BAR Harbor Bankshares: Form 10-Q for the period ended Jun 30, 2024

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 six months ended June 30, 2024 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).

• Liquidity remains strong, with cash and available for sale securities representing approximately 14.1% of our total assets at June 30, 2024. 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 to total assets of 0.16% of our total assets as of June 30, 2024 and net charge-offs of $85 thousand, reflecting our strong credit performance in midst of a challenging environment.

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, 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.

QUARTERLY PERFORMANCE SUMMARY

Earnings (second quarter 2024, compared to the same period of 2023)

• GAAP net income was $10.3 million and $0.67 per diluted share and core (Non-GAAP) net income was $10.0 million or $0.66 per diluted share compared to GAAP and core (Non-GAAP) net income of $10.8 million or $0.71 per diluted share.
• Return on assets was 1.04% versus 1.10% and return on equity was 9.46% compared to 10.49%. The decrease in both ratios reflect higher respective average asset and equity balances and slightly lower net income driven by increased cost of funds. See the “Financial Position” section for further discussion.
• Net interest income was $27.8 million compared to $28.8 million and net interest margin (“NIM”) was 3.09%, versus 3.22%. The decrease was primarily driven by higher cost of funds offset in part by yield expansion on earnings assets.
• The provision for credit losses was an expense of $585 thousand compared with $750 thousand. Our credit trends continue to remain strong. Non-performing assets remain at 16 basis points of total assets while net charge-offs to average loans remain near zero.
• Non-interest income was $9.6 million compared to $9.0 million in the same quarter 2023. Wealth management income experienced 10% growth to $4.2 million compared to $3.8 million in the in the second quarter 2023. Assets under management grew 12% in the second quarter 2024 to $2.6 billion from $2.3 billion in the second quarter 2023 driven by higher security valuations and a 2% growth in the managed accounts.
• Non-interest expense was $24.0 million in the second quarter 2024 compared to $23.4 million in the second quarter 2023 driven by salary and benefits, and other expenses offset by the gain on sale of our Avery Lane office and lower professional services fees. Other expenses increased to $4.4 million from $4.2 million in the second quarter 2023 primarily due to increases in charitable contributions to the community, software expenses, and debit and ATM card expenses.
• Efficiency ratio was 62.96% compared to 60.25% reflecting lower net interest income.

***Financial Position (***June 30, 2024, compared to March 31, 2024)

• Total assets grew $75.2 million at the end of the second quarter 2024 compared to the first quarter 2024 primarily due to loan growth and higher cash balances partially offset by lower securities available for sale at the end of the quarter.
• Total cash and cash equivalents were $101.8 million, compared to $76.2 million at end of the first quarter 2024. Interest-earning deposits held with other banks totaled $62.2 million compared to $45.5 million at end of the first quarter and yielded 5.65% and 5.88%, respectively.
• Securities available for sale decreased to $512.9 million compared to $527.6 million in the first quarter 2024 driven by amortizing securities pay-downs partially offset by security purchases. The weighted average yield of the total securities portfolio for the second quarter 2024 was 4.00% compared to 4.02% at the end of the previous quarter.
• Total loans grew $52.5 million or 7% on an annualized basis. Commercial loans grew by $68.6 million or 14% annualized compared to first quarter 2024.
• Credit quality continues to remain stable and strong. The ratio of the ACL to total loans was 0.94% for both periods. Net charge-offs continue to be insignificant and near zero.
• Total deposits were at $3.1 billion at the end of the second quarter 2024 and first quarter 2024. We continued to see a shift from non-maturity deposits to certificate of deposit accounts (“CDs”).
• Senior borrowings increased $59.9 million to $329.4 million from the first quarter 2024 driven by funding loan growth and liquidity.
• The Company's book value per share was $28.81 as of June 30, 2024 compared to $28.64 as of March 31, 2024. Unrealized losses on securities, net of taxes, reduced book value per share by $3.43 and $3.26 at the end of those respective periods. Tangible book value per share (non-GAAP) was $20.68 at the end of the second quarter 2024, compared to $20.48 at the end of the first quarter 2024.

In the first quarter of 2024, we were recognized by Forbes as one of the “World’s Best Banks” for the second consecutive year. Of the 75 US-based banks to make the list, Bar Harbor Bank & Trust is one of only three banks headquartered in Northern New England.

COMPARISON OF FINANCIAL CONDITION AT JUNE 30, 2024 AND DECEMBER 31, 2023

Cash and cash equivalents

Total cash and cash equivalents were $101.8 million, compared to $94.8 million at year-end 2023. Interest-earning cash held with other banks totaled $62.1 million compared to $52.6 million at year-end 2023 and yielded 5.65% and 6.42%, respectively.

Securities

Securities decreased to $512.9 million compared to $534.6 million at year-end 2023 driven by $408 thousand in net amortization, and $22.0 million of amortizing securities pay-downs offset by security purchases of $18.1 million. Fair value adjustments decreased the security portfolio by $68.5 million at quarter-end compared to $62.4 million at year-end. The year to date weighted average yield of the securities portfolio was 4.00% compared to 3.85% at year-end primarily due to 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 and all securities remain classified as available for sale to provide flexibility in asset funding and other opportunities as they arise.

Loans

Total loans grew 4%, on an annualized basis to $3.1 billion. Commercial loans grew by $103.7 million driven by an $82.6 million or 11% increase in commercial real estate and $21.1 million or 11% increase in commercial and industrial growth. Residential loans decreased by $35.2 million or 7% compared to the fourth quarter 2023, primarily due to continued lower demand for prevailing mortgage rates. Tax exempt loans decreased by $6.2 million or 21% driven by payoffs within the second quarter 2024.

Allowance for Credit Losses

The ACL increased to $28.9 million at the end of second quarter 2024 compared to $28.1 million at the end of the fourth quarter 2023. Our ACL continues to be driven by a combination of portfolio loan growth, nominal credit movement and general macroeconomic trends. Non-accruing loans increased during the second quarter 2024 to $6.3 million from $5.5 million in the fourth quarter 2023, but declined 6% on a year-over-year basis. Charge-offs and specific reserves on non-accruing loans remain nominal, with these non-accruing relationships supported by relatively strong collateral values.

Deposits and Borrowings

Total deposits were flat at $3.1 billion. Time deposits increased by $100.9 million primarily due to remix into higher yielding deposit categories. Weighted average yield on time deposits increased to 4.25% from 2.14% as of the fourth quarter 2023. Brokered CDs increased by $73.1 million compared to year end. Interest bearing demand deposits decreased $64.9 million at a weighted average yield of 1.39% compared to 1.33% as of the fourth quarter 2023. Non-interest bearing demand deposits decreased $16.6 million compared to the fourth quarter 2023. Senior borrowings increased $58.3 million to $329.3 million in the second quarter 2024 compared to $271.0 million at the end of the fourth quarter 2023.

Equity

Total equity was $438.9 million at June 30, 2024 compared with $432.1 million at year-end. Tangible book value per share (non-GAAP) was $20.68 at June 30, 2024 compared with $20.28 at year-end. Equity including Fair value adjustments decreased the security portfolio by $68.5 million at quarter-end compared to $62.4 million at year-end.

COMPARISON OF OPERATING RESULTS FOR THE THREE AND SIX MONTHS ENDED JUNE 30, 2024 AND JUNE 30, 2023

Net Income

Net income in the second quarter 2024 was $10.3 million, compared to $10.8 million. Diluted earnings per share was $0.67, compared to $0.71. Net income for the first half of 2024 was $20.4 million, or $1.33 per diluted share compared to $23.8 million, or $1.57 per diluted share, in the same period of 2023. The decrease was primarily driven by a higher cost of funds partially offset by rising asset yields in the second quarter and first half of 2024.

Interest and Dividend Income

Total interest and dividend income in the second quarter 2024 increased by $4.0 million or 9.23% to $46.8 million compared to $42.8 million in the second quarter 2023 primarily driven by the repricing of adjustable loans and originations of higher fixed rate loans within the commercial portfolio. The yield on commercial real estate loans grew to 5.61% at the end of the second quarter 2024 from 5.21% in the second quarter 2023. Commercial and industrial yield grew to 6.76% at the end of the second quarter 2024 compared to 6.42% at the end of the second quarter 2023. Increases in yields were driven by the current rate environment.

Total interest and dividend income in the first half 2024 increased by $9.4 million or 11.33% to $92.7 million compared to $83.2 million in comparative prior year primarily driven by the growth in the portfolio driven by originations of higher fixed rate loans and the repricing of the adjustable loans within the commercial portfolio. The yield on commercial real estate loans grew to 5.53% at the end of the first half 2024 from 5.14% in the first half 2023. Commercial and industrial yield grew to 6.71% at the end of the first half 2024 compared to 6.14% at the end of the first half 2023. Increases in yields were driven by the current rate environment.

Net Interest Income

NIM in the second quarter 2024 was 3.09% compared to 3.22% in the second quarter 2023. The yield on loans grew to 5.41% in the second quarter 2024, up from 4.99% in the same quarter 2023. Costs of interest-bearing deposits increased to 2.35% from 1.45% in the second quarter 2023. Borrowings decreased $69.5 million from the second quarter 2023 compounded with a decrease in yields on interest bearing liabilities to 4.57% in the second quarter 2024.

NIM in the first half of 2024 was 3.12% compared to 3.39% in the first half of 2023. The yield on loans grew to 5.36% in the first half 2024, up from 4.90% in the comparative period 2023. Costs of interest-bearing deposits increased to 2.30% from 1.18% in the first half 2023. Borrowings decreased $69.5 million from the second quarter 2023 compounded with a decrease in yields on interest bearing liabilities to 4.45% in the first half 2024.

The decrease in both periods was primarily driven by higher cost of funds partially offset by lower borrowing costs. Competitive pricing within the interest rate environment and a $186 million growth in interest-bearing deposit balances year-over-year showing a deposit mix shift from non-maturity deposits to CDs.

Provision for Credit Losses

The provision for credit losses in the second quarter 2024 was $585 thousand compared to $750 thousand in the second quarter 2023 as net charge-offs to total loans continue to remain nominal. Non-accruing loans to total loans declined to 0.20% at the end of second quarter 2024 compared to 0.22% in the second quarter 2023.

The provision for credit losses in the first half 2024 was $874 thousand compared to $1.5 million in the second quarter first half 2023. The increase ACL balance in the first half of 2023 was largely due to loan growth, however, the ratio of ACL to total loans increased to 0.94% in the first half of 2024 from 0.91% at the end of 2023 due to more refined economic forecasting, especially in the national unemployment figures. Net charge-offs to total loans were $161 thousand compared to $49 thousand in the first half of 2023.

Non-Interest Income

Non-interest income was $9.6 million in the second quarter 2024 compared to $9.0 million in the same quarter 2023. Wealth management income grew 10% to $4.2 million compared to $3.8 million in the in the second quarter 2023. Assets under management grew 12% in the second quarter 2024 to $2.6 billion from $2.3 billion in the second quarter 2023 driven by higher security valuations and a 2% growth in the managed accounts. Mortgage banking income increased $180 thousand compared to the second quarter 2023 driven by increased margins on our held–for-sale mortgage business.

Non-interest income remained flat $18.2 million in the first half of 2024 and 2023. Wealth management income grew $503 thousand to $7.9 million compared to $7.4 million in the in the first half 2023 driven by the same reasons as discussed in the quarterly above. BOLI income decreased $503 thousand driven by timing of one-time death benefits that occurred during the first quarter 2023. Mortgage banking income increased $157 thousand compared to the first half 2023 driven by increased volume and margins on our held–for-sale mortgage business.

Non-Interest Expense

Non-interest expense was $24.0 million in the second quarter 2024 compared to $23.4 million in the second quarter 2023 driven by salary and benefits, and other expenses partially offset by the gain on sale of our Avery Lane office and lower professional services fees. Salary and benefit expenses increased 5% or $637 thousand from the comparative quarter 2023 driven in part by stock compensation due to increases in stock price and lower loan origination fee deferrals in the second quarter 2024. Other expenses increased to $4.4 million from $4.2 million in the second quarter 2023 primarily due to increases in charitable contributions to the community, software expenses, and debit and ATM card expenses.

Non-interest expense in the first half of 2024 was $47.7 million compared to $46.1 million driven by the same reasons as discussed in the quarterly period above.

Income Tax Expense

Income tax expense was $2.5 million in the second quarter 2024 compared with $2.8 million in the prior year quarter. The effective tax rate was 19.8% the second quarter 2024 compared to 20.8% the second quarter 2023.

Income tax expense for the first half of 2024 was $5.1 million compared with $6.4 million in the prior year first half. The effective tax rate was 20.0% the first half 2024 compared to 21.2% the first half 2023.

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 June 30, 2024, available same-day liquidity totaled approximately $1.2 billion, 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 June 30, 2024, we had unused borrowing capacity at the FHLB of $364.8 million, unused borrowing capacity at the Federal Reserve of $92.3 million and unused lines of credit totaling $41.0 million, in addition to $101.8 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 June 30, 2024 and December 31, 2023 - 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 $8.7 million and $8.1 million for the six months ended June 30, 2024 and 2023, 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 AND ESTIMATES

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 and estimates since December 31, 2023. 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 June 30, 2024 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 23.82% in the second quarter of 2024 and 24.01% for the first quarter 2024 and 23.80% for 2023.

(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. Other types of market risk do not arise in the normal course of our business activities.

The responsibility for interest rate risk management oversight is the function of the Bank’s Asset and Liability Committee, or 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 June 30, 2024, 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 June 30, 2024 and 2023:

(in thousands, except ratios)

Assuming short-term and long-term interest rates decline 200 basis points from current levels (i.e., a parallel yield curve shift) over the next twelve months 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 short-term and long-term interest rates increase 200 basis points from current levels (i.e., a parallel yield curve shift) over the next twelve months and the Bank’s balance sheet structure and size remain at current levels, management believes net interest income will improve over the one year horizon while improving further from that level over the two-year horizon.

As compared to June 30, 2023, asset sensitivity has increased in both year one and year two.

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 Executive Team and 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 June 30, 2024, 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.

We believe there were no material changes to the risk factors discussed in Part I, Item 1A. “Risk Factors” of our

Form 10-K.