Business description of Waterstone-Financial-Inc from last 10-k form
WATERSTONE FINANCIAL, INC.
(Exact name of registrant as specified in its charter)
(414) 761-1000
Registrant's telephone number, including area code:
Securities registered pursuant to Section 12(b) of the Act:
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).
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.
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.
Indicate by check mark whether the registrant has submitted electronically and posted on its corporate Web site, if any, every Interactive Data File required to be submitted and posted 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 and post such files)
Indicate by check mark if disclosure of delinquent filers pursuant to Item 405 of Regulation S-K is not contained herein, and will not be contained, to the best of registrant's knowledge, in definitive proxy or information statements incorporated by reference in Part III of this Form 10-K or any amendment to this Form 10-K. [ X ]
Indicate by check mark whether the registrant is a large accelerated filer, an accelerated filer, a non-accelerated filer or a smaller reporting company. See definitions of "large accelerated filer," "accelerated filer" and "smaller reporting company" in Rule 12b-2 of the Exchange Act
Indicate by check mark whether the registrant is a shell company (as defined in Rule 12b-2 under the Exchange Act).
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 January 23, 2014 (the first day of trading in the Registrant's common stock) as reported by the NASDAQ Global Select Market® was approximately $366.8 million.
As of February 28, 2014, 34,389,312 shares of the Registrant's Common Stock were issued and outstanding.
FORM 10-K ANNUAL REPORT TO THE SECURITIES AND EXCHANGE COMMISSION
FOR THE YEAR ENDED DECEMBER 31, 2013
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PART 1
Item 1. Business
Forward-Looking Statements
This Form 10-K contains or incorporates 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, are intended to identify forward-looking statements. These forward-looking statements include, but are not limited to:
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.
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.
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Waterstone Financial, Inc.
Waterstone Financial, Inc., A Maryland Corporation, ("New Waterstone") was organized in June 2013. Upon completion of the mutual-to-stock conversion of Lamplighter Financial, MHC in January 2014, New Waterstone became the holding company of WaterStone Bank SSB ("WaterStone Bank") 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, 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, SSB, 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, Inc.'s executive offices are located at 11200 West Plank Court, Wauwatosa, Wisconsin 53226, and its telephone number at this address is (414) 761-1000.
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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 Corporation, which had 89 offices in 22 states as of December 31, 2013.
WaterStone Bank conducts its community banking business from nine banking offices located in Milwaukee, Washington and Waukesha Counties, Wisconsin, as well as a loan production office in Maple Grove, Minnesota. WaterStone Bank's principal lending activity is originating one- to four-family and multi-family residential real estate loans for retention in its portfolio. At December 31, 2013, such loans comprised 37.9% and 47.8%, respectively, of WaterStone Bank's loan portfolio. WaterStone Bank also offers, to a lesser extent, home equity loans and lines of credit, construction and land loans, commercial real estate and 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, non-interest bearing demand accounts and individual retirement accounts. Our investment securities portfolio is comprised principally of mortgage-backed securities, government-sponsored enterprise bonds and municipal obligations.
WaterStone Bank is subject to comprehensive regulation and examination by the WDFI and the Federal Deposit Insurance Corporation.
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 to be a part of this prospectus.
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 lines of credit with other financial institutions as needed. During both years ended December 31, 2013 and 2012, Waterstone Mortgage Corporation originated approximately $1.75 billion in mortgage loans held for sale.
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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 four branch offices in Milwaukee County, four branch offices in Waukesha County and one branch office in Washington County. At June 30, 2013 (the latest date for which information was publicly available), 47.8% of deposits in the State of Wisconsin were located in the seven-county metropolitan Milwaukee market and 41.8% 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. In addition, in October 2013 we opened a loan production office in Maple Grove, Minnesota, which is expected to have a primary lending market area of the Minneapolis-St. Paul, Minnesota metropolitan market.
From 2000 to 2010, our market area experienced population increases from a high of 13.1% in Jefferson County to a low of 0.8% in Milwaukee County, compared to 6.0% for Wisconsin and 9.7% for the United States as a whole. Projections indicate that through 2017, the population will continue to increase in all market area counties ranging from a low of 1.0% in Racine County to a high of 4.6% in Washington County compared to projected increases of 3.2% and 4.9% in Wisconsin and the United States, respectively. Consistent with trends in population, our market areas experienced increases in households from 2000 to 2010 at rates ranging from a high of 17.7% in Washington County to a low of 1.6% in Milwaukee County, compared to increases in households of 9.4% in Wisconsin and 10.7% in the United States. Through 2017, households are projected to increase at rates ranging from 1.6% in Racine County to 4.7% in Washington County, compared to 3.6% in Wisconsin and 5.1% in the United States.
The 2000 median household income levels of six of our seven community banking market area counties were above the state and national levels, with Milwaukee County being the only county with per capita income levels below state and national levels. The 2000 median household income levels ranged from a low of $38,100 in Milwaukee County to a high of $62,839 in Waukesha County. From 2000 to 2010, median household income increased in all area counties by percentages ranging from a low of 6.8% in Milwaukee County to a high of 19.4% in Walworth County. In 2010, median household income ranged from a low of $40,702 in Milwaukee County to a high of $73,703 in Ozaukee County, with all but Milwaukee County having higher median income levels than both the state and national levels of $50,395 and $50,046, respectively. By 2017, the projected increases in median household income are expected to range from 3.0% in Walworth County to 22.8% in Milwaukee County, with median household income levels in Jefferson, Milwaukee and Walworth Counties increasing less than both state and national levels and the four other counties increasing more that the increases at the state and national levels. The 2017 projected median household income levels ranged from $50,001 in Milwaukee County to $81,501 in Waukesha County, compared to $57,220 in Wisconsin and $56,895 in the United States.
In 2008, four of the seven counties in the market area had lower unemployment rates than that of the State of Wisconsin as a whole while the remaining three counties had unemployment rates lower than that of the United States as a whole. Through 2010, unemployment rates increased in the United States and in Milwaukee County but decreased in Wisconsin as a whole and in six of the market area counties. In 2011 and 2012, unemployment rates continued to decrease in all market areas. In 2013, unemployment rates decreased in all market area counties, with the exception of Racine County and ranged from a high of 8.6% in Racine County to a low of 5.4% in Ozaukee County compared to 6.8% in Wisconsin and 7.4% in the United States.
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According to the 2010 Census, the median home values in the community banking market area ranged from a low of $159,800 in Milwaukee County to a high of $253,700 in Ozaukee County, with an average of $204,414 for the seven market area counties. Median 2010 home values for the State of Wisconsin and for the United States were $166,700 and $179,900, respectively.
In March 2013, Corelogic reported that the foreclosure rate in the metropolitan Milwaukee area, Milwaukee, Waukesha, Ozaukee and Washington Counties, fell to 1.97% of mortgaged homes in January 2013 from 2.69% in January 2012. Similarly, the foreclosure rate for the State of Wisconsin fell to 1.68% in January 2013 from 2.30% in January 2012. For the United States, the foreclosure rate dropped to 2.8% in 2013 compared to 3.5% in 2012. In a related trend, year-over-year increases in home sales in market area counties are reported. According to Metro MLS Inc. data released by the Greater Milwaukee Association of Realtors, home sales in December 2013 increased by 5.0% compared to December 2012 for the metropolitan area defined as Milwaukee, Waukesha, Ozaukee, and Washington counties.
Waterstone Mortgage Corporation. As of December 31, 2013, Waterstone Mortgage Corporation had 21 offices in Wisconsin, 11 offices in Florida, 10 offices in Pennsylvania, 8 offices in Minnesota, six offices in each of North Carolina and Virginia, four offices in Indiana, three offices in each of Arizona, Ohio and Tennessee, two offices in each of Illinois and Iowa and one office in each of Arkansas, Colorado, Idaho, Massachusetts, Maryland, Maine, New Hampshire, Oklahoma, Oregon and Washington.
Competition
WaterStone Bank. WaterStone Bank faces competition within our market area both in making real estate loans and attracting deposits. The Milwaukee-Waukesha-West Allis metropolitan statistical area has a high concentration of financial institutions, including large commercial banks, community banks and credit unions. The Federal Deposit Insurance Corporation has determined that our market area is a "high-rate" area with regard to deposit pricing as compared to the rest of the United States. As of June 30, 2013, based on the Federal Deposit Insurance Corporation's annual Summary of Deposits Report, we had the eighth largest market share in our metropolitan statistical area out of 56 financial institutions in our metropolitan statistical area, representing 1.6% 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, private banking and brokerage and insurance services.
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. In 2013, the Business Journal of Milwaukee ranked Waterstone Mortgage Corporation as southeastern Wisconsin's largest mortgage lender for the fifth year in a row.
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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 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 $413.6 million, or 37.9%, of our total loan portfolio at December 31, 2013. Multi-family residential mortgage loans represented $521.6 million, or 47.8%, of our total loan portfolio at December 31, 2013. We also offer construction and land loans, commercial real estate loans, home equity lines of credit and commercial loans. At December 31, 2013, commercial real estate loans, construction and land loans, home equity loans and commercial business loans totaled $71.7 million, $31.9 million, $35.4 million and $18.3 million, respectively.
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,
2013
2012
2011
2010
2009
Amount
Percent
(Dollars in Thousands)
Mortgage loans:
Residential real estate:
One- to four-family
$
413,614
37.85
%
460,821
40.65
496,736
40.83
582,026
44.56
679,657
47.86
Multi-family
521,597
47.75
514,363
45.37
552,240
45.39
542,602
41.53
536,731
37.80
Home equity
35,432
3.24
36,494
3.22
38,599
3.17
46,149
3.53
57,589
4.06
Construction and land
31,905
2.92
33,818
2.98
39,528
3.25
53,961
4.13
61,953
4.36
Commercial real estate
71,698
6.56
65,495
5.78
65,434
5.38
51,733
3.96
48,948
3.45
Commercial loans
18,296
1.67
22,549
1.99
24,018
1.97
29,812
2.28
34,513
2.43
Consumer
134
0.01
132
109
154
619
0.04
Total loans
1,092,676
100.00
1,133,672
1,216,664
1,306,437
1,420,010
Allowance for loan losses
(24,264
)
(31,043
(32,430
(29,175
(28,494
Loans, net
1,068,412
1,102,629
1,184,234
1,277,262
1,391,516
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Loan Portfolio Maturities and Yields. The following table summarizes the final maturities of our loan portfolio at December 31, 2013. 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
Due during the year ended
Weighted
December 31,
Average Rate
2014
38,910
37,561
5.64
9,378
4.18
6,761
4.51
2015
6,889
4.83
24,105
5.03
7,310
4.01
4,574
3.90
2016
9,216
4.85
16,116
4.77
3,806
5.34
5,867
3.57
2017
3,244
4.44
27,985
3.98
1,689
5.45
177
2018
7,018
3.95
65,504
4.11
3,463
5.09
6,999
3.79
2019 and thereafter
348,337
4.84
350,326
5.01
9,786
7,527
4.58
Total
4.87
4.88
4.37
Commercial Real Estate
Commercial Business
Consumer
Total
3,240
5.68
7,002
5.43
106
6.49
102,958
5.35
5,342
5.28
1,661
5.58
-
49,881
4.80
14,950
5.57
652
5.92
28
4.56
50,635
4.94
6,436
4.82
861
5.07
40,392
4.24
10,649
4.33
3,494
4.74
97,127
4.16
31,081
5.18
4,626
4.99
751,683
4.92
5.13
5.20
4.71
4.86
The following table sets forth the scheduled repayments of fixed and adjustable rate loans at December 31, 2013 that are contractually due after December 31, 2014.
Due After December 31, 2014
Fixed
Adjustable
Total
(In Thousands)
Mortgage loans
Real estate loans:
One- to four-family
$
19,203
355,501
374,704
Multi-family
85,444
398,592
484,036
Home equity
5,986
20,068
26,054
Construction and land
11,940
13,204
25,144
Commercial
34,156
34,302
68,458
10,151
1,143
11,294
Consumer
28
-
Total loans
166,908
822,810
989,718
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One- to Four-Family Residential Mortgage Loans. WaterStone Bank's primary lending activity is originating residential mortgage loans secured by properties located in Milwaukee and surrounding counties. One- to four-family residential mortgage loans totaled $413.6 million, or 37.9% of total loans at December 31, 2013. One- to four-family residential mortgage loans originated for investment during the year ended December 31, 2013 totaled $24.5 million, or 17.5% of all loans originated for investment. Our one- to four-family residential mortgage loans have fixed or adjustable rates. Our 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. We do not and have never offered residential mortgage loans specifically designed for borrowers with sub-prime credit scores, including Alt-A and negative amortization loans. Further, prior to 2007, we did not offer indexed, adjustable-rate loans other than home equity lines of credit, and we have never offered "teaser rate" first mortgage products.
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.
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 single family first mortgage loan balance was $184,000 and the largest outstanding balance was $3.8 million on December 31, 2013. The average two- to four-family first mortgage loan balance was $154,000 on December 31, 2013, and the largest outstanding balance on that date was $5.0 million, which is a consolidation loan that is collateralized by 29 properties.
Multi-family Real Estate Loans. Multi-family loans totaled $521.6 million, or 47.8% of total loans at December 31, 2013. Multi-family loans originated during the year ended December 31, 2013 totaled $82.9 million, or 59.3% of all loans originated for investment. 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, business 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. We generally require that the properties securing these real estate loans have debt service coverage ratios (the ratio of earnings before interest, 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 by the principals and by the owners of 20% or more of the borrower.
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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 all 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 $757,000 on December 31, 2013, with the largest outstanding balance at $7.9 million. At December 31, 2013, our largest exposure to one borrower or to a related group of borrowers was $23.9 million. The largest loan in the group is a mortgage loan with an outstanding balance at December 31, 2013 of $7.9 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, 2013, outstanding home equity loans and equity lines of credit totaled $35.4 million, or 3.2% of total loans outstanding. At December 31, 2013, the unadvanced portion of home equity lines of credit totaled $14.7 million. Home equity loans and lines originated during the year ended December 31, 2013 totaled $6.1 million, or 4.3% of all loans originated for investment. 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 10 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 $50,000 at December 31, 2013, with the largest outstanding balance at that date of $862,000.
Residential Construction and Land Loans. We originate construction loans to individuals and contractors for the construction and acquisition of single and multi-family residences. At December 31, 2013, construction and land loans totaled $31.9 million, or 2.9% of total loans. Construction and land loans originated during the year ended December 31, 2013 totaled $6.7 million, or 4.8% of all loans originated for investment. At December 31, 2013, the unadvanced portion of these construction loans totaled $8.6 million.
Our construction mortgage loans generally provide for the payment of interest only during the construction phase, which is typically up to nine months although our policy is to consider construction periods as long as 12 months or more. At the end of the construction phase, the construction loan converts to a longer-term mortgage loan. Construction loans can be made with a maximum loan-to-value ratio of 90%, provided that the borrower obtains private mortgage insurance if the loan balance exceeds 80% of the lesser of the appraised value or sales price of the secured property. The average outstanding construction loan balance totaled $1.5 million on December 31, 2013, with the largest outstanding balance at $5.1 million. The average outstanding land loan balance was $297,000 on December 31, 2013, and the largest outstanding balance on that date was $4.0 million.
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Before making a commitment to fund a residential 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 the percentage of completion method.
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.
Commercial Real Estate Loans. Commercial real estate loans totaled $71.7 million at December 31, 2013, or 6.6% of total loans, and are made up of loans secured by office and retail buildings, churches, restaurants, other retail properties and mixed use properties. Commercial real estate loans originated during the year ended December 31, 2013 totaled $12.1 million, or 8.6% of all loans originated for investment. 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 30-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 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. We generally require that the properties securing these real estate loans have debt service coverage ratios (the ratio of earnings before interest, 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, 2013 was $481,000, and the largest outstanding balance at that date was $3.2 million.
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Commercial Loans. Commercial loans totaled $18.3 million at December 31, 2013, or 1.7% of total loans, and are made up of loans secured by accounts receivable, inventory, equipment and real estate. Commercial loans originated during the year ended December 31, 2013 totaled $7.6 million, or 5.4% of all loans originated. In an effort to increase our commercial loan portfolio, we established a commercial loan department in 2007 and we currently have four commercial business loan officers.
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 working capital ratios 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, 2013, the unadvanced portion of working capital lines of credit totaled $10.4 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. These loans generally amortize over 15 to 25 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. The average outstanding commercial loan at December 31, 2013 was $178,000 and the largest outstanding balance on that date was $2.1 million.
The following table shows loan origination, principal repayment activity, transfers to real estate owned, charge-offs and sales during the years indicated.
As of or for the Year Ended December 31,
(In Thousands)
Total gross loans receivable and held for sale at beginning of year
1,267,285
1,304,947
1,443,824
Real estate loans originated for investment:
Residential
24,504
17,088
13,651
82,938
51,816
60,367
6,079
3,112
4,328
6,676
2,695
3,487
12,098
14,572
25,398
Total real estate loans originated for investment
132,295
89,283
107,231
Consumer loans originated for investment
12
35
Commercial loans originated for investment
7,612
9,857
9,366
Total loans originated for investment
139,919
99,175
116,597
Real estate loans purchased for investment:
12,148
3,338
Total real estate loans purchased for investment
15,486
Principal repayments
(154,739
(164,392
(200,074
Transfers to real estate owned
(13,552
(22,282
(28,259
Loan principal charged-off
(12,624
(10,978
(19,291
Net activity in loans held for investment
(40,996
(82,991
(131,027
Loans originated for sale
1,751,054
1,749,426
1,027,346
Loans sold
(1,787,646
(1,704,097
(1,035,196
Net activity in loans held for sale
(36,592
45,329
(7,850
Total gross loans receivable and held for sale at end of year
1,189,697
- 13 -
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, discretionary rate adjustments that are not tied to an independent index and pre-payment penalties.
Exclusive of our mortgage banking operations, we generally retain in our portfolio a significant majority of the loans that we originate. At December 31, 2013, WaterStone Bank was servicing $2.8 million in loan participations we 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.
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 are authorized to approve and close any loan that qualifies under WaterStone Bank underwriting guidelines within the following lending limits:
•
A secured one- to four-family mortgage loan up to $500,000 for a borrower with total outstanding loans from us of less than $1,000,000 that is independently underwritten can be approved by select loan officers.
•
A loan up to $500,000 for a borrower with total outstanding loans from us of less than $500,000 can be approved by select commercial loan officers.
Any secured mortgage loan ranging from $500,001 to $2,999,999 or any new loan to a borrower with outstanding loans from us exceeding $1,000,000 must be approved by the Officer Loan Committee.
Any loan for $3,000,000 or more 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 $10,000,000 must be reviewed by the board of directors prior to closing.
- 14 -
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 such loans are placed on non-accrual status when they become more than 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.
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 collectibility 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 collectibility of the total contractual principal and interest is no longer in doubt.
The table below sets forth the amounts and categories of our non-accrual loans and real estate owned at the dates indicated.
Non-accrual loans:
30,207
46,467
55,609
56,759
45,988
13,498
23,205
13,680
20,587
16,683
1,585
1,578
1,334
712
1,159
4,195
2,215
6,946
3,013
6,269
938
668
514
1,577
2,773
Commercial
521
511
135
1,530
2,441
17
24
Total non-accrual loans
50,961
74,668
78,218
84,178
75,313
Real estate owned
12,980
17,353
27,449
28,142
27,016
3,040
9,890
16,231
14,903
8,824
6,258
7,029
8,796
9,926
10,458
385
1,702
4,194
4,781
4,631
Total real estate owned
22,663
35,974
56,670
57,752
50,929
Total non-performing assets
73,624
110,642
134,888
141,930
126,242
Total accruing troubled debt restructurings
10,336
16,011
24,589
33,592
42,730
Total non-accrual loans to total loans, net
4.66
6.59
6.43
6.44
5.30
Total non-accrual loans and accruing troubled debt restructurings to total loans receivable
Total non-accrual loans to total assets
2.62
4.50
4.57
4.65
4.03
Total non-performing assets to total assets
3.78
6.66
7.88
7.85
6.76
- 15 -
All loans that exceed 90 days with respect to past due principal and interest are recognized as non-accrual. Troubled debt restructurings which are still on nonaccrual either due to being past due greater than 90 days, or which have not yet performed under the modified terms for a reasonable period of time, are included in the table above. In addition, loans 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 contractual past due dates 60 and 90 days. Upon determining the updated estimated value of the collateral, a loan loss provision is recorded to establish a specific reserve to the extent that the outstanding principal balance exceeds the updated estimated net realizable value of the collateral. When a loan is determined to be uncollectible, 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 year indicated.
At December 31,
2013
2012
2011
2010
2009
Balance at beginning of year
$
74,668
78,218
84,178
75,313
107,730
Additions
33,488
44,617
59,703
87,349
76,435
Transfers to real estate owned
(13,552
)
(22,282
(28,259
(41,781
(54,072
Charge-offs
(11,792
(8,379
(14,138
(24,395
(23,541
Returned to accrual status
(26,005
(8,194
(12,021
(7,936
(17,601
Principal paydowns and other
(5,846
(9,312
(11,245
(4,372
(13,638
Balance at end of year
50,961
Total non-accrual loans decreased by $23.7 million, or 31.7%, to $51.0 million as of December 31, 2013 compared to $74.7 million as of December 31, 2012. The ratio of non-accrual loans to total loans receivable was 4.66% at December 31, 2013 compared to 6.59% at December 31, 2012. During the year ended December 31, 2013, $26.0 million in loans were returned to accrual status, $13.6 million were transferred to real estate owned (net of charge-offs), $11.8 million in loan principal was charged off and $5.8 million in principal payments were received. Offsetting this activity, $33.5 million in loans were placed on non-accrual status during the year ended December 31, 2013.
Of the $51.0 million in total non-accrual loans as of December 31, 2013, $45.0 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 $9.7 million in partial charge-offs have been recorded with respect to these loans as of December 31, 2013. 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. In addition, specific reserves totaling $5.1 million have been recorded as of December 31, 2013. The remaining $5.9 million of non-accrual loans were reviewed on an aggregate basis and $1.6 million in general valuation allowance was deemed necessary related to those loans as of December 31, 2013. The $1.6 million in general valuation allowance is based upon a migration analysis performed with respect to similar non-accrual loans in prior periods.
- 16 -
Our largest non-accrual loan as of December 31, 2013 was collateralized by multi-family residential real estate located in southeastern Wisconsin. This loan had a principal balance of $3.8 million at December 31, 2013 and a specific valuation allowance of $525,000. Our second largest non-accrual loan as of December 31, 2013 was collateralized by a single-family residence located in Idaho. This loan had a principal balance of $1.7 million at December 31, 2013. Based upon an updated valuation, the estimated net realizable value of the collateral exceeds the principal balance of the loan, thus a specific valuation was not deemed necessary as of December 31, 2013. Our third largest non-accrual loan as of December 31, 2013 was collateralized by a single-family residence located in southeastern Wisconsin. This loan had a principal balance of $1.6 million and a specific valuation allowance of $418,000 at December 31, 2013. Our fourth largest non-accrual loan as of September 30, 2013 was collateralized by multi-family real estate located in southeastern Wisconsin with a principal balance of $1.5 million and a specific valuation of $236,000. Our next largest non-accrual loan as of December 31, 2013 was collateralized by improved land held for development, located in southeastern Wisconsin. This loan had a principal balance of $1.4 million at December 31, 2013, which is net of life-to-date charge offs of $1.5 million. Together, these five largest non-accrual loans comprised 19.9% of total non-accrual loans at December 31, 2013.
For the year ended December 31, 2013, gross interest income that would have been recorded had our non-accruing loans been current in accordance with their original terms was $3.2 million. We recognized $2.1 million of interest income on such loans during the year ended December 31, 2013.
There were no accruing loans past due 90 days or more during the years ended December 31, 2013, 2012 or 2011.
Troubled Debt Restructurings.
The following table summarizes troubled debt restructurings by the Company's internal risk rating.
Troubled debt restructurings
Substandard
25,258
48,449
47,220
15,769
18,003
Watch
4,329
11,172
8,192
20,703
34,082
Total troubled debt restructurings
29,587
59,621
55,412
36,472
52,085
Troubled debt restructurings totaled $29.6 million at December 31, 2013, compared to $59.6 million at December 31, 2012. At December 31, 2013, $23.7 million of troubled debt restructurings, or 80.2%, 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.
- 17 -
We do not participate in government-sponsored troubled debt restructuring programs. Our troubled debt restructurings are short-term modifications. Typical initial restructured terms include six to twelve months of principal forbearance, a reduction in interest rate or both. Restructured terms do not include a reduction of the outstanding principal balance unless mandated by a bankruptcy court. Troubled debt restructuring terms may be renewed or further modified at the end of the initial term for an additional period if performance has been acceptable and the short-term borrower difficulty persists.
Information with respect to the accrual status of our troubled debt restructurings is provided in the following table.
At December 31,
2013
2012
Accruing
Non-accruing
6,218
11,875
9,921
21,847
Over four-family
2,710
5,314
3,917
20,030
972
986
1,408
833
2,173
79
Commercial real estate
257
668
10,336
19,251
16,011
43,610
The following table sets forth activity in our troubled debt restructurings for the years indicated.
At or for the Year Ended December 31,
Accruing
Non-accruing
(In Thousands)
16,011
43,610
24,589
30,823
230
1,489
3,651
24,049
Change in accrual status
4,684
(4,684
(2,060
2,060
-
(2,459
(270
(1,795
Returned to contractual/market terms
(9,453
(13,848
(8,773
(8,502
Transferred to real estate owned
(3,094
(125
(1,009
(1,136
(1,763
(1,001
(2,016
Balance at end of period
10,336
19,251
For the year ended December 31, 2013, gross interest income that would have been recorded had our troubled debt restructurings been current in accordance with their contractual terms was $1.9 million. We recognized $1.5 million of interest income on such loans during the year ended December 31, 2013.
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.
- 18 -
Loan Delinquency. The following table summarizes loan delinquency in total dollars and as a percentage of the total loan portfolio:
(Dollars in Thousands)
Loans past due less than 90 days
13,231
23,092
Loans past due 90 days or more
30,780
51,358
Total loans past due
44,011
74,450
Total loans past due to total loans receivable
4.03
%
6.57
Past due loans decreased by $30.4 million, or 40.9%, to $44.0 million at December 31, 2013 from $74.5 million at December 31, 2012. Loans past due 90 days or more decreased by $20.6 million, or 40.1%, during the year ended December 31, 2013 while loans past due less than 90 days decreased by $9.9 million, or 42.7%. The $20.6 million decrease in loans past due 90 days or more was primarily due to an $11.0 million lending relationship that was brought current during the year ended December 31, 2013. The $9.9 million decrease in loans past due less than 90 days or more was primarily attributable to a $6.9 million decrease in loans collateralized by one- to four –family loans.
Real Estate Owned.
Total real estate owned decreased by $13.3 million, or 37.0%, to $22.7 million at December 31, 2013, compared to $36.0 million at December 31, 2012. During the year ended December 31, 2013, $13.6 million was transferred from loans to real estate owned upon completion of foreclosure. Declines in property values evidenced by updated appraisals, responses to list prices on properties held for sale and/or deterioration in the condition of properties resulted in write-downs totaling $1.4 million during the year ended December 31, 2013. During the same period, sales of real estate owned totaled $25.7 million, resulting in a net gain of $2.8 million.
In an effort to strengthen our oversight of problem assets and minimize overall costs and expenses as well as any loss on the sale of real estate owned, during 2011 we established an internal asset management group and an internal sales group, which also enable our lenders to focus on loan origination instead of foreclosed asset management.
New appraisals received on real estate owned and collateral dependent impaired loans are based upon an "as is value" assumption. During the period of time in which we are awaiting receipt of an updated appraisal, loans evaluated for impairment based upon collateral value are measured by the following:
•
Applying an updated adjustment factor (as described previously) to an existing appraisal;
Confirming that the physical condition of the real estate has not significantly changed since the last valuation date;
Comparing the estimated current value of the collateral to that of updated sales values experienced on similar collateral;
Comparing the estimated current value of the collateral to that of updated values seen on current appraisals of similar collateral; and
Comparing the estimated current value to that of updated listed sales prices on our real estate owned and that of similar properties (not owned by us).
- 19 -
We owned 158 properties at December 31, 2013, compared to 223 properties as of December 31, 2012 and 323 properties at December 31, 2011. Habitable real estate owned is managed with the intent of attracting a lessee to generate revenue. Foreclosed properties are recorded at the lower of carrying value or fair value 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 asset. 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 assets are then evaluated and accounted for in accordance with generally accepted accounting principles.
- 20 -
The following table sets forth activity in our allowance for loan losses for the years indicated.
At or for the Year
Ended December 31,
Balance at beginning of year
31,043
32,430
29,175
28,494
25,167
Provision for loan losses
4,532
8,300
22,077
25,832
26,687
Charge-offs:
Mortgage loans
8,706
6,472
11,553
16,906
13,602
1,640
1,108
3,996
3,439
3,304
630
485
634
1,480
1,668
1,745
2,319
3,957
160
1,182
734
575
910
4
10
13
9
8
59
1,470
1,000
Total charge-offs
12,624
10,978
19,291
25,341
23,643
Recoveries:
Mortgage loans
957
667
311
127
181
258
56
40
55
23
25
7
3
1
51
250
69
2
77
6
293
Total recoveries
1,313
1,291
469
190
283
Net charge-offs
11,311
9,687
18,822
25,151
23,360
Allowance at end of year
24,264
Ratios:
Allowance for loan losses to non-performing loans at end of year
Allowance for loan losses to net loans outstanding at end of year
Net charge-offs to average loans outstanding
Current year provision for loan losses to net charge-offs
Net charge-offs to beginning of the year allowance
- 21 -
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.
Allowance for Loan Losses
% of Loans in Category to Total Loans
% of Allowance in Category to Total Allowance
Real Estate:
11,549
47.59
17,819
57.40
17,475
53.89
7,211
29.72
7,734
24.90
8,252
25.44
1,807
7.45
2,097
1,998
6.16
1,613
6.65
1,323
4.26
2,922
9.01
1,402
1,259
941
2.90
34
0.14
781
2.52
814
2.51
648
2.67
30
0.10
0.09
Total allowance for loan losses
(Dollars In Thousands)
16,150
55.36
17,875
62.73
6,877
23.57
5,208
18.28
1,196
4.10
1,642
5.76
3,252
11.14
2,635
9.25
671
2.30
720
2.53
1,001
3.43
371
1.30
43
0.15
- 22 -
All impaired loans meeting the criteria established by management are evaluated either 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.
The above analysis is both quantitative and subjective, as it requires us to make estimates that are susceptible to revisions as more information becomes available. Although we believe that we have established the allowance at levels appropriate to absorb probable and estimable losses, additions may be necessary if future economic conditions differ substantially from the current environment.
At December 31, 2013, the allowance for loan losses was $24.3 million, compared to $31.0 million at December 31, 2012. As of December 31, 2013, the allowance for loan losses to total loans receivable was 2.22% and equal to 47.61% of non-performing loans, compared to 2.74%, and 41.58%, respectively at December 31, 2012. The decrease in the allowance for loan losses during the year ended December 31, 2013 reflects a stabilization in both the quality of the loan portfolio as well as the overall local real estate market. During each period we experienced a stabilization or improvement in a number of key loan-related loan quality metrics, including impaired loans, substandard loans, loans contractually past due and non-accrual loans. In addition, the decrease in the allowance for loan losses reflects a decrease in the overall balance of loans outstanding.
Net charge-offs totaled $11.3 million, or an annualized 0.93% of average loans for the year ended December 31, 2013, compared to $9.7 million, or an annualized 0.76% of average loans for the year ended December 31, 2012. The $1.6 million increase in net charge-offs was primarily the result of an increase in charge-offs related to loans secured by one- to four-family residential loans, which increased $1.9 million, or 33.5%, to $7.7 million for year ended December 31, 2013, as compared to $5.8 million for the year ended December 31, 2012. The increase in net charge-offs reflects $1.4 million in charge-offs related to one borrower with six loans. The $1.4 million had been included in specific reserves as of December 31, 2012.
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 quantified deterioration of the credit quality of our loan portfolio as described above is the direct result of borrowers who were not financially strong enough to make regular interest and principal payments or maintain their properties when the economic environment no longer allowed them the option of converting estimated real estate value increases into short-term cash flow.
- 23 -
Mortgage Banking Activity
In addition to the lending activities previously discussed, we also originate residential mortgage loans for sale in the secondary market through Waterstone Mortgage Corporation. We originated $1.75 billion in mortgage loans held for sale during the year ended December 31, 2013, which was consistent with the $1.75 billion originated during the year ended December 31, 2012. Proceeds from sales to third parties during the years ended December 31, 2013 and 2012 totaled $1.86 billion and $1.79 billion, respectively. Margins earned on loans sold declined during the year ended December 31, 2013 such that total mortgage banking segment revenues declined $3.1 million, or 3.5%, to $84.9 million during the year ended December 31, 2013 compared to $87.9 million during the year ended December 31, 2012. 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 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. During the year ended December 31, 2013, the growth in loan origination volume resulted in a shift towards higher yielding governmental loans and loans originated for the purchase of a residential property, however, margins decreased for all loan types and loan purpose, compared to the year ended December 31, 2012. Loans originated for the purchase of a residential property, which generally yield a higher margin than loans originated for refinancing existing loans, comprised 67.9% of total originations during the year ended December 31, 2013, compared to 55.4% of total originations during the year ended December 31, 2012. The mix of loan type has changed slightly with conventional loans and governmental loans comprising 62.7% and 37.3% of all loan originations, respectively, during the year ended December 31, 2013, compared 67.3% and 32.7% of all loan originations, respectively, during the year ended December 31, 2012.
Partially offsetting the decline in revenues related to the origination and sale of loans during the year ended December 31, 2013, the Company sold mortgage servicing rights related to $541.6 million in loans receivable with a book value $2.8 million at a gain of $2.6 million. The sales were timed to take advantage of preferable market pricing conditions. There were no comparable transactions during the year ended December 31, 2012.
Operating expenses related to our mortgage banking segment increased $7.1 million, or 10.3% to $76.2 million during the year ended December 31, 2013, compared to $69.1 million during the year ended December 31, 2012. The increase in operating expenses resulted from the expansion of our branch network as well as an increase in support staffing levels during the end of 2012 and beginning half of 2013 in anticipation of increased volumes. During the quarter ended December 31, 2013, the Company reduced support staffing levels in response to lower than anticipated origination volumes. The anticipated increase in origination volumes did not materialize during the last six months of the year due in large part to the significant increase in interest rates on in fixed-rate mortgages during the year which led to lower demand for refinance mortgage products. Compensation expense associated with our mortgage banking activities increased by $4.7 million, or 9.3%, to $55.5 million during the year ended December 31, 2013 compared to $50.7 million for the year ended December 31, 2012. Occupancy expense increased $1.3 million, or 34.7%, to $5.2 million during the year ended December 31, 2013 compared to $3.9 million during the year ended December 31, 2012. The increases resulted from an expansion of the branch network as well as the relocation of the mortgage banking segment's corporate headquarters to a larger leased facility.
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Investment Activities
Wauwatosa Investments, Inc. is WaterStone Bank's investment subsidiary headquartered in the State of Nevada. Wauwatosa Investments, Inc. manages WaterStone Bank's investment portfolio. Our Treasurer and Treasury Officer are responsible for implementing 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 our 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 Treasurer and Treasury Officer who may act jointly or severally. In addition, the President of Wauwatosa Investments, Inc. has execution authority for securities transactions. The Treasurer 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 Treasurer, the Treasury Officer and the President of Wauwatosa Investments, Inc. are authorized to execute investment transactions (purchases and sales) without the prior approval of the board and 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 year ended December 31, 2013, municipal securities with a total book value of $930,000 were sold at a loss of $9,000. During the year ended December 31, 2012, collateralized mortgage obligations with a total book value of $18.0 million were sold at a gain of $282,000 and municipal securities with a total book value of $11.6 million were sold at a gain of $240,000. During the year ended December 31, 2011, collateralized mortgage obligations with a total book value of $3.2 million were sold at a gain of $53,000.
Available for Sale Portfolio
Government Sponsored Enterprise Bonds. At December 31, 2013, our Government sponsored enterprise bond portfolio totaled $17.9 million, all of which were issued by Federal National Mortgage Associated (Fannie Mae), Federal Home Loan Mortgage Corporation (Freddie Mac) or Federal Home Loan Bank (FHLB) and were classified as available for sale. The weighted average yield on these securities was 1.08% and the weighted average remaining average life was 4.0 years at December 31, 2013. 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, 2013 was $237,000 less than the amortized cost of $18.2 million. A total of $988,000 of government enterprise bonds are pledged as collateral for borrowings at December 31, 2013.
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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 and collateralized mortgage obligations issued by investment banks. We invest in mortgage-backed securities and collateralized mortgage obligations 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 and collateralized mortgage obligations are created by the pooling of mortgages and the issuance of a security with an interest rate which is less than the interest rate on the underlying mortgages. 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 and collateralized mortgage obligations 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, 2013, mortgage-backed securities totaled $104.9 million. The mortgage-backed securities portfolio had a weighted average yield of 2.17% and a weighted average remaining life of 3.9 years at December 31, 2013. The estimated fair value of our mortgage-backed securities portfolio at December 31, 2013 was $461,000 more than the amortized cost of $104.5 million. Mortgage-backed securities valued at $80.4 million are pledged as collateral for borrowings at December 31, 2013. 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 market 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, 2013, collateralized mortgage obligations totaled $19.2 million. At December 31, 2013, 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 2.45% and a weighted average remaining life of 2.4 years at December 31, 2013. The estimated fair value of our collateralized mortgage obligations portfolio at December 31, 2013 was $295,000 more than the amortized cost of $18.9 million. Collateralized mortgage obligations valued at $19.2 million are pledged as collateral for borrowings at December 31, 2013. 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 market 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.
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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. At December 31, 2013, our municipal obligations portfolio totaled $58.8 million, all of which was classified as available for sale. The weighted average yield on this portfolio was 3.97% at December 31, 2013, with a weighted average remaining life of 8.9 years. The estimated market value of our municipal obligations bond portfolio at December 31, 2013 was $2.2 million less than the amortized cost of $61.0 million. During the year ended December 31, 2012, the Company identified two municipal securities that were deemed to be other-than-temporarily impaired. Both securities were issued by a tax incremental district in a municipality located in Wisconsin. During the year ended December 31, 2012, the Company's analysis of these securities resulted in $100,000 in credit losses that were charged to earnings with respect to these two municipal securities. No additional other-than-temporary impairment was deemed necessary during the year ended December 31, 2013. As of December 31, 2013, these securities had a combined amortized cost of $215,000 and a combined estimated fair value of $189,000.
Other Debt Securities. As of December 31, 2013, we held a trust preferred security with a fair value of $5.2 million and amortized cost of $5.0 million. This security, which yields 10.0% is callable beginning in the second quarter of 2013 with final maturity in 2068.
Certificates of Deposit. At December 31, 2013, we held certificates of deposit with a fair value and amortized cost of $7.4 million. The weighted average yield on these securities was 1.05% and the weighted average remaining average life was 1.9 years at December 31, 2013. While these certificates 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.
Investment Securities Portfolio.
The following table sets forth the carrying values of our available for sale securities portfolio at the dates indicated.
2011
Amortized
Cost
Fair Value
Securities available for sale:
Mortgage-backed securities
104,462
104,923
116,813
119,056
33,561
35,417
Collateralized mortgage obligations
Government sponsored enterprise issued
18,946
19,241
29,207
29,579
32,650
33,196
Private label issued
19,475
18,451
Government sponsored enterprise bonds
18,171
17,934
8,000
8,017
71,210
71,349
Municipal obligations
61,014
58,793
35,493
37,371
37,644
39,068
Other debt securities
5,000
5,160
5,070
5,118
Certificates of deposit
7,350
7,367
5,880
5,924
3,920
Total securities available for sale
214,943
213,418
200,393
205,017
203,460
206,519
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The following table sets forth the amortized cost and estimated fair value of securities, by issuer, as of December 31, 2013, that exceeded 10% of our stockholders' equity as of that date.
At December 31, 2013
Amortized Cost
Fannie Mae
99,227
99,480
Freddie Mac
35,655
36,033
Portfolio Maturities and Yields. The composition and maturities of the securities portfolio at December 31, 2013 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
Carrying
Average
Value
Yield
101,490
2.13
3,433
3.17
2.17
361
5.31
18,880
2.39
2.45
1.08
666
3.52
10,983
4.72
21,135
2.85
26,009
4.60
3.97
10.00
1,966
0.93
5,401
1.09
1.05
2,993
2.02
154,688
2.18
34,602
5.20
2.76
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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 who work or reside 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, 2013, regular savings accounts included $388.7 million in deposits from our second-step offering and comprised 31.2% of total customer deposits at December 31, 2013, with a weighted average cost of 0.01%. Excluding the deposits received in connection with the stock offering, certificates of deposit comprised 74.5% of total customer deposits at December 31, 2013, and had a weighted average cost of 0.69% 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, 2013 and December 31, 2012, $637.8 million and $736.9 million of our deposit accounts were certificates of deposit, of which $505.8 million and $454.6 million, respectively, had maturities of one year or less. The percentage of our deposit accounts that are certificates of deposit is greater than most of our competitors.
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Deposits increased by $305.2 million, or 32.5%, from December 31, 2012 to December 31, 2013. The increase in deposits was the result of a $395.3 million increase in money market and savings accounts (including $388.7 million of deposits from the second-step offering) and a $9.1 million, or 10.9%, increase in demand deposits, partially offset by a $99.2 million, or 13.5%, decrease in time deposits. As of December 31, 2013, the Company had no deposits obtained from brokers. Deposits obtained from brokers totaled $100,000 at December 31, 2012. Brokered deposits have historically been utilized when the relative cost compares favorably to the cost of retail deposits we generate directly. Brokered deposits have also been historically utilized in order to obtain significant additional deposit funding over a period of weeks rather than months.
The following table sets forth the distribution of total deposit accounts, by account type, at the dates indicated.
Average
Balance
Rate
Deposit type:
Demand deposits
45,850
3.68
0.00
39,767
4.23
28,812
2.74
NOW accounts
47,425
3.81
0.03
44,373
4.72
39,645
3.77
0.08
Regular savings
451,476
36.27
54,837
5.84
45,511
0.20
Money market and savings deposits
62,240
5.00
0.11
63,616
6.77
58,591
0.41
Total transaction accounts
606,991
48.76
0.02
202,593
21.56
172,559
16.41
0.21
Certificates of deposit
637,750
51.24
0.69
736,920
78.44
0.83
878,733
83.59
1.53
Total deposits
1,244,741
0.36
939,513
0.67
1,051,292
1.31
30,030
24,255
2.08
37,705
3.29
37,165
3.19
44,540
3.89
0.22
45,219
3.88
0.48
58,863
5.14
46,809
4.02
0.46
171,138
14.94
0.24
153,448
13.17
0.30
974,391
85.06
1.74
1,011,442
86.83
1,145,529
1.51
1,164,890
2.22
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As of December 31, 2013, regular savings accounts included $388.7 million in deposits from our second-step offering. These deposits had a stated rate of 0.01%. Exclusive of these deposits the weighted average rate of the remaining regular savings accounts, total transaction accounts and total deposits was 0.04%, 0.05% and 0.53%, respectively.
At December 31, 2013, the aggregate balance of certificates of deposit of $100,000 or more was approximately $165.9 million. The following table sets forth the maturity of those certificates at December 31, 2013.
(In Thousands)
Due in:
Three months or less
25,938
Over three months through six months
55,430
Over six months through 12 months
53,151
Over 12 months
31,417
Total
165,936
Borrowings. Our borrowings at December 31, 2013 consist of $350.0 million in advances from the Federal Home Loan Bank of Chicago, $84.0 million in repurchase agreements collateralized by investment securities and $21.2 million in short-term repurchase agreements used to finance 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,
Borrowings:
(Dollars in Thousands)
Balance outstanding at end of year
455,197
479,888
461,138
Weighted average interest rate at the end of year
3.86
%
3.82
3.93
Maximum amount of borrowings outstanding at any
month end during the year
490,124
491,053
465,290
Average balance outstanding during the year
479,952
475,114
446,401
Weighted average interest rate during the year
3.84
3.87
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Legal Proceedings
The Company and its subsidiaries are not involved in any legal proceedings where the outcome, if adverse to us, would have a material and adverse affect on our financial condition or results of operations.
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 an inactive 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-Federal's board of directors.
Waterstone Mortgage Corporation. Acquired in February 2006, Waterstone Mortgage Corporation is a mortgage banking business with offices in Wisconsin, Pennsylvania, Minnesota, Florida, Ohio, Arizona, Idaho, Indiana, Iowa, Illinois, Colorado and Maryland. Waterstone Mortgage Corporation was the largest mortgage broker in the Milwaukee area based on 2013 dollar volume of retail first and second mortgages originated. It has its own board of directors currently comprised of its President, its Chief Financial Officer, the WaterStone Bank Chief Executive Officer, Chief Financial Officer and Senior Vice President and General Counsel.
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, bank-owned branch office facilities and real estate securing loans.
Personnel
As of December 31, 2013, we had approximately 849 full-time equivalent employees. Our employees are not represented by any collective bargaining group. Management believes that we have good working relations with our employees.
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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 12 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 access the capital markets, pay dividends, 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, New Waterstone 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. New Waterstone 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 New Waterstone, 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 New Waterstone. 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 New Waterstone.
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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 or 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. The Interstate Banking Act 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. The Interstate Banking Act, as amended, authorizes de novo branching into another state at locations at which banks chartered by the host state could establish a branch. Additionally, the IBA authorizes branching by merger, subject to certain state law limitations.
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 15% of the savings bank's capital plus an additional 10% for loans fully secured by readily marketable collateral. In addition, and notwithstanding the 15% of capital and additional 10% 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, 2013, 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, 2013, WaterStone Bank maintained 98.0% of its assets in qualified thrift investments and therefore met the qualified thrift lender requirement.
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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. Wisconsin law and regulations issued by the WDFI impose on Wisconsin savings banks certain fairness in lending requirements and prohibit savings banks from discriminating against a loan applicant based upon the applicant's physical condition, developmental disability, sex, marital status, race, color, creed, national origin, religion or ancestry.
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.
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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 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 depository institutions. An institution's assessment rate depends upon the category to which it is assigned and certain adjustments specified by Federal Deposit Insurance Corporation regulations, with less risky institutions paying lower rates. Assessment rates (inclusive of possible adjustments) currently range from 2 ½ to 45 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's current system represents a change, required by the Dodd-Frank Act, from its prior practice of basing the assessment on an institution's aggregate deposits.
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On November 12, 2009, the Federal Deposit Insurance Corporation issued a rule requiring all depository institutions to prepay their estimated assessments for the fourth quarter of 2009, and for all of 2010, 2011 and 2012. Under the rule, this prepayment was due on December 31, 2009. The assessment rate for the fourth quarter of 2009 and for 2010 was based on each institution's total base assessment rate for the third quarter of 2009, modified to assume that the assessment rate in effect on September 30, 2009 had been in effect for the entire third quarter, and the assessment rate for 2011 and 2012 would be equal to the modified third quarter assessment rate plus an additional three basis points. In addition, each institution's base assessment rate for each period was calculated using its third quarter assessment base, adjusted quarterly for an estimated 5% annual growth rate in the assessment base through the end of 2012. WaterStone Bank received a waiver from the Federal Deposit Insurance Corporation relative to the 2010, 2011 and 2012 prepayment.
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.
In addition to the Federal Deposit Insurance Corporation assessments, the Financing Corporation (FICO) is authorized to impose and collect, with the approval of the Federal Deposit Insurance Corporation, assessments for anticipated payments, issuance costs and custodial fees on bonds issued by the FICO in the 1980s to recapitalize the former Federal Savings and Loan Insurance Corporation. The bonds issued by the FICO are due to mature in 2017 through 2019. For the quarter ended December 31, 2013, the annualized FICO assessment was equal to 0.64 basis points of total assets less tangible capital.
Capitalization
Wisconsin Law and Regulation. Wisconsin savings banks are required to maintain a minimum capital to 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 declaration of dividends. At December 31, 2013 and 2012, WaterStone Bank's capital to assets ratio, as calculated under Wisconsin law, was 10.65% and 11.15%, respectively.
Federal Law and Regulation. Under Federal Deposit Insurance Corporation regulations, federally insured state-chartered banks that are not members of the Federal Reserve System ("state non-member banks"), such as WaterStone Bank, are required to comply with minimum capital requirements. For an institution the Federal Deposit Insurance Corporation determines is not anticipating or experiencing significant growth and is, in general, a strong banking organization, rated composite 1 under the Uniform Financial Institutions Ranking System established by the Federal Financial Institutions Examination Council, the minimum Tier 1 leverage capital to total assets ratio is 3%. For all other institutions, the minimum leverage capital ratio is not less than 4%. Tier 1 leverage capital is the sum of common shareholders' equity, non-cumulative perpetual preferred stock (including any related surplus) and minority investments in certain subsidiaries, less intangible assets (except for certain servicing rights and credit card relationships) and certain other specified items.
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The Federal Deposit Insurance Corporation regulations require state non-member banks to maintain certain levels of regulatory capital in relation to regulatory risk-weighted assets. The ratio of regulatory capital to regulatory risk-weighted assets is referred to as a bank's "risk-based capital ratio." Risk-based capital ratios are determined by allocating assets and specified off-balance sheet items (including recourse obligations, direct credit substitutes and residual interests) to four risk-weighted categories generally ranging from 0% to 200%, with higher levels of capital being required for the categories perceived as representing greater risk. For example, under the Federal Deposit Insurance Corporation's risk-weighting system, cash and securities backed by the full faith and credit of the U.S. government are given a 0% risk weight, loans secured by one- to four-family residential properties generally have a 50% risk weight, and commercial loans have a risk weighting of 100%.
State non-member banks, such as WaterStone Bank, must maintain a minimum ratio of total capital to risk-weighted assets of at least 8%, of which at least one-half must be Tier 1 capital. Total capital consists of Tier 1 capital plus Tier 2 or supplementary capital, which includes allowances for loan losses in an amount of up to 1.25% of risk-weighted assets, cumulative preferred stock and certain other capital instruments, and a portion of the net unrealized gain on equity securities. The includable amount of Tier 2 capital cannot exceed the amount of the institution's Tier 1 capital. Savings banks that engage in specified levels of trading activities are subject to adjustments in their risk-based capital calculation to ensure the maintenance of sufficient capital to support market risk.
The Federal Deposit Insurance Corporation, along with the other federal banking agencies, has adopted a regulation providing that the agencies will take into account the exposure of a bank's capital and economic value to changes in interest rate risk in assessing a bank's capital adequacy. The Federal Deposit Insurance Corporation also has authority to establish individual minimum capital requirements in appropriate cases upon a determination that an institution's capital level is, or is likely to become, inadequate in light of the particular circumstances.
In July 2013, the Federal Deposit Insurance Corporation and the other federal bank regulatory agencies issued a final rule that will revise their leverage and risk-based capital requirements and the method for calculating risk-weighted assets to make them consistent with agreements that were reached by the Basel Committee on Banking Supervision and certain provisions of the Dodd-Frank Act. The final rule applies to all depository institutions, top-tier bank holding companies with total consolidated assets of $500 million or more and all top-tier savings and loan holding companies. Among other things, the rule establishes a new common equity Tier 1 minimum capital requirement (4.5% of risk-weighted assets), increases the minimum Tier 1 capital to risk-based assets requirement (from 4% to 6% of risk-weighted assets) and assigns a higher risk weight (150%) to exposures that are more than 90 days past due or are on nonaccrual status and to certain commercial real estate facilities that finance the acquisition, development or construction of real property. The final rule also requires unrealized gains and losses on certain "available-for-sale" securities holdings to be included for purposes of calculating regulatory capital requirements unless a one-time opt-in or opt-out is exercised. The rule limits a banking organization's capital distributions and certain discretionary bonus payments if the banking organization does not hold a "capital conservation buffer" consisting of 2.5% of common equity Tier 1 capital to risk-weighted assets in addition to the amount necessary to meet its minimum risk-based capital requirements. The final rule becomes effective for WaterStone Bank on January 1, 2015. The capital conservation buffer requirement will be phased in beginning January 1, 2016 and ending January 1, 2019, when the full capital conservation buffer requirement will be effective.
Safety and Soundness Standards
Each federal banking agency, including the Federal Deposit Insurance Corporation, has adopted guidelines establishing general standards relating to internal controls, information and internal audit systems, loan documentation, credit underwriting, interest rate exposure, asset growth, asset quality, earnings and compensation, fees and benefits. 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.
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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 shall be 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 6.0% or more, has a Tier 1 leverage capital ratio of 5.0% 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 4.0% or more and a Tier 1 leveraged capital ratio of 4.0% or more (3.0% under certain circumstance) 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 4.0% or a Tier 1 leverage capital ratio that is less than 4.0% (3.0% under certain circumstances); (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 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%. 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" may be subject to growth limitations and may be required to submit a capital restoration plan, and a holding company that controls such a savings bank may be 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.
The recently adopted final rule that will increase regulatory capital requirements will adjust the prompt corrective action categories accordingly.
At December 31, 2013, WaterStone Bank was considered well-capitalized with a Tier 1 leverage ratio of 12.48%, a Tier 1 risk-based ratio of 20.41% and a total risk based capital ratio of 21.67%.
Regulatory Developments
On November 25, 2009, pursuant to a Stipulation and Consent to the Issuance of a Consent Order, WaterStone Bank agreed to the issuance of a Consent Order jointly issued by the Federal Deposit Insurance Corporation and the WDFI, WaterStone Bank's primary banking regulators. At the same time, pursuant to a Stipulation and Consent to Issuance of Order to Cease and Desist, Waterstone-Federal agreed to the issuance of an Order to Cease and Desist by the Office of Thrift Supervision, Waterstone-Federal's holding company regulator at the time. Collectively, the Stipulation and Consent to the Issuance of a Consent Order which became effective on December 18, 2009 and the Stipulation and Consent to Issuance of Order to Cease and Desist which became effective on December 1, 2009, are referred to as the "Orders".
The Order issued by the Federal Deposit Insurance Corporation and the WDFI prohibited the payment of cash dividends to Waterstone-Federal without prior regulatory consent, and required, among other things, that WaterStone Bank (i) maintain minimum Tier 1 capital of 8.5% of total average assets and minimum total risk-based capital of 12.0% of risk-weighted assets; (ii) perform a study with respect to the management of WaterStone Bank; and (iii) manage its bad loans and real estate acquired in foreclosure.
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The Order issued by the Office of Thrift Supervision required, among other things, that Waterstone-Federal adopt a two year capital plan that included plans for WaterStone Bank to maintain minimum Tier 1 capital of 8.5% of total average assets and minimum total risk-based capital of 12.0% of risk-weighted assets. The Order also prohibited the payment of cash dividends or repurchases of common stock, and restricted the ability of Waterstone-Federal to incur debt, in each case without prior regulatory non-objection.
Effective December 11, 2012, the WDFI and the Federal Deposit Insurance Corporation terminated the Order issued to WaterStone Bank. The terminated Order was replaced with a memorandum of understanding that required, among other things, maintenance of a minimum Tier 1 capital ratio of 8.0% and a minimum total risk based capital ratio of 12.0%, and also prohibited dividend payments without prior regulatory non-objection. The memorandum of understanding also required WDFI and Federal Deposit Insurance Corporation non-objection prior to WaterStone Bank materially changing or deviating from its strategic plan, such as material changes to funding strategies or asset mix. Effective November 4, 2013, the WDFI and the Federal Deposit Insurance Corporation terminated the memorandum of understanding.
Effective July 9, 2013, the Federal Reserve Board terminated the Order issued to Waterstone-Federal and requested that the board of directors adopt resolutions related to the operations of Waterstone-Federal. The board resolutions adopted by Waterstone-Federal require written approval from the Federal Reserve Board prior to the declaration or payment of dividends, any increase in debt or the redemption of holding company stock.
Failure to comply with the board resolutions could result in additional enforcement actions by the Federal Reserve Board. We have incurred significant expense in complying with the Orders, and continued compliance with the board resolutions may restrict our operations or result in continued expense, either of which could have adverse effects on our operations and financial condition.
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. If the paid-in surplus of the savings bank does not equal its capital stock, the board of directors may not declare a dividend unless at least 10% of the net profits of the preceding half year, in the case of quarterly or semi-annual dividends, or 10% of the net profits of the preceding year, in the case of annual dividends, has been transferred to paid-in surplus. 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. In addition, since WaterStone Bank is a subsidiary of a savings and loan holding company, WaterStone Bank must file a notice with the Federal Reserve Board at least 30 days before the board declares a dividend or approves a capital distribution.
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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, 2013, 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 and United States Government agencies. At December 31, 2013, 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. For 2013, a depository institution is required to maintain average daily reserves equal to 3% on the first $79.5 million of transaction accounts and an initial reserve of $1.4 million, plus 10% of that portion of total transaction accounts in excess of $79.5 million. The first $12.4 million of otherwise reservable balances (subject to adjustment by the Federal Reserve Board) are exempt from the reserve requirements. These percentages and threshold limits are subject to adjustment by the Federal Reserve Board. Savings institutions have authority to borrow from the Federal Reserve's "discount window," but Federal Reserve policy generally requires savings institutions to exhaust all other sources before borrowing from the Federal Reserve. As of December 31, 2013, WaterStone Bank met its Regulation D reserve requirements.
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, agent, or attorney of the savings bank, either individually or as an agent or partner of another, except as approved by 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 New Waterstone. 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.
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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 statutory sections also require that all such transactions be on terms that are consistent with safe and sound banking practices. 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 covered transaction by a savings bank with an affiliate and any purchase of assets or services by a savings bank from an affiliate 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.
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 comparable to the loans-to-one-borrower limit applicable to WaterStone Bank's loans. All 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 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 collectibility.
An exception to this 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, 2013, the rate of interest on an employee rate mortgage loan was 1.68%, compared to the weighted average rate of 4.51% on all single family mortgage loans. This rate decreased to 1.65% effective March 1, 2014. Employee rate mortgage loans totaled $3.0 million, or 0.3%, of our residential mortgage loan portfolio on December 31, 2013.
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Transactions between Bank Customers and Affiliates
Under Wisconsin and federal laws and regulations, Wisconsin savings banks, such as WaterStone Bank, are subject to the prohibitions on certain tying arrangements. A savings bank is prohibited, subject to certain exceptions, 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. Federal regulations require annual on-site examinations for all depository institutions except certain well-capitalized and highly rated institutions with assets of less than $500 million which are examined every 18 months. WaterStone Bank is required to pay examination fees and annual assessments to fund its supervision.
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) 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 12 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 $17.5 million at December 31, 2013.
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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, 2013, WaterStone Bank had $350.0 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.
Dodd-Frank Act
The Dodd-Frank Wall Street Reform and Consumer Protection Act of 2010 (the "Dodd-Frank Act") has resulted in significant changes to the regulation of insured depository institutions. Under the Dodd-Frank Act, the Office of Thrift Supervision was eliminated as of July 21, 2011. Responsibility for the supervision and regulation of federal savings banks was transferred to the Office of the Comptroller of the Currency, which is the agency that is currently primarily responsible for the regulation and supervision of national banks. At the same time, responsibility for the regulation and supervision of savings and loan holding companies, such as Lamplighter Financial, MHC and Waterstone-Federal, was transferred to the Federal Reserve Board, which also supervises bank holding companies.
Additionally, the Dodd-Frank Act created a new Consumer Financial Protection Bureau as an independent bureau of the Federal Reserve Board. The Consumer Financial Protection Bureau has assumed responsibility for the implementation of the federal financial consumer protection and fair lending laws and regulations, a function previously assigned to prudential regulators, and has authority to impose new requirements. Institutions of less than $10 billion in assets, however, such as WaterStone Bank, will continue to be examined for compliance with consumer protection and fair lending laws and regulations by, and be subject to the primary enforcement authority of, their primary bank regulators rather than the Consumer Financial Protection Bureau.
In addition to eliminating the Office of Thrift Supervision and creating the Consumer Financial Protection Bureau, the Dodd-Frank Act, among other things, directed changes in the way that institutions are assessed for deposit insurance, mandated the imposition of consolidated capital requirements on savings and loan holding companies, required originators of securitized loans to retain a percentage of the risk for the transferred loans, provided for regulatory rate-setting for certain debit card interchange fees, repealed restrictions on the payment of interest on commercial demand deposits and contained a number of reforms related to mortgage originations. Many of the provisions of the Dodd-Frank Act are subject to delayed effective dates and/or require the issuance of implementing regulations. Their impact on operations cannot yet be fully assessed. However, it is likely that the Dodd-Frank Act will, at a minimum, result in increased regulatory burden, compliance costs and interest expense for WaterStone Bank and New Waterstone.
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Volcker Rule
Effective December 10, 2013, pursuant to the Dodd-Frank Act, federal banking and securities regulators issued Final Rules to implement Section 619 of the Dodd-Frank Act (the "Volcker Rule"). The Final Rules prohibit banking entities from (1) engaging in short-term proprietary trading for their own accounts, and (2) having certain ownership interests in and relationships with hedge funds or private equity funds. The Final Rules are intended to provide greater clarity with respect to both the extent of those primary prohibitions and of the related exemptions and exclusions. The Final Rules also require each regulated entity to establish an internal compliance program that is consistent with the extent to which it engages in activities covered by the Volcker Rule, which must include (for the largest entities) making regular reports about those activities to regulators. Although the Final Rules provide some tiering of compliance and reporting obligations based on size, the fundamental prohibitions of the Volcker Rule apply to banking entities of any size, including the Company and Bank. The Final Rules are effective April 1, 2014, but the conformance period has been extended from its statutory end date of July 21, 2014 until July 21, 2015. The Company has evaluated the implications of the Final Rules on its investments and does not expect any material financial implications.
Under the Final Rules, banking entities would have been prohibited from owning certain Collateralized Debt Obligations (CDOs) backed by Trust Preferred Securities (TruPS) as of July 21, 2015, which could have forced banking entities to recognize unrealized market losses based on the inability to hold any such investments to maturity. However, on January 14, 2014, the U.S. financial regulators issued an interim rule ("Interim Rule"), effective April 1, 2014, exempting TruPS CDOs from the Volcker Rule if (i) the CDO was established prior to May 19, 2010, (ii) the banking entity reasonably believes that the offering proceeds of the CDO were used to invest primarily in TruPS issued by banks with less than $15 billion in assets, and (iii) the banking entity acquired the CDO on or before December 10, 2013. The Company currently does not have any impermissible holdings of TruPS CDOs under the Interim Rule, and therefore, will not be required to divest of any such investments or change the accounting treatment. However, regulators are soliciting comments to the Interim Rule, and this exemption could change prior to its effective date.
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.
Holding Company Regulation
New Waterstone 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 New Waterstone and its non-savings institution subsidiaries. Among other things, this 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. New Waterstone is subject to regulation as a savings bank holding company under Wisconsin law. However, the WDFI has not issued specific regulations governing savings bank holding companies.
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As a savings and loan holding company, New Waterstone's activities are limited to those activities permissible by law for financial holding companies (if New Waterstone makes an election to be treated as a financial holding company and meets the other requirements to be a financial holding company) or multiple savings and loan holding companies. A financial holding company may engage in activities that are financial in nature, incidental to financial activities or complementary to a financial activity. Such activities include lending and other activities permitted for bank holding companies, insurance and underwriting equity securities. Multiple savings and loan holding companies are authorized to engage in activities specified by federal regulation.
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.
Savings and loan holding companies historically have not been subject to consolidated regulatory capital requirements. However, the Dodd-Frank Act requires the Federal Reserve Board to establish minimum consolidated capital requirements for all depository institution holding companies that are as stringent as those required for the insured depository subsidiaries. The components of Tier 1 capital are restricted to capital instruments that are currently considered to be Tier 1 capital for insured depository institutions, which excludes instruments such as trust preferred securities and cumulative preferred stock. Instruments issued before May 19, 2010 are grandfathered for companies with consolidated assets of $15 billion or less. The final capital rule discussed above implements the consolidated capital requirements for savings and loan holding companies effective January 1, 2015.
The Dodd-Frank Act extended the "source of strength" doctrine to savings and loan holding companies. The regulatory agencies must promulgate regulations implementing the "source of strength" policy that 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 holding companies 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 the 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 policy statement also states that a holding company should inform the Federal Reserve Board supervisory staff 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 New Waterstone to pay dividends, repurchase shares of common stock or otherwise engage in capital distributions.
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Federal Securities Laws Regulation
Securities Exchange Act. New Waterstone common stock is registered with the Securities and Exchange Commission after the conversion and stock offering. New Waterstone is subject to the information, proxy solicitation, insider trading restrictions and other requirements under the Securities Exchange Act of 1934.
The registration under the Securities Act of 1933 of shares of common stock issued in New Waterstone's public offering does not cover the resale of those shares. Shares of common stock purchased by persons who are not affiliates of New Waterstone may be resold without registration. Shares purchased by an affiliate of New Waterstone will be subject to the resale restrictions of Rule 144 under the Securities Act of 1933. If New Waterstone meets the current public information requirements of Rule 144 under the Securities Act of 1933, each affiliate of New Waterstone 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 New Waterstone, or the average weekly volume of trading in the shares during the preceding four calendar weeks. In the future, New Waterstone 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 New Waterstone 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 federal law, means ownership, control of or holding irrevocable proxies representing more than 25% of any class of voting stock, control in any manner of the election of a majority of the institution's directors, or a determination by the regulator that the acquiror has the power, directly or indirectly, to exercise a controlling influence over the management or policies of the institution. 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 New Waterstone, the issuer has registered securities under Section 12 of the Securities Exchange Act of 1934.
In addition, federal regulations provide that no company may acquire control of a savings and loan holding company 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.
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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. All tax years prior to 2010 are closed to federal tax examination. During the quarter ended June 30, 2012, following receipt of notice from the Internal Revenue Service, we made a protective payment of $982,000 to cover all tax adjustments and estimated interest and penalties resulting from an audit of our federal tax returns for calendar years 2005 through 2009.
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, 2013, WaterStone Bank had no reserves subject to recapture in excess of its base year.
New Waterstone 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, 2013, our total federal pre-base year bad debt reserve was approximately $16.7 million.
Alternative Minimum Tax. The Internal Revenue Code imposes an alternative minimum tax at a rate of 20% on a base of regular taxable income plus certain tax preferences, less any available exemption. The alternative minimum tax is imposed to the extent it exceeds the regular income tax. Net operating losses can offset no more than 90% of alternative taxable income. Certain payments of alternative minimum tax may be used as credits against regular tax liabilities in future years. Due to a federal net operating loss carry back generated in 2008, Waterstone-Federal became subject to alternative minimum tax for 2006 and 2007. At December 31, 2013, the Company had no such amounts available as credits for carryover.
Net Operating Loss Carryovers. A financial institution may carry back net operating losses to the preceding two taxable years and forward to the succeeding 20 taxable years. A 2009 federal tax law change allows for a one-time carry back of either 2008 or 2009 taxable losses for up to five years. Waterstone-Federal had a federal net operating loss carryforward of $3.0 million at December 31, 2011, which was fully utilized during the year ended December 31, 2012.
Corporate Dividends-Received Deduction. New Waterstone 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 80% when the corporation receiving the dividend owns at least 20% of the stock of the distributing corporation. The dividends-received deduction is 70% when the corporation receiving the dividend owns less than 20% of the distributing corporation.
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State Taxation
Wisconsin State Taxation. The Company is subject to the Wisconsin corporate franchise (income) tax. 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. Prior to January 1, 2009, the income of the Nevada subsidiary was only subject to taxation in Nevada, which currently does not impose a corporate income or franchise tax. In February 2009, the Wisconsin legislature passed legislation that requires combined state tax reporting effective January 1, 2009. This legislation results in the apportioned income of the Nevada subsidiary being subject to the Wisconsin corporate franchise tax of 7.9%.
Our state tax returns for the years ended 2010 through 2013 remain open for audit.
As a Maryland business corporation, New Waterstone is required to file an annual report and pay franchise taxes to the state of Maryland.
Item 1A. Risk Factors
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, pay dividends, acquire other financial institutions or establish new branches.
Federal regulations governing the mutual-to-stock conversion require that we prepare a business plan that addresses, among other items, our projected operations and activities for three years following the conversion. The business plan is a confidential document that is submitted to the banking regulatory agencies and may not reflect currently unanticipated potential business opportunities or activities, such as increased dividends or acquisitions of other financial institutions. Federal regulations require that we operate within the parameters of the business plan, and that the Federal Reserve Board approve any material deviation from the business plan. This could affect our ability to conduct activities that deviate from the regulatory business plan that would otherwise benefit our stockholders.
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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. Our interest-bearing liabilities generally reprice or mature more quickly than our interest-earning assets. If rates increase rapidly, we may have to increase the rates we pay on our deposits, particularly our higher cost time deposits and borrowed funds, more quickly than any changes in interest rates earned on our loans and investments, resulting in a negative effect on interest spreads and net interest income. Furthermore, our mortgage banking income varies directly with movements in interest rates, and increases in interest rates could negatively affect our ability to originate loans in the same volumes as we have in recent years. Increases in interest rates may also make it more difficult for borrowers to repay adjustable rate loans.
Conversely, should market interest rates fall below current levels, our net interest margin could also be negatively affected if competitive pressures keep us from further reducing rates on our deposits, while the yields on our assets decrease more rapidly through loan prepayments and interest rate adjustments. 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.
See "Management's Discussion and Analysis of Financial Condition and Results of Operations—Management of Market Risk."
Higher interest rates may reduce our mortgage banking revenues, which would negatively impact our net income.
Our mortgage banking operations provide a significant portion of our non-interest income and are significantly affected by market interest rates. Any increase in market interest rates may reduce our mortgage banking income. For example, following the increase in interest rates in the spring of 2013, our mortgage banking revenues decreased to $36.5 million for the final two quarters of 2013 compared to $48.4 first two quarters of the year. We generate revenues primarily from gains on the sale of mortgage loans to investors. We also earn interest on loans held for sale while they are awaiting delivery to our investors. In a rising or higher interest rate environment, our mortgage loan originations may decrease, resulting in fewer loans that are available for sale. This would result in a decrease in interest income, a decrease in revenues from loan sales and a corresponding decrease in non-interest income. In addition, our results of operations are affected by the amount of non-interest expenses associated with mortgage banking activities, such as salaries and employee benefits, occupancy, equipment, data processing and other operating costs. During periods of reduced loan demand, our results of operations may be adversely affected to the extent that we are unable to reduce expenses commensurate with the decline in mortgage loan origination activity.
A discontinuation of the Federal Reserve Board's bond purchasing program may adversely affect our mortgage banking revenues.
The Federal Reserve Board has undertaken an unprecedented bond purchase program, known as "quantitative easing." This program is designed to keep market interest rates low and encourage growth. A continued slowdown of the Federal Reserve Board's bond repurchase program will likely cause an increase in market interest rates, which may reduce our loan originations by our mortgage banking subsidiary.
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We continue to experience high levels of delinquencies, non-accrual loans and charge-offs, which negatively affects our financial condition and results of operations.
We continue to experience high levels of non-accrual loans and loan delinquencies. Our non-accrual loans totaled $51.0 million, or 4.66% of total loans, at December 31, 2013, $74.7 million, or 6.59% of total loans, at December 31, 2012 and $78.2 million, or 6.43% of total loans, at December 31, 2011. Our loans past due totaled $44.0 million, or 4.0% of total loans receivable, at December 31, 2013, $74.4 million, or 6.6% of total loans receivable, at December 31, 2012 and $93.4 million, or 7.7% of total loans, at December 31, 2011. The continued elevated level of non-performing and delinquent loans has resulted in high levels of loan charge-offs. During the year ended December 31, 2013 and the year ended December 31, 2012, net charge-offs totaled $11.3 million and $9.7 million, respectively. Our high level of problem assets has also increased our costs associated with monitoring delinquent loans and managing and disposing of foreclosed property. We expect these costs to remain elevated until our delinquencies improve and we dispose of our foreclosed property. To the extent that our loan portfolio deteriorates, our financial condition and results of operations will be materially and adversely affected. Continued deterioration may also lead to actions by regulators that may have a direct material effect on our financial condition and results of operations.
The recent federal government shutdown resulted in reduced loan originations and related gains on sale during the fourth quarter of 2013, and any future federal government shutdown could negatively affect our financial condition and results of operations.
Our mortgage banking operations provide a significant portion of our non-interest income. During the recent federal government shutdown, we were not able to close certain loans and recognize non-interest income on the sale of those loans due to our inability to verify information related to borrowers, such as payments of federal income taxes. Also, some of the loans we originate are sold directly to government agencies, and some of these sales were unable to be consummated during the shutdown. Although we ultimately closed a majority of these loans, we incurred higher borrowing costs related to the longer period we maintain an outstanding commitment to fund a loan. In addition, we believe that some of these borrowers determined not to proceed with their home purchase and not close on their loans, which resulted in a permanent loss of the related non-interest income. Any future federal government shutdown could have the same negative effect.
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.
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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.
In an effort to increase our commercial loan portfolio, we established a commercial loan department in 2007 and we currently have four commercial business loan officers. We also continue to focus on originating 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.
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.
If we are required to repurchase mortgage loans that we have previously sold, it would 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. We have experienced more frequent disputes and repurchase demands from these buyers. If we are required to repurchase mortgage loans or provide indemnification or other recourse, this could significantly increase our costs and thereby affect our future earnings.
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Proposed and final regulations could restrict our ability to originate and sell loans.
The Consumer Financial Protection Bureau has issued a rule designed to clarify for lenders how they can avoid legal liability under the Dodd-Frank Act, which would hold lenders accountable for ensuring a borrower's ability to repay a mortgage. Loans that meet this "qualified mortgage" definition will be presumed to have complied with the new ability-to-repay standard. Under the Consumer Financial Protection Bureau's rule, a "qualified mortgage" loan must not contain certain specified features, including:
excessive upfront points and fees (those exceeding 3% of the total loan amount, less "bona fide discount points" for prime loans);
interest-only payments;
negative-amortization; and
terms longer than 30 years
Also, to qualify as a "qualified mortgage," a borrower's total monthly debt-to-income ratio may not exceed 43%. Lenders must also verify and document the income and financial resources relied upon to qualify the borrower for the loan and underwrite the loan based on a fully amortizing payment schedule and maximum interest rate during the first five years, taking into account all applicable taxes, insurance and assessments. The Consumer Financial Protection Bureau's rule on qualified mortgages could limit our ability or desire to make certain types of loans or loans to certain borrowers, or could make it more expensive/and or time consuming to make these loans, which could limit our growth or profitability.
In addition, the Dodd-Frank Act requires the regulatory agencies to issue regulations that require securitizers of loans to retain not less than 5% of the credit risk for any asset that is not a "qualified residential mortgage." The regulatory agencies have issued a proposed rule to implement this requirement. The Dodd-Frank Act provides that the definition of "qualified residential mortgage" can be no broader than the definition of "qualified mortgage" issued by the Consumer Financial Protection Bureau for purposes of its regulations (as described above). Although the final rule with respect to the retention of credit risk has not yet been issued, the final rule could have a significant effect on the secondary market for loans and the types of loans we originate, and restrict our ability to make loans.
A continuation or worsening of economic conditions could adversely affect our financial condition and results of operations.
Although the U.S. economy has emerged from the severe recession that occurred in 2008 and 2009, economic growth has been slow and unemployment levels remain high despite the Federal Reserve Board's unprecedented efforts to maintain low market interest rates and encourage economic growth. Recovery by many businesses has been impaired by lower consumer spending. The discontinuation of the Federal Reserve Board's bond purchasing program could result in higher interest rates and reduced economic activity. Moreover, a return to prolonged deteriorating economic conditions could significantly affect the markets in which we do business, the value of our loans and investments, and our ongoing operations, costs and profitability. Declines in real estate values and sales volumes and continued elevated unemployment levels may result in greater loan delinquencies, increases in our nonperforming, criticized and classified assets and a decline in demand for our products and services. These events may cause us to incur losses and may adversely affect our financial condition and results of operations.
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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 collectibility 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, 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.
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.
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.
Our inability to achieve profitability on new branches may negatively affect our earnings.
Subject to our ability to receive regulatory approval, we currently intend to open six new full-service branch offices by the end of 2016, with two branch offices opening in each of 2014, 2015 and 2016. The profitability of these branches will depend on whether the income that we generate from the additional branches will offset the increased expenses resulting from operating new branches. We expect that it may take time before new branches become profitable. During this period, operating new branches may negatively affect our operating results.
For information on restrictions on our ability to establish new branch offices, see "Supervision and Regulation—General."
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Financial reform legislation is expected to increase our costs of operations.
The Dodd-Frank Act has significantly changed the bank regulatory structure and affected the lending, investment, trading and operating activities of depository institutions and their holding companies. The Dodd-Frank Act authorized the Federal Reserve Board to supervise and regulate all savings and loan holding companies, such as New Waterstone, in addition to bank holding companies. The Dodd-Frank Act also instructed the Federal Reserve Board to set minimum capital levels for holding companies that are as stringent as those required for their insured depository subsidiaries, and requires the components of Tier 1 capital to be restricted to capital instruments that are currently considered to be Tier 1 capital for insured depository institutions. Savings and loan holding companies are subject to a five-year transition period before the holding company capital requirement will apply.
The Dodd-Frank Act also created a new Consumer Financial Protection Bureau with broad powers to supervise and enforce consumer protection laws. The Consumer Financial Protection Bureau has broad rule-making authority for a wide range of consumer protection laws that apply to all banks and savings institutions, such as WaterStone Bank, including the authority to prohibit "unfair, deceptive or abusive" acts and practices. The Consumer Financial Protection Bureau has examination and enforcement authority over all banks and savings institutions with more than $10 billion in assets. Banks and savings institutions with $10 billion or less in assets, such as WaterStone Bank, will be examined by their applicable bank regulators.
It is difficult to predict at this time the effect that the legislation and implementing regulations will have on community banks with regard to lending and credit practices. Many of the provisions of the Dodd-Frank Act have delayed effective dates, and the legislation requires various federal agencies to promulgate numerous and extensive implementing regulations over the next several years. Although the substance and scope of all of these regulations cannot be determined at this time, it is expected that the legislation and implementing regulations, particularly those relating to the new Consumer Financial Protection Bureau, will increase our operating and compliance costs.
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.
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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.
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 security 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. In addition, any compromise of our systems could deter customers from using our products and services. Although we rely on security systems to provide security and authentication necessary to effect the secure transmission of data, these precautions may not protect our systems from security breaches.
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 thereby subjecting us to additional regulatory scrutiny, or could expose us to litigation and possible financial liability. Any of these events could have a material adverse effect on our financial condition and results of operations.
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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.
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 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.
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Our failure to effectively deploy the net proceeds of our recently completed stock offering may have an adverse effect on our financial performance.
Of the total $248 million in net proceeds from the stock offering, we invested approximately $124 million in WaterStone Bank. We may use the remaining net proceeds to invest in short-term investments, repurchase shares of common stock, pay dividends or for other general corporate purposes. We also expect to use a portion of the net proceeds we retain to fund a loan to our employee stock ownership plan to purchase shares of common stock in the offering. WaterStone Bank may use the net proceeds it receives to fund new loans, expand its retail banking franchise by establishing or acquiring new branches or by acquiring other financial institutions or other financial services companies, or for other general corporate purposes. However, with the exception of the loan to the employee stock ownership plan, we have not allocated specific amounts of the net proceeds for any of these purposes, and we will have significant flexibility in determining the amount of the net proceeds we apply to different uses and when we apply or reinvest such proceeds. Also, certain of these uses, such as opening new branches or acquiring other financial institutions, may require the approval of the WDFI, the Federal Deposit Insurance Corporation or the Federal Reserve Board. We have not established a timetable for reinvesting the net proceeds, and we cannot predict how long we will require to reinvest the net proceeds. Our failure to utilize these funds effectively would reduce our profitability and may adversely affect the value of our common stock.
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 New Waterstone 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
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Item 2. Properties
We operate from our corporate center, our nine full-service banking offices, our drive-through office and nine automated teller machines, located in Milwaukee, Washington and Waukesha Counties, Wisconsin. In addition, we operate a loan production office in Maple Grove, Minnesota. The net book value of our premises, land, equipment and leasehold improvements was $27.1 million at December 31, 2013. The following table sets forth information with respect to our corporate center and our full-service banking offices as of February 28, 2014.
Corporate Center
11200 West Plank Court
Wauwatosa, Wisconsin 53226
Wauwatosa, Wisconsin 53226
Wauwatosa
7500 West State Street
Wauwatosa, Wisconsin 53213
Wauwatosa, Wisconsin 53213
Brookfield (1)
17495 W Capitol Dr.
Brookfield, WI 53045
Brookfield, WI 53045
Franklin/Hales Corners
6555 South 108th Street
Franklin, Wisconsin 53132
Franklin, Wisconsin 53132
Germantown/Menomonee Falls
W188N9820 Appleton Avenue
Germantown, Wisconsin 53022
Germantown, Wisconsin 53022
Oak Creek
6560 South 27th Street
Oak Creek, Wisconsin 53154
Oak Creek, Wisconsin 53154
Oconomowoc/Lake Country (1)
1233 Corporate Center Drive
Oconomowoc, Wisconsin 53066
Oconomowoc, Wisconsin 53066
Pewaukee
1230 George Towne Drive
Pewaukee, Wisconsin 53072
Pewaukee, Wisconsin 53072
Waukesha/Brookfield
21505 East Moreland Blvd
Waukesha, Wisconsin 53186
Waukesha, Wisconsin 53186
West Allis
10101 West Greenfield Avenue
West Allis, Wisconsin 53214
West Allis, Wisconsin 53214
Commercial Real Estate
Loan Production Site
13700 Reimer Drive N., Suite 100
Maple Grove, MN 55311
13700 Reimer Drive N., Suite 100
Maple Grove, MN 55311
(1)
Leased property
In addition to our banking offices, as of December 31, 2013, our mortgage banking operation has 21 offices in Wisconsin, 11 offices in Florida, 10 offices in Pennsylvania, 8 offices in Minnesota, six offices in each of North Carolina and Virginia, four offices in Indiana, three offices in each of Arizona, Ohio and Tennessee, two offices in each of Illinois and Iowa and one office in each of Arkansas, Colorado, Idaho, Massachusetts, Maryland, Maine, New Hampshire, Oklahoma, Oregon and Washington.
Item 3. Legal Proceedings
We are not involved in any pending legal proceedings as a defendant other than routine legal proceedings occurring in the ordinary course of business. At December 31, 2013, we were not involved in any legal proceedings, the outcome of which would be material to our financial condition or results of operations.
Item 4. Mine Safety Disclosures
Not applicable
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Part II
Item 5. Market for Registrant's Common Equity and Related Stockholder Matters and Issuer Purchase of Equity Securities
On June 6, 2013, the Board of Directors of Lamplighter Financial, MHC ("MHC") and the Board of Directors of the Waterstone Financial, Inc. ("Waterstone-Federal") adopted a new Plan of Conversion and Reorganization (the "Plan"). Pursuant to the Plan, Waterstone Financial, Inc., a Maryland Corporation, ("New Waterstone") was organized and the MHC converted from the mutual holding company form of organization to the fully public form on January 23, 2014. As part of the conversion, the MHC's ownership interest of the New Waterstone was offered for sale in a public offering. The existing publicly held shares of the Waterstone-Federal, were exchanged for new shares of common stock of New Waterstone. The exchange ratio ensured that immediately after the conversion and public offering, the public shareholders of the Waterstone-Federal owned the same aggregate percentage of New Waterstone common stock that they owned immediately prior to that time (excluding shares purchased in the stock offering and cash received in lieu of fractional shares). When the conversion and public offering was completed, New Waterstone became the holding company of Waterstone Bank and succeeded to all of the business and operations of Waterstone-Federal and each of Waterstone-Federal and Lamplighter Financial, MHC ceased to exist.
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 New Waterstone common stock as of February 28, 2014 was 1,054. On that same date there were 34,389,312 shares of common stock outstanding.
The following table presents the high and low quarterly trading prices for for Waterstone-Federal's common stock for the years ended December 31, 2013 and 2012.
2013
Historical
Restated
High
Low
1st Quarter
$ 8.68
$ 6.66
$ 7.91
$ 6.07
2nd Quarter
10.16
7.59
9.26
6.92
3rd Quarter
11.09
9.63
10.11
8.78
4th Quarter
11.55
10.00
10.53
9.11
2012
High
Low
$ 3.18
$ 1.78
$ 2.90
$ 1.62
4.05
3.01
3.69
2.74
5.19
3.33
4.73
3.03
8.39
5.16
7.65
4.70
Stock prices have been restated to reflect the completion of our second-step conversion at an exchange rate of 1.0973-to-one.
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The Plan provided for the establishment of special "liquidation accounts" for the benefit of certain depositors of WaterStone Bank in an amount equal to the greater of the MHC's ownership interest in the retained earnings of the Company as of the date of the latest balance sheet contained in the prospectus or the retained earnings of Waterstone Bank at the time it reorganized into the MHC. Following the completion of the conversion, under the rules of the Board of Governors of the Federal Reserve System, WaterStone Bank is not permitted to pay dividends on its capital stock to Waterstone Financial, Inc., its sole shareholder, if Waterstone Bank's shareholder's equity would be reduced below the amount of the liquidation accounts. The liquidation accounts will be reduced annually to the extent that eligible account holders have reduced their qualifying deposits. Subsequent increases will not restore an eligible account holder's interest in the liquidation accounts.
As of December 31, 2013, Waterstone Financial had never paid cash dividends. However, on March 18, 2014, the board declared a dividend of $0.05 per share, payable to stockholders of record as of April 11, 2014. The future payment of dividends will depend upon a number of factors, including capital requirements, our financial condition and results of operations, tax considerations, statutory and regulatory limitations and general economic conditions and regulatory restrictions that affect our ability to pay dividends. We cannot assure you that any dividends will not be reduced or eliminated in the future. Special cash or stock dividends, to the extent permitted by applicable policy and regulation, may be paid in addition to, or in lieu of, regular cash dividends.
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, 2008, in Waterstone Financial, Inc. common stock and each of those indices.
Period Ending
Index
12/31/08
12/31/09
12/31/10
12/31/11
12/31/12
12/31/13
Waterstone Financial, Inc. (MHC)
100.00
61.19
97.01
56.42
232.84
331.34
SNL Thrift NASDAQ index
91.01
90.01
80.38
95.93
121.63
Russell 2000
127.17
161.32
154.59
179.86
249.69
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Item 6. Selected Financial Data
SELECTED CONSOLIDATED FINANCIAL AND OTHER 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. The following data should be read together with the Company's consolidated financial statements and related notes and "Management's Discussion and Analysis of Financial Condition and Results of Operations" later in this report. The Company's subscription offering related to its second step conversion closed on December 17, 2013. As a result, cash and cash equivalents and deposits at December 31, 2013 include $388.7 million in proceeds from the offering. The result has a significant impact on certain comparative balance sheet totals and on ratios that are based on those numbers.
At or for the Year Ended December 31,
2010
2009
(In Thousands, except per share amounts)
Selected Financial Condition Data:
Total assets
1,947,039
1,661,076
1,712,851
1,808,966
1,868,266
Securities available for sale
203,166
205,415
Federal Home Loan Bank stock
17,500
20,193
21,653
Loans receivable, net
1,068,412
1,102,629
1,184,234
1,277,262
1,391,516
Loans held for sale
97,021
133,613
88,283
96,133
45,052
Cash and cash equivalents
429,169
71,469
80,380
75,331
71,120
Deposits
1,244,741
939,513
1,051,292
1,145,529
1,164,890
Borrowings
455,197
479,888
461,138
456,959
507,900
Total shareholders' equity
214,472
202,634
166,372
172,220
168,592
Allowance for loan losses
24,264
31,043
32,430
29,175
28,494
Real estate owned
22,663
35,974
56,670
57,752
50,929
Selected Operating Data:
Interest income
62,864
69,846
79,352
89,933
98,488
Interest expense
23,658
27,901
32,836
40,269
54,577
Net interest income
39,206
41,945
46,516
49,664
43,911
Provision for loan losses
4,532
8,300
22,077
25,832
26,687
Net interest income after
provision for loan losses
34,674
33,645
24,439
23,832
17,224
Noninterest income
87,799
91,203
43,229
38,993
12,208
Noninterest expense
99,144
102,138
74,579
64,627
40,876
Income (loss) before income taxes
23,329
22,710
(6,911
)
(1,802
(11,444
Provision for income taxes (benefit)
8,621
(12,204
562
52
(1,306
Net income (loss)
14,708
34,914
(7,473
(1,854
(10,138
Income (loss) per share – basic
0.43
1.02
(0.22
(0.05
(0.30
Income (loss) per share – diluted
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Selected Financial Ratios and Other Data:
Performance Ratios:
Return (loss) on average assets
0.90
2.07
(0.43
%)
(0.10
(0.53
Return (loss) on average equity
7.01
18.89
(4.47
(1.09
(6.12
Interest rate spread (1)
2.36
2.45
2.67
2.21
Net interest margin (2)
2.56
2.62
2.82
2.83
2.41
Noninterest expense to average assets
6.05
6.04
4.27
3.49
2.14
Efficiency ratio (3)
78.31
76.71
83.12
72.90
72.84
Average interest-earning assets to average interest-bearing liabilities
113.96
109.84
107.67
107.11
106.68
Capital Ratios:
Equity to total assets at end of period
11.02
12.20
9.71
9.52
9.02
Average equity to average assets
12.82
10.94
9.55
9.18
8.67
Total capital to risk-weighted assets
21.67
17.34
14.58
14.13
13.83
Tier I capital to risk-weighted assets
20.41
16.07
13.31
12.87
12.57
Tier I capital to average assets
12.48
11.13
9.16
8.83
8.77
Asset Quality Ratios:
Allowance for loan losses as a percent of total loans
2.22
2.74
2.23
2.01
Allowance for loan losses as a percent of non-performing loans
47.61
41.58
41.46
34.66
37.83
Net charge-offs to average outstanding loans during the period
0.94
0.76
1.43
1.75
1.54
Non-performing loans as a percent of total loans
4.66
6.59
6.43
6.44
5.30
Non-performing assets as a percent of total assets
3.78
6.66
7.88
7.85
6.76
Other Data:
Number of full-service banking offices
8
Number of full-time equivalent employees
849
726
574
595
518
(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 non-interest expense divided by the sum of net interest income and non-interest income.