Marathon Bancorp, Inc.: Form 10-Q for the period ended Sep 30, 2023

This discussion and analysis reflects our consolidated financial statements and other relevant statistical data, and is intended to enhance your understanding of our financial condition and results of operations. The information in this section has been derived from the accompanying consolidated financial statements. You should read the information in this section in conjunction with the business and financial information regarding Marathon Bancorp, Inc. provided in this Form 10-Q and the Company’s Annual Report on Form 10-K for the year ended June 30, 2023 as filed with the Securities and Exchange Commission on September 20, 2023.

CAUTIONARY NOTE REGARDING FORWARD-LOOKING STATEMENTS

This quarterly report contains certain forward-looking statements, which are included pursuant to the “safeharbor” provisions of the Private Securities Litigation Reform Act of 1995, and reflect management’s beliefs and expectations based on information currently available. These forward-looking statements, which can be identified by the use of words such as “estimate,” “project,” “believe,” “intend,” “anticipate,” “assume,” “plan,” “seek,” “expect,” “will,” “may,” “should,” “indicate,” “would,” “contemplate,” “continue,” “potential,” “target” and words of similar meaning. 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 portfolios; and
• estimates of our risks and future costs and benefits.

These forward-looking statements are based on our current beliefs and expectations 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. We are under no duty to and do not take any obligation to update any forward-looking statements after the date of this Quarterly Report on Form 10-Q.

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:

• inflation and changes in the interest rate environment that reduce our margins and yields, our mortgage banking revenues, the fair value of financial instruments or our level of loan originations, or increase the level of defaults, losses and prepayments on loans we have made and make;
• general economic conditions, either nationally or in our market areas, that are worse than expected;
• events involving the failure of financial institutions may adversely affect our business, and the market price of our common stock;
• changes in the level and direction of loan delinquencies and write-offs and changes in estimates of the adequacy of the allowance for credit losses;
• our ability to access cost-effective funding;
• fluctuations in real estate values and both residential and commercial real estate market conditions;
• demand for loans and deposits in our market area;
• our ability to implement and change our business strategies;
• competition among depository and other financial institutions;
• adverse changes in the securities or secondary mortgage markets, including our ability to sell loans in the secondary market;
• changes in laws or government regulations or policies affecting financial institutions, including changes in regulatory fees and capital requirements;
• changes in the quality or composition of our loan or investment portfolios;
• technological changes that may be more difficult or expensive than expected;
• the inability of third-party providers to perform as expected;
• a failure or breach of our operational or security systems or infrastructure, including cyberattacks;
• our ability to manage market risk, credit risk and operational risk in the current economic environment;
• our ability to enter new markets successfully and capitalize on growth opportunities;
• our ability to successfully integrate into our operations any assets, liabilities, customers, systems and management personnel we may acquire and our ability to realize related revenue synergies and cost savings within expected time frames, and any goodwill charges related thereto;
• changes in consumer 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;
• any future FDIC insurance premium increases or special assessments may adversely affect our earnings;
• our ability to prevent or mitigate fraudulent activity;
• our ability to evaluate the amount and timing of recognition of future tax assets and liabilities;
• our ability to control operating costs and expenses, including compensation expense associated with equity allocated or awarded to our employees; and
• changes in the financial condition, results of operations or future prospects of issuers of securities that we own.

Overview

Net Interest Income. Our primary source of income is net interest income. Net interest income is the difference between interest income, which is the income we earn on our loans and investments, and interest expense, which is the interest we pay on our deposits and borrowings.

Provision for Credit Losses. We charge provisions for credit losses to operations in order to maintain our allowance for credit losses on loans and reserve for unfunded commitments at a level that is considered reasonable and necessary to absorb expected credit losses inherent in the loan portfolio and expected losses on commitments to grant loans that are expected to be advanced at the consolidated balance sheet date. In determining the level of the allowance for credit losses, we consider our past loan loss experience, known and inherent risks in the portfolio, adverse situations that may affect the borrower’s ability to repay, the estimated value of any underlying collateral, composition of the loan portfolio, current economic conditions, and the levels of non-performing and other classified loans. The amount of the allowance is based on estimates and the ultimate losses may vary from such estimates as more information becomes available or conditions change. We assess the allowance for credit losses on a quarterly basis and make provisions for credit losses in order to maintain the allowance.

Non-interest Income. Our primary sources of non-interest income are mortgage banking income, service charges on deposit accounts and net gains in the cash surrender value of bank owned life insurance and gain on proceeds from life insurance. Other sources of non-interest income include net gain or losses on sales and calls of securities, net gain or loss on disposal of foreclosed assets and other income.

Non-Interest Expenses. Our non-interest expenses consist of salaries and employee benefits, net occupancy and equipment, data processing and office, professional fees, marketing expenses, foreclosed assets and other general and administrative expenses, including premium payments we make to the FDIC for insurance of our deposits.

Provision for Income Taxes. Our income tax expense is the total of the current year income tax due or refundable and the change in deferred tax assets and liabilities. Deferred tax assets and liabilities are the expected future tax amounts for the temporary differences between the carrying amounts and the tax basis of assets and liabilities, computed using enacted tax rates. A valuation allowance, if needed, reduces deferred tax assets to the amounts expected to be realized.

Summary of Significant Accounting Policies and Estimates

The discussion and analysis of the financial condition and results of operations are based on our consolidated financial statements, which are prepared in conformity with U.S. GAAP. The preparation of these financial statements requires management to make estimates and assumptions affecting the reported amounts of assets and liabilities, disclosure of contingent assets and liabilities, and the reported amounts of income and expenses. We consider the accounting policies discussed below to be significant accounting policies. The estimates and assumptions that we use are based on historical experience and various other factors and are believed to be reasonable under the circumstances. Actual results may differ from these estimates under different assumptions or conditions, resulting in a change that could have a material impact on the carrying value of our assets and liabilities and our results of operations.

In 2012, the JOBS Act was signed into law. The JOBS Act contains provisions that, among other things, reduce certain reporting requirements for qualifying public companies. As an “emerging growth company” we may delay adoption of new or revised accounting pronouncements applicable to public companies until such pronouncements are made applicable to private companies. We intend to take advantage of the benefits of this extended transition period. Accordingly, our financial statements may not be comparable to companies that comply with such new or revised accounting standards.

The following represent our significant accounting policies and estimates:

Allowance for Credit Losses. We establish the allowance for credit losses through charges to earnings in the form of a provision for credit losses. Loan losses are charged against the allowance for credit losses for the difference between the carrying value of the loan and the estimated net realizable value or fair value of the collateral, if collateral dependent, when management believes that the collectability of the principal is unlikely. Subsequent recoveries, if any, are credited to the allowance.

The allowance for credit losses (“ACL”) at September 30, 2023 represents the Company’s current estimate of the lifetime credit losses expected from its loan portfolio. Management estimates the ACL by projecting a lifetime loss rate conditional on a forecast of economic parameters and other qualitative adjustments, for the loans’ expected remaining term.

Management’s judgment in determining the level of the allowance is based on evaluations of historical loan losses, current conditions and reasonable and supportable forecasts relevant to the collectability of loans. In addition, management’s estimate of expected credit losses is based on the discounted cash flows over the remaining life of loans held for investment, and changes in expected prepayment behavior may result in changes in the remaining life of loans and expected credit losses.

The allowance may be affected materially by a variety of qualitative factors that the Company considers to reflect its current judgement of various events and risks that are not measured in our statistical procedures. These qualitative risk factors include: (1) lending policies and procedures, including underwriting standards and collection, charge-off, and recovery practices; (2) changes in the value of underlying collateral for collateral dependent loans; (3) nature and volume of the portfolio and terms of loans; (4) volume and severity of past due, classified and nonaccrual loans as well as loan modifications; (5) existence and effect of any concentrations of credit and changes in the level of such concentrations; (6) experience, ability, and depth of lending department management and other relevant staff; (7) quality of loan review and board of directors oversight; (8) the effect of other external factors such as competition, legal and regulatory requirements; and (9) changes in national and local economic conditions related to unemployment, house price index, and gross domestic product. This evaluation is inherently subjective because it requires estimates that are susceptible to significant revision as more information becomes available. In evaluating the level of the allowance, we consider a range of possible assumptions and outcomes related to the various factors identified above. The level of the allowance is particularly sensitive to changes in the actual and forecasted probability of default of benchmarked banks and changes in current conditions or reasonably expected future conditions affecting the collectability of loans.

Although we believe that we use the best information available to establish the allowance for credit losses, future adjustments to the allowance may be necessary if economic conditions differ substantially from the assumptions used in making the evaluation. In addition, the FDIC and the WDFI, as an integral part of their examination process, periodically review our allowance for credit losses, and as a result of such reviews, we may have to adjust our allowance for credit losses. However, regulatory agencies are not directly involved in establishing the allowance for credit losses as the process is our responsibility and any increase or decrease in the allowance is the responsibility of management. A large loss could deplete the allowance and require increased provisions to replenish the allowance, which would adversely affect earnings.

Provision for Income Taxes. Deferred tax assets and liabilities are recognized for the estimated future tax consequences attributable to differences between the financial statement carrying amounts of existing assets and liabilities and their respective tax basis. Deferred tax assets and liabilities are measured using enacted tax rates in effect for the year in which those temporary differences are expected to be recovered or settled. The effect on deferred tax assets and liabilities of a change in tax rates is recognized in income in the period that includes the enactment date. Deferred tax assets are reduced by a valuation allowance when, in the opinion of management, it is more likely than not that some portion or all of the deferred tax assets will not be realized.

We recognize the tax effects from an uncertain tax position in the financial statements only if the position is more likely than not to be sustained on audit, based on the technical merits of the position. We recognize the financial statement benefit of a tax position only after determining that the relevant tax authority would more likely than not sustain the position following an audit. For tax positions meeting the more-likely-than-not threshold, the amount recognized in the financial statements is the largest benefit that has a greater than 50% likelihood of being realized, upon ultimate settlement with the relevant tax authority. We recognize interest and penalties accrued or released related to uncertain tax positions in current income tax expense or benefit.

Debt Securities. For available-for-sale and held to maturity debt securities in an unrealized loss position, the Company first assesses whether it intends to sell, or it is more likely than not that it will be required to sell the security before recovery of its amortized cost basis. If either of the criteria regarding intent or requirement to sell is met, the security’s amortized cost basis is written down to fair value through a provision for credit losses. For debt securities that do not meet the aforementioned criteria, the Company evaluates whether the decline in fair value has resulted from credit losses or other factors. In making this assessment, management considers the extent to which fair value is less than amortized cost, any changes to the rating of the security by a rating agency and adverse conditions specifically related to the security, among other factors. If this assessment indicates that a credit loss exists, the present value of cash flows expected to be collected from the security are compared to the amortized cost basis of the security. If the present value of cash flows expected to be collected is less than the amortized cost basis, a credit loss exists and an allowance for credit losses is recorded, limited by the amount that the fair value is less than the amortized cost basis. Any impairment that has not been recorded through an allowance for credit loss is recognized in other comprehensive income.

Comparison of Financial Condition at September 30, 2023 and June 30, 2023

Total Assets. Total assets decreased $3.2 million, or 1.3%, to $235.6 million at September 30, 2023 from $238.8 million at June 30, 2023. The decrease was primarily due to a decrease of $4.8 million, or 40.7%, in cash and cash equivalents offset by an increase in premises and equipment of $1.6 million.

Cash and Cash Equivalents. Total cash and cash equivalents decreased $4.8 million, or 40.7%, to $7.0 million at September 30, 2023 from $11.8 million at June 30, 2023, primarily due to a decrease in total deposits of $8.6 million offset by an increase in FHLB borrowings of $5.0 million. The Company also purchased a building for $1.6 million for a future new branch location.

Debt Securities Available for Sale. Total debt securities available for sale decreased $296,000, or 3.3%, to $8.6 million at September 30, 2023 from $8.9 million at June 30, 2023. The decrease was primarily due to paydowns and maturities and a decrease in the fair value of a corporate bond. Debt securities available for sale are carried at fair value with the unrealized gain or loss reflected in accumulated other comprehensive income (loss).

Loans. Loans decreased $180,000, or 0.09%, to $199.7 million at September 30, 2023 from $199.9 million at June 30, 2023. The decrease was primarily due to a decrease in consumer loans of $1.0 million, or 35.7%, to $1.8 million at September 30, 2023 from $2.8 million at June 30, 2023, a $586,000, or 30.8%, decrease in construction loans to $1.3 million at September 30, 2023 from $1.9 million at June 30, 2023 and a decrease in commercial and industrial loans of $267,000, or 3.9%, to $6.6 million at September 30, 2023 from $6.9 million at June 30, 2023. Offsetting these decreases was an increase in commercial real estate loans of $489,000, or 0.6%, to $85.1 million at September 30, 2023 from $84.6 million at June 30, 2023. One- to four-family residential loans also increased by $107,000, or 0.2%, to $59.7 million at September 30, 2023 from $59.6 million at June 30, 2023. The decrease in consumer loans was primarily related to the payoff of a consumer loan which was secured by a $650,000 certificate of deposit account and the decrease in construction loans was due to two construction loans totaling $613,000 which were converted to permanent financings.

Deposits. Total deposits decreased $8.6 million, or 4.4%, to $188.6 million at September 30, 2023 from $197.2 million at June 30, 2023. Non-interest-bearing demand accounts decreased $1.7 million, or 6.6%, to $24.5 million at September 30, 2023 from $26.2 million at June 30, 2023. Certificates of deposit decreased $1.2 million, or 1.4%, to $82.6 million at September 30, 2023 from $83.8 million at June 30, 2023. Demand, NOW and money market accounts decreased $3.6 million, or 8.1%, to $41.1 million at September 30, 2023 from $44.7 million at June 30, 2023. Savings deposits decreased $2.1 million, or 5.0%, to $40.4 million at September 30, 2023 from $42.5 million at June 30, 2023. The decrease in all deposit categories was related to customers moving funds from non-interest bearing demand accounts and demand, NOW and money market accounts to certificates of deposit accounts and the Company being less aggressive in matching competitor interest rates.

Federal Home Loan Bank (FHLB) Advances. Federal Home Loan Bank (FHLB) advances increased $5.0 million to $13.0 million at September 30, 2023 compared to $8.0 million in FHLB advances at June 30, 2023 to provide additional funding associated with the decrease in deposits and the acquisition of a building for a future new branch location.

Stockholders’ Equity. Total stockholders’ equity increased by $178,000, or 0.6%, to $31.5 million at September 30, 2023 from $31.3 million at June 30, 2023. The increase was primarily due to the implementation of CECL (notes 1 and 4), net of tax of $133,000 and net income of $86,000 for the three months ended September 30, 2023. These increases were offset by an increase in accumulated other comprehensive loss, net of tax of $92,000 which was primarily related to the decrease in fair value of a corporate bond as a result of the increase in interest rates.

Average Balance Sheets

The following table sets forth average balances, average yields and costs, and certain other information for the periods indicated. No tax-equivalent yield adjustments have been made, as the effects would be immaterial. All average balances are daily average balances. Non-accrual loans were included in the computation of average balances. The yields set forth below include the effect of deferred fees, discounts, and premiums that are amortized or accreted to interest income or interest expense, as applicable. Loan balances include loans held for sale.

(1) Annualized.

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

(3) Net interest-earning assets represent total interest-earning assets less total interest-bearing liabilities.

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

The following table presents 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 total column represents the sum of the prior columns. For purposes of this table, changes attributable to both rate and volume, which cannot be segregated, have been allocated proportionately based on the changes due to rate and the changes due to volume.

(In thousands)

Comparison of Operating Results for the Three Months Ended September 30, 2023 and 2022

General. Net income was $86,000 for the three months ended September 30, 2023, a decrease of $425,000, or 83.1%, from net income of $511,000 for the three months ended September 30, 2022. The decrease in net income for the three months ended September 30, 2023 was primarily attributable to a decrease of $150,000 in net-interest income, a decrease in non-interest income of $132,000, and increases in non-interest expenses and provision for income taxes of $18,000 and $85,000, respectively.

Interest Income. Interest income increased by $378,000, or 18.7%, to $2.4 million for the three months ended September 30, 2023 compared to $2.0 million for the three months ended September 30, 2022 primarily due to increases in loan interest income of $269,000 and other interest income (cash and cash equivalents and other) of $121,000. The increase in other interest income was primarily due to an increase in the average yield of 273 basis points to 4.72% on our cash and cash equivalents investments due to the increases in the federal funds rate. Cash and cash equivalents include investments in certificates of deposits of other banks with original maturities of less than one year. These increases were offset by a small decrease in debt securities interest income of $12,000 due to paydowns on securities.

Loan interest income increased by $269,000, or 14.1%, to $2.2 million for the three months ended September 30, 2023 from $1.9 million for the three months ended September 30, 2022, due to an increase in the average balance of the loan portfolio and an increase in the average yield on loans. The average balance of the loan portfolio increased by $7.6 million, or 4.0%, from $189.6 million for the three months ended September 30, 2022 to $197.1 million for the three months ended September 30, 2023. The increase in the average balance of loans was due to our continued efforts to increase commercial and multi-family real estate loans in Southeastern Wisconsin. The average balance of one-to-four family residential loans also increased. The increase was due to additional growth with respect to adjustable-rate one-to four-family residential loans. The average yield on the loan portfolio increased by 40 basis points from 4.06% for the three months ended September 30, 2022 to 4.46% for the three months ended September 30, 2023 as a result of rising interest rates.

Debt securities interest income decreased by $12,000, or 17.5%, to $58,000 for the three months ended September 30, 2023 from $70,000 for the three months ended September 30, 2022 due to a $1.9 million decrease in the average balance of debt securities associated with securities paydowns. This was in addition to a decrease of six basis points in the average yield on the debt securities portfolio to 2.50% for the three months ended September 30, 2023 from 2.56% for the three months ended September 30, 2022. The decrease in the average yield was related to paydowns on securities bearing higher interest rates and the decrease in the average yield of our collateralized mortgage obligations with inverse floating rates.

Interest Expense. Interest expense increased $528,000, or 167.9%, to $842,000 for the three months ended September 30, 2023 from $314,000 for the three months ended September 30, 2022, due to an increase of $459,000 in interest paid on deposits and an increase of $69,000 in interest paid on borrowings.

Interest expense on deposits increased $459,000, or 150.6%, to $763,000 for the three months ended September 30, 2023 from $304,000 for the three months ended September 30, 2022 due to an increase in the average rate paid on all deposit categories excluding savings deposits and an increase in the average balance of certificates of deposit which increased by $24.3 million, to $84.8 million as compared to $60.5 million when comparing the three months ended September 30, 2023 to the three months ended September 30, 2022. The increase in the average rate paid on all deposit categories excluding savings deposits was due to the Bank raising the interest rates on these deposit categories to maintain customers and keep the rates in line with those competitors are offering. The increase in the average balance of certificates of deposit was due to the offering of higher rate certificate of deposit products to attract new funds to the Bank.

The increase in interest paid on borrowings was due to the average balance of FHLB advances increasing by $8.5 million.

Net Interest Income. Net interest income decreased by $150,000, or 8.7%, to $1.6 million for the three months ended September 30, 2023 from $1.7 million for the three months ended September 30, 2022. Net interest-earning assets decreased by $1.4 million, or 3.5%, to $37.1 million for the three months ended September 30, 2023 from $38.4 million for the three months ended September 30, 2022. Net interest rate spread decreased by 59 basis points to 2.57% for the three months ended September 30, 2023 from 3.16% for the three months ended September 30, 2022, reflecting a 111 basis points increase in the average rate paid on interest-bearing liabilities which was offset by a 52 basis points increase in the average yield on interest-earning assets. The net interest margin decreased by 43 basis points to 2.85% for the three months ended September 30, 2023 from 3.28% for the three months ended September 30, 2022. The increase in the average yield on interest earning assets for the three months ended September 30, 2023 compared to the three months ended September 30, 2022 was primarily due to an increase in the average yield of 273 basis points on our cash and cash equivalents investments due to the recent increases in the federal funds rate. The increase in the average interest rate paid on interest-bearing liabilities was due to the Bank raising the interest rates on all deposit categories excluding savings accounts to maintain customers and keep the rates in line with what the competitors were offering and to attract new funds to the Bank.

Provision for Credit Losses. We charge provisions for credit losses to operations in order to maintain our allowance for credit losses on loans and reserve for unfunded commitments at a level that is considered reasonable and necessary to absorb expected credit losses inherent in the loan portfolio and expected losses on commitments to grant loans that are expected to be advanced at the consolidated balance sheet date. In determining the level of the allowance for credit losses, we consider our past loan loss experience, known and inherent risks in the portfolio, adverse situations that may affect the borrower’s ability to repay, the estimated value of any underlying collateral, composition of the loan portfolio, current economic conditions, and the levels of non-performing and other classified loans. The amount of the allowance is based on estimates and the ultimate losses may vary from such estimates as more information becomes available or conditions change. We assess the allowance for credit losses on a quarterly basis and make provisions for credit losses in order to maintain the allowance.

Based on our evaluation of the above factors, we recorded a provision for credit losses of $41,000 for the three months ended September 30, 2023 compared to no provision for the three months ended September 30, 2022, respectively. The allowance for credit losses was $2.0 million, or 1.01%, of loans outstanding at September 30, 2023 and $2.1 million, or 1.05%, of loans outstanding at September 30, 2022.

To the best of our knowledge, we have recorded our best estimate of expected losses in the loan portfolio and for unfunded commitments at September 30, 2023. However, future changes in the factors described above, including, but not limited to, actual loss experience with respect to our loan portfolio, could result in material increases in our provision for credit losses. In addition, the WDFI and the FDIC, as an integral part of their examination process, will periodically review our allowance for credit losses, and as a result of such reviews, we may have to adjust our allowance for credit losses. However, regulatory agencies are not directly involved in establishing the allowance for credit losses as the process is our responsibility and any increase or decrease in the allowance is the responsibility of management.

Non-interest Income. Non-interest income information is as follows.

(Dollars in thousands)

Non-interest income decreased by $132,000 to $228,000 for the three months ended September 30, 2023 from $360,000 for the three months ended September 30, 2022 due primarily to a gain on proceeds from a life insurance death benefit of $173,000 recorded in the three months ended September 30, 2022.

Non-interest Expenses. Non-interest expenses information is as follows.

(Dollars in thousands)

Non-interest expenses were $1.5 million for the three months ended September 30, 2023 compared to $1.4 million for the three months ended September 30, 2022. The increase was primarily due to an increase in other expenses of $59,000 offset by a decrease in salaries and employee benefits of $59,000. The increase in other expenses was primarily related to an increase in FDIC insurance premiums and the cost of a loan appraisal paid for by the Company on behalf of a customer while the decrease in salaries and employee benefits was primarily related to the prior year period including a bonus accrual compared to no bonus accrual for the current three month period.

Provision for Income Taxes. Income tax expense was $201,000 for the three months ended September 30, 2023, an increase of $84,000, as compared to income tax expense of $117,000 for the three months ended September 30, 2022. The increase in income tax expense was primarily due to a change in the Company’s effective tax rate. The effective tax rate for the three months ended September 30, 2023 and 2022 was 70.0% and 18.6%, respectively. The effective tax rate increased during the three months ended September 30, 2023 as compared to the prior year period as a result of a change in Wisconsin tax law that provides for a subtraction from the Bank’s state taxable income for loan and fee interest income from certain commercial and agricultural loans requiring the Company to record a valuation allowance against its state deferred tax asset of $154,889 and the fact that the gain on life insurance proceeds was not subject to income taxes during the three months ended September 30, 2022.

Asset Quality

Loans Past Due and Non-Performing Assets. Loans are reviewed on a regular basis. Non-accrual loans are loans for which collectability is questionable and, therefore, interest on such loans will no longer be recognized on an accrual basis. All loans that become 90 days or more delinquent are placed on non-accrual status unless the loan is well secured and in the process of collection. When loans are placed on non-accrual status, unpaid accrued interest is fully reversed, and further income is recognized only to the extent received on a cash basis or cost recovery method.

When we acquire real estate as a result of foreclosure, the real estate is classified as real estate owned. Assets acquired through, or in lieu of, loan foreclosure are held for sale and are initially recorded at fair value less estimated cost to sell at the date of foreclosure, establishing a new cost basis. Subsequent to foreclosure, valuations are periodically performed by management and the assets are carried at the lower of carrying amount or fair value less cost to sell. Revenue and expenses from operations and changes in the valuation allowance are included in net expenses from foreclosed assets. Costs relating to the development and improvement of the property, however, are capitalized to the extent of estimated fair value less estimated costs to sell.

Delinquent Loans. The following table sets forth our loan delinquencies, including non-accrual loans, by type and amount at the dates indicated.

(In thousands)

Non-Performing Assets. The following table sets forth information regarding our non-performing assets.

(Dollars in thousands)

Non-performing assets includes other real estate owned of $2.3 million related to the foreclosure of collateral supporting a construction loan which was valued at $2.3 million and is included in foreclosed assets. The valuation was based on recently obtained independent appraisals subject to certain discounts less estimated costs to sell.

Classified Assets. Federal regulations provide for the classification of loans and other assets, such as debt and equity securities considered to be of lesser quality, as “substandard,” “doubtful” or “loss.” An asset is considered “substandard” if it is inadequately protected by the current net worth and paying capacity of the obligor or of the collateral pledged, if any. “Substandard” assets include those characterized by the “distinct possibility” that the insured institution will sustain “some loss” if the deficiencies are not corrected. Assets classified as “doubtful” have all of the weaknesses inherent in those classified “substandard,” with the added characteristic that the weaknesses present make “collection or liquidation in full,” on the basis of currently existing facts, conditions, and values, “highly questionable and improbable.” Assets classified as “loss” are those considered “uncollectible” and of such little value that their continuance as assets without the establishment of an allowance for credit loss is not warranted. Assets which do not currently expose the insured institution to sufficient risk to warrant classification in one of the aforementioned categories but possess weaknesses are designated as “special mention” or “Watch” by our management.

When an insured institution classifies problem assets as either substandard or doubtful, it may establish general allowances in an amount deemed prudent by management to cover probable accrued losses. General allowances represent loss allowances which have been established to cover probable accrued losses associated with lending activities, but which, unlike specific allowances, have not been allocated to particular problem assets. When an insured institution classifies problem assets as “loss,” it is required either to establish a specific allowance for losses equal to 100% of that portion of the asset so classified or to charge-off such amount. An institution’s determination as to the classification of its assets and the amount of its valuation allowances is subject to review by the regulatory authorities, which may require the establishment of additional general or specific loss allowances.

On the basis of our review of our loans our classified and special mention or watch loans at the dates indicated were as follows:

(In thousands)

Allowance for Credit Losses

Allowance for Credit Losses. We establish the allowance for credit losses through charges to earnings in the form of a provision for credit losses. Credit losses are charged against the allowance for credit losses for the difference between the carrying value of the loan and the estimated net realizable value or fair value of the collateral, if collateral dependent, when management believes that the collectability of the principal is unlikely. Subsequent recoveries, if any, are credited to the allowance.

The allowance for credit losses (“ACL”) at September 30, 2023 represents the Company’s current estimate of the lifetime credit losses expected from its loan portfolio. Management estimates the ACL by projecting a lifetime loss rate conditional on a forecast of economic parameters and other qualitative adjustments, for the loans’ expected remaining term.

Management’s judgment in determining the level of the allowance is based on evaluations of historical loan losses, current conditions and reasonable and supportable forecasts relevant to the collectability of loans. In addition, management’s estimate of expected credit losses is based on the discounted cash flows over the remaining life of loans held for investment, and changes in expected prepayment behavior may result in changes in the remaining life of loans and expected credit losses.

The allowance may be affected materially by a variety of qualitative factors that the Company considers to reflect its current judgement of various events and risks that are not measured in our statistical procedures. These qualitative risk factors include: (1) lending policies and procedures, including underwriting standards and collection, charge-off, and recovery practices; (2) changes in the value of underlying collateral for collateral dependent loans; (3) nature and volume of the portfolio and terms of loans; (4) volume and severity of past due, classified and nonaccrual loans as well as loan modifications; (5) existence and effect of any concentrations of credit and changes in the level of such concentrations; (6) experience, ability, and depth of lending department management and other relevant staff; (7) quality of loan review and board of directors oversight; (8) the effect of other external factors such as competition, legal and regulatory requirements; and (9) changes in national and local economic conditions related to unemployment, house price index, and gross domestic product. This evaluation is inherently subjective because it requires estimates that are susceptible to significant revision as more information becomes available. In evaluating the level of the allowance, we consider a range of possible assumptions and outcomes related to the various factors identified above. The level of the allowance is particularly sensitive to changes in the actual and forecasted probability of default of benchmarked banks and changes in current conditions or reasonably expected future conditions affecting the collectability of loans.

Although we believe that we use the best information available to establish the allowance for credit losses, future adjustments to the allowance may be necessary if economic conditions differ substantially from the assumptions used in making the evaluation. In addition, the FDIC and the WDFI, as an integral part of their examination process, periodically review our allowance for credit losses, and as a result of such reviews, we may have to adjust our allowance for credit losses. However, regulatory agencies are not directly involved in establishing the allowance for credit losses as the process is our responsibility and any increase or decrease in the allowance is the responsibility of management. A large loss could deplete the allowance and require increased provisions to replenish the allowance, which would adversely affect earnings.

The following table sets forth activity in our allowance for credit losses for the periods indicated.

(Dollars in thousands)

Allocation of Allowance for Credit Losses. The following table sets forth the allowance for credit losses allocated by loan category and the percent of the allowance in each category to the total allocated allowance at the dates indicated. The allowance for credit 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.

(Dollars in thousands)

(Dollars in thousands)

Liquidity and Capital Resources

Liquidity describes our ability to meet the financial obligations that arise in the ordinary course of business. Liquidity is primarily needed to meet the borrowing and deposit withdrawal requirements of our customers and to fund current and planned expenditures. Our primary sources of funds are deposits, principal and interest payments on loans and securities, proceeds from the sale of loans, and proceeds from maturities of securities. We also have the ability to borrow from the Federal Home Loan Bank of Chicago. At September 30, 2023, we had a $84.0 million line of credit with the Federal Home Loan Bank of Chicago, which had $13.0 million in borrowings outstanding as of that date. The Bank also has $25.0 million available to borrow from the Federal Reserve Bank when pledging acceptable assets and an unsecured Federal Funds purchasing limit of $5.0 million with the Bank’s correspondent bank.

While maturities and scheduled amortization of loans and securities are predictable sources of funds, deposit flows and loan prepayments are greatly influenced by general interest rates, economic conditions, and competition. Our most liquid assets are cash and short-term investments including interest-bearing demand deposits. The levels of these assets are dependent on our operating, financing, lending, and investing activities during any given period.

Our cash flows are comprised of three primary classifications: cash flows from operating activities, investing activities, and financing activities. Net cash provided by operating activities was $367,000 as compared to $1.5 million of cash provided by operating activities for the three months ended September 30, 2023 and 2022, respectively. Net cash used in investing activities, which consists primarily of disbursements for loan origination, the purchase of securities, and the purchase of premises and equipment offset by principal collections on loans, proceeds from the sale of securities and proceeds from maturing securities and pay downs on securities, was $1.4 million and $5.7 million for the three months ended September 30, 2023 and 2022, respectively. Net cash used in financing activities, consisting of activity in deposit accounts and borrowings, was $3.6 million compared to $13.7 million being provided by financing activities for the three months ended September 30, 2023 and 2022, respectively.

We are committed to maintaining a strong liquidity position. We monitor our liquidity position on a daily basis. We anticipate that we will have sufficient funds to meet our current funding commitments. Based on our deposit retention experience, current pricing strategy and regulatory restrictions, we anticipate that a substantial portion of maturing time deposits will be retained, and that we can supplement our funding with borrowings in the event that we allow these deposits to run off at maturity.

At September 30, 2023, Marathon Bank was classified as “well capitalized” for regulatory capital purposes. See Note 9-Minimum Regulatory Capital Requirements in the accompanying consolidated financial statements for additional information.

Off-Balance Sheet Arrangements and Aggregate Contractual Obligations

Commitments. As a financial services provider, we routinely are a party to various financial instruments with off-balance-sheet risks, such as commitments to extend credit and unused lines of credit. While these contractual obligations represent our future cash requirements, a significant portion of commitments to extend credit may expire without being drawn upon. Such commitments are subject to the same credit policies and approval process accorded to loans we make. At September 30, 2023, we had outstanding commitments to originate loans of $7.2 million, and $1.2 million in outstanding commitments to sell loans. We anticipate that we will have sufficient funds available to meet our current lending commitments. Time deposits that are scheduled to mature in one year or less from September 30, 2023 totaled $53.4 million, which include $4.2 million in brokered certificates of deposit. Management expects that a substantial portion of the maturing time deposits will be renewed. However, if a substantial portion of these deposits is not retained, we may utilize additional Federal Home Loan Bank advances or other borrowings, which may result in higher levels of interest expense.

Contractual Obligations. In the ordinary course of our operations, we enter into certain contractual obligations. Such obligations include data processing services, operating leases for premises and equipment, agreements with respect to borrowed funds and deposit liabilities.

Recent Accounting Pronouncements

Please refer to Note 1 to the consolidated financial statements for a description of recent accounting pronouncements that may affect our financial condition and results of operations.

Impact of Inflation and Changing Price

The financial statements and related data presented herein have been prepared in accordance with U.S. GAAP, which requires the measurement of financial position and operating results in terms of historical dollars without considering changes in the relative purchasing power of money over time due to inflation. The primary impact of inflation on our operations is reflected in increased operating costs. Unlike most industrial companies, virtually all of the assets and liabilities of a financial institution are monetary in nature. As a result, interest rates, generally, have a more significant impact on a financial institution’s performance than does inflation. Interest rates do not necessarily move in the same direction or to the same extent as the prices of goods and services.

Evaluation of Disclosure Controls and Procedures

Disclosure controls and procedures are the controls and other procedures that are designed to ensure that information required to be disclosed in the reports that the Company files or submits under the Securities and Exchange Act of 1934, as amended (the “Exchange Act”) is recorded, processed, summarized, and reported within the time periods specified in the SEC’s rules and forms. Disclosure controls and procedures include, without limitation, controls and procedures designed to ensure that information required to be disclosed in the reports that the Company files or submits under the Exchange Act is accumulated and communicated to management, including the Chief Executive Officer and Chief Financial Officer, as appropriate, to allow timely decisions regarding required disclosure. In designing and evaluating the disclosure controls and procedures, management recognizes that any controls and procedures, no matter how well designed and operated, can only provide reasonable assurance of achieving the desired control objectives. In addition, the design of disclosure controls and procedures must necessarily reflect the fact that there are resource constraints and that management is required to apply its judgement in evaluating the benefits of possible controls and procedures relative to their costs.

Under the supervision and with the participation of the Company’s management, including the Company’s Chief Executive Officer and Chief Financial Officer , the Company has evaluated the effectiveness of the Company’s disclosure controls and procedures as defined in Rules 13a-15 and 15d-15(e) under the Exchange Act as of September 30, 2023.

We identified a material weakness in our controls over accounting that occurred beginning in the fourth quarter of fiscal year 2021 through the first quarter of fiscal year 2024 relating to special provisions in the tax laws regarding a Bank’s allowable tax bad debt deductions and related tax bad debt reserves as described below. Based upon that discovery, our Chief Executive Officer and Chief Financial Officer have concluded that our disclosure controls and procedures were not effective at a level that provides reasonable assurance as of the last day of the period covered by this report.

The material weakness in internal control over financial reporting resulted from the lack of controls which allowed for the Company to erroneously maintain a deferred tax liability, which it will not be required to recapture as management does not intend to redeem stock, make distributions or take other actions that would result in the recapture of this reserve. The Company erroneously applied the Section 585 reserve method, whereby it was allowed to, in 1996, change to the specific charge-off method (with no reserve) and recapture the thrift reserves in their entirety if it switched from a thrift charter to a commercial charter prior to 1996. This material weakness resulted in the correction of the material errors and restatement of prior financial statements as disclosed in Note 1 to the consolidated audited financial statements contained in the Company’s Annual Report on Form 10-K as filed with the Securities and Exchange Commission on September 20, 2023. Management has identified effective control plans for the remediation of the material weakness which will be implemented in fiscal year 2024.

Internal Control over Financial Reporting

Other than the remediation described above, there has been no change in the Company’s internal control over financial reporting during the first quarter of the fiscal year ended June 30, 2024 that has materially affected, or is reasonably likely to materially affect, the Company’s internal control over financial reporting.