Item 2. Management’s Discussion and Analysis
Item 2. Management’s Discussion and Analysis of Financial Condition and Results of Operations
General
Management’s discussion and analysis is intended to enhance your understanding of our financial condition and results of operations. The financial information in this section is derived from the accompanying consolidated financial statements. You should read the financial information in this section in conjunction with the business and financial information contained in this report and in the Company’s definitive prospectus dated May 10, 2024, as filed with the Securities and Exchange Commission on May 20, 2024.
Cautionary Note Regarding Forward-Looking Statements
This report contains forward-looking statements, which can be identified by the use of words such as “estimate,” “project,” “believe,” “intend,” “anticipate,” “assume,” “plan,” “seek,” “expect,” “will,” “may,” “should,” “indicate,” “would,” “believe,” “contemplate,” “continue,” “target” and words of similar meaning. These forward-looking statements include, but are not limited to:
● statements of our goals, intentions and expectations;
● statements regarding our business plans, prospects, growth and operating strategies;
● statements regarding the asset quality of our loan and investment portfolios; and
● estimates of our risks and future costs and benefits.
These forward-looking statements are based on our current beliefs and expectations and are inherently subject to significant business, economic and competitive uncertainties and contingencies, many of which are beyond our control. In addition, these forward-looking statements are subject to assumptions with respect to future business strategies and decisions that are subject to change. We are under no duty to and do not take any obligation to update any forward-looking statements after the date of this prospectus.
The following factors, among others, could cause actual results to differ materially from the anticipated results or other expectations expressed in the forward-looking statements:
● general economic conditions, either nationally or in our market area, which are worse than expected;
● inflation and changes in the interest rate environment that reduce our margins and yields, the fair value of our financial instruments, or our loan origination volume, or increase the level of defaults, losses and prepayments within our loan portfolio;
● changes in the level and direction of loan delinquencies and write-offs and changes in estimates of the adequacy of the allowance for credit losses;
● our ability to access cost-effective funding;
● our ability to maintain adequate liquidity, primarily through deposits;
● fluctuations in real estate values and in the conditions of the residential real estate market;
● demand for loans and deposits in our market area;
● our ability to implement and change our business strategies;
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● competition among depository and other financial institutions;
● adverse changes in the securities markets;
● changes in laws or government regulations or policies affecting financial institutions, including changes in regulatory fees, capital requirements and insurance premiums;
● changes in the quality or composition of our loan or investment portfolios;
● technological changes that may be more difficult or expensive than expected;
● the inability of third-party providers to perform as expected;
● a failure or breach of our operational or information security systems or infrastructure, including cyberattacks;
● our ability to manage market risk, credit risk, operational risk and reputation risk;
● our ability to enter new markets successfully and capitalize on growth opportunities;
● changes in consumer spending, borrowing and savings habits;
● changes in accounting policies and practices, as may be adopted by bank regulatory agencies, the Financial Accounting Standards Board, the Securities and Exchange Commission or the Public Company Accounting Oversight Board;
● our ability to retain key employees; and
● changes in the financial condition, results of operations or future prospects of issuers of securities that we own.
Because of these and a wide variety of other uncertainties, our actual future results may be materially different from the results indicated by these forward-looking statements. Except as required by applicable law or regulation, the Company assumes no obligation and disclaims any obligation to update any forward-looking statements.
Critical Accounting Policies and Use of Critical Accounting Estimates
The discussion and analysis of the financial condition and results of operations are based on our financial statements, which are prepared in conformity with GAAP. The preparation of these financial statements requires management to make estimates and assumptions affecting the reported amounts of assets and liabilities, disclosure of contingent assets and liabilities, and the reported amounts of income and expenses. We consider the accounting policy discussed below to be our critical accounting policy. The estimates and assumptions that we use are based on historical experience and various other factors and are believed to be reasonable under the circumstances. Actual results may differ from these estimates under different assumptions or conditions, resulting in a change that could have a material impact on the carrying value of our assets and liabilities and our results of operations.
The Jumpstart Our Business Startups Act of 2012 (JOBS Act) contains provisions that, among other things, reduce certain reporting requirements for qualifying public companies. As an “emerging growth company” we may delay adoption of new or revised accounting pronouncements applicable to public companies until such pronouncements are made applicable to private companies. We intend to take advantage of the benefits of this extended transition period. Accordingly, our financial statements may not be comparable to companies that comply with such new or revised accounting standards.
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We consider the accounting policy for the allowance for credit losses to be our critical accounting policy. Effective January 1, 2023, we adopted the Current Expected Credit Loss (CECL) methodology. Under the CECL methodology, the allowance for credit losses represents management’s estimate of lifetime credit losses in loans as of the balance sheet date using relevant available information, from both internal and external sources, relating to past events, current conditions, and reasonable and supportable forecasts. For reporting periods before January 1, 2023 and the adoption of CECL, we used the incurred loss impairment method to estimate the allowance for loan losses on loans receivable. Under the incurred loss impairment methodology, the allowance for loan losses was based upon management’s periodic review of the collectability of the loans in light of historical experience, the nature and volume of the loan portfolio, and other factors, and consisted of allocated and unallocated components.
Internal Control Over Financial Reporting
We have identified material weaknesses in our internal control over financial reporting with respect to our allowance for credit losses that existed as of September 30, 2024 and December 31, 2023. A material weakness is a deficiency, or combination of deficiencies, in internal control over financial reporting, such that there is a reasonable possibility that a material misstatement of our annual or interim financial statements may not be prevented or detected on a timely basis. We concluded that our procedures were not effective as of December 31, 2023 and un-remediated as of September 30, 2024. Specifically, we identified, the following material weaknesses in our internal control over our financial reporting:
● management did not maintain sufficient evidence of independent review or supporting documentation related to key methodologies, assumptions, and calculations, including support for the qualitative factors, utilized in the allowance for credit losses as of September 30, 2024 and December 31, 2023; and
● management did not maintain sufficient evidence of independent review or supporting documentation, including support for the qualitative factors, related to the January 1, 2023 adoption of Accounting Standard Update (ASU) 2016-13 Financial Instruments – Credit Losses.
These material weaknesses could result in misstatements of our allowance for credit losses and related disclosures that would result in a material misstatement of our financial statements that would not be prevented or detected.
We intend to remediate these material weaknesses. We currently are assessing and improving our processes and control procedures to ensure they will operate at an acceptable level of assurance. The remedial measures we will take to address these material weaknesses include calculating an allowance for credit losses on unfunded commitments; revising the peer group of institutions to include institutions whose loan portfolios better reflect the composition of our loan portfolio; obtaining updated independent appraisals for loans being evaluated for impairment; enhancing qualitative factors support to include data points tied to a specified timeframe, such as, for example, the unemployment rate, to consistently allocate basis point reserves for each reporting period; using qualitative factors to adjust the allowance for credit losses for economic conditions that impact us and documenting the adjustments in a narrative accompanying the allowance calculation; and assigning an independent individual to review the allowance calculation to assure its accuracy and completeness.
We believe these actions and any other that we may determine need to be implemented, when complete, will remediate the control weaknesses. However, the weaknesses will not be considered fully remediated until the applicable controls operate for a sufficient period of time for management to test the results for operating effectiveness. Once implemented, we intend to continue periodic testing and reporting of the internal controls to ensure continuity of compliance.
The decrease in the allowance for credit losses as of September 30, 2024 as compared to December 31, 2023 was driven by various factors, including the evolving economic outlook, values in the local real estate market, low net charge-offs, and refining our peer group selection to better align with peers whose loan portfolios reflect the composition of our own loan portfolio and the current local economic conditions. Adjusting this component of our estimate has
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resulted in a reduced peer group loss rate and corresponding adjustments to our peer comparisons. In turn our CECL reserve percentage was decreased resulting in a $1.1 million reversal in our allowance for credit loss.
Comparison of Financial Condition at September 30, 2024 and December 31, 2023
Total Assets. Total assets were $523.8 million at September 30, 2024, an increase of $43.0 million, or 9.0%, compared to $480.8 million at December 31, 2023. This increase is primarily due to $14.8 million increase in cash and cash equivalents, $25.9 million increase in investment securities available-for-sale, and $2.7 million increase in loans receivable, net.
Cash and Cash Equivalents. Cash and cash equivalents increased by $14.8 million, or 76.6%, to $34.1 million at September 30, 2024 from $19.3 million at December 31, 2023. This increase resulted primarily from the cash received for subscriptions to purchase shares of the Company’s common stock in its initial public offering. The net proceeds of the public offering are reflected in Stockholders’ equity at September 30, 2024.
Investment Securities Available-for-Sale. Investment securities available-for-sale increased $25.9 million, or 38.1%, to $93.8 million at September 30, 2024 from $67.9 million at December 31, 2023. Securities purchased totaled $48.2 million during the nine months ended September 30, 2024, securities sold totaled $18.7 million, and calls, maturities, and repayments totaled $5.3 million.
Loans Receivable, Net. Loans receivable, net, increased by $2.7 million, or 0.7%, to $367.7 million at September 30, 2024 from $365.0 million at December 31, 2023. During the nine months ended September 30, 2024, loan originations were $26.9 million and loan repayments totaled $24.2 million. During the nine months ended September 30, 2024, commercial and industrial loans increased by $3.7 million, primarily from the purchase of the guaranteed portion of government loans, and Bankers Healthcare loans. 1-4 single family mortgages decreased by $2.8 million, home equity loans decreased by $629,000, construction loans increased by $1.5 million, and we reversed $1.1 million from our allowance for credit losses.
Deposits. Deposits decreased by $5.9 million, or 1.5%, to $384.1 million at September 30, 2024, from $390.0 million at December 31, 2023. Certificates of deposit increased $3.6 million, or 1.59%, to $231.8 million at September 30, 2024, from $228.1 million at December 31, 2023. The majority of the increase in certificates of deposit was driven by new customer activity and migration from lower yielding money markets accounts. NOW accounts increased $2.0 million, or 3.9%, to $52.8 million at September 30, 2024, from $50.8 million at December 31, 2023. MMDA accounts decreased $4.4 million, or 16.8%, to $22.0 million at September 30, 2024, from $26.4 million at December 31, 2023. Savings Accounts decrease $7.1 million, or 8.37%, to $77.5 million at September 30, 2024, from $84.6 million at December 31, 2023.
Total Stockholders’ Equity. Total stockholders’ equity increased by $50.1 million, or 64.4%, to $127.9 million at September 30, 2024, from $77.8 million at December 31, 2023. The increase resulted from the sale of stock in the initial public offering that totaled $53.2 million, offset by the unearned ESOP of $4.3 million, the accumulated other comprehensive loss (as a result of market value adjustment of investment securities available-for-sale due to the rise in market interest rates during the period) declining $2.5 million and retained earnings decreasing $1.2 million due to the net loss for the period ended September 30, 2024.
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Average Balances and Yields . The following table sets forth average balance sheets, average yields and rates, and other information for the periods indicated. No tax-equivalent yield adjustments have been made, as the effects are immaterial. Average balances are calculated using daily average balances. Non-accrual loans are included in average balances only. Average yields include the effect of deferred fees, discounts, and premiums that are amortized or accreted to interest income or interest expense. Net deferred loan fees/costs are immaterial.
For the Three Months Ended September 30,
2024
2023
Average
Average
Outstanding
Average
Outstanding
Average
Balance
Interest
Yield/Rate (4)
Balance
Interest
Yield/Rate (4)
Interest-earning assets:
Cash and cash equivalents
$
40,493
$
548
5.37
%
$
9,515
$
115
4.80
%
Investment securities available-for-sale
82,639
772
3.71
69,232
419
2.40
Loans receivable, net
368,805
3,863
4.16
361,902
3,611
3.96
Restricted stock
896
10
4.43
855
10
4.64
Total interest-earning assets
492,833
5,193
4.18
441,504
4,155
3.73
Noninterest-earning assets
32,408
31,942
Total assets
$
525,241
$
473,446
Interest-bearing liabilities:
Savings accounts
$
79,804
20
0.10
%
$
93,070
23
0.10
%
NOW accounts
66,363
3
0.02
51,511
3
0.02
Money market accounts
22,193
28
0.50
31,682
42
0.53
Certificates of deposit
235,163
2,259
3.81
208,568
1,691
3.22
Total interest-bearing deposits
403,523
2,310
2.27
384,831
1,759
1.81
Federal Home Loan Bank advances
—
—
—
3,348
43
5.10
Total interest-bearing liabilities
403,523
2,310
2.27
388,179
1,802
1.84
Noninterest-bearing demand deposits
1,185
898
Other noninterest-bearing liabilities
10,542
9,263
Total liabilities
415,250
398,340
Total stockholders' equity
109,991
75,106
Total liabilities and stockholders' equity
525,241
473,446
Net interest income
$
2,883
$
2,353
Net interest rate spread (1)
1.91
%
1.89
%
Net interest-earning assets (2)
$
89,310
$
53,325
Net interest margin (3)
2.32
%
2.11
%
Average interest-earning assets to interest-bearing liabilities
122.13
%
113.74
%
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For the Nine Months Ended September 30,
2024
2023
Average
Average
Outstanding
Average
Outstanding
Average
Balance
Interest
Yield/Rate (4)
Balance
Interest
Yield/Rate (4)
Interest-earning assets:
Cash and cash equivalents
$
27,197
$
1,061
5.20
%
$
12,901
$
441
4.55
%
Investment securities available-for-sale
71,213
1,675
3.13
72,983
1,273
2.32
Loans receivable, net
366,991
11,375
4.13
357,360
10,444
3.89
Restricted stock
889
24
3.60
846
20
3.15
Total interest-earning assets
466,290
14,135
4.04
444,090
12,178
3.65
Noninterest-earning assets
32,572
30,802
Total assets
$
498,862
$
474,892
Interest-bearing liabilities:
Savings accounts
$
81,915
61
0.10
%
$
97,525
73
0.10
%
NOW accounts
47,957
9
0.02
53,940
10
0.02
Money market accounts
23,870
91
0.51
35,648
143
0.53
Certificates of deposit
236,268
6,763
3.81
201,327
4,100
2.71
Total interest-bearing deposits
390,010
6,924
2.36
388,440
4,326
1.48
Federal Home Loan Bank advances
113
4
4.72
1,128
43
5.08
Total interest-bearing liabilities
390,123
6,928
2.37
389,568
4,369
1.49
Noninterest-bearing demand deposits
1,116
1,383
Other noninterest-bearing liabilities
9,598
8,071
Total liabilities
400,837
399,022
Total stockholders' equity
98,025
75,870
Total liabilities and stockholders' equity
498,862
474,892
Net interest income
$
7,207
$
7,809
Net interest rate spread (1)
1.67
%
2.16
%
Net interest-earning assets (2)
$
76,167
$
54,522
Net interest margin (3)
2.06
%
2.34
%
Average interest-earning assets to interest-bearing liabilities
119.52
%
114.00
%
(1) Net interest rate spread represents the difference between the weighted average yield on interest-earning assets and the weighted average rate of interest-bearing liabilities.
(2) Net interest-earning assets represent total interest-earning assets less total interest-bearing liabilities.
(3) Net interest margin represents net interest income divided by average total interest-earning assets.
(4) Average yield/rate is an annualized amount.
Comparison of Operating Results for the Three Months Ended September 30, 2024 and 2023
General . Net income (loss) for the three months ended September 30, 2024, was ($788,000), a decrease of $827,000, or 2,120.5%, compared to $39,000 for the three months ended September 30, 2023. The net loss was primarily from an increase in non-interest expense of $1.6 million resulting from a $1.3 million charitable contribution to establish the Fifth District Community Foundation, a $508,000 increase in interest expense, partially offset by a $1.0 million increase in interest income, and a $220,000 decrease in provision for income taxes.
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Interest and Dividend Income. Interest and dividend income increased by $1.0 million, or 25.0%, to $5.2 million for the three months ended September 30, 2024, compared to $4.2 million for the three months ended September 30, 2023. The increase is attributed to a $252,000, or 7.0%, increase in interest on loans, a $433,000, or 346.4%, increase in interest on other interest-earning assets and $353,000, or 84.3%, increase in interest on investment securities available-for-sale.
During the three months ended September 30, 2024, average loans receivable, net, increased by $6.9 million, or 1.9%, from the three months ended September 30, 2023. The average yield on loans increased to 4.16% for the three months ended September 30, 2024, from 3.96% for the three months ended September 30, 2023, due to the rising market rate environment.
The average balance of investment securities available-for-sale increased $13.4 million, or 19.4%, to $82.6 million for the three months ended September 30, 2024, from $69.2 million for the three months ended September 30, 2023. The average yield on available-for-sale investment securities increased to 3.71% for the three months ended September 30, 2024, from 2.40% for the three months ended September 30, 2023. The increase in the average yield on available-for-sale investment securities was primarily due to the rising market interest rate environment.
Interest income on cash and cash equivalents, comprised primarily of overnight deposits, increased by $433,000, or 376.5%, for the three months ended September 30, 2024, due to an increase in the average yield to 5.37% for the three months ended September 30, 2024, from 4.80% for the three months ended September 30, 2023. The increase in interest income was mainly due to the increase in the balance of cash and cash equivalents arising from the cash received for the purchase of stock in the IPO. The increase in average yield was due to the rise in market interest rates.
Interest Expense . Total interest expense increased $508,000 or 28.2%, to $2.3 million for the three months ended September 30, 2024, from $1.8 million for the three months ended September 30, 2023. The increase was primarily due to the increase in the average cost of deposits to 2.27% for the three months ended September 30, 2024, from 1.81% for the three months ended September 30, 2023, reflecting the rising market interest rate environment. The average balance of interest-bearing deposits increased by $18.7 million, or 4.9%, to $403.5 million for the three months ended September 30, 2024, from $384.8 million for the three months ended September 30, 2023.
Net Interest Income . Net interest income increased $530,000, or 22.5%, to $2.9 million for the three months ended September 30, 2024, compared to $2.4 million for the three months ended September 30, 2023. The increase reflects the increase in the interest rate spread to 1.91% for the three months ended September 30, 2024, from 1.89% for the three months ended September 30, 2023, while average net interest-earning assets increased $36.0 million period-to-period. The net interest margin increased to 2.32% for the three months ended September 30, 2024, from 2.11% for the three months ended September 30, 2023. The average yield on interest-earning assets increased from 3.73% for the three months ended September 30, 2023, to 4.18% for the three months ended September 30, 2024. The average rate paid on interest-bearing liabilities increased from 1.84% for the three months ended September 30, 2023, to 2.27% for the three months ended September 30, 2024, primarily due to an increase in the average rate paid on certificates of deposit from 3.22% in 2023 to 3.81% in 2024. The increase in the average rate paid on certificates of deposit contributed to migration from lower yielding savings accounts and money market accounts, to higher yielding certificates of deposit. The average balance of certificates of deposit increased from $208.6 million as of September 30, 2023, to $235.2 million as September 30, 2024, while over the same period the average balance of savings accounts decreased from $93.1 million to $79.8 million, and the average balance of money market accounts decreased from $31.7 million to $22.2 million.
Provision (Recovery) for Credit Losses . The recovery of credit losses on loans decreased $100,000 to $0 for the three months ended September 30, 2024, compared to $100,000 for the three months ended September 30, 2023. The allowance for credit losses on loans represented 0.46% of total loans at September 30, 2024, and 0.76% of total loans at September 30, 2023. The recovery of credit losses is based on our evaluation of the adequacy of the allowance for credit losses throughout the reporting period.
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The recovery of credit losses on unfunded commitments increased $110,000 for the three months ended September 30, 2024 compared to no recovery for the three months ended September 30, 2023. The recovery of credit losses on unfunded commitments is based on an evaluation of the historical usage rate.
Total non-performing loans were $647,000 at September 30, 2024, compared to $0 at September 30, 2023. We did not have any loans over 90 days delinquent at September 30, 2023 compared to $647,000 at September 30, 2024. Classified loans totaled $647,000 at September 30, 2024, compared to $106,000 at September 30, 2023. As a percentage of nonperforming loans, the allowance for credit losses on loans was 262.6% at September 30, 2024, and there were no non-performing loans at September 30, 2023.
Noninterest Income . Noninterest income totaled $252,000 for the three months ended September 30, 2024, an increase of $3,000, or 1.2%, from $249,000 for the three months ended September 30, 2023.
Noninterest Expense . Noninterest expense increased $1.6 million, or 59.9%, to $4.2 million for the three months ended September 30, 2024, compared to $2.7 million for the three months ended September 30, 2023. The increase was primarily due to an increase in salaries and employee benefits of $243,000, or 15.9%, an increase in occupancy and equipment expense of $28,000, or 6.5%, an increase in professional and legal fees of $16,000, or 41.0%, an increase in data processing expense of $9,000, or 3.3%, an increase in audit and examination fees of $68,000, or 194.3%, and an increase in charitable contributions of $1.3 million, or 9,615.4% from establishing the Fifth District Community Foundation, partially offset by a $5,000, or 8.8%, decrease in FDIC insurance expense, an $18,000, or 19.8% decrease in directors fees, and a $25,000, or 45.5% decrease in advertising.
Provision (Benefit) for Income Taxes . The provision (benefit) for income taxes decreased by $220,000, or 2,200.0%, to ($210,000) for the three months ended September 30, 2024, compared to $10,000 for the three months ended September 30, 2023. The decrease was due to a $1.0 million, or 2,136.7%, decrease in pretax income. The effective tax rate was 21% for both periods.
Comparison of Operating Results for the Nine Months Ended September 30, 2024 and 2023
General . Net income (loss) for the nine months ended September 30, 2024, was ($1.2) million, a decrease of $1.9 million, or 299.8%, compared to $619,000 for the nine months ended September 30, 2023. The net loss was primarily from an increase in non-interest expense of $1.9 million resulting from a $1.3 million charitable contribution to establish the Fifth District Community Foundation, an increase in interest expense of $2.6 million, a decrease in non-interest income of $956,000, partially offset by an increase in interest income of $2.0 million, and a $493,000 decrease in provision for income taxes.
Interest and Dividend Income. Interest and dividend income increased by $2.0 million, or 16.1%, to $14.1 million for the nine months ended September 30, 2024, compared to $12.2 million for the nine months ended September 30, 2023. The increase in interest income is attributed to a $931,000, or 8.9%, increase in interest on loans, a $624,000, or 135.4%, increase in interest on other interest-earning assets and $402,000, or 31.6%, increase in interest on investment securities available-for-sale.
During the nine months ended September 30, 2024, average loans receivable, net, increased by $9.6 million, or 2.7%, from the nine months ended September 30, 2023. The average yield on loans increased to 4.13% for the nine months ended September 30, 2024, from 3.89% for the nine months ended September 30, 2023, due to the rising market interest rate environment.
The average balance of investment securities available-for-sale decreased $1.8 million, or 2.4%, to $71.2 million for the nine months ended September 30, 2024, from $73.0 million for the nine months ended September 30, 2023. The average yield on available-for-sale investment securities increased to 3.13% for the nine months ended September 30, 2024, from 2.32% for the nine months ended September 30, 2023. The increase in the average yield on
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available-for-sale investment securities was primarily due to the rising market interest rate environment as well as selling low yielding bonds to reinvest in higher yielding bonds.
Interest income on cash and cash equivalents, comprised primarily of certificate of deposit in other financial institutions and overnight deposits, increased by $620,000, or 140.8%, for the nine months ended September 30, 2024, due to an increase in the average yield to 5.20% for the nine months ended September 30, 2024, from 4.55% for the nine months ended September 30, 2023. The increase in average yield was due to the rise in market interest rates.
Interest Expense . Total interest expense increased $2.6 million, or 58.6%, to $6.9 million for the nine months ended September 30, 2024, from $4.4 million for the nine months ended September 30, 2023. The increase was primarily due to the increase in the average cost of deposits to 2.36% for the nine months ended September 30, 2024, from 1.48% for the nine months ended September 30, 2023, reflecting the rising market interest rate environment. The average balance of interest-bearing deposits increased by $1.6 million, or 0.4%, to $390.0 million for the nine months ended September 30, 2024, from $388.4 million for the nine months ended September 30, 2023.
Net Interest Income . Net interest income decreased $602,000, or 7.7%, to $7.2 million for the nine months ended September 30, 2024, compared to $7.8 million for the nine months ended September 30, 2023. The decrease reflects the decrease in the interest rate spread to 1.67% for the nine months ended September 30, 2024, from 2.16% for the nine months ended September 30, 2023, while average net interest-earning assets increased $21.6 million period-to-period. The net interest margin decreased to 2.06% for the nine months ended September 30, 2024, from 2.34% for the nine months ended September 30, 2023. Both the interest rate spread and net interest margin decreased due to the rising interest rate environment. The average yield on interest-earning assets increased from 3.65% for the nine months ended September 30, 2023, to 4.04% for the nine months ended September 30, 2024. The average rate paid on interest-bearing liabilities increased from 1.49% for the nine months ended September 30, 2023, to 2.37% for the nine months ended September 30, 2024, primarily due to an increase in the average rate paid on certificates of deposit from 2.71% in 2023 to 3.81% in 2024. The increase in the average rate paid on certificates of deposit contributed to migration from lower yielding savings accounts, NOW accounts and money market accounts, to higher yielding certificates of deposit. The average balance of certificates of deposit increased from $201.3 million as of September 30, 2023, to $236.3 million as of September 30, 2024, while over the same period the average balance of savings accounts decreased from $97.5 million to $81.9 million, the average balance of NOW accounts decreased from $53.9 million to $48.0 million and the average balance of money market accounts decreased from $35.6 million to $23.9 million.
Provision (Recovery) for Credit Losses . The recovery of credit losses on loans increased $1.0 million to $1.1 million for the nine months ended September 30, 2024, compared to $100,000 for the nine months ended September 30, 2023. The recovery was primarily due to changes in the peer group for the CECL calculation. The allowance for credit losses on loans represented 0.46% of total loans at September 30, 2024, and 0.86% of total loans at September 30, 2023. The recovery of credit losses is based on our evaluation of the adequacy of the allowance for credit losses throughout the reporting period.
The recovery of credit losses on unfunded commitments increased $110,000 for the three months ended September 30, 2024 compared to no recovery for the three months ended September 30, 2023. The recovery of credit losses on unfunded commitments is based on an evaluation of the historical usage rate.
Total non-performing loans were $647,000 at September 30, 2024, compared to $0 at September 30, 2023. We did not have any loans over 90 days delinquent at September 30, 2023 compared to $647,000 at September 30, 2024. Classified loans totaled $647,000 at September 30, 2024, compared to $106,000 at September 30, 2023. As a percentage of nonperforming loans, the allowance for credit losses on loans was 262.6% at September 30, 2024, and there were no non-performing loans at September 30, 2023.
Noninterest Income (Loss) . Noninterest income (loss) totaled ($231,000) for the nine months ended September 30, 2024, a decrease of $956,000, or 131.9%, from $725,000 for the nine months ended September 30, 2023. The decrease was primarily due to the $1.1 million realized loss on the sale of investment securities available-for-sale and a $10,000, or 3.3%, decrease in ATM and check card fees, offset by a $34,000, or 14.4%, increase in the cash surrender value of the
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bank owned life insurance, a $13,000, or 8.6%, increase in deposit service charges and fees, and a $141,000 gain on sale of property.
Noninterest Expense . Noninterest expense increased $1.9 million, or 24.2%, to $9.8 million for the nine months ended September 30, 2024, compared to $7.9 million for the nine months ended September 30, 2023. The increase was primarily due to an increase in salaries and employee benefits of $382,000, or 8.4%, an increase in occupancy and equipment expense of $109,000, or 8.8%, an increase in FDIC insurance of $36,000, or 30.8%, an increase in data processing expense of $93,000, or 11.7%, an increase in audit and examination fees of $118,000, or 105.4%, an increase in other fees of $45,000 or 11.6%, and an increase in charitable contributions of $1.3 million, or 3,289.5% from establishing the Fifth District Community Foundation, offset by a $90,000, or 45.7%, decrease in advertising expense, and a $56,000, or 20.4% decrease in directors fees.
Provision (Benefit) for Income Taxes . The provision (benefit) for income taxes decreased by $493,000, or 300.6%, to ($329,000) for the nine months ended September 30, 2024, compared to $164,000 for the nine months ended September 30, 2023. The decrease was due to a $2.3 million, or 300.0%, decrease in pretax income. The effective tax rate was 21% for both periods.
Liquidity and Capital Resources
Liquidity describes our ability to meet the financial obligations that arise in the ordinary course of business. Liquidity is primarily needed to meet the borrowing and deposit withdrawal requirements of our customers and to fund current and planned expenditures. Our primary sources of funds are deposits, principal and interest payments on loans and securities, and proceeds from maturities of securities. We also have the ability to borrow from the Federal Home Loan Bank of Dallas and from two correspondent banks and, until March 11, 2024, had the ability to obtain advances under the Federal Reserve Board’s Bank Term Funding Program. Under the terms of the Bank Term Funding Program, advances cannot be obtained after March 11, 2024. At September 30, 2024, we had no outstanding advances from the Federal Home Loan Bank of Dallas. At September 30, 2024, we had no outstanding balances under the correspondent bank credit facilities and no outstanding balance under the Bank Term Funding Program.
Time deposits that meet or exceed the Federal Deposit Insurance Corporation (FDIC) insurance limit of $250,000 at September 30, 2024 and December 31, 2023 were $45.2 million and $42.2 million, respectively.
Based on collateral pledged, consisting of all shares of FHLB stock owned and the blanket pledge of approximately $237.0 million of its qualifying mortgage loans as of September 30, 2024, the Company was eligible to borrow up to an additional $180.5 million as of September 30, 2024.
The Company has an unsecured federal funds line of credit with FNBB that expires on September 30, 2025. The Company is eligible to borrow up to $27.2 million. There was no amount outstanding on this line of credit as of September 30, 2024 and December 31, 2023.
The Company is eligible to borrow from TIB’s Federal Funds Purchase Line Program, which provides overnight liquidity through pledge of certain qualifying securities. The Bank is eligible to borrow up to $15.0 million and repayment is due the next day. There was no amount outstanding on this line of credit as of September 30, 2024 and December 31, 2023.
While maturities and scheduled amortization of loans and securities are predictable sources of funds, deposit flows and loan prepayments are greatly influenced by general interest rates, economic conditions, and competition. Our most liquid assets are cash and short-term investments. The levels of these assets depend on our operating, financing, lending, and investing activities during any given period.
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Our cash flows are comprised of three primary classifications: cash flows from operating activities, cash flows from investing activities, and cash flows from financing activities. See the accompanying Statements of Cash Flows for further information.
Fifth District Bancorp, Inc. is a separate legal entity from Fifth District Savings Bank and must provide for its own liquidity to pay its operating expenses and other financial obligations. Its primary source of income is dividends received from the Bank. The amount of dividends that the Bank may declare and pay to the Company is governed by applicable bank regulations. At September 30, 2024, the Company (on an unconsolidated basis) had liquid assets of $21.4 million.
We believe we maintain a strong liquidity position, and are committed to maintaining it. We monitor our liquidity position on a daily basis. We anticipate that we will have sufficient funds to meet our current funding commitments. Based on our deposit retention experience and current pricing strategy, we anticipate that a significant portion of maturing time deposits will be retained.
At September 30, 2024, the Bank was categorized as well-capitalized under applicable bank regulatory capital guidelines. Management is not aware of any conditions or events since the most recent notification that would change its category.
Off-Balance Sheet Arrangements
At September 30, 2024, we had $23.6 million of outstanding commitments to originate loans, which primarily consists of $8.4 million of remaining funds to be disbursed on construction loans in process and $13.4 million of unused balances of home equity lines of credit. At September 30, 2024, certificates of deposit that are scheduled to mature on or before September 30, 2025 totaled $215.2 million. Management expects that a substantial portion of the maturing certificates of deposit will be renewed. However, if a substantial portion of these deposits is not retained, we may raise interest rates on deposits to attract new accounts or utilize Federal Home Loan Bank of Dallas advances, which may result in higher levels of interest expense.
Management of Market Risk
General . Our most significant form of market risk is interest rate risk because, as a financial institution, the majority of our assets and liabilities are sensitive to changes in interest rates. Therefore, a principal part of our operations is to manage interest rate risk and limit the exposure of our financial condition and results of operations to changes in market interest rates. All directors participate in discussions during the regular board meetings evaluating the interest rate risk inherent in our assets and liabilities, and the level of risk that is appropriate. These discussions take into consideration our business strategy, operating environment, capital, liquidity and performance objectives consistent with the policy and guidelines approved by them. The board of directors establishes policies and guidelines for managing interest rate risk.
Our asset/liability management strategy attempts to manage the impact of changes in interest rates on net interest income, our primary source of earnings. Among the techniques we are using to manage interest rate risk are:
● maintaining capital levels that substantially exceed the thresholds for well-capitalized status under federal regulations;
● maintaining a high liquidity level;
● growing our core deposit accounts; and
● managing our investment securities portfolio to reduce the average maturity and effective life of the portfolio.
By following these strategies, we believe that we are better positioned to react to increases and decreases in market interest rates.
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We have not engaged in hedging activities, such as investing in futures or options. We do not anticipate entering into hedging transactions in the future.
Economic Value of Equity . We compute amounts by which the net present value of our assets and liabilities (economic value of equity or “EVE”) would change in the event of a range of assumed changes in market interest rates. This model uses a discounted cash flow analysis and an option-based pricing approach to measure the interest rate sensitivity of net portfolio value. The model estimates the economic value of each type of asset, liability and off-balance sheet contract under the assumptions that the United States Treasury yield curve increases instantaneously by 100, 200, 300 and 400 basis point increments or decreases instantaneously by 100, 200, 300 and 400 basis point increments, with changes in interest rates representing immediate and permanent, parallel shifts in the yield curve.
The following table sets forth, as of September 30, 2024, the calculation of the estimated changes in our EVE that would result from the designated immediate changes in the United States Treasury yield curve. All estimated changes presented in the table are within the policy limits established by the board of directors.
At September 30, 2024
EVE as a Percentage of Present Value
of Assets (3)
Estimated Increase (Decrease) in
Increase
EVE
(Decrease)
Change in Interest Rates (basis points) (1)
Estimated EVE (2)
Amount
Percent
EVE Ratio (4)
(basis points)
(Dollars in thousands)
400
$
52,713
$
(56,237)
(51.62)
%
13.56
%
(960)
300
$
63,445
$
(45,505)
(41.77)
%
15.66
%
(750)
200
$
77,920
$
(31,030)
(28.48)
%
18.31
%
(485)
100
$
93,572
$
(15,378)
(14.11)
%
20.89
%
(227)
Level
$
108,950
—
—
%
23.16
%
—
(100)
$
120,964
$
12,014
11.03
%
24.51
%
135
(200)
$
131,033
$
22,083
20.27
%
25.35
%
219
(300)
$
137,532
$
28,582
26.23
%
25.53
%
237
(400)
$
139,425
$
30,475
27.97
%
24.98
%
182
(1) Assumes an immediate uniform change in interest rates at all maturities.
(2) EVE is the discounted present value of expected cash flows from assets, liabilities and off-balance sheet contracts.
(3) Present value of assets represents the discounted present value of incoming cash flows on interest-earning assets.
(4) EVE Ratio represents EVE divided by the present value of assets.
The table above indicates that at September 30, 2024, we would have experienced a 28.48% decrease in EVE in the event of an instantaneous parallel 200 basis point increase in market interest rates and a 20.27% increase in EVE in the event of an instantaneous 200 basis point decrease in market interest rates.
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Change in Net Interest Income. The following table sets forth, as of September 30, 2024, the calculation of the estimated changes in our net interest income that would result from the designated immediate changes in the United States Treasury yield curve. All estimated changes presented in the table are within the policy limits established by the board of directors.
At September 30, 2024
Change in Interest Rates
Net Interest Income Year 1
(basis points) (1)
Forecast
Year 1 Change from Level
(Dollars in thousands)
400
$
8,528
(33.40)
%
300
$
9,612
(24.94)
%
200
$
10,718
(16.31)
%
100
$
11,771
(8.08)
%
Level
$
12,806
—
(100)
$
13,030
1.75
%
(200)
$
13,129
2.52
%
(300)
$
13,149
2.68
%
(400)
$
13,205
3.12
%
(1) Assumes an immediate uniform change in interest rates at all maturities.
The table above indicates that as of September 30, 2024, we would have experienced a 16.31% decrease in net interest income in the event of an instantaneous parallel 200 basis point increase in market interest rates and a 2.52% increase in net interest income in the event of an instantaneous 200 basis point decrease in market interest rates.
Certain shortcomings are inherent in the methodologies used in the above interest rate risk measurement. Modeling changes in EVE and NII require making certain assumptions that may or may not reflect the manner in which actual yields and costs respond to changes in market interest rates. For instance, the EVE and NII tables presented above assume that the composition of our interest-sensitive assets and liabilities existing at the beginning of a period remains constant over the period being measured and assumes that a particular change in interest rates is reflected uniformly across the yield curve regardless of the duration or repricing of specific assets and liabilities. However, the shape of the yield curve changes constantly and the value and pricing of our assets and liabilities, including our deposits, may not closely correlate with changes in market interest rates. Accordingly, although the EVE and NII tables may provide an indication of our interest rate risk exposure at a particular point in time and in the context of a particular yield curve, such measurements are not intended to and do not provide a precise forecast of the effect of changes in market interest rates on EVE and NII and will differ from actual results.
EVE and net interest NII calculations also may not reflect the fair values of financial instruments. For example, decreases in market interest rates can increase the fair values of our loans, deposits and borrowings.
Item 3. Quantitative and Qualitative Disclosures About Market Risk
The information in Item 2 under “Management’s Discussion and Analysis of Financial Condition and Results of Operations – Management of Market Risk” is incorporated in this Item 3 by reference.
Text extracted from the filing as submitted to EDGAR. Formatting, tables and exhibits are simplified for reading; the original document is authoritative for anything you rely on.