What changed in this filing

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Item 7. Management’s Discussion and Analysis

2023-03-10 compared with 2022-03-11 · 210 added, 427 removed, 481 unchanged (57% of the section changed)

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Its wholly-owned subsidiary, Unity Bank (the “Bank” or, when consolidated with the Parent Company, the “Company”) is chartered by the New Jersey Department of Banking and Insurance and commenced operations on September 13, 1991.

The Bank provides a full range of commercial and retail banking services through the Internet and its nineteen branch offices located in Bergen, Hunterdon, Middlesex, Somerset, Union and Warren counties in New Jersey, and Northampton County in Pennsylvania.

The Bank provides a full range of commercial and retail banking services through the Internet and its nineteen branch offices located in Bergen, Hunterdon, Middlesex, Ocean, Somerset, Union and Warren counties in New Jersey and Northampton County in Pennsylvania.

These services include the acceptance of demand, savings and time deposits and the extension of consumer, real estate, Small Business Administration ("SBA") and other commercial credits.

The Bank has multiple subsidiaries used to hold part of its investment and loan portfolios.

Results of Operations

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Highlights for the year include:

● Net income before tax increased 54.7 percent to $48.1 million from $31.1 million in the prior year.

● Net interest income increased $12.6 million or 19.6 percent to $77.0 million from $64.4 million in the prior year, due to commercial loan growth, receipt of SBA PPP loan fees on forgiveness and residential construction loan growth.

● Net income before provision for income taxes increased 6.8 percent to $51.4 million from $48.1 million in the prior year.

● Net interest income increased $13.1 million, or 17.0 percent, to $90.1 million from $77.0 million in the prior year, primarily due to additional interest income resulting from commercial, residential mortgage and residential construction loan growth.

● Net interest margin increased 24 basis points to 4.40 percent compared to 4.16 percent in the prior year.

● Noninterest income was $12.1 million, an $892 thousand decrease compared to $12.9 million in the prior year, primarily due to a decrease in the volume of residential mortgage loan sales and a decision to not sell SBA available for sale loans in the latter half of 2021, partially offset by an increase in servicing and loan fee income.

● Noninterest income was $8.0 million, a 33.3 percent decrease compared to $12.1 million in the prior year, primarily due to a decrease in the volume of residential mortgage loan sales and net unrealized securities losses in the current year.

● Noninterest expense totaled $42.6 million, an increase of $1.8 million when compared to $40.8 million in the prior year.

The increase was primarily due to increased compensation expenses and a one-time adjustment in retirement benefit calculation.

The increase was primarily due to increased compensation and benefits expenses.

● The effective tax rate increased to 25.2 percent compared to 25.0 percent in the prior year.

● A 1.3 percent increase in total loans driven by a 38.3 percent increase in residential construction loans and a 10.9 percent increase in commercial loans.

● Total gross loans increased $457.1 million, or 27.7 percent from the prior year.

The increase was driven by a 47.8 percent increase in residential mortgage loans, a 35.6 percent increase in residential construction loans and a 27.5 percent increase in commercial loans.

SBA PPP loans decreased 87.3 percent or $40.5 million due to loans being forgiven and paid off.

● A 12.9 percent increase in total deposits with a 52.4 percent increase in savings deposits, a 19.5 percent increase in interest-bearing demand deposits and a 15.1 percent increase in non-interest bearing demand deposits.

● Total deposits increased $28.6 million, or 1.6 percent from the prior year.

The increase was primarily driven by interest-bearing demand deposits and time deposits, partially offset by decreases in noninterest-bearing demand deposits and savings.

● Total securities increased $61.6 million, or 77.7 percent from the prior year.

The increase was primarily driven by purchases of debt securities classified as available for sale and held to maturity in the current year.

● Total borrowed funds increased $343 million, or 857.5 percent from the prior year.

The increase was due to loan demand.

The Company’s performance ratios for the past three years are listed in the following table:

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It is defined as noninterest expense divided by the sum of net interest income plus noninterest income, less any gains or losses on securities.

On March 13, 2020, the Coronavirus Disease (“COVID-19”) pandemic was declared a national emergency by the President of the United States.

The spread of COVID-19 has negatively impacted the national and local economy, disrupted supply chains and increased unemployment levels.

In response to the COVID-19 pandemic, many businesses have been faced with restrictions in an effort to prioritize public health.

The initial temporary closure and gradual reopening of many businesses and the implementation of social distancing and stay-at-home policies as new variants have spread, has impacted many of the Company’s customers.

The Company is committed to supporting its customers, employees and communities during this difficult time and has adapted to the changing environment.

We have taken and continue taking steps to protect the health and safety of our employees and to work with our customers experiencing economic consequences from the epidemic.

The Company has and is working with its loan customers to provide short term payment deferrals and to waive certain fees.

These accommodations are likely to have a negative impact on the Company’s results of operations during the duration of the epidemic, and depending on how quickly the businesses of our customers rebound after the emergency, could lead to an increase in nonperforming assets.

The full impact of the pandemic remains unknown and continues to evolve.

The outbreak has had a significant adverse impact on certain industries the Company serves, including retail, accommodations, and restaurants and food services.

Although the COVID-19 pandemic continues, the restrictions that have been in place for over a year are beginning to loosen in many areas as vaccines are administered and people start to feel safer.

However, some of this progress has been interrupted by the spread of new variants of the virus.

It is still unknown what changes in the behavior of customers, businesses and their employees will result from the COVID-19 pandemic.

While states have re-opened, several restrictions remain in place, which have resulted in lower commercial activity and consumer spending.

This decrease in commercial activity may result in our customers' inability to meet their loan obligations to us.

In addition, the economic pressures and uncertainties related to the COVID-19 pandemic have resulted in changes in consumer spending behaviors, which may negatively impact the demand for loans and other services we offer.

Because of the significant uncertainties related to the ultimate duration of the COVID-19 pandemic and its effects on our customers and prospects, and on the local and national economy, there can be no assurances as to how the crisis may ultimately affect the Company's loan portfolio, and business as a whole.

The extent of such impact will depend on future developments,

which remain uncertain.

As such, the Company could be subject to certain risks, any of which could have a material, adverse effect on our business, financial condition, liquidity, and results of operations.

On March 27, 2020, the Coronavirus Aid, Relief, and Economic Security (“CARES”) Act was signed into law.

It contained substantial tax and spending provisions intended to address the impact of the COVID-19 pandemic.

The CARES Act included a range of other provisions designed to support the U.S.

economy and mitigate the impact of COVID-19 on financial institutions and their customers, including through the authorization of various relief programs and measures that the U.S.

Department of the Treasury, the Small Business Administration, the Federal Reserve Board (“FRB”) and other federal banking agencies have implemented or may implement.

The CARES Act provided assistance to small businesses through the establishment of the Paycheck Protection Program ("PPP").

The PPP provided small businesses with funds to pay up to 24 weeks of payroll costs, including certain benefits.

The funds were provided in the form of loans that would be fully or partially forgiven when used for payroll costs, interest on mortgages, rent, and utilities.

The payments on these loans were deferred for up to six months.

Loans made after June 5, 2020, mature in five years, and loans made prior to June 5, 2020, mature in two years but can be extended to five years if the lender agrees.

Forgiveness of the PPP loans is based on the employer maintaining or quickly rehiring employees and maintaining salary levels.

Most small businesses with 500 or fewer employees were eligible.

Applications for the PPP loans started on April 3, 2020 and the application period was extended to August 8, 2020, and then reopened pursuant to the terms of the Economic Aid Act discussed below.

As an existing SBA 7(a) lender, the Company opted to participate in the program.

The Company approved 1,224 applications and provided fundings of approximately $143.0 million during the year ended December 31, 2020.

The Company has $1.9 million of PPP loans originated under the CARES Act remaining on our balance sheet as of December 31, 2021 and believes that the majority of these loans will be forgiven by the SBA.

Economic Aid Act

On December 27, 2020, the Economic Aid to Hard-Hit Small Businesses, Nonprofits, and Venues (“Economic Aid”) Act was signed into law.

It provided additional assistance to the hardest-hit small businesses, nonprofits, and venues that were struggling to recover from the impact of the COVID-19 pandemic.

The Economic Aid Act provided funding for a new application period for PPP loans, a second round of PPP loans for small businesses and nonprofits experiencing significant revenue losses, made programmatic improvements to PPP, funded grants to shuttered venues, and enacted emergency enhancements to other SBA lending programs.

The PPP allowed certain eligible borrowers that previously received a PPP loan to apply for a Second Draw PPP Loan with the same general loan terms as their First Draw PPP Loan, and for borrowers that did not initially receive a PPP loan to apply for one.

Most small businesses with 300 or fewer employees that could demonstrate at least a 25% reduction in gross receipts between comparable quarters in 2019 and 2020 were eligible.

Applications for PPP loans under the Economic Aid Act started on January 13, 2021 and were available until March 31, 2021.

The Company participated in the re-opened PPP loan process.

The Company approved 955 applications and provided fundings of approximately $101.0 million under the Economic Aid Act.

As of December 31, 2021, the Company has $44.6 million of PPP loans originated under the Economic Aid Act in its portfolio.

On March 22, 2020, the federal bank regulatory agencies issued an “Interagency Statement on Loan Modifications and Reporting for Financial Institutions Working with Customers Affected by the Coronavirus.” This guidance encourages financial institutions to work prudently with borrowers that may be unable to meet their contractual obligations because of the effects of COVID-19.

The guidance goes on to explain that, in consultation with the FASB staff, the federal bank regulatory agencies concluded that short-term modifications made on a good faith basis to borrowers who were current

as of the implementation date of a relief program are not Troubled Debt Restructurings (“TDRs”).

Section 4013 of the CARES Act also addresses COVID-19 related modifications and specifies that COVID-19 related modifications on loans that were current as of December 31, 2019, are not TDRs.

Beginning in March 2020, the Company proactively communicated with its customers to address their financial needs.

The Company worked closely with its customers to educate and guide them on their options for financial assistance, including disaster loans, the PPP and payment relief through deferrals and waived fees.

As a result of our proactive approach to provide financial assistance to our customers, loans have been modified through payment deferrals and are not categorized as TDRs, in accordance with regulatory guidance and the CARES Act.

The table below summarizes the loans that are in deferral as of December 31, 2021:

(In thousands)

Total loan portfolio balance

Unpaid principal balance of full deferrals

Unpaid principal balance of principal only deferrals

Unpaid principal balance on deferral

% total deferrals to total loans

SBA loans held for sale

SBA loans held for investment

SBA PPP loans

Commercial loans

Residential mortgage loans

Consumer loans

Residential construction loans

Consent Order

In July 2020, Unity Bank agreed to the issuance of a Consent Order by the Federal Deposit Insurance Corporation (“FDIC”) and agreed to an Acknowledgement and Consent of the FDIC Consent Order with the Commissioner of Banking and Insurance for the State of New Jersey.

The Consent Order requires the Bank to strengthen its Bank Secrecy Act (“BSA”)/anti-money laundering (“AML”) program, and to address related matters.

The Bank hired a consulting firm to assist management in effectively addressing all matters pertaining to the Consent Order.

Although the Bank believes it is complying with all requirements of the Consent Order, we can give no assurance that the FDIC and the NJDOBI will agree that the Bank is fully complying or that the Bank will not incur material additional expense in complying with the Consent Order.

The full impact of the Coronavirus Disease (“COVID-19”) pandemic remains unknown and continues to evolve.

The outbreak has had a significant adverse impact on certain industries the Company serves, including retail, accommodations, restaurants and food services.

It is unknown how long the adverse conditions associated with the COVID-19 pandemic will last and what the complete financial effect will be to the Bank.

It is reasonably possible that estimates made in the financial statements could be materially impacted in the near term as a result of these conditions.

The Company continues to monitor the impact closely, including its impact on employees, customers, communities and results of operations and the impact of other government or Federal Reserve actions.

The Coronavirus Aid, Relief, and Economic Security (CARES) Act provided funding for the SBA’s Paycheck Protection Program (PPP) and established rules for qualifying borrowers to receive loan forgiveness by the SBA under this program.

The Company approved 1,224 applications and provided funding of approximately $143.0 million during the year ended December 31, 2020.

As of December 31, 2022, the Company had no PPP loans originated under the CARES Act remaining on its balance sheet.

The Economic Aid to Hard-Hit Small businesses, Nonprofits and Venues (“Economic Aid”) Act provided additional assistance to the hardest-hit small businesses, nonprofits, and venues that were struggling to recover from the impact of the COVID-19 Pandemic.

The Company approved 955 applications and provided funding of approximately $101.0 million under the Economic Aid Act.

As of December 31, 2022, the Company had $5.9 million of PPP loans originated under the Economic Aid Act in its portfolio.

Additionally, in accordance with provisions set forth by the CARES Act and regulatory guidance, the Company provided financial assistance through loan payment deferrals and waived fees.

The Company has no outstanding loans remaining that would qualify for the payment deferral period as set forth by the CARES Act and regulatory guidance.

Net Interest Income

The primary source of the Company’s operating income is net interest income, which is the difference between interest and dividends earned on earning assets and fees earned on loans, and interest paid on interest-bearing liabilities.

Earning assets include loans to individuals and businesses, investment securities, interest-earning deposits and federal funds sold.

The primary source of the Company’s operating income is net interest income, which is the difference between interest and dividends earned on interest-earning assets and fees earned on loans, versus interest paid on interest-bearing liabilities.

Interest-earning assets include loans to individuals and businesses, investment securities and interest-earning deposits.

Interest-bearing liabilities include interest-bearing demand, savings and time deposits, FHLB advances and other borrowings.

Net interest income is determined by the difference between the yields earned on earning assets and the rates paid on interest-bearing liabilities (“net interest spread”) and the relative amounts of earning assets and interest-bearing liabilities.

The Company’s net interest spread is affected by regulatory, economic and competitive factors that influence interest rates, loan demand, deposit flows and general levels of nonperforming assets.

Net interest income is determined by the difference between the yields earned on interest-earning assets and the rates paid on interest-bearing liabilities (“net interest spread”) and the relative amounts of interest-earning assets and interest-bearing liabilities.

The Company’s net interest spread is affected by regulatory, economic and

competitive factors that influence interest rates, loan demand, deposit demand and general levels of nonperforming assets.

2022 compared to 2021

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The net interest margin increased 24 basis points to 4.40 percent for the year ended December 31, 2022, compared to 4.16 percent for the same period in 2021.

The net interest spread was 4.15 percent for 2022, a 20 basis point increase compared to 3.95 for the same period in 2021.

During 2022, tax-equivalent interest income was $100.7 million, an increase of $16.0 million, or 18.8 percent, when compared to the same period in the prior year.

This increase was mainly driven by increases in the balance of average loans, the yield on loans, the balance of average securities and the yield on securities.

● Of the $16.0 million increase in interest income on a tax-equivalent basis, $9.2 million was due to the increased volume of interest-earning assets and $6.8 million was due to increased yields on average interest-earning assets.

● The average volume of interest-earning assets increased $196.9 million to $2.0 billion for 2022 compared to $1.9 billion for 2021.

This was primarily due to a $165.3 million increase in average loans, with growth in all portfolios except SBA PPP loans.

The increase was complemented by a $77.3 million increase in investment securities, partially offset by a $47.9 million decrease in interest-bearing deposits.

● The yield on total interest-earning assets increased 34 basis points to 4.92 percent for the year ended December 31, 2022 when compared to 2021.

The yield on the loan portfolio increased 12 basis points to 5.13 percent.

Total interest expense was $10.6 million in 2022, an increase of $2.9 million or 37.3 percent compared to 2021.

This increase was primarily driven by the increased rates and volume of savings deposits and increased volume of borrowed funds and subordinated debentures:

● Of the $2.9 million increase in interest expense, $1.8 million was due to increased rates on interest-bearing liabilities while $1.1 million was due to the increased volume of average interest-bearing liabilities.

● The average cost of interest-bearing liabilities increased 14 basis points to 0.77 percent in 2022 when compared to 2021.

The cost of interest-bearing deposits increased 1 basis point in 2022.

The cost of borrowed funds and subordinated debentures increased 129 basis points in 2022.

● Interest-bearing liabilities averaged $1.4 billion in 2022, an increase of $141.9 million or 11.5 percent, compared to 2021.

The increase in interest-bearing liabilities was primarily due to an increase in savings, interest-bearing demand deposits and borrowed funds, partially offset by a decrease in time deposits.

2021 compared to 2020

During 2021, tax-equivalent net interest income amounted to $77.0 million, an increase of $12.6 million or 19.6 percent when compared to the same period in 2020.

The net interest margin increased 31 basis points to 4.16 percent for the year ended December 31, 2021 compared to 3.85 percent for the same period in 2020.

The net interest spread was 3.95 percent for 2021, a 47 basis point increase compared to the same period in 2020.

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The increase in interest-bearing liabilities was primarily due to an increase in savings and interest-bearing demand deposits offset by decreases in time deposits and borrowed funds.

2020 compared to 2019

Tax-equivalent net interest income amounted to $64.4 million in 2020, an increase of $6.8 million from $57.6 million in 2019.

The Company’s net interest margin decreased 10 basis points to 3.85 percent in 2020, compared to 3.95 percent in 2019.

The net interest spread was 3.48 percent, a decrease of 6 basis points from 3.54 percent in 2019.

During 2020, tax-equivalent interest income was $78.9 million, an increase of $3.2 million or 4.3 percent when compared to 2019.

This increase was driven primarily by the increase in the average volume of loans:

● Of the $3.2 million increase in interest income on a tax-equivalent basis, $8.6 million of the increase was due primarily to the increased volume of earning assets offset by a $5.4 million decline related to a decrease in yields on average interest-earning assets.

● The yield on interest-earning assets decreased 47 basis points to 4.71 percent in 2020 when compared to 2019.

● The average volume of interest-earning assets increased $214.4 million to $1.7 billion in 2020 compared to $1.5 billion in 2019.

This was due primarily to a $197.2 million increase in average loans, primarily SBA, PPP, commercial, residential mortgage and consumer loans, and a $25.2 million increase in average federal funds and interest-bearing deposits, partially offset by a $8.0 million decrease in average investment securities.

Total interest expense was $14.5 million in 2020, a decrease of $3.6 million or 19.8 percent compared to 2019.

This decrease was driven by the decreased rates on interest-bearing deposits, partially offset by an increase in the average volume of interest-bearing deposits:

● Of the $3.6 million decrease in interest expense, $4.8 million was due to decreased rates on interest-bearing liabilities, partially offset by an increase of $1.2 million in the volume of average interest-bearing liabilities.

● The average cost of interest-bearing liabilities decreased 41 basis points to 1.23 percent in 2020 when compared to 2019.

The cost of interest-bearing deposits and borrowed funds and subordinated debentures decreased 41 basis points and 35 basis points, respectively, in 2020.

● Interest-bearing liabilities averaged $1.2 billion in 2020, an increase of $75.7 million or 6.9 percent, compared to 2019.

The increase in interest-bearing liabilities was primarily due to an overall increase in time, savings, and interest-bearing demand deposits.

Consolidated Average Balance Sheets

The following table reflects the components of net interest income, setting forth for the periods presented herein:

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Rates/yields are computed on a fully tax-equivalent basis, assuming a federal income tax rate of 21 percent.

Consolidated Average Balance Sheets

(Dollar amounts in thousands, interest amounts and interest rates/yields on a fully tax-equivalent basis)

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Total securities (A)

SBA PPP loans

Commercial loans

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Provision for Loan Losses

The provision for loan losses totaled $181 thousand for 2021, $7.0 million in 2020 and $2.1 million in 2019.

The provision for loan losses totaled $4.2 million for 2022, $0.2 million in 2021 and $7.0 million in 2020.

During 2020 the provision for loan losses was elevated due to uncertainty and the risk of loan defaults related to COVID-19.

The provision for loan losses decreased $6.8 million for the year ended 2021 due to a reduction of specific reserves on impaired loans.

The provision for loan losses increased $4.0 million for the year ended 2022 primarily due to the sizeable increase in total loans, as well as management's view of current economic conditions.

Each period’s loan loss provision is the result of management’s analysis of the loan portfolio and reflects changes in the size and composition of the portfolio, the level of net charge-offs, delinquencies, current economic conditions and other internal and external factors impacting the risk within the loan portfolio.

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Gain on sale of mortgage loans, net

Net security gains

Gain on sale of premises and equipment

Net securities (losses) gains

Total noninterest income

2021 compared to 2020

Noninterest income was $12.1 million for 2021, an $892 thousand decrease compared to $12.9 million for 2020.

This decrease was primarily due to decreased gains on sales of mortgages and SBA loans held for sale.

Changes in noninterest income reflect:

● Branch fee income increased $84 thousand to $1.1 million when compared to 2020, primarily due reduced overdraft and transaction fees in 2020 related to COVID-19 compared to 2021.

● Service and loan fee income increased $1.0 million in 2021, primarily due to an increase in loan payoff charges and loan prepayment penalties.

● Net gains on the sale of SBA loans decreased $901 thousand in 2021 as a result of management’s decision to not sell SBA available for sale loans in the latter half of the year.

SBA loan sales totaled $5.37 million in 2021 and $18.2 million in 2020.

● Gains on sales of mortgage loans decreased $1.8 million in 2021 as a result of a volume decrease.

During the year, $255.5 million in residential mortgage loans were sold at a gain of $4.6 million compared to $290.8 million in loans sold at a gain of $6.3 million during the prior year.

● BOLI income increased $76 thousand from prior year, primarily due to a death benefit received.

● Gains on sales of securities totaled $43 thousand in 2021, compared to $322 thousand in 2020.

Gains of $561 thousand were realized from the increase in market value of equity securities in 2021, compared to a decrease of $229 thousand in 2020.

● There were no gains on sale of premises and equipment in 2021.

● Other income increased $95 thousand, primarily due to an increase in card interchange fees.

2020 compared to 2019

Noninterest income was $12.9 million for 2020, a $3.4 million increase compared to $9.5 million for 2019.

This increase was primarily due to increased gains on sales of mortgages

Changes in noninterest income reflect:

● Branch fee income decreased $456 thousand to $1.0 million when compared to 2019, primarily due to a decrease in overdraft fees and transactions as a result of COVID-19.

● Service and loan fee income, which consists of prepayment fees, application fees and servicing fees, decreased $223 thousand in 2020, primarily due to lower loan late charges from waived fees for customers during the COVID-19 pandemic.

● Net gains on the sale of SBA loans increased $733 thousand in 2020 as a result of higher premiums on loan sales.

In 2020, $18.2 million in SBA loans were sold compared to $14.9 million in the prior year.

● Gains on sales of mortgage loans increased $4.2 million in 2020 as a result of a volume increase.

During the year, $290.8 million in residential mortgage loans were sold at a gain of $6.3 million compared to $120.2 million in loans sold at a gain of $2.1 million during the prior year.

● BOLI income increased $25 thousand from prior year.

● Gains on sales of securities totaled $322 thousand in 2020, compared to $52 thousand in 2019.

In 2020, these gains were partially offset by $229 thousand from the decrease in the market value of equity securities, as compared to an increase of $321 thousand in 2019.

● There were no gains on sale of premises and equipment in 2020.

The 2019 gain in premises and equipment was primarily due to the sale of our Union, NJ branch building.

● Other income increased $120 thousand, primarily due to an increase in wire transfer fee income.

Noninterest income was $8.0 million for 2022, a $4.0 million decrease compared to $12.1 million for 2021.

This decrease was primarily due to decreased realized gains on sales of mortgages and net unrealized securities losses.

The decreased realized gains on sales of mortgages was primarily due to an industry-wide trend of decreased volume in conforming residential loan originations as interest rates rose in 2022.

Noninterest income was $12.1 million for 2021, a $0.9 million decrease compared to $12.9 million for 2020.

This decrease was primarily due to decreased realized gains on sales of mortgages and SBA loans held for sale.

Noninterest Expense

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Director fees

Loan collection & OREO expenses

Loan collection expenses

Other expenses

Total noninterest expense

2021 compared to 2020

Noninterest expense totaled $42.6 million for the year ended December 31, 2022, an increase of $1.8 million when compared to $40.8 million in 2021.

The majority of this increase is attributable to increased salary expenses and a one-time deferred compensation adjustment.

Changes in noninterest expense reflect:

● Compensation and benefits expense, the largest component of noninterest expense, increased $1.6 million for the year ended December 31, 2021, when compared to 2020.

The yearly increase is primarily due to increased salary expenses and a one-time deferred compensation adjustment.

● Processing and communications, which includes items processed and electronic banking fees, decreased $105 thousand for the year ended December 31, 2021 when compared to 2020.

● Occupancy expense increased $118 thousand in 2021 when compared to 2020 primarily due to increased ground maintenance and rent expenses.

● Furniture and equipment expense, which includes network and software maintenance, decreased $16 thousand in 2021.

● Professional service fees increased $293 thousand in 2021, primarily due to higher legal and consulting related expenses.

● Advertising expenses increased $330 thousand for the year ended December 31, 2021, versus 2020 primarily due to increased initiatives in mortgage advertising and community related events and a reduced level of marketing expenses in 2020 as a result of COVID-19.

● Other loan expenses, which consist of expenses such as appraisals, filings and credit reports, increased $300 thousand in 2021, when compared to 2020 primarily due to SBA expense reimbursements.

● Deposit insurance expense increased $170 thousand in 2021 when compared to 2020

● Director fees increased $37 thousand in 2021 when compared to 2020.

● BSA expenses were $701 thousand in 2021 due to consulting expenses in connection with BSA/AML remediation related to the Bank’s Consent Order.

● Loan collection and OREO expenses decreased $80 thousand in 2021, primarily due to the sale of all OREO properties.

● Other expenses decreased $75 thousand in 2021.

2020 compared to 2019

The majority of this increase is primarily attributable to increased compensation and benefits, reflecting ordinary course increases, as well as increased competition for employees.

Noninterest expense totaled $40.8 million for the year ended December 31, 2021, an increase of $1.5 million when compared to $39.3 million in 2020.

The majority of this increase is attributable to increased compensation due to mortgage commissions paid on a higher origination volume and expenses related to enhancing our BSA program and complying with our Consent Order with the FDIC and NJDOBI.

Changes in noninterest expense reflect:

● Compensation and benefits expense, the largest component of noninterest expense, increased $2.5 million for the year ended December 31, 2020, when compared to 2019.

The yearly increase is primarily due to increased mortgage commissions on a higher origination volume.

● Processing and communications, which includes items processed and electronic banking fees, increased $231 thousand for the year ended December 31, 2020 when compared to 2019, primarily due to data processing expenses.

● Furniture and equipment expense, which includes network and software maintenance, decreased $288 thousand in 2020.

● Occupancy expense decreased $107 thousand in 2020 when compared to 2019.

● BSA expenses were $1.8 million in 2020 due to consulting expenses in connection with BSA/AML remediation related to the Bank’s Consent Order.

● Professional service fees increased $83 thousand in 2020, primarily due to higher external audit and tax expenses.

● Advertising expenses decreased $452 thousand for the year ended December 31, 2020, versus 2019 primarily due to decreased community relations expenses and marketing event related expenses due to the impact of COVID-19.

● Director fees increased $101 thousand in 2020 when compared to 2019.

● Other loan expenses, which consist of expenses such as appraisals, filings and credit reports, increased $350 thousand in 2020, when compared to 2019.

● Deposit insurance expense increased $373 thousand in 2020 when compared to 2019 primarily due to a $279 FDIC assessment credit in 2019.

● Loan collection and OREO expenses increased $174 thousand in 2020, primarily due to increased property tax expenses on OREO properties.

● Other expenses decreased $178 thousand in 2020 when compared to 2019, primarily due to lower officer and employee expenses.

The majority of this increase is primarily attributable to increased salary expenses and a one-time deferred compensation adjustment.

Income Tax Expense

For 2022, the Company reported income tax expense of $13.0 million for an effective tax rate of 25.2%, compared to an income tax expense of $12.0 million and an effective tax rate of 25.0% in 2021 and an income tax expense of $7.5 million and an effective tax rate of 24.0% in 2020.

On July 1, 2018, New Jersey’s Assembly Bill 4202 was signed into law.

The bill, effective January 1, 2018, imposed a temporary surtax on corporations earning New Jersey allocated income in excess of $1 million at a rate of 2.5% for tax years beginning on or after January 1, 2018 through December 31, 2019, and at a rate of 1.5% for years beginning on or after January 1, 2020, through December 31, 2021.

In addition, New Jersey adopted mandatory unitary combined reporting for its Corporation Business Tax.

On September 29, 2020, New Jersey’s Assembly Bill 4721 was signed into law.

The bill, retroactively effective January 1, 2020, extends the 2.5% corporate income surtax until December 31, 2023.

For additional information on income taxes, see Note 11 to the Consolidated Financial Statements.

Financial Condition

Total assets were $2.0 billion at December 31, 2021 and December 31, 2020, respectively.

The commercial loan portfolio increased by $91.9 million, the consumer construction and other consumer loan portfolios increased by $33.4 million and $11.8 million, respectively.

The increases were offset by a decrease of $58.2 million in the residential mortgage portfolio and a decrease of $57.3 million in the SBA Portfolio, which houses our PPP loan portfolio.

The investment portfolio increased $31.8 million primarily due to purchases, and Federal Home Loan Bank Stock decreased by $7.0 million due to a decrease in borrowings and their stock ownership requirements.

Total deposits increased $200.9 million, primarily due to increases of $69.6 million in noninterest-bearing demand deposits, $238.7 million in savings deposits, and $39.8 million in interest-bearing demand deposits, partially offset by a decrease of $147.2 million in time deposits.

Borrowed funds decreased $160.0 million to $40.0 million at December 31, 2021.

Total shareholders’ equity increased $31.8 million from year end 2020, primarily due to net income from operations, less dividends paid on our common stock.

Net income was $36.1 million for the year ended December 31, 2021, an increase of $12.5 million from the prior year.

Other changes in shareholder’s equity included an increase in accumulated other comprehensive income of $1.5 million, common stock dividends of $3.7 million paid in 2021 and treasury stock purchases of $4.2 million.

Total assets increased $411.2 million or 20.2 percent, to $2.4 billion at December 31, 2022, when compared to year end 2021.

This increase was primarily due to increases of $457.1 million in gross loans, mostly due to commercial, residential mortgage and residential construction loan growth, partially offset by SBA PPP loans forgiven and paid off.

Total assets also included an increase of $61.6 million in total securities, offset a decrease of $130.0 million in cash and cash equivalents.

Total deposits increased $28.6 million, due to increases of $133.9 million in time deposits and $32.1 million in interest-bearing demand deposits, offset by a decrease of $102.3 million in savings deposits and $35.0 million in noninterest-bearing demand deposits.

Borrowed funds increased $343.0 million to $383.0 million at December 31, 2022.

Total shareholders’ equity increased $33.5 million over year end 2021, due to earnings and an increase in common stock, offset by dividends paid and net accumulated other comprehensive losses.

These fluctuations are discussed in further detail in the sections that follow.

The Company’s securities portfolio consists of available for sale (“AFS”) debt securities, held to maturity (“HTM”) securities, and equity investments.

The Company’s securities portfolio consists of available for sale (“AFS”) debt securities, held to maturity (“HTM”) debt securities and equity investments.

Management determines the appropriate security classification of AFS and HTM at the time of purchase.

The investment securities portfolio is maintained for asset-liability management purposes, as well as for liquidity and earnings purposes.

The following table provides the major components of AFS debt securities, HTM debt securities and equity investments at their carrying value as of December 31, 2022 and December 31, 2021:

(In thousands)

December 31, 2022

December 31, 2021

Available for sale, at fair value:

Government sponsored entities

State and political subdivisions

Residential mortgage-backed securities

Corporate and other securities

Total securities available

Held to maturity, at amortized cost:

Government sponsored entities

State and political subdivisions

Residential mortgage-backed securities

Total securities held to

Equity Securites, at fair value:

Total Equity Securites

AFS debt securities are investments carried at fair value that may be sold in response to changing market and interest rate conditions or for other business purposes.

Activity in this portfolio is undertaken primarily to manage liquidity and interest rate risk, to take advantage of market conditions that create economically attractive returns and as an additional source of earnings.

AFS debt securities consist primarily of obligations of state and political subdivisions, mortgage-backed securities, asset backed securities, corporate and other securities.

Activity in this portfolio is undertaken primarily to manage liquidity and

interest rate risk, to take advantage of market conditions that create economically attractive returns and as an additional source of earnings.

AFS debt securities consist primarily of obligations of U.S.

government sponsored entities, state and political subdivisions, mortgage-backed securities and corporate and other securities.

AFS debt securities totaled $95.4 million at December 31, 2022, an increase of $38.9 million or 68.9 percent, compared to $56.5 million at December 31, 2021.

This net increase was the result of:

● Purchase of $49.3 million,

● $4.5 million in principal payments, maturities and called bonds,

● $7.0 million in sales net of realized gains, which consisted of six corporate bonds,

● $343 thousand of appreciation in the market value of the portfolio.

At December 31, 2021, the portfolio had a net unrealized gain of $38 thousand compared to a net unrealized loss of $304 thousand at

December 31, 2020.

These net unrealized losses and gains are reflected net of tax in shareholders’ equity as accumulated other comprehensive income,

● $205 thousand in net amortization, and

● An increase of $30.3 million from the purchase of thirteen asset backed securities and four corporate bonds.

● $5.8 million of depreciation in the market value of the portfolio.

At December 31, 2022, the portfolio had a net unrealized loss of $5.8 million compared to a net unrealized gain of $38 thousand at December 31, 2021.

These net unrealized losses and gains are reflected net of tax in shareholders’ equity as accumulated other comprehensive income, and

● $0.1 million in net amortization.

The weighted average life of AFS debt securities, adjusted for prepayments, amounted to 6.4 years and 6.9 years at December 31, 2022 and 2021, respectively.

The effective duration of AFS debt securities amounted to 1.9 and 3.1 at December 31, 2022 and December 31, 2021, respectively.

HTM securities, which are carried at amortized cost, are investments for which there is the positive intent and ability to hold to maturity.

The portfolio was comprised of obligations of U.S.

Government and obligations of state and political subdivisions.

HTM debt securities totaled $14.3 million at December 31, 2021 compared to no HTM securities at December 31, 2020.

The portfolio is comprised of obligations of the U.S.

Government and its agencies, obligations of state and political subdivisions and mortgage-backed securities.

HTM debt securities totaled $35.8 million at December 31, 2022, an increase of $21.5 million, or 150.5 percent, compared to $14.3 million at December 31, 2021.

The increase was due to:

● $7.6 million in principal payments,

● $4 thousand of depreciation in the market value of the portfolio and

● An increase of $21.9 million from the purchase of three agency notes/ bonds and three mortgage-backed securities.

● Purchases of $26.7 million,

● $5.3 million in principal payments, and

● $0.1 million of net accretion.

The weighted average life of HTM securities, adjusted for prepayments, amounted to 18.0 years and 14.0 years at December 31, 2022 and December 31, 2021, respectively.

As of December 31, 2022, the fair value of HTM securities was $28.6 million, compared to $14.2 million at December 31, 2021.

The effective duration of HTM securities amounted to 10.5 and 5.6 at December 31, 2022 and December 31, 2021, respectively.

Equity securities are investments carried at fair value that may be sold in response to changing market and interest rate conditions or for other business purposes.

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Equity securities consist of Community Reinvestment Act ("CRA") investments and the equity holdings of financial institutions.

Equity securities totaled $8.6 million at December 31, 2021, an increase of $6.6 million, compared to $2.0 million at December 31, 2020.

Equity securities totaled $9.8 million at December 31, 2022, an increase of $1.2 million, or 14.3 percent, compared to $8.6 million at December 31, 2021.

This net increase was the result of:

● The purchase of two additional equity holdings of financial institutions for $3.5 million and $2.6 million in additional CRA investments,

● $565 thousand in market value adjustments throughout the year, and

● $53 thousand in sales net of realized loss from the sale of one community bank holding.

The average balance of taxable securities amounted to $43.8 million in 2021 compared to $52.7 million in 2020.

The average yield earned on taxable securities decreased 26 basis points to 2.96 percent in 2021, from 3.22 percent in 2020.

The average balance of tax-exempt securities amounted to $1.6 million in 2021 compared to $3.1 million in 2020.

The average yield earned on tax-exempt securities increased 1 basis point to 2.45 percent in 2021, from 2.44 percent in 2020.

Securities with a carrying value of $1.2 million and $1.6 million at December 31, 2021 and December 31, 2020, respectively, were pledged to secure other borrowings, collateralize hedging instruments and for other purposes required or permitted by law.

Approximately 48 percent of the total investment portfolio had a fixed rate of interest at December 31, 2021 and December 31, 2020.

● The purchase of $2.5 million, including $1.0 million in additional CRA investments, and

● $1.3 million decrease in market value adjustments throughout the year.

The following table provides the remaining contractual maturities and average yields within the investment portfolios.

The carrying value of securities at December 31, 2022 is distributed by contractual maturity.

Mortgage-backed securities and other securities, which may have principal prepayment provisions, are distributed based on contractual maturity.

Expected maturities will differ materially from contractual maturities as a result of early prepayments and calls.

Within one year

After one through five years

After five through ten years

After ten years

Total carrying value

(In thousands, except percentages)

Available for sale at fair value:

Government sponsored entities

State and political subdivisions

Residential mortgage-backed securities

Corporate and other securities

Total debt securities available for sale

Held to maturity at cost

Government sponsored entities

State and political subdivisions

Residential mortgage-backed securities

Total debt securities held for maturity

Equity Securities at fair value:

Total equity securities

Securities with a carrying value of $835 thousand and $1.2 million at December 31, 2022 and December 31, 2021, respectively, were pledged to secure other borrowings, collateralize hedging instruments and for other purposes required or permitted by law.

Approximately 63 percent of the total investment portfolio had a fixed rate of interest at December 31, 2022, compared to 48 percent at December 31, 2021.

For additional information on securities, see Note 2 to the Consolidated Financial Statements.

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Total loans were $2.1 billion at December 31, 2022, an increase of $457.1 million or 27.7 percent when compared to year end 2021.

Commercial, residential construction, SBA and consumer loans increased $91.9 million, $33.4 million, $14.5 million and $11.8 million, respectively, partially offset by a decrease of $71.8 million and $58.2 million in SBA PPP and residential loans, respectively.

The following table sets forth the classification of loans by major category, including unearned fees, deferred costs and excluding the allowance for loan losses at December 31 st for the past five years:

Commercial, residential mortgage, residential construction and SBA loans increased $255.8 million, $195.7 million, $42.9 million and $2.9 million, respectively, partially offset by a decrease of $40.5 million in SBA PPP loans, reflecting forgiveness and payoff of these loans.

The following table sets forth the classification of loans by major category, including unearned fees, deferred costs and excluding the allowance for loan losses as of December 31, 2022 and December 31, 2021:

(In thousands, except percentages)

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Average loans increased $165.3 million or 10.0 percent from $1.7 billion in 2021, to $1.8 billion in 2022.

The increase in average loans was due to increases in average commercial, PPP, residential construction and SBA loans.

The increase in average loans was due to increases in average commercial, residential mortgage, residential construction, SBA and consumer loans.

The yield on the overall loan portfolio increased 12 basis points to 5.13 percent for the year ended December 31, 2022, compared to 5.01 percent for the prior year.

SBA 7(a) loans, on which the SBA historically has provided guarantees of up to 90 percent of the principal balance, are considered a higher risk loan product for the Company than its other loan products.

These loans are made for the purposes of providing working capital and for financing the purchase of equipment, inventory or commercial real estate.

These loans are made to small businesses for the purposes of providing working capital and for financing the purchase of equipment, inventory or commercial real estate.

Generally, an SBA 7(a) loan has a deficiency in its credit profile that would not allow the borrower to qualify for a traditional commercial loan, which is why the SBA provides the guarantee.

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In addition, many SBA 7(a) loans are for start up businesses where there is no historical financial information.

Finally, many SBA borrowers do not have an ongoing and continuous banking relationship with the Bank, but merely work with the Bank on a single transaction.

The guaranteed portion of the Company’s SBA loans is generally sold in the secondary market with the nonguaranteed portion held in the portfolio as a loan held for investment.

SBA 7(a) loans held for sale, carried at the lower of cost or market, amounted to $27.4 million at December 31, 2021, an increase of $18.0 million from $9.3 million at December 31, 2020.

SBA 7(a) loans held for investment amounted to $36.1 million at December 31, 2021, a decrease of $3.5 million from $39.6 million at December 31, 2020.

Finally, many SBA borrowers do not have an ongoing and continuous banking relationship with the Bank, and work with the Bank on a single transaction.

The guaranteed portion of the Company’s SBA loans may be sold in the secondary market.

SBA 7(a) loans held for sale, carried at the lower of cost or market, amounted to $27.9 million at December 31, 2022, an increase of $555.0 thousand from $27.4 million at December 31, 2021.

SBA 7(a) loans held for investment amounted to $38.5 million at December 31, 2022, an increase of $2.4 million from $36.1 million at December 31, 2021.

The yield on SBA 7(a) loans, which is generally floating and adjusts quarterly to the Prime Rate, was 6.60 percent for the year ended December 31, 2022, compared to 6.10 percent in the prior year.

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The guarantee rates are determined by the SBA and can vary from year to year depending on government funding and the goals of the SBA program.

The carrying value of SBA loans held for sale represents the guaranteed portion to be sold into the secondary market.

The carrying value of SBA loans held for investment represents the unguaranteed portion, which is the Company’s portion of SBA loans originated, reduced by the guaranteed portion that is sold into the secondary market.

Approximately $72.1 million and $87.4 million in SBA loans were sold but serviced by the Company at December 31, 2022 and December 31, 2021, respectively, and are not included on the Company’s balance sheet.

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SBA loans are underwritten to the same credit standards irrespective of the guarantee percentage.

The CARES Act provided assistance to small businesses through the establishment of the PPP.

The PPP provided eligible small businesses with funds to pay up to 24 weeks of payroll costs, including certain benefits.

The funds are provided in the form of loans that may be fully or partially forgiven when used for payroll costs, interest on mortgages, rent, and utilities.

The payments on these loans were deferred for up to six months.

Loans made after June 5, 2020, mature in five years, and loans made prior to June 5, 2020, mature in two years and can be extended to five years if the lender agrees.

Forgiveness of the PPP loans is based on the employer/borrower maintaining or quickly rehiring employees and maintaining salary levels.

Most small businesses with 500 or fewer employees were eligible.

Applications for the PPP loans started on April 3, 2020 and the application period was extended through August 8, 2020.

Applications for PPP loans under the Economic Aid Act started on January 13, 2021 and were available until March 31, 2021.

As an existing SBA 7(a) lender, the Company opted to participated in the PPP program as initially enacted under the CARES Act and as extended by the Economic Aid Act.

Commercial loans are generally made in the Company’s marketplace for the purpose of providing working capital, financing the purchase of equipment, inventory or commercial real estate and for other business purposes.

These loans amounted to $931.7 million at December 31, 2021, an increase of $91.9 million from year end 2020.

amounted to $1.2 billion at December 31, 2022, an increase of $255.8 million from year end 2021.

The yield on commercial loans was 5.10 percent for 2022, compared to 4.98 percent for the same period in 2021.

The SBA 504 program, which consists of real estate backed commercial mortgages where the Company has the first mortgage and the SBA has the second mortgage on the property, is included in the Commercial loan portfolio.

Generally, the Company has a 50 percent LTV ratio on SBA 504 program loans at origination.

The Commercial Real Estate sub-category includes both owner occupied and non-owner occupied commercial real estate related loans.

Residential mortgage loans consist of loans secured by 1 to 4 family residential properties.

These loans amounted to $409.4 million at December 31, 2021, a decrease of $58.2 million from year end 2020.

Sales of mortgage loans totaled $286.4 million for 2021.

These loans amounted to $605.1 million at December 31, 2022, an increase of $195.7 million from year end 2021.

Sales of mortgage loans totaled $74.4 million and $286.4 million for 2022 and 2021, respectively.

Approximately $13.7 million and $18.8 million in residential loans were sold but serviced by the Company at December 31, 2022 and December 31, 2021, respectively, and are not included on the Company’s balance sheet.

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As a result, the residential mortgage loan portfolio of the Bank includes fixed and adjustable rate mortgages with rates that exceed the rates on conventional fixed-rate mortgage loan products but are not considered high priced mortgages.

Consumer loans consist of home equity loans and loans for the purpose of financing the purchase of consumer goods, home improvements, and other personal needs, and are generally secured by the personal property being purchased.

These loans amounted to $77.9 million at December 31, 2021, an increase of $11.8 million from December 31, 2020.

Consumer loans consist of home equity loans and loans for the purpose of financing the purchase of consumer goods, home improvements and other personal needs, and are generally secured by the personal property.

These loans amounted to $78.2 million at December 31, 2022, an increase of $220.0 thousand from December 31, 2021.

The yield on consumer loans was 5.27 percent for 2022, compared to 4.73 percent for 2021.

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The yield on residential construction loans was 6.17 percent for 2022, compared to 5.97 percent for 2021.

There are no concentrations of loans to any borrowers or group of borrowers exceeding 10 percent of the total loan portfolio and no foreign loans in the portfolio.

There are no concentrations of loans to any borrowers or group of borrowers exceeding 10 percent of the total loan portfolio.

In the normal course of business, the Company may originate loan products whose terms could give rise to additional credit risk.

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Declines in the market values of real estate in the Company’s trade area impact the value of the collateral securing its loans.

This could lead to greater losses in the event

of defaults on loans secured by real estate.

This could lead to greater losses in the event of defaults on loans secured by real estate.

At December 31, 2022, approximately 96 percent of the Company’s loan portfolio was secured by real estate compared to 92 percent at December 31, 2021.

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Residential construction loans

Amount of loans with maturities or repricing dates greater than one year:

Fixed interest rates

Floating or adjustable interest rates

The following table shows the balance of loans and the allocation of variable, hybrid and fixed interest rates based upon maturity or repricing date as of December 31, 2022:

December 31, 2022

One year or less

Over one year

For additional information on loans, see Note 3 to the Consolidated Financial Statements.

Troubled Debt Restructurings

TDRs occur when a creditor, for economic or legal reasons related to a debtor’s financial condition, grants a concession to the debtor that it would not otherwise consider.

These concessions typically include reductions in interest rate, extending the maturity of a loan, or a combination of both.

Deferrals complying with the terms of the CARES Act and regulatory guidance (i.e., deferrals of up to six months to borrowers impacted by COVID-19 pandemic, where the borrower was current at either December 31, 2019, or prior to the deferral being granted) are not considered TDR’s.

When the Company modifies a loan, management evaluates for any possible impairment using either the discounted cash flows method, where the value of the modified loan is based on the present value of expected cash flows, discounted at the contractual interest rate of the original loan agreement, or by using the fair value of the collateral less selling costs.

If management determines that the value of the modified loan is less than the recorded investment in the loan, impairment is recognized by segment or class of loan, as applicable, through an allowance estimate or charge-off to the allowance.

This process is used, regardless of loan type, and for loans modified as TDRs that subsequently default on their modified terms.

At December 31, 2021, there were three loans totaling $1.0 million that were classified as TDRs and deemed impaired, compared to one loan totaling $663 thousand at December 31, 2020.

At December 31, 2022, there were three loans totaling $1.4 million that were classified as TDRs, compared to three loans totaling $1.0 million at December 31, 2021.

Restructured loans that are placed in nonaccrual status may be removed after six months of contractual payments and the borrower showing the ability to service the debt going forward.

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Commercial real estate

Through December 31, 2021, TDRs consisted of principal reduction, interest only periods and maturity extensions.

Commercial other

The following table shows the types of modifications done by class through December 31, 2022:

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Principal reduction

Interest only with nominal principal

For additional information on TDRs, see Note 3 to the Consolidated Financial Statements.

Asset Quality

Inherent in the lending function is credit risk, which is the possibility a borrower may not perform in accordance with the contractual terms of their loan.

A borrower’s inability to pay their obligations according to the contractual terms can create the risk of past due loans and, ultimately, credit losses, especially on collateral deficient loans.

The Company minimizes its credit risk by loan diversification and adhering to strict credit administration policies and procedures.

Due diligence on loans begins when we initiate contact regarding a loan with a borrower.

Documentation, including a borrower’s credit history, materials establishing the value and liquidity of potential collateral, the purpose of the loan, the source of funds for repayment of the loan, and other factors, are analyzed before a loan is submitted for approval.

The loan portfolio is then subject to on-going internal reviews for credit quality, as well as independent credit reviews by an outside firm.

The risk of loss is difficult to quantify and is subject to fluctuations in collateral values, general economic conditions and other factors.

In some cases, these factors have also resulted in significant impairment to the value of loan collateral.

The Company values its collateral through the use of appraisals, broker price opinions, and knowledge of its local market.

Nonperforming assets consist of nonperforming loans and OREO.

Nonperforming loans consist of loans that are not accruing interest (nonaccrual loans) as a result of principal or interest being delinquent for a period of 90 days or more or when the ability to collect principal and interest according to the contractual terms is in doubt.

When a loan is classified as nonaccrual, interest accruals discontinue and all past due interest previously recognized as income is reversed and charged against current period income.

Generally, until the loan becomes current, any payments received from the borrower are applied to outstanding principal, until such time as management determines that the financial condition of the borrower and other factors merit recognition of a portion of such payments as interest income.

Loans past due 90 days or more and still accruing interest are not included in nonperforming loans.

Loans past due 90 days or more and still accruing generally represent loans that are well secured and in process of collection.

The following table sets forth information concerning nonperforming assets and loans past due 90 days or more and still accruing interest at December 31 st for the past five years:

The following table sets forth information concerning nonperforming assets and loans past due 90 days or more and still accruing interest at December 31, 2022 and December 31, 2021:

(In thousands, except percentages)

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Nonperforming loans and TDRs to total loans (2)

Nonperforming assets to total loans and OREO

Nonperforming assets to total assets

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(2) Performing TDRs

Nonperforming loans were $9.7 million at December 31, 2021, a $2.4 million decrease from $12.1 million at year end 2020.

Since year end 2020, nonperforming loans in the SBA, residential mortgage and consumer loan segments decreased, partially offset by an increase in nonperforming commercial and residential construction loans.

Included in nonperforming loans at December 31, 2021 are approximately $59 thousand of loans guaranteed by the SBA, compared to $371 thousand at December 31, 2020.

In addition, there were no loans past due 90 days or more and still accruing interest at December 31, 2021, compared to $449 thousand at December 31, 2020.

Nonperforming loans were $9.1 million at December 31, 2022, a $621 thousand decrease from $9.7 million at year end 2021.

Since year end 2021, nonperforming loans in the commercial and consumer loan segments decreased, partially offset by an increase in nonperforming residential construction, SBA and residential mortgage loans.

In addition, there were no loans past due 90 days or more and still accruing interest at December 31, 2022 and 2021, respectively.

The Company also monitors potential problem loans.

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Allowance for Loan Losses and Reserve for Unfunded Loan Commitments

Management reviews the level of the allowance for loan losses on a quarterly basis.

The standardized methodology used to assess the adequacy of the allowance includes the allocation of specific and general reserves.

Specific reserves are made to individual impaired loans, which have been defined to include all nonperforming loans and TDRs.

The general reserve is set based upon a representative average historical net charge-off rate adjusted for certain environmental factors such as:

delinquency and impairment trends, charge-off and recovery trends, volume and loan term trends, risk and underwriting policy trends, staffing and experience changes, national and local economic trends, industry conditions and credit concentration changes.

When calculating the five-year historical net charge-off rate, the Company weights the past three years more heavily as it believes they are more indicative of future charge-offs.

All of the environmental factors are ranked and assigned a basis points value based on the following scale:

low, low moderate, moderate, high moderate and high risk.

The factors are evaluated separately for each type of loan.

For example, commercial loans are broken down further into commercial and

industrial loans, commercial mortgages, construction loans, etc.

Each type of loan is risk weighted for each environmental factor based on its individual characteristics.

According to the Company’s policy, a loss (“charge-off”) is to be recognized and charged to the allowance for loan losses as soon as a loan is recognized as uncollectable.

All credits which are 90 days past due must be analyzed for the Company’s ability to collect on the credit.

Once a loss is known to exist, the charge-off approval process is immediately expedited.

The allowance for loan losses totaled $25.2 million at December 31, 2022, compared to $22.3 million at December 31, 2021, with resulting allowance to total loan ratios of 1.20 percent and 1.35 percent, respectively.

Net charge-offs amounted to $984 thousand for 2021, compared to $290 thousand for 2020.

The following table is a summary of the changes to the allowance for loan losses for the past five years, including net charge-offs to average loan ratios for each major loan category:

For the years ended December 31,

Net charge-offs amounted to $1.3 million for 2022, compared to $984 thousand for 2021.

The following table is a summary of the changes to the allowance for loan losses for December 31, 2022 and 2021, including net charge-offs to average loan ratios for each major loan category:

(In thousands, except percentages)

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Commercial loans

Residential mortgage loans

Consumer loans

Total chargeoffs

Total charge-offs

SBA loans held for investment

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Selected loan quality ratios:

Net chargeoffs (recoveries) to average loans:

Net charge-offs (recoveries) to average loans:

SBA loans held for investment

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Allowance to nonperforming loans

The following table sets forth, for each of the major lending categories, the amount of the allowance for loan losses allocated to each category and the percentage of total loans represented by such category, as of December 31 st of the past five years.

The allocated allowance is the total of identified specific and general reserves by loan category.

allocation is not necessarily indicative of the categories in which future losses may occur.

The allocation is not necessarily indicative of the categories in which future losses may occur.

The total allowance is available to absorb losses from any segment of the portfolio.

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Balance applicable to:

SBA loans held for investment

Commercial loans

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Residential construction loans

Total loans held for investment

SBA loans held for sale

In addition to the allowance for loan losses, the Company maintains a reserve for unfunded loan commitments that is maintained at a level that management believes is adequate to absorb estimated probable losses.

Adjustments to the reserve are made through other expense and applied to the reserve, which is maintained in other liabilities.

At December 31, 2021, a $400 thousand commitment reserve was reported on the balance sheet as an “other liability”, compared to a $288 thousand commitment reserve at December 31, 2020.

For additional information on the allowance for loan losses and reserve for unfunded loan commitments, see Note 5 to the Consolidated Financial Statements.

See Note 4 to the accompanying Consolidated Financial Statements for more information regarding the Allowance for Loan Losses and Reserve for Unfunded Loan Commitments.

Deposits, which include noninterest-bearing demand deposits, interest-bearing demand deposits, savings deposits and time deposits, are the primary source of the Company’s funds.

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The Company continues to focus on establishing a comprehensive relationship with business borrowers, seeking deposits as well as lending relationships.

The following table shows period-end deposits and the concentration of each category of deposits for the past three years:

The following table shows period-end deposits and the concentration of each category of deposits for the past two years:

(In thousands, except percentages)

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Total deposits

2021 compared to 2020

Total deposits increased $200.9 million to $1.8 billion at December 31, 2021, from $1.6 billion at December 31, 2020.

This increase in deposits was due to increases of $238.7 million in savings deposits, $69.6 million in noninterest-bearing demand deposits and $39.8 million in interest-bearing demand deposits, partially offset by a decrease of $147.2 million in time deposits.

The following table details the maturity distribution of time deposits as of December 31, 2022 and 2021:

(In thousands)

At December 31, 2022:

Less than $250,000

$250,000 or more

At December 31, 2021:

Less than $250,000

$250,000 or more

Total deposits increased $28.6 million to $1.8 billion at December 31, 2022.

This increase in deposits was due to increases of $133.9 million in time deposits and $32.1 million in interest-bearing demand deposits, partially offset by a decrease of $102.3 million in savings deposits and $35.0 million in noninterest-bearing demand deposits.

Further, brokered certificates of deposits, which are disclosed in time deposits above, increased $69.3 million, to $189.6 million at December 31, 2022, compared to $120.3 million at December 31, 2021.

The Company’s deposit composition at December 31, 2022, consisted of 33.1 percent savings deposits, 27.6 percent noninterest-bearing demand deposits, 23.8 percent time deposits and 15.5 percent interest-bearing demand deposits.

change in the composition of the portfolio from December 31, 2020 reflects a 0.8 percent increase in interest-bearing demand deposits, a 0.6 percent increase in noninterest-bearing demand deposits, and a 10.2 percent increase in savings deposits, partially offset by a 11.6 percent decrease in time deposits.

The change in the composition of the portfolio from December 31, 2021 reflects a 45.9 percent increase in time deposits and a 13.2 percent increase in interest-bearing demand deposits, partially offset by a 14.7 percent decrease in savings deposits and a 6.6 percent decrease in noninterest-bearing demand deposits.

The following table shows average deposits and the concentration of each category of deposits for the past two years:

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Borrowed Funds and Subordinated Debentures

Borrowed funds consist or previously consisted primarily of adjustable and fixed rate advances from the Federal Home Loan Bank of New York.

These borrowings are used as a source of liquidity or to fund asset growth not supported by deposit generation.

Residential mortgages and commercial loans collateralize the borrowings from the FHLB.

As part of the Company’s overall funding and liquidity management program, from time to time the Company borrows from the Federal Home Loan Bank of New York.

Residential mortgages and commercial loans collateralize these borrowings.

Borrowed funds and subordinated debentures totaled $393.3 million and $50.3 million at December 31, 2022 and December 31, 2021, respectively, and are broken down in the following table:

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FHLB borrowings:

Fixed rate advances

Adjustable rate advances

Non-overnight, fixed rate advances

Overnight advances

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Total borrowed funds and subordinated debentures

Borrowed funds decreased $160.0 million from prior year-end due to a $130.0 million decrease in FHLB overnight advances and a $30.0 million decrease in FHLB adjustable-rate advances during the year ended December 31, 2021.

FHLB Borrowings

At December 31, 2021 and December 31, 2020, the Company had $40.0 million in fixed rate advances.

The terms of this transaction are as follows:

● A $40.0 million FHLB borrowing with a maturity date of August 22, 2024, at a rate of 1.810%.

At December 31, 2021, there were no adjustable rate (“ARC”) advances.

At December 31,2020, the $30.0 million FHLB adjustable rate advances consisted of one $20.0 million advance and one $10.0 million advance.

At December 31, 2021, there were no FHLB overnight borrowings compared to $130.0 million at a rate of 0.340% at December 31, 2020.

In December 2021, the FHLB issued a $112.0 million municipal deposit letter of credit in the name of Unity Bank naming the NJ Department of Banking and Insurance as beneficiary, to secure municipal deposits as required under New Jersey law.

In December 2022, the FHLB issued a $140.0 million municipal deposits letter of credit in the name of Unity Bank naming the New Jersey Department of Banking and Insurance as beneficiary, to secure municipal deposits as required under New Jersey law, compared to a letter of credit with a balance of $112.0 million as of December 31, 2021.

At December 31, 2022, the Company had $198.0 million of additional credit available at the FHLB.

Pledging additional collateral in the form of 1 to 4 family residential mortgages, commercial loans and investment securities can increase the line with the FHLB.

For the year ending December 31, 2022, average FHLB borrowings were $102.5 million with a weighted average cost of 2.96%.

The maximum borrowing during the year was $383.0 million.

Subordinated Debentures

On July 24, 2006, Unity (NJ) Statutory Trust II, a statutory business trust and wholly-owned subsidiary of the Parent Company, issued $10.0 million of floating rate capital trust pass through securities to investors due on July 24, 2036.

On July 24, 2006, Unity (NJ) Statutory Trust II, a statutory business trust and wholly-owned subsidiary of Unity Bancorp, Inc., issued $10.0 million of floating rate capital trust pass through securities to investors due on July 24, 2036.

The subordinated debentures are redeemable in whole or part, prior to maturity but after July 24, 2011.

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The floating interest rate was 6.319% at December 31, 2022 and 1.806% at December 31, 2021.

At December 31, 2020 and 2019, the subordinated debentures had a swap instrument which modified the borrowing to a 3 year fixed rate borrowing at 3.435%.

The swap instrument matured on June 23, 2021.

For additional information on borrowed funds and subordinated debentures, see Note 9 to the Consolidated Financial Statements.

Based on the Company’s business, the two largest risks facing the Company are market risk and credit risk.

The Company is currently evaluating its LIBOR-based exposure for this instrument.

Market risk for the Company is primarily limited to interest rate risk, which is the impact that changes in interest rates would have on future earnings.

The Company’s Risk Management Committee (“RMC”) manages this risk.

The principal objectives of RMC are to establish prudent risk management guidelines, evaluate and control the level of interest rate risk in balance sheet accounts, determine the level of appropriate risk given the business focus, operating environment, capital, and liquidity requirements, and actively manage risk within Board-approved guidelines.

The principal

objectives of RMC are to establish prudent risk management guidelines, evaluate and control the level of interest rate risk in balance sheet accounts, determine the level of appropriate risk given the business focus, operating environment, capital and liquidity requirements and actively manage risk within Board-approved guidelines.

The RMC reviews the maturities and repricing of loans, investments, deposits and borrowings, cash flow needs, current market conditions and interest rate levels.

The Company uses various techniques to evaluate risk levels on both a short and long-term basis.

One of the monitoring tools is the “gap” ratio.

A gap ratio, as a percentage of assets, is calculated to determine the maturity and repricing mismatch between interest rate-sensitive assets and interest rate-sensitive liabilities.

A gap is considered positive when the amount of interest rate-sensitive assets repricing exceeds the amount of interest rate-sensitive liabilities repricing in a designated time period.

A positive gap should result in higher net interest income with rising interest rates, as the amount of the assets repricing exceeds the amount of liabilities repricing.

Conversely, a gap is considered negative when the amount of interest rate-sensitive liabilities exceeds interest rate-sensitive assets, and lower rates should result in higher net interest income.

Repricing of mortgage-related securities is shown by contractual amortization and estimated prepayments based on the most recent 3-month constant prepayment rate.

Callable agency securities are shown based upon their option-adjusted spread modified duration date (“OAS”), rather than the next call date or maturity date.

The OAS date considers the coupon on the security, the time to the next call date, the maturity date, market volatility and current rate levels.

Fixed rate loans are allocated based on expected amortization.

The following table sets forth the gap ratio at December 31, 2021.

Assumptions regarding the repricing characteristics of certain assets and liabilities are critical in determining the projected level of rate sensitivity.

Certain savings and interest checking accounts are less sensitive to market interest rate changes than other interest-bearing sources of funds.

deposits such as interest-bearing demand, savings and money market deposits are allocated based on their expected repricing in relation to changes in market interest rates.

(In thousands, except percentages)

Cash and due from banks

Federal funds sold and interest-bearing deposits

Federal Home Loan Bank stock

Allowance for loan losses

Liabilities and shareholders’ equity:

Noninterest-bearing demand deposits

Savings and interest-bearing demand deposits

Time deposits

Borrowed funds and subordinated debentures

Other liabilities

Shareholders’ equity

Total liabilities and shareholders’ equity

Cumulative gap

Cumulative gap to total assets

At December 31, 2021, there was a six-month asset-sensitive gap of $153.3 million and a one-year asset-sensitive gap of $328.5 million, as compared to a six-month asset-sensitive gap of $51.5 million and a one-year asset-sensitive gap of $112.9 million at December 31, 2020.

The six-month and one-year cumulative gap to total assets ratios were within the Board-approved guidelines of +/- 20 percent.

Other models are also used in conjunction with the static gap table, which is not able to capture the risk of changing spread relationships over time, the effects of projected growth in the balance sheet or dynamic decisions such as the modification of investment maturities as a rate environment unfolds.

For these reasons, a simulation model is used, where numerous interest rate scenarios and balance sheets are combined to produce a range of potential income results.

Net interest income is managed within guideline ranges for interest rates rising or falling by 200 basis points.

Results outside of guidelines require action by the RMC to correct the imbalance.

Simulations are typically created over a 12 to 24 month time horizon.

At December 31, 2021, these simulations show that with a 200 basis point immediate rate increase, net interest income would increase by approximately $3.5 million, or 4.6 percent in the first twelve months.

Assuming rates remain stable in the second year, net interest income would increase by approximately $9.7 million, or 13.0 percent.

A 200 basis point immediate rate decline would decrease net interest income by approximately $2 million or 2.6 percent in the first twelve months.

Assuming rates remain stable in the second year, net interest income would decrease net interest income by approximately $4.7 million or 6.3 percent.

These variances in net interest income are within the Board-approved guidelines of +/- 10 percent.

Finally, to measure the impact of longer-term asset and liability mismatches beyond two years, the Company utilizes Modified Duration of Equity and Economic Value of Portfolio Equity (“EVPE”) models.

The modified duration of equity measures the potential price risk of equity to changes in interest rates.

A longer modified duration of equity indicates a greater degree of risk to rising interest rates.

Because of balance sheet optionality, an EVPE analysis is also used to dynamically model the present value of asset and liability cash flows, with rate shocks of 200 basis points.

The economic value of equity is likely to be different as interest rates change.

Results falling outside prescribed ranges require action by the RMC.

The Company’s variance in the economic value of equity with rate shocks of 200 basis points is an increase of 4.3 percent in a rising rate environment and a decrease of 12.3 percent in a falling rate environment at December 31, 2021.

At December 31, 2020, the Company’s variance in the economic value of equity with rate shocks of 200 basis points is an increase of 4.1 percent in a rising rate environment and a decrease of 7.5 percent in a falling rate environment.

The variance in the EVPE at December 31, 2021 and 2020 were within the Board-approved guidelines in place at the time of +/- 20 percent.

The following table presents the Company’s EVE and NII sensitivity exposure related to an instantaneous and sustained parallel shift in market interest rate of 100, 200 and 300 bps, which were all in compliance with Board approved tolerances at December 31, 2022 and December 31, 2021:

Estimated Increase/ (Decrease) in EVE

Estimated Increase/ (Decrease) In NII

December 31, 2022:

December 31, 2021:

Consolidated Bank Liquidity

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As the Consolidated Bank comprises the majority of the assets of the Company, the Consolidated Statement of Cash Flows is indicative of the Consolidated Bank’s activity.

At December 31, 2021, the balance of cash and cash equivalents was $244.8 million, an increase of $25.5 million from December 31, 2020.

At December 31, 2022, the balance of cash and cash equivalents was $114.8 million, a decrease of $130.0 million from December 31, 2021.

A discussion of the cash provided by and used in operating, investing and financing activities follows.

Operating activities provided $23.5 million and $33.7 million in net cash for the years ended December 31, 2021 and 2020.

The primary sources of funds were net income from operations and adjustments to net income, such as the proceeds from the sale of mortgage and SBA loans held for sale, partially offset by originations of mortgage and SBA loans held for sale.

Operating activities provided $42.7 million and $32.5 million in net cash for the years ended December 31, 2022 and 2021, respectively.

The primary sources of funds were net income from operations and adjustments to net income, such as the provision for loan losses and depreciation and amortization.

Investing activities used $541.3 million and $40.5 million in net cash for the years ended December 31, 2022 and 2021, respectively.

Cash was primarily used to purchase FHLB stock and other investment securities, partially offset by cash inflows from proceeds from the redemption of FHLB stock.

Cash was primarily used to originate loans, purchase FHLB stock and other investment securities, partially offset by cash inflows from proceeds from the SBA forgiveness of PPP loans.

● Securities.

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This excludes the Parent Company’s securities discussed under the heading “Parent Company Liquidity” below.

Projected cash flows from securities over the next twelve months are $6.6 million.

The SBA loans held for sale portfolio amounted to $27.9 million and $27.4 million at December 31, 2022 and December 31, 2021, respectively.

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● Outstanding Commitments .

The Company was committed to advance approximately $399.8 million to its borrowers as of December 31, 2021, compared to $288.4 million at December 31, 2020.

The Company was committed to advance approximately $514.8 million to its borrowers as of December 31, 2022, compared to $399.8 million at December 31, 2021, respectively.

At December 31, 2022, $177.7 million of these commitments expire within one year, compared to $170.1 million at December 31, 2021.

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Many of these commitments will expire and never be funded.

Financing activities used $33.5 million and $214.3 million in net cash for the years ended December 31, 2021 and 2020, respectively, primarily due to repayments of borrowings, partially offset by proceeds from new borrowings and an increase in the Company’s deposits.

Financing activities provided $368.6 million and $33.5 million in net cash for the years ended December 31, 2022 and 2021, respectively, primarily due to the proceeds of new borrowings and an increase in the Company’s deposits.

As of December 31, 2022, deposits included $296.5 million of Government deposits, as compared to $247.7 million at year end 2021.

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The Company believes that the current level of these types of deposits is appropriate.

Included in the portfolio were $233.5 million of deposits from fifteen municipalities with account balances in excess of $5.0 million.

Included in the portfolio were $281.1 million of deposits from eighteen municipalities with account balances in excess of $5.0 million.

The withdrawal of these deposits, in whole or in part, would not create a liquidity shortfall for the Company.

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Only expenses specifically for the benefit of the Parent Company are paid using its cash, which typically includes the payment of operating expenses, cash dividends on common stock and payments on trust preferred debt.

At December 31, 2021, the Parent Company had $1.7 million in cash and cash equivalents and $5.0 million in investment securities valued at fair market value, compared to $640 thousand in cash and cash equivalents and $1.0 million in investment securities at December 31, 2020.

At December 31, 2022, the Parent Company had $2.2 million in cash and cash equivalents and $5.7 million in investment securities valued at fair market value, compared to $1.7 million in cash and cash equivalents and $5.0 million in investment securities at December 31, 2021.

Off-Balance Sheet Arrangements and Contractual Obligations

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For additional information on time deposits, see Note 8 to the Consolidated Financial Statements.

Borrowed funds and subordinated debentures include adjustable rate borrowings from the Federal Home Loan Bank and subordinated debentures.

Borrowed funds and subordinated debentures include fixed and adjustable rate borrowings from the Federal Home Loan Bank and subordinated debentures.

The borrowings have defined terms and under certain circumstances are callable at the option of the lender.

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Shareholders’ equity increased $33.5 million to $239.2 million at December 31, 2022 compared to $205.7 million at December 31, 2021, primarily due to net income of $38.5 million.

Other items impacting shareholders’ equity included $4.2 million in treasury stock purchased at cost, $3.6 million in dividends paid on common stock, $2.0 million from the issuance of common stock under employee benefit plans and $1.5 million in accumulated other comprehensive income net of tax.

The issuance of common stock under employee benefit plans includes nonqualified stock options and restricted stock expense related entries, employee option exercises and the tax benefit of options exercised.

Other increases were due to $3.0 million from the issuance of common stock under employee benefit plans, net of tax.

These increases were partially offset by (i) $42 thousand in treasury stock purchased at cost, (ii) $4.4 million in dividends paid on common stock, and (iii) $3.6 million in accumulated other comprehensive loss, net of tax.

For additional information on shareholders’ equity, see Note 13 to the Consolidated Financial Statements.

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● Total trading assets and trading liabilities of 5% or less of total consolidated assets.

On April 6, 2020, the federal banking regulators, implementing the applicable provisions of the CARES Act, modified the CBLR framework so that:

(i) beginning in the second quarter 2020 and until the end of the year, a banking organization that has a leverage ratio of 8% or greater and meets certain other criteria may elect to use the CBLR framework;

and (ii) community banking organizations will have until January 1, 2022, before the CBLR requirement is re-established at greater than 9%.

Under the interim rules, the minimum CBLR will be 8% beginning in the second quarter and for the remainder of calendar year 2020, 8.5% for calendar year 2021, and 9% thereafter.

The numerator of the CBLR is Tier 1 capital, as calculated under present rules.

The denominator of the CBLR is the QCBO’s average assets, calculated in accordance with the QCBO’s Call Report instructions less assets deducted from Tier 1 capital.

The Bank has opted into the CBLR and is therefore not required to comply with the Basel III capital requirements.

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Critical Accounting Policies and Estimates

“Management’s Discussion and Analysis of Financial Condition and Results of Operations” is based upon the Company’s Consolidated Financial Statements, which have been prepared in accordance with U.S.

generally accepted accounting principles (“GAAP”).

The preparation of these financial statements requires the Company to make estimates and judgments that affect the reported amounts of assets, liabilities, revenues and expenses.

Note 1 to the Company’s Audited Consolidated Financial Statements for the year ended December 31, 2021, contains a summary of the Company’s significant accounting policies.

Management believes the Company’s policies with respect to the methodology for the determination of the allowance for loan losses, valuation of deferred tax and servicing assets, the carrying value of loans held for sale and other real estate owned, the valuation of securities and the determination of other-than-temporary impairment for securities and fair value disclosures involve a higher degree of complexity and require management to make difficult and subjective judgments, which often require assumptions or estimates about highly uncertain matters.

Changes in these judgments, assumptions or estimates could materially impact results of operations.

These critical policies are periodically reviewed with the Audit Committee and the Board of Directors.

Other-Than-Temporary Impairment

The Company has a process in place to identify debt securities that could potentially incur credit impairment that is other-than-temporary.

This process involves monitoring late payments, pricing levels, downgrades by rating agencies, key financial ratios, financial statements, revenue forecasts and cash flow projections as indicators of credit issues.

Management evaluates securities for other-than-temporary impairment at least on a quarterly basis, and more frequently when economic or market concern warrants such evaluation.

This evaluation considers relevant facts and circumstances in evaluating whether a credit or interest rate-related impairment of a security is other-than-temporary.

Relevant facts and circumstances considered include:

(1) the extent and length of time the fair value has been below cost;

(2) the reasons for the decline in value;

(3) the financial position and access to capital of the issuer, including the current and future impact of any specific events and (4) for fixed maturity securities, the intent to sell a security or whether it is more likely than not the security will be required to be sold before the recovery of its amortized cost which, in some cases, may extend to maturity and for equity securities, the ability and intent to hold the security for a forecasted period of time that allows for the recovery in value.

Management assesses its intent to sell or whether it is more likely than not that it will be required to sell a security before recovery of its amortized cost basis less any current-period credit losses.

For debt securities that are considered other-than-temporarily impaired with no intent to sell and no requirement to sell prior to recovery of its amortized cost basis, the amount of the impairment is separated into the amount that is credit related (credit loss component) and the amount due to all other factors.

The credit loss component is recognized in earnings and is the difference between the security’s amortized cost basis and the present value of its expected future cash flows.

The remaining difference between the security’s fair value and the present value of future expected cash flows is due to factors that are not credit related and is recognized in other comprehensive income.

For debt securities where management has the intent to sell, the amount of the impairment is reflected in earnings as realized losses.

The present value of expected future cash flows is determined using the best estimate cash flows discounted at the effective interest rate implicit to the security at the date of purchase or the current yield to accrete an asset-backed or floating rate security.

The methodology and assumptions for establishing the best estimate cash flows vary depending on the type of security.

The asset-backed securities cash flow estimates are based on bond specific facts and circumstances that may include collateral characteristics, expectations of delinquency and default rates, loss severity and prepayment speeds and structural support, including subordination and guarantees.

The corporate bond cash flow estimates are derived from scenario-based outcomes of expected corporate restructurings or the disposition of assets using bond specific facts and circumstances including timing, security interests and loss severity.

For additional information on other-than-temporary impairment, see Note 3 to the Consolidated Financial Statements.

Servicing Assets

Servicing assets represent the estimated fair value of retained servicing rights, net of servicing costs, at the time loans are sold.

Servicing assets are amortized in proportion to, and over the period of, estimated net servicing revenues.

Impairment is evaluated based on stratifying the underlying financial assets by date of origination and term.

Fair value is determined using prices for similar assets with similar characteristics, when available, or based upon discounted cash flows using market-based assumptions.

Any impairment, if temporary, would be reported as a valuation allowance.

For additional information on servicing assets, see Note 4 to the Consolidated Financial Statements.

New Authoritative Accounting Guidance

See Note 1 of the consolidated financial statements for a description of recent accounting pronouncements, including the dates of adoption and the anticipated effect on our results of operations and financial condition.

Allowance for Loan Losses and Unfunded Loan Commitments

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Compared sentence by sentence after normalising whitespace, quotation marks, case and digits, so re-formatting and restated figures do not read as changed language. Wording changes appear as one removal and one addition. The current filing and the prior one are authoritative.

What changed 10-K

Item 7. Management’s Discussion and Analysis