ESSA BANCORP, INC. Management’s Discussion and Analysis of Financial Condition and Results of Operations (form 10-Q)
Forward Looking Statements
This Quarterly Report on Form 10-Q contains forward-looking statements, which
can be identified by the use of such words as estimate, project, believe,
intend, anticipate, plan, seek, expect and similar expressions. These
forward-looking statements include:
• statements of our goals, intentions and expectations;
• statements regarding our business plans and prospects and growth and
operating strategies; • statements regarding the asset quality of our loan and investment portfolios; and • estimates of our risks and future costs and benefits. By identifying these forward-looking statements for you in this manner, we are alerting you to the possibility that our actual results and financial condition may differ, possibly materially, from the anticipated results and financial condition indicated in these forward-looking statements. Important factors that could cause our actual results and financial condition to differ from those indicated in the forward-looking statements include, among others, those discussed under "Risk Factors" in Part I, Item 1A of the Company's Annual Report on Form 10-K and Part II, Item 1A of this and any previous Quarterly Report on Form 10-Q filed since our most recent Annual Report on Form 10-K, as well as the following factors:
• significantly increased competition among depository and other financial
institutions;
• inflation and changes in the interest rate environment that reduce our
margins or reduce the fair value of financial instruments;
• general economic conditions, either nationally or in our market areas, that
are worse than expected; • adverse changes in the securities markets; • legislative or regulatory changes that adversely affect our business;
• our ability to enter new markets successfully and take advantage of growth
opportunities, and the possible short-term dilutive effect of potential
acquisitions or de novo branches, if any; • changes in consumer spending, borrowing and savings habits;
• changes in accounting policies and practices, as may be adopted by the bank
regulatory agencies and the FASB; and • changes in our organization, compensation and benefit plans. Further, the COVID-19 pandemic has caused local and national economic disruption and has had and may continue to have an impact on the Company's operations and financial results. Given its ongoing and dynamic nature, it is difficult to predict what effects the pandemic will have on our business and results of operations in the future. The pandemic and related local and national economic disruption may, among other effects, result in a decline in demand for our products and services; increased levels of loan delinquencies, problem assets and foreclosures; branch closures, work stoppages and unavailability of personnel; and increased cybersecurity risks, as employees increasingly work remotely.
These risks and uncertainties should be considered in evaluating forward-looking
statements and undue reliance should not be placed on such statements.
Comparison of Financial Condition at
Total Assets. Total assets increased by$4.1 million , or 0.2%, to$1.87 billion atMarch 31, 2022 from$1.86 billion atSeptember 30, 2021 due primarily to increases in cash and due from banks and investments securities held to maturity partially offset by decreases in investment securities available for sale. At the onset of the pandemic, the Company moved quickly to build its liquidity as an offset to the economic uncertainty caused by the resulting economic slowdown. The Company has and will continue to maintain a strong liquidity position against the changing economic forecasts through daily monitoring. Total Cash and Cash Equivalents. Total cash and cash equivalents increased$31.3 million , or 19.7%, to$190.2 million atMarch 31, 2022 from$158.9 million atSeptember 30, 2021 . Decreases in investment securities available for sale outstanding accounted for the majority of the increase. The Company built the majority of its cash position in the fiscal second quarter of 2020 and has maintained that position through the first quarter of fiscal 2022 to remain prepared for ongoing economic uncertainties. 36 -------------------------------------------------------------------------------- Net Loans. Net loans decreased$536,000 , or 0.04%, to$1.34 billion during the six month period endedMarch 31, 2022 . During this period, residential loans increased$7.7 million to$588.0 million , construction loans increased$4.3 million to$18.3 million , commercial real estate loans increased$32.1 million to$623.2 million , commercial loans decreased$16.8 million to$46.7 million partially due to the repayment and forgiveness of$17.2 million in PPP loans carried in the commercial loan portfolio, obligations of states and political subdivisions decreased$21.0 million to$35.2 million , home equity loans and lines of credit decreased$147,000 to$38.3 million , auto loans decreased$6.4 million to$7.5 million reflecting expected runoff of the portfolio following the Company's previously announced discontinuation of indirect auto lending inJuly 2018 , and other loans decreased$110,000 to$1.5 million . The Company sold$13.6 million in residential mortgage loans to theFederal Home Loan Bank of Pittsburgh during the six month period endedMarch 31, 2022 , recording gains on the sale of these loans in noninterest income. Investment Securities Available for Sale. Investment securities available for sale decreased$77.2 million , or 32.1%, to$163.4 million atMarch 31, 2022 from$240.6 million atSeptember 30, 2021 due primarily to the maturity of securities in the portfolio. The Company has continued to maintain a liquid position in cash and cash equivalents and has limited its investment purchases. Investment Securities Held to Maturity. Investment securities held to maturity increased to$60.4 million atMarch 31, 2022 from$21.5 million atSeptember 30, 2021 . The Company carries some investment as held to maturity to manage fluctuations in comprehensive loss caused by interest rate changes. Deposits. Deposits decreased$15.2 million , or 0.9%, to$1.62 billion atMarch 31, 2022 from$1.64 billion atSeptember 30, 2021 . Decreases in interest bearing demand accounts of$5.9 million , money market accounts of$10.4 million and certificates of deposit of$41.7 million were offset in part by increases in savings and club accounts of$8.9 million and non-interest bearing demand accounts of$33.93 million . The overall decrease in certificates of deposit reflected a decrease in brokered certificates of$15.0 million . Stockholders' Equity. Stockholders' equity increased by$10.9 million , or 5.4%, to$212.7 million atMarch 31, 2022 from$201.8 million atSeptember 30, 2021 . The increase in stockholders' equity was primarily due to net income of$9.2 million and other comprehensive income of$3.3 million partially offset by regular cash dividends of$0.24 per share which reduced stockholders' equity by$2.3 million . Unrealized losses due to rising interest rates in the Company's available for sale investment portfolio were more than offset by unrealized gains in the Company's derivative balance sheet hedges. 37 --------------------------------------------------------------------------------
Average Balance Sheets for the Three and Six Months Ended
2021
The following tables set forth average balance sheets, average yields and costs,
and certain other information for the periods indicated. All average balances
are daily average balances, the yields set forth below include the effect of
deferred fees and discounts and premiums that are amortized or accreted to
interest income.
For the Three Months Ended March 31,
2022 2021
Interest Income/ Interest Income/
Average Balance Expense Yield/Cost Average Balance Expense Yield/Cost
(dollars in thousands)
Interest-earning assets:
Loans(1) $ 1,349,160 $ 13,590 4.09 % $ 1,390,803 $ 13,671 3.99 %
Investment Securities
Taxable(2) 87,848 647 2.99 % 71,378 524 2.98 %
Exempt from federal income
tax(2)(3) 3,665 19 2.66 % 8,453 40 2.43 %
Total investment securities 91,513 666 2.97 % 79,831 564 2.92 %
Mortgage-backed securities 125,876 522 1.68 % 90,451 358 1.61 %
Federal Home Loan Bank stock 4,920 55 4.53 % 3,576 36 4.08 %
Other 195,327 75 0.16 % 225,368 34 0.06 %
Total interest-earning assets 1,766,796 14,908 1,790,029 14,663
Allowance for loan losses (18,217 ) 3.42 % (16,515 ) 3.32 %
Noninterest-earning assets 111,894 121,245
Total assets $ 1,860,473 $ 1,894,759
Interest-bearing liabilities:
NOW accounts $ 304,924 $ 43 0.06 % $ 249,393 $ 74 0.12 %
Money market accounts 434,417 139 0.13 % 400,677 172 0.17 %
Savings and club accounts 196,363 25 0.05 % 175,667 23 0.05 %
Certificates of deposit 408,759 486 0.48 % 570,746 1,320 0.94 %
Borrowed funds - - - 8,770 43 1.94 %
Total interest-bearing liabilities 1,344,463 693 0.21 % 1,405,253 1,632 0.47 %
Non-interest-bearing NOW
accounts 275,696 260,430
Non-interest-bearing liabilities 29,157 31,065
Total liabilities 1,649,316 1,696,748
Equity 211,157 198,011
Total liabilities and equity $ 1,860,473 $ 1,894,759
Net interest income $ 14,215 $ 13,031
Interest rate spread 3.21 % 2.85 %
Net interest-earning assets $ 422,333 $ 384,776
Net interest margin(4) 3.26 % 2.95 %
Average interest-earning assets to
average interest-bearing liabilities 131.41 % 127.38 %
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For the Six Months Ended March 31,
2022 2021
Interest Income/ Interest Income/
Average Balance Expense Yield/Cost Average Balance Expense Yield/Cost
(dollars in thousands)
Interest-earning assets:
Loans(1) $ 1,356,354 $ 26,849 3.97 % $ 1,405,075 $ 27,431 3.92 %
Investment Securities
Taxable(2) 110,003 1,244 2.27 % 82,972 1,157 2.80 %
Exempt from federal income
tax(2)(3) 3,810 38 2.53 % 8,464 81 2.43 %
Total investment securities 113,813 1,282 2.28 % 91,436 1,238 2.76 %
Mortgage-backed securities 112,551 936 1.67 % 95,261 722 1.52 %
Federal Home Loan Bank stock 4,814 109 4.54 % 4,502 114 5.08 %
Other 182,892 140 0.15 % 201,712 71 0.07 %
Total interest-earning assets 1,770,424 29,316 3.32 % 1,797,986 29,576 3.30 %
Allowance for loan losses (18,194 ) (16,096 )
Noninterest-earning assets 113,615 120,191
Total assets $ 1,865,845 $ 1,902,081
Interest-bearing liabilities:
Interest bearing demand accounts $ 305,182 $ 78 0.05 % $ 255,210 $ 171 0.13 %
Money market accounts 442,163 280 0.13 % 406,529 373 0.18 %
Savings and club accounts 194,237 51 0.05 % 169,736 44 0.05 %
Certificates of deposit 415,813 1,130 0.54 % 553,383 2,773 1.00 %
Borrowed funds - - - 36,620 271 1.48 %
Total interest-bearing liabilities 1,357,395 1,539 0.23 % 1,421,478 3,632 0.51 %
Non-interest-bearing NOW
accounts 273,203 253,887
Non-interest-bearing liabilities 26,905 30,658
Total liabilities 1,657,503 1,706,023
Equity 208,342 196,058
Total liabilities and equity $ 1,865,845 $ 1,902,081
Net interest income $ 27,777 $ 25,944
Interest rate spread 3.09 % 2.79 %
Net interest-earning assets $ 413,029 $ 376,508
Net interest margin(4) 3.15 % 2.89 %
Average interest-earning assets to
average interest-bearing liabilities 130.43 % 126.49 %
_____________________
(1) Non-accruing loans are included in the outstanding loan balances.
(2) Available for sale securities are reported at fair value.
(3) Yields on tax exempt securities have been calculated on a fully tax
equivalent basis assuming a tax rate of 21.00% for the three months ended
(4) Represents the difference between interest earned and interest paid, divided
by average total interest earning assets.
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Comparison of Operating Results for the Three Months Ended
Net Income. Net income increased$252,000 , or 5.8%, to$4.6 million for the three months endedMarch 31, 2022 compared to net income of$4.3 million for the comparable period in 2021. The increase was primarily due to an increase in net interest income and a decline in the provision for loan losses partially offset by an increase in income tax provision and a decrease in non-interest income.
Net Interest Income. Net interest income increased
million
Interest Income. Total interest income was$14.9 million for the three months endedMarch 31, 2022 compared with$14.7 million for the three months endedMarch 31, 2021 reflecting an increase in interest rates and total yield on average interest earning assets from 3.32% for the quarter endedMarch 31, 2021 to 3.42% for the quarter endedMarch 31, 2022 . A decline of$23.2 million in average interest earning assets partially offset the increase in interest income. Interest Expense. Interest expense was$639,000 for the quarter endedMarch 31, 2022 compared to$1.6 million for the same period in 2021. The cost of interest-bearing liabilities declined to 0.21% in the quarter endedMarch 31, 2022 from 0.47% a year earlier, reflecting lower interest rates, timely repricing of deposits and roll-off of higher-cost borrowings. Average interest-bearing liabilities decreased$60.8 million year-over-year. Provision for Loan Losses. In evaluating the level of the allowance for loan losses, management considers historical loss experience, the types of loans and the amount of loans in the loan portfolio, adverse situations that may affect a borrower's ability to repay, the estimated value of any underlying collateral, peer group information and prevailing economic conditions. This evaluation is inherently subjective as it requires estimates that are subject to interpretation and revision as more information becomes available or as future events occur. After an evaluation of these factors, management made no provision for loan losses for the three month period endedMarch 31, 2022 compared to$900,000 for the three month period endedMarch 31, 2021 . The allowance for loan losses was$18.2 million , or 1.34% of loans outstanding, atMarch 31, 2022 , compared to$18.1 million , or 1.33% of loans outstanding, atSeptember 30, 2021 . As the economic impact of the COVID-19 pandemic continues to evolve, our customers may experience decreased cash flows, which may correlate to an inability to make timely loan payments. This, in turn may require increases in our allowance for loan losses and increases in the level of charge-offs in our loan portfolio. Non-interest Income. Noninterest income decreased 44.5% to$2.0 million for the three months endedMarch 31, 2022 , compared with$3.5 million for the three months endedMarch 31, 2021 . Decreases in loan swap fees of$408,000 , earnings on bank-owned life insurance of$4,000 , other income of$50,000 , gain on sale of investments, net of$417,000 and gains on sales of residential mortgages of$649,000 were partially offset by an increase in trust and investment fees of$75,000 in the quarter endedMarch 31, 2022 compared with the comparable period in 2021. Non-interest Expense. Noninterest expense decreased$37,000 or 0.4% to$10.4 million for the three months endedMarch 31, 2022 compared with the comparable period a year earlier primarily reflecting increases in professional fees of$221,000 , occupancy and equipment of$44,000 , data processing of$12,000 and advertising of$128,000 which were partially offset by decreases inFederal Deposit Insurance Corporation premiums of$161,000 , compensation and employee benefits of$67,000 and gains on foreclosed real estate of$3,000 .
Income Taxes. Income tax expense increased
three months ended
The effective tax rate for the three months ended
compared to 16.7% for the 2021 period.
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Comparison of Operating Results for the Six Months Ended
Net Income. Net income increased$730,000 , or 8.6%, to$9.2 million for the six months endedMarch 31, 2022 compared to net income of$8.5 million for the comparable period in 2021. The increase was primarily due to an increase in net interest income and a decline in the provision for loan losses partially offset by the income tax provision and a decrease in non-interest income. Net Interest Income. Net interest income increased$1.8 million , or 7.1%, to$27.8 million for the six months endedMarch 31, 2022 compared to$25.9 million for the comparable period in 2021. Interest Income. Total interest income was$29.3 million for the six months endedMarch 31, 2022 compared with$29.6 million for the six months endedMarch 31, 2021 reflecting a decline of$27.6 million in average interest earning assets partially offset by an increase in the total yield on average interest earning assets from 3.30% for the quarter endedMarch 31, 2021 to 3.32% for the quarter endedMarch 31, 2022 . Interest Expense. Interest expense was$1.5 million for the six months endedMarch 31, 2022 compared to$3.6 million for the same period in 2021. The cost of interest-bearing liabilities declined to 0.23% in the six months endedMarch 31, 2022 from 0.51% a year earlier, reflecting lower interest rates, timely repricing of deposits and roll-off of higher-cost borrowings. Average interest-bearing liabilities decreased$64.1 million year-over-year. Provision for Loan Losses. In evaluating the level of the allowance for loan losses, management considers historical loss experience, the types of loans and the amount of loans in the loan portfolio, adverse situations that may affect a borrower's ability to repay, the estimated value of any underlying collateral, peer group information and prevailing economic conditions. This evaluation is inherently subjective as it requires estimates that are subject to interpretation and revision as more information becomes available or as future events occur. After an evaluation of these factors, management made no provision for loan losses for the six month period endedMarch 31, 2022 compared to$1.8 million for the six month period endedMarch 31, 2021 . The allowance for loan losses was$18.2 million , or 1.34% of loans outstanding, atMarch 31, 2022 , compared to$18.1 million , or 1.33% of loans outstanding, atSeptember 30, 2021 . As the economic impact of the COVID-19 pandemic continues to evolve, our customers may experience decreased cash flows, which may correlate to an inability to make timely loan payments. This, in turn may require increases in our allowance for loan losses and increases in the level of charge-offs in our loan portfolio. Non-interest Income. Noninterest income decreased 35.6% to$4.3 million for the six months endedMarch 31, 2022 , compared with$6.7 million for the six months endedMarch 31, 2021 . Decreases in loan swap fees of$472,000 , earnings on bank-owned life insurance of$154,000 , other income of$98,000 , gain on sale of investments, net of$417,000 and gains on sales of residential mortgages of$1.2 million were partially offset by an increase in trust and investment fees of$170,000 in the quarter endedMarch 31, 2022 compared with the comparable period in 2021. Non-interest Expense. Noninterest expense increased$89,000 or 0.4% to$20.7 million for the six months endedMarch 31, 2022 compared with$20.6 million for the comparable period a year earlier primarily reflecting increases in professional fees of$383,000 , occupancy and equipment of$71,000 , advertising of$120,000 and data processing of$110,000 which were partially offset by decreases inFederal Deposit Insurance Corporation premiums of$270,000 , compensation and employee benefits of$129,000 , gains on foreclosed real estate of$15,000 and other expenses of$178,000 . Income Taxes. Income tax expense increased$445,000 to$2.2 million for the six months endedMarch 31, 2022 from$1.7 million for the comparable 2021 period. The effective tax rate for the six months endedMarch 31, 2022 was 18.9% compared to 16.7% for the 2021 period. 41
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The following table provides information with respect to the Bank’s
non-performing assets at the dates indicated (dollars in thousands).
September 30,
March 31, 2022 2021
Non-performing assets:
Non-accruing loans $ 8,183 $ 15,864
Non-accruing purchased credit impaired loans 1 3
Total non-performing loans 8,184 15,867
Foreclosed real estate 85 461
Total non-performing assets $ 8,269 $ 16,328
Ratio of non-performing loans to total loans 0.60 % 1.17 %
Ratio of non-performing loans to total assets 0.44 % 0.85 %
Ratio of non-performing assets to total assets 0.44 % 0.88 %
Ratio of allowance for loan losses to total loans 1.34 % 1.33 %
Loans are reviewed on a regular basis and are placed on non-accrual status when
they become 90 days delinquent. When loans are placed on non-accrual status,
unpaid accrued interest is fully reserved, and further income is recognized only
to the extent received. Non-performing assets decreased $8.1 million from
September 30, 2021 to March 31, 2022 . The primary reason for the decrease in
nonperforming assets at March 31, 2022 as compared to September 30, 2021 was the
repayment of two non-performing commercial loan relationships. The $8.2 million
of non-accruing loans at March 31, 2022 included 25 residential loans with an
aggregate outstanding balance of $1.8 million ,180 commercial and commercial real
estate loans with aggregate outstanding balances of $5.9 million and 27 consumer
loans with aggregate balances of $436,000 . Within the residential loan balance
were $609,000 of loans past due less than 90 days. In the quarter ended March
31, 2022 , the Company identified eight residential loans which, although paying
as agreed, have a high probability of default. Foreclosed real estate decreased
$376,000 to $85,000 at March 31, 2022 . Foreclosed real estate consists of four
residential properties.
At March 31, 2022 , the principal balance of troubled debt restructures ("TDRs")
was $2.7 million compared to $9.7 million at September 30, 2021 . Of the $2.7
million of troubled debt restructures at March 31, 2022 $2.5 million are
non-accrual loans.
As of March 31, 2022 , TDRs were comprised of nine residential loans totaling
$962,000 , six commercial and commercial real estate loans totaling $1.7 million
and four consumer loans (home equity loans, home equity lines and credit,
indirect auto and other loans) totaling $48,000 .
For the six month period ended March 31, 2022 , four loans were removed from TDR
status due to completion of one year of consecutive on time payments and one was
removed for paying off.
The Company continues to closely monitor all customer credit positions,
particularly loans requesting payment relief. As of March 31, 2022 , three of our
commercial clients had requested loan payment deferrals or payments of interest
only on loans totaling $9.0 million . In accordance with interagency guidance
issued in March 2020 , these short-term deferrals are not considered TDRs unless
the borrower was previously experiencing financial difficulty. As the economic
impact of the COVID-19 pandemic continues to evolve, our customers may
experience decreased cash flows, which may correlate to an inability to make
timely loan payments. This, in turn may require increases in our allowance for
loan losses and increases in the level of chargeoffs in our loan portfolio.
Liquidity and Capital Resources
We maintain liquid assets at levels we consider adequate to meet both our
short-term and long-term liquidity needs. We adjust our liquidity levels to fund
deposit outflows, repay our borrowings and to fund loan commitments. We also
adjust liquidity as appropriate to meet asset and liability management
objectives.
Our primary sources of liquidity are deposits, prepayment and repayment of loans
and mortgage-backed securities, maturities of investment securities and other
short-term investments, and earnings and funds provided from operations, as well
as access to FHLB advances and other borrowing sources. While scheduled
principal repayments on loans and mortgage-backed securities are a relatively
predictable source of funds, deposit flows and loan prepayments are greatly
influenced by market interest rates, economic conditions, and rates offered by
our competition. We set the interest rates on our deposits to maintain a desired
level of total deposits.
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A portion of our liquidity consists of cash and cash equivalents and borrowings,
which are a product of our operating, investing and financing activities. At
March 31, 2022 , $190.2 million of our assets were invested in cash and cash
equivalents. Our primary sources of cash are principal repayments on loans,
proceeds from the maturities of investment securities, principal repayments of
mortgage-backed securities and increases in deposit accounts and borrowings. As
of March 31, 2022 , we had no borrowings outstanding from the Pittsburgh FHLB. We
have access to total FHLB advances of up to approximately $731.9 million .
At March 31, 2022 , we had $423.4 million in loan commitments outstanding, which
included, in part, $198.5 million in undisbursed construction loans and land
development loans, $51.5 million in unused home equity lines of credit, $128.4
million in commercial lines of credit and commitments to originate commercial
loans, $14.7 million in performance standby letters of credit and $30.3 million
in other unused commitments which are primarily to originate residential
mortgage loans and multifamily loans. Certificates of deposit due within one
year of March 31, 2022 totaled $115.2 million , or 68.5% of certificates of
deposit. If these maturing deposits do not remain with us, we will be required
to seek other sources of funds, including other certificates of deposit and
borrowings. Depending on market conditions, we may be required to pay higher
rates on such deposits or other borrowings than we currently pay on the
certificates of deposit due on or before March 31, 2023 . We believe, however,
based on past experience that a significant portion of our certificates of
deposit will remain with us. We have the ability to attract and retain deposits
by adjusting the interest rates offered.
As reported in the Consolidated Statements of Cash Flow, our cash flows are
classified for financial reporting purposes as operating, investing or financing
cash flows. Net cash provided by operating activities was $8.5 million and $8.4
million for the six months ended March 31, 2022 and 2021, respectively. These
amounts differ from our net income because of a variety of cash receipts and
disbursements that did not affect net income for the respective periods. Net
cash provided by investing activities was $32.8 million and $77.4 million for
the six months ended March 31, 2022 and 2021, respectively, principally
reflecting our loan and investment security activities. Deposit and borrowing
cash flows have comprised most of our financing activities, which resulted in
net cash (used for) provided by, of $(10.0) million and $69.2 million for the
six months ended March 31, 2022 and 2021, respectively.
Critical Accounting Policies
We consider accounting policies that require management to exercise significant
judgment or discretion or make significant assumptions that have, or could have,
a material impact on the carrying value of certain assets or on income, to be
critical accounting policies. We consider the following to be our critical
accounting policies:
Allowance for Loan Losses. The allowance for loan losses is the estimated amount
considered necessary to cover credit losses inherent in the loan portfolio at
the balance sheet date. The allowance is established through the provision for
loan losses which is charged against income. In determining the allowance for
loan losses, management makes significant estimates and has identified this
policy as one of our most critical. The methodology for determining the
allowance for loan losses is considered a critical accounting policy by
management due to the high degree of judgment involved, the subjectivity of the
assumptions utilized and the potential for changes in the economic environment
that could result in changes to the amount of the recorded allowance for loan
losses.
As a substantial amount of our loan portfolio is collateralized by real estate,
appraisals of the underlying value of property securing loans and discounted
cash flow valuations of properties are critical in determining the amount of the
allowance required for specific loans. Assumptions for appraisals and discounted
cash flow valuations are instrumental in determining the value of properties.
Overly optimistic assumptions or negative changes to assumptions could
significantly impact the valuation of a property securing a loan and the related
allowance determined. The assumptions supporting such appraisals and discounted
cash flow valuations are carefully reviewed by management to determine that the
resulting values reasonably reflect amounts realizable on the related loans.
Management performs a quarterly evaluation of the adequacy of the allowance for
loan losses. Consideration is given to a variety of factors in establishing this
estimate including, but not limited to, current economic conditions, delinquency
statistics, geographic and industry concentrations, the adequacy of the
underlying collateral, the financial strength of the borrower, results of
internal and external loan reviews and other relevant factors. This evaluation
is inherently subjective, as it requires material estimates that may be
susceptible to significant revision based on changes in economic and real estate
market conditions.
The analysis of the allowance for loan losses has two components: specific and
general allocations. Specific allocations are made for loans that are determined
to be impaired. Impairment is measured by determining the present value of
expected future cash flows or, for collateral-dependent loans, the fair value of
the collateral adjusted for market conditions and selling expenses. The general
allocation is determined by segregating the remaining loans by type of loan,
risk weighting (if applicable) and payment history. We also analyze historical
loss experience, delinquency trends, general economic conditions and geographic
and industry concentrations. This analysis establishes factors that are applied
to the loan groups to determine the amount of the general allocations. Actual
loan losses may be significantly more than the allowance for loan losses we have
established which could have a material negative effect on our financial
results.
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Goodwill and Intangible Assets. Goodwill is not amortized, but it is tested at
least annually for impairment in the fourth quarter, or more frequently if
indicators of impairment are present. If the estimated current fair value of a
reporting unit exceeds its carrying value, no additional testing is required and
an impairment loss is not recorded. The Company uses market capitalization and
multiples of tangible book value methods to determine the estimated current fair
value of its reporting unit. Based on this analysis, no impairment was recorded
in 2022 or 2021.
The other intangibles assets are assigned useful lives, which are amortized on
an accelerated basis over their weighted-average lives. The Company periodically
reviews the intangible assets for impairment as events or changes in
circumstances indicate that the carrying amount of such asset may not be
recoverable. Based on these reviews, no impairment was recorded in 2022 or 2021.
Derivative Instruments and Hedging Activities. The Company records all
derivatives on the balance sheet at fair value. The accounting for changes in
the fair value of derivatives depends on the intended use of the derivative,
whether the Company has elected to designate a derivative in a hedging
relationship and apply hedge accounting and whether the hedging relationship has
satisfied the criteria necessary to apply hedge accounting. Derivatives
designated and qualifying as a hedge of the exposure to changes in the fair
value of an asset, liability, or firm commitment attributable to a particular
risk, such as interest rate risk, are considered fair value hedges. Derivatives
designated and qualifying as a hedge of the exposure to variability in expected
future cash flows, or other types of forecasted transactions, are considered
cash flow hedges. Derivatives may also be designated as hedges of the foreign
currency exposure of a net investment in a foreign operation. Hedge accounting
generally provides for the matching of the timing of gain or loss recognition on
the hedging instrument with the recognition of the changes in the fair value of
the hedged asset or liability that are attributable to the hedged risk in a fair
value hedge or the earnings effect of the hedged forecasted transactions in a
cash flow hedge. The Company may enter into derivative contracts that are
intended to economically hedge certain of its risk, even though hedge accounting
does not apply or the Company elects not to apply hedge accounting.
Fair Value Measurements. We group our assets at fair value in three levels,
based on the markets in which the assets are traded and the reliability of the
assumptions used to determine fair value. These levels are:
• Level I – Valuation is based upon quoted prices for identical instruments
traded in active markets.
• Level II – Valuation is based upon quoted prices for similar instruments in
active markets, quoted prices for identical or similar instruments in
markets that are not active, and model-based valuation techniques for which
all significant assumptions are observable in the market.
• Level III – Valuation is generated from model-based techniques that use
significant assumptions not observable in the market. These unobservable
assumptions reflect the Company’s own estimates of assumptions that market
participants would use in pricing the asset.
We base our fair values on the price that would be received to sell an asset or
paid to transfer a liability in an orderly transaction between market
participants at the measurement date. It is our policy to maximize the use of
observable inputs and minimize the use of unobservable inputs when developing
fair value measurements, in accordance with the fair value hierarchy in
generally accepted accounting principles.
Fair value measurements for most of our assets are obtained from independent
pricing services that we have engaged for this purpose. When available, we, or
our independent pricing service, use quoted market prices to measure fair value.
If market prices are not available, fair value measurement is based upon models
that incorporate available trade, bid, and other market information.
Subsequently, all of our financial instruments use either of the foregoing
methodologies to determine fair value adjustments recorded to our financial
statements. In certain cases, however, when market observable inputs for
model-based valuation techniques may not be readily available, we are required
to make judgments about assumptions market participants would use in estimating
the fair value of financial instruments. The degree of management judgment
involved in determining the fair value of a financial instrument is dependent
upon the availability of quoted market prices or observable market parameters.
For financial instruments that trade actively and have quoted market prices or
observable market parameters, there is minimal subjectivity involved in
measuring fair value. When observable market prices and parameters are not fully
available, management judgment is necessary to estimate fair value. In addition,
changes in the market conditions may reduce the availability of quoted prices or
observable data. When market data is not available, we use valuation techniques
requiring more management judgment to estimate the appropriate fair value
measurement. Therefore, the results cannot be determined with precision and may
not be realized in an actual sale or immediate settlement of the asset.
Additionally, there may be inherent weaknesses in any calculation technique, and
changes in the underlying assumptions used, including discount rates and
estimates of future cash flows, that could significantly affect the results of
current or future valuations.
Other-than-Temporary Investment Security Impairment. Securities are evaluated
periodically to determine whether a decline in their value is
other-than-temporary. Management utilizes criteria such as the magnitude and
duration of the decline, in addition to the reasons underlying the decline, to
determine whether the loss in value is other-than-temporary. The term
"other-than-temporary" is
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not intended to indicate that the decline is permanent, but indicates that the
prospect for a near-term recovery of value is not necessarily favorable, or that
there is a lack of evidence to support a realizable value equal to or greater
than the carrying value of the investment. Once a decline in value is determined
to be other-than-temporary, the value of the security is reduced and a
corresponding charge to earnings is recognized.
Deferred Income Taxes. We use the asset and liability method of accounting for
income taxes. Under this method, deferred tax assets and liabilities are
recognized for the future tax consequences attributable to differences between
the financial statement carrying amounts of existing assets and liabilities and
their respective tax bases. Deferred tax assets and liabilities are measured
using enacted tax rates expected to apply to taxable income in the years in
which those temporary differences are expected to be recovered or settled. If
current available information raises doubt as to the realization of the deferred
tax assets, a valuation allowance is established. We consider the determination
of this valuation allowance to be a critical accounting policy because of the
need to exercise significant judgment in evaluating the amount and timing of
recognition of deferred tax liabilities and assets, including projections of
future taxable income. These judgments and estimates are reviewed on a continual
basis as regulatory and business factors change. A valuation allowance for
deferred tax assets may be required if the amount of taxes recoverable through
loss carryback declines, or if we project lower levels of future taxable income.
Such a valuation allowance would be established through a charge to income tax
expense that would adversely affect our operating results.
Off-Balance Sheet Arrangements
We do not have any off-balance sheet arrangements (as such term is defined in applicableSecurities and Exchange Commission rules) that are reasonably likely to have a current or future material effect on our financial condition, results of operations, liquidity, capital expenditures or capital resources. Item 3. Quantitative and Qualitative Disclosures About Market Risk The majority of our assets and liabilities are monetary in nature. Consequently, our most significant form of market risk is interest rate risk. Our assets, consisting primarily of mortgage loans, have longer maturities than our liabilities, consisting primarily of deposits and borrowings. As a result, a principal part of our business strategy is to manage interest rate risk and reduce the exposure of our net interest income to changes in market interest rates. Accordingly, our Board of Directors has approved guidelines for managing the interest rate risk inherent in our assets and liabilities, given our business strategy, operating environment, capital, liquidity and performance objectives. Senior management monitors the level of interest rate risk on a regular basis and the asset/liability committee meets quarterly to review our asset/liability policies and interest rate risk position. We have sought to manage our interest rate risk in order to minimize the exposure of our earnings and capital to changes in interest rates. The net proceeds from the Company's stock offering increased our capital and provided management with greater flexibility to manage our interest rate risk. In particular, management used the majority of the capital we received to increase our interest-earning assets. There have been no material changes in our interest rate risk sinceSeptember 30, 2021 . Item 4. Controls and Procedures Under the supervision and with the participation of our management, including our Principal Executive Officer and Principal Financial Officer, we evaluated the effectiveness of the design and operation of our disclosure controls and procedures (as defined in Rule 13a-15(e) and 15d-15(e) under the Securities Exchange Act of 1934) as of the end of the period covered by this Report. Based upon that evaluation, the Principal Executive Officer and Principal Financial Officer concluded that, as of the end of the period covered by this Report, our disclosure controls and procedures were effective. There were no changes made in the Company's internal controls over financial reporting (as defined by Rule 13a-15(f) and 15d-15(f) under the Securities Exchange Act of 1934) or in other factors that have materially affected, or are reasonably likely to materially affect, the Company's internal controls over financial reporting during the period covered by this Quarterly Report on Form 10-Q. 45
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