BAR Harbor Bankshares: Form 10-Q for the period ended Sep 30, 2023

The following is management’s discussion and analysis of the major factors that influenced our results of operations and financial condition as of and for the three and nine months ended September 30, 2023 and should be read in conjunction with our unaudited consolidated financial statements and condensed notes thereto included elsewhere in this Form 10-Q as well as our audited consolidated financial statements and notes thereto included in our Form 10-K. The following discussion contains "forward-looking statements" that reflect our future plans, estimates, beliefs and expected performance. We caution that assumptions, expectations, projections, intentions or beliefs about future events may, and often do, vary from actual results and the differences can be material. Factors that could cause such differences are discussed in the sections titled "Cautionary Statement Regarding Forward-Looking Statements" and "Part II, Item 1A. Risk Factors" in this Form 10-Q. All amounts, dollars and percentages presented in this Form 10-Q are rounded and therefore approximate.

GENERAL

The Company is a bank holding company headquartered in Maine, providing a broad array of banking and nonbanking products and services to businesses and consumers primarily within our three-state footprint. The Company's primary sources of revenue, through the Bank, are net interest income (predominantly from loans and investment securities) and noninterest income (principally fees and other revenue from financial services provided to customers or ancillary services tied to loans and deposits).

NON-GAAP FINANCIAL MEASURES

Our accounting and reporting policies conform to GAAP and the prevailing practices in the financial services industry. However, we also evaluate our performance by reference to certain additional financial measures discussed in this Form 10-Q that we identify as being “non-GAAP financial measures.” In accordance with SEC rules, we classify a financial measure as being a non-GAAP financial measure if that financial measure excludes or includes amounts, or is subject to adjustments that have the effect of excluding or including amounts, that are included or excluded, as the case may be, in the most directly comparable measure calculated and presented in accordance with GAAP as in effect from time to time in the United States in our statements of income, balance sheets or statements of cash flows. Non-GAAP financial measures do not include operating and other statistical measures or ratios or statistical measures calculated using exclusively either financial measures calculated in accordance with GAAP, operating measures or other measures that are not non-GAAP financial measures or both.

The non-GAAP financial measures that we discuss in this Form 10-Q should not be considered in isolation or as a substitute for the most directly comparable or other financial measures calculated in accordance with GAAP. Moreover, the manner in which we calculate the non-GAAP financial measures that we discuss in this Form 10-Q may differ from that of other companies reporting measures with similar names. You should understand how such other banking organizations calculate their financial measures similar or with names similar to the non-GAAP financial measures we have discussed in this Form 10-Q when comparing such non-GAAP financial measures.

Recent Banking Crisis

In light of recent events in the banking sector, including recent bank failures, continuing interest rate hikes and recessionary concerns, we intend to continue to position our balance sheet to mitigate the risks affecting the Company and the overall banking industry in order to serve our clients and communities.

• Liquidity remains strong, with cash and available for sale securities representing approximately 16.2% of our total assets at September 30, 2023. We maintain the ability to access considerable sources of contingent liquidity at the FHLB and the FRB. We consider the Company's current liquidity position to be adequate to meet both short-term and long-term liquidity needs. Refer to “Liquidity and Cash Flows” for additional information.
• Capital remains strong, with capital ratios of both the Company and the Bank remaining well-capitalized under regulatory guidelines at period end as further described in Note 6 – “Capital Ratios and Shareholders’ Equity” to our unaudited consolidated financial statements.
• Asset quality remains solid, with a non-performing asset ratio of 0.17% of our total assets as of September 30, 2023 and net charge-offs of near zero, reflecting our disciplined underwriting and conservative lending philosophy which has supported the Company's strong credit performance during prior financial crises.

We will continue our safe and sound banking practices, but the continuing impact of the banking crisis and further extent on the Company's operations and financial results for the remainder of 2023 is uncertain and cannot be predicted.

QUARTERLY PERFORMANCE SUMMARY

Earnings (third quarter of 2023, compared to the same period of 2022)

• Net income was $11.1 million, compared to $11.4 million. Diluted earnings per share was $0.73, compared to $0.76. Net interest income along with non-interest income and expense was relatively consistent in both periods. A benefit from a lower provision for loan credit losses was offset by a higher provision for income taxes due to one-time charges.
• Return on assets was 1.11% versus 1.20% and return on equity was 10.72% compared to 11.55%. The decrease in both ratios reflect higher respective average asset and equity balances and slightly lower net income. See the “Financial Position” section for further discussion.
• Net interest income was $29.2 million compared to $29.9 million and net interest margin (“NIM”) was 3.18%, versus 3.47%. The decrease was primarily driven by higher cost of funds offset in part by yield expansion on earnings assets. Our accumulated deposit beta stands at 27% at quarter-end.
• The provision for credit losses was an expense of $673 thousand compared with $1.3 million. Our credit trends remain strong as expected. Non-performing assets remain at 17 basis points of total assets while net charge-offs to average loans remain near zero.
• Non-interest income was $8.8 million in both periods on a steady source of customer service and wealth management fees.
• Non-interest expense was $23.0 million in third quarter and the prior year quarter. Prior year expense includes $635 thousand of non-recurring items.
• Efficiency ratio was 58.59% compared to 57.67% reflecting lower net interest income.

Financial Position (September 30, 2023, compared to June 30, 2023)

• Total assets were $4.0 billion, at the end of the third and second quarters of 2023, primarily due to relatively flat loan growth and lower security balances as interest rates continued to rise during the quarter.
• Cash and cash equivalents remained at consistent levels of $122.8 million, and $123.8 million.
• Securities were $509.5 million, or 13% of total assets, compared to $556.0 million, or 14% of total assets as proceeds from amortization and prepayments were used to fund loans. Net unrealized losses increased to $86.5

million from $71.9 million as market rates for similar duration securities continued to increase during the current quarter.

• Total loans were $3.0 billion at the end of both the third and second quarters 2023.
• The ratio of the ACL to total loans was 0.94% compared with 0.91%. Net charge-offs continue to be insignificant and near zero.
• Total deposits grew 7% on an annualized basis during the quarter on an increasing number of customer accounts and gain in market share.
• Borrowings decreased by $91.8 million to $367.5 million as excess cash generated from operations was used to pay down higher costs on Federal Home Loan Bank advances.
• Total book value per share was $26.67 compared to $27.12. Unrealized losses on securities, net of taxes, reduced book value per share by $4.39 and $3.65 at the end of the respective periods. Tangible book value per share excluding net unrealized security losses (non-GAAP) increased 5.5% on annualized basis on net income offset by dividends to shareholders.

We are honored and proud to be recognized by Forbes as one of the “World’s Best Banks” in the first quarter of 2023, based largely on service and trust metrics. Of the 75 U.S.-based banks to make the list, Bar Harbor Bank & Trust is one of only three banks headquartered in Northern New England. We believe that this recognition is a reflection of our customers’ experience with us and their trust in Bar Harbor Bank & Trust.

COMPARISON OF FINANCIAL CONDITION AT SEPTEMBER 30, 2023 AND DECEMBER 31, 2022

Cash and cash equivalents

Total cash and cash equivalents were $122.8 million as of September 30, 2023, compared to $92.3 million at year-end. Interest-earning cash held with other banks totaled $81.6 million compared to $52.4 million at year-end 2022 and yielded 5.02% and 4.00%, respectively.

Securities

Securities totaled $524.3 million at September 30, 2023 and were $574.4 million at year-end 2022. Year to date, security purchases totaled $1.0 million and were offset by $32.5 million of maturities, calls and pay-downs of amortizing securities. Fair value adjustments increased the security portfolio to $86.5 million at quarter-end compared to $71.8 million at year-end. The weighted average yield of the securities portfolio was 3.61% at September 30, 2023 compared to 3.58% at year-end primarily due to a repricing of variable rates, acceleration of discounts due to prepayments, and a run-off of lower coupon fixed-rate securities. As of quarter-end and year-end, our securities portfolio had an average life of nine years with an effective duration of five years. All securities remain classified as available for sale to provide flexibility in loan funding and management of our cost of funds.

Loans

Total loans increased by $90.0 million to $3.0 billion from year-end 2022. The increase was primarily due to a $54.4 million increase in commercial real estate loans and $38.6 million increase in commercial and industrial loans. Commercial real estate originations during 2023 totaled $208 million primarily in the health care, real estate rental, and retail trade industries. Commercial and industrial loan originations totaled $79.5 million, which serves a diverse portfolio of industries, but predominantly in businesses of finance and insurance, and accommodation and food services. Originations of both commercial real estate and commercial and industrial loans were offset by payoffs and paydowns of lower yielding loans. Residential loans decreased by $1.4 million from year end 2022, primarily due to lower demand for prevailing mortgage rates.

Allowance for Credit Losses

The ACL was $28.0 million at September 30, 2023 compared to $25.9 million at year-end and the ratio of ACL to total loans increased to 0.94% from 0.89% at year-end. The increase ACL balance is largely due to commercial loan growth and a specific reserve on one non-accrual commercial and industrial loan that is expected to be settled in the fourth quarter of 2023. While total non-accruing loans increased to $6.8 million from $6.5 million at year-end, we continue to see improvement in the commercial categories as we continue to work-out those loans.

Deposits and Borrowings

Total deposits increased by $97.1 million during 2023 from $3.0 billion at year-end 2022. Demand and other non-interest bearing deposits decreased $57.9 million driven by large institutional outflows mainly due to seasonality. While our deposit base does contain some larger institutional accounts, our community banking model caters to the high volume, lower average balance accounts, which generally are less rate sensitive and less likely to run-off. Time deposits increased $335.0 million due to a shift of interest-earning deposits to higher interest-bearing accounts, and a $186.8 million increase in brokered deposits to support loan growth at favorable rates. Our deposit composition at the end of quarter was 48% commercial customers and 52% consumer customers, compared with 47% and 53%, respectively at year-end. Estimated uninsured and uncollateralized deposits, excluding intercompany deposits, were 8.7% of total deposits at September 30, 2023, compared to 11.2% at December 31, 2022. Total borrowings decreased by $26.8 million from year-end and $91.9 million over the prior quarter due to our initiatives pay-down higher costing wholesale debt with excess cash generated from operations.

Equity

Total equity was $404.2 million at September 30, 2023 compared with $393.4 million at year-end. Tangible book value per share (non-GAAP) was $18.45 at September 30, 2023 compared with $17.78 at year-end. Equity included net unrealized losses on securities totaling a $66.5 million loss at September 30, 2023 compared to $55.3 million at year-end 2022. Excluding unrealized net losses on securities, our tangible book value per share was $22.84 per share at September 30, 2023 compared with $21.44 per share at year-end, which is an annualized increase of 8.13%.

COMPARISON OF OPERATING RESULTS FOR THE THREE AND NINE MONTHS ENDED SEPTEMBER 30, 2023 AND 2022

Net Income

Net income in the third quarter 2023 was $11.1 million, or $0.73 per diluted share, versus $11.4 million, or $0.76 per diluted share, in the same quarter of 2022. Net interest income along with non-interest income and expense was relatively consistent in both periods. The benefit from a lower provision for loan credit losses was offset by a higher provision for income taxes due to one-time charges.

Net Interest Income

Net interest margin in the third quarter 2023 was 3.18% compared to 3.47% in the third quarter of 2022. The decrease was primarily driven by a higher cost of funds offset in part by yield expansion on earning assets. The yield on loans expanded to 5.11% in the third quarter of 2023, up from 4.04% in the same quarter of 2022. The yield from securities steadily increased over the past year primarily due to a repricing of variable rates, acceleration of discounts due to prepayments, and a run-off of lower coupon fixed-rate securities. Costs of interest-bearing liabilities increased to 2.19% from 0.48% in the third quarter 2022 as our costs continue to drift upwards from subsequent rate hikes. We also experienced a shift in deposit composition from non-maturity deposits to certificates of deposits, and had a heavier reliance on whole-sale borrowings in the third quarter 2023 as compared with the prior year quarter of 2022.

For the first nine months of 2023, net interest income was $88.9 million compared with $80.7 million in the same period of 2022. The comparison of NIM and earning asset yields for the respective nine month periods of 2023 and 2022 were 3.18% and 3.22%, and 3.76% and 3.47%, respectively. Interest-bearing cash balances increased NIM by 3 basis point in the first nine months of 2023 and same period in prior year. The explanations for the improvement in NIM are consistent with those provided in the year-over-year three month comparison above.

Provision for Credit Losses

The provision for credit losses was $673 thousand in the third quarter 2023 compared to $1.3 million in the prior year quarter driven by timing of economic forecasts and loan growth year over year.

For the nine months ended 2023 and 2022, the provision for credit losses was flat at $2.2 million. Both periods are driven by loan growth, improved economic forecasts and strong credit quality. The ratio of net charge-offs to total loans was near zero for the quarter and year-to-date period ended September 30, 2023 compared to 0.01% and zero in the same comparative periods of 2022. Net charge-offs continue at historic lows over the past five years, which we believe is due to our conservative lending and underwriting standards.

Non-Interest Income

Non-interest income was $8.8 million in the third quarter 2023 and 2022. Our fee-based revenue remains a significant portion of total revenue (non-GAAP) due to the diversity of sources and considerable size of our wealth management business. Wealth management income was $3.5 million in both periods as higher inflows of cash since 2022 were offset by lower security valuations in 2023. Customer service fees grew to $3.9 million in the third quarter 2023 from $3.8 million in the same quarter of 2022 on a higher number of transactional accounts. Mortgage banking income was $415 thousand in the third quarter of 2023, compared to $315 thousand in the same period of 2022, which reflects a increase in sales in the secondary market, but overall lower production related to higher interest rates.

Non-interest income for the first nine months of 2023 was $27.0 million and in the same period in 2022. Wealth management fees were $10.9 million and $11.1 million and customer service fees were $3.9 million and $3.8 million for the nine months of 2023 and 2022, respectively. The reasons for these changes are the same as the quarterly comparison above.

Non-Interest Expense

Non-interest expense was $23.0 million in the third quarter 2023 and 2022. Salary and benefit expense was up 6% over the prior year quarter principally due to annual merit increases and lower expense deferral on decreased loan production. Other expense in the third quarter 2022 included one-time charges of $635 thousand related to the write-off of a few reconciling items.

For the first nine months of 2023, non-interest expense was $69.1 million and $66.6 million in the same period of 2022. The increase in non-interest expense is due to the same reasons as discussed in the quarterly period above. The Company's year-to-date efficiency ratio was 58.59% in 2023 compared to 57.67% in 2022 which reflects management’s disciplined approach to expense management as revenue continues to grow.

Income Tax Expense

Income tax expense was $3.2 million in the third quarter 2023 compared with $3.0 million in the prior year quarter. The effective tax rate in the third quarter 2023 was 22.4%, compared to 20.6% in the same quarter of 2022. One-time charges due to an audit settlement with the State of New Hampshire and 2022 return to provision adjustments totaled $268 thousand. Excluding one-time charges, our effective tax rate in the third quarter 2023 was consistent with the prior year quarter.

Liquidity and Cash Flows

Liquidity is measured by our ability to meet short-term cash needs at a reasonable cost or minimal loss. We seek to obtain favorable sources of liabilities and to maintain prudent levels of liquid assets in order to satisfy varied liquidity demands. Besides serving as a funding source for maturing obligations, liquidity provides flexibility in responding to customer-initiated needs. Many factors affect our ability to meet liquidity needs, including variations in the markets served by our network of offices, mix of assets and liabilities, reputation and credit standing in the marketplace, and general economic conditions.

The Bank actively manages its liquidity position through target ratios established under its Asset-Liability Management Policy. Continual monitoring of these ratios, by using historical data and through forecasts under multiple rate and stress scenarios, allows the Bank to employ strategies necessary to maintain adequate liquidity. The Bank's policy is to maintain a liquidity position of at least 8% of total assets. A portion of the Bank’s deposit base has been historically seasonal in nature, with balances typically declining in the winter months through late spring, during which period the Bank’s liquidity position tightens.

As of September 30, 2023, available same-day liquidity totaled approximately $551.1 million, including cash, borrowing capacity at FHLB and the Federal Reserve Discount Window and various lines of credit. Additional sources of liquidity include cash flows from operations, wholesale deposits, cash flow from our amortizing securities and loan portfolios. As of September 30, 2023, we had unused borrowing capacity at the FHLB of $219.3 million, unused borrowing capacity at the Federal Reserve of $158.0 million and unused lines of credit totaling $51.0 million, in addition to $122.8 million in cash.

The Bank maintains a liquidity contingency plan approved by the Bank’s Board of Directors. This plan addresses the steps that would be taken in the event of a liquidity crisis, and identifies other sources of liquidity available to us. Our management believes the level of liquidity is sufficient to meet current and future funding requirements. However, changes in economic conditions, including consumer savings habits and availability or access to the brokered deposit market could potentially have a significant impact on our liquidity position.

Capital Resources

Please refer to “Comparison of Financial Condition at September 30, 2023 and December 31, 2022 - Equity” for a discussion of shareholders’ equity together with Note 6 “Capital Ratios and Shareholders’ Equity” in the unaudited consolidated financial statements. Additional information about regulatory capital is contained in the notes to the consolidated financial statements and in our most recent Form 10-K.

We expect to continue our current practice of paying quarterly cash dividends with respect to our common stock subject to our Board of Directors’ discretion to modify or terminate this practice at any time and for any reason without prior notice. We believe our quarterly dividend rate per share as approved by our Board of Directors, enables us to balance our multiple objectives of managing our business and returning a portion of our earnings to our shareholders. Historically, and a practice we intend to continue, our principal cash expenditure is the payment of dividends on our common stock, if as and when declared by our Board of Directors. Dividends were paid to our shareholders in the aggregate amount of $12.4 million and $11.4 million for the nine months ended September 30, 2023 and 2022, respectively. All dividends declared and distributed by us will be in compliance with applicable state corporate law and regulatory requirements.

Off-Balance Sheet Arrangements

We are, from time to time, a party to certain off-balance sheet arrangements that have or are reasonably likely to have a current or future effect on our financial condition, changes in financial condition, revenues or expenses, results of operations, liquidity, capital expenditures or capital resources, that may be material to investors.

Our off-balance sheet arrangements are limited to standby letters of credit whereby the Bank guarantees the obligations or performance of certain customers. These letters of credit are sometimes issued in support of third-party debt. The risk involved in issuing standby letters of credit is essentially the same as the credit risk involved in extending loan facilities to customers, and such letters of credit are subject to the same origination, portfolio maintenance and management procedures in effect to monitor other credit products. The amount of collateral obtained, if deemed necessary by the Bank upon issuance of a standby letter of credit, is based upon management's credit evaluation of the customer.

Our off-balance sheet arrangements have not changed materially since previously reported in our Form 10-K.

IMPACT OF NEW ACCOUNTING PRONOUNCEMENTS

Please refer to Note 1 – “Basis of Presentation—Recent Accounting Pronouncements” of the Consolidated Financial Statements in this Form 10-Q and Note 1—“Summary of Significant Accounting Policies” of the Consolidated Financial Statements to our Form 10-K.

CRITICAL ACCOUNTING POLICIES

Our Consolidated Financial Statements were prepared in accordance with GAAP and follow general practices within the industries in which we operate. The most significant accounting policies we follow are presented in Note 1—“Summary of Significant Accounting Policies” of the Consolidated Financial Statements to our Form 10-K. Application of these principles requires us to make estimates, assumptions, and judgments that affect the amounts reported in the Consolidated Financial Statements and accompanying notes. Most accounting policies are not considered by management to be critical accounting policies. Several factors are considered in determining whether or not a policy is critical in the preparation of the Consolidated Financial Statements. These factors include among other things, whether the policy requires management to make difficult, subjective, and complex judgments about matters that are inherently uncertain and because it is likely that materially different amounts would be reported under different conditions or using different assumptions. The accounting policies which we believe to be most critical in preparing our Consolidated Financial Statements are presented in the section titled “Management's Discussion and Analysis of Financial Condition and Results of Operations - Critical Accounting Policies and Estimates” included in our Form 10-K. There have been no significant changes in our application of critical accounting policies since December 31, 2022. Refer to Note 1 – “Basis of Presentation--Recent Accounting Pronouncements” of the consolidated financial statements for discussion of accounting pronouncements issued but yet to be adopted and implemented.

SELECTED FINANCIAL DATA

The following summary data is based in part on the unaudited consolidated financial statements and accompanying notes and other information appearing elsewhere in this Form 10-Q or prior SEC filings.

(1) Non-GAAP financial measure. Refer to the Reconciliation of Non-GAAP Financial Measures section of the “Management’s Discussion and Analysis of Financial Condition and Results of Operations,” in this Form 10-Q for additional information.

(2) All performance ratios are annualized and are based on average balance sheet amounts, where applicable.

(3) Fully taxable equivalent considers the impact of tax-advantaged investment securities and loans.

(4) Earning assets includes non-accruing loans and securities are valued at amortized cost.

CONSOLIDATED LOAN AND DEPOSIT ANALYSIS (UNAUDITED)

The following tables present the quarterly trend in loan and deposit data and accompanying growth rates as of September 30, 2023 on an annualized basis:

LOAN ANALYSIS

(in thousands, except ratios)

DEPOSIT ANALYSIS

(in thousands, except ratios)

63

AVERAGE BALANCES AND AVERAGE YIELDS/RATES (UNAUDITED)

The following tables present average balances and average yields and rates on an annualized fully taxable equivalent basis for the periods included:

(in thousands, except ratios)

(1) The average balances of loans include non-accrual loans and unamortized deferred fees and costs.

(2) The average balance for securities available for sale is based on amortized cost.

(3) Fully taxable equivalent considers the impact of tax-advantaged securities and loans.

(in millions, except ratios)

(1) The average balances of loans include non-accrual loans and unamortized deferred fees and costs.

(2) The average balance for securities available for sale is based on amortized cost.

(3) Fully taxable equivalent considers the impact of tax-advantaged securities and loans.

RECONCILIATION OF NON-GAAP FINANCIAL MEASURES (UNAUDITED)

The following reconciliation table provides a more detailed analysis of these, and reconciliation for, each of non-GAAP financial measures:

(in thousands)

(in thousands)

(1) Assumes a marginal tax rate of 23.80% for 2023 and 23.41% for 2022.

(2) Non-GAAP financial measure.

(3) Tangible shareholders' equity is computed by taking total shareholders' equity less the intangible assets at period-end. Tangible assets is computed by taking total assets less the intangible assets at period-end.

(4) Securities adjustment, net of tax represents the total unrealized losses and gains on available-for-sale securities recorded on our consolidated balance sheets within total common shareholders' equity.

(5) All performance ratios are based on average balance sheet amounts, where applicable.

(6) Efficiency ratio is computed by dividing core non-interest expense net of franchise taxes and intangible amortization divided by core revenue on a fully taxable equivalent basis.

Market Risk

Market risk is the risk of loss in a financial instrument arising from adverse changes in market rates/prices, such as interest rates, foreign currency exchange rates, commodity prices and equity prices. The most significant market risk that affects us is interest rate risk.

The responsibility for interest rate risk management oversight is the function of the Bank’s Asset and Liability Committee (“ALCO”), chaired by the Bank’s Chief Financial Officer and composed of various members of the Bank’s senior management. ALCO meets regularly to review balance sheet structure, formulate strategies in light of current and expected economic conditions, adjust product prices as necessary, implement policy, monitor liquidity, and review performance against guidelines established to control exposure to the various types of inherent risk.

Interest Rate Risk

Interest rate risk can be defined as an exposure to movement in interest rates that could have an adverse impact on the Bank's net interest income. Interest rate risk arises from the imbalance in the re-pricing, maturity and/or cash flow characteristics of assets and liabilities. Management’s objectives are to measure, monitor and develop strategies in response to the interest rate risk profile inherent in the Bank’s balance sheet. The objectives in managing the Bank's balance sheet are to preserve the sensitivity of net interest income to actual or potential changes in interest rates, and to enhance profitability through strategies that promote sufficient reward for understood and controlled risk.

The Bank’s interest rate risk measurement and management techniques incorporate the re-pricing and cash flow attributes of balance sheet and off-balance sheet instruments as each relate to current and potential changes in interest rates. The level of interest rate risk, measured in terms of the potential future effect on net interest income, is determined through the use of modeling and other techniques under multiple interest rate scenarios. Interest rate risk is evaluated in depth on a quarterly basis and reviewed by ALCO and the Bank’s Board of Directors.

The Bank's Asset Liability Management Policy, approved annually by the Bank’s Board of Directors, establishes interest rate risk limits in terms of variability of net interest income under rising, flat, and decreasing rate scenarios. It is the role of the ALCO to evaluate the overall risk profile and to determine actions to maintain and achieve a posture consistent with policy guidelines.

Interest Rate Sensitivity Modeling:

The Bank utilizes an interest rate risk model widely recognized in the financial industry to monitor and measure interest rate risk. The model simulates the behavior of interest income and expense for all balance sheet and off-balance sheet instruments, under different interest rate scenarios together with a dynamic future balance sheet. Interest rate risk is measured in terms of potential changes in net interest income based upon shifts in the yield curve.

The interest rate risk sensitivity model requires that assets and liabilities be broken down into components as to fixed, variable, and adjustable interest rates, as well as other homogeneous groupings, which are segregated as to maturity and type of instrument. The model includes assumptions about how the balance sheet is likely to evolve through time and in different interest rate environments. The model uses contractual re-pricing dates for variable products, contractual maturities for fixed rate products, and product-specific assumptions for deposit accounts, such as money market accounts, that are subject to re-pricing based on current market conditions. Re-pricing margins are also determined for adjustable rate assets and incorporated in the model. Investment securities and borrowings with option provisions are examined on an individual basis in each rate environment to estimate the likelihood of exercise. Prepayment assumptions for mortgage loans are calibrated using specific Bank experience while mortgage-backed securities are developed from industry standard models of prepayment speeds, based upon similar coupon ranges and degree of seasoning. Cash flows and maturities are then determined, and for certain assets, prepayment assumptions are estimated under different interest rate scenarios. Interest income and interest expense are then simulated under several hypothetical interest rate conditions.

The simulation models a parallel and pro rata shift in rates over a 12-month period. Using this approach, we are able to produce simulation results that illustrate the effect that both a gradual “rate ramp” and a “rate shock” have on earnings expectations. Our net interest income sensitivity analysis reflects changes to net interest income assuming no balance sheet growth and a parallel shift in interest rates. All rate changes were “ramped” over the first 12-month period and then maintained at those levels over the remainder of the simulation horizon. Changes in net interest income based upon these simulations are measured against the flat interest rate scenario.

As of September 30, 2023, interest rate sensitivity modeling results indicate that the Bank’s balance sheet was asset sensitive over the one- and two-year horizons.

The following table presents the changes in sensitivities on net interest income for the periods ended September 30, 2023 and 2022:

(in thousands, except ratios)

Assuming short-term and long-term interest rates decline 100 basis points from current levels (i.e., a parallel yield curve shift) and the Bank’s balance sheet structure and size remain at current levels, management believes net interest income will deteriorate over the one-year horizon while deteriorating further from that level over the two-year horizon.

Assuming the Bank’s balance sheet structure and size remain at current levels and the Federal Reserve increases short-term interest rates by 200 basis points with the balance of the yield curve shifting in parallel with these increases, management believes net interest income will improve over both the one- and two-year horizons.

As compared to September 30, 2022, sensitivity to both a down 100 basis point rate movement and an up 200 basis point rate movement has decreased.

The preceding sensitivity analysis does not represent a forecast and should not be relied upon as being indicative of expected operating results. These hypothetical estimates are based upon numerous assumptions including: the nature and timing of interest rate levels and yield curve shape, prepayment speeds on loans and securities, deposit rates, pricing decisions on loans and deposits, reinvestment or replacement of asset and liability cash flows, and renegotiated loan terms with borrowers. While assumptions are developed based upon current economic and local market conditions, we cannot make any assurances as to the predictive nature of these assumptions including how customer preferences or competitor influences might change.

As market conditions vary from those assumed in the sensitivity analysis, actual results may also differ due to: prepayment and refinancing levels deviating from those assumed; the impact of interest rate changes, caps or floors on adjustable rate assets; the potential effect of changing debt service levels on customers with adjustable rate loans; depositor early withdrawals and product preference changes; and other such variables. The sensitivity analysis also does not reflect additional actions that the Bank’s senior management and the Bank’s Board of Directors might take in responding to or anticipating changes in interest rates, and the anticipated impact on the Bank’s net interest income.

(a) Disclosure controls and procedures.

Under the supervision and with the participation of our senior management, consisting of our principal executive officer and our principal financial officer, we conducted an evaluation of the effectiveness of the design and operation of its disclosure controls and procedures, as defined in Rules 13a-15(e) and 15d-15(e) under the Exchange Act, as of the end of the period covered by this Form 10-Q. Based on this evaluation, our management, including our principal executive officer and principal financial officer, concluded that as of September 30, 2023, our disclosure controls and procedures were effective to ensure that information required to be disclosed by the reports that we file under the Exchange Act is recorded, processed, summarized and reported within the time periods specified in SEC rules and forms. Our disclosure controls and procedures include, without limitation, controls and procedures designed to ensure that information required to be disclosed by using our Exchange Act reports is accumulated and communicated to our management, including our principal executive officer and principal financial officer, as appropriate to allow timely decisions regarding required disclosure. Management recognizes that any controls and procedures, no matter how well designed and operated, can provide only reasonable assurance of achieving their objectives, and management necessarily applies its judgment in evaluating the cost-benefit relationship of possible controls and procedures.

(b) Changes in internal control over financial reporting.

There were no changes in our internal control over financial reporting that occurred during the last fiscal quarter that have materially affected, or are reasonably likely to materially affect, our internal control over financial reporting.

Investing in the Company involves various risks which are particular to our Company, our industry and our market area. We believe there were no material changes to the risk factors discussed in Part I, Item 1A. of our Form 10-K. In addition to the other information set forth in this Form 10-Q, you should carefully consider those risk factors, which could materially affect our business, financial condition and future operating results. Those risk factors are not the only risks facing our Company. Additional risks and uncertainties not currently known to us or that we currently deem to be immaterial also may have a material adverse effect on our business, financial condition and operating results.