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EX-32 - EXHIBIT 32 - WELLS FINANCIAL CORPt1502618_ex32.htm
EX-31 - EXHIBIT 31 - WELLS FINANCIAL CORPt1502618_ex31.htm

 

 

 

UNITED STATES

SECURITIES AND EXCHANGE COMMISSION

Washington, D.C. 20549

 

FORM 10-Q

 

x QUARTERLY REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES EXCHANGE ACT OF 1934

 

For the quarterly period ended September 30, 2015

or

¨ TRANSITION REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES EXCHANGE ACT OF 1934

 

For the transition period from ____________ to ____________

 

Commission File No. 333-202694

 

WELLS FINANCIAL CORP.

(Exact name of registrant as specified in its charter)

 

Minnesota   41-1799504
(State or other jurisdiction of incorporation or organization)   (IRS Employer Identification No.)
     
53 First Street, S.W., Wells, Minnesota   56097
(Address of principal executive offices)   (Zip Code)

 

(507) 553-3151

(Registrant's telephone number, including area code)

 

N/A

(Former name, former address and former fiscal year, if changed since last report)

 

Indicate by check mark whether the registrant (1) has filed all reports required to be filed by Section 13 or 15(d) of the Securities Exchange Act of 1934 during the preceding 12 months (or for such shorter period that the registrant was required to file such reports), and (2) has been subject to such filing requirements for the past 90 days.

Yes x          No ¨

 

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 (§232.405 of this chapter) during the preceding 12 months (or for such shorter period that the registrant was required to submit and post such files).

Yes x            No ¨

 

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 the definitions of "large accelerated filer,” “accelerated filer" and “smaller reporting company” in Rule 12b-2 of the Exchange Act.

 

Large accelerated filer ¨ Accelerated filer ¨   Non-accelerated filer ¨ Smaller reporting company x

 

Indicate by check mark whether the registrant is a shell company (as defined in Rule 12b-2 of the Exchange Act).

Yes ¨           No x

 

As of November 13, 2015 there were issued and outstanding 805,710 shares of the registrant's common stock.

  

 

  

 

 

 

WELLS FINANCIAL CORP.

 

FORM 10-Q

 

FOR THE QUARTER ENDED SEPTEMBER 30, 2015

 

INDEX

 

    Page
Part I FINANCIAL INFORMATION  
     
Item 1. Financial Statements 1-31
Item 2. Management's Discussion and Analysis of Financial Condition and Results of Operations 32-39
Item 3. Quantitative and Qualitative Disclosures About Market Risk 40
Item 4. Controls and Procedures 40
     
Part II OTHER INFORMATION  
     
Item 1. Legal Proceedings 40
Item 1A. Risk Factors 40
Item 2. Unregistered Sales of Equity Securities and Use of Proceeds 41
Item 3. Defaults Upon Senior Securities 41
Item 4. Mine Safety Disclosures 41
Item 5. Other Information 42
Item 6. Exhibits 42
     
SIGNATURES 43

 

EXHIBITS and CERTIFICATIONS

 

 

 

PART I. FINANCIAL INFORMATION

Item 1. Financial Statements

 

Wells Financial Corp. and Subsidiary

Consolidated Balance Sheets

(Dollars in Thousands, Except Per Share Data)

 

   September 30,   December 31, 
  2015   2014 
   (unaudited)     
Assets        
Cash and cash equivalents, including interest-bearing accounts, 2015, $5,435; 2014, $7,411  $9,896   $14,373 
Certificates of deposit, at cost   9,521    4,181 
Federal funds sold   3,000    2,000 
Securities available for sale   35,495    34,177 
Federal Home Loan Bank stock, at cost   2,036    2,079 
Loans held for sale   1,719    1,707 
Loans receivable, net of allowance for loan loss of $2,125 in 2015;  $2,158 in 2014;   197,336    182,050 
Accrued interest receivable   1,252    834 
Premises and equipment, net   3,417    3,172 
Mortgage servicing rights, net   1,862    1,886 
Foreclosed real estate   1,975    3,656 
Other assets   1,041    1,711 
Total assets  $268,550   $251,826 
           
Liabilities, Mezzanine Equity and Stockholders’ Equity          
           
Liabilities          
Deposits  $232,714   $221,972 
Advances from borrowers for taxes and insurance   3,639    2,630 
Accrued interest payable   83    17 
Accrued expenses and other liabilities   903    588 
Total liabilities   237,339    225,207 
           
Commitments, Contingencies and Credit Risk          
           
Mezzanine Equity          
Redeemable common stock held by ESOP, $0.10 par value, shares issued and outstanding, 85,160  at September 30, 2015; 95,602  at December 31, 2014   2,257    2,533 
Stockholders’ Equity          
Preferred stock, no par value; 500,000 shares authorized; none outstanding   -    - 
Common stock, $0.10 par value; 7,000,000 shares authorized;          

2,181,076 shares issued at September 30, 2015;

2,091,898 shares issued at December 31, 2014

   217    209 
Additional paid-in capital   18,119    17,110 
Retained earnings, substantially restricted   39,879    35,552 
Accumulated other comprehensive income   170    93 
Unallocated Employee Stock Ownership Plan shares   (172)   - 
Treasury stock, 2015, 1,459,526 shares; 2014, 1,445,248 shares   (29,259)   (28,878)
Total stockholders’ equity   28,954    24,086 
Total liabilities, mezzanine equity and stockholders’ equity  $268,550   $251,826 

 

See Notes to Consolidated Financial Statements.

 1 

 

Wells Financial Corp. and Subsidiary

 

Consolidated Statements of Income

(Dollars in Thousands, Except Per Share Data)

 

   Three Months Ended
September 30,
   Nine Months Ended
September 30,
 
   2015   2014   2015   2014 
   (unaudited)   (unaudited) 
Interest income:                    
Loans receivable  $2,293   $2,026   $6,530   $5,903 
Investment securities and interest-bearing deposits   185    177    508    548 
Total interest income   2,478    2,203    7,038    6,451 
                     
Interest expense:                    
Deposits   125    148    350    462 
Total interest expense   125    148    350    462 
                     
Net interest income   2,353    2,055    6,688    5,989 
                     
Provision for loan losses   (70)   100    -    420 
Net interest income after provision for loan losses   2,423    1,955    6,688    5,569 
                     
Noninterest income:                    
Gain on sale of loans held for sale   302    214    826    564 
Loan servicing fees   210    168    640    600 
Insurance commissions   188    195    529    487 
Fees and service charges   113    129    342    346 
Bargain purchase gain   2,848    -    2,848    - 
Other   204    211    650    698 
Total noninterest income   3,865    917    5,835    2,695 
                     
Noninterest expenses:                    
Compensation and benefits   1,168    1,093    3,425    3,460 
Occupancy   196    172    553    573 
Data processing   268    266    698    685 
Advertising   71    71    194    181 
Amortization of mortgage servicing rights   98    90    275    239 
Other real estate owned   173    -    429    398 
Other   546    570    1,491    1,540 
Total noninterest expenses   2,520    2,262    7,065    7,076 
                     
Income before income taxes   3,768    610    5,458    1,188 
                     
Income tax expense   348    92    995    323 
Net income  $3,420   $518   $4,463   $865 
                     
Earnings per share:                    
Basic  $4.63   $0.68   $5.88   $1.14 
Diluted  $4.63   $0.68   $5.88   $1.14 

 

See Notes to Consolidated Financial Statements.

 

 2 

 

 

Wells Financial Corp. and Subsidiary

 

Consolidated Statements of Comprehensive Income

(Dollars in Thousands, Except Per Share Data)

   Three Months Ended
September 30,
   Nine Months Ended
September 30,
 
   2015   2014   2015   2014 
   (unaudited)   (unaudited) 
                 
Net income  $3,420   $518   $4,463   $865 
Other comprehensive income (loss):                    
Unrealized gain (loss)  on securities, net of related taxes   129    (1)   77    343 
Comprehensive income  $3,549   $517   $4,540   $1,208 

 

See Notes to Consolidated Financial Statements.

 

 3 

 

Wells Financial Corp. and Subsidiary

 

Consolidated Statements of Stockholders’ Equity and Mezzanine Equity

(Dollars in thousands, Except Per Share Data)

(Unaudited)

 

    Common
Stock
    Additional Paid-In
Capital
    Retained
Earnings
    Accumulated
Other
Comprehensive
Income (Loss)
    Unallocated
ESOP Plan
Shares
    Treasury
Stock
    Total
Stockholders’
Equity
    Mezzanine Equity
Redeemable
Common
Stock
 
Nine Months Ended September 30, 2015    
Balance, December 31, 2014   $ 209     $ 17,110     $ 35,552     $ 93     $ -     $ (28,878 )   $ 24,086     $ 2,533  
Net income     -       -       4,463       -       -       -       4,463       -  
Issuance of 78,736 shares of common stock including 6,299 shares acquired by the ESOP, net of issuance costs     8       999       -       -       (172 )     -       835       -  
Other comprehensive income, net of related taxes     -       -       -       77       -       -       77       -  
Cash dividends declared ($0.54 per share)     -       -       (412 )     -       -       -       (412 )     -  
Stock-based compensation     -       10       -       -       -       -       10       -  
Treasury stock purchases, 14,278 shares, including 10,442 of redeemable common shares     -       -       276       -       -       (381 )     (105 )     (276 )
Change in fair value related to redeemable common stock     -       -       -       -       -       -       -       -  
Balance, September 30, 2015   $ 217     $ 18,119     $ 39,879     $ 170     $ (172 )   $ (29,259 )   $ 28,954     $ 2,257  

  

   Common
Stock
   Additional
Paid-In
Capital
   Retained
Earnings
   Accumulated
Other
Comprehensive
Income (Loss)
   Treasury
Stock
   Total
Stockholders’
Equity
   Mezzanine
Equity
Redeemable
Common
Stock
 
Nine Months Ended September 30, 2014 
Balance, December 31, 2013  $209   $17,096   $34,893   $(264)  $(28,193)  $23,741   $2,342 
Net income   -    -    865    -    -    865    - 
Other comprehensive income, net of related taxes   -    -    -    343    -    343    - 
Cash dividends declared ($0.45 per share)   -    -    (342)   -    -    (342)   - 
Stock-based compensation   -    25    -    -    -    25    - 
Treasury stock purchases, 22,633 shares   -    -    -    -    (563)   (563)   - 
Change in fair value related to redeemable common stock   -    -    -    -    -    -    - 
Balance, September 30, 2014  $209   $17,121   $35,416   $79   $(28,756)  $24,069   $2,342 

 

See Notes to Consolidated Financial Statements

 

 4 

 

Wells Financial Corp. and Subsidiary

 

Consolidated Statements of Cash Flows

(Dollars in Thousands, Except Per Share Data)

 

   Nine Months Ended
September 30,
 
   2015   2014 
   (Unaudited) 
Cash Flows From Operating Activities          
Net income  $4,463   $865 
Adjustment to reconcile net income to net cash (used in) provided by operating activities:          
Provision for loan losses   -    420 
Gain on sale of loans   (826)   (564)
Originations of loans held for sale   (15,597)   (18,307)
Proceeds from the sale of loans held for sale   16,411    18,969 
Net change in mortgage servicing rights   24    324 
Loss (gain) on sales of foreclosed real estate, net   4    (27)
Depreciation expense   146    134 
Amortization of net deferred loan origination fees   (43)   (61)
Amortization of securities premiums   165    160 
Impairment of foreclosed real estate   232    252 
Stock-based compensation expense   10    25 
Bargain purchase gain   (2,848)   - 
Changes in assets and liabilities, net of effects of business combination:          
Accrued interest receivable   (309)   (252)
Other assets   703    (216)
Accrued expenses and other liabilities   76    173 
Net cash provided by operating activities   2,611    1,895 
           
Cash Flows From Investing Activities          
Net decrease (increase) in loans   2,154    (12,983)
Net decrease (increase) in certificates of deposit   274    (1,221)
Net (increase) decrease in federal funds sold   (1,000)   3,500 
Purchase of Federal Home Loan Bank stock   (114)   (181)
Proceeds from sale of Federal Home Loan Bank stock   190    116 
Purchase of securities available-for-sale   (5,815)   (7,803)
Maturities of available-for-sale securities   5,400    11,537 
Net cash received in conversion/merger   1,337    - 
Purchase of premises and equipment   (25)   (203)
Investment in foreclosed real estate   -    (109)
Proceeds from sales of foreclosed real estate   1,589    360 
 Net cash provided by (used in) investing activities   3,990    (6,987)
           
Cash Flows From Financing Activities          
Net  (decrease) increase in deposits   (12,301)   5,914 
Net increase in advances from borrowers for taxes and insurance   1,009    961 
Issuance of 78,736 shares of common stock, net of issuance costs and ESOP shares   1,007    - 
Dividends paid   (412)   (342)
Purchase of treasury stock   (381)   (563)
Net cash (used in) provided by financing activities   (11,078)   5,970 
Net  (decrease) increase in cash and cash equivalents   (4,477)   878 
           
Cash and Cash Equivalents          
Beginning   14,373    12,625 
Ending  $9,896   $13,503 

 

Significant noncash financing and investing activities for the nine months ended September 30, 2015, which include the recognition of assets acquired and liabilities assumed, are disclosed in Note 11.

 

See Notes to Consolidated Financial Statements

 

 5 

 

Wells Financial Corp. and Subsidiary

 

Notes to Consolidated Financial Statements (Unaudited)

(Dollars in Thousands, Except Per Share Data)

 

Note 1. Nature of Operations

 

Operations of Wells Financial Corp. (the “Company”) primarily consist of banking services through Wells Federal Bank (the “Bank”), and Wells Insurance Agency, Inc., a property and casualty insurance agency. The Company serves its customers through the Bank’s nine locations in south central Minnesota.

 

Note 2. Summary of Significant Accounting Policies

 

Basis of Financial Statement Presentation: The accompanying unaudited interim consolidated financial statements have been prepared pursuant to the rules and regulations of the Securities and Exchange Commission. Certain information and footnote disclosures normally included in annual consolidated financial statements prepared in accordance with accounting principles generally accepted in the United States of America have been condensed or omitted as permitted by such rules and regulations. The accompanying consolidated balance sheet and related notes as of December 31, 2014 are derived from the audited consolidated financial statements as of that date. These condensed financial statements and related notes should be read in conjunction with the consolidated financial statements and notes thereto included in the Company’s audited consolidated financial statements for the year ended December 31, 2014 contained in the Company’s Form S-1. In the opinion of management, all adjustments (which consist of normal recurring accruals) necessary for a fair presentation of the consolidated financial statements have been included. Results for any interim period are not necessarily indicative of results to be expected for the year or any other interim period.

 

Segment reporting: The Company’s activities are considered to be a single industry segment for financial reporting purposes. The Company is engaged in commercial and retail banking, investment and insurance services with operations in southern Minnesota. Substantially all income is derived from a diverse base of commercial and retail lending activities.

 

Note 3. Certificates of Deposit

 

Certificates of deposit with a carrying value of $9,521 and $4,181 at September 30, 2015 and December 31, 2014, respectively, had weighted-average yields of 1.28% and 0.41%, respectively, and weighted average contractual maturities of 1.7 and 0.5 years, respectively.

 

 6 

 

Wells Financial Corp. and Subsidiary

 

Notes to Consolidated Financial Statements (Unaudited)

(Dollars in Thousands, Except Per Share Data)

 

Note 4. Securities Available for Sale

 

   September 30, 2015 
       Gross   Gross     
   Amortized   Unrealized   Unrealized     
   Cost   Gains   Losses   Fair Value 
Residential mortgage-backed agencies  $22,356   $96   $(71)  $22,381 
SBA pools   2,645    4    (3)   2,646 
Obligations of states and political subdivisions   10,201    162    (20)   10,343 
Government-sponsored enterprise equity   40    85    -    125 
   $35,242   $347   $(94)  $35,495 

 

   December 31, 2014 
       Gross   Gross     
   Amortized   Unrealized   Unrealized     
   Cost   Gains   Losses   Fair Value 
Residential mortgage-backed agencies  $22,677   $60   $(192)  $22,545 
SBA pools   1,835    6    (9)   1,832 
Obligations of states and political subdivisions   9,474    250    (26)   9,698 
Government-sponsored enterprise equity   40    62    -    102 
   $34,026   $378   $(227)  $34,177 

 

 7 

 

Wells Financial Corp. and Subsidiary

 

Notes to Consolidated Financial Statements (Unaudited)

(Dollars in Thousands, Except Per Share Data)

 

Contractual maturities: The amortized cost and fair value of securities available for sale as of September 30, 2015, by contractual maturity are shown below. Maturities may differ from contractual maturities in residential mortgage-backed securities and Small Business Administration (SBA) pools because the mortgages underlying the securities may be called or repaid without any penalties. In addition, government-sponsored enterprise equity securities have no maturity. Therefore, these securities are not included in the maturity categories in the following maturity summary.

 

   September 30, 2015 
   Amortized Cost   Fair Value 
         
Due in one year or less  $872   $873 
Due in one to five years   3,695    3,739 
Due after five through 10 years   3,890    3,951 
Due after 10 years   1,744    1,780 
    10,201    10,343 
           
Residential mortgage-backed agencies   22,356    22,381 
SBA pools   2,645    2,646 
Government-sponsored enterprise equity   40    125 
   $35,242   $35,495 

 

Pledged securities: Securities with a carrying value of $30,556 and $20,961 at September 30, 2015 and December 31, 2014, respectively, were pledged to secure borrowed funds and for other purposes as required or permitted by law.

 

Changes in other comprehensive income—unrealized gains on securities available for sale:

 

   Three Months Ended
September 30,
   Nine Months Ended
September 30,
 
   2015   2014   2015   2014 
                 
Balance, beginning  $41   $80   $93   $(264)
Unrealized gains  during the year   208    -    119    417 
Deferred tax effect relating to unrealized gain   (79)   (1)   (42)   (74)
Balance, ending  $170   $79   $170   $79 

 

 8 

 

Wells Financial Corp. and Subsidiary

 

Notes to Consolidated Financial Statements (Unaudited)

(Dollars in Thousands, Except Per Share Data)

 

Temporarily impaired securities:

 

   September 30, 2015 
   Continuous Unrealized   Continuous Unrealized         
   Losses Existing   Losses Existing         
   12 Months or Less   Greater Than 12 Months   Total 
   Fair   Unrealized   Fair   Unrealized   Fair   Unrealized 
   Value   Loss   Value   Loss   Value   Loss 
Residential mortgage-backed agencies  $4,197   $9   $8,575   $62   $12,772   $71 
SBA Pools   1,049    3    -    -    1,049    3 
Obligations of states and political subdivisions   490    4    920    16    1,410    20 
   $5,737   $16   $9,495   $78   $15,232   $94 

 

   December 31, 2014 
   Continuous Unrealized   Continuous Unrealized         
   Losses Existing   Losses Existing         
   12 Months or Less   Greater Than 12 Months   Total 
   Fair   Unrealized   Fair   Unrealized   Fair   Unrealized 
   Value   Loss   Value   Loss   Value   Loss 
Residential mortgage-backed agencies  $5,679   $20   $10,566   $172   $16,245   $192 
SBA pools   -    -    1,250    9    1,250    9 
Obligations of states and political subdivisions   1,495    6    1,180    20    2,675    26 
   $7,174   $26   $12,996   $201   $20,170   $227 

 

There were 25 and 37 securities in unrealized loss positions as of September 30, 2015 and December 31, 2014, respectively.

 

Unrealized losses are deemed to be temporary. Most of these underlying securities consist of mortgage-backed securities. Market fluctuations are caused primarily by changes in interest rates and prepayments of underlying mortgages. Volatility in economic conditions influences the prices of these securities. There were no sales of available-for-sale securities during the nine months ended September 30, 2015 and 2014.

 

 9 

 

Wells Financial Corp. and Subsidiary

 

Notes to Consolidated Financial Statements (Unaudited)

(Dollars in Thousands, Except Per Share Data)

 

Note 5. Loans Receivable and Loans Held for Sale

 

Composition of loans receivable:

 

   September 30,   December 31, 
   2015   2014 
Residential real estate  $61,091   $56,674 
Commercial real estate   32,255    30,653 
Agricultural real estate   40,469    38,128 
Commercial construction real estate   2,827    4,035 
Residential construction real estate   1,319    940 
Home equity, home improvement and second mortgages   33,031    32,741 
Commercial operating and term   9,551    5,718 
Agricultural operating and term   9,839    7,714 
Vehicle   2,720    1,671 
Consumer   6,573    6,279 
Total loans   199,675    184,553 
Net deferred loan origination fees   (214)   (345)
Allowance for loan loss   (2,125)   (2,158)
Loans receivable, net  $197,336   $182,050 

 

Loans are made to individuals as well as to commercial and tax-exempt entities. Specific loan terms vary as to interest rate, repayment and collateral requirements based on the type of loan requested and the creditworthiness of the prospective borrower. Credit risk tends to be geographically concentrated in that a majority of the loan customers are located in the markets serviced by the Company.

 

The Company’s extension of credit is governed by the individual loan policies that were established to control the quality of the Company’s loans. These policies and procedures are reviewed and approved by the Board of Directors on a regular basis.

 

Residential real estate loans: The Company originates residential real estate loans in its service area and also originates loans throughout Minnesota through its correspondent bank relationships. Currently, the majority of these loan originations are sold in the secondary market.

 

Commercial real estate loans: The Company’s goal is to create and maintain a high-quality portfolio of commercial real estate loans with customers who meet the credit quality and relationship profitability objectives of the Company. Commercial real estate loans are subject to underwriting standards and processes similar to commercial operating and term loans. These loans are analyzed using projected cash flows, and the repayment of these loans is largely dependent on the successful operation of the property. Loan performance may be adversely affected by factors impacting the general economy or conditions specific to the real estate market, such as geographic location and property type.

 

Agricultural real estate loans: The Company originates loans secured by agricultural real estate in its service area. Agricultural land in the Company’s service area is considered to be prime agricultural land. These loans are underwritten using both a cash flow analysis and appraised values. These are amortizing loans, and loan-to-value ratios generally do not exceed 60 percent at loan inception.

 

 10 

 

Wells Financial Corp. and Subsidiary

 

Notes to Consolidated Financial Statements (Unaudited)

(Dollars in Thousands, Except Per Share Data)

 

Commercial construction real estate loans: The Company defines construction loans as loans where the loan proceeds are controlled by the Company and used exclusively for the improvement of real estate in which the Company holds a mortgage. Due to the inherent risk in this type of loan, they are subject to other industry-specific policy guidelines outlined in the Company’s credit risk policy and are monitored closely.

 

Residential construction real estate loans: Residential construction loans originated by the Company generally are limited to six-month terms. When construction is completed, these loans are converted to permanent financing or sold to the secondary market.

 

Commercial operating and term loans: Commercial operating and term loans are originated in the Company’s primary service area. These loans are made to individuals, partnerships, corporations, limited liability partnerships and limited liability companies for the purpose of assisting in the development of a business enterprise. Loans to closely held businesses will generally be guaranteed in full or for a meaningful amount by the businesses’ major owners. Commercial loans are made based primarily on the historical and projected cash flow of the borrower and secondarily on the underlying collateral provided by the borrower. The cash flows of borrowers, however, may not perform as forecasted, and collateral securing loans may fluctuate in value due to economic or individual performance factors. Minimum standards and underwriting guidelines have been established for all commercial loan types.

 

Agricultural operating and term loans: Agricultural operating and term loans are originated in the Company’s primary service area and are generally used to purchase agricultural equipment or crop inputs. These loans are primarily secured by agricultural real estate and agricultural equipment or crops. Agricultural term and operating loans are made based primarily on the historical and projected cash flow of the borrower and secondarily on the underlying collateral provided by the borrower. The cash flows of borrowers, however, may not behave as forecasted, and collateral securing loans may fluctuate in value due to economic or individual performance factors. Minimum standards and underwriting guidelines have been established for all agricultural loan types.

 

Consumer loans, including home equity, home improvement and second mortgages, and vehicle loans: The Company originates direct consumer loans, including home equity lines and loans, credit cards, and vehicle loans, using a scoring-based credit analysis as part of the underwriting process. Each loan type has a separate specified scoring that consists of several factors, including debt to income, type of collateral and loan-to-collateral value, credit history, and Company relationship with the borrower.

 

 11 

 

Wells Financial Corp. and Subsidiary

 

Notes to Consolidated Financial Statements (Unaudited)

(Dollars in Thousands, Except Per Share Data)

 

Loans receivable:

 

   September 30, 2015 
               Loans Past         
       30–59 Days   60–89 Days   Due 90 Days   Total     
   Current   Past Due   Past Due   or More   Past Due   Total 
                         
Residential real estate  $58,636   $964   $99   $1,392   $2,455   $61,091 
Commercial real estate   32,173    -    82    -    82    32,255 
Agricultural real estate   39,914    -    -    555    555    40,469 
Commercial construction real estate   2,827    -    -    -    -    2,827 
Residential construction real estate   1,319    -    -    -    -    1,319 
Home equity, home improvement and second mortgages   32,793    131    59    48    238    33,031 
Commercial operating and term   9,248    -    -    303    303    9,551 
Agricultural operating and term   9,839    -    -    -    -    9,839 
Vehicle   2,659    22    3    36    61    2,720 
Consumer   6,505    46    -    22    68    6,573 
Total loans  $195,913   $1,163   $243   $2,356   $3,762   $199,675 
                               
Nonperforming loans  $-   $-   $-   $2,356   $2,356   $2,356 

 

   December 31, 2014 
               Loans Past         
       30–59 Days   60–89 Days   Due 90 Days   Total     
   Current   Past Due   Past Due   or More   Past Due   Total 
                         
Residential real estate  $54,698   $782   $507   $687   $1,976   $56,674 
Commercial real estate   30,653    -    -    -    -    30,653 
Agricultural real estate   37,843    285    -    -    285    38,128 
Commercial construction real estate   4,035    -    -    -    -    4,035 
Residential construction real estate   940    -    -    -    -    940 
Home equity, home improvement and second mortgages   32,291    193    2    255    450    32,741 
Commercial operating and term   5,569    82    -    67    149    5,718 
Agricultural operating and term   7,674    40    -    -    40    7,714 
Vehicle   1,661    8    1    1    10    1,671 
Consumer   6,243    26    10    -    36    6,279 
Total loans  $181,607   $1,416   $520   $1,010   $2,946   $184,553 
                               
Nonperforming loans  $-   $-   $-   $1,010   $1,010   $1,010 

 

 12 

Wells Financial Corp. and Subsidiary

 

Notes to Consolidated Financial Statements (Unaudited)

(Dollars in Thousands, Except Per Share Data)

 

Recorded investment in nonaccrual loans and loans past due 90 days or more and still accruing by class of loans as of September 30, 2015 and December 31, 2014, were as follows:

 

   September 30, 2015 
       Loans Past Due 
       90 Days or More 
   Nonaccrual   and Still Accruing 
         
Residential real estate  $1,392   $- 
Commercial real estate   -    - 
Agricultural real estate   555    - 
Commercial construction real estate   -    - 
Residential construction real estate   -    - 
Home equity, home improvement and second mortgages   48    - 
Commercial operating and term   303    - 
Agricultural operating and term   -    - 
Vehicle    36    - 
Consumer   22    - 
Total  $2,356   $- 

 

   December 31, 2014 
       Loans Past Due 
       90 Days or More 
   Nonaccrual   and Still Accruing 
         
Residential real estate  $687   $- 
Commercial real estate   -    - 
Agricultural real estate   -    - 
Commercial construction real estate   -    - 
Residential construction real estate   -    - 
Home equity, home improvement and second mortgages   255    - 
Commercial operating and term   67    - 
Agricultural operating and term   -    - 
Vehicle   1    - 
Consumer   -    - 
Total  $1,010   $- 

 

No interest income was recognized on nonaccrual loans for the nine months ended September 30, 2015 and 2014. There are no additional funds to be advanced on these loans.

 

 13 

 

Wells Financial Corp. and Subsidiary

 

Notes to Consolidated Financial Statements (Unaudited)

(Dollars in Thousands, Except Per Share Data)

 

The Company utilizes an internal asset classification system as a means of reporting problem and potential problem loans. Under the Company’s risk-rating system, the Company classifies problem and potential problem loans as “Special Mention,” “Substandard” and “Doubtful,” which correspond to risk ratings five, six and seven, respectively. Substandard loans include those characterized by the distinct possibility that the Company will sustain some loss if the deficiencies are not corrected. Loans classified as Doubtful, or risk-rated seven, have all the weaknesses inherent in those classified as Substandard, with the added characteristic that the weaknesses present make collection or liquidation in full, on the basis of currently existing facts, conditions and values, highly questionable and improbable. Loans that do not currently expose the Company to sufficient risk to warrant classification in one of the aforementioned categories but possess weaknesses that deserve management’s close attention, are deemed to be Special Mention, or risk-rated five. Risk ratings are updated any time the situation warrants.

 

Loans not meeting the criteria above that are analyzed individually as part of the above-described process are considered to be pass-rated loans. Loans listed as not rated are included in groups of homogeneous loans with similar risk and loss characteristics. The following tables present the risk category of loans by class of loans based on the most recent analyses performed and the contractual aging as of September 30, 2015 and December 31, 2014:

 

   September 30, 2015 
       Special             
   Pass   Mention   Substandard   Doubtful   Total 
                     
Commercial real estate  $29,012   $1,980   $1,263   $-   $32,255 
Agricultural real estate   39,914    165    390    -    40,469 
Commercial construction real estate   2,827    -    -    -    2,827 
Commercial operating and term   9,523    58    258    -    9,551 
Agricultural operating and term   9,806    33    -    -    9,839 
Total   $91,082   $2,236   $1,911   $-   $94,941 

 

   December 31, 2014 
       Special             
   Pass   Mention   Substandard   Doubtful   Total 
                     
Commercial real estate  $26,449   $3,556   $648   $-   $30,653 
Agricultural real estate   38,128    -    -    -    38,128 
Commercial construction real estate   4,035    -    -    -    4,035 
Commercial operating and term   5,426    -    292    -    5,718 
Agricultural operating and term   7,714    -    -    -    7,714 
Total  $43,624   $3,556   $940   $-   $48,120 

 

 14 

 

Wells Financial Corp. and Subsidiary

 

Notes to Consolidated Financial Statements (Unaudited)

(Dollars in Thousands, Except Per Share Data)

 

For consumer, residential real estate, agricultural real estate, home equity, vehicle and residential construction loan classes, the Company collectively evaluates loans for impairment. The Company evaluates credit quality based on the aging status of the loan, which was previously presented, and by payment activity. Loans where credit quality and aging indicate potential weakness are placed on nonaccrual and are deemed to be nonperforming.

 

Impaired loans also include loans modified in a troubled debt restructuring where concessions have been granted to borrowers experiencing financial difficulties. These concessions could include a reduction in interest rate on the loan, payment extensions, forgiveness of principal, forbearance or other actions intended to maximize collections. There was one troubled debt restructuring of loans during the three and nine months ended September 30, 2015. There were no troubled debt restructuring of loans during the three and nine months ended September 30, 2014.

 

Payments received on nonaccrual loans are applied as a direct reduction of principal. Nonaccrual loans that are brought current, and do not have additional credit risk factors noted, are returned to accrual status.

 

There were no loans modified in a troubled debt restructuring during the previous twelve month period that subsequently defaulted during the three and nine months ended September 30, 2015 and 2014.

 

Loans individually evaluated for impairment by class of loans as of September 30, 2015 and December 31, 2014 are as follows:

 

   September 30. 2015 
   Unpaid       Allowance for   Average   Interest 
   Principal   Recorded   Loan Losses   Recorded   Income 
   Balance   Investment   Allocated   Investment   Recognized 
With no related allowance recorded:                         
Residential real estate  $473   $473   $-   $493   $18 
Commercial real estate   575    575    -    666    18 
With an allowance recorded:                         
Residential real estate   414    414    79    440    27 
Commercial real estate   1,884    1,884    329    1,910    58 
Home equity, home improvement and second mortgages   -    -    -    -    - 
Commercial operating and term   209    209    181    221    6 
Consumer   7    7    5    3    1 
Vehicle   2    2    2    8    - 
Total  $3,564   $3,564   $596   $3,741   $128 

 

   December 31, 2014 
   Unpaid       Allowance for   Average   Interest 
   Principal   Recorded   Loan Losses   Recorded   Income 
   Balance   Investment   Allocated   Investment   Recognized 
With no related allowance recorded:                         
Residential real estate  $461   $461   $-   $505   $27 
With an allowance recorded:                         
Residential real estate   822    822    115    830    34 
Commercial real estate   2,637    2,637    341    2,690    99 
Home equity, home improvement and  second mortgages   73    73    73    74    2 
Commercial operating and term   63    63    32    -    2 
Consumer   16    16    12    16    2 
Total  $4,072   $4,072   $573   $4,115   $166 
                          
 15 

 

Wells Financial Corp. and Subsidiary

 

Notes to Consolidated Financial Statements (Unaudited)

(Dollars in Thousands, Except Per Share Data)

 

Allowance for loan losses:

 

   Three Months Ended September 30, 2015 
   Balance,               Balance, 
   Beginning   Charge-offs   Recoveries   Provision   Ending 
                     
Residential real estate  $528   $-   $-   $(49)  $479 
Commercial real estate   786    -    -    (83)   703 
Agricultural real estate   159    -    -    (14)   145 
Commercial construction real estate   6    -    -    8    14 
Residential construction real estate   6    -    -    1    7 
Home equity, home improvement and second mortgages   447    (26)   4    (25)   400 
Commercial operating and term   117    -    -    144    261 
Agricultural operating and term   30    -    -    (1)   29 
Vehicle   27    -    -    -    27 
Consumer   78    (17)   50    (51)   60 
Total  $2,184   $(43)  $54   $(70)  $2,125 

 

   Nine Months Ended September 30, 2015 
   Balance,               Balance, 
   Beginning   Charge-offs   Recoveries   Provision   Ending 
                     
Residential real estate  $545   $(9)  $9   $(66)  $479 
Commercial real estate   722    -    -    (19)   703 
Agricultural real estate   155    -    -    (10)   145 
Commercial construction real estate   12    -    -    2    14 
Residential construction real estate   13    -    -    (6)   7 
Home equity, home improvement and second mortgages   431    (115)   18    66    400 
Commercial operating and term   109    -    -    152    261 
Agricultural operating and term   31    -    -    (2)   29 
Vehicle   28    -    4    (5)   27 
Consumer   112    (26)   86    (112)   60 
Total  $2,158   $(150)  $117   $-   $2,125 

 

 16 

 

Wells Financial Corp. and Subsidiary

 

Notes to Consolidated Financial Statements (Unaudited)

(Dollars in Thousands, Except Per Share Data)

 

   Three Months Ended September 30, 2014 
   Balance,               Balance, 
   Beginning   Charge-offs   Recoveries   Provision   Ending 
                     
Residential real estate  $484   $(3)  $11   $9   $501 
Commercial real estate   712    -    -    (16)   696 
Agricultural real estate   142    -    -    9    151 
Commercial construction real estate   8    -         14    22 
Residential construction real estate   11    -    -    (5)   6 
Home equity, home improvement and second mortgages   314    (4)   2    80    392 
Commercial operating and term   93    -    -    21    114 
Agricultural operating and term   14    -    -    7    21 
Vehicle   30    -    1    (4)   27 
Consumer   126    (14)   13    (15)   110 
Total  $1,934   $(21)  $27   $100   $2,040 

 

   Nine Months Ended September 30, 2014 
   Balance,               Balance, 
   Beginning   Charge-offs   Recoveries   Provision   Ending 
                     
Residential real estate  $433   $(6)  $11   $63   $501 
Commercial real estate   624    -    7    65    696 
Agricultural real estate   130    -    -    21    151 
Commercial construction real estate   2    -    -    20    22 
Residential construction real estate   11    -    -    (5)   6 
Home equity, home improvement and second mortgages   254    (181)   39    280    392 
Commercial operating and term   87    (1)   -    28    114 
Agricultural operating and term   18    -    -    3    21 
Vehicle   30    -    3    (6)   27 
Consumer   135    (24)   48    (49)   110 
Total  $1,724   $(212)  $108   $420   $2,040 

 

 17 

 

Wells Financial Corp. and Subsidiary

 

Notes to Consolidated Financial Statements (Unaudited)

(Dollars in Thousands, Except Per Share Data)

 

The recorded investment in loans and the allowance for loan losses by portfolio segment and based on impairment method as of September 30, 2015 and December 31, 2014, are as follows:

 

   September 30, 2015 
   Individually   Collectively     
   Evaluated for   Evaluated for     
   Impairment   Impairment   Total 
Loans:               
Residential real estate  $887   $60,204   $61,091 
Commercial real estate   2,459    29,796    32,255 
Agricultural real estate   -    40,469    40,469 
Commercial construction real estate   -    2,827    2,827 
Residential construction real estate   -    1,319    1,319 
Home equity, home improvement and second mortgages   -    33,031    33,031 
Commercial operating and term   209    9,342    9,551 
Agricultural operating and term   -    9,839    9,839 
Vehicle   2    2,718    2,720 
Consumer   7    6,566    6,573 
Total  $3,564   $196,111   $199,675 

 

   September 30, 2015 
   Individually   Collectively     
   Evaluated for   Evaluated for     
   Impairment   Impairment   Total 
Allowance for loan losses:               
Residential real estate  $79   $400   $479 
Commercial real estate   329    374    703 
Agricultural real estate   -    145    145 
Commercial construction real estate   -    14    14 
Residential construction real estate   -    7    7 
Home equity, home improvement and second mortgages   -    400    400 
Commercial operating and term   181    80    261 
Agricultural operating and term   -    29    29 
Vehicle   2    25    27 
Consumer   5    55    60 
Total  $596   $1,529   $2,125 

  

 18 

 

Wells Financial Corp. and Subsidiary

 

Notes to Consolidated Financial Statements (Unaudited)

(Dollars in Thousands, Except Per Share Data)

 

   December 31, 2014 
   Individually   Collectively     
   Evaluated for   Evaluated for     
   Impairment   Impairment   Total 
Loans:               
Residential real estate  $1,283   $55,390   $56,674 
Commercial real estate   2,637    28,016    30,653 
Agricultural real estate   -    38,128    38,128 
Commercial construction real estate   -    4,035    4,035 
Residential construction real estate   -    940    940 
Home equity, home improvement and second mortgages   73    32,668    32,741 
Commercial operating and term   63    5,655    5,718 
Agricultural operating and term   -    7,714    7,714 
Vehicle   -    1,671    1,671 
Consumer   16    6,263    6,279 
Total  $4,072   $180,481   $184,553 

  

   December 31, 2014 
   Individually   Collectively     
   Evaluated for   Evaluated for     
   Impairment   Impairment   Total 
Allowance for loan losses:               
Residential real estate  $115   $430   $545 
Commercial real estate   341    381    722 
Agricultural real estate   -    155    155 
Commercial construction real estate   -    12    12 
Residential construction real estate   -    13    13 
Home equity, home improvement and second mortgages   73    358    431 
Commercial operating and term   32    77    109 
Agricultural operating and term   -    31    31 
Vehicle   -    28    28 
Consumer   12    100    112 
Total  $573   $1,585   $2,158 

 

Loans with a carrying value of $92,639 and $96,740 at September 30, 2015 and December 31, 2014, respectively, were pledged to secure borrowed funds.

 

 19 

 

Wells Financial Corp. and Subsidiary

 

Notes to Consolidated Financial Statements (Unaudited)

(Dollars in Thousands, Except Per Share Data)

 

Related-party loans: The Company has entered into transactions with its executive officers, directors, significant shareholders, and their affiliates (related parties). The aggregate amounts of loans to such related parties at September 30, 2015 and December 31, 2014, were $190 and $342, respectively. During 2015 and 2014, new loans to such related parties were $97 and $185, respectively, and repayments were $152 and $67, respectively. In the opinion of management, these loans have terms similar to other customer loans and do not present more than normal risk of collection.

 

Loans held for sale: As of September 30, 2015 and December 31, 2014, the Company’s loans held for sale were $1,719 and $1,707, respectively, and consisted of one- to four-family residential real estate loans.

 

Interest rate lock commitments related to the origination of mortgage loans that will be sold are considered derivative instruments. The Company estimates the fair value of these derivatives using the difference between the guaranteed interest rate in the commitments and the current market interest rate. To reduce the net interest rate exposure arising from its loan sale activity, the Company enters into a commitment to sell these loans at the same time that the interest rate lock commitment is quoted. The commitments to sell loans are also considered derivative instruments, with offsetting estimated fair values based on changes in current market rates. These commitments are not designated as hedging instruments and, therefore, changes in fair value are recognized immediately into income. The fair values of the Company’s derivative instruments are offsetting and deemed to be immaterial.

 

Note 6. Loan Servicing

 

Mortgage loans serviced for others are not included in the accompanying consolidated balance sheets. The unpaid principal balances of these loans as of September 30, 2015 and December 31, 2014, were $320,669 and $332,075, respectively, and consist of one- to four-family residential real estate loans. These loans are serviced primarily for the Federal Home Loan Mortgage Corporation, Federal Home Loan Bank and Federal National Mortgage Association.

 

Custodial escrow balances maintained in connection with the foregoing loan servicing, and included in advances from borrowers for taxes and insurance, were $3,176 and $2,347 at September 30, 2015 and December 31, 2014, respectively.

 

Mortgage servicing rights are summarized as follows for the nine months ended September 30, 2015 and 2014:

 

   September 30,   September 30, 
   2015   2014 
         
Balance at beginning of year, net  $1,886   $1,952 
Mortgage servicing rights capitalized   251    181 
Amortization expense   (275)   (239)
Valuation provision change   -    - 
Balance at end of period, net  $1,862   $1,894 

 

The estimated fair value of mortgage servicing rights was $2,143 and $2,578 at September 30, 2015 and December 31, 2014, respectively. At September 30, 2015 and December 31, 2014, the valuation allowance was $15 and $15, respectively.

 

 20 

 

Wells Financial Corp. and Subsidiary

 

Notes to Consolidated Financial Statements (Unaudited)

(Dollars in Thousands, Except Per Share Data)

 

Note 7. Stockholders’ Equity, Regulatory Capital and Dividend Restrictions

 

The Bank is subject to various regulatory capital requirements administered by the federal banking agencies. Failure to meet minimum capital requirements can initiate certain mandatory—and possibly additional discretionary—actions by regulators that, if undertaken, could have a direct material effect on the Company’s financial statements. Under capital adequacy guidelines and the regulatory framework for prompt corrective action, the Bank must meet specific capital guidelines that involve quantitative measures of the Company’s assets, liabilities, and certain off-balance-sheet items as calculated under regulatory accounting practices. The Bank’s capital amounts and classification are also subject to qualitative judgments by the regulators about components, risk weightings and other factors.

 

Quantitative measures established by regulation to ensure capital adequacy require the Bank to maintain minimum amounts and ratios (set forth in the following table) of common equity Tier I, Tier I capital and total capital (as defined in the regulations) to risk-weighted assets (as defined), and of Tier I capital (as defined) to average assets (as defined). Management believes, as of September 30, 2015, that the Bank meets all capital adequacy requirements to which they are subject.

 

As of September 30, 2015, the most recent notification of the Federal Deposit Insurance Corporation categorized the Bank as “well capitalized” under the regulatory framework for Prompt Corrective Action. To be categorized as “well capitalized,” the Bank must maintain minimum total risk-based, common equity Tier I, Tier I risk-based, and Tier I leverage ratios. There are no conditions or events since that notification that management believes have changed the Bank’s category.

 

 21 

 

Wells Financial Corp. and Subsidiary

 

Notes to Consolidated Financial Statements (Unaudited)

(Dollars in Thousands, Except Per Share Data)

 

The following table summarizes the Bank’s compliance with its regulatory capital requirements:

 

                   Minimum to Be Well 
           Minimum   Capitalized Under 
           for Capital   Prompt Corrective 
   Actual   Adequacy Purposes   Action Provisions 
   Amount   Percent   Amount   Percent   Amount   Percent 
Bank as of September 30, 2015:                              
Tier I capital
(to average assets)
  $28,221    10.37%  $10,884    4.00%  $13,605    5.00%
Tier I capital common equity
(to risk weighted assets)
   28,221    11.37%   11,166    4.50%   16,129    6.50%
Tier I capital
(to risk weighted assets)
   28,221    11.37%   14,889    6.00%   19,851    8.00%
Total risk based capital
(to risk weighted assets)
   30,384    12.24%   19,851    8.00%   24,814    10.00%
                               
Bank as of December 31, 2014:                              
Tier I capital
(to average assets)
   25,380    9.90%   10,255    4.00%   12,819    5.00%
Tier I capital
(to risk weighted assets)
   25,380    13.58%   7,478    4.00%   11,217    6.00%
Total capital
(to risk weighted assets)
   27,566    14.74%   14,956    8.00%   18,695    10.00%

 

 22 

 

Wells Financial Corp. and Subsidiary

 

Notes to Consolidated Financial Statements (Unaudited)

(Dollars in Thousands, Except Per Share Data)

 

Note 8. Earnings Per Share

 

A reconciliation of the income and common stock share amounts used in the calculation of basic and diluted earnings per share follows:

 

   Three Months Ended September 30, 2015 
           Per Share 
   Income   Shares   Amount 
Basic earnings per share:               
Net income  $3,420    738,439   $4.63 
Effect of dilutive securities:               
Stock options        432      
Diluted earnings per share:               
Net income plus assumed conversions  $3,420    738,871   $4.63 

 

   Nine Months Ended September 30, 2015 
           Per Share 
   Income   Shares   Amount 
Basic earnings per share:               
Net income  $4,463    759,012   $5.88 
Effect of dilutive securities:               
Stock options        432      
Diluted earnings per share:               
Net income plus assumed conversions  $4,463    759,444   $5.88 

 

   Three Months Ended September 30, 2014 
           Per Share 
   Income   Shares   Amount 
Basic earnings per share:               
Net income  $518    757,323   $0.68 
Effect of dilutive securities:               
Stock options        1,218      
Diluted earnings per share:               
Net income plus assumed conversions  $518    758,541   $0.68 

 

   Nine Months Ended September 30, 2014 
           Per Share 
   Income   Shares   Amount 
Basic earnings per share:               
Net income  $865    760,297   $1.14 
Effect of dilutive securities:               
Stock options        1,218      
Diluted earnings per share:               
Net income plus assumed conversions  $865    761,515   $1.14 

 

 23 

 

Wells Financial Corp. and Subsidiary

 

Notes to Consolidated Financial Statements (Unaudited)

(Dollars in Thousands, Except Per Share Data)

 

At September 30, 2015, all options were included in the dilutive earnings per share computation. At September 30, 2014, 15,850 options are not included in the dilutive earnings per share computation because their inclusion would be antidilutive.

 

Note 9. Financial Instruments With Off-Balance-Sheet Risk

 

The Company is a party to financial instruments with off-balance-sheet risk in the normal course of business to meet the financing needs of its customers. These financial instruments include primarily commitments to extend credit. Those instruments involve, to varying degrees, elements of credit risk and interest rate risk in excess of the amount recognized in the consolidated balance sheet.

 

The Company’s exposure to credit loss in the event of nonperformance by the other party to the financial instrument for commitments to extend credit, standby letters of credit, and financial guarantees written is represented by the contractual notional amount of those instruments. The Company uses the same credit policies in making commitments and conditional obligations as it does for on-balance-sheet instruments.

 

Commitments to extend credit on loans totaled approximately $44,312 and $38,110 at September 30, 2015 and December 31, 2014, respectively.

 

Commitments to extend credit are agreements to lend to a customer as long as there is no violation of any condition established in the contract. Commitments generally have fixed expiration dates or other termination clauses and may require payment of a fee. Since some of the commitments are expected to expire without being drawn upon, the total commitment amounts do not necessarily represent future cash requirements. The Company evaluates each customer’s creditworthiness on a case-by-case basis. The amount of collateral obtained, if it is deemed necessary by the Company upon extension of credit, is based on management’s credit evaluation of the counterparty. Collateral held varies but normally includes real estate and personal property.

 

Note 10. Fair Value Measurements

 

ASC Topic 820 defines fair value as the price that would be received to sell an asset or paid to transfer a liability in an orderly transaction between market participants. A fair value measurement assumes that the transaction to sell the asset or transfer the liability occurs in the principal market for the asset or liability or, in the absence of a principal market, the most advantageous market for the asset or liability. The price in the principal (or most advantageous) market used to measure the fair value of the asset or liability shall not be adjusted for transaction costs. An orderly transaction is a transaction that assumes exposure to the market for a period prior to the measurement date to allow for marketing activities that are usual and customary for transactions involving such assets and liabilities; it is not a forced transaction. Market participants are buyers and sellers in the principal market that are (i) independent, (ii) knowledgeable, (iii) able to transact and (iv) willing to transact.

 

 24 

 

Wells Financial Corp. and Subsidiary

 

Notes to Consolidated Financial Statements (Unaudited)

(Dollars in Thousands, Except Per Share Data)

 

ASC Topic 820 establishes a fair value hierarchy for valuation inputs that gives the highest priority to quoted prices in active markets for identical assets or liabilities and the lowest priority to unobservable inputs. The fair value hierarchy is as follows:

 

Level 1:Quoted prices (unadjusted) for identical assets or liabilities in active markets that the entity has the ability to access as of the measurement date

 

Level 2:Significant other observable inputs other than Level 1 prices, such as quoted prices for similar assets or liabilities, quoted prices in markets that are not active, or other inputs that are observable or can be corroborated by observable market data

 

Level 3:Significant unobservable inputs that reflect a reporting entity’s own assumptions about the assumptions that market participants would use in pricing an asset or liability

 

A description of the valuation methodologies used for instruments measured at fair value, as well as the general classification of such instruments pursuant to the valuation hierarchy, is set forth below.

 

In general, fair value is based upon quoted market prices, where available. If such quoted market prices are not available, fair value is based upon models that primarily use, as inputs, observable market-based parameters. Valuation adjustments may be made to ensure that financial instruments are recorded at fair value. While management believes the Company’s valuation methodologies are appropriate and consistent with other market participants, the use of different methodologies or assumptions to determine the fair value of certain financial instruments could result in a different estimate of fair value at the reporting date.

 

Investment securities available for sale: The fair values of exchange-listed equity securities are based on quoted market prices and are categorized as Level 1 of the fair value hierarchy. The fair values of debt securities were generally determined based on matrix pricing. Matrix pricing is a mathematical technique that utilizes observable market inputs including, for example, yield curves, credit ratings and prepayment speeds. Fair values determined using matrix pricing are categorized as Level 2 in the fair value hierarchy.

 

 25 

 

Wells Financial Corp. and Subsidiary

 

Notes to Consolidated Financial Statements (Unaudited)

(Dollars in Thousands, Except Per Share Data)

 

Redeemable common stock: The Company has certain shares of common stock outstanding whereby the holder may put its shares to the Company for cash. This redeemable common stock is recorded at its fair value in the mezzanine equity section of our consolidated balance sheets and changes in fair value are recorded in retained earnings. The fair value of a share of common stock was determined by applying a market valuation approach based upon comparative financial and pricing analysis of the Company with a peer group of publicly traded financial institutions. The comparative financial analysis is based on three types of market pricing ratios: price to earnings, price to book (or price to tangible book) and price to assets, with a greater emphasis given to price to earnings and price to book value. Valuations include assumptions not observable in the marketplace, and the related fair value measurements have been categorized as Level 3 measurements.

 

The Company is required, on a nonrecurring basis, to adjust the carrying value of certain assets or provide valuation allowances related to certain assets, using fair value measurements in accordance with generally accepted accounting principles.

 

Impaired loans: The specific reserves for collateral-dependent impaired loans are based on the fair value of the collateral less estimated costs to sell. The fair value of collateral was determined based on appraisals, with further adjustments made to the appraised values due to various factors, including the age of the appraisal, age of comparables included in the appraisal, and changes in the market and in the collateral. As these significant adjustments are based on unobservable inputs, the resulting fair value measurements have been categorized as Level 3 measurements.

 

Foreclosed real estate: Foreclosed real estate is recorded at fair value based on property appraisals, less estimated selling costs, at the date of transfer. The carrying value of foreclosed real estate is not remeasured to fair value on a recurring basis, but is subject to fair value adjustments when the carrying value exceeds the fair value, less estimated selling costs. Property appraisals are based on assumptions generally not observable in the marketplace, and the related nonrecurring fair value measurement adjustments have generally been classified as Level 3.

 

Mortgage servicing rights: Mortgage servicing rights are initially measured at fair value in the Company’s consolidated balance sheet. The Company utilizes the amortization method to subsequently measure its capitalized servicing assets. In accordance with ASC Topic 860, the Company must record impairment charges when the carrying value of certain strata exceeds their estimated fair value. To estimate the fair value of servicing rights, the Company considers market prices for similar assets and the present value of expected future cash flows associated with the servicing rights calculated using assumptions that market participants would use in estimating future servicing income and expense. Such assumptions include estimates of the cost of servicing loans, loan default rates, an appropriate discount rate, and prepayment speeds. For purposes of evaluating and measuring impairment of capitalized servicing rights, the Company stratifies such assets based on the predominant risk characteristics of the underlying financial instruments that are expected to have the most impact on projected prepayments, cost of servicing, and other factors affecting future cash flows associated with the servicing rights. Such factors may include financial asset or loan type, note rate and term. The amount of impairment recognized is the amount by which the carrying value of the capitalized servicing rights for a stratum exceeds estimated fair value. Impairment is recognized through a valuation allowance. The determination of fair value of capitalized servicing rights is considered a Level 3 valuation.

 

 26 

 

Wells Financial Corp. and Subsidiary

 

Notes to Consolidated Financial Statements (Unaudited)

(Dollars in Thousands, Except Per Share Data)

 

The following tables summarize assets and liabilities measured at fair value as of September 30, 2015 and December 31, 2014, segregated by the level of the valuation inputs within the fair value hierarchy utilized to measure fair value:

 

   September 30, 2015 
   Level 1   Level 2   Level 3   Total 
   Inputs   Inputs   Inputs   Fair Value 
Recurring:                    
Investment securities available for sale:                    
Residential mortgage-backed securities  $-   $22,381   $-   $22,381 
SBA pools   -    2,646    -    2,646 
Obligations of states and political subdivisions   -    10,343    -    10,343 
Government-sponsored enterprise equity securities   -    125    -    125 
Redeemable common stock   -    -    (2,257)   (2,257)
Nonrecurring:                    
Foreclosed real estate   -    -    1,975    1,975 
Collateral-dependent impaired loans   -    -    1,914    1,914 
Mortgage servicing rights   -    -    315    315 

 

   December 31, 2014 
   Level 1   Level 2   Level 3   Total 
   Inputs   Inputs   Inputs   Fair Value 
Recurring:                    
Investment securities available for sale:                    
Residential mortgage-backed securities  $-   $22,545   $-   $22,545 
SBA pools   -    1,832    -    1,832 
Obligations of states and political subdivisions   -    9,698    -    9,698 
Government-sponsored enterprise equity securities   -    102    -    102 
Redeemable common stock   -    -    (2,533)   (2,533)
Nonrecurring:                    
Foreclosed real estate   -    -    3,656    3,656 
Collateral-dependent impaired loans   -    -    3,002    3,002 
Mortgage servicing rights   -    -    646    646 

 

 27 

 

Wells Financial Corp. and Subsidiary

 

Notes to Consolidated Financial Statements (Unaudited)

(Dollars in Thousands, Except Per Share Data)

 

The following tables present additional quantitative information about the unobservable inputs used in the fair value measurement of mortgage servicing rights measured on a non-recurring basis that were categorized within Level 3 of the fair value hierarchy:

 

   Fair Value at
September 30,
2015
   Valuation Technique  Unobservable Input  Range 
   (in thousands)           
               
Mortgage servicing rights  $315   Discounted cash flows(1)  Prepayment PSA   157 – 335 
           Discount rate   8.50% – 9.25% 
           Maturity (months) WAM   37 – 325 
           Costs to service   $65 - $750 

 

   Fair Value at
December 31,
2014
   Valuation Technique  Unobservable Input  Range 
   (in thousands)           
               
Mortgage servicing rights  $646   Discounted cash flows(1)  Prepayment PSA   157- 335 
           Discount rate   8.50% – 9.25%
           Maturity (months) WAM   37- 325 
           Costs to service   $65 - $750 

 

(1) The estimated fair value on mortgage servicing rights is determined through a cash flow analysis performed at the loan level and is based on the objective attributes of the portfolio (i.e., note rate, loan amount, etc.) and industry assumptions used in the marketplace.

 

There was no change in the per share fair value of redeemable common stock, which is a recurring fair value measurements using significant unobservable inputs (Level 3), between December 31, 2014 and September 30, 2015.

 

For the three and nine months ended September 30, 2015 and 2014 there were no transfers in or out of Levels 1, 2, and 3.

 

ASC Topic 825 requires disclosure of the fair value of financial assets and financial liabilities, including those financial assets and financial liabilities that are not recognized at fair value on a recurring basis or nonrecurring basis. The methodologies for estimating the fair value of financial assets and financial liabilities that are recognized at fair value on a recurring or nonrecurring basis are discussed above.

 

 28 

 

Wells Financial Corp. and Subsidiary

 

Notes to Consolidated Financial Statements (Unaudited)

(Dollars in Thousands, Except Per Share Data)

 

The estimated fair values of the Company’s financial instruments are as follows:

 

      September 30,   December 31, 
      2015   2014 
   Level in
Fair
Value
  Carrying   Fair   Carrying   Fair 
   Hierarchy  Amount   Value   Amount   Value 
Financial assets:                       
Cash and cash equivalents  Level 1  $9,896   $9,896   $14,373   $14,373 
Certificates of deposit  Level 2   9,521    9,521    4,181    4,181 
Federal funds sold  Level 2   3,000    3,000    2,000    2,000 
Securities available for sale  Level 2   35,495    35,495    34,177    34,177 
Federal Home Loan Bank stock  Level 2   2,036    2,036    2,079    2,079 
Loans held for sale  Level 2   1,719    1,719    1,707    1,707 
Loans receivable, net  Level 2   197,336    201,241    182,050    183,219 
Accrued interest receivable  Level 2   1,252    1,252    834    834 
Mortgage servicing rights  Level 3   1,862    2,143    1,886    2,578 
Financial liabilities:                       
Deposits  Level 2   232,714    232,131    221,972    215,199 
Advances from borrowers for taxes and insurance   Level 2   3,639    3,639    2,630    2,630 
Accrued interest payable  Level 2   83    83    17    17 
Redeemable common stock  Level 3   2,257    2,257    2,533    2,533 

 

Note 11. Business Combination

 

Effective July 16, 2015, the Company completed its previously reported acquisition of St. James Federal Savings and Loan Association, St. James, Minnesota (St. James), in a conversion merger transaction. As a result of the conversion merger transaction, St. James converted from a mutual to stock institution and merged with and into the Bank, with the Bank as the surviving institution. The Company acquired 100% of the voting shares of St. James. The Company issued and sold 78,736 shares of common stock at a price of $27.36 per share, which reflected a 5% discount on the 30 day average price as prescribed in the merger agreement. The shares were offered to depositor and borrower members of St. James in a subscription offering and to stockholders of the Company and members of the general public in a community offering. The Company’s ESOP acquired 8%, or 6,299 shares, of the newly issued shares using funds borrowed from the Company. The fair value of consideration paid to the prior depositors and borrowers of St. James was determined to approximate zero. Gross offering proceeds totaled approximately $2,154, including $172 purchased by the Company’s ESOP. As a result of the stock offering, the Company had 814,758 shares of common stock outstanding as of the close of business on July 16, 2015. St. James’ sole office, located in St. James, Minnesota, has become a branch office of the Bank. The Company’s primary reasons for the acquisition are to provide for asset growth, improve capital and competitive positions, and increase the limit on loans to one borrower.

 

 29 

 

Wells Financial Corp. and Subsidiary

 

Notes to Consolidated Financial Statements (Unaudited)

(Dollars in Thousands, Except Per Share Data)

 

Note 11. Business Combination (continued)

 

The Company has determined that the acquisition constitutes a business combination as defined by the Financial Accounting Standards Board (FASB) Accounting Standards Codification (ASC) Topic 805, Business Combinations. Accordingly, the assets acquired and liabilities assumed are presented at their estimated fair values as required by the guidance. Fair values were determined based on the requirements of ASC Topic 820, Fair Value Measurements.

 

The determination of these fair values required management to make estimates about discount rates, future expected cash flows, market conditions and other future events which are highly subjective in nature. The assets acquired and liabilities assumed in the transaction are presented at estimated fair value on the acquisition date.

 

The Company recorded the following assets and liabilities as of July 16, 2015. The discounts and premiums resulting from the fair value adjustments will be accreted or amortized over the anticipated lives of the underlying assets and liabilities. The excess fair value of assets acquired over liabilities assumed, resulted in a $2,848 bargain purchase gain. The merger resulted in a gain because of the legal and financial barriers that St. James would have incurred to convert to a stock form of ownership in a stand-alone transaction, including the related transaction costs associated with a conversion and stock issuance. The bargain purchase gain was recorded in non-interest income in the Company’s consolidated statements of income for the three and nine months ended September 30, 2015.

 

   July 16, 2015 
Recognized amounts of identifiable assets acquired and liabilities assumed     
Fair value of assets acquired     
Cash  $1,337 
Certificates of deposit   5,616 
Securities – available for sale   995 
Loans   17,506 
Premises and equipment   366 
Real estate owned   35 
Accrued interest and other assets   131 
Core deposit intangible   208 
Total assets acquired  $26,194 
      
Fair value of liabilities assumed     
Deposits  $23,043 
Deferred tax liability   238 
Accrued interest and other liabilities   65 
Total liabilities assumed  $23,346 
      
Net assets acquired  $2,848 

 

The fair value of the loan portfolio was estimated by performing a discounted cash flow analysis. The valuation was performed at the loan level on real estate loans and at the cohort level for all other loan types, and is based on the objective attributes of the loans in the portfolio (e.g., the rate of interest on the loan, the original term of the loan, the current term of the loan, etc.) and current statistical performance variables used in the market place.

 

 30 

 

Wells Financial Corp. and Subsidiary

 

Notes to Consolidated Financial Statements (Unaudited)

(Dollars in Thousands, Except Per Share Data)

 

Note 11. Business Combination (continued)

 

The analysis was based on the contractually specified amounts of principal and interest to be received modified by our estimates of prepayment, default and loss severity to be experienced prospectively. The prepayment, default and loss severity assumptions were applied at the loan level based on the characteristics of the loan.

 

The composition of the acquired loans at July 16, 2015 was as follows:

 

   Contractual
Amount
   Fair Value
Adjustments
   Fair Value 
Residential real estate  $6,480   $74   $6,554 
Revolving, open end residential real estate   336    (1)   335 
Agricultural real estate   5,437    57    5,494 
Agricultural operating and term   2,588    2    2,590 
Commercial real estate   1,262    2    1,264 
Automobile loans   721    (8)   713 
Other consumer   602    (46)   556 
Total  $17,426   $80   $17,506 

 

The Company estimates that $79 of the contractual amounts receivable for loans acquired will not be collected.

 

The following table presents pro forma financial information assuming the acquisition occurred on January 1, 2014:

 

   Three Months Ended
September 30,
   Nine Months Ended
September 30,
 
   2015   2014   2015   2014 
Revenues (interest and noninterest income)  $3,614   $3,403   $10,419   $9,547 
Net income  $542   $507   $1,641   $888 
Diluted net income per share  $0.66   $0.61   $1.96   $1.06 
Diluted weighted-average shares  $0.66   $0.61   $1.96   $1.06 

 

The bargain purchase gain is excluded from the pro forma table above.

 

To determine pro forma information, the Company adjusted its three and nine months ended September 30, 2015 and three and nine months ended September 30, 2014 historical results to include the historical results of St. James.

 

Stock issuance costs incurred totaled $1,147. The stock issuance costs were offset against the proceeds of the offering, which was recognized as paid-in capital.

 

Merger costs of $332 and $334 were expensed during the three and nine months ended September 30, 2015, respectively. Merger costs of $9 and $27 were expensed during the three and nine months ended September 30, 2014.

 

 31 

 

ITEM 2. MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS OF OPERATIONS

 

Forward-Looking Statements

 

The Company may from time to time make written or oral “forward-looking statements” including statements contained in this report and in other communications by the Company which are made in good faith pursuant to the “safe harbor” provisions of the Private Securities Litigation Reform Act of 1995. These forward-looking statements, such as statements of the Company’s plans, objectives, estimates and intentions, involve risks and uncertainties and are subject to change based on various important factors (some of which are beyond the Company’s control). The following factors, among others, could cause the Company’s financial performance to differ materially from the plans, objectives, expectations, estimates and intentions expressed in such forward-looking statements: the strength of the United States economy in general and the strength of the local economies in which the Company conducts operations; the effects of, and changes in, trade, monetary and fiscal policies and laws, including interest rate policies of the Board of Governors of the Federal Reserve System, inflation, interest rate, market and monetary fluctuations; the timely development of and acceptance of new products and services of the Company and the perceived overall value of the products and services by users, including the features, pricing and quality compared to competitor’s products and services; the willingness of users to substitute competitors’ products and services for the Company’s products and services; the success of the Company in gaining regulatory approval of its products and services, when required; the impact of changes in financial services’ laws and regulations (including laws concerning taxes, banking, securities and insurance); technological changes; acquisitions; changes in consumer spending and savings habits; and the success of the Company at managing the risks involved in the foregoing.

 

The Company cautions that the foregoing list of important factors is not exclusive. The Company does not undertake to update any forward-looking statement, whether written or oral, that may be made from time to time by or on behalf of the Company.

 

General

 

The Company’s primary source of income is the Bank’s net income. The Bank’s primary source of net income is its net interest income, which is determined by (i) the difference between yields earned on interest-earning assets and rates paid on interest-bearing liabilities (interest rate spread) and (ii) the relative amounts of interest-earning assets and interest-bearing liabilities. The Bank’s interest rate spread is affected by regulatory, economic, and competitive factors that influence interest rates, loan demand, and deposit flows. In order to maintain interest rate spread and reduce interest rate risk, management has elected to diversify the Bank’s loan portfolio by emphasizing its investment in agriculture and commercial mortgages, agricultural and commercial operating and term loans and consumer loans.

 

The Bank’s secondary sources of income are, primarily, the gain on sale of loans originated for sale and loan servicing fees. When comparing the first nine months of 2015 with the first nine months of 2014, a greater volume of loans were originated and sold to the secondary market.

 

The operations of the Bank and the entire banking industry are significantly affected by prevailing economic conditions, competition, and the monetary and fiscal policies of the federal government and governmental agencies. The demand for and supply of housing, competition among lenders, the level of interest rates, and the availability of funds influence lending activities. Deposit flows and costs of funds are influenced by prevailing market rates of interest, primarily on competing investments, account maturities, and the levels of personal income and savings in the Bank's market area.

 

 32 

 

Comparison of Financial Condition at September 30, 2015 and December 31, 2014

 

At September 30, 2015, total assets were $268.6 million, an increase of $16.8 million from $251.8 million at December 31, 2014. Increases in loans receivable and securities available for sale that were recorded in the acquisition of St. James Federal Savings and Loan Association (St. James) were the primary reasons for the increase in assets.

 

Securities available for sale increased from $34.2 million at December 31, 2014 to $35.5 million at September 30, 2015. Purchases of mortgage backed-securities and obligations of state and political subdivisions totaling $5,055,000 and $1,707,000, respectively, were only partially offset by the maturities and principal repayments totaling $5,380,000.

 

Loans held for sale stayed relatively constant at $1.7 million at December 31, 2014 and September 30, 2015. On December 31, 2014 and September 30, 2015, the Company had firm commitments to sell the loans that were classified as held for sale. Loans receivable increased by $15.3 million, or 8.4%, from $182.1 million at December 31, 2014 to $197.3 million at September 30, 2015. The increase in loans receivable resulted primarily from the $17.5 million in loans acquired in the conversion/merger with St. James.

 

In accordance with the Bank’s internal classification of assets policy, management evaluates the loan portfolio on a quarterly basis to identify and determine the adequacy of the allowance for loan losses. As of September 30, 2015 and December 31, 2014, the balance in the allowance for loan losses and the allowance for loan losses as a percentage of total loans was $2.1 million and $2.2 million and 1.1% and 1.2%, respectively.

 

Loans on which the accrual of interest had been discontinued amounted to $2.4 million and $1.0 million at September 30, 2015 and December 31, 2014, respectively. The Company considers all nonaccrual loans impaired. The amount of impaired loans at September 30, 2015 and December 31, 2014 was $3.6 million and $4.1 million, respectively and the related allowance for loan loss for these loans was $596,000 and $573,000, respectively.

 

Foreclosed real estate decreased to $2.0 million at September 30, 2015 from $3.7 million at December 31, 2014, as the Company disposed of eight properties during the nine months ended September 30, 2015. At September 30, 2015, foreclosed real estate consisted of two residential and six commercial properties.

 

Liabilities increased by $12.1 million, from $225.2 million at December 31, 2014 to $237.3 million at September 30, 2015 due, primarily, to the deposits that were assumed in the St. James conversion/merger.

 

Stockholders’ equity increased by $4.9 million from $24.1 million at December 31, 2014 to $29.0 million at September 30, 2015. The increase in stockholders’ equity resulted, primarily, from the retention of net income of $4,463,000, partially offset by payments of $412,000 in cash dividends and the purchase of $381,000 in treasury stock.

 

 33 

 

Comparison of Operating Results for the Three and Nine Months Ended September 30, 2015 and 2014

 

General. Net income increased by $2,902,000 and $3,598,000, or 560.2% and 416.0% for the three and nine months ended September 30, 2015, respectively, when compared to the same periods in 2014 due, primarily, to the bargain purchase gain of $2,848,000 that resulted from the conversion/merger with St. James. See Note 11 in the accompanying financial statements for additional information. Diluted earnings per share increased by $3.99 and $4.92 for the three and nine months ended September 30, 2015, respectively, when compared to the three and nine months ended September 30, 2014. Net interest income increased by $398,000 and $699,000, or 20.4% and 11.7%, in the three and nine months ended September 30, 2015, respectively, when compared to the same periods in 2014. When comparing the three and nine months ended September 30, 2015 to the same periods in 2014, the provision for loan loss decreased by $170,000 and $420,000, respectively, and noninterest income increased by $2,918,000 and $3,201,000, respectively. Increases in net interest income and noninterest income and the decrease in provision for loan loss were the primary reasons for the increase in earnings.

 

Interest Income. Interest income increased by $275,000 and $587,000, or 12.5% and 9.1%, for the three and nine months ended September 30, 2015 when compared to the three and nine months ended September 30, 2014. For the quarter ended September 30, 2015, interest income from both the loan and securities portfolios exceeded interest income from those portfolios for the same quarter in 2014. For the first nine months of 2015 an increase in interest income from loans receivable more than offset a decrease in interest income from investments. The changes in interest income from the loan portfolio and investment securities and other interest bearing deposits resulted, primarily, from changes in the average balances and yields on those interest earning assets. For the three months ended September 30, 2015, the average balance of loans receivable increased $19.6 million, or 11.3%, and the yield increased by eight basis points when compared to the same period in 2014. For the same period, average investments increased by $485,000, or 0.1%, and the yield increased by four basis points. For the nine months ended September 30, 2015 the average balance of loans receivable decreased $2.4 million, or 1.4%, and the yield increased by one basis point. Average investments decreased $5.2 million, or 8.5%, and the yield on investments increased by one basis point. As a result of the increase in loans as a percentage of earning assets, however, the yield on interest-earning assets increased by 13 basis points between the nine-month periods.

 

Interest Expense. Interest expense on deposits decreased by $23,000 and $212,000, or 15.5% and 37.7%, for the three and nine months, respectively ended September 30, 2015 when compared to the three and nine months ended September 30, 2014. These changes resulted from changes in the average balances and interest rates. Although average interest-bearing liabilities increased $17.9 million, or 8.3%, to $233.9 million for the three months ended September 30, 2015 compared to $216.0 million for the three months ended September 30, 2014, the average cost of interest-bearing liabilities decreased 6 basis points to 0.21% for the three months ended September 30, 2015 compared to 0.27% for the three months ended September 30, 2014. Although average interest-bearing liabilities increased $9.8 million to $225.5 million for the nine months ended September 30, 2015, compared to $215.7 million for the nine months ended September 30, 2014, the average cost of interest-bearing liabilities decreased 7 basis points to 0.21% for the nine months ended September 30, 2015 from 0.28% for the nine months ended September 30, 2014, reflecting the continued low interest rate environment.

 

Net Interest Income. Net interest income increased by $398,000 and $699,000, or 20.4% and 11.7%, for the three and nine months ended September 30, 2015, respectively, when compared to the same periods in 2014, due to the changes in interest income and interest expense described above. For the three months ended September 30, 2015, the interest rate spread increased by 20 basis points to 3.74% compared to 3.54% for the three months ended September 30, 2014 as a result of a 14 basis point increase in the average yield of interest-bearing assets to 3.95% for the three months ended September 30, 2015 from 3.81% for the three months ended September 30, 2014 and a six basis point decrease in the average cost on interest-bearing liabilities to 0.21% for the three months ended September 30, 2015 from 0.27% for the three months ended September 30, 2014. The Company’s net interest margin improved 19 basis points to 3.75% for the three months ended September 30, 2015 compared to 3.56% for the three months ended September 30, 2014. The Company’s interest rate spread increased by 20 basis points to 3.67% for the nine months ended September 30, 2015, compared to 3.47% for the nine months ended September 30, 2014 as the result of a 13 basis point increase in the average yield on interest-earning assets to 3.88% in the nine months ended September 30, 2015 from 3.75% in the nine months ended September 30, 2014 and a 7 basis point decrease in the average cost of interest-bearing liabilities to 0.21% in the nine months ended September 30, 2015

 

 34 

 

from 0.28% in the nine months ended September 30, 2014. The Company’s net interest margin improved 21 basis points to 3.69% for the nine months ended September 30, 2015 compared to 3.48% for the nine months ended September 30, 2014.

 

Provision for Loan Losses. The provision for loan loss decreased by $170,000 and $420,000 for the three and nine months ended September 30, 2015 when compared to the same periods in 2014. The provision reflects management’s monitoring of the allowance for loan losses in relation to the size and quality of the loan portfolio and adjusts the provision for loan losses to adequately provide for loan losses. Due to changes in economic conditions and changes in the composition of the loan portfolio, it is possible that the provision for loan losses may increase in future periods.

 

Noninterest Income. Noninterest income increased by $2,948,000 and $3,140,000 for the three and nine months ended September 30, 2015 when compared to the same periods in 2014 due, primarily, to the bargain purchase gain of $2,848,000 that resulted from the conversion/merger with St. James. See Note 11 in the accompanying financial statements for additional information. Increases in the gain on sale of loans held for sale also contributed to the increase in noninterest income. During the first nine months of 2015, a higher volume of loans were originated and sold to the secondary market than during the first nine months of 2014.

 

Noninterest Expense. Noninterest expense increased by $258,000 and decreased by $11,000, or 11.4% and 0.2%, for the three and nine months ended September 30, 2015 when compared to the three and nine months ended September 30, 2014 due, primarily, to increases in expenses related to other real estate owned during the three-month period and decreases in compensation and benefits and other expenses during the nine month period.

 

Income Tax Expense. Income tax expense increased by $256,000 and $672,000, or 278.3% and 208.0%, for the three months and nine months ended September 30, 2015 when compared to the same periods in 2014 due to the increase in income before income taxes. Income tax expense as a percent of income before taxes was 9.2% and 15.1% for the three months ended September 30, 2015 and 2014, respectively, and 18.2% and 27.2% for the nine months ended September 30, 2015 and 2014, respectively. The difference in income tax as percentage of income before taxes is due, primarily, to the non-taxable nature of the bargain purchase gain that was realized in the third quarter of 2015.

 

 35 

 

Average Balances and Yields

 

The following table sets forth average balance sheets, average yields and costs, and certain other information at the date and for the periods indicated. All average balances are based on daily averages, unless otherwise noted. The yields set forth below include the effect of deferred fees, discounts and premiums that are amortized or accreted to interest income or expense.

 

   Nine Months Ended September 30, 
   2015   2014 
   Average
Balance
   Interest   Average
Yield/Cost
   Average
Balance
   Interest   Average
Yield/Cost
 
   (Dollars in thousands) 
Interest earning assets:                              
Loans receivable (1)  $186,436   $6,530    4.67%  $168,853   $5,903    4.66%
Investments (2)   55,467    508    1.22%   60,652    548    1.21%
Total interest-earning assets   241,903    7,038    3.88%   229,505    6,451    3.75%
Non interest-earning assets   15,869              16,519           
Total assets  $257,772             $246,024           
                               
Interest-bearing liabilities:                              
Savings, NOW and money
market accounts (3)
  $159,846   $54    0.05%  $141,616   $48    0.04%
Certificates of deposit   65,638    296    0.60%   74,056    414    0.75%
Total interest-bearing liabilities   225,484    350    0.21%   215,672    462    0.28%
                               
Non interest-bearing liabilities   4,321              3,965           
Total liabilities   206,071              219,637           
Equity (4)   27,967              26,387           
Total liabilities and equity  $230,917             $246,024           
Net interest income       $6,688             $5,989      
Interest rate spread (5)             3.67%             3.47%
Net interest margin (6)             3.69%             3.48%
Ratio of average interest earning assets
to average interest bearing liabilities
   1.07 X             1.06X          

 

(1)Average balances include non-accrual loans and loans held for sale.
(2)Includes interest-bearing deposits in other financial institutions.
(3)Includes $4,957,000 and $5,288,000 in non-interest-bearing deposits for the nine months ended September 30, 2015 and 2014, respectively.
(4)Consists of stockholders’ equity and mezzanine equity.
(5)Interest-rate spread represents the difference between the average yield on interest-earning assets and the average cost of interest-bearing liabilities.
(6)Net interest margin represents net interest income as a percentage of average interest-earning assets.

 

 36 

 

   Three Months Ended September 30, 
   2015   2014 
   Average
Balance
   Interest   Average
Yield/Cost
   Average
Balance
   Interest   Average
Yield/Cost
 
   (Dollars in thousands) 
Interest earning assets:                              
Loans receivable (1)  $193,189   $2,293    4.75%  $173,575   $2,026    4.67%
Investments (2)   58,076    185    1.27%   57,591    177    1.23%
Total interest-earning assets   251,265    2,478    3.95%   231,166    2,203    3.81%
Non interest-earning assets   16,702              15,225           
Total assets  $267,967             $246,391           
                               
Interest-bearing liabilities:                              
Savings, NOW and money
market accounts (3)
  $167,012   $20    0.05%  $143,539   $16    0.05%
Certificates of deposit   66,926    105    0.63%   72,499    132    0.73%
Total interest-bearing liabilities   233,938    125    0.21%   216,038    148    0.27%
                               
Non interest-bearing liabilities   4,557              3,850           
Total liabilities   238,495              219,888           
Equity (4)   29,472              26,503           
Total liabilities and equity  $264,912             $246,391           
Net interest income       $2,353             $2,055      
Interest rate spread (5)             3.74%             3.54%
Net interest margin (6)             3.75%             3.56%
Ratio of average interest earning assets
to average interest bearing liabilities
   1.07X             1.07X          

 

(1)Average balances include non-accrual loans and loans held for sale.
(2)Includes interest-bearing deposits in other financial institutions.
(3)Includes $5,880,000 and $4,091,000 in non-interest-bearing deposits for the three months ended September 30, 2015 and 2014, respectively.
(4)Consists of stockholders’ equity and mezzanine equity.
(5)Interest-rate spread represents the difference between the average yield on interest-earning assets and the average cost of interest-bearing liabilities.
(6)Net interest margin represents net interest income as a percentage of average interest-earning assets.

 

 37 

 

Liquidity and Capital Resources

 

The Bank’s primary sources of funds are deposits, amortization and prepayment of loans, maturities of investment securities and funds provided from operations. While scheduled loan repayments are a relatively predictable source of funds, deposit flows and loan prepayments are significantly influenced by general interest rates, economic conditions and competition. If needed, the Bank’s primary source of funds can be supplemented by wholesale funds obtained through additional advances from the Federal Home Loan Bank system. The Bank invests excess funds in overnight deposits, which not only serve as liquidity, but also earn interest income until funds are needed to meet required loan funding.

 

The Bank’s most liquid asset is cash, including investments in interest bearing accounts at the United Bankers Bank and the FHLB of Des Moines that have no withdrawal restrictions. The levels of these assets are dependent on the Bank’s operating, financing and investing activities during any given period. At September 30, 2015, the Bank’s noninterest bearing cash was $4.5 million. In addition, at September 30, 2015, the Bank had $10.3 million and $10.6 million invested in interest bearing accounts at the United Bankers Bank and the FHLB of Des Moines, respectively.

 

At September 30, 2015, the Bank had no outstanding advances from the FHLB of Des Moines. At September 30, 2015, the Bank had the ability to borrow up to $67.8 million based upon the pledged collateral. The Bank has the option of pledging additional collateral which will increase the amount available to borrow.

 

The Bank is required to maintain specified amounts of capital. The capital standards generally require the maintenance of regulatory capital sufficient to meet a common equity Tier 1 requirement, a leverage capital requirement and a risk-based capital requirement. At September 30, 2015, the Bank’s Tier 1 leverage capital totaled $28.2 million, or 10.37% of adjusted total assets, which substantially exceeded the 4.0% Tier 1 leverage capital requirement at that date by $17.3 million, or 6.87% of adjusted total assets. The Bank’s common equity Tier 1 and total risk-based capital totaled $28.2 million, and $30.4 million at September 30, 2015 or 11.37%, and 12.24% of risk-weighted assets, respectively, which exceeded the current requirements of 4.5% and 8.0% of risk-weighted assets by $17.0 million and $10.5 million or 6.37% and 4.24% of risk-weighted assets, respectively. The Bank will be subject to higher capital requirements in the future as capital conservation buffer rules become fully effective from 2016 through 2019.

 

The reconciliation of the equity of Wells Federal Bank to each major category of regulatory capital is as follows:

 

   At
September 30,
   At
December 31,
 
   2015   2014 
   (In thousands) 
         
Equity under generally accepted accounting principles  $28,516   $25,662 
Unrealized (gains) losses on available for sale securities   (170)   (93)
Disallowed intangible assets   (125)   - 
Disallowed servicing assets   -    (189)
Tier 1 capital   28,221    25,380 
Allowance for loan losses included in Tier 2 capital   2,125    2,158 
Unrealized gains on available for sale equity securities   38    28 
Total risk-based capital  $30,384   $27,566 

 

 38 

 

Off-Balance Sheet Arrangements

 

As a financial services provider, we routinely are a party to various financial instruments with off-balance-sheet risks in the normal course of business to meet the financing needs of our customers. These financial instruments include primarily commitments to extend credit. Those instruments involve, to varying degrees, elements of credit risk and interest rate risk in excess of the amount recognized in the consolidated balance sheet.

 

The Company’s exposure to credit loss in the event of nonperformance by the other party to the financial instrument for commitments to extend credit, standby letters of credit, and financial guarantees written is represented by the contractual notional amount of those instruments. The Company uses the same credit policies in making commitments and conditional obligations as it does for on-balance-sheet instruments. For additional information, see Note 9 of the Notes to the Consolidated Financial Statements

 

Critical Accounting Policies

 

The consolidated financial statements include amounts that are based on informed judgments of management. These estimates and judgments are the result of management’s need to estimate the effect of matters that are inherently uncertain. Therefore, actual results could vary significantly from the estimates used. Management considers the following items to be the critical accounting estimates contained in the consolidated financial statements.

 

Allowance for Loan Loss. The allowance for loan loss is based on management’s periodic review of the loan portfolio. In evaluating the adequacy of the allowance for loan loss, management considers factors including, but not limited to, specific loan impairment, historical loss experience, the size and composition of the loan portfolio and current economic conditions. Although management believes that the allowance for loan loss is maintained at an adequate level, there can be no assurance that further additions will not be made to the allowance and that losses will not exceed the estimated amounts.

 

Available for Sale Securities. The fair value of equity securities is based on quoted market prices and the fair value of debt securities is generally determined based on matrix pricing utilizing yield curves, credit ratings and prepayment speeds. The Company believes the unrealized losses are temporary because the primary reason for the unrealized losses is changes in market interest rates from the date of purchase to the reporting date.

 

Mortgage Servicing Rights. Mortgage servicing rights are capitalized and then amortized over the period of estimated servicing income. Management periodically evaluates its capitalized mortgage servicing rights for impairment. The valuation of mortgage servicing rights is based on estimated prepayment speeds, ancillary income received from servicing the loans and current interest rates. Changes in these estimates may have a material effect on the valuation of the mortgage servicing rights. Although management believes that the estimates used to determine the value of the mortgage servicing rights are reasonable, future material adjustments may be necessary if economic conditions vary from those used to estimate the value of the mortgage servicing rights.

 

Foreclosed Real Estate. Foreclosed real estate is reported at the lower of cost or fair value, less estimated costs to sell. The Company monitors the net fair value of the property on a monthly basis, taking into consideration market and economic factors, including comparison to sales of like properties.

 

Loans acquired in business combination. Loans acquired as part of the conversion/merger with St. James were recognized at fair value as of the acquisition date. The fair value was estimated by performing a discounted cash flow analysis. The valuation was performed at the loan level on real estate loans and at the cohort level for all other loan types, and is based on the objective attributes of the loans in the portfolio and current statistical performance variables used in the market place. The analysis was based on the contractually specified amounts of principal and interest to be received modified by our estimates of prepayment, default and loss severity to be experienced prospectively.

 39 

 

ITEM 3. QUANTITATIVE AND QUALITATIVE DISCLOSURES ABOUT MARKET RISK

 

Not applicable as the Company is a smaller reporting company.

 

ITEM 4. CONTROLS AND PROCEDURES

 

Disclosure Controls and Procedures

 

Evaluation of disclosure controls and procedures. Based on their evaluation of the Company's disclosure controls and procedures (as defined in Rule 15a-15(e) under the Securities Exchange Act of 1934, (the "Exchange Act")), the Company's principal executive officer and principal financial officer have concluded that as of the end of the period covered by this Quarterly Report on Form 10-Q, such disclosure controls and procedures are effective to ensure that information required to be disclosed by the Company in reports that it files or submits under the Exchange Act is recorded, processed, summarized and reported within the required time periods specified in the SEC’s rules and forms.

 

Internal Controls

 

Changes in internal control over financial reporting. During the last quarter, there was no change in the Company's internal control over financial reporting that has materially affected, or is reasonably likely to materially affect, the Company's internal control over financial reporting.

 

PART II. OTHER INFORMATION

 

ITEM 1. LEGAL PROCEEDINGS

 

The Company was not a party to any material legal proceedings other than routine matters in the ordinary course of business.

 

ITEM 1A. RISK FACTORS

 

Not applicable as the Company is a smaller reporting company.

 

 40 

 

ITEM 2. UNREGISTERED SALES OF EQUITY SECURITIES AND USE OF PROCEEDS

 

(a)Unregistered Sales of Equity Securities. Not applicable.

 

(b)Use of Proceeds. Not applicable.

 

(c)Issuer Purchases of Equity Securities.

 

Period  (a) Total Number
Of Shares (or
Units) Purchased
   (b) Average Price
Paid per Share
(or Unit)
   (c) Total Number of
Shares (or Units)
Purchased as Part of
Publicly Announced
Plans or Programs
   (d) Maximum Number (or
Approximate Dollar Value)
of Shares (or Units) that
May Yet Be Purchased
Under the Plans or 
Programs
 
July 1 through 31, 2015   3,280   $30.25    -    - 
August 1 through 31, 2015   4,768   $24.50    -    - 
September 1 through 30, 2015   -    -    -    - 
Total   8,048   $26.84    -    - 

 

ITEM 3. DEFAULTS UPON SENIOR SECURITIES

 

None.

 

ITEM 4. MINE SAFETY DISCLOSURES

 

Not applicable.

 

 41 

 

ITEM 5. OTHER INFORMATION

 

None.

 

ITEM 6. EXHIBITS

 

3.1 Articles of Incorporation of Wells Financial Corp. *
   
3.2 Bylaws of Wells Financial Corp. *
   
4 Form of Common Stock Certificate of Wells Financial Corp. *
   
31 Certification of CEO and CFO as required by Rule 15d-14(a).
   
32 Certification required by 18 U.S.C. §1350.
   
101.INS XBRL Instance Document **
   
101.SCH XBRL Schema Document **
   
101.CAL XBRL Calculation Linkbase Document **
   
101.LAB XBRL Labels Linkbase Document **
   
101.PRE XBRL Presentation Linkbase Document **
   
101.DEF XBRL Definition Linkbase Document **

 

* Incorporated by reference from identically numbered exhibit to Registration Statement on Form S-1 (File No. 333-202694).
   
** Submitted as Exhibits 101 to this Form 10-Q are documents formatted in XBRL (Extensible Business Reporting Language).

 

 42 

 

SIGNATURES

 

Pursuant to the requirements of the Securities Exchange Act of 1934, the registrant has duly caused this report to be signed on its behalf by the undersigned thereunto duly authorized.

 

  WELLS FINANCIAL CORP.
   
Date: November 16, 2015 /s/ James D. Moll
  James D. Moll
  President and Chief Executive Officer
  Treasurer and Chief Financial Officer
  (Duly Authorized Officer and Principal Executive
and Financial Officer)

 

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