OTTAWA BANCORP, INC.

 

Form 10-K for Fiscal Year Ended

 

December 31, 2019

 

TABLE OF CONTENTS

 

		Page
PART I
Item 1.	Business	1
Item 1A.	Risk Factors	24
Item 1B.	Unresolved Staff Comments	30
Item 2.	Properties	30
Item 3.	Legal Proceedings	31
Item 4.	Mine Safety Disclosures	31
PART II
Item 5.	Market for Registrant’s Common Equity, Related Stockholder Matters and Issuer Purchases of Equity Securities	31
Item 6.	Selected Financial Data	32
Item 7.	Management’s Discussion and Analysis of Financial Condition and Results of Operations	34
Item 7A.	Quantitative and Qualitative Disclosures About Market Risk	44
Item 8.	Financial Statements and Supplementary Data	44
Item 9.	Changes in and Disagreements with Accountants on Accounting and Financial Disclosure	44
Item 9A.	Controls and Procedures	44
Item 9B.	Other Information	44
PART III
Item 10.	Directors, Executive Officers and Corporate Governance	45
Item 11.	Executive Compensation	45
Item 12.	Security Ownership of Certain Beneficial Owners and Management and Related Stockholder Matters	45
Item 13.	Certain Relationships and Related Transactions, and Director Independence	45
Item 14.	Principal Accounting Fees and Services	45
PART IV
Item 15.	Exhibits and Financial Statement Schedules	46
Item 16.	Form 10-K Summary	47
INDEX TO FINANCIAL STATEMENTS		F-1
SIGNATURES		S-1

 

 

PART I

  Forward-Looking Statements

 

Statements contained in this report that are not historical facts may constitute forward-looking statements (within the meaning of Section 21E of the Securities Exchange Act of 1934, as amended), which involve significant risks and uncertainties. The Company intends such forward-looking statements to be covered by the safe harbor provisions for forward-looking statements contained in the Private Securities Litigation Reform Act of 1995 and is including this statement for purposes of invoking these safe harbor provisions. Forward-looking statements, which are based on certain assumptions and describe future plans, strategies and expectations of the Company, are generally identifiable by the use of the words “believe,” “expect,” “intend,” “anticipate,” “estimate,” “project,” “plan,” or similar expressions. The Company’s ability to predict results or the actual effect of future plans or strategies is inherently uncertain and actual results may differ from those predicted. The Company undertakes no obligation to update these forward-looking statements in the future. The Company cautions readers of this report that a number of important factors could cause the Company’s actual results subsequent to December 31, 2019 to differ materially from those expressed in forward-looking statements. Factors that could cause actual results to differ from those predicted and could affect the future prospects of the Company include, but are not limited to, fluctuations in market rates of interest and loan and deposit pricing, changes in the securities or financial market, a deterioration of general economic conditions either nationally or locally, the outbreak of the coronavirus or other highly infectious or contagious disease,our ability to realize estimated benefits (including, but not limited to, cost savings, synergies and growth) from acquired or merged entities, our ability to successfully integrate acquired or merged entities with us, legislative or regulatory changes that adversely affect our business, adverse developments or changes in the composition of our loan or investment portfolios, significant increases in competition, changes in real estate values, difficulties in identifying attractive acquisition opportunities or strategic partners to complement our Company’s approach and the products and services the Company offers, the possible dilutive effect of potential acquisitions or expansion, and our ability to raise new capital as needed and the timing, amount and type of such capital raises. The consequence of these factors, many of which could hurt our business, could include, among other things, increased loan delinquencies, an escalation in problem assets and foreclosures, a decline in demand for our products and services, a reduction in the value of certain assets held by us, an inability to meet our liquidity needs and an inability to engage in certain lines of business. These risks and uncertainties should be considered in evaluating forward-looking statements. Except to the extent required by applicable law or regulation the Company does not undertake any obligation to update any forward-looking statement to reflect circumstances or events that occur after the date the forward-looking statements are made. See also “Item 1A. Risk Factors” and other risk factors discussed elsewhere in this Annual Report.

 

ITEM 1.

BUSINESS

 

General

 

Ottawa Bancorp, Inc. (the “Company”) is a Maryland corporation that was incorporated in May 2016 to be the successor to Ottawa Savings Bancorp, Inc. (“Ottawa Savings Bancorp”) upon completion of the second-step conversion of Ottawa Savings Bank (the “Bank”) from the two-tier mutual holding company structure to the stock holding company structure. Ottawa Savings Bancorp MHC was the former mutual holding company for Ottawa Savings Bancorp prior to completion of the second-step conversion. In conjunction with the second-step conversion, Ottawa Savings Bancorp MHC merged into Ottawa Savings Bancorp (and ceased to exist), and Ottawa Savings Bancorp merged into the Company, with the Company as the surviving entity and unitary savings and loan holding company for Ottawa Savings Bank, a federally chartered savings bank. The second-step conversion was completed on October 11, 2016, at which time the Company sold, for gross proceeds of $23.8 million, a total of 2,383,950 shares of common stock at $10.00 per share, including 190,716 shares purchased by the Bank’s employee stock ownership plan. Capital increased an additional $126,000 due to cash contributed by Ottawa Savings Bancorp MHC upon merging into Ottawa Savings Bancorp, Inc. Also as part of the second-step conversion, treasury shares held by Ottawa Savings Bancorp were retired and each of the existing outstanding shares of Ottawa Savings Bancorp common stock owned by persons other than Ottawa Savings Bancorp MHC was converted into 1.1921 of a share of Company common stock. The Company is a publicly traded banking company with assets of $300.5 million at December 31, 2019 and is headquartered in Ottawa, Illinois.

 

 Our business activities are primarily conducted through Ottawa Savings Bank, headquartered in Ottawa, Illinois, which is located in north-central Illinois approximately 80 miles southwest of Chicago. Ottawa Savings Bank conducts business from its main office in Ottawa and through its branch offices located in Marseilles and Morris, Illinois and loan production offices located in Shorewood, LaSalle and Sandwich Illinois. Ottawa Savings Bank’s market area includes LaSalle County, Grundy County and parts of contiguous counties in Illinois. On December 31, 2014, Ottawa Savings Bancorp acquired Twin Oaks Savings Bank (“Twin Oaks”) and merged Twin Oaks with and into Ottawa Savings Bank, which facilitated Ottawa Savings Bank’s expansion into Grundy County.

 

 

Ottawa Savings Bank’s principal business consists of originating one-to-four family residential real estate mortgage loans and home equity lines of credit, and to a lesser extent, non-residential real estate, multi-family and construction loans. We also offer commercial and industrial loans and other consumer loans. We offer a variety of retail deposits to the general public in the areas surrounding our main office and our branch offices. We offer our customers a variety of deposit products with interest rates that are competitive with those of similar products offered by other financial institutions in our market area. Our revenues are derived primarily from interest on loans and, to a lesser extent, interest on investment securities and mortgage-backed securities. We also generate revenues from other income including realized gains on sales of loans associated with loan production, deposit fees and service charges, realized gains on sales of other real estate owned, realized gains on sales of securities and loan fees.

 

Business Strategy

 

The Company’s business strategy is to operate as a well-capitalized and profitable community savings bank dedicated to providing high quality customer service and innovative new products. Highlights of our business strategy are as follows:

 

●

Continue to emphasize the origination of one-to four-family mortgage loans, including investor-owned (e.g., non-owner occupied) one-to-four family mortgage loans;

●

Aggressively market core deposits;

●

Offer a broad range of financial products and services to both retail and commercial customers in our market area;

●

Pursue opportunities to increase non-residential real estate lending, which we consider to be comprised of commercial real estate, land and multi-family loans in our market area;

●

Continue to utilize conservative underwriting guidelines to limit credit risk in our loan portfolio to achieve a high level of asset quality; and

●

Consider judicious expansion into new market areas to grow our business through the addition of new branch locations and/or through possible acquisitions.

 

 Market Area and Competition

 

          The Company is headquartered in Ottawa, Illinois, which is located in north-central Illinois approximately 80 miles southwest of Chicago. Its market area, which benefits from its proximity to Chicago, includes LaSalle County, Grundy County and parts of contiguous counties.

 

The Bank faces significant competition for the attraction of deposits and origination of loans. Our most direct competition for deposits and loans has historically come from the several financial institutions operating in our market area, including a number of independent banks, and, to a lesser extent, from other financial service companies, such as brokerage firms, credit unions, mortgage companies and mortgage brokers. In addition, the Bank faces competition for investors’ funds from money market funds and other corporate and government securities. Competition for loans also comes from the increasing number of non-depository financial service companies entering the mortgage and consumer credit market, such as securities companies and specialty finance companies. The Bank believes that its long-standing presence in Ottawa, Illinois, its expansion into Grundy County as a result of the Twin Oaks acquisition, and its personal service philosophy enhance its ability to compete favorably in attracting and retaining individual and business customers. The Company actively solicits deposit-related customers and competes for deposits by offering customers personal attention, professional service and competitive interest rates.

 

Lending Activities

 

          General. Our loan portfolio consists primarily of one-to-four family residential mortgage loans. To a lesser extent, our loan portfolio includes multi-family and non-residential real estate, commercial, construction and consumer loans. Excluding our purchased loan portfolio and except as noted below, the majority of our loans are made within our local market. However, on occasion we originate loans to borrowers outside our market area. At December 31, 2019, loans made to borrowers outside our market area totaled $34.1 million, or 13.8% of our total loan portfolio.

 

 

          Loan Portfolio Composition. The following table sets forth the composition of our loan portfolio by type of loan as of the dates indicated, including a reconciliation of gross loans receivable after consideration of the allowance for loan losses.

 

		At December 31,
		2019								2018								2017								2016								2015
		(Dollars in Thousands)
						Percent								Percent								Percent								Percent								Percent
		Amount				Of Total				Amount				Of Total				Amount				Of Total				Amount				Of Total				Amount				Of Total
One-to-four family		$	155,143				61.88	%		$	141,780				59.43	%		$	124,118				59.24	%		$	103,872				63.80	%		$	99,255				69.73	%
Multi-family			5,861				2.34	%			6,776				2.84	%			5,664				2.70	%			5,182				3.18	%			3,970				2.79	%
Non-residential			30,680				12.24	%			35,286				14.79	%			32,133				15.34	%			22,560				13.85	%			20,177				14.18	%
Commercial			23,915				9.54	%			17,242				7.23	%			20,759				9.91	%			16,645				10.22	%			12,069				8.48	%
Consumer direct			20,563				8.20	%			15,390				6.45	%			6,282				3.00	%			2,860				1.76	%			1,651				1.16	%
Purchased auto			14,551				5.80	%			22,080				9.26	%			20,551				9.81	%			11,714				7.19	%			5,212				3.66	%
Total loans, gross			250,713				100.00	%			238,554				100.00	%			209,507				100.00	%			162,833				100.00	%			142,334				100.00	%
Allowance for loan losses			(2,937	)							(2,628	)							(2,472	)							(2,247	)							(2,224	)
Total loans, net		$	247,776							$	235,926							$	207,035							$	160,586							$	140,110

 

 Listed below are the outstanding balances of purchased loans, which have been included in the table above.

 

		At December 31,
		2019				2018				2017				2016				2015
		(In Thousands)
One-to-four family		$	-			$	-			$	-			$	-			$	1,978
Multi-family			549				566				582				599				-
Non-residential			983				3,983				3,060				1,148				711
Commercial			3,387				3,574				6,750				4,814				2,922
Purchased auto loans			14,551				22,080				20,551				11,714				5,212
Total		$	19,470			$	30,203			$	30,943			$	18,275			$	10,823

 

 

          Maturity of Loan Portfolio. The following tables show the remaining contractual maturity of our loans at December 31, 2019. The tables do not include the effect of possible prepayments or due on sale clause payments.

 

		At December 31, 2019
		One-to-								Non-
		four								residential								Consumer				Purchased
		Family				Multi-family				real estate				Commercial				direct				auto				Total
		(In Thousands)
Amounts due one year or less		$	15,234			$	-			$	3,195			$	6,656			$	88			$	131			$	25,304
After one year
More than one year to three years			3,194				562				2,504				10,773				5,304				9,011				31,348
More than three years to five years			2,435				759				944				1,948				12,873				5,409				24,368
More than five years to ten years			7,275				288				6,047				3,305				2,151				-				19,066
More than ten years to twenty years			48,800				2,019				14,918				-				147				-				65,884
More than twenty years			78,205				2,233				3,072				1,233				-				-				84,743
Total due after December 31, 2020			139,909				5,861				27,485				17,259				20,475				14,420				225,409
Gross loans receivable		$	155,143			$	5,861			$	30,680			$	23,915			$	20,563			$	14,551			$	250,713
Less:
Allowance for loan losses																											2,937
Total loans, net																										$	247,776

 

		Due After December 31, 2020
		Fixed				Adjustable				Total
		(In Thousands)
One-to-four family		$	65,118			$	74,791			$	139,909
Multi-family			1,194				4,667				5,861
Non-residential			11,359				16,126				27,485
Commercial			12,508				4,751				17,259
Consumer direct			20,475				-				20,475
Purchased auto			14,420				-				14,420
Total		$	125,074			$	100,335			$	225,409

 

 

          Asset Quality. Within our investment portfolio we have no subprime or Alt-A backed instruments among our securities. Historically, our lending activity has promoted home ownership in the communities we serve. Our consumer and residential mortgage loans are originated consistent with the underwriting approach described herein. This includes an assessment of each borrower’s personal financial condition, including a review of credit reports and related FICO scores as well as verification of income and assets. The Company does not conduct lending programs that target the subprime market. During the ordinary course of business to achieve our goal of being a community bank, we originate and manage loans in our portfolio to some borrowers with a risk of default higher than customers considered prime. Thus, an extended economic downturn may affect us indirectly, albeit to a lesser extent than it would likely impact those banks and thrifts that produce and retain significant portfolios that target such loans and securities. While we believe that the nature of our one-to-four family lending niche and our underwriting standards would limit the impact of the downward turn in the credit cycle on the quality of our assets—particularly in comparison with those institutions that directly target subprime and Alt-A lending—another downturn in the credit cycle could result in our experiencing higher levels of charge-offs and/or provisions for loan losses, which might impact our results of operations.

 

          One- to-Four Family Residential Loans. Our primary lending activity is the origination of mortgage loans to enable borrowers to purchase or refinance existing homes or to construct new residential dwellings in our market area. We offer fixed-rate and adjustable-rate mortgage loans with terms up to 30 years. Borrower demand for adjustable-rate loans versus fixed-rate loans is a function of the level of interest rates, the expectations of changes in the level of interest rates, the difference between the interest rates and loan fees offered for fixed-rate mortgage loans and the initial period interest rates and loan fees for adjustable-rate loans. The relative amount of fixed-rate mortgage loans and adjustable-rate mortgage loans that can be originated or purchased at any time is largely determined by the demand for each in a competitive environment and the effect each has on our interest rate risk. The loan fees charged, interest rates, and other provisions of mortgage loans are determined by us on the basis of our own pricing criteria and competitive market conditions.

 

We offer fixed rate loans with terms of either 15, 20 or up to 30 years. We traditionally sell 30-year fixed rate loans into the secondary market, resulting in a fixed rate loan portfolio primarily composed of loans with less than 15 to 20 year terms, however, 30 year loans may be retained. Our adjustable-rate mortgage loans are based on either a 15, 20 or up to 30-year amortization schedule and interest rates and payments on our adjustable-rate mortgage loans adjust every one, three, five or seven years. Interest rates and payments on our adjustable-rate loans generally are adjusted to a rate that is based on the respective one, three, and five year monthly Constant Maturity Treasury indices. The maximum amount by which the interest rate may be increased or decreased is generally 1% to 2% per adjustment period, depending on the type of loan, and the lifetime interest rate ceiling is generally 5% over the initial interest rate of the loan. The initial and floor rates for owner occupied properties range from are 2.675% to 4.625% for the one, three, five and seven-year adjustable rate loans for non-owner occupied one-to-four family properties, respectively, at this time.

 

Due to historically low interest rate levels, borrowers generally have preferred fixed-rate loans in recent years. While we anticipate that our adjustable-rate loans will better offset the adverse effects on our net interest income of an increase in interest rates as compared to fixed-rate mortgages, the increased mortgage payments required of adjustable-rate loans in a rising interest rate environment could cause an increase in delinquencies and defaults. The marketability of the underlying property also may be adversely affected in a high interest rate environment. In addition, although adjustable-rate mortgage loans help make our asset base more responsive to changes in interest rates, the extent of this interest rate sensitivity is limited by the annual and lifetime interest rate adjustment limits.

 

While one-to-four family residential real estate loans are normally originated with up to 30-year terms, such loans typically remain outstanding for substantially shorter periods because borrowers often prepay their loans in full upon sale of the property pledged as security or upon refinancing the original loan. Therefore, average loan maturity is a function of, among other factors, the level of purchase and sale activity in the real estate market, prevailing interest rates and the interest rates payable on outstanding loans.

 

We also regularly make loans secured by non-owner occupied one-to-four family residential properties. Loans secured by non-owner occupied properties generally expose a lender to greater risk of non-payment and loss than loans secured by owner occupied properties because repayment of such loans depend primarily on the tenant’s continuing ability to pay rent to the property owner, who is our borrower, or, if the property owner is unable to find a tenant, the property owner’s ability to repay the loan without the benefit of a rental income stream. In addition, the physical condition of non-owner occupied properties is often below that of owner occupied properties due to lax property maintenance standards, which has a negative impact on the value of the collateral properties. In reaching a decision on whether to originate a non-owner occupied one-to-four family residential real estate loan, we consider the net operating income of the property, the borrower’s credit history and profitability, and the value of the underlying property. At December 31, 2019, loans secured by non-owner occupied one-to-four family properties totaled $29.2 million, or 18.8% of our total one-to-four family residential loan portfolio.

 

We generally do not make conventional loans with loan-to-value ratios exceeding 80%. Loans with loan-to-value ratios in excess of 80% generally require private mortgage insurance, government guarantee or additional collateral. We require all properties securing mortgage loans to be appraised by an independent appraiser approved by our Board of Directors and licensed by the State of Illinois. We require title insurance on all first mortgage loans. Borrowers must obtain hazard insurance, or flood insurance for loans on property located in a flood zone, before closing the loan.

 

 

Our largest one-to-four family residential loan at December 31, 2019 was a loan for $3.5 million that is secured by multiple one-to-four family and condominium units, of which $3.2 million is outstanding. This loan is performing in accordance with its terms.

 

We participate with the USDA Rural Development Company to offer loans to qualifying customers. Loans are granted up to 100% of appraised value and the USDA guarantees up to 90% of the loan. These loans require no down payment but are subject to maximum income limitations.

 

 Residential and Commercial Construction Loans. On occasion we originate (i) residential construction loans to individuals and purchase loans that finance the construction of residential dwellings for personal use, which we classify within our one-to-four family loan portfolio, and (ii) commercial construction loans for the development of projects including condominiums, apartment buildings, single-family subdivisions, single-family investor loans, as well as owner-occupied properties used for business, which we classify within our loan portfolio based on the type of property under construction.

 

Our residential construction loans generally provide for the payment of interest only during the construction phase, which is usually twelve months. At the end of the construction phase, substantially all of our loans automatically convert to permanent mortgage loans. Construction loans generally can be made with a maximum loan to value ratio of 80% or up to 95% with private mortgage insurance of the appraised value with maximum terms of 30 years. We also require periodic inspections of the property during the term of the construction. At December 31, 2019, our largest outstanding residential construction loan was for $1.2 million, of which $0.4 million was disbursed.

 

Our commercial construction loans provide for payment of interest only during the construction phase and may, in the case of an apartment or commercial building, convert to a permanent mortgage loan upon the completion of construction. In the case of a single-family subdivision or construction or builder loan, as individual lots are sold, the principal balance is reduced by a minimum of 80% of the net lot sales price. In the case of a commercial construction loan, the construction period may be from nine months to two years. Loans are generally made to a maximum of 70% of the appraised value as determined by an appraisal of the property made by an independent licensed appraiser. We also require periodic inspections of the property during the term of the construction loan. At December 31, 2019, our largest outstanding commercial construction loan was for $1.7 million, all of which was disbursed.

 

Lines of Credit. We offer lines of credit, principally home equity lines of credit, which have adjustable rates of interest that are indexed to the prime rate as published in The Wall Street Journal for terms of up to 20 years. These loans are originated with maximum loan-to-value ratios of 80% of the appraised value of the property, and we require that we have a second lien position on the property if we do not have a first lien. We also offer secured and unsecured lines of credit for well-qualified individuals and small businesses. Management includes these loans based on the collateral supporting the line of credit in either the non-residential, multi-family, commercial or one-to-four family categories for the purposes of monitoring and evaluating the portfolio.  

 

Multi-Family and Non-Residential Real Estate Loans. We offer fixed rate and adjustable-rate mortgage loans secured by multi-family, non-residential real estate and agricultural real estate loans. Our loans in the category are generally secured by condominiums, apartment buildings, single-family subdivisions, owner-occupied properties used for businesses and agricultural land used for production.

 

We originate and purchase multi-family, non-residential real estate and agricultural loans with terms generally up to 30 years. Interest rates and payments on adjustable-rate loans adjust every one, three and five years. Interest rates and payments on our adjustable rate loans generally are adjusted to a rate typically equal to the interest rate used for one- to- four family loan products, plus 50 basis points to 100 basis points based on credit-worthiness and risk. Loan amounts generally do not exceed 80% of the appraised value for well-qualified borrowers.

 

We originate and purchase land loans to individuals on approved residential building lots for personal use for terms of up to 15 years and to a maximum loan to value ratio of 80% of the appraised value. Our land loans are adjustable rate loans with adjustments occurring every one, three and five years, based on the original contract. Interest rate adjustments are based on the CMT plus a spread.  For adjustable rate loans in this class, the loans generally have an interest rate floor.

 

Our largest non-residential real estate loan at December 31, 2019 was for $1.3 million, all of which is outstanding. This loan is performing in accordance with its terms. For adjustable rate loans in this category, there generally is an interest rate floor ranging from 3.75% to 6.00%.

 

 

Loans secured by multi-family and non-residential real estate generally have larger balances and involve a greater degree of risk than one-to-four family residential mortgage loans. Of primary concern in multi-family and non-residential real estate lending is the borrower’s credit-worthiness and the feasibility and cash flow potential of the project. Payments on loans secured by income producing properties often depend on successful operation and management of the properties. As a result, repayment of such loans may be subject, to a greater extent than residential real estate loans, to adverse conditions in the real estate market or the economy. In reaching a decision on whether to make a multi-family or non-residential real estate loan, we consider the net operating income of the property, the borrower’s expertise, credit history and profitability, and the value of the underlying property.

 

Commercial Business Loans. These loans consist of operating lines of credit secured by general business assets, equipment, inventory and crops. We loan primarily to businesses with less than $5,000,000 in annual revenues. The operating lines of credit are generally short term in nature with interest rates tied to short term rates and adjustments occurring daily, monthly, or quarterly based on the original contract. For adjustable loans, there is also an interest rate floor. The equipment loans are typically made with maturities of less than five years and are priced with a fixed interest rate. The Bank has originated commercial loans from Bankers Healthcare Group in prior years. Bankers Healthcare Group specializes in loans to healthcare professionals of all specialties throughout the United States. These loans are primarily comprised of working capital and equipment loans. We underwrite these loans based on our criteria and service the loans in-house.

 

Consumer Loans. We offer a variety of consumer loans, which include auto, share loans and personal unsecured loans to our customer base. Unsecured loans generally have a maximum borrowing limit of $25,000 and a maximum term of five years.

 

The procedures for underwriting consumer loans include an assessment of the applicant’s payment history on other debts and ability to meet existing obligations and payments on the proposed loans. Although the applicant’s credit-worthiness is a primary consideration, the underwriting process also includes a comparison of the value of the collateral, if any, to the proposed loan amount.

 

Consumer loans may entail greater risk than do residential mortgage loans, particularly in the case of consumer loans that are unsecured or secured by assets that depreciate rapidly. In such cases, repossessed collateral for a defaulted consumer loan may not provide an adequate source of repayment for the outstanding loan and the remaining deficiency often does not warrant further substantial collection efforts against the borrower. In addition, consumer loan collections depend on the borrower’s continuing financial stability, and therefore are more likely to be adversely affected by job loss, divorce, illness, or personal bankruptcy. Furthermore, the application of various federal and state laws, including federal and state bankruptcy and insolvency laws may limit the amount which can be recovered on such loans.

 

Purchased Auto Loans. We purchase auto loans from regulated financial institutions. At December 31, 2019 and 2018, we had $14.6 million and $22.1 million of purchased auto loans outstanding, respectively. These types of loans are primarily low balance individual auto loans. We have the opportunity to review the loans at least three days prior to our purchase and we have a right to refuse any specific loan within thirty days of the purchase of any given loan pool. We did not purchase any auto loans during the year ended December 31, 2019 and purchased $10.0 million of auto loans during the year ended December 31, 2018.

 

Loan Origination, Purchases and Sales. Loan originations come from a number of sources. The primary source of loan originations are our in-house loan originators, and to a lesser extent, advertising and referrals from customers. We occasionally purchase loans or participation interests in loans. As of December 31, 2019, we had an aggregate of $19.5 million in purchased loan participations outstanding, including the auto loan purchases discussed in the previous paragraph. The largest outstanding loan participation as of December 31, 2019 was a commercial loan for $3.1 million. This loan is performing in accordance with its terms.

 

We sell some of the longer-term fixed-rate one-to-four family mortgage loans that we originate in the secondary market based on prevailing market interest rate conditions, an analysis of the composition and risk of the loan portfolio, liquidity needs and interest rate risk management goals. Generally, loans are sold without recourse and with servicing retained. We sold $18.9 million and $19.8 million of loans in the years ended December 31, 2019 and 2018, respectively. We occasionally sell participation interests in loans and may sell loan participations in the future.

 

 

The following table shows our loan originations, purchases, sales and repayment activities for the periods indicated.

 

		For The Years Ended
		December 31,
		2019				2018				2017				2016				2015
		(In Thousands)
Beginning balance, net		$	235,926			$	207,035			$	160,586			$	140,110			$	142,501
Loans originated
One-to-four family			29,944				52,421				49,105				34,876				19,581
Multi-family			300				3,160				733				901				2,413
Non-residential			5,941				3,481				13,756				5,544				1,898
Commercial			11,461				1,322				11,080				4,288				6,352
Construction			9,903				9,681				6,577				5,199				757
Consumer direct			10,541				9,421				5,309				2,460				842
Total loans originated			68,090				79,486				86,560				53,268				31,843
Loans purchased
One-to-four family			6,604				3,844				-				-				2,000
Multi-family			-				-				-				600				-
Non-residential			-				-				2,027				1,100				-
Commercial			-				346				3,478				3,146				-
Consumer direct			1,859				3,349				-				-				-
Purchased auto			-				10,013				14,141				10,357				-
Total loans purchased			8,463				17,642				19,646				15,203				2,000
Loan sales (1)			(17,659	)			(19,801	)			(21,786	)			(18,287	)			(7,630	)
Principal payments			(46,735	)			(48,280	)			(37,746	)			(29,685	)			(28,695	)
Change in allowance for loan losses			(309	)			(156	)			(225	)			(23	)			91
Ending balance, net		$	247,776			$	235,926			$	207,035			$	160,586			$	140,110

   

(1)	All loan sales were one-to-four family loans.

 

Loan Approval Procedures and Authority. Our lending activities follow written, non-discriminatory underwriting standards and loan origination procedures established by our Board of Directors and management.

 

For one-to-four family loans and owner occupied residential loans, our President may approve loans up to $500,000. Residential loans and all commercial loans above $500,000 and up to $2 million in the aggregate to any borrower(s) must be approved by a majority of our level one loan committee. This committee consists of our President, Executive Vice-President/Chief Lending Officer and Commercial Loan Officers. For loans to any borrower(s) in the aggregate of more than $2 million up to $4 million, approval is required by a majority of our level two loan committee, which consists of specific members of the level one committee, one designated outside director and our Chairman of the Board. For loan requests above $4 million in the aggregate to any borrower(s), approval is required by a majority of the Board of Directors, as a whole.

 

Loans to One Borrower. The maximum amount that we may lend to one borrower and the borrower’s related entities is limited by regulation to generally 15% of our stated capital and reserves. At December 31, 2019, our regulatory maximum was $7.3 million.

 

Loan Commitments. We issue commitments for fixed-rate and adjustable-rate mortgage loans conditioned upon the occurrence of certain events. Commitments to originate mortgage loans are legally binding agreements to lend to our customers and generally expire in 45 days.

 

Delinquencies. When a borrower fails to make a required loan payment, we take a number of steps to have the borrower cure the delinquency and restore the loan to current status. We make initial contact with the borrower when the loan becomes 10 days past due. If payment is not then received by the 30^th day of delinquency, additional letters are sent and phone calls are made to the customer. When the loan becomes 120 days past due, we generally commence foreclosure proceedings against any real property that secures the loan or attempt to repossess any personal property that secures a consumer loan. If a foreclosure action is instituted and the loan is not brought current, paid in full, or refinanced before the foreclosure sale, the real property securing the loan generally is sold at foreclosure. We may consider loan workout arrangements with certain borrowers under certain circumstances.

 

 

Management informs the Board of Directors on a monthly basis of the amount of loans delinquent more than 60 days, all loans in foreclosure and all foreclosed and repossessed property that we own.

 

Delinquent Loans

 

The following table presents information with respect to the delinquent loans at the dates indicated.

 

		December 31, 2019
		60-89 Days								90 Days or More								Total
		(Dollars in Thousands)
		Number of				Principal				Number of				Principal				Number of				Principal
		Loans				Balance				Loans				Balance				Loans				Balance
One-to-four family			6			$	607				7			$	986				13			$	1,593
Multi-family			-				-				-				-				-				-
Non-residential			1				64				-				-				1				64
Commercial			1				53				-				-				1				53
Purchased auto			1				22				1				19				2				41
Total			9			$	746				8			$	1,005				17			$	1,751

 

		December 31, 2018
		60-89 Days								90 Days or More								Total
		(Dollars in Thousands)
		Number of				Principal				Number of				Principal				Number of				Principal
		Loans				Balance				Loans				Balance				Loans				Balance
One-to-four family			8			$	549				9			$	788				17			$	1,337
Multi-family			-				-				-				-				-				-
Non-residential			1				129				1				127				2				256
Commercial			-				-				-				-				-				-
Purchased auto			1				16				-				-				1				16
Total			10			$	694				10			$	915				20			$	1,609

 

		December 31, 2017
		60-89 Days								90 Days or More								Total
		(Dollars in Thousands)
		Number of				Principal				Number of				Principal				Number of				Principal
		Loans				Balance				Loans				Balance				Loans				Balance
One-to-four family			10			$	986				3			$	100				13			$	1,086
Multi-family			-				-				-				-				-				-
Non-residential			2				395				-				-				2				395
Commercial			1				10				-				-				1				10
Purchased auto			-				-				1				1				1				1
Total			13			$	1,391				4			$	101				17			$	1,492

 

		December 31, 2016
		60-89 Days								90 Days or More								Total
		(Dollars in Thousands)
		Number of				Principal				Number of				Principal				Number of				Principal
		Loans				Balance				Loans				Balance				Loans				Balance
One-to-four family			1			$	23				9			$	1,089				10			$	1,112
Multi-family			-				-				-				-				-				-
Non-residential			-				-				2				681				2				681
Purchased auto			-				-				1				25				1				25
Total			1			$	23				12			$	1,795				13			$	1,818

 

 

		December 31, 2015
		60-89 Days								90 Days or More								Total
		(Dollars in Thousands)
		Number of				Principal				Number of				Principal				Number of				Principal
		Loans				Balance				Loans				Balance				Loans				Balance
One-to-four family			5			$	753				10			$	737				15			$	1,490
Multi-family			-				-				-				-				-				-
Non-residential			1				113				1				18				2				131
Purchased auto			-				-				1				3				1				3
Total			6			$	866				12			$	758				18			$	1,624

 

Classified Assets. Federal Deposit Insurance Corporation regulations and our Asset Classification Policy provide that loans and other assets considered to be of lesser quality be classified as “substandard,” “doubtful” or “loss” assets. An asset is considered “substandard” if it is inadequately protected by the current net worth and paying capacity of the obligor or of the collateral pledged, if any. “Substandard” assets include those characterized by the “distinct possibility” that the institution will sustain “some loss” if the deficiencies are not corrected. Assets classified as “doubtful” have all of 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.” Assets classified as “loss” are those considered “uncollectible” and of such little value that their continuance as assets without the establishment of a specific loss reserve is not warranted. We classify an asset as “special mention” if the asset has a potential weakness that warrants management’s escalated level of attention. While such assets are not impaired, management has concluded that if the potential weakness in the asset is not addressed, the value of the asset may deteriorate, adversely affecting the repayment of the asset. Loans classified as impaired for financial reporting purposes are generally those loans classified as substandard or doubtful for regulatory reporting purposes.

 

An insured institution is required to establish allowances for loan losses in an amount deemed prudent by management for loans classified as substandard or doubtful, as well as for other problem loans. General allowances represent loss allowances which have been established to recognize the inherent losses associated with lending activities, but which, unlike specific allowances, have not been allocated to particular problem assets. When an insured institution classifies problem assets as “loss,” it is required to charge off such amounts. An institution’s determination as to the classification of its assets and the amount of its valuation allowances is subject to review by the Office of the Comptroller of the Currency (“OCC”). 

 

On the basis of management’s review of our assets, at December 31, 2019 and 2018, we classified $0.04 million and $0.34 million, respectively, of our assets as special mention and $2.3 million and $1.5 million, respectively, of our assets as substandard. We classified none of our assets as doubtful and there were no assets classified as loss for the years ended December 31, 2019 and 2018. The loan portfolio is reviewed on a regular basis to determine whether any loans require classification in accordance with applicable regulations. Not all classified assets constitute non-performing assets.

 

The economy continued to stabilize in our market during 2019 which meant foreclosures and liquidations as a manner of reducing non-performing assets continued but at a much slower pace. This is not our primary means to resolve credit issues, however, there are certain circumstances when foreclosure and liquidations are the remedy pursued. From time to time, the Company as part of our loss mitigation strategy may renegotiate the loan terms (i.e. interest rate, structure, repayment term, A/B note format, etc.) based on the economic or legal reasons related to the borrower’s financial difficulties. There were no new troubled debt restructurings (“TDRs”) during 2019 and 2018. TDRs are considered to be non-performing, except for those that have established a sufficient performance history (generally a minimum of six consecutive months of performance) under the terms of the restructured loan.

 

At December 31, 2019, one loan (with a balance of $0.1 million) of our 29 substandard loans (with aggregate balances of $2.3 million) was considered a TDR and was included in non-performing assets. At December 31, 2018, one loan (with a balance of $0.1 million) of our 22 substandard loans (with aggregate balances of $1.5 million) was considered a TDR and was included in non-performing assets. The TDR balance included in impaired loans was primarily a result of no new loans being downgraded to TDRs during the year.

 

 

The following table shows the amounts and relevant ratios of nonperforming assets for the periods indicated:

 

		December 31,
		2019				2018				2017				2016				2015
Non-accrual:						(In Thousands)
One-to-four family		$	2,089			$	1,049			$	1,214			$	2,693			$	2,982
Multi-family			-				-				-				-				-
Non-residential real estate			144				455				355				2,265				2,070
Commercial			-				-				10				-				-
Purchased auto			19				-				1				24				3
Total non-accrual loans			2,252				1,504				1,580				4,982				5,055
Past due greater than 90 days and still accruing:
One-to-four family			-				-				-				-				-
Lines of credit			-				-				-				-				-
Non-residential real estate			-				-				-				-				-
Total nonperforming loans			2,252				1,504				1,580				4,982				5,055
Foreclosed real estate			-				-				84				33				313
Other repossessed assets			13				79				-				2				17
Total nonperforming assets		$	2,265			$	1,583			$	1,664			$	5,017			$	5,385

 

Ratios

 

		December 31,
		2019				2018				2017				2016				2015
Allowance for loan losses as a percent of gross loans receivable			1.17	%			1.10	%			1.18	%			1.38	%			1.56	%
Allowance for loan losses as a percent of total nonperforming loans			130.42	%			174.73	%			156.46	%			45.10	%			44.00	%
Nonperforming loans as a percent of gross loans receivable			0.90	%			0.63	%			0.75	%			3.06	%			3.55	%
Nonperforming loans as a percent of total assets			0.75	%			0.51	%			0.62	%			2.16	%			2.37	%
Nonperforming assets as a percent of total assets			0.75	%			0.54	%			0.65	%			2.18	%			2.52	%

 

The total amount of non-accrual loans increased to $2.3 million as of December 31, 2019, from $1.5 million at December 31, 2018. Total non-performing loans consist of 39 loans to 29 borrowers for the year ended December 31, 2019, as compared to 22 loans to 15 borrowers for the year ended December 31, 2018. For the years ended December 31, 2019 and 2018, gross interest income of $97,000 and $108,000, respectively, would have been recorded had the non-accrual loans at the end of the period been on accrual status throughout the period. We recognized no cash basis interest income on impaired loans for the years ended December 31, 2019 and 2018, respectively.

 

Allowance for Loan Losses

 

Our allowance for loan losses is maintained at a level necessary to absorb loan losses which are both probable and reasonably estimable. Management, in determining the allowance for loan losses, considers the losses inherent in its loan portfolio and changes in the nature and volume of loan activities, along with the general economic and real estate market conditions. We utilize a two-tier approach: (1) identification of impaired loans and establishment of specific loss allowances on such loans; and (2) establishment of general valuation allowances on the remainder of our loan portfolio. We maintain a loan review system, which allows for a periodic review of our loan portfolio and the early identification of potential impaired loans. Such system takes into consideration, among other things, delinquency status, size of loans, type and market value of collateral and financial condition of the borrowers. Specific loan loss allowances are established for identified losses based on a review of such information. A loan evaluated for impairment is considered to be impaired when, based on current information and events, it is probable that we will be unable to collect all amounts due according to the contractual terms of the loan agreement. All loans identified as impaired are evaluated independently. We do not aggregate such loans for evaluation purposes. Loan impairment is measured based on the present value of expected future cash flows discounted at the loan’s effective interest rate or, as a practical expedient, at the loan’s observable market price or the fair value of the collateral if the loan is collateral dependent. The interest on these loans is accounted for on the cash-basis or cost-recovery method, until qualifying for return to accrual status. Should full collection of principal be expected, cash collected on nonaccrual loans can be recognized as interest income.

 

The general component consists of quantitative and qualitative factors and covers non-impaired loans. The quantitative factors are based on historical loss experience adjusted for qualitative factors. The historical loss experience is determined by portfolio segment and is based on the actual loss history experienced by the Company using the most recent twelve quarters with heavier weighting given to the most recent quarters.

 

 

Actual loss experience is supplemented with other qualitative factors based on the risks present for each portfolio segment. These qualitative factors include consideration of the following:

 

●

Levels of and trends in delinquencies and impaired loans

●

Levels of and trends in charge-offs and recoveries

●

Trends in volume and terms of loans

●

Effects of any changes in risk selection and underwriting standards

●

Other changes in lending policies, procedures and practices

●

Experience, ability and depth of lending management and other relevant staff

●

National and local economic trends and conditions

●

Industry conditions

●

Effects of changes in credit concentrations

 

The allowance is increased through provisions charged against current earnings and offset by recoveries of previously charged-off loans. Loans which are determined to be uncollectible are charged against the allowance. Management uses available information to recognize probable and reasonably estimable loan losses, but future loss provisions may be necessary based on changing economic conditions. The allowance for loan losses as of December 31, 2019 is maintained at a level that represents management’s best estimate of losses inherent in the loan portfolio, and such losses were both probable and reasonably estimable. In addition, the OCC, as an integral part of its examination process, periodically reviews our allowance for loan losses.

 

Allowance for Loan Losses. The following table analyzes changes in the allowance for the periods indicated. 

 

		Year Ended December 31,
		2019				2018				2017				2016				2015
		(Dollars in Thousands)
Balance at beginning of year		$	2,628			$	2,472			$	2,247			$	2,224			$	2,315
Charge-offs:
One-to-four family			285				312				259				233				296
Multi-family			-				-				-				-				34
Non-residential			-				-				62				171				18
Commercial			-				-				-				-				-
Consumer			48				-				9				-				64
Purchased auto			161				166				85				109				74
			494				478				415				513				486
Recoveries:
One-to-four family			138				50				11				60				95
Multi-family			32				16				16				16				16
Non-residential real estate			-				-				8				-				-
Commercial			-				-				-				-				-
Consumer			4				16				8				8				7
Purchased auto			34				24				22				10				7
			208				106				65				94				125
Net charge-offs			285				372				350				419				361
Additions charged to operations			595				528				575				442				270
Balance at end of year		$	2,937			$	2,628			$	2,472			$	2,247			$	2,224
Net charge-offs to average gross loans outstanding			0.11	%			0.17	%			0.18	%			0.27	%			0.25	%

 

 

Allocation of Allowance for Loan Losses. The following table presents an analysis of the allocation of the allowance for loan losses at the dates indicated. The allocation of the allowance to each category is not necessarily indicative of future loss in any particular category and does not restrict the use of the allowance to absorb losses in other categories.

 

		2019
						Percent Of				Percent Of Gross Loans In
						Allowance To				Each Category To Total
		Amount				Total Allowance				Gross Loans
		(Dollars in Thousands)
One-to-four family		$	2,121				72.22	%			61.88	%
Multi-family			24				0.82	%			2.34	%
Non-residential			207				7.05	%			12.24	%
Commercial			199				6.78	%			9.54	%
Consumer			192				6.54	%			8.20	%
Purchased auto			194				6.61	%			5.80	%
Total allowance for loan losses		$	2,937				100.00	%			100.00	%

 

		2018
						Percent Of				Percent Of Gross Loans In
						Allowance To				Each Category To Total
		Amount				Total Allowance				Gross Loans
		(Dollars in Thousands)
One-to-four family		$	1,762				67.05	%			59.43	%
Multi-family			26				0.99	%			2.84	%
Non-residential			344				13.09	%			14.79	%
Commercial			135				5.14	%			7.23	%
Consumer			83				3.16	%			6.45	%
Purchased auto			278				10.58	%			9.26	%
Total allowance for loan losses		$	2,628				100.00	%			100.00	%

 

		2017
						Percent Of				Percent Of Gross Loans In
						Allowance To				Each Category To Total
		Amount				Total Allowance				Gross Loans
		(Dollars in Thousands)
One-to-four family		$	1,477				59.75	%			59.24	%
Multi-family			22				0.89	%			2.70	%
Non-residential			371				15.01	%			15.34	%
Commercial			154				6.23	%			9.91	%
Consumer			140				5.66	%			3.00	%
Purchased auto			308				12.46	%			9.81	%
Total allowance for loan losses		$	2,472				100.00	%			100.00	%

 

 

		2016
						Percent Of				Percent Of Gross Loans In
						Allowance To				Each Category To Total
		Amount				Total Allowance				Gross Loans
		(Dollars in Thousands)
One-to-four family		$	1,427				63.51	%			63.80	%
Multi-family			93				4.14	%			3.18	%
Non-residential			367				16.33	%			13.85	%
Commercial			97				4.32	%			10.22	%
Consumer			79				3.52	%			1.76	%
Purchased auto			184				8.18	%			7.19	%
Total allowance for loan losses		$	2,247				100.00	%			100.00	%

 

		2015
						Percent Of				Percent Of Gross Loans In
						Allowance To				Each Category To Total
		Amount				Total Allowance				Gross Loans
		(Dollars in Thousands)
One-to-four family		$	1,728				77.71	%			69.73	%
Multi-family			142				6.38	%			2.79	%
Non-residential			198				8.90	%			14.18	%
Commercial			51				2.29	%			8.48	%
Consumer			37				1.66	%			1.16	%
Purchased auto			68				3.06	%			3.66	%
Total allowance for loan losses		$	2,224				100.00	%			100.00	%

 

Each quarter, management evaluates the total balance of the allowance for loan losses based on several factors that are not loan specific, but are reflective of the inherent losses in the loan portfolio. This process includes, but is not limited to, a periodic review of loan collectability in light of historical experience, the nature and volume of loan activity, conditions that may affect the ability of the borrower to repay, underlying value of collateral, if applicable, and economic conditions in our market areas. First, we group loans by delinquency status. All loans 90 days or more delinquent and all loans classified as substandard or doubtful are evaluated individually, based primarily on the value of the collateral securing the loan. Specific loss allowances are established as required by this analysis. All loans for which a specific loss allowance has not been assigned are segregated by type and delinquency status and a loss allowance is established by using loss experience data and management’s judgment concerning other matters it considers significant. The allowance is allocated to each category of loan based on the results of the above analysis.

 

Total allowance for loan losses increased to $2.9 million at December 31, 2019 as compared to $2.6 million at December 31, 2018. The increase reflected an increase of $0.3 million in the general portion of the reserve while specific reserves on impaired loans were consistent between the years. Impaired loans were $2.3 million with a valuation allowance of $200,000 at December 31, 2019, as compared to $1.5 million with a valuation allowance of $217,000 at December 31, 2018. Of the $2.3 million of impaired loans at December 31, 2019, $0.2 million were acquired in the merger with Twin Oaks and valued per FASB ASC 310-30 (see Note 4 to the Notes to the Consolidated Financial Statements). The increase in the general portion of the reserve was due primarily to balance increases in all categories of the loan portfolio. These increases to the allowance were partially off-set by improvements in historical loss levels resulting from stabilization in nonperforming asset levels and charge-off levels, off-set slightly by changes in the qualitative factors applied to reflect changes in risk.

 

This analysis process is inherently subjective, as it requires us to make estimates that are susceptible to revisions as more information becomes available. Although we believe that we have established the allowance at a level to absorb probable and estimable losses, additions may be necessary if economic or other conditions in the future differ from the current environment.

 

 

Investment Activities

 

We have legal authority to invest in various types of liquid assets, including U.S. Treasury obligations, securities of various federal agencies and of state and municipal governments, mortgage-backed securities and certificates of deposit of federally insured institutions.

 

At December 31, 2019, our investment portfolio consisted primarily of municipal securities with maturities of five to more than ten years and residential mortgage-backed securities issued by Fannie Mae, Freddie Mac, and Ginnie Mae with stated final maturities of 30 years or less.

 

Our investment objectives are to provide and maintain liquidity, to maintain a balance of high quality, diversified investments to minimize risk, to provide collateral for pledging requirements, to establish an acceptable level of interest rate risk, to provide an alternate source of low-risk investments when demand for loans is weak and to generate a favorable return. Our Board of Directors has the overall responsibility for our investment portfolio, including approval of our investment policy and appointment of our Investment Committee. The Investment Committee is responsible for approval of investment strategies and monitoring of investment performance. Our President and CFO are the designated investment officers and they are responsible for the daily investment activities and are authorized to make investment decisions consistent with our investment policy. The Investment Committee, consisting of seven non-employee members of the Board of Directors , meets regularly with the President and CFO to review and determine investment strategies and transactions.

 

The following table sets forth the carrying value of our investment portfolio at the dates indicated.

 

		December 31,
		2019								2018								2017
		Carrying				Fair				Carrying				Fair				Carrying				Fair
		Amount				Value				Amount				Value				Amount				Value
		(In Thousands)
Available-for-sale
State and municipal securities		$	13,465			$	13,465			$	13,187			$	13,187			$	13,971			$	13,971
Residential mortgage-backed securities			11,051				11,051				12,347				12,347				12,075				12,075
Total available-for-sale		$	24,516			$	24,516			$	25,534			$	25,534			$	26,046			$	26,046

 

Portfolio Maturities and Yields. The composition and maturities of the investment securities portfolio at December 31, 2019 are summarized in the following table. Maturities are based on the final contractual payment dates, and do not reflect the impact of prepayments or early redemptions that may occur. Certain mortgage-backed securities have interest rates that are adjustable and will re-price annually within the various maturity ranges. These re-pricing schedules are not reflected in the table below.

 

		At December 31, 2019
																		More than Five
										More than One Year								Years Through Ten								More than Ten
		One Year or Less								Through Five Years								Years								Years								Total Securities
						Weighted								Weighted								Weighted								Weighted								Weighted
		Carrying				Average				Carrying				Average				Carrying				Average				Carrying				Average				Carrying				Average
		Value				Yield				Value				Yield				Value				Yield				Value				Yield				Value				Yield
		(Dollars in Thousands)
Available-for-sale securities:
State and municipal securities		$	1,770				2.97	%		$	4,446				3.58	%		$	3,968				3.86	%		$	3,281				4.15	%		$	13,465				3.72	%
Residential mortgage-backed securities			75				1.19	%			10,748				2.63	%			228				3.60	%			-				0.00	%			11,051				2.64	%
Total securities available-for-sale		$	1,845				2.90	%		$	15,194				2.91	%		$	4,196				3.85	%		$	3,281				4.15	%		$	24,516				3.23	%

 

Deposit Activities and Other Sources of Funds

 

General. Deposits and loan repayments are the major sources of our funds for lending and other investment purposes. Loan repayments are a relatively stable source of funds, while deposit inflows and outflows and loan prepayments are significantly influenced by general interest rates and market conditions.

 

 

Deposit Accounts. The vast majority of our depositors are residents of LaSalle County, with some deposit relationships in Grundy County. Deposits are raised primarily from within our primary market area through the offering of a broad selection of deposit instruments, including checking accounts, money market accounts, regular savings accounts, club savings accounts, certificate accounts and various retirement accounts. The Bank also is a member of the Certificate of Deposit Registry Service (CDARS), which allows the Bank to retain high deposit relationships with its depository customer base, while still allowing the customer to enjoy FDIC deposit insurance on amounts in excess of the current limit of $250,000. During 2017, the Bank became a member of the QuickRate CD listing service, which allows the Bank to obtain institutional deposits when needed to help meet loan funding needs. During 2018, the Bank also began a relationship with Financial Northeastern Companies, a CD broker, to obtain institutional deposits when needed to help meet loan funding needs. Deposit account terms vary according to the minimum balance required, the time periods the funds must remain on deposit, and the interest rate among other factors. In determining the terms of our deposit accounts, we consider the rates offered by our competition, profitability to us, matching deposit and loan products and customer preferences and concerns. We generally review our deposit mix and pricing weekly. Our current strategy is to offer competitive rates, but not be the market leader in every type and maturity.

 

The following table sets forth the dollar amount of deposits by type as of the dates indicated. 

 

		At December 31,
		2019								2018								2017
						Percent								Percent								Percent
		Amount				Of Total				Amount				Of Total				Amount				Of Total
		(Dollars In Thousands)
Non-Interest Bearing Checking		$	13,665				5.78	%		$	14,058				6.29	%		$	11,563				6.32	%
Interest Bearing Checking			62,474				26.44	%			54,292				24.30	%			29,081				15.91	%
Money Market accounts			22,452				9.50	%			25,033				11.20	%			27,560				15.08	%
Savings accounts			25,008				10.58	%			25,720				11.51	%			25,966				14.21	%
Certificates of Deposit accounts			112,715				47.70	%			104,346				46.70	%			88,605				48.48	%
Total deposit accounts		$	236,314				100.00	%		$	223,449				100.00	%		$	182,775				100.00	%
Certificate Accounts, by rate
Less than 1.00%		$	6,422				5.70	%		$	9,980				9.56	%		$	17,481				19.73	%
1.00% to 1.99%			36,587				32.46	%			53,673				51.44	%			66,410				74.95	%
2.00% to 2.99%			59,809				53.06	%			39,114				37.49	%			4,714				5.32	%
3.00% to 3.99%			9,897				8.78	%			1,579				1.51	%			-				0.00	%
Total Certificate Accounts		$	112,715				100.00	%		$	104,346				100.00	%		$	88,605				100.00	%

 

The following table sets forth the distribution of average deposit accounts, by account type, at the dates indicated.

 

		Years Ended December 31,
		2019								2018								2017
		Weighted				Average				Weighted				Average				Weighted				Average
		Avg. Rate				Amount				Avg. Rate				Amount				Avg. Rate				Amount
		(Dollars In Thousands)
Non-Interest Bearing Checking			0.00	%		$	10,052				0.00	%		$	12,210				0.00	%		$	10,784
Interest Bearing Checking			0.84	%			43,889				0.90	%			42,340				0.07	%			29,048
Money Market accounts			0.26	%			23,416				0.27	%			26,837				0.28	%			29,961
Savings accounts			0.06	%			26,713				0.06	%			26,148				0.06	%			26,230
Certificate of Deposit accounts			2.15	%			111,866				1.77	%			101,025				1.20	%			83,283
Total			1.34	%		$	215,936				1.15	%		$	208,560				0.69	%		$	179,306

 

 

Deposit Activity. The following table sets forth the deposit activities for the periods indicated.

 

		Years Ended December 31,
		2019				2018				2017
		(In Thousands)
Beginning of period		$	223,449			$	182,775			$	172,547
Net deposits (withdrawals)			10,680				39,448				9,305
Interest credited on deposit accounts			2,185				1,226				923
End of period		$	236,314			$	223,449			$	182,775
Percent change			5.76	%			22.25	%			5.93	%

 

The following table indicates the dollar amount of certificates of deposit as of December 31, 2019, by time remaining until maturity.

 

		Three				Over Three				Over Six				Over
		Months				To Six				To Twelve				Twelve
		Or Less				Months				Months				Months				Total
		(In Thousands)
Less than $100,000		$	8,307			$	10,493			$	6,419			$	23,559			$	48,777
$100,000 to $250,000			7,459				10,412				7,140				21,817				46,827
Over $250,000			3,327				1,974				1,238				10,571				17,110
Total		$	19,093			$	22,879			$	14,797			$	55,947			$	112,715

 

		Less than				1 to 2				2 to 3				3 to 4				4 to 5
		1 year				years				years				years				years				Total
		(In Thousands)
Less than 1.00%		$	6,264			$	158			$	-			$	-			$	-			$	6,422
1.00% to 1.99%			12,016				14,658				3,176				1,990				4,747				36,587
2.00% to 2.99%			29,584				14,813				9,586				3,182				2,644				59,809
3.00% to 3.99%			8,905				249				494				-				249				9,897
Total		$	56,769			$	29,878			$	13,256			$	5,172			$	7,640			$	112,715

 

Borrowings. If necessary, we borrow from the Federal Home Loan Bank of Chicago to supplement our supply of lendable funds and to meet deposit withdrawal requirements. The Federal Home Loan Bank functions as a central reserve bank providing credit for member financial institutions. As a member, we are required to own capital stock in the Federal Home Loan Bank of Chicago and are authorized to apply for advances on the security of such stock and certain of our mortgage loans and other assets (principally securities that are obligations of, or guaranteed by, the United States), provided certain standards related to credit-worthiness have been met. Advances are made under several different programs, each having its own interest rate and range of maturities. Depending on the program, limitations on the amount of advances are based either on a fixed percentage of an institution’s net worth or on the Federal Home Loan Bank’s assessment of the institution’s credit-worthiness. Under its current credit policies, the Federal Home Loan Bank generally limits advances to 35% of a member’s assets, and short-term borrowings of less than one year may not exceed 10% of the institution’s assets. The Federal Home Loan Bank determines specific lines of credit for each member institution. There were $9.1 million of Federal Home Loan Bank advances outstanding at December 31, 2019. At December 31, 2019, we had the ability to borrow an additional $65.8 million from the Federal Home Loan Bank of Chicago. In addition, as of December 31, 2019, the Bank had $7.9 million of available credit from Bankers Bank of Wisconsin to purchase federal funds and $5.0 million of available credit from Midwest Independent Bank to purchase federal funds.

 

Personnel

 

At December 31, 2019, we had 57 full-time employees and 13 part-time employees, none of whom is represented by a collective bargaining unit. We believe our relationship with our employees is good.

 

Subsidiaries

 

The Company’s only subsidiary is Ottawa Savings Bank.

 

 

REGULATION AND SUPERVISION

 

General

 

Ottawa Savings Bank as a federal savings bank is currently subject to extensive regulation, examination and supervision by the Office of the Comptroller of the Currency (OCC), as its primary federal regulator, and the Federal Deposit Insurance Corporation, as the insurer of its deposits. Ottawa Savings Bank is a member of the Federal Home Loan Bank System and its deposit accounts are insured up to applicable limits by the Deposit Insurance Fund (“DIF”) managed by the Federal Deposit Insurance Corporation (“FDIC”). Ottawa Savings Bank must file reports with the OCC and the Federal Deposit Insurance Corporation concerning its activities and financial condition in addition to obtaining regulatory approvals prior to entering into certain transactions such as mergers with, or acquisitions of, other financial institutions. There are periodic examinations by the OCC and, under certain circumstances, the FDIC to evaluate Ottawa Savings Bank’s safety and soundness and compliance with various regulatory requirements. This regulatory structure is intended primarily for the protection of the insurance fund and depositors. The regulatory structure also gives the regulatory authorities extensive discretion in connection with their supervisory and enforcement activities and examination policies, including policies with respect to the classification of assets and the establishment of adequate allowance for loan losses for regulatory purposes. Any change in such policies, whether by the OCC, the FDIC or Congress, could have a material adverse impact on Ottawa Bancorp, Inc., and Ottawa Savings Bank and their operations.

 

Certain of the regulatory requirements that are applicable to Ottawa Savings Bank and Ottawa Bancorp, Inc. are described below. This description of statutes and regulations is not intended to be a complete explanation of such statutes and regulations and their effects on Ottawa Savings Bank and Ottawa Bancorp, Inc.

 

Federal Banking Regulation

 

Business Activities. The activities of federal savings banks, such as Ottawa Savings Bank, are governed by federal laws and regulations. Those laws and regulations delineate the nature and extent of the business activities in which federal savings banks may engage. In particular, certain lending authority for federal savings banks, e.g., commercial, non-residential real property loans and consumer loans, is limited to a specified percentage of the institution’s capital or assets.

 

Capital Requirements. In July 2013, the OCC and the Federal Reserve Board approved a new rule that will substantially amend the regulatory risk-based capital rules applicable to Ottawa Savings Bank. The final rule implemented the “Basel III” regulatory capital reforms and changes required by the Dodd-Frank Act. The final rule included new minimum risk-based capital and leverage ratios, which became effective for Ottawa Savings Bank on January 1, 2015, and refined the definition of what constitutes “capital” for purposes of calculating these ratios. The minimum capital requirements under the final rule are: (i) a common equity Tier 1 capital ratio of 4.5%; (ii) a Tier 1 to risk-based assets capital ratio of 6% (increased from 4%); (iii) a total capital ratio of 8% (unchanged); and (iv) a Tier 1 leverage ratio of 4%. The final rule also established a “capital conservation” buffer of 2.5%, and resulted in the following minimum ratios: (i) a common equity Tier 1 capital ratio of 7%; (ii) a Tier 1 to risk-based assets capital ratio of 8.5%; and (iii) a total capital ratio of 10.5%. The new capital conservation buffer requirement was phased in beginning in January 2016 at 0.625% of risk-weighted assets and was increased each year until it was fully implemented in January 2019. An institution will be subject to limitations on paying dividends, engaging in share repurchases, and paying discretionary bonuses if its capital level falls below the buffer amount. These limitations will establish a maximum percentage of eligible retained income that can be utilized for such actions.

 

Prompt Corrective Regulatory Action. Prompt corrective action regulations provide five classifications: well capitalized, adequately capitalized, undercapitalized, significantly undercapitalized and critically undercapitalized, although these terms are not used to represent overall financial condition. If adequately capitalized, regulatory approval is required to accept broker deposits. The OCC is required to take certain supervisory actions against undercapitalized institutions, the severity of which depends upon the institution’s degree of undercapitalization. In addition, numerous mandatory supervisory actions become immediately applicable to an undercapitalized institution, including, but not limited to, increased monitoring by regulators and restrictions on growth, capital distributions and expansion. The OCC could also take any one of a number of discretionary supervisory actions, including the issuance of a capital directive and the replacement of senior executive officers and directors. Significantly and critically undercapitalized institutions are subject to additional mandatory and discretionary measures.

 

Insurance of Deposit Accounts. The Bank’s deposits are insured up to applicable limits, which are $250,000 per depositor by the Deposit Insurance Fund (“DIF”) of the FDIC. Under the FDIC’s risk-based assessment system, insured institutions are assigned a risk category based on supervisory evaluations, regulatory capital levels and certain other factors. An institution’s assessment rate depends upon the category to which it is assigned, and certain adjustments specified by Federal Deposit Insurance Corporation regulations. Institutions deemed less risky pay lower assessments. The Federal Deposit Insurance Corporation may adjust the scale uniformly, except that no adjustment can deviate more than two basis points from the base scale without notice and comment. No institution may pay a dividend if in default of the federal deposit insurance assessment.

 

 

The Dodd-Frank Act required the Federal Deposit Insurance Corporation to revise its procedures to base its assessments upon each insured institution’s total assets less tangible equity instead of deposits. The Federal Deposit Insurance Corporation finalized a rule, effective April 1, 2011, that set the assessment range at 2.5 to 45 basis points of total assets less tangible equity.

 

The Federal Deposit Insurance Corporation has authority to increase insurance assessments. A significant increase in insurance premiums would likely have an adverse effect on the operating expenses and results of operations of Ottawa Savings Bank. Management cannot predict what insurance assessment rates will be in the future.

 

Loans to One Borrower. Federal law provides that savings banks are generally subject to the limits on loans to one borrower applicable to national banks. Generally, subject to certain exceptions, savings banks may not make a loan or extend credit to a single or related group of borrowers in excess of 15% of its unimpaired capital and surplus. An additional amount may be lent, equal to 10% of unimpaired capital and surplus, if secured by specified readily-marketable collateral.

 

Qualified Thrift Lender Test. Federal law requires savings associations to meet a qualified thrift lender test. Under the test, a savings bank is required to either qualify as a “domestic building and loan association” under the Internal Revenue Code or maintain at least 65% of its “portfolio assets” (total assets less: (i) specified liquid assets up to 20% of total assets; (ii) intangibles, including goodwill; and (iii) the value of property used to conduct business) in certain “qualified thrift investments” (primarily multi-family residential mortgages and related investments, including certain mortgage-backed securities but also including education, credit card and small business loans) in at least 9 months out of each 12-month period.

 

A savings association that fails the qualified thrift lender test is subject to certain operating restrictions and the Dodd-Frank Act also specifies that failing the qualified thrift lender test is a violation of law that could result in an enforcement action and dividend limitations. As of December 31, 2019, Ottawa Savings Bank maintained 88.0% of its portfolio assets in qualified thrift investments and, therefore, met the qualified thrift lender test.

 

Limitation on Capital Distributions. Federal regulations impose limitations upon all capital distributions by a savings association, including cash dividends, payments to repurchase its shares and payments to stockholders of another institution in a cash-out merger. Under the regulations, an application to and the prior approval of the OCC is required before any capital distribution if the institution does not meet the criteria for “expedited treatment” of applications under OCC regulations (i.e., generally, examination and Community Reinvestment Act ratings in the two top categories), the total capital distributions for the calendar year exceed net income for that year plus the amount of retained net income for the preceding two years, the institution would be undercapitalized following the distribution or the distribution would otherwise be contrary to a statute, regulation or agreement with the OCC. If an application is not required, the institution must still provide 30-days prior written notice to and receive the non-objection of, the Federal Reserve Board of the capital distribution if, like Ottawa Savings Bank, it is a subsidiary of a holding company, as well as an informational notice filing to the OCC. If Ottawa Savings Bank’s capital were ever to fall below its regulatory requirements or the OCC notified it that it was in need of increased supervision, its ability to make capital distributions could be restricted. In addition, the OCC could prohibit a proposed capital distribution by any institution which would otherwise be permitted by the regulation, if the OCC determines that such distribution would constitute an unsafe or unsound practice.

 

Community Reinvestment Act. All federal savings associations have a responsibility under the Community Reinvestment Act and related regulations to help meet the credit needs of their communities, including low- and moderate-income neighborhoods. An institution’s failure to satisfactorily comply with the provisions of the Community Reinvestment Act could result in denials of regulatory applications. Ottawa Savings Bank received a “satisfactory” Community Reinvestment Act rating in its most recently completed examination.

 

Transactions with Related Parties. Federal law limits Ottawa Savings Bank’s authority to engage in transactions with “affiliates” (e.g., any entity that controls or is under common control with Ottawa Savings Bank, including Ottawa Bancorp and their other subsidiaries). The aggregate amount of covered transactions with any individual affiliate is limited to 10% of the capital and surplus of the savings association. The aggregate amount of covered transactions with all affiliates is limited to 20% of the savings association’s capital and surplus. Certain transactions with affiliates are required to be secured by collateral in an amount and of a type specified by federal law. The purchase of low quality assets from affiliates is generally prohibited. Transactions with affiliates must generally be on terms and under circumstances that are at least as favorable to the institution as those prevailing at the time for comparable transactions with non-affiliated companies. In addition, savings associations are prohibited from lending to any affiliate that is engaged in activities that are not permissible for bank holding companies and no savings association may purchase the securities of any affiliate other than a subsidiary.

 

 

The Sarbanes-Oxley Act of 2002 generally prohibits loans by Ottawa Bancorp to its executive officers and directors. However, the law contains a specific exception for loans by a depository institution to its executive officers and directors in compliance with federal banking laws. Under such laws, Ottawa Savings Bank’s authority to extend credit to executive officers, directors and 10% stockholders (“insiders”), as well as entities such persons’ control, is limited. The laws limit both the individual and aggregate amount of loans that Ottawa Savings Bank may make to insiders based, in part, on Ottawa Savings Bank’s capital level and requires that certain board approval procedures be followed. Such loans are required to be made on terms substantially the same as those offered to unaffiliated individuals and not involve more than the normal risk of repayment. There is an exception for loans made pursuant to a benefit or compensation program that is widely available to all employees of the institution and does not give preference to insiders over other employees. Loans to executive officers are subject to additional limitations based on the type of loan involved.

 

In accordance with banking regulations, the Board of Directors reviews all loans made to a director or executive officer in an amount that, when aggregated with the amount of all other loans to such person and his or her related interests, exceed the greater of $25,000 or 5% of Ottawa Bancorp’s capital and surplus (up to a maximum of $500,000) and such loans must be approved in advance by a majority of the disinterested members of the Board of Directors. Additionally, pursuant to the Company’s Code of Ethics and Business Conduct, all executive officers and directors of the Company must disclose any existing or emerging conflicts of interest to the President and Chief Executive Officer of the Company. Such potential conflicts of interest include, but are not limited to, the following: (i) the Company conducting business with or competing against an organization in which a family member of an executive officer or director has an ownership or employment interest; and (ii) the ownership of more than 1% of the outstanding securities (or that represents more than 5% of the total assets of the employee and/or family member) of any business entity that does business with or is in competition with the Company.

 

Enforcement. The OCC currently has primary enforcement responsibility over savings associations and has authority to bring actions against the institution and all institution-affiliated parties, including stockholders, and any attorneys, appraisers and accountants who knowingly or recklessly participate in wrongful actions likely to have an adverse effect on an insured institution. Formal enforcement action may range from the issuance of a capital directive or cease and desist order to removal of officers and/or directors to institution of receivership, conservatorship or termination of deposit insurance. Civil penalties cover a wide range of violations and can amount to $25,000 per day, or even $1.0 million per day in especially egregious cases. The FDIC has the authority to recommend to the OCC that enforcement action be taken with respect to a particular savings association. If action is not taken by the OCC, the FDIC has authority to take such action under certain circumstances. Federal law also establishes criminal penalties for certain violations.

 

Federal Home Loan Bank System. Ottawa Savings Bank is a member of the Federal Home Loan Bank System, which consists of 11 regional Federal Home Loan Banks. The Federal Home Loan Bank provides a central credit facility primarily for member institutions. Ottawa Savings Bank, as a member of the Federal Home Loan Bank of Chicago is required to acquire and hold shares of capital stock in that Federal Home Loan Bank. Ottawa Savings Bank was in compliance with this requirement with an investment in Federal Home Loan Bank stock at December 31, 2019 of $0.6 million.

 

Federal Reserve System. The Federal Reserve Act authorizes the Federal Reserve Board to require savings associations to maintain noninterest-earning reserves against their transaction accounts (primarily Negotiable Order of Withdrawal “NOW” and regular checking accounts). The amounts are adjusted annually and, for 2019, the regulations provided that reserves be maintained against aggregate transaction accounts as follows: a 3% reserve ratio is assessed on net transaction accounts up to and including $127.5 million; and a 10% reserve ratio is applied above $127.5 million. The first $16.9 million of otherwise reservable balances (subject to adjustments by the Federal Reserve Board) were exempted from the reserve requirements. Ottawa Savings Bank complied with the foregoing requirements during 2019. On March 15, 2020, the Federal Reserve Board reduced reserve requirement to 0% effective as of March 26, 2020, which eliminated reserve requirements for all depository institutions.

 

Other Regulations. Ottawa Savings Bank’s operations are also subject to federal laws applicable to credit transactions, such as, but not limited to, the:

•

Truth-In-Lending Act, governing disclosures of credit terms to consumer borrowers;

•

Home Mortgage Disclosure Act of 1975, requiring financial institutions to provide information to enable the public and public officials to determine whether a financial institution is fulfilling its obligation to help meet the housing needs of the community it serves;

•

Equal Credit Opportunity Act, prohibiting discrimination on the basis of race, creed or other prohibited factors in extending credit;

•

Fair Credit Reporting Act of 1978, governing the use and provision of information to credit reporting agencies;

•

Fair Debt Collection Act, governing the manner in which consumer debts may be collected by collection agencies; and

•

Rules and regulations of the various federal agencies charged with the responsibility of implementing such federal laws.

 

The operations of Ottawa Savings Bank also are subject to the:

•

Right to Financial Privacy Act, which imposes a duty to maintain confidentiality of consumer financial records and prescribes procedures for complying with administrative subpoenas of financial records;

 

 

•

Electronic Funds Transfer Act and Regulation E promulgated thereunder, which govern automatic deposits to and withdrawals from deposit accounts and customers’ rights and liabilities arising from the use of automated teller machines and other electronic banking services;

•

Check Clearing for the 21st Century Act (also known as “Check 21”), which gives “substitute checks,” such as digital check images and copies made from that image, the same legal standing as the original paper check;

•

Title III of The Uniting and Strengthening America by Providing Appropriate Tools Required to Intercept and Obstruct Terrorism Act of 2001 (referred to as the “USA PATRIOT Act”), and the related regulations of the Federal Reserve Board, which require savings associations operating in the United States to develop new anti-money laundering compliance programs (including a customer identification program that must be incorporated into the AML compliance program), due diligence policies and controls to ensure the detection and reporting of money laundering; and

•

The Bank Secrecy Act of 1970, which requires financial institutions in the United States to keep records of cash purchases of negotiable instruments, file reports of cash purchases of negotiable instruments exceeding a daily amount of $10,000 or more and to report suspicious activity that might signify money laundering, tax evasion, or other criminal activities.

 

Holding Company Regulation

 

General. As a savings and loan holding company, Ottawa Bancorp, Inc. is subject to Federal Reserve Board regulations, examinations, supervision, reporting requirements and regulations regarding its activities. Among other things, this authority permits the Federal Reserve Board to restrict or prohibit activities that are determined to be a serious risk to Ottawa Savings Bank.

 

Pursuant to federal law and regulations and policy, a savings and loan holding company such as Ottawa Bancorp may generally engage in the activities permitted for financial holding companies under Section 4(k) of the Bank Holding Company Act and certain other activities that have been authorized for savings and loan holding companies by regulation.

 

Federal law prohibits a savings and loan holding company from, directly or indirectly or through one or more subsidiaries, acquiring more than 5% of the voting stock of another savings association, or savings and loan holding company thereof, without prior written approval of the Federal Reserve Board or from acquiring or retaining, with certain exceptions, more than 5% of a non-subsidiary holding company or savings association. A savings and loan holding company is also prohibited from acquiring more than 5% of a company engaged in activities other than those authorized by federal law or acquiring or retaining control of a depository institution that is not insured by the Federal Deposit Insurance Corporation. In evaluating applications by holding companies to acquire savings associations, the Federal Reserve Board must consider the financial and managerial resources and future prospects of the company and institution involved, the effect of the acquisition on the risk to the insurance funds, the convenience and needs of the community and competitive factors.

 

The Federal Reserve Board is prohibited from approving any acquisition that would result in a multiple savings and loan holding company controlling savings associations in more than one state, except: (i) the approval of interstate supervisory acquisitions by savings and loan holding companies; and (ii) the acquisition of a savings association in another state if the laws of the state of the target savings association specifically permit such acquisitions. The states vary in the extent to which they permit interstate savings and loan holding company acquisitions.

 

Capital Requirements. Savings and loan holding companies with less than $3 billion in assets are not subject to specific regulatory capital requirements. The Dodd-Frank Act, however, requires the Federal Reserve Board to promulgate consolidated capital requirements for depository institution holding companies that are no less stringent, both quantitatively and in terms of components of capital, than those applicable to institutions themselves.

 

Source of Strength. The Dodd-Frank Act also extends the “source of strength” doctrine to savings and loan holding companies. The regulatory agencies must issue regulations requiring that all banks and savings and loan holding companies serve as a source of strength to their subsidiary depository institutions by providing capital, liquidity and other support in times of financial stress.

 

Dividends and Stock Repurchases. The Federal Reserve Board has the power to prohibit dividends by savings and loan holding companies if their actions constitute unsafe or unsound practices. The Federal Reserve Board has issued a policy statement on the payment of cash dividends by bank holding companies, which also applies to savings and loan holding companies and which expresses the Federal Reserve Board’s view that a holding company should pay cash dividends only to the extent that the company’s net income for the past year is sufficient to cover both the cash dividends and a rate of earnings retention that is consistent with the company’s capital needs, asset quality and overall financial condition. The Federal Reserve Board also indicated that it would be inappropriate for a holding company experiencing serious financial problems to borrow funds to pay dividends. Under the prompt corrective action regulations, the Federal Reserve Board may prohibit a bank holding company from paying any dividends if the holding company’s bank subsidiary is classified as “undercapitalized.”

 

 

Federal Reserve Board policy also provides that a holding company should inform the Federal Reserve Board supervisory staff prior to redeeming or repurchasing common stock or perpetual preferred stock if the holding company is experiencing financial weaknesses or if the repurchase or redemption would result in a net reduction, as of the end of a quarter, in the amount of such equity instruments outstanding compared with the beginning of the quarter in which the redemption or repurchase occurred.

 

Acquisition of Control. Under the federal Change in Bank Control Act, a notice must be submitted to the Federal Reserve Board if any person (including a company), or group acting in concert, seeks to acquire direct or indirect “control” of a savings and loan holding company or savings association. Under certain circumstances, a change of “control” may occur, and prior notice is required, upon the acquisition of 10% or more of the voting stock of a savings and loan holding company or savings institution, unless the Federal Reserve Board has found that the acquisition will not result in a change of control. Under the Change in Bank Control Act, the Federal Reserve Board has 60 days from the filing of a complete notice to act, taking into consideration certain factors, including the financial and managerial resources of the acquirer and the anti-trust effects of the acquisition. Any company that so acquires control would then be subject to regulation as a savings and loan holding company.

 

Federal Securities Laws

 

Ottawa Bancorp, Inc. common stock is registered with the Securities and Exchange Commission under the Securities Exchange Act of 1934. Ottawa Bancorp, Inc. is subject to the information, proxy solicitation, insider trading restrictions and other requirements under the Securities Exchange Act of 1934.

 

FEDERAL AND STATE TAXATION

 

Federal Income Taxation

 

General. The following discussion of tax matters is intended only as a summary and does not purport to be a comprehensive description of the tax rules applicable to us. We report our income on a calendar year basis using the accrual method of accounting. The federal income tax laws apply to us in the same manner as to other corporations with some exceptions, including particularly our reserve for bad debts discussed below. Our federal income tax returns have been either audited or closed under the statute of limitations through tax year 2016. For its 2019 fiscal year, Ottawa Savings Bank’s maximum federal income tax rate was 21%.

 

On December 22, 2017, the Tax Cuts and Jobs Act was enacted, which amended the Internal Revenue Code of 1986, reducing tax rates and modifying certain policies, credits, and deductions for individuals and businesses. Included in this legislation was a reduction of the federal corporate income tax rate from 35% to 21%. As a result of this reduction, we were required to revalue our existing net deferred tax assets, which resulted in a charge to income tax expense during the fourth quarter of 2017. The Tax Cuts and Jobs Act also added limitations on the deductibility of business interest expense. While this limitation should not impact the deductibility of the Company’s interest expense, the limitation could impact our commercial borrowers. The Tax Cuts and Jobs Act also includes changes to personal income taxes that may impact the Bank’s borrowers, including: (i) a lower limit on the deductibility of mortgage interest on single-family residential mortgages; (ii) the elimination of interest deductions for home equity loans; and (iii) a limitation on the deductibility of property taxes and state and local income taxes.

 

Bad Debt Reserves. For fiscal years beginning before June 30, 1996, thrift institutions that qualified under certain definitional tests and other conditions of the Internal Revenue Code were permitted to use certain favorable provisions to calculate their deductions from taxable income for annual additions to their bad debt reserve. A reserve could be established for bad debts on qualifying real property loans, generally secured by interests in real property improved or to be improved, under the percentage of taxable income method or the experience method. The reserve for non-qualifying loans was computed using the experience method. Federal legislation enacted in 1996 repealed the reserve method of accounting for bad debts for institutions with assets in excess of $500 million and the percentage of taxable income method for all institutions for tax years beginning after 1995 and requires savings institutions to recapture or take into income certain portions of their accumulated bad debt reserves. Approximately $2.3 million of our accumulated bad debt reserves would not be recaptured into taxable income unless Ottawa Savings Bank makes a “non-dividend distribution” to Ottawa Bancorp, Inc. as described below.

 

Distributions. If Ottawa Savings Bank makes “non-dividend distributions” to Ottawa Bancorp, Inc., the distributions will be considered to have been made from Ottawa Savings Bank’s un-recaptured tax bad debt reserves, to the extent of the “non-dividend distributions,” and then from Ottawa Savings Bank’s supplemental reserve for losses on loans, to the extent of those reserves, and an amount based on the amount distributed, but not more than the amount of those reserves, will be included in Ottawa Savings Bank’s taxable income. Non-dividend distributions include distributions in excess of Ottawa Savings Bank’s current and accumulated earnings and profits, as calculated for federal income tax purposes, distributions in redemption of stock, and distributions in partial or complete liquidation. Dividends paid out of Ottawa Savings Bank’s current or accumulated earnings and profits will not be so included in Ottawa Savings Bank’s taxable income.

 

 

The amount of additional taxable income triggered by a non-dividend is an amount that, when reduced by the tax attributable to the income, is equal to the amount of the distribution. Therefore, if Ottawa Savings Bank makes a non-dividend distribution to Ottawa Bancorp, Inc., approximately one and one-half times the amount of the distribution not in excess of the amount of the reserves would be includable in income for federal income tax purposes, assuming a 21% federal corporate income tax rate. Ottawa Savings Bank does not intend to pay dividends that would result in a recapture of any portion of its bad debt reserves.

 

State Taxation

 

Ottawa Savings Bank is required to file Illinois income tax returns and pay tax at an effective tax rate of approximately 9.5% of Illinois taxable income. For these purposes, Illinois taxable income generally means federal taxable income subject to certain modifications, primarily the exclusion of interest income on United States obligations.

 

 

ITEM 1A. RISK FACTORS

 

Our origination or purchase of non-residential real estate, multi-family, commercial or construction loans may expose us to increased lending risks.

 

Our loan portfolio includes non-residential real estate, multi-family, commercial and construction loans. We intend to continue to underwrite loans of this nature when it is prudent to do so from a business standpoint as long as the loans fall within internal policy limits and enable us to remain in compliance with regulatory guidelines and limits. These types of loans generally expose a lender to greater risk of non-payment and loss than one-to-four family residential mortgage loans because repayment of the loans often depends on the successful operation of the property and the income stream of the borrowers. Such loans typically involve larger loan balances to single borrowers or groups of related borrowers compared to one-to-four family residential mortgage loans. Also, many of these types of borrowers have more than one loan outstanding with us. Consequently, an adverse development with respect to one loan or one credit relationship can expose us to a significantly greater risk of loss compared to an adverse development with respect to a one- to-four family residential mortgage loan.

 

Our origination of non-owner occupied one-to-four family residential mortgage loans may expose us to increased lending risks.

 

At December 31, 2019, loans secured by non-owner occupied one-to-four family residential properties totaled $29.2 million, or 18.8% of our total residential loan portfolio. We intend to continue to make loans secured by non-owner occupied one-to-four family residential properties in the future. Loans secured by non-owner occupied properties generally expose a lender to greater risk of non-payment and loss than loans secured by owner occupied properties because repayment of such loans depend primarily on the tenant’s continuing ability to pay rent to the property owner, who is our borrower, or, if the property owner is unable to find a tenant, the property owner’s ability to repay the loan without the benefit of a rental income stream. In addition, the physical condition of non-owner occupied properties is often below that of owner occupied properties due to lax property maintenance standards, which has a negative impact on the value of the collateral properties.

 

Our allowance for loan losses may prove to be insufficient to absorb potential losses in our loan portfolio.

 

We established our allowance for loan losses and maintain it at a level considered adequate by management to absorb loan losses that are inherent in the portfolio. The amount of future loan losses is susceptible to changes in economic, operating and other conditions, including changes in interest rates, which may be beyond our control, and such losses may exceed current estimates. At December 31, 2019, our allowance for loan losses as a percentage of total gross loans was 1.17% and as a percentage of total non-performing loans was approximately 130.42%. Because of the concentration of one-to-four family, non-residential and commercial loans in our loan portfolio, the movement of a small number of loans to non-performing status can have a significant impact on this ratio. Although management believes that the allowance for loan losses as of December 31, 2019, was adequate to absorb losses on any existing loans that may become uncollectible, in light of the current economic environment, we cannot predict loan losses with certainty, and we cannot assure you that our allowance for loan losses will prove sufficient to cover actual loan losses in the future, particularly if economic conditions worsen beyond what management currently expects. Additional provisions to the allowance for loan losses and loan losses in excess of our allowance for loan losses may adversely affect our business, financial condition and results of operations.   For additional details, see “Management’s Discussion and Analysis of Financial Condition and Results of Operation -- Comparison of Financial Condition at December 31, 2019 and December 31, 2018-- Provision for Loan Losses.”

 

We may not be able to realize our deferred tax asset.

 

We recognize deferred tax assets and liabilities based on differences between the financial statement carrying amounts and the tax bases of assets and liabilities. At December 31, 2019, we had $1.7 million of net deferred tax assets. We have determined that no valuation allowance is required as of December 31, 2019, although there is no guarantee that those assets will be fully recognizable in future periods. Management regularly reviews the net deferred tax asset for recoverability based on our history of earnings, expectations for future earnings and expected timing of reversals of temporary differences. Realization of the net deferred tax asset ultimately depends on the existence of sufficient taxable income, including taxable income in prior carryback years, as well as future taxable income. At December 31, 2019, we had federal net operating loss carry forwards of $0.4 million. The federal net operating loss carry forwards will begin to expire in 2034. Future events such as the expiration of net operating loss carry forwards, capital raises or transactions that result in a change in control, could trigger the application of certain tax laws which materially limit the utilization of the net deferred tax assets. This is a complex analysis and requires us to make certain judgments in determining the annual limitation. It is possible that we could ultimately not be able to use or lose a significant portion of the net deferred tax assets. Realization of our net deferred tax assets would significantly improve our earnings and capital.

 

 

The outbreak of the recent coronavirus (“COVID-19”), or an outbreak of another highly infectious or contagious disease, could adversely affect our business, financial condition and results of operations. 

 

Our business is dependent upon the willingness and ability of its customers to conduct banking and other financial transactions. The spread of a highly infectious or contagious disease, such as COVID-19, could cause severe disruptions in the U.S. economy, which could in turn disrupt the business, activities, and operations of our customers, as well the business and operations of the Company and the Bank. Moreover, since the beginning of January 2020, the coronavirus outbreak has caused significant disruption in the financial markets both globally and in the United States. The spread of COVID-19, or an outbreak of another highly infectious or contagious disease, may result in a significant decrease in business and/or cause our customers to be unable to meet existing payment or other obligations to us, particularly in the event of a spread of COVID-19 or an outbreak of an infectious disease in our market area. Although we maintain contingency plans for pandemic outbreaks, a spread of COVID-19, or an outbreak of another contagious disease, could also negatively impact the availability of our key personnel necessary to conduct the business of Company and the Bank. Such a spread or outbreak could also negatively impact the business and operations of third party service providers who perform critical services for our business. If COVID-19, or another highly infectious or contagious disease, spreads or the response to contain COVID-19 is unsuccessful, we could experience a material adverse effect on our business, financial condition, and results of operations.

 

Fiscal challenges facing the U.S government could negatively impact financial markets which in turn could have an adverse effect on our financial position or results of operations.

 

Many of our investment securities are issued by the U.S. government and government agencies and sponsored entities. Future uncertain domestic political conditions could result in the possibility of the federal government defaulting on its obligations for a period of time due to debt ceiling limitations or other unresolved political issues, investments in financial instruments issued or guaranteed by the federal government pose liquidity risks. In 2011, Standard & Poor’s lowered its long term sovereign credit rating on the U.S. from AAA to AA+. A further downgrade or a downgrade by other rating agencies, as well as sovereign debt issues facing the governments of other countries, could have a material adverse impact on financial markets and economic conditions in the U.S. and worldwide. Additionally, the U.S. government and the governments of other countries took steps to stabilize the financial system, including investing in financial institutions, and implementing programs to improve general economic conditions, but there can be no assurances that these efforts will restore long-term stability and that they will not result in adverse unintended consequences.

 

Fluctuations in interest rates could reduce our profitability and affect the value of our assets.

 

 Our net income depends to a great extent upon the level of our net interest income. Changes in interest rates can increase or decrease net interest income and net income. Net interest income is the difference between the interest income earned on loans, investments, and other interest-earning assets, and the interest paid on interest-bearing liabilities, such as deposits and borrowings. Net interest income is affected by changes in market interest rates, because different types of assets and liabilities may react differently, and at different times, to market interest rate changes. When interest-bearing liabilities mature or re-price more quickly than interest-earning assets in a period, an increase in market rates of interest could reduce net interest income. Similarly, when interest-earning assets mature or re-price more quickly than interest-bearing liabilities, falling interest rates could reduce net interest income. 

 

Changes in market interest rates are affected by many factors beyond our control, including inflation, unemployment, money supply, international events, and events in world financial markets. The Company attempts to manage its risk from changes in market interest rates by adjusting the rates, maturity, re-pricing, and balances of the different types of interest-earning assets and interest-bearing liabilities, but interest rate risk management techniques are not exact. As a result, a rapid increase or decrease in interest rates could have an adverse effect on our net interest margin and results of operations. Changes in the market interest rates for types of products and services in various markets also may vary significantly from location to location and over time based upon competition and local or regional economic factors.

 

Strong competition within our market area could hurt our profits and slow growth.

 

We face intense competition both in making loans and attracting deposits. This competition has made it more difficult for us to make new loans and at times has forced us to offer higher deposit rates. Price competition for loans and deposits might result in us earning less on our loans and paying more on our deposits, which reduces net interest income. According to data obtained from the FDIC, as of June 30, 2019, we held approximately 7.2% of all bank and thrift deposits in LaSalle County, which was the 5^th largest market share of deposits out of 22 financial institutions (excluding credit unions) in LaSalle County. For Grundy County, we held approximately 3.0% of all bank and thrift deposits which was the 8^th largest market share of deposits out of 13 financial institutions (excluding credit unions). We face substantial competition from the other financial institutions that operate in our market area, most of which have substantially greater resources and lending limits than we have and may offer services that we do not provide. We expect competition to increase in the future as a result of legislative, regulatory and technological changes and the continuing trend of consolidation in the financial services industry. Our profitability depends upon our continued ability to compete successfully in our market area.

 

 

Our small size makes it more difficult for us to compete.

 

Our small asset size makes it more difficult to compete with other financial institutions which are generally larger and can more easily afford to invest in the marketing and technologies needed to attract and retain customers. Because our principal source of income is the net interest income we earn on our loans and investments after deducting interest paid on deposits and other sources of funds, our ability to generate the revenues needed to cover our expenses and finance such investments is limited by the size of our loan and investment portfolios. Accordingly, we are not always able to offer new products and services as quickly as our competitors. Our ability to originate larger loans is limited by our lower loans to one borrower limit, which reduces our ability to compete for certain types of loans and can reduce our interest income. Our lower earnings also make it more difficult to offer competitive salaries and benefits. In addition, our smaller customer base makes it difficult to generate meaningful non-interest income. Finally, as a smaller institution, we are disproportionately affected by the ongoing increased costs of compliance with banking and other regulations.

 

Future expansion strategy may negatively impact our earnings.

 

We consider our primary market area to consist of LaSalle County, Grundy County and parts of contiguous counties in Illinois. We currently operate three full-service branches with our headquarters located in Ottawa, Illinois and two additional branch locations in Marseilles and Morris, Illinois, and loan production offices in Shorewood, LaSalle, and Sandwich, Illinois. Although we do not currently have any specific plans for expansion, in the future we may consider expanding our presence throughout our market area and may also decide to pursue further expansion through the establishment of one or more branches or additional loan production offices. The profitability of any expansion policy will depend on whether the income that we generate from the additional branches we may establish will offset the increased expenses resulting from operating new branches. It may take a period of time before any new branches would become profitable, especially in areas in which we do not have an established presence. During this period, operating any new branches would likely have a negative impact on our net income.

 

The loss of any one of our senior executive officers could hurt our operations.

 

We rely heavily on our senior executive officers. The loss of any one of these officers could have an adverse effect on us because, as a small community bank, each of these officers has more responsibilities than would be typical at a larger financial institution with more employees. In addition, as a small community bank, we have fewer management level personnel who are in a position to assume the responsibilities of such officers’ positions with us should we need to find replacements for any of these senior members of management.

 

Our geographic concentration means that our performance may be affected by economic, regulatory and demographic conditions in our market area.

 

As of December 31, 2019, most of our total loans were to individuals and/or secured by properties located in our market area. As a result, our revenues and profitability are subject to prevailing economic, regulatory, demographic and other conditions in these counties. Because our business is concentrated in this area, adverse economic, regulatory, demographic or other developments that are limited to this area may have a disproportionately greater effect on us than they would have if we did business in markets outside that particular geographic area. A continued decline in local economic conditions could adversely affect the value of the real estate collateral securing our loans, and a further decline in property values would further diminish our ability to recover on defaulted loans by selling the real estate collateral, making it more likely that we would suffer losses on defaulted loans. Additionally, decreases in asset quality have required and may require further additions to our allowance for loan losses through increased provisions for loan losses, which would hurt our profits. Also, a continued decline in local economic conditions may have a greater effect on our earnings and capital than on the earnings and capital of larger financial institutions whose real estate loan portfolios are more geographically diverse. Real estate values are affected by various factors in addition to local economic conditions, including, among other things, changes in general or regional economic conditions, governmental rules or policies and natural disasters.

 

The value of our goodwill and other intangible assets may decline in the future.

 

As of December 31, 2019, we had $650,000 of goodwill and $781,000 of other intangible assets, which include core deposit intangible and mortgage servicing rights. A significant decline in our expected future cash flows, a significant adverse change in the business climate, slower growth rates or a significant and sustained decline in the price of our common stock, any or all of which could be materially impacted by many of the risk factors discussed herein, may necessitate our taking charges in the future related to the impairment of our goodwill. Future regulatory actions could also have a material impact on assessments of goodwill for impairment. If the fair value of our net assets improves at a faster rate than the market value of our reporting units, or if we were to experience increases in book values of a reporting unit in excess of the increase in fair value of equity, we may also have to take charges related to the impairment of our goodwill. If we were to conclude that a future write-down of our goodwill is necessary, we would record the appropriate charge, which could have a material adverse effect on our results of operations.

 

 

Identifiable intangible assets other than goodwill consist of core deposit intangibles and mortgage servicing rights. Adverse events or circumstances could impact the recoverability of these intangible assets including loss of core deposits, increased competition or adverse changes in the economy. To the extent these intangible assets are deemed unrecoverable, a non-cash impairment charge would be recorded, which could have a material adverse effect on our results of operations.

 

Ineffective liquidity management could adversely affect our financial results and condition.

 

Effective liquidity management is essential for the operation of our business. We require sufficient liquidity to meet customer loan requests, customer deposit maturities/withdrawals, payments on our debt obligations as they come due and other cash commitments under both normal operating conditions and other unpredictable circumstances causing industry or general financial market stress. Our access to funding sources in amounts adequate to finance our activities on terms that are acceptable to us could be impaired by factors that affect us specifically or the financial services industry or economy generally. Factors that could detrimentally impact our access to liquidity sources include a downturn in the geographic markets in which our loans and operations are concentrated or difficult credit markets. Our access to deposits may also be affected by the liquidity needs of our depositors. In particular, a majority of our liabilities are checking accounts and other liquid deposits, which are payable on demand or upon several days’ notice, while by comparison, a substantial majority of our assets were loans, which cannot be called or sold in the same time frame. Although we have historically been able to replace maturing deposits and advances as necessary, we might not be able to replace such funds in the future, especially if a large number of our depositors seek to withdraw their accounts, regardless of the reason. A failure to maintain adequate liquidity could materially and adversely affect our business, results of operations or financial condition.

 

We are a community bank and our ability to maintain our reputation is critical to the success of our business. The failure to do so may adversely affect our performance.

 

We are a community bank and our reputation is one of the most valuable assets of our business. A key component of our business strategy is to rely on our reputation for customer service and knowledge of local markets to expand our presence by capturing new business opportunities from existing and prospective customers in our market area and contiguous areas. As such, we strive to conduct our business in a manner that enhances our reputation. This is done, in part, by recruiting, hiring and retaining employees who share our core values of being an integral part of the communities we serve, delivering superior service to our customers and caring about our customers. If our reputation is negatively affected by the actions of our employees, by our inability to conduct our operations in a manner that is appealing to current or prospective customers or otherwise, our business and operating results may be materially adversely affected.

 

We continually encounter technological change, and we may have fewer resources than our competitors to continue to invest in technological improvements.

 

The financial services industry continues to undergo rapid technological changes, with frequent introductions of new technology-driven products and services. In addition to serving customers better, the effective use of technology increases efficiency and enables financial institutions to reduce costs. Our future success may depend, in part, upon our ability to address the needs of our customers by using technology to provide products and services that will satisfy customer demands for convenience, as well as to create additional efficiencies in our operations. Many of our competitors have substantially greater resources to invest in technological improvements. We cannot assure you that we will be able to effectively implement new technology-driven products and services or be successful in marketing these products and services to our customers.

 

 An interruption in or breach in security of our information systems may result in a loss of customer business.

 

We rely heavily on communications and information systems to conduct our business, and while we have established policies and procedures to prevent or limit the impact of system failures, interruptions, or security breaches, there can be no guarantees that such events will not occur or that they will be adequately addressed if they do. In addition, we outsource certain aspects of our data processing and other operational functions to third-party providers. If our third-party providers encounter difficulties, or if we are unable to communicate with them, our ability to adequately process and account for transactions could be affected, and our business operations could be adversely impacted. The occurrence of any failures, interruptions, or security breaches to our systems or those of our third-party providers could result in a loss of customer business, additional regulatory scrutiny, and exposure to legal liability, which would have a material adverse effect on our business, financial condition, results of operations and cash flows.

 

 

Cyber-attacks or other security breaches could adversely affect our operations, net income or reputation.

 

We regularly collect, process, transmit and store significant amounts of confidential information regarding our customers, employees and others and concerning our own business, operations, plans and strategies. In some cases, this confidential or proprietary information is collected, compiled, processed, transmitted or stored by third parties on our behalf.

 

Information security risks have generally increased in recent years because of the proliferation of new technologies, the use of the Internet and telecommunications technologies to conduct financial and other transactions and the increased sophistication and activities of perpetrators of cyber-attacks and mobile phishing. Mobile phishing, a means for identity thieves to obtain sensitive personal information through fraudulent e-mail, text or voice mail, is an emerging threat targeting the customers of popular financial entities. A failure in or breach of our operational or information security systems, or those of our third-party service providers, as a result of cyber-attacks or information security breaches or due to employee error, malfeasance or other disruptions could adversely affect our business, result in the disclosure or misuse of confidential or proprietary information, damage our reputation, increase our costs and/or cause losses.

 

If this confidential or proprietary information were to be mishandled, misused or lost, we could be exposed to significant regulatory consequences, reputational damage, civil litigation and financial loss.

 

Although we employ a variety of physical, procedural and technological safeguards to protect this confidential and proprietary information from mishandling, misuse or loss, these safeguards do not provide absolute assurance that mishandling, misuse or loss of the information will not occur, and that if mishandling, misuse or loss of information does occur, those events will be promptly detected and addressed. Similarly, when confidential or proprietary information is collected, compiled, processed, transmitted or stored by third parties on our behalf, our policies and procedures require that the third party agree to maintain the confidentiality of the information, establish and maintain policies and procedures designed to preserve the confidentiality of the information, and permit us to confirm the third party’s compliance with the terms of the agreement. As information security risks and cyber threats continue to evolve, we may be required to expend additional resources to continue to enhance our information security measures and/or to investigate and remediate any information security vulnerabilities.

 

The trading history of our common stock is characterized by low trading volume. The value of your common stock may be subject to sudden decreases due to the volatility of the price of our common stock.

 

Although our common stock trades on the Nasdaq Capital Market (“Nasdaq”), we cannot predict the extent to which investor interest in us will lead to a more active trading market in our common stock or how liquid that market might become. A public trading market having the desired characteristics of depth, liquidity and orderliness depends upon the presence in the marketplace of willing buyers and sellers of our common stock at any given time, which presence is dependent upon the individual decisions of investors, over which we have no control.

 

The market price of our common stock may be highly volatile and subject to wide fluctuations in response to numerous factors, including, but not limited to, the factors discussed in other risk factors and the following:

 

●

actual or anticipated fluctuations in our operating results;

●

changes in interest rates;

●

changes in the legal or regulatory environment in which we operate;

●

press releases, announcements or publicity relating to us or our competitors or relating to trends in our industry;

●

changes in expectations as to our future financial performance, including financial estimates or recommendations by securities analysts and investors;

●

future sales of our common stock;

●

changes in economic conditions in our marketplace, general conditions in the U.S. economy, financial markets or the banking industry; and

●

other developments affecting our competitors or us.

 

These factors may adversely affect the trading price of our common stock, regardless of our actual operating performance, and could prevent you from selling your common stock at or above the price at which you purchased shares. In addition, the stock markets, from time to time, experience extreme price and volume fluctuations that may be unrelated or disproportionate to the operating performance of companies. These broad fluctuations may adversely affect the market price of our common stock, regardless of our trading performance.

 

 

We operate in a highly-regulated environment and we may be adversely affected by changes in laws and regulations.

 

We are subject to extensive regulation, supervision and examination by the OCC, our chartering authority and the FDIC, as insurer of our deposits. Ottawa Bancorp, Inc. and Ottawa Savings Bank are both subject to regulation and supervision by the Federal Reserve Board. Such regulation and supervision governs the activities in which an institution and its holding company may engage, and are intended primarily for the protection of the insurance fund and depositors. Regulatory authorities have extensive discretion in their supervisory and enforcement activities, including the imposition of restrictions on our operations, the classification of our assets and determination of the level of our allowance for loan losses. Any change in such regulation and oversight, whether in the form of regulatory policy, regulations, legislation or supervisory action, may have a material impact on our operations.

 

The financial services industry, as well as the broader economy, may be subject to new legislation, regulation, and government policy.

 

At this time, it is difficult to predict the legislative and regulatory changes that will result due to the upcoming election. If a new President of the United States is elected and a change in the make-up of either the Houses of Congress, the White House and/or the House of Representatives and one or all having a majority membership from the same political party or divided between the political parties. The tone of these chambers being willing to advocate for a reduction of financial services regulation, to include amendments to the Dodd-Frank Act and structural changes to the CFPB or possibly an increase in the regulations facing financial services industry. A new Administration, Congress and/or House of Representatives may also cause broader economic changes due to changes in governing ideology and governing style. New appointments to the Board of Governors of the Federal Reserve could affect monetary policy and interest rates, and changes in fiscal policy could affect broader patterns of trade and economic growth. Future legislation, regulation, and government policy could affect the banking industry as a whole, including our business and results of operations, in ways that are difficult to predict. In addition, our results of operations also could be adversely affected by changes in the way in which existing statutes and regulations are interpreted or applied by courts and government agencies.

 

We may be adversely affected by recent changes in U.S. tax laws and regulations.

 

Changes in tax laws contained in the Tax Cuts and Jobs Act, which was enacted in December 2017, included a number of provisions that will continue to impact the banking industry, borrowers and the market for residential real estate. Included in this legislation was a reduction of the corporate income tax rate from 35% to 21%. In addition, other changes included: (i) a lower limit on the deductibility of mortgage interest on single-family residential mortgage loans, (ii) the elimination of interest deductions for home equity loans, (iii) a limitation on the deductibility of business interest expense and (iv) a limitation on the deductibility of property taxes and state and local income taxes.

 

These changes in the tax laws may have an adverse effect on the market for, and valuation of, residential properties, and on the demand for such loans in the future, and could make it harder for borrowers to make their loan payments. If home ownership becomes less attractive, demand for mortgage loans could decrease. The value of the properties securing loans in our loan portfolio may be adversely impacted as a result of the changing economics of home ownership, which could require an increase in our provision for loan losses, which would reduce our profitability and could materially adversely affect our business, financial condition and results of operations.

 

The fiscal and monetary policies of the federal government and its agencies could have a material adverse effect on our earnings.

 

The Board of Governors of the Federal Reserve System regulates the supply of money and credit in the United States. Its policies determine in large part the cost of funds for lending and investing and the return earned on those loans and investments, both of which affect the net interest margin. The resultant changes in interest rates can also materially decrease the value of certain financial assets we hold, such as debt securities. Its policies can also adversely affect borrowers, potentially increasing the risk that they may fail to repay their loans. Changes in Federal Reserve Board policies are beyond our control and difficult to predict; consequently, the impact these changes on our activities and results of operations is difficult to predict.

 

 

Global economic and political conditions, tariffs and other factors beyond the Company’s control may adversely impact our business, financial condition and results of operations.

 

Negative economic events in other parts of the world may have a negative impact on the U.S. economy, and a severe market reaction to global economic or political conditions could have a material impact on our liquidity, financial condition, results of operations, and ability to meet regulatory requirements. Similarly, tariffs, retaliatory tariffs or other trade restrictions on products and materials that our customers import or export, including among others, agricultural products, could cause the prices of our customers’ products to increase which could reduce demand for such products, could cause the prices of our customers’ products to increase which could reduce demand for such products, or reduce our customer’s margins, and adversely impact their revenues, financial results and ability to service debt, which, in turn, could adversely affect our financial condition and results of operations.    

 

We may be subject to more stringent capital requirements.

 

In July 2013, the OCC and the Federal Reserve Board approved a new rule that will substantially amend the regulatory risk-based capital rules applicable to Ottawa Savings Bank. The final rule implements the “Basel III” regulatory capital reforms and changes required by the Dodd-Frank Act.

 

The final rule included new minimum risk-based capital and leverage ratios, which became effective for Ottawa Savings Bank on January 1, 2015, and refined the definition of what constitutes “capital” for purposes of calculating these ratios. Under the final rule, minimum capital requirements are: (i) a common equity Tier 1 capital ratio of 4.5%; (ii) a Tier 1 to risk-based assets capital ratio of 6% (increased from 4%); (iii) a total capital ratio of 8% (unchanged); and (iv) a Tier 1 leverage ratio of 4%. The final rule also established a “capital conservation” buffer of 2.5% and resulted in the following minimum ratios: (i) a common equity Tier 1 capital ratio of 7%; (ii) a Tier 1 to risk-based assets capital ratio of 8.5%; and (iii) a total capital ratio of 10.5%. The new capital conservation buffer requirement was phased in beginning in January 2016 at 0.625% of risk-weighted assets and increased each year until it was fully implemented in January 2019. An institution will be subject to limitations on paying dividends, engaging in share repurchases, and paying discretionary bonuses if its capital level falls below the buffer amount. These limitations will establish a maximum percentage of eligible retained income that can be utilized for such actions.

 

The application of more stringent capital requirements for Ottawa Savings Bank could among other things, result in lower returns on equity, require the raising of additional capital, and result in regulatory actions constraining us from paying dividends or repurchasing shares if we were unable to comply with such requirements.

 

The implementation of a new accounting standard could require the Company to increase its allowance for loan losses and may have a material adverse effect on its financial condition and results of operations.

 

FASB has adopted a new accounting standard that will be effective for the Company’s first fiscal year after December 15, 2022. This standard, referred to as Current Expected Credit Loss, or CECL, will require financial institutions to determine periodic estimates of lifetime expected credit losses on loans, and provide for the expected credit losses as allowances for loan losses. This will change the current method of providing allowances for loan losses that are probable, which the Company expects could require it to increase its allowance for loan losses, and will likely greatly increase the data the Company would need to collect and review to determine the appropriate level of the allowance for loan losses. Any increase in the allowance for loan losses, or expenses incurred to determine the appropriate level of the allowance for loan losses, may have a material adverse effect on the Company’s financial condition and results of operations.

 

ITEM 1B. UNRESOLVED STAFF COMMENTS

 

None.

 

ITEM 2. PROPERTIES

 

We are located and conduct our business at our main office at 925 LaSalle Street, Ottawa, Illinois, as well as at our two branch offices in Marseilles and Morris, Illinois and our loan production offices in Shorewood, Sandwich and LaSalle, Illinois. The Company believes that the current facilities are adequate to meet its present and immediately foreseeable needs.

 

 

The following table sets forth certain information relating to these facilities at December 31, 2019.

 

				Net Book
		Year		Value at
		Opened/		December		Square		Owned/
Location		Acquired		31, 2019		Footage		Leased
925 LaSalle Street, Ottawa, IL 61350		1958		$5,836,478		21,000		Owned
125 West Bluff Street, Marseilles, IL 61341		2014		$286,302		3,286		Owned
1508 Creek Drive, Morris, IL 60450		2014		$395,142		2,729		Owned
119 Joliet Street, LaSalle, IL 61301 (1)		2018		-		350		Leased (2)
566 Brook Forest Avenue, Shorewood, IL 60404 (1)		2017		-		1,239		Leased (3)
100 South Latham Street, Sandwich, IL 60548 (1)		2018		-		850		Leased (4)

_________
(1) Denotes loan production office
(2) Lease expires in August 2020
(3) Lease expires in March 2020 (4) Lease expires in June 2020

 

ITEM 3. LEGAL PROCEEDINGS

 

The Company and the Bank are not involved in any pending proceedings other than legal proceedings occurring in the ordinary course of business. Such legal proceedings, in the aggregate, are believed by management to be immaterial to the Company’s business, financial condition, results of operations and cash flows.

 

 

ITEM 4. MINE SAFETY DISCLOSURES

 

Not applicable.

 

PART II

 

ITEM 5. MARKET FOR REGISTRANT’S COMMON EQUITY, RELATED STOCKHOLDER MATTERS AND ISSUER PURCHASES OF EQUITY SECURITIES

 

The Company’s common stock is currently traded on the Nasdaq Capital Market under the symbol “OTTW”. At December 31, 2019, the Company had 304 record holders of its common stock.

 

Dividend Policy

 

The Company paid aggregate cash dividends of $0.629 per share during 2019, including a special dividend of $0.35 per share paid on April 12, 2019. We intend to pay cash dividends on a quarterly basis however, the amount of dividends to be paid will be subject to our capital requirements, our financial condition and results of operations, tax considerations, statutory and regulatory limitations, and general economic conditions. We cannot assure you that we will pay dividends in the future, or that any such dividends will not be reduced or eliminated in the future.

 

Ottawa Bancorp is subject to state law limitations and federal bank regulatory policy on the payment of dividends. Maryland law generally limits dividends if the corporation would not be able to pay its debts in the usual course of business after giving effect to the dividend or if the corporation’s total assets would be less than the corporation’s total liabilities plus the amount needed to satisfy the preferential rights upon dissolution of stockholders whose preferential rights on dissolution are superior to those receiving the distribution.

 

Dividends from the Company may depend upon receipt of dividends from the Bank. Federal and state law imposes certain limitations on dividends by savings associations. The Company files a consolidated federal tax return with the Bank. Accordingly, it is anticipated that any cash distributions made by us to our stockholders would be treated as cash dividends and not as a non-taxable return of capital for federal tax purposes.

 

 

Issuer Purchases

 

On November 7, 2018, the Company issued a press release announcing that it had approved a stock repurchase program authorizing the purchase of 337,440 shares, representing 10% of the Company’s outstanding shares of common stock.  The stock repurchase program was approved in connection with the expiration of the Company’s previously approved stock repurchase program, which occurred on November 15, 2018.  Repurchases will be conducted through open market purchases, which may include purchases under a trading plan adopted pursuant to Securities and Exchange Commission Rule 10b5-1, or through privately negotiated transactions.  Repurchases will be made from time to time depending on market conditions and other factors. 

 

The following table sets forth information regarding the Company’s repurchases of its common stock during the year ended December 31, 2019:

 

										Number of Shares				Maximum Number
										Purchased as Part				of Shares that
		Number				Average				of Publicly				may yet be
		of Shares				Price Paid				Announced				Purchased Under
		Purchased				per Share				Programs				the Program
October 1-31, 2019			3,290			$	13.09				3,290				132,547
November 1-30, 2019			3,330				13.80				3,330				129,217
December 1-31, 2019			6,960				13.92				6,960				122,257
Total			13,580			$	13.69				13,580				122,257

 

Equity Compensation Plans

 

The following table sets forth information as of December 31, 2019 about Company common stock that may be issued under the Company’s equity compensation plans. All plans were approved by the Company’s stockholders.

 

Number of Securities

Remaining Available for

Number of Securities to

Weighted Average

Future Issuance Under

be issued upon Exercise

Exercise Price

Equity Compensation

of Outstanding Options,

of Outstanding Options,

Plans (Excluding securities

Warrants and Rights

Warrants and Rights

reflected in column a)

(a)

(b)

(c)

Equity Compensation Plans Approved by Stockholders

7,500

3.57

328,503

Equity Compensation Plans not Approved by Stockholders

-

-

-

Total

7,500

5.82

328,503

 

ITEM 6. SELECTED FINANCIAL DATA

 

The following tables set forth selected financial and other data of the Company for the periods and at the dates indicated. The information should be read in conjunction with the Consolidated Financial Statements and Notes beginning on page F-1.

 

		At December 31,
		2019				2018				2017
		(In Thousands, except per share data)
Financial Condition Data:
Total Assets		$	300,532			$	292,836			$	255,400
Loans, net (1)			247,776				235,926				207,035
Securities available for sale			24,516				25,534				26,046
Deposits			236,314				223,449				182,775
Stockholders' Equity			50,711				52,824				53,102
Book Value per common share		$	16.05			$	15.73			$	15.38
Tangible Book Value per common share (2)		$	15.79			$	15.47			$	15.11

 

(1)	Net of undisbursed portion of construction loans, deferred loan (costs) fees, and allowance for loan losses.

(2)	Non-GAAP measure. Excludes goodwill and core deposit intangible.

 

 

		Years Ended December 31,
		2019				2018				2017
		(In Thousands, except per share data)
Operations Data:
Total interest and dividend income		$	12,517			$	11,099			$	9,634
Total interest expense			3,100				1,981				1,045
Net interest income			9,417				9,118				8,589
Provision for loan losses			595				528				575
Other income			2,471				2,283				2,209
Other expense			8,630				8,200				7,905
Income tax expense			726				679				1,504
Net income		$	1,937			$	1,994			$	814
Basic earnings per share		$	0.62			$	0.62			$	0.25
Diluted earnings per share		$	0.61			$	0.62			$	0.25
Dividends per share		$	0.629			$	0.265			$	0.16

 

		At or for the Years Ended
		December 31,
		2019				2018				2017
Performance Ratios:
Return on average assets			0.65	%			0.73	%			0.34	%
Return on average stockholders' equity			3.29				3.77				1.55
Average stockholders' equity to average assets			19.86				19.29				21.66
Stockholders' equity to total assets at end of period			16.87				18.04				20.79
Net interest rate spread (1)			3.17				3.39				3.70
Net interest margin (2)			3.41				3.57				3.84
Average interest-earning assets to average interest-bearing liabilities			121.54				123.14				128.39
Other expense to average assets			2.91				2.99				3.26
Efficiency ratio (3)			72.59				71.92				72.96
Dividend payout ratio			101.45				42.74				64.00
Regulatory Capital Ratios:
Total risk-based capital (to risk-weighted assets)			22.21				21.08				22.52
Tier 1 core capital (to risk-weighted assets)			20.96				19.88				21.27
Common equity Tier 1 (to risk-weighted assets)			20.96				19.88				21.27
Tier 1 leverage (to adjusted total assets)			15.00				15.16				16.21
Asset Quality Ratios:
Net charge-offs (recoveries) to average gross loans outstanding			0.11				0.16				0.18
Allowance for loan losses to gross loans outstanding			1.17				1.10				1.18
Non-performing loans to gross loans (4)			0.90				0.63				0.75
Non-performing assets to total assets (4)			0.75				0.54				0.65
Other Data:
Number of full-service offices			3				3				3

 

(1)	The net interest rate spread represents the difference between the weighted average yield on interest-earning assets and the weighted average cost of interest-bearing liabilities.
(2)	The net interest margin represents net interest income as a percent of average interest-earning assets.
(3)	The efficiency ratio represents other expense as a percent of net interest income before the provision for loan losses and other income.
(4)	Non-performing assets consist of non-performing loans, foreclosed real estate, and other foreclosed assets. Non-performing loans consist of all loans 90 days or more past due and all loans no longer accruing interest.

 

 

ITEM 7. MANAGEMENT’S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS OF OPERATION

 

General

 

This discussion and analysis reflects the Company’s consolidated financial statements and other relevant statistical data and is intended to enhance your understanding of our financial condition and results of operations. The information in this section has been derived from and should be read in conjunction with the consolidated financial statements and notes to the consolidated financial statements, which appear beginning on page F-1.

 

Our results of operations depend primarily on our net interest income. Net interest income is the difference between the interest income we earn on our interest-earning assets, consisting primarily of loans, investment securities, mortgage-backed securities and other interest-earning assets (primarily cash and cash equivalents), and the interest we pay on our interest-bearing liabilities, consisting of money market accounts, statement savings accounts, individual retirement accounts, certificates of deposit and borrowings. Our results of operations also are affected by our provisions for loan losses, non-interest income and non-interest expense. Non-interest income currently consists primarily of fees, service charges, and gains on the sale of loans. Non-interest expense currently consists primarily of salaries and employee benefits, deposit insurance premiums, directors’ fees, occupancy, data processing and professional fees. Our results of operations also may be affected significantly by general and local economic and competitive conditions, changes in market interest rates, governmental policies and actions of regulatory authorities.

 

Critical Accounting Policies

 

We consider accounting policies involving significant judgments and assumptions by management that have, or could have, a material impact on the carrying value of certain assets or on income to be critical accounting policies. We consider the allowance for loan losses to be our critical accounting policy.

 

Allowance for Loan Losses. The allowance for loan losses is an amount necessary to absorb known or inherent losses that are both probable and reasonably estimable and is established through a provision for loan losses charged to earnings. Loan losses are charged against the allowance when management believes the uncollectibility of a loan balance is confirmed. Subsequent recoveries, if any, are credited to the allowance. The allowance for loan losses is evaluated on a regular basis by management and is based upon management’s periodic review of the collectibility of the loans in light of historical experience, the nature and volume of the loan portfolio, adverse situations that may affect each borrower’s ability to repay, estimated value of any underlying collateral and prevailing economic conditions. This evaluation is inherently subjective as it requires estimates that are susceptible to significant revision as more information becomes available.

 

A loan is considered impaired when, based on current information and events, it is probable that we will be unable to collect the scheduled payments of principal or interest when due according to the contractual terms of the loan agreement. Factors considered by management in determining impairment include payment status, collateral value, and the probability of collecting scheduled principal and interest payments when due. Loans that experience insignificant payment delays and payment shortfalls generally are not classified as impaired. Management determines the significance of payment delays and payment shortfalls on a case-by-case basis, taking into consideration all of the circumstances surrounding the loan and the borrower, including the length of the delay, the reasons for the delay, the borrower’s prior payment record, and the amount of the shortfall in relation to the principal and interest owed. Impairment is measured on a loan by loan basis by either the present value of expected future cash flows discounted at the loan’s effective interest rate, the loan’s obtainable market price, or the fair value of the collateral if the loan is collateral dependent.

 

Comparison of Financial Condition at December 31, 2019 and December 31, 2018

 

The Company's total assets increased $7.7 million, or 2.63%, to $300.5 million at December 31, 2019, from $292.8 million at December 31, 2018. The increase was primarily due to an increase of $11.9 million in the net loan portfolio, an increase in time deposits of $3.0 million and an increase in loans held for sale of $1.2 million. These increases were partially offset by a decrease in cash and cash equivalents of $4.1 million, a decrease in federal funds sold of $1.5 million, a decrease in securities available for sale of $1.0 million and an overall $1.8 million decrease in the remaining other asset categories.

 

Cash and cash equivalents decreased $2.4 million, or 48.8%, to $4.3 million at December 31, 2019 from $8.4 million at December 31, 2018, primarily as a result of cash used in investing activities of $10.8 million exceeding cash provided by financing activities of $5.1 million and cash provided by operating activities of $3.3 million. The cash used in investing activities includes the purchases of available for sale securities of $3.1 million, increases in time deposits of $1.2 million, increase in loans of $12.9 million, purchase of property and equipment of $0.1 million, partially offset by sales, calls, maturities and paydowns of available for sale securities of $4.5 million, proceeds on sale of OREO of $0.2 million, decrease in federal funds sold of $1.5 million and proceeds on sale of repossessed assets of $0.3 million. The net cash provided by financing activities includes proceeds from Federal Home Loan Bank advances of $11.5 million and increases in deposits of $12.9 million, partially offset by a principal reduction in Federal Home Loan Bank advances of $14.5 million, shares repurchased and cancelled of $2.9 million and dividends paid of $1.9 million.

 

 

Federal funds sold decreased approximately $1.5 million, or 26.3%, to $4.2 million at December 31, 2019 from $5.7 million at December 31, 2018.

 

Securities available for sale decreased $1.0 million, or 3.9%, to $24.5 million at December 31, 2019 from $25.5 million at December 31, 2018. The decrease was primarily due to sales, calls and maturities of $1.4 million and pay-downs of $3.1 million, offset by $3.1 million in purchases. The remaining decreases were attributable to net amortization/accretion of premiums and discounts, and changes in unrealized gains/losses.

 

Loans, net of the allowance for loan losses, increased $11.9 million, or 5.0%, to $247.8 million at December 31, 2019 from $235.9 million at December 31, 2018. The increase in loans, net of the allowance for loan losses, was primarily due to a $13.4 million increase in one-to-four family loans, a $6.6 million increase in commercial loans and a $5.1 million increase in consumer direct loans. The increases were offset by decreases of $1.0 million in multi-family loans, $4.7 million in non-residential real estate loans and $7.5 million in purchased auto loans. The changes above are net of normal pay-downs and principal reductions.

 

Total deposits increased $12.9 million, or 5.8%, to $236.3 million at December 31, 2019 from $223.4 million at December 31, 2018. The increase is primarily due to an increase in certificates of deposit of $8.4 million, or 8.0%, and an increase in checking balances of $7.8 million, or 11.4%, partially offset by a decrease in money market balances of $2.6 million, or 10.3% and savings accounts of$0.7 million or 2.8% from December 31, 2018 to December 31, 2019. The increase in certificates of deposit is primarily due to management’s continued efforts to strategically price interest rates to position the Bank for changes in interest rate environment, and customers seeking short-term products as they determine where to invest during the current rate environment.

 

FHLB advances decreased $3.0 million, to $9.1 million at December 31, 2019 compared to $12.1 million at December 31, 2018.

 

Stockholders’ equity decreased $2.1 million to $50.7 million at December 31, 2019 from $52.8 million at December 31, 2018. The decrease reflects $2.8 million used to repurchase and cancel 204,448 outstanding shares of Company common stock and the payment of $1.9 million in cash dividends. The decreases were partially offset by an increase of $0.4 million in other comprehensive income due to an increase in the fair value of securities available for sale, net income of $1.9 million for the year ended December 31, 2019 and proceeds from stock options exercised, equity incentive plan shares issued and the allocation of ESOP shares totaling $0.3 million.    

 

Comparison of Results of Operations for the Years Ended December 31, 2019 and December 31, 2018

 

General. Net income for the year ended December 31, 2019 decreased approximately $0.1 million, or 2.9%, to $1.9 million compared to net income of $2.0 million for the year ended December 31, 2018. The decrease in net income was primarily the result of total other expense and tax expense increasing more than the increase in total other income and net interest income after provision for loan losses.

 

Net Interest Income. The following table summarizes interest and dividend income and interest expense for the years ended December 31, 2019 and 2018.

 

		Years Ended December 31,
		2019				2018				$ change				% change
		(Dollars in thousands)
Interest and dividend income:
Interest and fees on loans		$	11,541			$	10,229			$	1,312				12.83	%
Securities:
Mortgage-backed and related securities			295				281			$	14				4.98
State and municipal securities			400				409			$	(9	)			(2.20	)
Non-marketable equity securities			26				25			$	1				4.00
Interest-bearing deposits			255				155			$	100				64.52
Total interest and dividend income			12,517				11,099				1,418				12.78
Interest expense:
Deposits			2,823				1,762			$	1,061				60.22
Borrowings			277				218			$	58				26.48
Total interest expense			3,100				1,981				1,119				56.49
Net interest income		$	9,417			$	9,118			$	299				3.28	%

 

 

Net interest income increased by $0.3 million, or 3.3%, to $9.4 million for the year ended December 31, 2019, from $9.1 million for the year ended December 31, 2018. Interest and dividend income increased $1.4 million, or 12.8%, primarily due to an increase in the average balances of interest-earning assets of $21.3 million. The increase in net interest income was partially offset by an increase in interest expense as the average cost of funds increased 40 basis points to 1.36% for the year ended December 31, 2019. The net interest margin decreased by 16 basis points, or 4.48% to 3.41% during the year ended December 31, 2019.

 

Provision for Loan Losses. Management recorded a provision for loan losses of $0.6 million and $0.5 million for the years ended December 31, 2019 and 2018, respectively. The allowance for loan losses was $2.9 million, or 1.17% of total gross loans at December 31, 2019 compared to $2.6 million, or 1.10% of gross loans at December 31, 2018. Net charge-offs were $0.3 million for the year ended December 31, 2019 compared $0.4 million for the year ended December 31, 2018. General reserves were higher at December 31, 2019, when compared to December 31, 2018, primarily due to the balances in all loan categories increasing during the year ended December 31, 2019. This increase in the allowance due to loan growth was partially offset by improvements in historical loss levels. Although non-performing loans increased, the necessary reserves on non-performing loans as of December 31, 2019 were approximately $17,000 lower than they were as of December, 2018 due to the transfer of one non-performing loan to foreclosed real estate, the charge-off of the specific reserve for a non-performing loan, improvements in the payment status of several other non-performing loans and the new loans added not requiring as large of specific reserves as those removed. Management’s assessment of risk in the portfolio is reflected in the qualitative factors, as discussed on pages 11 and 12. Based on a review of the loans that were in the loan portfolio at December 31, 2019, management believes that the allowance is maintained at a level that represents its best estimate of inherent losses in the loan portfolio that were both probable and reasonably estimable.

 

Management uses available information to establish the appropriate level of the allowance for loan losses. Future additions or reductions to the allowance may be necessary based on estimates that are susceptible to change as a result of changes in economic conditions and other factors. As a result, our allowance for loan losses may not be sufficient to cover actual loan losses, and future provisions for loan losses could materially adversely affect the Company’s operating results. In addition, various regulatory agencies, as an integral part of their examination process, periodically review the Company’s allowance for loan losses. Such agencies may require the Company to recognize adjustments to the allowance based on their judgments about information available to them at the time of their examination.

 

Other Income. The following table summarizes other income for the years ended December 31, 2019 and 2018.

 

		Years Ended December 31,
		2019				2018				$ change				% change
		(Dollars in thousands)
Other income:
Gain on sale of loans, net		$	759			$	585			$	174				29.74	%
Gain on sale of foreclosed real estate			16				116				(100	)			(86.21	)
Gain on sale of repossessed assets			19				5				14				280.00
Loan origination and servicing income			949				858				91				10.61
Origination of mortgage servicing rights, net of amortization			88				23				65				282.61
Customer service fees			473				528				(55	)			(10.42	)
Increase in cash surrender value of life insurance			48				48				-				-
Other			119				120				(1	)			(0.83	)
Total other income		$	2,471			$	2,283			$	188				8.23	%

 

 

The increase in total other income was primarily due to an increase in gains on sale of loans, an increase in the origination of mortgage servicing rights, and an increase in loan origination and servicing income all of which were primarily the result of increased loan volume in 2019. These increases were partially offset by a decrease in customer service fees and a decrease in gain on sale of foreclosed real estate.

 

Other Expenses. The following table summarizes other expenses for the years ended December 31, 2019 and 2018.

 

		Years Ended December 31,
		2019				2018				$ change				% change
		(Dollars in thousands)
Other expenses:
Salaries and employee benefits		$	4,730			$	4,295			$	435				10.13	%
Directors fees			172				181			$	(9	)			(4.97	)
Occupancy			683				638			$	45				7.05
Deposit insurance premium			34				66			$	(32	)			(48.48	)
Legal and professional services			326				388			$	(62	)			(15.98	)
Data processing			682				665			$	17				2.56
Loan expense			718				725			$	(7	)			(0.97	)
Valuation adjustments and expenses on foreclosed real estate			35				26			$	9				34.62
Other			1,250				1,216			$	34				2.80
Total other expenses		$	8,630			$	8,200			$	430				5.24	%
Efficiency ratio (1)			72.59				71.92

 

(1) Computed as other expenses divided by the sum of net interest income and other income.

 

Total other expense increased $0.4 million, or 5.2%, to $8.6 million for the year December 31, 2019, as compared to $8.2 million for the year ended December 31, 2018. The increase was primarily due to higher salaries and employee benefits, occupancy, data processing and other costs. These increases were offset slightly by reductions in loan expense, deposit insurance premiums, and legal and professional fees.

 

Income Taxes. The Company recorded income tax expense of approximately $0.7 million for both of the years ended December 31, 2019 and 2018.

 

 

Average Balance Sheet

 

The following table presents for the periods indicated the total dollar amount of interest income from average interest earning assets and the resultant yields, as well as the interest expense on average interest bearing liabilities, expressed both in dollars and rates. No tax equivalent adjustments were made. All average balances are monthly average balances. Non-accruing loans have been included in the table as loans carrying a zero yield. The amortization of loan fees is included in computing interest income; however, such fees are not material.

 

		Year Ended December 31,
		2019												2018												2017
		(Dollars in Thousands)
										AVERAGE												AVERAGE												AVERAGE
		AVERAGE								YIELD/				AVERAGE								YIELD/				AVERAGE								YIELD/
		BALANCE				INTEREST				COST				BALANCE				INTEREST				COST				BALANCE				INTEREST				COST
ASSETS
Interest-earning assets
Securities, net (1)		$	24,749			$	695				2.81	%		$	25,277			$	690				2.73	%		$	37,149			$	914				2.46	%
Loans receivable, net (2)			240,855				11,541				4.79	%			221,885				10,229				4.61	%			183,508				8,678				4.73	%
Non-marketable equity securities			852				26				3.05	%			776				25				3.22	%			766				12				1.57	%
Other investments			9,970				255				2.56	%			7,222				155				2.15	%			2,476				30				1.21	%
Total interest-earning assets			276,426			$	12,517				4.53	%			255,160			$	11,099				4.35	%			223,899			$	9,634				4.30	%
Non-interest-earning assets			19,926												19,336												18,778
TOTAL ASSETS		$	296,352											$	274,496											$	242,677
LIABILITIES AND EQUITY
Interest-bearing liabilities
Money Market accounts		$	23,416			$	61				0.26	%		$	26,837			$	75				0.28	%		$	29,961			$	74				0.25	%
Savings accounts			26,713				19				0.07	%			26,148				19				0.07	%			26,229				19				0.07	%
Certificates of Deposit accounts			111,866				2,252				2.01	%			101,025				1,484				1.47	%			83,283				854				1.03	%
Checking accounts			53,941				491				0.91	%			42,340				185				0.44	%			29,047				16				0.06	%
Advances and borrowed funds			11,496				277				2.41	%			10,856				218				2.01	%			5,866				82				1.40	%
Total interest-bearing liabilities			227,432				3,100				1.36	%			207,206				1,981				0.96	%			174,386				1,045				0.60	%
Non-interest-bearing liabilities			10,052												14,239												15,736
TOTAL LIABILITIES			237,484												221,445												190,122
EQUITY			58,868												52,961												52,555
TOTAL LIABILITIES AND EQUITY		$	296,352											$	274,406											$	242,677
NET INTEREST INCOME						$	9,417											$	9,118											$	8,589
NET INTEREST RATE SPREAD (3)											3.17	%											3.39	%											3.70	%
NET INTEREST MARGIN (4)											3.41	%											3.57	%											3.84	%
RATIO OF AVERAGE INTEREST- EARNING ASSETS TO AVERAGE
INTEREST-BEARING LIABILITIES											121.54	%											123.14	%											128.39	%

 

(1) Includes unamortized discounts and premiums

(2) Amount is net of deferred loan origination (costs) fees, undisbursed loan funds, unamortized discounts and allowance for loan losses and includes non-performing loans.

(3) Net interest rate spread represents the difference between the yield on average interest-earning assets and the average cost of interest-bearing liabilities.

(4) Net interest margin represents net interest income divided by average interest-earning assets.

 

 

Rate/Volume Analysis

 

The following table shows the dollar amount of changes in interest income and interest expense for major components of interest-earning assets and interest-bearing liabilities. It distinguishes between the changes related to changes in outstanding balances and those due to the changes in interest rates. For each category of interest-earning assets and interest-bearing liabilities, information is provided on changes attributable to (i) changes in volume (i.e., changes in volume multiplied by old rate) and (ii) changes in rate (i.e., changes in rate multiplied by old volume). For purposes of this table, changes attributable to both rate and volume, which cannot be segregated, have been allocated proportionately to the change due to volume and the change due to rate.

 

		Year Ended December 31,
		2019 COMPARED TO 2018												2018 COMPARED TO 2017
		INCREASE (DECREASE) DUE TO												INCREASE (DECREASE) DUE TO
		VOLUME				RATE				NET				VOLUME				RATE				NET
		(Dollars in Thousands)
Interest earned on
Securities, net		$	(15	)		$	20			$	5			$	(324	)		$	100			$	(224	)
Loans receivable, net			909				403				1,312				1,771				(220	)			1,551
Non-marketable equity securities			2				(1	)			1				-				13				13
Other investments			70				30				100				102				23				125
Total interest-earning assets		$	967			$	451			$	1,418			$	1,544			$	(84	)		$	1,465
Interest expense on
Money Market accounts		$	(9	)		$	(5	)		$	(14	)		$	(9	)		$	9			$	-
Certificates of Deposit accounts			218				550				768				265				365				630
Checking accounts			106				200				306				60				109				169
Borrowed funds			15				44				59				101				36				137
Total interest-bearing liabilities			331				788				1,119				417				519				936
Change in net interest income		$	636			$	(337	)		$	299			$	1,132			$	(603	)		$	529

 

Management of Market Risk

 

General. The majority of our assets and liabilities are monetary in nature. Consequently, our most significant form of market risk is interest rate risk. Our assets, consisting primarily of residential mortgage loans, have longer maturities than our liabilities, consisting primarily of deposits. As a result, a principal part of our business strategy is to manage interest rate risk and reduce the exposure of our net interest income to changes in market interest rates. Accordingly, our Board of Directors has established an Asset/Liability Management Committee which is responsible for evaluating the interest rate risk inherent in our assets and liabilities, for determining the level of risk that is appropriate given our business strategy, operating environment, capital, liquidity and performance objectives, and for managing this risk consistent with the guidelines approved by the Board of Directors. Senior management monitors the level of interest rate risk on a regular basis and the Asset/Liability Management Committee, which consists of senior management operating under a policy adopted by the Board of Directors, meets as needed to review our asset/liability policies and interest rate risk position.

 

We have sought to manage our interest rate risk in order to limit the exposure of our earnings and capital to changes in interest rates. In an attempt to accomplish this, we offer a variety of loan products, some of which are based on the prime rate and some loan products that adjust on one- to-five year intervals, based on various indices including the prime rate and U.S. Treasury securities. To shorten asset duration, we purchase investments, which are usually three to five years in length, as well as balance our investment purchases to ensure extension risk is minimized. In addition, we have attempted to lengthen the maturities of our deposit accounts by offering proportionately higher interest rates for longer terms, 3-5 year certificate accounts and by increasing our core deposits, in which the overall balances are generally less volatile to interest rate fluctuations than certificate accounts.

 

For additional information on our risk management strategy, see the sections entitled, “Item 1. Business – Delinquent Loans,” “Item 1. Business – Nonperforming Assets,” “Item 1. Business Ratios,” and “Item 1. Business - Allowance for Loan Losses.”

 

Net Portfolio Value. The net present value of an institution’s cash flow from assets, liabilities and off-balance sheet items (the institution’s net portfolio value or “NPV”) would change in the event of a range of assumed changes in market interest rates. The Company has engaged a third-party provider to value its portfolios. The model utilized by the Company’s third-party provider utilizes a discounted cash flow analysis and an option-based pricing approach to measure the interest rate sensitivity of net portfolio value. The model estimates the economic value of each type of asset, liability and off-balance sheet contract under the assumption that the United States Treasury yield curve increases by 100 to 300 basis points, or decreases by 100 basis points instantaneously. A basis point equals one-hundredth of one percent, and 100 basis points equals one percent. An increase in interest rates from 3% to 4% would mean, for example, a 100 basis point increase in the “Change in Interest Rates” column below.

 

 

The tables below set forth, as of the periods indicated, net portfolio value and the estimated changes in our net portfolio value that would result from the designated instantaneous changes in the United States Treasury yield curve.

 

			Year Ended December 31, 2019
															Net Portfolio Value As A
			Net Portfolio Value												Percentage Of Present Value Assets
Change In
Interest Rates			Estimated				Amount				Percent Of				NPV				Change In
(Basis Points)			NPV				Of Change				Change				Ratio				Basis Points
			(Dollars In Thousands)
+400			$	50,495			$	(9,984	)			-16.51	%			18.10	%			(150	)
+300				53,847				(6,632	)			-10.97	%			18.80	%			(90	)
+200				56,692				(3,787	)			-6.26	%			19.30	%			(40	)
+100				58,984				(1,495	)			-2.47	%			19.60	%			(10	)
0				60,479				-				-				19.70	%			-
-100				60,976				497				0.82	%			19.40	%			(30	)
-200				61,980				1,501				2.48	%			19.40	%			-

 

			Year Ended December 31, 2018
															Net Portfolio Value As A
			Net Portfolio Value												Percentage Of Present Value Assets
Change In
Interest Rates			Estimated				Amount				Percent Of				NPV				Change In
(Basis Points)			NPV				Of Change				Change				Ratio				Basis Points
			(Dollars In Thousands)
+400			$	54,362			$	(10,286	)			-15.91	%			20.30	%			(150	)
+300				57,194				(7,454	)			-11.53	%			20.80	%			(120	)
+200				60,293				(4,355	)			-6.74	%			21.40	%			(60	)
+100				62,977				(1,671	)			-2.58	%			21.80	%			(20	)
0				64,648				-				-				22.00	%			-
-100				65,327				679				1.05	%			21.80	%			(20	)
-200				65,301				(26	)			-0.04	%			21.40	%			(40	)

  

The table above indicates that at December 31, 2019, in the event of a 100-basis point increase in interest rates, we would experience a decrease of approximately 2.5% in net portfolio value. In the event of a 200-basis point increase in interest rates, we would experience a decrease of approximately 6.3% in net portfolio value. For a 300-basis point increase in interest rates, we would experience a decreased value of approximately 10.9% in net portfolio value. In the event of a 400-basis point increase in interest rates, we would experience a decrease of approximately 16.5% in net portfolio value. In the event of a 100-basis point decrease in interest rates, we would experience an increase of approximately 0.8% in net portfolio value. In the event of a 200-basis point decrease in interest rates, we would experience an increase of approximately 2.5% in net portfolio value.

 

Certain shortcomings are inherent in the methodology used in the above interest rate risk measurement. Modeling changes in net portfolio value requires making certain assumptions that may or may not reflect the manner in which actual yields and costs respond to changes in market interest rates. In this regard, the net portfolio value table presented assumes that the composition of our interest-sensitive assets and liabilities existing at the beginning of a period remains constant over the period being measured and assumes that a particular change in interest rates is reflected uniformly across the yield curve regardless of the duration or re-pricing of specific assets and liabilities. Accordingly, although the net portfolio value table provides an indication of our interest rate risk exposure at a particular point in time, such measurements are not intended to and do not provide a precise forecast of the effect of changes in market interest rates on our net interest income and will differ from actual results.

 

 

Liquidity and Capital Resources

 

We maintain liquid assets at levels we believe are adequate to meet our liquidity needs. Our liquidity ratio averaged 6.13% for the year ended December 31, 2019 compared to 5.00% for the year ended December 31, 2018. We adjust our liquidity levels to fund deposit outflows, pay real estate taxes on mortgage loans, repay our borrowings, and to fund loan commitments. We also adjust liquidity as appropriate to meet asset and liability management objectives.

 

Our liquidity ratio cannot be calculated using amounts disclosed in our consolidated financial statements, as many of the calculations involve monthly, quarterly, or annual averages. To calculate our liquidity ratio, the average liquidity base from the prior month is used as the denominator to calculate a daily liquidity ratio. The liquidity base consists of savings account balances, certificate of deposit balances, checking and money market balances, deposit loans and borrowings. The daily balances of these components are averaged to arrive at the liquidity base for the month, and the daily cash balances in selected general ledger accounts are used to derive our liquidity position. A daily liquidity ratio is calculated using the liquidity for the day divided by the prior month’s average liquidity base. At the end of each month, a monthly liquidity position is calculated using the average liquidity position for the month divided by the prior month’s average liquidity base. To calculate quarterly and annual liquidity ratios, we take the average liquidity for the three- or twelve-month period, respectively, and average it.

 

We maintain a liquidity ratio policy that establishes a target range of 1% to 5% for the liquidity ratio to assist in the management of this metric. However, during the existing low interest rate environment, we have strategically allowed this metric to at times be above 5% to provide for the effective management of extension risk and other interest rate risks.

 

Our primary sources of liquidity are deposits, amortization and prepayment of loans and mortgage-backed securities, maturities of investment securities, other short-term investments, earnings, and funds provided from operations. While scheduled principal repayments on loans and mortgage-backed securities are a relatively predictable source of funds, deposit flows and loan prepayments are greatly influenced by market interest rates, economic conditions, and rates offered by our competition. We set the interest rates on our deposits to maintain a desired level of total deposits. In addition, we invest excess funds in short-term interest-earning assets, which provide liquidity to meet lending requirements.

 

Our cash flows are derived from operating activities, investing activities and financing activities as reported in our Consolidated Statements of Cash Flows included with the Consolidated Financial Statements which begin on page F-1 of this Form 10-K.

 

Our primary investing activities are the origination and purchase of one-to-four family, non-residential and multi-family real estate and other loans, including loans originated for sale, and the purchase of investment securities. For the years ended December 31, 2019 and 2018, our loan originations totaled $68.1 million and $79.5 million, respectively. For the year ended December 31, 2019, we purchased loans totaling $8.5 million, compared to the purchase of loans totaling $17.6 million for the year ended December 31, 2018. For the years ended December 31, 2019 and 2018, we received $18.4 million and $20.4 million, respectively, from the sale of loans, resulting in gains of $0.8 million and $0.6 million, respectively. Cash received from the sales, calls, maturities and pay-downs on securities totaled $4.5 million and $4.3 million for the years ended December 31, 2019 and 2018 respectively. We purchased $3.1 million and $4.2 million in securities for the years ended December 31, 2019 and 2018, respectively. For a more detailed breakdown of our loan activity, see the section entitled “Item 1. Business-Lending Activities.”

 

Deposit flows are generally affected by the level of interest rates, the interest rates and products offered by local competitors, and other factors. Deposits increased $12.9 million for the year ended December 31, 2019 and increased $40.6 million for the year ended December 31, 2018. For a more detailed breakdown of our deposit activity, see the section entitled “Item 1. Business-Deposit Activities and Other Sources of Funds.” 

 

Liquidity management is both a daily and long-term function of business management. If we require funds beyond our ability to generate them internally, borrowing agreements exist with the Federal Home Loan Bank of Chicago (“FHLBC”) to provide advances and with Bankers Bank of Wisconsin to purchase Federal Funds. As a member of the FHLBC, we are required to own capital stock in the Federal Home Loan Bank of Chicago and are authorized to apply for advances on the security of such stock and certain of our mortgage loans and other assets (principally securities which are obligations of, or guaranteed by, the United States), provided certain standards related to credit-worthiness have been met. We had an available borrowing limit of $65.8 million and $74.6 million from the FHLBC as of December 31, 2019 and 2018, respectively. In addition, as of December 31, 2019 and 2018, the Bank had $7.9 million of available credit from Bankers Bank of Wisconsin to purchase Federal Funds. Additionally, at December 31, 2019 and 2018, we had a $5.0 million line of credit available with Midwest Independent Bank to purchase federal funds. There were $9.1 million and $12.1 million, respectively of Federal Home Loan Bank advances at December 31, 2019 and 2018 and no Federal Funds purchased outstanding at December 31, 2019 and 2018.

 

 

At December 31, 2019, we had outstanding commitments to originate loans of $6.9 million, unfunded commitments under lines of credit of $14.1 million, unfunded commitments on construction loans of $5.0 million, and $10.0 thousand unfunded standby letters of credit. At December 31, 2019, certificates of deposit scheduled to mature in less than one year totaled $56.8 million. Based on prior experience, management believes that a significant portion of such deposits will remain with us, although there can be no assurance that this will be the case. In the event a significant portion of our deposits are not retained by us, we will have to utilize other funding sources, such as FHLBC advances, in order to maintain our level of assets. Alternatively, we could reduce our level of liquid assets, such as our cash and cash equivalents. In addition, the cost of such deposits may be significantly higher if market interest rates are higher at the time of renewal.

 

The Company is a separate legal entity from Ottawa Savings Bank and must provide for its own liquidity. In addition to its operating expenses, the Company is responsible for paying any dividends declared to its shareholders, and interest and principal on outstanding debt, if any.  The Company’s primary source of income is dividends received from Ottawa Savings Bank.  The amount of dividends that Ottawa Savings Bank may declare and pay to the Company in any calendar year, without the receipt of prior approval from the Federal Reserve Board, but with prior notice to the Federal Reserve Board, cannot exceed net income for that year to date plus retained net income (as defined) for the preceding two calendar years. At December 31, 2019, the Company had liquid assets of $2.2 million.

 

Off-Balance Sheet Arrangements and Contractual Obligations

 

For the year ended December 31, 2019, the Company did not engage in any off-balance sheet transactions reasonably likely to have a material adverse effect on its financial condition, results of operations or cash-flows.

 

Recent Accounting Pronouncements

 

In May 2014, the FASB issued ASU No. 2014-09, Revenue from Contracts with Customers (Topic 606). ASU 2014-09 outlines a single model for companies to use in accounting for revenue arising from contracts with customers and supersedes most current revenue recognition guidance, including industry-specific guidance. ASU 2014-09 will require that companies recognize revenue based on the value of transferred goods or services as they occur in the contract and will also require additional disclosures. The new authoritative guidance was originally effective for reporting periods after December 15, 2016. In August 2015, ASU 2015-14, Revenue from Contracts with Customers (Topic 606) was issued to delay the effective date of ASU 2014-09 by one year. The FASB issued four subsequent ASUs in 2016 which are intended to improve and clarify the implementation guidance related to ASU 2014-09. The Company’s revenue is comprised of net interest income, which is explicitly excluded from the scope of ASU 2014-09, and non-interest income. The Company has completed its overall assessment of non-interest income and review of related contracts potentially affected by the guidance. The Company adopted the guidance on January 1, 2018 and a cumulative effect adjustment to retained earnings was not necessary.

 

The standard allowed the use of either the full retrospective or modified retrospective transition method. We elected to apply the modified retrospective transition method to incomplete contracts as of the initial date of application on January 1, 2018. The adoption of the new standards did not have a material impact on our financial condition or results of operations as the revenue recognition patterns under the new standards did not change significantly from our current practice of recognizing the in-scope non-interest income. In addition, we did not retroactively revise prior period amounts or record a cumulative adjustment to retained earnings upon adoption. We considered the nature, amount, timing, and uncertainty of revenue from contracts with customers and determined that significant revenue streams are sufficiently disaggregated in the consolidated statements of income.

 

Descriptions of our significant revenue-generating transactions that are within the scope of the new revenue recognition standards, which are presented in the consolidated statements of income as components of non-interest income, are as follows:

 

●

Service charges on deposit accounts. The Company earns fees from its deposit customers for transaction-based, account maintenance and overdraft services. Transaction-based fees, which include services such as ATM use fees, stop payment charges, statement rendering and ACH fees, are recognized at the time the transaction is executed as that is the point in time the Company fulfills the customer's request. Account maintenance fees, which relate primarily to monthly maintenance, are earned over the course of a month, representing the period over which the Company satisfies the performance obligation. Similarly, overdraft fees are recognized at the point in time that the overdraft occurs as this corresponds with the Company's performance obligation. Service charges on deposit accounts are withdrawn from the customer's account balance.

 

●

Gains/losses on sale of foreclosed real estate and repossessed assets. The Company records a gain or loss from the sale of foreclosed real estate and repossessed assets when control of the property transfers to the buyer, which generally occurs at the time of the executed deed. When the Company finances the sale of foreclosed real estate and repossessed assets to the buyer, the Company assesses whether the buyer is committed to perform their obligations under the contract and whether collectability of the transaction price is probable. Once these criteria are met, the foreclosed real estate and repossessed asset is derecognized and the gain or loss on sale is recorded upon the transfer of control of the property to the buyer. In determining the gain or loss on the sale, the Company adjusts the transaction price and related gain (loss) on sale if a significant component is present.

 

 

●

Other. Other noninterest income consists of other recurring revenue streams such as transaction fees, safe deposit rental income, and insurance commissions. Transaction fees primarily include check printing sales commissions, collection fees, and wire transfer fees which arise from in-branch transactions. Insurance commissions are agent commissions earned by the Company and earned upon the effective date of the bound coverage. Merchant referral income is associated with a program whereby the Company receives a share of processing revenue that is generated from clients that were referred by the Company to the service provider. Revenue is recognized at the point in time when the transaction occurs.

 

In January 2016, the FASB issued ASU 2016-01, Financial Instruments—Overall (Subtopic 825-10): Recognition and Measurement of Financial Assets and Financial Liabilities, which updates certain aspects of recognition, measurement, presentation and disclosure of financial instruments. ASU 2016-01 was effective for the Company on January 1, 2018.  The adoption of the new financial instruments standard did not have a material impact on the consolidated financial statements. There was no cumulative effect adjustment recorded with the adoption of this guidance.

 

In February 2016, the FASB issued ASU 2016-02, Leases (Topic 842). Under the new guidance in this ASU, lessees will be required to recognize the following for all leases (with the exception of short-term leases) at the commencement date: (1) a lease liability, which is a lessee`s obligation to make lease payments arising from a lease, measured on a discounted basis; and (2) a right-of-use asset, which is an asset that represents the lessee's right to use, or control the use of, a specified asset for the lease term. Under the new guidance, lessor accounting is largely unchanged. Certain targeted improvements were made to align, where necessary, lessor accounting with the lessee accounting model and Topic 606, Revenue from Contracts with Customers. The new lease guidance also simplified the accounting for sale and leaseback transactions primarily because lessees must recognize lease assets and lease liabilities. Lessees will no longer be provided with a source of off-balance sheet financing. ASU 2016-02 was effective for public business entities for fiscal years beginning after December 15, 2018, including interim periods within those fiscal years. Lessees (for capital and operating leases) and lessors (for sales-type, direct financing, and operating leases) must apply a modified retrospective transition approach for leases existing at, or entered into after, the beginning of the earliest comparative period presented in the financial statements. The modified retrospective approach would not require any transition accounting for leases that expired before the earliest comparative period presented. Lessees and lessors may not apply a full retrospective transition approach. The Company adopted the guidance on January 1, 2019 and the standard did not have a material impact on its consolidated financial statements.

 

In June 2016, the FASB issued ASU 2016-13, Financial Instruments - Credit Losses (Topic 326): Measurement of Credit Losses on Financial Instruments. ASU 2016-13 requires the measurement of all expected credit losses for financial assets held at the reporting date based on historical experience, current conditions, and reasonable and supportable forecasts and requires enhanced disclosures related to the significant estimates and judgments used in estimating credit losses, as well as the credit quality and underwriting standards of an organization’s portfolio. In addition, ASU 2016-13 amends the accounting for credit losses on available-for-sale debt securities and purchased financial assets with credit deterioration. ASU 2016-13 is effective for public business entities for fiscal years beginning after December 15, 2019, including interim periods within those fiscal years. Early adoption is permitted for fiscal years beginning after December 31, 2018, including interim periods within those fiscal years. On October 16, 2019, the FASB unanimously approved to delay the required implementation date for this guidance until fiscal years beginning after December 12, 2022 for certain entities. The delay would apply to small reporting companies (as defined by the SEC), such as the Company, non-SEC public companies and private companies. The Company is currently evaluating the provisions of ASU 2016-13, to determine the potential impact of the new accounting guidance on its consolidated financial statements.

 

In January 2017, the FASB issued ASU No. 2017-04, Intangibles – Goodwill and Other (Topic 350): Simplifying the Test for Goodwill Impairment. This ASU simplifies measurement of goodwill and eliminates Step 2 from the goodwill impairment test. The Company should perform its goodwill impairment test by comparing the fair value of a reporting unit with its carrying amount. An impairment charge should be recognized for the amount by which the carrying amount exceeds the reporting unit’s fair value. The impairment charge is limited to the amount of goodwill allocated to that reporting unit. The amendments in this update are effective for fiscal years beginning after December 15, 2019, including interim periods within those fiscal years. The Company does not believe the adoption of this standard will have a material impact on its consolidated financial statements.

 

In March 2017, the FASB issued ASU 2017-08, Receivables – Nonrefundable Fees and Other Costs (Subtopic 310-20), Premium Amortization on Purchased Callable Debt Securities, which shortens the period of amortization of the premium on certain callable debt securities to the earliest call date. Currently, generally accepted accounting principles (“GAAP”) excludes certain callable debt securities from consideration of early repayment of principal even if the holder is certain that the call will be exercised. As a result, upon the exercise of a call on a callable debt security held at a premium, the unamortized premium is recorded as a loss in earnings. ASU 2017-08 requires that premiums on certain callable debt securities be amortized to the shortest call date. Securities within the scope of this ASU are those that have explicit, noncontingent call features that are callable at fixed prices and on preset dates. This ASU was effective for annual periods beginning after December 15, 2018, including interim periods within those annual periods. The impact of adopting this ASU did not have an effect as our current bond accounting is consistent with the requirements of this guidance.

 

 

Impact of Inflation and Changing Prices

 

The consolidated financial statements and related notes of the Company have been prepared in accordance with GAAP, which generally requires the measurement of financial position and operating results in terms of historical dollars without consideration for changes in the relative purchasing power of money over time due to inflation. The impact of inflation is reflected in the increased cost of our operations. Unlike industrial companies, our assets and liabilities are primarily monetary in nature. As a result, changes in market interest rates have a greater impact on performance than the effects of inflation.

 

ITEM 7A. QUANTITATIVE AND QUALITATIVE DISCLOSURES ABOUT MARKET RISK

 

The information required by this item is incorporated herein by reference to Part II, Item 7, “Management’s Discussion and Analysis of Financial Condition and Results of Operation.”

 

ITEM 8. FINANCIAL STATEMENTS AND SUPPLEMENTARY DATA

 

The information required by this Item 8 is contained on pages F-1 through F-50 of this Form 10-K.

 

ITEM 9. CHANGES IN AND DISAGREEMENTS WITH ACCOUNTANTS ON ACCOUNTING AND FINANCIAL DISCLOSURE

 

None.

 

ITEM 9A. CONTROLS AND PROCEDURES

 

(a)

Disclosure Controls and Procedures

 

As of the end of the period covered by this report, the Company carried out an evaluation, under the supervision, and with the participation of our management, including our Chief Executive Officer and Chief Financial Officer, of the effectiveness of the design and operation of our “disclosure controls and procedures” as contemplated by Exchange Act Rule 13a-15(d). Based upon their evaluation, and as of the end of the period covered by this report, the Chief Executive Officer and Chief Financial Officer concluded that the Company’s disclosure controls and procedures are effective, in all material respects, in timely alerting them to material information relating to the Company (and its consolidated subsidiary) required to be included in the periodic reports the Company is required to file and submit to the SEC under the Exchange Act.

 

(b)

Internal Controls Over Financial Reporting

 

Management’s annual report on internal control over financial reporting is incorporated herein by reference to page 46 of this Annual Report on Form 10-K.

 

(c)

Changes to Internal Controls Over Financial Reporting

 

There were no changes in the Company's internal control over financial reporting identified in connection with the evaluation required by Exchange Act Rule 13a-15(d) that occurred during the fourth quarter of 2019 that have materially affected, or are reasonably likely to materially affect, the Company's internal control over financial reporting.

 

ITEM 9B. OTHER INFORMATION

 

None.

 

 

PART III

 

ITEM 10. DIRECTORS, EXECUTIVE OFFICERS, AND CORPORATE GOVERNANCE

 

The information required in response to this item regarding the Company’s directors, executive officers, the audit committee, the audit committee financial expert, the code of ethics and business conduct and compliance with Section 16(a) of the Exchange Act will be contained in the Company’s Proxy Statement for its Annual Meeting of Stockholders to be held on May 16, 2020 (the “Proxy Statement”) under the captions “Proposal 1—Election of Directors,” “Corporate Governance—Meetings and Committees of the Board of Directors,” “Corporate Governance—Code of Ethics and Business Conduct,” and “Section 16(a) Beneficial Ownership Reporting Compliance” and the information included therein is incorporated herein by reference.

 

ITEM 11. EXECUTIVE COMPENSATION

 

The information required in response to this item will be contained in the Proxy Statement under the caption “Executive Compensation” and the information included therein is incorporated herein by reference.

 

ITEM 12. SECURITY OWNERSHIP OF CERTAIN BENEFICIAL OWNERS AND MANAGEMENT AND RELATED STOCKHOLDER MATTERS

 

(a)

Securities Authorized for Issuance under Equity Compensation Plans. The information required in response to this item is included in Part II, Item 5, “Market for Registrant’s Common Equity, Related Stockholder Matters and Issuer Purchases of Equity Securities” and is incorporated herein by reference.

 

(b)

Stock Ownership. The information required in response to this item will be contained in the Proxy Statement under the caption “Stock Ownership” and the information included therein is incorporated herein by reference.

 

 

ITEM 13. CERTAIN RELATIONSHIPS AND RELATED TRANSACTIONS, AND DIRECTOR INDEPENDENCE

 

The information required in response to this item will be contained in the Proxy Statement under the caption “Proposal 1— Election of Directors” and “Transactions with Related Persons” and the information included therein is incorporated herein by reference.

 

ITEM 14. PRINCIPAL ACCOUNTANT FEES AND SERVICES

 

The information required in response to this item will be contained in the Proxy Statement under the caption “Proposal 2—Ratification of Independent Registered Public Accounting Firm” and the information included therein is incorporated herein by reference.

 

 

PART IV

 

ITEM 15. EXHIBITS

 

Exhibit No.		Description of Exhibits
3.1		Articles of Incorporation of Ottawa Bancorp, Inc. (incorporated by reference to Exhibit 3.1 to Company’s Registration Statement on Form S-1 (File No. 333-211860) initially filed with the Securities and Exchange Commission on June 6, 2016)
3.2		Bylaws of Ottawa Bancorp, Inc. (incorporated by reference to Exhibit 3.2 to Company’s Registration Statement on Form S-1 (File No. 333-211860) initially filed on June 6, 2016)
4.0		Form of Stock Certificate of Ottawa Bancorp, Inc. (incorporated by reference to Exhibit 4.0 to Company’s Registration Statement on Form S-1 (File No. 333-211860) initially filed on June 6, 2016)
4.1		Description of Common Stock
10.1		Ottawa Savings Bank Voluntary Deferred Compensation Plan (incorporated by reference to Exhibit 10.3 the Company’s Registration Statement on Form S-1 (File No. 333-211860) initially filed with the Securities and Exchange Commission on June 6, 2016) *
10.2		Amendment to Ottawa Savings Bank Voluntary Deferred Compensation Plan for Directors (incorporated by reference to Exhibit 10.4 the Company’s Registration Statement on Form S-1 (File No. 333-211860) initially filed with the Securities and Exchange Commission on June 6, 2016) *
10.3		Ottawa Bancorp, Inc. 2006 Equity Incentive Plan (incorporated by reference to Exhibit 10.7 the Company’s Registration Statement on Form S-1 (File No. 333-211860) initially filed with the Securities and Exchange Commission on June 6, 2016) *
10.4		Ottawa Bancorp, Inc. 2018 Equity Incentive Plan (incorporated by reference to Appendix A to the Company’s Definitive Proxy Statement on Schedule 14A (File No. 001-37914) filed with the Securities and Exchange Commission on April 11, 2018) *
10.5		Change in Control Agreement by and between Ottawa Savings Bank, Ottawa Bancorp, Inc. and Craig M. Hepner (incorporated by reference to Exhibit 10.1 to the Company’s Current Report on Form 8-K (File No. 001-37914) filed with the Securities and Exchange Commission on October 4, 2019) *
10.6		Change in Control Agreement by and between Ottawa Savings Bank, Ottawa Bancorp, Inc. and Marc N. Kingry (incorporated by reference to Exhibit 10.2 to the Company’s Current Report on Form 8-K (File No. 001-37914) filed with the Securities and Exchange Commission on October 4, 2019) *
10.7		Change in Control Agreement by and between Ottawa Savings Bank, Ottawa Bancorp, Inc. and Mark M. Stoudt (incorporated by reference to Exhibit 10.3 to the Company’s Current Report on Form 8-K (File No. 001-37914) filed with the Securities and Exchange Commission on October 4, 2019) *
21.0		Subsidiaries
23.1		Consent of RSM US, LLP

 

 

31.1		Rule 13a-14(a)/15d-14(a) Certification of Chief Executive Officer
31.2		Rule 13a-14(a)/15d-14(a) Certification of Chief Financial Officer
32.1		Section 1350 Certifications
101.0		The following materials from the Ottawa Savings Bancorp, Inc. Annual Report on Form 10-K for the year ended December 31, 2019 formatted in Extensible Business Reporting Language (XBRL): (i) the Condensed Consolidated Statements of Financial Condition, (ii) the Condensed Consolidated Statements of Operations, (iii) the Condensed Statements of Comprehensive Income; (iv) the Condensed Statements of Stockholders' Equity; (V) The Condensed Consolidated Statements of Cash Flows and (vi) related notes.
	* Indicates management contract or compensation plan or arrangement.

 

 

ITEM 16. FORM 10-K SUMMARY

 

None.

 

MANAGEMENT’S REPORT ON INTERNAL CONTROL OVER FINANCIAL REPORTING

 

The management of the Company is responsible for establishing and maintaining adequate internal control over financial reporting. The internal control process has been designed under our supervision to provide reasonable assurance regarding the reliability of financial reporting and the preparation of the Company’s consolidated financial statements for external reporting purposes in accordance with accounting principles generally accepted in the United States of America.

 

Management conducted an assessment of the effectiveness of the Company’s internal control over financial reporting as of December 31, 2019, utilizing the framework established in Internal Control – Integrated Framework of 2013 issued by the Committee of Sponsoring Organizations of the Treadway Commission (COSO). Based on this assessment, management has determined that the Company’s internal control over financial reporting as of December 31, 2019, is effective.

 

Our internal control over financial reporting includes policies and procedures that pertain to the maintenance of records that accurately and fairly reflect, in reasonable detail, transactions and dispositions of assets; and provide reasonable assurances that: (1) transactions are recorded as necessary to permit preparation of financial statements in accordance with accounting principles generally accepted in the United States; (2) receipts and expenditures are being made only in accordance with authorizations of management and the directors of the Company; and (3) unauthorized acquisition, use, or disposition of the Company’s assets that could have a material effect on the Company’s financial statements are prevented or timely detected.

 

All internal control systems, no matter how well designed, have inherent limitations. Therefore, even those systems determined to be effective can provide only reasonable assurance with respect to financial statement preparation and presentation. Also, projections of any evaluation of effectiveness to future periods are subject to the risk that controls may become inadequate because of changes in conditions, or that the degree of compliance with the policies or procedures may deteriorate.

 

This annual report does not include an attestation report of the Company’s registered public accounting firm regarding internal control over financial reporting. Management’s report was not subject to attestation by the Company’s registered public accounting firm pursuant to the rules of the Securities and Exchange Commission that permit the Company to provide only management’s report in this annual report.

 

 

 

 

 

 

 

 

Ottawa Bancorp, Inc. & Subsidiary

 

 

Consolidated Financial Statements

December 31, 2019

 

 

 

 

Ottawa Bancorp, Inc. & Subsidiary

 

 

Contents

 

 

Report of Independent Registered Public Accounting Firm	F-2
Consolidated Financial Statements
Consolidated balance sheets	F-3
Consolidated statements of operations	F-4
Consolidated statements of comprehensive income	F-5
Consolidated statements of stockholders’ equity	F-6
Consolidated statements of cash flows	F-7
Notes to consolidated financial statements	F-9

 

 

Report of Independent Registered Public Accounting Firm

 

 

 

To the Stockholders and the Board of Directors

Ottawa Bancorp, Inc. and Subsidiary

 

Opinion on the Financial Statements

We have audited the accompanying consolidated balance sheets of Ottawa Bancorp, Inc. and Subsidiary (the Company) as of December 31, 2019 and 2018, the related consolidated statements of operations, comprehensive income, stockholders’ equity and cash flows for the years then ended, and the related notes to the consolidated financial statements (collectively, the financial statements). In our opinion, the financial statements present fairly, in all material respects, the financial position of the Company as of December 31, 2019 and 2018, and the results of its operations and its cash flows for the years then ended, in conformity with accounting principles generally accepted in the United States of America.

 

Basis for Opinion

These financial statements are the responsibility of the Company’s management. Our responsibility is to express an opinion on the Company’s financial statements based on our audits. We are a public accounting firm registered with the Public Company Accounting Oversight Board (United States) (PCAOB) and are required to be independent with respect to the Company in accordance with U.S. federal securities laws and the applicable rules and regulations of the Securities and Exchange Commission and the PCAOB.

 

We conducted our audits in accordance with the standards of the PCAOB. Those standards require that we plan and perform the audit to obtain reasonable assurance about whether the financial statements are free of material misstatement, whether due to error or fraud. The Company is not required to have, nor were we engaged to perform, an audit of its internal control over financial reporting. As part of our audits we are required to obtain an understanding of internal control over financial reporting but not for the purpose of expressing an opinion on the effectiveness of the Company's internal control over financial reporting. Accordingly, we express no such opinion.

 

Our audits included performing procedures to assess the risks of material misstatement of the financial statements, whether due to error or fraud, and performing procedures that respond to those risks. Such procedures included examining, on a test basis, evidence regarding the amounts and disclosures in the financial statements. Our audits also included evaluating the accounting principles used and significant estimates made by management, as well as evaluating the overall presentation of the financial statements. We believe that our audits provide a reasonable basis for our opinion.

 

/s/ RSM US LLP

 

We have served as the Company's auditor since 2005.

 

Chicago, Illinois

March 30, 2020

 

 

Ottawa Bancorp, Inc. & Subsidiary

Consolidated Balance Sheets

December 31, 2019 and 2018

 

 

See Accompanying Notes to Consolidated Financial Statements.

 

 

Ottawa Bancorp, Inc. & Subsidiary

Consolidated Statements of Operations

Years Ended December 31, 2019 and 2018

 

 

See Accompanying Notes to Consolidated Financial Statements.

 

 

Ottawa Bancorp, Inc. & Subsidiary

Consolidated Statements of Comprehensive Income

Years Ended December 31, 2019 and 2018

 

 

See Accompanying Notes to Consolidated Financial Statements.

 

 

Ottawa Bancorp, Inc. & Subsidiary

Consolidated Statements of Stockholders' Equity

Years Ended December 31, 2019 and 2018

 

 

See Accompanying Notes to Consolidated Financial Statements.

 

 

Ottawa Bancorp, Inc. & Subsidiary

Consolidated Statements of Cash Flows

Years Ended December 31, 2019 and 2018

 

 

 

Ottawa Bancorp, Inc. & Subsidiary

Consolidated Statements of Cash Flows (continued)

Years Ended December 31, 2019 and 2018

 

 

See Accompanying Notes to Consolidated Financial Statements.

 

 

Ottawa Bancorp, Inc. & Subsidiary

Notes to Consolidated Financial Statements

 

SIGNATURES

 

In accordance with Section 13 or 15(d) of the Exchange Act, the registrant caused this report to be signed on its behalf by the undersigned, thereunto duly authorized.

 

	OTTAWA BANCORP, INC.
Date: March 30, 2020	By:	/s/    CRAIG M. HEPNER
		Craig M. Hepner
		President, Chief Executive Officer and Director

 

In accordance with the Exchange Act, this report has been signed below by the following persons on behalf of the registrant in the capacities and on the dates indicated.

 

Name		Title		Date
/s/ CRAIG M. HEPNER		President, Chief Executive Officer and		March 30, 2020
Craig M. Hepner		Director (principal executive officer)
/s/ MARC N. KINGRY		Chief Financial Officer (principal		March 30, 2020
Marc N. Kingry		accounting and financial officer)
/s/ JAMES A. FERRERO		Director		March 30, 2020
James A. Ferrero
/s/ KEITH JOHNSON		Director		March 30, 2020
Keith Johnson
/s/ ARTHUR C. MUELLER		Director		March 30, 2020
Arthur C. Mueller
/s/ JOHN M. ARMSTRONG		Director		March 30, 2020
John M. Armstrong

 

 

/s/ THOMAS M. ADLER		Director		March 30, 2020
Thomas M. Adler
/s/ WILLIAM J. KUIPER		Director		March 30, 2020
William J. Kuiper
/s/ JON L. KRANOV		Director		March 30, 2020
Jon L. Kranov

 

S-2