Item 1A. Risk Factors
ITEM 1A.
Risk Factors
In
addition to factors discussed in the description of our business and elsewhere in this report, the following are factors that could adversely
affect our future results of operations and financial condition.
Economic and Market Area
Inflation can have an adverse
impact on our business and on our customers.
Inflation risk is the risk that
the value of assets or income from investments will be worth less in the future as inflation decreases the value of money. Recently, there
have been market indicators of a pronounced rise in inflation and the Federal Reserve Board has indicated its intention to raise certain
benchmark interest rates in an effort to combat inflation. As inflation increases and market interest rates rise, the value of our investment
securities, particularly those with longer maturities, would decrease, although this effect can be less pronounced for floating rate instruments.
In addition, inflation generally increases the cost of goods and services we use in our business operations, such as electricity and other
utilities, which increases our noninterest expenses. Furthermore, our customers are also affected by inflation and the rising costs of
goods and services used in their households and businesses, which could have a negative impact on their ability to repay their loans with
us.
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The
COVID-19 Pandemic Has and Will Continue to Pose Risks and Could Harm Our Business, Results of Operations and Prospects.
The
COVID-19 pandemic is having an adverse impact on the Company, its customers and the communities it serves. Given its ongoing and dynamic
nature, it is difficult to predict the full impact of the COVID-19 outbreak on the business of the Company, its customers, employees and
third-party service providers. The extent of such impact will depend on future developments, which are highly uncertain, including when
the coronavirus can be controlled and abated and when and how the economy may be reopened in an efficient manner. Additionally, the responses
of various governmental and nongovernmental authorities to curtail business and consumer activities in an effort to mitigate the pandemic
will have material long-term effects on the Company and its customers which are difficult to quantify in the near-term or long-term.
As
the result of the COVID-19 pandemic and the related adverse local and national economic consequences, the Company is subject to the following
risks, any of which could have a material, adverse effect on the business, financial condition, liquidity, and results of operations of
the Company:
•
risks to the capital markets that may impact the performance of the investment
securities portfolio of the Company, as well as limit our access to capital markets and other funding sources;
•
effects on key employees, including operational management personnel and
those charged with preparing, monitoring and evaluating the companies’ financial reporting and internal controls;
•
declines in demand for loans and other banking services and products, as
well as a decline in the credit quality of our loan portfolio, owing to the effects of COVID-19 in the markets served by the Company;
•
if the economy is unable to substantially reopen or reopen in an efficient
manner, and high levels of unemployment continue for an extended period of time, loan delinquencies, problem assets, and foreclosures
may increase, resulting in increased charges and reduced income;
•
collateral for loans, especially real estate, may continue to decline in
value, which could cause loan losses to increase;
•
allowance for loan losses may increase if borrowers experience financial
difficulties, which will adversely affect net income;
•
the net worth and liquidity of loan guarantors may decline, impairing their
ability to honor commitments;
•
as the result of the decline in the Federal Reserve Board’s target
federal funds rate to near 0%, the yield on assets may decline to a greater extent than the decline in cost of interest-bearing liabilities,
reducing net interest margin and spread and reducing net income;
•
cyber security risks are increased as the result of an increase in the number
of employees working remotely;
•
declines in demand resulting from adverse impacts of the disease on businesses
deemed to be “non-essential” by governments in the markets served by the Company; and
•
increasing or protracted volatility in the price of the Company’s
common stock.
A
Worsening of Economic Conditions Could Reduce Demand for Our Products and Services and/or Result in Increases in Our Level of Non-performing
Loans, Which Could Have an Adverse Effect on Our Results of Operations.
Unlike
larger financial institutions that are more geographically diversified, our profitability depends primarily on the general economic conditions
in New Jersey and the greater New York metropolitan area. Local economic conditions have a significant impact on our commercial real estate
and construction and consumer loans, the ability of the borrowers to repay these loans and the value of the collateral securing these
loans. Almost all of our loans are to borrowers located in or secured by collateral located in New Jersey and the New York metropolitan
area.
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
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where it operates
may adversely affect the Company’s business, results of operations and financial condition for an indefinite period of time.
A
deterioration in economic conditions could result in the following consequences, any of which could have a material adverse effect on
our business, financial condition, liquidity and results of operations:
•
demand for our products and services may decline;
•
loan delinquencies, problem assets and foreclosures may increase;
•
collateral for loans, especially real estate, may decline in value, in turn
reducing customers’ future borrowing power, and reducing the value of assets and collateral associated with existing loans;
•
the value of our securities portfolio may decline; and
•
the net worth and liquidity of loan guarantors may decline, impairing their
ability to honor commitments to us.
Moreover,
a significant decline in general economic conditions, caused by inflation, recession, acts of terrorism, an outbreak of hostilities or
other international or domestic calamities, unemployment or other factors beyond our control could further impact these local economic
conditions and could further negatively affect the financial results of our banking operations. In addition, deflationary pressures, while
possibly lowering our operating costs, could have a significant negative effect on our borrowers, especially our business borrowers, and
the values of underlying collateral securing loans, which could negatively affect our financial performance.
Strong
Competition Within Our Market Area May Limit Our Growth and Profitability.
Competition
in the banking and financial services industry is intense. In our market area, we compete with commercial banks, savings institutions,
mortgage brokerage firms, credit unions, finance companies, mutual funds, insurance companies, and brokerage and investment banking firms
operating locally and elsewhere. Some of our competitors have substantially greater resources and lending limits than we, have greater
name recognition and market presence that benefit them in attracting business, and offer certain services that we do not or cannot provide.
In addition, larger competitors may be able to price loans and deposits more aggressively than we do. Our profitability depends upon our
continued ability to successfully compete in our market area. The greater resources and deposit and loan products offered by some of our
competitors may limit our ability to increase our interest-earning assets. For additional information see “Business of Magyar Bank-Competition.”
We Are a Community Bank and Our
Ability to Maintain Our Reputation is Critical to the Success of Our Business. The Failure to do so May Adversely Affect Our Performance.
We are a community bank and our
reputation is one of the most valuable assets of our business. A key component of our business strategy is to rely on our reputation for
customer service and knowledge of local markets to expand our presence by capturing new business opportunities from existing and prospective
customers in our market area. As such, we strive to conduct our business in a manner that enhances our reputation. This is done, in part,
by recruiting, hiring and retaining employees who share our core values of being an integral part of the communities we serve, delivering
superior service to our customers and caring about our customers. If our reputation is negatively affected by the actions of our employees,
by our inability to conduct our operations in a manner that is appealing to current or prospective customers or otherwise, our business
and operating results may be materially adversely affected.
Interest Rate and Asset Quality
The reversal of the historically
low interest rate environment may adversely affect our net interest income and profitability.
The Federal Reserve Board decreased
benchmark interest rates significantly, to near zero, in response to the COVID-19 pandemic. The Federal Reserve Board is reversing its
policy of near zero interest rates given its concerns over inflation. In recent periods, market interest rates have risen in response
to the Federal Reserve Board’s recent rate increases. As discussed below, the increase in market interest rates could have an adverse
effect on our net interest income and profitability.
Changes in Interest Rates May
Hurt Our Profits and Asset Values.
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Our earnings largely depend on
our net interest income, which could be negatively affected by changes in interest rates. Net interest income is the difference between:
·
the interest income we earn on our interest-earning assets, such as loans and securities; and
·
the interest expense we pay on our interest-bearing liabilities, such as deposits and borrowings.
The rates we earn on our assets
and the rates we pay on our liabilities are generally fixed for a contractual period of time. While we have taken steps to attempt to
reduce our exposure to increases in interest rates, historically our liabilities generally have shorter contractual maturities than our
assets. This imbalance can create significant earnings volatility, because market interest rates change over time. In a period of rising
interest rates, the interest income earned on our assets may not increase as rapidly as the interest paid on our liabilities. Likewise,
in a period of falling interest rates, the interest expense paid on our liabilities may not decrease as rapidly as the interest income
received on our assets. See “Management’s Discussion and Analysis of Financial Condition and Results of Operations-Management
of Market Risk.”
In addition, changes in interest
rates can affect the average life of loans and mortgage-backed securities. A reduction in interest rates causes increased prepayments
of loans and mortgage-backed securities as borrowers tend to refinance their debt to reduce their borrowing costs. This creates reinvestment
risk, which is the risk that we may not be able to reinvest the funds from faster prepayments at rates that are comparable to the rates
we earned on the prepaid loans or securities. Additionally, increases in interest rates may decrease loan demand and/or make it more difficult
for borrowers to repay adjustable-rate loans.
Changes in interest rates
also affect the current market value of our interest-earning securities portfolio. Generally, the value of securities moves inversely
with changes in interest rates. At September 30, 2022, the fair value of our total securities portfolio was $89.1 million. The unrealized
net loss on securities totaled $13.7 million on a pre-tax basis at September 30, 2022.
We evaluate interest rate
sensitivity using models that estimate the change in Magyar Bank’s net interest income over a range of interest rate scenarios.
At September 30, 2022, in the event of an immediate 200 basis point increase in interest rates, the model projects that we would experience
a $212,000, or 0.7%, decrease in net interest income in the first year following the change in interest rates, and a $1.1 million, or
3.4%, increase in net interest income in the second year following the change in interest rates. At September 30, 2022, in the event of
an immediate 200 basis point decrease in interest rates, the model projects that we would experience a $946,000, or 3.3%, decrease in
net interest income in the first year following the change in interest rates, and a $2.7 million, or 8.6%, decrease in net interest income
in the second year following the change in interest rates.
At September 30, 2022,
our available-for-sale securities portfolio at fair value totaled $9.2 million, which consisted entirely of mortgage-backed securities.
To the extent interest rates decrease and the value of our available-for-sale portfolio increases, our stockholders’ equity will
be affected accordingly.
Because
We Intend to Continue our Emphasis on the Origination of Commercial Business Loans and Commercial Real Estate Loans, Our Lending Risk
Has Increased in Recent Years and May Increase in Future Years.
At September 30, 2022,
our portfolio of commercial real estate and commercial business loans totaled $377.5 million, or 60.0% of our total loans, compared to
$349.6 million (including $25.1 million in PPP loans), or 58.8% of our total loans at September 30, 2021 and $349.1 million (including
$56.0 million in PPP loans), or 57.1% of our total loans at September 30, 2020. It is our intent to continue to emphasize the origination
of commercial business and commercial real estate loans. Commercial business and commercial real estate loans generally have more risk
than one-to four-family residential mortgage loans. At September 30, 2022, there were no non-performing commercial real estate and commercial
business loans compared with $2.4 million at September 30, 2021.
Because the repayment of
commercial business and commercial real estate loans depends on the successful management and operation of the borrower’s properties
or related businesses, repayment of these loans has been and may continue to be affected by adverse conditions in the real estate market
or the local economy. Further, these loans typically have larger loan balances, and several of our borrowers have more than one commercial
business and commercial real estate loan outstanding with us. Consequently, an adverse development with respect to one loan or one credit
relationship can expose us to significantly greater risk of loss compared to an adverse development with respect to a one- to four-family
residential mortgage loan. Finally, if we foreclose on a commercial business or commercial real estate loan, our holding period for the
collateral, if any, typically is longer than for one- to four-family residential mortgage loans because there are fewer potential purchasers
of the collateral. Because we plan to continue to emphasize the origination of these loans, it may be necessary to
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increase our allowance for loan losses because
of the increased credit risk associated with these types of loans. Any increase to our allowance for loan losses would adversely affect
our earnings.
If
Our Allowance for Loan Losses is Not Sufficient to Cover Actual Loan Losses, Our Earnings Could Decrease.
Our allowance for loan
losses may not be sufficient to cover losses inherent in our loan portfolio, requiring additions to our allowance, which could materially
decrease our net income. The allowance for loan losses increased by $358,000 during the year ended September 30, 2022 to $8.4 million
from $8.1 million for the year ended September 30, 2021. The increases were attributable to the growth in loan receivable, which increased
by $34.3 million to $628.9 million at September 30, 2022 from $594.6 million at September 30, 2021, and higher adjustments to the economic
conditions. The allowance for loan losses as a percentage of non-performing loans increased to 297.5% at September 30, 2022 compared with
99.0% at September 30, 2021. At September 30, 2022 our allowance for loan losses as a percentage of total loans was 1.34%, 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 total loans receivable, increases in non-performing loans
and charge-offs, deterioration of collateral values securing impaired real estate loans, and deterioration of the current economic environment.
We make various assumptions and judgments 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 amount
of the allowance for loan losses, we review our loans and our loss and delinquency experience, and we evaluate economic conditions. Based
on this review, we believe our allowance for loan losses is adequate to absorb losses in our loan portfolio as of September 30, 2022.
Bank regulators periodically
review our allowance for loan losses and may require us to increase our provision for loan losses or recognize further loan charge-offs.
Any increase in our allowance for loan losses or loan charge-offs as required by these regulatory authorities will have a material adverse
effect on our financial condition and results of operations.
The Financial Accounting Standards
Board has adopted a new accounting standard that is referred to as Current Expected Credit Loss, or CECL. The implementation of CECL has
been delayed for smaller reporting companies, such as the Company, until January 2023 (effective October 1, 2023 for the Company). CECL
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 may require us to increase our allowance for loan losses, and to greatly increase the types of data we will 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.
Regulatory Matters
We
Operate in a Highly Regulated Environment and May Be Adversely Affected by Changes in Laws and Regulations.
Magyar Bank is subject to extensive
regulation, supervision and examination by the NJDBI, its chartering authority, and by the Federal Deposit Insurance Corporation, which
insures Magyar Bank’s deposits. As a bank holding company, Magyar Bancorp, Inc. is subject to regulation and supervision by the
Federal Reserve Board. Such regulation and supervision govern the activities in which financial institutions and their holding companies
may engage and are intended primarily for the protection of the federal deposit insurance fund and depositors. These regulatory authorities
have extensive discretion in connection with their supervisory and enforcement activities, including the imposition of restrictions on
the operations of financial institutions, the classification of assets by financial institutions and the adequacy of financial institutions’
allowance for loan losses. Any change in such regulation and oversight, whether in the form of regulatory policy, regulations, or legislation,
could have a material impact on Magyar Bank and Magyar Bancorp, Inc.
Magyar Bank’s operations
are also subject to extensive regulation by other federal, state and local governmental authorities, and are subject to various laws and
judicial and administrative decisions that impose requirements and restrictions on operations. These laws, rules and regulations are frequently
changed by legislative and regulatory authorities. There can be no assurance that changes to existing laws, rules and regulations, or
any other new laws, rules or regulations, will not be adopted in the future, which could make compliance more difficult or expensive or
otherwise adversely affect our business, financial condition or prospects.
Non-compliance with the USA PATRIOT
Act, Bank Secrecy Act, or Other Laws and Regulations Could Result in Fines or Sanctions.
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The USA PATRIOT and Bank Secrecy
Acts require financial institutions to develop programs to prevent financial institutions from being used for money laundering and terrorist
activities. If such activities are detected, financial institutions are obligated to file suspicious activity reports with the U.S. Treasury’s
Office of Financial Crimes Enforcement Network. These rules require financial institutions to establish procedures for identifying
and verifying the identity of customers seeking to open new financial accounts. Failure to comply with these regulations could result
in fines or sanctions, including restrictions on conducting acquisitions or establishing new branches. During the last year, several banking
institutions have received large fines for non-compliance with these laws and regulations. While we have developed policies and procedures
designed to assist in compliance with these laws and regulations, these policies and procedures may not be effective in preventing violations
of these laws and regulations.
Security
System Failure or Breaches of Our Network Security
Could Subject Us to Increased Operating Costs as well as Litigation and Other Liabilities.
The computer systems and
network infrastructure we and our third-party service providers use could be vulnerable to unforeseen problems. Our operations are dependent
upon our ability to protect our computer equipment against damage from physical theft, fire, power loss, telecommunications failure or
a similar catastrophic event, as well as from security breaches, denial of service attacks, viruses, worms and other disruptive problems
caused by hackers. Any damage or failure that causes an interruption in our operations could have a material adverse effect on our financial
condition and results of operations. Computer break-ins, phishing and other disruptions could also jeopardize the security of information
stored in and transmitted through our computer systems and network infrastructure, which may result in significant liability to us and
may cause existing and potential customers to refrain from doing business with us. Although we, with the help of third-party service providers,
intend to continue to implement security technology and establish operational procedures designed to prevent such damage, our security
measures may not be successful. In addition, advances in computer capabilities, new discoveries in the field of cryptography or other
developments could result in a compromise or breach of the algorithms we and our third-party service providers use to encrypt and protect
customer transaction data. A failure of such security measures could have a material adverse effect on our financial condition and results
of operations.
It is possible that a significant
amount of time and money may be spent to rectify the harm caused by a breach or hack. While we have general liability insurance, there
are limitations on coverage as well as dollar amount. Furthermore, cyber incidents carry a greater risk of injury to our reputation. Finally,
depending on the type of incident, banking regulators can impose restrictions on our business and consumer laws may require reimbursement
of customer loss.
Risks Associated with Cyber-Security
Could Negatively Affect Our Earnings.
The financial services industry
has experienced an increase in both the number and severity of reported cyber-attacks aimed at gaining unauthorized access to bank systems
as a way to misappropriate assets and sensitive information, corrupt and destroy data, or cause operational disruptions. We have established
policies and procedures to prevent or limit the impact of security breaches, but such events may still occur or may not be adequately
addressed if they do occur. Although we rely on security safeguards to secure our data, these safeguards may not fully protect our systems
from compromises or breaches.
We also rely on the integrity
and security of a variety of third party processors, payment, clearing and settlement systems, as well as the various participants involved
in these systems, many of which have no direct relationship with us. Failure by these participants or their systems to protect our customers'
transaction data may put us at risk for possible losses due to fraud or operational disruption.
Our customers are also the target
of cyber-attacks and identity theft. Large scale identity theft could result in customers' accounts being compromised and fraudulent activities
being performed in their name. We have implemented certain safeguards against these types of activities but they may not fully protect
us from fraudulent financial losses.
The occurrence of a breach of
security involving our customers' information, regardless of its origin, could damage our reputation and result in a loss of customers
and business and subject us to additional regulatory scrutiny, and could expose us to litigation and possible financial liability. Any
of these events could have a material adverse effect on our financial condition and results of operations.
ITEM 1B.
Unresolved Staff Comments
Not required for smaller reporting
companies.
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