MLVF Malvern Bancorp, Inc. - 10-K

Item 1A. Risk Factors.

Ownership of our common stock involves certain risks. The risks and uncertainties described below are not the only ones we face. You should carefully consider the risks described below, as well as all other information contained in this Report. Additional risks and uncertainties not presently known to us or that we currently deem immaterial may also impair our business operations. If any of these risks actually occurs, our business, financial condition and results of operations could be materially and adversely affected.

Risks Related to Our Business

We are subject to credit risk in connection with our lending activities, and our financial condition and results of operations may be negatively impacted by economic conditions and other factors that adversely affect our borrowers.

Our financial condition and results of operations are affected by the ability of our borrowers to repay their loans, and in a timely manner. The risks of non-payment and late payments are assessed through our underwriting and loan review procedures based on several factors including credit risks of a particular borrower, changes in economic conditions, the duration of the loan and in the case of a collateralized loan, uncertainties as to the future value of the collateral and other factors. Despite our efforts, we do and will experience loan losses, and our financial condition and results of operations will be adversely affected. Unfavorable or uncertain economic and market conditions can be caused by declines in economic growth, business activity or investor or business confidence; limitations on the availability or increases in the cost of credit and capital; increases in inflation or interest rates; high unemployment, natural disasters, terrorist acts, cyber-attacks, or a combination of these or other factors.

Our loan portfolio has been significantly affected by the economic disruptions resulting from COVID-19, which contributed to our loan losses and delinquencies increasing, and we may need to significantly add to our allowance for loan losses.

The economic disruptions related to COVID-19 have resulted in a significant increase in delinquencies and loans on nonaccrual status across our loan portfolio as certain industries were particularly hard-hit by COVID-19, which adversely affected the ability of certain of our borrowers to repay their loans.

For example, in November 2021 we announced that we completed a sale to a single investor of certain problem loans. Specifically, the Company sold three loans with a book balance of $29.3 million with a write down of approximately $10.4 million. The loans sold included approximately $12.2 million of non-accruing loans and $17.1 million of performing troubled debt restructurings. The Company had classified the loans as “held for sale” at September 30, 2021 after taking write downs to reflect the anticipated sale price of such loans. Including the write down, the Company recorded a provision for loan and lease losses of approximately $10.6 million at the quarter ended September 30, 2021. The loan sale had a material negative impact on the Company’s earnings for the quarter and year ended September 30, 2021. Notwithstanding the sale of the above-mentioned loans, as of the date of the filing   th e Company still retains one non-performing commercial real estate loan in the metropolitan New York area carried at a fair value of $13.3 million, classified as held for sale as of September 30, 2022, which could potentially be sold at an additional loss and could further have a material negative impact on our earnings and financial condition. Additionally the Bank is paying real estate taxes associated with the property to maintain its collateral position . It is also possible that the prior and any future impact of COVID-19 on the economy and our loan portfolio may increase our exposure to elevated loan losses and delinquencies, and as a result, we may further increase our allowance for loan losses.

If our allowance for loan losses is not sufficient to cover actual loan losses, our earnings will decrease.

We make various assumptions and judgements about the collectability of our loan portfolio, including the creditworthiness of our borrowers and the value of the real estate and other assets serving as collateral for the repayment of many of our loans. In determining the required amount of the allowance for loan losses, we evaluate certain loans individually and establish loan loss allowances for specifically identified impairments. For all non-impaired loans, including those not individually reviewed, we estimate losses and establish loan loss allowances based upon historical and environmental loss factors. If the assumptions used in our calculation methodology are incorrect, our allowance for loan losses may not be sufficient to cover losses inherent in our loan portfolio, resulting in further additions to our allowance. COVID-19 further impacted the assumptions and methodologies typically used in making allowances for loan losses, and the availability and reliability of materials and other market information, including appraisals, have been impacted by COVID-19, making assumptions more subjective. At September 30, 2022, our allowance for loan losses was 1.12 percent of total loans. Significant additions to our allowance could materially decrease our net income.

Our results of operations and financial condition may be adversely affected by changing economic conditions.

A return to a recessionary period, continued increased inflation, continued disruption in global and domestic supply chains, and other economic conditions could negatively impact our customers in a manner that would adversely affect our results of operations and financial condition. Volatility in the housing markets, real estate values and unemployment levels, and the deterioration of economic conditions in our market area, could affect our customers’ ability to take out loans, repay loans and adversely affect our results of operations and future growth potential in the following ways:

Loan delinquencies may increase;

Problem assets and foreclosures may increase;

Demand for our products and services may decline;

The carrying value of our OREO may decline; and

Collateral for loans made by us, especially real estate, may decline in value, in turn reducing a customer’s borrowing power, and reducing the value of assets and collateral associated with our loans.

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Changes in interest rates could adversely affect our financial condition and results of operation.

Our net income depends primarily upon our net interest income. Net interest income is the difference between interest income earned on loans, investments and other interest-earning assets and the interest expense incurred on deposits and borrowed funds. The level of net interest income is primarily a function of the average balance of our interest-earning assets, the average balance of our interest-bearing liabilities, and the spread between the yield on such assets and the cost of such liabilities. These factors are influenced by both the pricing and mix of our interest-earning assets and our interest-bearing liabilities which, in turn, are impacted by such external factors as the local economy, competition for loans and deposits, the monetary policy of the Federal Open Market Committee of the Federal Reserve Board of Governors (the “FOMC”), and market interest rates.

Different types of assets and liabilities may react differently, and at different times, to changes in market interest rates. We expect that we will periodically experience gaps in the interest rate sensitivities of our assets and liabilities. That means either our interest-bearing liabilities will be more sensitive to changes in market interest rates than our interest-earning assets, or vice versa. When interest-bearing liabilities mature or re-price more quickly than interest-earning assets, an increase in market rates of interest could reduce our net interest income. Likewise, when interest-earning assets mature or re-price more quickly than interest-bearing liabilities, falling interest rates could reduce our net interest income. We are unable to predict changes in market interest rates, which are affected by many factors beyond our control, including inflation, deflation, recession, unemployment, money supply, domestic and international events and changes in the United States and other financial markets.

We also attempt to manage risk from changes in market interest rates, in part, by controlling the mix of interest rate sensitive assets and interest rate sensitive liabilities. However, interest rate risk management techniques are not exact. A rapid increase or decrease in interest rates could adversely affect our results of operations and financial performance.

Our high concentration of commercial real estate loans exposes us to increased lending risk.

As of September 30, 2022, the primary composition of our total loan portfolio was as follows:

commercial real estate loans of $406.9 million, or 50.2 percent of total loans;

residential real estate loans of $176.0 million, or 21.7 percent of total loans;

commercial and industrial loans of $102.7 million, or 12.7 percent of total loans;

construction and development loans of $24.9 million, or 3.1 percent of total loans; and

consumer loans of $19.8 million, or 2.4 percent of total loans.

Commercial real estate loans expose us to a greater risk of loss than do residential mortgage loans. Commercial real estate loans typically involve larger loan balances to single borrowers or groups of related borrowers compared to residential loans. Consequently, an adverse development with respect to one commercial loan or one credit relationship exposes us to a significantly greater risk of loss compared to an adverse development with respect to one residential mortgage loan. Any significant failure to pay on time by our customers or a significant default by our customers would materially and adversely affect us.

We can give you no assurance that the economy and the real estate market in particular will grow or that any rate of growth will accelerate to historic levels. Many factors could significantly reduce or halt growth in our local economy and real estate market. Accordingly, it may become more difficult for commercial real estate borrowers to repay their loans in a timely manner, as commercial real estate borrowers’ ability to repay their loans frequently depends on the successful development and/or operation of their properties. The deterioration of one or more of our commercial real estate loans could cause a material increase in our level of nonperforming loans, which would result in a loss of revenue from these loans and could result in an increase in the provision for loan and lease losses and/or an increase in charge-offs, all of which could have a material adverse impact on our net income. We also may incur losses on commercial real estate loans due to declines in occupancy rates and rental rates, which may decrease property values and may reduce the likelihood that a borrower may find permanent financing alternatives. Weaknesses in the commercial real estate market in general could negatively impact our collateral. Any weakening of the commercial real estate market may increase the likelihood of default of these loans, which could negatively impact our loan portfolio’s performance and asset quality. If we are required to liquidate the collateral securing a loan to satisfy the debt during a period of reduced real estate values, we could incur material losses. Any of these events could increase our costs, require management time and attention, and materially and adversely affect our financial condition and results of operations.

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Nonperforming assets take significant time to resolve and adversely affect our results of operations and financial condition, and could result in further losses in the future.

Our nonperforming assets could adversely affect our net income in various ways. We do not record interest income on nonaccrual loans or OREO, thereby adversely affecting our net interest income, net income and returns on assets and equity, and our loan administration costs increase, which together with reduced interest income adversely affects our efficiency ratio. When we take collateral in foreclosure and similar proceedings, we are required to mark the collateral to its then-fair market value, which may result in a loss. These nonperforming loans and other real estate owned also increase our risk profile and the level of capital our regulators believe is appropriate for us to maintain in light of such risks. The resolution of nonperforming assets requires significant time commitments from management and can be detrimental to the performance of their other responsibilities. If we experience increases in nonperforming loans and nonperforming assets, our net interest income may be negatively impacted and our loan administration costs could increase, each of which would have an adverse effect on our net income and related ratios, such as return on assets and equity.

We engage in lending secured by real estate and may be forced to foreclose on the collateral and own the underlying real estate, subjecting us to the costs and potential risks associated with the ownership of the real property, or consumer protection initiatives or changes in state or federal law may substantially raise the cost of foreclosure or prevent us from foreclosing at all.

Since we originate loans secured by real estate, we may have to foreclose on the collateral property to protect our investment and may thereafter own and operate such property, in which case we would be exposed to the risks inherent in the ownership of real estate. Our inability to manage the amount of costs or size of the risks associated with the ownership of real estate, or write-downs in the value of our owned real property, including OREO, could have an adverse effect on our business, financial condition and results of operations.

Additionally, consumer protection initiatives or changes in state or federal law may substantially increase the time and expense associated with the foreclosure process or prevent us from foreclosing at all. If new state or federal laws or regulations are ultimately enacted that significantly raise the cost of foreclosure or raise outright barriers, such laws or regulations could have an adverse effect on our business, financial condition and results of operation.

Appraisals and other valuation techniques we use in evaluating and monitoring loans secured by real property, other real estate owned and repossessed personal property may not accurately describe the net value of the asset.

In considering whether to make a loan secured by real property, we generally require an appraisal of the property. However, an appraisal is only an estimate of the value of the property at the time the appraisal is made and, as real estate values may change significantly in value in relatively short periods of time (especially in periods of heightened economic uncertainty and changing interest rates), this estimate may not accurately describe the net value of the real property collateral after the loan is made. As a result, we may not be able to recover the full amount of any remaining indebtedness when we foreclose on and sell the relevant property. In addition, we rely on appraisals and other valuation techniques to establish the value of our other real estate owned, or OREO, and personal property that we acquire through foreclosure proceedings and to determine certain loan impairments. If any of these valuations are inaccurate, our combined and consolidated financial statements may not reflect the correct value of our OREO, and our allowance for loan losses may not reflect accurate loan impairments. This could have an adverse effect on our business, financial condition or results of operations.

The   concentration   of our   commercial   real   estate   loan   portfolio   subjects   us to heightened   regulatory   scrutiny .

The FDIC, the FRB and the OCC have promulgated joint guidance on sound risk management practices for financial institutions with concentrations in commercial real estate lending. Under the joint guidance, a financial institution that, like us, is actively involved in commercial real estate lending should perform a risk assessment to identify concentrations. A financial institution may have a concentration in commercial real estate lending if, among other factors: (i) total reported loans for construction, land development, and other land represent 100 percent or more of total risk-based capital or (ii) total reported loans for construction, land development and other land and loans secured by multifamily and non-owner occupied non-farm residential properties (excluding loans secured by owner-occupied properties) represent 300 percent or more of total risk-based capital and the institution’s commercial real estate loan portfolio has increased by 50 percent or more during the prior 36 month period. In such event, management should employ heightened risk management practices, including board and management oversight and strategic planning, development of underwriting standards, risk assessment and monitoring through market analysis and stress testing.

Our total reported loans for construction, land development and other land represented 15.0  percent of risk-based capital at September 30, 2022, as compared to 35.7 percent of capital at September 30, 2021. This ratio is below the regulatory commercial real estate concentration guideline level of 100 percent for land and construction loans. Our total reported commercial real estate loans to total risk-based capital was 250.8  percent at September 30, 2022, as compared to 298.88 percent of capital at September 30, 2021. This ratio is below the regulatory commercial real estate concentration guideline level of 300 percent for all investor real estate loans.

Strong competition within our market area could hurt our profits and slow our growth.

The banking and financial services industry in our market area is highly competitive. We may not be able to compete effectively in our markets, which could adversely affect our results of operations. The increasingly competitive environment is a result of changes in regulation, advances in technology and product delivery systems, and consolidation among financial service providers. Larger institutions, and institutions with an on-line presence, have greater resources and access to capital markets, with higher lending limits, higher rates of interest on deposits, more advanced technology and broader suites of services. Competition at times requires increases in deposit rates and decreases in loan rates, and adversely impact our net interest margin.

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Climate change and related legislative and regulatory initiatives may materially affect the Company ’ s business and results of operations.

The effects of climate change continue to create an alarming level of concern for the state of the global environment. As a result, the global business community has increased its political and social awareness surrounding the issue, and the United States has entered into international agreements in an attempt to reduce global temperatures, such as reentering the Paris Agreement. Further, the U.S. Congress, state legislatures and federal and state regulatory agencies continue to propose numerous initiatives to supplement the global effort to combat climate change. Similar and even more expansive initiatives are expected under the current administration, including potentially increasing supervisory expectations with respect to banks’ risk management practices, accounting for the effects of climate change in stress testing scenarios and systemic risk assessments, revising expectations for credit portfolio concentrations based on climate-related factors and encouraging investment by banks in climate-related initiatives and lending to communities disproportionately impacted by the effects of climate change. The lack of empirical data surrounding the credit and other financial risks posed by climate change render it difficult, or even impossible, to predict how specifically climate change may impact our financial condition and results of operations; however, the physical effects of climate change may also directly impact us. Specifically, unpredictable and more frequent weather disasters may adversely impact the real property, and/or the value of the real property, securing the loans in our portfolios. Additionally, if insurance obtained by our borrowers is insufficient to cover any losses sustained to the collateral, or if insurance coverage is otherwise unavailable to our borrowers, the collateral securing our loans may be negatively impacted by climate change, natural disasters and related events, which could impact our financial condition and results of operations. Further, the effects of climate change may negatively impact regional and local economic activity, which could lead to an adverse effect on our customers and impact the communities in which we operate. Overall, climate change, its effects and the resulting, unknown impact could have a material adverse effect on our financial condition and results of operations.

Risks Related to the Merger

The consummation of the recently-announced merger with First Bank is contingent upon the satisfaction of a number of conditions, including shareholder and regulatory approvals, that may be outside of our control and that we may be unable to satisfy or obtain or which may delay the consummation of the merger or result in the imposition of conditions that could cause the parties to abandon the Merger.

As noted in “ Note 21 – Subsequent Events ” in “—Notes to Consolidated Financial Statements”, on December 13, 2022, Malvern Bancorp, Malvern Bank and First Bank entered into an Agreement and Plan of Merger (the “Merger Agreement”), pursuant to which, and subject to the terms and conditions of the Merger Agreement, Malvern Bancorp will merge with and into First Bank immediately followed by the merger of Malvern Bank with and into First Bank, with First Bank continuing as the surviving corporation in each case (collectively, the “Merger”).

Before the transactions contemplated in the Merger Agreement can be completed, approvals must be obtained from regulatory authorities, shareholders and other customary closing conditions must have been satisfied or waived. The required regulatory approvals may require changes to the terms of the transactions contemplated by the Merger Agreement. There can be no assurance that our or First Bank’s regulators will not impose any additional conditions, limitations, obligations or restrictions on the parties, or that they will not have the effect of delaying or preventing the completion of the Merger, imposing additional material costs on or materially limiting the revenues of the surviving entity following the Merger or otherwise reducing the anticipated benefits of the Merger.

Uncertainties about the effect of the Merger may impair our ability to attract, retain and motivate key personnel until the Merger is consummated and for a period of time thereafter, and could cause customers and others that deal with us to seek to change their existing business relationships with us. It is not unusual for competitors to use mergers as an opportunity to target the merging parties’ customers and to hire certain of their employees. Employee retention may be particularly challenging during the pendency of the Merger, as employees may experience uncertainty about their roles with the surviving entity following the Merger.

The Merger Agreement contains provisions that restrict our ability to, among other things, initiate, solicit, knowingly encourage or knowingly facilitate, inquiries or proposals with respect to, or, subject to certain exceptions generally related to our Board of Directors’ exercise of fiduciary duties, engage in any negotiations concerning, or provide any confidential information relating to, any alternative acquisition proposals. These provisions, which include payment of a termination fee of $5,900,000 (the “Termination Fee”) payable to First Bank, which, under certain circumstances, may discourage any potential competing acquirer having an interest in acquiring us from proposing a transaction, or may result in the offer of a lower per share price to acquire us than might otherwise have been proposed.

The value to be recognized by our shareholders from the Merger is subject to material uncertainties.

The Merger Agreement provides that upon the closing of the Merger our shareholders will receive per share of common stock of Malvern, $7.80 in cash and 0.7733 shares of common stock, par value $5.00 per share, of First Bank, subject to adjustment in accordance with the terms of the Merger Agreement if Malvern’s adjusted shareholders’ equity as of the tenth day prior to the closing of the Merger does not equal or exceed $140,000,000. The cash consideration and exchange ratio for the conversion of our common stock into common stock of First Bank (the “First Bank Common Stock”) were set based upon information available to the boards of directors and financial advisors of each company at the time of Merger Agreement was entered into. The market price of our common stock and of First Bank Common Stock fluctuates constantly in response to a variety of factors that are inherently unpredictable and outside of our control, including changes in our and First Bank’s business, operations and prospects, and regulatory considerations, the historical and anticipated future financial results of our respective banking operations and general market and economic developments affecting the United States and international businesses and financial markets. The substantial differences between our business and the business of First Bank will subject our shareholders to new and different risks than those they are familiar with. A period of months may transpire between the date that our shareholders are asked to approve the Merger and the earliest date the Merger can be closed, during which time the price of the Company’s common stock and First Bank Common Stock will continue to fluctuate and Malvern’s adjusted shareholders’ equity may continue to fluctuate. As a result, at the time that our shareholders must decide whether to approve the Merger Agreement, they may not necessarily know the precise value of the merger consideration they will receive, which could be materially different than the value of the merger consideration at the closing of the Merger.

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Failure to complete the proposed Merger could negatively impact our business, financial results and stock price.

If the proposed Merger is not completed for any reason, our ongoing business may be adversely affected and, without realizing any of the benefits of having completed the Merger, we would be subject to a number of related risks, including the following:

We may be required, under certain circumstances, to pay First Bank the Termination Fee under the Merger Agreement and reimbursement of First Bank's fees and expenses up to $350,000, which may adversely affect our financial performance and the price of our common stock;

We will have incurred substantial expenses and will be required to pay significant costs relating to the Merger, whether or not it is completed, such as legal, accounting, due diligence, financial advisor and printing fees;

The Merger Agreement places certain restrictions on the conduct of our business prior to completion of the Merger, which may adversely affect our ability to execute certain of our business strategies and cause certain other projects to be delayed or abandoned;

Matters relating to the Merger require substantial commitments of time and resources by our management team that could have been devoted to the pursuit of other opportunities beneficial to us as an independent company; and

We may be subject to negative reactions from the financial markets and from our customers and employees that could materially affect our business, financial results and stock price; the market price of our common stock could decline to the extent that current market prices of our common stock reflect a market assumption that the Merger will be completed.

Litigation could prevent or delay the closing of the proposed Merger or otherwise negatively impact our business and operations.

We may be subject to legal proceedings related to the agreed terms of the proposed Merger, the manner in which the Merger was considered and approved by our board of directors or any failure to complete the Merger or perform our obligations under the Merger Agreement. Such litigation, regardless of the merits, could delay or block the consummation of the Merger, have an adverse effect on our financial condition and impose material costs on us or the surviving entity. One of the conditions to the closing of the Merger is that no regulation, judgment, decree, injunction or other order of a governmental authority (including any federal, state or local court or administrative or regulatory agency) which prohibits the consummation of the Merger be in effect. If any plaintiff were successful in obtaining an injunction prohibiting us or First Bank from completing the Merger on the agreed upon terms, then such injunction may prevent the Merger from becoming effective or from becoming effective within the expected timeframe.

O perational, Compliance and Legal Risks

The fair value of our loans held-for-sale and investment securities can fluctuate due to market conditions outside of our control.

As of September 30, 2022, the fair value of loans held-for-sale was $13.8 million, which primarily consisted of one commercial real estate loan in the New York metropolitan area with a fair value of $13.3 million, and two residential loans with a carrying value of $548,000. The fair value of our investment available-for-sale securities portfolio was $49.8 million as of September 30, 2022.

With respect to our loans held-for-sale, various assumptions are used in connection with calculating the fair value of such loans and the ultimate exit price for such loans might differ materially from the fair value estimates. Factors beyond our control can significantly influence the fair value of loans held-for-sale in our portfolio and can cause potential adverse changes. These factors include, but are not limited to, general market conditions, changes in market interest rates, as well as all of the various other risks and assumptions noted throughout this Report with respect to market and other changes that can impact our loan portfolio in general. Additionally, and as mentioned elsewhere in this Report, loans made to our borrowers in the New York metropolitan area have been particularly affected by COVID-19 and otherwise, and commercial real estate properties in the New York metropolitan area have suffered declines in occupancy rates and rental rates, as well as general decreases in property values. Any weakening of the commercial real estate market in this market may impact the one loan in the New York metropolitan area with a fair value of $13.3 million. Any of these factors (including the ultimate sale price of any loans held-for-sale), among others, could cause realized and/or unrealized losses in future periods, which could have a material adverse effect on us and our financial condition.

With respect to our investment securities portfolio, we have historically adopted a conservative investment strategy, with concentrations of securities that are backed by government sponsored enterprises. Factors beyond our control can significantly influence the fair value of securities in our portfolio and can cause potential adverse changes to the fair value of these securities. These factors include, but are not limited to, rating agency actions in respect of the securities, defaults by the issuer or with respect to the underlying securities, and changes in market interest rates and continued instability in the capital markets. Any of these factors, among others, could cause other-than-temporary impairments and realized and/or unrealized losses in future periods and declines in other comprehensive income, which could have a material adverse effect on us. The process for determining whether impairment of a security is other-than-temporary usually requires complex, subjective judgments about the future financial performance and liquidity of the issuer and any collateral underlying the security in order to assess the probability of receiving all contractual principal and interest payments on the security.

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Our financial instruments expose us to certain market risks and may increase the volatility of earnings and AOCI.

We hold certain financial instruments measured at fair value. For those financial instruments measured at fair value, we are required to recognize the changes in the fair value of such instruments in earnings or accumulated other comprehensive income (“AOCI”) each quarter. Therefore, any increases or decreases in the fair value of these financial instruments have a corresponding impact on reported earnings or AOCI. Fair value can be affected by a variety of factors, many of which are beyond our control, including our credit position, interest rate volatility, capital markets volatility, and other economic factors. Accordingly, we are subject to mark-to-market risk and the application of fair value accounting may cause our earnings and AOCI  to be more volatile than would be suggested by our underlying performance.

Our business strategy could be adversely affected if we are not able to attract and retain skilled employees or if we lose the services of our senior management team.

Our ability to grow will depend upon our ability to continue to attract, hire and retain skilled employees. The unanticipated loss of members of our senior management team, including in connection with the Merger could have a material adverse effect on our results of operations and ability to execute our strategic goals. Our success will also depend on the ability of our officers and key employees to continue to implement and improve our operational and other systems, to manage multiple, concurrent customer relationships and to hire, train and manage our employees. COVID-19, along with general economic conditions, has made it more difficult to retain existing employees and to attract new employees.  Paying increased salaries to retain employees may negatively impact our financial condition.

We operate in a highly regulated environment and are subject to extensive laws and regulations.

We are subject to extensive regulation, supervision and examination by the FRB, our primary federal regulator, the OCC, the Bank’s primary federal regulator, and by the FDIC, as insurer of the Bank’s deposits. Such regulation and supervision govern the activities in which an institution and its holding company may engage and are intended primarily for the protection of the insurance fund and the depositors and borrowers of the Bank. Regulatory authorities have extensive discretion in their supervisory and enforcement activities, including the imposition of restrictions on our operations, the classification of our assets and determination of the level of our allowance for loan losses. We are also subject to regulation and enforcement by the SEC, as a publicly-traded reporting company, and by Nasdaq, the stock exchange where our common stock is listed. Any change in such regulation and oversight, whether in the form of regulatory policy, regulations, legislation or supervisory action, or any enforcement or related action, may have a material impact on our operations and financial condition. Additionally, being subject to such regulations and oversight, and being subject to any enforcement or related actions, increases the professional fees we incur in connection with legal, accounting and audit expense, which could in turn impact our financial condition.

On October 18, 2022 the FDIC adopted a final rule to increase initial base deposit insurance assessment rates for insured depository institutions by 2 basis points, beginning with the first quarterly assessment period of 2023. The increased assessment rate schedules would remain in effect unless and until the reserve ratio of the Deposit Insurance Fund meets or exceeds 2 percent. As a result of the new rule, the FDIC insurance costs of insured depository institutions, including Malvern Bank, would generally increase.

A new accounting standard will likely require us to increase our allowance for loan losses and may have a material adverse effect on our financial condition and results of operations.

The Financial Accounting Standards Board (“FASB”) has adopted a new accounting standard, the Current Expected Credit Loss (“CECL”), that will be effective for the Company and the Bank for fiscal years beginning October 1, 2023.  The CECL standard will require financial institutions to determine periodic estimates of lifetime expected credit losses on loans and recognize the expected credit losses as allowances for loan losses.  This will change the current method of providing allowances for loan losses that are probable, which would likely require us to increase our allowance for loan losses, and to greatly increase the types of data we would need to collect and review to determine the appropriate level of the allowance for loan losses.  Any increase in our allowance for loan losses or expenses incurred to determine the appropriate level of the allowance for loan losses may have a material adverse effect on our financial condition and results of operations.

Uncertainty relating to the LIBOR determination process and LIBOR discontinuance may adversely affect our results of operations.

LIBOR is the reference rate used for many of our transactions, including our lending and borrowing and our purchase and sale of securities that we use to manage risk related to such transactions. However, a reduced volume of interbank unsecured term borrowing coupled with recent legal and regulatory proceedings related to rate manipulation by certain financial institutions has led to international reconsideration of LIBOR as a financial benchmark. The United Kingdom Financial Conduct Authority (“FCA”), which regulates the process for establishing LIBOR, announced in July 2017 that the sustainability of LIBOR cannot be guaranteed. The administrator for LIBOR announced on March 5, 2021 that it will permanently cease to publish most LIBOR settings beginning on January 1, 2022 and cease to publish the overnight, one-month, three-month, six-month and 12-month USD LIBOR settings on July 1, 2023. Accordingly, the FCA has stated that is does not intend to persuade or compel banks to submit to LIBOR after such respective dates. Until such time, however, FCA panel banks have agreed to continue to support LIBOR.

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The market transition away from LIBOR to an alternative reference rate is complex and could have a range of adverse effects on the Company’s business, financial condition, and results of operations. In particular, any such transition could:

adversely affect the interest rates paid or received on, and the revenue and expenses associated with, the Company’s floating rate obligations, loans, deposits and other financial instruments tied to LIBOR rates, or other securities or financial arrangements given LIBOR’s role in determining market interest rates globally;

adversely affect the value of the Company’s floating rate obligations, loans, deposits and other financial instruments tied to LIBOR rates, or other securities or financial arrangements given LIBOR’s role in determining market interest rates globally;

prompt inquiries or other actions from regulators in respect of the Company’s preparation and readiness for the replacement of LIBOR with an alternative reference rate;

result in disputes, litigation or other actions with counterparties regarding the interpretation and enforceability of certain fallback language in LIBOR-based securities; and

require the transition to or development of appropriate systems and analytics to effectively transition our risk management processes from LIBOR-based products to those based on the applicable alternative pricing benchmark.

In addition, the implementation of LIBOR reform proposals may result in increased compliance costs and operational costs, including costs related to continued participation in LIBOR and the transition to a replacement reference rate or rates. We cannot reasonably estimate the expected cost.

We are dependent on our information technology and telecommunications systems and third-party servicers, and cyber-attacks, systems failures, interruptions or breaches of security could have a material adverse effect on us.

Information technology systems are critical to our business. We use various technology systems to manage our customer relationships, general ledger, securities, deposits, and loans. We have established policies and procedures to prevent or limit the impact of system failures, interruptions, and security breaches (including privacy breaches), but such events may still occur and may not be adequately addressed if they do occur. In addition, any compromise of our systems could deter customers from using our products and services. Although we rely on security systems to provide security and authentication necessary to effect the secure transmission of data, these precautions may not protect our systems from compromises or breaches of security.

We also outsource a majority of our data processing to certain third-party providers. If these third-party providers encounter difficulties, or if we have difficulty communicating with them, our ability to adequately process and account for transactions could be affected, and our business operations could be adversely affected. Threats to information security also exist in the processing of customer information through various other vendors and their personnel.

The occurrence of any system failures, interruption, or breach of security could damage our reputation and result in a loss of customers and business, thereby subjecting us to additional regulatory scrutiny, or could result in financial loss or expose us to litigation and possible financial liability. Furthermore, we may be required to expend significant additional resources to modify our protective measures or to investigate and remediate vulnerabilities or other exposures arising from operational and security risks or cyber-attacks. Any of these events could have a material adverse effect on our financial condition and results of operations.

Legislative changes may increase our tax expense.

In 2019 New Jersey adopted legislation that increased our state income tax liability and could increase our overall tax expense. The legislation imposed a temporary surtax on corporations earning New Jersey allocated income in excess of $1 million of 2.5 percent for tax years beginning on or after January 1, 2018 through December 31, 2019, and of 1.5 percent for tax years beginning on or after January 1, 2020 through December 31, 2021. However, in 2020, this surtax was extended through December 31, 2023, at the 2.5 percent level. The legislation also required combined filing for members of an affiliated group for years beginning on or after January 1, 2019, changing New Jersey’s current status as a separate return state, and limits, to varying degrees related to the Company’s size, operating area and organizational structure, the deductibility of dividends received. These changes are not temporary. Although regulations implementing the legislative changes have not yet been issued, it is possible that the Company will lose the benefit of at least certain of its tax management strategies and, if so, our total tax expense will increase.

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Beginning January 1, 2023, the Pennsylvania corporate net income tax rate will decrease 1 percentage point to 8.99 percent. Each year thereafter the rate will decrease 0.5 percentage points until it reaches 4.99 percent at the beginning of 2031. Additionally, the law includes a provision that will increase the amount of capital investment pass-through business owners can deduct on their individual income tax returns the year the investments were made.

Any changes in administration could also lead to changes in federal tax laws as well as changes in regulatory requirements and oversight. We are subject to changes in tax law that could increase our effective tax rates. These law changes may be retroactive to previous periods and as a result could negatively affect our current and future financial performance. An increase in our corporate tax rate could have an unfavorable impact on our earnings and capital generation abilities. Similarly, our clients could experience varying effects from changes in tax laws and such effects, whether positive or negative, may have a corresponding impact on our business and the economy as a whole. In addition, changes to regulatory requirements and oversight could increase our costs of regulatory compliance and may significantly affect the markets in which we do business, the markets for and value of our loans and investments, and our ongoing operations, costs and profitability.

Increasing scrutiny and evolving expectations from customers, regulators, investors, and other stakeholders with respect to our environmental, social and governance practices may impose additional costs on us or expose us to new or additional risks.

Companies are facing increasing scrutiny from customers, regulators, investors, and other stakeholders related to their environmental, social and governance (“ESG”) practices and disclosure. Investor advocacy groups, investment funds and influential investors are also increasingly focused on these practices, especially as they relate to the environment, health and safety, diversity, labor conditions and human rights. Increased ESG related compliance costs could result in increases to our overall operational costs. Failure to adapt to or comply with regulatory requirements or investor or stakeholder expectations and standards could negatively impact our reputation, ability to do business with certain partners, and our stock price. New government regulations could also result in new or more stringent forms of ESG oversight and expanding mandatory and voluntary reporting, diligence, and disclosure.

Risks Related to COVID-19

The global COVID-19 pandemic led to periods of significant volatility in financial, real estate, commodities and other markets and it could harm our business and results of operations.

In December 2019, a COVID-19 outbreak was reported in China, and, in March 2020, the World Health Organization declared it a pandemic. Since that time, COVID-19 has had many variants and spread throughout the United States, including in the regions and communities in which the Company operates. In response, many state and local governments, including the Commonwealth of Pennsylvania and the State of New Jersey, instituted various emergency restrictions that substantially limited the operation of non-essential businesses and the activities of individuals. These restrictions resulted, and if implemented again could continue to result, in significant adverse effects on our borrowers and many different types of small and mid-sized businesses within the Company’s client base, particularly those in the retail, hotel, construction, commercial real estate, medical, leisure, hospitality and food and beverage industries, among others, and resulted in a significant number of layoffs and furloughs of employees nationwide and in the regions and communities in which we operate.

The ultimate effect of COVID-19, its variants, and related events, including those described above and those not yet known or knowable, could have a negative effect on the stock price, business prospects, financial condition and results of operations of the Company, including as a result of quarantines, market volatility, market downturns, changes in consumer behavior, business closures, deterioration in the credit quality of borrowers or the inability of borrowers to satisfy their obligations to the Company (and any related forbearances or restructurings that may be implemented), declines in the value of collateral securing outstanding loans, branch or office closures and business interruptions.

COVID-19 resulted in authorities implementing numerous measures to try to contain the virus, such as quarantines and shelter in place orders. These measures may be implemented again and could adversely affect our business, operations and financial condition, as well as the business, operations and financial conditions of our customers and business partners. The Company maintains a Telework Policy that allows for a modified work schedule of in-person and remote working. We may decide to take further related actions as may be required by government authorities or that we determine are in the best interests of our employees and customers. There is no certainty that such measures will be sufficient to mitigate the risks posed by COVID-19 or its variants, or otherwise be satisfactory to government authorities.

We are subject to increasing credit risk as a result of COVID-19, which could adversely impact our profitability.

Our business depends on our ability to successfully measure and manage credit risk. We are exposed to the risk that the principal of, or interest on, a loan will not be paid timely or at all or that the value of any collateral supporting a loan will be insufficient to cover our outstanding exposure. In addition, we are exposed to risks resulting from changes in economic and industry conditions and risks inherent in dealing with loans and borrowers. As the overall economic climate in the U.S., generally, and in our market areas specifically, experienced, and may continue to experience, material disruption due to COVID-19 and its resulting variants, our borrowers have had, and may continue to have, difficulties in repaying their loans. Governmental actions providing payment relief to borrowers and guarantors affected by COVID-19 could preclude our ability to initiate foreclosure proceedings in certain circumstances and, as a result, the collateral we hold may decrease in value or become illiquid, and the level of our nonperforming loans, charge-offs and delinquencies could rise and require significant additional provisions for loan losses. Additional factors related to the credit quality of certain commercial real estate and multifamily residential loans included the duration of state and local moratoriums on evictions for non-payment of rent or other fees, which moratoriums could be implemented again. The payment on these loans that are secured by income producing properties are typically dependent on the successful operation of the related real estate property and may subject us to risks from adverse conditions in the real estate market or the general economy.

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Bank regulatory agencies and various governmental authorities urged financial institutions to work prudently with borrowers who are or may be unable to meet their contractual payment obligations because of the effects of COVID-19. We have worked to support our borrowers to mitigate the impact of COVID-19 on them and on our loan portfolio, including through loan modifications that defer payments for those who experienced a hardship as a result of COVID-19. Although regulatory guidance provides that such loan modifications are exempt from the calculation and reporting of troubled debt restructurings (“TDRs”) and loan delinquencies, we cannot predict whether any such loan modifications may ultimately have an adverse impact on our profitability in future periods. Our inability to successfully manage the increased credit risk caused by COVID-19 could have a material adverse effect on our business, financial condition and results of operations.

The impact of COVID-19 on the metropolitan New York area commercial real estate market was, and continues to be, particularly uncertain. Loans made to our borrowers in the New York area have been particularly affected by COVID-19. We may continue to incur losses on commercial real estate loans due to any prior and future declines in occupancy rates and rental rates and decreases in property values. The Bank currently has one $13.3 million non-accrual commercial real estate loan held for sale in the metropolitan New York area. The effects of COVID-19 variants create further ambiguity on the strength or likelihood of a full financial recovery or a full recovery in the commercial real estate market, and the expiration of federal and state stimulus programs, eviction moratoriums, and other support programs may present additional challenges. Changing consumer and business preferences related to shopping, travel, and returning to the office have led and may continue to lead to medium-and long-term income and valuation challenges in certain commercial real estate sectors. Any further weakening of the commercial real estate market may increase the likelihood of default of these loans, which could negatively impact our loan portfolio’s performance and asset quality. If we are required to liquidate the collateral securing a loan to satisfy the debt during a period of reduced real estate values, we could incur material losses. Any of these events could increase our costs, require management time and attention, and materially and adversely affect us.

Interest rate volatility stemming from COVID-19 and related events could negatively affect our net interest income, lending activities, deposits and profitability.

Our net interest income, lending activities, deposits and profitability could be negatively affected by volatility in interest rates caused by uncertainties and other matters stemming from COVID-19 and related events.  In March 2020, the FRB lowered the target range for the federal funds rate to a range from 0 to 0.25 percent, citing concerns about the impact of COVID-19 on markets and stress in certain sectors.  More recently, the FRB has continued to increase the federal funds rates to combat inflation. A prolonged period of extremely volatile and unstable market conditions may increase our funding costs and negatively affect market risk mitigation strategies. Higher income volatility from changes in interest rates and spreads to benchmark indices could cause a loss of future net interest income and a decrease in current fair market values of our assets. Fluctuations in interest rates will impact both the level of income and expense recorded on most of our assets and liabilities and the market value of all interest-earning assets and interest-bearing liabilities, which in turn could have a material adverse effect on our net income, operating results, and financial condition.

Unpredictable future developments related to or resulting from COVID-19 could materially and adversely affect our business and results of operations.

Given the ongoing and dynamic nature of the circumstances, it is not possible to predict the ultimate impact of COVID-19 and its variants on the stock price, business prospects, financial condition or results of operations of the Company. Any future development is highly uncertain and cannot be predicted, including the scope and duration of the pandemic and new COVID-19 variants, the continued effectiveness of any work from home arrangements, third party providers’ ability to support our operation, and any actions taken by governmental authorities and other third parties in response. We are continuing to monitor COVID-19 and related risks, although the development and fluidity of the situation precludes any specific prediction as to its ultimate impact on us. However, if COVID-19 continues to spread, evolve, or otherwise results in a continuation or worsening of the current economic and commercial environments, our business, financial condition, results of operations and cash flows as well as our regulatory capital and liquidity ratios could be materially adversely affected and many of the risks described herein will be heightened.

Our prior participation in the SBA PPP loan program could expose us to risks related to noncompliance with the Paycheck Protection Program ( “ PPP ” ), which could have a material adverse impact on our business, financial condition and results of operations.

The Company was a participating lender in the PPP, a loan program administered through the SBA, which was created to help eligible businesses, organizations and self-employed persons fund their operational costs during COVID-19. Under this program, the SBA guaranteed 100% of the amounts loaned under the PPP. As previously announced, the Company subsequently sold the entirety of its PPP loan portfolio; however, we may be required to repurchase, and as a result be exposed to credit risk, on sold PPP loans in certain circumstances if a determination is made by the SBA that there was a deficiency by the Bank with respect to the manner in which the loan was originated, funded, or serviced.

General Risk Factors

Our risk management framework may not be effective in mitigating risk and reducing the potential for significant losses.

Our risk management framework is designed to effectively manage and mitigate risk while minimizing exposure to potential losses. We seek to identify, measure, monitor, report and control our exposure to risk, including strategic, market, liquidity, compliance and operational risks. While we use a broad and diversified set of risk monitoring and mitigation techniques, these techniques are inherently limited because they cannot anticipate the existence or future development of currently unanticipated or unknown risks. Recent economic conditions and heightened legislative and regulatory scrutiny of the financial services industry, among other developments, have increased our level of risk. Accordingly, we could suffer losses as a result of our failure to properly anticipate and manage these risks.

We could be adversely affected by failure in our internal controls.

A failure in our internal controls could have a significant negative impact not only on our earnings, but also on the perception that customers, regulators and investors may have of us. We continue to devote a significant amount of effort, time and resources to continually strengthening our controls and ensuring compliance with complex accounting standards and banking regulations. Compliance with increased or new standards and regulations applicable to our Company may entail management spending increased time addressing such standards and regulations. Further, the Company may be required to expend additional capital resources on professional advisors, which could increase operational expenses and therefore negatively impact our net income.

Management’s Discussion and Analysis of Financial Condition and Results of Operations is based on our consolidated financial statements, which have been prepared in accordance with U. S. generally accepted accounting principles (“GAAP”). The preparation of these financial statements requires us to make estimates and judgments that affect the reported amounts of assets, liabilities, revenues and expenses. In particular, the Company has identified the determination of the ALLL, OREO, fair value measurements, the evaluation of deferred tax assets, the other-than-temporary impairment evaluation of securities, and the valuation of our derivative positions to be critical because management must make subjective and/or complex judgments about matters that are inherently uncertain and could be most subject to revision as new information becomes available. Note 2 to our audited consolidated financial statements contains a summary of our significant accounting policies. Management believes our policy with respect to the methodology for the determination of the allowance for loan losses involves more complexity and requires management to make difficult and subjective judgments which often require assumptions or estimates about highly uncertain matters. Changes in these judgments, assumptions or estimates could materially impact results of operations. This critical policy and its application are periodically reviewed with the Audit Committee and our Board of Directors.

The Company makes estimates and assumptions that affect the reported amount of assets and liabilities, disclosure of contingent assets and liabilities at the date of the consolidated financial statements, and the reported amounts of revenue and expenses during the reporting period. Such estimates include ALLL, fair value of financial estimates, along with assumptions used in the calculation of income taxes, among others. These estimates and assumptions are based on management’s best estimates and judgment. Management evaluates its estimates and assumptions on an ongoing basis using loss experience and other factors, including the current economic environment, which management believes to be reasonable under the circumstances. We adjust such estimates and assumptions when facts and circumstances dictate. As future events and their effects cannot be determined with precision, actual results could differ significantly from these estimates. Changes in estimates resulting from continuing changes in the economic environment will be reflected in the financial statements in future periods. There can be no assurances that actual results will not differ from those estimates.

Operating, Accounting and Reporting Considerations related to COVID-19

The COVID-19 pandemic has negatively impacted the global economy. In response to the crisis, the Coronavirus Aid, Relief, and Economic Security (“CARES”) Act was passed by Congress and signed into law on March 27, 2020. The CARES Act provided an estimated $2.2 trillion to fight the COVID-19 pandemic and stimulate the economy by supporting individuals and businesses through loans, grants, tax changes, and other types of relief. Under Section 4013 of the CARES Act and based upon regulatory guidance promulgated by federal banking regulators, qualifying short-term loan modifications resulting in payment deferrals that are attributable to the adverse impact of COVID-19 are not considered to be troubled debt restructurings (“TDRs”). Some of the provisions applicable to the Company include, but are not limited to:

Accounting for Loan Modifications – The CARES Act provides that a financial institution may elect to suspend (1) the requirements under GAAP for certain loan modifications that would otherwise be categorized as a TDR and (2) any determination that such loan modifications would be considered a TDR, including the related impairment for accounting purposes. The suspension is applicable for the term of the loan modification that occurs during the applicable period for a loan that was not more than 30 days past due as of December 31, 2019. The suspension is not applicable to any adverse impact on the credit of a borrower that is not related to the pandemic.

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Paycheck Protection Program – The CARES Act established the Paycheck Protection Program (“PPP”), an expansion of the Small Business Administration’s 7(a) loan program and the Economic Injury Disaster Loan Program (“EIDL”), administrated directly by the Small Business Administration (“SBA”).

Also in response to the COVID-19 pandemic, the Board of Governors of the Federal Reserve System (“FRB”), the Federal Deposit Insurance Corporation (“FDIC”), the National Credit Union Administration (“NCUA”), the Office of the Comptroller of the Currency (“OCC”), and the Consumer Financial Protection Bureau (“CFPB”), in consultation with the state financial regulators (collectively, the “agencies”) issued a joint interagency statement (issued March 22, 2020; revised statement issued April 7, 2020). Some of the provisions applicable to the Company include, but are not limited to:

Accounting for Loan Modifications – Loan modifications that do not meet the conditions of the CARES Act may still qualify as a modification that does not need to be accounted for as a TDR. The agencies confirmed with FASB staff that short-term modifications made on a good faith basis in response to COVID-19 to borrowers who are current on payments prior to any relief granted to them are not TDRs. This includes short-term (e.g., six months) modifications such as payment deferrals, fee waivers, extensions of repayment terms, or insignificant delays in payments. Loan modifications were made in accordance with Section 4013 of the CARES Act and the Interagency Statement on Loan Modifications and Reporting for Financial Institutions working with customers affected by COVID-19 and therefore were not classified as TDRs.

Past Due Reporting – With regard to loans not otherwise reportable as past due, financial institutions are not expected to designate loans with deferrals granted due to COVID-19 as past due because of the deferral. A loan’s payment date is governed by the due date stipulated in the legal agreements. If a financial institution agrees to a payment deferral, these loans would not be considered past due during the period of the deferral.

Nonaccrual Status and Charge-offs – During short-term COVID-19 modifications, these loans generally should not be reported as nonaccrual or as classified.

On December 27, 2020, the 2021 Consolidated Appropriations Act was signed into law. The $900 billion relief package includes legislation that extends certain relief provisions of the CARES Act that were set to expire on December 31, 2020. This new legislation extends this relief to the earlier of 60 days after the national emergency declared by the President is terminated or January 1, 2022.

Paycheck Protection Program

The CARES Act established the PPP, an expansion of the EIDL, administrated directly by the SBA.

The Company started accepting and processing applications for loans under the PPP in early April 2020, when the program was officially launched by the SBA and Treasury Department under the CARES Act. The Company sold the entirety of its PPP loan portfolio in December 2020.

Liquidity Sources

Management has reviewed all primary and secondary sources of liquidity in preparation for any unforeseen funding needs due to the COVID-19 pandemic and prioritized based on available capacity, term flexibility, and cost. As of September 30, 2022, the Company had adequate sources of liquidity.

Capital Strength

The Bank’s capital ratios continue to exceed the highest required regulatory benchmark levels. As of September 30, 2022, common equity Tier 1 capital ratio was 19.27 percent, Tier 1 leverage ratio was 16.30 percent, Tier 1 risk-based capital ratio was 19.27 percent and the total risk-based capital ratio was 20.34 percent.

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Deferral and Modification Requests

The CARES Act provided guidance around the modification of loans as a result of the COVID-19 pandemic, which outlined, among other criteria, that short-term modifications made on a good faith basis to borrowers who were current as defined under the CARES Act prior to any relief, are not TDRs. This includes short-term modifications such as payment deferrals, fee waivers, extensions of repayment terms, or other delays in payment that are insignificant. Borrowers are considered current under the CARES Act and related regulatory guidance if they are less than 30 days past due on their contractual payments at the time a modification program is implemented. As of September 30, 2022, the Company had three COVID-19 pandemic related loan modification agreements totaling $32.0 million representing 4.1 percent of gross loans outstanding. Further details regarding these modifications are provided in the table below. At September 30, 2021, the Company had eight COVID-19-related modified loan deferrals totaling $61.2 million or 6.7% of total loans. Of the remaining $32.0 million deferrals, none of the deferrals are paying the contractual interest payments. For loans subject to the program, each borrower is required to resume making regularly scheduled loan payments at the end of the modification period and the deferred amounts will be moved to the end of the loan term. Management anticipates this activity will continue beyond fiscal year 2022.

September 30, 2022

Number of Loans

Loan Modified Exposure

Gross Loans September 30, 2022

Percentage of Gross Loans Modified

(Dollars in thousands)

Residential mortgage

Construction and Development:

Residential and commercial

Land loans

Total Construction and Development

Commercial:

Commercial real estate

Farmland

Multi-family

Commercial and industrial

Other

Total Commercial

Consumer:

Home equity lines of credit

Second mortgages

Other

Total Consumer

Total loans

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September 30, 2021

Number of Loans

Loan Deferment Exposure

Gross Loans September 30, 2021

Percentage of Gross Loans Modified

(Dollars in thousands)

Residential mortgage

Construction and Development:

Residential and commercial

Land loans

Total Construction and Development

Commercial:

Commercial real estate

Farmland

Multi-family

Commercial and industrial

Other

Total Commercial

Consumer:

Home equity lines of credit

Second mortgages

Other

Total Consumer

Total loans

Allowance for Loan Losses

The allowance for loan losses represents management’s estimate of probable loan losses inherent in the loan portfolio. Determining the amount of the allowance for loan losses is considered a critical accounting estimate because it requires significant judgment and the use of estimates related to the amount and timing of expected future cash flows on impaired loans, estimated losses on pools of homogeneous loans based on historical loss experience, and consideration of current economic trends and conditions, all of which may be susceptible to significant change. The loan portfolio also represents the largest asset type on the Company’s Consolidated Statements of Financial Condition.

The evaluation of the adequacy of the allowance for loan losses includes, among other factors, an analysis of historical loss rates by loan category applied to current loan totals and qualitative factors. However, actual loan losses may be higher or lower than historical trends, which vary. Actual losses on specified problem loans, which also are provided for in the evaluation, may vary from estimated loss percentages, which are established based upon a limited number of potential loss classifications. The allowance for loan losses is established through a provision for loan losses charged to expense. Management believes that the current allowance for loan losses will be adequate to absorb loan losses on existing loans that may become uncollectible based on the evaluation of known and inherent risks in the loan portfolio. The evaluation takes into consideration such factors as changes in the nature and size of the portfolio, overall portfolio quality, and specific problem loans and current economic conditions which may affect our borrowers’ ability to pay.

The evaluation also details historical losses by loan category and the resulting loan loss rates which are projected for current loan total amounts. Loss estimates for specified problem loans are also detailed. In addition, the OCC, as an integral part of its examination process, periodically reviews our allowance for loan losses. The OCC may require us to make additional provisions for loan losses based upon information available at the time of the examination. All of the factors considered in the analysis of the adequacy of the allowance for loan losses may be subject to change. To the extent actual outcomes differ from management estimates, additional provisions for loan losses may be required that could materially adversely impact earnings in future periods.

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Qualitative or environmental factors that may result in further adjustments to the quantitative analyses include items such as changes in lending policies and procedures, economic and business conditions, nature and volume of the portfolio, changes in delinquency, concentration of credit trends, and value of underlying collateral. The total net adjustments due to qualitative factors, pay-offs and charge-offs decreased the allo wance for loan losses by approximately $2.4 million to $9.1 million from $11.5 million at September 30, 2022 and September 30, 2021, respectively.

An unallocated component is maintained to cover uncertainties that could affect management’s estimate of probable losses. The unallocated component of the allowance reflects the margin of imprecision inherent in the underlying assumptions used in the methodologies for estimating specific and general losses in the portfolio.

Fair Value Measurements

The Company uses fair value measurements to record fair value adjustments to certain assets and to determine fair value disclosures. Investment securities available for sale, equity securities and interest rate swap agreements are recorded at fair value on a recurring basis. Additionally, from time to time, the Company may be required to record at fair value other assets on a nonrecurring basis, such as impaired loans, other real estate owned and certain other assets. These nonrecurring fair value adjustments typically involve application of lower-of-cost-or-market accounting or write-downs of individual assets.

Under the FASB Accounting Standards Codification (“ASC”) Topic 820, Fair Value Measurements, the Company groups its assets at fair value in three levels, based on the markets in which the assets are traded and the reliability of the assumptions used to determine fair value. These levels are:

Level 1 – Valuation is based upon quoted prices for identical instruments traded in active markets.

Level 2 – Valuation is based upon quoted prices for similar instruments in active markets, quoted prices for identical or similar instruments in markets that are not active, and model-based valuation techniques for which all significant assumptions are observable in the market.

Level 3 – Valuation is generated from model-based techniques that use significant assumptions not observable in the market. These unobservable assumptions reflect the Company’s own estimates of assumptions that market participants would use in pricing the asset.

Under FASB ASC Topic 820, the Company bases its fair values on the price that would be received to sell an asset or paid to transfer a liability in an orderly transaction between market participants at the measurement date. It is our policy to maximize the use of observable inputs and minimize the use of unobservable inputs when developing fair value measurements, in accordance with the fair value hierarchy in FASB ASC Topic 820.

Fair value measurements for assets where there exists limited or no observable market data and, therefore, are based primarily upon the Company’s or other third-party’s estimates, are often calculated based on the characteristics of the asset, the economic and competitive environment and other such factors. Therefore, the results cannot be determined with precision and may not be realized in an actual sale or immediate settlement of the asset. Additionally, there may be inherent weaknesses in any calculation technique, and changes in the underlying assumptions used, including discount rates and estimates of future cash flows, that could significantly affect the results of current or future valuations. At September 30, 2022, the Company had $14.0 million of assets that were measured at fair value on a non-recurring basis using Level 3 measurements.

Income Taxes

We make estimates and judgments to calculate some of our tax liabilities and determine the realizability of some of our DTAs, which arise from temporary differences between the tax and financial statement recognition of revenues and expenses. We also estimate a reserve for DTAs if, based on the available evidence, it is more likely than not that some portion of the recorded DTAs will not be realized in future periods. These estimates and judgments are inherently subjective. Historically, our estimates and judgments to calculate our deferred tax accounts have not required significant revision to our initial estimates.

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In evaluating our ability to recover DTAs, we consider all available positive and negative evidence, including our past operating results and our forecast of future taxable income. In determining future taxable income, we make assumptions for taxable income, the reversal of temporary differences and the implementation of feasible and prudent tax planning strategies. These assumptions require us to make judgments about our future taxable income and are consistent with the plans and estimates we use to manage our business. Any reduction in estimated future taxable income may require us to record a valuation allowance against our DTAs. An increase in the valuation allowance would result in additional income tax expense in the period and could have a significant impact on our future earnings.

Realization of a DTA requires us to exercise significant judgment and is inherently uncertain because it requires the prediction of future occurrences. Our net DTA amounted to $3.7 million and $3.5 million at September 30, 2022 and at September 30, 2021, respectively. In accordance with ASC Topic 740, the Company evaluates on a quarterly basis, all evidence, both positive and negative, to determine whether, based on the weight of that evidence, a valuation allowance for DTAs is needed. In conducting this evaluation, management explores all possible sources of taxable income available under existing tax laws to realize the net DTA beginning with the most objectively verifiable evidence first, including available carry back claims and viable tax planning strategies. If needed, management will look to future taxable income as a potential source. Management reviews the Company’s current financial position and its results of operations for the current and preceding years. That historical information is supplemented by all currently available information about future years. The Company understands that projections about future performance are subjective. The Company did not have a DTA valuation allowance as of September 30, 2022 and September 30, 2021.

Other-Than-Temporary Impairment of Securities

Securities are evaluated on a quarterly basis, and more frequently when market conditions warrant such an evaluation, to determine whether declines in their value are other-than-temporary. To determine whether a loss in value is other-than-temporary, management utilizes criteria such as the reasons underlying the decline, the magnitude and duration of the decline and whether management intends to sell or expects that it is more likely than not that it will be required to sell the security prior to an anticipated recovery of the fair value. The term “other-than-temporary” is not intended to indicate that the decline is permanent but indicates that the prospects for a near-term recovery of value is not necessarily favorable, or that there is a lack of evidence to support a realizable value equal to or greater than the carrying value of the investment. Once a decline in value for a debt security is determined to be other-than-temporary, the other-than-temporary impairment is separated into (a) the amount of the total other-than-temporary impairment related to a decrease in cash flows expected to be collected from the debt security (the credit loss) and (b) the amount of the total other-than-temporary impairment related to all other factors. The amount of the total other-than-temporary impairment related to the credit loss is recognized in earnings. The amount of the total other-than-temporary impairment related to all other factors is recognized in other comprehensive income.

Derivatives

The Company enters into derivative financial instruments to manage exposures that arise from business activities that result in the payment of future uncertain cash amounts, the value of which are determined by interest rates. The Company is exposed to certain risks arising from both its business operations and economic conditions. The Company principally manages its exposures to a wide variety of business and operational risks through management of its core business activities. The Company manages economic risks, including interest rate, liquidity, and credit risk primarily by managing the amount, sources, and duration of its debt funding and the use of derivative financial instruments. The Company primarily uses interest rate swaps as part of its interest rate risk management strategy.

Interest rate swaps are valued by a third party, using models that primarily use market observable inputs, such as yield curves, and are validated by comparison with valuations provided by the respective counterparties. The credit risk associated with derivative financial instruments that are subject to master netting agreements is measured on a net basis by counterparty portfolio. The significant assumptions used in the models, which include assumptions for interest rates, are independently verified against observable market data where possible. Where observable market data is not available, the estimate of fair value becomes more subjective and involves a high degree of judgment. In this circumstance, fair value is estimated based on management’s judgment regarding the value that market participants would assign to the asset or liability. This valuation process takes into consideration factors such as market illiquidity. Imprecision in estimating these factors can impact the amount recorded on the balance sheet for an asset or liability with related impacts to earnings or other comprehensive income.

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Other assets increased from $13.9 million at September 30, 2021, to $18.7 million at September 30, 2022, due to current year gains on our cash flow hedge and an increase in receivables related to an OREO sale. Other liabilities decreased from $12.3 million at September 30, 2021, to $6.0 million at September 30, 2022, primarily due to the payments related to prior year participation loans purchased settled during fiscal year 2022.

Results of Operations

Net income for the year ended September 30, 2022, was $7.0 million as compared to a net loss of ($92,000) in fiscal year 2021. For fiscal year 2022, the fully diluted earnings per common share was $0.92 as compared with fully diluted loss per common share of ($0.01) in fiscal year 2021.

The increase in net income and diluted earnings per share were primarily due to no provision recorded in fiscal year 2022 compared to a $11.2 million provision for the same period ending 2021.

For the year ended September 30, 2022, the Company’s return on average equity (‘‘ROAE’’) was 4.79 percent and its return on average assets (‘‘ROAA’’) was 0.63 percent. The comparable ratios for the year ended September 30, 2021 were ROAE of (0.06) percent and ROAA of (0.01) percent.

Net Interest Income and Margin

Net interest income is the difference between the interest earned on the portfolio of earning assets (principally loans and investments) and the interest paid for deposits and borrowings, which support these assets.

The following table presents the components of net interest income for the periods indicated.

Net Interest Income

Year Ended September 30,

Increase

Increase

(Decrease)

(Decrease)

from Prior

Percent

from Prior

Percent

(In thousands)

Amount

Year

Change

Amount

Year

Change

Interest income:

Loans, including fees

Investment securities

Dividends, restricted stock

Interest-bearing cash accounts

Total interest income

Interest expense:

Deposits

Short-term borrowings

Long-term borrowings

Subordinated debt

Total interest expense

Net interest income

Net interest income is directly affected by changes in the volume and mix of interest-earning assets and interest-bearing liabilities, which support those assets, as well as changes in the rates earned and paid.

Net interest income for the year ended September 30, 2022 increased $1.3 million, or 4.47 percent, to $29.3 million, from $28.1 million for fiscal year 2021. The Company’s net interest margin increased 33 basis points to 2.95 percent in fiscal year ended September 30, 2022, from 2.62 percent for the fiscal year ended September 30, 2021. During fiscal year 2022, our net interest margin was impacted by a decrease in the costs of money market and interest-bearing demand deposit accounts.

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As previously mentioned, the increase in net interest income during fiscal year 2022 was attributable in part to decrease in costs on money market and interest-bearing demand deposit accounts. The Company experienced an increase of $5.3 million in average noninterest-bearing deposits during fiscal year 2022 and a decrease of $67.0 million in average interest-bearing demand, savings, money market and time deposits during fiscal year 2022. During the fiscal year ended September 30, 2022, the Company’s net interest spread increased by 33 basis points reflecting a decrease in both the average yield on interest-earning assets and the average interest rates paid on interest-bearing liabilities of 6 basis points and 39 basis points, respectively.

For the fiscal year ended September 30, 2022, average interest-earning assets decreased by $78.8 million to $1.0 billion, as compared with the fiscal year ended September 30, 2021. The change in average interest-earning asset volume was primarily due to decreased loan volume. Average interest-bearing liabilities decreased by $114.4 million in fiscal year 2022 compared to fiscal year 2021, primarily due to a decrease in average interest-bearing deposits.

The factors underlying the year-to-year changes in net interest income are reflected in the tables presented above. The table on page 36 presents the Average Statements of Condition with Interest and Average Rates shows the Company’s consolidated average balance of assets, liabilities and shareholders’ equity, the amount of income produced from interest-earning assets and the amount of expense incurred from interest-bearing liabilities, and net interest income as a percentage of average interest-earning assets.

Total Interest Income

Interest income for the year ended September 30, 2022, decreased by $3.4 million, or 8.9 percent, as compared with the year ended September 30, 2021. This decrease was primarily due to a decrease in loan volume, partially offset by an increase in investments.

The average balance of the Company’s loan portfolio decreased $129.3 million in fiscal year 2022 to $854.8 million from $984.1 million in fiscal year 2021, primarily driven by a decrease in loan volume.

The average loan portfolio represented 86.1 percent of the Company’s interest-earning assets (on average) during fiscal year 2022 and 91.8 percent for fiscal year 2021. Average investment securities increased during fiscal year 2022 by $38.4 million compared to fiscal year 2021. Interest-bearing cash increased in fiscal year 2022 by $14.3 million compared to fiscal year 2021. The average yield on interest-earning assets decreased from 3.58 percent in fiscal year 2021 to 3.52 percent in fiscal year 2022.

Interest Expense

Interest expense for the year ended September 30, 2022, was impacted by both rate related and volume related factors. The changes resulted in decreased expense of $4.7 million primarily due to a decrease in rates paid on money market and other interest-bearing deposits from fiscal year 2021 to fiscal year 2022.

The cost of total average interest-bearing liabilities decreased to 0.64 percent for the year ended September 30, 2022, a decrease of 39 basis points, from 1.03 percent for the year ended September 30, 2021.

The Company’s net interest spread, (i.e., the average yield on average interest-earning assets minus the average rate paid on interest-bearing liabilities) increased 33 basis points to 2.88 percent in fiscal year 2022 from 2.55 percent for fiscal year 2021. The increase in fiscal year 2022 reflected a decreased cost in interest-bearing liabilities.

Rate/Volume Analysis

The following table quantifies the impact on net interest income and margin resulting from volume changes in average balances of interest earning assets, interest bearing liabilities, and average related yields and associated funding costs over the past two years. Any change in interest income or expense attributable to both changes in volume and changes in rate has been allocated in proportion to the relationship of the absolute dollar amount of change in each category.

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Analysis of Variance in Net Interest Income Due to Volume and Rates

Fiscal Year 2022/2021

Increase (Decrease)

Due to Change in:

Average

Average

Net

(In thousands)

Volume

Rate

Change

Interest-earning assets:

Loans, including fees

Investment securities

Interest-bearing cash accounts

Dividends, restricted stock

Total interest-earning assets

Interest-bearing liabilities:

Money market deposits

Savings deposits

Certificates of deposit

Other interest-bearing deposits

Total interest-bearing deposits

Borrowings

Total interest-bearing liabilities

Change in net interest income

The following table, ‘‘Average Statements of Condition with Interest and Average Rates’’ presents for the years ended September 30, 2022 and 2021, the Company’s average assets, liabilities, and shareholders’ equity. The Company’s net interest income, net interest spreads and net interest income as a percentage of interest-earning assets (net interest margin) are also reflected. No tax equivalent adjustments have been made as the amounts are not material.

Year Ended September 30,

Average

Interest

Average

Average

Interest

Average

Outstanding

Earned

Yield

Outstanding

Earned

Yield/

Balance

/Paid

/Rate

Balance

/Paid

Rate

(In thousands)

ASSETS

Interest earning assets:

Loans receivable (1)

Investment securities

Deposits in other banks

FHLB stock

Total interest earning assets (1)

Non-interest earning assets

Cash and due from banks

Bank owned life insurance

Other assets

Other real estate owned

Allowance for loan losses

Total non-interest earning assets

Total assets

LIABILITIES AND SHAREHOLDERS’ EQUITY

Interest bearing liabilities:

Money Market accounts

Savings accounts

Certificate accounts

Other interest-bearing deposits

Total deposits

Borrowed funds

Total interest-bearing liabilities

Non-interest bearing liabilities

Demand deposits

Other liabilities

Total non-interest-bearing liabilities

Shareholders’ equity

Total liabilities and shareholders’ equity

Net interest spread

Net interest margin

Net interest income

Includes non-accrual loans during the respective periods. Calculated net of unamortized deferred loan fees, loan discounts, undisbursed portions of loans-in-process, and allowance for loan losses.

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Other Income

The following table presents the principal categories of other (“non-interest”) income for each of the years in the two-year period ended September 30, 2022.

Year Ended September 30,

Increase

(Decrease)

Change

(In thousands)

Service charges and other fees

Rental income-other

Net gains on sale and call of available for sale securities

Net gains on sale of loans

Earnings on bank-owned life insurance

Total other income

For the fiscal year ended September 30, 2022, total other income decreased $1.4 million compared to the fiscal year ended September 30, 2021. This decrease was primarily a result of decreases of $779,000 in net gain on sale and call of available for sale securities and $688,000 in net gain on sale of loans, partially offset by an increase of $138,000 in excess of death benefit on banked-owned life insurance.

The increase on the sale of investments resulted from managing and optimizing normal portfolio activity during 2021. The decrease in the gain on sale of loans was primarily the result of a strategic effort to originate and sell residential loans in the low interest rate environment throughout fiscal year 2021 and the gain on sale of PPP loans during 2021.

Other Expense

The following table presents the principal categories of other expense for each of the years in the two-year period ended September 30, 2022.

Year Ended September 30,

Increase

(Decrease)

Change

(In thousands)

Salaries and employee benefits

Occupancy expense

Federal deposit insurance premium

Advertising

Data processing

Professional fees

Other real estate owned expense, net

Pennsylvania shares tax

Other operating expense

Total other expense

Total other expense for the fiscal year ended September 30, 2022 increased $1.8 million, or 8.7%, to $22.8 when compared to the fiscal year ended September 30, 2021. The increase was primarily due to an increase of $1.6 million, or a 51.4% increase in other operating expenses.  The increase in other operating expenses was mainly due to $1.5 million of real estate tax expense and $359,000 valuation allowance adjustment related to a $13.3 million loan held for sale. In addition, professional fees increased by $653,000 to $3.8 million at September 30, 2022, from $3.2 million at September 30, 2021, primarily due to legal fees associated with loan workouts and related matters concerning nonperforming loans. These increases were offset by a decrease in other real estate owned (“OREO”) expenses of $561,000 to $305,000 at September 30, 2022, when compared to $866,000 for the fiscal year ended September 30, 2021.

Financial Condition

Investment Portfolio

For the year ended September 30, 2022, the average volume of investment securities increased by $38.4 million to approximately $96.0 million or 9.7 percent of average interest-earning assets, from $57.7 million or 5.4 percent of average interest-earning assets, for the year ended September 30, 2021. At September 30, 2022, the total investment portfolio amounted to $110.0 million, an increase of $39.2 million from September 30, 2021. The increase in the investment portfolio was primarily due to purchases in the investment portfolio of $53.8 million, partially offset by maturities, calls and principal repayments in the amount of $6.1 during fiscal year 2022. At September 30, 2022, the principal components of the investment portfolio were government agency obligations, federal agency obligations, including mortgage-backed securities, obligations of U.S. states and political subdivision, corporate bonds and notes, a trust preferred security and equity securities.

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During the year ended September 30, 2022, volume related factors increased investment revenue by $1.0 million. The yield on investments was relatively flat decreasing by two basis points to 2.68 percent from a yield of 2.70 percent during the year ended September 30, 2021.

As of September 30, 2022, the estimated fair value of the available-for-sale securities disclosed below was primarily dependent upon the movement in market interest rates, particularly given the negligible inherent credit risk associated with these securities. These investment securities are comprised of securities that are rated investment grade by at least one bond credit rating service. Although the fair value will fluctuate as the market interest rates move, management believes that these fair values will recover as the underlying portfolios mature and are reinvested in market rate yielding investments. The Company does not intend to sell and expects that it is not more likely than not that it will be required to sell these securities until such time as the value recovers or the securities mature. Management does not believe any individual unrealized loss as of September 30, 2022, represents other-than-temporary impairment.

Securities available-for-sale are a part of the Company’s interest rate risk management strategy and may be sold in response to changes in interest rates, changes in prepayment risk, liquidity management and other factors. The Company continues to reposition the investment portfolio as part of an overall corporate-wide strategy to produce reasonable and consistent margins where feasible, while attempting to limit risks inherent in the Company’s balance sheet.

For fiscal year 2022, there were no sales of available-for-sale investment securities. For fiscal year 2021, proceeds of available-for-sale investment securities sold amounted to $17.3 million and gross realized gains on investment securities sold amounted to $779,000,

The varying amount of sales from the available-for-sale portfolio reflects the significant volatility present in the market. Given the historic low interest rates prevalent in the market, it is necessary for the Company to protect itself from interest rate exposure. Securities that once appeared to be sound long-term investments can, after changes in the market, become securities that the Company wishes to sell to avoid losses and mismatches of interest-earning assets and interest-bearing liabilities at a later time.

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The table below illustrates the maturity distribution and weighted average yield for investment securities at September 30, 2022, based on a contractual maturity.

More than Five

More than One Year

Years through Ten

More than Ten

One year or less

through Five Years

Years

Years

Total

Weighted

Weighted

Weighted

Weighted

Weighted

Amortized

Average

Amortized

Average

Amortized

Average

Amortized

Average

Amortized

Fair

Average

Cost

Yield

Cost

Yield

Cost

Yield

Cost

Yield

Cost

Value

Yield

(In thousands)

Available for Sale Securities:

U.S. government agencies

State and municipal obligations

Single issuer trust preferred security

Corporate debt securities

US Treasury Note

Mortgage- backed securities ("MBS")

MBS

Total

Held to Maturity Securities:

U.S. government agencies and obligations

State and municipal obligations

Corporate debt securities

Mortgage- backed securities

Mortgage Backed Security ("MBS"), fixed-rate

Collateralized mortgage obligations ("CMO"), fixed-rate

Total

Equity Securities:

Mutual fund

Total

Total Investment Securities

For information regarding the carrying value of the investment portfolio, see Note 6 and Note 12 of the Notes to the Consolidated Financial Statements.

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The following table sets forth the carrying value of the Company’s investment securities, as of September 30, for each of the last two years.

(In thousands)

Investment Securities Available-for-Sale:

U.S. government agencies

State and municipal obligations

Single issuer trust preferred security

Corporate debt securities

MBS Securities

U.S. Treasury Note

Total available-for-sale

Investment Securities Held-to-Maturity:

U.S. government agencies

State and municipal obligations

Corporate debt securities

Mortgage-backed securities:

Mortgage Backed Security ("MBS"), fixed-rate

Collateralized mortgage obligations ("CMO"), fixed-rate

Total held-to-maturity

Equity Securities:

Mutual fund

Total equity securities

Total investment securities

For additional information regarding the Company’s investment portfolio, see Note 6 and Note 12 of the Notes to the Consolidated Financial Statements.

Loan Portfolio

Lending is the Company’s primary business activity. The Company’s loan portfolio consists of residential, construction and development, commercial and consumer loans, serving the diverse customer base in its market area. The composition of the Company’s portfolio continues to change due to the local economy. Factors such as the economic climate, interest rates, real estate values and employment all contribute to these changes in the composition of the Company’s portfolio. Growth is generated through business development efforts, repeat customer requests for new financings, penetration into existing markets and entry into new markets.

The Company seeks to create growth in commercial lending, which primarily includes commercial real estate, multi-family, farmland, and commercial and industrial lending, by offering customer-focused products and competitive pricing and by capitalizing on the positive trends in its market area. Products offered are designed to meet the financial requirements of the Company’s customers. It is the objective of the Company’s credit policies to diversify the commercial loan portfolio to limit concentrations in any single industry.

At September 30, 2022, total gross loans amounted to $810.4 million, a decrease of $103.4 million or 11.3 percent as compared to September 30, 2021. At September 30, 2022, total net loans amounted to $801.9 million, a decrease of $101.1 million or 11.2 percent as compared to September 30, 2021. For the fiscal year ended September 30, 2022, the gross loan portfolio saw declines of $22.8 million in residential mortgage loans, $40.0 million in commercial loans, and $38.8 million in construction and land loans.

The average balance of our total loans decreased $129.3 million, or 13.1 percent, for the fiscal year ended September 30, 2022, as compared to the fiscal year ended September 30, 2021, while the average yield on loans increased 2 basis points to 3.72 percent for the fiscal year ended September 30, 2022, from 3.70 percent for the fiscal year ended September 30, 2021. During fiscal year 2022 compared to fiscal year 2021, the volume-related factors contributed to a decrease of interest income on loans of $4.8 million, while the rate-related changes increased interest income by $247,000.

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The following table presents information regarding the components of the Company’s loan portfolio (which does not include loans held for sale, except as noted below) on the dates indicated.

September 30,

(In thousands)

Residential mortgage

Construction and Development:

Residential and commercial

Land

Total construction and development

Commercial:

Commercial real estate

Farmland

Multi-family

Commercial and industrial

Other

Total commercial

Consumer:

Home equity lines of credit

Second mortgages

Other

Total consumer

Total loans

Deferred loan fees and costs, net

Allowance for loan losses

Loans receivable, net

At September 30, 2022, our net loan portfolio totaled $801.9 million or 76.8 percent of total assets. Our principal lending activity has been the origination of residential, commercial, and commercial real estate loans. Through our loan policy, we utilize strict underwriting guidelines to maintain low average loan-to-value (“LTV”) ratios and require maximum gross debt ratios and minimum debt coverage ratios.

Loans are subject to federal and state law and regulations. Interest rates charged by us on loans are affected principally by the demand for such loans and the supply of money available for lending purposes and the rates offered by our competitors. These factors are, in turn, affected by general and economic conditions, the monetary policy of the federal government, including the Federal Reserve Bank, legislative tax policies and governmental budgetary matters.

The loans receivable portfolio is segmented into residential mortgage loans, construction and development loans, commercial loans and consumer loans. The residential mortgage loan segment has one class, one- to four-family first lien residential mortgage loans. The construction and development loan segment consists of the following classes: residential and commercial construction loans and land loans. Residential construction loans are made for the acquisition of and/or construction on a lot or lots on which a residential dwelling is to be built and occupied by the homeowner. Commercial construction loans are made for the purpose of acquiring, developing, and constructing a commercial use structure and for acquisition, development, and construction of residential properties by residential developers. The commercial loan segment consists of the following classes: commercial real estate loans, multi-family real estate loans, and other commercial loans, which are also generally known as commercial and industrial loans or commercial business loans. The consumer loan segment consists of the following classes: home equity lines of credit, second mortgage loans and other consumer loans, primarily unsecured consumer lines of credit.

Residential Lending. Residential mortgage originations are secured primarily by properties located in the Company’s market areas and surrounding areas. At September 30, 2022, $176.0 million, or 21.7 percent, of our total loans in our portfolio consisted of single-family residential mortgage loans.

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Our single-family residential mortgage loans generally are underwritten on terms and documentation conforming to guidelines issued by Federal Home Loan Mortgage Corporation (“Freddie Mac”) and the Federal National Mortgage Association (“Fannie Mae”). Applications for one- to four-family residential mortgage loans are taken by our loan origination officers and are accepted at any of our banking offices and are then referred to the lending department in order to process the loan, which consists primarily of obtaining all documents required by Freddie Mac and Fannie Mae underwriting standards, and completing the underwriting, which includes making a determination whether the loan meets our underwriting standards such that the Bank can extend a loan commitment to the customer. We generally have retained for our portfolio a substantial portion of the single-family residential mortgage loans that we originate. We currently originate fixed-rate, fully amortizing mortgage loans with maturities of 10 to 30 years. We also offer adjustable rate mortgage (“ARM”) loans where the interest rate either adjusts on an annual basis or is fixed for the initial one, three, five or seven years and then adjusts annually. However, due to the low interest rate environment and demand for fixed rate products, we have not originated a significant amount of ARM loans in recent years. At September 30, 2022, $49.8 million, or 28.3 percent, of our one- to four-family residential mortgage loans consisted of ARM loans.

In prior years, the Company purchased single-family residential mortgage loans and consumer loans from a network of mortgage brokers. The Company now has correspondent lending relationships, but the Bank independently underwrites these loans.

We underwrite one- to four-family residential mortgage loans with loan-to-value ratios of up to 95 percent, provided that the borrower obtains private mortgage insurance on loans that exceed 80 percent of the appraised value or sales price, whichever is less, of the secured property. We also require that title insurance, hazard insurance and, if appropriate, flood insurance be maintained on all properties securing real estate loans. We require that a licensed appraiser from our list of approved appraisers perform and submit to us an appraisal on all properties secured by a first mortgage on one- to four-family first mortgage loans. Our mortgage loans generally include due-on-sale clauses, which provide us with the contractual right to deem the loan immediately due and payable in the event the borrower transfers ownership of the property. Due-on-sale clauses are an important means of adjusting the yields of fixed-rate mortgage loans in portfolio and we generally exercise our rights under these clauses.

Construction and Development Loans . The amount of our outstanding construction and development loans in our portfolio decreased to $24.9 million or 3.0 percent of gross loans at September 30, 2022 from $63.7 million or 7.0 percent of gross loans as of September 30, 2021. We generally limit construction loans to builders and developers with whom we have an established relationship, or who are otherwise known to officers of the Bank. Our construction loans also include single-family residential construction loans which may, if approved, convert to permanent, long-term mortgage loans upon completion of construction (“construction/perm” loans). During the initial or construction phase, these construction/perm loans require payment of interest only, which generally is tied to the prime rate, as the home is being constructed. On residential construction to perm loans the final interest rate is approved upon the earlier of the completion of construction or one year. These loans if approved by the appropriate approving authority, convert to long-term (generally 30 years), amortizing, fixed-rate single-family mortgage loans.

Our portfolio of construction loans generally have a maximum term as approved based upon the underwriting (for individual, owner-occupied dwellings), and loan-to-value ratios less than 80 percent. Residential construction loans to developers are made on either a pre-sold or speculative (unsold) basis. Limits are placed on the number of units that can be built on a speculative basis based upon the reputation and financial position of the builder, his/her present obligations, the location of the property and prior sales in the development and the surrounding area. Generally, a limit of two unsold homes (one model home and one speculative home) is placed per project.

Prior to committing to a construction loan, we require that an independent appraiser prepare an appraisal of the property. Each project also is reviewed and inspected at its inception and prior to every disbursement of loan proceeds. Disbursements are made after inspections based upon a percentage of project completion and monthly payment of interest is required on all construction loans.

Our construction loans also include loans for the acquisition and development of land for sale (i.e., roads, sewer and water lines). We typically make these loans only in conjunction with a commitment for a construction loan for the units to be built on the site. These loans are secured by a lien on the property and are limited to a loan-to-value ratio not exceeding 75 percent of the appraised value at the time of origination. The loans have a variable rate of interest and require monthly payments of interest. The principal of the loan is repaid as units are sold and released. We limit loans of this type to our market area and to developers with whom we have established relationships. In most cases, we also obtain personal guarantees from the borrowers.

Our loan portfolio included one loan secured by unimproved real estate and lots (“land loan”), with an outstanding balance of $550,000, constituting 0.1 percent of total loans, at September 30, 2022.

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In order to mitigate some of the risks inherent to construction lending, we inspect properties under construction, review construction progress prior to advancing funds, work with builders with whom we have established relationships, require annual updating of tax returns and other financial data of developers and obtain personal guarantees from the principals. At September 30, 2022, approximately $134,000, or 1.5 percent, of our allowance for loan losses was attributed to construction and development loans. We had no construction and development loans that were non-performing at September 30, 2022 or September 30, 2021. We had no construction and development loans that were performing TDRs at September 30, 2022 or September 30, 2021.

Commercial Lending. At September 30, 2022, our loans secured by commercial real estate amounted to $406.9 million and constituted 50.2 percent of our gross loans at such date. During the fiscal year ended September 30, 2022, the commercial real estate loan portfolio decreased by $20.0 million, or 4.7 percent. During fiscal year 2022, we had no charge-offs of commercial real estate loans, as compared to $11.9 million of charge-offs of commercial real estate loans for fiscal year 2021.

Our commercial real estate loan portfolio consists primarily of loans secured by office buildings, retail and industrial use buildings, strip shopping centers, mixed-use and other properties used for commercial purposes located in our market area.

Although terms for commercial real estate and multi-family loans vary, our underwriting standards generally allow for terms up to 10 years with the interest rate being reset in the fifth year and with amortization typically not greater than 25 years and loan-to-value ratios of not more than 80 percent. Interest rates are either fixed or adjustable, based upon the index rate plus a margin, and fees ranging from 0.5 percent to 1.50 percent are charged to the borrower at the origination of the loan. Prepayment fees are charged on most loans in the event of early repayment. Generally, we obtain personal guarantees of the principals as additional collateral for commercial real estate and multi-family real estate loans.

Commercial and multi-family real estate loans generally present a higher level of risk than loans secured by one- to four-family residences. This greater risk is due to several factors, including the concentration of principal in a limited number of loans and borrowers, the effect of general economic conditions on income producing properties and the increased difficulty of evaluating and monitoring these types of loans. Furthermore, the repayment of loans secured by commercial and multi-family real estate is typically dependent upon the successful operation of the related real estate project. If the cash flow from the project is reduced (for example, if leases are not obtained or renewed, a bankruptcy court modifies a lease term, or a major tenant is unable to fulfill its lease obligations), the borrower’s ability to repay the loan may be impaired. As of September 30, 2022, there were no non-accruing commercial real estate mortgage loans, other than one commercial real estate mortgage loan held-for-sale that was non-accruing in the amount of $13.3 million. As of September 30, 2022, $6.1 million, or 67.2 percent of our allowance for loan losses, was allocated to commercial real estate mortgage loans. As of September 30, 2022, our commercial real estate loans held in our portfolio that were deemed performing troubled debt restructurings decreased to $594,000 from $12.2 million as of September 30, 2021.

At September 30, 2022, our multi-family loan portfolio included 23 loans with an aggregate book value of $55.3 million secured by multi-family (more than four units) properties, constituting 6.8 percent of our gross loans at such date. As of September 30, 2022, we had no non-accruing multi-family loans.

At September 30, 2022, we had $102.7 million in commercial business loans, or 12.7 percent of gross loans outstanding, in our portfolio. Our commercial business loans generally have been made to small to mid-sized businesses located in our market area. The commercial business loans in our portfolio assist us in our asset/liability management since they generally provide shorter maturities and/or adjustable rates of interest in addition to generally having higher rates of return which are designed to compensate for the additional credit risk associated with these loans. The commercial business loans which we have originated may be either a revolving line of credit or for a fixed term of generally 10 years or less. Interest rates are adjustable, indexed to a published prime rate of interest, or fixed. Generally, equipment, machinery, real property or other corporate assets secure such loans. Personal guarantees from the business principals are generally obtained as additional collateral.

Generally, commercial business loans are characterized as having higher risks associated with them than single-family residential mortgage loans. As of September 30, 2022, we had no non-accruing commercial loans in our loan portfolio. At such date, approximately $1.0 million, or 10.5 percent of the allowance for loan losses was allocated to commercial business loans.  At September 30, 2022, one commercial business loan totaling $625,000 was deemed a performing troubled debt restructuring loan.

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In our underwriting procedures, consideration is given to the stability of the property’s cash flow history, future operating projections, current and projected occupancy levels, location, and physical condition. Generally, our practice is to impose a debt service ratio (the ratio of net cash flows from operations before the payment of debt service/debt service) of not less than 120 percent. We also evaluate the credit and financial condition of the borrower, and if applicable, the guarantor. Appraisal reports prepared by independent appraisers are obtained on each loan to substantiate the property’s market value and are reviewed by us prior to the closing of the loan.

Consumer Lending. In our efforts to provide a full range of financial services to our customers, we offer various types of consumer loans. Our consumer loans amounted to $19.8 million or 2.4 percent of our total loan portfolio at September 30, 2022. The largest components of our consumer loans are home equity lines of credit, which amounted to $13.2 million at September 30, 2022, and loans secured by second mortgages, consisting primarily of home equity loans, which amounted to $4.4 million at September 30, 2022. Our consumer loans also include automobile loans, unsecured personal loans and loans secured by deposits. Consumer loans are originated primarily through existing and walk-in customers and direct advertising.

Our home equity lines of credit are variable rate loans tied to LIBOR, treasury, and prime rates. Our second mortgages may have fixed or variable rates, although they generally have had fixed rates in recent periods. Our second mortgages have a maximum term to maturity of 15 years. Both our second mortgages and our home equity lines of credit generally are secured by the borrower’s primary residence. However, our security generally consists of a second lien on the property. Our lending policy provides that the maximum loan-to-value ratio on our home equity lines of credit is 80 percent when the Bank has the first mortgage. However, the maximum loan-to-value ratio on our home equity lines of credit is reduced to 75 percent when the Bank does not have the first mortgage. At September 30, 2022, the unused portion of our home equity lines of credit was $27.9 million.

Consumer loans generally have higher interest rates and shorter terms than residential loans; however, they have additional credit risk due to the type of collateral securing the loan or in some cases the absence of collateral. In the year ended September 30, 2022, we recovered $57,000 of previously charged-off consumer loans mostly consisting of second mortgage loans, as compared to $129,000 of recoveries, mostly consisting of second mortgage loans during the year ended September 30, 2021. As of September 30, 2022, we had $148,000 of non-accruing second mortgage loans and $20,000 of non-accruing home equity lines of credit, representing a decrease of $133,000 over the amount of non-accruing second mortgage loans and home equity lines of credit at September 30, 2021. At September 30, 2022, $317,000 of our consumer loans were classified as substandard consumer loans. At September 30, 2022, an aggregate of $88,000 of our allowance for loan losses was allocated to second mortgages and home equity lines of credit.

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The following table presents the contractual maturity of our loans held in our portfolio at September 30, 2022. The table does not include the effect of prepayments or scheduled principal amortization. Loans having no stated repayment schedule or maturity and overdraft loans are reported as being due in one year or less.

At September 30, 2022, Maturing

After One

Years

After Five

In One Year

Through

Through

After

or Less

Five Years

Fifteen Years

Fifteen Years

Total

(In thousands)

Residential mortgage

Construction and Development:

Residential and commercial

Land

Total construction and development

Commercial:

Commercial real estate

Farmland

Multi-family

Commercial and industrial

Other

Total commercial

Consumer:

Home equity lines of credit

Second mortgages

Other

Total consumer

Total

Loans with:

Fixed rates

Variable rates

Total

For additional information regarding loans, see Note 7 of the Notes to the Consolidated Financial Statements.

Allowance for Loan Losses and Related Provision

The purpose of the allowance for loan losses (“ALLL” or “allowance”) is to absorb the impact of probable losses inherent in the loan portfolio. Additions to the allowance are made through provisions charged against current operations and through recoveries made on loans previously charged-off. The allowance is maintained at an amount considered adequate by management to provide for potential loan losses based upon a periodic evaluation of the risk characteristics of the loan portfolio. In establishing an appropriate allowance, an assessment of the individual borrowers, a determination of the value of the underlying collateral, a review of historical loss experience and an analysis of the levels and trends of loan categories, delinquencies and problem loans are considered. Such qualitative factors as changes in lending policies and procedures, economic and business conditions, nature and volume of the portfolio, changes in delinquency, concentration of credit trends, value of underlying collateral, the level and trend of interest rates, and peer group statistics are also reviewed. At September 30, 2022, the level of the allowance was $9.1 million as compared to a level of $11.5 million at September 30, 2021. The Company made no loan loss provisions in fiscal year 2022 compared with $11.2 million in fiscal year 2021. Provision expense was higher during the fiscal year ended September 30, 2021, due primarily to four commercial loans that were transferred to held-for-sale. The level of the allowance during the fiscal years of 2022 and 2021 reflects the change in average volume, credit quality within the loan portfolio, the level of charge-offs, and loan volume recorded during the periods and the Company’s focus on the changing composition of the commercial and residential real estate loan portfolios.

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At September 30, 2022, the allowance amounted to 1.12 percent of total gross loans. In management’s view, the level of the allowance at September 30, 2022 is adequate to cover losses inherent in the loan portfolio. Management’s judgment regarding the adequacy of the allowance constitutes a ‘‘Forward Looking Statement’’ under the Private Securities Litigation Reform Act of 1995. Actual results could differ materially from management’s analysis, based principally upon the factors considered by management in establishing the allowance.

Although management uses the best information reasonably available to it, the level of the allowance remains an estimate, which is subject to significant judgment and short-term change. The OCC, as an integral part of its examination process, periodically reviews the Company’s allowance. The OCC may require the Company to increase the allowance based on its analysis of information available to it at the time of its examination. Furthermore, the majority of the Company’s loans are secured by real estate in the State of New Jersey and the State of Pennsylvania. Future adjustments to the allowance may be necessary due to economic factors impacting real estate in the Bank’s market areas and a deterioration of the economic climate, as well as, operating, regulatory and other conditions beyond the Company’s control, including those as a result of COVID-19. The allowance as a percentage of total loans amounted to 1.12 percent and 1.21 percent at September 30, 2022 and 2021, respectively. Net charge-offs were $2.4 million in fiscal year 2022, compared to net charge-offs of $12.1 million in fiscal year 2021. Charge-offs were higher primarily in the commercial and industrial loan portfolio segment in fiscal year 2022.

At September 30, 2022, the Company held one non-accrual commercial real estate loan transferred to held-for-sale with an aggregate book balance of $13.3 million, for which the Company continues to evaluate a sale of this loan.

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Five-Year Statistical Allowance for Loan Losses

The following table reflects the relationship of loan volume, the provision and allowance for loan losses and net charge-offs for the past five years.

September 30,

(In thousands)

Average loans outstanding

Total loans at end of period

Analysis of the Allowance of Loan Losses

Balance at beginning of year

Charge-offs:

Residential mortgage

Commercial:

Commercial real estate

Commercial and industrial

Consumer:

Home equity lines of credit

Second mortgages

Other

Total charge-offs

Recoveries:

Residential mortgage

Construction and Development:

Residential and commercial

Commercial:

Commercial real estate

Commercial and industrial

Consumer:

Home equity lines of credit

Second mortgages

Other

Total recoveries

Net charge-offs

Provision for loan losses

Balance at end of year

Ratio of net charge-offs during the year to average loans outstanding during the year

Allowance for loan losses as a percentage of total loans at end of year

Balance includes loans held for sale.

For additional information regarding loans, see Note 7 of the Notes to the Consolidated Financial Statements.

Implicit in the lending function is the fact that loan losses will be experienced and that the risk of loss will vary with the type of loan being made, the creditworthiness of the borrower and prevailing economic conditions. The allowance for loan losses has been allocated in the table below according to the estimated amount deemed to be reasonably necessary to provide for the possibility of losses being incurred within the following categories of loans at September 30, for each of the past five years.

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The table below shows, by type of loan, the amounts of the allowance allocable to such loans and the percentage of such loans to total loans.

September 30,

Loans

Loans

Loans

Loans

Loans

Total

Total

Total

Total

Total

Amount

Loans

Amount

Loans

Amount

Loans

Amount

Loans

Amount

Loans

(In thousands)

Residential mortgage

Construction and Development:

Residential and commercial

Land loans

Commercial:

Commercial real estate

Farmland

Multi-family

Commercial and industrial

Other

Consumer:

Home equity lines of credit

Second mortgages

Other

Total allocated

Unallocated

Balance at end of period

In assessing the adequacy of the allowance, it is recognized that the process, methodology and underlying assumptions require a significant degree of judgment and uncertainty. The estimation of loan losses is not precise; the range of factors considered is wide and is significantly dependent upon management’s judgment, including the outlook and potential changes in the economic environment and general market conditions.  At present, components of the commercial loan segments of the portfolio are new originations and the associated volumes continue to see increased growth.  At the same time, historical loss levels have decreased as factors utilized in assessing the portfolio.  Any unallocated portion of the allowance reflects management’s estimate of probable inherent but undetected losses within the portfolio due to uncertainties in economic conditions, delays in obtaining information, including unfavorable information about a borrower’s financial condition, the difficulty in identifying triggering events that correlate perfectly to subsequent loss rates, and risk factors that have not yet manifested in loss allocation factors.

Asset Quality

The Company manages asset quality and credit risk by maintaining diversification in its loan portfolio and through review processes that include analysis of credit requests and ongoing examination of outstanding loans and delinquencies, with particular attention to portfolio dynamics and mix. The Company strives to identify loans experiencing difficulty early enough to attempt to correct the problems, to record charge-offs promptly based on realistic assessments of current collateral values, and to maintain an adequate allowance for loan losses at all times.

It is generally the Company’s policy to discontinue interest accruals once a loan is past due as to interest or principal payments for a period of 90 days. When a loan is placed on non-accrual status, interest accruals cease and uncollected accrued interest is reversed and charged against current income. Payments received on non-accrual loans are applied against principal. A loan may only be restored to an accruing basis when it again becomes well secured and in the process of collection or all past due amounts have been collected and a satisfactory period of ongoing repayment exists. Accruing loans past due 90 days or more are generally well secured and in the process of collection. For additional information regarding loans, see Note 7 of the Notes to the Consolidated Financial Statements.

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Non-Performing, Past Due Loans and OREO

Non-performing loans include non-accrual loans and accruing loans which are contractually past due 90 days or more. Non-accrual loans represent loans on which interest accruals have been suspended. It is the Company’s general policy to consider the charge-off of loans at the point they become past due in excess of 90 days, with the exception of loans that are both well-secured and in the process of collection. Troubled debt restructurings represent loans on which a concession was granted to a borrower, such as a reduction in interest rate to a rate lower than the current market rate for new debt with similar risks, and which are currently performing in accordance with the modified terms. For additional information regarding loans, see Note 7 of the Notes to the Consolidated Financial Statements.

The following table sets forth, as of the dates indicated, the amount of the Company’s non-accrual loans, accruing loans past due 90 days or more, OREO and troubled debt restructurings.

At September 30,

(In thousands)

Non-accrual loans:

Residential mortgage

Commercial:

Commercial real estate

Commercial and industrial

Total commercial

Consumer:

Home equity lines of credit

Second mortgages

Other

Total consumer

Total non-accrual loans

Accruing loans past due 90 days or more

Total non-performing loans

Other real estate owned

Total non-performing assets

Troubled debt restructured loans — performing

Non-accrual loans, excluding loans held-for-sale, totaled $753,000 at September 30, 2022, and $3.7 million at September 30, 2021. The decrease in non-accrual loans was primarily due a charge-off of $2.4 million related to one non-accrual commercial and industrial loan during the fiscal year and then transferred to OREO at a carrying value of $259,000. The decrease in OREO of $4.7 million at September 30, 2022, compared to September 30, 2021, was attributed to a sale at carrying value and the transfer of a new commercial and industrial loan to OREO during fiscal year 2022 totaling $259,000. Non-accrual loans to total loans were 0.09% and 0.39% at September 30, 2022 and 2021, respectively. The allowance for loan losses to non-accrual loans were 1,207.2% at September 30, 2022 compared to 310.3% at September 30, 2021.

Performing TDR loans were $5.0 million at September 30, 2022, and $17.6 million at September 30, 2021. The decrease is primarily related to two TDR commercial real estate loans totaling $17.1 million that were sold during the fiscal year 2021.

At September 30, 2022, non-performing assets ("NPAs") totaled $1.3 million, or 0.12% of total assets, as compared with $8.7 million, or 0.72% of total assets, at September 30, 2021. The decrease in NPAs is due to the decrease in non-accrual loans and OREO as described above.

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Provision for Income Taxes

The Company recorded a $1.9 million income tax expense in fiscal year 2022 compared to a $212,000 income tax benefit in fiscal year 2021. For a more detailed description of income taxes see Note 13 of the Notes to Consolidated Financial Statements.

Recent Accounting Pronouncements

Please refer to the note on Recent Accounting Pronouncements in Note 2 to the consolidated financial statements in Item 8 for a detailed discussion of new accounting pronouncements.

Asset and Liability Management

Asset and liability management encompasses an analysis of market risk, the control of interest rate risk (interest sensitivity management) and the ongoing maintenance and planning of liquidity and capital. The composition of the Company’s statement of condition is planned and monitored by the Company’s Asset and Liability Committee (“ALCO”). In general, management’s objective is to optimize net interest income and minimize market risk and interest rate risk by monitoring the components of the statement of condition and the interaction of interest rates.

Short-term interest rate exposure analysis is supplemented with an interest sensitivity gap model. The Company utilizes interest sensitivity analysis to measure the responsiveness of net interest income to changes in interest rate levels. Interest rate risk arises when an earning asset matures or when its interest rate changes in a time period different than that of a supporting interest-bearing liability, or when an interest-bearing liability matures or when its interest rate changes in a time period different than that of an earning asset that it supports. While the Company matches only a small portion of specific assets and liabilities, total earning assets and interest-bearing liabilities are grouped to determine the overall interest rate risk within a number of specific time frames. The difference between interest-sensitive assets and interest-sensitive liabilities is referred to as the interest sensitivity gap. At any given point in time, the Company may be in an asset-sensitive position, whereby its interest-sensitive assets exceed its interest-sensitive liabilities, or in a liability-sensitive position, whereby its interest-sensitive liabilities exceed its interest-sensitive assets, depending in part on management’s judgment as to projected interest rate trends.

The Company’s interest rate sensitivity position in each time frame may be expressed as assets less liabilities, as liabilities less assets, or as the ratio between rate sensitive assets (“RSA”) and rate sensitive liabilities (“RSL”). For example, a short-funded position (liabilities repricing before assets) would be expressed as a net negative position, when period gaps are computed by subtracting repricing liabilities from repricing assets. When using the ratio method, an RSA/RSL ratio of 1 indicates a balanced position, a ratio greater than 1 indicates an asset-sensitive position and a ratio less than 1 indicates a liability-sensitive position.

A negative gap and/or a rate sensitivity ratio less than 1 tends to expand net interest margins in a falling rate environment and reduce net interest margins in a rising rate environment. Conversely, when a positive gap occurs, generally margins expand in a rising rate environment and contract in a falling rate environment. From time to time, the Company may elect to deliberately mismatch liabilities and assets in a strategic gap position.

At September 30, 2022, the Company reflected a positive interest sensitivity gap with an interest sensitivity ratio of 1.20:1.00 at the cumulative one-year position. Based on current rising interest rate environment, that at the current time is estimated to continue through the first half of 2023, emphasis will be on controlling liability costs and duration in our efforts to insulate the net interest spread for a potential future decline in rates.

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The following table sets forth the amounts of our interest-earning assets and interest-bearing liabilities outstanding at September 30, 2022, which we expect, based upon certain assumptions, to reprice or mature in each of the future time periods shown (the “GAP Table”). Except as stated below, the amount of assets and liabilities shown which reprice or mature during a particular period were determined in accordance with the earlier of term to repricing or the contractual maturity of the asset or liability. The GAP Table sets forth approximation of the projected repricing of assets and liabilities at September 30, 2022, on the basis of contractual maturities, anticipated prepayments, and scheduled rate adjustments within a three-month period and subsequent selected time intervals. The loan amounts in the GAP Table reflect principal balances expected to be redeployed and/or repriced as a result of contractual amortization and anticipated prepayments of adjustable-rate loans and fixed-rate loans, and as a result of contractual rate adjustments on adjustable-rate loans.

More than

More than

More than

6 Months

6 Months

1 Year

3 Year

More than

Total

or Less

to 1 Year

to 3 Years

to 5 Years

5 Years

Amount

(In thousands)

Interest-earning assets (1) :

Loans receivable (2)

Investment securities and restricted securities

Other interest-earning assets

Total interest-earning assets

Interest-bearing liabilities:

Demand and NOW accounts

Money market accounts

Savings accounts

Certificate accounts

Borrowings

Total interest-bearing liabilities

Interest-earning assets less interest- bearing liabilities

Cumulative interest-rate sensitivity gap (3)

Cumulative interest-rate gap as a percentage of total assets at September 30, 2022

Cumulative interest-earning assets as a percentage of cumulative interest-bearing liabilities at September 30, 2022

Interest-earning assets are included in the period in which the balances are expected to be redeployed and /or repriced as a result of anticipated prepayments, scheduled rate adjustments and contractual maturities.

For purposes of the gap analysis, loans receivable excludes non-accrual loans gross of the allowance for loan losses, undisbursed loan funds, unamortized discounts and deferred loans fees.

Interest-rate sensitivity gap represents the net cumulative difference between interest-earning assets and interest-bearing liabilities.

Net Portfolio Value and Net Interest Income Analysis. Our interest rate sensitivity is also monitored by management through the use of models which generate estimates of the change in its net portfolio value (“NPV”) and net interest income (“NII”) over a range of interest rate scenarios. NPV is the present value of expected cash flows from assets, liabilities, and off-balance sheet contracts. The NPV ratio, under any interest rate scenario, is defined as the NPV in that scenario divided by the market value of assets in the same scenario.

The table below sets forth as of September 30, 2022 and 2021 the estimated changes in our NPV that would result from designated instantaneous changes in the United States Treasury yield curve. Computations of prospective effects of hypothetical interest rates changes are based on numerous assumptions, including relative levels of market interest rates, loan prepayments and deposit decay, and should not be relied upon as indicative of actual results.

As of September 30, 2022

As of September 30, 2021

Dollar

Percentage

Dollar

Percentage

Changes in Interest Rates

Change from

Change from

Change from

Change from

(basis points) (1)

Amount

Base

Base

Amount

Base

Base

(In thousands)

Assumes an instantaneous uniform change in interest rates. A basis point equals 0.01%.

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In addition to modeling changes in NPV, we also analyze potential changes to NII for a twelve-month period under rising and falling interest rate scenarios. The following table shows our NII model as of September 30, 2022.

Net Interest

Changes in Interest Rates in Basis Points (Rate Shock)

Income

$ Change

% Change

(In thousands)

Static

As is the case with the GAP Table, certain shortcomings are inherent in the methodology used in the above interest rate risk measurements. Modeling changes in NPV and NII require the making of certain assumptions which may or may not reflect the manner in which actual yields and costs respond to changes in market interest rates. In this regard, the models presented assume that the composition of our interest sensitive assets and liabilities existing at the beginning of a period remains constant over the period being measured and also assumes that a particular change in interest rates is reflected uniformly across the yield curve regardless of the duration to maturity or repricing of specific assets and liabilities. Accordingly, although the NPV measurements and net interest income models provide an indication of 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 net interest income and will differ from actual results.

Estimates of Fair Value

The estimation of fair value is significant to a number of the Company’s assets, including loans held for sale, investment securities available-for-sale and interest rate swaps. These are all recorded at either fair value or the lower of cost or fair value. Fair values are volatile and may be influenced by a number of factors. Circumstances that could cause estimates of the fair value of certain assets and liabilities to change include a change in prepayment speeds, discount rates, or market interest rates. Fair values for most available-for-sale investment securities are based on quoted market prices. If quoted market prices are not available, fair values are based on judgments regarding future expected loss experience, current economic condition risk characteristics of various financial instruments, and other factors. These estimates are subjective in nature, involve uncertainties and matters of significant judgment and therefore cannot be determined with precision. Changes in assumptions could significantly affect the estimates.

Liquidity

The liquidity position of the Company is dependent primarily on successful management of the Bank’s assets and liabilities to meet the needs of both deposit and credit customers. Liquidity needs arise principally to accommodate possible deposit outflows and to meet customers’ requests for loans. Scheduled principal loan repayments, maturing investments, short-term liquid assets and deposit inflows, can satisfy such needs. The objective of liquidity management is to enable the Company to maintain sufficient liquidity to meet its obligations in a timely and cost-effective manner.

Management monitors current and projected cash flows and adjusts positions as necessary to maintain adequate levels of liquidity. Under its liquidity risk management program, the Company regularly monitors correspondent bank funding exposure and credit exposure in accordance with guidelines issued by the banking regulatory authorities. Management uses a variety of potential funding sources and staggering maturities to reduce the risk of potential funding pressure. Management also maintains a detailed contingency funding plan designed to respond adequately to situations which could lead to stresses on liquidity. Management believes that the Company has the funding capacity to meet the liquidity needs arising from potential events. The Company maintains borrowing capacity through the Federal Home Loan Bank of Pittsburgh secured with loans and marketable securities.

The Company’s primary sources of short-term liquidity consist of cash and cash equivalents and investment securities available-for-sale.

At September 30, 2022, the Company had $53.3 million in cash and cash equivalents compared to $136.6 million at September 30, 2021. The decrease in cash and cash equivalents year over year was due to decreased deposits to $785.3 million at September 30, 2022 from $938.2 million at September 30, 2021 combined with an increase in investment securities to $110.0 million at September 30, 2022 from $70.8 million at September 30, 2021. In fiscal year 2021,

t he Company decided to build liquidity during the economic downturn, with the cash received from loan paydowns and payoffs throughout the year.

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Deposits

Total deposits decreased to $785.3 million at September 30, 2022, from $938.2 million at September 30, 2021. Total interest-bearing deposits decreased from $884.3 million at September 30, 2021, to $727.3 million at September 30, 2022, a decrease of $157.0 million or 17.8 percent. Time deposits $250,000 and over increased $46.5 million at September 30, 2022, as compared to September 30, 2021, and represented 41.6 percent of total time deposits at September 30, 2022, compared to 14.8 percent at September 30, 2021. We had brokered deposits totaling $9.1 million at September 30, 2022, compared to $6.1 million at September 30, 2021.

The Company continues to place the main focus of its deposit gathering efforts in the maintenance, development, and expansion of its core deposit base.

The following table depicts the Company’s deposits classified by interest rates with percentages to total deposits at September 30, 2022 and 2021:

September 30,

September 30,

Dollar

Amount

Percentage

Amount

Percentage

Change

(In thousands)

Balances by types of deposit:

Savings

Money market accounts

Interest bearing demand

Non-interest bearing demand

Certificates of deposit

Total

At September 30, 2022, our certificates of deposit and other time deposits with a balance of $250,000 or more amounted to $63.0 million, of which $47.7 million are scheduled to mature within twelve months. At September 30, 2022, the weighted average remaining maturity of our certificate of deposit accounts was 7.9 months. The following table presents the maturity of our certificates of deposit and other time deposits with balances of $250,000 or more at September 30, 2022.

Amount

(In thousands)

Maturity Period:

Three months or less

Over three months through six months

Over six months through twelve months

Over twelve months

Total

Borrowings

Borrowings from the FHLB of Pittsburgh are available to supplement the Company’s liquidity position and, to the extent that maturing deposits do not remain with the Company, management may replace such funds with advances. As of September 30, 2022 and 2021, the Company’s outstanding balance of FHLB advances totaled $80.0 million and $90.0 million, respectively. The $80.0 million in advances as of September 30, 2022 represents two short-term FHLB advances of fixed-rate borrowing with rollover of 90 days and three additional short term-borrowings.

During both fiscal year 2022 and 2021, the Company did not purchase any securities sold under agreements to repurchase as a short-term funding source.

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Cash Flows

The Consolidated Statements of Cash Flows present the changes in cash and cash equivalents resulting from the Company’s operating, investing and financing activities. During the fiscal year ended September 30, 2022, cash and cash equivalents decreased by $83.3 million from the balance at September 30, 2021 of $136.6 million. Net cash of $5.9 million was provided by operating activities in fiscal year 2022 compared to net cash of $14.8 million provided by operating activities in fiscal year 2021. Net cash provided by investing activities amounted to $73.6 million in fiscal year 2022 compared to net cash provided by investing activities of $58.0 million in fiscal year 2021. Net cash of $162.9 million was used in financing activities in fiscal year 2022 compared to net cash of $2.4 million provided by financing activities in fiscal year 2021.

In the normal course of operations, the Company engages in a variety of financial transactions that, in accordance with GAAP, are not recorded in its financial statements. These transactions involve, to varying degrees, elements of credit, interest rate, and liquidity risk. Such transactions are used primarily to manage customers’ requests for funding and take the form of loan commitments, lines of credit and letters of credit.

The contractual amounts of commitments to extend credit represent the amounts of potential accounting loss should the contract be fully drawn upon, the customer defaults and the value of any existing collateral becomes worthless. We use the same credit policies in making commitments and conditional obligations as we do for on-balance sheet instruments. Financial instruments whose contract amounts represent credit risk at September 30, 2022 and 2021 were as follows:

September 30,

(In thousands)

Commitments to extend credit: (1)

Future loan commitments

Undisbursed construction loans

Undisbursed home equity lines of credit

Undisbursed commercial lines of credit

Overdraft protection lines

Standby letters of credit

Total commitments

Commitments to extend credit are agreements to lend to a customer as long as there is no violation of any condition established in the contract. Commitments may require payment of a fee and generally have fixed expiration dates or other termination clauses.

We anticipate that we will continue to have sufficient funds and alternative funding sources to meet our current commitments.

Shareholders ’ Equity

Total shareholders’ equity amounted to $146.4 million, or 14.0 percent of total assets at September 30, 2022, compared to $142.2 million, or 11.8 percent of total assets at September 30, 2021. Book value per common share was $19.18 at September 30, 2022, compared to $18.65 at September 30, 2021.

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Capital

The Bank’s capital ratios as of September 30, 2022 and September 30, 2021, are as follows:

To Be Well

Capitalized

Under Prompt

Excess Over

Required for Capital

Corrective

Well-Capitalized

Actual

Adequacy Purposes

Action Provisions

Provision

Amount

Ratio

Amount

Ratio

Amount

Ratio

Amount

Ratio

As of September 30, 2022:

(Dollars in thousands)

Tier 1 leverage (core) capital (to adjusted tangible assets)

Common equity Tier 1 (to risk-weighted assets)

Tier 1 risk-based capital (to risk-weighted assets)

Total risk-based capital (to risk-weighted assets)

As of September 30, 2021:

Tier 1 leverage (core) capital (to adjusted tangible assets)

Common equity Tier 1 (to risk-weighted assets)

Tier 1 risk-based capital (to risk-weighted assets)

Total risk-based capital (to risk-weighted assets)

Looking Forward

One of the Company’s primary objectives is the improvement of asset quality and capital preservation. Additional objectives are balancing asset and revenue growth, while at the same time expanding market presence and diversifying the Company’s financial products. However, it is recognized that objectives, no matter how focused, are subject to factors beyond the control of the Company, which can impede its ability to achieve these goals. The following factors should be considered when evaluating the Company’s ability to achieve its objectives:

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The financial market place is rapidly changing. Banks are no longer the only place to obtain loans, nor the only place to keep financial assets. The banking industry has lost market share to other financial service providers. The future is predicated on the Company’s ability to adapt its products, provide superior customer service and compete in an ever-changing marketplace. Net interest income, the primary source of earnings, is impacted favorably or unfavorably by changes in interest rates. Although the impact of interest rate fluctuations is mitigated by ALCO strategies, significant changes in interest rates can have a material adverse impact on profitability.

The ability of customers to repay their obligations is often impacted by changes in the regional and local economy. Although the Company sets aside loan loss provisions toward the allowance for loan losses when management determines such action to be appropriate, significant unfavorable changes in the economy could impact the assumptions used in the determination of the adequacy of the allowance.

Technological changes will have a material impact on how financial service companies compete for and deliver services and products. It is recognized that these changes will have a direct impact on how the marketplace is approached and ultimately on profitability. The Company has taken steps to improve its traditional delivery channels. However, continued success will likely be measured by the Company’s ability to anticipate and react to future technological changes.

This ‘‘Looking Forward’’ discussion constitutes a forward-looking statement under the Private Securities Litigation Reform Act of 1995. Actual results could differ materially from those projected in the Company’s forward-looking statements due to numerous known and unknown risks and uncertainties, including the factors referred to above, on the first page of this Report and in other sections of this Report.