Rhinebeck Bancorp, Inc. (RBKB)

Item 7.    Management’s Discussion and Analysis of Financial Condition and Results of Operations

This discussion and analysis reflects information contained in our audited consolidated 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 consolidated financial statements contained within this Form 10-K.

Overview

Net Interest Income. Our primary source of income is net interest income. Net interest income is the difference between interest income, which is the income we earn on our loans and investments, and interest expense, which is the interest we pay on our deposits and borrowings.

Provision for Credit Losses. The allowance for credit losses is a valuation allowance for the estimated lifetime credit losses. The allowance for credit losses is increased through charges to the provision for credit losses. Loans are charged against the allowance when management believes that the collectability of the principal loan amount is not probable. Recoveries on loans previously charged-off, if any, are credited to the allowance for credit losses when realized.

Non-Interest Income. Our primary sources of non-interest income are service charges on deposit accounts, investment advisory income, net gains in the cash surrender value of bank owned life insurance and other income.

Non-Interest Expenses. Our non-interest expenses consist of salaries and employee benefits, net occupancy and equipment, data processing, professional fees, marketing expenses, premium payments we make to the FDIC for insurance of our deposits and other general and administrative expenses.

Income Tax Expense. Our income tax expense is the total of the current year income tax due or refundable and the change in deferred tax assets and liabilities. Deferred tax assets and liabilities are the expected future tax amounts for the temporary differences between the carrying amounts and the tax basis of assets and liabilities, computed using enacted tax rates. A valuation allowance, if needed, reduces deferred tax assets to the amounts expected to be realized.

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Business Strategy

Based on an extensive review of the current opportunities in our primary market area as well as our resources and capabilities, we are pursuing the following business strategies:

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Significant Accounting Policies, Critical Accounting Estimates

Our most significant accounting policies are described in Note 1 to the consolidated financial statements.  Certain of these accounting policies require management to use significant judgment and estimates, which can have a material impact on the carrying value of certain assets and liabilities, and we consider these policies to be our critical accounting estimates.  The judgment and assumptions made are based upon historical experience, future forecasts, or other factors that management believes to be reasonable under the circumstances.  Because of the nature of the judgment and assumptions, actual results could differ from estimates, which could have a material effect on our financial condition and results of operations.

The following accounting policies materially affect our reported earnings and financial condition and require significant judgments and estimates.

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Allowance for Credit Losses

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The allowance for credit losses is an estimate of current expected credit losses considering available information relevant to assessing collectability of cash flows over the contractual term of the financial assets necessary to cover lifetime expected credit losses inherent in financial assets at the balance sheet date. The methodology for determining the allowance for credit losses is considered a critical accounting policy by management because of the high degree of judgment involved, the subjectivity of the assumptions used, and the potential for changes in the forecasted economic environment that could result in changes to the amount of the recorded allowance for credit losses. The loan portfolio also represents the largest asset type on the Company’s Consolidated Statements of Financial Condition.

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Our methodology for estimating lifetime expected credit losses for our loan portfolio includes the following key components:

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The Company’s allowance for credit losses for loans totaled $8.5 million and $8.1 million as of December 31, 2024 and December 31, 2023, respectively. The $415,000 increase in our allowance for credit losses for loans was primarily driven by an increase in our collectively evaluated loans, partially offset by a decrease in the allowance for credit losses on individually analyzed loans.

The quantitative component of our allowance for credit losses on collectively evaluated loans, which is largely based on a selection of various economic forecasts, decreased by $151,000 as of December 31, 2024, when compared to December 31, 2023. The decrease was primarily attributable to decreased loan balances of indirect automobile loans and an update to the Loss Driver Analysis that had a favorable impact on the Multifamily Real Estate Loan probability of default (“PD”) and loss given default (“LGD”) factors in the CECL model.

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The qualitative component of our allowance for credit losses (“ACL”), which is largely based on management’s judgment of qualitative loss factors, was relatively unchanged during the first half of 2024, but was adjusted in the second half to account for increased delinquency and higher net charge-offs. The Company’s automobile loan portfolio

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has continued to experience elevated delinquency rates, and this combined with a simultaneous decrease in collateral values, has resulted in increases to forecasted net charge-offs. Moderate qualitative adjustments were made to account for both of these risks. The Company also retained moderated qualitative adjustments related to economic conditions as inflationary pressures and higher interest rates continue to have an adverse effect on both consumers and businesses.

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The following table shows the change in the ACL for collectively evaluated loans:

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The Company’s allowance for credit losses for collectively evaluated loans totaled $8.4 million as of December 31, 2024, which included nearly $4.0 million of allowance related to indirect automobile loans. In comparison, the Company’s allowance related to indirect automobile loans totaled nearly $4.2 million as of December 31, 2023, a reduction of nearly $200,000 from January 1, 2024. The allowance amount attributed to qualitative adjustments at year end for indirect automobile loans was $1.7 million, an increase of approximately $400,000 from January 1, 2024. As previously mentioned, actual as well as forecasted increases in delinquencies and net charge-offs for automobile loans drove management’s increase in qualitative loss factors.

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Our allowance for credit losses for individually analyzed loans is determined using the fair value of the collateral, less estimated selling costs, as applicable. As of December 31, 2024, the Company’s allowance for credit losses on individually analyzed loans decreased $56,000 from December 31, 2023. This decrease was primarily due to a decrease of individually analyzed indirect automobile loans, with additional decreases in commercial and commercial real estate loans also contributing to the overall decrease.

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As noted above, we consider a number of variables in our evaluation of the adequacy of the allowance for credit losses. The most significant variables are portfolio growth and any changing historical loss trends within the specific business segments. As of December 31, 2024, the $264,000 decrease in our allowance for credit losses reflected the reduction in indirect automobile loan originations. Based on our model, if all segments of the portfolio grew by an additional 5% on a year-over-year basis, our allowance for credit losses as of December 31, 2024 would have increased by $418,000 to $9.0 million, holding all other variables constant. Conversely, if all segment balances of our loan portfolio had fallen by 5% during the year ended December 31, 2024, our allowance for credit losses would have decreased by $418,000 to $8.1 million, holding all other variables constant.

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The above hypothetical sensitivity calculation reflect the sensitivity of the allowance but lacks other qualitative adjustments that are part of the quarterly reserving process. As such, this does not necessarily reflect the nature and extent of future changes in the allowance for reasons including increases or decreases in qualitative adjustments, changes in the risk profile of the portfolio, changes in the macroeconomic scenario and/or the range of scenarios under management consideration.

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Goodwill and Intangible Assets

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The assets (including identifiable intangible assets) and liabilities acquired in a business combination are recorded at fair value at the date of acquisition. Goodwill is recognized as the excess of the acquisition cost over the fair values of the net assets acquired and is not subsequently amortized. Identifiable intangible assets include customer lists and core deposit intangibles and are being amortized on a straight-line basis over their estimated lives. Goodwill is not amortized, but it is tested at least annually, or more frequently if indicators of impairment are present.

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Management evaluated goodwill as of October 1, 2024, utilizing various methods including an income approach that incorporated a discounted cash flow model that involved management assumptions based upon future growth and earnings projections. A weighted average of the various methods was calculated to determine the estimated fair value of the reporting unit. The estimated fair value of the reporting unit was then compared to the current carrying value to determine if impairment had occurred. It is our opinion that, as of the measurement date, the aggregate fair value of the reporting unit exceeded the carrying value of the reporting unit. Therefore, management concluded that goodwill was not impaired. Although we believe our assumptions are reasonable, actual results may vary significantly. If for any future period it is determined that there has been impairment in the carrying value of our goodwill balances, the Company will record a charge to earnings, which could have a material adverse effect on net income, but not risk-based capital ratios.

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Income Taxes

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We are subject to the income tax laws of the United States, New York State, and the municipalities in which we operate.  These tax laws are complex and subject to different interpretations by the taxpayer and the relevant government taxing authorities.  We use the asset and 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.  See Note 8 to the Consolidated Financial Statements for a further description of our provision and related income tax assets and liabilities.

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In establishing a provision for income tax expense, we must make judgments and interpretations about the application of these inherently complex tax laws.  We must also make estimates about when in the future certain items will affect taxable income.  Disputes over interpretations of the tax laws may be subject to review/adjudication by the court systems of the various tax jurisdictions or may be settled with the taxing authority upon examination or audit.

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If current available information raises doubt as to the realization of the deferred tax assets, a valuation allowance is established. We consider the determination of this valuation allowance to be a critical accounting policy because of the need to exercise significant judgment in evaluating the amount and timing of recognition of deferred tax liabilities and assets, including projections of future taxable income. These judgments and estimates are reviewed on a continual basis as regulatory and business factors change.

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A valuation allowance for deferred tax assets may be required if the amount of taxes recoverable through loss carryback declines, or if we project lower levels of future taxable income. Such a valuation allowance would be established through a charge to income tax expense, which would adversely affect our operating results.

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Although management believes that the judgments and estimates used are reasonable, actual results could differ and we may be exposed to losses or gains that could be material.  An unfavorable tax settlement would result in an increase in our effective income tax rate in the period of resolution.  A favorable tax settlement would result in a reduction in our effective income tax rate in the period of resolution.

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Selected Financial Data

The following selected consolidated financial data sets forth certain financial highlights of the Company and should be read in conjunction with the audited consolidated financial statements and related notes included elsewhere in this Annual Report on Form 10-K for 2024 and 2023.

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Comparison of Financial Condition at December 31, 2024 and December 31, 2024

Total Assets.  Total assets were $1.26 billion at December 31, 2024, representing a decrease of $57.4 million, or 4.4%, compared to $1.31 billion at December 31, 2023. The decrease was primarily due to decreases in: (i) net loans receivable of $37.1 million, or 3.7%, (ii) available for sale securities of $32.0 million, or 16.7%, (iii) premises and equipment of $3.5 million, or 19.7%, (iv) Federal Home Loan Bank stock of $2.5 million, or 39.2%, and (v) deferred tax assets of $1.8 million, or 18.3%. The decrease in total assets was partially offset by an increase in cash and cash equivalents of $15.4 million, or 69.4%, and an increase in other assets of $4.3 million, or 22.4%

Cash and Cash Equivalents.  Cash and cash equivalents grew by $15.4 million, or 69.4%, to $37.5 million as of December 31, 2024, compared to $22.1 million at December 31, 2023. This increase was mainly driven by higher deposits at the Federal Reserve Bank of New York and the Federal Home Loan Bank of New York, as cash was generated from proceeds from maturing loans and securities sales.

Investment Securities Available for Sale.  Investment securities available for sale decreased $32.0 million, or 16.7%, to $159.9 million at December 31, 2024 from $192.0 million at December 31, 2023. The decrease was due to $75.0 million of sales and $32.1 million of paydowns and maturities, partially offset by purchases of $71.4 million and an unrealized holding gain of $3.7 million. The change in the securities portfolio reflected a balance sheet restructuring in which the Company sold lower-yielding securities and reinvested the proceeds in higher-yielding securities with a shorter duration. In September 2024, the Bank sold $58.6 million of available-for-sale securities. The proceeds from these sales were reinvested into new securities offering yields that were 3.11% higher than those of the securities sold. In December 2024, the Bank sold an additional $16.4 million of available-for-sale securities. The proceeds from these sales were reinvested into new securities offering yields that were 3.06% higher than those of the securities sold. The Company recognized a one-time pre-tax loss of $16.0 million as a result of these transactions.

Net Loans.  Net loans receivable were $971.8 million at December 31, 2024, a decrease of $37.1 million, or 3.7%, as compared to $1.01 billion at December 31, 2023. The decrease was primarily due to a decrease in indirect automobile loans of $98.6 million, or 25.0%, reflecting a strategic decision to decrease that loan portfolio as a percentage of the balance sheet. At December 31, 2024, indirect automobile loans were 23.5% of assets, compared to 30.0% at December 31, 2023. Partially offsetting the decrease in automobile loans were increases in commercial real estate loans of $54.5 million, or 12.7%, and residential real estate loans of $9.4 million, or 12.2%. The increase in commercial real estate loans was primarily due to the closing of three large loans secured by a retail shopping center and two hotels totaling $26.9 million. The increase in residential real estate loans reflected the strategic decision to hold new production in our portfolio instead of selling these loans.

Allowance for Credit Losses. During the year, the allowance for credit losses increased $415,000, or 5.1%, reflecting an increase of expected losses in our loan portfolio. Non-accrual loans decreased $47,000, or 1.1%, to $4.1 million at December 31, 2024 from $4.2 million at December 31, 2023. Non-performing assets decreased $72,000, or 1.7%. Non-performing assets included $25,000 in other real estate owned as of December 31, 2023. The Company had no other real estate owned as of December 31, 2024. Past due loans decreased $2.5 million, or 12.8%, between December 31, 2023 and December 31, 2024, finishing at $16.7 million, or 1.7%, of total loans, down from $19.2 million, or 1.9%, of total loans at year-end 2023. The decrease was most notable in non-residential commercial real-estate, as a few large loans were brought current and one loan was paid off. Our allowance for credit losses was 0.88% of total loans and 206.56% of non-performing loans at December 31, 2024 as compared to 0.81% of total loans and 194.31% of non-performing loans at December 31, 2023.

Federal Home Loan Bank Stock. FHLB stock decreased $2.6 million, or 39.2%, to $4.0 million at December 31, 2024, from $6.5 million at December 31, 2023, primarily due to a reduction in additional shares required to support borrowing activity as advances from the FHLB decreased.

Premises and Equipment. Premises and equipment decreased $3.5 million, or 19.7%, as our former Beacon, New York branch office was closed, and the property sold during the first quarter of 2024 for $2.9 million.

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Total Liabilities.  Total liabilities decreased $65.6 million, or 5.5%, to $1.13 billion at December 31, 2024 from $1.20 billion at December 31, 2023 primarily due to a decrease in advances from the FHLB of $58.3 million, or 45.5% and a decrease in deposits of $9.7 million, or 0.9%, partially offset by an increase in accrued expenses and other liabilities of $2.3 million, or 8.6%.

Deposits.  Deposits decreased $9.7 million, or 0.9%, to $1.02 billion at December 31, 2024 from $1.03 billion at December 31, 2023. Interest bearing accounts increased $1.9 million, or 0.2%, to $782.7 million while non-interest bearing balances decreased $11.7 million, or 4.7%, finishing the year at $238.1 million. The increase in interest bearing accounts represented an increase in time deposits of $19.6 million, or 6.2%, which was offset by a decrease transaction accounts including NOW, savings and money market accounts of $17.6 million, or 3.8%. The continued growth in time deposits was primarily due to depositors seeking higher interest rates, which contributed to the decrease in non-interest bearing and lower interest-bearing deposits.

We participate in reciprocal deposit programs, obtained through the Certificate Deposit Account Registry Service (CDARS) and IntraFi Cash Service (ICS) networks, that provide access to FDIC-insured deposit products in aggregate amounts exceeding the current limits for depositors. This allows us to maintain deposits that might otherwise be uninsured. Our reciprocal deposits obtained through the CDARS and ICS networks totaled $25.4 million and $13.5 million, respectively, at December 31, 2024. At December 31, 2023, we had reciprocal deposits obtained through CDARS and ICS networks of $23.4 million and $16.7 million, respectively. We had no brokered deposits at December 31, 2024 and 2023.

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Borrowed Funds.  Advances from the FHLB decreased $58.3 million, or 45.5%, from $128.1 million at December 31, 2023 to $69.8 million at December 31, 2024 as proceeds from investment sales were used to pay down debt.

Stockholders’ Equity. Stockholders' equity increased $8.1 million, or 7.2%, to $121.8 million at December 31, 2024. The increase was primarily due to a $16.6 million decrease in accumulated other comprehensive loss reflecting the results of the balance sheet restructuring, which was partially offset by a net loss of $8.6 million. The Company's ratio of average equity to average assets was 9.23% for the year ended December 31, 2024 and 8.19% for the year ended December 31, 2023.

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Comparison of Operating Results for the Years Ended December 31, 2024 and December 31, 2023

Net Income.  Net loss for the year ended December 31, 2024 was $8.6 million, compared to net income of $4.4 million for the year ended December 31, 2023, a decrease of $13.0 million, or 296.1%. Diluted loss per share was $0.80 for the year ended December 31, 2024, compared to diluted earnings per share of $0.40 for the year ended December 31, 2023. The decrease in net income for the year ended December 31, 2024 was primarily due to a balance sheet restructuring, which resulted in a $16.0 million loss on sale of securities. Net income was also impacted by an increase in net interest income, an increase in the provision for credit losses and an increase in non-interest expense. Interest and dividend income increased $3.1 million, or 5.1%, interest expense increased $2.8 million, or 12.5%, and the provision for credit losses increased $1.1 million, or 64.5%. Non-interest income decreased $15.3 million, reflecting the loss on securities, while non-interest expenses increased $419,000, or 1.2%, as compared to 2023. Taxes decreased by $3.5 million due to the 2024 net loss, in contrast to the net income in 2023.

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Net Interest Income.  Net interest income increased $266,000, or 0.7%, to $38.2 million for the year ended December 31, 2024, as compared to $38.0 million for the year ended December 31, 2023. The increase was primarily driven by higher yields on interest-earning asset balances, which were partially offset by higher costs on interest-bearing liability balances. The yield on interest earning assets increased 48 basis points to 5.36% in 2024 from 4.88% in 2023, primarily due to the rising interest rate environment in 2024. The costs of interest bearing liabilities increased 43 basis points to 2.87% in 2024 from 2.44% in 2023 driven by increases in general market rates, competitive market forces and a greater percentage of higher-yielding certificates of deposits and FHLB advances. The interest rate spread increased by 5 basis points to 2.49%. The net interest margin was 3.21% for the year ended December 31, 2024 and 3.06% for the year ended December 31, 2023. The ratio of average interest-earning assets to average interest-bearing liabilities decreased 0.9% to 133.68%.

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Interest Income.  Interest income increased $3.1 million, or 5.1%, to $63.8 million for 2024 from $60.7 million for 2023. The increase resulted primarily from increased asset yields, offset by a decrease in the average balance. The average yield on interest-bearing depository accounts increased to 5.29% for 2024 from 5.19% for 2023. The average yield on loans increased to 5.91% for 2024 from 5.47% in 2023. The average yields on investment securities increased to 2.14% for 2024 from 1.91% for 2023. Average interest earning assets decreased $52.2 million from $1.24 billion for the year ended December 31, 2023 to $1.19 billion for the year ended December 31, 2024. The decrease in average interest earning assets during 2024 compared to 2023 included decreases of $19.3 million in average loan balances and $30.8 million in available for sale securities.

Interest Expense.  Interest expense increased $2.8 million, or 12.5%, to $25.5 million for 2024 from $22.7 million for 2023. This was primarily due to a 43 basis point increase in the overall cost of interest bearing liabilities to 2.87% for 2024 from 2.44% for 2023, partially offset by a decrease in average interest bearing liability balances of $38.3 million, or 4.1%, year over year. The average balance of the total interest-bearing deposits decreased by $23.8 million, while the cost increased 52 basis points. The average balance of FHLB advances decreased $13.5 million, while the cost decreased 24 basis points.

Provision for Credit Losses.  The Company records a provision for credit losses, which is recognized in earnings. The Company adopted the CECL model beginning on January 1, 2023, which requires that we make assumptions of credit quality, macroeconomic factors and conditions, and loan composition which are inherently subjective due to the use of estimates that are susceptible to significant revision as more information becomes available or as future events occur. Although we believe that we use the best information available to establish the allowance for credit losses, based on industry standards and historical experience, future additions to the allowance may be necessary, as a result of changes in economic conditions and other factors. In addition, the FDIC and NYSDFS, as an integral part of their examination process, will periodically review our allowance for credit losses. These agencies may require us to recognize adjustments to the allowance, based on their judgments about information available to them at the time of their examination.

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The Company recorded a provision for credit losses of $2.8 million for the year ended December 31, 2024, an increase of $1.1 million, or 64.5%, as compared to $1.7 million for the year ended December 31, 2023. Of this $1.1 million increase, $1.1 million is related to the provision for credit losses on loans, while the provision for credit losses on unfunded commitments decreased $43,000. The increase to the provision was primarily attributable to higher charge-offs and updates to assumptions on prepayments and other qualitative and quantitative components in our expected credit loss analysis.

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Net charge-offs increased $333,000, or 16.1%, to $2.4 million for the year ended December 31, 2024. The increase was primarily due to a $291,000 commercial real estate loan charged-off in 2024. Net charge-offs on indirect automobile loans remained relatively stable at $1.4 million in both 2024 and 2023. The percentage of overdue account balances to total loans decreased to 1.71% as of December 31, 2024, from 1.90% as of December 31, 2023 and non-performing assets decreased $72,000, or 1.7%, to $4.1 million at December 31, 2024.

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Non-Interest Income. Non-interest loss totaled $9.5 million for the year ended December 31, 2024, a decrease of $15.3 million, from non-interest income of $5.8 million in 2023, due primarily to the $16.0 million loss on sale of investment securities resulting from the previously mentioned balance sheet restructuring. The Company recorded an increase of $368,000, or 31.6%, in investment advisory income resulting from the improved market and economic conditions, an increase of $192,000 related to gains on life insurance, an increase of $122,000, or 4.2%, in service charges on deposit accounts, an increase of $86,000, or 12.9%, in the cash surrender value of life insurance, and an increase in the gain on sales of loans of $42,000, partially offset by a decrease of $64,000 on the disposal of premises and equipment.

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Non-Interest Expense. Non-interest expense totaled $36.8 million for the year ended December 31, 2024, an increase of $419,000, or 1.2%, over 2023. The increase was primarily due to a $913,000 increase in salaries and benefits primarily due to higher production commissions and higher medical insurance costs, an increase of $33,000 in marketing expense and a $26,000 increase in data processing costs. These increases were partially offset by the $375,000 write-down of the Beacon, New York branch in the fourth quarter of 2023, which was sold in the first quarter of 2024. FDIC deposit insurance and other insurance decreased $127,000, or 10.3%, primarily due to a decreased assessment rate while other non-interest expense decreased $61,000 primarily due to decreased lending expenses.

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Income Taxes.  Income tax provision decreased by $3.5 million, or 290.1%, to a net benefit of $2.3 million for the year ended December 31, 2024 as compared to an expense of $1.2 million for the year ended December 31, 2023, primarily due to a pre-tax net loss recorded in 2024. Our effective tax rate for the year ended December 31, 2024 was 21.18% compared to 21.71% in 2023. The statutory tax rate was impacted by the benefits derived mainly from tax-exempt bond income and income received on the bank owned life insurance to arrive at the effective tax rate.

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Average Balance Sheets for the Years Ended December 31, 2024 and 2023

The following tables set forth average balance sheets, average yields and costs, and certain other information for the periods indicated. No tax-equivalent yield adjustments have been made, as the effects would be immaterial. All average balances are daily average balances. The yields set forth below include the effect of deferred fees and discounts and premiums that are amortized or accreted to interest income. Loan balances include loans held for sale. Deferred loan fees included in interest income totaled $60,000 and $67,000 for the years ended December 31, 2024 and 2023, respectively.

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Rate/Volume Analysis

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The following table presents the effects of changing rates and volumes on our net interest income for the years indicated. The rate column shows the effects attributable to changes in rate (changes in rate multiplied by prior volume). The volume column shows the effects attributable to changes in volume (changes in volume multiplied by prior rate). The net column represents the sum of the prior columns. For purposes of this table, changes attributable to 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. The Company does not have any excludable out-of-period items or adjustments.

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In 2024, net interest income increased by $266,000 driven by a $932,000 gain from improved rates, despite a $666,000 loss from declining volumes. Interest income rose by $3.1 million, with rate increases in loans receivable and securities offsetting volume losses. Interest expenses increased by $2.8 million due to higher deposit rates, despite volume declines in deposits and Federal Home Loan Bank advances. Rate improvements were the primary driver of the overall positive impact, outweighing the negative effects of reduced volumes. The net interest rate spread increased 5 basis points to 2.49% for the year ended December 31, 2024 as compared to 2.44% for the year ended December 31, 2023.  Net interest margin increased 15 basis points to 3.21% for 2024 from 3.06% for 2023.

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Management of Market Risk

General.  The majority of our assets and liabilities are monetary in nature. Consequently, our most significant form of market risk is interest rate risk. Our assets, consisting primarily of loans, have longer maturities than our liabilities, consisting primarily of deposits. As a result, a principal part of our business strategy is to manage our exposure to changes in market interest rates. Accordingly, the Board of Directors maintains a management-level Asset/Liability Management Committee (the “ALCO”), which takes initial responsibility for reviewing the asset/liability management process and related procedures, establishing and monitoring reporting systems and ascertaining that established asset/liability strategies are being maintained. On at least a quarterly basis, the ALCO reviews and reports asset/liability management outcomes with the Board of Directors. This committee also implements any changes in strategies and reviews the performance of any specific asset/liability management actions that have been implemented.

We try to manage our interest rate risk to minimize the exposure of our earnings and capital to changes in market interest rates. We have implemented the following strategies to manage our interest rate risk: originating loans with adjustable interest rates, holding more residential mortgage loans in our portfolio, promoting core deposit products and managing the interest rates and maturities of funding sources, as favorably as possible. By following these strategies, we believe that we can be better positioned to react to changes in market interest rates.

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Net Economic Value Simulation.  We analyze our sensitivity to changes in interest rates through a net economic value of equity (“EVE”) model. EVE represents the present value of the expected cash flows from our assets less the present value of the expected cash flows arising from our liabilities adjusted for the value of off-balance sheet contracts. The EVE ratio represents the dollar amount of our EVE divided by the present value of our total assets for a given interest rate scenario. EVE attempts to quantify our economic value using a discounted cash flow methodology while the EVE ratio reflects that value as a form of capital ratio. We estimate what our EVE would be at a specific date. We then calculate what the EVE would be at the same date throughout a series of interest rate scenarios representing immediate and permanent, parallel shifts in the yield curve. We currently calculate EVE under the assumptions that interest rates increase 100 to 400 basis points from current market rates and that interest rates decrease from 100 to 400 basis points from current market rates.

The following table presents the estimated changes in our EVE that would result from changes in market interest rates at December 31, 2024. All estimated changes presented in the table are within the policy limits approved by our Board of Directors.

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The table above shows that in the event of an instantaneous 200 basis point increase in interest rates, our EVE would decrease by 11.8%; and in the event of an instantaneous 200 basis point decrease in interest rates, our EVE would decrease by 2.1%. 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 table above assumes that the composition of our interest-sensitive assets and liabilities existing at the date indicated remains constant uniformly across the yield curve regardless of the duration or repricing of specific assets and liabilities. Accordingly, although the table provides an indication of our interest rate risk exposure at a particular point in time, such measurements are not intended to and do not provide a precise forecast of the effect of changes in market interest rates on our EVE and will differ from actual results.

Liquidity Management

We maintain liquid assets at levels we consider adequate to meet both our short-term and long-term liquidity needs. We adjust our liquidity levels to fund deposit outflows, repay our borrowings and to fund loan commitments. We also adjust liquidity as appropriate to meet asset and liability management objectives.

Our primary sources of liquidity are deposits, amortization and prepayment of loans and mortgage-backed securities, maturities of investment securities and other short-term investments, and earnings and funds provided from operations, as well as access to FHLB advances and other borrowings. While scheduled principal repayments on loans and mortgage-backed securities are a relatively predictable source of funds, deposit flows, loan sales and prepayments are greatly influenced by market interest rates, economic conditions, interest rate risk management and rates offered by our competition. We set the interest rates on our deposits in an attempt to maintain a desired level of total deposits.

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As reported in the Consolidated Statements of Cash Flows, our cash flows are classified for financial reporting purposes as operating, investing, or financing cash flows. Net cash provided by operating activities was $8.5 million and $7.0 million for the years ended December 31, 2024 and 2023, respectively. These amounts differ from our net income because of certain cash receipts and disbursements that did not affect net income for the respective periods. Net cash provided by investing activities was $74.7 million in 2024 as compared to $14.7 million in 2023. Net cash provided by investing activities principally reflects our investment security and loan activities in the respective periods. Net cash inflows of $33.4 million for a decrease in loans was the primary contributor to the cash provided by investing activities for the year ended December 31, 2024, as loans increased $16.2 million in 2023. Deposit and borrowing cash flows have traditionally comprised most of our financing activities, which resulted in a net cash outflow $67.9 million in the year ended December 31, 2024, as compared to $31.0 million in fiscal year 2023.

At December 31, 2024, we had the following main sources of availability of liquid funds and borrowings:

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The Bank has access to a preapproved secured line of credit with the FHLB not to exceed $627.3 million at December 31, 2024. Additional funds available under this line are not included in the table above as we do not consider it to be as readily accessible as the funds above.

The following table summarizes our main contractual obligations and other commitments to make future payments as of December 31, 2024. The amount of the obligations presented in the table reflect principal amounts only and exclude the amount of interest we are obligated to pay. Also excluded from the table are a number of obligations to be settled in cash. These excluded items are reflected in our consolidated balance sheet and include deposits with no stated maturity, trade payables, and accrued interest payable.

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Off-Balance Sheet Arrangements.  In the normal course of operations, we engage in a variety of financial transactions that, in accordance with generally accepted accounting principles (“GAAP”) are not recorded in our financial statements. These transactions involve, to varying degrees, elements of credit, interest rate and liquidity risk. Such transactions are used primarily to manage customers’ requests for funding and take the form of loan commitments and lines of credit. For information about our loan commitments, letters of credit and unused lines of credit, see Note 11 to the Consolidated Financial Statements. For 2024, we did not engage in any off-balance-sheet transactions other than loan origination commitments and standby letters of credit in the normal course of our lending activities.

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Impact of Inflation and Changing Prices

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

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Item 7.    Management’s Discussion and Analysis of Financial Condition and Results of Operations

This discussion and analysis reflects information contained in our audited consolidated 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 consolidated financial statements contained within this Form 10-K.

Overview

Net Interest Income. Our primary source of income is net interest income. Net interest income is the difference between interest income, which is the income we earn on our loans and investments, and interest expense, which is the interest we pay on our deposits and borrowings.

Provision for Credit Losses. The allowance for credit losses is a valuation allowance for the estimated lifetime credit losses. The allowance for credit losses is increased through charges to the provision for credit losses. Loans are charged against the allowance when management believes that the collectability of the principal loan amount is not probable. Recoveries on loans previously charged-off, if any, are credited to the allowance for credit losses when realized.

Non-Interest Income. Our primary sources of non-interest income are service charges on deposit accounts, investment advisory income and net gains in the cash surrender value of bank owned life insurance and other income.

Non-Interest Expenses. Our non-interest expenses consist of salaries and employee benefits, net occupancy and equipment, data processing, professional fees, marketing expenses, premium payments we make to the FDIC for insurance of our deposits and other general and administrative expenses.

Income Tax Expense. Our income tax expense is the total of the current year income tax due or refundable and the change in deferred tax assets and liabilities. Deferred tax assets and liabilities are the expected future tax amounts for the temporary differences between the carrying amounts and the tax basis of assets and liabilities, computed using enacted tax rates. A valuation allowance, if needed, reduces deferred tax assets to the amounts expected to be realized.

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Business Strategy

Based on an extensive review of the current opportunities in our primary market area as well as our resources and capabilities, we are pursuing the following business strategies:

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Critical Accounting Policies

Our most significant accounting policies are described in Note 1 to the consolidated financial statements.  Certain of these accounting policies require management to use significant judgment and estimates, which can have a material impact on the carrying value of certain assets and liabilities, and we consider these policies to be our critical accounting estimates.  The judgment and assumptions made are based upon historical experience, future forecasts, or other factors that management believes to be reasonable under the circumstances.  Because of the nature of the judgment and assumptions, actual results could differ from estimates, which could have a material effect on our financial condition and results of operations.

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The following accounting policies materially affect our reported earnings and financial condition and require significant judgments and estimates.

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Allowance for Credit Losses

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The allowance for credit losses is an estimate of current expected credit losses considering available information relevant to assessing collectability of cash flows over the contractual term of the financial assets necessary to cover lifetime expected credit losses inherent in financial assets at the balance sheet date. The methodology for determining the allowance for credit losses is considered a critical accounting policy by management because of the high degree of judgment involved, the subjectivity of the assumptions used, and the potential for changes in the forecasted economic environment that could result in changes to the amount of the recorded allowance for credit losses. The loan portfolio also represents the largest asset type on the Company’s Consolidated Statements of Financial Condition.

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The Company adopted ASU No. 2016-13, Financial Instruments – Credit Losses (Topic 326): Measurement of Credit Losses on Financial Instruments effective January 1, 2023. The new accounting rule required the measurement of all expected credit losses for financial assets held at the reporting date based on historical experience, current conditions, and reasonable and supportable forecasts. Based on the Company’s portfolio balances and forecasted economic conditions as of December 31, 2022, the adoption of the CECL standard resulted in an increase in the reserves for loans of $580,000, and brought the allowance for credit losses on loans to $8.5 million at January 1, 2023, as compared to the Company’s December 31, 2022 reserve of $7.9 million.

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Our methodology for estimating lifetime expected credit losses for our loan portfolios include the following key components:

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The following table shows the impact of adoption on the allowance for credit losses on loans:

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The Company’s allowance for credit losses for loans totaled $8.1 million and $8.5 million as of December 31, 2023 and January 1, 2023, respectively. The $400,000 decrease in our allowance for credit losses for loans was primarily driven by a decrease in our collectively evaluated loans, partially offset by an increase in the allowance for credit losses on individually analyzed loans.

The quantitative component of our allowance for credit losses on collectively evaluated loans, which is largely based on a selection of various economic forecasts, decreased by $506,000 as of December 31, 2023, when compared to January 1, 2023. The decrease was primarily attributable to decreased loan balances of indirect automobile loans and an update to the Loss Driver Analysis that had a favorable impact on the Consumer Loan probability of default (“PD”) and loss given default (“LGD”) factors in the CECL model. The qualitative component of our allowance for credit losses (“ACL”), which is largely based on management’s judgment of qualitative loss factors, was relatively unchanged during the first half of 2023, but was adjusted in the second half to account for anticipated increases in delinquencies and net charge-offs. Automobile loans are experiencing increased delinquencies and net charge-offs are forecast to grow so moderate qualitative adjustments were made to account for those factors. Recently, prolonged inflation and higher interest rates are forecast to have an adverse effect on both consumers and businesses so qualitative adjustments were made to account for those negative factors.

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The following table shows the change in collectively evaluated loans between January 1, 2023 and December 31, 2023:

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The Company’s allowance for credit losses for collectively evaluated loans totaled $8.4 million as of January 1, 2023, which included nearly $5.5 million of allowance related to indirect automobile loans. Included in that allowance related to the indirect automobile loans was $386 thousand attributable to qualitative loss factors. In comparison, the Company’s allowance related to indirect automobile loans totaled $4.2 million as of December 31, 2023, a reduction of nearly $1.3 million from January 1, 2023. The allowance amount attributed to qualitative adjustments at year end for indirect automobile loans was $1.3 million, an increase of approximately $900,000 from January 1, 2023. As previously mentioned, actual as well as forecasted increases in delinquencies and net charge-offs for automobile loans drove management’s increase in qualitative loss factors.

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Our allowance for credit losses for individually analyzed loans is determined on an individual basis using the fair value of the collateral, less estimated selling costs, as applicable. As of December 31, 2023, the Company’s allowance for credit losses on individually analyzed loans increased $106,000 from January 1, 2023. This increase was primarily due to the increase of individually analyzed indirect automobile loans.

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As noted above, we consider a number of variables in our evaluation of the adequacy of the allowance for credit losses. One of the most significant variables being portfolio growth, evaluated for the changing historical loss trends within the specific business segments. As of December 31, 2023, $150,000 of our allowance for credit losses reflected the specific risk relative to portfolio growth trends. Based on our model, if all segments of the portfolio grew by an additional 5% on a year-over-year basis, our allowance for credit losses as of December 31, 2023, would have increased by $394,000 to $8.5 million, holding all other variables constant. Conversely, if all segment balances of our loan portfolio had fallen by 5% during the year ended December 31, 2023, our allowance for credit losses would have decreased by $394,000 to $7.7 million, holding all other variables constant.

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Another variable in our evaluation of the allowance for credit losses is the forecasted unemployment rate sourced from the FOMC Summary of Economic Projections for the Civilian Unemployment Rate, Median (Percent). A hypothetical increase of 250 basis points in the unemployment rate would have increased our allowance by $85,000, holding all other variables constant.

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The above hypothetical sensitivity calculations reflect the sensitivity of the allowance but lacks other qualitative adjustments that are part of the quarterly reserving process. As such, this does not necessarily reflect the nature and extent of future changes in the allowance for reasons including increases or decreases in qualitative adjustments, changes in the risk profile, changes in the severity of the macroeconomic scenario and the range of scenarios under management consideration.

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Goodwill and Intangible Assets

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The assets (including identifiable intangible assets) and liabilities acquired in a business combination are recorded at fair value at the date of acquisition. Goodwill is recognized as the excess of the acquisition cost over the fair values of the net assets acquired and is not subsequently amortized. Identifiable intangible assets include customer lists and core deposit intangibles and are being amortized on a straight-line basis over their estimated lives. Goodwill is not amortized, but it is tested at least annually, or more frequently if indicators of impairment are present.

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Management evaluated goodwill as of October 1, 2023, utilizing various methods including an income approach that incorporated a discounted cash flow model that involved management assumptions based upon future growth and earnings projections. A weighted average of the various methods was calculated to determine the estimated fair value of the reporting unit. The estimated fair value of the reporting unit was then compared to the current carrying value to determine if impairment had occurred. It is our opinion that, as of the measurement date, the aggregate fair value of the reporting unit exceeded the carrying value of the reporting unit. Therefore, management concluded that goodwill was not impaired. Although we believe our assumptions are reasonable, actual results may vary significantly and it is impossible to know the future impact of evolving economic conditions. If for any future period it is determined that there has been impairment in the carrying value of our goodwill balances, the Company will record a charge to earnings, which could have a material adverse effect on net income, but not risk based capital ratios.

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Income Taxes

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We are subject to the income tax laws of the United States, New York State, and the municipalities in which we operate.  These tax laws are complex and subject to different interpretations by the taxpayer and the relevant government taxing authorities.  We use the asset and 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.  See Note 8 to the Consolidated Financial Statements for a further description of our provision and related income tax assets and liabilities.

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In establishing a provision for income tax expense, we must make judgments and interpretations about the application of these inherently complex tax laws.  We must also make estimates about when in the future certain items will affect taxable income.  Disputes over interpretations of the tax laws may be subject to review/adjudication by the court systems of the various tax jurisdictions or may be settled with the taxing authority upon examination or audit.

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If current available information raises doubt as to the realization of the deferred tax assets, a valuation allowance is established. We consider the determination of this valuation allowance to be a critical accounting policy because of the need to exercise significant judgment in evaluating the amount and timing of recognition of deferred tax liabilities and assets, including projections of future taxable income. These judgments and estimates are reviewed on a continual basis as regulatory and business factors change.

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A valuation allowance for deferred tax assets may be required if the amount of taxes recoverable through loss carryback declines, or if we project lower levels of future taxable income. Such a valuation allowance would be established through a charge to income tax expense which would adversely affect our operating results.

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Although management believes that the judgments and estimates used are reasonable, actual results could differ and we may be exposed to losses or gains that could be material.   An unfavorable tax settlement would result in an increase in our effective income tax rate in the period of resolution.  A favorable tax settlement would result in a reduction in our effective income tax rate in the period of resolution.

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Selected Financial Data

The following selected consolidated financial data sets forth certain financial highlights of the Company and should be read in conjunction with the audited consolidated financial statements and related notes included elsewhere in this Annual Report on Form 10-K for 2023 and 2022.

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NON-GAAP FINANCIAL INFORMATION

This Report contains financial information determined by methods other than in accordance with GAAP. Such non-GAAP financial information includes the following measure: “tangible book value per common share.” Management uses this non-GAAP measure because we believe that it may provide useful supplemental information for evaluating our operations and performance, as well as in managing and evaluating our business and in discussions about our operations and performance. Management believes this non-GAAP measure may also provide users of our financial information with a meaningful measure for assessing our financial results, as well as a comparison to financial results for prior periods. This non-GAAP measure should be viewed in addition to, and not as an alternative to or substitute for, measures determined in accordance with GAAP and are not necessarily comparable to other similarly titled measures used by other companies. To the extent applicable, reconciliations of these non-GAAP measures to the most directly comparable measures as reported in accordance with GAAP are included below.

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Comparison of Financial Condition at December 31, 2023 and December 31, 2022

Total Assets.  Total assets were $1.313 billion at December 31, 2023, representing a decrease of $22.8 million, or 1.7%, compared to $1.336 billion at December 31, 2022. The decrease was primarily due to a decrease in available for sale securities of $31.7 million, or 14.2%, a decrease in cash and cash equivalents of $9.3 million, or 29.5%, and a decrease in premises and equipment of $1.2 million, or 6.2%, partially offset by an increase in net loans receivable of $14.5 million, or 1.5%, and an increase in Federal Home Loan Bank stock of $3.3 million, or 99.9%.

Cash and Cash Equivalents.  Cash and cash equivalents decreased $9.3 million, or 29.5%, to $22.1 million at December 31, 2023 from $31.4 million at December 31, 2022, primarily due to a decrease in deposits held at the Federal Reserve Bank of New York and the Federal Home Loan Bank of New York, as cash was used to help cover deposit outflows.

Investment Securities Available for Sale.  Investment securities available for sale decreased $31.7 million, or 14.2%, to $192.0 million at December 31, 2023 from $223.7 million at December 31, 2022. The decrease was primarily due to $34.1 million of paydowns and maturities, the proceeds of which were used to help offset deposit outflows. The decrease was partially offset by a decrease in unrealized loss on available for sale securities of $2.7 million.

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Net Loans.  Net loans receivable were $1.009 billion at December 31, 2023, an increase of $14.5 million, or 1.5%, as compared to $994.4 million at December 31, 2022. The increase was primarily due to increases of $57.5 million, or 15.5%, in commercial real estate loans and $23.5 million, or 43.8%, in residential real estate loans, while indirect automobile loans decreased $63.0 million, or 13.8%. The increase in commercial real estate loans was primarily due to the closing of three large loans totaling $28.7 million, secured by an auto dealership, a retail shopping center and a self-storage facility. The increase in residential real estate loans reflected the strategic decision to hold new production in our portfolio instead of selling these loans. The decrease in our indirect automobile portfolio was also due to a strategic decision to decrease that loan portfolio as a percentage of our balance sheet.

Allowance for Credit Losses. During the year, the allowance for credit losses increased $181,000, or 2.3%, reflecting an increase of expected losses in our loan portfolio. Non-accrual loans decreased $243,000, or 5.5%, to $4.2 million at December 31, 2023 from $4.4 million at December 31, 2022. Non-performing assets decreased $218,000, or 4.9%. Non-performing assets included $25,000 in other real estate owned as of December 31, 2023. The Company had no other real estate owned as of December 31, 2022. Past due loans decreased $3.5 million, or 15.6%, between December 31, 2022 and December 31, 2023, finishing at $19.2 million, or 1.90%, of total loans, down from $22.7 million, or 2.29%, of total loans at year-end 2022. Our allowance for credit losses was 0.81% of total loans and 194.31% of non-performing loans at December 31, 2023 as compared to 0.80% of total loans and 179.54% of non-performing loans at December 31, 2022.

Federal Home Loan Bank Stock. FHLB stock increased $3.3 million, or 99.9%, to $6.5 million at December 31, 2023, from $3.3 million at December 31, 2022, primarily due to the required purchase of additional shares to support additional borrowing activity.

Premises and Equipment. Premises and equipment decreased $1.2 million, or 6.2%, as overall purchases decreased substantially year-over-year as the Company significantly invested in on-line banking software in 2022. The Company also entered into an agreement for the property sale of our Beacon branch in Wappingers Falls, NY, resulting in an impairment charge of $375,000.

Total Liabilities.  Total liabilities decreased $28.3 million, or 2.3%, to $1.200 billion at December 31, 2023 from $1.228 billion at December 31, 2022 due to a decrease in deposits of $99.4 million, or 8.8%, partially offset by an increase in advances from the FHLB of $70.3 million, or 121.9%, to help offset deposit outflows.

Deposits.  Deposits decreased $99.4 million, or 8.8%, to $1.031 billion at December 31, 2023 from $1.130 billion at December 31, 2022. Interest bearing accounts decreased $65.7 million, or 7.8%, to $780.7 million while non-interest bearing balances decreased $33.8 million, or 11.9%, finishing the year at $249.8 million. Of the interest bearing accounts, transaction accounts including NOW, savings and money market accounts decreased $167.3 million, or 26.6%, which was partially offset by an increase in time deposits of $101.7 million, or 47.0%. The continued growth in time deposits was primarily due to depositors seeking higher interest rates, which contributed to the decrease in non-interest bearing and lower interest-bearing deposits. Deposits were also impacted as some depositors withdrew funds in reaction to the highly publicized bank failures in the first quarter of 2023 and as subsequent competition for deposits increased.

We participate in reciprocal deposit programs, obtained through the Certificate Deposit Account Registry Service (CDARS) and IntraFi Cash Service (ICS) networks, that provide access to FDIC-insured deposit products in aggregate amounts exceeding the current limits for depositors. This allows us to maintain deposits that might otherwise be uninsured. Our reciprocal deposits obtained through the CDARS and ICS networks totaled $23.4 million and $16.7 million, respectively, at December 31, 2023. At December 31, 2022, we had reciprocal deposits obtained through CDARS of $10.0 million. We had no brokered deposits at December 31, 2023 and $34.0 million in brokered deposits at December 31, 2022.

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Borrowed Funds.  Advances from the FHLB increased $70.3 million, or 121.9%, from $57.7 million at December 31, 2022 to $128.1 million at December 31, 2023 to offset decreased deposits.

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Stockholders’ Equity. Stockholders' equity increased $5.6 million, or 5.1%, to $113.7 million at December 31, 2023. The increase was primarily due to net income of $4.4 million and a $2.7 million decrease in accumulated other comprehensive loss primarily reflecting valuation improvements in our available-for-sale securities portfolio and the defined benefit pension plan due to current financial market conditions. The increase was partially offset by the repurchase of 200,000 shares of the Company’s stock, totaling $1.4 million, and a reduction in retained earnings of $633,000 due to the adoption of the current expected credit loss standard on January 1, 2023. At December 31, 2023, the Company’s book value per share was $10.27 and the Company’s ratio of stockholders’ equity-to-total assets was 8.7%. Unearned common stock held by the Bank’s employee stock ownership plan was $3.3 million and $3.5 million at December 31, 2023 and 2022, respectively.

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

Net Income.  Net income for the year ended December 31, 2023 was $4.4 million ($0.41 per basic and $0.40 per diluted share), compared with $7.0 million ($0.65 per basic and $0.64 per diluted share) for the year ended December 31, 2022, a decrease of $2.6 million, or 37.2%. The decrease in net income for the year ended December 31, 2023 was primarily due to a decrease in net interest income, an increase in the provision for credit losses and a decrease in non-interest income, partially offset by a decrease in operating expenses. Interest and dividend income increased $12.1 million, or 24.8%, interest expense increased $15.9 million, or 235.9%, and the provision for credit losses increased $288,000, or 20.4%. Non-interest income decreased $116,000, or 2.0%, while non-interest expenses decreased $993,000, or 2.7%, as compared to 2022. Taxes decreased $680,000 or 35.8% on lower net income.

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Net Interest Income.  Net interest income decreased $3.9 million, or 9.3%, to $38.0 million for the year ended December 31, 2023, as compared to $41.8 million for the year ended December 31, 2022. The decrease was primarily driven by higher costs on higher interest-bearing liability balances, which were partially offset by higher yields on higher interest-earning asset balances. The net interest margin was 3.06% for the year ended December 31, 2023 and 3.45% for the year ended December 31, 2022. The ratio of average interest-earning assets to average interest-bearing liabilities decreased 5.9% to 133.80%.  The costs of interest bearing liabilities increased 165 basis points to 2.44% in 2023 from 0.79% in 2022 driven by increases in general market rates, competitive forces and a greater percentage of higher-yielding certificates of deposits and FHLB advances. The yield on interest earning assets increased 87 basis points to 4.88% in 2023 from 4.01% in 2022, primarily due to the rising interest rate environment in 2023.

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Interest Income.  Interest income increased $12.1 million, or 24.8%, to $60.7 million for 2023 from $48.6 million for 2022. The increase resulted primarily from increased yields and higher average earning asset balances. The average yield on interest-bearing depository accounts increased to 5.19% for 2023 from 1.11% for 2022. The average yield on loans increased to 5.47% for 2023 from 4.80% in 2022. The average yields on investment securities increased to 1.91% for 2023 from 1.46% for 2022. Average interest earning assets increased $30.7 million from $1.212 billion for the year ended December 31, 2022 to $1.242 billion for the year ended December 31, 2023. The increase in average interest earning assets during 2023 compared to 2022 included increases of $81.9 million in average loan balances and $3.2 million in other interest earning assets partially offset by decreases of $47.7 million in available for sale securities and $6.8 million in average interest bearing depository accounts.

Interest Expense.  Interest expense increased $15.9 million, or 235.9%, to $22.7 million for 2023 from $6.8 million for 2022. This was primarily due to a 165 basis point increase in the overall cost of interest bearing liabilities to 2.44% for 2023 from 0.79% for 2022, supplemented by an increase in average interest bearing liability balances of $76.4 million, or 9.0%, year over year. The average balance of FHLB advances increased $66.3 million, while the cost increased 166 basis points. The average balance of the total interest-bearing deposits increased by $8.8 million, while the cost increased 147 basis points.

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Provision for credit losses.  The Company establishes a provision for credit losses through the allowance for credit losses, which are charged to earnings. The Company adopted the CECL model beginning on January 1, 2023. The CECL model requires that we make assumptions of credit quality, macroeconomic factors and conditions, and loan composition which are inherently subjective due to the use of estimates that are susceptible to significant revision as more information becomes available or as future events occur. Although we believe that we use the best information available to establish the allowance for credit losses, based on industry standards and historical experience, future additions to the allowance may be necessary, as a result of changes in economic conditions and other factors. In addition, the FDIC and NYSDFS, as an integral part of their examination process, will periodically review our allowance for credit losses. These agencies may require us to recognize adjustments to the allowance, based on their judgments about information available to them at the time of their examination.

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The Company recorded a provision for credit losses of $1.7 million for the year ended December 31, 2023, an increase of $288,000, or 20.4%, as compared to $1.4 million for the year ended December 31, 2022. Of this $288,000 increase, $252,000 is related to the provision for credit losses on loans, while the remaining $36,000 is related to the provision for credit losses on unfunded commitments. The increase to the provision was primarily attributable to an increase in loan balances and changes to qualitative factors in response to changing economic conditions.

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Net charge-offs for the year ended December 31, 2023 totaled $2.1 million, compared to $1.0 for the year ended December 31, 2022. The increase was primarily due to a $710,000 charge-off of one commercial loan in the second quarter of 2023, a $126,000 charge-off of a commercial loan in the fourth quarter of 2023 and increased net charge-offs in indirect automobile loans of $642,000. The percentage of overdue account balances to total loans decreased to 1.90% as of December 31, 2023 from 2.29% as of December 31, 2022, while non-performing assets decreased $218,000, or 4.9%, to $4.2 million at December 31, 2023.

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Non-Interest Income. Non-interest income totaled $5.8 million for the year ended December 31, 2023, a decrease of $116,000, or 2.0%, from the comparable period in the prior year, due primarily to a decrease in the net gain on sales of mortgage loans as activity decreased due to fewer originations in the increasing interest rate environment and a strategic decision to hold new production in our portfolio instead of selling these loans. Gain on sales of mortgage loans decreased $746,000, or 86.3%, compared to the prior year as we sold $4.8 million of residential mortgage loans in 2023 as compared to $23.8 million in 2022. Investment advisory income decreased $69,000, or 5.6%, primarily the result of a challenging investment market and economic conditions. These decreases were partially offset by a $221,000 gain on life insurance, the prior year period net realized loss on the sale of securities of $170,000 and a $148,000 increase in other non-interest income as the income from mortgage servicing rights increased.

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Non-Interest Expense. For the year ended December 31, 2023, non-interest expense totaled $36.4 million, a decrease of $993,000, or 2.7%, over 2022. The decrease was primarily due to a decrease in salaries and benefits of $2.1 million as the number of employees decreased when the Company made the difficult decision to layoff approximately 5% of its workforce in the first quarter of 2023, a decrease in occupancy expense of $327,000 due to the closure of our Monroe branch at the end of 2022 and a decrease in marketing fees of $138,000 due to decreased advertising. These decreases were partially offset by the growth in other non-interest expense of $533,000, or 8.9%, primarily due to a decrease in deferred loan commitments and inflationary pressures on our service contracts, an increase in FDIC deposit insurance assessments of $403,000, or 48.6%, due to an increased assessment rate, and an impairment charge of $375,000 in the fourth quarter of 2023, as we entered into an agreement for the property sale of our Beacon Branch in Wappingers Falls, NY. The sale closed in the first quarter of 2024.

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Income Taxes.  Income tax provision decreased by $680,000, or 35.8%, to $1.2 million for the year ended December 31, 2023 as compared to $1.9 million for the year ended December 31, 2022, primarily due to the decline in pre-tax income. Our effective tax rate for the year ended December 31, 2023 was 21.71% compared to 21.35% in 2022. The statutory tax rate is impacted by the benefits derived mainly from tax-exempt bond income and income received on the bank owned life insurance to arrive at the effective tax rate.

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Average Balance Sheets for the Years Ended December 31, 2023 and 2022

The following tables set forth average balance sheets, average yields and costs, and certain other information for the periods indicated. No tax-equivalent yield adjustments have been made, as the effects would be immaterial. All average balances are daily average balances. The yields set forth below include the effect of deferred fees and discounts and premiums that are amortized or accreted to interest income. Loan balances include loans held for sale. Deferred loan fees included in interest income totaled $67,000 and $1.2 million for the years ended December 31, 2023 and 2022, respectively.