Magyar Bancorp, Inc. 10-Q

Item 2. Management's Discussion and Analysis of Financial Condition and Results of Operations Forward-Looking Statements When used in this filing and in future filings by the Company with the Securities and Exchange Commission, in the Company’s press releases or other public or shareholder communications, or in oral statements made with the approval of an authorized executive officer, the words or phrases, “anticipate,” “would be,” “will allow,” “intends to,” “will likely result,” “are expected to,” “will continue,” “is anticipated,” “estimated,” “projected,” “believes”, or similar expressions are intended to identify “forward looking statements.” Forward-looking statements are subject to numerous risks and uncertainties, including, but not limited to, those risks previously disclosed by the Company in Item 1A of its Annual Report on Form 10-K as may be supplemented by Quarterly Reports on Form 10-Q filed with the SEC, general economic conditions, changes in interest rates, regulatory considerations, competition, technological developments, retention and recruitment of qualified personnel, and market acceptance of the Company’s pricing, products and services, and with respect to the loans extended by the Company and real estate owned, the following: risks related to the economic environment in the market areas in which the Bank operates, particularly with respect to the real estate market in New Jersey; the risk that the value of the real estate securing these loans may decline in value; and the risk that significant expense may be incurred by the Company in connection with the resolution of these loans. In addition, the COVID-19 pandemic is having an adverse impact on the Company, its customers and the communities it serves. The adverse effect of the COVID-19 pandemic on the Company, its customers and the communities where it operates may adversely affect the Company’s business, results of operations and financial condition for an indefinite period of time. The Company wishes to caution readers not to place undue reliance on any such forward-looking statements, which speak only as of the date made, and advises readers that various factors, including regional and national economic conditions, substantial changes in levels of market interest rates, credit and other risks of lending and investing activities, and competitive and regulatory factors, could affect the Company’s financial performance and could cause the Company’s actual results for future periods to differ materially from those anticipated or projected. The Company does not undertake, and specifically disclaims any obligation, to update any forward-looking statements to reflect occurrences or unanticipated events or circumstances after the date of such statements. Critical Accounting Policies Critical accounting policies are defined as those that are reflective of significant judgments and uncertainties, and could potentially result in materially different results under different assumptions and conditions. Critical accounting policies may involve complex subjective decisions or assessments. We consider the following to be our critical accounting policies. Allowance for Loan Loss. The allowance for loan losses is the amount estimated by management as necessary to cover credit losses in the loan portfolio both probable and reasonably estimable at the balance sheet date. The allowance is established through the provision for loan losses which is charged against income. In determining the allowance for loan losses, management makes significant estimates and has identified this policy as one of our most critical. Due to the high degree of judgment involved, the subjectivity of the assumptions utilized and the potential for changes in the economic environment that could result in changes to the amount of the recorded allowance for loan losses, the methodology for determining the allowance for loan losses is considered a critical accounting policy by management. 23 Table of Contents As a substantial amount of our loan portfolio is collateralized by real estate, appraisals of the underlying value of property securing loans and discounted cash flow valuations of properties are critical in determining the amount of the allowance required for specific loans. Assumptions for appraisals and discounted cash flow valuations are instrumental in determining the value of properties. Overly optimistic assumptions or negative changes to assumptions could significantly affect the valuation of a property securing a loan and the related allowance determined. The assumptions supporting such appraisals and discounted cash flow valuations are carefully reviewed by management to determine that the resulting values reasonably reflect amounts realizable on the related loans. Management performs a quarterly evaluation of the adequacy of the allowance for loan losses. We consider a variety of factors in establishing this estimate including, but not limited to, current economic conditions, delinquency statistics, geographic and industry concentrations, the adequacy of the underlying collateral, the financial strength of the borrower, results of internal loan reviews and other relevant factors. This evaluation is inherently subjective as it requires material estimates by management that may be susceptible to significant change based on changes in economic and real estate market conditions. The evaluation has a specific and general component. The specific component relates to loans that are delinquent or otherwise identified as impaired through the application of our loan review process and our loan grading system. All such loans are evaluated individually, with principal consideration given to the value of the collateral securing the loan and discounted cash flows. Specific impairment allowances are established as required by this analysis. However, the Bank’s Federal and State regulators generally require that the specific reserve against impaired collateral-dependent loans be charged-off, reducing the carrying balance of the loan and allowance for loan loss. The general component is determined by segregating the remaining loans by type of loan, risk weighting (if applicable) and payment history. We analyze historical loss experience, delinquency trends, general economic conditions and geographic and industry concentrations in establishing the general portion of the reserve. This analysis establishes factors that are applied to the loan groups to determine the amount of the general component of the allowance for loan losses. Actual loan losses may be significantly greater than the allowances we have established, which could have a material negative effect on our financial results. Other Real Estate Owned. Real estate acquired through foreclosure, or a deed-in-lieu of foreclosure, is recorded at fair value less estimated selling costs at the date of acquisition or transfer, and subsequently at the lower of its new cost or fair value less estimated selling costs. Adjustments to the carrying value at the date of acquisition or transfer are charged to the allowance for loan losses. The carrying value of the individual properties is subsequently adjusted to the extent it exceeds estimated fair value less estimated selling costs, at which time a provision for losses on such real estate is charged to operations. Appraisals are critical in determining the fair value of the other real estate owned amount. Assumptions for appraisals are instrumental in determining the value of properties. Overly optimistic assumptions or negative changes to assumptions could significantly affect the valuation of a property. The assumptions supporting such appraisals are carefully reviewed by management to determine that the resulting values reasonably reflect amounts realizable. Investment Securities. If the fair value of a security is less than its amortized cost, the security is deemed to be impaired. Management evaluates all securities with unrealized losses quarterly to determine if such impairments are “temporary” or “other-than-temporary” in accordance with applicable accounting guidance. The Company accounts for temporary impairments based upon security classification as either available-for-sale, held-to-maturity, or trading. Temporary impairments on “available-for-sale” securities are recognized, on a tax-effected basis, through accumulated other comprehensive income (“AOCI”) with offsetting entries adjusting the carrying value of the security and the balance of deferred taxes. Conversely, the Company does not adjust the carrying value of “held-to-maturity” securities for temporary impairments, although information concerning the amount and duration of impairments on held to maturity securities is generally disclosed in periodic financial statements. The carrying value of securities held in a trading portfolio is adjusted to their fair value through earnings on a daily basis. However, the Company maintained no securities in trading portfolios at or during the periods presented in these financial statements. 24 Table of Contents The Company accounts for other-than-temporary impairments based upon several considerations. First, other-than-temporary impairments on securities that the Company has decided to sell as of the close of a fiscal period, or will, more likely than not, be required to sell prior to the full recovery of their fair value to a level equal to their amortized cost, are recognized in operations. If neither of these criteria apply, then the other-than-temporary impairment is separated into credit-related and noncredit-related components. The credit-related impairment generally represents the amount by which the present value of the cash flows that are expected to be collected on an other-than-temporarily impaired security fall below its amortized cost while the noncredit-related component represents the remaining portion of the impairment not otherwise designated as credit-related. The Company recognizes credit-related, other-than-temporary impairments in earnings, while noncredit-related, other-than-temporary impairments on debt securities are recognized, net of deferred taxes, in AOCI. Management did not account for any other-than-temporary impairments at or during the periods presented in these financial statements. Fair Value. We use fair value measurements to record fair value adjustments to certain assets and liabilities and to determine fair value disclosures. Our securities available-for-sale are recorded at fair value on a recurring basis. Additionally, from time to time, we may be required to record at fair value other assets or liabilities on a non-recurring basis, such as held-to-maturity securities, mortgage servicing rights, loans receivable and other real estate owned. These non-recurring fair value adjustments involve the application of lower-of-cost-or-market accounting or write-downs of individual assets. In accordance with ASC 820, Fair Value Measurements and Disclosures, we group our assets and liabilities 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. We base our 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. ASC 820 requires us to maximize the use of observable inputs and minimize the use of unobservable inputs when measuring fair value. Deferred Income Taxes. The Company records income taxes using the asset and liability method. Accordingly, deferred tax assets and liabilities: (i) are recognized for the expected future tax consequences of events that have been recognized in the financial statements or tax returns; (ii) are attributable to differences between the financial statement carrying amounts of existing assets and liabilities and their respective tax bases; and (iii) are measured using enacted tax rates expected to apply in the years when those temporary differences are expected to be recovered or settled. Where applicable, deferred tax assets are reduced by a valuation allowance for any portions determined not likely to be realized. The effect on deferred tax assets and liabilities of a change in tax rates is recognized in income tax expense in the period of enactment. The valuation allowance is adjusted, by a charge or credit to income tax expense, as changes in facts and circumstances warrant. Impact of the Coronavirus/COVID-19 Pandemic. During 2020 and continuing into 2021, the extraordinary impact of the COVID-19 pandemic has created an unprecedented environment for consumers and businesses alike. To protect our employees and customers from potential exposure to the virus, all Magyar Bank lobbies and operational areas continue to observe best practice protocols to limit exposure and/or spread of the virus. To assist our loan customers, Magyar Bank has offered loan payment deferrals to borrowers unable to make their contractual payments due to COVID-19. Loan payments are deferred until the contractual maturity of the loan. Deferral requests are considered on a case-by-case basis and are initially approved for a three-month period for principal and interest payments or for interest-only payments depending on the borrower’s circumstances. An additional three-month period is available for businesses that remain unable to operate and for consumers unable to make their mortgage or home equity payments due to COVID-19. Additional deferrals were considered for businesses experiencing a prolonged impact from the COVID-19 pandemic, such as the accommodation and food service industries. Magyar Bank’s loan portfolio does not have a significant exposure to the travel or entertainment industry. Through December 31, 2021, we had modified 284 loans aggregating $150.9 million for the deferral of principal and/or interest payments. Of these loans, 105 loans totaling $52.6 million repaid their deferred payments in full and 178 loans aggregating $96.9 million have resumed making their contractual loan payments. One loan totaling $1.4 million was past its deferral period and delinquent at December 31, 2021. The Company was not deferring any additional loan payments due to the COVID-19 pandemic at December 31, 2021. A total of $1.4 million in interest payments were deferred as of December 31, 2021. The Bank participated in the PPP to provide liquidity using the SBA platform to small businesses and self-employed individuals to maintain their staff and operations through the COVID-19 pandemic. This liquidity is in the form of a loan, 100% guaranteed by the SBA, that is forgivable provided the funds are used on qualifying payroll costs, and to a lesser extent, rent, utilities and interest on qualifying mortgage payments. The loans bear a fixed rate of 1.0% and loan payments are deferred for the first 10 months following the covered period, which is eight to twenty-four weeks following the date the loan is made. We originated 562 PPP loans totaling $91.3 million for which we received $3.5 million in origination fees from the SBA. These fees are being amortized over the five year contractual term of the loan unless repaid or forgiven sooner. Through December 31, 2021, 510 loans totaling $76.5 million had been repaid, leaving 52 loans totaling $14.8 million at December 31, 2021. The Company expects most of these loans to be approved for full forgiveness by the SBA. 25 Table of Contents The health of the banking industry is highly correlated with that of the economy. The temporary and/or partial closures of non-essential businesses in our local and national economies increases the likelihood of recession, which typically results in an increased level of credit losses. Accordingly, our provisions for loan losses have increased and will be closely monitored throughout the pandemic. In addition to utilizing quantitative loss factors, the Company considers qualitative factors, such as changes in underwriting policies, current economic conditions, delinquency statistics, the adequacy of the underlying collateral, and the financial strength of the borrower. The impact of the COVID-19 pandemic on the performance of our loan portfolio in future quarters is unknown, however all of these factors are likely to be affected by the COVID-19 pandemic. Comparison of Financial Condition at December 31, 2021 and September 30, 2021 Total Assets. Total assets increased $6.7 million, or 0.9%, to $780.7 million during the three months ended December 31, 2021 from $774.0 million at September 30, 2021. The increase was primarily attributable to increases in cash, interest-earning deposits and investment securities, partially offset by lower balances of loans receivable, net of allowance for loan loss. Cash and Interest-Earning Deposits with Banks. Cash and interest-earning deposits with banks increased $7.1 million, or 9.4%, to $82.3 million at December 31, 2021 from $75.2 million at September 30, 2021 from net loan repayments and deposit inflows during the three months ended December 31, 2021. Total Loans Receivable. Total loans receivable decreased $11.3 million, or 1.9%, to $583.4 million at December 31, 2021 from $594.6 million at September 30, 2021. The loans receivable were comprised of $279.0 million (47.8%) in commercial real estate loans, $200.8 million (34.4%) in one-to four-family residential mortgage loans, $58.3 million (10.0%) in commercial business loans, $24.3 million (4.2%) in construction loans, $17.7 million (3.0%) in home equity lines of credit, and $3.3 million (0.6%) in other loans. Included with the commercial business loans were $14.8 million in PPP loans. The decrease in total loans receivable during the quarter occurred in commercial business loans, which decreased $10.4 million (PPP loans decreased $10.3 million), one-to four-family residential real estate loans (including home equity lines of credit), which decreased $2.5 million, commercial real estate loans, which decreased $1.9 million, and other loans, which decreased $462,000. Partially offsetting these decreases were construction loans, which increased $3.9 million during the quarter. Total Non-Performing Loans. Total non-performing loans decreased $2.0 million, or 23.9%, to $6.2 million at December 31, 2021 from $8.2 million at September 30, 2021. Five loans totaling $1.5 million were brought current by payments from the borrowers. In addition, one non-performing residential mortgage loan totaling $473,000 was paid in full. There were no additions to the non-performing loans during the three months ended December 31, 2021. Included in the non-performing loan totals were two construction loans totaling $4.6 million, one commercial business loan totaling $1.3 million, three commercial real estate loans totaling $254,000, and one residential mortgage loan totaling $30,000. The ratio of non-performing loans to total loans decreased to 1.1% at December 31, 2021 from 1.4% at September 30, 2021. During the three months ended December 31, 2021, the allowance for loan losses increased $153,000 to $8.2 million from $8.1 million at September 30, 2021. The increase was attributable to provisions for loan losses totaling $101,000 and a $52,000 recovery from a loan previously charged off. The allowance for loan losses as a percentage of non-performing loans increased to 132.4% at December 31, 2021 from 99.0% at September 30, 2021. Our allowance for loan losses as a percentage of total loans was 1.41% at December 31, 2021 compared with 1.36% at September 30, 2021. Future increases in the allowance for loan losses may be necessary based on possible future increases in non-performing loans and charge-offs, the possible deterioration of collateral values, and the possible deterioration of the current economic environment. Investment Securities. At December 31, 2021, investment securities totaled $78.6 million, reflecting an increase of $8.1 million, or 11.4%, from September 30, 2021. The Company purchased three mortgage-backed securities totaling $7.5 million, one callable U.S. government-sponsored enterprise bond totaling $2.0 million, and one municipal bond totaling $600,000 during the three months ended December 31, 2021. During the quarter, the Company received payments from mortgage-backed securities totaling $2.0 million. There were no sales of investment securities during the period. 26 Table of Contents Investment securities at December 31, 2021 consisted of $58.2 million in mortgage-backed securities issued by U.S. government agencies and U.S. government-sponsored enterprises, $14.5 million in U.S. government-sponsored enterprise debt securities, $3.0 million in corporate notes, $2.7 million in municipal bonds, and $238,000 in “private-label” mortgage-backed securities. There were no other-than-temporary-impairment charges for the Company’s investment securities for the three months ended December 31, 2021. Other Real Estate Owned. Other real estate owned increased $13,000, or 2.0%, to $649,000 at December 31, 2021 from $636,000 at September 30, 2021. The increase was due to capital improvements to one property in order to market it for sale. At December 31, 2021, of the two properties that remain in the OREO portfolio, one was under contract of sale and the other was listed for sale. The Company is determining the proper course of action for its remaining other real estate owned, which may include holding the properties until the real estate market further improves, leasing properties to offset carrying costs and selling the properties. Total Deposits. Total deposits increased $7.9 million, or 1.2%, to $647.7 million at December 31, 2021 from $639.8 million at September 30, 2021. The inflow in deposits occurred in interest-bearing checking accounts (NOW), which increased $12.4 million, or 17.4%, to $83.7 million, in money market accounts, which increased $9.9 million, or 5.3%, to $197.8 million, in savings accounts, which increased $5.0 million, or 6.1%, to $86.7 million, and in non-interest bearing checking accounts, which increased $436,000, or 0.2%, to $182.4 million. Partially offsetting these increases were certificates of deposit (including individual retirement accounts), which decreased $19.9 million, or 17.0%, to $97.0 million. The Company held $6.0 million in brokered certificates of deposit at December 31, 2021 and September 30, 2021. Borrowings. Borrowings decreased $2.0 million, or 8.6%, to $21.4 million at December 31, 2021 from $23.4 million at September 30, 2021. The Company repaid a matured $2.0 million term borrowings from the Federal Home Loan Bank of New York during the quarter. Stockholders’ Equity. Stockholders’ equity increased $802,000, or 0.8%, to $98.4 million at December 31, 2021 from $97.6 million at September 30, 2021. The Company’s book value per share increased to $13.87 at December 31, 2021 from $13.76 at September 30, 2021. The increase in stockholders’ equity was attributable to the Company’s results from operations, partially offset by the special dividends paid during the quarter. The Company did not repurchase shares of its common stock during the three months ended December 31, 2021. Through December 31, 2021, the Company had repurchased 91,000 shares at an average price of $8.41 pursuant to the second stock repurchase plan. Average Balance Sheet for the Three Months Ended December 31, 2021 and 2020 The following table presents certain information regarding the Company’s financial condition and net interest income for the three months ended December 31, 2021 and 2020. The table presents the annualized average yield on interest-earning assets and the annualized average cost of interest-bearing liabilities. We derived the yields and costs by dividing annualized income or expense by the average balance of interest-earning assets and interest-bearing liabilities, respectively, for the periods shown. We derived average balances from daily balances over the period indicated. Interest income includes fees that we consider adjustments to yields. 27 Table of Contents For the Three Months Ended December 31, 2021 2020 Average Balance Interest Income/ Expense Yield/Cost (Annualized) Average Balance Interest Income/ Expense Yield/Cost (Annualized) (Dollars In Thousands) Interest-earning assets: Interest-earning deposits $ 84,088 $ 35 0.17% $ 54,463 $ 20 0.14% Loans receivable, net 579,131 6,721 4.60% 606,109 6,751 4.42% Securities Taxable 71,946 226 1.25% 47,624 205 1.71% Tax-exempt (1) 2,198 9 1.63% — — — FHLBNY stock 1,676 20 4.81% 1,981 25 5.05% Total interest-earning assets 739,039 7,011 3.76% 710,177 7,001 3.91% Noninterest-earning assets 44,299 43,502 Total assets $ 783,338 $ 753,679 Interest-bearing liabilities: Savings accounts (2) $ 84,542 36 0.17% $ 75,464 47 0.24% NOW accounts (3) 263,626 140 0.21% 256,876 262 0.40% Time deposits (4) 111,911 275 0.98% 120,898 456 1.50% Total interest-bearing deposits 460,079 451 0.39% 453,238 765 0.67% Borrowings 21,877 119 2.16% 65,387 191 1.16% Total interest-bearing liabilities 481,956 570 0.47% 518,625 956 0.73% Noninterest-bearing liabilities 202,334 176,867 Total liabilities 684,290 695,492 Retained earnings 99,048 58,187 Total liabilities and retained earnings $ 783,338 $ 753,679 Tax-equivalent basis adjustment (2 ) — Net interest and dividend income $ 6,439 $ 6,045 Interest rate spread 3.29% 3.18% Net interest-earning assets $ 257,083 $ 191,552 Net interest margin (5) 3.46% 3.38% Average interest-earning assets to average interest-bearing liabilities 153.34% 136.93% (1) Calculated using the Company's 21% federal tax rate. (2) Includes passbook savings, money market passbook and club accounts. (3) Includes interest-bearing checking and money market accounts. (4) Includes certificates of deposits and individual retirement accounts. (5) Calculated as annualized net interest income divided by average total interest-earning assets. Comparison of Operating Results for the Three Months Ended December 31, 2021 and 2020 Net Income . Net income increased $356,000, or 26.6% to $1.7 million for the three-month period ended December 31, 2021 compared with net income of $1.3 million for the three-month period ended December 31, 2020. The increase was due to higher net interest and dividend income, lower provisions for loan loss and lower other expenses, partially offset by lower non-interest income. 28 Table of Contents Net Interest and Dividend Income. Net interest and dividend income increased $394,000, or 6.5%, to $6.4 million for the three months ended December 31, 2021 from $6.0 million for the three months ended December 31, 2020. An eight basis point increase in the Company’s net interest margin to 3.46% for the three months ended December 31, 2021 from 3.38% for the three months ended December 31, 2020 as well as a $28.9 million increase in average-interest-earning assets to $739.0 million for the 2021 quarter from $710.1 million for the 2020 quarter resulted in higher net interest and dividend income. The cost of the Company’s interest-bearing liabilities decreased 26 basis points to 0.47% for the three months ended December 31, 2021 from 0.73% for the three months ended December 31, 2020 due to lower market interest rates. The cost of interest-bearing deposits decreased 28 basis points to 0.39% for the three months ended December 31, 2021 from 0.67% for the three months ended December 31, 2020. In addition, the average balance of non-interest bearing liabilities increased $28.1 million to $204.0 million for the three months ended December 31, 2021 from $175.9 million for the three months ended December 31, 2020. The increase in non-interest bearing liabilities was due to higher business checking account balances resulting from supply chain issues and a preference for liquidity during the COVID-19 pandemic. Interest and Dividend Income. Interest and dividend income was unchanged at $7.0 million for the three months ended December 31, 2021 and December 31, 2020. A $28.9 million, or 4.1%, increase in the average balance of interest-earning assets to $739.0 million was entirely offset by a 15 basis point decrease in the yield on such assets to 3.76% for the three months ended December 31, 2021 compared with 3.91% the prior year period. The yield on average investment securities and interest-earning deposits decreased 19 basis points to 0.68% for the three months ended December 31, 2021 from 0.87% for the three months ended December 31, 2020 due to lower market interest rates. Offsetting this decrease was an 18 basis point increase in the yield on loans receivable to 4.60% for the three months ended December 31, 2021 from 4.42% for the three months ended December 31, 2020. Lower interest income from lower average balances of loans receivable was offset by the receipt of $173,000 in interest payments received during the current quarter on previously non-performing loans. Also included in the yield on loans receivable is the recognition of PPP loan fees, which have been accelerated with the repayment of PPP loans through forgiveness by the SBA. The Company recorded $407,000 in PPP fees during the three months ended December 31, 2021 compared with $417,000 during the three months ended December 31, 2020. Interest earned on investment securities, including interest-earning deposits and excluding FHLB stock, increased $43,000, or 19.1%, to $268,000 for the quarter ended December 31, 2021 from $225,000 for the prior year quarter. A $56.1 million, or 55.0%, increase in the average balance of investment securities and interest-earning deposits to $158.2 million for the quarter ended December 31, 2021 more than offset the 19 basis point decrease in their average yield. Interest Expense. Interest expense decreased $386,000, or 40.4%, to $570,000 for the three months ended December 31, 2021 from $956,000 for the three months ended December 31, 2020. A 26 basis point decrease in the cost of interest-bearing liabilities to 0.47% for the three months ended December 31, 2021 as well as a lower average balance of interest-bearing liabilities, which decreased $36.7 million, or 7.1%, to $482.0 million, accounted for the lower interest expense between periods. The average balance of interest-bearing deposits increased $6.8 million, or 1.5%, to $460.0 million for the quarter ended December 31, 2021 from $453.2 million for the same quarter ended December 31, 2020, while the average cost of such deposits decreased 28 basis points to 0.39% from 0.67% between the two periods. As a result, interest paid on interest-bearing deposits decreased $314,000 to $451,000 for the three months ended December 31, 2021 compared with $765,000 for the three months ended December 31, 2020. Interest paid on borrowings decreased $72,000, or 37.7%, to $119,000 for the three months ended December 31, 2021 from $191,000 for the prior year period. A $43.5 million decrease in the average balance of such borrowings to $21.9 million for the quarter ended December 31, 2021 from $65.4 million for the quarter ended December 31, 2020 more than offset a 100 basis point increase in the cost of borrowings to 2.16% for the three months ended December 31, 2021 from 1.16% for the three months ended December 31, 2020. The reduction in average balances and corresponding increase in cost of borrowings between periods resulted from the repayment of $29.8 million in PPP Liquidity Facility borrowings costing 0.35% from the Federal Reserve Bank of New York. Provision for Loan Losses. We establish provisions for loan losses, which are charged to earnings, at a level necessary to absorb known and inherent losses that are both probable and reasonably estimable at the date of the financial statements. In evaluating the level of the allowance for loan losses, management considers historical loss experience, the types of loans and the amount of loans in the loan portfolio, adverse situations that may affect the borrower’s ability to repay, the estimated value of any underlying collateral, peer group information and prevailing economic conditions. This evaluation is inherently subjective as it requires estimates that are susceptible to significant revision as more information becomes available or as future events occur. 29 Table of Contents After an evaluation of these factors, management recorded a provision of $101,000 for the three months ended December 31, 2021 compared to $640,000 for the three months ended December 31, 2020. The decreased provision for loan losses resulted from contraction in the Company’s loan portfolio and a decrease in non-performing loans between periods. In addition, the Company recorded higher provisions during the three months ended December 31, 2020 related to COVID-19 pandemic adjustments to the historical loss rates used in its calculation. The Company recorded $52,000 in net recoveries for the three months ended December 31, 2021 compared with $90,000 in net recoveries during the three months ended December 31, 2020. Determining the amount of the allowance for loan losses necessarily involves a high degree of judgment. Management reviews the level of the allowance on a quarterly basis, and establishes the provision for loan losses based on the factors set forth in the preceding paragraph. As management evaluates the allowance for loan losses, the increased risk associated with larger non-homogenous construction, commercial real estate and commercial business loans may result in larger additions to the allowance for loan losses in future periods. In addition, the ongoing effects of the COVID-19 pandemic on the Company’s loan portfolio may also result in larger additions to the allowance for loan losses in future periods. Other Income. Other income decreased $575,000, or 46.9%, to $650,000 during the three months ended December 31, 2021 compared to $1.2 million for the three months ended December 31, 2020. Fees for other customer services were $0 for the three months ended December 31, 2021 compared with $464,000 for the three months ended December 31, 2020. The fees in the 2020 quarter were earned from the a local Small Business Relief Grant program offered in 2020 in response to the COVID-19 pandemic for which the Company received a fee of 3.0% of the grants it assisted with processing. In addition, the Company did not receive any interest rate swap fees during the three months ended December 31, 2021, compared with $102,000 during the three months ended December 31, 2020. Other Expenses. Other expenses decreased $103,000, or 2.2%, to $4.6 million during the three months ended December 31, 2021 from $4.7 million during the three months ended December 31, 2020. The decrease in other expenses was primarily attributable to decreases in professional fees, which decreased $141,000 to $387,000, due to lower legal and consulting fees related to the collection and foreclosure of non-performing loans, and in OREO expenses, which decreased $146,000 to $34,000, due to lower valuation allowances and fewer OREO properties between periods. Partially offsetting the decrease in professional fees and OREO expenses were increases in compensation and benefit expenses as well as marketing and business development expenses. Compensation and benefit expense increased $155,000, or 6.1%, to $2.7 million for the three months ended December 31, 2021 from $2.5 million for the three months ended December 31, 2020 from the addition of one commercial lending position as well as annual merit increases for employees and higher education and training expenses. Marketing and business development expense increased $81,000, or 184.1%, to $125,000 for the three months ended December 31, 2021 from $44,000 for the three months ended December 31, 2020 due to COVID-19 pandemic restrictions suppressing the 2020 spend and reflecting a higher spend in the current year as the Company celebrates its 100 th year anniversary in 2022. Income Tax Expense. The Company recorded tax expense of $674,000 on pre-tax income of $2.4 million for the three months ended December 31, 2021, compared to $569,000 on pre-tax income of $1.9 million for the three months ended December 31, 2020. The Company’s effective tax rate for the three months ended December 31, 2021 was 28.5% compared with 29.9% for the three months ended December 31, 2020. LIQUIDITY AND CAPITAL RESOURCES Liquidity The Company’s liquidity is a measure of its ability to fund loans, pay withdrawals of deposits, and other cash outflows in an efficient, cost-effective manner. The Company’s short-term sources of liquidity include maturity, repayment and sales of assets, excess cash and cash equivalents, new deposits, other borrowings, and new advances from the Federal Home Loan Bank. There has been no material adverse change during the three months ended December 31, 2021 in the ability of the Company and its subsidiaries to fund their operations. 30 Table of Contents Whether through significant deposit withdrawals, reductions in interest and principal payments on loans, or the tightening of the capital markets, it is possible that the COVID-19 pandemic will have a negative effect on the liquidity and capital resources of the Company. At December 31, 2021, the Company had commitments outstanding under letters of credit of $2.8 million, commitments to originate loans of $28.5 million, and commitments to fund undisbursed balances of closed loans and unused lines of credit of $61.9 million. There has been no material change during the three months ended December 31, 2021 in any of the Company’s other contractual obligations or commitments to make future payments. Capital Requirements At December 31, 2021, the Bank’s Tier 1 capital as a percentage of the Bank's total assets was 10.50%, and total qualifying capital as a percentage of risk-weighted assets was 17.18%. Under section 1102 of the CARES Act, a PPP loan is assigned a risk weight of zero percent under the risk-based capital rules of the federal banking agencies. On April 9, 2020, the Federal Reserve Board, the Office of the Comptroller of the Currency, and the Federal Deposit Insurance Corporation issued an interim final rule to allow banking organizations to neutralize the effect of PPP loans financed under the PPP Liquidity Facility on Tier 1 leverage capital ratios. Item 3- Quantitative and Qualitative Disclosures about Market Risk Not applicable to smaller reporting companies.