ECB Bancorp, Inc. /MD/ (ECBK) FY 2022 MD&A
This page reproduces the company's own Item 7 MD&A text from the linked SEC filing. It is filer text, not grepcent analysis, scoring, or investment advice.
ITEM 7. Management’s Discussion and Analysis of Financial Condition and Results of Operations
This discussion and analysis reflects our financial statements and other relevant statistical data, and is intended to enhance your understanding of our financial condition and results of operations. The information in this section has been derived from the audited financial statements, which appear beginning on page 50 of this Annual Report on Form 10-K.
Overview
Our business consists primarily of taking deposits from the general public and investing those deposits, together with funds generated from operations, in one- to four-family residential real estate loans, commercial real estate and multifamily loans, construction and land loans and home equity lines of credit. At December 31, 2022, $355.4 million, or 39.8%, of our total loan portfolio was comprised of one- to four-family residential real estate loans, $242.0 million, or 27.1%, of our total loan portfolio was comprised of multifamily real estate loans, $156.2 million, or 17.5%, of our total loan portfolio was comprised of commercial real estate loans, $107.3 million, or 12.0%, of our total loan portfolio was comprised of construction loans and $27.8 million, or 3.1%, of our total loan portfolio was comprised of home equity lines of credit and loans. We also invest in securities, consisting primarily of U.S. government and federal agency obligations, mortgage-backed securities and corporate bonds. We offer a variety of deposit accounts, including certificate of deposit accounts, IRAs, money market accounts, savings accounts and interest-bearing and noninterest-bearing checking accounts. We historically have utilized advances from the Federal Home Loan Bank of Boston (the “FHLB”) to fund our operations and we had $174.0 million of FHLB advances outstanding at December 31, 2022. Additionally, in recent years, we have also accepted brokered deposits as a non-retail funding source to fund our operations. At December 31, 2022 we had $100.8 million of brokered deposits.
For the years ended December 31, 2022 and 2021, we had net income of $2.7 million and $4.0 million, respectively. Our 2022 net income was affected by an after-tax charge of $2.3 million related to a charitable contribution to the Everett Co-operative Bank Charitable Foundation. Our 2021 net income was affected by an after-tax charge of $1.4 million related to our freezing of and withdrawal from a defined benefit plan. Our current business strategy includes continuing to focus on originating and growing our commercial real estate, multifamily real estate and construction loan portfolios and the origination of one- to four-family residential real estate loans.
Our results of operations depend primarily on our net interest income. Net interest income is the difference between the interest income we earn on our interest-earning assets and the interest we pay on our interest-bearing liabilities. Our results of operations also are affected by our provision for loan losses, noninterest income and noninterest expense. Noninterest income currently consists primarily of fees and service charges, gains on sales of loans and income on bank-owned life insurance. Noninterest expense currently consists primarily of expenses related to salary and employee benefits and director fees, occupancy and equipment, data processing, advertising, professional fees, federal deposit insurance assessments, charitable contributions and other general and administrative expenses.
Our results of operations also may be affected significantly by general and local economic and competitive conditions, changes in market interest rates, governmental policies and actions of regulatory authorities.
Business Strategy
Our principal objective is to build long-term value for our shareholders by operating a profitable community-oriented financial institution dedicated to meeting the banking needs of our customers. Highlights of our current business strategy include:
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Continuing to focus on enhancing our commercial real estate and multifamily lending. In order to increase the yield on our loan portfolio and reduce the term to maturity of our loan portfolio, we intend to continue our focus on growing the originations of commercial real estate loans and multifamily loans while maintaining what we believe are prudent underwriting standards and we expect that these loan categories will comprise a greater percentage of our total loan portfolio. In order to execute on this strategy, in January 2022 we hired a new Chief Lending Officer as well as some additional commercial lending and credit analyst personnel throughout the year. The capital raised in the offering has and will continue to allow us to increase our commercial lending capacity by enabling us to originate and retain all or a greater portion of loans that we historically participated out to other local institutions.
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Given that our regulatory loans to one borrower limits have increased with our increase in capital, we have revised our lending policies and loans to one borrower limitations to increase our lending limits and the type and size of loans we choose to originate and hold in our portfolio. Our commercial real estate and multifamily loan portfolios increased to $156.2 million and $242.0 million, respectively, at December 31, 2022 from $100.0 million and $59.5 million, respectively, at December 31, 2021.
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Reduced focus on one- to four-family residential real estate lending. We have been, and will continue to be, a one- to four-family residential real estate lender for borrowers in our market area and such lending will remain a core focus, but we expect that our lending strategy will result in a decrease to one-to-four family residential loans as a percentage of our total loan portfolio as we increase our focus on commercial real estate and multifamily lending. As of December 31, 2022, $355.4 million, or 39.8%, of our total loan portfolio, consisted of one- to four-family residential real estate loans and at that date an additional $27.8 million, or 3.1%, of our total loan portfolio, consisted of home equity lines of credit and loans. We expect that one- to four-family residential real estate lending will remain one of our primary lending activities.
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Maintaining our strong asset quality through prudent loan underwriting. As we seek to grow our loan portfolio, we intend to maintain prudent loan underwriting and credit monitoring processes. At December 31, 2022 and 2021, non-performing assets totaled $656,000 and $982,000, respectively, which represented 0.06% and 0.15% of total assets at those dates, respectively.
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Continuing to attract and retain customers in our market area and build our “core” deposits consisting of interest-bearing and noninterest-bearing checking, savings and money market accounts. Our strategy to enhance and grow our commercial real estate lending in a diligent and orderly manner is also designed to encourage relationship banking and increase our core deposits, including noninterest-bearing transaction accounts, and decrease our dependence on certificates of deposit. We plan to leverage our increased focus on commercial real estate and commercial lending efforts to also increase our opportunities to develop commercial business deposit relationships. Additionally, we believe the recent hire of our Senior Vice President of Retail Operations, who brings 35 years of banking experience to our retail sales and administrative team, will be invaluable to the implementation of the added product delivery channels and technological services such as additional electronic and mobile banking applications, which we believe will increase our core deposits.
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Remaining a community-oriented institution and relying on high quality service to maintain and build a loyal local customer base. We were established in 1890 and have been operating continuously in and around Everett, Massachusetts since that time. By using our recognized brand name and the goodwill developed over years of providing timely, efficient banking services, we believe we have been able to attract a solid base of local retail customers on which to continue to build our banking business. Additionally, we believe that the establishment and funding of the charitable foundation will further promote our relationships and exposure in our market area through our support of charitable organizations operating in our local community now and in the future.
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Expanding our banking franchise as opportunities arise through de novo branching and/or branch acquisitions. We currently operate from our two full-service banking offices. We believe there are branch expansion opportunities that exist within our primary market area. We intend to evaluate branch expansion opportunities, including through establishing one or more de novo branches and/or branch acquisitions as such opportunities arise.
Summary of Significant Accounting Policies
The discussion and analysis of the financial condition and results of operations are based on our consolidated financial statements, which are prepared in conformity with U.S. GAAP. The preparation of these consolidated financial statements requires management to make estimates and assumptions affecting the reported amounts of assets and liabilities, disclosure of contingent assets and liabilities, and the reported amounts of income and expenses. We consider the accounting policies discussed below to be significant accounting policies. The estimates and assumptions that we use are based on historical experience and various other factors and are believed to be reasonable under the circumstances. Actual results may differ from these estimates under different assumptions or conditions, resulting in a change that could have a material impact on the carrying value of our assets and liabilities and our results of operations.
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The JOBS Act contains provisions that, among other things, reduce certain reporting requirements for qualifying public companies. As an “emerging growth company” we have elected to use the extended transition period to delay adoption of new or revised accounting pronouncements applicable to public companies until such pronouncements are made applicable to private companies. Accordingly, our consolidated financial statements may not be comparable to the financial statements of public companies that comply with such new or revised accounting standards.
The following represent our significant accounting policies:
Allowance for Loan Losses. The allowance for loan losses is a reserve for estimated probable credit losses on individually evaluated loans determined to be impaired as well as estimated probable credit losses inherent in the loan portfolio. Actual credit losses, net of recoveries, are deducted from the allowance for loan losses. Loans are charged off when management believes that the collectability of the principal is unlikely. Subsequent recoveries, if any, are credited to the allowance for loan losses. A provision for loan losses, which is a charge against earnings, is recorded to bring the allowance for loan losses to a level that, in management’s judgment, is adequate to absorb probable losses in the loan portfolio. Management’s evaluation process used to determine the appropriateness of the allowance for loan losses is subject to the use of estimates, assumptions, and judgment. The evaluation process involves gathering and interpreting many qualitative and quantitative factors which could affect probable credit losses. Because interpretation and analysis involves judgment, current economic or business conditions can change, and future events are inherently difficult to predict, the anticipated amount of estimated loan losses and therefore the appropriateness of the allowance for loan losses could change significantly.
The allocation methodology applied by ECB Bancorp is designed to assess the appropriateness of the allowance for loan losses and includes allocations for specifically identified impaired loans and loss factor allocations for all remaining loans, with a component primarily based on historical loss rates and a component primarily based on other qualitative factors. The methodology includes evaluation and consideration of several factors, such as, but not limited to, management’s ongoing review and grading of loans, facts and issues related to specific loans, historical loan loss and delinquency experience, trends in past due and non-accrual loans, existing risk characteristics of specific loans or loan pools, the fair value of underlying collateral, current economic conditions and other qualitative and quantitative factors which could affect potential credit losses. While management uses the best information available to make its evaluation, future adjustments to the allowance may be necessary if there are significant changes in economic conditions or circumstances underlying the collectability of loans. Because each of the criteria used is subject to change, the allocation of the allowance for loan losses is made for analytical purposes and is not necessarily indicative of the trend of future loan losses in any particular loan category. The total allowance is available to absorb losses from any segment of the loan portfolio. Management believes the allowance for loan losses was adequate at December 31, 2022. The allowance analysis is reviewed by the board of directors on a quarterly basis in compliance with regulatory requirements. In addition, various regulatory agencies periodically review the allowance for loan losses. As a result of such reviews, we may choose to adjust our allowance for loan losses. However, regulatory agencies are not directly involved in the process of establishing the allowance for loan losses as the process is the responsibility of ECB Bancorp, Inc. and any increase or decrease in the allowance is the responsibility of management.
As noted above, we consider a number of variables in our evaluation of the adequacy of the allowance for loan losses, with one of the more significant variables being delinquency levels in the various segments of our loan portfolio. As of December 31, 2022 and December 31, 2021, $71,000 and $174,000 of our allowance for loan losses reflects the risk relative to portfolio delinquency. Based on our model, if all segments of our loan portfolio experienced delinquency rates of 5% of the outstanding balance of loans, our allowance for loan losses as of December 31, 2022 would have increased by $4.4 million to $11.6 million, holding all other variables constant.
Through December 31, 2022 we followed the incurred loss methodology for determining our allowance for loan losses. We adopted the Current Expected Credit Loss (CECL) methodology on January 1, 2023. This methodology replaces the existing incurred loss and impairment methodology in current GAAP with a methodology referred to as CECL. This methodology reflects expected credit losses and requires consideration of historical experience, current conditions, and reasonable and supportable forecasts of future economic conditions. Financial institutions will now use forward-looking information to estimate the expected credit loss on a loan at the time of origination. Credit losses on available-for-sale debt securities will be measured in a manner similar to current GAAP but will be recognized through an
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allowance rather than as a direct writedown. Upon the adoption of the change in methodology, the change from the incurred loss methodology to the CECL methodology will be recognized through an adjustment to retained earnings. The Company is continuing to evaluate the impact the adoption of this guidance will have on its consolidated financial statements, which is expected to be significant. Management is still finalizing the analysis of its current expected credit loss methodology and has not yet estimated the impact that this guidance will have on our allowance for loan losses.
Income Taxes. We use the liability method of accounting for income taxes. Under this method, deferred tax assets and liabilities are recognized for the future tax consequences attributable to differences between the financial statement carrying amounts of existing assets and liabilities and their respective tax bases. Deferred tax assets and liabilities are measured using enacted tax rates expected to apply to taxable income in the years in which those temporary differences are expected to be recovered or settled. Deferred tax assets are reduced by a valuation allowance when it is more likely than not that some portion of the deferred tax asset will not be realized. We exercise significant judgment in evaluating the amount and timing of recognition of the resulting tax liabilities and assets. These judgments may require us to make projections of future taxable income and/or to carryback to taxable income in prior years. The judgments and estimates we make in determining our deferred tax assets, which are inherently subjective, are reviewed on a continual basis as regulatory and business factors change. Any reduction in estimated future taxable income may require us to record a valuation allowance against our deferred tax assets.
Securities Valuation and Impairment. We classify our investments in debt securities as either held-to-maturity or available-for-sale. Securities classified as held-to maturity are recorded at cost or amortized cost. Available-for-sale securities are carried at fair value. We obtain our fair values from one or more third-party services. This service’s fair value calculations are based on quoted market prices when such prices are available. If quoted market prices are not available, estimates of fair value are computed using a variety of techniques, including extrapolation from the quoted prices of similar instruments or recent trades for thinly traded securities, fundamental analysis, or through obtaining purchase quotes. Due to the subjective nature of the valuation process, it is possible that the actual fair values of these investments could differ from the estimated amounts, thereby affecting our financial position, results of operations and cash flows. For any debt security with a fair value less than its amortized cost basis, we will determine whether we have the intent to sell the debt security or whether it is more likely than not we will be required to sell the debt security before the recovery of its amortized cost basis. If either condition is met, the Company will recognize a full impairment charge to earnings. For all other debt securities that are considered other-than-temporarily impaired and do not meet either condition, the credit loss portion of impairment will be recognized in earnings as realized losses. The other-than-temporary impairment related to all other factors will be recorded in other comprehensive income (loss). We also consider how long a security has been in a loss position in determining if it is other than temporarily impaired. Management also assesses the nature of the unrealized losses taking into consideration factors such as changes in risk-free interest rates, general credit spread widening, market supply and demand, creditworthiness of the issuer, and quality of the underlying collateral.
Comparison of Financial Condition at December 31, 2022 and December 31, 2021
Total Assets. Total assets increased $398.0 million, or 59.7%, to $1.06 billion at December 31, 2022 from $666.5 million at December 31, 2021. The increase was primarily the result of increases in loans, held-to-maturity securities, cash and cash equivalents and Federal Home Loan Bank stock.
Cash and Cash Equivalents. Cash and cash equivalents increased $9.1 million, or 17.1%, to $62.1 million at December 31, 2022 from $53.0 million at December 31, 2021, primarily due to an increase in proceeds from the offering, increases in deposits and FHLB advances, partially offset by funding loan growth and purchases of investment securities held-to-maturity.
Securities Held-To-Maturity. Securities held-to-maturity increased $12.0 million, or 18.3%, to $77.6 million at December 31, 2022 from $65.6 million at December 31, 2021, primarily due to purchases of securities of $22.6 million partially offset by principal repayments of $10.4 million.
Loans. Loans increased $368.5 million, or 71.3%, to $885.7 million at December 31, 2022 from $517.1 million at December 31, 2021. The largest increases in our loan portfolio were in the multi-family real estate loans, one- to four-family residential real estate loans, commercial real estate loans and construction loans. Multi-family real estate loans
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increased $182.4 million, or 306.5%, from December 31, 2021 to December 31, 2022, one- to four- family residential real estate loans increased $95.7 million, or 36.9%, from December 31, 2021 to December 31, 2022, commercial real estate loans increased $56.3 million, or 56.3%, to $156.2 million at December 31, 2022 from $100.0 million at December 31, 2021 and construction loans increased $36.6 million, or 51.9%, from $70.7 million at December 31, 2021 to $107.3 million at December 31, 2022. The increase in these loan portfolios reflects our strategy to grow the balance sheet by continuing to diversify into higher-yielding commercial real estate and multi-family real estate loans to improve net margins and manage interest rate risk. In addition, to help manage interest rate risk and generate non-interest income, we sell one- to four-family residential mortgage loans into the secondary market on a servicing-released basis. During the year ended December 31, 2022, we sold $5.8 million in loans and recognized gains of $84,000.
Federal Home Loan Bank stock. The Federal Home Loan Bank (FHLB) is a cooperative bank that provides services to its member banking institutions. The primary reason for our membership in the FHLB is to gain access to a reliable source of wholesale funding and as a tool to manage interest rate risk. The purchase of stock in the FHLB is a requirement for a member to gain access to funding. We purchase and/or are subject to redemption of FHLB stock proportional to the volume of funding received and view the holdings as a necessary long-term investment for the purpose of balance sheet liquidity and not for investment return. We held an investment in FHLB stock of $7.3 million and $1.1 million at December 31, 2022 and 2021, respectively. The amount of stock we are required to purchase is in proportion to our FHLB borrowings and level of total assets. Accordingly, the increase in the FHLB stock is due to increased borrowing.
Bank-owned Life Insurance. We invest in bank-owned life insurance to help offset the costs of our employee benefit plan obligations. Bank-owned life insurance also generally provides noninterest income that is nontaxable. Bank-owned life insurance decreased $68,000, or 0.5%, to $14.1 million at December 31, 2022 from $14.1 million at December 31, 2021. The decrease was due to a reduction of our cash surrender value of $466,000 related to policy claims due to the death of an insured individual. Partially offsetting the decrease to cash surrender value, we recognized $398,000 from the increase in cash surrender value of our bank-owned life insurance portfolio during the year ended December 31, 2022.
Deposits. Deposits increased $146.4 million, or 25.6%, to $718.1 million at December 31, 2022 from $571.8 million at December 31, 2021. Core deposits (defined as all deposits other than certificates of deposit and brokered deposits) increased $53.4 million, or 15.5%, to $398.3 million at December 31, 2022 from $344.9 million at December 31, 2021. This increase was primarily a result of a $98.3 million, or 196.4%, increase in savings accounts to $148.4 million at December 31, 2022 from $50.0 million at December 31, 2021 partially offset by a $47.1 million, or 25.7%, decrease in money market accounts to $136.1 million at December 31, 2022 from $183.2 million at December 31, 2021. Certificates of deposit increased $93.0 million, or 41.0%, to $319.8 million at December 31, 2022 from $226.8 million at December 31, 2021. At December 31, 2022 and 2021, we had $100.8 million and $19.9 million of brokered deposits, respectively.
Federal Home Loan Bank Advances. Advances from the Federal Home Loan Bank increased $165.0 million, or 1,833.3%, to $174.0 million at December 31, 2022 from $9.0 million at December 31, 2021. The increase in FHLB advances was utilized to support loan growth during the year ended December 31, 2022.
Shareholders' Equity. Total shareholders' equity increased $85.5 million, or 110.6%, to $162.7 million at December 31, 2022 from $77.3 million at December 31, 2021. The increase was primarily due to net offering proceeds received in connection with the conversion offering which closed in July 2022 of $79.2 million, $2.6 million in equity that was contributed to the Everett Co-operative Bank Charitable Foundation, and net income of $2.7 million for the year ended December 31, 2022.
Comparison of Operating Results for the Years Ended December 31, 2022 and December 31, 2021
Net Income. Net income was $2.7 million for the year ended December 31, 2022, compared to net income of $4.0 million for the year ended December 31, 2021, a decrease of $1.3 million, or 32.7%. The decrease was primarily due to a $4.5 million increase in noninterest expense, offset in part by a $2.4 million increase in net interest and dividend income after provision for loan losses.
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Interest and Dividend Income. Interest and dividend income increased $6.8 million, or 30.3%, to $29.1 million for the year ended December 31, 2022 from $22.4 million for the year ended December 31, 2021, primarily due to a $5.6 million increase in interest and fees on loans. The increase in interest and fees on loans was driven by an increase of $146.4 million in the average balance of the loan portfolio to $643.3 million for the year ended December 31, 2022 from $496.9 million for the year ended December 31, 2021, partially offset by a decrease in the yield by 10 basis points from 4.29% during the year ended December 31, 2021 to 4.19% during the year ended December 31, 2022. The yield for the year ended December 31, 2021 benefited from $653,000 in loan prepayment penalties as well as $332,000 in PPP loan fee income as compared to $66,000 in prepayment penalties and $135,000 in PPP loan fee income recognized during the year ended December 31, 2022.
Interest and dividends on securities increased $476,000, or 47.0% from $1.0 million for the year ended December 31, 2021 to $1.5 million for the year ended December 31, 2022. This increase was driven by an increase in the yield of investment securities held-to-maturity and available-for-sale of 36 basis points from 1.49% for the year ended December 31, 2021 to 1.85% for the year ended December 31, 2022 as well as an increase in the average balance of $8.5 million from $66.4 million during the year ended December 31, 2021 to $75.0 million during the year ended December 31, 2022. In addition, during the year ended December 31, 2022, we recognized interest and dividends of $101,000 on cost method investments as compared to interest and dividends of $24,000 recognized for the year ended December 31, 2021.
Other interest income increased $671,000, or 1,525% from $44,000 for the year ended December 31, 2021 to $715,000 for the year ended December 31, 2022. This increase was due to the yield on short term investments increasing by 1.61% from 0.10% for the year ended December 31, 2021 to 1.71% for the year ended December 31, 2022.
Average interest-earning assets increased $153.6 million, to $760.3 million for the year ended December 31, 2022 from $606.7 million for the year ended December 31, 2021. The yield on interest earning-assets increased by 14 basis points to 3.82% for the year ended December 31, 2022 from 3.68% for the year ended December 31, 2021.
Interest Expense. Total interest expense increased $1.8 million, or 49.8%, to $5.5 million for the year ended December 31, 2022 from $3.7 million for the year ended December 31, 2021. Interest expense on deposit accounts increased $1.0 million, or 28.8%, to $4.6 million for the year ended December 31, 2022 from $3.5 million for the year ended December 31, 2021, due to an increase in the weighted average rate on interest-bearing deposits to 0.85% for the year ended December 31, 2022 from 0.77% for the year ended December 31, 2021, as well as an increase in the average balance of interest-bearing deposits of $77.9 million, or 16.9% to $538.1 million for the year ended December 31, 2022 from $460.2 million for the year ended December 31, 2021.
Interest expense on Federal Home Loan Bank advances increased $813,000, or 602.2%, to $948,000 for the year ended December 31, 2022 from $135,000 for the year ended December 31, 2021. The average balance of Federal Home Loan Bank advances increased $27.5 million, or 222.5%, to $39.9 million for the year ended December 31, 2022 from $12.4 million for the year ended December 31, 2021. The average balance increased as we utilized advances to fund loan growth. For the year ended December 31, 2022, the weighted average cost of Federal Home Loan Advances was 2.38%, as compared to 1.09% for the year ended December 31, 2021.
Net Interest and Dividend Income. Net interest and dividend income increased $4.9 million, or 26.4%, to $23.6 million for the year ended December 31, 2022 from $18.7 million for the year ended December 31, 2021, primarily due to a $153.6 million increase in the average balance of interest-earning assets during the year ended December 31, 2022, together with an increase in the net interest margin to 3.10% for the year ended December 31, 2022 from 3.08% for the year ended December 31, 2021. The improvement in the net interest margin was largely due to the interest earning asset growth that was funded with the zero cost capital that was raised in the stock offering. The interest rate spread declined by 0.03% to 2.87% for the year ended December 31, 2022 from 2.90% for the year ended December 31, 2021. The decrease in the interest rate spread was due to an increase in the cost of interest-bearing liabilities that exceeded the increase in the yield on interest earning assets.
Provision for Loan Losses. Based on management’s analysis of the adequacy of the allowance for loan losses, a provision of $2.9 million was recorded for the year ended December 31, 2022, compared to a provision of $360,000 for
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the year ended December 31, 2021. The $2.6 million, or 716.7%, increase in the provision was primarily due to loan portfolio growth.
Noninterest Income. Noninterest income increased $179,000, or 14.6%, to $1.4 million for the year ended December 31, 2022 from $1.2 million for the year ended December 31, 2021. The increase was driven by $430,000 of gains recognized into income from life insurance policy death benefits. Partially offsetting this increase was a decrease of $362,000 in net gains on sales of loans due to the current interest rate environment and lower originations of saleable loans. The table below sets forth our noninterest income for the years ended December 31, 2022 and 2021:
| Year Ended December 31, | Change | ||||||||||||||||
|---|---|---|---|---|---|---|---|---|---|---|---|---|---|---|---|---|---|
| 2022 | 2021 | Amount | Percent | ||||||||||||||
| (Dollars in thousands) | |||||||||||||||||
| Customer service fees | $ | 446 | $ | 393 | $ | 53 | 13.5 | % | |||||||||
| Income from bank-owned life insurance | 828 | 355 | 473 | 133.2 | |||||||||||||
| Net gain on sales of loans | 84 | 446 | (362 | ) | (81.2 | ) | |||||||||||
| Other | 43 | 28 | 15 | 53.6 | |||||||||||||
| Total noninterest income | $ | 1,401 | $ | 1,222 | $ | 179 | 14.6 | % |
Noninterest Expense. Noninterest expense increased $4.5 million, or 32.0%, to $18.6 million for the year ended December 31, 2022 from $14.1 million for the year ended December 31, 2021. The increase was primarily due to an increase in charitable contributions to $3.3 million for the year ended December 31, 2022 from $54,000 for the year ended December 31, 2021 resulting from a $3.2 million contribution to the Everett Co-operative Bank Charitable Foundation, representing 260,000 shares of our common stock and $600,000 in cash contributed as part of our initial public offering. Professional fees and other expenses increased by $364,000, or 75.5%, and $388,000, or 36.7%, respectively, primarily due to operating a publicly traded company and implementing our growth strategy. FDIC assessments increased $69,000, or 44.2%. This increase was primarily due to asset growth. We expect FDIC assessment costs to continue to increase as the FDIC has increased assessment rates for all banks beginning in the first quarter of 2023. The table below sets forth our noninterest expense for the years ended December 31, 2022 and 2021:
| Year Ended December 31, | Change | ||||||||||||||||
|---|---|---|---|---|---|---|---|---|---|---|---|---|---|---|---|---|---|
| 2022 | 2021 | Amount | Percent | ||||||||||||||
| (Dollars in thousands) | |||||||||||||||||
| Salaries and employee benefits | $ | 9,928 | $ | 9,599 | $ | 329 | 3.4 | % | |||||||||
| Director Compensation | 429 | 430 | (1 | ) | (0.3 | ) | |||||||||||
| Occupancy and equipment | 766 | 721 | 45 | 6.2 | |||||||||||||
| Data processing | 704 | 684 | 20 | 2.9 | |||||||||||||
| Computer software and licensing fees | 247 | 253 | (6 | ) | (2.4 | ) | |||||||||||
| Advertising and promotions | 752 | 648 | 104 | 16.0 | |||||||||||||
| Professional fees | 846 | 482 | 364 | 75.5 | |||||||||||||
| FDIC Assessment | 225 | 156 | 69 | 44.2 | |||||||||||||
| Charitable contributions | 3,256 | 54 | 3,202 | 5,929.6 | |||||||||||||
| Other expense | 1,446 | 1,058 | 388 | 36.7 | |||||||||||||
| Total noninterest expense | $ | 18,599 | $ | 14,085 | $ | 4,514 | 32.0 | % |
Income Tax Expense. Income tax expense decreased $653,000, or 45.7%, to $776,000 for the year ended December 31, 2022 from $1.4 million for the year ended December 31, 2021. The effective tax rate was 22.2% and 26.1% for the years ended December 31, 2022 and 2021, respectively. The decrease in the effective tax rate was driven by increased non-taxable income from bank-owned life insurance in 2022 as compared to 2021.
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Average Balances and Yields. The following table sets forth average balance sheets, average yields and costs, and certain other information for the years indicated. Average balances are daily average balances. Non-accrual loans are included in average balances only. Average yields include the effect of deferred costs and fees, discounts, and premiums that are amortized or accreted to interest income or interest expense.
| For the Year Ended December 31, | ||||||||||||||||||||||||||
|---|---|---|---|---|---|---|---|---|---|---|---|---|---|---|---|---|---|---|---|---|---|---|---|---|---|---|
| 2022 | 2021 | |||||||||||||||||||||||||
| Average Outstanding Balance | Interest | Yield/ Rate(5) | Average Outstanding Balance | Interest | Yield/ Rate(5) | |||||||||||||||||||||
| (Dollars in thousands) | ||||||||||||||||||||||||||
| Interest-earning assets: | ||||||||||||||||||||||||||
| Total loans | $ | 643,298 | $ | 26,946 | 4.19 | % | $ | 496,915 | $ | 21,319 | 4.29 | % | ||||||||||||||
| Securities (1) | 74,950 | 1,387 | 1.85 | 66,420 | 988 | 1.49 | ||||||||||||||||||||
| Short term investments | 41,831 | 713 | 1.71 | 43,375 | 44 | 0.10 | ||||||||||||||||||||
| Interest bearing time deposits | 238 | 2 | 0.71 | — | — | — | ||||||||||||||||||||
| Total interest-earning assets | 760,317 | 29,048 | 3.82 | % | 606,710 | 22,351 | 3.68 | % | ||||||||||||||||||
| Non-interest-earning assets | 27,486 | 23,140 | ||||||||||||||||||||||||
| Total assets | $ | 787,803 | $ | 629,850 | ||||||||||||||||||||||
| Interest-bearing liabilities: | ||||||||||||||||||||||||||
| Regular savings accounts | $ | 70,106 | $ | 461 | 0.66 | % | $ | 47,042 | $ | 30 | 0.06 | % | ||||||||||||||
| Checking accounts | 35,900 | 29 | 0.08 | 25,837 | 59 | 0.23 | ||||||||||||||||||||
| Money market accounts | 177,549 | 864 | 0.49 | 163,933 | 555 | 0.34 | ||||||||||||||||||||
| Certificates of deposit | 254,543 | 3,212 | 1.26 | 223,366 | 2,902 | 1.30 | ||||||||||||||||||||
| Total interest-bearing deposits | 538,098 | 4,566 | 0.85 | 460,178 | 3,546 | 0.77 | ||||||||||||||||||||
| Federal Home Loan Bank advances | 39,859 | 948 | 2.38 | 12,359 | 135 | 1.09 | ||||||||||||||||||||
| Other borrowings | 27 | 1 | 3.70 | — | — | — | ||||||||||||||||||||
| Total interest-bearing liabilities | 577,984 | 5,515 | 0.95 | % | 472,537 | 3,681 | 0.78 | % | ||||||||||||||||||
| Non-interest-bearing demand deposits | 86,646 | 76,290 | ||||||||||||||||||||||||
| Non-interest-bearing liabilities | 8,344 | 5,309 | ||||||||||||||||||||||||
| Total liabilities | 672,974 | 554,136 | ||||||||||||||||||||||||
| Shareholders' Equity | 114,829 | 75,714 | ||||||||||||||||||||||||
| Total liabilities and shareholders' equity | $ | 787,803 | $ | 629,850 | ||||||||||||||||||||||
| Net interest income | $ | 23,533 | $ | 18,670 | ||||||||||||||||||||||
| Net interest rate spread (2) | 2.87 | % | 2.90 | % | ||||||||||||||||||||||
| Net interest-earning assets (3) | $ | 182,333 | $ | 134,173 | ||||||||||||||||||||||
| Net interest margin (4) | 3.10 | % | 3.08 | % | ||||||||||||||||||||||
| Average interest-earning assets to interest- bearing liabilities | 131.55 | % | 128.39 | % |
(1)
Excludes FHLB stock dividends of $52,000 and $22,000 for the years ended December 31, 2022 and December 31, 2021, respectively, and $49,000 and $2,000 of interest and dividends on cost method investments recorded within other assets for the years ended December 31, 2022 and December 31, 2021, respectively.
(2)
Net interest rate spread represents the difference between the weighted average yield on interest-earning assets and the weighted average rate of interest-bearing liabilities.
(3)
Net interest-earning assets represent total interest-earning assets less total interest-bearing liabilities.
(4)
Net interest margin represents net interest income divided by average total interest-earning assets.
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Rate/Volume Analysis. The following tables present the effects of changing rates and volumes on our net interest income for the periods indicated. The rate column shows the effects attributable to changes in rate (changes in rate multiplied by prior period volume). The volume column shows the effects attributable to changes in volume (changes in volume multiplied by prior rate). The total column represents the sum of the prior columns. For purposes of this table, changes attributable to both rate and volume, which cannot be segregated, have been allocated proportionately based on the changes due to rate and the changes due to volume. There were no out-of-period items or adjustments required to be excluded from the table below.
| Years Ended December 31, 2022 vs. 2021 | ||||||||||||
|---|---|---|---|---|---|---|---|---|---|---|---|---|
| Increase (Decrease) Due to | Total Increase | |||||||||||
| Volume | Rate | (Decrease) | ||||||||||
| (In thousands) | ||||||||||||
| Interest-earning assets: | ||||||||||||
| Loans | $ | 6,143 | $ | (516 | ) | $ | 5,627 | |||||
| Securities | 138 | 261 | 399 | |||||||||
| Short term investments | (2 | ) | 671 | 669 | ||||||||
| Interest bearing time deposits | 2 | - | 2 | |||||||||
| Total interest-earning assets | $ | 6,281 | $ | 416 | $ | 6,697 | ||||||
| Interest-bearing liabilities: | ||||||||||||
| Interest-bearing demand deposits | $ | 17 | $ | (47 | ) | $ | (30 | ) | ||||
| Regular savings and other deposits | 22 | 409 | 431 | |||||||||
| Money market deposits | 49 | 260 | 309 | |||||||||
| Certificates of deposit | 395 | (85 | ) | 310 | ||||||||
| Total deposits | 483 | 537 | 1,020 | |||||||||
| Advances from the Federal Home Loan Bank | 532 | 281 | 813 | |||||||||
| Other interest-bearing liabilities | 1 | - | 1 | |||||||||
| Total interest-bearing liabilities | $ | 1,016 | $ | 818 | $ | 1,834 | ||||||
| Change in net interest income | $ | 5,265 | $ | (402 | ) | $ | 4,863 |
Management of Market Risk
General. Our most significant form of market risk is interest rate risk because, as a financial institution, the majority of our assets and liabilities are sensitive to changes in interest rates. Therefore, a principal part of our operations is to manage interest rate risk and limit the exposure of our financial condition and results of operations to changes in market interest rates. Our chief financial officer is responsible for evaluating the interest rate risk inherent in our assets and liabilities, for determining the level of risk that is appropriate, given our business strategy, operating environment, capital, liquidity and performance objectives, and for managing this risk consistent with the policy and guidelines approved by our board of directors. We currently utilize a third-party modeling program, prepared on a quarterly basis, to evaluate our sensitivity to changing interest rates, given our business strategy, operating environment, capital, liquidity and performance objectives, and for managing this risk consistent with the guidelines approved by the board of directors.
We have sought to manage our interest rate risk in order to minimize the exposure of our earnings and capital to changes in interest rates. We have implemented the following strategies to manage our interest rate risk:
•
maintaining capital levels that exceed the thresholds for well-capitalized status under federal regulations;
•
maintaining a prudent level of liquidity;
•
growing our volume of core deposit accounts;
•
managing our investment securities portfolio to maintain a prudent balance between enhancing profitability and protecting the balance sheet against sensitivity to changes in interest rates;
•
managing our utilization of wholesale funding with borrowings from the Federal Home Loan Bank and brokered deposits in a prudent manner; and
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•
continuing to diversify our loan portfolio by adding more commercial-related loans, which typically have shorter maturities and/or balloon payments.
By following these strategies, we believe that we are better positioned to react to increases and decreases in market interest rates.
We have not engaged in hedging activities, such as engaging in swaps, futures or options. We may consider these activities in the future.
Net Interest Income. We analyze our sensitivity to changes in interest rates through a net interest income model. Net interest income is the difference between the interest income we earn on our interest-earning assets, such as loans and securities, and the interest we pay on our interest-bearing liabilities, such as deposits and borrowings. We estimate what our net interest income would be for a 12-month period. We then calculate what the net interest income would be for the same period under the assumptions that the United States Treasury yield curve increases or decreases instantaneously by various basis point increments, with changes in interest rates representing immediate and permanent, parallel shifts in the yield curve. A basis point equals one-hundredth of one percent, and 100 basis points equals one percent. An increase in interest rates from 3% to 4% would mean, for example, a 100-basis point increase in the “Change in Interest Rates” column below.
The table below sets forth, as of December 31, 2022, the calculation of the estimated changes in our net interest income that would result from the designated immediate changes in the United States Treasury yield curve.
| As of December 31, 2022 | ||||||||
|---|---|---|---|---|---|---|---|---|
| Change in Interest Rates (basis points) (1) | Net Interest Income Year 1 Forecast | Year 1 Change from Level | ||||||
| (Dollars in thousands) | ||||||||
| 400 | 21,237 | -18.9 | % | |||||
| 300 | 22,448 | -14.3 | % | |||||
| 200 | 23,657 | -9.7 | % | |||||
| 100 | 24,984 | -4.6 | % | |||||
| Level | 26,201 | 0.0 | % | |||||
| -100 | 26,746 | 2.1 | % | |||||
| -200 | 26,770 | 2.2 | % | |||||
| -300 | 26,983 | 3.0 | % | |||||
| -400 | 27,446 | 4.8 | % |
____________________
1.
Assumes an immediate uniform change in interest rates at all maturities.
The tables above indicate that at December 31, 2022, in the event of an instantaneous parallel 200 basis point increase in interest rates, we would experience a decrease in net interest income of 9.7%, and in the event of an instantaneous 200 basis point decrease in interest rates, we would experience a 2.2% increase in net interest income.
Economic Value of Equity. We also compute amounts by which the net present value of our assets and liabilities (economic value of equity or “EVE”) would change in the event of a range of assumed changes in market interest rates. This model uses a discounted cash flow analysis and an option-based pricing approach to measure the interest rate sensitivity of net portfolio value. The model estimates the economic value of each type of asset, liability and off-balance sheet contract under the assumptions that the United States Treasury yield curve increases instantaneously by 100, 200, 300 and 400 basis point increments or decreases instantaneously by 100 basis point increments, with changes in interest rates representing immediate and permanent, parallel shifts in the yield curve.
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The table below sets forth, as of December 31, 2022, the calculation of the estimated changes in our EVE that would result from the designated immediate changes in the United States Treasury yield curve.
| As of December 31, 2022 | ||||||||||||||||||||||
|---|---|---|---|---|---|---|---|---|---|---|---|---|---|---|---|---|---|---|---|---|---|---|
| Estimated Increase (Decrease) in EVE | EVE as a Percentage of Present Value of Assets (3) | |||||||||||||||||||||
| Change in Interest Rates (basis points) (1) | Estimated EVE (2) | Amount | Percent | EVE Ratio (4) | Increase (Decrease) (basis points) | |||||||||||||||||
| (Dollars in thousands) | ||||||||||||||||||||||
| 400 | 87,366 | (44,808 | ) | -33.9 | % | 9.6 | % | (340 | ) | |||||||||||||
| 300 | 97,712 | (34,462 | ) | -26.1 | % | 10.4 | % | (255 | ) | |||||||||||||
| 200 | 108,705 | (23,469 | ) | -17.8 | % | 11.3 | % | (169 | ) | |||||||||||||
| 100 | 121,322 | (10,852 | ) | -8.2 | % | 12.2 | % | (75 | ) | |||||||||||||
| — | 132,174 | 0 | 0.0 | % | 13.0 | % | 0 | |||||||||||||||
| -100 | 138,747 | 6,573 | 5.0 | % | 13.3 | % | 30 | |||||||||||||||
| -200 | 141,834 | 9,660 | 7.3 | % | 13.2 | % | 28 | |||||||||||||||
| -300 | 143,814 | 11,640 | 8.8 | % | 13.1 | % | 14 | |||||||||||||||
| -400 | 136,912 | 4,738 | 3.6 | % | 12.3 | % | (71 | ) |
(1)
Assumes an immediate uniform change in interest rates at all maturities.
(2)
EVE is the discounted present value of expected cash flows from assets, liabilities and off-balance sheet contracts.
(3)
Present value of assets represents the discounted present value of incoming cash flows on interest-earning assets.
(4)
EVE Ratio represents EVE divided by the present value of assets.
The table above indicates that at December 31, 2022, in the event of an instantaneous parallel 200 basis point increase in interest rates, we would experience a 17.8% decrease in EVE, and in the event of an instantaneous 200 basis point decrease in interest rates, we would experience a 7.3% increase in EVE.
Certain shortcomings are inherent in the methodologies used in the above interest rate risk measurements. Modeling changes require making certain assumptions that may or may not reflect the manner in which actual yields and costs respond to changes in market interest rates. The net interest income and net economic value tables presented assume that the composition of our interest-sensitive assets and liabilities existing at the beginning of a period remains constant over the period being measured and assumes that a particular change in interest rates is reflected uniformly across the yield curve regardless of the duration or repricing of specific assets and liabilities. Accordingly, although the tables provide an indication of our interest rate risk exposure at a particular point in time, such measurements are not intended to and do not provide a precise forecast of the effect of changes in market interest rates, and actual results may differ.
Interest rate risk calculations also may not reflect the fair values of financial instruments. For example, increases in market interest rates can decrease the fair values of our loans but increase the fair value of deposits and borrowings.
Liquidity and Capital Resources
Liquidity describes our ability to meet the financial obligations that arise in the ordinary course of business. Liquidity is primarily needed to meet the borrowing and deposit withdrawal requirements of our customers and to fund current and planned expenditures. Our primary sources of funds are deposits, principal and interest payments on loans and securities, and proceeds from maturities of securities. We are also able to borrow from the Federal Home Loan Bank of Boston. At December 31, 2022, we had outstanding advances of $174.0 million from the Federal Home Loan Bank. At December 31, 2022, we had unused borrowing capacity of $84.8 million with the Federal Home Loan Bank and $10.0 million with the Atlantic Community Bankers Bank.
While maturities and scheduled amortization of loans and securities are predictable sources of funds, deposit flows and loan prepayments are greatly influenced by general interest rates, economic conditions, and competition. Our most liquid assets are cash and short-term investments. The levels of these assets are dependent on our operating, financing, and investing activities during any given period.
Our cash flows are comprised of three primary classifications: cash flows from operating activities, investing activities, and financing activities.
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At December 31, 2022, we had $43.9 million in loan commitments outstanding. In addition to commitments to originate and purchase loans, we had $80.2 million in unused lines of credit to borrowers and $72.4 million in unadvanced construction loans.
Certificates of deposit due within one year of December 31, 2022 totaled $183.4 million, or 25.5%, of total deposits. If these deposits do not remain with us, we may be required to seek other sources of funds, including brokered deposits and FHLB advances. Depending on market conditions, we may be required to pay higher rates on such deposits or other borrowings than we currently pay on the certificates of deposit due on or before December 31, 2023, or on our savings and money market accounts.
We believe, however, based on historical experience and current market interest rates that we will retain upon maturity a large portion of our certificates of deposit with maturities of one year or less as of December 31, 2022.
Our primary investing activity is originating loans. During the years ended December 31, 2022 and 2021, we originated and purchased $557.5 million and $254.6 million of loans, respectively.
Financing activities consist primarily of activity in deposit accounts, as well as both FHLB advances and brokered deposits. We experienced net increases in deposits of $146.4 million and $80.3 million for the years ended December 31, 2022 and 2021, respectively. Deposit flows are affected primarily by the overall level of interest rates and the interest rates and products offered by us and our competitors. At December 31, 2022 and 2021, the level of brokered time deposits was $100.8 million and $19.9 million, respectively. At December 31, 2022 and 2021 the level of FHLB advances was $174.0 million and $9.0 million, respectively.
For additional information, see the consolidated statements of cash flows for the years ended December 31, 2022 and 2021 included as part of the consolidated financial statements appearing elsewhere in this 10-K.
We are committed to maintaining a strong liquidity position. We monitor our liquidity position on a daily basis. We anticipate that we will have sufficient funds to meet our current funding commitments. Based on our deposit retention experience and current pricing strategy, we anticipate that a significant portion of maturing time deposits will be retained.
At December 31, 2022, Everett Co-operative Bank exceeded all of its regulatory capital requirements, and was categorized as well-capitalized at that date. Management is not aware of any conditions or events since the most recent notification of well-capitalized status that would change our category. See Note 14 of the notes to consolidated financial statements.
Off-Balance Sheet Arrangements and Aggregate Contractual Obligations
Commitments. As a financial services provider, we routinely are a party to various financial instruments with off-balance-sheet risks, such as commitments to extend credit and unused lines of credit. While these contractual obligations represent our future cash requirements, a significant portion of commitments to extend credit may expire without being drawn upon. Such commitments are subject to the same credit policies and approval process accorded to loans we make. At December 31, 2022, we had outstanding commitments to originate and purchase loans of $43.9 million. We anticipate that we will have sufficient funds available to meet our current lending commitments. Time deposits that are scheduled to mature in less than one year from December 31, 2022 totaled $183.4 million. Management expects that a substantial portion of these time deposits will be retained. However, if a substantial portion of these time deposits is not retained, we may utilize advances from the Federal Home Loan Bank, brokered deposits or raise interest rates on deposits to attract new accounts, which may result in higher levels of interest expense.
Contractual Obligations. In the ordinary course of our operations, we enter into certain contractual obligations. Such obligations include data processing services, operating leases for premises and equipment, agreements with respect to borrowed funds and deposit liabilities.
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Recent Accounting Pronouncements
See Note 2 to the notes to the consolidated financial statements for a description of recent accounting pronouncements that may affect our financial condition and results of operations.
Impact of Inflation and Changing Price
The consolidated financial statements and related data presented in this 10-K have been prepared in accordance with U.S. GAAP, which requires the measurement of financial position and operating results in terms of historical dollars without considering changes in the relative purchasing power of money over time due to inflation. The primary impact of inflation on our operations is reflected in increased operating costs. Unlike most industrial companies, virtually all of the assets and liabilities of a financial institution are monetary in nature. As a result, interest rates, generally, have a more significant impact on a financial institution’s performance than does inflation. Interest rates do not necessarily move in the same direction or to the same extent as the prices of goods and services.