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WASHINGTON, D.C. 20549
Indicate by check mark whether the registrant (1) has filed all reports required to be filed by Section 13 or 15(d) of the Securities Exchange Act of 1934 during the preceding 12 months (or for such shorter period that the registrant was required to file such reports), and (2) has been subject to such filing requirements for the past 90 days.
Indicate by check mark whether the registrant has submitted electronically 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).
Indicate by check mark whether the registrant is a large accelerated filer, an accelerated filer, a non-accelerated filer, or a smaller reporting company. See definitions of “large accelerated filer,” “accelerated filer”, “smaller reporting company” and "emerging growth company" in Rule 12b-2 of the Exchange Act.
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. ☐
Indicate by check mark whether the registrant is a shell company (as defined in Rule 12b-2 of the Exchange Act).
The number of shares outstanding of the issuer’s common stock, $0.01 par value per share, was 25,232,284 at May 4, 2021.
Item 2.
Management’s Discussion and Analysis of Financial Condition and Results of Operations
Forward-Looking Information
This Quarterly Report on Form 10-Q may contain 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:
These forward-looking statements are based on current beliefs and expectations of our management and are inherently subject to significant business, economic and competitive uncertainties and contingencies, many of which are beyond our control. In addition, these forward-looking statements are subject to assumptions with respect to future business strategies and decisions that are subject to change.
The following factors, among others, could cause actual results to differ materially from the anticipated results or other expectations expressed in the forward-looking statements:
See also the factors referred to in reports filed by the Company with the Securities and Exchange Commission (particularly those under the caption “Risk Factors” in Item 1A of the Company’s Annual Report on Form 10-K for the year ended December 31, 2020).
The risks included here are not exhaustive. Other sections of this report may include additional factors which could adversely affect our business and financial performance. New risks emerge from time to time and it is not possible for management to predict all such risks, nor can it assess the impact of all such risks on our business or the extent to which any risk, or combination of risks, may cause actual results to differ materially from those contained in any forward-looking statements. Given these risks and uncertainties, investors should not place undue reliance on forward-looking statements as a prediction of actual results.
Overview
The following discussion and analysis is presented to assist the reader in understanding and evaluating the Company’s financial condition and results of operations. It is intended to complement the unaudited consolidated financial statements, footnotes, and supplemental financial data appearing elsewhere in this Quarterly Report on Form 10-Q and should be read in conjunction therewith. The detailed discussion in the sections below focuses on the results of operations for the three months ended March 31, 2021 and 2020 and the financial condition as of March 31, 2021 compared to the financial condition as of December 31, 2020.
As described in the notes to the unaudited consolidated financial statements, we have two reportable segments: community banking and mortgage banking. The community banking segment provides consumer and business banking products and services to customers primarily within Southeastern Wisconsin. Consumer products include loan products, deposit products, and personal investment services. Business banking products include loans for working capital, inventory and general corporate use, commercial real estate construction loans, and deposit accounts. The mortgage banking segment, which is conducted by offices in 21 states through Waterstone Mortgage Corporation, consists of originating residential mortgage loans primarily for sale in the secondary market.
Our community banking segment generates the significant majority of our consolidated net interest income and requires the significant majority of our provision for loan losses. Our mortgage banking segment generates the significant majority of our noninterest income and a majority of our noninterest expenses. We have provided below a discussion of the material results of operations for each segment on a separate basis for the three months ended March 31, 2021 and 2020, which focuses on noninterest income and noninterest expenses. We have also provided a discussion of the consolidated operations of the Company, which includes the consolidated operations of the Bank and Waterstone Mortgage Corporation, for the same periods.
Significant Items
Earnings comparisons for the three months ended March 31, 2021 and 2020 were impacted by the significant items summarized below.
COVID-19 and the CARES Act
The COVID-19 pandemic has caused economic and social disruption on an unprecedented scale. While some industries have been impacted more severely than others, all businesses have been impacted to some degree. This disruption has resulted in the shuttering of businesses across the country, significant job loss, and aggressive measures by the federal government.
In March 2020, the Coronavirus Aid, Relief and Economic Security (“CARES”) Act was signed into law as a $2 trillion legislative package. The goal of the CARES Act is to prevent a severe economic downturn through various measures, including direct financial aid to American families and economic stimulus to significantly impacted industry sectors. The package also includes extensive emergency funding for hospitals and providers. In March 2021, the American Rescue Plan Act of 2021 (the American Rescue Plan Act) was signed into law which provides approximately $1.9 trillion in spending to address the continued impact of COVID-19. While it is not possible to know the full universe or extent of these impacts as of the date this filing, we are disclosing potentially material items of which we are aware.
Our fee income could be reduced due to COVID-19. In keeping with guidance from regulators, we are working with COVID-19 affected customers to waive fees from a variety of sources, such as, but not limited to, insufficient funds and overdraft fees, ATM fees, account maintenance fees, etc. These reductions in fees are thought, at this time, to be temporary in conjunction with the length of the expected COVID-19 related economic crisis. At this time, we are unable to project the materiality of such an impact, but recognize the breadth of the economic impact is likely to impact our fee income in future periods.
Our interest income could be reduced due to COVID-19. In keeping with guidance from regulators, we are actively working with COVID-19 affected borrowers to defer their payments, interest, and fees. While interest and fees will still accrue to income, through normal GAAP accounting, should eventual credit losses on these deferred payments emerge, interest income and fees accrued would need to be reversed. In such a scenario, interest income in future periods could be negatively impacted. At this time, we are unable to project the materiality of such an impact, but recognize the breadth of the economic impact may affect our borrowers’ ability to repay in future periods.
As of March 31, 2021, all of our capital ratios, and our subsidiary bank’s capital ratios, were in excess of all regulatory requirements. While we believe that we have sufficient capital to withstand an extended economic recession brought about by COVID-19, our reported and regulatory capital ratios could be adversely impacted by further credit losses.
We maintain access to multiple sources of liquidity. Wholesale funding markets have remained open to us, but rates for short term funding have recently been volatile. If funding costs are elevated for an extended period of time, it could have an adverse effect on our net interest margin. If an extended recession caused large numbers of our deposit customers to withdraw their funds, we might become more reliant on volatile or more expensive sources of funding.
Comparison of Community Banking Segment Results of Operations for the Three Months Ended March 31, 2021 and 2020
Net income totaled $7.3 million for the three months ended March 31, 2021 compared to $4.1 million for the three months ended March 31, 2020. Net interest income increased $1.3 million to $14.2 million for the three months ended March 31, 2021 compared to $12.9 million for the three months ended March 31, 2020. Interest expense decreased as funding rates decreased. Offsetting the decrease in interest expense, interest income on loans, mortgage-related securities, and other interest-earning asset categories decreased as replacement rates were lower than in the prior year.
The Company delayed adoption of ASC Topic 326 as permited under the CARES Act. The Company calculated the current quarter allowance using the incurred loss model. There was a negative provision for loan losses of $1.1 million for the three months ended March 31, 2021 compared to a $750,000 provision for loan losses for the three months ended March 31, 2020. During the three months ended March 31, 2021, we made adjustments to our qualitative factors, primarily to account for the improvement in certain economic factors along with a decrease in loan balance.
Total noninterest income increased $215,000 due primarily to loan fees primarily due to loan prepayment fees. Cash surrender value of life insurance decreased as the balance decreased year over year as a result of the death benefits in the prior year leading to a lower insurance balance. Other income increased primarily due to wealth management revenue.
Compensation, payroll taxes, and other employee benefits expense decreased $193,000 to $5.0 million due primarily to an decrease in health insurance expense. Occupancy, office furniture and equipment increased slighty due primarily to increased snow removal expense. Advertising expense decreased primarily due to promotions for the new branch opening during the three months ended March 31, 2020. Data processing expense decreased $94,000 due to the implementation of a new digital banking platform in 2020. Other noninterest expense decreased $140,000 as certain loan expenses decreased offset by a decrease of credits received for FDIC premiums in 2020 but not in 2021.
Comparison of Mortgage Banking Segment Results of Operations for the Three Months Ended March 31, 2021 and 2020
Net income totaled $14.0 million for the three months ended March 31, 2021 compared to $2.0 million for the three months ended March 31, 2020. We originated $1.12 billion in mortgage loans held for sale (including sales to the community banking segment) during the three months ended March 31, 2021, which represents an increase of $406.3 million, or 57.3%, from the $708.8 million originated during the three months ended March 31, 2020. The increase in loan production volume was driven by a $264.8 million, or 117.9%, increase in refinance products as mortgage rates decreased. Mortgage purchase products increased $141.4 million, or 29.2% due to the high demand for single family homes and fixed-rate mortgages. Total mortgage banking noninterest income increased $24.2 million, or 78.7%, to $55.0 million during the three months ended March 31, 2021 compared to $30.8 million during the three months ended March 31, 2020. The increase in mortgage banking noninterest income was related to a 57.3% increase in volume and a 19.2% increase in gross margin on loans originated and sold for the three months ended March 31, 2021 compared to March 31, 2020. Gross margin on loans originated and sold is the ratio of mortgage banking income (excluding the change in interest rate lock fair value) divided by total loan originations. The gross margin on loans originated and sold expansion reflects increased industry demand due to the current low rate environment. We sell loans on both a servicing-released and a servicing-retained basis. Waterstone Mortgage Corporation has contracted with a third party to service the loans for which we retain servicing.
Additionally, our overall margin can be affected by the mix of both loan type (conventional loans versus governmental) and loan purpose (purchase versus refinance). Conventional loans include loans that conform to Fannie Mae and Freddie Mac standards, whereas governmental loans are those loans guaranteed by the federal government, such as a Federal Housing Authority or U.S. Department of Agriculture loan. Loans originated for the purchase of a residential property, which generally yield a higher margin than loans originated for refinancing existing loans, comprised 56.1% of total originations during the three months ended March 31, 2021, compared to 68.3% of total originations during the three months ended March 31, 2020, respectively, as refinance demand accelerated from the low rate environment. The mix of loan type trended towards more conventional loans and less governmental loans; with conventional loans and governmental loans comprising 79.0% and 21.0% of all loan originations, respectively, during the three months ended March 31, 2021, compared to 71.3% and 28.7% of all loan originations, respectively, during the three months ended March 31, 2020.
Total compensation, payroll taxes and other employee benefits increased $9.9 million, or 50.9%, to $29.3 million for the three months ended March 31, 2021 compared to $19.4 million for the three months ended March 31, 2020. The increase in compensation expense was primarily a result of the increase in commission expense, bonus, and incentives due to record originations. In addition, branch manager pay increased as branches were more profitable. Professional fees decreased $2.1 million to $524,000 of income during the quarter ended March 31, 2021 compared to $1.6 million of expense during the quarter ended March 31, 2020. The decrease related to receiving a legal settlement and lower litigation costs compared to the prior year as the Herrington settlement was resolved. Occupancy, office furniture, and equipment decreased due to lower rent and depreciation expenses. Loan processing expenses increased due primarily to increased application and funding volumes as interest rates remain low. Other noninterest expense increased primarily due to amortization of mortgage servicing rights as the size of the servicing portfolio has increased in 2021 compared to 2020.
Consolidated Waterstone Financial, Inc. Results of Operations
Net Interest Income
Average Balance Sheets, Interest and Yields/Costs
The following tables set forth average balance sheets, annualized average yields and costs, and certain other information for the periods indicated. Non-accrual loans are included in the computation of the average balances of loans receivable and held for sale. The yields set forth below include the effect of deferred fees, discounts and premiums that are amortized or accreted to interest income or expense. Yields on interest-earning assets are computed on a fully tax-equivalent yield, where applicable.
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(1) Interest income includes net deferred loan fee amortization income of $604,000 and $171,000 for the three months ended March 31, 2021 and 2020, respectively.
(2) Average balance of mortgage related and debt securities are based on amortized historical cost.
(3) Interest income from tax-exempt securities is computed on a taxable equivalent basis using a tax rate of 21% for the three months ended March 31, 2021 and 2020. The yields on debt securities, federal funds sold and short-term investments before tax-equivalent adjustments were 1.30% and 2.07% for the three months ended March 31, 2021 and 2020, respectively.
(4) Net interest rate spread represents the difference between the yield on average interest-earning assets and the cost of average interest-bearing liabilities and is presented on a fully tax equivalent basis.
(5) Net interest-earning assets represent total interest-earning assets less total interest-bearing liabilities.
(6) Net interest margin represents net interest income divided by average total interest-earning assets.
Rate/Volume Analysis
The following table sets forth the effects of changing rates and volumes on our net interest income for the periods indicated. The rate column shows the effects attributable to changes in rate (changes in rate multiplied by prior volume). The volume column shows the effects attributable to changes in volume (changes in volume multiplied by prior rate). The net column represents the sum of the prior columns. For purposes of this table, changes attributable to changes in both rate and volume that cannot be segregated have been allocated proportionately based on the changes due to rate and the changes due to volume.
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(1) Interest income includes net deferred loan fee amortization income of $604,000 and $171,000 for the three months ended March 31, 2021 and 2020, respectively.
(2) Non-accrual loans have been included in average loans receivable balance.
(3) Includes available for sale securities. Average balance of available for sale securities is based on amortized historical cost.
(4) Interest income from tax exempt securities is computed on a taxable equivalent basis using a tax rate of 21% for the three months ended March 31, 2021 and March 31, 2020.
Net interest income increased $1.4 million, or 11.4%, to $14.0 million during the three months ended March 31, 2021 compared to $12.5 million during the three months ended March 31, 2020.
Provision for Loan Losses
The Company delayed adoption of ASC Topic 326 as permited under the CARES Act and subsequently under the Consolidated Appropriations Act. The Company calculated the current quarter allowance using the incurred loss model. The negative provision for loan losses was $1.1 million for the three months ended March 31, 2021 compared to $750,000 of provision for loan losses for the three months ended March 31, 2020. During the three months ended March 31, 2021, we made adjustments to our qualitative factors, primarily to account for the improvement in certain economic factors along with a decrease in loan balance. We had a negative provision for loan losses of $1.1 million at the community banking segment and a provision for loan losses of $30,000 for the mortgage banking segment. Net recoveries were $27,000 for the three months ended March 31, 2021.
The provision is primarily a function of the Company's reserving methodology and assessments of certain quantitative and qualitative factors which are used to determine an appropriate allowance for loan losses for the period. See further discussion regarding the allowance for loan losses in the "Asset Quality" section for an analysis of charge-offs, nonperforming assets, specific reserves and additional provisions and the "Allowance for Loan Loss" section.
Noninterest Income
Total noninterest income increased $24.7 million, or 78.6%, to $56.2 million during the three months ended March 31, 2021 compared to $31.5 million during the three months ended March 31, 2020. The increase resulted primarily from an increase in mortgage banking income, service charges on loan and deposits, and other noninterest income.
Noninterest Expenses
Total noninterest expenses increased $7.8 million, or 22.1%, to $43.0 million during the three months ended March 31, 2021 compared to $35.2 million during the three months ended March 31, 2020.
Income Taxes
Income tax expense totaled $6.9 million for the three months ended March 31, 2021 compared to $1.9 million during the three months ended March 31, 2020. Income tax expense was recognized on the statement of income during the three months ended March 31, 2021 at an effective rate of 24.4% of pretax income compared to 24.1% during the three months ended March 31, 2020. The increase in rate is primarily due to higher pretax income, relative to permanent deductions.
Comparison of Financial Condition at March 31, 2021 and December 31, 2020
Total Assets – Total assets increased by $13.4 million, or 0.6%, to $2.20 billion at March 31, 2021 from $2.18 billion at December 31, 2020. The increase in total assets primarily reflects an increase in cash and cash equivalents, and prepaid expenses and other assets due to an increase in various receivables at the mortgage banking segment, partially offset by a decrease in loans receivable and loans held for sale. The total assets increase reflects liability increases in deposits and advance payments by borrowers for taxes.
Cash and Cash Equivalents – Cash and cash equivalents increased $103.6 million, or 109.4%, to $198.4 million at March 31, 2021, compared to $94.8 million at December 31, 2020. The increase in cash and cash equivalents primarily reflects the additional source of funds through an increase in deposits and advance payments by borrowers for taxes.
Securities Available for Sale – Securities available for sale increased $2.6 million to $162.3 million at March 31, 2021. The increase was primarily due to purchases of mortgage-related securities exceeding security paydowns for the year and maturities of debt securities.
Loans Held for Sale - Loans held for sale decreased $60.7 million to $341.3 million at March 31, 2021 due to the decrease of refinancing activity resulting from the increase in mortgage rates.
Loans Receivable - Loans receivable held for investment decreased $39.7 million to $1.34 billion at March 31, 2021. The decrease in total loans receivable was attributable to decreases in one- to four-family, construction and land, home equity, and consumer loan categories. Partially offsetting those decreases, multi-family, commercial real estate, and commercial loan categories increased.
The following table shows loan originations during the periods indicated.
Allowance for Loan Losses - The allowance for loan losses decreased $1.0 million to $17.8 million at March 31, 2021. The decrease resulted from a negative provision due to improvement in certain economic factors, decreasing the required allowance related to the loans collectively reviewed. The overall decrease was primarily related to each of the one- to four-family, multi-family, home equity, construction and land, commercial real estate, consumer, and commercial categories. See Note 3 for further discussion on the allowance for loan losses.
Real Estate Owned – Total real estate owned decreased $172,000 to $150,000 at March 31, 2021. During the three months ended March 31, 2021, no loans were transferred from loans receivable to real estate owned upon completion of foreclosure. During the same period, sales of real estate owned totaled $172,000. There were no writedowns during the three months ended March 31, 2021.
Prepaid expenses and other assets – Total prepaid expenses and other assets increased $6.7 million to $64.3 million at March 31, 2021. The increase was primarily due to increases in funding receivables from investors and hedging receivables.
Deposits – Total deposits increased $34.8 million to $1.22 billion at March 31, 2021. The increase was driven by an increase of $23.6 million in money market and savings deposits, $6.8 million in demand deposits, and $4.4 million in time deposits.
Borrowings – Total borrowings decreased $17.6 million, or 3.5%, to $490.5 million at March 31, 2021. The community banking segmen paid off $25.0 million in short-term FHLB borrowings. External short-term borrowings at the mortgage banking segment increased a total of $7.4 million at March 31, 2021 from December 31, 2020.
Advance Payments by Borrowers for Taxes - Advance payments by borrowers for taxes increased $8.5 million to $12.0 million at March 31, 2021. The increase was the result of payments received from borrowers for their real estate taxes and is seasonally normal, as balances increase during the course of the calendar year until real estate tax obligations are paid in the fourth quarter.
Other Liabilities - Other liabilities decreased $29.9 million to $45.1 million at March 31, 2021 compared to December 31, 2020. Other liabilities decreased primarily due to a seasonal decrease in outstanding checks related to advance payments by borrowers for taxes. The Company receives payments from borrowers for their real estate taxes during the course of the calendar year until real estate tax obligations are paid in the fourth quarter. At the time at which the disbursements are made, the outstanding checks are classified as other liabilities in the statements of financial condition. These amounts remain classified as other liabilities until settled. Additionally, other liabilities decreased due to the payment of the legal settlement and lower forward commitments to sell loans at the mortgage banking segment.
Shareholders’ Equity – Shareholders' equity increased $17.6 million to $430.7 million at March 31, 2021 from December 31, 2020. Shareholders' equity increased primarily due to net income, additional paid-in capital as stock options were exercised and equity awards vested, and unearned ESOP shares vesting. Partially offsetting the increases, there were decreases due to the declaration of dividends, a decrease in the fair value of the security portfolio, and the repurchase of stock.
ASSET QUALITY
NONPERFORMING ASSETS
All loans that are 90 days or more past due with respect to principal and interest are recognized as non-accrual. Troubled debt restructurings that are non-accrual either due to being past due greater than 90 days or which have not yet performed under the modified terms for a reasonable period of time, are included in the table above. In addition, loans that 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 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 when a loan is contractually past due between 60 and 89 days. Upon determining the updated estimated value of the collateral, a loan loss provision is recorded to establish a specific reserve to the extent that the outstanding principal balance exceeds the updated estimated net realizable value of the collateral. When a loan is determined to be uncollectible, typically 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 periods indicated.
Total non-accrual loans decreased by $1.4 million, or 24.8%, to $4.2 million as of March 31, 2021 compared to $5.6 million as of December 31, 2020. The ratio of non-accrual loans to total loans receivable was 0.31% at March 31, 2021 compared to 0.40% at December 31, 2020. During the three months ended March 31, 2021, $171,000 in loans were placed on non-accrual status. Offsetting this activity, $902,000 returned to accrual status and $649,000 in principal payments were received during the three months ended March 31, 2021.
Of the $4.2 million in total non-accrual loans as of March 31, 2021, $3.0 million in loans have been specifically reviewed to assess whether a specific valuation allowance is necessary. A specific valuation allowance is established for an amount equal to the impairment when the carrying value of the loan exceeds the present value of expected future cash flows, discounted at the loan's original effective interest rate or the fair value of the underlying collateral with an adjustment made for costs to dispose of the asset. Based upon these specific reviews, a total of $118,000 in cumulative partial net charge-offs have been recorded over the life of these loans as of March 31, 2021. 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 $21,000 have been recorded as of March 31, 2021. The remaining $1.2 million of non-accrual loans were reviewed on an aggregate basis and $233,000 in general valuation allowance was deemed appropriate related to those loans as of March 31, 2021. The $233,000 in 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 March 31, 2021 totaled $1.7 million, which represents 41.7% of total non-accrual loans as of that date. These five loans have not had any cumulative life-to-date net charge-offs and $21,000 in specific valuation allowance was deemed necessary based on net realizable collateral value with respect to these five loans as of March 31, 2021.
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.
As of March 31, 2021, there were no loans 90 or more days past due and still accruing interest. As of December 31, 2020, there was a $586,000 loan that was 90 or more days past due and still accruing interest. The bank received full payoff of the loan subsequent to December 31, 2020.
TROUBLED DEBT RESTRUCTURINGS
The following table summarizes information with respect to the accrual status of our troubled debt restructurings:
All troubled debt restructurings are considered to be impaired, are risk rated as either substandard or watch and are included in the internal risk rating tables disclosed in the notes to the unaudited consolidated financial statements. Specific reserves have been established to the extent that collateral-based impairment analyses indicate that a collateral shortfall exists.
We do not participate in government-sponsored troubled debt restructuring programs. Our troubled debt restructurings are short-term modifications. Typical initial restructured terms include six to twelve months of principal forbearance, a reduction in interest rate or both. Restructured terms do not include a reduction of the outstanding principal balance unless mandated by a bankruptcy court. Troubled debt restructuring terms may be renewed or further modified at the end of the initial term for an additional period if performance has been acceptable and the short-term borrower difficulty persists.
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.
We modified loans for borrowers that were not considered troubled debt restructings under the CARES Act. Loans less than 30 days past due as of December 31, 2019 were allowed for modifications if the borrower experienced a COVID-19 hardship. As of March 31, 2021, the Company had $910,000 of one-to four-family loans consisting of the deferral of principal and interest. In accordance with the CARES Act, these short term deferrals are not considered troubled debt restructurings.
LOAN DELINQUENCY
The following table summarizes loan delinquency in total dollars and as a percentage of the total loan portfolio:
Past due loans decreased by $974,000, or 12.3%, to $6.9 million at March 31, 2021 from $7.9 million at December 31, 2020. Loans past due 90 days or more decreased by $1.4 million, or 34.9%, primarily in the one- to four-family and commercial loan categories during the three months ended March 31, 2021. Loans past due less than 90 days increased by $408,000, or 10.4%, primarily in the one- to four-family loan category.
REAL ESTATE OWNED
Total real estate owned decreased by $172,000 to $150,000 at March 31, 2021, compared to $322,000 at December 31, 2020. During the three months ended March 31, 2021, no loans were transferred to real estate owned upon completion of foreclosure. During the same period, sales of real estate owned totaled $172,000. There were no write downs during the three months ended March 31, 2021. 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:
Virtually all habitable real estate owned (both residential and commercial properties) is managed with the intent of attracting a lessee to generate revenue. Foreclosed properties are recorded at the lower of carrying value or fair value, less costs to sell, with charge-offs, if any, charged to the allowance for loan losses upon transfer to real estate owned within 90 days of being transferred. Subsequent write-downs to reflect current fair market value, as well as gains and losses upon disposition and revenue and expenses incurred in maintaining such properties, are treated as period costs and included in real estate owned in the consolidated statements of income. The fair value is primarily based upon updated appraisals in addition to an analysis of current real estate market conditions.
ALLOWANCE FOR LOAN LOSSES
The allowance for loan losses decreased $1.0 million to $17.8 million at March 31, 2021, compared to $18.8 million at December 31, 2020. The decrease in allowance for loan losses reflects the $1.1 million negative provision for loan losses. The negative provision recorded during the current year reflects adjustments to our qualitative factors, primarily to account for the slight improvement in certain economic factors along with a decrease in loan balance.
We had net recoveries of $27,000, or 0.01% of average loans annualized, for the three months ended March 31, 2021, compared to net recoveries of $54,000, or less than 0.02% of average loans annualized, for the three months ended March 31, 2020. Of the $27,000 in recoveries during the three months ended March 31, 2021, the majority of the activity related to loans secured by one- to four-family residential and multi-family loans.
Our underwriting policies and procedures emphasize that credit decisions must rely on both the credit quality of the borrower and the estimated value of the underlying collateral. Credit quality is assured only when the estimated value of the collateral is objectively determined and is not subject to significant fluctuation.
The allowance for loan losses has been determined in accordance with GAAP. We are responsible for the timely and periodic determination of the amount of the allowance required. Any future provisions for loan losses will continue to be based upon our assessment of the overall loan portfolio and the underlying collateral, trends in non-performing loans, current economic conditions and other relevant factors. To the best of management’s knowledge, all probable losses have been provided for in the allowance for loan losses.
Management is validating the CECL model and methodologies; however we expect the change in the allowance for credit loss, including reserves for unfunded commitments, not to exceed 110% of the March 31, 2021 allowance based on a parallel computation. When finalized, this one-time increase as a result of the adoption of CECL will be recorded, net of tax, as an adjustment to retained earnings effective on the earlier of the termination date of the national emergency declaration by the President or January 1, 2022. This estimate is subject to change based on continuing refinement and validation of the model and methodologies.
The establishment of the amount of the loan loss allowance inherently involves judgments by management as to the appropriateness of the allowance, which ultimately may or may not be correct. Higher than anticipated rates of loan default would likely result in a need to increase provisions in future years.
Liquidity and Capital Resources
We maintain liquid assets at levels we consider adequate to meet our liquidity needs. We adjust our liquidity levels to fund loan commitments, repay our borrowings, fund deposit outflows and pay real estate taxes on mortgage loans. We also adjust liquidity as appropriate to meet asset and liability management objectives. The level of our liquidity position at any point in time is dependent upon the judgment of the senior management as supported by the Asset/Liability Committee. Liquidity is monitored on a daily, weekly and monthly basis using a variety of measurement tools and indicators.
Our primary sources of liquidity are deposits, amortization and repayment of loans, sales of loans held for sale, maturities of investment securities and other short-term investments, and earnings and funds provided from operations. While scheduled principal repayments on loans are a relatively predictable source of funds, deposit flows and loan repayments are greatly influenced by market interest rates, economic conditions, and rates offered by our competitors. 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. Additional sources of liquidity used for the purpose of managing long- and short-term cash flows include advances from the FHLB.
During the three months ended March 31, 2021, primary uses of cash and cash equivalents included: $1.11 billion in funding loans held for sale, $17.6 for short-term borrowings, $16.2 million for purchases of mortgage related securities, $4.8 million for cash dividends paid, $5.0 million for advance payments by borrowers for taxes, and $4.3 million to pay a legal settlement.
During the three months ended March 31, 2021, primary sources of cash and cash equivalents included: $1.22 billion in proceeds from the sale of loans held for sale, $39.7 for net loan receivables decrease, $34.8 million from an increase in deposits, $11.0 million in principal repayments on mortgage related securities, and $21.3 million in net income.
During the three months ended March 31, 2020, primary uses of cash and cash equivalents included: $687.7 million in funding loans held for sale, $21.3 million for funding of loans receivable, $14.2 million in purchases of our common stock, $2.4 million for cash dividends paid, $2.5 million for purchases of debt securities, a $3.0 million decrease in advance payments by borrowers for taxes, $1.4 million in repayment of short-term debt, and $686,000 for purchases of mortgage related securities.
During the three months ended March 31, 2020, primary sources of cash and cash equivalents included: $676.9 million in proceeds from the sale of loans held for sale, $40.0 million in additional proceeds from short-term FHLB borrowings, $18.3 million from an increase in deposits, $9.7 million in principal repayments on mortgage related securities, and $6.1 million in net income
A portion of our liquidity consists of cash and cash equivalents, which are a product of our operating, investing and financing activities. At March 31, 2021 and 2020, respectively, $198.4 million and $59.1 million of our assets were invested in cash and cash equivalents. At March 31, 2021, cash and cash equivalents were comprised of the following: $160.1 million in cash held at the Federal Reserve Bank and other depository institutions and $38.3 million in federal funds sold and short-term investments. Our primary sources of cash are principal repayments on loans, proceeds from the calls and maturities of debt and mortgage-related securities, increases in deposit accounts, advances from the FHLB, and repurchase agreements from other institutions.
Liquidity management is both a daily and longer-term function of business management. If we require funds beyond our ability to generate them internally, borrowing agreements exist with the FHLB which provide an additional source of funds. At March 31, 2021, we had $470.0 million in long term advances from the FHLB with contractual maturity dates in 2027, 2028, and 2029. The 2027 advance has a contractual maturity date in December 2027. There are four 2028 advances that have contractual maturities in 2028. The remaining 2028 advance maturities have single call options in May 2021, along with two advances that have quarterly call options beginning in June 2020 and September 2020. The 2029 advance maturities have quarterly call options currently available and the other options that began in November 2020, beginning in August 2021, and beginning in May 2022. As an additional source of funds, the mortgage banking segment has a repurchase agreement. At March 31, 2021, we had $16.5 million outstanding under the repurchase agreement with a total outstanding commitment of $35.0 million.
At March 31, 2021, we had outstanding commitments to originate loans receivable of $20.3 million. In addition, at March 31, 2021, we had unfunded commitments under construction loans of $65.8 million, unfunded commitments under business lines of credit of $18.2 million and unfunded commitments under home equity lines of credit and standby letters of credit of $14.0 million. At March 31, 2021, certificates of deposit scheduled to mature in one year or less totaled $594.2 million. Based on prior experience, management believes that, subject to the Bank’s funding needs, 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 is not retained by us, we will have to utilize other funding sources, such as FHLB advances, in order to maintain our level of assets. However, we cannot assure that such borrowings would be available on attractive terms, or at all, if and when needed. Alternatively, we could reduce our level of liquid assets, such as our cash and cash equivalents and securities available-for-sale in order to meet funding needs. In addition, the cost of such deposits may be significantly higher if market interest rates are higher or there is an increased amount of competition for deposits in our market area at the time of renewal.
Capital
Shareholders' equity increased $17.6 million to $430.7 million at March 31, 2021 from December 31, 2020. Shareholders' equity increased primarily due to net income, additional paid-in capital as stock options were exercised and equity awards vested, and unearned ESOP shares vesting. Partially offsetting the increases, there were decreases due to the declaration of dividends, a decrease in the fair value of the security portfolio, and the repurchase of stock.
The Company's Board of Directors authorized a stock repurchase program in the third quarter of 2020. As of March 31, 2021, the Company had repurchased 10.7 million shares at an average price of $14.39 under previously approved stock repurchase plans.
WaterStone Bank is subject to various regulatory capital requirements, including a risk-based capital measure. The risk-based capital guidelines include both a definition of capital and a framework for calculating risk-weighted assets by assigning assets and off-balance sheet items to broad risk categories. At March 31, 2021, WaterStone Bank exceeded all regulatory capital requirements and is considered “well capitalized” under regulatory guidelines. See “Notes to Unaudited Consolidated Financial Statements - Note 8 - Regulatory Capital.”
Contractual Obligations, Commitments, Contingent Liabilities, and Off-balance Sheet Arrangements
The following tables present information indicating various contractual obligations and commitments of the Company as of March 31, 2021 and the respective maturity dates.
(1) Secured under a blanket security agreement on qualifying assets, principally, mortgage loans. Excludes interest which will accrue on the advances. See call provisions in Note 7 - Borrowings.
(2) Represents non-cancelable operating leases for offices and equipment.
(3) Excludes interest.
See Note 10 - Commitments, Off-Balance Sheet Arrangements, and Contingent Liabilities of the notes to unaudited consolidated financial statements for additional information.
Off-Balance Sheet Commitments
The following table details the amounts and expected maturities of significant off-balance sheet commitments as of March 31, 2021.
General: Commitments to extend credit are agreements to lend to a customer as long as there is no violation of any condition established in the contract and generally have fixed expiration dates or other termination clauses.
(1) Commitments for loans are extended to customers for up to 90 days after which they expire.
(2) Unused portions of home equity loans are available to the borrower for up to 10 years.
(3) Unused portions of construction loans are available to the borrower for up to one year.