Marathon Bancorp, Inc.: Form 10-Q for the period ended Mar 31, 2024

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 (Recovery of) Credit Losses. We charge (credit) provisions for (recovery of) 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 (recovery of) 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. 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 (Benefit from) Income Taxes. Our income tax expense (benefit) 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 (credits) to earnings in the form of a provision for (recovery of) 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 March 31, 2024 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 (Benefit from) 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.

Foreclosed Assets. 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.

Comparison of Financial Condition at March 31, 2024 and June 30, 2023

Total Assets. Total assets decreased $13.0 million, or 5.4%, to $225.8 million at March 31, 2024 from $238.8 million at June 30, 2023. The decrease was primarily due to a decrease of $3.7 million, or 31.4%, in cash and cash equivalents, a decrease in net loans of $5.8 million, or 2.9%, a decrease in interest bearing deposits held in other financial institutions of $3.3 million, or 88.9%, a decrease in debt securities available for sale of $2.0 million, or 22.4% and finally, a decrease in foreclosed assets, net of $914,780, or 39.6%. These decreases were partially offset by an increase in premises and equipment of $2.0 million. The increase in premises and equipment was associated with the Bank’s new branch in Brookfield, Wisconsin which opened on January 22, 2024.

Cash and Cash Equivalents. Total cash and cash equivalents decreased $3.7 million, or 31.4%, to $8.1 million at March 31, 2024 from $11.8 million at June 30, 2023, primarily due to a decrease in total deposits of $27.6 million offset by an increase in FHLB borrowings of $15.0 million, a decrease in net loans of $5.8 million, and a decrease in interest bearing deposits held in other financial institutions of $3.3 million. The Bank 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 $2.0 million, or 22.4%, to $6.9 million at March 31, 2024 from $8.9 million at June 30, 2023. The decrease was primarily due to the call of $1.5 million in corporate bonds. Debt securities available for sale are carried at fair value with the unrealized gain or loss reflected in accumulated other comprehensive income (loss).

Loans. Gross loans decreased $6.2 million, or 3.1%, to $193.7 million at March 31, 2024 from $199.9 million at June 30, 2023. The decrease was primarily due to a decrease in all categories of loans with the exception of multi-family real estate loans which increased by $1.1 million, or 2.6%, to $45.3 million at March 31, 2024 from $44.2 million at June 30, 2023. Consumer loans decreased by $1.3 million, or 44.3%, primarily due to the payoff of a consumer loan which was secured by a $650,000 certificate of deposit account. The decrease in construction loans was primarily due to two construction loans totaling $613,000 which were converted to permanent financings. The remaining categories of loan decreases (commercial real estate, commercial and industrial and one-to-four-family residential) were primarily due to repayments exceeding new loan growth.

Foreclosed Assets. Foreclosed assets, net decreased by $914,780, or 39.6%. During the three months ended June 30, 2023, the Company foreclosed on collateral supporting a construction loan which was valued at $2.3 million and was included in foreclosed assets (OREO), net. The valuation was based on independent appraisals subject to certain discounts less estimated costs to sell. A subsequent independent appraisal was obtained in April 2024 resulting in a new valuation of $2.1 million subject to certain discounts less estimated costs to sell. After adjusting for estimated costs to sell, the revised valuation was $1.4 million resulting in a provision for valuation allowance of $937,000 being recorded during the three and nine months ended March 31, 2024. The Bank is pursuing legal remedies against the previous owner of the property.

Deposits. Total deposits decreased $27.6 million, or 14.0%, to $169.7 million at March 31, 2024 from $197.3 million at June 30, 2023. All categories of deposits decreased when comparing March 31, 2024 to June 30, 2023 with certificates of deposit decreasing the most by $17.7 million, or 21.1%. The decrease in all deposit categories was related to customers who changed banks to obtain higher rates and the Bank being less aggressive in matching competitor interest rates. Finally, we had a $4.2 million brokered certificate of deposit that matured in March 2024 and a $4.5 million brokered certificate of deposit that matured at the end of September 2023. Brokered certificates of deposit totaled $13.4 million and $22.2 million at March 31, 2024 and June 30, 2023, respectively.

Federal Home Loan Bank (FHLB) Advances. FHLB advances increased $15.0 million to $23.0 million at March 31, 2024 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. We were able to obtain more favorable borrowing rates from the FHLB than the rates that customers were requesting for certificates of deposit.

Stockholders’ Equity. Total stockholders’ equity remained virtually unchanged when comparing March 31, 2024 with June 30, 2023 with stockholders’ equity totaling $31.3 million at both dates.

Average Balance Sheets

The following tables set 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, if applicable, are 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.

(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)

(In thousands)

Comparison of Operating Results for the Three Months Ended March 31, 2024 and 2023

General. Net loss was $631,000 for the three months ended March 31, 2024, a decrease of $997,000, or 272.6%, from net income of $366,000 for the three months ended March 31, 2023. The decrease in net income for the three months ended March 31, 2024 was primarily attributable to an increase in expenses associated with foreclosed assets, net of $970,000, a decrease of $245,000 in net-interest income and a decrease in non-interest income of $112,000 offset by a recovery of credit losses of $122,000. Also, offsetting the net loss was the provision for (benefit from) income taxes which decreased by $261,000, from a provision for income taxes of $58,000 for the three months ended March 31, 2023 to a benefit from income taxes of $203,000 for the three months ended March 31, 2024.

Interest Income. Interest income increased by $35,000, or 1.5%, to $2.3 million for the three months ended March 31, 2024 as compared to the three months ended March 31, 2023 primarily due to an increase in loan interest income of $70,000 offset by a decrease in other interest income of $26,000.

Loan interest income increased by $70,000, or 3.4%, to $2.1 million for the three months ended March 31, 2024 as compared to the three months ended March 31, 2023, due to an increase in the average yield on loans offset by a decrease in the average balance of the loan portfolio. The average yield on the loan portfolio increased by 21 basis points from 4.32% for the three months ended March 31, 2023 to 4.53% for the three months ended March 31, 2024 as a result of rising interest rates. The average balance of the loan portfolio decreased by $4.5 million, or 2.3%, from $197.1 million for the three months ended March 31, 2023 to $192.6 million for the three months ended March 31, 2024.

Interest Expense. Interest expense increased $279,000, or 43.9%, to $916,000 for the three months ended March 31, 2024 from $637,000 for the three months ended March 31, 2023, due to an increase of $73,000 in interest paid on deposits and an increase of $206,000 in interest paid on borrowings.

Interest expense on deposits increased $73,000, or 11.6%, to $704,000 for the three months ended March 31, 2024 from $631,000 for the three months ended March 31, 2023 due to an increase in the average rate paid on all deposit categories except savings deposits. The increase in the average rate paid on all deposit categories except 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 interest expense related to the increase in the average rate paid on deposits was offset by a decrease in the average balances of all deposit categories. All categories of deposit average balances decreased when comparing the three months ended March 31, 2024 with the three months ended March 31, 2023. Average balances of certificates of deposit decreased the most by $14.6 million, or 17.2%. Average balances of demand, NOW and money market accounts also decreased by $9.4 million, or 18.1%. The decrease in the average balances of all deposits was related to customers who changed banks to obtain higher rates and the Bank being less aggressive in matching competitor interest rates. Finally, we had a $4.2 million brokered certificate of deposit that matured in March 2024 and a $4.5 million brokered certificate of deposit that matured at the end of September 2023.

Interest paid on FHLB borrowings increased $206,000, from $6,000 for the three months ended March 31, 2023 to $212,000 for the three months ended March 31, 2024. The increase in interest paid on borrowings was due to the average balance of FHLB advances increasing by $20.9 million and an increase in the average rate paid on borrowings of 94 basis points from 3.05% for the three months ended March 31, 2023 to 3.99% for the three months ended March 31, 2024. We were able to obtain more favorable borrowing rates from the FHLB than the rates that customers were requesting for certificates of deposit while also improving liquidity.

Net Interest Income. Net interest income decreased by $245,000, or 14.9%, to $1.4 million for the three months ended March 31, 2024 from $1.6 million for the three months ended March 31, 2023. Net interest-earning assets decreased by $4.5 million, or 11.0%, to $35.9 million for the three months ended March 31, 2024 from $40.3 million for the three months ended March 31, 2023. Net interest rate spread decreased by 43 basis points to 2.39% for the three months ended March 31, 2024 from 2.82% for the three months ended March 31, 2023, reflecting a 71 basis points increase in the average rate paid on interest-bearing liabilities which was offset by a 28 basis points increase in the average yield on interest-earning assets. The net interest margin decreased by 33 basis points to 2.73% for the three months ended March 31, 2024 from 3.06% for the three months ended March 31, 2023. The increase in the average yield on interest earning assets for the three months ended March 31, 2024 compared to the three months ended March 31, 2023 was primarily due to an increase in the average yield of all interest-earning asset categories related to the increase in market interest rates over the past year. 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 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 (Recovery of) Credit Losses. We charge (credit) provisions for (recovery of) 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 (recovery of) credit losses in order to maintain the allowance.

Based on our evaluation of the above factors, we recorded a recovery of credit losses of $122,000 for the three months ended March 31, 2024 compared to no provision for credit losses for the three months ended March 31, 2023. The recovery was related to an improvement in current and projected future economic conditions in our market area and the decline in the overall loan portfolio. We anticipate low unemployment and that the housing price index (HPI) will improve over the next two years due to continued high demand and the low inventory of residential real estate. These predictions align with the Bank’s historic charge-off history over the past 8-10 years.

The allowance for credit losses was $1.8 million, or 0.91%, of loans outstanding at March 31, 2024 and $2.1 million, or 1.01%, of loans outstanding at March 31, 2023.

To the best of our knowledge, we have recorded our best estimate of expected losses in the loan portfolio and for unfunded commitments at March 31, 2024. 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 $112,000 to $147,000 for the three months ended March 31, 2024 from $259,000 for the three months ended March 31, 2023 due primarily to a gain on proceeds from life insurance death benefit of $88,000 for the three months ended March 31, 2023 compared to no gains for the three months ended March 31, 2024. Mortgage banking income also decreased by $23,000 primarily due to higher mortgage rates which led to less loan originations.

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

(Dollars in thousands)

Non-interest expenses were $2.5 million for the three months ended March 31, 2024 compared to $1.5 million for the three months ended March 31, 2023. The increase was primarily related to an increase in expenses associated with foreclosed assets, net, of $970,000. The increase in expenses associated with foreclosed assets, net was primarily related to the recording of a valuation allowance of $937,000 during the three months ended March 31, 2024 associated with a new appraisal obtained on the Company’s only foreclosed asset. For further information, please see Comparison of Financial Condition at March 31, 2024 and June 30, 2023- Foreclosed Assets above.

Provision for (Benefit from) Income Taxes. Income tax benefit was $203,000 for the three months ended March 31, 2024, a decrease of $261,000, as compared to income tax expense of $58,000 for the three months ended March 31, 2023. The decrease in income tax expense was primarily due to a change in the Company’s income before income taxes and a change in the Company’s effective tax rate. The effective tax rate for the three months ended March 31, 2024 and 2023 was 24.3% and 13.7%, respectively. The effective tax rate increased during the three months ended March 31, 2024 as compared to the prior year period because the gain on life insurance proceeds was not subject to income taxes for the three months ended March 31, 2023.

Comparison of Operating Results for the Nine Months Ended March 31, 2024 and 2023

General. Net loss was $273,000 for the nine months ended March 31, 2024, a decrease of $1.5 million, or 123.2%, from net income of $1.2 million for the nine months ended March 31, 2023. The decrease in net income (loss) for the nine months ended March 31, 2024 was primarily attributable to an increase in expenses associated with foreclosed assets, net of $1.0 million, a decrease of $599,000 in net-interest income, and a decrease of $261,000 in non-interest income. These changes were partially offset by a recovery of loan losses of $216,000 and a decrease in the provision for income taxes of $297,000.

Interest Income. Interest income increased by $569,000, or 8.7%, to $7.1 million for the nine months ended March 31, 2024 compared to $6.6 million for the nine months ended March 31, 2023 primarily due to increases in loan interest income and other interest income (cash and cash equivalents and other). The increase in other interest income of $88,000 was primarily due to an increase in the average yield of 184 basis points on our cash and cash equivalents due to the increases in the federal funds rate which was offset by a decrease in the average balance of cash and cash equivalents of $3.4 million when comparing the nine months ended March 31, 2024 with the nine months ended March 31, 2023.

Loan interest income increased by $507,000, or 8.5%, to $6.5 million for the nine months ended March 31, 2024 from $6.0 million for the nine months ended March 31, 2023, due to a slight 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 $1.4 million, or 0.70%, from $193.7 million for the nine months ended March 31, 2023 to $195.1 million for the nine months ended March 31, 2024. The average yield on the loan portfolio increased by 31 basis points from 4.15% for the nine months ended March 31, 2023 to 4.46% for the nine months ended March 31, 2024 as a result of rising interest rates.

Interest Expense. Interest expense increased $1.2 million, or 77.5%, to $2.7 million for the nine months ended March 31, 2024 from $1.5 million for the nine months ended March 31, 2023, due to an increase of $764,000 in interest paid on deposits and an increase of $404,000 in interest paid on borrowings.

Interest expense on deposits increased $764,000, or 52.3%, to $2.2 million for the nine months ended March 31, 2024 from $1.5 million for the nine months ended March 31, 2023 due to an increase in interest expense on all deposit categories except savings deposits as a result of the increase in average rates. The average rate paid on demand, NOW and money market accounts and certificates of deposit increased with the average rate paid on demand, NOW and money market accounts increasing by 50 basis points and the average rate paid on certificates of deposit increasing 109 basis points. The increase in the average rate paid on all deposit categories was due to the Bank raising the interest rates on these deposit categories to maintain customers and keep the rates in line with what the competitors were offering and to attract new funds to the Bank. The average balance of certificates of deposit increased slightly by $2.5 million, or 3.3%, from $75.3 million for the nine months ended March 31, 2023 to $77.8 million for the nine months ended March 31, 2024. The average balance of interest-bearing demand, NOW and money market and savings accounts decreased by $10.8 million and $4.6 million, respectively. The increase in the average balance of certificates of deposit accounts was due to offering higher rate deposit products during the nine months ended March 31, 2024 offset by the maturity of two brokered certificates of deposit totaling $8.7 million during the nine months ended March 31, 2024. The decrease in the average balance of interest-bearing demand, NOW, money market and savings deposits was related to customers who changed banks to obtain higher rates and the Bank being less aggressive in matching competitor interest rates.

Interest paid on FHLB borrowings increased $404,000, from $45,000 for the nine months ended March 31, 2023 to $449,000 for the nine months ended March 31, 2024. The increase in interest paid on borrowings was due to the average balance of FHLB advances increasing by $14.1 million and an increase in the average rate paid on borrowings of 44 basis points from 3.33% for the nine months ended March 31, 2023 to 3.77% for the nine months ended March 31, 2024. We were able to obtain more favorable borrowing rates from the FHLB than the rates that customers were requesting for certificates of deposits while also improving liquidity.

Net Interest Income. Net interest income decreased by $599,000, or 11.9%, to $4.5 million for the nine months ended March 31, 2024 from $5.1 million for the nine months ended March 31, 2023. Net interest-earning assets decreased by $4.8 million, or 11.8%, to $36.1 million for the nine months ended March 31, 2024 from $41.0 million for the nine months ended March 31, 2023. Net interest rate spread decreased by 45 basis points to 2.44% for the nine months ended March 31, 2024 from 2.89% for the nine months ended March 31, 2023, reflecting a 87 basis points increase in the average rate paid on interest-bearing liabilities offset by a 42 basis points increase in the average yield on interest-earning assets. The net interest margin decreased 32 basis points to 2.77% for the nine months ended March 31, 2024 from 3.09% for the nine months ended March 31, 2023. The increase in the average yield on interest earning assets for the nine months ended March 31, 2024 compared to the nine months ended March 31, 2023 was primarily due to an increase in market interest rates. 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 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 (Recovery of) Credit Losses. We charge (credit) provisions for (recovery of) 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 (recovery of) credit losses in order to maintain the allowance.

Based on our evaluation of the above factors, we recorded a recovery of credit losses of $216,000 for the nine months ended March 31, 2024 compared to no provision for credit losses for the nine months ended March 31, 2023, respectively. The recovery was related to an improvement in the current and projected future economic conditions in our market area and the decline in the overall loan portfolio. We anticipate low unemployment and that the housing price index (HPI) will improve over the next two years due to continued high demand and the low inventory of residential real estate. These predictions align with the Bank’s historic charge-off history over the past 8-10 years. The allowance for credit losses was $1.8 million, or 0.91%, of loans outstanding at March 31, 2024 and $2.1 million, or 1.01%, of loans outstanding at March 31, 2023.

To the best of our knowledge, we have recorded our best estimate of expected losses in the loan portfolio and for unfunded commitments at March 31, 2024. 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 $261,000 to $552,000 for the nine months ended March 31, 2024 from $813,000 for the nine months ended March 31, 2023 due primarily to a gain on proceeds from a life insurance death benefit and net gain on securities transactions of $261,000 and $24,000, respectively, being recognized during the nine months ended March 31, 2023 compared to no such amounts being recognized during the nine months ended March 31, 2024. These decreases were partially offset by an increase in mortgage banking income of $46,000. The increase in mortgage banking income (consisting primarily of sales of fixed-rate one- to four-family residential real estate loans) increased as we sold $4.4 million of mortgage loans into the secondary market during the nine months ended March 31, 2024 compared to $2.1 million of such sales during the nine months ended March 31, 2023 as well as an increase in the mortgage servicing fees we receive.

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

(Dollars in thousands)

Non-interest expenses were $5.5 million for the nine months ended March 31, 2024 compared to $4.4 million for the nine months ended March 31, 2023. The increase was related to an increase in expenses associated with foreclosed assets, net, of $1.0 million and minor increases in the majority of other expense accounts which were offset by a decrease of $158,000 in salaries and employee benefits when comparing the two periods. The increase in expenses associated with foreclosed assets, net was primarily related to the recording of a valuation allowance of $937,000 during the nine months ended March 31, 2024 associated with a new appraisal obtained on the Company’s only foreclosed asset. For further information, please see Comparison of Financial Condition at March 31, 2024 and June 30, 2023- Foreclosed Assets above. The increase in other expenses was primarily related to an increase in FDIC premiums and to a lesser extent, check fraud losses. 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 nine month period.

Provision for (Recovery from) Income Taxes. Income tax benefit was $31,000 for the nine months ended March 31, 2024, a decrease of $297,000, as compared to income tax expense of $266,000 for the nine months ended March 31, 2023. The decrease in income tax expense was primarily the result of a decrease in income before income taxes of $1.7 million which was offset by 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. Based upon the provisions of this new state tax law, management determined that the Company was highly unlikely to incur a material Wisconsin tax liability in the foreseeable future, instead generating Wisconsin net operating loss carryforwards that would never be realized. Since the state rate at which net deferred tax assets are expected to be realized is 0%, the Company eliminated its state net deferred tax asset balances as of July 1, 2023, resulting in deferred tax expense of approximately $112,000 for the nine months ended March 31, 2024.

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 $1.4 million and $2.3 million, at March 31, 2024 and June 30, 2023, respectively. During the three months ended June 30, 2023, the Company foreclosed on collateral supporting a construction loan which was valued at $2.3 million and was included in foreclosed assets (OREO), net. The valuation was based on independent appraisals subject to certain discounts less estimated costs to sell. A subsequent independent appraisal was obtained in April 2024 resulting in a new valuation of $2.1 million subject to certain discounts less estimated costs to sell. After adjusting for estimated costs to sell, the revised valuation was $1.4 million resulting in a provision for valuation allowance of $937,000 being recorded during the three and nine months ended March 31, 2024. Non-performing assets also includes a multi-family real estate loan for $56,000 which was returned to accrual status in April 2024 upon renewal of the matured loan.

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.

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 (credits) to earnings in the form of a provision for (recovery of) 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 March 31, 2024 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)

(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)

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 March 31, 2024, we had a $82.0 million line of credit with the Federal Home Loan Bank of Chicago, which had $23.0 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. At March 31, 2024, the Bank did not borrow any additional funds from the Federal Reserve or from the 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 $188,000 and $1.3 million of cash provided by operating activities for the nine months ended March 31, 2024 and 2023, respectively. Net cash provided by (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 $8.7 million provided by investing activities compared to $16.9 million used in investing activities for the nine months ended March 31, 2024 and 2023, respectively. Net cash (used in) provided by financing activities, consisting of activity in deposit accounts and borrowings, was $12.6 million used in financing activities compared to $16.6 million being provided by financing activities for the nine months ended March 31, 2024 and 2023, 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 March 31, 2024, Marathon Bank was classified as “well capitalized” for regulatory capital purposes. See Note 10-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 March 31, 2024, we had outstanding commitments to originate loans of $4.8 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 March 31, 2024 totaled $44.3 million, which include $4.4 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 March 31, 2024.

We identified a material weakness in our controls over accounting that occurred beginning in the fourth quarter of fiscal year 2021 through the third 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.

We have implemented remediation efforts during the three months ended March 31, 2024 to address the material weakness in our internal control over financial reporting. These remediation efforts include a robust review of all current and previous income tax laws impacting the Company including the preparation of a detailed checklist governing income taxes for financial institutions. Management believes that the new procedures and controls will provide an appropriate remediation of the material weakness; however, the effectiveness of the controls have not been fully tested by management. The material weakness will be fully remediated when, in the opinion of management, the revised control processes have been operating for a sufficient period of time (two fiscal quarters) and independently validated by management.

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 third 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.