SR Bancorp, Inc.: Form 10-Q for the period ended Dec 31, 2023

Overview; Completed Stock Offering and Merger

Our principal business is to acquire deposits from individuals and businesses in the communities surrounding our offices and to use these deposits to fund loans.

As previously announced, the conversion of Somerset Savings Bank, SLA from the mutual to stock form of organization and related stock offering by the Company was completed on September 19, 2023. The Company’s common stock began trading on the Nasdaq Capital Market under the trading symbol “SRBK” on September 20, 2023.

The Company sold 9,055,172 shares of its common stock at a price of $10.00 per share, which included 760,634 shares sold to Somerset Regal Bank’s Employee Stock Ownership Plan. Additionally, the Company contributed 452,758 shares and $905,517 in cash to the Somerset Regal Charitable Foundation, Inc., a charitable foundation formed in connection with the conversion. Upon the completion of the conversion and offering, 9,507,930 shares of Company common stock were outstanding.

Promptly following the completion of the conversion and related stock offering, Regal Bancorp, Inc., a New Jersey corporation (“Regal Bancorp”), merged with and into the Company, with the Company as the surviving entity (the “Merger”). Immediately following the Merger, Regal Bank, a New Jersey chartered commercial bank headquartered in Livingston, New Jersey and the wholly-owned subsidiary of Regal Bancorp, merged with and into Somerset Bank, which converted to a commercial bank charter, and was renamed Somerset Regal Bank. In connection with the Merger, each outstanding share of Regal Bancorp common stock converted into the right to receive $23.00 in cash. The Merger was completed on September 19, 2023.

The financial information contained in this Form 10-Q as of and for the three and six months ended December 31, 2023 is for SR Bancorp and Somerset Regal Bank, unless indicated otherwise. However, due to the timing of the merger noted above, the income statement only includes operations of the combined entity since September 20, 2023. Financial information as of June 30, 2023 and for the three and six months ended December 31, 2022 is for Somerset Savings Bank, SLA, on a stand-alone basis.

Cautionary Note Regarding Forward-Looking Statements

This quarterly report contains forward-looking statements within the meaning of Section 21E of the Securities Exchange Act of 1934, which can be identified by the use of words such as “estimate,” “project,” “believe,” “intend,” “anticipate,” “assume,” “plan,” “seek,” “expect,” “will,” “may,” “should,” “indicate,” “would,” “believe,” “contemplate,” “continue,” “target” and words of similar meaning. These forward-looking statements include, but are not limited to:

• statements of our goals, intentions and expectations;
• statements regarding our business plans, prospects, growth and operating strategies;
• statements regarding the quality of our loan and investment portfolios; and
• estimates of our risks and future costs and benefits.

These forward-looking statements are based on our current beliefs and expectations and are inherently subject to significant business, economic and competitive uncertainties and contingencies, many of which are beyond our control. In addition, these forward-looking statements are subject to assumptions with respect to future business strategies and decisions that are subject to change. We are under no duty to and do not take any obligation to update any forward-looking statements after the date of this report.

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 areas, that are worse than expected, including potential recessionary conditions;
• inflation and changes in the interest rate environment that reduce our margins and yields, the fair value of financial instruments or our level of loan originations, or increase the level of defaults, losses and prepayments on loans we have made and make;
• our ability to integrate the operations of Regal Bank into Somerset Regal Bank in a timely and cost efficient manner;
• our inability to successfully integrate acquired employees or operations or achieve the expected level of synergies or cost savings;
• changes in the level and direction of loan delinquencies and write-offs and changes in estimates of the adequacy of the allowance for credit losses;
• our ability to access cost-effective funding;
• 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 implement and change our business strategy;
• competition among depository and other financial institutions;
• adverse changes in the securities or secondary mortgage markets;
• changes in laws or government regulations or policies affecting financial institutions, including changes in regulatory fees, capital requirements and insurance premiums or changes in the fiscal or monetary policies of the U.S. Treasury or Board of Governors of the Federal Reserve System;
• changes in the quality or composition of our loan or investment portfolios;
• technological changes that may be more difficult or expensive than expected;
• the inability of third-party providers to perform as expected;
• a failure or breach of our operational or security systems or infrastructure, including cyberattacks;
• our ability to manage market risk, credit risk and operational risk;
• 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;
• the current or anticipated impact of military conflict, terrorism or other geopolitical event;
• a potential government shutdown;
• our ability to retain key employees;
• 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.

Because of these and a wide variety of other uncertainties, our actual future results may be materially different from the results indicated by these forward-looking statements.

Critical Accounting Policies

Certain of our accounting policies are important to the presentation of our financial condition, since they require management to make difficult, complex or subjective judgments, some of which may relate to matters that are inherently uncertain. Estimates associated with these policies are susceptible to material changes as a result of changes in facts and circumstances. Facts and circumstances that could affect these judgments include, but are not limited to, changes in interest rates, changes in the performance of the economy and changes in the financial condition of borrowers. Our significant accounting policies are discussed in detail in Note 1 to our Consolidated Financial Statements included elsewhere in this Form 10-Q.

The JOBS Act contains provisions that, among other things, reduce certain reporting requirements for qualifying public companies. As an “emerging growth company” we plan to delay adoption of new or revised accounting pronouncements applicable to public companies until such pronouncements are made applicable to private companies. Accordingly, our consolidated financial statements may not be comparable to the financial statements of public companies that comply with such new or revised accounting standards.

Management believes our most critical accounting policies, which involve the most complex or subjective decisions or assessments, are as follows: allowance for credit losses and the valuation of our deferred tax assets.

Allowance for Credit Losses: The allowance for credit losses (“allowance” or “ACL”), calculated in accordance with ASC 326, is deducted from the amortized cost basis of loans. The ACL represents an amount that, in management’s judgment, is adequate to absorb the lifetime expected credit losses that may be experienced on outstanding loans at the balance sheet date based on the evaluation of the size and current risk characteristics of the loan portfolio, past events, current conditions, reasonable and supportable forecasts of future economic conditions and prepayment experience. The allowance for credit losses is measured and recorded upon the initial recognition of a financial asset. Determination of the adequacy of the allowance is inherently complex and requires the use of significant and highly subjective estimates. Loans are charged-off against the allowance when deemed uncollectible by management. Expected recoveries do not exceed the aggregate of amounts previously charged-off and expected to be charged-off. Adjustments to the allowance are reported in our income statement as a component of the provision for credit losses.

In calculating the allowance for credit losses, loans are segmented into pools based upon similar characteristics and risk profiles. Common characteristics and risk profiles include the type of loan, underlying collateral, geographical similarity and historical or expected credit loss patterns. The Company applies two methodologies to estimate the allowance on its pooled portfolio segments: a cohort method based on common characteristics and the weighted average remaining life method. The models related to these methodologies utilize the Company’s historical default and loss experience adjusted for future economic forecasts. The reasonable and supportable forecast period represents a one-year economic outlook for the applicable economic variables.

In some cases, management may determine that an individual loan exhibits unique risk characteristics that differentiate the loan from other loans within our loan pools. In such cases, the loans are evaluated for expected credit losses on an individual basis and excluded from the collective evaluation. Specific allocations of the allowance for credit losses are determined by analyzing the borrower’s ability to repay amounts owed, collateral deficiencies, the relative risk rating of the loan and economic conditions affecting the borrower, among other things.

Management qualitatively adjusts model results for risk factors that are not considered within our modeling processes but are nonetheless relevant in assessing the expected credit losses within our loan pools. These qualitative factor adjustments may increase or decrease management’s estimate of expected credit losses by a calculated percentage or amount based upon the estimated level of risk. The various risks that may be considered in making qualitative factor adjustments include, among other things: the impact of changes in lending policies and procedures, including changes in underwriting standards and practices for collections, write-offs, and recoveries; actual and expected changes in national, regional, and local economic and business conditions and developments that affect the collectability of the loan pools; changes in the composition and size of a loan or the loan pools and in the terms of the underlying loans; changes in the experience, ability, and depth of our lending management and staff; changes in volume and severity of past due and nonaccrual assets; changes to the quality of our internal loan review system; the existence, growth, and effect of any concentrations of credit; and other factors such as the regulatory, legal and environmental events. Management believes it uses relevant information available to make determinations about the allowance and that it has established the existing allowance in accordance with GAAP. However, the determination of the allowance requires significant judgment, and estimates of expected lifetime losses in the loan portfolio can vary significantly from the amounts actually observed. While management uses available information to recognize expected losses, future additions to the allowance may be necessary based on changes in the loans comprising the portfolio, changes in the current and forecasted economic conditions, changes to the interest rate environment and changes in the financial condition of borrowers.

Income Taxes: Income taxes are accounted for using the asset and liability 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.

The effect on deferred tax assets and liabilities of a change in tax rates is recognized in income in the period that includes the enactment date. The measurement of deferred tax assets is reduced by a valuation allowance for the amount of the deferred tax asset that is more likely than not to be realized.

A tax position is recognized as a benefit only if it is “more likely than not” that the tax position would be sustained in a tax examination, with a tax examination being presumed to occur. The amount recognized is the largest amount of tax benefit that is greater than 50% likely of being realized on examination. For tax positions not meeting the “more likely than not” test, no tax benefit is recorded.

We recognize interest and/or penalties related to income tax matters in other operating expenses.

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

Total Assets. Total assets increased $423.5 million, or 65.0%, to $1.07 billion at December 31, 2023 from $651.5 million at June 30, 2023. The increase was primarily the result of the acquisition of Regal Bancorp, and its wholly-owned subsidiary Regal Bank, on September 19, 2023, which had $428.0 million of assets at the time of the acquisition. The increase was also due to net proceeds of $86.9 million obtained from the completion of the Company’s stock offering on the same date.

Cash and Cash Equivalents. Cash and cash equivalents increased $47.8 million, or 112.6%, to $90.2 million at December 31, 2023 from $42.4 million at June 30, 2023 due to $55.3 million of cash and cash equivalents acquired from the Regal Bancorp acquisition and the net proceeds of $86.9 million retained from the stock offering, partially offset by $69.5 million paid for the acquisition of Regal Bancorp.

Securities Available-for-Sale. Securities available-for-sale decreased $1.3 million, or 3.6% to $34.8 million at December 31, 2023 from $36.1 million at June 30, 2023. The Company acquired $21.3 million of available-for-sale securities from the Regal Bancorp acquisition. Following the completion of the Merger, the Company sold $19.2 million of its available-for-sale portfolio, which resulted in a gain of $17,000. The remainder of the decrease was due to maturities and repayment of securities.

Securities Held-to-Maturity. Securities held-to-maturity decreased $6.0 million, or 3.5%, to $165.2 million at December 31, 2023 from $171.2 million at June 30, 2023 as the maturities of securities during the period more than offset the acquisition of $2.6 million of held-to-maturity securities from the Regal Bancorp acquisition.

Loans. Loans receivable, net, increased $333.5 million, or 92.1%, to $695.8 million at December 31, 2023 from $362.3 million at June 30, 2023. The Company acquired $336.0 million of loans from the Regal Bancorp acquisition, primarily consisting of $320.7 million of multi-family and commercial real estate loans and $13.4 million of commercial and industrial loans. As a result of the acquisition, the composition of the loan portfolio changed significantly from June 30, 2023. The percentage of residential mortgage loans to total loans decreased from 97.8% at June 30, 2023 to 53.47% at December 31, 2023. Commercial loans (consisting of multi-family and commercial real estate loans and commercial and industrial loans) accounted for 44.83% of loans at December 31, 2023.

Bank Owned Life Insurance. Bank owned life insurance increased $7.9 million, or 27.4%, to $36.6 million at December 31, 2023 from $28.7 million at June 30, 2023. The increase was primarily the result of the Regal Bancorp acquisition, which had $7.5 million of bank owned life insurance at the time of acquisition.

Goodwill and Intangible Assets. The Company acquired goodwill and a core deposit premium intangible through the acquisition of Regal Bancorp. At the time of acquisition, goodwill was $20.5 million and the core deposit premium intangible asset was $9.1 million. No impairment loss was recognized on goodwill during thesix months ended December 31, 2023. The carrying amount of the core deposit premium intangible, net of accumulated amortization, was $8.5 million at December 31, 2023.

Total Liabilities. Total liabilities increased $347.6 million, or 65.7%, to $877.0 million at December 31, 2023 from $529.4 million at June 30, 2023. The increase was primarily the result of the Regal Bancorp acquisition, which had $379.0 million of liabilities at the time of the acquisition.

Deposits. Deposits increased $339.4 million, or 67.4%, to $843.3 million at December 31, 2023 from $503.9 million at June 30, 2023 due primarily to the $373.2 millionof deposits assumed from the Regal Bank acquisition. At the time of the acquisition, Regal Bank’s deposits consisted of $90.8 million of noninterest-bearing deposits, $162.4 million in NOW, money market and savings accounts and $119.9 million of certificates of deposit.

Borrowings. We had $20.0 million of borrowings at December 31, 2023 and June 30, 2023, respectively.

Total Equity. Total equity increased $75.9 million, or 62.2%, to $198.0 million at December 31, 2023 from $122.1 million at June 30, 2023. The increase resulted from $84.0 million in stockholders’ equity from the Regal Bancorp acquisition and the net proceeds from the Company’s stock offering, other comprehensive income of $504,000, offset by a net loss of $8.9 million for the period.

Comparison of Operating Results for the Three Months Ended December 31, 2023 and 2022

General. Net income increased $1.2 million to $1.6 million for the three months ended December 31, 2023 from net income of $399,000 for the three months ended December 31, 2022. The increase was caused primarily by $1.4 million of net accretion income related to the fair value adjustments recorded in connection with the acquisition of Regal Bancorp. Excluding $32,000 of merger-related costs, offset by the aforementioned $1.4 million of net accretion income, net income would have been $605,000 for the three months ended December 31, 2023.

Interest Income. Interest income increased $8.4 million, or 215.6%, to $12.3 million for the three months ended December 31, 2023 from $3.9 million for the three months ended December 31, 2022. The increase resulted primarily from a $7.4 million, or 271.9%, increase in interest income on loans and a $1.0 million increase in interest income on other assets, offset by a $82,000, or 8.8%, decrease in interest income on securities. The average balance of loans increased $359.6 million, or 102.3%, to $711.2 million for the three months ended December 31, 2023, compared to $351.6 million for the three months ended December 31, 2022. In addition, the average yield on the loan portfolio increased 261 basis points to 5.73% for the three months ended December 31, 2023 from 3.12% for the three months ended December 31, 2022, which reflected the higher interest rate environment and the greater composition of commercial loans in the portfolio.

The average balance of securities decreased $26.6 million, or 11.6%, to $201.7 million for the three months ended December 31, 2023, compared to $228.3 million for the three months ended December 31, 2022. This decrease was offset by an increase of five basis points in the average yield of securities to 1.69% for the three months ended December 31, 2023 from 1.64% for the three months ended December 31, 2022.

The increase in the interest income on other assets was due to a 158 basis point increase in the average yield of other assets from 3.43% for the three months ended December 31, 2022 to 5.01% for the three months ended December 31, 2023 and a $74.1 million, or 289.2%, increase in the average balance of other assets from $25.6 million for the three months ended December 31, 2022 to $99.7 million for the three months ended December 31, 2023.

Interest Expense. Interest expense increased $2.8 million or 639.1%, to $3.3 million for the three months ended December 31, 2023 from $442,000 for the three months ended December 31, 2022. The increase in interest expense resulted primarily from an increase in interest expense on certificates of deposits. The average rate on certificates of deposit increased 279 basis points to 3.86% for the three months ended December 31, 2023 from 1.07% for the three months ended December 31, 2022 and the average balance of certificates of deposit increased $129.3 million, or 89.2%, to $274.1 million for the three months ended December 31, 2023 from $144.8 million for the three months ended December 31, 2022. This average balance of savings and club accounts increased $65.8 million, or 35.8%, to $249.2 million for the three months ended December 31, 2023 from $183.4 million for the three months ended December 31, 2022. The average balance of interest-bearing demand deposits increased $47.1 million, or 32.0%, to $194.1 million for the three months ended December 31, 2023 from $147.0 million for the three months ended December 31, 2022. The average rate on interest-bearing demand deposits increased 62 basis points to 0.69% for the three months ended December 31, 2023 from 0.07% for the three months ended December 31, 2022.

Net Interest Income. Net interest income increased $5.6 million, or 161.3%, to $9.0 million for the three months ended December 31, 2023 from $3.5 million for the three months ended December 31, 2022. Our net interest rate spread increased 88 basis points to 3.08% for the three months ended December 31, 2023 from 2.20% for the three months ended December 31, 2022 while our net interest margin increased 128 basis points to 3.56% for the three months ended December 31, 2023 from 2.28% for the three months ended December 31, 2022. Net interest-earning assets increased $145.0 million, or 111.4%, to $275.2 million for the three months ended December 31, 2023 from $130.2 million for the three months ended December 31, 2022. The increases in our net interest rate spread and our net interest margin were a result of both the acquisition of Regal Bancorp and the increasing yield on interest-earning assets outpacing the increasing cost of interest-bearing liabilities.

Average Balances and Yields

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, discounts, and premiums that are amortized or accreted to interest income or interest expense. Deferred loan fees totaled $134,000 and $197,000 for the three months ended December 31, 2023 and 2022, respectively.

(Dollars in thousands)

(1) Annualized.

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

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

Rate/Volume Analysis

The following tables present the effects of changing rates and volumes on our net interest income for the periods indicated. The rate column shows the effects attributable to changes in rate (changes in rate multiplied by prior volume). The volume column shows the effects attributable to changes in volume (changes in volume multiplied by prior rate). The total column represents the sum of the prior columns. For purposes of these tables, changes attributable to both rate and volume, which cannot be segregated, have been allocated proportionately based on the changes due to rate and the changes due to volume. There were no out-of-period items or adjustments required to be excluded from the tables below.

(In thousands)

Provision for Credit Losses. We establish provisions for credit losses, which are charged to operations in order to maintain the allowance for credit losses at a level we consider necessary to absorb credit losses incurred in the loan portfolio that are both probable and reasonably estimable at the balance sheet date. In determining the level of the allowance for credit losses, we consider, among other things, past and current loss experience, evaluations of real estate collateral, current and reasonably supportable economic conditions, volume and type of lending, adverse situations that may affect a borrower’s ability to repay a loan and the levels of delinquent loans. The amount of the allowance is based on estimates and the ultimate losses may vary from such estimates as more information becomes available or conditions change. We assess the allowance for credit losses and make provisions for credit losses on a monthly basis.

Based on our evaluation of the above factors, we reduced our provision for credit losses by $107,000 for the three months ended December 31, 2023 compared to having no change in our provision for the three months ended December 31, 2022. The reduction to our provision for credit losses for the three months ended December 31, 2023 reflected that we had no charge-offs for the period, one classified loan in the amount of $145,000 at December 31, 2023and $145,000 of non-performing loans for the three months ended December 31, 2023. The absence of a provision for credit losses for the three months ended December 31, 2022 reflected that we had no charge-offs for the period, no classified loans at December 31, 2022 and only $145,000 of non-performing loans for the three months ended December 31, 2022. Our allowance for credit losses as a percentage of total loans was 0.74% at December 31, 2023 compared to 0.31% at December 31, 2022, reflecting the establishment of a general credit reserve for the acquired loan portfolio. To the best of our knowledge, we have provided for all losses that are both probable and reasonable to estimate at December 31, 2023 and December 31, 2022.

Noninterest Income. Noninterest income was as follows:

(Dollars in thousands)

Noninterest income increased $12,000, or 3.4%, to $365,000 for the three months ended December 31, 2023 from $353,000 for the three months ended December 31, 2022, primarily as a result of an increase of $71,000 in the cash surrender value of bank-owned life insurance and an increase of $30,000 in service charges and fees on deposit accounts, offset by a decrease of $92,000 in other income.

Noninterest Expense. Noninterest expense was as follows:

(Dollars in thousands)

Noninterest expense increased $4.1 million, or 124.6%, to $7.5 million for the three months ended December 31, 2023 from $3.3 million for the three months ended December 31, 2022, primarily as a result of an increase in salaries and employee benefits, occupancy expenses, data processing expenses, professional fees and other miscellaneous expenses, all related to the Merger.

Income Tax Expense. The provision for income taxes was $408,000 for the three months ended December 31, 2023, compared to a tax provision of $76,000 for the three months ended December 31, 2022. Our effective tax rate was 20.2% and 16.0% for the three months ended December 31, 2023 and 2022, respectively, reflecting lower state income tax liabilities due to the application of net operating loss carryforwards and a lower state income tax rate applied to the net investment income derived by Somerset Regal Bank’s investment company subsidiary.

Comparison of Operating Results for the Six Months Ended December 31, 2023 and 2022

General. Net income decreased $9.6 million to a loss of $8.9 million for the six months ended December 31, 2023 from net income of $753,000 for the six months ended December 31, 2022. The decrease was caused primarily by a $5.4 million charitable contribution to the Somerset Regal Charitable Foundation established in connection with its conversion to the stock form of organization, which was funded with 452,758 shares of SR Bancorp common stock and $906,000 in cash.

The decrease was also due to a $4.2 million provision for credit losses and $3.9 million in noninterest expenses incurred during the three months ended September 30, 2023 related to the acquisition of Regal Bancorp. These expenses were partially offset by $1.6 million of net accretion income related to the fair value adjustments recorded in connection with the Merger during the six months ended December 31, 2023. Excluding the merger-related expenses totaling $3.9 million, the $4.2 million provision for credit losses and the charitable contribution of $5.4 million on an after-tax basis, offset by the $1.6 million of net accretion income in connection with the Merger, the Company would have reported net income of $1.2 million for the six months ended December 31, 2023.

Interest Income. Interest income increased $10.2 million, or 134.3%, to $17.8 million for the six months ended December 31, 2023 from $7.6 million for the six months ended December 31, 2022. The increase resulted primarily from a $8.6 million, or 161.2%, increase in interest income on loans and a $1.8 million increase in interest income on other assets, offset by a $172,000, or 9.1%, decrease in interest income on securities. The average balance of loans increased $212.9 million, or 61.6%, to $558.4 million for the six months ended December 31, 2023, compared to $345.5 million for the six months ended December 31, 2022. In addition, the average yield on the loan portfolio increased 190 basis points to 4.99% for the six months ended December 31, 2023 from 3.09%for the six months ended December 31, 2022, which reflected the higher interest rate environment and the greater composition of commercial loans in the portfolio. The average balance of securities decreased $29.1 million, or 12.5%, to $203.8 million for the six months ended December 31, 2023, compared to $232.9 million for the six months ended December 31, 2022. This decrease was offset by an increase of six basis points in the average yield of securities to 1.68% for the six months ended December 31, 2023 from 1.62% for the six months ended December 31, 2022. The increase in the interest income on other assets was due to a 169 basis point increase in the average yield of other assets from 3.25% for the six months ended December 31, 2022 to 4.94% for the six months ended December 31, 2023 and a $64.2 million, or 267.6%, increase in the average balance of other assets from $24.0 million for the six months ended December 31, 2022 to $88.2 million for the six months ended December 31, 2023.

Interest Expense. Interest expense increased $3.9 million, or 537.3%, to $4.7 million for the six months ended December 31, 2023 from $732,000 for the six months ended December 31, 2022. The increase in interest expense resulted primarily from an increase in interest expense on certificates of deposit. The average rate on certificates of deposit increased 244 basis points to 3.31% for the six months ended December 31, 2023 from 0.87% for the six months ended December 31, 2022 and the average balance of certificates of deposit increased $81.8 million, or 56.9%, to $225.5 million for the six months ended December 31, 2023 from $143.7 million for the six months ended December 31, 2022. The average balance of savings and club accounts increased $23.6 million, or 12.7%, to $209.5 million for the six months ended December 31, 2023 from $185.9 million for the six months ended December 31, 2022. The average balance of interest-bearing demand deposits increased $21.1 million, or 14.4%, to $167.2 million for the six months ended December 31, 2023 from $146.2 million for the six months ended December 31, 2022. The average rate on interest-bearing demand deposits increased 39 basis points to 0.46% for the six months ended December 31, 2023 from 0.07% for the six months ended December 31, 2022.

Net Interest Income. Net interest income increased $6.3 million, or 91.4%, to $13.2 million for the six months ended December 31, 2023 from $6.9 million for the six months ended December 31, 2022. Our net interest rate spread increased 47 basis points to 2.69% for the six months ended December 31, 2023 from 2.22% for the six months ended December 31, 2022 while our net interest margin increased 82 basis points to 3.10% for the six months ended December 31, 2023 from 2.28% for the six months ended December 31, 2022. Net interest-earning assets increased $101.4 million, or 80.0%, to $228.0 million for the six months ended December 31, 2023 from $126.6 million for the six months ended December 31, 2022. The increases in our net interest rate spread and our net interest margin were a result of both the acquisition of Regal Bancorp and the increasing yield on interest-earning assets outpacing the increasing cost of interest-bearing liabilities.

Average Balances and Yields

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, discounts, and premiums that are amortized or accreted to interest income or interest expense. Deferred loan fees totaled $250,000 and $319,000 for the six months ended December 31, 2023 and 2022, respectively.

(Dollars in thousands)

(1) Annualized.

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

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

Rate/Volume Analysis

The following tables present the effects of changing rates and volumes on our net interest income for the periods indicated. The rate column shows the effects attributable to changes in rate (changes in rate multiplied by prior volume). The volume column shows the effects attributable to changes in volume (changes in volume multiplied by prior rate). The total column represents the sum of the prior columns. For purposes of these tables, changes attributable to both rate and volume, which cannot be segregated, have been allocated proportionately based on the changes due to rate and the changes due to volume. There were no out-of-period items or adjustments required to be excluded from the tables below.

(In thousands)

Provision for Credit Losses. We recorded a provision for credit losses of $4.1 million in connection with the Merger for the six months ended December 31, 2023, whereas we recorded no provision for the six months ended December 31, 2022. The absence of a provision for credit losses for the six months ended December 31, 2022 reflects that we had no charge-offs for the period, no classified loans at December 31, 2022 and only $145,000 of non-performing loans for the six months ended December 31, 2022. Our allowance for credit losses as a percentage of total loans was 0.74% at December 31, 2023 compared to 0.31% at December 31, 2022, reflecting the establishment of a general credit reserve for the acquired loan portfolio. To the best of our knowledge, we have provided for all losses that are both probable and reasonable to estimate at December 31, 2023 and December 31, 2022.

Noninterest Income. Noninterest income was as follows:

(Dollars in thousands)

Noninterest income increased $177,000, or 25.2%, to $878,000 for the six months ended December 31, 2023 from $701,000 for the six months ended December 31, 2022, as a result of an increase of $80,000 in the cash surrender value of bank-owned life insurance, an increase of $38,000 in service charges and fees on deposit accounts and an increase of $59,000 in other noninterest income.

Noninterest Expense. Noninterest expense was as follows:

(Dollars in thousands)

Noninterest expense increased $13.7 million, or 204.4%, to $20.4 million for the six months ended December 31, 2023 from $6.7 million for the six months ended December 31, 2022, primarily as a result of a $5.4 million charitable contribution, captured within other expenses, as the Company established the Somerset Regal Charitable Foundation in connection with its conversion to the stock form of organization and funded it with 452,758 shares of SR Bancorp common stock and $906,000 in cash. The increase was also due to an increase in salaries and employee benefits for change in control payments totaling $2.6 million related to the Merger, an increase in professional fees for merger expenses totaling $760,000, an increase in data processing expenses primarily due to the payment of a $414,000 early termination fee related to the acquisition of Regal Bancorp, and additional miscellaneous expenses related to the Merger totaling $72,000.

Income Tax Expense. The benefit for income taxes was $1.5 million for the six months ended December 31, 2023, compared to a tax expense of $121,000 for the six months ended December 31, 2022. Our effective tax rate was 14.7%and 13.8% for the six months ended December 31, 2023 and 2022, respectively, reflecting lower state income tax liabilities due to the application of net operating loss carryforwards and a lower state income tax rate applied to the net investment income derived by Somerset Regal Bank’s investment company subsidiary.

Market Risk

General. Our most significant form of market risk is interest rate risk because, as a financial institution, the majority of our assets and liabilities are sensitive to changes in interest rates. Therefore, a principal part of our operations is to manage interest rate risk and limit the exposure of our financial condition and results of operations to changes in market interest rates. Our ALCO/Investment Committee, which consists of members of management, is responsible for evaluating the interest rate risk inherent in our assets and liabilities, for determining the level of risk that is appropriate, given our business strategy, operating environment, capital, liquidity and performance objectives, and for managing this risk consistent with the policy and guidelines approved by our Board of Directors. We currently utilize a third-party modeling program, prepared on a quarterly basis, to evaluate our sensitivity to changing interest rates, given our business strategy, operating environment, capital, liquidity and performance objectives, and for managing this risk consistent with the guidelines approved by the Board of Directors.

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. We have implemented the following strategies to manage our interest rate risk:

• growing target deposit accounts;
• rebalancing our loan portfolio through the Merger to include higher-yielding, shorter-term commercial real estate and C&I loans;
• utilizing our investment securities portfolio as part of our balance sheet asset and liability and interest rate risk management strategy to reduce the impact of movements in interest rates on net interest income and economic value of equity, which can create temporary valuation adjustments to equity in Accumulated Other Comprehensive Income; and
• continuing to price our one-to-four family residential real estate loan products in a way that encourages borrowers to select our adjustable-rate loans as opposed to longer-term, fixed-rate loans.

By following these strategies, we believe that we are better positioned to react to increases and decreases in market interest rates.

We generally do not engage in hedging activities, such as engaging in futures or options, or investing in high-risk mortgage derivatives, such as collateralized mortgage obligation residual interests, real estate mortgage investment conduit residual interests or stripped mortgage-backed securities.

Economic Value of Equity. We compute amounts by which the net present value of our cash flow from assets, liabilities and off-balance sheet items (economic value of equity “EVE”) would change in the event of a range of assumed changes in market interest rates. We measure potential change in our EVE through the use of a financial model. This model uses a discounted cash flow analysis and an option-based pricing approach to measure the interest rate sensitivity of net portfolio value. Historically, the model estimated the economic value of each type of asset, liability and off-balance sheet contract under the assumption that the United States Treasury yield curve increases or decreases instantaneously by 100 to 300 basis points in 100 basis point increments. However, given the current level of market interest rates, an EVE calculation for an interest rate decrease of greater than 100 basis points has not been prepared. A basis point equals one-hundredth of one percent, and 100 basis points equals one percent. An increase in interest rates from 3% to 4% would mean, for example, a 100-basis point increase in the “Basis Point Change in Interest Rates” column below.

The table below sets forth, as of December 31, 2023, the calculation of the estimated changes in our EVE that would result from the designated immediate changes in the United States Treasury yield curve.

At December 31, 2023

(Dollars in thousands)

(1) Assumes an immediate uniform change in interest rates at all maturities.

(2) EVE is the discounted present value of expected cash flows from assets, liabilities and off-balance sheet contracts.

The table above indicates that at December 31, 2023, in the event of an instantaneous parallel 200 basis point increase in interest rates, we would experience a 17.71% decrease in EVE, and in the event of an instantaneous 200 basis point decrease in interest rates, we would experience a 7.66% increase in EVE.

Change in Net Interest Income. The following table sets forth, at December 31, 2023, the calculation of the estimated changes in our net interest income (“NII”) that would result from the designated immediate changes in the United States Treasury yield curve.

At December 31, 2023

The table above indicates that at December 31, 2023, we would have experienced an 6.59% decrease in NII in the event of an instantaneous parallel 200 basis point increase in market interest rates and an 8.80% decrease in NII in the event of an instantaneous 200 basis point decrease in market interest rates.

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 above table 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.

Liquidity and Capital Resources

Liquidity is the ability to fund assets and meet obligations as they come due. Our primary sources of funds consist of deposit inflows, loan repayments, and repayments from investment securities. In addition, we have the ability to borrow in the wholesale markets or from the Federal Home Loan Bank of New York. While maturities and scheduled amortization of loans and securities are predictable sources of funds, deposit flows and mortgage prepayments are greatly influenced by general interest rates, economic conditions and competition. Our Asset/Liability Management Committee 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 seek to maintain a ratio of liquid assets (including cash and federal funds sold) as a percentage of total deposits ranging between 4% and 30%. At December 31, 2023, this ratio was 10.7%. We believe that we have sufficient sources of liquidity to satisfy our short- and long-term liquidity needs as of December 31, 2023.

We regularly adjust our investments in liquid assets based upon our assessment of:

(i) expected loan demand;

(ii) expected deposit flows;

(iii) yields available on interest-earning deposits and securities; and

(iv) the objectives of our asset/liability management program.

Excess cash is invested generally in interest-earning deposits and short- and intermediate-term securities.

Our most liquid assets are cash and cash equivalents. The levels of these assets depend on our operating, financing and investing activities during any given period. At December 31, 2023, cash and cash equivalents totaled

$90.2 million. Securities classified as available-for-sale, which provide additional sources of liquidity, totaled $34.8 million at December 31, 2023.

At December 31, 2023, we had $3.5 million in outstanding loan commitments and $35.5 million of unused lines of credit. Certificates of deposit due within one year of December 31, 2023 totaled $235.9 million, or 28.0% of total deposits. If these deposits do not remain with us, we will be required to seek other sources of funds, including loan sales, other deposit products, including replacement certificates of deposit, securities sold under agreements to repurchase (repurchase agreements) or advances from the Federal Home Loan Bank of New York and other borrowing sources. 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 after December 31, 2023. 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.

Our cash flows are derived from operating activities, investing activities and financing activities as reported in our Consolidated Statements of Cash Flows included in our Consolidated Financial Statements.

Our primary investing activities are originating and purchasing loans and purchasing mortgage-backed securities. During the six months ended December 31, 2023, we originated $21.6 million of loans and purchased $22.4 million. We had no purchases of securities classified as held to maturity during the six months ended December 31, 2023.

Financing activities consist primarily of activity in deposit accounts. Deposits increased $339.4 million, or 67.4%, to $843.3 million at December 31, 2023 from $503.9 million at June 30, 2023. At the time of the acquisition, Regal Bank’s deposits consisted of $90.8 million of noninterest-bearing deposits, $162.4 million in NOW, money market and savings accounts and $119.9 million of certificates of deposit. Deposit flows are affected by the overall level of interest rates, the interest rates and products offered by us and our local competitors, and by other factors.

We had a $20.0 million outstanding borrowing with the Federal Reserve Bank at December 31, 2023 and June 30, 2023.

Somerset Regal Bank is subject to various regulatory capital requirements, including a risk-based capital measure. The risk-based capital guidelines include both a definition of capital and a framework for calculating risk-weighted assets by assigning balance sheet assets and off-balance sheet items to broad risk categories. At December 31, 2023 Somerset Regal Bank exceeded all regulatory capital requirements. Somerset Regal Bank is considered “well capitalized” under regulatory guidelines. See “Regulation and Supervision—Federal Banking Regulation—Capital Requirements” and Note 12 of the Notes to the Consolidated Financial Statements.

The net proceeds from the offering significantly increase our liquidity and capital resources. Over time, the initial level of liquidity will be reduced as net proceeds from the stock offering are used for general corporate purposes, including the funding of loans. Our financial condition and results of operations will be enhanced by the net proceeds from the offering, resulting in increased net interest-earning assets and net interest income. However, due to the increase in equity resulting from the net proceeds raised in the offering, our return on equity will be adversely affected following the offering until such excess funds can be deployed.

Recent Accounting Pronouncements

For a discussion of the impact of recent accounting pronouncements, see Note 1 of the Notes to the Consolidated Financial Statements.

Impact of Inflation and Changing Prices

Our consolidated financial statements and related notes have been prepared in accordance with generally accepted accounting principles (“GAAP”). GAAP generally requires the measurement of financial position and operating results in terms of historical dollars without consideration for changes in the relative purchasing power of money over time due to inflation. The impact of inflation is reflected in the increased cost of our operations. Unlike industrial companies, our assets and liabilities are primarily monetary in nature. As a result, changes in market interest rates have a greater impact on our performance than the effects of inflation.

For information regarding material risk, see “Item 2. Management’s Discussion and Analysis of Financial Condition and Results of Operation—Market Risk.”

Evaluation of Disclosure Controls and Procedures

Management is responsible for the disclosure controls and procedures of the Company. Disclosure controls and procedures are controls and other procedures of an issuer that are designed to ensure that information required to be disclosed by the issuer in the reports that it files or submits under the Securities Exchange Act of 1934 is recorded, processed, summarized and reported within the time periods required by the SEC’s rules and forms. Disclosure controls and procedures include, without limitation, controls and procedures designed to ensure that information required to be so disclosed by an issuer is accumulated and communicated to the issuer’s management, including its principal executive and principal financial officers, or persons performing similar functions, as appropriate to allow timely decisions regarding required disclosure. As of the end of the period covered by this report, an evaluation was performed under the supervision and with the participation of the Company’s management, including the Chief Executive Officer (Principal Executive Officer) and Chief Financial Officer (Principal Financial and Accounting Officer), of the effectiveness of the design and operation of the Corporation’s disclosure controls and procedures. Based on that evaluation, the Company’s Chief Executive Officer and Chief Financial Officer concluded that the disclosure controls and procedures were effective as of December 31, 2023.

Changes in Internal Control over Financial Reporting

There were no changes in the Company's internal control over financial reporting (as defined in Rule 13a-15(f)) during the quarter ended December 31, 2023 that materially affected, or are reasonably likely to materially affect, the Corporation’s internal control over financial reporting.

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 June 30, 2023.