis results in an impairment. Under the Coronavirus Aid, Relief, and Economic Security ("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 ("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. The Company held approximately $3.3 million in loans, representing 0.3% of the total loan portfolio as of December 31, 2021, which had been modified as either a deferment of principal or principal and interest since the beginning of the pandemic. Of the $3.3 million in loans, $405,000 qualify as modifications under the CARES Act. The remaining $2.9 million is composed of three loan relationships that are classified as troubled debt restructurings. 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. - 11 - Information with respect to the accrual status of our troubled debt restructurings is provided in the following table. At December 31, 2021 2020 Accruing Non-accruing Accruing Non-accruing (In Thousands) One- to four-family $ $- $ $1,670 $ $2,733 $ $532 Commercial real estate 1,222 - 7,207 - Commercial 1,097 - 1,097 - $ $2,319 $ $1,670 $ $11,037 $ $532 The following table sets forth activity in our troubled debt restructurings for the years indicated. At or for the Year Ended December 31, 2021 2020 Accruing Non-accruing Accruing Non-accruing (In Thousands) Balance at beginning of year $ $11,037 $ $532 $ $3,018 $ $1,000 Additions - 1,299 8,032 - Change in accrual status - - - - Charge-offs - - - - Returned to contractual/market terms (5,985 ) (130 ) - (318 ) Transferred to real estate owned - - - - Principal paydowns (2,733 ) (31 ) (13 ) (150 ) Balance at end of period $ $2,319 $ $1,670 $ $11,037 $ $532 Interest payments received on non-accrual troubled debt restructurings 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. 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. The restructured loan will be classified as a troubled debt restructuring for at least the calendar year after the modification even after returning to a contractual/market rate and accrual status. Loan Delinquency. The following table summarizes loan delinquency in total dollars and as a percentage of the total loan portfolio: At December 31, 2021 2020 (Dollars in Thousands) Loans past due less than 90 days $ $2,694 $ $3,938 Loans past due 90 days or more 4,368 3,958 Total loans past due $ $7,062 $ $7,896 Total loans past due to total loans receivable 0.59 % 0.57 % Past due loans decreased by $834,000, or 10.6%, to $7.1 million at December 31, 2021 from $7.9 million at December 31, 2020. Loans past due less than 90 days decreased by $1.2 million during the year ended December 31, 2021. The decrease was primarily due to a $1.3 million decrease in one- to four-family loans during the year ended December 31, 2021. Loans past due 90 days or more increased $410,000. The increase in loans past due 90 days or more was primarily due to an increase in the one-to four-family loans of $684,000 during the year ended December 31, 2021. - 12 - Potential Problem Loans. We define potential problem loans as substandard loans which are still accruing interest. We do not necessarily expect to realize losses on potential problem loans, but we recognize potential problem loans carry a higher probability of default and require additional attention by management. The aggregate principal amounts of potential problem loans as of December 31, 2021 and 2020 were $7.9 million and $9.6 million, respectively. Management believes it has established an adequate allowance for probable loan losses as appropriate under generally accepted accounting principles. Real Estate Owned. Total real estate owned decreased by $174,000 to $148,000 at December 31, 2021, compared to $322,000 at December 31, 2020. During the year ended December 31, 2021, no loans were transferred from loans 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 year ended December 31, 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 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). We owned one property at December 31, 2021, compared to two properties as of December 31, 2020 and five properties at December 31, 2019. Habitable real estate owned is managed with the intent of attracting a lessee to generate revenue. Foreclosed properties are transferred to real estate owned at estimated net realizable value, with charge-offs, if any, charged to the allowance for loan losses upon transfer to real estate owned. The fair value is primarily based upon updated appraisals in addition to an analysis of current real estate market conditions. Allowance for Loan Losses We establish valuation allowances on loans that are deemed to be impaired. A loan is considered impaired when, based on current information and events, it is probable that we will not be able to collect all amounts due according to the contractual terms of the loan agreement. A valuation allowance is established for an amount equal to the impairment when the carrying amount of the loan exceeds the present value of the expected future cash flows, discounted at the loan’s original effective interest rate or the fair value of the underlying collateral. We also establish valuation allowances based on an evaluation of the various risk components that are inherent in the loan portfolio. The risk components that are evaluated include past loan loss experience; the level of non-performing and classified assets; current economic conditions; volume, growth, and composition of the loan portfolio; adverse situations that may affect the borrower’s ability to repay; the estimated value of any underlying collateral; regulatory guidance; and other relevant factors. The allowance is increased by provisions charged to earnings and recoveries of previously charged-off loans and reduced by charge-offs. The appropriateness of the allowance for loan losses is reviewed and approved quarterly by the WaterStone Bank board of directors. The allowance reflects management’s best estimate of the amount needed to provide for the probable loss on impaired loans and other inherent losses in the loan portfolio, and is based on a risk model developed and implemented by management and approved by the WaterStone Bank board of directors. Actual results could differ from this estimate, and future additions to the allowance may be necessary based on unforeseen changes in loan quality and economic conditions. In addition, the Federal Deposit Insurance Corporation and the WDFI, as an integral part of their examination process, periodically review WaterStone Bank’s allowance for loan losses. Such regulators have the authority to require WaterStone Bank to recognize additions to the allowance based on their judgments of information available to them at the time of their review or examination. Any loan that is 90 or more days past due is placed on non-accrual and classified as a non-performing loan. A loan is classified as impaired when it is probable that we will be unable to collect all amounts due in accordance with the terms of the loan agreement. Non-performing loans are then evaluated and accounted for in accordance with generally accepted accounting principles. - 13 - The following table sets forth activity in our allowance for loan losses for the years indicated. At or for the Year Ended December 31, 2021 2020 2019 2018 2017 (Dollars in Thousands) Balance at beginning of year $ $18,823 $ $12,387 $ $13,249 $ $14,077 $ $16,029 Provision (credit) for loan losses (3,990 ) 6,340 (900 ) (1,060 ) (1,166 ) Charge-offs: Mortgage loans One- to four-family 151 82 125 69 1,364 Multi-family - 5 3 14 92 Home equity - 13 44 1 - Construction and land 13 8 - - 14 Commercial real estate 10 - 2 - 7 Consumer 18 10 5 - - Commercial - - - - - Total charge-offs 192 118 179 84 1,477 Recoveries: Mortgage loans One- to four-family 949 148 135 159 293 Multi-family 116 21 30 89 208 Home equity 16 27 27 26 26 Construction and land 52 2 - 40 162 Commercial real estate 4 16 25 2 1 Consumer - - - - 1 Commercial - - - - - Total recoveries 1,137 214 217 316 691 Net (recoveries) charge-offs (945 ) (96 ) (38 ) (232 ) 786 Allowance at end of year $ $15,778 $ $18,823 $ $12,387 $ $13,249 $ $14,077 Ratios: Allowance for loan losses to non-accrual loans at end of year 283.06 % 338.54 % 176.33 % 202.12 % 231.99 % Allowance for loan losses to loans outstanding at end of year 1.31 % 1.37 % 0.89 % 0.96 % 1.09 % Net (recoveries) charge-offs to average loans: Mortgage One- to four-family (0.05 )% 0.00 % 0.00 % 0.00 % 0.06 % Multi family (0.01 )% 0.00 % 0.00 % 0.00 % (0.01 )% Home equity (0.03 )% (0.02 )% 0.02 % (0.03 )% (0.03 )% Construction and land (0.01 )% 0.00 % 0.00 % (0.06 )% (0.19 )% Commercial real estate 0.00 % 0.00 % 0.00 % 0.00 % 0.00 % Consumer 0.61 % 0.32 % 0.20 % 0.00 % (0.09 )% Commercial 0.00 % 0.00 % 0.00 % 0.00 % 0.00 % Net (recoveries) charge-offs to average loans outstanding (0.07 %) (0.01 %) 0.00 % (0.02 %) 0.06 % - 14 - Allocation of Allowance for Loan Losses. The following table sets forth the allowance for loan losses allocated by loan category, the total loan balances by category, and the percent of loans in each category to total loans at the dates indicated. The allowance for loan losses allocated to each category is not necessarily indicative of future losses in any particular category and does not restrict the use of the allowance to absorb losses in other categories. At December 31, 2021 2020 2019 Allowance for Loan Losses % of Loans in Category to Total Loans % of Allowance in Category to Total Allowance Allowance for Loan Losses % of Loans in Category to Total Loans % of Allowance in Category to Total Allowance Allowance for Loan Losses % of Loans in Category to Total Loans % of Allowance in Category to Total Allowance (Dollars in Thousands) Real Estate: Residential One- to four-family $ $3,963 24.92 % 25.12 % $ $5,459 31.04 % 29.00 % $ $4,907 34.60 % 39.62 % Multi-family 5,398 44.62 % 34.21 % 5,600 41.59 % 29.75 % 4,138 42.14 % 33.41 % Home equity 89 0.91 % 0.56 % 194 1.08 % 1.03 % 201 1.30 % 1.62 % Construction and land 1,386 6.85 % 8.78 % 1,755 5.61 % 9.32 % 610 2.67 % 4.92 % Commercial real estate 4,482 20.79 % 28.41 % 5,138 17.33 % 27.30 % 2,145 17.05 % 17.32 % Commercial 427 1.85 % 2.71 % 642 3.30 % 3.41 % 372 2.18 % 3.00 % Consumer 33 0.06 % 0.21 % 35 0.05 % 0.19 % 14 0.06 % 0.11 % Total allowance for loan losses $ $15,778 100.00 % 100.00 % $ $18,823 100.00 % 100.00 % $ $12,387 100.00 % 100.00 % At December 31, 2018 2017 Allowance for Loan Losses % of Loans in Category to Total Loans % of Allowance in Category to Total Allowance Allowance for Loan Losses % of Loans in Category to Total Loans % of Allowance in Category to Total Allowance (Dollars In Thousands) Real Estate: Residential One- to four-family $ $5,742 35.53 % 43.33 % $ $5,794 34.03 % 41.16 % Multi-family 4,153 43.29 % 31.35 % 4,431 44.77 % 31.48 % Home equity 325 1.45 % 2.45 % 356 1.64 % 2.53 % Construction and land 400 0.97 % 3.02 % 949 1.54 % 6.74 % Commercial real estate 2,126 16.35 % 16.05 % 1,881 15.16 % 13.36 % Commercial 483 2.38 % 3.65 % 656 2.84 % 4.66 % Consumer 20 0.03 % 0.15 % 10 0.02 % 0.07 % Total allowance for loan losses $ $13,249 100.00 % 100.00 % $ $14,077 100.00 % 100.00 % All impaired loans meeting the criteria established by management are evaluated individually, based primarily on the value of the collateral securing each loan and the ability of the borrowers to repay according to the terms of the loans, or based upon an analysis of the present value of the expected future cash flows under the original contract terms as compared to the modified terms in the case of certain troubled debt restructurings. Specific loss allowances are established as required by this analysis. At least once each quarter, management evaluates the appropriateness of the balance of the allowance for loan losses based on several factors, some of which are not loan specific, but are reflective of the inherent losses in the loan portfolio. This process includes, but is not limited to, a periodic review of loan collectability in light of historical experience, the nature and volume of loan activity, conditions that may affect the ability of the borrower to repay, underlying value of collateral and economic conditions in our immediate market area. All loans for which a specific loss review is not required are segregated by loan type and a loss allowance is established by using loss experience data and management’s judgment concerning other matters it considers significant including trends in non-performing loan balances, impaired loan balances, classified asset balances and the current economic environment. The allowance is allocated to each category of loans based on the results of the above analysis. 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. - 15 - 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. At December 31, 2021, the allowance for loan losses was $$15.8 million, compared to $$18.8 million at December 31, 2020. As of December 31, 2021, the allowance for loan losses to total loans receivable was 1.31% and 283.06% of non-performing loans, compared to 1.37%, and 338.54%, respectively at December 31, 2020. The decrease in the allowance for loan losses during the year ended December 31, 2021 reflects an improvement in certain economic factors, decreasing the required allowance related to the loans collectively reviewed. The overall decrease was related to each of the one- to four-family, multi family, home equity, construction and land, commercial real estate, consumer, and commercial categories. See Note 3 of the notes to the consolidated financial statements for further discussion on the allowance for loan losses. Net recoveries totaled $945,000, or 0.07% of average loans for the year ended December 31, 2021, compared to net recoveries $96,000, or 0.01% of average loans for the year ended December 31, 2020. The $849,000 increase in net recoveries was primarily the result of an increase in net recoveries in the one- to four-family and multi family categories. Net recoveries related to loans secured by one- to four-family residential loans increased $732,000, to $798,000 in net recoveries for year ended December 31, 2021, as compared to net recoveries of $66,000 for the year ended December 31, 2020. Net recoveries related to loans secured by multi family loans increased $100,000, to net recoveries of $116,000 for year ended December 31, 2021, as compared to net recoveries of $16,000 for the year ended December 31, 2020. Mortgage Banking Activity In addition to the lending activities previously discussed, we also originate single-family residential mortgage loans for sale in the secondary market through Waterstone Mortgage Corporation. Waterstone Mortgage Corporation originated, including loans sold to WaterStone Bank, $4.23 billion in mortgage loans held for sale during the year ended December 31, 2021, which was a volume decrease of $201.7 million, or 4.6%, from the $4.43 billion originated during the year ended December 31, 2020. The decrease in loan production volume was driven by a $433.6 million, or 25.2%, decrease in refinance products as mortgage rates increased from the prior year. Mortgage purchase products increased $231.9 million, or 8.6%, due to an increased housing demand. Total mortgage banking income decreased $39.1 million, or 16.5%, to $197.6 million during the year ended December 31, 2021 compared to $236.7 million during the year ended December 31, 2020. The decrease in mortgage banking noninterest income was related to a 4.6% decrease in volume and an 11.6% decrease in gross margin on loans originated and sold for the year ended December 31, 2021 compared to December 31, 2020. Gross margin on those 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. 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. Our gross 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 69.5% of total originations during the year ended December 31, 2021, compared to 61.1% of total originations during the year ended December 31, 2020. The mix of loan type trended towards more conventional loans and less governmental loans comprising 76.6% and 23.6% of all loan originations, respectively, during the year ended December 31, 2021, compared to 75.8% and 24.2% of all loan originations, respectively, during the year ended December 31, 2020. Investment Activities Wauwatosa Investments, Inc. is WaterStone Bank’s investment subsidiary headquartered in the State of Nevada. Wauwatosa Investments, Inc. manages the back office function for WaterStone Bank’s investment portfolio. Our Chief Financial Officer and Treasury Officer are responsible for executing purchases and sales in accordance with our investment policy and monitoring the investment activities of Wauwatosa Investments, Inc. The investment policy is reviewed annually by management and changes to the policy are recommended to and subject to the approval of WaterStone Bank's board of directors. Authority to make investments under the approved investment policy guidelines is delegated by the board to designated employees. While general investment strategies are developed and authorized by management, the execution of specific actions rests with the Chief Financial Officer and Treasury Officer who may act jointly in performing security trades. The Chief Financial Officer and Treasury Officer are responsible for ensuring that the guidelines and requirements included in the investment policy are followed and that all securities are considered prudent for investment. The Chief Financial Officer and the Treasury Officer are authorized to execute investment transactions (purchases and sales) without the prior approval of the board provided they are within the scope of the established investment policy. Our investment policy requires that all securities transactions be conducted in a safe and sound manner. Investment decisions are based upon a thorough analysis of each security instrument to determine its quality, inherent risks, fit within our overall asset/liability management objectives, effect on our risk-based capital measurement and prospects for yield and/or appreciation. Consistent with our overall business and asset/liability management strategy, which focuses on sustaining adequate levels of core earnings, our investment portfolio is comprised primarily of securities that are classified as available for sale. During the years ended December 31, 2021, 2020, and 2019, no investment securities were sold. - 16 - Available for Sale Portfolio Mortgage-backed Securities and Collateralized Mortgage Obligations. We purchase mortgage-backed securities and collateralized mortgage obligations guaranteed by Fannie Mae, Freddie Mac and Ginnie Mae. We invest in mortgage-backed securities, collateralized mortgage obligations, and private-label mortgage-backed securities to achieve positive interest rate spreads with minimal administrative expense, and to lower our credit risk. We regularly monitor the credit quality of this portfolio. Mortgage-backed securities, collateralized mortgage obligations, and private-label mortgage-backed securities are created by the pooling of mortgages and the issuance of a security. These securities typically represent a participation interest in a pool of single-family or multi-family mortgages, although we focus our investments on mortgage related securities backed by one- to four-family mortgages. The issuers of such securities pool and resell the participation interests in the form of securities to investors such as WaterStone Bank, and in the case of government agency sponsored issues, guarantee the payment of principal and interest to investors. Mortgage-backed securities, collateralized mortgage obligations, and private-label mortgage-backed securities generally yield less than the loans that underlie such securities because of the cost of payment guarantees, if any, and credit enhancements. These fixed-rate securities are usually more liquid than individual mortgage loans. At December 31, 2021, mortgage-backed securities totaled $19.5 million. The mortgage-backed securities portfolio had a weighted average yield of 2.34% and a weighted average remaining life of 6.3 years at December 31, 2021. The estimated fair value of our mortgage-backed securities portfolio at December 31, 2021 was $355,000 greater than the amortized cost of $19.1 million. Mortgage-backed securities valued at $430,000 were pledged as collateral for mortgage banking activities as of December 31, 2021. Investments in mortgage-backed securities involve a risk that actual prepayments may differ from estimated prepayments over the life of the security, which may require adjustments to the amortization of any premium or accretion of any discount relating to such instruments, thereby changing the net yield on such securities. There is also reinvestment risk associated with the cash flows from such securities or if such securities are redeemed by the issuer. In addition, the fair value of such securities may be adversely affected in a rising interest rate environment, particularly since all of our mortgage-backed securities have a fixed rate of interest. The relatively short weighted average remaining life of our mortgage-backed security portfolio mitigates our potential risk of loss in a rising interest rate environment. At December 31, 2021, collateralized mortgage obligations totaled $99.3 million. At December 31, 2021, the collateralized mortgage obligations portfolio consisted entirely of securities backed by government sponsored enterprises or U.S. Government agencies. The collateralized mortgage obligations portfolio had a weighted average yield of 1.54% and a weighted average remaining life of 3.5 years at December 31, 2021. The estimated fair value of our collateralized mortgage obligations portfolio at December 31, 2021 was $1.2 million less than the amortized cost of $100.5 million. Investments in collateralized mortgage obligations involve a risk that actual prepayments may differ from estimated prepayments over the life of the security, which may require adjustments to the amortization of any premium or accretion of any discount relating to such instruments, thereby changing the net yield on such securities. There is also reinvestment risk associated with the cash flows from such securities or if such securities are redeemed by the issuer. In addition, the fair value of such securities may be adversely affected in a rising interest rate environment, particularly since all of our collateralized mortgage obligations have a fixed rate of interest. The relatively short weighted average remaining life of our collateralized mortgage obligation portfolio mitigates our potential risk of loss in a rising interest rate environment. Private-Label Mortgage-backed Securities. At December 31, 2021, private-label mortgage-backed securities totaled $2.9 million. These securities had a weighted average yield of 2.80% and a weighted average remaining life of 0.8 years at December 31, 2021. The estimated fair value of our private-label mortgage-backed securities portfolio at December 31, 2021 was $30,000 greater than the amortized cost of $2.9 million. Investments in mortgage-backed securities involve a risk that actual prepayments may differ from estimated prepayments over the life of the security, which may require adjustments to the amortization of any premium or accretion of any discount relating to such instruments, thereby changing the net yield on such securities. There is also reinvestment risk associated with the cash flows from such securities or if such securities are redeemed by the issuer. In addition, the fair value of such securities may be adversely affected in a rising interest rate environment, particularly since all of our mortgage-backed securities have a fixed rate of interest. The relatively short weighted average remaining life of our mortgage-backed security portfolio mitigates our potential risk of loss in a rising interest rate environment. Government Sponsored Enterprise Bonds. At December 31, 2021, our Government sponsored enterprise bond portfolio totaled $2.4 million, all of which were issued by Federal National Mortgage Association ("Fannie Mae") and were classified as available for sale. The weighted average yield on these securities was 0.60% and the weighted average remaining average life was 3.7 years at December 31, 2021. While these securities generally provide lower yields than other investments in our securities investment portfolio, we maintain these investments, to the extent appropriate, for liquidity purposes and prepayment protection. The estimated fair value of our government sponsored enterprise bond portfolio at December 31, 2021 was $52,000 less than the amortized cost of $2.5 million. Municipal Obligations. These securities consist of obligations issued by school districts, counties and municipalities or their agencies and include general obligation bonds, industrial development revenue bonds and other revenue bonds. Our investment policy requires that such municipal obligations be rated A+ or better by a nationally recognized rating agency at the date of purchase. A security that is downgraded below investment grade will require additional analysis of creditworthiness and a determination will be made to hold or dispose of the investment. We regularly monitor the credit quality of this portfolio. At December 31, 2021, our municipal obligations portfolio totaled $43.5 million, all of which was classified as available for sale. The weighted average yield on this portfolio was 3.26% at December 31, 2021, with a weighted average remaining life of 3.3 years. The estimated fair value of our municipal obligations bond portfolio at December 31, 2021 was $1.2 million greater than the amortized cost of $42.3 million. As of December 31, 2021, the Company identified one municipal security that was deemed to be other-than-temporarily impaired. The security was issued by a tax incremental district in a municipality located in Wisconsin. During the year ended December 31, 2012, the Company received audited financial statements with respect to the municipal issuer that called into question the ability of the underlying taxing district that issued the securities to operate as a going concern. During the year ended December 31, 2012, the Company’s analysis of the security in this municipality resulted in $77,000 in credit losses that were charged to earnings with respect to this municipal security. An additional $17,000 credit loss was charged to earnings during the year ended December 31, 2014 with respect to this security as a sale occurred at a discounted price. As of December 31, 2021, the remaining impaired bond had an amortized cost of $116,000 and a total life-to-date impairment of $94,000. - 17 - Other Debt Securities. As of December 31, 2021, we held other debt securities with a fair value of $11.3 million and amortized cost of $12.5 million. Other debt securities consists of two corporate bonds. The weighted average yield on this portfolio was 1.77% at December 31, 2021, with a weighted average remaining life of 8.3 years. We regularly monitor the credit quality of this portfolio. The unrealized losses for the other debt securities is due to the current slope of the yield curve. One security earns a floating rate that is indexed to the 10 year Treasury interest rate which has decreased over the past few years. Portfolio Maturities and Yields. The composition and maturities of the securities portfolio at December 31, 2021 are summarized in the following table. Maturities are based on the final contractual payment dates and do not reflect the impact of prepayments or early redemptions that may occur. Municipal obligation yields have not been adjusted to a tax-equivalent basis. Certain mortgage related securities have interest rates that are adjustable and will reprice annually within the various maturity ranges. These repricing schedules are not reflected in the table below. One Year or Less More than One Year through Five Years More than Five Years through Ten Years More than Ten Years Total Securities Weighted Weighted Weighted Weighted Weighted Amortized Average Amortized Average Amortized Average Amortized Average Amortized Average Cost Yield Cost Yield Cost Yield Cost Yield Cost Yield (Dollars in Thousands) Securities available for sale: Mortgage-backed securities $ $1,787 2.36 % $ $11,116 2.33 % $ $303 4.43 % $ $5,927 2.25 % $ $19,133 2.34 % Collateralized mortgage obligations Government sponsored enterprise issued 806 2.73 % 95,176 1.54 % 4,561 1.32 % - 0.00 % 100,543 1.54 % Private-label issued - 0.00 % 2,913 2.80 % - 0.00 % - 0.00 % 2,913 2.80 % Government sponsored enterprise bonds - 0.00 % 2,500 0.60 % - 0.00 % - 0.00 % 2,500 0.60 % Municipal obligations 10,515 3.06 % 24,960 3.47 % 1,710 4.08 % 5,110 2.39 % 42,295 3.26 % Other debt securities - 0.00 % - 0.00 % 12,500 1.77 % - 0.00 % 12,500 1.77 % Total securities available for sale $ $13,108 2.94 % $ $136,665 1.96 % $ $19,074 1.91 % $ $11,037 2.32 % $ $179,884 2.02 % Sources of Funds General. Deposits have traditionally been our primary source of funds for use in lending and investment activities. We also rely on advances from the Federal Home Loan Bank of Chicago and borrowings from other commercial banks in the form of repurchase agreements collateralized by investment securities. In addition to deposits and borrowings, we derive funds from scheduled loan payments, investment maturities, loan prepayments, retained earnings and income on earning assets. While scheduled loan payments and income on earning assets are relatively stable sources of funds, deposit inflows and outflows can vary widely and are influenced by prevailing market interest rates, economic conditions and competition from other financial institutions. Deposits. A majority of our depositors are persons or businesses who work, reside, or are located in Milwaukee and Waukesha Counties and, to a lesser extent, other southeastern Wisconsin communities. We offer a selection of deposit instruments, including checking, savings, money market deposit accounts, and fixed-term certificates of deposit. Deposit account terms vary, with the principal differences being the minimum balance required, the amount of time the funds must remain on deposit and the interest rate. As of December 31, 2021, certificates of deposit comprised 50.8% of total customer deposits, and had a weighted average cost of 0.51% on that date. Our reliance on certificates of deposit has resulted in a higher cost of funds than would otherwise be the case if demand deposits, savings and money market accounts made up a larger part of our deposit base. Development of our branch network and expansion of our commercial products and services and aggressively seeking lower cost savings, checking and money market accounts are expected to result in decreased reliance on higher-cost certificates of deposit. Interest rates paid, maturity terms, service fees and withdrawal penalties are established on a periodic basis. Deposit rates and terms are based primarily on current operating strategies and market rates, liquidity requirements, rates paid by competitors and growth goals. To attract and retain deposits, we rely upon personalized customer service, long-standing relationships and competitive interest rates. We also provide remote deposit capture, internet banking and mobile banking. The flow of deposits is influenced significantly by general economic conditions, changes in money market and other prevailing interest rates and competition. The variety of deposit accounts that we offer allows us to be competitive in obtaining funds and responding to changes in consumer demand. Based on historical experience, management believes our deposits are relatively stable. The ability to attract and maintain money market accounts and certificates of deposit, and the rates paid on these deposits, has been and will continue to be significantly affected by market conditions. At December 31, 2021 and December 31, 2020, $626.7 million and $701.3 million of our deposit accounts were certificates of deposit, of which $533.0 million and $576.9 million, respectively, had remaining maturities of one year or less. Deposits increased by $48.5 million, or 4.1%, from December 31, 2020 to December 31, 2021. The increase in deposits was the result of a $123.2 million, or 25.5%, increase in total transaction accounts offset by a $74.7 million, or 10.6% decrease in time deposits. The Company had no deposits obtained directly from brokers as of December 31, 2021 and December 31, 2020. - 18 - The following table sets forth the distribution of total deposit accounts, by account type, at the dates indicated. At or For the Year Ended December 31, 2021 2020 2019 Average Ending Weighted Average Ending Weighted Average Ending Weighted Average Cost of Average Average Cost of Average Average Cost of Average Balance Funds Yield Balance Funds Yield Balance Funds Yield (Dollars in Thousands) Deposit type: Demand deposits $ $146,767 0.00 % 0.00 % $ $116,771 0.00 % 0.00 % $ $90,497 0.00 % 0.00 % NOW accounts 64,653 0.08 % 0.08 % 47,410 0.08 % 0.07 % 36,926 0.09 % 0.07 % Savings and escrow 69,988 0.04 % 0.03 % 75,643 0.04 % 0.03 % 72,872 0.05 % 0.04 % Money market 293,942 0.30 % 0.27 % 189,079 0.64 % 0.59 % 125,155 0.97 % 1.05 % Total transaction accounts 575,350 0.17 % 0.15 % 428,903 0.30 % 0.29 % 325,450 0.39 % 0.47 % Certificates of deposit 675,495 0.51 % 0.38 % 733,033 1.71 % 0.86 % 737,397 2.17 % 2.18 % Total deposits $ $1,250,845 0.35 % 0.27 % $ $1,161,936 1.19 % 0.63 % $ $1,062,847 1.62 % 1.65 % At December 31, 2021 and 2020, the aggregate balance of uninsured deposits of $250,000 or more was $263.3 million and $260.0 million, respectively. The Company does not have uninsured deposits less than $250,000 in aggregate balance. The following table sets forth the maturity of uninsured certificates of deposits at December 31, 2021 and 2020. At December 31, 2021 2020 (In Thousands) Due in: Three months or less $ $29,554 $ $22,036 Over three months through six months 25,018 28,802 Over six months through 12 months 31,572 32,571 Over 12 months 16,419 19,207 Total $ $102,563 $ $ 102,616 Borrowings. Our borrowings at December 31, 2021 consisted of $475.0 million in advances from the Federal Home Loan Bank of Chicago and $2.1 million outstanding balance in short-term repurchase agreements used to fund loans held for sale. The following table sets forth information concerning balances and interest rates on borrowings at the dates and for the periods indicated. At or For the Year Ended December 31, 2021 2020 2019 Borrowings: (Dollars in Thousands) Balance outstanding at end of year $ $477,127 $ $508,074 $ $483,562 Weighted average interest rate at the end of year 2.02 % 1.95 % 2.11 % Average balance outstanding during the year $ $479,262 $ $545,741 $ $484,801 Weighted average interest rate during the year 2.08 % 1.95 % 2.12 % - 19 - Human Capital As of December 31, 2021, we had 870 full-time equivalent employees. A total of 184 are WaterStone Bank employees and 686 are employees of Waterstone Mortgage Corporation. We believe we are able to attract and retain top talent by creating a culture that challenges and engages our employees, offering them opportunities to learn, grow and achieve their career goals. Further, our commitment to a culture of inclusion is integral to our goal of attracting and retaining the best talent and ultimately driving our business performance. Our Diversity and Inclusion strategy includes regular training and development for all employees and partnerships with non-profit organizations that share in our inclusion mission. Our employees participate in a wide array of volunteer activities and we support their charitable giving by matching employee contributions to qualified nonprofit organizations. We offer comprehensive compensation and benefits packages to our employees including a 401k Plan, Employee Stock Ownership Plan, healthcare and insurance benefits, health savings and flexible spending accounts, paid time off and certain family assistance programs, including paid family leave, flexible work arrangements, amongst others. We also offer stock-based compensation to certain management personnel as a way to attract and retain key talent. See Note 10 - Stock Based Compensation, Note 11 - Employee Benefit Plans, and Note 12 - Employee Stock Ownership Plan to the Consolidated Financial Statements included under Item 8 for further discussion of our stock-based compensation and benefit plans. We are committed and focused on the health and safety of our team members, customers, and communities. In response to the COVID-19 pandemic in March 2020, we pivoted to a remote working environment for those employees that could perform their job remotely as part of our commitment to the safety of our employees and the communities we serve. The COVID-19 pandemic has presented challenges to maintain team member and client safety while continuing to be open for business. Accordingly, we launched a proactive response to the COVID-19 pandemic that included the creation of an internal coronavirus resource page to manage our pandemic response, including providing access to recent safety standards from the Centers for Disease Control and Prevention, the World Health Organization, and other agencies; as well as our workplace guidelines for non-customer and customer environments. In addition, current information is shared through regular emails and other digital communications with our team members. Additional actions included adjusting our lobby usage and encouraging team members to work remotely where possible during the pandemic. Our banking centers are open for business and we continue to lend to qualified businesses for working capital and general business purposes. Supervision and Regulation General WaterStone Bank is a stock savings bank organized under the laws of the State of Wisconsin. The lending, investment, and other business operations of WaterStone Bank are governed by Wisconsin law and regulations, as well as applicable federal law and regulations, and WaterStone Bank is prohibited from engaging in any operations not authorized by such laws and regulations. WaterStone Bank is subject to extensive regulation, supervision and examination by the WDFI and by the Federal Deposit Insurance Corporation. This regulation and supervision establishes a comprehensive framework of activities in which an institution may engage and is intended primarily for the protection of the Federal Deposit Insurance Corporation’s Deposit Insurance Fund and depositors, and not for the protection of security holders. WaterStone Bank also is regulated to a lesser extent by the Federal Reserve Board, governing reserves to be maintained against deposits and other matters. WaterStone Bank also is a member of and owns stock in the Federal Home Loan Bank of Chicago, which is one of the 11 regional banks in the Federal Home Loan Bank System. Under this system of regulation, the regulatory authorities have extensive discretion in connection with their supervisory, enforcement, rulemaking and examination activities and policies, including rules or policies that: establish minimum capital levels; restrict the timing and amount of dividend payments; govern the classification of assets; determine the adequacy of loan loss reserves for regulatory purposes; and establish the timing and amounts of assessments and fees. Moreover, as part of their examination authority, the banking regulators assign numerical ratings to banks and savings institutions relating to capital, asset quality, management, liquidity, earnings and other factors. These ratings are inherently subjective and the receipt of a less than satisfactory rating in one or more categories may result in enforcement action by the banking regulators against a financial institution. A less than satisfactory rating may also prevent a financial institution, such as WaterStone Bank or its holding company, from obtaining necessary regulatory approvals to pay dividends, repurchase shares of common stock, acquire other financial institutions or establish new branches. In addition, we must comply with significant anti-money laundering and anti-terrorism laws and regulations, Community Reinvestment Act laws and regulations, and fair lending laws and regulations. Government agencies have the authority to impose monetary penalties and other sanctions on institutions that fail to comply with these laws and regulations, which could significantly affect our business activities, including our ability to acquire other financial institutions or expand our branch network. As a savings and loan holding company, Waterstone Financial is required to comply with the rules and regulations of the Federal Reserve Board. It is required to file certain reports with the Federal Reserve Board and is subject to examination by and the enforcement authority of the Federal Reserve Board. Waterstone Financial is also subject to the rules and regulations of the Securities and Exchange Commission under the federal securities laws. Any change in applicable laws or regulations, whether by the WDFI, the Federal Deposit Insurance Corporation, the Federal Reserve Board or Congress, could have a material adverse impact on the operations and financial performance of Waterstone Financial, WaterStone Bank and Waterstone Mortgage Corporation. Set forth below is a brief description of material regulatory requirements that are or will be applicable to WaterStone Bank, Waterstone Mortgage Corporation and Waterstone Financial. The description is limited to certain material aspects of the statutes and regulations addressed, and is not intended to be a complete description of such statutes and regulations and their effects on WaterStone Bank, Waterstone Mortgage Corporation and Waterstone Financial. - 20 - Intrastate and Interstate Merger and Branching Activities Wisconsin Law and Regulation. Any Wisconsin savings bank meeting certain requirements may, upon approval of the WDFI, establish one or more branch offices in the state of Wisconsin and the states of Illinois, Indiana, Iowa, Kentucky, Michigan, Minnesota, Missouri, and Ohio. In addition, upon WDFI approval, a Wisconsin savings bank may establish a branch office in any other state as the result of a merger or consolidation. Federal Law and Regulation . Federal law permits the federal banking agencies to, under certain circumstances, approve acquisition transactions between banks located in different states, regardless of whether an acquisition would be prohibited under state law. Federal law also authorizes de novo branching into another state at locations at which banks chartered by the host state could establish a branch. Loans and Investments Wisconsin Law and Regulations. Under Wisconsin law and regulation, WaterStone Bank is authorized to make, invest in, sell, purchase, participate or otherwise deal in mortgage loans or interests in mortgage loans without geographic restriction, including loans made on the security of residential and commercial property. Wisconsin savings banks also may lend funds on a secured or unsecured basis for business, commercial or agricultural purposes, provided the total of all such loans does not exceed 20% of the savings bank’s total assets, unless the WDFI authorizes a greater amount. Loans are subject to certain other limitations, including percentage restrictions based on total assets. Wisconsin savings banks may invest funds in certain types of debt and equity securities, including obligations of federal, state and local governments and agencies. Subject to prior approval of the WDFI, compliance with capital requirements and certain other restrictions, Wisconsin savings banks may invest in residential housing development projects. Wisconsin savings banks may also invest in service corporations or subsidiaries with the prior approval of the WDFI, subject to certain restrictions. Similarly, the line of credit that WaterStone Bank provides to Waterstone Mortgage Corporation is subject to the approval of the WDFI. Wisconsin savings banks may make loans and extensions of credit, both direct and indirect, to one borrower in amounts up to 20% of the savings bank’s capital plus an additional 5% for loans fully secured by readily marketable collateral. In addition, and notwithstanding the 20% of capital and additional 5% of capital limitations set forth above, Wisconsin savings banks may make loans to one borrower, or a related group of borrowers, for any purpose in an amount not to exceed $500,000, or to develop domestic residential housing units in an amount not to exceed the lesser of $30 million or 30% of the savings bank’s capital, subject to certain conditions. At December 31, 2021, WaterStone Bank did not have any loans which exceeded the “loans-to-one borrower” limitations. In addition, under Wisconsin law, WaterStone Bank must qualify for and maintain a level of qualified thrift investments equal to 60% of its assets as prescribed in Section 7701(a)(19) of the Internal Revenue Code of 1986, as amended. A Wisconsin savings bank that fails to meet this qualified thrift lender test becomes subject to certain operating restrictions otherwise applicable only to commercial banks. At December 31, 2021, WaterStone Bank maintained 88.2% of its assets in qualified thrift investments and therefore met the qualified thrift lender requirement. Federal Law and Regulation . Federal Deposit Insurance Corporation regulations also govern the equity investments of WaterStone Bank and, notwithstanding Wisconsin law and regulations, Federal Deposit Insurance Corporation regulations prohibit WaterStone Bank from making certain equity investments and generally limit WaterStone Bank’s equity investments to those that are permissible for national banks and their subsidiaries. Under Federal Deposit Insurance Corporation regulations, WaterStone Bank must obtain prior Federal Deposit Insurance Corporation approval before directly, or indirectly through a majority-owned subsidiary, engaging “as principal” in any activity that is not permissible for a national bank unless certain exceptions apply. The activity regulations provide that state banks that meet applicable minimum capital requirements would be permitted to engage in certain activities that are not permissible for national banks, including certain real estate and securities activities conducted through subsidiaries. The Federal Deposit Insurance Corporation will not approve an activity that it determines presents a significant risk to the Federal Deposit Insurance Corporation insurance fund. The current activities of WaterStone Bank and its subsidiaries are permissible under applicable federal regulations. Loans to, and other transactions with, affiliates of WaterStone Bank, such as Waterstone Financial, are restricted by the Federal Reserve Act and regulations issued by the Federal Reserve Board thereunder. See “Transactions with Affiliates and Insiders” below. Lending Standards Wisconsin Law and Regulation. Under Wisconsin law, WaterStone Bank is permitted to establish deposit accounts and accept deposits. WaterStone Bank’s board of directors, or its designee, determine the rate and amount of interest to be paid on or credited to deposit accounts. Federal Law and Regulation . The federal banking agencies have adopted uniform regulations prescribing standards for extensions of credit that are secured by liens on interests in real estate or made for the purpose of financing the construction of a building or other improvements to real estate. Under the joint regulations adopted by the federal banking agencies, all insured depository institutions, such as WaterStone Bank, must adopt and maintain written policies that establish appropriate limits and standards for extensions of credit that are secured by liens or interests in real estate or are made for the purpose of financing permanent improvements to real estate. These policies must establish loan portfolio diversification standards, prudent underwriting standards (including loan-to-value limits) that are clear and measurable, loan administration procedures, and loan documentation, approval and reporting requirements. The real estate lending policies must reflect consideration of the Interagency Guidelines for Real Estate Lending Policies that have been adopted by the federal bank regulators. - 21 - The Interagency Guidelines, among other things, require a depository institution to establish internal loan-to-value limits for real estate loans that are not in excess of the following supervisory limits: ● for loans secured by raw land, the supervisory loan-to-value limit is 65% of the value of the collateral; ● for land development loans (i.e., loans for the purpose of improving unimproved property prior to the erection of structures), the supervisory limit is 75%; ● for loans for the construction of commercial, over four-family or other non-residential property, the supervisory limit is 80%; ● for loans for the construction of one- to four-family properties, the supervisory limit is 85%; and ● for loans secured by other improved property (e.g., farmland, completed commercial property and other income-producing property, including non-owner occupied, one- to four-family property), the limit is 85%. Although no supervisory loan-to-value limit has been established for permanent mortgages on owner-occupied, one- to four-family and home equity loans, the Interagency Guidelines state that for any such loan with a loan-to-value ratio that equals or exceeds 90% at origination, an institution should require appropriate credit enhancement in the form of either mortgage insurance or readily marketable collateral. Deposits Wisconsin Law and Regulation. Under Wisconsin law, WaterStone Bank is permitted to establish deposit accounts and accept deposits. WaterStone Bank’s board of directors, or its designee, determines the rate and amount of interest to be paid on or credited to deposit accounts subject to Federal Deposit Insurance Corporation limitations. Deposit Insurance Wisconsin Law and Regulation. Under Wisconsin law, WaterStone Bank is required to obtain and maintain insurance on its deposits from a deposit insurance corporation. The deposits of WaterStone Bank are insured up to the applicable limits by the Federal Deposit Insurance Corporation. Federal Law and Regulation. WaterStone Bank is a member of the Deposit Insurance Fund, which is administered by the Federal Deposit Insurance Corporation. The Bank’s deposit accounts are insured by the Federal Deposit Insurance Corporation, generally up to a maximum of $250,000. The Federal Deposit Insurance Corporation imposes an assessment against all insured depository institutions. An institution’s assessment rate depends upon the perceived risk of the institution to the Deposit Insurance Fund, with less risky institutions paying lower rates. Currently, assessments for institutions of less than $10 billion of total assets are based on financial measures and supervisory ratings derived from statistical models estimating the probability of failure within three years. Assessment rates (inclusive of possible adjustments) currently range from 1.5 to 30 basis points of each institution’s total assets less tangible capital. The Federal Deposit Insurance Corporation may increase or decrease the range of assessments uniformly, except that no adjustment can deviate more than two basis points from the base assessment rate without notice and comment rulemaking. The Federal Deposit Insurance Corporation has the authority to increase insurance assessments. A significant increase in insurance premiums would have an adverse effect on the operating expenses and results of operations of WaterStone Bank. We cannot predict what deposit insurance assessment rates will be in the future. Insurance of deposits may be terminated by the Federal Deposit Insurance Corporation upon a finding that an institution has engaged in unsafe or unsound practices, is in an unsafe or unsound condition to continue operations or has violated any applicable law, regulation, rule, order or condition imposed by the Federal Deposit Insurance Corporation. We do not know of any practice, condition or violation that might lead to termination of deposit insurance. - 22 - Capitalization Wisconsin Law and Regulation . Wisconsin savings banks are required to maintain a minimum capital to total assets ratio of 6% and must maintain total capital necessary to ensure the continuation of insurance of deposit accounts by the Federal Deposit Insurance Corporation. If the WDFI determines that the financial condition, history, management or earning prospects of a savings bank are not adequate, the WDFI may require a higher minimum capital level for the savings bank. If a Wisconsin savings bank’s capital ratio falls below the required level, the WDFI may direct the savings bank to adhere to a specific written plan established by the WDFI to correct the savings bank’s capital deficiency, as well as a number of other restrictions on the savings bank’s operations, including a prohibition on the payment of dividends. At December 31, 2021, WaterStone Bank’s capital to assets ratio, as calculated under Wisconsin law, was 17.08%. Federal Law and Regulation . Federal regulations require Federal Deposit Insurance Corporation insured depository institutions to meet several minimum capital standards: a common equity Tier 1 capital to risk-based assets ratio of 4.5%, a Tier 1 capital to risk-based assets ratio of 6.0%, a total capital to risk-based assets of 8.0%, and a 4.0% Tier 1 capital to total assets leverage ratio. Common equity Tier 1 capital is generally defined as common stockholders’ equity and retained earnings. Tier 1 capital is generally defined as common equity Tier 1 and additional Tier 1 capital. Additional Tier 1 capital includes certain noncumulative perpetual preferred stock and related surplus and minority interests in equity accounts of consolidated subsidiaries. Total capital includes Tier 1 capital (common equity Tier 1 capital plus additional Tier 1 capital) and Tier 2 capital. Tier 2 capital is comprised of capital instruments and related surplus, meeting specified requirements, and may include cumulative preferred stock and long-term perpetual preferred stock, mandatory convertible securities, intermediate preferred stock and subordinated debt. Also included in Tier 2 capital is the allowance for loan and lease losses limited to a maximum of 1.25% of risk-weighted assets and, for institutions that have exercised an opt-out election regarding the treatment of Accumulated Other Comprehensive Income (“AOCI”), up to 45% of net unrealized gains on available-for-sale equity securities with readily determinable fair market values. Institutions that have not exercised the AOCI opt-out have AOCI incorporated into common equity Tier 1 capital (including unrealized gains and losses on available-for-sale-securities). WaterStone Bank exercised its AOCI opt-out election. Calculation of all types of regulatory capital is subject to deductions and adjustments specified in the regulations. In addition to establishing the minimum regulatory capital requirements, the regulations limit capital distributions and certain discretionary bonus payments to management if the institution does not hold a “capital conservation buffer” consisting of 2.5% of common equity Tier 1 capital to risk-weighted asset above the amount necessary to meet its minimum risk-based capital requirements. In assessing an institution’s capital adequacy, the Federal Deposit Insurance Corporation takes into consideration, not only these numeric factors, but qualitative factors as well, including the bank’s exposure to interest rate risk. The Federal Deposit Insurance Corporation has the authority to establish higher capital requirements for individual institutions where deemed necessary due to a determination that an institution’s capital level is, or is likely to become, inadequate in light of particular circumstances. Legislation enacted in May required the federal banking agencies, including the Federal Reserve Board, to establish a “community bank leverage ratio” of between 8 to 10% of average total consolidated assets for qualifying institutions with assets of less than $10 billion. Institutions with capital meeting the specified requirements and electing to follow the alternative framework are deemed to comply with the applicable regulatory capital requirements, including the risk-based requirements. A qualifying institution may opt in and out of the community bank leverage ratio on its quarterly call report. The federal regulators issued a final rule that set the optional community bank leverage ratio at 9%, commencing the first quarter of 2020. The rule also established a two-quarter grace period for a qualifying institution that ceases to meet any qualifying criteria provided that the bank maintains a leverage ratio 8% or greater. WaterStone Bank has not opted into the community bank leverage ratio Safety and Soundness Standards Each federal banking agency, including the Federal Deposit Insurance Corporation, has adopted guidelines establishing general standards relating to internal controls, internal audit systems, loan documentation, credit underwriting, interest rate exposure, asset growth, asset quality, earnings and compensation, fees and benefits, and information security. In general, the guidelines require, among other things, appropriate systems and practices to identify and manage the risks and exposures specified in the guidelines. The guidelines prohibit excessive compensation as an unsafe and unsound practice and describe compensation as excessive when the amounts paid are unreasonable or disproportionate to the services performed by an executive officer, employee, director, or principal shareholder. Prompt Corrective Regulatory Action Federal bank regulatory authorities are required to take "prompt corrective action" with respect to institutions that do not meet minimum capital requirements. For these purposes, the statute establishes five capital categories: well capitalized, adequately capitalized, undercapitalized, significantly undercapitalized, and critically undercapitalized. Under the regulations, a bank is deemed to be (i) "well capitalized" if it has total risk-based capital of 10.0% or more, has a Tier 1 risk-based capital ratio of 8.0% or more, has a Tier 1 leverage capital ratio of 5.0% or more and a common equity Tier 1 ratio of 6.5% or more, and is not subject to any written capital order or directive; (ii) "adequately capitalized" if it has a total risk-based capital ratio of 8.0% or more, a Tier 1 risk-based capital ratio of 6.0% or more, a Tier 1 leveraged capital ratio of 4.0% or more and a common equity Tier 1 ratio of 4.5% or more, and does not meet the definition of "well capitalized"; (iii) "undercapitalized" if it has a total risk-based capital ratio that is less than 8.0%, a Tier 1 risk-based capital ratio that is less than 6.0%, a Tier 1 leverage capital ratio that is less than 4.0% or a common equity Tier 1 ratio of less than 4.5%; (iv) "significantly undercapitalized" if it has a total risk-based capital ratio that is less than 6.0% and a Tier 1 risk-based capital ratio that is less than 4.0% or a common equity Tier 1 ratio of less than 3.0%; and (v) "critically undercapitalized" if it has a ratio of tangible equity to total assets that is equal to or less than 2.0%. - 23 - Federal law and regulations also specify circumstances under which a federal banking agency may reclassify a well capitalized institution as adequately capitalized and may require an institution classified as less than well capitalized to comply with supervisory actions as if it were in the next lower category (except that the Federal Deposit Insurance Corporation may not reclassify a significantly undercapitalized institution as critically undercapitalized). The Federal Deposit Insurance Corporation may order savings banks that have insufficient capital to take corrective actions. For example, a savings bank that is categorized as “undercapitalized” is subject to growth limitations and is required to submit a capital restoration plan, and a holding company that controls such a savings bank is required to guarantee that the savings bank complies with the restoration plan. A “significantly undercapitalized” savings bank may be subject to additional restrictions. Savings banks deemed by the Federal Deposit Insurance Corporation to be “critically undercapitalized” would be subject to the appointment of a receiver or conservator. At December 31, 2021, WaterStone Bank was considered well-capitalized with a common equity Tier 1 ratio of 24.50%, Tier 1 leverage ratio of 16.88%, a Tier 1 risk-based ratio of 24.50% and a total risk based capital ratio of 25.52%. A qualifying institution whose tier 1 capital equals or exceeds the specified community bank leverage ratio and opts into that framework will be considered well capitalized for prompt corrective action purposes. Banking regulators addressed the regulatory capital treatment of credit loss allowance under Accounting Standards Update (ASU) No. 2016-13, "Financial Instruments - Credit Losses (Topic 326): Measurement of Credit Losses on Financial Instruments" (CECL) methodology by allowing banking organizations an option to phase in the day-one regulatory capital effects. See Note 1 for the section "Impact of Recent Accounting Pronouncements" for additional information regarding the adoption of this standard. Dividends Under Wisconsin law and applicable regulations, a Wisconsin savings bank that meets its regulatory capital requirements may declare dividends on capital stock based upon net profits, provided that its paid-in surplus equals its capital stock. In addition, prior WDFI approval is required before dividends exceeding 50% of net profits for any calendar year may be declared and before a stock dividend may be declared out of retained earnings. Under WDFI regulations, a Wisconsin savings bank which has converted from mutual to stock form also is prohibited from paying a dividend on its capital stock if the payment causes the regulatory capital of the savings bank to fall below the amount required for its liquidation account. The Federal Deposit Insurance Corporation has the authority to prohibit WaterStone Bank from paying dividends if, in its opinion, the payment of dividends would constitute an unsafe or unsound practice in light of the financial condition of WaterStone Bank. Institutions may not pay dividends if they would be “undercapitalized” following payment of the dividend within the meaning of the prompt corrective action regulations. Information with respect to regulation regarding dividends declared and paid by Waterstone Financial is disclosed under "Holding Company Dividends." Liquidity and Reserves Wisconsin Law and Regulation. Under WDFI regulations, all Wisconsin savings banks are required to maintain a certain amount of their assets as liquid assets, consisting of cash and certain types of investments. The exact amount of assets a savings bank is required to maintain as liquid assets is set by the WDFI, but generally ranges from 4% to 15% of the savings bank’s average daily balance of net withdrawable accounts plus short-term borrowings (the “Required Liquidity Ratio”). At December 31, 2021, WaterStone Bank’s Required Liquidity Ratio was 8.0%, and WaterStone Bank was in compliance with this requirement. In addition, 50% of the liquid assets maintained by a Wisconsin savings bank must consist of “primary liquid assets,” which are defined to include securities issued by the United States Government, United States Government agencies, or the state of Wisconsin or a subdivision thereof, and cash. At December 31, 2021, WaterStone Bank was in compliance with this requirement. Federal Law and Regulation . Under federal law and regulations, WaterStone Bank is required to maintain sufficient liquidity to ensure safe and sound banking practices. Regulation D, promulgated by the Federal Reserve Board, imposes reserve requirements on all depository institutions, including WaterStone Bank, which maintain transaction accounts or non-personal time deposits. Checking accounts, NOW accounts, Super NOW checking accounts, and certain other types of accounts that permit payments or transfers to third parties fall within the definition of transaction accounts and are subject to Regulation D reserve requirements, as are any non-personal time deposits (including certain money market deposit accounts) at a savings institution. However, effective March 26, 2020, the Federal Reserve Board reduced reserve requirement ratios to zero, thereby effectively eliminating the requirements. The Federal Reserve Board took that action due to a change in its approach to monetary policy; it has indicated that it has no plans to re-impose reserve requirements but could in the future if conditions warrant. - 24 - Transactions with Affiliates and Insiders Wisconsin Law and Regulation . Under Wisconsin law, a savings bank may not make a loan to a person owning 10% or more of its stock, an affiliated person (including a director, officer, the spouse of either and a member of the immediate family of such person who is living in the same residence), agent, or attorney of the savings bank, either individually or as an agent or partner of another, except as under the rules of the WDFI and regulations of the Federal Deposit Insurance Corporation. In addition, unless the prior approval of the WDFI is obtained, a savings bank may not purchase, lease or acquire a site for an office building or an interest in real estate from an affiliated person, including a shareholder owning more than 10% of its capital stock, or from any firm, corporation, entity or family in which an affiliated person or 10% shareholder has a direct or indirect interest. Federal Law and Regulation. Sections 23A and 23B of the Federal Reserve Act govern transactions between an insured savings bank, such as WaterStone Bank, and any of its affiliates, including Waterstone Financial. The Federal Reserve Board has adopted Regulation W, which comprehensively implements and interprets Sections 23A and 23B, in part by codifying prior Federal Reserve Board interpretations under Sections 23A and 23B. An affiliate of a savings bank is any company or entity that controls, is controlled by or is under common control with the savings bank. A subsidiary of a savings bank that is not also a depository institution or a “financial subsidiary” under federal law is not treated as an affiliate of the savings bank for the purposes of Sections 23A and 23B; however, the Federal Deposit Insurance Corporation has the discretion to treat subsidiaries of a savings bank as affiliates on a case-by-case basis. Sections 23A and 23B limit the extent to which a savings bank or its subsidiaries may engage in “covered transactions” with any one affiliate to an amount equal to 10% of such savings bank’s capital stock and surplus, and limit all such transactions with all affiliates to an amount equal to 20% of such capital stock and surplus. The term “covered transaction” includes the making of loans, purchase of assets, issuance of guarantees and other similar types of transactions. Further, most loans and other extensions of credit by a savings bank to any of its affiliates must be secured by collateral in amounts ranging from 100% to 130% of the loan amounts, depending on the type of collateral. In addition, any affiliate transaction by a savings bank must be on terms that are substantially the same, or at least as favorable, to the savings bank as those that would be provided to a non-affiliate, and be consistent with safe and sound banking practices. A savings bank’s loans to its executive officers, directors, any owner of more than 10% of its stock (each, an insider) and any of certain entities affiliated with any such person (an insider’s related interest) are subject to the conditions and limitations imposed by Section 22(h) of the Federal Reserve Act and the Federal Reserve Board’s Regulation O thereunder. Under these restrictions, the aggregate amount of the loans to any insider and the insider’s related interests may not exceed the loans-to-one-borrower limit applicable to national banks, (which is generally 15% of capital and surplus). Aggregate loans by a savings bank to its insiders and insiders’ related interests in the aggregate may not exceed the savings bank’s unimpaired capital and unimpaired surplus. With certain exceptions, loans to an executive officer, other than loans for the education of the officer’s children and certain loans secured by the officer’s primary residence, may not exceed the greater of $25,000 or 2.5% of the savings bank’s unimpaired capital and unimpaired surplus, but in no event more than $100,000. Regulation O also requires that any proposed loan to an insider or a related interest of that insider be approved in advance by a majority of the board of directors of the savings bank, with any interested director not participating in the voting, if such loan, when aggregated with any existing loans to that insider and the insider’s related interests, would exceed either $500,000 or the greater of $25,000 or 5% of the savings bank’s unimpaired capital and surplus. Generally, such loans must be made on substantially the same terms as, and follow credit underwriting procedures that are no less stringent than, those that are prevailing at the time for comparable transactions with other persons and must not present more than a normal risk of collectability. An exception to the requirement is made for extensions of credit made pursuant to a benefit or compensation plan of a bank that is widely available to employees of the savings bank and that does not give any preference to insiders of the bank over other employees of the bank. Consistent with these requirements, the Bank offered employees special terms for home mortgage loans on their principal residences. Effective April 1, 2006, this program was discontinued for new loan originations. Under the terms of the discontinued program, the employee interest rate is based on the Bank’s cost of funds on December 31st of the immediately preceding year and is adjusted annually. At December 31, 2021, the rate of interest on an employee rate mortgage loan was 1.02%, compared to the weighted average rate of 4.10% on all single family mortgage loans. This rate will decrease to 0.73% effective March 1, 2022. Employee rate mortgage loans totaled $580,000, or 0.3%, of our single family residential mortgage loan portfolio on December 31, 2021. Transactions between Bank Customers and Affiliates Wisconsin savings banks, such as WaterStone Bank, are subject to the prohibitions on certain tying arrangements. Subject to certain exceptions, a savings bank is prohibited from extending credit to or offering any other service to a customer, or fixing or varying the consideration for such extension of credit or service, on the condition that such customer obtain some additional service from the institution or certain of its affiliates or not obtain services of a competitor of the institution. Examinations and Assessments WaterStone Bank is required to file periodic reports with and is subject to periodic examinations by the WDFI and FDIC. WaterStone Bank is required to pay examination fees and annual assessments to fund its supervision. Federal regulations require annual on-site examinations for all depository institutions except certain well-capitalized and highly rated institutions with assets of less than $3 billion which are examined every 18 months. - 25 - Customer Privacy Under Wisconsin and federal law and regulations, savings banks, such as WaterStone Bank, are required to develop and maintain privacy policies relating to information on its customers, restrict access to and establish procedures to protect customer data. Applicable privacy regulations further restrict the sharing of non-public customer data with non-affiliated parties if the customer requests. Community Reinvestment Act Under the Community Reinvestment Act, WaterStone Bank has a continuing and affirmative obligation consistent with its safe and sound operation to help meet the credit needs of its entire community, including low and moderate income neighborhoods. The Community Reinvestment Act does not establish specific lending requirements or programs for financial institutions nor does it limit an institution’s discretion to develop the types of products and services that it believes are best suited to its particular community, consistent with the Community Reinvestment Act. The Community Reinvestment Act requires the Federal Deposit Insurance Corporation, in connection with its examination of WaterStone Bank, to assess WaterStone Bank’s record of meeting the credit needs of its community and to take that record into account in the Federal Deposit Insurance Corporation’s evaluation of certain applications by WaterStone Bank. For example, the regulations specify that a bank’s Community Reinvestment Act performance will be considered in its expansion (e.g., branching or merger) proposals and may be the basis for approving, denying or conditioning the approval of an application. As of the date of its most recent regulatory examination, WaterStone Bank was rated “satisfactory” with respect to its Community Reinvestment Act compliance. Federal Home Loan Bank System The Federal Home Loan Bank System, consisting of 11 Federal Home Loan Banks, is under the jurisdiction of the Federal Housing Finance Board. The designated duties of the Federal Housing Finance Board are to supervise the Federal Home Loan Banks; ensure that the Federal Home Loan Banks carry out their housing finance mission; ensure that the Federal Home Loan Banks remain adequately capitalized and able to raise funds in the capital markets; and ensure that the Federal Home Loan Banks operate in a safe and sound manner. WaterStone Bank, as a member of the Federal Home Loan Bank of Chicago, is required to acquire and hold shares of capital stock in the Federal Home Loan Bank of Chicago in specified amounts. WaterStone Bank is in compliance with this requirement with an investment in Federal Home Loan Bank of Chicago stock of $24.4 million at December 31, 2021. Among other benefits, the Federal Home Loan Banks provide a central credit facility primarily for member institutions. It is funded primarily from proceeds derived from the sale of consolidated obligations of the Federal Home Loan Bank System. It makes advances to members in accordance with policies and procedures established by the Federal Housing Finance Board and the board of directors of the Federal Home Loan Bank of Chicago. At December 31, 2021, WaterStone Bank had $475.0 million in advances from the Federal Home Loan Bank of Chicago. USA PATRIOT Act The USA PATRIOT Act gives the federal government powers to address terrorist threats through enhanced domestic security measures, expanded surveillance powers, increased information sharing and broadened anti-money laundering requirements. The USA PATRIOT Act also required the federal banking agencies to take into consideration the effectiveness of controls designed to combat money laundering activities in determining whether to approve a merger or other acquisition application of a member institution. Accordingly, if we engage in a merger or other acquisition, our controls designed to combat money laundering would be considered as part of the application process. We have established policies, procedures and systems designed to comply with these regulations. Regulation of Waterstone Mortgage Corporation Waterstone Mortgage Corporation is subject to numerous federal, state and local laws and regulations and may be subject to various judicial and administrative decisions imposing various requirements and restrictions on its business. These laws, regulations and judicial and administrative decisions to which Waterstone Mortgage Corporation is subject include those pertaining to: real estate settlement procedures; fair lending; fair credit reporting; truth in lending; compliance with net worth and financial statement delivery requirements; compliance with federal and state disclosure and licensing requirements; the establishment of maximum interest rates, finance charges and other charges; secured transactions; collection, foreclosure, repossession and claims-handling procedures; other trade practices and privacy regulations providing for the use and safeguarding of non-public personal financial information of borrowers; and guidance on non-traditional mortgage loans issued by the federal financial regulatory agencies. Waterstone Mortgage Corporation may also be required to comply with any additional requirements that its customers may be subject to by their regulatory authorities. - 26 - Holding Company Regulation Waterstone Financial is a unitary savings and loan holding company subject to regulation and supervision by the Federal Reserve Board. The Federal Reserve Board has enforcement authority over Waterstone Financial and its non-savings institution subsidiaries. Among other things, that authority permits the Federal Reserve Board to restrict or prohibit activities that are determined to be a risk to WaterStone Bank. In addition, any company that owns or controls, directly or indirectly, more than 25% of the voting securities of a state savings bank is subject to regulation as a savings bank holding company by the WDFI. Waterstone Financial is subject to regulation as a savings bank holding company under Wisconsin law. However, the WDFI has not issued specific regulations governing stock savings bank holding companies. The business activities of savings and loan holding companies are generally limited to those activities permissible for bank holding companies under Section 4(c)(8) of the Bank Holding Company Act, subject to the prior approval of the Federal Reserve Board, and certain additional activities authorized by Federal Reserve Board regulations, unless the holding company has elected “financial holding company” status. A financial holding company may engage in activities that are financial in nature, including underwriting equity securities and insurance as well as activities that are incidental to financial activities or complementary to a financial activity. Waterstone Financial has not elected financial holding company status. Federal law generally prohibits the acquisition of more than 5% of a class of voting stock of a company engaged in impermissible activities. Federal law prohibits a savings and loan holding company, directly or indirectly, or through one or more subsidiaries, from acquiring more than 5% of another savings institution or savings and loan holding company without prior written approval of the Federal Reserve Board, and from acquiring or retaining control of any depository institution not insured by the Federal Deposit Insurance Corporation. In evaluating applications by holding companies to acquire savings institutions, the Federal Reserve Board must consider such things as the financial and managerial resources and future prospects of the company and institution involved, the effect of the acquisition on and the risk to the federal deposit insurance fund, the convenience and needs of the community and competitive factors. A savings and loan holding company may not acquire a savings institution in another state and hold the target institution as a separate subsidiary unless it is a supervisory acquisition under Section 13(k) of the Federal Deposit Insurance Act or the law of the state in which the target is located authorizes such acquisitions by out-of-state companies. The Dodd-Frank Act required the Federal Reserve Board to impose upon bank and savings and loan holding companies consolidated regulatory capital requirements that are equally stringent as those applicable to the subsidiary depository institutions. However, legislation enacted in 2018 required the Federal Reserve Board to raise the asset size threshold of its “small holding company” exception to the applicability of consolidated holding company capital requirements from $1 billion to $3 billion. Consequently, holding companies with less than $3 billion of consolidated assets, such as Waterstone Financial, are generally not subject to the requirements unless otherwise advised by the Federal Reserve Board. The Dodd-Frank Act extended the "source of strength" doctrine to savings and loan holding companies. The Federal Reserve Board promulgated regulations implementing the "source of strength" policy, which requires holding companies to act as a source of strength to their subsidiary depository institutions by providing capital, liquidity and other support in times of financial stress. The Federal Reserve Board has issued a policy statement regarding the payment of dividends and the repurchase of shares of common stock by bank and savings and loan holding companies. In general, the policy provides that dividends should be paid only out of current earnings and only if the prospective rate of earnings retention by the holding company appears consistent with the organization’s capital needs, asset quality and overall financial condition. Regulatory guidance provides for prior regulatory consultation with respect to capital distributions in certain circumstances such as where the company’s net income for the past four quarters, net of dividends previously paid over that period, is insufficient to fully fund a proposed dividend or the company’s overall rate of earnings retention is inconsistent with the company’s capital needs and overall financial condition. The ability of a holding company to pay dividends may be restricted if a subsidiary bank becomes undercapitalized. The guidance also provides for prior consultation with supervisory staff for material increases in the amount of a company’s common stock dividend. The policy statement also states that a holding company should inform the Federal Reserve Board supervisory staff, to provide opportunity for supervisory review and possible objection, prior to redeeming or repurchasing common stock or perpetual preferred stock if the holding company is experiencing financial weaknesses or if the repurchase or redemption would result in a net reduction, as of the end of a quarter, in the amount of such equity instruments outstanding compared with the beginning of the quarter in which the redemption or repurchase occurred. These regulatory policies may affect the ability of Waterstone Financial to pay dividends, repurchase shares of common stock or otherwise engage in capital distributions. - 27 - Holding Company Dividends Waterstone Financial is not permitted to pay dividends on its common stock if its stockholders’ equity would be reduced below the amount of the liquidation account established by Waterstone Financial in connection with the conversion. In addition, Waterstone Financial is subject to relevant state corporate law limitations and federal bank regulatory policy on the payment of dividends. Maryland law, which is the state of Waterstone Financial’s incorporation, generally limits dividends if the corporation would not be able to pay its debts in the usual course of business after giving effect to the dividend or if the corporation’s total assets would be less than the corporation’s total liabilities plus the amount needed to satisfy the preferential rights upon dissolution of stockholders whose preferential rights on dissolution are superior to those receiving the distribution. The dividend rate and continued payment of dividends will depend on a number of factors, including our capital requirements, our financial condition and results of operations, tax considerations, statutory and regulatory limitations, and general economic conditions. Federal Securities Laws Regulation Securities Exchange Act. Waterstone Financial common stock is registered with the Securities and Exchange Commission. Waterstone Financial is subject to the information, proxy solicitation, insider trading restrictions and other requirements under the Securities Exchange Act of 1934. Shares of common stock purchased by persons who are not affiliates of Waterstone Financial may be resold without registration. Shares purchased by an affiliate of Waterstone Financial are subject to the resale restrictions of Rule 144 under the Securities Act of 1933. If Waterstone Financial meets the current public information requirements of Rule 144 under the Securities Act of 1933, each affiliate of Waterstone Financial that complies with the other conditions of Rule 144, including those that require the affiliate’s sale to be aggregated with those of other persons, would be able to sell in the public market, without registration, a number of shares not to exceed, in any three-month period, the greater of 1% of the outstanding shares of Waterstone Financial, or the average weekly volume of trading in the shares during the preceding four calendar weeks. In the future, Waterstone Financial may permit affiliates to have their shares registered for sale under the Securities Act of 1933. Sarbanes-Oxley Act of 2002. The Sarbanes-Oxley Act of 2002 is intended to improve corporate responsibility, to provide for enhanced penalties for accounting and auditing improprieties at publicly traded companies and to protect investors by improving the accuracy and reliability of corporate disclosures pursuant to the securities laws. We have policies, procedures and systems designed to comply with these regulations, and we review and document such policies, procedures and systems to ensure continued compliance with these regulations. Change in Control Regulations Under the Change in Bank Control Act, no person may acquire control of a savings and loan holding company such as Waterstone Financial unless the Federal Reserve Board has been given 60 days’ prior written notice and has not issued a notice disapproving the proposed acquisition, taking into consideration certain factors, including the financial and managerial resources of the acquirer and the competitive effects of the acquisition. Control, as defined under the Change in Bank Control Act federal law, means ownership, control of or the power to vote 25% or more of any class of voting stock. Acquisition of more than 10% of any class of a savings and loan holding company’s voting stock constitutes a rebuttable determination of control under the regulations under certain circumstances including where, as is the case with Waterstone Financial, the issuer has registered securities under Section 12 of the Securities Exchange Act of 1934. In addition, the Savings and Loan Holding Company Act provides that no company may acquire control of a savings and loan holding company (as “control” is defined for purposes of that statute) without the prior approval of the Federal Reserve Board. Any company that acquires such control becomes a “savings and loan holding company” subject to registration, examination and regulation by the Federal Reserve Board. Effective September 30, 2020, the Federal Reserve Board adopted changes to its regulatory definition of “control” under the Savings and Loan Holding Company Act. Relevant factors include a company’s voting and nonvoting equity interests in the savings and loan holding company, director, officer and employee overlaps and the scope of business relationships between the company and the savings and loan holding company or its subsidiary institution. Federal and State Taxation Federal Taxation General. Waterstone Financial and subsidiaries are subject to federal income taxation in the same general manner as other corporations, with some exceptions discussed below. Waterstone Financial and subsidiaries constitute an affiliated group of corporations and, therefore, are eligible to report their income on a consolidated basis. The following discussion of federal taxation is intended only to summarize certain pertinent federal income tax matters and is not a comprehensive description of the tax rules applicable to Waterstone Financial or WaterStone Bank. The Company is no longer subject to federal tax examinations for years before 2017. - 28 - Method of Accounting. For federal income tax purposes, Waterstone Financial currently reports its income and expenses on the accrual method of accounting and uses a tax year ending December 31 for filing its federal income tax returns. Bad Debt Reserves. Prior to the Small Business Protection Act of 1996 (the "1996 Act"), WaterStone Bank was permitted to establish a reserve for bad debts and to make annual additions to the reserve. These additions could, within specified formula limits, be deducted in arriving at our taxable income. As a result of the 1996 Act, WaterStone Bank was required to use the specific charge-off method in computing its bad debt deduction beginning with its 1996 federal tax return. Savings institutions were required to recapture any excess reserves over those established as of December 31, 1987 (base year reserve). At December 31, 2021, WaterStone Bank had no reserves subject to recapture in excess of its base year. Waterstone Financial is required to use the specific charge-off method to account for tax bad debt deductions. Taxable Distributions and Recapture. Prior to 1996, bad debt reserves created prior to 1988 were subject to recapture into taxable income if WaterStone Bank failed to meet certain thrift asset and definitional tests or made certain distributions. Tax law changes in 1996 eliminated thrift-related recapture rules. However, under current law, pre-1988 tax bad debt reserves remain subject to recapture if WaterStone Bank makes certain non-dividend distributions, repurchases any of its common stock, pays dividends in excess of earnings and profits, or fails to qualify as a “bank” for tax purposes. At December 31, 2021, our total federal pre-base year bad debt reserve was approximately $16.7 million. Corporate Dividends-Received Deduction. Waterstone Financial may exclude from its federal taxable income 100% of dividends received from WaterStone Bank as a wholly-owned subsidiary by filing consolidated tax returns. The corporate dividends-received deduction is 65% when the corporation receiving the dividend owns at least 20% of the stock of the distributing corporation. The dividends-received deduction is 50% when the corporation receiving the dividend owns less than 20% of the distributing corporation. State Taxation The Company is subject to primarily the Wisconsin corporate franchise (income) tax and taxation in a number of states due primarily to the operations of the mortgage banking segment. Under current law, the state of Wisconsin imposes a corporate franchise tax of 7.9% on the combined taxable incomes of the members of our consolidated income tax group. The Company is no longer subject to state income tax examinations by certain state tax authorities for years before 2016. As a Maryland business corporation, Waterstone Financial is required to file an annual report and pay franchise taxes to the state of Maryland. Item 1A. Risk Factors An investment in our securities is subject to risks inherent in our business and the industry in which we operate. Before making an investment decision, you should carefully consider the risks and uncertainties described below and all other information included in this report, as well as other reports we file with the SEC. The risks described below may adversely affect our business, financial condition and operating results. In addition to these risks and the other risks and uncertainties described in Item 1, “Business-Forward Looking Statements” and Item 7, “Management's Discussion and Analysis of Financial Condition and Results of Operations,” there may be additional risks and uncertainties that are not currently known to us or that we currently deem to be immaterial that could materially and adversely affect our business, financial condition or operating results. The value or market price of our securities could decline due to any of these identified or other risks. Past financial performance may not be a reliable indicator of future performance, and historical trends should not be used to anticipate results or trends in future periods. Risks Related to the COVID-19 Pandemic The COVID-19 pandemic has adversely impacted our business and financial results, and the ultimate impact will depend on future developments, which are highly uncertain and cannot be predicted, including the scope and duration of the pandemic and actions taken by governmental authorities in response to the pandemic. The COVID-19 pandemic has created extensive disruptions to the global economy and to the lives of individuals throughout the world. Governments, businesses, and the public have taken unprecedented actions to contain the spread of COVID-19 and to mitigate its effects, including quarantines, travel bans, shelter-in-place orders, closures of businesses and schools, fiscal stimulus, and legislation designed to deliver monetary aid and other relief. While the scope, duration, and full effects of COVID-19 are continually evolving and not fully known, the pandemic and related efforts to contain it have disrupted global economic activity, adversely affected the functioning of financial markets, impacted interest rates, increased economic and market uncertainty, and disrupted trade and supply chains. If these effects continue for a prolonged period or result in sustained economic stress or recession, many of the risk factors identified in our Form 10-K could be exacerbated and such effects could have a material adverse impact on us in a number of ways related to credit, collateral, customer demand, funding, operations, interest rate risk, human capital and self-insurance, as described in more detail below. - 29 - • Credit Risk. Our risks of timely loan repayment and the value of collateral supporting the loans are affected by the strength of our borrower’s business. Concern about the spread of COVID-19 has caused business slowdowns, limitations on commercial activity and financial transactions, labor shortages, supply chain interruptions, commercial property vacancy rates, reduced profitability and ability for property owners to make mortgage payments, and overall economic and financial market instability, all of which may cause our customers to be unable to make scheduled loan payments. If the effects of COVID-19 result in widespread and sustained repayment shortfalls on loans in our portfolio, we could incur significant delinquencies, foreclosures and credit losses, particularly if the available collateral is insufficient to cover our exposure. The future effects of COVID-19 on economic activity could negatively affect the collateral values associated with our existing loans, the ability to liquidate the real estate collateral securing our residential and commercial real estate loans, our ability to maintain loan origination volume and to obtain additional financing, the future demand for or profitability of our lending and services, and the financial condition and credit risk of our customers. Further, in the event of delinquencies, regulatory changes and policies designed to protect borrowers may slow or prevent us from making our business decisions or may result in a delay in our taking certain remediation actions, such as foreclosure. In addition, we have unfunded commitments to extend credit to customers. During a challenging economic environment like now, our customers are more dependent on our credit commitments and increased borrowings under these commitments could adversely impact our liquidity. Furthermore, in an effort to support our communities during the pandemic, we participated in the Paycheck Protection Program (“PPP”) under the CARES Act whereby loans to small businesses are made and those loans are subject to the regulatory requirements that would require forbearance of loan payments for a specified time or that would limit our ability to pursue all available remedies in the event of a loan default. If the borrower under the PPP loan fails to qualify for loan forgiveness, we are at the heightened risk of holding these loans at unfavorable interest rates as compared to the loans to customers to which we would have otherwise extended credit. • Strategic Risk. Our success may be affected by a variety of external factors that may affect the price or marketability of our products and services, changes in interest rates that may increase our funding costs, reduced demand for our financial products due to economic conditions and the various response of governmental and nongovernmental authorities. In recent weeks, the COVID-19 pandemic has significantly increased economic and demand uncertainty and has led to disruption and volatility in the global capital markets. Furthermore, many of the governmental actions have been directed toward curtailing household and business activity to contain COVID-19. The future effects of COVID-19 on economic activity could negatively affect the future banking products we provide, including a decline in originating of loans. • Operational Risk. Current and future restrictions on our workforce’s access to our facilities could limit our ability to meet customer servicing expectations and have a material adverse effect on our operations. We rely on business processes and branch activity that largely depend on people and technology, including access to information technology systems as well as information, applications, payment systems and other services provided by third parties. In response to COVID-19, we have modified our business practices with a portion of our employees working remotely from their homes to have our operations uninterrupted as much as possible. Further, technology in employees’ homes may not be as robust as in our offices and could cause the networks, information systems, applications, and other tools available to employees to be more limited or less reliable than in our offices. Additionally, the productivity and availability of key personnel and other employees necessary to conduct business, and of third-party service providers who perform critical services, or otherwise may cause operational failures due to changes in normal business practices necessitated by or issues with employee retention caused by the pandemic and related governmental actions. The continuation of these work-from-home measures also introduces additional operational risk, including increased cybersecurity risk. These cyber risks include greater phishing, malware, and other cybersecurity attacks, vulnerability to disruptions of our information technology infrastructure and telecommunications systems for remote operations, increased risk of unauthorized dissemination of confidential information, limited ability to restore the systems in the event of a systems failure or interruption, greater risk of a security breach resulting in destruction or misuse of valuable information, and potential impairment of our ability to perform critical functions, including wiring funds, all of which could expose us to risks of data or financial loss, litigation and liability and could seriously disrupt our operations and the operations of any impacted customers. Moreover, we rely on many third parties in our business operations, including the appraiser of the real property collateral, vendors that supply essential services such as loan servicers, providers of financial information, systems and analytical tools and providers of electronic payment and settlement systems, and local and federal government agencies, offices, and courthouses. In light of the developing measures responding to the pandemic, many of these entities may limit the availability and access of their services. For example, loan origination could be delayed due to the limited availability of real estate appraisers for the collateral. Loan closings could be delayed related to reductions in available staff in recording offices or the closing of courthouses in certain counties, which slows the process for title work, mortgage and UCC filings in those counties. If the third-party service providers continue to have limited capacities for a prolonged period or if additional limitations or potential disruptions in these services materialize, it may negatively affect our operations. • Interest Rate Risk. Our net interest income, lending activities, deposits and profitability could be negatively affected by volatility in interest rates caused by uncertainties stemming from COVID-19. A prolonged period of extremely volatile and unstable market conditions would likely increase our funding costs and negatively affect market risk mitigation strategies. Higher income volatility from changes in interest rates and spreads to benchmark indices could cause a loss of future net interest income and a decrease in current fair market values of our assets. Fluctuations in interest rates will impact both the level of income and expense recorded on most of our assets and liabilities and the market value of all interest-earning assets and interest-bearing liabilities, which in turn could have a material adverse effect on our net income, operating results, or financial condition. - 30 - Because there have been no comparable recent global pandemics that resulted in similar global impact, we do not yet know the full extent of COVID-19’s effects on our business, operations, or the global economy as a whole. Any future development will be highly uncertain and cannot be predicted, including the scope and duration of the pandemic, the effectiveness of our work from home arrangements, third party providers’ ability to support our operation, and any actions taken by governmental authorities and other third parties in response to the pandemic. The uncertain future development of this crisis could materially and adversely affect our business, operations, operating results, financial condition, liquidity or capital levels. Risks Related to Regulatory Matters We operate in a highly regulated environment and we are subject to supervision, examination and enforcement action by various bank regulatory agencies. We are subject to extensive supervision, regulation, and examination by the WDFI, the Federal Deposit Insurance Corporation and the Federal Reserve Board. As a result, we are limited in the manner in which we conduct our business, undertake new investments and activities, and obtain financing. This system of regulation is designed primarily for the protection of the Deposit Insurance Fund and our depositors, and not for the benefit of our stockholders. Under this system of regulation, the regulatory authorities have extensive discretion in connection with their supervisory, enforcement, rulemaking and examination activities and policies, including rules or policies that: establish minimum capital levels; restrict the timing and amount of dividend payments; govern the classification of assets; determine the adequacy of loan loss reserves for regulatory purposes; and establish the timing and amounts of assessments and fees. Moreover, as part of their examination authority, the banking regulators assign numerical ratings to banks and savings institutions relating to capital, asset quality, management, liquidity, earnings and other factors. These ratings are inherently subjective and the receipt of a less than satisfactory rating in one or more categories may result in enforcement action by the banking regulators against a financial institution. A less than satisfactory rating may also prevent a financial institution, such as WaterStone Bank or its holding company, from obtaining necessary regulatory approvals to access the capital markets, paying dividends, acquiring other financial institutions or establishing new branches. In addition, we must comply with significant anti-money laundering and anti-terrorism laws and regulations, Community Reinvestment Act laws and regulations, and fair lending laws and regulations. Government agencies have the authority to impose monetary penalties and other sanctions on institutions that fail to comply with these laws and regulations, which could significantly affect our business activities, including our ability to acquire other financial institutions or expand our branch network. Non-compliance with the USA PATRIOT Act, Bank Secrecy Act, or other laws and regulations could result in fines or sanctions. The USA PATRIOT and Bank Secrecy Acts require financial institutions to develop programs to prevent financial institutions from being used for money laundering and terrorist activities. If such activities are detected, financial institutions are obligated to file suspicious activity reports with the U.S. Treasury’s Office of Financial Crimes Enforcement Network. These rules require financial institutions to establish procedures for identifying and verifying the identity of customers seeking to open new financial accounts. Failure to comply with these regulations could result in fines or sanctions. During the last year, several banking institutions have received large fines for non-compliance with these laws and regulations. While we have developed policies and procedures designed to assist in compliance with these laws and regulations, these policies and procedures may not be effective in preventing violations of these laws and regulations. Monetary policies and regulations of the Federal Reserve Board could adversely affect our business, financial condition and results of operations. In addition to being affected by general economic conditions, our earnings and growth are affected by the policies of the Federal Reserve Board. An important function of the Federal Reserve Board is to regulate the money supply and credit conditions. Among the instruments used by the Federal Reserve Board to implement these objectives are open market purchases and sales of U.S. government securities, adjustments of the discount rate and changes in banks’ reserve requirements against bank deposits. These instruments are used in varying combinations to influence overall economic growth and the distribution of credit, bank loans, investments and deposits. Their use also affects interest rates charged on loans or paid on deposits. We are subject to the Community Reinvestment Act and fair lending laws, and failure to comply with these laws could lead to material penalties. The Community Reinvestment Act (“CRA”), the Equal Credit Opportunity Act, the Fair Housing Act and other fair lending laws and regulations impose nondiscriminatory lending requirements on financial institutions. A successful regulatory challenge to an institution’s performance under the CRA or fair lending laws and regulations could result in a wide variety of sanctions, including the required payment of damages and civil money penalties, injunctive relief, imposition of restrictions on mergers and acquisitions activity and restrictions on expansion. Private parties may also have the ability to challenge an institution’s performance under fair lending laws in private class action litigation. Such actions could have a material adverse effect on our business, financial condition and results of operations. The Federal Reserve Board may require us to commit capital resources to support WaterStone Bank. Federal law requires that a holding company act as a source of financial and managerial strength to its subsidiary bank and to commit resources to support such subsidiary bank. Under the “source of strength” doctrine, the Federal Reserve Board may require a holding company to make capital injections into a troubled subsidiary bank and may charge the holding company with engaging in unsafe and unsound practices for failure to commit resources to a subsidiary bank. A capital injection may be required at times when the holding company may not have the resources to provide it and therefore may be required to borrow the funds or raise capital. Thus, any borrowing or funds needed to raise capital required to make a capital injection becomes more difficult and expensive and could have an adverse effect on our business, financial condition and results of operations. - 31 - Risks Related to Interest Rates Changing interest rates may have a negative effect on our results of operations. Our earnings and cash flows are dependent on our net interest income and income from our mortgage banking operations. Interest rates are highly sensitive to many factors that are beyond our control, including general economic conditions and policies of various governmental and regulatory agencies and, in particular, the Federal Reserve Board. Changes in market interest rates could have an adverse effect on our financial condition and results of operations. Decreases in interest rates often result in increased prepayments of loans and mortgage-related securities, as borrowers refinance their loans to reduce borrowings costs. Under these circumstances, we are subject to reinvestment risk to the extent we are unable to reinvest the cash received from such prepayments in loans or other investments that have interest rates that are comparable to the interest rates on existing loans and securities. Increases in interest rates can also have an adverse impact on our results of operations. A portion of our loans have adjustable interest rates. While the higher payment amounts we would receive on these loans in a rising interest rate environment may increase our interest income, some borrowers may be unable to afford the higher payment amounts, which may result in a higher rate of loan delinquencies and defaults, as well as lower loan originations, as borrowers who may qualify for a loan based on certain mortgage repayments, may not be able to afford repayments based on higher interest rates for the same loan amounts. The marketability of the underlying collateral also may be adversely affected in a high interest rate environment. Although we have implemented asset and liability management strategies designed to reduce the effects of changes in interest rates on our results of operations, any substantial, unexpected, prolonged change in market interest rate could have a material adverse effect on our financial condition and results of operations. Also, our interest rate models and assumptions likely may not fully predict or capture the impact of actual interest rate changes on our balance sheet. See “Management’s Discussion and Analysis of Financial Condition" and "Quantitative and Qualitative Disclosures About Market Risk—Management of Market Risk.” Risks Related to Lending Matters We intend to increase our commercial business lending, and we intend to continue our commercial real estate and multi-family residential real estate lending, which may expose us to increased lending risks and have a negative effect on our results of operations. We continue to focus on originating commercial business, commercial real estate and multi-family residential real estate loans. These types of loans generally have a higher risk of loss compared to our one- to four-family residential real estate loans. Commercial business loans may expose us to greater credit risk than loans secured by residential real estate because the collateral securing these loans may not be sold as easily as residential real estate. In addition, commercial business and commercial real estate loans may also involve relatively large loan balances to individual borrowers or groups of borrowers. These loans also have greater credit risk than residential real estate loans as repayment is generally dependent upon the successful operation of the borrower’s business. Also, the collateral underlying commercial business loans may fluctuate in value. Some of our commercial business loans are collateralized by equipment, inventory, accounts receivable or other business assets, and the liquidation of collateral in the event of default is often an insufficient source of repayment because accounts receivable may be uncollectible and inventories may be obsolete or of limited use. Multi-family residential real estate and commercial real estate loans involve increased risk because repayment is dependent on income being generated in amounts sufficient to cover property maintenance and debt service. In addition, if loans that are collateralized by real estate become troubled and the value of the real estate has been significantly impaired, then we may not be able to recover the full contractual amount of principal and interest that we anticipated at the time we originated the loan, which could cause us to increase our provision for loan losses and adversely affect our financial condition and results of operations. If our allowance for loan losses is not sufficient to cover actual loan losses, our results of operations would be negatively affected. In determining the amount of the allowance for loan losses, we analyze our loss and delinquency experience by loan categories and we consider the effect of existing economic conditions. In addition, we make various assumptions and judgments about the collectability of our loan portfolio, including the creditworthiness of our borrowers and the value of the real estate and other assets serving as collateral for the repayment of many of our loans. If the results of our analyses are incorrect, our allowance for loan losses may not be sufficient to cover losses inherent in our loan portfolio, which would require additions to our allowance and would decrease our net income. Our emphasis on loan growth and on increasing our portfolio of commercial real estate loans, as well as any future credit deterioration, could require us to increase our allowance further in the future. In addition, any future credit deterioration, including as a result of COVID-19, could require us to increase our allowance for loan losses in the future. In addition, bank regulators periodically review our allowance for loan losses and may require us to increase our provision for loan losses or recognize further loan charge-offs. Any increase in our allowance for loan losses or loan charge-offs as required by these regulatory authorities may have a material adverse effect on our results of operations and financial condition. We are subject to environmental liability risk associated with lending activities. A significant portion of our loan portfolio is secured by real estate, and we could become subject to environmental liabilities with respect to one or more of these properties. During the ordinary course of business, we may foreclose on and take title to properties securing defaulted loans. In doing so, there is a risk that hazardous or toxic substances could be found on these properties. If hazardous conditions or toxic substances are found on these properties, we may be liable for remediation costs, as well as for personal injury and property damage, civil fines and criminal penalties regardless of when the hazardous conditions or toxic substances first affected any particular property. Environmental laws may require us to incur substantial expenses to address unknown liabilities and may materially reduce the affected property’s value or limit our ability to use or sell the affected property. In addition, future laws or regulations, or more stringent interpretations or enforcement policies with respect to existing laws and regulations may increase our exposure to environmental liability, and heightened pressure from investors and other stakeholders may require us to incur additional expenses with respect to environmental matters. Although we have policies and procedures to perform an environmental review before initiating any foreclosure action on nonresidential real property, these reviews may not be sufficient to detect all potential environmental hazards. The remediation costs and any other financial liabilities associated with an environmental hazard could have a material adverse effect on us. - 32 - The foreclosure process may adversely impact our recoveries on non-performing loans The judicial foreclosure process is protracted, which delays our ability to resolve non-performing loans through the sale of the underlying collateral. The longer timelines have been the result of the economic crisis, additional consumer protection initiatives related to the foreclosure process, increased documentary requirements and judicial scrutiny, and, both voluntary and mandatory programs under which lenders may consider loan modifications or other alternatives to foreclosure. These reasons and the legal and regulatory responses have impacted the foreclosure process and completion time of foreclosures for residential mortgage lenders. This may result in a material adverse effect on collateral values and our ability to minimize its losses. Risks Related to Operational Matters We rely heavily on certificates of deposit, which has increased our cost of funds and could continue to do so in the future. Our reliance on certificates of deposit to fund our operations has resulted in a higher cost of funds than would otherwise be the case if we had a higher percentage of demand deposits, savings deposits and money market accounts. In addition, if our certificates of deposit do not remain with us, we may be required to access other sources of funds, including loan sales, other types of deposits, including replacement certificates of deposit, securities sold under agreements to repurchase, advances from the Federal Home Loan Bank of Chicago and other borrowings. Depending on market conditions, we may be required to pay higher rates on such deposits or other borrowings than we currently pay on our certificates of deposit. We may not be able to attract and retain skilled people. Our success depends, in large part, on our ability to attract and retain skilled people. Competition for the best people in most activities engaged in by us can be intense, and we may not be able to hire sufficiently skilled people or to retain them. The unexpected loss of services of one or more of our key personnel could have a material adverse impact on our business because of their skills, knowledge of our markets, years of industry experience, and the difficulty of promptly finding qualified replacement personnel. Loss of key employees may disrupt relationships with certain customers. Our business is primarily relationship-driven in that many of our key employees have extensive customer relationships. Loss of a key employee with such customer relationships may lead to the loss of business if the customers were to follow that employee to a competitor. While we believe our relationship with our key personnel is good, we cannot guarantee that all of our key personnel will remain with our organization. Loss of such key personnel, should they enter into an employment relationship with one of our competitors, could result in the loss of some of our customers. Because the nature of the financial services business involves a high volume of transactions, we face significant operational risks. We operate in diverse markets and rely on the ability of our employees and systems to process a high number of transactions. Operational risk is the risk of loss resulting from our operations, including but not limited to, the risk of fraud by employees or persons outside our company, the execution of unauthorized transactions by employees, errors relating to transaction processing and technology, breaches of the internal control system and compliance requirements, and business continuation and disaster recovery. Insurance coverage may not be available for such losses, or where available, such losses may exceed insurance limits. This risk of loss also includes the potential legal actions that could arise as a result of an operational deficiency or as a result of noncompliance with applicable regulatory standards, adverse business decisions or their implementation, and customer attrition due to potential negative publicity. In the event of a breakdown in the internal control system, improper operation of systems or improper employee actions, we could suffer financial loss, face regulatory action, and suffer damage to our reputation. Risks associated with system failures, interruptions, or breaches of cybersecurity could negatively affect our earnings. Information technology systems are critical to our business. We use various technology systems to manage our customer relationships, general ledger, securities investments, deposits and loans. We have established policies and procedures to prevent or limit the effect of system failures, interruptions, and security breaches, but such events may still occur or may not be adequately addressed if they do occur. Although we take numerous protective measures and otherwise endeavor to protect and maintain the privacy and security of confidential data, these systems may be vulnerable to unauthorized access, computer viruses, other malicious code, cyber-attacks, cyber-theft and other events that could have a security impact. If one or more of such events were to occur, this potentially could jeopardize confidential and other information processed and stored in, and transmitted through, our systems or otherwise cause interruptions or malfunctions in our or our customers' operations. In addition, we outsource a majority of our data processing to certain third-party providers. If these third-party providers encounter difficulties, or if we have difficulty communicating with them, our ability to adequately process and account for transactions could be affected, and our business operations could be adversely affected. Threats to information security also exist in the processing of customer information through various other vendors and their personnel. The occurrence of any system failures, interruption, or breach of security could damage our reputation and result in a loss of customers and business, subject us to additional regulatory scrutiny, or expose us to litigation and possible financial liability. We may be required to expend significant additional resources to modify our protective measures or to investigate and remediate vulnerabilities or other exposures, and we may be subject to litigation and financial losses that are not fully covered by our insurance. Any of these events could have a material adverse effect on our financial condition and results of operations. Our risk management framework may not be effective in mitigating risk and reducing the potential for significant losses. Our risk management framework is designed to minimize risk and loss to us. We seek to identify, measure, monitor, report and control our exposure to risk, including strategic, market, liquidity, compliance and operational risks. While we use a broad and diversified set of risk monitoring and mitigation techniques, these techniques are inherently limited because they cannot anticipate the existence or future development of currently unanticipated or unknown risks. Recent economic conditions and heightened legislative and regulatory scrutiny of the financial services industry, among other developments, have increased our level of risk. Accordingly, we could suffer losses as a result of our failure to properly anticipate and manage these risks. - 33 - Our business may be adversely affected by an increasing prevalence of fraud and other financial crimes. Our loans to businesses and individuals and our deposit relationships and related transactions are subject to exposure to the risk of loss due to fraud and other financial crimes. We have experienced losses due to apparent fraud and other financial crimes. While we have policies and procedures designed to prevent such losses, losses may still occur. Our funding sources may prove insufficient to replace deposits at maturity and support our future growth. We must maintain sufficient funds to respond to the needs of depositors and borrowers. As a part of our liquidity management, we use a number of funding sources in addition to core deposit growth and repayments and maturities of loans and investments. As we continue to grow, we are likely to become more dependent on these sources, which may include Federal Home Loan Bank advances, proceeds from the sale of loans, federal funds purchased and brokered certificates of deposit. Adverse operating results or changes in industry conditions could lead to difficulty or an inability to access these additional funding sources. Our financial flexibility will be severely constrained if we are unable to maintain our access to funding or if adequate financing is not available to accommodate future growth at acceptable interest rates. If we are required to rely more heavily on more expensive funding sources to support future growth, our revenues may not increase proportionately to cover our costs. In this case, our operating margins and profitability would be adversely affected. Risks Related to Competitive Matters Consumers may decide to use alternative options to complete financial transactions. Technology is allowing parties to complete financial transactions through alternative methods that historically have involved banks. Consumers can now easily access historically banking needs through online banking accounts, brokerage accounts, mutual funds or general-purpose reloadable prepaid cards. Consumers can also complete certain transactions without the assistance of banks. The removal of banking with financial transactions could result in the loss of customer loans, customer deposits, and the related fee income generated from those loans and deposits. The loss of these revenue streams and the lower cost of deposits as a source of funds could have a material adverse effect on our financial condition and results of operations. Strong competition within our market areas may limit our growth and profitability. Competition in the banking and financial services industry is intense. In our market areas, we compete with commercial banks, savings institutions, mortgage brokerage firms, credit unions, finance companies, mutual funds, money market funds, insurance companies, and brokerage firms operating locally and elsewhere. Some of our competitors have greater name recognition and market presence and offer certain services that we do not or cannot provide, all of which benefit them in attracting business. In addition, larger competitors may be able to price loans and deposits more aggressively than we do. Competitive factors driven by consumer sentiment or otherwise can also reduce our ability to generate fee income, such as through overdraft fees. Risks Related to Mortgage Banking Operations Secondary mortgage market conditions could have a material impact on our financial condition and results of operations. Our mortgage banking operations provide a significant portion of our non-interest income. In addition to being affected by interest rates, the secondary mortgage markets are also subject to investor demand for residential mortgage loans and increased investor yield requirements for these loans. These conditions may fluctuate or worsen in the future. In light of current conditions, there is greater risk in retaining mortgage loans pending their sale to investors. We believe our ability to retain fixed-rate residential mortgage loans is limited. As a result, a prolonged period of secondary market illiquidity may reduce our loan production volumes and could have a material adverse effect on our financial condition and results of operations. Changes in the programs offered by secondary market purchasers or our ability to qualify for their programs may reduce our mortgage banking revenues, which would negatively impact our non-interest income. We generate mortgage revenues primarily from gains on the sale of single-family mortgage loans pursuant to programs currently offered by Fannie Mae, Freddie Mac, Ginnie Mae and non-GSE investors. These entities account for a substantial portion of the secondary market in residential mortgage loans. Any future changes in these programs, our eligibility to participate in such programs, the criteria for loans to be accepted or laws that significantly affect the activity of such entities could, in turn, materially adversely affect our results of operations. If we are required to repurchase mortgage loans that we have previously sold, it could negatively affect our earnings. One of our primary business operations is our mortgage banking, which involves originating residential mortgage loans for sale in the secondary market under agreements that contain representations and warranties related to, among other things, the origination and characteristics of the mortgage loans. We may be required to repurchase mortgage loans that we have sold in cases of borrower default or breaches of these representations and warranties. If we are required to repurchase mortgage loans or provide indemnification or other recourse, this could increase our costs and thereby affect our future earnings. - 34 - Risks Related to Economic Matters Changes in economic conditions could adversely affect our earnings, as our borrowers’ ability to repay loans and the value of the collateral securing our loans decline. Economic conditions have an impact, to some extent, on our overall performance. Conditions such as an economic recession, rising unemployment, changes in interest rates, money supply and other factors beyond our control may adversely affect our asset quality, deposit levels and loan demand and, therefore, our earnings. Because a majority of our loans are secured by real estate, decreases in real estate values could adversely affect the value of property used as collateral. Adverse changes in the economy may also have a negative effect on the ability of our borrowers to make timely repayments of their loans, which could have an adverse impact on our earnings. Consequently, declines in the economy in our market area could have a material adverse effect on our financial condition and results of operations. Because most of our borrowers are located in the Milwaukee, Wisconsin metropolitan area, a prolonged downturn in the local economy, or a decline in local real estate values, could cause an increase in nonperforming loans or a decrease in loan demand, which would reduce our profits. Substantially all of our loans are secured by real estate located in our primary market area. Weakness in our local economy and our local real estate markets could adversely affect the ability of our borrowers to repay their loans and the value of the collateral securing our loans, which could adversely affect our results of operations. Real estate values are affected by various factors, including supply and demand, changes in general or regional economic conditions, interest rates, governmental rules or policies and natural disasters. Weakness in economic conditions also could result in reduced loan demand and a decline in loan originations. In particular, a significant decline in real estate values would likely lead to a decrease in new loan originations and increased delinquencies and defaults by our borrowers. Risks Related to Accounting Matters Changes in our accounting policies or in accounting standards could materially affect how we report our financial condition and results of operations. Our accounting policies are essential to understanding our financial condition and results of operations. Some of these policies require the use of estimates and assumptions that may affect the value of our assets or liabilities and financial results. Some of our accounting policies are critical because they require management to make difficult, subjective, and complex judgments about matters that are inherently uncertain, and because it is likely that materially different amounts would be reported under different conditions or using different assumptions. If such estimates or assumptions underlying our financial statements are incorrect, we may experience material losses. From time to time, the Financial Accounting Standards Board and the Securities and Exchange Commission change the financial accounting and reporting standards or the interpretation of those standards that govern the preparation of our financial statements. These changes are beyond our control, can be hard to predict and could materially affect how we report our financial condition and results of operations. We could also be required to apply a new or revised standard retroactively, which may result in our restating our prior period financial statements. The need to account for certain assets at estimated fair value may adversely affect our results of operations. We report certain assets, such as loans held for sale, at estimated fair value. Generally, for assets that are reported at fair value, we use quoted market prices or valuation models that utilize observable market inputs to estimate fair value. Because we carry these assets on our books at their estimated fair value, we may incur losses even if the asset in question presents minimal credit risk. Other Risks Related to Our Business A protracted government shutdown may result in reduced loan originations and related gains on sale and could negatively affect our financial condition and results of operations. Our mortgage banking operations provide a significant portion of our non-interest income. During any protracted federal government shutdown, we may not be able to close certain loans and we may not be able to recognize non-interest income on the sale of loans. Some of the loans we originate are sold directly to government agencies, and some of these sales may be unable to be consummated during the shutdown. In addition, we believe that some borrowers may determine not to proceed with their home purchase and not close on their loans, which would result in a permanent loss of the related non-interest income. A federal government shutdown could also result in reduced income for government employees or employees of companies that engage in business with the federal government, which could result in greater loan delinquencies, increases in our nonperforming, criticized and classified assets and a decline in demand for our products and services. - 35 - Legal and regulatory proceedings and related matters could adversely affect us or the financial services industry in general. We, and other participants in the financial services industry upon whom we rely to operate, have been and may in the future become involved in legal and regulatory proceedings. Most of the proceedings we consider to be in the normal course of our business or typical for the industry; however, it is inherently difficult to assess the outcome of these matters, and other participants in the financial services industry or we may not prevail in any proceeding or litigation. Any litigation or regulatory proceeding could entail substantial costs and divert management’s attention away from our operations, and any adverse determination could have a materially adverse effect on our business, brand or image, or our financial condition and results of our operations. We are currently a defendant in multiple lawsuits alleging that Waterstone Mortgage Corporation violated certain provisions of the Fair Labor Standards Act. Although we intend to vigorously defend our interests in this matter and pursue all possible defenses against the claims, we may ultimately be required to pay significant damages and attorney fees, which would adversely affect our financial condition and results of operations. See Note 14 - Commitments, Off-Balance Sheet Arrangements, and Contingent Liabilities of the notes to consolidated financial statements for additional information. We will be required to transition from the use of LIBOR in the future. We have certain loans indexed to LIBOR to calculate the loan interest rate. The LIBOR index will be discontinued for U.S. Dollar settings effective June 30, 2023. At this time, no consensus exists as to what rate or rates may become acceptable alternatives to LIBOR. The implementation of a substitute index or indices for the calculation of interest rates under our loan agreements with our borrowers may incur significant expenses in effecting the transition, may result in reduced loan balances if borrowers do not accept the substitute index or indices, and may result in disputes or litigation with customers over the appropriateness or comparability to LIBOR of the substitute index or indices, which could have an adverse effect on our results of operations. Additionally, since alternative rates are calculated differently, the transition may change our market risk profile, requiring changes to risk and pricing models. Changes in the valuation of our securities portfolio could adversely affect our profits. Our securities portfolio may be impacted by fluctuations in fair value, potentially reducing accumulated other comprehensive income and/or earnings. Fluctuations in fair value may be caused by changes in market interest rates, lower market prices for securities and limited investor demand. Management evaluates securities for other-than-temporary impairment on a monthly basis, with more frequent evaluation for selected issues. In analyzing a debt issuer’s financial condition, management considers whether the securities are issued by the federal government or its agencies, whether downgrades by bond rating agencies have occurred, industry analysts’ reports and, to a lesser extent given the relatively insignificant levels of depreciation in our debt portfolio, spread differentials between the effective rates on instruments in the portfolio compared to risk-free rates. In analyzing an equity issuer’s financial condition, management considers industry analysts’ reports, financial performance and projected target prices of investment analysts within a one-year time frame. If this evaluation shows impairment to the actual or projected cash flows associated with one or more securities, a potential loss to earnings may occur. Changes in interest rates can also have an adverse effect on our financial condition, as our available-for-sale securities are reported at their estimated fair value, and therefore are impacted by fluctuations in interest rates. We increase or decrease our stockholders’ equity by the amount of change in the estimated fair value of the available-for-sale securities, net of taxes. The declines in fair value could result in other-than-temporary impairments of these assets, which would lead to accounting charges that could have a material adverse effect on our net income and capital levels. New lines of business or new products and services may subject us to additional risks. From time to time, we may implement new lines of business or offer new products and services within existing lines of business. In addition, we will continue to make investments in research, development, and marketing for new products and services. There are substantial risks and uncertainties associated with these efforts, particularly in instances where the markets are not fully developed. In developing and marketing new lines of business and/or new products and services we may invest significant time and resources. Initial timetables for the development and introduction of new lines of business and/or new products or services may not be achieved and price and profitability targets may not prove feasible. Furthermore, if customers do not perceive our new offerings as providing significant value, they may fail to accept our new products and services. External factors, such as compliance with regulations, competitive alternatives, and shifting market preferences, may also impact the successful implementation of a new line of business or a new product or service. Furthermore, the burden on management and our information technology of introducing any new line of business and/or new product or service could have a significant impact on the effectiveness of our system of internal controls. Failure to successfully manage these risks in the development and implementation of new lines of business or new products or services could have a material adverse effect on our business, financial condition and results of operations. Increasing scrutiny and evolving expectations from customers, regulators, investors, and other stakeholders with respect to our environmental, social and governance practices may impose additional costs on us or expose us to new or additional risks. Companies are facing increasing scrutiny from customers, regulators, investors, and other stakeholders related to their environmental, social and governance (“ESG”) practices and disclosure. Investor advocacy groups, investment funds and influential investors are also increasingly focused on these practices, especially as they relate to the environment, health and safety, diversity, labor conditions and human rights. Increased ESG related compliance costs could result in increases to our overall operational costs. Failure to adapt to or comply with regulatory requirements or investor or stakeholder expectations and standards could negatively impact our reputation, ability to do business with certain partners, and our stock price. New government regulations could also result in new or more stringent forms of ESG oversight and expanding mandatory and voluntary reporting, diligence, and disclosure. - 36 - Acquisitions may disrupt our business and dilute stockholder value. We regularly evaluate merger and acquisition opportunities with other financial institutions and financial services companies. As a result, negotiations may take place and future mergers or acquisitions involving cash, debt, or equity securities may occur at any time. We would seek acquisition partners that offer us either significant market presence or the potential to expand our market footprint and improve profitability through economies of scale or expanded services. Acquiring other banks, businesses, or branches may have an adverse effect on our financial results and may involve various other risks commonly associated with acquisitions, including, among other things: • difficulty in estimating the value of the target company; • payment of a premium over book and market values that may dilute our tangible book value and earnings per share in the short and long term; • potential exposure to unknown or contingent tax or other liabilities of the target company; • exposure to potential asset quality problems of the target company; • potential volatility in reported income associated with goodwill impairment losses; • difficulty and expense of integrating the operations and personnel of the target company; • inability to realize the expected revenue increases, cost savings, increases in geographic or product presence, and/or other projected benefits; • potential disruption to our business; • potential diversion of our management’s time and attention; • the possible loss of key employees and customers of the target company; and • potential changes in banking or tax laws or regulations that may affect the target company. Various factors may make takeover attempts more difficult to achieve. Our articles of incorporation and bylaws, federal regulations, Maryland law, shares of restricted stock and stock options that we have granted or may grant to employees and directors and stock ownership by our management and directors, and various other factors may make it more difficult for companies or persons to acquire control of Waterstone Financial without the consent of our board of directors. A shareholder may want a takeover attempt to succeed because, for example, a potential acquiror could offer a premium over the then prevailing price of our common stock. Item 1B. Unresolved Staff Comments None - 37 - Item 2. Properties We operate from our corporate center, our 14 full-service banking offices, our drive-through office and 14 automated teller machines, located in Milwaukee, Washington and Waukesha Counties, Wisconsin. The net book value of our premises, land, equipment and leasehold improvements was $22.3 million at December 31, 2021. The following table sets forth information with respect to our corporate center and our full-service banking offices as of December 31, 2021. Corporate Center 11200 West Plank Court Wauwatosa, Wisconsin 53226 Wauwatosa 7500 West State Street Wauwatosa, Wisconsin 53213 Brookfield (1) 17495 W Capitol Dr. Brookfield, Wisconsin 53045 Franklin/Hales Corners 6555 South 108th Street Franklin, Wisconsin 53132 Germantown/Menomonee Falls W188N9820 Appleton Avenue Germantown, Wisconsin 53022 Oak Creek 6560 South 27th Street Oak Creek, Wisconsin 53154 Oconomowoc/Lake Country (1) 1233 Corporate Center Drive Oconomowoc, Wisconsin 53066 Pewaukee 1230 George Towne Drive Pewaukee, Wisconsin 53072 Waukesha/Brookfield 21505 East Moreland Blvd. Waukesha, Wisconsin 53186 West Allis/Greenfield Avenue 10101 West Greenfield Avenue West Allis, Wisconsin 53214 Fox Point/North Shore 8607 North Port Washington Road Fox Point, Wisconsin 53217 Greenfield/Loomis Road 5000 West Loomis Road Greenfield, Wisconsin 53220 West Allis/National Avenue 10296 West National Avenue West Allis, Wisconsin 53227 Oak Creek/Howell Avenue 8780 South Howell Avenue Oak Creek, Wisconsin 53154 Milwaukee/Oklahoma Avenue 6801 West Oklahoma Avenue Milwaukee, WI 53219 (1) Leased property In addition to our banking offices, as of December 31, 2021, Waterstone Mortgage Corporation had 11 offices in New Mexico, nine offices in Florida, seven offices in Wisconsin, three offices in each of Arizona, Colorado, Illinois, Oklahoma, and Texas, two offices in each of Idaho, Minnesota, Ohio, and Pennsylvania, and one office in each of Alabama, Arkansas, California, Georgia, Indiana, Iowa, Maryland, Michigan, New Hampshire, and Tennessee. Item 3. Legal Proceedings See Note 14 - Commitments, Off-Balance Sheet Arrangements, and Contingent Liabilities of the notes to consolidated financial statements for additional information. Item 4. Mine Safety Disclosures Not applicable. - 38 - Part II Item 5. Market for Registrant's Common Equity and Related Stockholder Matters and Issuer Purchase of Equity Securities Our shares of common stock are traded on the NASDAQ Global Select Market® under the symbol WSBF. The approximate number of shareholders of record of Waterstone common stock as of February 25, 2022 was 1,400. On that same date there were 24,230,968 shares of common stock issued and outstanding. Following are the Company's monthly common stock repurchases during the fourth quarter of 2021. Period Total Number of Shares Purchased Average Price Paid per Share Total Number of Shares Purchased as Part of Publicly Announced Plans Maximum Number of Shares that May Yet Be Purchased Under the Plan (a) October 1, 2021 - October 31, 2021 89,440 $ 20.43 89,440 669,943 November 1, 2021 - November 30, 2021 77,797 20.91 77,797 592,146 December 1, 2021 - December 31, 2021 96,474 21.37 96,474 3,449,226 Total 263,711 $ 20.91 263,711 3,449,226 (a) On December 10, 2021, the Board of Directors announced the termination of the then-existing stock repurchase plan and authorized the repurchase of 3,500,000 shares of common stock pursuant to a new share repurchase plan. This plan has no expiration date. - 39 - PERFORMANCE GRAPH Set forth below is a line graph comparing the cumulative total shareholder return on Waterstone Financial common stock, based on the market price of the common stock and assuming reinvestment of cash dividends, with the cumulative total return of companies on the SNL Thrift NASDAQ Index and the Russell 2000. The graph assumes $100 was invested on December 31, 2016, in Waterstone Financial, Inc. common stock and each of those indices. Waterstone Financial, Inc. Index 12/31/16 12/31/17 12/31/18 12/31/19 12/31/20 12/31/21 Waterstone Financial, Inc. 100.00 97.54 101.45 122.15 130.99 162.32 S&P Composite 1500 Thrifts & Mortgage Finance Index 100.00 107.60 87.31 118.66 112.03 138.18 Russell 2000 Index 100.00 114.65 102.02 128.06 153.62 176.39 Item 6 . [Reserved] Item 7. Management's Discussion and Analysis of Financial Condition and Results of Operations Overview The following discussion and analysis is presented to assist the reader in understanding and evaluating of the Company's financial condition and results of operations. It is intended to complement the consolidated financial statements, footnotes, and supplemental financial data appearing elsewhere in this Annual Report on Form 10-K and should be read in conjunction therewith. The detailed discussion in the sections below focuses on the results of operations for the year ended December 31, 2021, compared to the year ended December 2020, and the financial condition as of December 31, 2021 compared to the financial condition as of December 31, 2020. - 40 - As described in the notes to consolidated financial statements, we have two reportable segments: community banking and mortgage banking. The community banking segment provides consumer and business banking products and services to customers. Consumer products include loan products, deposit products, and personal investment services. Business banking products include loans for working capital, inventory and general corporate use, commercial real estate construction loans, and deposit accounts. The mortgage banking segment, which is conducted through Waterstone Mortgage Corporation, consists of originating residential mortgage loans primarily for sale in the secondary market. Our community banking segment generates the significant majority of our consolidated net interest income and requires the significant majority of our provision for 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 year ended December 31, 2021, compared the year ended December 31, 2020, which focuses on noninterest income and noninterest expenses. We have also provided a discussion of the consolidated operations of Waterstone Financial, which includes the consolidated operations of WaterStone Bank and Waterstone Mortgage Corporation, for the same periods. For a discussion of our results of operations for the year ended December 31, 2020 compared to the year ended December 31, 2019, see “Part II, Item 7: Management’s Discussion and Analysis of Financial Condition and Results of Operations” Discussion of Results of Operations included in our 2020 Form 10-K, filed with the SEC on March 2, 2021. Significant Items Earnings comparisons among the three years ended December 31, 2021 and 2020 were impacted by the Significant Items summarized below. There were no Significant Items during the year ended December 31, 2019. COVID-19 and the CARES 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. Congress, the President, and the Federal Reserve have taken several actions designed to cushion the economic fallout. Most notably, the Coronavirus Aid, Relief and Economic Security (“CARES”) Act was signed into law at the end of March 2020 as a $2 trillion legislative package. The goal of the CARES Act has been 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 included extensive emergency funding for hospitals and providers. 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. • The CARES Act allows 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 recently-enacted 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 December 31, 2021 and 2020 financial statements 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 impacted loans which involved principal deferrals or principal and interest deferrals are considered current. A financial institution suspended the requirements under GAAP for loan modifications related to COVID-19 that would otherwise be categorized as a troubled debt restructuring (“TDR”). 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 December 31, 2021 and 2020, the Company had modified three loans totaling $405,000 and $1.2 million, respectively, consisting of principal deferrals or principal and interest deferrals. In accordance with the CARES Act issued in April 2020 and the Consolidated Appropriations Act, 2021 signed in December 2020, 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 (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); 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 year ended December 31, 2021, the Company recognized $1.2 million in fees received from the SBA. During the year ended December 31, 2020, the Company originated a total of $30.1 million in PPP loans for customers and recognized $480,000 in fees received from the SBA. As of December 31, 2021 and 2020, we have PPP loans outstanding totaling $1.8 million and $18.1 million, respectively. - 41 - Capital and liquidity As of December 31, 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 causes large numbers of our deposit customers to withdraw their funds, we might become more reliant on volatile or more expensive sources of funding. Critical Accounting Policies Critical accounting policies are those that involve significant judgments and assumptions by management and that have, or could have, a material impact on our income or the carrying value of our assets. Allowance for Loan Losses. WaterStone Bank establishes valuation allowances on loans deemed to be impaired. A loan is considered impaired when, based on current information and events, it is probable that WaterStone Bank will not be able to collect all amounts due according to the contractual terms of the loan agreement. A valuation allowance is established for an amount equal to the impairment when the carrying amount of the loan exceeds the present value of the expected future cash flows, discounted at the loan’s original effective interest rate or the fair value of the underlying collateral (specific component). WaterStone Bank recognizes the change in present value of expected future cash flows on impaired loans attributable to the passage of time as bad debt expense. On an ongoing basis, at least quarterly for financial reporting purposes, the fair value of collateral dependent impaired loans and real estate owned is determined or reaffirmed by the following procedures: ● Obtaining updated real estate appraisals or performing updated discounted cash flow analysis; ● Confirming that the physical condition of the real estate has not significantly changed since the last valuation date; ● Comparing the estimated current book value to that of updated sales values experienced on similar real estate owned; ● Comparing the estimated current book value to that of updated values seen on more current appraisals of similar properties; and ● Comparing the estimated current book value to that of updated listed sales prices on our real estate owned and that of similar properties (not owned by the Company). WaterStone Bank also establishes valuation allowances based on an evaluation of the various risk components that are inherent in the credit portfolio (general component). The risk components that are evaluated include past loan loss experience; the level of non-performing and classified assets; current economic conditions; volume, growth, and composition of the loan portfolio; adverse situations that may affect the borrower’s ability to repay; the estimated value of any underlying collateral; regulatory guidance; and other relevant factors. The allowance is increased by provisions charged to earnings and recoveries of previously charged-off loans and reduced by charge-offs. Charge-offs approximate the amount by which the outstanding principal balance exceeds the estimated net realizable value of the underlying collateral. The appropriateness of the allowance for loan losses is reviewed and approved quarterly by the WaterStone Bank Board of Directors. The allowance reflects management’s best estimate of the amount needed to provide for the probable loss on impaired loans and other inherent losses in the loan portfolio, and is based on a risk model developed and implemented by management and approved by the WaterStone Bank Board of Directors. Actual results could differ from this estimate, and future additions to the allowance may be necessary based on unforeseen changes in loan quality and economic conditions. More specifically, if our future charge-off experience increases substantially from our past experience, or if the value of underlying loan collateral, in our case mostly real estate, declines in value by a substantial amount, or if unemployment in our primary market area increases significantly, our allowance for loan losses may be inadequate and we will incur higher provisions for loan losses and lower net income in the future. - 42 - In addition, state and federal regulators periodically review the WaterStone Bank allowance for loan losses. Such regulators have the authority to require WaterStone Bank to recognize additions to the allowance at the time of their examination. Income Taxes. The Company and its subsidiaries file consolidated federal, combined state income tax, and separate state income tax returns. The provision for income taxes is based upon income in the consolidated financial statements, rather than amounts reported on the income tax return. Deferred tax assets and liabilities are recognized for the future tax consequences attributable to differences between the financial statement carrying amounts of existing assets and liabilities and their respective tax bases as well as for net operating loss carry forwards. Deferred tax assets and liabilities are measured using enacted tax rates expected to apply to taxable income in the years in which those temporary differences are expected to be recovered or settled. The effect on deferred tax assets and liabilities of a change in tax rates is recognized as income or expense in the period that includes the enactment date. Under generally accepted accounting principles, a valuation allowance is required to be recognized if it is “more likely than not” that a deferred tax asset will not be realized. The determination of the realizability of deferred tax assets is highly subjective and dependent upon judgment concerning management's evaluation of both positive and negative evidence, the forecasts of future income, applicable tax planning strategies, and assessments of current and future economic and business conditions. Examples of positive evidence may include the existence of taxes paid in available carry-back years as well as the probability that taxable income will be generated in future periods. Examples of negative evidence may include cumulative losses in a current year and prior two years and general business and economic trends. Positions taken in the Company’s tax returns are subject to challenge by the taxing authorities upon examination. The benefit of uncertain tax positions are initially recognized in the financial statements only when it is more likely than not that the position will be sustained upon examination by the tax authorities. Such tax positions are both initially and subsequently measured as the largest amount of tax benefit that has a greater than 50% likelihood of being realized upon settlement with the tax authority, assuming full knowledge of the position and all relevant facts. Interest and penalties on income tax uncertainties are classified within income tax expense in the consolidated statements of operations. Fair Value Measurements. The Company determines the fair value of its assets and liabilities in accordance with ASC 820. ASC 820 establishes a standard framework for measuring and disclosing fair value under generally accepted accounting principles. A number of valuation techniques are used to determine the fair value of assets and liabilities in the Company’s financial statements. The valuation techniques include quoted market prices for investment securities, appraisals of real estate from independent licensed appraisers and other valuation techniques. Fair value measurements for assets and liabilities where limited or no observable market data exists are based primarily upon estimates, and are often calculated based on the economic and competitive environment, the characteristics of the asset or liability and other factors. Therefore, the valuation results cannot be determined with precision and may not be realized in an actual sale or immediate settlement of the asset or liability. Additionally, there are inherent weaknesses in any calculation technique, and changes in the underlying assumptions used, including discount rates and estimates of future cash flows, could significantly affect the results of current or future values. Significant changes in the aggregate fair value of assets and liabilities required to be measured at fair value or for impairment are recognized in the consolidated statements of operations under the framework established by generally accepted accounting principles. Recent Accounting Pronouncements. In June 2016, the FASB issued ASU 2016-13, Financial Instruments – Credit Losses (Topic 326): Measurement of Credit Losses on Financial Instruments amended the incurred loss impairment methodology in current GAAP with a methodology that reflects expected credit losses and requires consideration of a broader range of reasonable and supportable information for credit loss estimates. The measurement of expected credit losses is based on relevant information about past events, including historical experience, current conditions, and reasonable and supportable forecasts that affect the collectability of the reported amount. The authoritative guidance also requires a financial asset (or a group of financial assets) measured at amortized cost basis to be presented at the net amount expected to be collected (net of the allowance for credit losses). In addition, the credit losses relating to available-for-sale (AFS) debt securities should be recorded through an allowance for credit losses rather than a write-down. Based on our current analysis, we estimate that the impact of the standard on the allowance for credit losses ("ACL") as of December 31, 2021, would have been within a range of no change to a 10% increase and is in the process of finalizing the review of the most recent model run and the related underlying assumptions . Within the ACL calculation, we generally expect the ACL to be lower for commercial loans as they are shorter duration loans compared to the longer duration residential and real estate loans. We expect the standard may potentially have a material impact on the financial statements and we expect more volatility in the credit loss estimate over economic cycles. The ACL related to AFS securities is immaterial as the portfolio consists entirely of municipal securities with low expected losses. This estimate is subject to change based on continuing review of the models, assumptions, methodologies and judgments. Going forward, the quarterly evaluation of the allowance for loan losses will likely introduce additional volatility to earnings from changes in economic conditions and forecasts, as well as changes in the underlying loan portfolio. Refer to Note 1 of our consolidated financial statements for a description of recent accounting pronouncements including the respective dates of adoption and effects on results of operations and financial condition. - 43 - Selected Financial Data The summary financial information presented below is derived in part from the Company’s audited financial statements, although the table itself is not audited. At or for the Year Ended December 31, 2021 2020 2019 2018 2017 (In Thousands, except per share amounts) Selected Financial Condition Data: Total assets $ $2,215,858 $ $2,184,587 $ $1,996,347 $ $1,915,381 $ $1,806,401 Cash and cash equivalents 376,722 94,767 74,300 86,101 48,607 Securities available for sale 179,016 159,619 178,476 185,720 199,707 Loans held for sale 312,738 402,003 220,123 141,616 149,896 Loans receivable 1,205,785 1,375,137 1,388,031 1,379,148 1,291,814 Allowance for loan losses 15,778 18,823 12,387 13,249 14,077 Loans receivable, net 1,190,007 1,356,314 1,375,644 1,365,899 1,277,737 Real estate owned, net 148 322 748 2,152 4,558 Deposits 1,233,386 1,184,870 1,067,776 1,038,495 967,380 Borrowings 477,127 508,074 483,562 435,046 386,285 Total shareholders' equity 432,773 413,118 393,686 399,679 412,104 Selected Operating Data: Interest income $ $69,883 $ $78,484 $ $79,741 $ $73,700 $ $67,095 Interest expense 14,368 24,984 27,544 19,523 16,362 Net interest income 55,515 53,500 52,197 54,177 50,733 Provision for loan losses (3,990 ) 6,340 (900 ) (1,060 ) (1,166 ) Net interest income after provision for loan losses 59,505 47,160 53,097 55,237 51,899 Noninterest income 203,195 244,017 130,750 118,199 124,413 Noninterest expense 170,594 183,061 136,273 133,156 131,879 Income before income taxes 92,106 108,116 47,574 40,280 44,433 Provision for income taxes 21,315 26,971 11,671 9,526 18,469 Net income $ $70,791 $ $81,145 $ $35,903 $ $30,754 $ $25,964 Per common share: Income per share - basic $ $2.98 $ $3.32 $ $1.38 $ $1.12 $ $0.95 Income per share - diluted $ $2.96 $ $3.30 $ $1.37 $ $1.11 $ $0.93 Book value $ $17.45 $ $16.47 $ $14.50 $ $14.04 $ $13.97 Dividends declared $ $1.80 $ $1.36 $ $0.98 $ $0.98 $ $0.98 - 44 - At or for the Year Ended December 31, 2021 2020 2019 2018 2017 Selected Financial Ratios and Other Data: Performance Ratios: Return on average assets 3.20 % 3.77 % 1.82 % 1.64 % 1.43 % Return on average equity 16.38 20.18 9.14 7.60 6.32 Interest rate spread (1) 2.47 2.34 2.44 2.75 2.69 Net interest margin (2) 2.68 2.67 2.83 3.09 3.00 Noninterest expense to average assets 7.71 8.50 6.91 7.12 7.29 Efficiency ratio (3) 65.94 61.53 74.49 77.25 75.30 Average interest-earning assets to average interest-bearing liabilities 130.76 126.07 126.40 130.14 131.86 Dividend payout ratio (4) 43.62 38.55 71.01 87.50 103.16 Capital Ratios: Waterstone Financial, Inc.: Equity to total assets at end of period 19.53 % 18.91 % 19.72 % 20.87 % 22.81 % Average equity to average assets 19.53 18.68 19.91 21.63 22.70 Total capital to risk-weighted assets 29.01 24.80 26.17 28.22 30.75 Tier 1 capital to risk-weighted assets 27.99 23.71 25.37 27.32 29.74 Common equity tier 1 capital to risk-weighted assets 27.99 23.71 25.37 27.32 29.74 Tier 1 capital to average assets 19.29 18.38 19.69 21.06 22.43 WaterStone Bank: Total capital to risk-weighted assets 25.52 22.52 22.85 26.95 28.93 Tier I capital to risk-weighted assets 24.50 21.44 22.05 26.05 27.92 Common equity tier 1 capital to risk-weighted assets 24.50 21.44 22.05 26.05 27.92 Tier I capital to average assets 16.88 16.61 17.11 20.08 21.10 Asset Quality Ratios: Allowance for loan losses as a percent of total loans 1.31 % 1.37 % 0.89 % 0.96 % 1.09 % Allowance for loan losses as a percent of non-performing loans 283.06 338.54 176.33 202.12 231.99 Net (recoveries) charge-offs to average outstanding loans during the period (0.07 ) (0.01 ) 0.00 (0.02 ) 0.06 Non-accrual or performing loans as a percent of total loans 0.46 0.40 0.51 0.48 0.47 Non-performing assets as a percent of total assets 0.26 0.27 0.39 0.45 0.59 Other Data: Number of full-service banking offices 14 14 13 11 11 Number of full-time equivalent employees 870 812 824 888 927 (1) Represents the difference between the weighted average yield on average interest-earning assets and the weighted average cost of interest-bearing liabilities. (2) Represents net interest income as a percent of average interest-earning assets. (3) Represents noninterest expense divided by the sum of net interest income and noninterest income. (4) Represents dividends paid per share divided by basic earnings per share. Comparison of Consolidated Waterstone Financial, Inc. Financial Condition at December 31, 2021 and at December 31, 2020 Total Assets. Total assets increased by $31.3 million, or 1.4%, to $2.22 billion at December 31, 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 retained earnings, due to net income. Cash and Cash Equivalents. Cash and cash equivalents increased $282.0 million to $376.7 million at December 31, 2021 from $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, as well as paydowns of loans receivable and loans held for sale. Offsetting the increases, cash and cash equivalents decreased primarily due to the use of cash to pay dividends and repurchase shares since December 31, 2020. Securities Available for Sale . Securities available for sale increased by $19.4 million to $179.0 million at December 31, 2021 from $159.6 million at December 31, 2020. 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 $89.3 million, or 22.2%, to $312.7 million at December 31, 2021 from $402.0 million at December 31, 2020 due to the decrease of refinancing activity resulting from the increase in mortgage rates. - 45 - Loans Receivable . Loans receivable held for investment decreased $169.4 million, or 12.3%, to $1.21 billion at December 31, 2021 from $1.38 billion at December, 31, 2020. The decrease in total loans receivable was attributable to decreases in each of the one- to four-family, multi-family, home equity, commercial, and consumer loan categories. Allowance for Loan Losses. The allowance for loan losses decreased $3.0 million to $15.8 million at December 31, 2021 from $18.8 million at December 31, 2020. The overall decrease was primarily related to each of the one- to four-family, multi-family, home equity, construction and land, commercial real estate, consumer, and commercial categories. See Note 3 for further discussion on the allowance for loan losses. Real Estate Owned. Total real estate owned decreased $174,000 to $148,000 at December 31, 2021, compared to $322,000 at December 31, 2020. During the year ended December 31, 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 year ended December 31, 2021. Prepaid Expenses and Other Assets. Total prepaid expenses and other assets decreased $12.4 million to $45.1 million at December 31, 2021 from $57.5 million at December 31, 2020. 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. Deposits increased by $48.5 million to $1.23 billion at December 31, 2021, from $1.18 billion at December 31, 2020. The increase was driven by an increase of $97.0 million in money market and savings deposits and $26.2 million in demand deposits offset by a decrease of $74.7 million in time deposits. Borrowings. Total borrowings decreased $30.9 million to $477.1 million at December 31, 2021, from $508.1 million at December 31, 2020. 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 $6.9 million to $2.1 million at December 31, 2021 from $9.0 million at December 31, 2020. Other Liabilities. Other liabilities decreased $6.5 million to $68.5 million at December 31, 2021 compared to $75.0 million at December 31, 2020. Other liabilities decreased primarily due to liabilities resulting from payables due on back-to-back swaps, payment of a legal settlement, accrued compensation, tax escrow checks clearing, and forward commitments to sell loans at the mortgage banking segment offset by an increase in dividends payable as a special dividend was declared in December 2021. Shareholders’ Equity. Shareholders’ equity increased by $19.7 million, or 4.8%, to $432.8 million at December 31, 2021 from $413.1 million at December 31, 2020. Shareholders' equity increased primarily due to net income, and additional paid-in capital as stock options were exercised and equity awards vested. Partially offsetting the increases, there were decreases due to the declaration of regular and special dividends and the repurchase of stock. Comparison of Community Banking Segment Operations for the Years Ended December 31, 2021 and 2020 Net income from our community banking segment for the year ended December 31, 2021 totaled $28.3 million compared to $21.2 million for the year ended December 31, 2020. Net interest income increased $1.4 million to $56.1 million for the year ended December 31, 2021 compared to $54.6 million for the year ended December 31, 2020. Net interest income increased primarily due to a decrease in interest expense as interest on time deposits decreased as replacement rates were lower. Partially offsetting the decrease in interest expense, interest income decreased primarily due to decreases in loan interest and mortgage-related securities interest as replacement rates were lower. 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 $4.1 million for the year ended December 31, 2021 compared to a $6.1 million provision for loan losses for the year ended December 31, 2020. During the year ended December 31, 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 $945,000 during the year ended December 31, 2021. Noninterest income decreased $2.7 million for the year ended December 31, 2021 due primarily to a decrease in loan fees due to fees earned on loan swap originations in 2020. Noninterest income also decreased as we recognized gains from death benefit received on two bank owned life insurance policies during the year ended December 31, 2020. - 46 - Compensation, payroll taxes, and other employee benefits expense increased $61,000 to $20.3 million primarily due to an increase in employee stock ownership plan expenses offset by a decrease in salaries. Data processing expense decreased $245,000 due to the implementation of a new digital banking platform in 2020. Other noninterest expense decreased $533,000 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 Years Ended December 31, 2021 and 2020 Net income totaled $42.5 million for the year ended December 31, 2021 compared to $59.9 million for the year ended December 31, 2020. We originated $4.23 billion in mortgage loans held for sale (including sales to the community banking segment) during the year ended December 31, 2021, which represents a decrease of $201.7 million, or 4.6%, from the $4.43 billion originated during the year ended December 31, 2020. The decrease in loan production volume was driven by a $433.6 million, or 25.2%, decrease in refinance products driven by an increase in fixed mortgage rates. Mortgage purchase products increased $231.9 million, or 8.6% due to an increased housing demand. Total mortgage banking noninterest income decreased $39.1 million, or 16.5%, to $197.6 million during the year ended December 31, 2021 compared to $236.7 million during the year ended December 31, 2020. The decrease in mortgage banking noninterest income was related to an 11.6% decrease in gross margin on loans originated and by a 4.6% decrease in loan production volume for the year ended December 31, 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, 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 69.5% from 61.1% of total originations for the year ended December 31, 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 76.6% and 23.4%, respectively of all loan originations, respectively, during the year ended December 31, 2021, compared to 75.8% and 24.2% of all originations, respectively, during the year ended December 31, 2020. During the year ended December 31, 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. During the year ended December 31, 2020, mortgage servicing rights related to $975.9 million in loans receivable with a book value of $6.4 million were sold at a gain of $600,000. Total compensation, payroll taxes and other employee benefits decreased $4.2 million, or 3.5%, to $115.3 million for the year ended December 31, 2021 compared to $119.4 million for the year ended December 31, 2020 . The decrease 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 primarily due to a $4.25 million legal settlement in 2020 (see further discussion in Note 14 - Commitments, Off-Balance Sheet Arrangements, and Contingent Liabilities of the notes to consolidated financial statements for additional information) along with ongoing litigation costs related to the 2020 settlement. Additionally, the Company received a legal settlement in 2021 offsetting legal expenses. 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. Waterstone Mortgage Corporation originates loans in various states. The states where we originate greater than 10% of total activity are Florida and New Mexico. Comparison of Consolidated Waterstone Financial, Inc. Results of Operations for the Years Ended December 31, 2021 and 2020 Years Ended December 31, 2021 2020 (Dollars in Thousands, except per share amounts) Net income $ 70,791 $ 81,145 Earnings per share - basic 2.98 3.32 Earnings per share - diluted 2.96 3.30 Return on average assets 3.20 % 3.77 % Return on average equity 16.38 % 20.18 % - 47 - Average Balance Sheets, Interest and Yields/Costs The following table set forth average balance sheets, annualized average yields and costs, and certain other information for the periods indicated. Non-accrual loans were included in the computation of the average balances of loans receivable and held for sale. The yields set forth below include the effect of deferred fees, discounts and premiums that are amortized or accreted to interest income or expense. Yields on interest-earning assets are computed on a fully tax-equivalent yield, where applicable. Years Ended December 31, 2021 2020 2019 Average Average Average Average Average Average Balance Interest Rate Balance Interest Rate Balance Interest Rate (Dollars in Thousands) Interest-earning assets: Loans receivable and held for sale (1) $ $1,600,115 64,366 4.02 % $ $1,716,341 72,633 4.23 % $ $1,546,249 72,235 4.67 % Mortgage related securities (2) 103,324 1,954 1.89 % 101,345 2,488 2.45 % 113,659 2,978 2.62 % Debt securities, federal funds sold and short-term investments (2)(3) 366,949 3,827 1.04 % 187,910 3,644 1.94 % 181,897 4,826 2.65 % Total interest-earning assets 2,070,388 70,147 3.39 % 2,005,596 78,765 3.93 % 1,841,805 80,039 4.35 % Noninterest-earning assets 142,040 147,697 131,168 Total assets $ $2,212,428 $ $2,153,293 $ $1,972,973 Interest-bearing liabilities: Demand accounts $ $64,653 50 0.08 % $ $47,410 38 0.08 % $ $36,926 33 0.09 % Money market, savings, and escrow accounts 363,930 904 0.25 % 264,722 1,768 0.67 % 198,027 1,247 0.63 % Time deposits 675,495 3,466 0.51 % 733,033 12,559 1.71 % 737,397 15,998 2.17 % Total interest-bearing deposits 1,104,078 4,420 0.40 % 1,045,165 14,365 1.37 % 972,350 17,278 1.78 % Borrowings 479,262 9,948 2.08 % 545,741 10,619 1.95 % 484,801 10,266 2.12 % Total interest-bearing liabilities 1,583,340 14,368 0.91 % 1,590,906 24,984 1.57 % 1,457,151 27,544 1.89 % Noninterest-bearing liabilities Non-interest bearing deposits 146,767 116,771 90,497 Other non-interest bearing liabilities 50,140 43,460 32,594 Total non-interest bearing liabilities 196,907 160,231 123,091 Total liabilities 1,780,247 1,751,137 1,580,242 Equity 432,181 402,156 392,731 Total liabilities and equity $ $2,212,428 $ $2,153,293 $ $1,972,973 Net interest income / Net interest rate spread (4) 55,779 2.48 % 53,781 2.36 % 52,495 2.46 % Less: taxable equivalent adjustment 264 0.01 % 281 0.02 % 298 0.02 % Net interest income / Net interest rate spread, as reported 55,515 2.47 % 53,500 2.34 % 52,197 2.44 % Net interest-earning assets (5) $ $487,048 $ $414,690 $ $384,654 Net interest margin (6) 2.68 % 2.67 % 2.83 % Tax equivalent effect 0.01 % 0.01 % 0.02 % Net interest margin on a fully tax equivalent basis 2.69 % 2.68 % 2.85 % Average interest-earning assets to average interest-bearing liabilities 130.76 % 126.07 % 126.40 % (1) Includes net deferred loan fee amortization income of $2.1 million, $1.7 million and $672,000 for the years ended December 31, 2021, 2020, and 2019, respectively. (2) Includes available for sale securities. (3) Interest income from tax exempt securities is computed on a taxable equivalent basis using a tax rate of 21% for the years ended December 31, 2021, 2020, and 2019. The yields on debt securities, federal funds sold and short-term investments before tax-equivalent adjustments were 0.97%,1.79%, and 2.49% for the years ended December 31, 2021, 2020, and 2019, 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. There were no out-of-period items or adjustments for either of the years ending December 31, 2021 or 2020. Years Ended December 31, Years Ended December 31, 2021 versus 2020 2020 versus 2019 Increase (Decrease) due to Increase (Decrease) due to Volume Rate Net Volume Rate Net (In Thousands) Interest and dividend income: Loans receivable and held for sale (1) (2) $ ($(3,968) ) $ ($(4,299) ) $ ($(8,267) ) $ $7,543 $ ($(7,145) ) $ $398 Mortgage related securities (3) 47 (581 ) (534 ) (258 ) (232 ) (490 ) Other interest-earning assets (3) (4) 2,398 (2,215 ) 183 154 (1,336 ) (1,182 ) Total interest-earning assets (1,523 ) (7,095 ) (8,618 ) 7,439 (8,713 ) (1,274 ) Interest expense: Demand accounts 12 - 12 9 (4 ) 5 Money market, savings, and escrow accounts 1,285 (2,149 ) (864 ) 439 82 521 Time deposits (915 ) (8,178 ) (9,093 ) (94 ) (3,345 ) (3,439 ) Total interest-bearing deposits 382 (10,327 ) (9,945 ) 354 (3,267 ) (2,913 ) Borrowings (1,481 ) 810 (671 ) 975 (622 ) 353 Total interest-bearing liabilities (1,099 ) (9,517 ) (10,616 ) 1,329 (3,889 ) (2,560 ) Net change in net interest income $ ($(424) ) $ $2,422 $ $1,998 $ $6,110 $ ($(4,824) ) $ $1,286 (1) Includes net deferred loan fee amortization income of $2.1 million, $1.7 million and $672,000 for the years ended December 31, 2021, 2020, and 2019, respectively. (2) Non-accrual loans have been included in average loans receivable balance. (3) Includes available for sale securities. (4) Interest income from tax exempt securities is computed on a taxable equivalent basis using a tax rate of 21% for the years ended December 31, 2021, 2020, and 2019. Net Interest Income Net interest income increased $2.0 million, or 3.8%, to $55.5 million during the year ended December 31, 2021 compared to $53.5 million during the year ended December 31, 2020. • Interest income on loans decreased $8.3 million due primarily to a 21 basis point decrease in average yield on loans as LIBOR and U.S. Treasury rates continued to decrease and a $116.2 million, or 6.8%, decrease in average loans as payoffs continue to outpace originations. The decrease in average loan balance was driven by a decrease of $129.2 million, or 9.2%, in the average balance of loans held in portfolio offset by a $13.0 million, or 4.3%, increase in the average balance of loans held for sale. The yield on average loans decreased 21 basis points to 4.02% from 4.23%. • Interest income from mortgage related securities decreased $534,000 primarily as the yield decreased 56 basis points. Partially offsetting the decrease from yield, the average balance increased $2.0 million. • Interest income from other interest-earning assets (comprised of debt securities, federal funds sold and short-term investments) increased $200,000 due to a $179.0 million increase in average balance of other interest-earning assets. 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 82 basis points as higher rate securities matured and were placed in cash . • Interest expense on time deposits decreased $9.1 million, or 72.4%, primarily due to a 120 basis point decrease in average cost of time deposits. Additionally, the average balance of time deposits decreased $57.5 million compared to the prior year period. - 49 - • Interest expense on money market, savings, and escrow accounts decreased $864,000, or 48.9%, due primarily to a 42 basis point decrease in average cost of money market, savings, and escrow accounts offset by an increase in average balance of $99.2 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 $671,000, or 6.3%, due to a decrease of $66.5 million to $479.3 million in average borrowing volume during the year ended December 31, 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 2.08% during the year ended December 31, 2021, compared to 1.95% during the year ended December 31, 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 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 year allowance using the incurred loss model. The negative provision for loan losses was $4.0 million for the year ended December 31, 2021 compared to a provision for loan losses of $6.3 million for the year ended December 31, 2020. During the year ended December 31, 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. We had a negative provision for loan losses of $4.1 million at the community banking segment and $110,000 in provision for loan losses for the mortgage banking segment. Net recoveries were $945,000 for the year ended December 31, 2021 as loans with prior charge-offs paid in full. 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 Years Ended December 31, 2021 2020 $ Change % Change (Dollars in Thousands) Service charges on loans and deposits $ 3,325 $ 4,462 $ (1,137 ) (25.5 %) Increase in cash surrender value of life insurance 1,615 1,905 (290 ) (15.2 %) Mortgage banking income 191,035 233,245 (42,210 ) (18.1 %) Other 7,220 4,405 2,815 63.9 % Total noninterest income $ 203,195 $ 244,017 $ (40,822 ) (16.7 %) Total noninterest income decreased $40.8 million, or 16.7%, to $203.2 million during the year ended December 31, 2021 compared to $244.0 million during the year ended December 31, 2020. The decrease resulted primarily from a 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 as well as 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 decreased $133.9 million, or 3.1%, to $4.20 billion during the year ended December 31, 2021 compared to $4.33 billion during the year ended December 31, 2020. Gross margin on loans originated and sold decreased 11.6% at the mortgage banking segment. Gross margin on loans originated and sold is the ratio of mortgage banking income (excluding the change in interest rate lock fair value) divided by total loan originations. See "Comparison of Mortgage Banking Segment Results of Operations for the Year December 31, 2021 and 2020" above, for additional discussion of the increase in mortgage banking income. • Service charges on loans and deposits decreased primarily due to fees earned on loan swap originations in 2020 compared to none in 2021. • The decrease in cash surrender value of life insurance was due primarily to a lower average balance as death benefits were received on two policies during the year ended December 31, 2020. • The increase in other noninterest income was due primarily to increases in gain on sale of mortgage servicing rights. During the year ended December 31, 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. During the year ended December 31, 2020, mortgage servicing rights related to $975.9 million in loans receivable with a book value of $6.4 million were sold at a gain of $600,000. 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 year ended December 31, 2020. - 50 - Noninterest Expenses Years Ended December 31, 2021 2020 $ Change % Change (Dollars in Thousands) Compensation, payroll taxes, and other employee benefits $ 135,115 $ 139,046 $ (3,931 ) (2.8 %) Occupancy, office furniture and equipment 9,612 10,223 (611 ) (6.0 %) Advertising 3,528 3,691 (163 ) (4.4 %) Data processing 3,950 3,941 9 0.2 % Communications 1,309 1,329 (20 ) (1.5 %) Professional fees 1,275 8,118 (6,843 ) (84.3 %) Real estate owned 3 (8 ) 11 (137.5 %) Loan processing expense 4,610 4,646 (36 ) (0.8 %) Other 11,192 12,075 (883 ) (7.3 %) Total noninterest expenses $ 170,594 $ 183,061 $ (12,467 ) (6.8 %) Total noninterest expenses decreased $12.5 million, or 6.8%, to $170.6 million during the year ended December 31, 2021 compared to $183.1 million during the year ended December 31, 2020. • Compensation, payroll taxes and other employee benefit expense at our mortgage banking segment decreased $4.2 million, or 3.5%, to $115.3 million for the year ended December 31, 2021. The decrease 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 $61,000, or 0.3%, to $20.3 million during the year ended December 31, 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 $704,000 to $5.8 million during the year ended December 31, 2021 compared to the prior year resulting from lower rent and depreciation expense. • Occupancy, office furniture and equipment expense at the community banking segment increased $93,000 to $3.8 million during the year ended December 31, 2021 compared to the prior year. The increase was due primarily to snow plowing and computer supplies expenses. • Advertising expense decreased $102,000 at the mortgage banking segment and $61,000 at the community banking segment as both segments were less promotional in 2021. • Professional fees expense decreased $6.8 million to $1.3 million 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 (see further discussion in Note 14 - Commitments, Off-Balance Sheet Arrangements, and Contingent Liabilities of the notes to consolidated financial statements for additional information) and ongoing litigation costs. • Other noninterest expense decreased $883,000 for the year ended December 31, 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 decreased $5.7 million to $21.3 million during the year ended December 31, 2021, compared to $27.0 million during the year ended December 31, 2020 as pretax income decreased $16.0 million. Income tax expense was recognized during the year ended December 31, 2021 at an effective rate of 23.1% compared to an effective rate of 24.9% during the year ended December 31, 2020. During the year ended December 31, 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 year ended December 31, 2020. The Company recognized a benefit of $354,000 related to the proceeds received on the bank owned life insurance death benefit during the year ended December 31, 2020. Liquidity and Capital Resources We maintain liquid assets at levels we consider adequate to meet our liquidity needs. The liquidity ratio is equal to average daily cash and cash equivalents for the period divided by average total assets. We adjust our liquidity levels to fund loan commitments, repay our borrowings, fund deposit outflows and pay real estate taxes on mortgage loans. We also adjust liquidity as appropriate to meet asset and liability management objectives. The operational adequacy of our liquidity position at any point in time is dependent upon the judgment of the Chief Financial Officer as supported by the Asset/Liability Committee. Liquidity is monitored on a daily, weekly and monthly basis using a variety of measurement tools and indicators. Regulatory liquidity, as required by the WDFI, is based on current liquid assets as a percentage of the prior month’s average deposits and short-term borrowings. Minimum primary liquidity is equal to 4.0% of deposits and short-term borrowings and minimum total regulatory liquidity is equal to 8.0% of deposits and short-term borrowings. The Bank’s primary and total regulatory liquidity at December 31, 2021 were 33.1% and 46.5%, respectively. Our primary sources of liquidity are deposits, amortization and repayment of loans, sales of loans held for sale, maturities of investment securities and other short-term investments, and earnings and funds provided from operations. While scheduled principal repayments on loans are a relatively predictable source of funds, deposit flows and loan repayments are greatly influenced by market interest rates, economic conditions, and rates offered by our competitors. We set the interest rates on our deposits to maintain a desired level of total deposits. In addition, we invest excess funds in short-term, interest-earning assets, which provide liquidity to meet lending requirements. Additional sources of liquidity used to manage long- and short-term cash flows include advances from the FHLB. A portion of our liquidity consists of cash and cash equivalents, which are a product of our operating, investing and financing activities. At December 31, 2021 and 2020, $376.7 million and $94.8 million, respectively, of our assets were invested in cash and cash equivalents. Our primary sources of cash are principal repayments on loans, proceeds from the calls and maturities of debt and mortgage related securities, increases in deposit accounts, Federal funds purchased and advances from the FHLB. Our cash flows are derived from operating activities, investing activities and financing activities as reported in our Consolidated Statements of Cash Flows included in our Consolidated Financial Statements. During the years ended December 31, 2021, and 2020, we originated on a consolidated basis $4.20 billion and $4.33 billion in loans for sale and sold loans on a consolidated basis of $4.48 billion and $4.40 billion. During the year ended December 31, 2021, loan repayments net of loan originations resulted in a positive cash flows of $170.3 million and $12.4 million, respectively. Cash received from the principal repayments of debt and mortgage related securities and maturity and calls of debt securities totaled $49.5 million and $50.5 million for the years ended December 31, 2021 and 2020, respectively. We purchased $73.7 million and $29.5 million in debt securities and mortgage related securities classified as available for sale during the years ended December 31, 2021 and 2020, respectively. The net increases in deposits were $48.5 million and $117.1 million for the years ending December 31, 2021 and 2020. We received a $9.6 million death benefit on a bank owned life insurance policy in 2020. There was a net decrease in borrowings of $30.9 million for the year ended December 31, 2021. There was a net increase in borrowings of $24.5 million for the year ended December 31, 2020. During the years ended December 31, 2021 and 2020, we repurchased common stock of $10.2 million and $36.2 million, respectively. During the years ended December 31, 2021 and 2020, we paid cash dividends on common stock of $30.4 million and $31.5 million, respectively. Deposits increased by $48.5 million from December 31, 2020 to December 31, 2021. The increase was driven by an increase of $97.0 million in money market and savings deposits and $26.2 million in demand deposits offset by a decrease of $74.7 million in time deposits. Deposit flows are generally affected by the level of interest rates, market conditions and products offered by local competitors and other factors. Liquidity management is both a daily and longer-term function of business management. If we require funds beyond our ability to generate them internally, borrowing agreements exist with the FHLB which provide an additional source of funds. At December 31, 2021, we had $5.0 million in short term advances from the FHLB. At December 31, 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. As an additional source of funds, the mortgage banking segment has a repurchase agreement. At December 31, 2021, we had $2.1 million outstanding under the repurchase agreement with a total outstanding commitment of $75.0 million. - 52 - At December 31, 2021, we had outstanding commitments to originate loans receivable of $48.6 million. In addition, at December 31, 2021, we had unfunded commitments under construction loans of $50.3 million, unfunded commitments under business lines of credit of $17.9 million and unfunded commitments under home equity lines of credit and standby letters of credit of $13.4 million. At December 31, 2021, certificates of deposit scheduled to mature in less than one year totaled $533.0 million. Based on prior experience, management believes that a significant portion of such deposits will remain with us, although there can be no assurance that this will be the case. In the event a significant portion of our deposits are not retained by us, we will have to utilize other funding sources, such as Federal Home Loan Bank of Chicago advances, Federal Reserve Discount Window or brokered deposits to maintain our level of assets. However, such borrowings may not be available on attractive terms, or at all, if and when needed. Alternatively, we would reduce our level of liquid assets, such as our cash and cash equivalents and securities available for sale in order to meet funding needs. In addition, the cost of such deposits may be significantly higher if market interest rates are higher or there is an increased amount of competition for deposits in our market area at the time of renewal. Capital Shareholders’ equity increased by $19.7 million, or 4.8%, to $432.8 million at December 31, 2021 from $413.1 million at December 31, 2020. Shareholders' equity increased primarily due to net income, and additional paid-in capital as stock options were exercised and equity awards vested. Partially offsetting the increases, there were decreases due to the declaration of regular and special dividends and the repurchase of stock. The Company's Board of Directors authorized a stock repurchase program in the fourth quarter of 2021. As of December 31, 2021, the Company had repurchased 11.2 million shares at an average price of $14.66 under previously approved stock repurchase plans. Waterstone Financial, Inc. and WaterStone Bank are subject to various regulatory capital requirements, including a risk-based capital measure. The risk-based capital guidelines include both a definition of capital and a framework for calculating risk-weighted assets by assigning assets and off-balance sheet items to broad risk categories. At December 31, 2021, Waterstone Financial, Inc. and WaterStone Bank exceeded all regulatory capital requirements and are considered “well capitalized” under regulatory guidelines. See “Supervision and Regulation—Capital Requirements” and Note 9 - Regulatory Capital of the notes to the consolidated financial statements. Contractual Obligations, Commitments, Contingent Liabilities, and Off-balance Sheet Arrangements WaterStone Bank has various financial obligations, including contractual obligations and commitments that may require future cash payments. The following tables present information indicating various non-deposit contractual obligations and commitments of WaterStone Bank as of December 31, 2021 and the respective maturity dates. Contractual Obligations More Than More Than One Year Three Years One Year or Through Through Five Over Five Total Less Three Years Years Years (In Thousands) Deposits without a stated maturity (1) $ $606,723 $ $606,723 $ $- $ $- $ $- Time deposit (1) 626,663 533,010 91,672 1,981 - Repurchase agreements (1) 2,127 2,127 - - - Federal Home Loan Bank advances (2) 475,000 5,000 - - 470,000 Operating leases (3) 8,819 2,894 3,559 1,470 896 Total Contractual Obligations $ $1,719,332 $ $1,149,754 $ $95,231 $ $3,451 $ $470,896 _______________ (1) Excludes interest. (2) Secured under a blanket security agreement on qualifying assets, principally, mortgage loans. Excludes interest that will accrue on the advances. See call provisions in Note 8 - Borrowings. (3) Represents non-cancellable operating leases for offices and equipment. - 53 - Other Commitments More than More than One Year Three through Years One Year Three Through Over Five Total or Less Years Five Years Years (In Thousands) Real estate loan commitments (1) $ $48,626 $ $48,626 $ $- $ $- $ $- Unused portion of home equity lines of credit (2) 11,990 11,990 - - - Unused portion of construction loans (3) 50,303 50,303 - - - Unused portion of business lines of credit 17,916 17,916 - - - Standby letters of credit 1,379 1,379 - - - _______________ (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. See Note 14 - Commitments, Off-Balance Sheet Arrangements, and Contingent Liabilities of the notes to consolidated financial statements for additional information. Impact of Inflation and Changing Prices The financial statements and accompanying notes have been prepared in accordance with GAAP. GAAP generally requires the measurement of financial position and operating results in terms of historical dollars without consideration for changes in the relative purchasing power of money over time due to inflation. The impact of inflation is reflected in the increased cost of our operations. Unlike industrial companies, our assets and liabilities are primarily monetary in nature. As a result, changes in market interest rates have a greater impact on performance than do the effects of inflation. Quarterly Financial Information The following table sets forth certain quarterly data for the periods indicated: Quarter Ended March 31 June 30 September 30 December 31 (In thousands, except per share data) 2021 Interest income $ $17,969 $ $17,824 $ $17,506 $ $16,584 Interest expense 4,017 3,547 3,392 3,412 Net interest income 13,952 14,277 14,114 13,172 Provision for loan losses (1,070 ) (750 ) (700 ) (1,470 ) Net interest income after provision for loan losses 15,022 15,027 14,814 14,642 Total noninterest income 56,199 52,044 52,936 42,016 Total noninterest expense 43,000 43,297 43,323 40,974 Income before income taxes 28,221 23,774 24,427 15,684 Income taxes 6,877 5,880 5,427 3,131 Net income $ $21,344 $ $17,894 $ $19,000 $ $12,553 Income per share – basic $ $0.90 $ $0.75 $ $0.80 $ $ 0.53 Income per share - diluted $ $0.89 $ $0.74 $ $0.79 $ $0.53 2020 Interest income $ $19,452 $ $19,861 $ $19,544 $ $19,627 Interest expense 6,926 6,612 6,135 5,311 Net interest income 12,526 13,249 13,409 14,316 Provision (credit) for loan losses 785 4,500 1,025 30 Net interest income after provision for loan losses 11,741 8,749 12,384 14,286 Total noninterest income 31,464 66,904 75,763 69,886 Total noninterest expense 35,208 47,689 53,001 47,163 Income before income taxes 7,997 27,964 35,146 37,009 Income taxes 1,928 7,016 8,853 9,174 Net income $ $6,069 $ $20,948 $ $26,293 $ $27,835 Income per share – basic $ $0.24 $ $0.86 $ $1.08 $ $1.17 Income per share - diluted $ $0.24 $ $0.85 $ $1.08 $ $1.17 - 54 - Item 7A. Quantitative and Qualitative Disclosures About Market Risk Management of Market Risk General . The majority of our assets and liabilities are monetary in nature. Consequently, our most significant form of market risk is interest rate risk. Our assets, consisting primarily of mortgage loans, have longer maturities than our liabilities, consisting primarily of deposits. As a result, a principal part of our business strategy is to manage interest rate risk and reduce the exposure of our net interest income to changes in market interest rates. Accordingly, WaterStone Bank’s board of directors has established an Asset/Liability Committee which is responsible for evaluating the interest rate risk inherent in our assets and liabilities, for determining the level of risk that is appropriate given our business strategy, operating environment, capital, liquidity and performance objectives, and for managing this risk consistent with the guidelines approved by the board of directors. Management monitors the level of interest rate risk on a regular basis and the Asset/Liability Committee meets at least weekly to review our asset/liability policies and interest rate risk position, which are evaluated quarterly. We have sought to manage our interest rate risk in order to minimize the exposure of our earnings and capital to changes in interest rates. We have implemented the following strategies to manage our interest rate risk: (i) emphasizing variable rate loans including variable rate one- to four-family, and commercial real estate loans as well as three to five year commercial real estate balloon loans; (ii) reducing and shortening the expected average life of the investment portfolio; and (iii) whenever possible, lengthening the term structure of our deposit base and our borrowings from the FHLBC. These measures should reduce the volatility of our net interest income in different interest rate environments. Income Simulation . Simulation analysis is an estimate of our interest rate risk exposure at a particular point in time. At least quarterly we review the potential effect changes in interest rates may have on the repayment or repricing of rate sensitive assets and funding requirements of rate sensitive liabilities. Our most recent simulation uses projected repricing of assets and liabilities at December 31, 2021 on the basis of contractual maturities, anticipated repayments and scheduled rate adjustments. Prepayment rate assumptions may have a significant impact on interest income simulation results. Because of the large percentage of loans and mortgage-backed securities we hold, rising or falling interest rates may have a significant impact on the actual prepayment speeds of our mortgage related assets that may in turn affect our interest rate sensitivity position. When interest rates rise, prepayment speeds slow and the average expected lives of our assets would tend to lengthen more than the expected average lives of our liabilities and therefore would most likely have a positive impact on net interest income and earnings. The following interest rate scenario displays the percentage change in net interest income over a one-year time horizon assuming increases of 100, 200 and 300 basis points and a decrease of 100 basis points. The results incorporate actual cash flows and repricing characteristics for balance sheet accounts following an instantaneous parallel change in market rates based upon a static (no growth balance sheet). Analysis of Net Interest Income Sensitivity Immediate Change in Rates +300 +200 +100 -100 (Dollar Amounts in Thousands) As of December 31, 2021 Dollar Change $ $12,842 $ 10,364 $ 6,009 $ (3,165 ) Percentage Change 26.01 % 20.99 12.17 (6.41 ) At December 31, 2021, a 100 basis point instantaneous increase in interest rates had the effect of increasing forecast net interest income over the next 12 months by 12.17% while a 100 basis point decrease in rates had the effect of decreasing net interest income by 6.41%. - 55 - Item 8. Financial Statements and Supplementary Data Management’s Annual Report on Internal Control Over Financial Reporting The management of Waterstone Financial, Inc. (the “Company”) is responsible for establishing and maintaining adequate internal control over financial reporting. Internal control over financial reporting is defined in Rule 13a-15(1) promulgated under the Securities Exchange Act of 1934 as a process designed by, or under the supervision of; our principal executive and principal financial officers and effected by the board of directors, management and other personnel, to provide reasonable assurance regarding the reliability of financial reporting and the preparation of financial statements for external purposes in accordance with U.S. generally accepted accounting principles and includes those policies and procedures that: Pertain to the maintenance of records that in reasonable detail accurately and fairly reflect the transactions and dispositions of our assets; Provide reasonable assurance that transactions are recorded as necessary to permit preparation of financial statements in accordance with U.S. generally accepted accounting principles, and that our receipts and expenditures are being made only in accordance with authorizations of our management and directors; and Provide reasonable assurance regarding prevention or timely detection of unauthorized acquisition, use or disposition of our assets that could have a material effect on the financial statements. Because of its inherent limitations, internal control over financial reporting may not prevent or detect misstatements. Projections of any evaluation of effectiveness to future periods are subject to the risk that controls may become inadequate because of changes in conditions, or that the degree of compliance with the policies or procedures may deteriorate. Management assessed the effectiveness of our internal control over financial reporting as of December 31, 2021. In making this assessment, management used the criteria set forth by the Committee of Sponsoring Organizations of the Treadway Commission (“COSO”) in the 2013 Internal Control-Integrated Framework. Based on that assessment, we believe that, as of December 31, 2021, our internal control over financial reporting is effective based on those criteria. CliftonLarsonAllen LLP has audited the effectiveness of the Company’s internal control over financial reporting as of December 31, 2021, as stated in their report dated Feruary 28, 2022. /s/ Douglas S. Gordan /s/ Mark R. Gerke Douglas S. Gordon Mark R. Gerke Chief Executive Officer Chief Financial Officer - 56 - REPORT OF INDEPENDENT REGISTERED PUBLIC ACCOUNTING FIRM Board of Directors and Shareholders Waterstone Financial, Inc. Wauwatosa, Wisconsin Opinions on the Financial Statements and Internal Control over Financial Reporting We have audited the accompanying consolidated statement of financial condition of Waterstone Financial, Inc. and Subsidiaries (the Company) as of December 31, 2021, the related consolidated statements of operations, comprehensive income, changes in shareholders’ equity, and cash flows for the year ended December 31, 2021, and the related notes (collectively referred to as the financial statements). We also have audited the Company’s internal control over financial reporting as of December 31, 2021, based on criteria established in Internal Control—Integrated Framework , issued by the Committee of Sponsoring Organizations of the Treadway Commission (COSO) in 2013. In our opinion, the financial statements referred to above present fairly, in all material respects, the financial position of the Company as of December 31, 2021, and the results of its operations and its cash flows for the year ended December 31, 2021, in conformity with accounting principles generally accepted in the United States of America. Also in our opinion, the Company maintained, in all material respects, effective internal control over financial reporting as of December 31, 2021, based on criteria established in Internal Control—Integrated Framework , issued by COSO in 2013. Basis for Opinions The Company’s management is responsible for these financial statements, for maintaining effective internal control over financial reporting, and for its assessment of the effectiveness of internal control over financial reporting, included in the accompanying Management’s Annual Report on Internal Control Over Financial Reporting. Our responsibility is to express an opinion on the Company’s financial statements and an opinion on the Company's internal control over financial reporting based on our audit. We are a public accounting firm registered with the Public Company Accounting Oversight Board (United States) (PCAOB) and are required to be independent with respect to the Company in accordance with the U.S. federal securities laws and the applicable rules and regulations of the Securities and Exchange Commission and the PCAOB. We conducted our audit in accordance with the standards of the PCAOB. Those standards require that we plan and perform the audit to obtain reasonable assurance about whether the financial statements are free of material misstatement, whether due to error or fraud, and whether effective internal control over financial reporting was maintained in all material respects. - 57 - Our audit of the financial statements included performing procedures to assess the risks of material misstatement of the financial statements, whether due to error or fraud, and performing procedures that respond to those risks. Such procedures included examining, on a test basis, evidence regarding the amounts and disclosures in the financial statements. Our audit also included evaluating the accounting principles used and significant estimates made by management, as well as evaluating the overall presentation of the financial statements. Our audit of internal control over financial reporting included obtaining an understanding of internal control over financial reporting, assessing the risk that a material weakness exists, and testing and evaluating the design and operating effectiveness of internal control based on the assessed risk. Our audit also included performing such other procedures as we considered necessary in the circumstances. We believe that our audit provides a reasonable basis for our opinions. Definition and Limitations of Internal Control over Financial Reporting A company's internal control over financial reporting is a process designed to provide reasonable assurance regarding the reliability of financial reporting and the preparation of financial statements for external purposes in accordance with generally accepted accounting principles. A company's internal control over financial reporting includes those policies and procedures that (1) pertain to the maintenance of records that, in reasonable detail, accurately and fairly reflect the transactions and dispositions of the assets of the company; (2) provide reasonable assurance that transactions are recorded as necessary to permit preparation of financial statements in accordance with generally accepted accounting principles, and that receipts and expenditures of the company are being made only in accordance with authorizations of management and directors of the company; and (3) provide reasonable assurance regarding prevention or timely detection of unauthorized acquisition, use, or disposition of the company's assets that could have a material effect on the financial statements. Because of its inherent limitations, internal control over financial reporting may not prevent or detect misstatements. Also, projections of any evaluation of effectiveness to future periods are subject to the risk that controls may become inadequate because of changes in conditions, or that the degree of compliance with the policies or procedures may deteriorate. Critical Audit Matter The critical audit matter communicated below is a matter arising from the current period audit of the financial statements that were communicated or required to be communicated to the audit committee and that: (1) relate to accounts or disclosures that are material to the financial statements and (2) involved our especially challenging, subjective, or complex judgments. The communication of critical audit matter does not alter in any way our opinion on the financial statements, taken as a whole, and we are not, by communicating the critical audit matter below, providing a separate opinion on the critical audit matter or on the accounts or disclosures to which it relates. - 58 - Allowance for Loan Losses As described in Notes 1 and 3 to the consolidated financial statements, the Company’s allowance for loan losses is a valuation allowance for probable incurred losses in its loan portfolio to the extent they are reasonable to estimate. The allowance for loan losses was $15.8 million at December 31, 2021, which consists of two components (i) specific reserves based on probable losses on specific loans (specific reserves), none in the current year, and (ii) a general allowance based on historical loan loss experience, general economic conditions and other qualitative risk factors both internal and external to the Company (general reserves), representing $15.8 million. The general reserve component of the allowance for loan losses is based on a variety of risk considerations, both quantitative and qualitative. Quantitative factors include the Company’s historical loss experience, delinquency and charge-off trends, collateral values, known information about individual loans and other factors. Qualitative factors include various considerations regarding the general economic environment in the Company’s market area. The qualitative adjustment for the general reserve includes management’s consideration of levels of and trends in delinquencies and impaired loans, trends in volume and terms of loans; effects of any changes in risk selection and underwriting standards; other changes in lending policies, procedures and practices; experience, ability and depth of lending management and other relevant staff; national and local economic trends and conditions; industry conditions; and effects of changes in credit concentrations. The qualitative adjustment contributes significantly to the general reserve component of the allowance for loan losses. Management’s identification and analysis of these considerations and related adjustments requires significant judgment and could have a significant effect on the allowance for loan losses. We identified the estimate of the qualitative adjustment of the general reserve for the allowance for loan losses as a critical audit matter as they represent a significant portion of the total general reserve and because management’s estimate relies on a qualitative analysis to determine a quantitative adjustment which required especially subjective auditor judgment. The primary procedures we performed to address this critical audit matter included performing substantive testing, including evaluating management’s judgments and assumptions for developing the general reserve qualitative adjustments for the allowance for loan losses, which consisted of the following: • Evaluating the completeness and accuracy of data inputs used as a basis for the adjustments relating to qualitative general reserve factors and considering whether the sources of data and factors that management used in forming the assumptions are relevant, reliable, and sufficient for the purpose based on the information gathered. • Evaluating the reasonableness of management’s judgments related to the qualitative and quantitative assessment of the data used in the determination of the general reserve qualitative adjustments for consistency with each other, the supporting data, relevant historical data, and industry data. • Assessing whether historical data is comparable and consistent with data of the current year and considering whether the data is sufficiently reliable. Among other procedures, our evaluation considered evidence from internal and external sources, loan portfolio performance and whether such assumptions were applied consistently period to period. • Analytically evaluating the qualitative adjustment in the current year compared to prior years for directional consistency and reasonableness. • Testing the calculations used by management to translate the assumptions and key factors into the allowance estimated amount. /s/ CliftonLarsonAllen LLP CliftonLarsonAllen LLP We have served as the Company’s auditor since 2021. Milwaukee, Wisconsin February 28, 2022 - 59 - Report of Independent Registered Public Accounting Firm To the Shareholders and the Board of Directors of Waterstone Financial, Inc. Opinion on the Financial Statements We have audited the accompanying consolidated statements of financial condition of Waterstone Financial, Inc. and Subsidiaries (the Company) as of December 31, 2020, the related consolidated statements of operations, comprehensive income, changes in shareholders' equity and cash flows for each of the two years in the period ended December 31, 2020, and the related notes to the consolidated financial statements (collectively, the financial statements). In our opinion, the financial statements present fairly, in all material respects, the financial position of the Company as of December 31, 2020, and the results of its operations and its cash flows for each of the two years in the period ended December 31, 2020, in conformity with accounting principles generally accepted in the United States of America. Basis for Opinion These financial statements are the responsibility of the Company’s management. Our responsibility is to express an opinion on the Company’s financial statements based on our audits. We are a public accounting firm registered with the PCAOB and are required to be independent with respect to the Company in accordance with U.S. federal securities laws and the applicable rules and regulations of the Securities and Exchange Commission and the PCAOB. We conducted our audits in accordance with the standards of the PCAOB. Those standards require that we plan and perform the audits to obtain reasonable assurance about whether the financial statements are free of material misstatement, whether due to error or fraud. Our audits included performing procedures to assess the risks of material misstatement of the financial statements, whether due to error or fraud, and performing procedures that respond to those risks. Such procedures included examining, on a test basis, evidence regarding the amounts and disclosures in the financial statements. Our audits also included evaluating the accounting principles used and significant estimates made by management, as well as evaluating the overall presentation of the financial statements. We believe that our audits provide a reasonable basis for our opinion. Critical Audit Matter The critical audit matter communicated below is a matter arising from the current period audit of the financial statements that was communicated or required to be communicated to the Audit Committee and that: (1) relates to accounts or disclosures that are material to the financial statements and (2) involved our especially challenging, subjective, or complex judgments. The communication of the critical audit matter does not alter in any way our opinion on the financial statements, taken as a whole, and we are not, by communicating the critical audit matter below, providing a separate opinion on the critical audit matter or on the accounts or disclosures to which it relates. Allowance for Loan Losses - Adjustments to historical loss ratios As described in Notes 1 and 3 to the financial statements, the Company’s allowance for loan losses totaled $18,823,000, which consists of a reserve on loans collectively evaluated for impairment (“general reserve”) of $18,800,000 and a reserve on loans individually evaluated for impairment (“specific reserve”) of $23,000 at December 31, 2020. Management’s estimate of the allowance for loan losses is based on its assessment of probable loan losses inherent in the Company’s loan portfolio at December 31, 2020. The Company’s general reserve is estimated by applying historical loss ratios, adjusted for risk components not reflected in the historical loss experience, to the balance of the non-impaired loan portfolio. Historical loss ratios are calculated for each loan category based on historical losses experienced by the Company. Adjustments to historical loss ratios are made for differences in various risk components including changes in lending policies and personnel, economic conditions, portfolio origination activity, interest rates and past due and classified loan trends. The adjustments to historical loss ratios require a significant amount of judgement by management and are highly sensitive to changes in significant assumptions. We identified the adjustments to historical loss ratios in the general reserve component of the allowance for loan losses as a critical audit matter as auditing the underlying adjustments required significant auditor judgment as amounts determined by management rely on analysis that is highly subjective and are highly sensitive to changes in significant assumptions. Our audit procedures related to the adjustments to historical loss ratios in the general reserve component of the allowance for loan losses included the following, among others: • We obtained an understanding of the allowance for loan loss methodology and relevant controls related to the adjustments to historical loss ratios in the calculation of the allowance for loan losses and tested such controls for design and operating effectiveness, including the completeness and accuracy of information used in management’s assessment, and its challenge and review of the adjustments to historical loss ratios. • We tested the completeness and accuracy of data used by management in determining adjustments to historical loss ratios by agreeing this data to internal and external source data • We tested management’s conclusions regarding the appropriateness of the adjustments to historical loss ratios by challenging assumptions and rationale for the adjustments in total, both in magnitude and directional consistency, with underlying data used and for consistency with the Company’s policies. /s/ RSM US LLP We have served as the Company's auditor from 2014 through 2020 Chicago, Illinois March 1, 2021 - 60 - Waterstone Financial, Inc. and Subsidiaries Consolidated Statements of Financial Condition December 31, 2021 and 2020 December 31, 2021 2020 Assets (In Thousands, except share data) Cash $ 343,016 $ 56,190 Federal funds sold 13,981 18,847 Interest-earning deposits in other financial institutions and other short term investments 19,725 19,730 Cash and cash equivalents 376,722 94,767 Securities available for sale (at fair value) 179,016 159,619 Loans held for sale (at fair value) 312,738 402,003 Loans receivable 1,205,785 1,375,137 Less: Allowance for loan losses 15,778 18,823 Loans receivable, net 1,190,007 1,356,314 Office properties and equipment, net 22,273 23,722 Federal Home Loan Bank stock (at cost) 24,438 26,720 Cash surrender value of life insurance 65,368 63,573 Real estate owned, net 148 322 Prepaid expenses and other assets 45,148 57,547 Total assets $ 2,215,858 $ 2,184,587 Liabilities and Shareholders’ Equity Liabilities: Demand deposits $ 214,409 $ 188,225 Money market and savings deposits 392,314 295,317 Time deposits 626,663 701,328 Total deposits 1,233,386 1,184,870 Borrowings 477,127 508,074 Advance payments by borrowers for taxes 4,094 3,522 Other liabilities 68,478 75,003 Total liabilities 1,783,085 1,771,469 Commitments and contingencies (Note 14) Shareholders’ equity: Preferred stock (par value $ 0.01 per share) Authorized - 50,000,000 shares in 2021 and 2020 , no shares issued - - Common stock (par value $ 0.01 per share) Authorized - 100,000,000 shares in 2021 and 2020 Issued - 24,795,124 in 2021 and 25,087,976 in 2020 Outstanding - 24,795,124 in 2021 and 25,087,976 in 2020 248 251 Additional paid-in capital 174,505 180,684 Retained earnings 273,398 245,287 Unearned ESOP shares ( 14,243 ) ( 15,430 ) Accumulated other comprehensive (loss) income, net of taxes ( 1,135 ) 2,326 Total shareholders’ equity 432,773 413,118 Total liabilities and shareholders’ equity $ 2,215,858 $ 2,184,587 See accompanying notes to consolidated financial statements - 61 - Waterstone Financial, Inc. and Subsidiaries Consolidated Statements of Operations Years ended December 31, 2021, 2020 and 2019 Years ended December 31, 2021 2020 2019 (In Thousands, except per share amounts) Interest income: Loans $ 64,366 $ 72,633 $ 72,235 Mortgage-related securities 1,954 2,488 2,978 Debt securities, federal funds sold and short-term investments 3,563 3,363 4,528 Total interest income 69,883 78,484 79,741 Interest expense: Deposits 4,420 14,365 17,278 Borrowings 9,948 10,619 10,266 Total interest expense 14,368 24,984 27,544 Net interest income 55,515 53,500 52,197 Provision (credit) for loan losses ( 3,990 ) 6,340 ( 900 ) Net interest income after provision for loan losses 59,505 47,160 53,097 Noninterest income: Service charges on loans and deposits 3,325 4,462 2,363 Increase in cash surrender value of life insurance 1,615 1,905 1,935 Mortgage banking income 191,035 233,245 125,666 Other 7,220 4,405 786 Total noninterest income 203,195 244,017 130,750 Noninterest expenses: Compensation, payroll taxes, and other employee benefits 135,115 139,046 101,718 Occupancy, office furniture, and equipment 9,612 10,223 10,606 Advertising 3,528 3,691 3,885 Data processing 3,950 3,941 3,630 Communications 1,309 1,329 1,359 Professional fees 1,275 8,118 3,605 Real estate owned 3 ( 8 ) ( 146 ) Loan processing expense 4,610 4,646 3,288 Other 11,192 12,075 8,328 Total noninterest expenses 170,594 183,061 136,273 Income before income taxes 92,106 108,116 47,574 Income tax expense 21,315 26,971 11,671 Net income $ 70,791 $ 81,145 $ 35,903 Income per share: Basic $ 2.98 $ 3.32 $ 1.38 Diluted $ 2.96 $ 3.30 $ 1.37 Weighted average shares outstanding: Basic 23,741 24,464 26,021 Diluted 23,931 24,607 26,247 See accompanying notes to consolidated financial statements - 62 - Waterstone Financial, Inc. and Subsidiaries Consolidated Statements of Comprehensive Income Years ended December 31, 2021, 2020 and 2019 Years ended December 31, 2021 2020 2019 (In Thousands) Net income $ 70,791 $ 81,145 $ 35,903 Other comprehensive (loss) income, net of tax: Net unrealized holding (loss) gain on available for sale securities arising during the period, net of tax benefit (expense) of $ 1,294 , ($ 630 ) and ($ 1,122 ) respectively ( 3,461 ) 1,684 3,003 Total other comprehensive (loss) income ( 3,461 ) 1,684 3,003 Comprehensive income $ 67,330 $ 82,829 $ 38,906 See accompanying notes to consolidated financial statements - 63 - Waterstone Financial, Inc. and Subsidiaries Consolidated Statements of Changes in Shareholders’ Equity Years Ended December 31, 2021, 2020 and 2019 Common Stock Shares Amount Additional Paid-In Capital Retained Earnings Unearned ESOP Shares Accumulated Other Comprehensive Income (Loss) Total Shareholders' Equity (In Thousands) Balances at December 31, 2018 28,463 $ 285 $ 232,406 $ 187,153 ( 17,804 ) $ ( 2,361 ) $ 399,679 Comprehensive income: Net income - - - 35,903 - - 35,903 Other comprehensive income: - - - - - 3,003 3,003 Total comprehensive income 38,906 ESOP shares committed to be released to Plan participants - - 618 - 1,187 - 1,805 Cash dividends, $ 0.98 per share - - - ( 25,663 ) - - ( 25,663 ) Stock compensation activity 50 - 659 - - - 659 Stock based compensation expense - - 1,067 - - - 1,067 Purchase of common stock returned to authorized but unissued ( 1,365 ) ( 14 ) ( 22,753 ) - - - ( 22,767 ) Balances at December 31, 2019 27,148 $ 271 $ 211,997 $ 197,393 ( 16,617 ) $ 642 $ 393,686 Comprehensive income: Net income - $ - - 81,145 - - 81,145 Other comprehensive income: - - - - - 1,684 1,684 Total comprehensive income 82,829 ESOP shares committed to be released to Plan participants - - 489 - 1,187 - 1,676 Cash dividends, $ 1.36 per share - - - ( 33,251 ) - - ( 33,251 ) Stock compensation activity 293 3 3,701 - - - 3,704 Stock based compensation expense - - 716 - - - 716 Purchase of common stock returned to authorized but unissued ( 2,353 ) ( 23 ) ( 36,219 ) - - - ( 36,242 ) Balances at December 31, 2020 25,088 $ 251 $ 180,684 $ 245,287 ( 15,430 ) $ 2,326 $ 413,118 Comprehensive income: Net income - $ - - 70,791 - - 70,791 Other comprehensive loss: - - - - - ( 3,461 ) ( 3,461 ) Total comprehensive income 67,330 ESOP shares committed to be released to Plan participants - - 942 - 1,187 - 2,129 Cash dividends, $ 1.80 per share - - - ( 42,680 ) - - ( 42,680 ) Stock compensation activity 208 2 2,305 - - - 2,307 Stock based compensation expense - - 745 - - - 745 Purchase of common stock returned to authorized but unissued ( 501 ) ( 5 ) ( 10,171 ) - - - ( 10,176 ) Balances at December 31, 2021 24,795 $ 248 $ 174,505 $ 273,398 ( 14,243 ) $ ( 1,135 ) $ 432,773 See accompanying notes to consolidated financial statements - 64 - Waterstone Financial, Inc. and Subsidiaries Consolidated Statements of Cash Flows Years ended December 31, 2021, 2020 and 2019 Years ended December 31, 2021 2020 2019 (In Thousands) Operating activities: Net income $ 70,791 $ 81,145 $ 35,903 Adjustments to reconcile net income to net cash provided by (used in) operating activities: Provision (credit) for loan losses ( 3,990 ) 6,340 ( 900 ) Depreciation, amortization, accretion 6,048 5,608 4,698 Deferred income taxes 1,378 ( 2,620 ) 639 Stock based compensation 745 716 1,067 Origination of mortgage servicing rights ( 5,778 ) ( 13,406 ) ( 354 ) Proceeds on sales of mortgage servicing rights 12,448 6,985 - Gain on sale of loans held for sale ( 193,399 ) ( 245,358 ) ( 128,928 ) Loans originated for sale ( 4,198,139 ) ( 4,332,028 ) ( 2,853,222 ) Proceeds on sales of loans originated for sale 4,480,804 4,395,505 2,903,643 Gain on death benefit on bank owned life insurance - ( 1,456 ) - Decrease (increase) in accrued interest receivable 944 387 ( 7 ) Increase in cash surrender value of life insurance ( 1,615 ) ( 1,905 ) ( 1,935 ) Decrease (increase) in derivative assets 6,688 ( 9,222 ) ( 179 ) (Decrease) increase in accrued interest on deposits and borrowings ( 178 ) ( 422 ) 164 (Increase) decrease in prepaid income tax ( 2,558 ) 113 330 Legal settlement ( 4,250 ) 4,250 - (Decrease) increase in derivative liabilities ( 5,140 ) 5,140 ( 1,116 ) Net gain on real estate owned ( 12 ) ( 107 ) ( 304 ) Gain on sale of mortgage servicing rights ( 4,032 ) ( 600 ) - Change in other assets and other liabilities, net ( 6,301 ) 7,353 282 Net cash provided by (used in) operating activities 154,454 ( 93,582 ) ( 40,219 ) I nvesting activities: Net decrease (increase) in loans receivable 170,297 12,353 ( 9,896 ) Purchases of: FHLB stock - ( 5,570 ) ( 8,100 ) Debt securities - ( 10,125 ) - Mortgage related securities ( 73,687 ) ( 19,372 ) ( 28,860 ) Premises and equipment, net ( 778 ) ( 1,225 ) ( 3,114 ) Bank owned life insurance ( 180 ) ( 180 ) ( 180 ) Proceeds from: Principal repayments on mortgage-related securities 40,445 45,254 31,944 Maturities of debt securities 9,055 5,290 8,080 Sales of FHLB stock 2,282 - 6,300 Death benefit from bank owned life insurance - 9,633 - Sales of real estate owned 183 1,133 2,674 Net cash provided by (used in) investing activities 147,617 37,191 ( 1,152 ) Financing activities: Net increase in deposits 48,516 117,094 29,281 Net change in short term borrowings ( 30,947 ) 24,512 8,516 Repayment of long term debt - - ( 125,000 ) Proceeds from long term debt - - 165,000 Increase (decrease) in advance payments by borrowers for taxes 572 ( 690 ) ( 159 ) Cash dividends on common stock ( 30,388 ) ( 31,520 ) ( 25,960 ) Proceeds from stock option exercises 2,307 3,704 659 Purchase of common stock returned to authorized but unissued ( 10,176 ) ( 36,242 ) ( 22,767 ) Net cash (used in) provided by financing activities ( 20,116 ) 76,858 29,570 Increase (decrease) in cash and cash equivalents 281,955 20,467 ( 11,801 ) Cash and cash equivalents at beginning of year 94,767 74,300 86,101 Cash and cash equivalents at end of year $ 376,722 $ 94,767 $ 74,300 Supplemental information: Cash paid or credited during the period for: Income tax payments $ 22,663 $ 29,478 $ 10,703 Interest payments 14,546 25,406 27,380 Noncash investing activities: Loans receivable transferred to other real estate - 637 1,052 Dividends declared but not paid in other liabilities 17,525 5,232 3,501 See accompanying notes to consolidated financial statements - 65 - Waterstone Financial, Inc. and Subsidiaries Notes to Consolidated Financial Statements Years ended December 31, 2021, 2020 and 2019 1) Summary of Significant Accounting Policies The following significant accounting and reporting policies of Waterstone Financial, Inc. and subsidiaries (collectively, the “Company”), conform to U.S. generally accepted accounting principles, or (“GAAP”), and are used in preparing and presenting these consolidated financial statements. Certain prior period amounts have been reclassified to conform to current period presentation. These reclassifications did not result in any changes to previously reported net income. The Company reclassed certain line items in the Consolidated Statements of Cash Flows. a) Nature of Operations The Company is a one-bank holding company with two operating segments – community banking and mortgage banking. WaterStone Bank SSB (the "Bank" or "WaterStone Bank") is principally engaged in the business of attracting deposits from the general public and using such deposits to originate real estate, business and consumer loans. The Bank provides a full range of financial services to customers through branch locations in southeastern Wisconsin. The Bank is subject to the regulations of certain federal and state agencies and undergoes periodic examinations by those regulatory authorities. The Bank owns a mortgage banking subsidiary that originates residential real estate loans held for sale at various branch offices across the country. Mortgage banking volume fluctuates widely in connection with movements in interest rates. Mortgage banking income is reported as a single line item in the statements of operations while mortgage banking expense is distributed among the various noninterest expense lines. Compensation, payroll taxes and other employee benefits expense fluctuates in relation to fluctuations in mortgage banking income. b) Principles of Consolidation The consolidated financial statements include the accounts and operations of Waterstone Financial, Inc. and its wholly owned subsidiary, WaterStone Bank. The Bank has the following wholly owned subsidiaries: Wauwatosa Investments, Inc., Waterstone Mortgage Corporation, and Main Street Real Estate Holdings, LLC. All significant intercompany accounts and transactions have been eliminated in consolidation. c) Use of Estimates The preparation of the consolidated financial statements requires management of the Company to make a number of estimates and assumptions relating to the reported amount of assets and liabilities and the disclosure of contingent assets and liabilities at the date of the consolidated financial statements and the reported amounts of revenues and expenses during the period. Significant items subject to such estimates and assumptions include: the allowance for loan losses, income taxes, and fair value measurements. d) Cash and Cash Equivalents The Company considers federal funds sold and highly liquid debt instruments with a maturity of three months or less when purchased to be cash equivalents. e) Securities Available for Sale Securities At the time of purchase, investment debt securities are classified as available for sale, as management has the intent and ability to hold such securities for an indefinite period of time, but not necessarily to maturity. Any decision to sell investment securities available for sale would be based on various factors, including, but not limited to asset/liability management strategies, changes in interest rates or prepayment risks, liquidity needs, or regulatory capital considerations. Available for sale securities are carried at fair value, with the unrealized gains and losses, net of deferred tax, reported as a separate component of equity in accumulated other comprehensive income (loss). The cost of debt securities is adjusted for amortization of premiums and accretion of discounts to maturity or, in the case of mortgage-backed securities and collateralized mortgage obligations, over the estimated life of the security. Such amortization or accretion is included in interest income from securities. Realized gains or losses on securities sales (using specific identification method) are included in noninterest income. Declines in value judged to be other than temporary are included in net impairment losses recognized in earnings in the consolidated statements of operations. - 66 - Other-Than-Temporary Impairment One of the significant estimates related to securities is the evaluation of investments for other-than-temporary impairment. The Company assesses investment securities with unrealized loss positions for other than temporary impairment on at least a quarterly basis. When the fair value of an investment is less than its amortized cost at the balance sheet date of the reporting period for which impairment is assessed, the impairment is designated as either temporary or other-than-temporary. In evaluating other-than-temporary impairment, management considers the length of time and extent to which the fair value has been less than cost and the expected recovery period of the security, the financial condition and near-term prospects of the issuer, and the intent and ability of the Company to retain its investment in the issuer for a period of time sufficient to allow for any anticipated recovery in fair value in the near term. Declines in the fair value of investment securities below amortized cost are deemed to be other-than-temporary when the Company cannot assert that it will recover its amortized cost basis, including whether the present value of cash flows expected to be collected is less than the amortized cost basis of the security. If it is more likely than not that the Company will be required to sell the security before recovery or if the Company has the intent to sell, an other-than-temporary impairment write down is recognized in earnings equal to the difference between the security’s amortized cost and its fair value. If it is not more likely than not that the Company will be required to sell the security before recovery and if the Company does not intend to sell, the other-than-temporary impairment write down is separated into an amount representing credit loss, which is recognized in earnings, and an amount related to other factors, which is recognized as a separate component of equity. Following the recognition of an other than temporary impairment representing credit loss, the book value of an investment less the impairment loss realized becomes the new cost basis. The determination as to whether an other than temporary impairment exists and, if so, the amount considered other-than-temporarily impaired, or not impaired, is subjective and, therefore, the timing and amount of other than temporary impairments constitute material estimates that are subject to significant change. Federal Home Loan Bank Stock Federal Home Loan Bank ("FHLB") stock is carried at cost, which is the amount that the stock is redeemable by tendering to the FHLB or the amount at which shares can be sold to other FHLB members. f) Loans Held for Sale The origination of residential real estate loans is an integral component of the business of the Company. The Company generally sells its originations of long-term fixed interest rate mortgage loans in the secondary market, and on a selective basis, retains the rights to service the loans sold. Gains and losses on the sales of these loans are determined using the specific identification method. Mortgage loans originated for sale are generally sold within 45 days after closing. The Company has elected to carry loans held for sale at fair value. Fair value is generally determined by estimating a gross premium or discount, which is derived from pricing currently observable in the market. The amount by which cost differs from market value is accounted for as a valuation adjustment to the carrying value of the loans. Changes in value are included in mortgage banking income in the consolidated statements of operations. Costs to originate loans held for sale are expensed as incurred and are included on the appropriate noninterest expense lines of the statements of operations. Salaries, commissions and related payroll taxes are the primary costs to originate and comprised approximately 79.2 % of total mortgage banking noninterest expense for 2021. The value of mortgage loans held for sale and other residential mortgage loan commitments to customers are hedged by utilizing both best efforts and mandatory forward commitments to sell loans to investors in the secondary market. Such forward commitments are generally entered into at the time when applications are taken to protect the value of the mortgage loans from increases in market interest rates during the period held. The Company recognizes revenue associated with the expected future cash flows of servicing loans at the time a forward loan commitment is made. g) Loans Receivable and Related Interest Income Loans are classified as held for investment when management has both the intent and ability to hold the loan for the foreseeable future, or until maturity or payoff. Loans are carried at the principal amount outstanding, net of any unearned income, charge-offs and unamortized deferred fees and costs. Loan origination and commitment fees and certain direct loan origination costs are deferred and the net amount amortized as an adjustment of the related loan yield. Amortization is based on a level-yield method over the contractual life of the related loans or until the loan is paid in full. Loan interest income is recognized on the accrual basis. Accrual of interest is generally discontinued either when reasonable doubt exists as to the full, timely collection of interest or principal, or when a loan becomes contractually past due 90 days or more with respect to interest or principal. At that time, previously accrued and uncollected interest on such loans is reversed and additional income is recorded only to the extent that payments are received and the collection of principal is reasonably assured. Generally, loans are restored to accrual status when the obligation is brought current, has performed in accordance with the contractual terms for a reasonable period of time, and the ultimate collectability of the total contractual principal and interest is no longer in doubt. - 67 - A loan is accounted for as a troubled debt restructuring if the Company, for economic reasons related to the borrower’s financial condition, grants a concession to the borrower that it would not otherwise consider. A troubled debt restructuring typically involves a modification of terms such as a reduction of the stated interest rate, a deferral of principal payments or a combination of both for a temporary period of time. If the borrower was performing in accordance with the original contractual terms at the time of the restructuring, the restructured loan is accounted for on an accruing basis as long as the borrower continues to comply with the modified terms. If the loan was not accounted for on an accrual basis at the time of restructuring, the restructured loan remains in non-accrual status until the loan completes a minimum of six consecutive contractual payments. The provisions of the CARES Act included an election to not apply the guidance on accounting for troubled debt restructurings to loan modifications, such as extensions or deferrals, related to COVID-19 made between March 1, 2020 and the earlier of (i) December 31, 2020 or (ii) 60 days after the end of the COVID-19 national emergency. The relief can only be applied to modifications for borrowers that were not more than 30 days past due as of December 31, 2019. In December 2020, the Consolidated Appropriations Act, 2021 was passed, which extended the TDR provisions of the CARES Act to January 1, 2022. The Company elected to adopt these provisions of the CARES Act. h) Allowance for Loan Losses The allowance for loan losses is presented as a reserve against loans and represents the Company’s assessment of probable loan losses inherent in the loan portfolio. The allowance for loan losses is established as losses are estimated to have occurred through a provision for loan losses charged to income. Estimated loan losses are charged against the allowance when the loan balance is confirmed to be uncollectible directly or indirectly by the borrower or upon initiation of a foreclosure action by the Company. Subsequent recoveries, if any, are credited to the allowance. The allowance provides for probable losses that have been identified with specific customer relationships and for probable losses believed to be inherent in the loan portfolio, but have not been specifically identified. The Company utilizes its own loss history to estimate inherent losses on loans. Although the Bank allocates portions of the allowance to specific loans and loan types, the entire allowance is available for any loan losses that occur. The Company evaluates the need for specific valuation allowances on loans that are considered impaired. A loan is considered impaired when, based on current information and events, it is probable that the Company will not be able to collect all amounts due according to the contractual terms of the loan agreement. Within the loan portfolio, all non-accrual loans and loans modified under troubled debt restructurings have been determined by the Company to meet the definition of an impaired loan. In addition, other loans may be considered impaired loans. A valuation allowance is established for an amount equal to the impairment when the carrying amount of the loan exceeds the present value of the expected future cash flows, discounted at the loan’s original effective interest rate or the fair value of the underlying collateral. The Company also establishes valuation allowances based on an evaluation of the various risk components that are inherent in the loan portfolio. The risk components that are evaluated include lending policies and personnel, economic conditions, portfolio origination activity, interest rates, and past due and classified loan trends. The appropriateness of the allowance for loan losses is approved quarterly by the Company’s board of directors. The allowance reflects management’s best estimate of the amount needed to provide for the probable loss on impaired loans, as well as other credit risks of the Company, and is based on a risk model developed and implemented by management and approved by the Company’s board of directors. Actual results could differ from this estimate, and future additions to the allowance may be necessary based on unforeseen changes in economic conditions. In addition, federal regulators periodically review the Company’s allowance for loan losses. Such regulators have the authority to require the Company to recognize additions to the allowance at the time of their examination. i) Real Estate Owned Real estate owned consists of properties acquired through, or in lieu of, loan foreclosure. Real estate owned is transferred into the portfolio at estimated net realizable value. To the extent that the net carrying value of the loan exceeds the estimated fair value of the property at the date of transfer, the excess is charged to the allowance for loan losses within 90 days of being transferred. Subsequent write-downs to reflect current fair 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 operations. j) Mortgage Servicing Rights The Company sells residential mortgage loans in the secondary market and, on a selective basis, retains the right to service the loans sold. Upon sale, a mortgage servicing rights asset is capitalized, which represents the then current fair value of future net cash flows expected to be realized for performing servicing activities. Mortgage servicing rights, when purchased, are initially recorded at fair value. Mortgage servicing rights are amortized over the period of estimated net servicing income, and assessed for impairment at each reporting date. Mortgage servicing rights are carried at the lower of the initial capitalized amount, net of accumulated amortization, or estimated fair value, and are included in other assets in the consolidated statements of financial condition. To the extent that the Company sells mortgage servicing rights, a gain is recognized for the amount of which sale proceeds exceed the remaining unamortized cost of the servicing rights that were sold. Gains on sale of mortgage servicing rights are included in other noninterest income in the consolidated statements of operations. - 68 - k) Cash Surrender Value of Life Insurance The Company purchases bank owned life insurance on the lives of certain employees. The Company is the beneficiary of the life insurance policies. The cash surrender value of life insurance is reported at the amount that would be received in cash if the polices were surrendered. Increases in the cash value of the policies and proceeds of death benefits received are recorded in noninterest income. The increase in cash surrender value of life insurance is not subject to income taxes, as long as the Company has the intent and ability to hold the policies until the death benefits are received. l) Office Properties and Equipment Office properties and equipment, including leasehold improvements and software, are stated at cost, net of depreciation and amortization. Depreciation and amortization are computed on the straight-line method over the estimated useful lives of the related assets. Leasehold improvements are amortized over the lease term, if shorter than the estimated useful life. Maintenance and repairs are charged to expense as incurred, while additions or major improvements are capitalized and depreciated over their estimated useful lives. Estimated useful lives of the assets are 10 to 30 years for office properties, three years to 10 years for equipment, and three years for software. m) Income Taxes The Company and its subsidiaries file consolidated federal and combined state income tax returns. The provision for income taxes is based upon income in the consolidated financial statements, rather than amounts reported on the income tax returns. Deferred tax assets and liabilities are recognized for the future tax consequences attributable to differences between the financial statement carrying amounts of existing assets and liabilities and their respective tax bases, as well as net operating loss carry forwards. Deferred tax assets and liabilities are measured using enacted tax rates expected to apply to taxable income in the years in which those temporary differences are expected to be recovered or settled. The effect on deferred tax assets and liabilities of a change in tax rates is recognized as income or expense in the period that includes the enactment date. The Company evaluates the realizability of its deferred tax assets on a quarterly basis. Under generally accepted accounting principles, a valuation allowance is required to be recognized if it is “more likely than not” that a deferred tax asset will not be realized. The determination of the realizability of the deferred tax assets is highly subjective and dependent upon judgment concerning management's evaluation of both positive and negative evidence, the forecasts of future income, applicable tax planning strategies, and assessments of current and future economic and business conditions. Positions taken in the Company’s tax returns may be subject to challenge by the taxing authorities upon examination. The benefit of uncertain tax positions are initially recognized in the financial statements only when it is more likely than not the position will be sustained upon examination by the tax authorities. Such tax positions are both initially and subsequently measured as the largest amount of tax benefit that is greater than 50 % likely of being realized upon settlement with the tax authority, assuming full knowledge of the position and all relevant facts. Interest and penalties on income tax uncertainties are classified within income tax expense in the consolidated statements of operations. n) Earnings Per Share Earnings per share (EPS) are computed using the two-class method. Stock compensation awards that contain rights to receive nonforfeitable dividends prior to the awards being vested are considered participating securities and, as such, included in the common shares outstanding. Basic earnings per share is computed by dividing net income allocated to common shareholders by the weighted average number of common shares outstanding during the applicable period, excluding outstanding participating securities. Diluted earnings per share is computed by dividing net income by the weighted average number of common shares outstanding adjusted for the dilutive effect of all potential common shares. Diluted EPS reflects the potential dilution that could occur if securities or other contracts to issue common stock were exercised. Shares of the Employee Stock Ownership Plan committed to be released are considered outstanding for both common and diluted EPS. o) Comprehensive Income Comprehensive income is the total of reported net income and changes in unrealized gains or losses, net of tax, on securities available for sale. p) Employee Stock Ownership Plan (ESOP) Compensation expense under the ESOP is equal to the fair value of common shares released or committed to be released to participants in the ESOP in each respective period. Common stock purchased by the ESOP and not committed to be released to participants is included in the consolidated statements of financial condition at cost as a reduction of shareholders’ equity. - 69 - q) Share Repurchases The Company has a share repurchase program. Repurchases under the repurchase program may be made in the open market, through block trades and other negotiated transactions. The share repurchase program transactions take place primarily in open market transactions, subject to market conditions. There is no fixed termination date for the repurchase program, and the program may be suspended. Under Maryland law, shares repurchased are constituted as authorized but unissued. The Company reduced the common stock at par value and to the extent the cost acquired exceeds par value, it is recorded through additional paid-in capital on the consolidated statements of financial condition and consolidated statements of changes in shareholders’ equity. r) Revenue Recognition ASC 606, Revenue from Contracts with Customers (“ASC 606”), establishes principles for reporting information about the nature, amount, timing and uncertainty of revenue and cash flows arising from the entity's contracts to provide goods or services to customers. The core principle requires an entity to recognize revenue to depict the transfer of goods or services to customers in an amount that reflects the consideration that it expects to be entitled to receive in exchange for those goods or services recognized as performance obligations are satisfied. The majority of our revenue-generating transactions are not subject to ASC 606, including revenue generated from financial instruments, such as our loans, loans held for sale, investment securities, as well as revenue related to our mortgage servicing activities, as these activities are subject to other GAAP discussed elsewhere within our disclosures. Descriptions of our revenue-generating activities that are within the scope of ASC 606, which are presented in our income statements as components of non-interest income are as follows: Service charges on deposit accounts - these represent general service fees for monthly account maintenance and activity- or transaction-based fees and consist of transaction-based revenue, time-based revenue (service period), item-based revenue or some other individual attribute-based revenue. Revenue is recognized when our performance obligation is completed, which is generally monthly for account maintenance services or when a transaction has been completed (such as a stop payment). Payments for these activities are generally received at the time the performance obligations are satisfied. Wealth management fee income - this represents monthly fees due from wealth management customers as consideration for managing the customers' assets. Wealth management investment management and similar fiduciary activities. These fees are typically paid to us on a monthly basis and recognized as our performance obligation is satisfied each month. Other non-interest income includes items such as bank owned life insurance income, dividends on FHLB stock and other general operating income, none of which are subject to the requirements of ASC 606. Also included in other-non-interest income are interchange fees earned when our debit and credit card clients process transactions through card networks. Our performance obligations are generally complete when the transactions generating the fees are processed. s) Impact of Recent Accounting Pronouncements ASC Topic 326 "Financial Instruments - Credit Losses." Authoritative accounting guidance under ASC Topic 326, "Financial Instruments - Credit Losses" amended the incurred loss impairment methodology in current GAAP with a methodology that reflects expected credit losses and requires consideration of a broader range of reasonable and supportable information for credit loss estimates. The measurement of expected credit losses is based on relevant information about past events, including historical experience, current conditions, and reasonable and supportable forecasts that affect the collectability of the reported amount. The authoritative guidance also requires a financial asset (or a group of financial assets) measured at amortized cost basis to be presented at the net amount expected to be collected (net of the allowance for credit losses). In addition, the credit losses relating to available-for-sale (AFS) debt securities should be recorded through an allowance for credit losses rather than a write-down. On March 27, 2020, the Coronavirus Aid, Relief, and Economic Security Act (CARES Act) was signed into law. It included an option for entities to delay the adoption of ASC Topic 326 until the earlier of the termination date of the national emergency declaration by the President or December 31, 2020. Due to the uncertainty on the economy and unemployment from COVID-19, the Company determined to dela