Bogota Financial Corp.: Form 10-Q for the period ended Jun 30, 2023

General

Management’s discussion and analysis of financial condition and results of operations at June 30, 2023 and December 31, 2022 and for the three and six months ended June 30, 2023 and June 30, 2022 is intended to assist in understanding the financial condition and results of operations of Bogota Financial Corp. The information contained in this section should be read in conjunction with the unaudited financial statements and the notes thereto appearing in Part I, Item 1, of this Quarterly Report on Form 10-Q.

Cautionary Note Regarding Forward-Looking Statements

This report contains forward-looking statements, which can be identified by the use of words such as “estimate,” “project,” “believe,” “intend,” “anticipate,” “plan,” “seek,” “expect” 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 current beliefs and expectations of our management and are inherently subject to significant business, economic and competitive uncertainties and contingencies, many of which are beyond our control. In addition, these forward-looking statements are subject to assumptions with respect to future business strategies and decisions that are subject to change. The following factors, among others, could cause actual results to differ materially from the anticipated results or other expectations expressed in the forward-looking statements:

• general economic conditions, either nationally or in our market area, that are worse than expected;
• changes in the level and direction of loan delinquencies, charge-offs and non-performing and classified loans and changes in estimates of the adequacy of the allowance for credit losses;
• our ability to access cost-effective funding;
• changes in liquidity, including the size and composition of our deposit portfolio, including the percentage of uninsured deposits in the portfolio;
• 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 continue to implement our business strategies;
• competition among depository and other financial institutions;
• inflation and changes in market interest rates that reduce our margins and yields, reduce the fair value of financial instruments or reduce our volume of loan originations, or increase the level of defaults, losses and prepayments on loans we have made and make whether held in portfolio or sold in the secondary market;
• adverse changes in the securities markets;
• changes in laws or government regulations or policies affecting financial institutions, including changes in regulatory fees and capital requirements;
• our ability to manage market risk, credit risk and operational risk;
• our ability to enter new markets successfully and capitalize on growth opportunities;
• our ability to successfully integrate into our operations any assets, liabilities or systems we may acquire, as well as new management personnel or customers, 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;
• risks as it relates to cyber security against our information technology and those of our third-party providers and vendors;
• the current or anticipated impact of military conflict, terrorism or other geopolitical events;
• our 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.

Critical Accounting Policies

A summary of our accounting policies is described in Note 1 to the consolidated financial statements included with our Annual Report on Form 10-K at and for the year ended December 31, 2022. Critical accounting estimates are necessary in the application of certain accounting policies and procedures and are particularly susceptible to significant change. Critical accounting policies are defined as those involving significant judgments and assumptions by management that could have a material impact on the carrying value of certain assets or on income under different assumptions or conditions. Actual results could differ from these judgments and estimates under different conditions, resulting in a change that could have a material impact on the carrying values of our assets and liabilities and our results of operations. See Note 1, "Basis of Presentation" for additional information on the adoption of ASC 326, which changes the methodology under which management calculates its reserve for loans and investment securities, now referred to as the allowance for credit losses. Management considers the measurement of the allowance for credit losses to be a critical accounting policy. Other than the adoption of ASC 326, there have been no significant changes to the Company's critical accounting policies since December 31, 2022.

Comparison of Financial Condition at June 30, 2023 and December 31, 2022

Total Assets. Assets decreased $20.1 million, or 2.1%, from December 31, 2022 to $931.0 million at June 30, 2023 primarily due to a $13.1 million, or 1.8%, decrease in loans, a $13.9 million, or 16.3%, decrease in securities available for sale and a $7.6 million, or 9.8%, decrease in securities held to maturity, offset by a $12.2 million, or 72.3%, increase in cash and cash equivalents.

Cash and Cash Equivalents. Cash and cash equivalents increased $12.2 million, or 72.3%, to $29.0 million at June 30, 2023 from $16.8 million at December 31, 2022. The increase was primarily due to loan and investment repayments and excess cash from the increase in long-term FHLB advances during the six months ended June 30, 2023.

Securities Available for Sale. Securities available for sale decreased $13.9 million, or 16.3%, to $71.2 million at June 30, 2023 from $85.1 million at December 31, 2022. The decrease was due to a $4.9 million decrease in U.S treasury bills, a $2.9 million decrease in corporate bonds and a $6.0 million decrease in mortgage-backed securities.

Securities Held to Maturity. Securities held to maturity decreased $7.6 million, or 9.8%, to $69.8 million at June 30, 2023 from $77.4 million at December 31, 2022, due to a $7.7 million decrease in municipal bonds and a $1.4 million decrease in mortgage-backed securities offset by a $1.5 million in purchase of a corporate bond

Net Loans. Net loans decreased $13.1 million, or 1.8%, to $705.9 million at June 30, 2023 from $719.0 million at December 31, 2022. The decrease was due to a decrease of $7.1 million, or 1.4%, in one-to four-residential real estate loans to $488.6 million from $495.7 million at December 31, 2022 and a decrease of $13.1 million, or 21.3%, in construction loans to $48.7 million at June 30, 2023 from $61.8 million at December 31, 2022, offset by a $2.0 million, or 119.2%, increase in commercial and industrial loans to $3.7 million at June 30, 2023 from $1.7 million as of December 31, 2022, an increase of $4.7 million, or 4.9%, in commercial real estate loans to $100.8 million at June 30, 2023 from $96.0 million at December 31, 2022 and an increase of $607,000, or 0.9%, in multi-family real estate loans to $67.0 million at June 30, 2023 from $66.4 million at December 31, 2022. As of June 30, 2023 and December 31, 2022, the Bank had no loans held for sale. Upon adoption of the CECL method of calculating the allowance for credit losses on January 1, 2023, the Bank recorded a one-time decrease, net of tax, in retained earnings of $220,000, an increase to the allowance for credit losses of $157,000 and an increase in the reserve for unfunded liabilities of $152,000.

Deposits. Deposits decreased $44.9 million, or 6.4%, to $656.6 million at June 30, 2023 from $701.4 million at December 31, 2022 due to decreases in checking, savings and money market accounts offset by an increase certificates of deposit and non-interest bearing deposits. The decrease in deposits reflected a decrease in interest-bearing deposits of $63.3 million, or 9.6%, to $599.4 million as of June 30, 2023 from $662.8 million at December 31, 2022 offset by an increase in non-interest bearing deposits of $18.5 million, or 47.8%, to $57.1 million as of June 30, 2023 from $38.7 million as of December 31, 2022.

At June 30, 2023, municipal deposits totaled $44.9 million, which represented 6.8% of total deposits, and brokered deposits totaled $54.8 million, which represented 8.3% of deposits. At December 31, 2022, municipal deposits totaled $57.5 million, which represented 8.2% of deposits, and brokered deposits totaled $58.6 million, which represented 8.4% of total deposits. At June 30, 2023, uninsured deposits represented 8.2% of deposits.

Borrowings. Federal Home Loan Bank of New York borrowings increased $24.9 million, or 24.4%, to $127.2 million at June 30, 2023 from $102.3 million at December 31, 2022, as long-term advances increased $62.9 million, offset by a decrease in short-term advances of $38.0 million. The weighted average rate of borrowings was 3.98% and 3.36% as of June 30, 2023 and December 31, 2022, respectively. The increase in advances was used to offset withdrawals on deposits. Total borrowing capacity at the Federal Home Loan Bank is $330.4 million of which $127.2 million is advanced.

Total Equity. Stockholders’ equity decreased $461,000 to $139.2 million, primarily due to the repurchase of 216,559 shares of stock during the six months ended June 30, 2023 at a cost of $2.2 million and increased accumulated other comprehensive loss for securities available for sale of $438,000, offset by $1.8 million of net income for the six months ended June 30, 2023. At June 30, 2023, the Company’s ratio of average stockholders’ equity-to-total assets was 14.82%, compared to 15.61% at December 31, 2022.

Average Balance Sheets and Related Yields and Rates

The following tables present information regarding average balances of assets and liabilities, the total dollar amounts of interest income and dividends from average interest-earning assets, the total dollar amounts of interest expense on average interest-bearing liabilities, and the resulting annualized average yields and costs. The yields and costs for the periods indicated are derived by dividing income or expense by the average balances of assets or liabilities, respectively, for the periods presented. Average balances have been calculated using daily balances. Nonaccrual loans are included in average balances only. Loan fees are included in interest income on loans and are not material.

(Dollars in thousands)

(unaudited)

(1) Cash flow hedges are used to manage interest rate risk. During the three months ended June 30, 2023, the net effect on interest expense on the Federal Home Loan Bank advances was a reduced expense of $92,000.

(2) Interest rate spread represents the difference between the weighted average yield on interest-earning assets and the weighted average cost of

interest-bearing liabilities.

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

(Dollars in thousands)

1. Cash flow hedges are used to manage interest rate risk. During the three months ended June 30, 2023, the net effect on interest expense on the Federal Home Loan Bank advances was a reduced expense of $92,000.

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

3. Net interest margin represents net interest income divided by average total interest-earning assets.

Rate/Volume Analysis

The following table sets forth the effects of changing rates and volumes on net interest income. The rate column shows the effects attributable to changes in rate (changes in rate multiplied by prior volume). The volume column shows the effects attributable to changes in volume (changes in volume multiplied by prior rate). The net column represents the sum of the prior columns. Changes attributable to changes in both rate and volume that cannot be segregated have been allocated proportionally based on the changes due to rate and the changes due to volume.

(In thousands)

(unaudited)

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

General. Net income decreased by $785,000, or 47.8%, to $857,000 for the three months ended June 30, 2023 from $1.6 million for the three months ended June 30, 2022. This decrease was primarily due to a decrease of $1.4 million in net interest income, offset by a decrease of $225,000 in the provision for credit losses and a decrease of $410,000 in income tax expense.

Interest Income. Interest income increased $2.5 million, or 36.1%, from $6.9 million for the three months ended June 30, 2022 to $9.4 million for the three months ended June 30, 2023 due to increases in the average balances of and higher yields on interest earning assets.

Interest income on cash and cash equivalents increased $121,000, or 432.1%, to $149,000 for the three months ended June 30, 2023 from $28,000 for the three months ended June 30, 2022 due a 425 basis point increase in the average yield from 0.55% for the three months ended June 30, 2022 to 4.80% for the three months ended June 30, 2023 due to the higher interest rate environment. This was offset by an $8.3 million decrease in the average balance to $12.4 million for the three months ended June 30, 2023 from $20.7 million for the three months ended June 30, 2022, reflecting the use of excess liquidity to fund loan originations.

Interest income on loans increased $2.3 million, or 39.2%, to $8.1 million for the three months ended June 30, 2023 compared to $5.8 million for the three months ended June 30, 2022 due primarily to $118.5 million increase in the average balance to $712.2 million for the three months ended June 30, 2023 from $593.7 million for the three months ended June 30, 2022 and a 64 basis point increase in the average yield from 3.95% for the three months ended June 30, 2022 to 4.59% for the three months ended June 30, 2023. The increase was offset by a $347,000 reserve for nonaccrual interest on a delinquent construction loan.

Interest income on securities increased $38,000, or 3.9%, to $1.0 million for the three months ended June 30, 2023 from $979,000 for the three months ended June 30, 2022 due primarily due to a 63 basis point increase in the average yield from 2.15% for the three months ended June 30, 2022 to 2.78% for the three months ended June 30, 2023 offset by a $36.1 million decrease in the average balance to $146.2 million for the three months ended June 30, 2023 from $182.3 million for the three months ended June 30, 2022.

Interest Expense. Interest expense increased $3.9 million, or 324.0%, from $1.2 million for the three months ended June 30, 2022 to $5.1 million for the three months ended June 30, 2023 due to increases in the average balance and higher costs on interest-bearing liabilities.

Interest expense on interest-bearing deposits increased $3.4 million, or 395.5%, to $4.2 million for the three months ended June 30, 2023 from $850,000 for the three months ended June 30, 2022. The increase was due to a 209 basis point increase in the average cost of deposits to 2.68% for the three months ended June 30, 2023 from 0.59% for the three months ended June 30, 2022. The increase in the average cost of deposits was due to the higher interest rate environment and an increase in the average balances of certificates of deposit of $139.4 million to $494.0 million for the three months ended June 30, 2023 from $354.6 million for the three months ended June 30, 2022.

Interest expense on Federal Home Loan Bank borrowings increased $547,000, or 153.5%, from $356,000 for the three months ended June 30, 2022 to $903,000 for the three months ended June 30, 2023. The increase was due to an increase in the average cost of 142 basis points to 3.01% for the three months ended June 30, 2023 from 1.59% for the three months ended June 30, 2022 due to the new borrowings at higher rates. The increase was also due to an increase in the average balance of borrowings of $34.0 million to $120.5 million for the three months ended June 30, 2023 from $86.4 million for the three months ended June 30, 2022.

Net Interest Income. Net interest income decreased $1.4 million, or 24.8%, to $4.3 million for the three months ended June 30, 2023 from $5.7 million for the three months ended June 30, 2022. The decrease reflected a 116 basis point decrease in our net interest rate spread to 1.57% for the three months ended June 30, 2023 from 2.73% for the three months ended June 30, 2022. Our net interest margin decreased 89 basis points to 1.96% for the three months ended June 30, 2023 from 2.85% for the three months ended June 30, 2022.

Provision for Credit Losses. We recorded a $125,000 recovery for credit losses for the three months ended June 30, 2023 compared to a $100,000 provision for loan losses for the three-month period ended June 30, 2022, which reflects a decrease in the loan portfolio and continued to have a low level of delinquent loans in the portfolio, as well as no charge-offs. Non-performing assets were $13.4 million, or 1.42% of total assets, at June 30, 2023. The allowance for loan losses was $2.8 million, or 0.39% of loans outstanding and 21.1% of nonperforming loans, at June 30, 2023. During the three months ended June 30, 2023, the Bank added to non-accrual loans one commercial construction loan located in Totowa, New Jersey that is collateral dependent with a balance of $10.9 million with a loan to value ratio of 46% based on a recent appraisal.

Non-Interest Income. Non-interest income increased by $29,000, or 11.7%, to $283,000 for the three months ended June 30, 2023 from $254,000 for the three months ended June 30, 2022. Gain on sale of loans increased $16,000 and bank-owned life insurance income increased $21,000, or 12.2%, due to higher balances during 2023. These increases were partially offset by a decrease in fee and service charges and other income of $7,000.

Non-Interest Expense. For the three months ended June 30, 2023, non-interest expense increased $38,000, or 1.1%, over the comparable 2022 period. Salaries and employee benefits increased $202,000, or 9.6%, due to a higher employee count. Director fees decreased $44,000, or 21.7%, due to lower pension expense. FDIC insurance premiums increased $73,000, or 135.4%, due to a higher assessment rate in 2023. The increase in advertising expense of $5,000, or 5.4%, was due to additional promotions for branch locations and new promotions on deposit and loan products. Data processing expense decreased $96,000, or 28.9%, professional fees decreased $37,000, or 24.7% and other expense decreased $81,000, or 25.2% due to lower deferred compensation expense and other various expenses.

Income Tax Expense. Income tax expense decreased $410,000, or 65.8%, to $213,000 for the three months ended June 30, 2023 from $623,000 for the three months ended June 30, 2022. The increase was due to $1.2 million of lower taxable income. The effective tax rate for the three months ended June 30, 2023 and 2022 were 19.91% and 27.51%, respectively.

Comparison of Operating Results for the Six Months Ended June 30, 2023 and June 30, 2022

General. Net income decreased by $1.2 million, or 39.2%, to $1.8 million for the six months ended June 30, 2023 from $3.0 million for the six months ended June 30, 2022. This decrease was primarily due to a decrease of $2.0 million in net interest income, offset by a decrease of $225,000 in the provision for credit losses and a decrease of $637,000 in income tax expense.

Interest Income. Interest income increased $5.2 million, or 39.7%, from $13.2 million for the six months ended June 30, 2022 to $18.4 million for the six months ended June 30, 2023 due to increases in the average balances of and higher yields on interest-earning assets.

Interest income on cash and cash equivalents increased $197,000, or 345.6%, to $254,000 for the six months ended June 30, 2023 from $57,000 for the six months ended June 30, 2022 due a 457 basis point increase in the average yield from 0.25% for the six months ended June 30, 2022 to 4.82% for the six months ended June 30, 2023 due to the higher interest rate environment. This was offset by a $35.4 million decrease in the average balance to $10.6 million for the six months ended June 30, 2023 from $46.0 million for the six months ended June 30, 2022, reflecting the use of excess liquidity to fund loan originations and purchase investment securities.

Interest income on loans increased $4.5 million, or 39.1%, to $15.8 million for the six months ended June 30, 2023 compared to $11.4 million for the six months ended June 30, 2022 due to a $132.3 million increase in the average balance to $715.1 million for the six months ended June 30, 2023 from $582.8 million for the six months ended June 30, 2022 and a 53 basis point increase in the average yield from 3.92% for the six months ended June 30, 2022 to 4.45% for the six months ended June 30, 2023. The increase was offset by a $617,000 reserve for nonaccrual interest on a delinquent construction loan.

Interest income on securities increased $476,000, or 29.1%, to $2.1 million for the six months ended June 30, 2023 from $1.6 million for the six months ended June 30, 2022 due to a 70 basis point increase in the average yield from 2.04% for the six months ended June 30, 2022 to 2.74% for the six months ended June 30, 2023. The increase was offset by a $6.7 million decrease in the average balance of securities to $154.0 million for the six months ended June 30, 2023 from $160.7 million for the six months ended June 30, 2022.

Interest Expense. Interest expense increased $7.2 million, or 306.7%, from $2.4 million for the six months ended June 30, 2022 to $9.6 million for the six months ended June 30, 2023 due to increases in the average balance of and higher costs on interest-bearing liabilities.

Interest expense on interest-bearing deposits increased $6.3 million, or 372.9%, to $7.9 million for the six months ended June 30, 2023 from $1.7 million for the six months ended June 30, 2022. The increase was due to a 187 basis point increase in the average cost of interest-bearing deposits to 2.46% for the six months ended June 30, 2023 from 0.59% for the six months ended June 30, 2022. The increase in the average cost of deposits was due to the higher interest rate environment and an increase in the average balances of certificates of deposit of $145.8 million to $498.7 million for the six months ended June 30, 2023 from $352.8 million for the six months ended June 30, 2022.

Interest expense on Federal Home Loan Bank borrowings increased $994,000, or 144.9%, from $686,000 for the six months ended June 30, 2022 to $1.7 million for the six months ended June 30, 2023. The increase was due to an increase in the average cost of 155 basis points to 3.19% for the six months ended June 30, 2023 from 1.64% for the six months ended June 30, 2022 due to the new borrowings at higher rates. The increase was also due to an increase in the average balance of borrowings of $21.7 million to $106.1 million for the six months ended June 30, 2023 from $84.4 million for the six months ended June 30, 2022.

Net Interest Income. Net interest income decreased $2.0 million, or 18.6%, to $8.8 million for the six months ended June 30, 2023 from $10.8 million for the six months ended June 30, 2022. The increase reflected a 100 basis point decrease in our net interest rate spread to 1.61% for the six months ended June 30, 2023 from 2.61% for the six months ended June 30, 2022. Our net interest margin decreased 74 basis points to 2.01% for the six months ended June 30, 2023 from 2.75% for the six months ended June 30, 2022.

Provision for Credit Losses. We recorded a $125,000 credit for credit losses for the six months ended June 30, 2023 compared to a $100,000 provision for credit losses for the six-month period ended June 30, 2022. The Bank had a decrease in the loan portfolio, as well as no charge-offs. Non-performing assets were $13.4 million, or 1.42% of total assets, at June 30, 2023. The allowance for loan losses was $2.8 million, or 0.39% of loans outstanding and 21.1% of nonperforming loans, at June 30, 2023. During the six months ended June 30, 2023, the Bank added to non-accrual loans one commercial construction loan located in Totowa, New Jersey that is collateral dependent with a balance of $10.9 million with a loan to value ratio of 46% based on a recent appraisal. As of January 1, 2023, the Bank adopted CECL and recorded a one-time adjustment of $157,000 to the allowance for credit losses.

Non-Interest Income. Non-interest income decreased by $31,000, or 5.3%, to $567,000 for the six months ended June 30, 2023 from $598,000 for the six months ended June 30, 2022. Gain on sale of loans decreased $58,000, or 66.2%, as loan originations were lower in 2023. Other income decreased $33,000 or 34.0%. These decreases were partially offset by an increase in income from bank-owned life insurance of $51,000, or 15.6%, due to higher balances during 2023.

Non-Interest Expense. For the six months ended June 30, 2023, non-interest expense increased $14,000, or 0.2%, over the comparable 2022 period. Salaries and employee benefits increased $301,000, or 7.2%, due to a higher employee count. Director fees decreased $100,000, or 23.8%, due to lower pension expense. FDIC insurance premiums increased $79,000, or 73.3% due to a higher assessment rate in 2023. Data processing decreased $97,000 or 15.9%, due to the timing of an invoice. The increase in advertising expense of $31,000, or 14.6%, was due to additional promotions for branch locations and new promotions on deposit and loan products. Other expense decreased $223,000, or 34.7%, due to lower deferred compensation expense and other various expenses.

Income Tax Expense. Income tax expense decreased $637,000, or 55.5%, to $511,000 for the six months ended June 30, 2023 from $1.1 million for the six months ended June 30, 2022. The increase was due to $1.9 million, or 43.7%, of lower taxable income. The effective tax rate for the six months ended June 30, 2023 and 2022 were 21.65% and 27.40%, respectively.

Management of Market Risk

General. 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 loans and securities, 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 our exposure to changes in market interest rates. Accordingly, our board of directors has established an Asset/Liability Management Committee (the “ALCO”), which is comprised of three members of executive management and two independent directors, which oversees the asset/liability management processes and related procedures. The ALCO meets on at least a quarterly basis and reviews asset/liability strategies, liquidity positions, alternative funding sources, interest rate risk measurement reports, capital levels and economic trends at both national and local levels. Our interest rate risk position is also monitored quarterly by the board of directors.

We manage our interest rate risk to minimize the exposure of our earnings and capital to changes in market interest rates. We have implemented the following strategies to manage our interest rate risk: originating and purchasing loans with adjustable interest rates; promoting core deposit products; monitoring the length of our borrowings with the Federal Home Loan Bank and brokered deposits depending on the interest rate environment; maintaining a significant portion of our investments as available-for-sale; diversifying our loan portfolio; and strengthening our capital position. By following these strategies, we believe that we are better positioned to react to changes in market interest rates.

Net Portfolio Value Simulation. We analyze our sensitivity to changes in interest rates through a net portfolio value of equity (“NPV”) model. NPV represents the present value of the expected cash flows from our assets less the present value of the expected cash flows arising from our liabilities, adjusted for the value of off-balance sheet contracts. The NPV ratio represents the dollar amount of our NPV divided by the present value of our total assets for a given interest rate scenario. NPV attempts to quantify our economic value using a discounted cash flow methodology while the NPV ratio reflects that value as a form of capital ratio. We estimate what our NPV would be at a specific date. We then calculate what the NPV would be at the same date throughout a series of interest rate scenarios representing immediate and permanent, parallel shifts in the yield curve. We currently calculate NPV under the assumptions that interest rates increase 100, 200, 300 and 400 basis points from current market rates and that interest rates decrease 100, 200, 300 and 400 basis points from current market rates.

The following table presents the estimated changes in our net portfolio value that would result from changes in market interest rates as June 30, 2023. All estimated changes presented in the table are within the policy limits approved by the board of directors.

(Dollars in thousands)

Certain shortcomings are inherent in the methodologies used in the above interest rate risk measurements. Modeling changes require making certain assumptions that may or may not reflect the manner in which actual yields and costs respond to changes in market interest rates. The table above assumes that the composition of our interest-sensitive assets and liabilities existing at the date indicated remains constant uniformly across the yield curve regardless of the duration or repricing of specific assets and liabilities. Accordingly, although the table provides an indication of our interest rate risk exposure at a particular point in time, such measurements are not intended to and do not provide a precise forecast of the effect of changes in market interest rates on our NPV and will differ from actual results.

Net Interest Income Analysis. We also use income simulation to measure interest rate risk inherent in our balance sheet at a given point in time by showing the effect on net interest income, over specified time frames and using different interest rate shocks and ramps. The assumptions include management’s best assessment of the effect of changing interest rates on the prepayment speeds of certain assets and liabilities, projections for account balances in each of the product lines offered and the historical behavior of deposit rates and balances in relation to changes in interest rates. These assumptions are subject to change, and as a result, the model is not expected to precisely measure net interest income or precisely predict the impact of fluctuations in interest rates on net interest income. Actual results will differ from the simulated results due to timing, magnitude, and frequency of interest rate changes as well as changes in the balance sheet composition and market conditions. Assumptions are supported with quarterly back testing of the model to actual market rate shifts.

As of June 30, 2023, net interest income simulation results indicated that its exposure over one year to changing interest rates was within our guidelines. The following table presents the estimated impact of interest rate changes on our estimated net interest income over one year:

(1) The calculated change in net interest income assumes an instantaneous parallel shift of the yield curve.

The preceding simulation analyses does not represent a forecast of actual results and should not be relied upon as being indicative of expected operating results. These hypothetical estimates are based upon numerous assumptions, which are subject to change, including: the nature and timing of interest rate levels including the yield curve shape, prepayments on loans and securities, deposit decay rates, pricing decisions on loans and deposits, reinvestment/replacement of asset and liability cash flows, and others. Also, as market conditions vary, prepayment/refinancing levels, the varying impact of interest rate changes on caps and floors embedded in adjustable-rate loans, early withdrawal of deposits, changes in product preferences, and other internal/external variables will likely deviate from those assumed.

Liquidity and Capital Resources

Liquidity. Liquidity describes our ability to meet 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 and proceeds from calls, maturities and sales of securities and sales of loans. We also borrow from the Federal Home Loan Bank of New York. At June 30, 2023, we had the ability to borrow up to $330.4 million, of which $127.2 million was outstanding and $1.5 million was utilized as collateral for letters of credit issued to secure municipal deposits. At June 30, 2023, we had $39.0 million in unsecured lines of credit with three correspondent banks with no outstanding balance.

The board of directors is responsible for establishing and monitoring our liquidity targets and strategies in order to ensure that sufficient liquidity exists for meeting the borrowing needs and deposit withdrawals of our customers as well as unanticipated contingencies. We believe that we had ample sources of liquidity to satisfy our short- and long-term liquidity needs as of June 30, 2023.

While maturities and scheduled amortization of loans and securities are predictable sources of funds, deposit flows and loan prepayments are greatly influenced by market interest rates, economic conditions, and competition. Our most liquid assets are cash and cash equivalents. The levels of these assets are dependent on our operating, financing, lending and investing activities during any period. At June 30, 2023, cash and cash equivalents totaled $29.0 million. Securities classified as available-for-sale, which provide additional sources of liquidity, totaled $71.2 million at June 30, 2023.

We are committed to maintaining a strong liquidity position. We monitor our liquidity position on a daily basis. We anticipate we will have sufficient funds to meet our current funding commitments. Certificates of deposit due within one year of June 30, 2023 totaled $350.3 million, or 53.4% of total deposits. If these deposits do not remain with us, we will be required to seek other sources of funds, including other deposits and Federal Home Loan Bank of New York advances. Depending on market conditions, we may be required to pay higher rates on such deposits or borrowings than we currently pay. We believe, however, based on past experience that a significant portion of such deposits will remain with us. We have the ability to attract and retain deposits by adjusting the interest rates offered.

Capital Resources. We are subject to various regulatory capital requirements administered by the New Jersey Department of Banking and Insurance and the Federal Deposit Insurance Corporation. At June 30, 2023, we exceeded all applicable regulatory capital requirements, and were considered “well capitalized” under regulatory guidelines. As a result of the Economic Growth, Regulatory Relief, and Consumer Protection Act, as modified in April 2020, the federal banking agencies were required to develop a “Community Bank Leverage Ratio” (the ratio of a bank's Tier 1 “equity capital to average total consolidated assets) for financial institutions with less than $10 billion. A “qualifying community bank” with capital exceeding 9% will be considered compliant with all applicable regulatory capital and leverage requirements, including the capital requirements to be considered "well capitalized” under Prompt Corrective Action statutes. As of June 30, 2023, the Bank is reporting as a qualifying community bank with a ratio of 13.88%.

Inflation

Substantially all of the Company's assets and liabilities relate to banking activities and are monetary. The consolidated financial statements and related financial data are presented following GAAP. GAAP currently requires the Company to measure the financial position and results of operations in terms of historical dollars, except for securities available for sale, impaired loans, and other real estate loans that are measured at fair value. Changes in the value of money due to rising inflation can cause purchasing power loss. Management's opinion is that movements in interest rates affect the financial condition and results of operations to a greater degree than changes in the rate of inflation. It should be noted that interest rates and inflation do affect each other but do not always move in correlation with each other. The Company's ability to match the interest sensitivity of its financial assets to the interest sensitivity of its liabilities in its asset/liability management may tend to minimize the effect of changes in interest rates on the Company's performance.

Information with respect to quantitative and qualitative disclosures about market risk can be found in Item 2, “Management’s Discussion and Analysis of Financial Condition and Results of Operation – Management of Market Risk.”

An evaluation was performed under the supervision and with the participation of the Company’s management, including the Chief Executive Officer and the Chief Financial Officer, of the effectiveness of the design and operation of the Company’s disclosure controls and procedures (as defined in Rule 13a-15(e) promulgated under the Securities and Exchange Act of 1934, as amended) as of June 30, 2023. Based on that evaluation, the Company’s management, including the Chief Executive Officer and the Chief Financial Officer, concluded that the Company’s disclosure controls and procedures were effective.

During the three months ended June 30, 2023, there have been no changes in the Company’s internal controls over financial reporting that have materially affected, or are reasonably likely to materially affect, the Company’s internal control over financial reporting.

Except noted below, there have been no material changes in risk factors applicable to the Company from those disclosed in “Risk Factors” in Item 1A of the Company’s Annual Report on Form 10-K for the year ended December 31, 2022 and in Item 1A of the Company’s Quarterly Report on Form 10-Q for the quarter ended March 31, 2023.