ESSA BANCORP, INC. 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.
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 decreased by$15.0 million , or 0.8%, to$1.85 billion atJune 30, 2022 from$1.86 billion atSeptember 30, 2021 due primarily to decreases in cash and due from banks and investments securities available for sale partially offset by increases in investment securities held to maturity, loans receivable, and other assets. 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 decreased$75.8 million , or 47.7%, to$83.1 million atJune 30, 2022 from$158.9 million atSeptember 30, 2021 . Decreases in cash and due from banks accounted for the majority of the decrease. Increases in loans receivable of$39.3 million , investments securities held to maturity of$37.3 million and FHLB stock of$9.4 million along with a decrease in deposits of$264.8 million were the primary reasons for the decrease in cash and due from banks. Increases in FHLB borrowings of$225.0 million and a decline in investments securities available for sale of$39.7 million partially offset the decline in cash and due from banks. 39 -------------------------------------------------------------------------------- Net Loans. Net loans increased$39.3 million , or 2.9%, to$1.38 billion during the nine month period endedJune 30, 2022 . During this period, residential loans increased$17.3 million to$597.6 million , construction loans increased$5.8 million to$19.8 million , commercial real estate loans increased$58.1 million to$649.3 million , commercial loans decreased$20.8 million to$42.7 million partially due to the repayment and forgiveness of$20.7 million in PPP loans carried in the commercial loan portfolio, obligations of states and political subdivisions decreased$15.7 million to$40.5 million , home equity loans and lines of credit increased$3.4 million to$41.8 million , auto loans decreased$8.6 million to$5.3 million reflecting expected runoff of the portfolio following the Company's previously announced discontinuation of indirect auto lending inJuly 2018 , and other loans decreased$33,000 to$1.5 million . The Company sold$13.6 million in residential mortgage loans to theFederal Home Loan Bank of Pittsburgh during the nine month period endedJune 30, 2022 , recording gains on the sale of these loans in noninterest income. Investment Securities Available for Sale. Investment securities available for sale decreased$39.7 million , or 16.5%, to$200.9 million atJune 30, 2022 from$240.6 million atSeptember 30, 2021 due primarily to the maturity of securities in the portfolio. Investment Securities Held to Maturity. Investment securities held to maturity increased to$58.8 million atJune 30, 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$264.8 million , or 16.2%, to$1.37 billion atJune 30, 2022 from$1.64 billion atSeptember 30, 2021 . Decreases in interest bearing demand accounts of$239.8 million , money market accounts of$19.4 million and certificates of deposit of$66.2 million were offset in part by increases in savings and club accounts of$13.0 million and non-interest bearing demand accounts of$47.7 million . The decline in interest bearing demand accounts was primarily due to the Company shifting$225.0 million from brokered deposits to short term FHLB advances as part of the Company's balance sheet hedge strategy. The decrease in certificates of deposit reflected in part a decrease in brokered certificates of$15.0 million . Short Term Borrowings. Short term borrowings increased to$225.0 million atJune 30, 2022 as the Company shifted$225.0 million from brokered deposits to FHLB advances to take advantage of lower borrowing rates. Stockholders' Equity. Stockholders' equity increased by$11.4 million , or 5.7%, to$213.3 million atJune 30, 2022 from$201.8 million atSeptember 30, 2021 . The increase in stockholders' equity was primarily due to net income of$14.3 million and other comprehensive income of$295,000 partially offset by regular cash dividends of$0.39 per share which reduced stockholders' equity by$3.8 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. 40 --------------------------------------------------------------------------------
Average Balance Sheets for the Three and Nine Months Ended
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 June 30,
2022 2021
Interest Income/ Interest Income/
Average Balance Expense Yield/Cost Average Balance Expense Yield/Cost
(dollars in thousands)
Interest-earning assets:
Loans(1) $ 1,378,788 $ 13,615 3.96 % $ 1,397,096 $ 13,377 3.84 %
Investment securities
Taxable(2) 85,799 722 3.38 % 69,111 548 3.18 %
Exempt from federal income
tax(2)(3) 2,262 12 2.69 % 8,419 40 2.41 %
Total investment securities 88,061 734 3.36 % 77,530 588 3.10 %
Mortgage-backed securities 155,522 821 2.12 % 89,869 346 1.54 %
Federal Home Loan Bank stock 6,098 70 4.60 % 3,908 49 5.03 %
Other 137,728 259 0.75 % 245,800 43 0.07 %
Total interest-earning assets 1,766,197 15,499 3.52 % 1,814,203 14,403 3.19 %
Allowance for loan losses (18,269 ) (17,491 )
Noninterest-earning assets 119,196 110,582
Total assets $ 1,867,124 $ 1,907,294
Interest-bearing liabilities:
NOW accounts $ 338,103 $ 45 0.05 % $ 276,093 $ 63 0.09 %
Money market accounts 411,879 142 0.14 % 406,211 148 0.15 %
Savings and club accounts 200,515 26 0.05 % 186,267 25 0.05 %
Certificates of deposit 353,915 293 0.32 % 530,191 1,015 0.77 %
Borrowed funds 29,722 35 0.61 % - - -
Total interest-bearing liabilities 1,334,134 541 0.16 % 1,398,762 1,251 0.36 %
Non-interest-bearing NOW
accounts 284,467 276,919
Non-interest-bearing liabilities 33,545 31,521
Total liabilities 1,652,146 1,707,202
Equity 214,978 200,092
Total liabilities and equity $ 1,867,124 $ 1,907,294
Net interest income $ 14,958 $ 13,152
Interest rate spread 3.36 % 2.83 %
Net interest-earning assets $ 432,063 $ 415,441
Net interest margin(4) 3.40 % 2.91 %
Average interest-earning assets to
average interest-bearing liabilities 132.39 % 129.70 %
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For the Nine Months Ended June 30,
2022 2021
Interest Income/ Interest Income/
Average Balance Expense Yield/Cost Average Balance Expense Yield/Cost
(dollars in thousands)
Interest-earning assets:
Loans(1) $ 1,363,832 $ 40,464 3.95 % $ 1,402,415 $ 40,808 3.88 %
Investment securities
Taxable(2) 102,601 1,966 2.55 % 78,353 1,705 2.90 %
Exempt from federal income
tax(2)(3) 3,294 50 2.56 % 8,449 121 2.41 %
Total investment securities 105,895 2,016 2.55 % 86,802 1,826 2.85 %
Mortgage-backed securities 126,875 1,757 1.84 % 93,463 1,068 1.52 %
Federal Home Loan Bank stock 5,242 179 4.55 % 4,304 163 5.04 %
Other 167,126 399 0.32 % 215,719 113 0.07 %
Total interest-earning assets 1,768,970 44,815 3.38 % 1,802,703 43,978 3.25 %
Allowance for loan losses (18,126 ) (16,561 )
Noninterest-earning assets 115,332 117,664
Total assets $ 1,866,176 $ 1,903,806
Interest-bearing liabilities:
Interest bearing demand accounts $ 316,156 $ 123 0.05 % $ 262,171 $ 234 0.12 %
Money market accounts 432,068 421 0.13 % 406,423 521 0.17 %
Savings and club accounts 196,329 77 0.05 % 175,247 69 0.05 %
Certificates of deposit 395,180 1,424 0.47 % 545,653 3,788 0.92 %
Borrowed funds 9,907 35 0.86 % 24,414 271 1.48 %
Total interest-bearing liabilities 1,349,640 2,080 0.21 % 1,413,908 4,883 0.46 %
Non-interest-bearing NOW
accounts 276,958 261,565
Non-interest-bearing liabilities 29,024 30,930
Total liabilities 1,655,622 1,706,403
Equity 210,554 197,403
Total liabilities and equity $ 1,866,176 $ 1,903,806
Net interest income $ 42,735 $ 39,095
Interest rate spread 3.17 % 2.79 %
Net interest-earning assets $ 419,330 $ 388,795
Net interest margin(4) 3.22 % 2.89 %
Average interest-earning assets to
average interest-bearing liabilities 131.07 % 127.50 %
_____________________
(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 and nine 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$1.0 million , or 25.2%, to$5.0 million for the three months endedJune 30, 2022 compared to net income of$4.0 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 increases in non-interest expense and income tax provision and a decrease in non-interest income. Net Interest Income. Net interest income increased$1.8 million , or 13.7%, to$15.0 million for the three months endedJune 30, 2022 compared to$13.2 million for the comparable period in 2021. Interest Income. Total interest income was$15.5 million for the three months endedJune 30, 2022 compared with$14.4 million for the three months endedJune 30, 2021 reflecting increases in interest rates and total yield on average interest earning assets from 3.19% for the quarter endedJune 30, 2021 to 3.52% for the quarter endedJune 30, 2022 . A decline of$48.0 million in average interest earning assets partially offset the increase in interest income. Interest Expense. Interest expense was$541,000 for the quarter endedJune 30, 2022 compared to$1.3 million for the same period in 2021. The cost of interest-bearing liabilities declined to 0.16% for the quarter endedJune 30, 2022 from 0.36% a year earlier, reflecting lower interest rates, timely repricing of deposits and roll-off of higher-cost borrowings. Average interest-bearing liabilities decreased$64.6 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 endedJune 30, 2022 compared to$600,000 for the three month period endedJune 30, 2021 . The allowance for loan losses was$18.3 million , or 1.31% of loans outstanding, atJune 30, 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 6.4% to$2.1 million for the three months endedJune 30, 2022 , compared with$2.3 million for the three months endedJune 30, 2021 . Decreases in trust and investment fees of$12,000 , earnings on bank-owned life insurance of$4,000 , other income of$6,000 , gain on sale of investments, net of$42,000 , insurance commissions of$13,000 and gains on sales of residential mortgages of$250,000 were partially offset by an increase in loan swap fees of$57,000 , service fees on deposit accounts of$2,000 and service charges and fee on loans of$121,000 for the quarter endedJune 30, 2022 compared with the comparable period in 2021. Non-interest Expense. Noninterest expense increased$741,000 or 7.4% to$10.8 million for the three months endedJune 30, 2022 compared with the comparable period a year earlier primarily reflecting increases in compensation and employee benefits of$141,000 , professional fees of$233,000 , occupancy and equipment of$53,000 , data processing of$38,000 , gains on foreclosed real estate of$474,000 and advertising of$36,000 which were partially offset by decreases inFederal Deposit Insurance Corporation premiums of$132,000 , and other expenses of$93,000 . Gain on foreclosed real estate in the fiscal third quarter of 2021 also included a credit of$534,000 to other expense, reflecting a deferred income credit related to a prior sale of a foreclosed real estate property.
Income Taxes. Income tax expense increased
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Comparison of Operating Results for the Nine Months Ended
Net Income. Net income increased$1.7 million , or 13.9%, to$14.2 million for the nine months endedJune 30, 2022 compared to net income of$12.5 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 an increase in non-interest expenses, the income tax provision and a decrease in non-interest income. Net Interest Income. Net interest income increased$3.6 million , or 9.3%, to$42.7 million for the nine months endedJune 30, 2022 compared to$39.1 million for the comparable period in 2021. Interest Income. Total interest income was$44.8 million for the nine months endedJune 30, 2022 compared with$44.0 million for the nine months endedJune 30, 2021 reflecting an increase in the total yield on average interest earning assets from 3.25% for the nine months endedJune 30, 2021 to 3.38% for the nine months endedJune 30, 2022 which was partially offset by a decline of$33.7 million in average interest earning assets. Interest Expense. Interest expense was$2.1 million for the nine months endedJune 30, 2022 compared to$4.9 million for the same period in 2021. The cost of interest-bearing liabilities declined to 0.21% for the nine months endedJune 30, 2022 from 0.46% a year earlier, reflecting lower interest rates, timely repricing of deposits and roll-off of higher-cost borrowings. Average interest-bearing liabilities decreased$64.3 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 nine month period endedJune 30, 2022 compared to$2.4 million for the nine month period endedJune 30, 2021 . The allowance for loan losses was$18.3 million , or 1.31% of loans outstanding, atJune 30, 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 28.1% to$6.4 million for the nine months endedJune 30, 2022 , compared with$8.9 million for the nine months endedJune 30, 2021 . Decreases in loan swap fees of$415,000 , earnings on bank-owned life insurance of$158,000 , other income of$104,000 , gain on sale of investments, net of$459,000 and gains on sales of residential mortgages of$1.5 million were partially offset by an increase in trust and investment fees of$158,000 for the quarter endedJune 30, 2022 compared with the comparable period in 2021. Non-interest Expense. Noninterest expense increased$830,000 or 2.7% to$31.5 million for the nine months endedJune 30, 2022 compared with$30.6 million for the comparable period a year earlier primarily reflecting increases in professional fees of$616,000 , occupancy and equipment of$124,000 , advertising of$156,000 , compensation and employee benefits of$12,000 , gains on foreclosed real estate of$459,000 and data processing of$148,000 which were partially offset by decreases inFederal Deposit Insurance Corporation premiums of$402,000 and other expenses of$271,000 . Gain on foreclosed real estate in the fiscal third quarter of 2021 also included a credit of$534,000 to other expense, reflecting a deferred income credit related to a prior sale of a foreclosed real estate property. Income Taxes. Income tax expense increased$950,000 to$3.5 million for the nine months endedJune 30, 2022 from$2.5 million for the comparable 2021 period. The effective tax rate for the nine months endedJune 30, 2022 was 19.5% compared to 16.7% for the 2021 period. 44
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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,
June 30, 2022 2021
Non-performing assets:
Non-accruing loans $ 8,027 $ 15,864
Non-accruing purchased credit impaired loans - 3
Total non-performing loans 8,027 15,867
Foreclosed real estate 75 461
Total non-performing assets $ 8,102 $ 16,328
Ratio of non-performing loans to total loans 0.57 % 1.17 %
Ratio of non-performing loans to total assets 0.43 % 0.85 %
Ratio of non-performing assets to total assets 0.44 % 0.88 %
Ratio of allowance for loan losses to total loans 1.31 % 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$8.2 million fromSeptember 30, 2021 toJune 30, 2022 . The primary reason for the decrease in nonperforming assets atJune 30, 2022 as compared toSeptember 30, 2021 was the repayment of two non-performing commercial loan relationships. The$8.0 million of non-accruing loans atJune 30, 2022 included 27 residential loans with an aggregate outstanding balance of$2.1 million , 18 commercial and commercial real estate loans with aggregate outstanding balances of$5.6 million and 23 consumer loans with aggregate balances of$351,000 . Within the residential loan balance were$448,000 of loans past due less than 90 days. In the quarter endedJune 30, 2022 , the Company identified nine residential loans which, although paying as agreed, have a high probability of default. Foreclosed real estate decreased$386,000 to$75,000 atJune 30, 2022 . Foreclosed real estate consists of three residential properties. AtJune 30, 2022 , the principal balance of troubled debt restructures ("TDRs") was$2.6 million compared to$9.7 million atSeptember 30, 2021 . Of the$2.6 million of TDRs atJune 30, 2022 $2.2 million were non-accrual loans. As ofJune 30, 2022 , TDRs were comprised of eight residential loans totaling$870,000 , 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$42,000 . For the nine month period endedJune 30, 2022 , three loans were removed from TDR status due to completion of one year of consecutive on time payments and two were removed for paying off. The Company continues to closely monitor all customer credit positions, particularly loans requesting payment relief. As ofJune 30, 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 inMarch 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. A portion of our liquidity consists of cash and cash equivalents and borrowings, which are a product of our operating, investing and financing activities. AtJune 30, 2022 ,$83.1 million of our assets were invested in cash and cash equivalents. Our primary sources 45 -------------------------------------------------------------------------------- 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 ofJune 30, 2022 , we had$225 million of borrowings outstanding from the Pittsburgh FHLB. We have access to total FHLB advances of up to approximately$731.9 million . AtJune 30, 2022 , we had$411.7 million in loan commitments outstanding, which included, in part,$199.0 million in undisbursed construction loans and land development loans,$52.2 million in unused home equity lines of credit,$114.4 million in commercial lines of credit and commitments to originate commercial loans,$15.2 million in performance standby letters of credit and$30.9 million in other unused commitments which are primarily to originate residential mortgage loans and multifamily loans. Certificates of deposit due within one year ofJune 30, 2022 totaled$92.7 million , or 64.5% 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 beforeJune 30, 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$15.9 million and$14.1 million for the nine months endedJune 30, 2022 and 2021, respectively. These amounts differ from our net income because of a variety of cash receipts and disbursements that did not affect net income for the respective periods. Net cash (used for) provided by investing activities was$(57.2) million and$96.8 million for the nine months endedJune 30, 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 of$34.5 million and$81.4 million for the nine months endedJune 30, 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.
46
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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. 48
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