TEB BANCORP, INC This discussion and analysis reflects our consolidated financial statements and other relevant statistical data, and is intended to enhance your understanding of our financial condition and results of operations. The information in this section has been derived from the consolidated financial statements, which appear elsewhere in this annual report. You should read the information in this section in conjunction with the other business and financial information provided in this annual report.
Overview
Total assets decreased$6.8 million , or 2.2%, to$305.5 million atJune 30, 2020 from$312.2 million atJune 30, 2019 , primarily reflecting decreases in loans held for investment offset by increases in cash and cash equivalents and loans held for sale. Total deposits increased$21.5 million , or 9.2%, to$256.1 million atJune 30, 2020 from$234.6 million atJune 30, 2019 . This resulted from an increase in interest-bearing savings and NOW accounts, which increased$5.0 million , or 7.1%, to$75.4 million atJune 30, 2020 from$70.4 million atJune 30, 2019 , and an increase in demand deposits, which increased$16.2 million , or 20.9%, to$93.6 million atJune 30, 2020 from$77.4 million atJune 30, 2019 . Borrowed funds, consisting solely ofFederal Home Loan Bank of Chicago ("FHLB") advances, decreased$35.2 million , or 79.6%, to$9.0 million atJune 30, 2020 from$44.2 million atJune 30, 2019 . We had to rely on borrowings to fund our operations in prior periods as a result of certificate of deposit runoff, as described below. During the year, deposits increased and assets decreased which allowed us to pay down borrowings. Net income was$1.1 million for the year endedJune 30, 2020 , compared to a net loss of$399,000 for the year endedJune 30, 2019 . The increase in income was due to increases in non-interest income and non-interest expenses during the year endedJune 30, 2020 , offset by a decrease in net interest income. Net interest income decreased$336,000 , or 3.4%, to$9.5 million for the year endedJune 30, 2020 from$9.9 million for the year endedJune 30, 2019 , primarily as a result of a lower average balance of loans. Non-interest income increased by$3.6 million , or 140.5%, to$6.2 million for the year endedJune 30, 2020 from$2.6 million for the year endedJune 30, 2019 , primarily resulting from a$3.6 million , or 236.3%, increase in gain on sales of mortgage loans. Non-interest expenses increased$1.8 million , or 13.7%, to$14.7 million for the year endedJune 30, 2020 compared to$12.9 million for the year endedJune 30, 2019 . The increase in non-interest expenses was due to an increase in compensation and benefits expense and cost of operations for other real estate owned during the year endedJune 30, 2020 . In recent periods, prior to the termination of our amended Consent Order, we generally experienced certificate of deposit runoff at maturity because of our inability to pay competitive rates on deposits due to our classification as "adequately capitalized" for regulatory capital purposes, instead funding our operations with borrowings from the FHLB. Our classification as "adequately capitalized" (rather than "well-capitalized") for regulatory capital purposes restricted our ability to accept, renew or roll over brokered deposits, and further restricted us from paying interest rates on deposits that exceed 75 basis points above national rates, as posted by theFederal Deposit Insurance Corporation . Although we had received a waiver from theFederal Deposit Insurance Corporation that permitted us to use local market area rates instead of national rates as the baseline in determining interest rates we could pay on deposits, this restriction limited our ability to compete for deposits in our market area, based on interest rates, in the market rate environment. As a general matter, our interest-bearing liabilities reprice or mature more quickly than our interest-earning assets, which can result in interest expense increasing more rapidly than increases in interest income as interest rates increase. Therefore, increases in interest rates may adversely affect our net interest income and net economic value, which in turn would likely have an adverse effect on our results of operations. To help manage interest rate risk, we sell longer-term, fixed-rate loans and we intend to diversify our loan portfolio by originating more commercial-related and adjustable-rate loans. See "-Management of Market Risk."
Change in Fiscal Year
The
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Summary of Significant Accounting Policies
The discussion and analysis of the financial condition and results of operations are based on our financial statements, which are prepared in conformity with accounting principles generally accepted inthe United States of America ("U.S. GAAP"). The preparation of these financial statements requires management to make estimates and assumptions affecting the reported amounts of assets and liabilities, disclosure of contingent assets and liabilities, and the reported amounts of income and expenses. We consider the accounting policies discussed below to be significant accounting policies. The estimates and assumptions that we use are based on historical experience and various other factors and are believed to be reasonable under the circumstances. Actual results may differ from these estimates under different assumptions or conditions, resulting in a change that could have a material impact on the carrying value of our assets and liabilities and our results of operations. In 2012, the JOBS Act was signed into law. The JOBS Act contains provisions that, among other things, reduce certain reporting requirements for qualifying public companies. As an "emerging growth company" we may delay adoption of new or revised accounting pronouncements applicable to public companies until such pronouncements are made applicable to private companies. We determined to take advantage of the benefits of this extended transition period. Accordingly, our financial statements may not be comparable to companies that comply with such new or revised accounting standards.
The following represent our significant accounting policies:
Allowance for Loan Losses. The allowance for loan losses is established as
losses are estimated to have occurred through a provision for loan losses
charged to operations. Loan losses are charged against the allowance when
management believes the uncollectability of a loan balance is confirmed.
Subsequent recoveries, if any, are credited to the allowance for loan losses.
The allowance for loan losses consists of specific reserves on certain impaired
loans from analyses developed through specific credit allocations for individual
loans. The specific reserve relates to all loans for which the allowance for
loan losses is estimated on a loan by loan basis using either the present value
of expected future cash flows discounted at the loan's effective interest rate,
the loan's obtainable market price, or the fair value of the collateral if the
loan is collateral dependent. The general reserve is based on our historical
loss experience along with consideration of certain qualitative factors such as
(i) changes in the nature, volume and terms of loans, (ii) changes in lending
personnel, (iii) changes in the quality of the loan review function,
(iv) changes in nature and volume of past-due, non-accrual and/or classified
loans, (v) changes in concentration of credit risk, (vi) changes in economic and
industry conditions, (vii) changes in legal and regulatory requirements,
(viii) unemployment and inflation statistics, and (ix) changes in underlying
collateral values.
There are many factors affecting the allowance for loan losses, some are
quantitative while others require qualitative judgment. The allowance for loan
losses reflects management's best estimate of the probable and inherent losses
on loans. The adequacy of the allowance for loan losses is reviewed and approved
by our board of directors. Allocations of the allowance for loan losses may be
made for specific loans, but the entire allowance for loan losses is available
for any loan that, in management's judgment, should be charged-off.
As an integral part of their examination process, various regulatory agencies
review the allowance for loan losses as well. Such agencies may require that
changes in the allowance for loan losses be recognized when such regulatory
credit evaluations differ from those of management based on information
available to the regulators at the time of their examinations.
Income Taxes. Deferred tax assets and liabilities are recognized for the
estimated future tax consequences attributable to differences between the
financial statement carrying amounts of existing assets and liabilities and
their respective tax basis. Deferred tax assets and liabilities are measured
using enacted tax rates in effect for the year in which those temporary
differences are expected to be recovered or settled. The effect on deferred tax
assets and liabilities of a change in tax rates is recognized in income in the
period that includes the enactment date. Deferred tax assets are reduced by a
valuation allowance when, in the opinion of management, it is more likely than
not that some portion or all of the deferred tax assets will not be realized.
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We recognize the tax effects from an uncertain tax position in the consolidated financial statements only if the position is more likely than not to be sustained on audit, based on the technical merits of the position. We recognize the financial statement benefit of a tax position only after determining that the relevant tax authority would more likely than not sustain the position following an audit. For tax positions meeting the more-likely-than-not threshold, the amount recognized in the consolidated financial statements is the largest benefit that has a greater than 50% likelihood of being realized, upon ultimate settlement with the relevant tax authority. We recognize interest and penalties accrued or released related to uncertain tax positions in current income tax expense or benefit.
COVID-19 Outbreak
InDecember 2019 , a coronavirus (COVID-19) was reported inChina , and, inMarch 2020 , theWorld Health Organization declared it a pandemic. OnMarch 12, 2020 the President ofthe United States declared the COVID-19 outbreak inthe United States a national emergency. The COVID-19 pandemic has caused significant economic dislocation inthe United States as many state and local governments ordered non-essential businesses to close and residents to shelter in place at home. This has resulted in an unprecedented slow-down in economic activity and a related increase in unemployment. Since the COVID-19 outbreak, millions of individuals have filed claims for unemployment, and stock markets have declined in value and in particular bank stocks have significantly declined in value. In response to the COVID-19 outbreak, theFederal Reserve has reduced the benchmark fed funds rate to a target range of 0% to 0.25%, and the yields on 10- and 30-year treasury notes have declined to historic lows. Various state governments and federal agencies are requiring lenders to provide forbearance and other relief to borrowers (e.g., waiving late payment and other fees). The federal banking agencies have encouraged financial institutions to prudently work with affected borrowers and recently passed legislation has provided relief from reporting loan classifications due to modifications related to the COVID-19 outbreak. Certain industries have been particularly hard-hit, including the travel and hospitality industry, the restaurant industry, and the retail industry. The following table shows the Company's exposure within these hard-hit industries. Commercial Loan Type June 30, 2020 Percentage of Portfolio Loans Restaurant, food service, bar$ 1,852,023 0.78 % Retail 1,910,969 0.80 % Hospitality and tourism - - %$ 3,762,992 1.58 % The Company's allowance for loan losses increased$59,000 to$1.4 million atJune 30, 2020 compared to$1.3 million atJune 30, 2019 . Provisions were booked totaling$135,000 during the year endedJune 30, 2020 , compared to no provision in the year endedJune 30, 2019 . AtJune 30, 2020 andJune 30, 2019 , the allowance for loan losses represented 0.57% and 0.50% of total loans, respectively. In the first quarter of 2020, the Company adjusted the economic risk factor methodology to incorporate the current economic implications and rising unemployment rate from the COVID-19 pandemic, leading to the increase in the allowance for loan losses as a percentage of total loans. In determining its allowance for loan loss level atJune 30, 2020 , the Company considered the quality and composition of its loan portfolio going into the COVID-19 pandemic as well as economic changes noted during the second quarter of 2020. AtMarch 31, 2020 , approximately 99.2% of the Company's loan portfolio was collateralized by real estate. AtJune 30, 2020 , approximately 98.67% of the Company's loan portfolio was collateralized by real estate. This decrease was largely due to the new PPP loans originated during the quarter, discussed previously. As ofJune 30, 2020 , approximately 1.6% of the Company's loan portfolio is to borrowers in the more particularly hard-hit industries (including the restaurant and food service industries, retail industry, and hospitality and tourism industries) and the Company has no international exposure. Finally, the spread of the COVID-19 has caused us to modify our business practices, including employee travel, employee work locations, and cancellation of physical participation in meetings, events, and conferences. We have many employees working remotely and we may take further actions as may be required by government authorities or that we determine are in the best interests of our employees, customers, and business partners. 41
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Given the ongoing and dynamic nature of the circumstances, it is difficult to predict the full impact of the COVID-19 outbreak on our business. The extent of such impact will depend on future developments, which are highly uncertain, including when the coronavirus can be controlled and abated and when and how the economy may be reopened. As the result of the COVID-19 pandemic and the related adverse local and national economic consequences, we could be subject to any of the following risks, any of which could have a material, adverse effect on our business, financial condition, liquidity, and results of operations:
? demand for our products and services may decline, making it difficult to grow
assets and income;
if the economy is unable to substantially reopen, and high levels of
? unemployment continue for an extended period of time, loan delinquencies,
problem assets, and foreclosures may increase, resulting in increased charges
and reduced income;
? collateral for loans, especially real estate, may decline in value, which could
cause loan losses to increase;
our allowance for loan losses may have to be increased if borrowers experience
? financial difficulties beyond forbearance periods, which will adversely affect
our net income;
? the net worth and liquidity of loan guarantors may decline, impairing their
ability to honor commitments to us;
as the result of the decline in the
? funds rate to near 0%, the yield on our assets may decline to a greater extent
than the decline in our cost of interest-bearing liabilities, reducing our net
interest margin and spread and reducing net income;
? our uninsured investment revenues may decline with continuing market turmoil;
? our cyber security risks are increased as the result of an increase in the
number of employees working remotely;
we rely on third-party vendors for certain services and the unavailability of a
? critical service due to the COVID-19 outbreak could have an adverse effect on
us; and
?
experiences additional resolution costs.
Moreover, our future success and profitability substantially depends on the management skills of our executive officers and directors, many of whom have held officer and director positions with us for many years. The unanticipated loss or unavailability of key employees due to the outbreak could harm our ability to operate our business or execute our business strategy. We may not be successful in finding and integrating suitable successors in the event of key employee loss or unavailability.
Any one or a combination of the factors identified above could negatively impact our business, financial condition, and results of operations and prospects.
The Coronavirus Aid, Relief, and Economic Security Act, or CARES Act, was signed into law onMarch 27, 2020 and provided over$2.0 trillion in emergency economic relief to individuals and businesses impacted by the COVID-19 pandemic. The CARES Act authorized theSmall Business Administration ("SBA") to temporarily guarantee loans under a new 7(a) loan program call the Paycheck Protection Program ("PPP"). Although we were not already a qualified SBA lender, we enrolled in the PPP by completing the required documentation. An eligible business can apply for a PPP loan up to the lesser of: (1) 2.5 times its average monthly "payroll costs"; or (2)$10.0 million . PPP loans will have: (a) an interest rate of 1.0%; (b) a two-year loan term to maturity; and (c) principal and interest payments deferred for six months from the date of disbursement. The SBA will guarantee 100% of the PPP loans made to eligible borrowers. The entire principal amount of the borrower's PPP loan, including any accrued 42
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interest, is eligible to be reduced by the loan forgiveness amount under the PPP so long as employee and compensation levels of the business are maintained and 60% of the loan proceeds are used for payroll expenses, with the remaining 40% of the loan proceeds used for other qualifying expenses. As ofJune 30, 2020 , the Company originated 16 PPP loans totaling$1.1 million and generated approximately$35,000 from the processing fees, which have been recognized. To work with customers impacted by COVID-19, the Company is offering short-term (i.e., three months or less with the potential to extend up to six months, if necessary) loan modifications on a case by case basis to borrowerswho were current in their payments at the inception of the loan modification program. Under Section 4013 of the CARES Act, loans less than 30 days past due as ofDecember 31, 2019 are considered current for COVID-19 modifications. A financial institution can then suspend the requirements under GAAP for loan modifications related to COVID-19 that would otherwise be categorized as a TDR, and suspend any determination of a loan modified as a result of COVID-19 as being a TDR, including the requirement to determine impairment for accounting purposes. Financial institutions wishing to utilize this authority must make a policy election, which applies to any COVID-19 modification made betweenMarch 1, 2020 and the earlier of eitherDecember 31, 2020 or the 60th day after the end of the COVID-19 national emergency. Similarly, theFinancial Accounting Standards Board has confirmed that short-term modifications made on a good faith basis in response to COVID-19 to loan customerswho were current prior to any relief are not TDRs. Lastly, prior to the enactment of the CARES Act, the banking regulatory agencies provided guidance as to how certain short-term modifications would not be considered TDRs, and have subsequently confirmed that such guidance could be applicable for loans that do not qualify for favorable accounting treatment under Section 4013 of the CARES Act. As ofJune 30, 2020 , the Company had modified 87 loans aggregating$28.0 million , primarily consisting of the deferral of principal and interest payments and the extension of the maturity date. Of these modifications,$27.8 million , or 99.3%, were performing in accordance with the accounting treatment under Section 4013 of the CARES Act and therefore did not qualify as TDRs. One loan totaling$196,000 that was modified did not qualify for the favorable accounting treatment under Section 4013 of the CARES Act and therefore is reported as a TDR. Management has evaluated the loan and determined that based on the liquidation value of the collateral, no specific reserve is necessary. The Company determined to make provisions to the allowance for loan losses totaling$135,000 during the year endedJune 30, 2020 . The provision increased the allowance as a percentage of total loans from 0.50% as ofJune 30, 2019 to 0.57% as ofJune 30, 2020 . The Company determined the provisions made in 2020 to be an adequate response to COVID-19 because of an excess in the allowance for loan losses that had accumulated due to the historical loss history showing significant decreases in loss percentages within the non-owner-occupied commercial real estate category as ofJune 30, 2020 . The historical loss percentage decreased from 4.15% as ofDecember 31, 2019 to 1.22% as ofJune 30, 2020 . This reduction created an addition to the general reserve of$589,000 during the first quarter of 2020. In addition to the provisions made in 2020, the Company allocated more than$500,000 across the loan portfolio as part of our qualitative assessment in our allowance for loan loss calculation, primarily in the national and local economic impact factor.
Comparison of Financial Condition at
Total assets decreased$6.8 million , or 2.2%, to$305.5 million atJune 30, 2020 from$312.2 million atJune 30, 2019 , primarily reflecting decreases in loans held for investment offset by increases in cash and cash equivalents and loans held for sale. Cash and cash equivalents increased$7.5 million , or 132.8%, to$13.1 million atJune 30, 2020 from$5.6 million atJune 30, 2019 due to the increased balance in deposit accounts during the year. Loans held for investment decreased$22.5 million , or 8.6%, to$238.7 million atJune 30, 2020 from$261.2 million atJune 30, 2019 , primarily reflecting a decrease in one- to four-family owner occupied loans of$24.3 million , or 19.5%, to$100.5 million atJune 30, 2020 from$124.8 million atJune 30, 2019 . The decrease in one - to four - family owner occupied loans resulted from increased refinances and loan paydowns. These decreases were partially offset by an 43
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increase in multifamily loans of
Loans held for sale increased$11.6 million , or 164.0%, to$18.7 million atJune 30, 2020 from$7.1 million atJune 30, 2019 . We currently sell a majority of the fixed-rate one- to four-family residential real estate loans that we originate. The balances at any month end vary based on the timing and volume of loan originations and sales. The decrease in mortgage interest rates due to COVID-19 resulted in a greater volume of loans originated and sold in the last quarter of the fiscal year endedJune 30, 2020 . Total deposits increased$21.5 million , or 9.2%, to$256.1 million atJune 30, 2020 from$234.6 million atJune 30, 2019 . The increase was due to an increase in demand deposits of$16.2 million , or 20.9%, to$93.6 million atJune 30, 2020 , from$77.4 million atJune 30, 2019 , an increase in certificates of deposit of$285,000 , or 0.3%, to$87.0 million atJune 30, 2020 from$86.8 million atJune 30, 2019 , and an increase in interest-bearing savings and NOW accounts of$5.0 million , or 7.1%, to$75.4 million atJune 30, 2020 from$70.4 million atJune 30, 2019 , due to customary balance fluctuations. Prior to the termination of our amended Consent Order, we generally experienced certificate of deposit runoff at maturity because of our inability to pay competitive rates on deposits due to our classification as "adequately capitalized" for regulatory capital purposes, instead funding our operations with borrowings from the FHLB. Our classification as "adequately capitalized" (rather than "well-capitalized") for regulatory capital purposes restricted our ability to accept, renew or roll over brokered deposits, and further restricted us from paying interest rates on deposits that exceed 75 basis points above national rates, as posted by theFederal Deposit Insurance Corporation . Although we had received a waiver from theFederal Deposit Insurance Corporation that permitted us to use local market area rates instead of national rates as the baseline in determining interest rates we could pay on deposits, this restriction limited our ability to compete for deposits in our market area. Borrowed funds, consisting solely of FHLB advances, decreased$35.2 million , or 79.6%, to$9.0 million atJune 30, 2020 from$44.2 million atJune 30, 2019 . During the year deposits increased and assets decreased which allowed us to pay down borrowings. Total equity decreased$895,000 , or 3.7%, to$23.5 million atJune 30, 2020 from$24.4 million atJune 30, 2019 as a result of an increased loss in the accumulated other comprehensive loss offset by net income in retained earnings. Accumulated other comprehensive loss increased as a result of lower interest rates used to calculate the pension liabilities due to historically low rates and lower gains on the portfolio than were actually projected due to COVID-19.
Average Balance Sheet
The following table sets forth average balance sheets, average yields and costs,
and certain other information at and for the periods indicated. No
tax-equivalent yield adjustments have been made, as the effects would be
immaterial. All average balances are daily average balances. Non-accrual loans
were included in the computation of average balances.
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The yields set forth below include the effect of deferred fees, discounts, and
premiums that are amortized or accreted to interest income or interest expense.
Loan balances exclude loans held for sale.
For the Year Ended June 30, 2020 For the Year Ended June 30, 2019
Average Average
Outstanding Average Outstanding Average
Balance Interest Yield/Rate Balance Interest Yield/Rate
(Dollars in thousands)
Interest-earning assets:
Loans $ 249,657 $ 11,173 4.48 % $ 261,008 $ 11,762 4.51 %
Securities 21,719 604 2.78 % 20,989 591 2.82 %
Federal Home Loan Bank of Chicago
stock 1,288 53 4.12 % 2,215 122 5.51 %
Other 4,688 49 1.05 % 2,594 55 2.11 %
Total interest-earning assets 277,352 11,879 4.28 % 286,806 12,530 4.37 %
Non-interest-earning assets 25,971 20,386
Total assets $ 303,323 $ 307,192
Interest-bearing liabilities:
Demand deposits $ 49,837 29 0.06 % $ 47,508 28 0.06 %
Savings and NOW deposits 74,453 62 0.08 % 80,994 65 0.08 %
Certificates of deposit 94,481 1,733 1.84 % 90,498 1,407 1.55 %
Total interest-bearing deposits 218,771 1,824 0.83 % 219,000 1,500 0.69 %
Borrowings 23,300 398 1.71 % 47,569 1,173 2.47 %
Other - - - % 1 - - %
Total interest-bearing
liabilities 242,071 2,222 0.92 % 266,570 2,673 1.00 %
Non-interest-bearing liabilities 35,852 24,634
Total liabilities 277,923 291,204
Total equity 25,400 15,988
Total liabilities and equity $ 303,323 $ 307,192
Net interest income $ 9,657 $ 9,857
Net interest rate spread (1) 3.36 % 3.37 %
Net interest-earning assets (2) $ 35,281 $ 20,236
Net interest margin (3) 3.48 % 3.44 %
Average interest-earning assets
to interest-bearing liabilities 114.57 % 107.59 %
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Net interest rate spread represents the difference between the weighted (1) average yield on interest-earning assets and the weighted average rate of
interest-bearing liabilities.
(2) Net interest-earning assets represent total interest-earning assets less
total interest-bearing liabilities.
(3) Net interest margin represents net interest income divided by average total
interest-earning assets.
Rate/Volume Analysis
The following table presents the effects of changing rates and volumes on our
net interest income for the years indicated. The rate column shows the effects
attributable to changes in rate (changes in rate multiplied by prior volume).
The volume column shows the effects attributable to changes in volume (changes
in volume multiplied by prior rate). The total column represents the sum of the
prior columns. For purposes of this table, changes attributable to both rate and
volume, which cannot be segregated, have been allocated proportionately based on
the changes due to rate and the changes due to volume.
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12 Months Ended June 30, 2020 vs. 12 Months Ended June 30, 2019 vs.
2019 Nine Months 2018
Increase (Decrease) Total Increase (Decrease) Total
Due to Increase Due to Increase
Volume Rate (Decrease) Volume Rate (Decrease)
(In thousands)
Interest-earning assets:
Loans $ (508) $ (81) $
(589)
20 (7) 13 8 151 159
Federal Home Loan Bank of
Chicago stock (38) (31) (69) 44 48 92
Other 22 (28) (6) 24 17 41
Total interest-earning assets (504) (147) (651) 294 3,414 3,708
Interest-bearing liabilities:
Demand deposits 2 (1) 1 - 7 7
Savings and NOW deposits (6) 2 (4) (2) 13 11
Certificates of deposit 73 254 327 (194) 778 584
Total interest-bearing deposits 69 255 324 (196) 798 602
Borrowings (415) (360) (775) 434 381 815
Other - - - - - -
Total interest-bearing
liabilities (346) (105) (451) 238 1,179 1,417
Change in net interest income $ (158) $ (42) $ (200) $ 56 $ 2,235 $ 2,291 Comparison of Operating Results for the Years Ended
General. Net income was$1.1 million for the year endedJune 30, 2020 , compared to net loss of$399,000 for year endedJune 30, 2019 . The increase in income was due to an increase in non-interest income offset by a decrease in net interest income, described in more detail below. Interest Income. Interest income decreased$651,000 , or 5.2%, to$11.9 million for the year endedJune 30, 2020 compared to$12.5 million for the year endedJune 30, 2019 . Interest income on loans, which is our primary source of interest income, decreased$589,000 , or 5.0%, to$11.2 million for the year endedJune 30, 2020 compared to$11.8 million for the year endedJune 30, 2019 . Our annualized average yield on loans decreased three basis points to 4.48% for the year endedJune 30, 2020 from 4.51% for the year endedJune 30, 2019 , reflecting recent decreases in market interest rates. The average balance of loans also decreased by$11.4 million , or 4.3%, to$249.7 million for the year endedJune 30, 2020 from$261.0 million for the year endedJune 30, 2019 . Interest Expense. Interest expense decreased$450,000 , or 16.8%, to$2.2 million for the year endedJune 30, 2020 compared to$2.7 million for the year endedJune 30, 2019 , due to decreases in interest expense on borrowings and deposits. Interest expense on borrowings decreased$775,000 to$398,000 for the year endedJune 30, 2020 from$1.2 million for the year endedJune 30, 2019 . This decrease resulted from the decreases in both the average balance of borrowings and the average rate we paid on borrowings. The average balance of borrowings decreased$24.3 million to$23.3 million for the year endedJune 30, 2020 from$47.6 million for the year endedJune 30, 2019 , and the annualized average rate we paid on borrowings decreased 76 basis points to 1.71% for the year endedJune 30, 2020 , from 2.47% for the year endedJune 30, 2019 . As described above, during the year endedJune 30, 2019 , we relied on borrowings to fund our operations as a result of certificate of deposit runoff. During the year deposits increased and assets decreased which allowed us to pay down borrowings. The decrease in rates paid on borrowings reflects recent decreases in market interest rates. Interest expense on deposits increased$324,000 , or 21.6%, to$1.8 million for the year endedJune 30, 2020 from$1.5 million for the year endedJune 30, 2019 . Specifically, interest expense on certificates of deposit increased$327,000 , or 46
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23.2%, to$1.7 million for the year endedJune 30, 2020 from$1.4 million for the year endedJune 30, 2019 . This increase resulted from an increase in the annualized average rate we paid on certificates of deposit, which increased 29 basis points to 1.84% for the year endedJune 30, 2020 from 1.55% for the year endedJune 30, 2019 . The increase in rates paid on certificates of deposit reflects increases in market interest rates during 2019 and our ability to compete for deposits after the termination of our amended Consent Order. Net Interest Income. Net interest income decreased$336,000 , or 3.4%, to$9.5 million for the year endedJune 30, 2020 from$9.9 million for the year endedJune 30, 2019 , primarily as a result of the decreased interest income from loans. Our net interest rate spread decreased by one basis points to 3.36% for the year endedJune 30, 2020 from 3.37% for the year endedJune 30, 2019 , and our net interest margin increased by four basis points to 3.48% for the year endedJune 30, 2020 from 3.44% for the year endedJune 30, 2019 , as our cost of borrowings decreased more quickly than the decrease in the yield earned on loans. Provision for Loan Losses. Provisions for loan losses are charged to operations to establish an allowance for loan losses at a level necessary to absorb known and inherent losses in our loan portfolio that are both probable and reasonably estimable at the date of the financial statements. In evaluating the level of the allowance for loan losses, management analyzes several qualitative loan portfolio risk factors including, but not limited to, management's ongoing review and grading of loans, facts and issues related to specific loans, historical loan loss and delinquency experience, trends in past due and non-accrual loans, existing risk characteristics of specific loans or loan pools, changes in the nature, volume and terms of loans, the fair value of underlying collateral, changes in lending personnel, current economic conditions and other qualitative and quantitative factors which could affect potential credit losses. See "-Summary of Significant Accounting Policies" for additional information. After an evaluation of these factors, we recorded a$135,000 provision for the year endedJune 30, 2020 and no provision for the year endedJune 30, 2019 . Our allowance for loan losses increased$59,000 , or 4.6%, to$1.4 million atJune 30, 2020 from$1.3 milion atJune 30, 2019 . The allowance for loan losses to total loans increased to at 0.57% atJune 30, 2020 and from 0.50% atJune 30, 2019 , and the allowance for loan losses to non-performing loans increased to 100.91% atJune 30, 2020 from 84.86% atJune 30, 2019 . The increase in the provision for loan losses resulted from COVID-19 as discussed above. To the best of our knowledge, we have recorded all loan losses that are both probable and reasonable to estimate atJune 30, 2020 . However, future changes in the factors described above, including, but not limited to, actual loss experience with respect to our loan portfolio, could result in material increases in our provision for loan losses. In addition, the WDFI and theFederal Deposit Insurance Corporation , as an integral part of their examination process, will periodically review our allowance for loan losses, and as a result of such reviews, we may have to adjust our allowance for loan losses.
Non-interest Income. Non-interest income information is as follows.
Year Ended June 30, Change
2020 2019 Amount Percent
(Dollars in thousands)
Service fees on deposits $ 430 $ 467 $ (37) (7.9) %
Service fees on loans 238 276 (38) (13.8)
Gain on sale of mortgage loans 5,120 1,523 3,597 236.2
Income on sale of uninsured products 321 321 - -
Gain (loss) on sale of other real
estate owned 118 (23) 141 (613.0)
Other 20 34 (14) (41.2)
Total non-interest income $ 6,247 $ 2,598 $ 3,649 140.5 %
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Service fees on loans decreased as a result of a decrease in prepayment penalties and late charges collected during the year endingJune 30, 2020 . Gain on sale of mortgage loans (consisting solely of one- to four-family residential real estate loans) increased as we sold$334.9 million of mortgage loans during the year endedJune 30, 2020 compared to$105.3 million of such sales during the nine months endedJune 30, 2019 . Gain on sale of other real estate owned increased as we made four sales of other real estate during the year endedJune 30, 2020 in excess of the principal balance and did not make any sales of other real estate during the year endedJune 30, 2019 in excess of the principal balance.
Non-interest Expenses. Non-interest expenses information is as follows.
Year Ended June 30, Change
2020 2019 Amount Percent
(Dollars in thousands)
Compensation and benefits $ 8,503 $ 7,425 $ 1,078 14.5 %
Occupancy 1,969 1,930 39 2.0
Advertising 227 279 (52) (18.6)
Data processing services 1,096 1,218 (122) (10.0)
FDIC assessment 112 458 (346) (75.5)
Cost of operations of other real
estate owned 1,047 125 922 737.6
Insurance 156 161 (5) (3.1)
Professional Fees 489 427 62 14.5
Other 1,078 886 192 21.7
Total non-interest income $ 14,677 $ 12,909 $ 1,768 13.7 %
Compensation and benefits expense increased primarily as a result of the
increased commissions from greater loan volume. FDIC assessment decreased as we
received Small Bank Assessment Credits from the FDIC and a lower premium rate.
Cost of operations of other real estate owned increased due to a large write off
on other real estate loans during the year ending June 30, 2020 . Data processing
services decreased as we were able to renegotiate the terms of our contract due
to our improved financial condition. Professional fee expenses increased for
the year ended June 30, 2020 due to the increased costs of audits as a public
company. Other expenses increased due the increase in sold loan commsion fees
offset due to the increase in loans sold.
Income Tax Expense. We recognized no income tax expense or benefit for the year
ended June 30, 2020 due to a full valuation allowance being recorded against the
Company's deferred tax assets. We recognized an income tax benefit of $55,000
for the year ended June 30, 2019 .
Management of Market Risk
General. Our most significant form of market risk is interest rate risk because,
as a financial institution, the majority of our assets and liabilities are
sensitive to changes in interest rates. Therefore, a principal part of our
operations is to manage interest rate risk and limit the exposure of our
financial condition and results of operations to changes in market interest
rates. Our Asset/Liability Management Committee, consisting of members of our
senior management, is responsible for evaluating the interest rate risk inherent
in our assets and liabilities, for determining the level of risk that is
appropriate, given our business strategy, operating environment, capital,
liquidity and performance objectives, and for managing this risk consistent with
the policy and guidelines approved by our board of directors. The board of
directors receives a monthly report from the Asset/Liability Management
Committee. We currently utilize a third-party modeling program, prepared on a
quarterly basis, to evaluate our sensitivity to changes in interest rates.
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We have sought to manage our interest rate risk in order to minimize the exposure of our earnings and capital to changes in interest rates. The following represent our primary strategies to manage our interest rate risk:
? selling our longer-term, fixed-rate loans into the secondary market;
? limiting our reliance on non-core/wholesale funding sources;
? growing our volume of transaction deposit accounts; and
? diversifying our loan portfolio by adding more commercial-related loans, which
typically have shorter maturities and/or balloon payments.
By following these strategies, we believe that we are better positioned to react to increases in market interest rates.
We do not engage in hedging activities, such as engaging in futures, options or swap transactions, or investing in high-risk mortgage derivatives, such as collateralized mortgage obligation residual interests, real estate mortgage investment conduit residual interests or stripped mortgage backed securities.
Net Interest Income. We analyze our sensitivity to changes in interest rates through a net interest income model. Net interest income is the difference between the interest income we earn on our interest-earning assets, such as loans and securities, and the interest we pay on our interest-bearing liabilities, such as deposits and borrowings. We estimate what our net interest income would be for a 12-month period. We then calculate what the net interest income would be for the same period under the assumptions thatthe United States Treasury yield curve increases or decreases instantaneously by 200 and 400 basis point increments, with changes in interest rates representing immediate and permanent, parallel shifts in the yield curve. A basis point equals one-hundredth of one percent, and 100 basis points equals one percent. An increase in interest rates from 3% to 4% would mean, for example, a 100 basis point increase in the "Change in Interest Rates" column below. The tables below set forth, as ofJune 30, 2020 (the latest date for which information is available), the calculation of the estimated changes in our net interest income that would result from the designated immediate changes inthe United States Treasury yield curve. June 30, 2020 Change in Interest Rates Net Interest Income Year 1 Change (basis points) (1) Year 1 Forecast from Level (Dollars in thousands) +400 $ 10,700 12.60 % +200 10,199 7.33 % Level 9,502 - % (200) 9,057 (4.69) % (400) 8,887 (6.48) %
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(1) Assumes an immediate uniform change in interest rates at all maturities.
The table above indicates that atJune 30, 2020 , in the event of an instantaneous parallel 200 basis point increase in interest rates, we would have experienced a 7.33% increase in net interest income, and in the event of an instantaneous 200 basis point decrease in interest rates, we would have experienced an 4.69% decrease in net interest income. AtJune 30, 2019 in the event of an instantaneous parallel 200 basis point increase in interest rates, we would have experienced a 2.82% increase in net interest income, and in the event of an instantaneous 200 basis point decrease in interest rates, we would have experienced a 8.69%% decrease in net interest income. Net Economic Value. We also compute amounts by which the net present value of our assets and liabilities (net economic value or "NEV") would change in the event of a range of assumed changes in market interest rates. This 49
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model uses a discounted cash flow analysis and an option-based pricing approach to measure the interest rate sensitivity of net portfolio value. The model estimates the economic value of each type of asset, liability and off-balance sheet contract under the assumptions that the United States Treasury yield curve increases or decreases instantaneously by 200 and 400 basis point increments, with changes in interest rates representing immediate and permanent, parallel shifts in the yield curve. The tables below set forth, as ofJune 30, 2020 (the most recent date for which information is available), the calculation of the estimated changes in our NEV that would result from the designated immediate changes inthe United States Treasury yield curve. At June 30, 2020 NEV as a Percentage of Present Value of Assets (3) Change in Rates (basis Estimated Increase (Decrease) in Increase Interest points) Estimated NEV NEV (Decrease) (1) NEV (2) Amount Percent Ratio (4) (basis points) (Dollars in thousands) +400$ 45,701 $ 6,662 17.06 % 16.06 % 374 +200 44,882 5,843 14.97 % 14.90 % 257 - 39,039 - - % 12.32 % - (200) 36,537 (2,502) (6.41) % 10.96 % (136) (400) 46,393 7,354 18.84 % 13.52 % 120
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(1) Assumes an immediate uniform change in interest rates at all maturities.
(2) NEV is the discounted present value of expected cash flows from assets,
liabilities and off-balance sheet contracts.
(3) Present value of assets represents the discounted present value of incoming
cash flows on interest-earning assets.
(4) NEV Ratio represents NEV divided by the present value of assets.
The table above indicates that atJune 30, 2020 , in the event of an instantaneous parallel 200 basis point increase in interest rates, we would have experienced a 14.97% increase in net economic value, and in the event of an instantaneous 200 basis point decrease in interest rates, we would have experienced a 6.41% decrease in net economic value. AtJune 30, 2019 in the event of an instantaneous parallel 200 basis point increase in interest rates, we would have experienced a 0.36% decrease in net economic value, and in the event of an instantaneous 200 basis point decrease in interest rates, we would have experienced a 15.35% decrease in net economic value. Certain shortcomings are inherent in the methodologies used in the above interest rate risk measurements. Modeling changes require making certain assumptions that may or may not reflect the manner in which actual yields and costs respond to changes in market interest rates. In this regard, the net interest income and net economic value tables presented assume that the composition of our interest-sensitive assets and liabilities existing at the beginning of a period remains constant over the period being measured and assumes that a particular change in interest rates is reflected uniformly across the yield curve regardless of the duration or repricing of specific assets and liabilities. Accordingly, although the net interest income and NEV tables provide an indication of our interest rate risk exposure at a particular point in time, such measurements are not intended to and do not provide a precise forecast of the effect of changes in market interest rates on net interest income and NEV and will differ from actual results. Furthermore, although certain assets and liabilities may have similar maturities or periods to repricing, they may react in different degrees to changes in market interest rates. Additionally, certain assets, such as adjustable-rate loans, have features that restrict changes in interest rates both on a short-term basis and over the life of the asset.
Interest rate risk calculations also may not reflect the fair values of financial instruments. For example, decreases in market interest rates can increase the fair values of our loans, deposits and borrowings.
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Liquidity and Capital Resources
Liquidity describes our ability to meet the financial obligations that arise in the ordinary course of business. Liquidity is primarily needed to meet the borrowing and deposit withdrawal requirements of our customers and to fund current and planned expenditures. Our primary sources of funds are deposits, principal and interest payments on loans and securities, proceeds from the sale of loans, and proceeds from maturities of securities. We also have the ability to borrow from the FHLB and fromU.S. Bank . AtJune 30, 2020 , we had an$130.8 million line of credit with the FHLB, and had$9.0 million of borrowings outstanding as of that date, and we also had a$5.0 million line of credit withU.S. Bank , with no borrowings outstanding as of that date. While maturities and scheduled amortization of loans and securities are predictable sources of funds, deposit flows and loan prepayments are greatly influenced by general interest rates, economic conditions, and competition. Our most liquid assets are cash and short-term investments including interest-bearing demand deposits. The levels of these assets are dependent on our operating, financing, lending, and investing activities during any given period. Our cash flows are comprised of three primary classifications: cash flows from operating activities, investing activities, and financing activities. Net cash provided by (used in) operating activities was$(4.7) million and$(586,000) for the year endedJune 30, 2020 and the year endedJune 30, 2019 . Net cash provided by (used in) investing activities, which consists primarily of disbursements for loan originations and the purchase of securities, offset by principal collections on loans, and proceeds from maturing securities and pay downs on securities, was$26.2 million and$919,000 for the year endedJune 30, 2020 , and the year endedJune 30, 2019 . Net cash provided by (used in) financing activities, consisting of activity in deposit accounts, borrowings, and net proceeds from the sale of common stock less initial capitalization of TEB MHC, was$(14.0) million and$(837,000) for the year endedJune 30, 2020 and the year endedJune 30, 2019 . We are committed to maintaining a strong liquidity position. We monitor our liquidity position on a daily basis. We anticipate that we will have sufficient funds to meet our current funding commitments. Based on our deposit retention experience, current pricing strategy and regulatory restrictions, we anticipate that a substantial portion of maturing time deposits will be retained, and that we can supplement our funding with borrowings in the event that we allow these deposits to run off at maturity. AtJune 30, 2020 , we exceeded all of our regulatory capital requirements, and we were categorized as well capitalized atJune 30, 2020 . Management is not aware of any conditions or events since the most recent notification that would change our category.
Off-Balance Sheet Arrangements and Aggregate Contractual Obligations
Commitments. As a financial services provider, we routinely are a party to various financial instruments with off-balance-sheet risks, such as commitments to extend credit and unused lines of credit. While these contractual obligations represent our future cash requirements, a significant portion of commitments to extend credit may expire without being drawn upon. Such commitments are subject to the same credit policies and approval process accorded to loans we make. AtJune 30, 2020 , we had outstanding commitments to originate loans of$15.8 million , and outstanding commitments to sell loans of$106.0 million . We anticipate that we will have sufficient funds available to meet our current lending commitments. Time deposits that are scheduled to mature in one year or less fromJune 30, 2020 totaled$41.9 million . Management expects that a substantial portion of the maturing time deposits will be renewed. However, if a substantial portion of these deposits is not retained, we may utilize FHLB advances or other borrowings to offset projected portfolio loan production. Contractual Obligations. In the ordinary course of our operations, we enter into certain contractual obligations. Such obligations include data processing services, operating leases for premises and equipment, agreements with respect to borrowed funds and deposit liabilities. 51
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Recent Accounting Pronouncements
Please refer to Note 1 to the Financial Statements included as Item 8 in this Annual Report for a description of recent accounting pronouncements that may affect our financial condition and results of operations.
Impact of Inflation and Changing Prices
The financial statements and related data presented herein have been prepared in accordance withU.S. GAAP, which requires the measurement of financial position and operating results in terms of historical dollars without considering changes in the relative purchasing power of money over time due to inflation. The primary impact of inflation on our operations is reflected in increased operating costs. Unlike most industrial companies, virtually all of the assets and liabilities of a financial institution are monetary in nature. As a result, interest rates, generally, have a more significant impact on a financial institution's performance than does inflation. Interest rates do not necessarily move in the same direction or to the same extent as the prices of goods and services.
ITEM 7A. Quantitative and Qualitative Disclosures About Market Risk
For information regarding market risk, see "Item 7. Management's Discussion and Analysis of Financial Condition and Results of Operations".
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