ESSA BANCORP, INC. Business Strategy
Our business strategy is to grow and improve our profitability by:
• Increasing customer relationships through the offering of excellent
service and the distribution of that service through effective delivery
systems;
• Continuing to transform into a full service community bank by meeting the
financial services needs of our customers;
• Continuing to develop into a high performing financial institution, in
part by increasing net interest and fee income and managing operating
expenses efficiently;
• Remaining within our risk management parameters; and
• Employing affordable technology to increase profitability and improve
customer service.
30
--------------------------------------------------------------------------------We intend to continue to pursue our business strategy, subject to changes necessitated by future market conditions and other factors. We also intend to continue focusing on the following:
• Increasing customer relationships through a continued commitment to
service and enhancing products and delivery systems. We will continue to
increase customer relationships by focusing on customer satisfaction with
regard to service, products, systems and operations. We have upgraded and
expanded certain of our facilities, including our corporate center and
added additional facilities to provide additional capacity to manage
future growth and expand our delivery systems.
• Continuing to develop into a high performing financial institution. We
will continue to enhance profitability by focusing on increasing
non-interest income as well as increasing commercial products, including
commercial real estate lending, which often have a higher profit margin
than more traditional products. We also will pursue lower-cost commercial
deposits as part of this strategy.
• Remaining within our risk management parameters. We place significant
emphasis on risk management and compliance training for all of our
directors, officers and employees. We focus on establishing regulatory
compliance programs to determine the degree of such compliance and to
maintain the trust of our customers and community.
• Employing cost-effective technology to increase profitability and improve
customer service. We will continue to upgrade our technology in an
efficient manner. We have implemented new software for marketing purposes
and have upgraded both our internal and external communication systems.
• Continuing our emphasis on commercial real estate lending to improve our
overall performance. We intend to continue to emphasize the origination
of higher interest rate margin commercial real estate loans as market
conditions, regulations and other factors permit. We have expanded ourcommercial banking capabilities by adding experienced commercial bankers,
and enhancing our direct marketing efforts to local businesses.
• Expanding our banking franchise through branching and acquisitions. We
will attempt to use our stock holding company structure to expand our
market footprint through de novo branching as well as through additional
acquisitions of banks, savings institutions and other financial service
providers in our primary market area. We will also consider establishing
de novo branches or acquiring additional financial institutions in
contiguous counties. We will continue to review and assess locations for
new branches both within Monroe County and the counties around Monroe.
There can be no assurance that we will be able to consummate any new
acquisitions or establish any additional new branches. We may continue to
explore acquisition opportunities involving other banks and thrifts, and
possibly financial service companies, when and as they arise, as a means
of supplementing internal growth, filling gaps in our current geographic
market area and expanding our customer base, product lines and internal
capabilities, although we have no current plans, arrangements or
understandings to make any acquisitions.
• Maintaining the quality of our loan portfolio. Maintaining the quality of
our loan portfolio is a key factor in managing our growth. We will
continue to use customary risk management techniques, such as independent
internal and external loan reviews, risk-focused portfolio credit
analysis and field inspections of collateral in overseeing the
performance of our loan portfolio.
Critical Accounting Policies
We consider accounting policies that require management to exercise significant
judgment or discretion or make significant assumptions that have, or could have,
a material impact on the carrying value of certain assets or on income, to be
critical accounting policies. We consider the following to be our critical
accounting policies:
Allowance for Loan Losses. The allowance for loan losses is the estimated amount
considered necessary to cover credit losses inherent in the loan portfolio at
the balance sheet date. The allowance is established through the provision for
loan losses which is charged against income. In determining the allowance for
loan losses, management makes significant estimates and has identified this
policy as one of our most critical. The methodology for determining the
allowance for loan losses is considered a critical accounting policy by
management due to the high degree of judgment involved, the subjectivity of the
assumptions utilized and the potential for changes in the economic environment
that could result in changes to the amount of the recorded allowance for loan
losses.
31
--------------------------------------------------------------------------------
As a substantial amount of our loan portfolio is collateralized by real estate,
appraisals of the underlying value of property securing loans and discounted
cash flow valuations of properties are critical in determining the amount of the
allowance required for specific loans. Assumptions for appraisals and discounted
cash flow valuations are instrumental in determining the value of properties.
Overly optimistic assumptions or negative changes to assumptions could
significantly impact the valuation of a property securing a loan and the related
allowance determined. The assumptions supporting such appraisals and discounted
cash flow valuations are carefully reviewed by management to determine that the
resulting values reasonably reflect amounts realizable on the related loans.
Management performs a quarterly evaluation of the adequacy of the allowance for
loan losses. Consideration is given to a variety of factors in establishing this
estimate including, but not limited to, current economic conditions, delinquency
statistics, geographic and industry concentrations, the adequacy of the
underlying collateral, the financial strength of the borrower, results of
internal and external loan reviews and other relevant factors. This evaluation
is inherently subjective, as it requires material estimates that may be
susceptible to significant revision based on changes in economic and real estate
market conditions.
The analysis of the allowance for loan losses has two components: specific and
general allocations. Specific allocations are made for loans that are determined
to be impaired. Impairment is measured by determining the present value of
expected future cash flows or, for collateral-dependent loans, the fair value of
the collateral adjusted for market conditions and selling expenses. The general
allocation is determined by segregating the remaining loans by type of loan,
risk weighting (if applicable) and payment history. We also analyze historical
loss experience, delinquency trends, general economic conditions and geographic
and industry concentrations. This analysis establishes factors that are applied
to the loan groups to determine the amount of the general allocations. Actual
loan losses may be significantly more than the allowance for loan losses we have
established which could have a material negative effect on our financial
results.
Goodwill and Intangible Assets. Goodwill is not amortized, but it is tested at
least annually for impairment in the fourth quarter, or more frequently if
indicators of impairment are present. If the estimated current fair value of a
reporting unit exceeds its carrying value, no additional testing is required and
an impairment loss is not recorded. The Company uses market capitalization and
multiples of tangible book value methods to determine the estimated current fair
value of its reporting unit. Based on this analysis, no impairment was recorded
in fiscal 2022 or fiscal 2021.
The other intangibles assets are assigned useful lives, which are amortized on
an accelerated basis over their weighted-average lives. The Company periodically
reviews the intangible assets for impairment as events or changes in
circumstances indicate that the carrying amount of such asset may not be
recoverable. Based on these reviews, no impairment was recorded in fiscal 2022
or fiscal 2021.
Derivative Instruments and Hedging Activities. The Company records all
derivatives on the balance sheet at fair value. The accounting for changes in
the fair value of derivatives depends on the intended use of the derivative,
whether the Company has elected to designate a derivative in hedging
relationship and apply hedge accounting and whether the hedging relationship has
satisfied the criteria necessary to apply hedge accounting. Derivatives
designated and qualifying as a hedge of the exposure to changes in the fair
value of an asset, liability, or firm commitment attributable to a particular
risk, such as interest rate risk, are considered fair value hedges. Derivatives
designated and qualifying as a hedge of the exposure to variability in expected
future cash flows, or other types of forecasted transactions, are considered
cash flow hedges. Derivatives may also be designated as hedges of the foreign
currency exposure of a net investment in a foreign operation. Hedge accounting
generally provides for the matching of the timing of gain or loss recognition on
the hedging instrument with the recognition of the changes in the fair value of
the hedged asset or liability that are attributable to the hedged risk in a fair
value hedge or the earnings effect of the hedged forecasted transactions in a
cash flow hedge. The Company may enter into derivative contracts that are
intended to economically hedge certain of its risk, even though hedge accounting
does not apply or the Company elects not to apply hedge accounting.
Employee Benefit Plans. The Bank maintains a noncontributory, defined benefit
pension plan for all employees who have met age and length of service
requirements. The Bank also maintains a defined contribution Section 401(k) plan
covering eligible employees. The Company created an employee stock ownership
plan ("ESOP") for the benefit of employees who meet certain eligibility
requirements. The Company makes cash contributions to the ESOP on an annual
basis.
The Company maintains an equity incentive plan to provide for issuance or
granting of shares of common stock for stock options or restricted stock. The
Company has recorded stock-based employee compensation cost using the fair value
method as allowed under generally accepted accounting principles. Management
estimated the fair values of all option grants using the Black-Scholes
option-pricing model. Management estimated the expected life of the options
using the simplified method as allowed under generally accepted accounting
principles. The risk-free rate was determined utilizing the treasury yield for
the expected life of the option contract.
32
--------------------------------------------------------------------------------Fair Value Measurements. We group our assets at fair value in three levels, based on the markets in which the assets are traded and the reliability of the assumptions used to determine fair value. These levels are:
• Level I - Valuation is based upon quoted prices for identical instruments
traded in active markets.
• Level II - Valuation is based upon quoted prices for similar instruments
in active markets, quoted prices for identical or similar instruments in
markets that are not active, and model-based valuation techniques for
which all significant assumptions are observable in the market.
• Level III - Valuation is generated from model-based techniques that use
significant assumptions not observable in the market. These unobservable
assumptions reflect the Company's own estimates of assumptions that
market participants would use in pricing the asset.
We base our fair values on the price that would be received to sell an asset or
paid to transfer a liability in an orderly transaction between market
participants at the measurement date. It is our policy to maximize the use of
observable inputs and minimize the use of unobservable inputs when developing
fair value measurements, in accordance with the fair value hierarchy in
generally accepted accounting principles.
Fair value measurements for most of our assets are obtained from independent
pricing services that we have engaged for this purpose. When available, we, or
our independent pricing service, use quoted market prices to measure fair value.
If market prices are not available, fair value measurement is based upon models
that incorporate available trade, bid, and other market information.
Subsequently, all of our financial instruments use either of the foregoing
methodologies to determine fair value adjustments recorded to our financial
statements. In certain cases, however, when market observable inputs for
model-based valuation techniques may not be readily available, we are required
to make judgments about assumptions market participants would use in estimating
the fair value of financial instruments. The degree of management judgment
involved in determining the fair value of a financial instrument is dependent
upon the availability of quoted market prices or observable market parameters.
For financial instruments that trade actively and have quoted market prices or
observable market parameters, there is minimal subjectivity involved in
measuring fair value. When observable market prices and parameters are not fully
available, management judgment is necessary to estimate fair value. In addition,
changes in the market conditions may reduce the availability of quoted prices or
observable data. When market data is not available, we use valuation techniques
requiring more management judgment to estimate the appropriate fair value
measurement. Therefore, the results cannot be determined with precision and may
not be realized in an actual sale or immediate settlement of the asset.
Additionally, there may be inherent weaknesses in any calculation technique, and
changes in the underlying assumptions used, including discount rates and
estimates of future cash flows, that could significantly affect the results of
current or future valuations.
Other-than-Temporary Investment Security Impairment. Securities are evaluated
periodically to determine whether a decline in their value is
other-than-temporary. Management utilizes criteria such as the magnitude and
duration of the decline, in addition to the reasons underlying the decline, to
determine whether the loss in value is other-than-temporary. The term
"other-than-temporary" is not intended to indicate that the decline is
permanent, but indicates that the prospect for a near-term recovery of value is
not necessarily favorable, or that there is a lack of evidence to support a
realizable value equal to or greater than the carrying value of the investment.
Once a decline in value is determined to be other-than-temporary, the value of
the security is reduced and a corresponding charge to earnings is recognized.
Deferred Income Taxes. We use the asset and liability method of accounting for
income taxes. Under this method, deferred tax assets and liabilities are
recognized for the future tax consequences attributable to differences between
the financial statement carrying amounts of existing assets and liabilities and
their respective tax bases. Deferred tax assets and liabilities are measured
using enacted tax rates expected to apply to taxable income in the years in
which those temporary differences are expected to be recovered or settled. If
current available information raises doubt as to the realization of the deferred
tax assets, a valuation allowance is established. We consider the determination
of this valuation allowance to be a critical accounting policy because of the
need to exercise significant judgment in evaluating the amount and timing of
recognition of deferred tax liabilities and assets, including projections of
future taxable income. These judgments and estimates are reviewed on a continual
basis as regulatory and business factors change. A valuation allowance for
deferred tax assets may be required if the amount of taxes recoverable through
loss carryback declines, or if we project lower levels of future taxable income.
Such a valuation allowance would be established through a charge to income tax
expense which would adversely affect our operating results.
Comparison of Financial Condition at
Total Assets. Total assets increased
Cash and Due from Banks. Cash and due from banks decreased$126.9 million , or 86.4%, to$20.0 million atSeptember 30, 2022 from$146.8 million atSeptember 30, 2021 . The primary reason for the decrease was an increase in loans receivable. Interest-Bearing Deposits with Other Institutions. Interest-bearing deposits with other institutions decreased$4.1 million , or 34.2%, to$8.0 million atSeptember 30, 2022 from$12.1 million atSeptember 30, 2021 . 33 -------------------------------------------------------------------------------- Investment Securities Available for Sale and Held to Maturity. Investment securities available for sale decreased$31.9 million , or 13.3%, to$208.6 million atSeptember 30, 2022 from$240.6 million atSeptember 30, 2021 . The decrease was due primarily to decreases in US governmentTreasury securities of$100.0 million , obligations of states and political subdivisions of$3.3 million and other debt securities of$3.5 million , which were offset in part by increases in US government agency securities of$7.3 million , US government mortgage backed securities of$55.1 million , and corporate securities of$12.5 million . The Company had$54.8 million in US government mortgage backed securities and$2.4 million of US government agency securities which were classified as held to maturity atSeptember 30, 2022 . Net Loans. Net loans increased$94.9 million , or 7.1%, to$1.4 billion atSeptember 30, 2022 fromSeptember 30, 2021 . The primary reasons for the increase were increases in residential real estate loans, construction loans, commercial real estate loans, home equity loans and lines of credit and other loans, offset in part by decreases in commercial loans, obligations of states and political subdivisions and auto loans. Commercial real estate loans increased by$87.7 million to$678.8 million atSeptember 30, 2022 from$591.1 million atSeptember 30, 2021 . Commercial loans decreased$25.3 million to$38.2 million atSeptember 30, 2022 from$63.5 million atSeptember 30, 2021 due primarily to declines in PPP loans of$21.9 million . Obligations of states and political subdivisions decreased by$15.7 million to$40.4 million atSeptember 30, 2022 from$56.2 million atSeptember 30, 2021 . One- to four-family loans increased by$43.1 million to$623.4 million atSeptember 30, 2022 from$580.3 million atSeptember 30, 2021 . The Company paused its sales of one- to four-family mortgage loans to theFederal Home Loan Bank of Pittsburgh during the fiscal first quarter of the year due to increasing interest rates. Home equity loans and lines of credit increased by$4.7 million to$43.2 million atSeptember 30, 2022 from$38.4 million atSeptember 30, 2021 . Auto loans decreased$10.2 million to$3.6 million atSeptember 30, 2022 from$13.9 million atSeptember 30, 2021 . The Company discontinued indirect auto lending inJuly 2018 . Deposits. Deposits decreased by$256.1 million , or 15.6%, to$1.4 billion atSeptember 30, 2022 , primarily as a result of decreases in interest bearing demand accounts, money market accounts, and certificates of deposit partially offset by increases in savings accounts and non-interest bearing demand accounts. Noninterest bearing demand accounts were$290.1 million , up 12.5% fromSeptember 30, 2021 . Interest bearing demand accounts declined to$357.5 million fromSeptember 30, 2021 as the Bank shifted$225.0 million in brokered deposits to FHLB advances to take advantage of lower interest rates. Money market accounts were$402.1 million atSeptember 30, 2022 , down 6.1% fromSeptember 30, 2021 . Certificates of deposit declined to$133.7 million from$209.9 million atSeptember 30, 2021 . Borrowed Funds. Borrowed funds, short term and other, increased to$230.8 million atSeptember 30, 2022 from no borrowed funds atSeptember 30, 2021 as the Company shifted funding from brokered deposits. All borrowed funds are from the FHLB. Stockholders' Equity. Stockholders' equity increased by$10.5 million , or 5.2%, to$212.3 million atSeptember 30, 2022 from$201.8 million atSeptember 30, 2021 . The increase was primarily due to net income of$20.1 million partially offset by other comprehensive loss of$3.6 million , cash dividends paid of$5.3 million and common stock repurchases of$1.9 million .
Comparison of Operating Results for the Years Ended
Net Income. Net income increased by$3.6 million , or 22.2%, to$20.1 million for the fiscal year endedSeptember 30, 2022 from$16.4 million for the fiscal year endedSeptember 30, 2021 . The increase was primarily due to a decrease in interest expense, a decrease in the provision for loan losses and an increase in interest income partially offset by a decrease in noninterest income, increase in non-interest expense and an increase in income taxes. Net Interest Income. Net interest income increased by$6.9 million , or 13.0%, to$59.8 million for fiscal year 2022 from$52.9 million for fiscal year 2021, primarily due to the decreases in interest expense from deposits and short-term borrowings, and an increase in total interest income. Interest Income. Interest income increased$4.1 million , or 7.0%, to$62.8 million for fiscal year 2022 from$58.7 million for fiscal year 2021. The increase resulted from an increase of 28 basis points in the overall yield on interest earning assets to 3.56% from 3.28%, which had the effect of increasing interest income by$3.5 million along with a decrease of$21.2 million in average interest earning assets, which had the effect of increasing interest income by$663,000 . The decrease in average interest earning assets during 2022 compared to 2021 included decreases in average loans receivable of$18.4 million and other assets of$66.5 million . These decreases were partially offset by increases in average mortgage backed securities of$45.6 million , average FHLB stock of$3.1 million and average investment securities of$14.6 million . The average yield on loans increased to 4.07% for the fiscal year 2022, from 3.91% for the fiscal year 2021. The average yields on investment securities remained at 2.78% and the average yields on mortgage backed securities increased to 2.04% for 2022 from 1.55% for the 2021 period. 34 -------------------------------------------------------------------------------- Interest Expense. Interest expense decreased$2.8 million , or 47.5%, to$3.0 million for fiscal year 2022 from$5.8 million for fiscal year 2021. The decrease in interest expense resulted from a 19 basis point decrease in the overall cost of interest bearing liabilities to 0.23% for fiscal 2022 from 0.42% for fiscal 2021 which had the effect of decreasing interest expense by$1.7 million along with a decrease in average interest bearing liabilities which had the effect of decreasing interest expense by$1.1 million . For fiscal 2022, average borrowed funds increased$45.4 million compared to fiscal 2021. Average savings and club accounts increased by$19.1 million , average interest bearing demand deposit accounts increased$55.0 million , average money market accounts increased$17.2 million and average certificates of deposit decreased$185.3 million . The cost of money market accounts remained at 0.16% for fiscal year 2022. The cost of interest bearing demand deposit accounts remained at 0.10% for fiscal year 2022. The cost of savings and club accounts remained at 0.05% for fiscal 2022. The cost of certificates of deposit decreased to 0.47% from 0.87% and the cost of borrowed funds decreased to 0.61% from 1.48% for fiscal years 2022 and 2021, respectively. Provision for Loan Losses. The Company establishes provisions for loan losses, which are charged to earnings, at a level necessary to absorb known and inherent losses that are both probable and reasonably estimable at the date of the financial statements. In evaluating the level of the allowance for loan losses, management considers historical loss experience, the types of loans and the amount of loans in the loan portfolio, adverse situations that may affect the borrower's ability to repay, the estimated value of any underlying collateral, peer group information and prevailing economic conditions. This evaluation is inherently subjective as it requires estimates that are susceptible to significant revision as more information becomes available or as future events occur. After an evaluation of these factors, the Company made no loan loss provision for fiscal year 2022 compared to a$2.7 million provision for the 2021 fiscal year. The allowance for loan losses was$18.5 million , or 1.27% of loans outstanding, atSeptember 30, 2022 , compared to$18.1 million , or 1.33% of loans outstanding, atSeptember 30, 2021 . Determining the amount of the allowance for loan losses necessarily involves a high degree of judgment. Management reviews the level of the allowance on a quarterly basis, and establishes the provision for loan losses based on the factors set forth in the preceding paragraph. Historically, the Bank's loan portfolio has consisted primarily of one- to four-family residential mortgage loans. However, our current business plan calls for increases in commercial real estate loan originations. As management evaluates the allowance for loan losses, the increased risk associated with larger non-homogenous commercial real estate may result in large additions to the allowance for loan losses in future periods. Loans secured by commercial real estate generally expose a lender to greater risk of non-payment and loss than one- to four-family residential mortgage loans because repayment of the loans often depends on the successful operation of the property and the income stream of the underlying property. Additionally, such loans typically involve larger loan balances to single borrowers or groups of related borrowers compared to one- to four-family residential mortgage loans. Accordingly, an adverse development with respect to one loan or one credit relationship can expose us to greater risk of loss compared to an adverse development with respect to a one- to four-family residential mortgage loan. Although we believe that we use the best information available to establish the allowance for loan losses, future additions to the allowance may be necessary, based on estimates that are susceptible to change as a result of changes in economic conditions and other factors. In addition, theFDIC , as an integral part of its examination process, will periodically review our allowance for loan losses. This agency may require us to recognize adjustments to the allowance, based on its judgments about information available to it at the time of its examination. Non-Interest Income. Non-interest income decreased$3.0 million , or 26.0%, to$8.5 million for the year endedSeptember 30, 2022 , from$11.5 million for the comparable 2021 period. The decrease was primarily due to decreases in gain on sale of investments, net of$460,000 , gain on sale of loans, net of$1.9 million , service charges and fees on loans of$35,000 , loan swap fees of$341,000 , earnings on bank owned life insurance of$95,000 , insurance commissions of$70,000 and other noninterest income of$147,000 . Gain on sale of loans declined as the Company paused sales of one-to-four family residential mortgages due to increasing interest rates. These decreases were offset, in part, by increases in service fees on deposit accounts of$6,000 and trust and investment fees of$105,000 . Non-Interest Expense. Non-interest expense increased$1.5 million , or 3.6%, to$43.3 million for fiscal year 2022 from$41.8 million for the comparable period in 2021. The primary reasons for the increase in noninterest expense were increases in compensation and employee benefits of$330,000 , occupancy and equipment of$161,000 , professional fees of$1.4 million , data processing of$141,000 , advertising of$131,000 and a decrease in gain on foreclosed real estate of$466,000 . These increases were partially offset by decreases in prepayment on FHLB advances of$254,000 ,FDIC insurance premiums of$511,000 and other expenses of$330,000 . Income Taxes. Income tax expense of$4.9 million was recognized for fiscal year 2022 compared to an income tax expense of$3.5 million recognized for fiscal year 2021. The effective tax rate for the year endedSeptember 30, 2022 was 19.7% compared to 17.5% for the 2021 period. 35 --------------------------------------------------------------------------------
Average Balance Sheets for the Years Ended
The following tables set forth average balance sheets, average yields and costs,
and certain other information for the periods indicated. All average balances
are daily average balances, the yields set forth below include the effect of
deferred fees and discounts and premiums that are amortized or accreted to
interest income.
For the Years Ended September 30,
2022 2021
Interest Interest
Average Income/ Yield/ Average Income/ Yield/
Balance Expense Cost Balance Expense Cost
(Dollars in thousands)
Interest-earning assets:
Loans (1) (2) $ 1,376,133 $ 56,051 4.07 % $ 1,394,498 $ 54,459 3.91 %
Investment securities
Taxable (3) 100,019 2,788 2.79 % 80,254 2,255 2.81 %
Exempt from federal income
tax (3) (4) 2,947 61 2.62 % 8,068 156 2.45 %
Total investment securities 102,966 2,849 2.78 % 88,322 2,411 2.78 %
Mortgage-backed securities 138,237 2,820 2.04 % 92,282 1,429 1.55 %
Regulatory stock 7,397 404 5.46 % 4,295 204 4.75 %
Other 142,473 688 0.48 % 208,964 184 0.09 %
Total interest-earning assets 1,767,206 62,812 3.56 % 1,788,361 58,687 3.28 %
Allowance for loan losses (18,265 ) (16,885 )
Noninterest-earning assets 114,939 114,232
Total assets $ 1,863,880 $ 1,885,708
Interest-bearing liabilities:
Interest bearing demand
accounts 325,281 324 0.10 % 270,238 273 0.10 %
Money market accounts 426,771 678 0.16 % 409,568 667 0.16 %
Savings and club accounts 197,616 104 0.05 % 178,534 94 0.05 %
Certificates of deposit 330,657 1,546 0.47 % 515,937 4,488 0.87 %
Borrowed funds 63,754 389 0.61 % 18,310 271 1.48 %
Total interest-bearing
liabilities 1,344,079 3,041 0.23 % 1,392,587 5,793 0.42 %
Non-interest bearing demand
accounts 277,189 264,160
Noninterest-bearing liabilities 30,693 30,686
Total liabilities 1,651,961 1,687,433
Equity 211,919 198,275
Total liabilities and equity $ 1,863,880 $ 1,885,708
Net interest income $ 59,771 $ 52,894
Interest rate spread 3.33 % 2.86 %
Net interest-earning assets $ 423,127 $ 395,774
Net interest margin (5) 3.38 % 2.96 %
Average interest-earning assets
to
average interest-bearing
liabilities 131.48 % 128.42 %
(1) Non-accruing loans are included in the outstanding loan balances.
(2) Interest income on loans includes net amortized costs on loans totaling
(3) Held to maturity securities are reported as amortized cost. Available for
sale securities are reported at fair value.
(4) Yields on tax exempt securities have been calculated on a fully tax
equivalent basis assuming a tax rate of 21%.
(5) Represents the difference between interest earned and interest paid, divided
by average total interest earning assets.
36
--------------------------------------------------------------------------------Rate/Volume Analysis
The following table presents the effects of changing rates and volumes on our
net interest income for the years indicated. The rate column shows the effects
attributable to changes in rate (changes in rate multiplied by prior volume).
The volume column shows the effects attributable to changes in volume (changes
in volume multiplied by prior rate). The net column represents the sum of the
prior columns. For purposes of this table, changes attributable to both rate and
volume, which cannot be segregated, have been allocated proportionately based on
the changes due to rate and the changes due to volume. There were no
out-of-period items or adjustments for 2022 or 2021
For the
Years Ended September 30,
2022 vs. 2021
Increase (Decrease)
Due to
Volume Rate Net
(In thousands)
Interest-earning assets:
Loans $ (756 ) $ 2,348 $ 1,592
Investment securities 442 (4 ) 438
Mortgage-backed securities 851 540 1,391
Regulatory stock 166 34 200
Other (40 ) 544 504
Total interest-earning assets 663 3,462 4,125
Interest-bearing liabilities:
NOW accounts 51 - 51
Money market accounts 11 - 11
Savings and club accounts 10 - 10
Certificates of deposit (1,290 ) (1,652 ) (2,942 )
Borrowed funds 155 (37 ) 118
Total interest-bearing liabilities (1,063 ) (1,689 ) (2,752 )
Net change in interest income
Management of Market Risk General. The majority of our assets and liabilities are monetary in nature. Consequently, our most significant form of market risk is interest rate risk. Our assets, consisting primarily of loans, having longer maturities than our liabilities, consisting primarily of deposits and borrowings. As a result, a principal part of our business strategy is to manage interest rate risk and reduce the exposure of our net interest income to changes in market interest rates. Accordingly, our Board of Directors has approved guidelines for managing the interest rate risk inherent in our assets and liabilities, given our business strategy, operating environment, capital, liquidity and performance objectives. Senior management monitors the level of interest rate risk on a regular basis and the asset/liability committee meets quarterly to review our asset/liability policies and interest rate risk position. We have sought to manage our interest rate risk in order to minimize the exposure of our earnings and capital to changes in interest rates. Net interest income, which is the primary source of the Company's earnings, is impacted by changes in interest rates and the relationship of different interest rates. To manage the impact of the rate changes, the balance sheet should be structured so that repricing opportunities exist for both assets and liabilities at approximately the same time intervals. The Company uses net interest simulation to assist in interest rate risk management. The process includes simulating various interest rate environments and their impact on net interest income. As ofSeptember 30, 2022 , the level of net interest income at risk in a 200 basis points increase or a 100 basis point decrease was within the Company's policy limit of a decline less than 10% of net interest income. 37 --------------------------------------------------------------------------------
The following table sets forth the results of the twelve month projected net
interest income model as of
Net Interest Income
Amount Change Change
Change in Interest Rates in Basis Points (Rate Shock) $ $ (%)
(Dollars in thousands)
-100 67,143 (1,449 ) (2.1 )
Static 68,592 - -
+100 69,307 715 1.0
+200 69,810 1,218 1.8
+300 70,376 1,784 2.6
+400 70,913 2,321 3.4
The above table indicates that as of September 30, 2022 , in the event of a 400
basis point instantaneous increase in interest rates, the Company would
experience an 3.4%, or $2.3 million , increase in net interest income. In the
event of a 100 basis point decrease in interest rates, the Company would
experience a 2.1%, or $1.4 million , decrease in net interest income.
Another measure of interest rate sensitivity is to model changes in the economic
value of equity through the use of immediate and sustained interest rate shocks.
The following table illustrates the economic value of equity model results as of
September 30, 2022 .
Economic Value of Equity
Amount Change Change
Change in Interest Rates in Basis Points $ $ (%)
(Dollars in thousands)
-100 410,728 1,264 0.3
Flat 409,464 - -
+100 405,252 (4,212 ) (1.0 )
+200 396,169 (13,295 ) (3.2 )
+300 387,926 (21,538 ) (5.3 )
+400 379,261 (30,203 ) (7.4 )
The preceding table indicates that as of September 30, 2022 , in the event of an
immediate and sustained 400 basis point increase in interest rates, the Company
would experience a 7.4%, or $30.2 million , decrease in the present value of
equity. If rates were to decrease 100 basis points, the Company would experience
a 0.3%, or $1.3 million , increase in the present value of equity.
Certain shortcomings are inherent in the methodologies used in the above
interest rate risk measurements. Modeling changes in net interest income
requires the making of certain assumptions regarding prepayment and deposit
decay rates, which may or may not reflect the manner in which actual yields and
costs respond to changes in market interest rates. While management believes
such assumptions are reasonable, there can be no assurance that assumed
prepayment rates and decay rates will approximate actual future loan prepayment
and deposit withdrawal activity. Moreover, the net interest income table
presented assumes that the composition of interest sensitive assets and
liabilities existing at the beginning of a period remains constant over the
period being measured and also assumes that a particular change in interest
rates is reflected uniformly across the yield curve regardless of the duration
to maturity or repricing of specific assets and liabilities. Accordingly,
although the net interest income table provides an indication of the Company's
interest rate risk exposure at a particular point in time, such measurement is
not intended to and does not provide a precise forecast of the effect of changes
in market interest rates on net interest income and will differ from actual
results.
Liquidity and Capital Resources
We maintain liquid assets at levels we consider adequate to meet both our
short-term and long-term liquidity needs. We adjust our liquidity levels to fund
deposit outflows, repay our borrowings and to fund loan commitments. We also
adjust liquidity as appropriate to meet asset and liability management
objectives.
Our primary sources of liquidity are deposits, amortization and prepayment of
loans and mortgage-backed securities, maturities of investment securities and
other short-term investments, and earnings and funds provided from operations,
as well as access to FHLB advances and other borrowings. While scheduled
principal repayments on loans and mortgage-backed securities are a relatively
predictable source of funds, deposit flows and loan prepayments are greatly
influenced by market interest rates, economic conditions, and rates offered by
our competition. We set the interest rates on our deposits to maintain a desired
level of total deposits.
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A portion of our liquidity consists of cash and cash equivalents and borrowings,
which are a product of our operating, investing and financing activities. At
September 30, 2022 , $27.9 million of our assets were invested in cash and cash
equivalents. Our primary sources of cash are principal repayments on loans,
proceeds from the maturities of investment securities, principal repayments of
mortgage-backed securities and increases in deposit accounts. There were $8.0
million in short-term investment securities (maturing in one year or less) at
September 30, 2022 . As of September 30, 2022 , we had $230.8 million in
borrowings outstanding from the FHLB-Pittsburgh. We have access to FHLB advances
of up to approximately $756.1 million .
At September 30, 2022 , we had $431.7 million in loan commitments outstanding,
which included $212.7 million in undisbursed construction loans, $53.9 million
in unused home equity lines of credit, $114.2 million in commercial lines of
credit and $36.4 million in other unused commitments. Certificates of deposit
due within one year of September 30, 2022 totaled $85.5 million , or 64.0% of
certificates of deposit. If these maturing deposits do not remain with us, we
will be required to seek other sources of funds, including other certificates of
deposit and borrowings. Depending on market conditions, we may be required to
pay higher rates on such deposits or other borrowings than we currently pay on
the certificates of deposit due on or before September 30, 2022 . We believe,
however, based on past experience that a significant portion of our certificates
of deposit will remain with us. We have the ability to attract and retain
deposits by adjusting the interest rates offered.
As reported in the Consolidated Statements of Cash Flows, our cash flows are
classified for financial reporting purposes as operating, investing or financing
cash flows. Net cash provided by operating activities was $22.7 million and
$19.4 million for the years ended September 30, 2022 and 2021, respectively.
These amounts differ from our net income because of a variety of cash receipts
and disbursements that did not affect net income for the respective periods. Net
cash (used) provided by investing activities was $(128.1) million and $31.8
million in fiscal years 2022 and 2021, respectively, principally reflecting our
loan and investment security activities in the respective periods. Cash proceeds
from principal repayments, maturities and sales of investment securities
amounted to $129.2 million and $111.4 million in the years ended September 30,
2022 and 2021, respectively. Deposit and borrowing cash flows have traditionally
comprised most of our financing activities which resulted in net cash used for
financing activities of $25.6 million in fiscal year 2022, and $48.1 million in
fiscal year 2021.
We also have obligations under our post retirement plan as described in Note 12
to the Consolidated Financial Statements. The post retirement benefit payments
represent actuarially determined future payments to eligible plan participants.
We froze our pension plan in fiscal year 2017.
Off-Balance Sheet Arrangements. In the normal course of operations, we engage in
a variety of financial transactions that, in accordance with generally accepted
accounting principles are not recorded in our financial statements. These
transactions involve, to varying degrees, elements of credit, interest rate and
liquidity risk. Such transactions are used primarily to manage customers'
requests for funding and take the form of loan commitments and lines of credit.
For information about our loan commitments, letters of credit and unused lines
of credit, see Note 10 of the notes to the Consolidated Financial Statements.
The Company also uses derivative financial instruments to manage interest rate
risk. For information about the Company's derivatives and hedging activities,
see Note 17 of the notes to the Consolidated Financial Statements.
For fiscal year 2022, we did not engage in any off-balance-sheet transactions
other than loan origination commitments and standby letters of credit in the
normal course of our lending activities. The Company used derivative financial
instruments as part of its interest rate hedging activities in 2022.
Impact of Inflation and Changing Prices
The financial statements and related notes ofESSA Bancorp have been prepared in accordance withUnited States generally accepted accounting principles ("GAAP"). GAAP generally requires the measurement of financial position and operating results in terms of historical dollars without consideration for changes in the relative purchasing power of money over time due to inflation. The impact of inflation is reflected in the increased cost of our operations. Unlike industrial companies, our assets and liabilities are primarily monetary in nature. As a result, changes in market interest rates have a greater impact on performance than the effects of inflation. Item 7A. Quantitative and Qualitative Disclosures About Market Risk
For information regarding market risk, see "Item 7. Management's Discussion and Analysis of Financial Conditions and Results of Operation." Item 8. Financial Statements and Supplementary Data
The Financial Statements are included in Part IV, Item 15 of this Annual Report on Form 10-K.
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