SECURITIES AND EXCHANGE COMMISSION
Washington, D.C.   20549

F O R M   10-K

[X] ANNUAL REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES EXCHANGE ACT OF 1934
For the fiscal year ended December 31, 2020

Commission file number: 001-36271

WATERSTONE FINANCIAL, INC.
(Exact name of registrant as specified in its charter)

Maryland
 
90-1026709
(State or other jurisdiction of incorporation or organization)
 
(I.R.S.  Employer Identification No.)
 
 
 
11200 W Plank Ct, Wauwatosa,  Wisconsin
 
53226
(Address of principal executive offices)
 
(Zip Code)

(414) 761-1000
Registrant's telephone number, including area code:

Securities registered pursuant to Section 12(b) of the Act:

Title of each class
 
 Trading Symbol
 
Name of each exchange on which registered
Common Stock, $0.01 Par Value
 
WSBF 
 
The NASDAQ Stock Market LLC

Securities registered pursuant to Section 12(g) of the Act:
NONE

Indicate by check mark whether the registrant is a well-known seasoned issuer (as defined in Rule 405 of the 1933 Act).
Yes                    No    T


Indicate by check mark whether the registrant is not required to file reports pursuant to Section 13 or Section 15(d) of the 1934 Act.
Yes                    No    T
 
Indicate by check mark whether the registrant (1) has filed all reports required to be filed by Section 13 or 15(d) of the Securities Exchange Act of 1934 during the preceding 12 months (or for such shorter period that the registrant was required to file such reports), and (2) has been subject to such filing requirements for the past 90 days.
Yes      T            No      

Indicate by check mark whether the registrant has submitted electronically every Interactive Data File required to be submitted pursuant to Rule 405 of Regulation S-T during the preceding 12 months (or for such shorter period that the registrant was required to submit such files)
Yes      T            No      

Indicate by check mark whether the registrant is a large accelerated filer, an accelerated filer, a non-accelerated filer, a smaller reporting company, or an emerging growth company.  See definitions of “large accelerated filer,” “accelerated filer,” “smaller reporting company,” and "emerging growth company" in Rule 12b-2 of the Exchange Act.

Large accelerated filer
 
Accelerated filer
 
Non-accelerated filer
 
Smaller Reporting Company
Emerging growth company
                 

If an emerging growth company, indicate by check mark if the registrant has elected not to use the extended transition period for complying with any new or revised financial accounting standards provided pursuant to Section 13(a) of the Exchange Act. o

Indicate by check mark whether the registrant has filed a report on and attestation to its management’s assessment of the effectiveness of its internal control over financial reporting under Section 404(b) of the Sarbanes-Oxley Act (15 U.S.C. 7262(b)) by the registered public accounting firm that prepared or issued its audit report. T

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

Yes                    No    T

The aggregate market value of the voting and non-voting common equity held by non-affiliates of the Registrant, computed by reference to the price at which the common equity was last sold on June 30, 2020 as reported by the NASDAQ Global Select Market®, was approximately $383.3 million.

As of February 26, 2021, 25,117,634 shares of the Registrant’s Common Stock were issued and outstanding.

DOCUMENTS INCORPORATED BY REFERENCE
 
 
Part of Form 10-K Into Which
Document
 
Portions of Document are Incorporated
Proxy Statement for Annual Meeting of
 
Part III
Shareholders on May 18, 2021
 
 




WATERSTONE FINANCIAL, INC.

FORM 10-K ANNUAL REPORT TO THE SECURITIES AND EXCHANGE COMMISSION
FOR THE YEAR ENDED DECEMBER 31, 2020
 
TABLE OF CONTENTS
 
 
 
 
ITEM
 
 
PAGE
 
 
 
 
PART I
 
 
 
 
 
 
 
1.
Business
 
3-29
1A.
Risk Factors
 
29-37
1B.
Unresolved Staff Comments
 
37
2.
Properties
 
38
3.
Legal Proceedings
 
38
4.
Mine Safety Disclosures
 
38
 
 
 
 
PART II
 
 
 
 
 
 
 
5.
Market for Registrant's Common Equity, Related Stockholders Matters and Issuer Purchases of Equity Securities
 
39-40
6.
Selected Financial Data
 
41-42
7.
Management's Discussion and Analysis of Financial Condition and Results of Operations
 
42-54
7A.
Quantitative and Qualitative Disclosures About Market Risk
 
55
8.
Financial Statements and Supplementary Data
 
56-97
9.
Changes in and Disagreements with Accountants on Accounting and Financial Disclosure
 
98
9A.
Controls and Procedures
 
98-99
9B.
Other Information
 
100
 
 
 
 
PART III
 
 
 
 
 
 
 
10.
Directors, Executive Officers and Corporate Governance
 
100
11.
Executive Compensation
 
100
12.
Security Ownership of Certain Beneficial Owners and Management and Related Stockholder Matters
 
100
13.
Certain Relationships and Related Transactions, and Director Independence
 
101
14.
Principal Accountant Fees and Services
 
101
 
 
 
 
PART IV
 
 
 
 
 
 
 
15.
Exhibits and Financial Statement Schedules
 
101-103
16.
Form 10-K Summary
 
102
 
Signatures
 
103-104
 
2


PART 1

Item 1.   Business

Forward-Looking Statements

This Annual Report on Form 10-K may contain or incorporate by reference various forward-looking statements, which can be identified by the use of words such as “estimate,” “project,” “believe,” “intend,” “anticipate,” “plan,” “seek,” “expect” and similar expressions and verbs in the future tense. These forward-looking statements include, but are not limited to:

 
Statements of our goals, intentions and expectations;
 
Statements regarding our business plans, prospects, growth and operating strategies;
 
Statements regarding the quality of our loan and investment portfolio;
 
Estimates of our risks and future costs and benefits.

These forward-looking statements are based on current beliefs and expectations of our management and are inherently subject to significant business, economic and competitive uncertainties and contingencies, many of which are beyond our control. In addition, these forward-looking statements are subject to assumptions with respect to future business strategies and decisions that are subject to change.

The following factors, among others, could cause actual results to differ materially from the anticipated results or other expectations expressed in the forward-looking statements.

 
general economic conditions, either nationally or in our market area, including employment prospects, that are different than expected;
 
the effect of any pandemic; including COVID-19;
 
competition among depository and other financial institutions;
 
inflation and changes in the interest rate environment that reduce our margins and yields, our mortgage banking revenues or reduce the fair value of financial instruments or reduce the origination levels in our lending business, or increase the level of defaults, losses or prepayments on loans we have made and make whether held in portfolio or sold in the secondary markets;
 
adverse changes in the securities or secondary mortgage markets;
 
changes in laws or government regulations or policies affecting financial institutions, including changes in regulatory fees and capital requirements;
 
changes in monetary or fiscal policies of the U.S. Government, including policies of the U.S. Treasury and the Federal Reserve Board;
 
our ability to manage market risk, credit risk and operational risk in the current economic conditions;
 
our ability to enter new markets successfully and capitalize on growth opportunities;
 
our ability to successfully integrate acquired entities;
 
decreased demand for our products and services;
 
changes in tax policies or assessment policies;
 
changes in consumer demand, spending, borrowing and savings habits;
 
changes in accounting policies and practices, as may be adopted by the bank regulatory agencies, the Financial Accounting Standards Board, the Securities and Exchange Commission or the Public Company Accounting Oversight Board;
 
our ability to retain key employees;
 
cyber attacks, computer viruses and other technological risks that may breach the security of our websites or other systems to obtain unauthorized access to confidential information and destroy data or disable our systems;
 
technological changes that may be more difficult or expensive than expected;
 
the ability of third-party providers to perform their obligations to us;
 
the effects of federal government shutdown;
 
the ability of the U.S. Government to manage federal debt limits;
 
significant increases in our loan losses; and
 
changes in the financial condition, results of operations or future prospects of issuers of securities that we own.

See also the factors regarding future operations discussed in "Management's Discussion and Analysis of Financial Condition and Results of Operations" and "Risk Factors" below.

Waterstone Financial, Inc.

Waterstone Financial, Inc., a Maryland corporation (“New Waterstone”), was organized in 2013.  Upon completion of the mutual-to-stock conversion of Lamplighter Financial, MHC in 2014, New Waterstone became the holding company of WaterStone Bank SSB and succeeded to all of the business and operations of Waterstone Financial, Inc., a Federal corporation (“Waterstone-Federal”) and each of Waterstone-Federal and Lamplighter Financial, MHC ceased to exist.  In this report, we refer to WaterStone Bank SSB, our wholly owned subsidiary, both before and after the reorganization, as “WaterStone Bank” or the “Bank.”

Waterstone Financial, Inc. and its subsidiaries, including WaterStone Bank, are referred to herein as the “Company,” “Waterstone Financial,” or “we.”

The Company maintains a website at www.wsbonline.com. We make available through that website, free of charge, copies of our Annual Reports on Form 10-K, Quarterly Reports on Form 10-Q, Current Reports on Form 8-K, amendments to those reports and proxy materials as soon as is reasonably practical after the Company electronically files those materials with, or furnishes them to, the Securities and Exchange Commission. You may access those reports by following the links under “Investor Relations” at the Company’s website. Information on this website is not and should not be considered a part of this document.

Waterstone Financial’s executive offices are located at 11200 West Plank Court, Wauwatosa, Wisconsin 53226, and its telephone number at this address is (414) 761-1000.
3



BUSINESS OF WATERSTONE BANK

General

WaterStone Bank is a community bank that has served the banking needs of its customers since 1921. WaterStone Bank also has an active mortgage banking subsidiary, Waterstone Mortgage Corporation, which had 59 offices in 22 states as of December 31, 2020.

WaterStone Bank conducts its community banking business from 14 banking offices located in Milwaukee, Washington and Waukesha counties, Wisconsin. WaterStone Bank’s principal lending activity is originating one- to four-family, multi-family residential, and commercial real estate loans for retention in its portfolio. At December 31, 2020, such loans comprised 31.0%, 41.6%, and 17.3%, respectively, of WaterStone Bank’s loan portfolio. WaterStone Bank also offers home equity loans and lines of credit, construction and land loans, commercial business loans, and consumer loans. WaterStone Bank funds its loan production primarily with retail deposits and Federal Home Loan Bank advances. Our deposit offerings include certificates of deposit, money market savings accounts, transaction deposit accounts, noninterest bearing demand accounts and individual retirement accounts. Our investment securities portfolio is comprised principally of mortgage-backed securities, government-sponsored enterprise bonds, private-label enterprise bonds, municipal obligations, and other debt securities.

WaterStone Bank is subject to comprehensive regulation and examination by the Wisconsin Department of Financial Institutions (the "WDFI") and the Federal Deposit Insurance Corporation (the "FDIC").

WaterStone Bank’s executive offices are located at 11200 West Plank Court, Wauwatosa, Wisconsin 53226, and its telephone number is (414) 761-1000.  Its website address is www.wsbonline.com. Information on this website is not and should not be considered a part of this document.

WaterStone Bank’s mortgage banking operations are conducted through its wholly-owned subsidiary, Waterstone Mortgage Corporation.  Waterstone Mortgage Corporation originates single-family residential real estate loans for sale into the secondary market.  Waterstone Mortgage Corporation utilizes lines of credit provided by WaterStone Bank as a primary source of funds, and also utilizes a line of credit with another financial institution as needed.  On a consolidated basis, Waterstone Mortgage Corporation originated approximately $4.33 billion in mortgage loans held for sale during the year ended December 31, 2020, which excludes the loans originated from Waterstone Mortgage Corporation and purchased by WaterStone Bank.

Subsidiary Activities

Waterstone Financial currently has one wholly-owned subsidiary, WaterStone Bank, which in turn has three wholly-owned subsidiaries. Wauwatosa Investments, Inc., which holds and manages our investment portfolio, is located and incorporated in Nevada. Waterstone Mortgage Corporation is a mortgage banking business incorporated in Wisconsin. Main Street Real Estate Holdings, LLC is a Wisconsin limited liability corporation and previously owned WaterStone Bank office facilities and held WaterStone Bank office facility leases.

Wauwatosa Investments, Inc.  Established in 1998, Wauwatosa Investments, Inc. operates in Nevada as WaterStone Bank’s investment subsidiary.  This wholly-owned subsidiary owns and manages the majority of the consolidated investment portfolio.  It has its own board of directors currently comprised of its President, the WaterStone Bank Chief Financial Officer, Treasury Officer and the Chairman of Waterstone Financial’s board of directors.

Waterstone Mortgage Corporation.  Acquired in 2006, Waterstone Mortgage Corporation is a mortgage banking business with offices in 22 states.  It has its own board of directors currently comprised of its President, its Chief Financial Officer, the WaterStone Bank Chief Executive Officer, Chief Financial Officer and Executive Vice President and General Counsel.

Main Street Real Estate Holdings, LLC.  Established in 2002, Main Street Real Estate Holdings, LLC was established to acquire and hold WaterStone Bank office and retail facilities, both owned and leased.  Main Street Real Estate Holdings, LLC currently conducts real estate broker activities limited to real estate owned.

Market Area

WaterStone Bank.  WaterStone Bank’s market area is broadly defined as the Milwaukee, Wisconsin metropolitan market, which is geographically located in the southeast corner of the state.  WaterStone Bank’s primary market area is Milwaukee and Waukesha counties and the five surrounding counties of Ozaukee, Washington, Jefferson, Walworth and Racine. We have nine branch offices in Milwaukee County, four branch offices in Waukesha County and one branch office in Washington County.  At June 30, 2020 (the latest date for which information was publicly available), 47.7% of deposits in the State of Wisconsin were located in the seven-county Milwaukee metropolitan market and 40.9% of deposits in the State of Wisconsin were located in the three counties in which the Bank has a branch office.

WaterStone Bank’s primary market area for deposits includes the communities in which we maintain our banking office locations. Our primary lending market area is broader than our primary deposit market area and includes all of the primary market area noted above but extends further west to the Madison, Wisconsin market and further north to the Appleton and Green Bay, Wisconsin markets.

Waterstone Mortgage Corporation.  As of December 31, 2020, Waterstone Mortgage Corporation had nine offices in Wisconsin, eight offices in each of Florida and New Mexico, four offices in Minnesota, three offices in each of Illinois and Texas, two offices in each of Arizona, Colorado, Idaho, Maryland, Ohio, Oklahoma, Oregon, and Virginia, and one office in each of Arkansas, California, Georgia, Iowa, Michigan, New Hampshire, Pennsylvania, and Tennessee.
4


Competition

WaterStone BankWaterStone Bank faces competition within our market area both in making real estate loans and attracting deposits. The Milwaukee-Waukesha metropolitan statistical area has a high concentration of financial institutions, including large commercial banks, community banks and credit unions. As of June 30, 2020, based on the FDIC annual Summary of Deposits Report, we had the ninth largest market share in our metropolitan statistical area out of 48 financial institutions, representing 1.57% of all deposits.

Our competition for loans and deposits comes principally from commercial banks, savings institutions, mortgage banking firms and credit unions. We face additional competition for deposits from money market funds, brokerage firms, and mutual funds. Some of our competitors offer products and services that we do not offer, such as trust services and private banking.

Our primary focus is to build and develop profitable consumer and commercial customer relationships while maintaining our role as a community bank.

Waterstone Mortgage Corporation.  Waterstone Mortgage Corporation faces competition for originating loans both directly within the markets in which it operates and from entities that provide services throughout the United States through internet services.  Waterstone Mortgage Corporation’s competition comes principally from other mortgage banking firms, as well as from commercial banks, savings institutions and credit unions.

Lending Activities

 The scope of the discussion included under “Lending Activities” is limited to lending operations related to loans originated for investment.  A discussion of the lending activities related to loans originated for sale is included under “Mortgage Banking Activities.”

 Historically, our principal lending activity has been originating mortgage loans for the purchase or refinancing of residential and commercial real estate. Generally, we retain the loans that we originate, which we refer to as loans originated for investment. One- to four-family residential mortgage loans represented $426.8 million, or 31.0%, of our total loan portfolio at December 31, 2020.  Multi-family residential mortgage loans represented $571.9 million, or 41.6%, of our total loan portfolio at December 31, 2020.  Commercial real estate loans represented $238.4 million, or 17.3%, of our total loan portfolio at December 31, 2020. We also offer construction and land loans, home equity lines of credit and commercial loans.  At December 31, 2020, commercial business loans, home equity loans, and land and construction loans totaled $45.4 million, $14.8 million and $77.1 million, respectively.

The largest exposure to one borrower or group of related borrowers was $40.7 million in the multi-family category.  The borrower represented a total of 3.0% of the total loan portfolio as of December 31, 2020.

Loan Portfolio Composition.  The following table sets forth the composition of our loan portfolio in dollar amounts and as a percentage of the total portfolio at the dates indicated.

    
At December 31,
 
   
2020
   
2019
   
2018
   
2017
   
2016
 
     
Amount
   
Percent
   
Amount
   
Percent
   
Amount
   
Percent
   
Amount
   
Percent
   
Amount
   
Percent
 
     
(Dollars in Thousands)
 
Mortgage loans:
                                                           
Residential real estate:
                                                           
One- to four-family
 
$
$426,792
     
31.04
%
 
$
$480,280
     
34.60
%
 
$
$489,979
     
35.53
%
 
$
$439,597
     
34.03
%
 
$
$392,817
     
33.35
%
Multi-family
   
571,948
     
41.59
%
   
584,859
     
42.14
%
   
597,087
     
43.29
%
   
578,440
     
44.77
%
   
558,592
     
47.42
%
Home equity
   
14,820
     
1.08
%
   
18,071
     
1.30
%
   
19,956
     
1.45
%
   
21,124
     
1.64
%
   
21,778
     
1.85
%
Construction and land
   
77,080
     
5.61
%
   
37,033
     
2.67
%
   
13,361
     
0.97
%
   
19,859
     
1.54
%
   
18,179
     
1.54
%
Commercial real estate
   
238,375
     
17.33
%
   
236,703
     
17.05
%
   
225,522
     
16.35
%
   
195,842
     
15.16
%
   
159,401
     
13.53
%
Commercial loans
   
45,386
     
3.30
%
   
30,253
     
2.18
%
   
32,810
     
2.38
%
   
36,697
     
2.84
%
   
26,798
     
2.28
%
Consumer
   
736
     
0.05
%
   
832
     
0.06
%
   
433
     
0.03
%
   
255
     
0.02
%
   
319
     
0.03
%
                                                                                 
Total loans
   
1,375,137
     
100.00
%
   
1,388,031
     
100.00
%
   
1,379,148
     
100.00
%
   
1,291,814
     
100.00
%
   
1,177,884
     
100.00
%
                                                                                 
Allowance for loan losses
   
(18,823
)
           
(12,387
)
           
(13,249
)
           
(14,077
)
           
(16,029
)
       
                                                                                 
Loans, net
 
$
$1,356,314
           
$
$1,375,644
           
$
$1,365,899
           
$
$1,277,737
           
$
$1,161,855
         

5

Loan Portfolio Maturities and Yields.  The following table summarizes the final maturities of our loan portfolio at December 31, 2020. Maturities are based upon the final contractual payment dates and do not reflect the impact of prepayments and scheduled monthly payments that will occur.

 
One- to four-family
   
Multi-family
   
Home Equity
   
Construction and Land
 
Maturing in the year ended
       
Weighted
         
Weighted
         
Weighted
         
Weighted
 
 December 31,
 
Amount
   
Average Rate
   
Amount
   
Average Rate
   
Amount
   
Average Rate
   
Amount
   
Average Rate
 
   
(Dollars in Thousands)
 
One year or less
 
$
$12,970
     
3.38
%
 
$
$24,263
     
4.08
%
 
$
$1,517
     
5.08
%
 
$
$12,934
     
4.04
%
More than one year through five years
   
53,608
     
4.80
%
   
271,561
     
4.17
%
   
6,933
     
4.85
%
   
49,825
     
3.02
%
More than five years through 15 years
   
89,869
     
4.75
%
   
271,756
     
3.65
%
   
6,328
     
4.35
%
   
14,278
     
4.48
%
More than 15 years
   
270,345
     
4.22
%
   
4,368
     
4.37
%
   
42
     
4.76
%
   
43
     
2.33
%
Total
 
$
$426,792
     
4.38
%
 
$
$571,948
     
3.92
%
 
$
$14,820
     
4.66
%
 
$
$77,080
     
3.46
%
                                                                 
                                                                 
   
Commercial Real Estate
   
Commercial
   
Consumer
   
Total
 
Maturing the year ended
         
Weighted
           
Weighted
           
Weighted
           
Weighted
 
 December 31,
 
Amount
   
Average Rate
   
Amount
   
Average Rate
   
Amount
   
Average Rate
   
Amount
   
Average Rate
 
   
(Dollars in Thousands)
 
One year or less
 
$
$17,597
     
4.11
%
 
$
$6,602
     
4.38
%
 
$
$723
     
7.22
%
 
$
$76,606
     
4.04
%
More than one year through five years
   
141,366
     
4.24
%
   
29,333
     
2.16
%
   
13
     
7.69
%
   
552,639
     
4.05
%
More than five years through 15 years
   
79,237
     
3.80
%
   
3,372
     
4.33
%
   
-
     
0.00
%
   
464,840
     
3.93
%
More than 15 years
   
175
     
5.71
%
   
6,079
     
6.74
%
   
-
     
0.00
%
   
281,052
     
4.28
%
Total
 
$
$238,375
     
4.09
%
 
$
$45,386
     
3.26
%
 
$
$736
     
7.23
%
 
$
$1,375,137
     
4.05
%

The following table sets forth the scheduled repayments of fixed and adjustable rate loans at December 31, 2020 that are contractually due after December 31, 2021.

    
Due After December 31, 2021
 
     
Fixed
   
Adjustable
   
Total
 
     
(In Thousands)
 
Mortgage loans
                 
Real estate loans:
             
One- to four-family
 
$
$22,918
   
$
$390,904
   
$
$413,822
 
Multi-family
   
209,191
     
338,494
     
547,685
 
Home equity
   
2,872
     
10,431
     
13,303
 
Construction and land
   
20,462
     
43,684
     
64,146
 
Commercial
   
140,360
     
80,418
     
220,778
 
Commercial
   
32,818
     
5,966
     
38,784
 
Consumer
   
13
     
-
     
13
 
Total loans
 
$
$428,634
   
$
$869,897
   
$
$1,298,531
 

One- to Four-Family Residential Mortgage Loans.  One- to four-family residential mortgage loans totaled $426.8 million, or 31.0% of total loans at December 31, 2020.  Our one- to four-family residential mortgage loans have fixed or adjustable rates.  Our single family adjustable-rate mortgage loans generally provide for maximum annual rate adjustments of 200 basis points, with a lifetime maximum adjustment of 600 basis points.  Our adjustable-rate mortgage loans typically amortize over terms of up to 30 years, and are indexed to the 12-month LIBOR rate.  Single family adjustable rate mortgage loans are originated at both our community banking segment and our mortgage banking segment.   We do not offer and have never offered residential mortgage loans specifically designed for borrowers with sub-prime credit scores, including Alt-A and negative amortization loans.

Adjustable rate mortgage loans can decrease the interest rate risk associated with changes in market interest rates by periodically repricing, but involve other risks because, as interest rates increase, the loan payments by the borrower increase, thus increasing the potential for default by the borrower. At the same time, the marketability of the underlying collateral may be adversely affected by higher interest rates. Upward adjustment of the contractual interest rate is also limited by the maximum periodic and lifetime interest rate adjustments permitted by our loan documents and, therefore, the effectiveness of adjustable rate mortgage loans in decreasing the risk associated with changes in interest rates may be limited during periods of rapidly rising interest rates. Moreover, during periods of rapidly declining interest rates the interest income received from the adjustable rate loans can be significantly reduced, thereby adversely affecting interest income.
6


All residential mortgage loans that we originate include “due-on-sale” clauses, which give us the right to declare a loan immediately due and payable in the event that, among other things, the borrower sells or otherwise transfers the real property subject to the mortgage and the loan is not repaid.  We also require homeowner’s insurance and where circumstances warrant, flood insurance, on properties securing real estate loans.  The average one- to four-family first mortgage loan balance was approximately $231,000 on December 31, 2020, and the largest outstanding balance on that date was $6.2 million, which is a consolidation loan that is collateralized by 86 single family properties.  A total of 52.3% of our one- to four-family loans are collateralized by properties in the state of Wisconsin.

Multi-family Real Estate Loans.  Multi-family loans totaled $571.9 million, or 41.6% of total loans at December 31, 2020. These loans are generally secured by properties located in our primary market area. Our multi-family real estate underwriting policies generally provide that such real estate loans may be made in amounts of up to 80% of the appraised value of the property provided the loan complies with our current loans-to-one borrower limit. Multi-family real estate loans are offered with interest rates that are fixed for periods of up to five years or are variable and either adjust based on a market index or at our discretion. Contractual maturities do not exceed 10 years while principal and interest payments are typically based on a 30-year amortization period. In reaching a decision whether to make a multi-family real estate loan, we consider gross revenues and the net operating income of the property, the borrower’s expertise and credit history, global cash flows, and the appraised value of the underlying property. We will also consider the terms and conditions of the leases and the credit quality of the tenants. We generally require that the properties securing these real estate loans have debt service coverage ratios (the ratio of earnings before interest, income taxes, depreciation and amortization divided by interest expense and current maturities of long term debt) of at least 1.15 times. Generally, multi-family loans made to corporations, partnerships and other business entities require personal guarantees from the principals and by the owners of 20% or more of the borrower.

A multi-family borrower’s financial information is monitored on an ongoing basis by requiring periodic financial statement updates, payment history reviews and periodic face-to-face meetings with the borrower.  We generally require borrowers with aggregate outstanding balances exceeding $1.0 million to provide updated financial statements and federal tax returns annually.  These requirements also apply to most guarantors on these loans.  We also require borrowers with rental investment property to provide an annual report of income and expenses for the property, including a tenant list and copies of leases, as applicable.  The average outstanding multi-family mortgage loan balance was approximately $1.0 million on December 31, 2020, with the largest outstanding balance at $11.8 million.

Loans secured by multi-family real estate generally involve larger principal amounts than owner-occupied, one- to four-family residential mortgage loans. Because payments on loans secured by multi-family properties often depend on the successful operation or management of the properties, repayment of such loans may be affected by adverse conditions in the real estate market or the economy.

Home Equity Loans and Lines of Credit. We also offer home equity loans and home equity lines of credit, both of which are secured by owner-occupied and non-owner occupied one- to four-family residences.  At December 31, 2020, outstanding home equity loans and equity lines of credit totaled $14.8 million, or 1.1% of total loans outstanding.  At December 31, 2020, the unadvanced portion of home equity lines of credit totaled $13.7 million.  The underwriting standards utilized for home equity loans and home equity lines of credit include a determination of the applicant’s credit history, an assessment of the applicant’s ability to meet existing obligations and payments on the proposed loan, and the value of the collateral securing the loan.  Home equity loans are offered with adjustable rates of interest and with terms up to seven years.  The loan-to-value ratio for our home equity loans and our lines of credit is generally limited to 90% when combined with the first security lien, if applicable.  Our home equity lines of credit have ten-year terms and adjustable rates of interest, subject to a contractual floor, which are indexed to the prime rate, as reported in The Wall Street Journal.  Interest rates on home equity lines of credit are generally limited to a maximum rate of 18%.  The average outstanding home equity loan balance was approximately $43,000 at December 31, 2020, with the largest outstanding balance at that date of $334,000.

Construction and Land Loans.  We originate construction loans for the acquisition of land and the construction of single-family residences, multi-family residences, and commercial real estate buildings.  At December 31, 2020, construction and land loans totaled $77.1 million, or 5.6% of total loans.   A total of $74.2 million had yet to be advanced as of December 31, 2020.

Our construction mortgage loans generally provide for the payment of interest only during the construction phase, which is typically up to nine months for single-family residences although our policy is to consider construction periods as long as three years for multi-family residences and commercial buildings. At the end of the construction phase, the construction loan converts to a longer-term mortgage loan upon stabilization. Construction loans can be made with a maximum loan-to-value ratio of 90%, provided that the borrower obtains private mortgage insurance if the owner-occupied residential loan balance exceeds 80% of the lesser of the appraised value or acquisition cost of the secured property. The average outstanding construction loan balance totaled approximately $2.9 million on December 31, 2020, with the largest outstanding balance at $17.9 million.  The average outstanding land loan balance was approximately $303,000 on December 31, 2020, and the largest outstanding balance on that date was $1.8 million.

Before making a commitment to fund a construction loan, we require an appraisal of the property by an independent licensed appraiser. We also review and inspect each property before disbursement of funds during the term of the construction loan. Loan proceeds are disbursed after inspection based on either the percentage of completion method or the actual cost of the completed work.

Construction financing is generally considered to involve a higher degree of credit risk than longer-term financing on improved, owner-occupied real estate. Risk of loss on a construction loan depends largely upon the accuracy of the initial estimate of the value of the property at completion of construction compared to the estimated cost (including interest) of construction and other assumptions. If the estimate of construction cost is inaccurate, we may be required to advance funds beyond the amount originally committed in order to protect the value of the property. Additionally, if the estimate of value is inaccurate, we may be confronted with a project, when completed, with a value that is insufficient to ensure full repayment of the loan.
7


Commercial Real Estate Loans.  Commercial real estate loans totaled $238.4 million at December 31, 2020, or 17.3% of total loans, and are made up of loans secured by office and retail buildings, industrial buildings, churches, restaurants, other retail properties and mixed use properties. These loans are generally secured by property located in our primary market area. Our commercial real estate underwriting policies provide that such real estate loans may be made in amounts of up to 80% of the appraised value of the property. Commercial real estate loans are offered with interest rates that are fixed up to five years or are variable and either adjust based on a market index or at our discretion. Contractual maturities do not exceed 10 years while principal and interest payments are typically based on a 20 to 25-year amortization period. In reaching a decision whether to make a commercial real estate loan, we consider gross revenues and the net operating income of the property, the borrower’s expertise and credit history, business and global cash flow, and the appraised value of the underlying property. In addition, we will also consider the terms and conditions of the leases and the credit quality of the tenants, if applicable. We generally require that the properties securing these real estate loans have debt service coverage ratios (the ratio of earnings before interest, income taxes, depreciation and amortization divided by interest expense and current maturities of long term debt) of at least 1.15 times. Environmental surveys are required for commercial real estate loans when environmental risks are identified. Generally, commercial real estate loans made to corporations, partnerships and other business entities require personal guarantees by the principals and by the owners of 20% or more of the borrower.

A commercial real estate borrower’s financial information is monitored on an ongoing basis by requiring periodic financial statement updates, payment history reviews and periodic face-to-face meetings with the borrower.  We generally require borrowers with aggregate outstanding balances exceeding $1.0 million to provide annual updated financial statements and federal tax returns.  These requirements also apply to all guarantors on these loans.  We also require borrowers to provide an annual report of income and expenses for the property, including a tenant list and copies of leases, as applicable.  The average commercial real estate loan in our portfolio at December 31, 2020 was approximately $899,000, and the largest outstanding balance at that date was $13.0 million.

Commercial Loans.  Commercial loans totaled $45.4 million at December 31, 2020, or 3.3% of total loans, and are made up of loans secured by accounts receivable, inventory, equipment and real estate. Included in commercial loans are the Paycheck Protection Program (PPP) loans, which totaled $18.1 million at December 31, 2020.

As a qualified SBA lender, we were automatically authorized to originate PPP loans.  The Company is actively participating in assisting our customers with applications for resources through the program.  PPP loans have: (a) an interest rate of 1.0%, (b) a five-year loan term to maturity for loans made on or after June 5, 2020 (loans made prior to June 5, 2020 have a two-year term, however borrowers and lenders may mutually agree to extend the maturity for such loans to five years); and (c) principal and interest payments deferred for six months from the date of disbursement.  The SBA will guarantee 100% of the PPP loans made to eligible borrowers.  The entire principal amount of the borrower’s PPP loan, including any accrued interest, is eligible to be reduced by the loan forgiveness amount under the PPP.

Our commercial loans are generally made to borrowers that are located in our primary market area.  Working capital lines of credit are granted for the purpose of carrying inventory and accounts receivable or purchasing equipment.  These lines require that certain collateral levels must be maintained and are monitored on a monthly or quarterly basis.  Working capital lines of credit are short-term loans of 12 months or less with variable interest rates.  At December 31, 2020, the unadvanced portion of working capital lines of credit totaled $19.2 million.  Outstanding balances fluctuate up to the maximum commitment amount based on fluctuations in the balance of the underlying collateral.  Personal property loans secured by equipment are considered commercial business loans and are generally made for terms of up to 84 months and for up to 80% of the value of the underlying collateral.  Interest rates on equipment loans may be either fixed or variable.  Commercial business loans are generally variable rate loans with initial fixed rate periods of up to five years.

A commercial business borrower’s financial information is monitored on an ongoing basis by requiring periodic financial statement updates, usually quarterly, payment history reviews and periodic face-to-face meetings with the borrower. Excluding the PPP loan balance, the average outstanding commercial loan at December 31, 2020 was $268,000 and the largest outstanding balance on that date was $6.1 million.

Origination and Servicing of Loans.  All loans originated for investment are underwritten pursuant to internally developed policies and procedures.  While we generally underwrite owner-occupied residential mortgage loans to Freddie Mac and Fannie Mae standards, due to several unique characteristics, our loans originated prior to 2008 do not conform to the secondary market standards.  The unique features of these loans include interest payments in advance of the month in which they are earned and discretionary rate adjustments that are not tied to an independent index.

Exclusive of our mortgage banking operations, we retain in our portfolio all of the loans that we originate. At December 31, 2020, WaterStone Bank was not servicing any loan it originated and subsequently sold to unrelated third parties. Loan servicing includes collecting and remitting loan payments, accounting for principal and interest, contacting delinquent mortgagors, supervising foreclosures and property dispositions in the event of unremedied defaults, making certain insurance and tax payments on behalf of the borrowers and generally administering the loans.
8


Loan Approval Procedures and Authority.  WaterStone Bank’s lending activities follow written, non-discriminatory, underwriting standards and loan origination procedures established by WaterStone Bank’s board of directors. The loan approval process is intended to assess the borrower’s ability to repay the loan, the viability of the loan and the adequacy of the value of the property that will secure the loan, if applicable. To assess the borrower’s ability to repay, we review the employment and credit history and information on the historical and projected income and expenses of borrowers. Loan officers, with concurrence from independent credit officers and underwriters, are authorized to approve and close any loan that qualifies under WaterStone Bank underwriting guidelines within the following lending limits:

Any secured mortgage loan up to $500,000 for a borrower with total outstanding loans from us of less than $1.0 million that is independently underwritten can be approved by the Chief Credit Officer or select lending personnel.
 
Any secured mortgage loan up to $1.0 million can be approved jointly the Chief Executive Officer and Chief Lending Officer.
 
Any secured mortgage loan ranging from $500,001 to $3.0 million or any new loan to a borrower with outstanding loans from us exceeding $1.0 million must be approved by the Officer Loan Committee.
 
Any non-real estate loan up to $250,000 for a borrower with total outstanding loans from us of less than $250,000 that is independently underwritten can be approved by select lending personnel.
 
Any non-real estate loan up to $500,000 for a borrower with total outstanding loans from us of less than $500,000 that is independently underwritten can be approved by the Chief Executive Officer, Chief Lending Officer or Business Banking Manager.
 
Any non-real estate loan ranging from $500,001 to $3.0 million or any new non-real estate loan to a borrower with outstanding loans exceeding $500,000 must be approved by the Officer Loan Committee.
 
Any new loan over $3.0 million must be approved by the Officer Loan Committee and the board of directors prior to closing. Any new loan to a borrower with outstanding loans from us exceeding $10.0 million must be reviewed by the board of directors.

Asset Quality

When a loan becomes more than 30 days delinquent, WaterStone Bank sends a letter advising the borrower of the delinquency.  The borrower is given a specific date by which delinquent payments must be made or by which they must contact WaterStone Bank to make arrangements to bring the loan current over a longer period of time.  If the borrower fails to bring the loan current within the specified time period or to make arrangements to cure the delinquency over a longer period of time, the matter is referred to legal counsel and foreclosure or other collection proceedings are considered.

All loans are reviewed on a regular basis, and loans are placed on non-accrual status when they become 90 or more days delinquent. When loans are placed on non-accrual status, unpaid accrued interest is reversed, and further income is recognized only to the extent received when collection of the remaining principal balance is reasonably assured.

Non-Performing Assets.  Non-performing assets consist of non-accrual loans and other real estate owned.  Loans are generally placed on non-accrual status when contractually past due 90 days or more as to interest or principal payments.  Additionally, whenever management becomes aware of facts or circumstances that may adversely impact the collectability of principal or interest on loans, management may place such loans on non-accrual status immediately, rather than waiting until the loan becomes 90 days past due. At the time a loan is placed on non-accrual status, previously accrued and uncollected interest on such loans is reversed and additional income is recorded only to the extent that payments are received and the collection of principal is reasonably assured.  Generally, loans are restored to accrual status when the obligation is brought current, has performed in accordance with the contractual terms for a reasonable period of time, and the ultimate collectability of the total contractual principal and interest is no longer in doubt.
9


The table below sets forth the amounts and categories of our non-accrual loans and real estate owned at the dates indicated.

    
At December 31,
 
   
2020
   
2019
   
2018
   
2017
   
2016
 
     
(Dollars in Thousands)
 
Non-accrual loans:
                             
Residential
                             
One- to four-family
 
$
$5,072
   
$
$5,985
   
$
$4,902
   
$
$4,677
   
$
$7,623
 
Multi-family
   
341
     
667
     
1,309
     
1,007
     
1,427
 
Home equity
   
63
     
70
     
201
     
107
     
344
 
Construction and land
   
43
     
-
     
-
     
-
     
-
 
Commercial real estate
   
41
     
303
     
125
     
251
     
422
 
Commercial
   
-
     
-
     
18
     
26
     
41
 
Consumer
   
-
     
-
     
-
     
-
     
-
 
Total non-accrual loans
   
5,560
     
7,025
     
6,555
     
6,068
     
9,857
 
                                         
Real estate owned
                                       
One- to four-family
   
-
     
46
     
163
     
1,330
     
2,141
 
Multi-family
   
-
     
-
     
-
     
-
     
-
 
Construction and land
   
322
     
1,256
     
3,327
     
4,582
     
5,082
 
Commercial real estate
   
-
     
-
     
300
     
300
     
300
 
Total real estate owned
   
322
     
1,302
     
3,790
     
6,212
     
7,523
 
Valuation allowance at end of period
   
-
     
(554
)
   
(1,638
)
   
(1,654
)
   
(1,405
)
Total real estate owned, net
   
322
     
748
     
2,152
     
4,558
     
6,118
 
                                         
Total non-performing assets
 
$
$5,882
   
$
$7,773
   
$
$8,707
   
$
$10,626
   
$
$15,975
 
                                         
Total non-accrual loans to total loans, net
   
0.40
%
   
0.51
%
   
0.48
%
   
0.47
%
   
0.84
%
Total non-accrual loans to total assets
   
0.25
%
   
0.35
%
   
0.34
%
   
0.34
%
   
0.55
%
Total non-performing assets to total assets
   
0.27
%
   
0.39
%
   
0.45
%
   
0.59
%
   
0.89
%

All loans that meet or exceed 90 days with respect to past due principal and interest are recognized as non-accrual. Troubled debt restructurings which are still on non-accrual status either due to being past due 90 days or greater, or which have not yet performed under the modified terms for a reasonable period of time, are included in the table above. In addition, loans which are past due less than 90 days are evaluated to determine the likelihood of collectability given other credit risk factors such as early stage delinquency, the nature of the collateral or the results of a borrower fiscal review. When the collection of all contractual principal and interest is determined to be unlikely, the loan is moved to non-accrual status and an updated appraisal of the underlying collateral is ordered. This process generally takes place between 60 and 90 days past contractual due dates. Upon determining the updated estimated value of the collateral, a loan loss provision is recorded to establish a specific reserve to the extent that the outstanding principal balance exceeds the updated estimated net realizable value of the collateral. When a loan is determined to be uncollectible, generally coinciding with the initiation of foreclosure action, the specific reserve is reviewed for adequacy, adjusted if necessary, and charged-off.

The following table sets forth activity in our non-accrual loans for the years indicated.

 
At and for the Year Ended December 31,
 
   
2020
   
2019
   
2018
   
2017
   
2016
 
   
(Dollars in Thousands)
 
                               
Balance at beginning of year
 
$
$7,025
   
$
$6,555
   
$
$6,068
   
$
$9,857
   
$
$17,604
 
Additions
   
3,356
     
3,716
     
3,147
     
3,149
     
3,114
 
Transfers to real estate owned
   
(637
)
   
(1,052
)
   
(545
)
   
(2,171
)
   
(4,590
)
Charge-offs
   
(11
)
   
(31
)
   
(6
)
   
(766
)
   
(667
)
Returned to accrual status
   
(2,501
)
   
(650
)
   
(777
)
   
(2,716
)
   
(4,183
)
Principal paydowns
   
(1,672
)
   
(1,513
)
   
(1,332
)
   
(1,285
)
   
(1,421
)
Balance at end of year
 
$
$5,560
   
$
$7,025
   
$
$6,555
   
$
$6,068
   
$
$9,857
 


10

Total non-accrual loans decreased by $1.5 million, or 20.9%, to $5.6 million as of December 31, 2020 compared to $7.0 million as of December 31, 2019.  The ratio of non-accrual loans to total loans receivable was 0.40% at December 31, 2020 compared to 0.51% at December 31, 2019.  During the year ended December 31, 2020, $637,000 was transferred to real estate owned, $11,000 in loan principal was charged off, $1.7 million in principal payments were received and $2.5 million in loans were returned to accrual status. Offsetting this activity, $3.4 million in loans were placed on non-accrual status during the year ended December 31, 2020.

Of the $5.6 million in total non-accrual loans as of December 31, 2020, $4.5 million in loans have been specifically reviewed to assess whether a specific valuation allowance is necessary.  A specific valuation allowance is established for an amount equal to the impairment when the carrying value of the loan exceeds the present value of expected future cash flows, discounted at the loan’s original effective interest rate or the fair value of the underlying collateral with an adjustment made for costs to dispose of the asset.  Based upon these specific reviews, a total of $214,000 in partial charge-offs have been recorded with respect to these loans as of December 31, 2020. Partially charged-off loans measured for impairment based upon net realizable collateral value are maintained in a “non-performing” status and are disclosed as impaired loans.  In addition, specific reserves totaling $23,000 have been recorded as of December 31, 2020.  The remaining $1.1 million of non-accrual loans were reviewed on an aggregate basis and $216,000 in general valuation allowance was deemed necessary related to those loans as of December 31, 2020.  The $216,000 in general valuation allowance is based upon a migration analysis performed with respect to similar non-accrual loans in prior periods.

The outstanding principal balance of our five largest non-accrual loans as of December 31, 2020 totaled $2.4 million, which represents 43.8% of total non-accrual loans as of that date.  These five loans did not have any charge-offs or require any specific valuation allowances as of December 31, 2020.

Interest payments received are treated as interest income on a cash basis as long as the remaining book value of the loan (i.e., after charge-off of all identified losses) is deemed to be fully collectible. If the remaining book value is not deemed to be fully collectible, all payments received are applied to unpaid principal. Determination as to the ultimate collectability of the remaining book value is supported by an updated credit department evaluation of the borrower's financial condition and prospects for repayment, including consideration of the borrower's sustained historical repayment performance and other relevant factors.

There was one accruing loan with a balance of $586,000 past due 90 days or more during the years ended December 31, 2020.  The Company believed the loan was well collateralized and full collection of principal and interest was expected. There were no accruing loans past due 90 days or more during the years ended December 31,  2019 or 2018.

Troubled Debt Restructurings.  The following table summarizes troubled debt restructurings by the Company’s internal risk rating.

   
At December 31,
 
   
2020
   
2019
   
2018
   
2017
   
2016
 
   
(Dollars in Thousands)
 
Troubled debt restructurings
                             
Substandard
 
$
$9,249
   
$
$4,018
   
$
$4,256
   
$
$5,035
   
$
$7,025
 
Watch
   
2,320
     
-
     
2,476
     
47
     
3,112
 
Total troubled debt restructurings
 
$
$11,569
   
$
$4,018
   
$
$6,732
   
$
$5,082
   
$
$10,137
 

Troubled debt restructurings totaled $11.6 million at December 31, 2020, compared to $4.0 million at December 31, 2019. At December 31, 2020, all of the troubled debt restructurings were performing in accordance with their restructured terms. All troubled debt restructurings are considered to be impaired and are risk rated as either substandard or watch and are included in the internal risk rating tables disclosed in the notes to the consolidated financial statements. Specific reserves have been established to the extent that the collateral-based impairment analyses indicate that a collateral shortfall exists or to the extent that a discounted cash flow analysis results in an impairment.

We do not participate in government-sponsored troubled debt restructuring programs.  Under the Coronavirus Aid, Relief, and Economic Security (CARES) Act, loans less than 30 days past due as of December 31, 2019 and COVID-19 modifications are considered current. A financial institution suspended the requirements under accounting principles generally accepted in the United States (US GAAP) for loan modifications related to COVID-19 that would otherwise be categorized as a troubled debt restructuring (“TDR”).  This includes a suspension of the requirement to determine impairment of these modifications for accounting purposes.  In keeping with regulatory guidance to work with borrowers during this unprecedented situation, the Company has executed a payment deferral program for our lending clients that are adversely affected by the pandemic.  As of December 31, 2020, the Company had modified a total of $1.2 million consisting of principal or principal and interest.  The $1.2 million in deferrals are not considered troubled debt restructurings.

Our troubled debt restructurings are short-term modifications.  Typical initial restructured terms include six to twelve months of principal forbearance, a reduction in interest rate or both.  Restructured terms do not include a reduction of the outstanding principal balance unless mandated by a bankruptcy court. Troubled debt restructuring terms may be renewed or further modified at the end of the initial term for an additional period if performance has been acceptable and the short-term borrower difficulty persists.
11


Information with respect to the accrual status of our troubled debt restructurings is provided in the following table.

 
At December 31,
 
   
2020
   
2019
 
   
Accruing
   
Non-accruing
   
Accruing
   
Non-accruing
 
   
(In Thousands)
 
                         
One- to four-family
 
$
$2,733
   
$
$532
   
$
$2,740
   
$
$685
 
Multi-family
   
-
     
-
     
-
     
308
 
Commercial real estate
   
7,207
     
-
     
278
     
7
 
Commercial
   
1,097
     
-
     
-
     
-
 
   
$
$11,037
   
$
$532
   
$
$3,018
   
$
$1,000
 

The following table sets forth activity in our troubled debt restructurings for the years indicated.

 
At or for the Year Ended December 31,
 
   
2020
   
2019
 
   
Accruing
   
Non-accruing
   
Accruing
   
Non-accruing
 
   
(In Thousands)
 
Balance at beginning of year
 
$
$3,018
   
$
$1,000
   
$
$5,499
   
$
$1,233
 
Additions
   
8,032
     
-
     
-
     
-
 
Change in accrual status
   
-
     
-
     
-
     
-
 
Charge-offs
   
-
     
-
     
-
     
-
 
Returned to contractual/market terms
   
-
     
(318
)
   
-
     
-
 
Transferred to real estate owned
   
-
     
-
     
-
     
-
 
Principal paydowns
   
(13
)
   
(150
)
   
(2,481
)
   
(233
)
Balance at end of period
 
$
$11,037
   
$
$532
   
$
$3,018
   
$
$1,000
 

Interest payments received on non-accrual troubled debt restructurings are treated as interest income on a cash basis as long as the remaining book value of the loan (i.e., after charge-off of all identified losses) is deemed to be fully collectible. If the remaining book value is not deemed to be fully collectible, all payments received are applied to unpaid principal. Determination as to the ultimate collectability of the remaining book value is supported by an updated credit department evaluation of the borrower's financial condition and prospects for repayment, including consideration of the borrower's sustained historical repayment performance and other relevant factors.

If a restructured loan is current in all respects and a minimum of six consecutive restructured payments have been received, it can be considered for return to accrual status.  After a restructured loan that is current in all respects reverts to contractual/market terms, if a credit department review indicates no evidence of elevated market risk, the loan is removed from the troubled debt restructuring classification. The restructured loan will be classified as a troubled debt restructuring for at least the calendar year after the modification even after returning to a contractual/market rate and accrual status.

Loan Delinquency.  The following table summarizes loan delinquency in total dollars and as a percentage of the total loan portfolio:

   
At December 31,
 
   
2020
   
2019
 
    
(Dollars in Thousands)
 
             
Loans past due less than 90 days
 
$
$3,938
   
$
$1,833
 
Loans past due 90 days or more
   
3,958
     
4,632
 
Total loans past due
 
$
$7,896
   
$
$6,465
 
                 
Total loans past due to total loans receivable
   
0.57
%
   
0.47
%

Past due loans increased by $1.4 million, or 22.1%, to $7.9 million at December 31, 2020 from $6.5 million at December 31, 2019.  Loans past due less than 90 days increased by $2.1 million during the year ended December 31, 2020.  The increase was primarily due to a $2.1 million increase in one- to four-family loans during the year ended December 31, 2020. Loans past due 90 days or more decreased $674,000. The decrease in loans past due 90 days or more was primarily due to a decrease in the one-to four-family loans of $439,000 during the year ended December 31, 2020.
12


Potential Problem Loans.  We define potential problem loans as substandard loans which are still accruing interest.  We do not necessarily expect to realize losses on potential problem loans, but we recognize potential problem loans carry a higher probability of default and require additional attention by management.  The aggregate principal amounts of potential problem loans as of December 31, 2020 and 2019 were $9.6 million and $4.0 million, respectively.  Management believes it has established an adequate allowance for probable loan losses as appropriate under generally accepted accounting principles.

Real Estate Owned.  Total real estate owned decreased by $426,000 to $322,000 at December 31, 2020, compared to $748,000 at December 31, 2019.  During the year ended December 31, 2020, $637,000 was transferred from loans to real estate owned upon completion of foreclosure. During the same period, sales of real estate owned totaled $1.1 million. There were no write-downs during the year ended December 31, 2020.

 New appraisals received on real estate owned and collateral dependent impaired loans are based upon an "as is value" assumption.  During the period of time in which we are awaiting receipt of an updated appraisal, loans evaluated for impairment based upon collateral value are measured by the following:

● Applying an updated adjustment factor to an existing appraisal;

● Confirming that the physical condition of the real estate has not significantly changed since the last valuation date;

● Comparing the estimated current value of the collateral to that of updated sales values experienced on similar collateral;

● Comparing the estimated current value of the collateral to that of updated values seen on current appraisals of similar collateral; and

● Comparing the estimated current value to that of updated listed sales prices on our real estate owned and that of similar properties (not owned by the Company).

We owned two properties at December 31, 2020, compared to five properties as of December 31, 2019 and 12 properties at December 31, 2018.  Habitable real estate owned is managed with the intent of attracting a lessee to generate revenue. Foreclosed properties are transferred to real estate owned at estimated net realizable value, with charge-offs, if any, charged to the allowance for loan losses upon transfer to real estate owned.  The fair value is primarily based upon updated appraisals in addition to an analysis of current real estate market conditions.

Allowance for Loan Losses

We establish valuation allowances on loans that are deemed to be impaired. A loan is considered impaired when, based on current information and events, it is probable that we will not be able to collect all amounts due according to the contractual terms of the loan agreement. A valuation allowance is established for an amount equal to the impairment when the carrying amount of the loan exceeds the present value of the expected future cash flows, discounted at the loan’s original effective interest rate or the fair value of the underlying collateral.

We also establish valuation allowances based on an evaluation of the various risk components that are inherent in the loan portfolio. The risk components that are evaluated include past loan loss experience; the level of non-performing and classified assets; current economic conditions; volume, growth, and composition of the loan portfolio; adverse situations that may affect the borrower’s ability to repay; the estimated value of any underlying collateral; regulatory guidance; and other relevant factors. The allowance is increased by provisions charged to earnings and recoveries of previously charged-off loans and reduced by charge-offs. The appropriateness of the allowance for loan losses is reviewed and approved quarterly by the WaterStone Bank board of directors. The allowance reflects management’s best estimate of the amount needed to provide for the probable loss on impaired loans and other inherent losses in the loan portfolio, and is based on a risk model developed and implemented by management and approved by the WaterStone Bank board of directors.

Actual results could differ from this estimate, and future additions to the allowance may be necessary based on unforeseen changes in loan quality and economic conditions. In addition, the Federal Deposit Insurance Corporation and the WDFI, as an integral part of their examination process, periodically review WaterStone Bank’s allowance for loan losses. Such regulators have the authority to require WaterStone Bank to recognize additions to the allowance based on their judgments of information available to them at the time of their review or examination.

Any loan that is 90 or more days past due is placed on non-accrual and classified as a non-performing loan. A loan is classified as impaired when it is probable that we will be unable to collect all amounts due in accordance with the terms of the loan agreement. Non-performing loans are then evaluated and accounted for in accordance with generally accepted accounting principles.
13


The following table sets forth activity in our allowance for loan losses for the years indicated.

     
At or for the Year
 
      
Ended December 31,
 
   
2020
   
2019
   
2018
   
2017
   
2016
 
      
(Dollars in Thousands)
 
                               
Balance at beginning of year
 
$
$12,387
   
$
$13,249
   
$
$14,077
   
$
$16,029
   
$
$16,185
 
Provision (credit) for loan losses
   
6,340
     
(900
)
   
(1,060
)
   
(1,166
)
   
380
 
Charge-offs:
                                       
Mortgage loans
                                       
One- to four-family
   
82
     
125
     
69
     
1,364
     
1,003
 
Multi-family
   
5
     
3
     
14
     
92
     
489
 
Home equity
   
13
     
44
     
1
     
-
     
112
 
Construction and land
   
8
     
-
     
-
     
14
     
3
 
Commercial real estate
   
-
     
2
     
-
     
7
     
-
 
Consumer
   
10
     
5
     
-
     
-
     
-
 
Commercial
   
-
     
-
     
-
     
-
     
-
 
Total charge-offs
   
118
     
179
     
84
     
1,477
     
1,607
 
Recoveries:
                                       
   Mortgage loans
                                       
One- to four-family
   
148
     
135
     
159
     
293
     
811
 
Multi-family
   
21
     
30
     
89
     
208
     
152
 
Home equity
   
27
     
27
     
26
     
26
     
36
 
Construction and land
   
2
     
-
     
40
     
162
     
72
 
Commercial real estate
   
16
     
25
     
2
     
1
     
-
 
Consumer
   
-
     
-
     
-
     
1
     
-
 
Commercial
   
-
     
-
     
-
     
-
     
-
 
Total recoveries
   
214
     
217
     
316
     
691
     
1,071
 
                                         
Net (recoveries) charge-offs
   
(96
)
   
(38
)
   
(232
)
   
786
     
536
 
Allowance at end of year
 
$
$18,823
   
$
$12,387
   
$
$13,249
   
$
$14,077
   
$
$16,029
 
                                         
Ratios:
                                       
Allowance for loan losses to non-performing loans at end of year
   
338.54
%
   
176.33
%
   
202.12
%
   
231.99
%
   
162.62
%
Allowance for loan losses to loans outstanding at end of year
   
1.37
%
   
0.89
%
   
0.96
%
   
1.09
%
   
1.36
%
Net (recoveries) charge-offs to average loans:
                                       
Mortgage
                                       
One- to four-family
   
0.00
%
   
0.00
%
   
0.00
%
   
0.06
%
   
0.01
%
Multi family
   
0.00
%
   
0.00
%
   
0.00
%
   
(0.01
)%
   
0.02
%
Home equity
   
(0.02
)%
   
0.02
%
   
(0.03
)%
   
(0.03
)%
   
0.08
%
Construction and land
   
0.00
%
   
0.00
%
   
(0.06
)%
   
(0.19
)%
   
(0.09
)%
Commercial real estate
   
0.00
%
   
0.00
%
   
0.00
%
   
0.00
%
   
0.00
%
Consumer
   
0.32
%
   
0.20
%
   
0.00
%
   
(0.09
)%
   
0.00
%
Commercial
   
0.00
%
   
0.00
%
   
0.00
%
   
0.00
%
   
0.00
%
Net (recoveries) charge-offs to average loans outstanding
   
(0.01
%)
   
0.00
%
   
(0.02
%)
   
0.06
%
   
0.05
%
14


Allocation of Allowance for Loan Losses.  The following table sets forth the allowance for loan losses allocated by loan category, the total loan balances by category, and the percent of loans in each category to total loans at the dates indicated. The allowance for loan losses allocated to each category is not necessarily indicative of future losses in any particular category and does not restrict the use of the allowance to absorb losses in other categories.

    
At December 31,
 
   
2020
   
2019
   
2018
 
     
Allowance for Loan Losses
   
% of Loans in Category to Total Loans
   
% of Allowance in Category to Total Allowance
   
Allowance for Loan Losses
   
% of Loans in Category to Total Loans
   
% of Allowance in Category to Total Allowance
   
Allowance for Loan Losses
   
% of Loans in Category to Total Loans
   
% of Allowance in Category to Total Allowance
 
     
(Dollars in Thousands)
 
Real Estate:
                                                     
Residential
                                                     
One- to four-family
 
$
$5,459
     
31.04
%
   
29.00
%
 
$
$4,907
     
34.60
%
   
39.62
%
 
$
$5,742
     
35.53
%
   
43.33
%
Multi-family
   
5,600
     
41.59
%
   
29.75
%
   
4,138
     
42.14
%
   
33.41
%
   
4,153
     
43.29
%
   
31.35
%
Home equity
   
194
     
1.08
%
   
1.03
%
   
201
     
1.30
%
   
1.62
%
   
325
     
1.45
%
   
2.45
%
Construction and land
   
1,755
     
5.61
%
   
9.32
%
   
610
     
2.67
%
   
4.92
%
   
400
     
0.97
%
   
3.02
%
Commercial real estate
   
5,138
     
17.33
%
   
27.30
%
   
2,145
     
17.05
%
   
17.32
%
   
2,126
     
16.35
%
   
16.05
%
Commercial
   
642
     
3.30
%
   
3.41
%
   
372
     
2.18
%
   
3.00
%
   
483
     
2.38
%
   
3.65
%
Consumer
   
35
     
0.05
%
   
0.19
%
   
14
     
0.06
%
   
0.11
%
   
20
     
0.03
%
   
0.15
%
Total allowance for loan losses
 
$
$18,823
     
100.00
%
   
100.00