Rhinebeck Bancorp, Inc. (RBKB) 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 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 Loan Losses. The allowance for loan losses is a valuation allowance for probable incurred credit losses. The allowance for loan losses is increased through charges to the provision for loan 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 loan losses when realized.
Non-interest Income. Our primary sources of non-interest income are mortgage banking income, 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:
| Column 1 | Column 2 | Column 3 |
|---|---|---|
| ● | Maintain our indirect automobile loan portfolio. We originate automobile loans through a network of 95 automobile dealerships (63 in the Hudson Valley region and 32 in Albany, New York). In 2022, we exceeded our goals to grow this portfolio. Our indirect automobile loan portfolio totaled $457.2 million, or 46.2% of our total loan portfolio and 34.2% of total assets, at December 31, 2022 as compared to $382.1 million, or 44.8% of our total loan portfolio and 29.8% of total assets, at December 31, 2021. In addition, our direct automobile portfolio totaled $8.3 million at December 31, 2022. While we still plan to originate such loans, we plan to slow the growth of our indirect automobile loan portfolio by decreasing loan originations through increased pricing and limiting risk selections. Current management’s risk appetite limits our total indirect automobile loan portfolio to 45% of total assets. |
| Column 1 | Column 2 | Column 3 |
|---|---|---|
| ● | Focus on commercial real estate, multi-family real estate and commercial business lending. We believe that commercial real estate, multi-family real estate and general commercial business lending offer opportunities to invest in our community, while helping to increase the overall yield earned on our loan portfolio and assisting in managing interest rate risk. We intend to continue to increase our originations of these types of loans in our primary market area and may consider hiring additional lenders as well as originating loans secured by properties located in areas that are contiguous to our current market area. We also occasionally participate in commercial real estate loans originated in areas in which we do not have a market presence. The purchase of loan pools may be considered in the event our organic loan production does not meet our expectations. |
| Column 1 | Column 2 | Column 3 |
|---|---|---|
| ● | Increase core deposits, including demand deposits. Deposits are our primary source of funds for lending and investment. We intend to focus on expanding our core deposits (which we define as all deposits except for certificates of deposit), particularly non-interest-bearing demand deposits, because they have no cost and are less sensitive to withdrawal when interest rates fluctuate. Core deposits represented 80.9% of our total deposits at December 31, 2022 compared to 85.8% at December 31, 2021. Going forward, we will focus on increasing our core deposits by increasing our commercial lending activities and enhancing our relationships with our retail customers. We are also working to continue to increase our market share in Orange County, New York, having opened four new branches in the county in 2021. |
| Column 1 | Column 2 | Column 3 |
|---|---|---|
| ● | Continue expense control. Management continues to focus on controlling our level of non-interest expense and identifying cost savings opportunities, such as reducing our staffing levels, renegotiating key third-party contracts and reducing other operating expenses. Our non-interest expense was $37.4 million and $35.5 million for the years ended December 31, 2022 and 2021, respectively. |
| Column 1 | Column 2 | Column 3 |
|---|---|---|
| ● | Manage credit risk to maintain a low level of non-performing assets. We believe that strong asset quality is a key to long-term financial success. Our strategy for credit risk management focuses on an experienced team of credit professionals, well-defined and implemented credit policies and procedures, conservative loan underwriting criteria and active credit monitoring. Our ratio of non-performing loans to total assets was 0.33% at December 31, 2022, which decreased from 0.52% at December 31, 2021. |
| Column 1 | Column 2 | Column 3 |
|---|---|---|
| ● | Grow the balance sheet. During 2021 we opened four new branches in Orange County: two in Warwick and Monroe, as the result of a purchase from ConnectOne Bank, and two in Newburgh and Middletown, as de novo locations. While our focus on developing Orange County remains a strategic priority for the Bank, we made the business decision to permanently close the Monroe branch at year-end 2022. The branch location and sheer number of financial institutions in the market made it difficult to gain any meaningful traction. We believe that the remaining offices, and the Bank overall, will continue to benefit from a large customer base that prefers doing business with a local institution and may be reluctant to do business with larger institutions. By providing our customers with quality service, coupled with a home-town ambience, we expect to continue our strong organic growth. Also, as the pandemic retreats, we expect that the pent- up demand of commercial activity will return to a more normal pace providing renewed growth opportunities for our loan portfolio. |
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Terms of 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.
The following accounting policies materially affect our reported earnings and financial condition and require significant judgments and estimates.
Allowance for loan losses
The allowance for loan losses is the estimated amount considered necessary to cover credit losses inherent in the loan portfolio at the balance sheet date. The allowance is established through the provision for loan losses which is charged against income. Determining the appropriateness of the allowance is complex and requires judgment by management about the effect of matters that are inherently uncertain. Subsequent evaluations of the then-existing loan portfolio, in light of the factors then prevailing, may result in significant changes in the allowance in those future periods.
In determining the allowance for loan losses, management makes significant estimates and has identified this policy as one of our most critical. The methodology for determining the allowance for loan losses is considered a critical accounting policy by management due to the high degree of judgment involved, the subjectivity of the assumptions utilized and the potential for unanticipated changes in the economic environment that could result in changes to the amount of the recorded allowance for loan losses.
As a substantial amount of our loan portfolio is collateralized by real estate, appraisals of the underlying value of property securing loans and discounted cash flow valuations of properties are critical in determining the amount of the allowance required for specific impaired loans. Assumptions for appraisals and discounted cash flow valuations are instrumental in determining the value of properties.
Management performs a quarterly evaluation of the adequacy of the allowance for loan losses. Consideration is given to a variety of factors in establishing the allowance including, but not limited to, current economic conditions, delinquency statistics, geographic and industry concentrations, the adequacy of the underlying collateral, the financial strength of the borrower, results of internal and external loan reviews and other relevant factors. This evaluation is inherently subjective, as it requires material estimates that may be susceptible to significant revision based on changes in economic and real estate market conditions.
The analysis of the allowance for loan losses has two components: specific and general allocations. Specific allocations are made for loans that are determined to be impaired. Impairment is measured by determining the present value of expected future cash flows or, for collateral-dependent loans, the fair value of the collateral adjusted for market conditions and selling expenses. The general allocation is determined by segregating the remaining loans by type of loan and using applicable historical loss experience plus qualitative factors including, but not limited to, delinquency trends, general economic conditions and geographic and industry concentrations.
The allowance represents management’s best estimate, but worsening loan quality and economic conditions could result in an additional allowance. Likewise, external events could potentially improve loan quality and economic conditions, which may allow a reduction in the required allowance. In either instance, unanticipated and unforeseeable changes could have a significant impact on results of operations.
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Overly optimistic assumptions or negative changes to assumptions could significantly impact the valuation of a property securing a loan and the related allowance determined. The assumptions supporting such appraisals and discounted cash flow valuations are carefully reviewed by management to determine that the resulting values reasonably reflect amounts realizable on the related loans. Actual loan losses may be significantly more than the allowance for loan losses we have established, which could have a material negative effect on our financial results. In addition, our banking regulators, as an integral part of their examination process, periodically review our allowance for loan losses. Our banking regulators may require us to recognize adjustments to the allowance based on judgments about information available to them at the time of its examination.
The Company is adopting Accounting Standards Update (“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 requires 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. Financial institutions and other organizations will now use forward-looking information to enhance their credit loss estimates.
The Company’s CECL implementation efforts are continuing to focus on model validation, developing new disclosures, establishing formal policies and procedures and other governance and control documentation. Based on the Company’s portfolio balances and forecasted economic conditions as of December 31, 2022, management believes the adoption of the CECL standard will result in an increase in the current reserves of approximately $800,000, or 10%, bringing the reserve to $8.7 million at January 1, 2023, as compared to the Company’s current reserve levels of $7.9 million. This preliminary estimate is contingent upon continued testing and refinement of the model, methodologies and judgments utilized to determine the estimate. The actual impact of the adoption will be dependent upon the portfolio composition and credit quality at the adoption date, as well as economic conditions and forecasts at that time. At adoption, we expect to have a cumulative-effect adjustment to retained earnings, net of tax, for this change in the ACL, which would likely decrease our capital. We expect to continue to be well capitalized under the Basel III regulatory framework after the adoption of this standard.
Our methodology for estimating lifetime expected credit losses for our loan portfolios will include the following key components:
| Column 1 | Column 2 | Column 3 |
|---|---|---|
| a. | Segmentation of loans into pools that share common risk characteristics; |
| Column 1 | Column 2 | Column 3 |
|---|---|---|
| b. | An economic forecast period based on the relation of losses with key economic variables for each portfolio segment; |
| Column 1 | Column 2 | Column 3 |
|---|---|---|
| c. | Reversion period to historical loss experience using a straight-line method; |
| Column 1 | Column 2 | Column 3 |
|---|---|---|
| d. | Inclusion of qualitative adjustments to consider factors that have not been accounted for; |
| Column 1 | Column 2 | Column 3 |
|---|---|---|
| e. | Discounted cash flow method to measure credit impairment on each of our loan portfolio segments; |
| Column 1 | Column 2 | Column 3 |
|---|---|---|
| f. | Credit losses for loans that do not share similar risk characteristics are estimated on an individual basis. The lifetime losses for individually measured loans are estimated based on one of several methods, including the estimated fair value of the underlying collateral, observable market value of similar debt or the present value of expected cash flows; and |
| Column 1 | Column 2 | Column 3 |
|---|---|---|
| g. | The estimation methodology for credit losses on unfunded lending-related commitments is similar to the process for estimating credit losses for loans, although with the addition of a probability of draw estimate that is applied to each loan portfolio segment. |
As noted above, we consider a number of variables in our evaluation of the adequacy of the allowance for loan 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, 2022, $1.2 million of our allowance for loan 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 loan losses as of December 31, 2022, would have increased by $408,000 to $8.2 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, 2022, our allowance for loan losses would have decreased by $377,000 to $7.5 million, holding all other variables constant.
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Goodwill and Intangible Assets
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 for impairment in the fourth quarter, or more frequently if indicators of impairment are present.
The determination of fair values is based on valuations using management’s assumptions of future growth rates, future attrition, discount rates, multiples of earnings or other relevant factors. In evaluating whether it is more likely than not that the fair value is less than its carrying amount, management assessed seven qualitative factors including, but not limited to, macroeconomic conditions, industry and market considerations, overall financial performance and other relevant company-specific events.
Changes in these factors, as well as downturns in economic or business conditions, could have a significant adverse impact on the carrying value of goodwill and could result in impairment losses affecting our financial statements. A prolonged economic downturn or deterioration in the economic outlook may lead management to conclude that an interim quantitative impairment test of our goodwill is required prior to the annual impairment test. Based on our impairment tests, no impairment was recorded in 2022 or 2021.
Income Taxes
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 9 to the Consolidated Financial Statements for a further description of our provision and related income tax assets and liabilities.
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.
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.
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.
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 2022 and 2021.
| | | | | | | |
|---|---|---|---|---|---|---|
| | | At December 31, | ||||
| | 2022 | 2021 | ||||
| | | (In thousands) | ||||
| Selected Financial Condition Data: | | | | | | |
| Total assets | | $ | 1,335,977 | | $ | 1,281,166 |
| Cash and cash equivalents | | 31,384 | | 72,091 | ||
| Securities available-for-sale | | 223,659 | | 280,283 | ||
| Loans receivable, net | | 994,368 | | 854,967 | ||
| Bank owned life insurance | | 29,794 | | 29,131 | ||
| Goodwill and other intangibles | | 2,569 | | 2,668 | ||
| | | | | | | |
| Total liabilities | | 1,227,845 | | 1,155,197 | ||
| Deposits | | 1,129,933 | | 1,101,999 | ||
| Federal Home Loan Bank advances | | 57,723 | | 18,041 | ||
| Subordinated debt | | 5,155 | | 5,155 | ||
| | | | | | | |
| Total stockholders’ equity | | $ | 108,132 | | $ | 125,969 |
| | | | | | | |
|---|---|---|---|---|---|---|
| | | For the Year Ended December 31, | ||||
| | 2022 | 2021 | ||||
| | | (In thousands, except per share data) | ||||
| Selected Operating Data: | | | | | | |
| Interest and dividend income | | $ | 48,592 | | $ | 43,700 |
| Interest expense | | 6,756 | | 4,287 | ||
| Net interest income | | 41,836 | | 39,413 | ||
| Provision for (credit to) loan losses | | 1,414 | | (3,667) | ||
| Net interest income after provision for (credit to) loan losses | | 40,422 | | 43,080 | ||
| Non-interest income | | 5,896 | | 7,423 | ||
| Non-interest expense | | 37,422 | | 35,512 | ||
| Income before income tax expense | | 8,896 | | 14,991 | ||
| Income tax expense | | 1,899 | | 3,433 | ||
| Net income | | $ | 6,997 | | $ | 11,558 |
| Earnings per share (diluted) | | $ | 0.64 | | $ | 1.06 |
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| | | | | | |
|---|---|---|---|---|---|
| | | At or For the Year Ended December 31, | |||
| | 2022 | 2021 | |||
| Performance Ratios: | |||||
| Return on average assets(1) | 0.54 | % | 0.95 | % | |
| Return on average equity(2) | 6.06 | % | 9.49 | % | |
| Interest rate spread(3) | 3.22 | % | 3.28 | % | |
| Net interest margin(4) | 3.45 | % | 3.45 | % | |
| Efficiency ratio(5) | 78.40 | % | 75.82 | % | |
| Average interest-earning assets to average interest-bearing liabilities | 142.18 | % | 144.89 | % | |
| Total loans to total assets | 74.14 | % | 66.62 | % | |
| Equity to assets(6) | 8.91 | % | 10.02 | % | |
| | | | | | |
| Capital Ratios(7): | |||||
| Tier 1 capital (to adjusted total assets) | 9.75 | % | 9.65 | % | |
| Tier I capital (to risk-weighted assets) | 11.55 | % | 12.76 | % | |
| Total capital (to risk-weighted assets) | 12.25 | % | 13.54 | % | |
| Common equity Tier 1 capital (to risk-weighted assets) | 11.55 | % | 12.76 | % | |
| | | | | | |
| Asset Quality Ratios: | |||||
| Allowance for loan losses as a percent of total loans | 0.80 | % | 0.89 | % | |
| Allowance for loan losses as a percent of non-performing loans | 179.54 | % | 113.01 | % | |
| Net charge-offs to average outstanding loans | (0.11) | % | (0.05) | % | |
| Non-performing loans as a percent of total loans | 0.45 | % | 0.78 | % | |
| Non-performing assets as a percent of total assets | 0.33 | % | 0.52 | % | |
| | | | | | |
| Other Data: | |||||
| Book value per common share | | $ 9.58 | | $ 11.15 | |
| Tangible book value per common share(8) | | $ 9.35 | | $ 10.92 | |
| Number of offices | 17 | 18 | |||
| Number of full-time equivalent employees | 190 | 192 |
| Column 1 | Column 2 |
|---|---|
| (1) | Represents net income divided by average total assets. |
| Column 1 | Column 2 |
|---|---|
| (2) | Represents net income divided by average equity. |
| Column 1 | Column 2 |
|---|---|
| (3) | Represents the difference between the weighted average yield on average interest-earning assets and the weighted average cost on average interest-bearing liabilities. |
| Column 1 | Column 2 |
|---|---|
| (4) | Represents net interest income as a percent of average interest-earning assets. |
| Column 1 | Column 2 |
|---|---|
| (5) | Represents non-interest expense divided by the sum of net interest income and non-interest income. |
| Column 1 | Column 2 |
|---|---|
| (6) | Represents average equity divided by average total assets. |
| Column 1 | Column 2 |
|---|---|
| (7) | Capital ratios are for Rhinebeck Bank only. Rhinebeck Bancorp, Inc. is not subject to the minimum consolidated capital requirements as a small bank holding company with assets less than $3.0 billion. |
| Column 1 | Column 2 |
|---|---|
| (8) | Represents a non-GAAP financial measure, see table below for a reconciliation of the non-GAAP financial measures. |
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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.
| | | | | | | |
|---|---|---|---|---|---|---|
| | | | December 31, | |||
| (In thousands, except per share amounts) | | 2022 | | 2021 | ||
| Book value per common share reconciliation | | | | | | |
| Total shareholders' equity (book value) (GAAP) | | $ | 108,132 | | $ | 125,969 |
| Total shares outstanding | | | 11,285 | | | 11,296 |
| Book value per common share | | $ | 9.58 | | $ | 11.15 |
| Total common equity | | | | | | |
| Total shareholders' equity (book value) (GAAP) | | $ | 108,132 | | $ | 125,969 |
| Goodwill | | | (2,235) | | | (2,235) |
| Intangible assets, net | | | (334) | | | (433) |
| Tangible common equity (non-GAAP) | | $ | 105,563 | | $ | 123,301 |
| Tangible book value per common share | | | | | | |
| Tangible common equity (non-GAAP) | | $ | 105,563 | | $ | 123,301 |
| Total shares outstanding | | | 11,285 | | | 11,296 |
| Tangible book value per common share (non-GAAP) | | $ | 9.35 | | $ | 10.92 |
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Comparison of Financial Condition at December 31, 2022 and December 31, 2021
Total Assets. Total assets were $1.34 billion at December 31, 2022, representing an increase of $54.8 million, or 4.3%, compared to $1.28 billion at December 31, 2021. The increase was primarily related to an increase in net loans receivable of $139.4 million, or 16.3%, and an increase in deferred tax assets of $6.8 million, or 202.2%, partially offset by a decrease in available for sale securities of $56.6 million, or 20.2% and a decrease in cash and cash equivalents of $40.7 million, or 56.5%.
Cash and Cash Equivalents. Cash and cash equivalents decreased $40.7 million, or 56.5%, to $31.4 million at December 31, 2022 from $72.1 million at December 31, 2021, primarily due to a decrease in deposits held at the Federal Reserve Bank of New York, as excess cash was used to fund loan growth.
Investment Securities Available for Sale. Investment securities available for sale decreased $56.6 million, or 20.2%, to $223.7 million at December 31, 2022 from $280.3 million at December 31, 2021. The decrease was primarily due to $39.4 million of paydowns and maturities and $14.8 million of sales and calls, the proceeds of which were used to fund loan growth. A decrease of $32.2 million in unrealized market losses, due to the impact of an increasing interest rate environment on market valuations, also contributed to the decrease. The decrease was partially offset by $30.2 million in purchases, primarily in new U.S. government agency securities.
Net Loans. Net loans receivable were $994.4 million at December 31, 2022, an increase of $139.4 million, or 16.3%, as compared to $855.0 million at December 31, 2021. The increase was primarily due to increases of $75.1 million, or 19.7%, in indirect automobile loans and $58.9 million, or 18.9%, in commercial real estate loans, while commercial and industrial loans decreased $16.3 million, or 15.7%. The decrease in commercial and industrial loans was due to a decrease in PPP loans of $28.9 million, primarily as a result of SBA loan forgiveness. Excluding PPP loans, commercial and industrial loans increased $12.6 million, or 16.8%.
During the year, the allowance for loan losses increased $384,000, or 5.1%, reflecting an increase in our loan portfolio. Non-accrual loans and non-performing assets decreased $2.3 million, or 33.9%, to $4.4 million at December 31, 2022 from $6.7 million at December 31, 2021. The Company had no other real estate owned at the end of either period.
Deferred Tax Assets. Deferred tax assets increased $6.8 million, or 202.2%, to $10.1 million at December 31, 2022, primarily due to an increase in the unrealized loss on available for sale securities, driven by the impacts of an increasing interest rate environment on market valuations. The unrealized loss on available for sale securities was $35.7 million at December 31, 2022 as compared to $3.5 million at December 31, 2021.
Total Liabilities. Total liabilities increased $72.6 million, or 6.3%, in 2022 primarily due to an increase in FHLB advances of $39.7 million, or 220.0%, an increase in deposits of $27.9 million, or 2.5%, and an increase in accrued expenses and other liabilities of $4.4 million, or 21.2%.
Deposits. Deposits increased $27.9 million, or 2.5%, to $1.13 billion at December 31, 2022. Interest bearing accounts grew 7.5%, or $59.2 million, to $846.4 million. The increase resulted from an increase in certificates of deposit of $59.5 million, or 37.9% and an increase in money market accounts of $7.7 million, or 2.7%. This was partially offset by decreases in savings accounts of $5.6 million, or 3.1% and NOW accounts of $2.3 million, or 1.5%. Included within certificates of deposit were $34.0 million in brokered certificates of deposit, which were utilized as their costs were more favorable than FHLB borrowings. Non-interest bearing balances decreased 9.9%, or $31.3 million, finishing the year at $283.6 million. Mortgagors’ escrow accounts increased $602,000, or 6.6%, to $9.7 million at December 31, 2022. The increase in deposits was primarily driven by the branch acquisitions and organic growth in customer relationships.
Borrowed Funds. Advances from the FHLB increased $39.7 million, or 220.0%, from $18.0 million at December 31, 2021 to $57.7 million at December 31, 2022 as loan growth significantly outpaced deposit growth.
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Stockholders’ Equity. Stockholders' equity decreased $17.8 million to $108.1 million at December 31, 2022, primarily due to an increase in accumulated other comprehensive loss of $25.6 million partially offset by $7.0 million in net income. At December 31, 2022, the Company’s book value per share was $9.58 and the Company’s ratio of stockholders’ equity-to-total assets was 8.09%. At December 31, 2021, the Company’s book value per share was $11.15 and the Company’s ratio of stockholders’ equity-to-total assets was 9.83%. Unearned common stock held by the Bank’s employee stock ownership plan was $3.5 million and $3.7 million at December 31, 2022 and 2021, respectively.
Comparison of Operating Results for the Years Ended December 31, 2022 and December 31, 2021
Net Income. Net income for the year ended December 31, 2022 was $7.0 million ($0.65 per basic and $0.64 per diluted share), compared with $11.6 million ($1.07 per basic and $1.06 per diluted share) for the year ended December 31, 2021, a decrease of $4.6 million, or 39.5%. Interest and dividend income increased $4.9 million, or 11.2%, interest expense increased $2.5 million, or 57.6%, and the provision for loan losses increased $5.1 million, or 138.6%. Non-interest income decreased $1.5 million, or 20.6%, while non-interest expenses increased $1.9 million, or 5.4%, as compared to 2021. Taxes decreased $1.5 million or 44.7% on lower net income. The overall decrease in net income came largely from the provision for loan losses of $1.4 million in 2022 as compared to a credit to the provision of $3.7 million in 2021.
Net Interest Income. Net interest income increased $2.4 million, or 6.1%, to $41.8 million for the year ended December 31, 2022, as compared to $39.4 million for the year ended December 31, 2021. The increase was primarily driven by higher yields on higher interest-earning asset balances, which were partially offset by higher costs on interest-bearing liabilities. The net interest margin was 3.45% at both December 31, 2022 and 2021. The ratio of average interest-earning assets to average interest-bearing liabilities decreased 1.9% to 142.18%. The yield on interest earning assets increased 19 basis points to 4.01% in 2022 from 3.82%, primarily due to the rising interest rate environment in 2022. Deposit and borrowing costs increased 25 basis points to 0.79% in 2022 from 0.54% in 2021 driven by increases in general market rates and competitive forces.
Interest Income. Interest income increased $4.9 million, or 11.2%, to $48.6 million for fiscal year 2022 from $43.7 million for fiscal year 2021. The increase resulted primarily from increased yields and higher average earning asset balances. The average yield on interest-bearing depository accounts increased to 1.11% for fiscal year 2022 from 0.13% for fiscal year 2021. The average yield on loans remained unchanged at 4.80% for the fiscal year 2022 and fiscal year 2021. The average yields on investment securities increased to 1.49% for the fiscal year 2022 from 1.12% for 2021. Average interest earning assets increased $68.5 million from $1.14 billion at December 31, 2021 to $1.21 billion at December 31, 2022. The increase in average interest earning assets during 2022 compared to 2021 included increases of $63.4 million in average loan balances and $58.9 million in available for sale securities partially offset by a decrease of $53.8 million in average interest bearing depository accounts.
Interest Expense. Interest expense increased $2.5 million, or 57.6%, to $6.8 million for fiscal year 2022 from $4.3 million for fiscal year 2021. This was primarily due to a 25 basis point increase in the overall cost of interest bearing liabilities to 0.79% for fiscal 2022 from 0.54% for fiscal 2021, supplemented by an increase in average interest bearing liability balances of $63.2 million, or 8.0%, year over year. The average balance of the total interest-bearing deposits increased by $61.0 million, while the cost increased 21 basis points. The average balance of other interest-bearing liabilities increased $2.2 million, while the cost increased 94 basis points.
Provision for Loan Losses. The Company establishes provisions for loan losses, which are charged to earnings, at a level necessary to absorb known and inherent losses that are both probable and reasonably estimable at the date of the financial statements. In evaluating the level of the allowance for loan losses, management considers historical loss experience, the types and amount of loans in the loan portfolio, adverse situations that may affect the borrower’s ability to repay, the estimated value of any underlying collateral, and prevailing economic conditions, among other qualitative factors. This evaluation is inherently subjective as it requires estimates that are susceptible to significant revision as more information becomes available or as future events occur.
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The Company recorded a provision for loan losses of $1.4 million for the year ended December 31, 2022, an increase of $5.1 million, or 138.6%, as compared to the year ended December 31, 2021. The credit to the provision in 2021 was primarily attributable to a decline in loan balances, exclusive of PPP loans, a reduction in specific allocations to the allowance for loan losses and a general improvement in economic conditions as our customers showed signs of recovering from the pandemic. An increase in indirect automobile loan balances, an increase in specific allocations to the allowance for loan losses and declining economic conditions, primarily due to high inflation, were the primary factors leading to the increase in the provision in 2022.
Net charge-offs for the year ended December 31, 2022 totaled $1.0 million, compared to $407,000 for the year ended December 31, 2021. The increase was primarily due to a $449,000 charge-off of one commercial loan in the fourth quarter and $230,000 in increased charge-offs in our indirect automobile portfolio. The percentage of overdue account balances to total loans increased to 2.29% as of December 31, 2022 from 1.58% as of December 31, 2021 while our non-performing assets decreased $2.3 million, or 33.9%, to $4.4 million.
Although we believe that we use the best information available to establish the allowance for loan losses, future additions to the allowance may be necessary, based on estimates that are susceptible to change 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 loan 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.
With the adoption of CECL beginning on January 1, 2023, provision expense may become more volatile due to changes in CECL model assumptions of credit quality, macroeconomic factors and conditions, and loan composition, which drive the allowance for credit losses balance. Based upon a fourth quarter parallel run, the Company expects the adoption to result in an approximate 10% increase to its current reserve of $7.9 million.
Non-Interest Income. For the year ended December 31, 2022, total non-interest income decreased $1.5 million, or 20.6%, from the prior year. The reduction between periods was mostly due to the decrease in the gain on the sale of mortgage loans of $1.7 million, or 66.5%. The decrease was primarily due to decreased activity as there were fewer loan originations in the increasing interest rate environment as well as a strategic decision that was made to hold most of our new production in our portfolio instead of selling these loans. The 2021 one-time gain from the collection of a life insurance claim of $195,000 and a net realized loss in 2022 from the sale of securities of $170,000 also contributed to the decrease in total non-interest income. The decrease was partially offset by an increase in service charges on deposit accounts of $245,000, an improvement in investment advisory income of $103,000, a $69,000 increase in the cash value of life insurance, and a net improvement of $199,000 in other income items.
Non-Interest Expense. For the year ended December 31, 2022, non-interest expense totaled $37.4 million, an increase of $1.9 million, or 5.4%, over 2021. The increase was primarily due to an increase in salaries and benefits of $1.5 million, or 7.4%, due to branch expansion, new hires, annual merit increases, production incentives and employee benefit increases, as well as the competitive pressures of the current job market. For the year ended December 31, 2022, occupancy expenses increased $459,000, or 11.1%, primarily as a result of the additional rent, depreciation and other expenses related to branch expansion. The one-time closure and lease cancellation costs for our Monroe branch in December 2022 also contributed to the increase in occupancy expenses. Our addition of four branches in 2021 was also primarily responsible for increased data processing costs of $138,000 and increased FDIC insurance costs of $60,000 during 2022. These increases were partially offset by decreased professional fees of $99,000 and a decrease in other non-interest expenses of $118,000 in 2022. The decrease in other non-interest expense was primarily due to a reserve put in place in 2021 for potential consumer compliance issues in the Bank’s indirect automobile portfolio. These issues were resolved in 2022 and no further material negative impact to earnings is expected.
Income Taxes. Income tax provision decreased by $1.5 million, or 44.7%, to $1.9 million for the year ended December 31, 2022 as compared to $3.4 million in 2021, primarily due to the decline in pre-tax income. Our effective tax rate for the year ended December 31, 2022 was 21.35% compared to 22.90% in 2021. 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, 2022 and 2021
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 $1.2 million and $2.7 million for the years ended December 31, 2022 and 2021, respectively.
| | | | | | | | | | | | | | | | | | |
|---|---|---|---|---|---|---|---|---|---|---|---|---|---|---|---|---|---|
| | | For the Year Ended December 31, | |||||||||||||||
| | | 2022 | | 2021 | | ||||||||||||
| | Average | Interest and | | Average | Interest and | | |||||||||||
| | | Balance | | Dividends | | Yield/Cost | | Balance | | Dividends | | Yield/Cost | | ||||
| | | (Dollars in thousands) | |||||||||||||||
| Assets: | | | | | |||||||||||||
| Interest bearing depository accounts | | $ | 29,368 | | $ | 325 | 1.11 | % | $ | 83,169 | | $ | 105 | 0.13 | % | ||
| Loans(1) | | 924,581 | | 44,419 | 4.80 | % | 861,207 | | 41,363 | 4.80 | % | ||||||
| Available for sale securities | | 257,740 | | 3,848 | 1.49 | % | 198,795 | | 2,232 | 1.12 | % | ||||||
| Total interest-earning assets | | | 1,211,689 | | | 48,592 | 4.01 | % | | 1,143,171 | | | 43,700 | 3.82 | % | ||
| Non-interest-earning assets | | 84,310 | | | 72,091 | | | ||||||||||
| Total assets | | $ | 1,295,999 | | | $ | 1,215,262 | | | ||||||||
| Liabilities and equity: | | | | | | ||||||||||||
| NOW accounts | | $ | 160,172 | | $ | 228 | 0.14 | % | $ | 148,851 | | $ | 241 | 0.16 | % | ||
| Money market accounts | | 315,231 | | 3,395 | 1.08 | % | 244,412 | | 1,395 | 0.57 | % | ||||||
| Savings accounts | | 188,188 | | 443 | 0.24 | % | 174,369 | | 283 | 0.16 | % | ||||||
| Certificates of deposit | | 143,449 | | 1,435 | 1.00 | % | 178,360 | | 1,577 | 0.88 | % | ||||||
| Total interest-bearing deposits | | 807,040 | | 5,501 | 0.68 | % | 745,992 | | 3,496 | 0.47 | % | ||||||
| Escrow accounts | | 9,931 | | 110 | 1.11 | % | 9,045 | | 105 | 1.16 | % | ||||||
| FHLB and FRB advances | | 30,074 | | 948 | 3.15 | % | 28,792 | | 573 | 1.99 | % | ||||||
| Subordinated debt | | 5,155 | | 197 | 3.82 | % | 5,155 | | 113 | 2.19 | % | ||||||
| Other interest-bearing liabilities | | 45,160 | | 1,255 | 2.78 | % | 42,992 | | 791 | 1.84 | % | ||||||
| Total interest-bearing liabilities | | | 852,200 | | | 6,756 | 0.79 | % | | 788,984 | | | 4,287 | 0.54 | % | ||
| Non-interest-bearing deposits | | 304,488 | | | 284,279 | | | ||||||||||
| Other non-interest-bearing liabilities | | 23,865 | | | 20,250 | | | ||||||||||
| Total liabilities | | | 1,180,553 | | | | 1,093,513 | | | ||||||||
| Total stockholders’ equity | | 115,446 | | | 121,749 | | | ||||||||||
| Total liabilities and stockholders’ equity | | $ | 1,295,999 | | | $ | 1,215,262 | | | ||||||||
| Net interest income | | | $ | 41,836 | | | $ | 39,413 | | ||||||||
| Interest rate spread | | | 3.22 | % | | 3.28 | % | ||||||||||
| Net interest margin(2) | | | 3.45 | % | | 3.45 | % | ||||||||||
| Average interest-earning assets to average interest-bearing liabilities | | | 142.18 | % | | 144.89 | % |
| Column 1 | Column 2 |
|---|---|
| (1) | Non-accruing loans are included in the outstanding loan balance. |
| Column 1 | Column 2 |
|---|---|
| (2) | Represents the difference between interest earned and interest paid, divided by average total interest earning assets. |
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Rate/Volume Analysis
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.
| | | | | | | | | | | |
|---|---|---|---|---|---|---|---|---|---|---|
| | | Year Ended December 31, 2022 | | |||||||
| | | Compared to Year Ended | | |||||||
| | | December 31, 2021 | | |||||||
| | | Increase (Decrease) | | |||||||
| | | Due to | | |||||||
| | Volume | Rate | Net | |||||||
| | | (In thousands) | ||||||||
| Interest income: | | | | |||||||
| Interest bearing depository accounts | | $ | (108) | | $ | 328 | | $ | 220 | |
| Loans receivable | | 3,045 | | 11 | | 3,056 | | |||
| Available for sale securities | | 764 | | 852 | | 1,616 | | |||
| Total interest-earning assets | | 3,701 | | 1,191 | | 4,892 | | |||
| Interest expense: | | | | | ||||||
| Deposits | | 202 | | 1,804 | | 2,006 | | |||
| Escrow accounts | | 9 | | (5) | | 4 | | |||
| Federal Home Loan Bank advances | | 27 | | 348 | | 375 | | |||
| Subordinated debt | | — | | 84 | | 84 | | |||
| Total interest-bearing liabilities | | 238 | | 2,231 | | 2,469 | | |||
| Net increase in net interest income | | $ | 3,463 | | $ | (1,040) | | $ | 2,423 | |
As the table above shows, net interest income for the year ended December 31, 2022 has been affected most significantly by the increase in volume of loans and securities, partially offset by the increase in interest-bearing liability balances and rates on interest-bearing liabilities. Net interest rate spread decreased 6 basis points to 3.22% for the year ended December 31, 2022 as compared to 3.28% for the year ended December 31, 2021. Net interest margin was stable at 3.45% at both December 31, 2022 and 2021.
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, 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, 200, 300 and 400 basis points from current market rates and that interest rates decrease 100 and 200 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, 2022. All estimated changes presented in the table are within the policy limits approved by our Board of Directors.
| | | | | | | | | | | | | | | |
|---|---|---|---|---|---|---|---|---|---|---|---|---|---|---|
| | | | | | | | | | | | Net Economic Value as a | |||
| | | Net Economic Value | | | Percentage of Assets | |||||||||
| | Dollar | Dollar | Percent | | EVE | Percent | ||||||||
| Basis Point Change in Interest Rates | | Amount | | Change | | Change | | | Ratio | | Change | |||
| | | (Dollars in thousands) | | | | | | |||||||
| 400 | | $ | 158,218 | | $ | (30,594) | (16.2) | % | | 13.27 | % | (9.0) | % | |
| 300 | | 165,896 | | (22,916) | (12.1) | % | | 13.64 | % | (6.5) | % | |||
| 200 | | 172,773 | | (16,039) | (8.5) | % | | 13.93 | % | (4.5) | % | |||
| 100 | | 181,239 | | (7,573) | (4.0) | % | | 14.31 | % | (1.9) | % | |||
| 0 | | 188,812 | | — | — | % | | 14.58 | % | — | % | |||
| (100) | | | 188,594 | | | (218) | (0.1) | % | | 14.25 | % | (2.3) | % | |
| (200) | | | 180,056 | | | (8,756) | (4.6) | % | | 13.30 | % | (8.8) | % |
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 above table 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, loan sales, 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 and loan sales and prepayments are greatly influenced by market interest rates, economic conditions, and rates offered by our competition. We set the interest rates on our deposits 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 $14.8 million and $7.7 million for the years ended December 31, 2022 and 2021, respectively. These amounts differ from our net income because of a variety of cash receipts and disbursements that did not affect net income for the respective periods. Net cash used for investing activities was $123.6 million and $135.7 million in fiscal years 2022 and 2021, respectively, principally reflecting our investment security and loan activities in the respective periods. Cash outlays for the purchase of securities decreased from $244.6 million for the year ended December 31, 2021 to $30.2 million for the year ended December 31, 2022. We used cash to finance a net increase in loans of $144.5 million in 2022, compared to cash provided by a net decrease in loans of $23.7 million in 2021, as prepayments and maturities exceeded originations in 2021. We also received $32.8 million in cash from the acquisition of two branches and related deposits in 2021. Deposit and borrowing cash flows have traditionally comprised most of our financing activities which, together with other funding cash flows, resulted in net cash provided of $68.1 million in fiscal year 2022, and $106.7 million in fiscal year 2021.
At December 31, 2022, we had the following main sources of availability of liquid funds and borrowings:
| | | | |
|---|---|---|---|
| (In thousands) | Total | ||
| Available liquid funds: | | | |
| Cash and cash equivalents | | $ | 31,384 |
| Unencumbered securities | | | 207,294 |
| Amount available from the Paycheck Protection Plan Loan Facility | | | 537 |
| Availability of borrowings: | | | |
| Zions Bank line of credit | | | 10,000 |
| Pacific Coast Bankers Bank line of credit | | | 50,000 |
| Other secured FHLB credit facility | | | 142,729 |
| Total available sources of funds | | $ | 441,944 |
The following table summarizes our main contractual obligations and other commitments to make future payments as of December 31, 2022. 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.
| | | | | | | | | | | | | |
|---|---|---|---|---|---|---|---|---|---|---|---|---|
| | | December 31, 2022 | ||||||||||
| (In thousands) | Total | One Year or Less | After One but within Five Years | After 5 Years | ||||||||
| Payments Due: | | | | | | | | | ||||
| Federal Home Loan Bank advances | | $ | 57,723 | | $ | 51,273 | | $ | 6,450 | | $ | — |
| Operating lease agreements | | | 8,054 | | | 761 | | | 2,899 | | | 4,394 |
| Subordinated debt | | | 5,155 | | | — | | | — | | | 5,155 |
| Time deposits with stated maturity dates | | | 216,382 | | | 151,591 | | | 64,791 | | | — |
| Total contractual obligations | | $ | 287,314 | | $ | 203,625 | | $ | 74,140 | | $ | 9,549 |
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 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 12 to the Consolidated Financial Statements. For fiscal year 2022, 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 Rhinebeck Bancorp, Inc. 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.