Waterstone Financial, Inc.: Form 10-Q for the period ended Sep 30, 2022

Forward-Looking Information

This Quarterly Report on Form 10-Q may contain various forward-looking statements, which can be identified by the use of words such as “estimate,” “project,” “believe,” “intend,” “anticipate,” “plan,” “seek,” “expect” and similar expressions and verbs in the future tense. 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 portfolio; 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, including employment prospects, that are different than expected;
• the effects of any pandemic, including COVID-19, and related government actions;
• competition among depository and other financial institutions;
• inflation and changes in the interest rate environment that reduce our margins and yields, our mortgage banking revenues, the fair value of financial instruments or the origination levels in our lending business, or increase the level of defaults, losses or prepayments on loans we have made and make whether held in portfolio or sold in the secondary markets;
• 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 and capital requirements;
• changes in monetary or fiscal policies of the U.S. Government, including policies of the U.S. Treasury and the Federal Reserve Board;
• our ability to manage market risk, credit risk and operational risk in the current economic conditions;
• our ability to enter new markets successfully and capitalize on growth opportunities;
• our ability to successfully integrate acquired entities;
• decreased demand for our products and services;
• changes in tax policies or assessment policies;
• the inability of third-party providers to perform their obligations to us;
• changes in consumer demand, 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;
• cyber attacks, computer viruses and other technological risks that may breach the security of our websites or other systems to obtain unauthorized access to confidential information and destroy data or disable our systems;
• technological changes that may be more difficult or expensive than expected;
• the ability of third-party providers to perform their obligations to us;
• the effects of any federal government shutdown;
• the effects of global or national war, conflict or acts of terrorism;
• the ability of the U.S. Government to manage federal debt limits;
• significant increases in our loan losses; and
• changes in the financial condition, results of operations or future prospects of issuers of securities that we own.

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See also the factors referred to in reports filed by the Company with the Securities and Exchange Commission (particularly those under the caption “Risk Factors” in Item 1A of the Company’s Annual Report on Form 10-K for the year ended December 31, 2021).

The risks included here are not exhaustive. Other sections of this report may include additional factors which could adversely affect our business and financial performance. New risks emerge from time to time and it is not possible for management to predict all such risks, nor can it assess the impact of all such risks on our business or the extent to which any risk, or combination of risks, may cause actual results to differ materially from those contained in any forward-looking statements. Given these risks and uncertainties, investors should not place undue reliance on forward-looking statements as a prediction of actual results.

Overview

The following discussion and analysis is presented to assist the reader in understanding and evaluating the Company’s financial condition and results of operations. It is intended to complement the unaudited consolidated financial statements, footnotes, and supplemental financial data appearing elsewhere in this Quarterly Report on Form 10-Q and should be read in conjunction therewith. The detailed discussion in the sections below focuses on the results of operations for the three and nine months ended September 30, 2022 and 2021 and the financial condition as of September 30, 2022 compared to the financial condition as of December 31, 2021.

As described in the notes to the unaudited consolidated financial statements, we have two reportable segments: community banking and mortgage banking. The community banking segment provides consumer and business banking products and services to customers primarily within Southeastern Wisconsin. Consumer products include loan products, deposit products, and personal investment services. Business banking products include loans for working capital, inventory and general corporate use, commercial real estate construction loans, and deposit accounts. The mortgage banking segment, which is conducted by offices in 27 states through Waterstone Mortgage Corporation, consists of originating residential mortgage loans primarily for sale in the secondary market.

Our community banking segment generates the significant majority of our consolidated net interest income and requires the significant majority of our provision for loan losses. Our mortgage banking segment generates the significant majority of our noninterest income and a majority of our noninterest expenses. We have provided below a discussion of the material results of operations for each segment on a separate basis for the three and nine months ended September 30, 2022 and 2021, which focuses on noninterest income and noninterest expenses. We have also provided a discussion of the consolidated operations of the Company, which includes the consolidated operations of the Bank and Waterstone Mortgage Corporation, for the same periods.

Significant Items

There were no significant items that impacted earnings for the three and nine months ended September 30, 2022 and 2021.

Comparison of Community Banking Segment Results of Operations for the Three Months Ended September 30, 2022 and 2021

Net income totaled $6.6 million for the three months ended September 30, 2022 compared to $6.8 million for the three months ended September 30, 2021. Net interest income increased $1.4 million to $15.5 million for the three months ended September 30, 2022 compared to $14.1 million for the three months ended September 30, 2021. Interest income on loans increased as replacement rates and average loans held for investment balances were higher than in the prior year and interest income on mortgage-related securities increased due to the increase in the average balance and replacement rates. Offsetting the increase in interest income on loans and mortgage-related securities, interest expense on deposits increased as replacement rates increased.

There was a provision for credit losses of $234,000 for the three months ended September 30, 2022 compared to a $750,000 negative provision for loan losses for the three months ended September 30, 2021. The provision for credit losses of $234,000 consisted of a $262,000 provision related to loans and a $28,000 of negative provision related to unfunded commitments for the three months ended September 30, 2022. During the three months ended September 30, 2022, we made adjustments to our qualitative factors, primarily to account for the changes in internal metrics and external risk factors. The forecast factor remained unchanged as we monitor the economic environment going forward.

Total noninterest income decreased $610,000 to $1.1 million during the three months ended September 30, 2022 due primarily to a decrease in prepayment penalties on loans.

Compensation, payroll taxes, and other employee benefits expense decreased $936,000 to $4.4 million primarily due to a decrease in health insurance expense and variable compensation expense compared to the quarter ending September 30, 2021. Other noninterest expense increased $1.1 million to $1.5 million as certain loan fees paid to the mortgage banking segment for the purchase of single-family adjustable rate mortgage loans increased. These fees are eliminated in the consolidated statements of income.

Comparison of Mortgage Banking Segment Results of Operations for the Three Months Ended September 30, 2022 and 2021

Net loss totaled $1.3 million for the three months ended September 30, 2022 compared to net income of $12.3 million for the three months ended September 30, 2021. We originated $729.9 million in mortgage loans held for sale (including sales to the community banking segment) during the three months ended September 30, 2022, which represents a decrease of $325.6 million, or 30.8%, from the $1.06 billion originated during the three months ended September 30, 2021. The decrease in loan production volume was driven by a $234.2 million, or 84.7%, decrease in refinance products as mortgage rates have increased. Mortgage purchase products decreased $91.4 million, or 11.7%, due to inventory constraints in the market, affordability, and interest rate increases. Total mortgage banking noninterest income decreased $24.0 million, or 46.8%, to $27.3 million during the three months ended September 30, 2022 compared to $51.3 million during the three months ended September 30, 2021. The decrease in mortgage banking noninterest income was related to a 30.8% decrease in volume and a 18.5% decrease in gross margin on loans originated and sold for the three months ended September 30, 2022 compared to September 30, 2021. Gross margin on loans originated and sold is the ratio of mortgage banking income (excluding the change in interest rate lock fair value) divided by total loan originations. The gross margin on loans originated and sold contraction reflects decreased industry demand due to the increased competition from mortgage originators. We sell loans on both a servicing-released and a servicing-retained basis. Waterstone Mortgage Corporation has contracted with a third party to service the loans for which we retain servicing.

Additionally, our overall margin can be affected by the mix of both loan type (conventional loans versus governmental) and loan purpose (purchase versus refinance). Conventional loans include loans that conform to Fannie Mae and Freddie Mac standards, whereas governmental loans are those loans guaranteed by the federal government, such as a Federal Housing Authority or U.S. Department of Agriculture loan. Loans originated for the purchase of a residential property, which generally yield a higher margin than loans originated for refinancing existing loans, comprised 94.2% of total originations during the three months ended September 30, 2022, compared to 73.8% of total originations during the three months ended September 30, 2021, respectively, as refinance demand decelerated due to an increase in interest rates over the past year. The mix of loan type trended towards more governmental loans and less conventional loans, with governmental loans and conventional loans comprising 33.3% and 66.7% of all loan originations, respectively, during the three months ended September 30, 2022, compared to 26.2% and 73.8% of all loan originations, respectively, during the three months ended September 30, 2021.

Total compensation, payroll taxes and other employee benefits decreased $7.1 million, or 24.6%, to $21.9 million for the three months ended September 30, 2022 compared to $29.0 million for the three months ended September 30, 2021. The decrease in compensation expense was primarily related to decreased commission expense and branch manager compensation driven by decreased loan origination volume and branch profitability as gross margins decreased. Other noninterest expense increased $301,000 to $2.6 million during the quarter ended September 30, 2022. The increase related to an increase in provision of loan sale losses and provision for branch losses offset by a decrease in mortgage servicing rights amortization expense. During the nine months ended September 30, 2022 the segment has added 11 branches and a total of 130 loan origination personnel. Losses associated with these new branches added in 2022 totaled approximately $683,000 for the three months ended September 30, 2022. These new branch losses are net of corporate revenue of approximately $492,000 for the three months ended September 30, 2022.

Consolidated Waterstone Financial, Inc. Results of Operations

(Dollars In Thousands, except per share amounts)

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Net Interest Income

Average Balance Sheets, Interest and Yields/Costs

The following table sets forth average balance sheets, annualized average yields and costs, and certain other information for the periods indicated. Non-accrual loans are included in the computation of the average balances of loans receivable and held for sale. The yields set forth below include the effect of deferred fees, discounts and premiums that are amortized or accreted to interest income or expense. Yields on interest-earning assets are computed on a fully tax-equivalent yield, where applicable.

(Dollars in Thousands)

(1) Interest income includes net deferred loan fee amortization income of $113,000 and $644,000 for the three months ended September 30, 2022 and 2021, respectively.

(2) Average balance of mortgage related and debt securities are based on amortized historical cost.

(3) Interest income from tax-exempt securities is computed on a taxable equivalent basis using a tax rate of 21% for the three months ended September 30, 2022 and 2021. The yields on debt securities, federal funds sold and short-term investments before tax-equivalent adjustments were 2.41% and 0.88% for the three months ended September 30, 2022 and 2021, respectively.

(4) Net interest rate spread represents the difference between the yield on average interest-earning assets and the cost of average interest-bearing liabilities and is presented on a fully tax equivalent basis.

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

(6) 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 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 net column represents the sum of the prior columns. For purposes of this table, changes attributable to changes in both rate and volume that cannot be segregated have been allocated proportionately based on the changes due to rate and the changes due to volume.

(In Thousands)

(1) Interest income includes net deferred loan fee amortization income of $113,000 and $644,000 for the three months ended September 30, 2022 and 2021, respectively.

(2) Non-accrual loans have been included in average loans receivable balance.

(3) Includes available for sale securities. Average balance of available for sale securities is based on amortized historical cost.

(4) Interest income from tax exempt securities is computed on a taxable equivalent basis using a tax rate of 21% for the three months ended September 30, 2022 and September 30, 2021.

Net interest income increased $1.3 million, or 9.1%, to $15.4 million during the three months ended September 30, 2022 compared to $14.1 million during the three months ended September 30, 2021.

• Interest income on loans increased $104,000, or 0.6%, to $16.2 million due primarily to a 25 basis point increase in average yield on loans as interest rates continue to increase over the past year. This increase was partially offset by an $80.7 million decrease in average loan balance as loans held for sale originations decreased as interest rates are increasing. The decrease in average loan balance was driven by a decrease of a $136.1 million, or 42.9%, decrease in the average balance of loans held for sale offset by an increase of $55.4 million, or 4.4%, in average loans held for investment.
• Interest expense on time deposits increased $56,000, or 8.0%, to $757,000 primarily due to a nine basis point increase in average cost of time deposits. Offsetting the increase, the average balance of time deposits decreased $77.3 million compared to the prior year period.
• Interest expense on money market, savings, and escrow accounts decreased $25,000, or 10.7%, to $208,000 due primarily to a three basis point decrease in average cost of money market, savings, and escrow accounts as the account mix shifted towards more savings accounts. Partially offsetting the decrease in average cost, the average balance increased $7.0 million.
• Interest expense on borrowings decreased $699,000, or 28.6%, to $1.7 million due to a $178.9 million decrease in the average balance of borrowings during the three months ended September 30, 2022 compared to the three months ended September 30, 2021 as the FHLB borrowings balance decreased $175.0 million during 2022. Offsetting the decrease in average balance, the cost of borrowings increased 30 basis points to 2.34% during the three months ended September 30, 2022, compared to 2.04% during the three months ended September 30, 2021.

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Provision for Credit Losses

There was a provision for credit losses of $332,000 for the three months ended September 30, 2022 compared to a $700,000 negative provision for loan losses for the three months ended September 30, 2021. The $332,000 provision for credit losses consisted of a $360,000 provision related to loans and a $28,000 of negative provision related to unfunded commitments for the three months ended September 30, 2022. During the three months ended September 30, 2022, we made adjustments to our qualitative factors, primarily to account for the changes in internal metrics and external risk factors. The forecast factor remained unchanged as we monitor the economic environment going forward.

The provision is primarily a function of the Company's reserving methodology and assessments of certain quantitative and qualitative factors which are used to determine an appropriate allowance for credit losses for the period. See further discussion regarding the allowance for loan losses in the "Asset Quality" section for an analysis of charge-offs, nonperforming assets, specific reserves and additional provisions and the "Allowance for Credit Loss" section.

Noninterest Income

(Dollars In Thousands)

Total noninterest income decreased $25.5 million, or 48.2%, to $27.4 million during the three months ended September 30, 2022 compared to $52.9 million during the three months ended September 30, 2021. The decrease resulted primarily from a decrease in mortgage banking noninterest income and other income.

• The decrease in mortgage banking income was primarily the result of a decrease in loan origination volume and gross margin on loans originated and sold. Gross margin on loans originated and sold is the ratio of mortgage banking income (excluding the change in interest rate lock fair value) divided by total loan originations. Total loan origination volume on a consolidated basis decreased $377.5 million, or 36.0%, to $671.2 million during the three months ended September 30, 2022 compared to $1.05 billion during the three months ended September 30, 2021. Gross margin on loans originated and sold decreased 18.5% at the mortgage banking segment. See "Comparison of Mortgage Banking Segment Results of Operations for the Three Months Ended September 30, 2022 and 2021" above for additional discussion of the decrease in mortgage banking income.
• The decrease in other noninterest income was due primarily to a decrease in gain on sale of mortgage serving rights and in mortgage servicing fee income. During the quarter ended September 30, 2021, the Company sold mortgage servicing rights related to $1.24 billion in loans serviced for third parties. The sale generated $12.4 million in net proceeds and a $4.0 million gain. There were no comparable sales during the quarter ended September 30, 2022. As of September 30, 2022 and September 30, 2021, the Company maintained servicing rights related to $378.7 million and $160.8 million, respectively, in loans previously sold to third parties.

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(Dollars In Thousands)

Total noninterest expenses decreased $7.6 million, or 17.6%, to $35.7 million during the three months ended September 30, 2022 compared to $43.3 million during the three months ended September 30, 2021.

• Compensation, payroll taxes and other employee benefits expense at our mortgage banking segment decreased $7.1 million, or 24.6%, to $21.9 million during the three months ended September 30, 2022. The decrease in compensation expense was primarily related to decreased commission expense and branch manager compensation driven by decreased loan origination volume and branch profitability as gross margins decreased.
• Compensation, payroll taxes and other employee benefits expense at the community banking segment decreased $936,000, or 17.5%, to $4.4 million during the three months ended September 30, 2022. The decrease was due primarily to a decrease in health insurance expense and variable compensation expense.
• Occupancy, office furniture and equipment expense at the mortgage banking segment decreased $238,000 to $1.3 million during the three months ended September 30, 2022, primarily resulting from lower rent and depreciation expense.
• Occupancy, office furniture and equipment expense at the community banking segment increased $46,000 to $955,000 during the three months ended September 30, 2022. The increase was due primarily to increased utilities expenses, maintenance, and computer equipment.
• Advertising expense increased $302,000, or 36.2%, to $1.1 million during the three months ended September 30, 2022. This was primarily due to marketing increases at the mortgage banking segment to attract customers as rates are higher than in the prior year. Advertising at the community banking segment decreased as customer promotions slowed.
• Data processing expense increased $98,000, or 9.9%, to $1.1 million during the three months ended September 30, 2022. This was primarily due to increases at the community banking and mortgage banking segments for continued investments in technology and security.
• Professional fees decreased $157,000 to $393,000 of income during the three months ended September 30, 2022. The decrease related to a decrease in legal fees at the mortgage banking segment.
• Other noninterest expense increased $419,000, or 15.1%, to $3.2 million during the three months ended September 30, 2022. The increase at the mortgage banking segment related to an increase in provision of loan sale losses and provision for branch losses offset by a decrease in mortgage servicing rights amortization expense. The increase at the community banking segment was due to placement fees.

Income Taxes

Income tax expense totaled $1.5 million for the three months ended September 30, 2022 compared to $5.4 million during the three months ended September 30, 2021. Income tax expense was recognized on the statement of income during the three months ended September 30, 2022 and September 30, 2021 at an effective rate of 22.2% of pretax income. The effective rate as of September 30, 2022 reflects an increase of permanent deductions relative to the amount of pretax income. The effective rate as of September 30, 2021 reflects a $949,000 return to provision income tax adjustment to reflect actual state tax apportionment based on the final 2020 tax returns. There was no return to provision adjustment during the three months ended September 30, 2022.

Comparison of Community Banking Segment Results of Operations for the Nine Months Ended September 30, 2022 and 2021

Net income totaled $17.1 million for the nine months ended September 30, 2022 compared to $21.6 million for the nine months ended September 30, 2021. Net interest income decreased $2.0 million to $40.9 million for the nine months ended September 30, 2022 compared to $42.9 million for the nine months ended September 30, 2021. Interest income on loans decreased as average balances were lower than in the prior year. Offsetting the decrease in interest income on loans, interest income on mortgage-related securities increased due to an increase in average balance and yield and interest expense on deposits decreased as replacement rates decreased.

There was a provision for credit losses of $53,000 for the nine months ended September 30, 2022 compared to a $2.6 million negative provision for loan losses for the nine months ended September 30, 2021. The provision for credit losses of $53,000 consisted of a $449,000 provision related to loans due to loan growth and a $396,000 of negative provision related to unfunded commitments as the balance decreased for the nine months ended September 30, 2022. During the nine months ended September 30, 2022, we made adjustments to our forecast factor to reflect the current economic forecast, and qualitative factors, primarily to account for the changes in internal metrics and external risk factors.

Total noninterest income decreased $411,000, or 8.9%, to $4.2 million due primarily to a decrease in service fees on deposits and prepayment fees on loans during the nine months ended September 30, 2022, offset by a gain from death benefit received on one bank owned life insurance policy and an increase in bank owned life insurance as interest rates increased.

Compensation, payroll taxes, and other employee benefits expense decreased $977,000 to $14.2 million primarily due to a decrease in health insurance and ESOP expense compared to the nine months ended September 30, 2021. Other noninterest expense increased $1.8 million to $3.1 million as certain loan-related expenses paid to the mortgage banking segment for the purchase of single-family adjustable rate mortgage loans increased. These fees are eliminated in the consolidated statements of income.

Comparison of Mortgage Banking Segment Results of Operations for the Nine Months Ended September 30, 2022 and 2021

Net income totaled $1.5 million for the nine months ended September 30, 2022 compared to $36.6 million for the nine months ended September 30, 2021. We originated $2.22 billion in mortgage loans held for sale (including sales to the community banking segment) during the nine months ended September 30, 2022, which represents a decrease of $1.02 billion, or 31.5%, from the $3.24 billion originated during the nine months ended September 30, 2021. The decrease in loan production volume was driven by a $750.2 million, or 73.0%, decrease in refinance products as mortgage rates have increased. Mortgage purchase products decreased $268.5 million, or 12.2%, due to inventory constraints in the market, housing affordability, and as interest rates have increased. Total mortgage banking noninterest income decreased $70.8 million, or 45.2%, to $86.0 million during the nine months ended September 30, 2022 compared to $156.9 million during the nine months ended September 30, 2021. The decrease in mortgage banking noninterest income was related to a 31.5% decrease in volume and a 18.8% decrease in gross margin on loans originated and sold for the nine months ended September 30, 2022 compared to September 30, 2021. Gross margin on loans originated and sold is the ratio of mortgage banking income (excluding the change in interest rate lock fair value) divided by total loan originations. The gross margin on loans originated and sold contraction reflects decreased industry demand due to the increased competition from mortgage originators. We sell loans on both a servicing-released and a servicing-retained basis. Waterstone Mortgage Corporation has contracted with a third party to service the loans for which we retain servicing.

Additionally, our overall margin can be affected by the mix of both loan type (conventional loans versus governmental) and loan purpose (purchase versus refinance). Conventional loans include loans that conform to Fannie Mae and Freddie Mac standards, whereas governmental loans are those loans guaranteed by the federal government, such as a Federal Housing Authority or U.S. Department of Agriculture loan. Loans originated for the purchase of a residential property, which generally yield a higher margin than loans originated for refinancing existing loans, comprised 87.5% of total originations during the nine months ended September 30, 2022, compared to 68.2% of total originations during the nine months ended September 30, 2021, respectively, as refinance demand decelerated due to an increase in interest rates over the past year. The mix of loan type trended towards more governmental loans and less conventional loans, with governmental loans and conventional loans comprising 27.8% and 72.2% of all loan originations, respectively, during the nine months ended September 30, 2022, compared to 23.1% and 76.9% of all loan originations, respectively, during the nine months ended September 30, 2021.

Total compensation, payroll taxes and other employee benefits decreased $23.8 million, or 27.2%, to $63.6 million for the nine months ended September 30, 2022 compared to $87.4 million for the nine months ended September 30, 2021. The decrease in compensation expense was primarily related to decreased commission expense and branch manager compensation driven by decreased loan origination volume and branch profitability as gross margins decreased. During the nine months ended September 30, 2022 the segment has added 11 branches and a total of 130 loan origination personnel. Losses associated with these new branches totaled approximately $1.2 million for the nine months ended September 30, 2022. These branch losses are net of corporate revenue of approximately $599,000 for the nine months ended September 30, 2022.

Consolidated Waterstone Financial, Inc. Results of Operations

(Dollars In Thousands, except per share amounts)

47

Net Interest Income

Average Balance Sheets, Interest and Yields/Costs

The following table sets forth average balance sheets, annualized average yields and costs, and certain other information for the periods indicated. Non-accrual loans are included in the computation of the average balances of loans receivable and held for sale. The yields set forth below include the effect of deferred fees, discounts and premiums that are amortized or accreted to interest income or expense. Yields on interest-earning assets are computed on a fully tax-equivalent yield, where applicable.

(Dollars in Thousands)

(1) Interest income includes net deferred loan fee amortization income of $495,000 and $1.7 million for the nine months ended September 30, 2022 and 2021, respectively.

(2) Average balance of mortgage related and debt securities are based on amortized historical cost.

(3) Interest income from tax-exempt securities is computed on a taxable equivalent basis using a tax rate of 21% for the nine months ended September 30, 2022 and 2021. The yields on debt securities, federal funds sold and short-term investments before tax-equivalent adjustments were 1.26% and 1.07% for the nine months ended September 30, 2022 and 2021, respectively.

(4) Net interest rate spread represents the difference between the yield on average interest-earning assets and the cost of average interest-bearing liabilities and is presented on a fully tax equivalent basis.

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

(6) 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 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 net column represents the sum of the prior columns. For purposes of this table, changes attributable to changes in both rate and volume that cannot be segregated have been allocated proportionately based on the changes due to rate and the changes due to volume.

(In Thousands)

(1) Interest income includes net deferred loan fee amortization income of $495,000 and $1.7 million for the nine months ended September 30, 2022 and 2021, respectively.

(2) Non-accrual loans have been included in average loans receivable balance.

(3) Includes available for sale securities. Average balance of available for sale securities is based on amortized historical cost.

(4) Interest income from tax exempt securities is computed on a taxable equivalent basis using a tax rate of 21% for the nine months ended September 30, 2022 and September 30, 2021.

Net interest income decreased $1.0 million, or 2.4%, to $41.3 million during the nine months ended September 30, 2022 compared to $42.3 million during the nine months ended September 30, 2021.

• Interest income on loans decreased $4.9 million, or 10.0%, to $44.3 million during the nine months ended September 30, 2022 compared to $49.2 million during the nine months ended September 30, 2021 due primarily to a $198.1 million, or 12.2%, decrease in average loans as loans held for sale originations decreased as interest rates are increasing. This decrease was partially offset by a 10 basis point increase in average yield on loans as interest rates continue to increase over the past year. The decrease in average loan balance was driven by a decrease of $51.8 million, or 4.0%, in the average balance of loans held in portfolio along with a $146.2 million, or 45.5%, decrease in the average balance of loans held for sale.
• Interest expense on time deposits decreased $1.2 million, or 39.5%, to $1.9 million primarily due to a 18 basis point decrease in average cost of time deposits. Additionally, the average balance of time deposits decreased $92.7 million compared to the prior year period.
• Interest expense on money market, savings, and escrow accounts increased $159,000, or 35.2%, to $611,000 due primarily to a three basis point increase in average cost of money market, savings, and escrow accounts and the average balance increased $52.7 million.
• Interest expense on borrowings decreased $1.7 million, or 22.9%, to $5.7 million due to a $124.7 million decrease in the average balance of borrowings during the nine months ended September 30, 2022 compared to the nine months ended September 30, 2021 as the FHLB borrowings balance decreased $175.0 million during the nine months ended September 30, 2022.

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Provision for Credit Losses

The Company adopted ASC Topic 326 as of January 1, 2022, which resulted in an opening balance adjustment of $430,000 to increase the allowance for credit losses. Additionally, there was a $1.4 million opening balance adjustment to record an allowance for credit losses on unfunded loan commitments, which is presented in Other Liabilities on the Consolidated Statements of Financial Condition. Net of tax impact, the adoption of the CECL model resulted in a $1.4 million reduction to retained earnings.

There was a provision for credit losses of $304,000 for the nine months ended September 30, 2022 compared to a $2.5 million negative provision for loan losses for the nine months ended September 30, 2021. The $304,000 provision for credit losses consisted of a $700,000 provision related to loans and a $396,000 of negative provision related to unfunded commitments for the nine months ended September 30, 2022. During the nine months ended September 30, 2022, we made adjustments to our forecast factor to reflect the current economic forecast, and qualitative factors, primarily to account for the changes in internal metrics and external risk factors.

The provision is primarily a function of the Company's reserving methodology and assessments of certain quantitative and qualitative factors which are used to determine an appropriate allowance for credit losses for the period. See further discussion regarding the allowance for loan losses in the "Asset Quality" section for an analysis of charge-offs, nonperforming assets, specific reserves and additional provisions and the "Allowance for Credit Loss" section.

Noninterest Income

(Dollars In Thousands)

Total noninterest income decreased $72.7 million, or 45.1%, to $88.5 million during the nine months ended September 30, 2022 compared to $161.2 million during the nine months ended September 30, 2021. The decrease resulted primarily from a decrease in mortgage banking noninterest income.

• The decrease in mortgage banking income was primarily the result of a decrease in loan origination volume and gross margin on loans originated and sold. Gross margin on loans originated and sold is the ratio of mortgage banking income (excluding the change in interest rate lock fair value) divided by total loan originations. Total loan origination volume on a consolidated basis decreased $1.10 billion, or 34.1%, to $2.12 billion during the nine months ended September 30, 2022 compared to $3.21 billion during the nine months ended September 30, 2021. Gross margin on loans originated and sold decreased 18.8% at the mortgage banking segment. See "Comparison of Mortgage Banking Segment Results of Operations for the Nine Months Ended September 30, 2022 and 2021" above for additional discussion of the decrease in mortgage banking income.
• The decrease in other noninterest income was due primarily to a gain on sale of mortgage servicing rights in 2021, decreases in mortgage servicing fee income as a result of the servicing fees prior to the sale, and decreases to loan prepayment fees. During the year ended September 30, 2021, the Company sold mortgage servicing rights related to $1.24 billion in loans serviced for third parties. The sale generated $12.4 million in net proceeds and a $4.0 million gain. There was no comparable sale during the year ended September 30, 2022. As of September 30, 2022 and September 30, 2021, the Company maintained servicing rights related to $378.7 million and $204.8 million, respectively, in loans previously sold to third parties. Offsetting the decreases, there was a $340,000 increase in gain from death benefit received on one bank owned life insurance policy during the nine months ended September 30, 2022 compared to none during the nine months ended September 30, 2021.

50

Noninterest Expenses

(Dollars In Thousands)

Total noninterest expenses decreased $23.9 million, or 18.5%, to $105.7 million during the nine months ended September 30, 2022 compared to $129.6 million during the nine months ended September 30, 2021.

• Compensation, payroll taxes and other employee benefits expense at our mortgage banking segment decreased $23.8 million, or 27.2%, to $63.6 million during the nine months ended September 30, 2022. The decrease in compensation expense was primarily related to decreased commission expense and branch manager compensation driven by decreased loan origination volume and branch profitability as gross margins decreased.
• Compensation, payroll taxes and other employee benefits expense at the community banking segment decreased $977,000, or 6.4%, to $14.2 million during the nine months ended September 30, 2022. The decrease was primarily due to a decrease in health insurance and ESOP expense as the average stock average price has decreased compared to the quarter ending September 30, 2021, offset by an increase in salaries due to annual raises.
• Occupancy, office furniture and equipment expense at the mortgage banking segment decreased $753,000, or 16.6%, to $3.8 million during the nine months ended September 30, 2022, primarily resulting from lower rent, computer, and depreciation expense.
• Occupancy, office furniture and equipment expense at the community banking segment decreased $53,000, or 1.9%, to $2.8 million during the nine months ended September 30, 2022. The decrease was due primarily to decreased snow removal expense and maintenance expense.
• Advertising expense increased $434,000, or 16.9%, to $3.0 million during the nine months ended September 30, 2022. This was primarily due to an increase at the mortgage banking segment in an effort to increase new customers.
• Data processing expense increased $559,000, or 19.5%, to $3.4 million during the nine months ended September 30, 2022. This was primarily due to increases at the community banking and mortgage banking segments for continued investments in technology and security.
• Professional fees increased $399,000, or 49.6%, to $1.2 million during the nine months ended September 30, 2022. The increase related to receiving a countersuit settlement at the mortgage banking segment during the nine months ended September 30, 2021.
• Other noninterest expense increased $304,000, or 3.3%, to $9.4 million during the nine months ended September 30, 2022. The increase at the community banking segment related to an increase in certain loan-related expenses paid to the mortgage banking segment for the purchase of single-family adjustable rate mortgage loans during the nine months ended September 30, 2022 compared to the nine months ended September 30, 2021. These fees are eliminated in the consolidated statements of income. Additionally, there were increases in placement fees and correspondent bank fees. Offsetting the increase at the community banking segment, other noninterest expenses decreased at the mortgage banking segment as the amortization expense on mortgage servicing rights decreased due to the bulk sale of mortgage servicing rights during the third quarter of 2021.

Income Taxes

Income tax expense decreased $12.9 million, or 71.0% , to $5.3 million for the nine months ended September 30, 2022 compared to $18.2 million during the nine months ended September 30, 2021. Income tax expense was recognized on the statement of income during the nine months ended September 30, 2022 at an effective rate of 22.1% of pretax income compared to 23.8% during the nine months ended September 30, 2021. The decrease in the effective rate reflects an increase of permanent deductions relative to the amount of pretax income and additionally the 2022 rate reflects the lower state tax apportionment based on the final 2020 tax returns. The effective rate as of September 30, 2021 reflects a $949,000 return to provision income tax adjustment to reflect actual state tax apportionment based on the final 2020 tax returns. There was no return to provision adjustment during the nine months ended September 30, 2022.

Comparison of Financial Condition at September 30, 2022 and December 31, 2021

Total Assets – Total assets decreased by $240.8 million, or 10.9%, to $1.98 billion at September 30, 2022 from $2.22 billion at December 31, 2021. The decrease in total assets primarily reflects a decrease in cash and cash equivalents and loans held for sale, partially offset by an increase in loans held for investment, securities available for sale and other assets. The total assets decrease reflects liability decreases in deposits and borrowings.

Cash and Cash Equivalents – Cash and cash equivalents decreased $303.8 million, or 80.6%, to $72.9 million at September 30, 2022, compared to $376.7 million at December 31, 2021. The decrease in cash and cash equivalents primarily reflects the increases in loans held for investment, securities available for sale and decrease of funding sources from deposits and borrowings.

Securities Available for Sale – Securities available for sale increased $18.3 million to $197.3 million at September 30, 2022. The increase was primarily due to purchases of mortgage-related securities as the interest rates continue to rise. The purchases are exceeding security paydowns for the year and maturities of debt securities.

Loans Held for Sale - Loans held for sale decreased $126.7 million to $186.0 million at September 30, 2022 due to the decrease of refinancing and purchase activity resulting from the increase in mortgage rates.

Loans Receivable - Loans receivable held for investment increased $148.7 million to $1.35 billion at September 30, 2022. The increase in total loans receivable was attributable to increases in each of the one- to four-family, multi-family, and commercial real estate loan categories.

The following table shows loan originations during the periods indicated.

(In Thousands)

52

Allowance for Credit Losses - Loans - The allowance for credit losses increased $1.7 million to $17.5 million at September 30, 2022. The increase primarily resulted from the CECL model adoption on January 1, 2022. The CECL calculation resulted in an opening balance adjustment of $430,000 to increase the allowance for credit losses. Additionally, net recoveries totaled $810,000 for the nine months ended September 30, 2022. With the adoption of CECL, estimated recoveries may be accounted for within the calculation and do not impact the provision for credit losses line item when cash is received.

There was a provision for credit losses - loans of $700,000 for the nine months ended September 30, 2022. During the nine months ended September 30, 2022, we made adjustments to our forecast factor to reflect the current economic forecast, and qualitative factors, primarily to account for the changes in internal metrics and external risk factors. See Note 3 - Loans Receivable of the notes to unaudited consolidated financial statements for further discussion on the allowance for credit losses.

Prepaid expenses and other assets – Total prepaid expenses and other assets increased $33.1 million to $78.3 million at September 30, 2022. The increase was primarily due to an increase in the fair value mark on derivatives as interest rates increased and deferred taxes increased as unrealized losses on available for sale securities increased due to rising interest rates.

Deposits – Total deposits decreased $46.3 million to $1.19 billion at September 30, 2022. The decrease was driven by a decrease of $33.0 million in time deposits and $45.4 million in money market and savings deposits offset by an increase of $32.1 million in demand deposits.

Borrowings – Total borrowings decreased $157.2 million, or 32.9%, to $320.0 million at September 30, 2022. The community banking segment paid off $270.0 million in long-term FHLB borrowings, borrowing $50.0 million of new long-term FHLB borrowings, and $50.0 million in new short-term FHLB borrowings. External short-term borrowings at the mortgage banking segment increased a total of $17.8 million at September 30, 2022 from December 31, 2021.

Advance Payments by Borrowers for Taxes - Advance payments by borrowers for taxes increased $20.0 million to $24.1 million at September 30, 2022. The increase was the result of payments received from borrowers for their real estate taxes and is seasonally normal, as balances increase during the course of the calendar year until real estate tax obligations are paid in the fourth quarter.

Other Liabilities - Other liabilities decreased $764,000 to $67.7 million at September 30, 2022. Other liabilities decreased primarily due to a seasonal decrease in outstanding checks related to advance payments by borrowers for taxes. The Company receives payments from borrowers for their real estate taxes during the course of the calendar year until real estate tax obligations are paid in the fourth quarter. At the time at which the disbursements are made, the outstanding checks are classified as other liabilities in the statements of financial condition, and these amounts remain classified as other liabilities until settled. Additionally, other liabilities decreased due to the payment of the special dividend in the first quarter. Offsetting the decreases, the fair value mark on derivative liabilities related to the loans held for sale and the back-to-back swaps increased with the increase in interest rates.

Shareholders’ Equity – Shareholders' equity decreased $56.6 million to $376.2 million at September 30, 2022. Shareholders' equity decreased primarily due to the declaration of dividends, a decrease in the fair value of the security portfolio, the repurchase of stock and the adoption of CECL. Partially offsetting the decreases, there were increases due to the net income, additional paid-in capital as stock options were exercised and equity awards vested, and unearned ESOP shares vesting.

ASSET QUALITY

NONPERFORMING ASSETS

(Dollars in Thousands)

All loans that are 90 days or more past due with respect to principal and interest are recognized as non-accrual. Troubled debt restructurings that are non-accrual, either due to being past due greater than 90 days or which have not yet performed under the modified terms for a reasonable period of time, are included in the table above. In addition, loans that are past due less than 90 days are evaluated to determine the likelihood of collectability given other credit risk factors such as early stage delinquency, the nature of the collateral or the results of a borrower review. When the collection of all contractual principal and interest is determined to be unlikely, the loan is moved to non-accrual status and an updated appraisal of the underlying collateral is ordered. This process generally takes place when a loan is contractually past due between 60 and 89 days.

A loan is considered collateral-dependent when the debtor is experiencing financial difficulty and repayment is expected to be provided substantially through the sale or operation of the collateral. For all classes of loans and leases deemed collateral-dependent, the Company elected the practical expedient to estimate expected credit losses based on the collateral’s fair value less cost to sell. In most cases, the Company records a specific valuation allowance or a partial charge-off to reduce the loan’s carrying value to the collateral’s fair value less cost to sell. Substantially all of the collateral consists of various types of real estate including residential and commercial properties.

The following table sets forth activity in our non-accrual loans for the periods indicated.

(In Thousands)

Total non-accrual loans decreased by $499,000, or 9.0%, to $5.1 million as of September 30, 2022 compared to $5.6 million as of December 31, 2021. The ratio of non-accrual loans to total loans receivable was 0.37% at September 30, 2022 compared to 0.46% at December 31, 2021. During the nine months ended September 30, 2022, $2.9 million in loans were placed on non-accrual status. Offsetting this activity, $2.7 million in principal payments were received and $694,000 in loans returned to accrual status during the nine months ended September 30, 2022.

Of the $5.1 million in total non-accrual loans as of September 30, 2022, $3.3 million in loans have been specifically reviewed to assess whether a specific valuation allowance is necessary. A specific valuation allowance is established for an amount equal to the impairment when the carrying value of the loan exceeds the present value of expected future cash flows, discounted at the loan's original effective interest rate or the fair value of the underlying collateral with an adjustment made for costs to dispose of the asset. Based upon these specific reviews, a total of $30,000 in cumulative partial net charge-offs have been recorded over the life of these loans as of September 30, 2022. Partially charged-off loans measured for impairment based upon net realizable collateral value are maintained in a "non-performing" status and are disclosed as impaired loans. There were no specific reserves as of September 30, 2022. The remaining $1.7 million of non-accrual loans were reviewed on an aggregate basis as of September 30, 2022.

The outstanding principal balance of our five largest non-accrual loans as of September 30, 2022 totaled $3.6 million, which represents 70.2% of total non-accrual loans as of that date. Four of the five loans have not had any cumulative life-to-date net charge-offs and no specific reserve was deemed necessary based on net realizable collateral value with respect to these four loans as of September 30, 2022. One of the loans was reviewed on an aggregate basis along with the other loans held for investment at the mortgage segment.

Interest payments received are treated as interest income on a cash basis as long as the remaining book value of the loan (i.e., after charge-off of all identified losses) is deemed to be fully collectible. If the remaining book value is not deemed to be fully collectible, all payments received are applied to unpaid principal. Determination as to the ultimate collectability of the remaining book value is supported by an updated credit department evaluation of the borrower's financial condition and prospects for repayment, including consideration of the borrower's sustained historical repayment performance and other relevant factors.

As of September 30, 2022 and December 31, 2021, there were no loans 90 or more days past due and still accruing interest.

TROUBLED DEBT RESTRUCTURINGS

The following table summarizes information with respect to the accrual status of our troubled debt restructurings:

(In Thousands)

(In Thousands)

All troubled debt restructurings are considered to be impaired, are risk rated as either substandard or watch and are included in the internal risk rating tables disclosed in the notes to the unaudited consolidated financial statements. Specific reserves have been established to the extent that collateral dependent impairment analyses indicate that a collateral shortfall exists.

We do not participate in government-sponsored troubled debt restructuring programs. Our troubled debt restructurings are short-term modifications. Typical initial restructured terms include six to twelve months of principal forbearance, a reduction in interest rate or both. Restructured terms do not include a reduction of the outstanding principal balance unless mandated by a bankruptcy court. Troubled debt restructuring terms may be renewed or further modified at the end of the initial term for an additional period if performance has been acceptable and the short-term borrower difficulty persists.

If a restructured loan is current in all respects and a minimum of six consecutive restructured payments have been received, it can be considered for return to accrual status. After a restructured loan that is current in all respects reverts to contractual/market terms, if a credit department review indicates no evidence of elevated market risk, the loan is removed from the troubled debt restructuring classification. The restructured loan will be classified as a troubled debt restructuring for at least the calendar year after the modification even after returning to a contractual/market rate and accrual status

LOAN DELINQUENCY

The following table summarizes loan delinquency in total dollars and as a percentage of the total loan portfolio:

(Dollars in Thousands)

Past due loans decreased by $535,000, or 7.6%, to $6.5 million at September 30, 2022 from $7.1 million at December 31, 2021. Loans past due 90 days or more decreased by $772,000, or 17.7%, primarily in the one- to four-family loan category during the nine months ended September 30, 2022 .Loans past due less than 90 days increased by $237,000, or 8.8%, primarily in the home equity and commercial loan categories.

ALLOWANCE FOR CREDIT LOSSES - LOANS

(Dollars in Thousands)

(1) The Company adopted ASU 2016-13 as of January 1, 2022. The 2021 amount presented is calculated under the prior accounting standard.

The allowance for credit losses - loans increased $1.7 million to $17.5 million at September 30, 2022 from $15.8 million at December 31, 2021. The increase resulted from the CECL model adoption on January 1, 2022 along with loan growth throughout the year. The CECL calculation resulted in an opening balance adjustment of $430,000 to increase the allowance for credit losses and a $700,000 provision for credit losses. Additionally, net recoveries totaled $544,000 for the nine months ended September 30, 2022. With the adoption of CECL, estimated recoveries may be accounted for within the calculation and do not impact the provision for credit losses line item when cash is received.

We had net recoveries of $544,000, or 0.06% of average loans annualized, for the nine months ended September 30, 2022, compared to net recoveries of $487,000, or 0.05% of average loans annualized, for the nine months ended September 30, 2021. Of the $544,000 in net recoveries during the nine months ended September 30, 2022, the majority of the activity related to loans secured by multi-family loan categories.

Our underwriting policies and procedures emphasize that credit decisions must rely on both the credit quality of the borrower and the estimated value of the underlying collateral. Credit quality is assured only when the estimated value of the collateral is objectively determined and is not subject to significant fluctuation.

The allowance for credit losses - loans has been determined in accordance with GAAP. We are responsible for the timely and periodic determination of the amount of the allowance required. Any future provisions for loan losses will continue to be based upon our assessment of the overall loan portfolio and the underlying collateral, trends in non-performing loans, current economic conditions and other relevant factors. To the best of management’s knowledge, all probable losses have been provided for in the allowance for credit losses - loans.

The establishment of the amount of the allowance for credit loss inherently involves judgments by management as to the appropriateness of the allowance, which ultimately may or may not be correct. Higher than anticipated rates of loan default would likely result in a need to increase provisions in future years.

Liquidity and Capital Resources

We maintain liquid assets at levels we consider adequate to meet our liquidity needs. We adjust our liquidity levels to fund loan commitments, repay our borrowings, fund deposit outflows and pay real estate taxes on mortgage loans. We also adjust liquidity as appropriate to meet asset and liability management objectives. The level of our liquidity position at any point in time is dependent upon the judgment of the senior management as supported by the Asset/Liability Committee. Liquidity is monitored on a daily, weekly and monthly basis using a variety of measurement tools and indicators.

Our primary sources of liquidity are deposits, amortization and repayment of loans, sales of loans held for sale, maturities of investment securities and other short-term investments, and earnings and funds provided from operations. While scheduled principal repayments on loans are a relatively predictable source of funds, deposit flows and loan repayments are greatly influenced by market interest rates, economic conditions, and rates offered by our competitors. We set the interest rates on our deposits to maintain a desired level of total deposits. In addition, we invest excess funds in short-term, interest-earning assets, which provide liquidity to meet lending requirements. Additional sources of liquidity used for the purpose of managing long- and short-term cash flows include advances from the FHLB.

During the nine months ended September 30, 2022, primary uses of cash and cash equivalents included: $2.12 billion in funding loans held for sale, $148.1 million to fund loans held for investment, $77.4 million for purchases of mortgage related securities, $270.0 million for payoffs of long-term borrowings, $26.0 million for cash dividends paid, $46.3 million for decrease in deposits, and $45.2 million for purchases of our common stock.

During the nine months ended September 30, 2022, primary sources of cash and cash equivalents included: $2.31 billion in proceeds from the sale of loans held for sale, $27.9 million in principal repayments on mortgage related securities, $14.9 million in maturities of debt securities, $8.7 million in sales of FHLB stock, and $18.6 million in net income.

During the nine months ended September 30, 2021, primary uses of cash and cash equivalents included: $3.21 billion in funding loans held for sale, $55.3 million for purchases of mortgage related securities, $33.1 million for short-term borrowings, $26.3 million for cash dividends paid, $4.7 million for purchases of our common stock, and $4.3 million to pay a legal settlement.

During the nine months ended September 30, 2021, primary sources of cash and cash equivalents included: $3.44 billion in proceeds from the sale of loans held for sale, $148.8 million for net loan receivables decrease, $61.7 million from an increase in deposits, $30.8 million in principal repayments on mortgage related securities, $6.4 million in maturities of debt securities, and $58.2 million in net income.

A portion of our liquidity consists of cash and cash equivalents, which are a product of our operating, investing and financing activities. At September 30, 2022 and 2021, respectively, $72.9 million and $358.6 million of our assets were invested in cash and cash equivalents. At September 30, 2022, cash and cash equivalents were comprised of the following: $37.2 million in cash held at the Federal Reserve Bank and other depository institutions and $35.7 million in federal funds sold and short-term investments. Our primary sources of cash are principal repayments on loans, proceeds from the calls and maturities of debt and mortgage-related securities, increases in deposit accounts, advances from the FHLB, and repurchase agreements from other institutions.

Liquidity management is both a daily and longer-term function of business management. If we require funds beyond our ability to generate them internally, borrowing agreements exist with the FHLB which provide an additional source of funds. At September 30, 2022, we had $250.0 million in long term advances from the FHLB with contractual maturity dates in 2025, 2027, 2028, and 2029. The 2025 advance has a contractual maturity date in September 2025 with a single call option in 2023. The 2027 advance has a contractual maturity date in December 2027. There is one advance that has a contractual maturity in September 2028. There are two advances with contractual maturities in 2029. The 2028 and 2029 advance maturities have quarterly call options currently available.

At September 30, 2022, we had outstanding commitments to originate loans receivable of $57.8 million. In addition, at September 30, 2022, we had unfunded commitments under construction loans of $36.2 million, unfunded commitments under business lines of credit of $17.3 million and unfunded commitments under home equity lines of credit and standby letters of credit of $12.6 million. At September 30, 2022, certificates of deposit scheduled to mature in one year or less totaled $498.3 million. Based on prior experience, management believes that, subject to the Bank’s funding needs, a significant portion of such deposits will remain with us, although there can be no assurance that this will be the case. In the event a significant portion of our deposits is not retained by us, we will have to utilize other funding sources, such as FHLB advances, in order to maintain our level of assets. However, we cannot assure that such borrowings would be available on attractive terms, or at all, if and when needed. Alternatively, we could reduce our level of liquid assets, such as our cash and cash equivalents and securities available-for-sale in order to meet funding needs. In addition, the cost of such deposits may be significantly higher if market interest rates are higher or there is an increased amount of competition for deposits in our market area at the time of renewal.

Waterstone Financial, Inc. is a separate legal entity from WaterStone Bank and must provide for its own liquidity to pay dividends to its shareholders, repurchase shares of its common stock, and for other corporate purposes. The primary source of liquidity for Waterstone Financial, Inc. is dividend payments from WaterStone Bank. The ability of WaterStone Bank to pay dividends is subject to regulatory restrictions. At September 30, 2022, Waterstone Financial, Inc. (on an unconsolidated basis) had liquid assets totaling $52.1 million.

Capital

Shareholders' equity decreased $56.6 million to $376.2 million at September 30, 2022. Shareholders' equity decreased primarily due to the declaration of dividends, a decrease in the fair value of the security portfolio, the repurchase of stock and the adoption of CECL. Partially offsetting the decreases, there were increases due to the net income, additional paid-in capital as stock options were exercised and equity awards vested, and unearned ESOP shares vesting.

The Company's Board of Directors authorized a stock repurchase program in the fourth quarter of 2021. As of September 30, 2022, the Company has 925,000 shares remaining in the plan.

WaterStone 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 assets and off-balance sheet items to broad risk categories. At September 30, 2022, WaterStone Bank exceeded all regulatory capital requirements and is considered “well capitalized” under regulatory guidelines. See “Notes to Unaudited Consolidated Financial Statements - Note 7 - Regulatory Capital.”

Contractual Obligations, Commitments, Contingent Liabilities, and Off-balance Sheet Arrangements

During the three months ended September 30, 2022, we repaid $75.0 million in FHLB long-term debt and borrowed $50.0 million of FHLB long-term debt and $50.0 million of short-term debt. During the nine months ended September 30, 2022, we repaid $270.0 million in FHLB long-term debt.

See Note 6 - Borrowings of the notes to unaudited consolidated financial statements for additional information about the remaining maturities of our FHLB long-term debt.

Our commitments, contingent liabilities, and off-balance sheet arrangements have not changed materially since previously reported in our Annual Report on Form 10-K for the year ended December 31, 2021.

See Note 9 - Commitments, Off-Balance Sheet Arrangements, and Contingent Liabilities of the notes to unaudited consolidated financial statements for additional information.

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 mortgage loans, have longer maturities than our liabilities, consisting primarily of deposits. As a result, a principal part of our business strategy is to manage interest rate risk and reduce the exposure of our net interest income to changes in market interest rates. Accordingly, WaterStone Bank’s board of directors has established an Asset/Liability Committee which 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 guidelines approved by the board of directors. Management monitors the level of interest rate risk on a regular basis and the Asset/Liability Committee meets at least weekly to review our asset/liability policies and interest rate risk position, which are evaluated quarterly.

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: (i) emphasizing variable rate loans including variable rate one- to four-family, and commercial real estate loans as well as three to five year commercial real estate balloon loans; (ii) reducing and shortening the expected average life of the investment portfolio; and (iii) whenever possible, lengthening the term structure of our deposit base and our borrowings from the FHLB. These measures should reduce the volatility of our net interest income in different interest rate environments.

Income Simulation. Simulation analysis is an estimate of our interest rate risk exposure at a particular point in time. At least quarterly we review the potential effect changes in interest rates may have on the repayment or repricing of rate sensitive assets and funding requirements of rate sensitive liabilities. Our most recent simulation uses projected repricing of assets and liabilities at September 30, 2022 on the basis of contractual maturities, anticipated repayments and scheduled rate adjustments. Prepayment rate assumptions may have a significant impact on interest income simulation results. Because of the large percentage of loans and mortgage-backed securities we hold, rising or falling interest rates may have a significant impact on the actual prepayment speeds of our mortgage related assets that may in turn affect our interest rate sensitivity position. When interest rates rise, prepayment speeds slow and the average expected lives of our assets would tend to lengthen more than the expected average lives of our liabilities and therefore would most likely have a positive impact on net interest income and earnings.

The following interest rate scenario displays the percentage change in net interest income over a one-year time horizon assuming increases of 100, 200 and 300 basis points and a decreases of 100 basis points. The results incorporate actual cash flows and repricing characteristics for balance sheet accounts following an instantaneous parallel change in market rates based upon a static no growth, balance sheet.

Analysis of Net Interest Income Sensitivity

At September 30, 2022, a 100 basis point instantaneous increase in interest rates had the effect of decreasing forecast net interest income over the next 12 months by 2.37% while a 100 basis point decrease in rates had the effect of increasing net interest income by 0.52%.

Disclosure Controls and Procedures: Company management, with the participation of the Company’s Chief Executive Officer and Chief Financial Officer, has evaluated the effectiveness of the Company’s disclosure controls and procedures (as such term is defined in Rules 13a-15(e) and 15d-15(e) under the Securities Exchange Act of 1934, as amended (the “Exchange Act”)) as of the end of the period covered by this report. Based on such evaluation, the Company’s Chief Executive Officer and Chief Financial Officer have concluded that, as of the end of such period, the Company’s disclosure controls and procedures are effective.

Internal Control Over Financial Reporting: There have been no changes in the Company’s internal control over financial reporting (as such term is defined in Rules 13a-15(f) and 15d-15(f) under the Exchange Act) during the fiscal quarter to which this report relates that have materially affected, or are reasonably likely to materially affect, the Company’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 December 31, 2021.