SR Bancorp, Inc. (SRBK)

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

The objective of this section is to assist in the understanding of the financial performance of the Company and its subsidiaries through a discussion of our results of operations and financial condition as of the dates presented. You should read this discussion in conjunction with the SR Bancorp Consolidated Financial Statements and Notes to the Consolidated Financial Statements that appear at the end of this document. Due to the timing of the stock offering and acquisition noted below, the financial information provided herein as of and for the year ended June 30, 2023 is solely that of Somerset Savings Bank, SLA, and its subsidiaries, unless indicated otherwise.

Conversion, Stock Offering and Merger

The conversion of Somerset Savings Bank, SLA from the mutual to stock form of organization and related stock offering by SR Bancorp, Inc. (the "Company"), the holding company for Somerset Savings Bank, SLA, was completed on September 19, 2023. The Company’s common stock began trading on the Nasdaq Capital Market under the trading symbol “SRBK” on September 20, 2023.

The Company sold 9,055,172 shares of its common stock at a price of $10.00 per share, which included 760,634 shares sold to Somerset Regal Bank’s Employee Stock Ownership Plan. Additionally, the Company contributed 452,758 shares and $906,000 in cash to the Somerset Regal Charitable Foundation, Inc., a charitable foundation formed in connection with the conversion. Upon the completion of the conversion and offering, 9,507,930 shares of Company common stock were outstanding.

Promptly following the completion of the conversion and related stock offering, Regal Bancorp, Inc., a New Jersey corporation (“Regal Bancorp”), merged with and into the Company, with the Company as the surviving entity (the “Merger”). Immediately following the Merger, Regal Bank, a New Jersey chartered commercial bank headquartered in Livingston, New Jersey and the wholly-owned subsidiary of Regal Bancorp, merged with and into Somerset Bank, which had converted to a commercial bank charter, and was renamed Somerset Regal Bank (the “Bank”). In connection with the Merger, each outstanding share of Regal Bancorp common stock converted into the right to receive $23.00 in cash. The Merger was completed on September 19, 2023.

Overview

Our principal business is to acquire deposits from individuals and businesses in the communities surrounding our offices and to use these deposits to fund loans.

Somerset Regal Bank is a New Jersey-chartered commercial bank that operates from 15 branches in Essex, Hunterdon, Middlesex, Morris, Somerset and Union Counties, New Jersey. Somerset Regal Bank offers a variety of deposit and loan products to individuals and small businesses, most of which are located in our primary market. The acquisition of Regal Bancorp and its wholly owned subsidiary, Regal Bank, expanded our market presence into Essex, Morris and Union Counties, New Jersey and enhanced our market presence in Somerset County, New Jersey. At June 30, 2024, SR Bancorp had total assets of $1.02 billion, deposits of $807.1 million and total equity of $199.5 million.

Income. Our primary source of pre-tax income is net interest income. Net interest income is the difference between interest income, which is the income that we earn on our loans and investments, and interest expense, which is the interest that we pay on our deposits. Changes in levels of interest rates affect our net interest income.

A secondary source of income is noninterest income, which is revenue that we receive from providing products and services. The majority of our noninterest income generally comes from service charges and fees related to deposit accounts and net gains in cash surrender value of bank-owned life insurance. In some years, we recognize income from the sale of securities.

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Allowance for Credit Losses. The allowance for credit losses is a valuation allowance for the current expected credit losses in the loan portfolio. We evaluate the need to establish allowances against losses on loans on a quarterly basis. When additional allowances are necessary, a provision for credit losses is charged to earnings. 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.

Expenses. The noninterest expenses we incur in operating our business consist of salaries and employee benefits expenses, occupancy expenses, furniture and equipment expenses, data processing, advertising, FDIC insurance premiums, directors fees, professional fees, insurance, telephone, postage and supplies and other miscellaneous expenses.

Our largest noninterest expense is salaries and employee benefits, which consist primarily of salaries and wages paid to our employees, payroll taxes, expenses for retirement plans and other employee benefits including disability insurance and health insurance and compensation expenses related to the recently implemented employee stock ownership plan.

Occupancy expenses and furniture and equipment expenses are the fixed and variable costs of buildings and equipment, and consist primarily of depreciation charges, furniture and equipment expenses, repair and maintenance costs, real estate taxes and costs of utilities. Depreciation of premises and equipment is computed using a straight-line method based on the estimated useful lives of the related assets or the expected lease terms, if shorter.

Data processing expenses are fees paid to third parties for use of their software and for processing customer information, deposits and loans.

Advertising includes most marketing expenses including multi-media advertising (public and in-branch), promotional events and materials, civic and sales focused memberships, and community support.

Federal deposit insurance premiums are payments we make to the FDIC for insurance of our deposit accounts.

Professional fees include legal, accounting, auditing, risk management and payroll processing expenses.

Insurance includes expenses for worker’s compensation, property and casualty insurance and professional insurance.

Other expenses include expenses for directors fees, office supplies, postage, telephone and other miscellaneous operating expenses.

Critical Accounting Policies

Certain of our accounting policies are important to the presentation of our financial condition, since they require management to make difficult, complex or subjective judgments, some of which may relate to matters that are inherently uncertain. Estimates associated with these policies are susceptible to material changes as a result of changes in facts and circumstances. Facts and circumstances that could affect these judgments include, but are not limited to, changes in interest rates, changes in the performance of the economy and changes in the financial condition of borrowers. Our significant accounting policies are discussed in detail in Note 1 to our Consolidated Financial Statements included elsewhere in this document.

The JOBS Act contains provisions that, among other things, reduce certain reporting requirements for qualifying public companies. As an “emerging growth company” we plan to delay adoption of new or revised accounting pronouncements applicable to public companies until such pronouncements are made applicable to private companies. Accordingly, our consolidated financial statements may not be comparable to the financial statements of public companies that comply with such new or revised accounting standards.

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Management believes our most critical accounting policies, which involve the most complex or subjective decisions or assessments, are as follows: the determination of the allowance for credit losses, the assessment of the impairment of goodwill and intangible assets and the valuation of our deferred tax assets.

Allowance for Credit Losses: The allowance for credit losses (“ACL”), calculated in accordance with ASC 326, is deducted from the amortized cost basis of loans. The ACL represents an amount that, in management’s judgment, is adequate to absorb the lifetime expected credit losses that may be experienced on outstanding loans at the balance sheet date based on the evaluation of the size and current risk characteristics of the loan portfolio, past events, current conditions, reasonable and supportable forecasts of economic conditions and prepayment experience. The allowance for credit losses is measured and recorded upon the initial recognition of a financial asset. Determination of the adequacy of the allowance is inherently complex and requires the use of significant and highly subjective estimates. Loans are charged-off against the allowance when deemed uncollectible by management. Adjustments to the allowance are reported in our income statement as a component of the provision for credit losses.

In calculating the allowance for credit losses, loans are segmented into pools based upon similar characteristics and risk profiles. Common characteristics and risk profiles include the type of loan, underlying collateral, geographical similarity and historical or expected credit loss patterns. The Company applies two methodologies to estimate the allowance on its pooled portfolio segments: a cohort method based on common characteristics and the weighted average remaining life method. The models related to these methodologies utilize the Company’s historical default and loss experience adjusted for future economic forecasts. The reasonable and supportable forecast period represents a one-year economic outlook for the applicable economic variables.

In some cases, management may determine that an individual loan exhibits unique risk characteristics that differentiate the loan from other loans within our loan pools. In such cases, the loans are evaluated for expected credit losses on an individual basis and excluded from the collective evaluation. Specific allocations of the allowance for credit losses are determined by analyzing, among other things, the borrower’s ability to repay amounts owed, collateral deficiencies, the relative risk rating of the loan and economic conditions affecting the borrower.

Management qualitatively adjusts model results for risk factors that are not considered within our modeling processes but are nonetheless relevant in assessing the expected credit losses within our loan pools. These qualitative factor adjustments may increase or decrease management’s estimate of expected credit losses by a calculated percentage or amount based upon the estimated level of risk. The various risks that may be considered in making qualitative factor adjustments include, among other things: the impact of changes in lending policies and procedures, including changes in underwriting standards and practices for collections, write-offs, and recoveries; actual and expected changes in national, regional, and local economic and business conditions and developments that affect the collectability of the loan pools; changes in the composition and size of the loan portfolio and in the terms of the underlying loans; changes in the experience, ability, and depth of our lending management and staff; changes in volume and severity of past due and nonaccrual assets; changes to the quality of our internal loan review system; the existence, growth, and effect of any concentrations of credit; and regulatory, legal and environmental events. Management believes it uses relevant information available to make determinations about the allowance and that it has established the existing allowance in accordance with GAAP. However, the determination of the allowance requires significant judgment, and estimates of expected lifetime losses in the loan portfolio can vary significantly from the amounts actually observed. While management uses available information to recognize expected losses, future additions to the allowance may be necessary based on changes in the loans comprising the portfolio, changes in the current and forecasted economic conditions, changes to the interest rate environment and changes in the financial condition of borrowers.

Goodwill and Other Intangible Assets: Our intangible assets consist primarily of goodwill and core deposit intangibles. The initial recording of goodwill and other intangible assets requires subjective judgments concerning estimates of the fair value of the acquired assets and assumed liabilities. Goodwill is not amortized but is subject to annual tests for impairment, or more often if events or circumstances indicate it may be impaired. We may elect to perform a qualitative assessment as a part of the annual impairment test. If the qualitative assessment indicates it is more likely than not that the fair value of a reporting unit is less than its carrying amount, or if we elect not to perform a qualitative assessment, then we would be required to perform a quantitative test for goodwill impairment. If the estimated fair value of the reporting unit less than the carrying value, goodwill is impaired and is written down to its estimated fair value.

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In the year ended June 30, 2024, we performed a qualitative assessment of goodwill. Based on that assessment, we determined that it was more likely than not that the unit's fair value was not less than its carrying amount. We concluded that our goodwill was not impaired as of June 30, 2024.

Core deposit intangibles are amortized on an accelerated basis using an estimated life of ten years. The core deposit intangibles are evaluated annually for impairment in accordance with GAAP. An impairment loss will be recognized if the carrying amount of the intangible asset is not recoverable and exceeds fair value. The carrying amount of the intangible asset is not considered recoverable if it exceeds the sum of the undiscounted cash flows expected to result from the use of the asset.

Income Taxes: Income taxes are accounted for using the asset and liability 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.

The effect on deferred tax assets and liabilities of a change in tax rates is recognized in income in the period that includes the enactment date. The measurement of deferred tax assets is reduced by a valuation allowance for the amount of the deferred tax asset that is more likely than not to be realized.

A tax position is recognized as a benefit only if it is “more likely than not” that the tax position would be sustained in a tax examination, with a tax examination being presumed to occur. The amount recognized is the largest amount of tax benefit that is greater than 50% likely of being realized on examination. For tax positions not meeting the “more likely than not” test, no tax benefit is recorded.

We recognize interest and/or penalties related to income tax matters in other operating expenses.

Business Strategy

Our business strategy is to operate and grow a profitable community-oriented financial institution.We plan to achieve this by:

Leveraging our residential and commercial lending expertise to pursue new opportunities to increase lending in our primary market area and expand our existing loan relationships. Prior to the Merger, Somerset Savings Bank’s principal business activity historically had been the origination of residential mortgage loans, while Regal Bank’s principal business activity historically had been the origination of multi-family and commercial real estate loans. Somerset Regal Bank will continue to provide products and services that meet the needs of the existing residential lending customers and be able to offer such products, services and expertise to the former Regal Bank customers throughout its newly-expanded market area. Additionally, Somerset Regal Bank will continue to provide products and services that meet the needs of the existing commercial customers and be able to offer such products, services and expertise to the former Somerset Savings Bank customers throughout its newly-expanded market area.

The opportunity for both banks to diversify their loan portfolios and leverage their lending expertise in new markets were primary factors for the Merger. Moreover, with the additional capital raised in the stock offering, we can increase our loan originations in our market area and originate loans with larger balances. Somerset Regal Bank’s legal lending limit was $29.9 million at June 30, 2024. While Somerset Regal Bank’s credit risk management policies will result in an internal loan to one borrower limit less than Somerset Regal Bank’s regulatory limit, the legal lending limit will provide opportunities to expand existing customer relationships and reach new larger customers.

We intend to leverage the SBA preferred lender expertise to expand SBA lending activity in our market areas. SBA lending capabilities provide an opportunity to establish additional commercial account relationships and the potential to generate additional noninterest income related to the sale and servicing of the guaranteed portion of an SBA loan on the secondary market.

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Continuing to use prudent underwriting practices to maintain a high-quality loan portfolio. Maintaining high asset quality is a key to long-term financial success. Somerset Regal Bank seeks to grow its loan portfolio while keeping non-performing assets to a minimum. Somerset Regal Bank’s strategy for credit risk management focuses on having an experienced team of credit professionals, well-defined policies and procedures, appropriate and conservative loan underwriting criteria and active credit monitoring. At June 30, 2024, Somerset Regal Bank had $50,000 of non-performing loans.

Building profitable business and consumer relationships through enhanced product offerings and by continuing to provide superior customer service. We are a full-service financial services company offering our customers a broad range of loan and deposit products and services, including internet banking, which enables our customers to pay bills on-line. Our commercial lending capacity has been significantly enhanced through our merger, which allows us to continue to increase the commercial real estate and commercial business loans we originate and better serve the small businesses in our market area, and realize higher fees and yields associated with such type of lending. Further, commercial deposit accounts, generally yield higher average balances than can be acquired from retail deposit relationships.

As a community-oriented financial institution, we emphasize providing superior customer service to attract and retain customers. We deliver personalized service and respond with flexibility to customer needs. We believe that our community orientation is attractive to our customers and distinguishes us from the larger institutions that operate in our area. Further, given our attractive market area, we believe we are well-positioned to increase our customer relationships without a proportional increase in overhead expense or operating risk.

Increasing transaction deposit accounts and deposit balances. 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 certificates of deposit). Core deposits represented 66.2% of our total deposits at June 30, 2024 compared to 68.4% of our total deposits at June 30, 2023. We believe core deposits will increase by increasing our commercial lending activities and enhancing our relationships with retail customers through our commitment to quality customer service along with the introduction of additional products and services, such as remote deposit capture and enhanced online business account services.

Continuing to leverage technology to maintain efficient operations and enhance customer service. We have historically focused on leveraging technology to maintain efficient operations and provide our customers with secure means to conduct business outside of our traditional branch network. Customer facing applications include online banking and mobile banking with bill payment capabilities, mobile deposit and debit card control functionality. We have been a Zelle™ participant since 2019, which has allowed our customers the ability to send and receive real-time payments online and through mobile banking. Our online loan application platform affords customers the convenience of submitting a loan application online. Internally we leverage technology to achieve efficiencies for tasks such as document preparation and retention, data analytics and call report preparation. We intend to build on this foundation and have plans to add, among other services, online deposit account opening for existing customers, tokenization (meaning the process of exchanging sensitive data with a less sensitive equivalent (or token), specifically Apply Pay©, Google Pay© and Samsung Pay©), and expanded business online banking capabilities including wire transfer origination and ACH origination services. These additional services are in various stages of implementation, and we anticipate customer availability for most prior to the end of 2024. Our investment in technology allows us to remain competitive, effectively serve our customers and results in operating efficiencies.

Comparison of Financial Condition at June 30, 2024 and June 30, 2023

Total Assets. Total assets increased $369.4 million, or 56.7%, to $1.02 billion at June 30, 2024 from $651.5 million at June 30, 2023. The increase was primarily the result of the acquisition of Regal Bancorp, and its wholly-owned subsidiary Regal Bank, on September 19, 2023, which had $427.8 million of assets at the time of the acquisition. The increase was also due to net proceeds of $86.9 million obtained from the completion of the Company’s stock offering on the same date. These increases were offset by a $20.0 million repayment of a borrowing and a decrease in deposits due to the interest rate environment and competition in our market area.

Cash and Cash Equivalents. Cash and cash equivalents increased $3.5 million, or 8.2%, to $45.9 million at June 30, 2024 from $42.4 million at June 30, 2023 due to $55.3 million of cash and cash equivalents acquired from

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the Regal Bancorp acquisition and the net proceeds of $86.9 million retained from the stock offering, partially offset by $69.5 million paid for the acquisition of Regal Bancorp, offset by a $20.0 million repayment of a borrowing and a decrease in deposits due to the interest rate environment and competition in our market area.

Securities Available-for-Sale. Following the completion of the Merger, the Company sold $19.2 million of its available-for-sale portfolio, followed by the sale of the remaining $35.4 million of securities-available-for-sale in the fourth quarter of the year ended June 30, 2024 at a loss of $4.4 million as part of its balance sheet restructuring. The Company held no securities available-for-sale at June 30, 2024. The Company redeployed the proceeds from the sale of these lower yielding securities into higher yielding loans as part of a balance sheet restructuring strategy. The loans originated had a positive spread differential of approximately 472 basis points over the securities that were sold, which is expected to result in $1.4 million in additional pre-tax earnings, on an annualized basis. As such, the Company estimates that the loss on the sale of securities will be recouped within approximately 3.23 years.

Securities Held-to-Maturity. Securities held-to-maturity decreased $12.9 million, or 7.5%, to $158.3 million at June 30, 2024 from $171.2 million at June 30, 2023 as the maturities of securities during the period more than offset the acquisition of $2.6 million of held-to-maturity securities from the Regal Bancorp acquisition.

Loans. Loans receivable, net, increased $369.6 million, or 102.0%, to $731.9 million at June 30, 2024 from $362.3 million at June 30, 2023. The Company acquired $321.6 million of loans from the Regal Bancorp acquisition, primarily consisting of multi-family and commercial real estate loans. As a result of the acquisition, the composition of the loan portfolio changed significantly from June 30, 2023. The percentage of residential mortgage loans to total loans decreased from 97.8% at June 30, 2023 to 53.7% at June 30, 2024. Commercial loans (consisting of multi-family and commercial real estate loans and commercial and industrial loans) accounted for 44.7% of loans at June 30, 2024.

Bank Owned Life Insurance. Bank owned life insurance increased $8.4 million, or 29.2%, to $37.1 million at June 30, 2024 from $28.7 million at June 30, 2023. The increase was primarily the result of the Regal Bancorp acquisition, which had $7.5 million of bank owned life insurance at the time of acquisition.

Goodwill and Intangible Assets. The Company recognized goodwill and a core deposit premium intangible through the acquisition of Regal Bancorp. At the time of acquisition, goodwill was $20.5 million and the core deposit premium intangible asset was $9.1 million. Finalization of the purchase allocation reduced goodwill to $20.4 million at June 30, 2024. No impairment loss was recognized on goodwill during the year ended June 30, 2024. The carrying amount of the core deposit premium intangible, net of accumulated amortization, was $7.7 million at June 30, 2024.

Total Liabilities. Total liabilities increased $292.0 million, or 55.1%, to $821.4 million at June 30, 2024 from $529.4 million at June 30, 2023. The increase was primarily the result of the Regal Bancorp acquisition, which had $378.7 million of liabilities at the time of the acquisition, offset by a $20.0 million repayment of a borrowing and a decrease in deposits due to the interest rate environment and competition in our market area.

Deposits. Deposits increased $303.2 million, or 60.2%, to $807.1 million at June 30, 2024 from $503.9 million at June 30, 2023 due primarily to the $371.9 million of deposits assumed from the Regal Bank acquisition offset by a decrease in deposits due to the interest rate environment and competition in our market area. At the time of the acquisition, Regal Bank’s deposits consisted of $90.8 million of noninterest-bearing deposits, $162.4 million in NOW, money market and savings accounts and $118.7 million of certificates of deposit.

Borrowings. We had no borrowings outstanding at June 30, 2024 as the $20.0 million of borrowings outstanding at June 30, 2023 were repaid during the year ended June 30, 2024.

Total Equity. Total equity increased $77.4 million, or 63.4%, to $199.5 million at June 30, 2024 from $122.1 million at June 30, 2023. The increase resulted primarily from the $86.9 million in net proceeds from the Company’s stock offering and other comprehensive income of $3.8 million, partially offset by the $7.6 million initial funding of the ESOP and a net loss of $10.9 million for the period.

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Comparison of Operating Results for the Years Ended June 30, 2024 and June 30, 2023

General. The Company recorded a net loss for the year ended June 30, 2024 of $10.9 million, compared to net income of $1.6 million for the year ended June 30, 2023. The decrease was due primarily to one-time merger-related expenses of $4.4 million, a $4.2 million provision for credit losses, a $5.4 million charitable contribution to establish the Somerset Regal Charitable Foundation and a $4.5 million loss on the sale of available-for-sale securities, partially offset by $4.1 million of net accretion income related to fair value adjustments.

Interest Income. Interest income increased $24.7 million, or 153.5%, to $40.9 million for the year ended June 30, 2024 from $16.1 million for the year ended June 30, 2023. The increase resulted primarily from a $22.3 million, or 197.1%, increase in interest income on loans and a $2.8 million increase in interest income on interest bearing deposits at other banks, offset by a $482,000, or 13.1%, decrease in interest income on securities. The average balance of loans increased $282.2 million, or 80.2%, to $634.3 million for the year ended June 30, 2024, compared to $352.1 million for the year ended June 30, 2023. In addition, the average yield on the loan portfolio increased 209 basis points to 5.30% for the year ended June 30, 2024 from 3.21% for the year ended June 30, 2023, which reflected the higher interest rate environment and the greater proportion of commercial loans in the portfolio.

The decrease in income on securities was primarily due to the sales of $54.6 million of available-for-sale securities during the year as part of a balance sheet restructuring, which resulted in the average balance of securities decreasing $29.1 million, or 13.0%, to $195.8 million for the year ended June 30, 2024, compared to $225.0 million for the year ended June 30, 2023.

The increase in the interest income on interest bearing deposits and federal funds sold was due to a 80 basis point increase in the average yield from 3.64% for the year ended June 30, 2023 to 4.44% for the year ended June 30, 2024, due to the higher interest rate environment, and a $60.4 million, or 196.1%, increase in the average balance from $30.8 million for the year ended June 30, 2023 to $91.2 million for the year ended June 30, 2024 due to excess cash from the merger and the offering.

Interest Expense. Interest expense increased $9.1 million or 373.4%, to $11.5 million for the year ended June 30, 2024 from $2.4 million for the year ended June 30, 2023. The increase in interest expense resulted primarily from an increase in interest expense on certificates of deposits. The average balance of certificates of deposit increased $100.9 million, or 67.9%, to $249.4 million for the year ended June 30, 2024 from $148.5 million for the year ended June 30, 2023, while the average rate increased 246 basis points to 3.79% for the year ended June 30, 2024 from 1.33% for the year ended June 30, 2023 as the Company increased rates on certificates of deposit to increase deposits and liquidity. The average balance of interest-bearing demand deposits increased $55.8 million, to $199.2 million for the year ended June 30, 2024 from $143.5 million for the year ended June 30, 2023. The average rate on interest-bearing demand deposits increased 49 basis points to 0.56% for the year ended June 30, 2024 from 0.07% for the year ended June 30, 2023.

Net Interest Income. Net interest income increased $15.7 million, or 114.5%, to $29.4 million for the year ended June 30, 2024 from $13.7 million for the year ended June 30, 2023. The net interest rate spread increased 59 basis points to 2.73% for the year ended June 30, 2024 from 2.14% for the year ended June 30, 2023 while the net interest margin increased 94 basis points to 3.19% for the year ended June 30, 2024 from 2.25% for the year ended June 30, 2023. The average balance of net interest-earning assets increased $116.34 million, or 88.8%, to $247.2 million for the year ended June 30, 2024 from $130.9 million for the year ended June 30, 2023. The increases in the net interest rate spread and net interest margin were a result of both the acquisition of Regal Bancorp and the increasing yield on interest-earning assets outpacing the increasing cost of interest-bearing liabilities primarily due to the change in the composition of the loan portfolio.

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Average Balances and Yields. The following table sets forth average balance sheets, average yields and costs, and certain other information for the periods indicated. No tax-equivalent yield adjustments have been made, as the effects are immaterial. Average balances are calculated using month-end average balances, rather than daily average balances. We believe the use of month-end average balances is representative of our operations. Non-accrual loans are included in average balances only. Average yields include the effect of deferred fees, discounts, and premiums that are amortized or accreted to interest income or interest expense. Deferred loan fees are immaterial.

(1)
Net interest-earning assets represent total interest-earning assets less total interest-bearing liabilities.

(2)
Net interest margin represents net interest income divided by average total interest-earning assets.

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Rate/Volume Analysis

The following table sets forth the effects of changing rates and volumes on our net interest income. 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. Changes attributable to both rate and volume that cannot be segregated have been allocated proportionately based on the changes due to rate and the changes due to volume.

Provision for Credit Losses. We establish provisions for credit losses, which are charged to operations in order to maintain the allowance for credit losses at a level necessary to absorb credit losses incurred in the loan portfolio that are both probable and reasonably estimable at the balance sheet date. In determining the level of the allowance for credit losses, we consider, among other things, loss experience, evaluations of real estate collateral, current and reasonably supportable economic conditions, volume and type of lending, adverse situations that may affect a borrower’s ability to repay a loan and the levels of delinquent loans. The amount of the allowance is based on estimates and the ultimate losses may vary from such estimates as more information becomes available or conditions change. We assess the allowance for credit losses and make provisions for credit losses on a monthly basis.

Based on our evaluation of the above factors, we recorded a provision for credit losses of $4.1 million for the year ended June 30, 2024 compared to having no provision for the year ended June 30, 2023. The provision recorded related to the Day 1 allowance for credit losses on Regal Bancorp's loan portfolio in the amount of $4.2 million was recorded through the provision for credit losses within the Consolidated Statements of (Loss) Income. In 2024, we had no charge-offs and had only one classified and non-performing loan at June 30, 2024 totaling $50,000. The absence of a provision for credit losses for the year ended June 30, 2023 reflected that we had no charge-offs for the period, no classified loans at June 30, 2023 and only one non-performing loan in the amount of $145,000 at June 30, 2023. Our allowance for credit losses as a percentage of total loans was 0.71% at June 30, 2024 compared to 0.31% at June 30, 2023, reflecting the establishment of a $4.2 million general credit reserve for the acquired loan portfolio. To the best of our knowledge, we have provided for all losses that are both probable and reasonable to estimate at June 30, 2024 and June 30, 2023.

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Noninterest Income. Noninterest income was as follows:

Noninterest income decreased $3.8 million, or 296.9%, to a loss of $2.5 million for the year ended June 30, 2024 from $1.3 million for the year ended June 30, 2023, primarily as a result of a decrease of $4.3 million on the sale of securities due to the $4.44 million loss incurred in connection with the sale of securities as part of the Company's balance sheet restructuring. Offsetting this decrease were increases of $249,000 in the cash surrender value of bank-owned life insurance and $151,000 in service charges and fees on deposit accounts. The increase in the cash surrender value of bank-owned life insurance was attributable to the additional bank-owned life insurance acquired in the Merger.

Noninterest Expense. Noninterest expense was as follows:

Noninterest expense increased $21.4 million, or 162.9%, to $34.6 million for the year ended June 30, 2024 from $13.2 million for the year ended June 30, 2023, primarily as a result of a $5.4 million charitable contribution, contained within other expenses, as the Company established the Somerset Regal Charitable Foundation in connection with its conversion to the stock form of organization and funded it with 452,758 shares of SR Bancorp common stock and $905,517 in cash. The increase was also due to an increase in salaries and employee benefits for change in control payments totaling $2.6 million related to the Merger, an increase in professional fees for merger expenses totaling $760,000, an increase in data processing expenses primarily due to the payment of a $414,000 early termination fee related to the acquisition of Regal Bancorp, and additional miscellaneous expenses related to the Merger totaling $72,000. Furthermore, the fact the Company was operating at a significantly greater asset size for the majority of the year ended June 30, 2024, as compared to the asset size for the year ended June 30, 2023, was a contributing factor to the increase in total noninterest expense.

Income Tax Expense. The benefit for income taxes was $909,000 for the year ended June 30, 2024, compared to a tax expense of $250,000 for the year ended June 30, 2023. The benefit for the year ended June 30, 2024 was due

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to the loss for the period and is net of a $2.2 million provision for an allowance against certain of the Company's deferred tax assets. Our effective tax rate was 7.7% and 13.9% for the year ended June 30, 2024 and 2023, respectively, reflecting lower state income tax liabilities due to the application of net operating loss carryforwards and a lower state income tax rate applied to the net investment income derived by Somerset Regal Bank’s investment company subsidiary.

Market Risk

General. Our most significant form of market risk is interest rate risk because, as a financial institution, the majority of our assets and liabilities are sensitive to changes in interest rates. Therefore, a principal part of our operations is to manage interest rate risk and limit the exposure of our financial condition and results of operations to changes in market interest rates. Our ALCO/Investment Committee, which consists of members of management, is responsible for evaluating the interest rate risk inherent in our assets and liabilities, for determining the level of risk that is appropriate, given our business strategy, operating environment, capital, liquidity and performance objectives, and for managing this risk consistent with the policy and guidelines approved by our Board of Directors. We currently utilize a third-party modeling program, prepared on a quarterly basis, to evaluate our sensitivity to changing interest rates.

We have sought to manage our interest rate risk in order to minimize the exposure of our earnings and capital to changes in interest rates. We have implemented the following strategies to manage our interest rate risk:

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growing transaction deposit accounts;

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rebalancing our loan portfolio through the Merger to include higher-yielding, shorter-term commercial real estate and commercial and industrial loans; and

•
continuing to price our one-to-four family residential real estate loan products in a way that encourages borrowers to select our adjustable-rate loans as opposed to longer-term, fixed-rate loans.

By following these strategies, we believe that we are better positioned to react to changes in market interest rates.

We generally do not engage in hedging activities, such as engaging in futures or options, or investing in high-risk mortgage derivatives, such as collateralized mortgage obligation residual interests, real estate mortgage investment conduit residual interests or stripped mortgage-backed securities.

Economic Value of Equity. We compute amounts by which the net present value of our cash flow from assets, liabilities and off-balance sheet items (economic value of equity “EVE”) would change in the event of a range of assumed changes in market interest rates. We measure potential change in our EVE through the use of a financial model. This model uses a discounted cash flow analysis and an option-based pricing approach to measure the interest rate sensitivity of net portfolio value. A basis point equals one-hundredth of one percent, and 100 basis points equals one percent. An increase in interest rates from 3% to 4% would mean, for example, a 100-basis point increase in the “Basis Point Change in Interest Rates” column below.

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The table below sets forth, as of June 30, 2024 the calculation of the estimated changes in our EVE that would result from the designated immediate changes in the United States Treasury yield curve.

(1)
Assumes an immediate uniform change in interest rates at all maturities.

(2)
EVE is the discounted present value of expected cash flows from assets, liabilities and off-balance sheet contracts.

The table above indicates that at June 30, 2024, in the event of an instantaneous parallel 200 basis point increase in interest rates, we would experience a 18.2% decrease in EVE, and in the event of an instantaneous 200 basis point decrease in interest rates, we would experience a 7.4% increase in EVE.

Change in Net Interest Income. The following table sets forth, as of June 30, 2024, the calculation of the estimated changes in our net interest income (“NII”) that would result from the designated immediate changes in the United States Treasury yield curve.

(1)
Assumes an immediate uniform change in interest rates at all maturities.

The table above indicates that at June 30, 2024, after one year, we would have experienced an 7.5% decrease in NII in the event of an instantaneous parallel 200 basis point increase in market interest rates and an 7.0% decrease in NII in the event of an instantaneous 200 basis point decrease in market interest rates.

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 NPV and will differ from actual results.

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Liquidity and Capital Resources

Liquidity is the ability to fund assets and meet obligations as they come due. Our primary sources of funds consist of deposit inflows, loan repayments, and repayments from investment securities. In addition, we have the ability to borrow in the wholesale markets or from the Federal Home Loan Bank of New York. While maturities and scheduled amortization of loans and securities are predictable sources of funds, deposit flows and mortgage prepayments are greatly influenced by general interest rates, economic conditions and competition. Our Asset/Liability Management Committee is responsible for establishing and monitoring our liquidity targets and strategies in order to ensure that sufficient liquidity exists for meeting the borrowing needs and deposit withdrawals of our customers as well as unanticipated contingencies. We seek to maintain a ratio of liquid assets (including cash and federal funds sold) as a percentage of total deposits ranging between 4% and 30%. At June 30, 2024, this ratio was 5.7% We believe that we have sufficient sources of liquidity to satisfy our short- and long-term liquidity needs as of June 30, 2024.

We regularly adjust our investments in liquid assets based upon our assessment of:

(i)
expected loan demand;

(ii)
expected deposit flows;

(iii)
yields available on interest-earning deposits and securities; and

(iv)
the objectives of our asset/liability management program.

Excess cash is invested generally in interest-earning deposits and short- and intermediate-term securities.

Our most liquid assets are cash and cash equivalents. The levels of these assets depend on our operating, financing and investing activities during any given period. At June 30, 2024, cash and cash equivalents totaled $45.9 million.

At June 30, 2024, we had $36.0 million in outstanding loan commitments and $36.1 million of unused lines of credit. Certificates of deposit due within one year of June 30, 2024 totaled $111.4 million, or 13.8% of total deposits. If these deposits do not remain with us, we will be required to seek other sources of funds, including loan sales, other deposit products, including replacement certificates of deposit, securities sold under agreements to repurchase (repurchase agreements) or advances from the Federal Home Loan Bank of New York and other borrowing sources. Depending on market conditions, we may be required to pay higher rates on such deposits or other borrowings than we currently pay on the certificates of deposit due on or after June 30, 2024. We believe, however, based on past experience that a significant portion of such deposits will remain with us. We have the ability to attract and retain deposits by adjusting the interest rates offered.

Our cash flows are derived from operating activities, investing activities and financing activities as reported in our Consolidated Statements of Cash Flows included in our Consolidated Financial Statements.

Our primary investing activities are originating and purchasing loans and purchasing mortgage-backed securities. During the year ended June 30, 2024, we originated $74.1 million of loans and purchased $41.5 million. We had no purchases of securities during the year ended June 30, 2024.

Financing activities consist primarily of activity in deposit accounts. Deposits increased $303.2 million, or 60.2%, to $807.1 million at June 30, 2024 from $503.9 million at June 30, 2023. At the time of the acquisition, Regal Bank’s deposits consisted of $90.8 million of noninterest-bearing deposits, $162.4 million in NOW, money market and savings accounts and $118.7 million of certificates of deposit. Deposit flows are affected by the overall level of interest rates, the interest rates and products offered by us and our local competitors, and by other factors.

We had no outstanding borrowings with the Federal Reserve Bank at June 30, 2024 and a $20.0 million outstanding borrowing at June 30, 2023.

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Regulatory Capital

Somerset Regal Bank is subject to various regulatory capital requirements, including a risk-based capital measure. The risk-based capital guidelines include both a definition of capital and a framework for calculating risk-weighted assets by assigning balance sheet assets and off-balance sheet items to broad risk categories. At June 30, 2024 Somerset Regal Bank exceeded all regulatory capital requirements. Somerset Regal Bank is considered “well capitalized” under regulatory guidelines. See “Regulation and Supervision—Federal Banking Regulation—Capital Requirements” and Note 14 of the Notes to the Consolidated Financial Statements.

The net proceeds from the offering significantly increased our liquidity and capital resources. Over time, the initial level of liquidity will be reduced as net proceeds from the stock offering are used for general corporate purposes, including the funding of loans. Our financial condition and results of operations will be enhanced by the net proceeds from the offering, resulting in increased net interest-earning assets and net interest income. However, due to the increase in equity resulting from the net proceeds raised in the offering, our return on equity will be adversely affected following the offering until such excess funds can be deployed.

Recent Accounting Pronouncements

For a discussion of the impact of recent accounting pronouncements, see Note 1 of the Notes to the Consolidated Financial Statements.

Impact of Inflation and Changing Prices

Our consolidated financial statements and related notes have been prepared in accordance with generally accepted accounting principles (“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 our performance than the effects of inflation.

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

The objective of this section is to assist in the understanding of the financial performance of the Company and its subsidiaries through a discussion of our results of operations and financial condition as of the dates presented. You should read this discussion in conjunction with the Somerset Savings Bank Consolidated Financial Statements and Notes to the Consolidated Financial Statements that appear at the end of this document. The financial information provided herein as of June 30, 2023 and June 30, 2022 is solely that of Somerset Savings Bank, SLA and its subsidiaries, unless indicated otherwise.

Stock Offering and Acquisition of Regal Bancorp, Inc. and Regal Bank

On July 25, 2022, SR Bancorp and Somerset Savings Bank entered into an Agreement and Plan of Merger, as amended on March 7, 2023 and July 10, 2023, pursuant to which SR Bancorp proposed to acquire Regal Bancorp, Inc., a New Jersey corporation and sole shareholder of Regal Bank, a New Jersey chartered commercial bank headquartered in Livingston, New Jersey. The acquisition was completed on September 19, 2023 and each Regal Bancorp shareholder received $23.00 in cash for each share of Regal Bancorp common stock they owned, for an aggregate purchase price of $69.5 million. As part of the acquisition, Regal Bank merged into Somerset Savings Bank, with Somerset Savings Bank as the surviving entity operating under the name “Somerset Regal Bank.”

In addition, on September 19, 2023, SR Bancorp completed the stock offering of 9,055,172 shares of its common stock at a purchase price of $10.00 per share. The stock offering resulted in net proceeds of $86.9 million, of which $43.5 million was downstreamed to Somerset Regal Bank, as required by regulatory requirements. As part of its stock offering, the Company established the Somerset Regal Charitable Foundation and funded the foundation with 452,758 shares of SR Bancorp common stock and $906,000 in cash.

Overview

Our principal business is to acquire deposits from individuals and businesses in the communities surrounding our offices and to use these deposits to fund loans.

As of September 19, 2023, Somerset Regal Bank is a New Jersey-chartered commercial bank that operates from 17 branches in Essex, Hunterdon, Middlesex, Morris, Somerset and Union Counties, New Jersey. Somerset Regal Bank offers a variety of deposit and loan products to individuals and small businesses, most of which are located in our primary market. The acquisition of Regal Bancorp and its wholly owned subsidiary, Regal Bank, expanded our market presence into Essex, Morris and Union Counties, New Jersey and enhanced our market presence in Somerset County, New Jersey. At June 30, 2023, Somerset Savings Bank had total assets of $651.5 million, deposits of $503.9 million and total equity of $122.1 million. At June 30, 2023, Regal Bank had total assets of $461.8 million, deposits of $389.1 million and total equity of $51.5 million.

Income. Our primary source of pre-tax income is net interest income. Net interest income is the difference between interest income, which is the income that we earn on our loans and investments, and interest expense, which is the interest that we pay on our deposits. Changes in levels of interest rates affect our net interest income.

A secondary source of income is noninterest income, which is revenue that we receive from providing products and services. The majority of our noninterest income generally comes from service charges and fees related to deposit accounts and net gains in cash surrender value of bank-owned life insurance. In some years, we recognize income from the sale of securities.

Allowance for Loan Losses. The allowance for loan losses is a valuation allowance for probable losses inherent in the loan portfolio. We evaluate the need to establish allowances against losses on loans on a quarterly basis. When additional allowances are necessary, a provision for loan losses is charged to earnings. 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.

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Expenses. The noninterest expenses we incur in operating our business consist of salaries and employee benefits expenses, occupancy expenses, furniture and equipment expenses, advertising, FDIC insurance premiums, directors fees, professional fees, insurance, telephone, postage and supplies and other miscellaneous expenses.

Our largest noninterest expense is salaries and employee benefits, which consist primarily of salaries and wages paid to our employees, payroll taxes, and expenses for retirement plans and other employee benefits including disability insurance and health insurance. Following the stock offering, we will recognize additional annual employee compensation expenses stemming from the adoption of new equity benefit plans.

Occupancy and equipment expenses and furniture and equipment expenses are the fixed and variable costs of buildings and equipment, and consist primarily of depreciation charges, furniture and equipment expenses, repair and maintenance costs, real estate taxes and costs of utilities. Depreciation of premises and equipment is computed using a straight-line method based on the estimated useful lives of the related assets or the expected lease terms, if shorter. Furniture and equipment also includes fees paid to third parties for use of their software and for processing customer information, deposits and loans.

Advertising includes most marketing expenses including multi-media advertising (public and in-branch), promotional events and materials, civic and sales focused memberships, and community support.

Federal deposit insurance premiums are payments we make to the FDIC for insurance of our deposit accounts.

Professional fees include legal, accounting, auditing, risk management and payroll processing expenses.

Insurance includes expenses for worker’s compensation, property and casualty insurance and professional insurance.

Other expenses include expenses for directors fees, office supplies, postage, telephone and other miscellaneous operating expenses.

Critical Accounting Policies

Certain of our accounting policies are important to the presentation of our financial condition, since they require management to make difficult, complex or subjective judgments, some of which may relate to matters that are inherently uncertain. Estimates associated with these policies are susceptible to material changes as a result of changes in facts and circumstances. Facts and circumstances that could affect these judgments include, but are not limited to, changes in interest rates, changes in the performance of the economy and changes in the financial condition of borrowers. Our significant accounting policies are discussed in detail in Note 1 to our Consolidated Financial Statements included elsewhere in this document.

The JOBS Act contains provisions that, among other things, reduce certain reporting requirements for qualifying public companies. As an “emerging growth company” we plan to delay adoption of new or revised accounting pronouncements applicable to public companies until such pronouncements are made applicable to private companies. Accordingly, our consolidated financial statements may not be comparable to the financial statements of public companies that comply with such new or revised accounting standards.

Management believes our most critical accounting policies, which involve the most complex or subjective decisions or assessments, are as follows: allowance for loan losses and the valuation of our deferred tax assets.

Allowance for Loan Losses: The allowance for loan losses is a valuation allowance for probable and reasonably estimable incurred credit losses in the loan portfolio as of the balance sheet date. Loan losses are charged against the allowance when management believes the collectability of a loan balance is not probable. Subsequent recoveries, if any, are credited to the allowance. Management estimates the allowance balance required for all portfolio segments using past loan loss experience, the nature and volume of the portfolio, information about specific borrower situations and estimated collateral values, economic conditions, and other factors. Allocations of the allowance may be made for specific loans, but the entire allowance is available for any loan that, in management’s judgment, should be charged off.

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The allowance consists of specific and general components. The specific component of the allowance relates to loans that are individually classified as impaired. A loan is impaired when, based on current information and events, it is probable that we will be unable to collect all amounts due according to the contractual terms of the loan agreement. Loans for which the terms have been modified resulting in a concession and for which the borrower is experiencing financial difficulties, are considered troubled debt restructurings and classified as impaired.

Factors considered by management in determining impairment include payment status, collateral value, and the probability of collecting scheduled principal and interest payments when due. Loans that experience insignificant payment delays and payment shortfalls generally are not classified as impaired. Management determines the significance of payment delays and payment shortfalls on a case-by-case basis, taking into consideration all of the circumstances surrounding the loan and the borrower, including the length of the delay, the reasons for the delay, the borrower’s prior payment record, and the amount of the shortfall in relation to the principal and interest owed.

Impaired loans are measured based on the present value of expected future cash flows, discounted at the loan’s effective interest rate, or, as a practical expedient, at the loan’s observable market price or the fair value of the collateral if the loan is collateral dependent. Large groups of smaller balance homogeneous loans, such as consumer and residential real estate loans, are collectively evaluated for impairment. We have defined the population of impaired loans to generally be all non-accrual non-residential, multi-family, and construction and land loans, and troubled debt restructurings.

Troubled debt restructured loans are those loans whose terms have been modified such that a concession has been granted because of deterioration in the financial condition of the borrower. Modifications could include extension of the terms of the loan, reduced interest rates, and forgiveness of accrued interest and/or principal. Once an obligation has been classified a troubled debt restructuring, it continues to be considered a troubled debt restructuring and is individually evaluated for impairment until paid in full. For a cash flow dependent loan, we record an impairment charge equal to the difference between the present value of the estimated future cash flows under the restructured terms discounted at the loans original effective interest rate, and the original loan’s carrying amount. For a collateral dependent loan, we record an impairment when the current estimated fair value, net of estimated costs to sell when necessary, of the property that collateralizes the impaired loan is less than the recorded investment in the loan.

For all loan classes, the accrual of income on loans, including impaired loans, is generally discontinued when a loan becomes more than 90 days delinquent or when certain factors indicate reasonable doubt as to the ability of the borrower to meet contractual principal and/or interest obligations. Loans on which the accrual of income has been discontinued are designated as non-accrual loans. All previously accrued interest is reversed and income is recognized subsequently only in the period received, provided the remaining principal balance is deemed collectible. A non-accrual loan is not returned to an accrual status until principal and interest payments are brought current and factors indicating doubtful collection no longer exist.

Principal and interest payments received on non-accrual loans for which the remaining principal balance is not deemed collectible are applied as a reduction to principal and interest income is not recognized. If the principal balance on the loan is later deemed collectible and the loan is returned to accrual status, any interest payments that were applied to principal while on non-accrual are recorded as an unearned discount on the loan, classified as deferred fees, costs and discounts, and are recognized into interest income using the level-yield method over the remaining contractual life of the individual loan, adjusted for actual prepayments. The general component of the allowance covers non-impaired loans and is based on historical loss experience adjusted for current qualitative factors. The historical loss experience is a quantitative factor determined by portfolio segment and is based on our actual loss history. This actual loss experience is supplemented with other factors based on the risks present for each portfolio segment. These factors include consideration of the following:

•
Lending policies and procedures, including underwriting standards and collection, charge-off and recovery loans practices.

•
National, regional and local economic and business conditions as well as the condition of various market segments.

•
Nature and volume of the portfolio and terms of loans.

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•
Volume and severity of past due, classified and non-accrual loans as well as other loan modifications.

•
Existence and effect of any concentrations of credit and changes in the level of such concentrations.

•
Effect of external factors, such as competition and legal and regulatory requirements.

•
Value of underlying collateral for collateral dependent loans.

•
The experience, ability, and depth of lending management and other relevant staff.

•
Quality of the institution’s loan review system.

The loan portfolio is categorized according to collateral type, loan purpose, lien position, or borrower type (i.e., commercial, consumer). The categories used include residential one-to-four family, multi-family, non-residential, construction and land, junior liens, and consumer and other.

Income Taxes: Income taxes are accounted for using the asset and liability 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.

The effect on deferred tax assets and liabilities of a change in tax rates is recognized in income in the period that includes the enactment date. The measurement of deferred tax assets is reduced by a valuation allowance for the amount of the deferred tax asset that is more likely than not to be realized.

A tax position is recognized as a benefit only if it is “more likely than not” that the tax position would be sustained in a tax examination, with a tax examination being presumed to occur. The amount recognized is the largest amount of tax benefit that is greater than 50% likely of being realized on examination. For tax positions not meeting the “more likely than not” test, no tax benefit is recorded.

We recognize interest and/or penalties related to income tax matters in other operating expenses.

Business Strategy

The business strategy of the combined entity is to operate and grow a profitable community-oriented financial institution. Following completion of the conversion and related stock offering and the Merger on September 19, 2023, we plan to achieve this by:

Leveraging the residential lending expertise of Somerset Savings Bank and the commercial lending expertise of Regal Bank to pursue new opportunities to increase lending in our primary market area and expand our existing loan relationships. Prior to the Merger, Somerset Savings Bank’s principal business activity historically had been the origination of residential mortgage loans, which comprised 97.8% of its total loan portfolio at June 30, 2023. Prior to the Merger, Regal Bank’s principal business activity historically had been the origination of multi-family and commercial real estate loans, which comprised 94.5% of its total loan portfolio at June 30, 2023. Somerset Regal Bank will continue to provide products and services that meet the needs of the existing residential lending customers and be able to offer such products, services and expertise to the former Regal Bank customers throughout its newly-expanded market area. Additionally, Somerset Regal Bank will continue to provide products and services that meet the needs of Regal Bank’s existing commercial customers and be able to offer such products, services and expertise to the former Somerset Savings Bank customers and throughout its newly-expanded market area.

The opportunity for Somerset Savings Bank and Regal Bank to diversify their loan portfolios and leverage their lending expertise in new markets were primary factors for the Merger. Moreover, with the additional capital raised in the stock offering, we will be able to increase our loan originations in our market area, and originate loans with larger balances. Regal Bank’s legal lending limit was $9.1 million as of June 30, 2023 and Somerset Savings Bank’s legal lending limit was $18.3 million at June 30, 2023. While Somerset Regal Bank’s credit risk

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management policies will result in an internal loan to one borrower limit less than Somerset Regal Bank’s regulatory limit, the legal lending limit of Somerset Regal Bank will provide opportunities to expand a portion of the existing customer relationships that Somerset Savings Bank will acquire in its merger with Regal Bank.

We intend to leverage the SBA preferred lender expertise of Regal Bank to expand SBA lending activity in our market areas. SBA lending capabilities provide an opportunity to establish additional commercial account relationships and the potential to generate additional noninterest income related to the sale and servicing of the guaranteed portion of an SBA loan on the secondary market.

Continuing to use prudent underwriting practices to maintain the high quality of the Somerset Regal Bank loan portfolio. Somerset Savings Bank and Regal Bank each believed that maintaining high asset quality is a key to long-term financial success. Both companies sought to grow their respective loan portfolios while keeping non-performing assets to a minimum. Each of Somerset Savings Bank’s and Regal Bank’s strategy for credit risk management focused on having an experienced team of credit professionals, well-defined policies and procedures, appropriate and conservative loan underwriting criteria and active credit monitoring. At June 30, 2023, there were $200,000 of non-performing loans in Somerset Savings Bank’s loan portfolio and $337,000 of non-performing loans in Regal Bank’s loan portfolio. Although as a result of, and following the Merger, the resulting bank’s commercial loan portfolio increased, Somerset Regal Bank maintains the philosophy of managing large loan exposures through a prudent approach to lending.

Building profitable business and consumer relationships through enhanced product offerings and by continuing to provide superior customer service. We are a full-service financial services company offering our customers a broad range of loan and deposit products and services, including internet banking, which enables our customers to pay bills on-line, among other conveniences. Following the Merger, our commercial lending capacity has been significantly enhanced, which will allow us to seek to increase the commercial real estate and commercial business loans we originate and better serve the small businesses in our market area, which generally have higher fees and yields associated with them when compared to residential mortgages. Further, the Merger with Regal Bancorp will allow us to expand our commercial deposit accounts, which generally yield higher average balances than can be acquired from retail deposit relationships.

As a community-oriented financial institution, we emphasize providing superior customer service as a means to attract and retain customers. We deliver personalized service and respond with flexibility to customer needs. We believe that our community orientation is attractive to our customers and distinguishes us from the larger institutions that operate in our area but are headquartered elsewhere. Further, given our attractive market area, we believe we are well-positioned to increase our customer relationships without a proportional increase in overhead expense or operating risk.

Increasing transaction deposit accounts and deposit balances. 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). Core deposits represented 68.4% of our total deposits at June 30, 2023 compared to 72.5% of our total deposits at June 30, 2022. Going forward, we believe that Somerset Regal Bank will increase its core deposits by increasing its commercial lending activities and enhancing our relationships with its retail customers through our commitment to quality customer service along with the introduction of additional products and services, such as remote deposit capture and enhanced online business account services.

Continuing to leverage technology to maintain efficient operations and enhance customer service. We have historically focused on leveraging technology to maintain efficient operations and provide our customers with secure means to conduct business with Somerset Savings Bank outside of our traditional branch network. Customer facing applications include online banking and mobile banking with bill payment capabilities, mobile deposit and debit card control functionality. We have been a Zelle™ participant since 2019, which has allowed our customers the ability to send and receive real-time payments online and through mobile banking. Our online loan application platform affords customers the convenience of submitting a loan application online at their convenience. Internally we leverage technology to achieve internal efficiencies for tasks such as document preparation and retention, data analytics and call report preparation. We intend to build on this foundation and have plans to add, among other services, online deposit account opening for existing customers, tokenization (meaning the process of exchanging sensitive data with a less sensitive equivalent (or token), specifically Apply Pay©, Google Pay© and Samsung Pay©),

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and expanded business online banking capabilities including wire transfer origination and ACH origination services. These additional services are in various stages of implementation and we anticipate customer availability for most prior to the end of 2023. We believe our investment in technology allows us to remain competitive, effectively serve our customers and results in efficiencies which contribute to the maintenance of favorable operating expense.

Expanding our franchise through acquisitions (including our Merger with Regal Bancorp) and other possible transactions in our primary market area. The Merger was completed on September 19, 2023 and has created a larger deposit base and loan portfolio. The combined bank, with more than $1.0 billion in assets, will offer a fuller and broader array of financial products encompassing retail and commercial banking, real estate, consumer and commercial lending, than either Somerset Savings Bank or Regal Bank offered. We will continue to consider both organic growth as well as acquisition opportunities that may enhance the value of our franchise and yield potential financial benefits for our shareholders. The capital we raised in the stock offering will allow us the ability to explore further acquisitions, although we do not currently have any agreements or planned activity regarding any specific acquisition transaction.

Comparison of Financial Condition at June 30, 2023 and June 30, 2022

Total Assets. Total assets increased $2.9 million, or 0.4%, to $651.5 million at June 30, 2023 from $648.6 million at June 30, 2022. The increase was primarily the result of a $27.7 million increase in loans and a $7.1 million increase in cash and cash equivalents, offset in part by decreases of $21.7 million in securities held-to-maturity and $11.8 million in securities available-for-sale.

Cash and Cash Equivalents. Cash and cash equivalents increased $7.1 million, or 20.1%, to $42.4 million at June 30, 2023 from $35.3 million at June 30, 2022 as Somerset Savings Bank borrowed $20.0 million from the Federal Reserve under the new Bank Term Funding Program, which was established in March 2023 to provide additional funding to eligible depository institutions. In light of the events in the banking industry that occurred earlier in the year and general economic conditions, we have increased our efforts to monitor deposit inflows and outflows and improved our liquidity position as a precaution. There have been no indications of a deposit run at our institution as our deposit base remains intact and our capital position remains strong.

Securities. Total securities (securities held for sale and held to maturity) decreased $33.5 million, or 13.9%, to $207.3 million at June 30, 2023 from $240.8 million at June 30, 2022. The decrease was due in part to the regular principal and interest payments on our securities portfolio as well as the sale of $4.5 million of securities.

Loans. Loans held for investment, net, increased $27.7 million, or 8.3%, to $362.3 million at June 30, 2023 from $334.6 million at June 30, 2022. Residential mortgage loans increased $27.9 million, or 8.6%, to $353.6 million at June 30, 2023 from $325.7 million at June 30, 2022 primarily due to an increase in loans purchased through our correspondent relationships.

Deposits. Deposits decreased $18.2 million, or 3.5%, to $503.9 million at June 30, 2023 from $522.1 million at June 30, 2022. NOW and money market accounts decreased $8.9 million, or 6.1%, to $137.5 million at June 30, 2023 from $146.4 million at June 30, 2022. Savings accounts decreased $21.9 million, or 11.6%, to $166.3 million at June 30, 2023 from $188.1 million at June 30, 2022. Noninterest-bearing deposits decreased $3.0 million, or 6.9%, to $40.7 million at June 30, 2023 from $43.7 million at June 30, 2022. Certificates of deposit increased $15.7 million, or 10.9%, to $159.5 million at June 30, 2023 from $143.8 million at June 30, 2022. The increase in certificates of deposit and the decrease in savings accounts reflected the decision of many depositors to take advantage of increased market rates being paid on certificates of deposit.

Borrowings. During the year ended June 30, 2023, we borrowed $20.0 million from the Federal Reserve under the new Bank Term Funding Program as a precautionary measure to provide for additional liquidity due to current market conditions. We had no borrowings at June 30, 2022.

Total Equity. Total equity increased $3.9 million, or 3.3%, to $122.1 million at June 30, 2023 from $118.2 million at June 30, 2022. The increase resulted from net income of $1.6 million for the year ended June 30, 2023, and a decrease of $2.3 million in accumulated other comprehensive loss.

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Average Balances and Yields. The following table sets forth average balance sheets, average yields and costs, and certain other information for the periods indicated. No tax-equivalent yield adjustments have been made, as the effects are immaterial. Average balances are calculated using month-end average balances, rather than daily average balances. We believe the use of month-end average balances is representative of our operations. Non-accrual loans are included in average balances only. Average yields include the effect of deferred fees, discounts, and premiums that are amortized or accreted to interest income or interest expense. Deferred loan fees are immaterial.

(1)
Annualized.

(2)
Net interest-earning assets represent total interest-earning assets less total interest-bearing liabilities.

(3)
Net interest margin represents net interest income divided by average total interest-earning assets.

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Rate/Volume Analysis

The following table sets forth the effects of changing rates and volumes on our net interest income. 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. Changes attributable to both rate and volume that cannot be segregated have been allocated proportionately based on the changes due to rate and the changes due to volume.

Comparison of Operating Results for the Years Ended June 30, 2023 and 2022

General. Net income decreased $318,000, or 17.0%, to $1.6 million for the year ended June 30, 2023 from $1.9 million for the year ended June 30, 2022. The decrease was caused by increases in interest expense and noninterest expense, offset in part by an increase in interest income.

Interest Income. Interest income increased $2.7 million, or 20.0%, to $16.1 million for the year ended June 30, 2023 from $13.4 million for the year ended June 30, 2022. The increase resulted primarily from an increase of $2.0 million, or 21.7%, in interest income on loans and an increase in the interest income of other assets of $995,000 to $1.1 million for the year ended June 30, 2023 from $127,000 for the year ended June 30, 2022, partially offset by a $323,000 decrease in interest income on securities. The average balance on loans increased $46.9 million, or 15.4%, to $352.1 million for the year ended June 30, 2023, compared to $305.1 million for the year ended June 30, 2022. In addition, the average yield on the loan portfolio increased 16 basis points to 3.21% for the year ended June 30, 2023 from 3.05% for the year ended June 30, 2022. The average balance on securities decreased $33.2 million, or 12.9%, to $225.0 million for the year ended June 30, 2023 from $258.2 million for the year ended June 30, 2022. This decrease was partially offset by an increase of nine basis points in the average yield of securities to 1.64% at June 30, 2023 from 1.55% at June 30, 2022. The increase in the interest income on other assets was due to a 338 basis point increase in the average yield of other assets to 3.64% for the year ended June 30, 2023 from 0.26% for the year ended June 30, 2022, offset in part by a $17.4 million, or 36.1%, decrease in the average balance of other assets from $48.2 million for the year ended June 30, 2022 to $30.8 million for the year ended June 30, 2023.

Interest Expense. Interest expense increased $893,000, or 58.2%, to $2.4 million for the year ended June 30, 2023 from $1.5 million for the year ended June 30, 2022. The increase in interest expense resulted from an increase in interest expense on deposits. The average rate we paid on certificates of deposit increased 45 basis points to 1.33% for the year ended June 30, 2023 from 0.88% for the year ended June 30, 2022 while the average balance of certificates of deposit decreased $4.0 million, or 2.6%, to $148.5 million for the year ended June 30, 2023 from $152.5 million for the year ended June 30, 2022. The average balance of interest-bearing demand deposits increased $1.6 million, or 1.1%, to $143.5 million for the year ended June 30, 2023 from $141.9 million for the year ended

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June 30, 2022. The average balance of savings and club accounts decreased $1.1 million, or 0.6%, to $179.8 million for the year ended June 30, 2023 from $180.9 million for the year ended June 30, 2022.

Net Interest Income. Net interest income increased $1.8 million, or 15.1%, to $13.7 million for the year ended June 30, 2023 from $11.9 million for the year ended June 30, 2022. We had increases in our net interest rate spread of 27 basis points to 2.14% for the year ended June 30, 2023 from 1.87% for the year ended June 30, 2022, and increases in our net interest margin of 41 basis points to 3.00% for the year ended June 30, 2023 from 2.59% for the year ended June 30, 2022, offset in part by a decrease in our net interest-earning assets of $5.3 million, or 3.9%, to $131.0 million for the year ended June 30, 2023 from $136.3 million for the year ended June 30, 2022. The increases in our net interest rate spread and our net interest margin were primarily a result of the cost of interest-bearing liabilities increasing at a slower rate than the yield on interest-earning assets.

Provision for Loan Losses. We establish provisions for loan losses, which are charged to operations in order to maintain the allowance for loan losses at a level we consider necessary to absorb credit losses incurred in the loan portfolio that are both probable and reasonably estimable at the balance sheet date. In determining the level of the allowance for loan losses, we consider, among other things, past and current loss experience, evaluations of real estate collateral, current economic conditions, volume and type of lending, adverse situations that may affect a borrower’s ability to repay a loan and the levels of delinquent loans. The amount of the allowance is based on estimates and the ultimate losses may vary from such estimates as more information becomes available or conditions change. We assess the allowance for loan losses and make provisions for loan losses on a monthly basis.

Based on our evaluation of the above factors, we did not record a provision for loan losses for either the year ended June 30, 2023 or the year ended June 30, 2022. The absence of a provision for loan losses reflects that we had no charge-offs for the year ended June 30, 2023 and $200,000 of non-performing loans and $145,000 of classified loans at June 30, 2023. Our allowance for loan losses as a percentage of total loans was 0.31% at June 30, 2023 compared to 0.33% at June 30, 2022, reflecting continued strong credit quality in our loan portfolio. To the best of our knowledge, we have provided for all losses that are both probable and reasonable to estimate at June 30, 2023 and June 30, 2022.

Noninterest Income. Noninterest income was as follows:

Noninterest income decreased $86,000, or 6.4%, to $1.3 million for the year ended June 30, 2023 from $1.4 million for the year ended June 30, 2022, primarily as a result of the loss on the sale of securities of $119,000 for the year ended June 30, 2023 compared to no loss on the sale of securities for the year ended June 30, 2022.

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Noninterest Expense. Noninterest expense was as follows:

Noninterest expense increased $2.1 million, or 19.4%, to $13.2 million for the year ended June 30, 2023 from $11.0 million for the year ended June 30, 2022, primarily as a result of a $1.4 million, or 22.3%, increase in salaries and employee benefits and a $617,000, or 149.8%, increase in professional services primarily related to the acquisition of Regal Bancorp and Regal Bank. The increase in salaries and employee benefits represents annual merit adjustments and increased health care and pension plan costs.

Income Tax Expense. The provision for income taxes was $250,000 for the year ended June 30, 2023, compared to $363,000 for the year ended June 30, 2022. Our effective tax rate was 13.9% for the year ended June 30, 2023 compared to 16.2% for the year ended June 30, 2022. The lower effective tax rates for fiscal years 2023 and 2022 reflect lower state income tax liabilities due to the application of net operating loss carryforwards and a lower state income tax rate applied to the net investment income derived by Somerset Savings Bank’s subsidiary.

Market Risk

General. Our most significant form of market risk is interest rate risk because, as a financial institution, the majority of our assets and liabilities are sensitive to changes in interest rates. Therefore, a principal part of our operations is to manage interest rate risk and limit the exposure of our financial condition and results of operations to changes in market interest rates. Our ALCO/Investment Committee, which consists of members of management, is responsible for evaluating the interest rate risk inherent in our assets and liabilities, for determining the level of risk that is appropriate, given our business strategy, operating environment, capital, liquidity and performance objectives, and for managing this risk consistent with the policy and guidelines approved by our Board of Directors. We currently utilize a third-party modeling program, prepared on a quarterly basis, to evaluate our sensitivity to changing interest rates, given our business strategy, operating environment, capital, liquidity and performance objectives, and for managing this risk consistent with the guidelines approved by the Board of Directors.

We have sought to manage our interest rate risk in order to minimize the exposure of our earnings and capital to changes in interest rates. We have implemented the following strategies to manage our interest rate risk:

•
growing target deposit accounts;

•
utilizing our investment securities portfolio as part of our balance sheet asset and liability and interest rate risk management strategy to reduce the impact of movements in interest rates on net interest income and economic value of equity, which can create temporary valuation adjustments to equity in Accumulated Other Comprehensive Income; and

•
continuing to price our one-to-four family residential real estate loan products in a way that encourages borrowers to select our adjustable-rate loans as opposed to longer-term, fixed-rate loans.

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By following these strategies, we believe that we are better positioned to react to increases and decreases in market interest rates.

We generally do not engage in hedging activities, such as engaging in futures or options, or investing in high-risk mortgage derivatives, such as collateralized mortgage obligation residual interests, real estate mortgage investment conduit residual interests or stripped mortgage-backed securities.

Economic Value of Equity. We compute amounts by which the net present value of our cash flow from assets, liabilities and off-balance sheet items (economic value of equity “EVE”) would change in the event of a range of assumed changes in market interest rates. We measure potential change in our EVE through the use of a financial model. This model uses a discounted cash flow analysis and an option-based pricing approach to measure the interest rate sensitivity of net portfolio value. Historically, the model estimated the economic value of each type of asset, liability and off-balance sheet contract under the assumption that the United States Treasury yield curve increases or decreases instantaneously by 100 to 300 basis points in 100 basis point increments. However, given the current level of market interest rates, an EVE calculation for an interest rate decrease of greater than 100 basis points has not been prepared. A basis point equals one-hundredth of one percent, and 100 basis points equals one percent. An increase in interest rates from 3% to 4% would mean, for example, a 100-basis point increase in the “Basis Point Change in Interest Rates” column below.

The table below sets forth, as of June 30, 2023, the calculation of the estimated changes in our EVE that would result from the designated immediate changes in the United States Treasury yield curve.

(1)
Assumes an immediate uniform change in interest rates at all maturities.

(2)
EVE is the discounted present value of expected cash flows from assets, liabilities and off-balance sheet contracts.

The table above indicates that at June 30, 2023, in the event of an instantaneous parallel 200 basis point increase in interest rates, we would experience a 26.5% decrease in EVE, and in the event of an instantaneous 200 basis point decrease in interest rates, we would experience a 15.3% increase in EVE.

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Change in Net Interest Income. The following table sets forth, as of June 30, 2023, the calculation of the estimated changes in our net interest income (“NII”) that would result from the designated immediate changes in the United States Treasury yield curve.

(1)
Assumes an immediate uniform change in interest rates at all maturities.

The table above indicates that at June 30, 2023, after one year, we would have experienced an 7.3% decrease in NII in the event of an instantaneous parallel 200 basis point increase in market interest rates and an 9.0% decrease in NII in the event of an instantaneous 200 basis point decrease in market interest rates.

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 NPV and will differ from actual results.

Liquidity and Capital Resources

Liquidity is the ability to fund assets and meet obligations as they come due. Our primary sources of funds consist of deposit inflows, loan repayments, and repayments from investment securities. In addition, we have the ability to collateralize borrowings in the wholesale markets or borrow advances from the Federal Home Loan Bank of New York. While maturities and scheduled amortization of loans and securities are predictable sources of funds, deposit flows and mortgage prepayments are greatly influenced by general interest rates, economic conditions and competition. Our Asset/Liability Management Committee is responsible for establishing and monitoring our liquidity targets and strategies in order to ensure that sufficient liquidity exists for meeting the borrowing needs and deposit withdrawals of our customers as well as unanticipated contingencies. We seek to maintain a ratio of liquid assets (including cash and federal funds sold) as a percentage of total deposits ranging between 4% and 30%. At June 30, 2023, this ratio was 8.4%. We believe that we have enough sources of liquidity to satisfy our short- and long-term liquidity needs as of June 30, 2023. We anticipate that we will maintain higher liquidity levels following the completion of the stock offering.

We regularly adjust our investments in liquid assets based upon our assessment of:

(i)
expected loan demand;

(ii)
expected deposit flows;

(iii)
yields available on interest-earning deposits and securities; and

(iv)
the objectives of our asset/liability management program.

Excess cash is invested generally in interest-earning deposits and short- and intermediate-term securities.

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Our most liquid assets are cash and cash equivalents. The levels of these assets depend on our operating, financing and investing activities during any given period. At June 30, 2023, cash and cash equivalents totaled $42.4 million. Securities classified as available-for-sale, which provide additional sources of liquidity, totaled $36.1 million at June 30, 2023.

At June 30, 2023, we had $6.7 million in outstanding loan commitments and $23.7 million of unused lines of credit. Certificates of deposit due within one year of June 30, 2023 totaled $138.4 million, or 27.5% of total deposits. If these deposits do not remain with us, we will be required to seek other sources of funds, including loan sales, other deposit products, including replacement certificates of deposit, securities sold under agreements to repurchase (repurchase agreements) and advances from the Federal Home Loan Bank of New York and other borrowing sources. Depending on market conditions, we may be required to pay higher rates on such deposits or other borrowings than we currently pay on the certificates of deposit due on or after June 30, 2023. We believe, however, based on past experience that a significant portion of such deposits will remain with us. We have the ability to attract and retain deposits by adjusting the interest rates offered.

Our cash flows are derived from operating activities, investing activities and financing activities as reported in our Consolidated Statements of Cash Flows included in our Consolidated Financial Statements.

Our primary investing activities are originating and purchasing loans and purchasing mortgage-backed securities. During the year ended June 30, 2023, we originated $17.7 million of loans and purchased $42.6 million of loans. We purchased $900,000 in securities classified as held to maturity and no securities classified as available for sale during the year ended June 30, 2023.

Financing activities consist primarily of activity in deposit accounts. We experienced a net decrease in total deposits of $18.2 million for the year ended June 30, 2023. The decrease for the year ended June 30, 2023 resulted primarily from a $21.9 million decrease in savings accounts offset in part by an increase in certificates of deposit of $15.7 million. Deposit flows are affected by the overall level of interest rates, the interest rates and products offered by us and our local competitors, and by other factors.

We have a $20.0 million borrowing with the Federal Reserve Bank under the Bank Term Funding Program at June 30, 2023. We had no outstanding borrowings at June 30, 2022.

Somerset Savings Bank is subject to various regulatory capital requirements, including a risk-based capital measure. The risk-based capital guidelines include both a definition of capital and a framework for calculating risk-weighted assets by assigning balance sheet assets and off-balance sheet items to broad risk categories. At June 30, 2023, Somerset Savings Bank exceeded all regulatory capital requirements. Somerset Savings Bank is considered “well capitalized” under regulatory guidelines. See “Regulation and Supervision—Federal Banking Regulation—Capital Requirements” and Note 11 of the Notes to the Consolidated Financial Statements.

The net proceeds from the stock offering will significantly increase our liquidity and capital resources. Over time, the initial level of liquidity will be reduced as net proceeds from the stock offering are used for general corporate purposes, including the funding of loans. Our financial condition and results of operations will be enhanced by the net proceeds from the stock offering, resulting in increased net interest-earning assets and net interest income. However, due to the increase in equity resulting from the net proceeds raised in the stock offering, our return on equity will be adversely affected following the stock offering.

Recent Accounting Pronouncements

For a discussion of the impact of recent accounting pronouncements, see Note 1 of the Notes to the Consolidated Financial Statements.

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Impact of Inflation and Changing Prices

Our consolidated financial statements and related notes have been prepared in accordance with generally accepted accounting principles (“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 our performance than the effects of inflation.