SENECA FINANCIAL CORP. This discussion and analysis reflect our audited consolidated financial statements and other relevant statistical data and is intended to enhance your understanding of our financial condition and results of operations. The information in this section has been derived from the audited consolidated financial statements, which appear elsewhere in this annual report. You should read the information in this section in conjunction with the other business and financial information provided in this annual report. Overview
Our results of operations depend primarily on our net interest income. Net interest income is the difference between the interest income we earn on our interest-earning assets, consisting primarily of loans, investment securities and other interest-earning assets (cash and cash equivalents), and the interest we pay on our interest-bearing liabilities, consisting primarily of demand accounts, NOW accounts, savings accounts, money market accounts, certificate of deposit accounts and borrowings. Our results of operations also are affected by non-interest income, our provision for loan losses and non-interest expense. Non-interest income consists primarily of fee income and service charges, income from our financial services division, earnings on bank owned life insurance, realized gains on sales of loans and securities and other income. Non-interest expenses consist primarily of compensation and employee benefits, core processing, premises and equipment, professional fees, postage and office supplies,FDIC premiums, advertising and other expenses. Our results of operations also may be affected significantly by general and local economic and competitive conditions, changes in market interest rates, government policies and actions of regulatory authorities. For the year endedDecember 31, 2019 , we had net income of$1.1 million compared to net income of$850,000 for the year endedDecember 31, 2018 . The year over year$267,000 increase in net income was primarily attributable to an increase in net interest income of$412,000 , and an increase in non-interest income of$183,000 partially offset by an increase in the provision for loan losses of$232,000 , an increase in non-interest expense of$5,000 and an increase in the provision for income taxes of$91,000 . AtDecember 31, 2019 , we had$210.2 million in consolidated assets, an increase of$14.9 million , or 7.6%, from$195.3 million atDecember 31, 2018 . During 2019, we focused on loan production, particularly with respect to commercial loans. Business Strategy We intend to operate as a well-capitalized and profitable community bank dedicated to providing exceptional personal service to our individual and business customers. We believe that we have a competitive advantage in the markets we serve because of our knowledge of the local marketplace and our long-standing history of providing superior, relationship-based customer service. Our current executive management team is comprised of individuals with strong banking backgrounds who have joined Seneca Savings beginning in 2013. InOctober 2013 , we appointedJoseph G. Vitale as our President and Chief Executive Officer. Shortly thereafter, we hiredVincent J. Fazio as Executive Vice President and Chief Financial Officer. The new management team has significant banking experience with our two executives each having approximately 20 years or more of banking experience. The management team has worked to revise our business strategy and position Seneca Savings for future growth and profitability.
Our current business strategy consists of the following:
• Continuing to provide one- to four-family residential mortgage loans in our
communities while selling the majority of our newly originated longer-term,
fixed-rate residential loans. We have been and will continue to be a one- to
four-family residential mortgage lender to borrowers in our market area. As of
one- to four-family residential mortgage loans. We historically have held all
of our loan originations, including our fixed-rate one- to four-family
residential mortgage loans, in our loan portfolio. However, over the last four
years, we started regularly selling loans in the secondary market. Loans that
we sell into the secondary market consist of long-term (20 years or greater),
conforming fixed-rate residential real estate mortgage loans, which we
primarily sell to the FHLB of
and to Freddie Mac. We intend to increase the amount of sales of longer-term
fixed-rate one- to four-family residential mortgage loans into the secondary
market and retain the shorter-term one- to four-family residential mortgage
loans in our portfolio. 36
• Increasing commercial real estate and commercial and industrial lending. In
order to increase the yield on our loan portfolio and reduce the term to
repricing, our management team began to increase our commercial real estate and
commercial and industrial loan portfolios while maintaining what we believe are
conservative underwriting standards. We focus our commercial lending to small
businesses located in our market area, targeting owner-occupied businesses such
as manufacturers and professional service providers. Our commercial real estate
portfolio has grown from
from
The additional capital raised in our initial public offering has increased our
commercial lending capacity by enabling us to originate more loans that we
intend to retain in our portfolio.
• Increasing our lower-cost core deposits. NOW, Demand, savings and money market
accounts are a lower cost source of funds than time deposits, and we have made
a concerted effort to increase these lower-cost transaction deposit accounts.
For instance, we partnered with
of retail checking accounts. We plan to continue to market our core transaction
accounts, emphasizing our high-quality service and competitive pricing of these
products. We also offer the convenience of technology-based products, such as
mobile deposit capture, bill pay, card valet, internet and mobile banking. We
have become a participating bank with ZRent, a leading vendor of rent payment
technology, to create a free deposit account which provides rent payment technology to our landlord and property management clients.
• Managing credit risk to maintain a low level of non-performing assets.
We
believe strong asset quality is a key to our long-term financial success. Our
strategy for credit risk management focuses on having an experienced team of
credit professionals, well-defined policies and procedures, appropriate loan
underwriting criteria and active credit monitoring. Our non-performing assets
to total assets ratio was 0.92% at
related to one- to four-family residential real estate loans. At
2019, we had two commercial mortgages totaling$962,000 that were non-performing TDRs.
• Offering a wide selection of non-deposit investment products and
services. Financial Quest, a division of Seneca Savings, offers asset
management, financial planning, annuities, insurance and other financial
products. We have dedicated investment representatives who evaluate the needs
of clients to determine suitable investment and insurance solutions to meet
their short and long-term wealth management goals. At
assets under management were$59.0 million .
• Growing organically and through opportunistic branch acquisitions. We expect
to consider both organic growth as well as acquisition opportunities that we
believe would enhance the value of our franchise and yield potential financial
benefits for our stockholders. We expect to focus our growth in
with specific considerations to optimizing our scale. We will consider
expanding our branch network through the opening of additional branches or the
acquisition of branches if the right opportunity occurs. For example in the 4th
quarter of 2019 we opened our fourth banking location in
which will provide banking services to an underserved community and will expand
our geographical reach into
in our operating facilities and customer delivery services in order to enhance
our competitiveness.
Summary of Significant Accounting Policies
The discussion and analysis of the financial condition and results of operations are based on our consolidated financial statements, which are prepared in conformity withU.S. GAAP. The preparation of these consolidated financial statements requires management to make estimates and assumptions affecting the reported amounts of assets and liabilities, disclosure of contingent assets and liabilities, and the reported amounts of income and expenses. We consider the accounting policies discussed below to be significant accounting policies. The estimates and assumptions that we use are based on historical experience and various other factors and are believed to be reasonable under the circumstances. Actual results may differ from these estimates under different assumptions or conditions, resulting in a change that could have a material impact on the carrying value of our assets and liabilities and our results of operations.
37 OnApril 5, 2012 , the JOBS Act was signed into law. The JOBS Act contains provisions that, among other things, reduce certain reporting requirements for qualifying public companies. As an "emerging growth company", we may delay adoption of new or revised accounting pronouncements applicable to public companies until such pronouncements are made applicable to private companies. We intend to take advantage of the benefits of this extended transition period. Accordingly, our consolidated financial statements may not be comparable to companies that comply with such new or revised accounting standards.
The following represent our significant accounting policies:
Allowance for Loan Losses. The allowance for loan losses represents management's estimate of losses inherent in the loan portfolio as of the date of the statement of condition and it is recorded as a reduction of loans. The allowance is increased by the provision for loan losses, and decreased by charge-offs, net of recoveries. Loans deemed to be uncollectible are charged against the allowance for loan losses, and subsequent recoveries, if any, are credited to the allowance. All, or part, of the principal balance of loans receivable are charged off to the allowance as soon as it is determined that the repayment of all, or part, of the principal balance is highly unlikely. Because all identified losses are immediately charged off, no portion of the allowance for loan losses is restricted to any individual loan and the entire allowance is available to absorb all loan losses. The allowance for loan losses is maintained at a level considered adequate to provide for losses that can be reasonably anticipated. Management performs a quarterly evaluation of the adequacy of the allowance. The allowance is based on our past loan loss experience, known and inherent risks in the portfolio, adverse situations that may affect the borrower's ability to repay, the estimated value of any underlying collateral, composition of the loan portfolio, current economic conditions and other relevant factors. This evaluation is inherently subjective, as it requires material estimates that may be susceptible to significant revision as more information becomes available. The allowance consists of specific, general and unallocated components. The specific component relates to loans that are classified as impaired. For loans that are classified impaired, an allowance is established when the discounted cash flows or collateral value of the impaired loan are lower than the carrying value of that loan. The general component covers pools of loans, by loan class, including commercial loans not considered impaired, as well as smaller balance homogenous loans, such as residential real estate, home equity and other consumer loans. These pools of loans are evaluated for loss exposure based on historical loss rates for each of these categories of loans, which are adjusted for qualitative factors. The qualitative factors include:
• Lending policies and procedures, including underwriting standards and
collection, charge-off and recovery practices;
• National, regional and local economic and business conditions as well as the
condition of various market segments, including the value of underlying
collateral for collateral dependent loans;
• Nature and volume of the portfolio and terms of the loans;
• Experience, ability and depth of the lending management and staff;
• Volume and severity of past due, classified and non-accrual loans, as well as
other loan modifications; and
• Quality of our loan review system and the degree of oversight by our board of
directors. 38
Each factor is assigned a value to reflect improving, stable or declining conditions based on management's best judgment using relevant information available at the time of the evaluation. Adjustments to the factors are supported through documentation of changes in conditions in a narrative accompanying the allowance for loan loss analysis and calculation.
An unallocated component is maintained to cover uncertainties that could affect management's estimate of probable losses. The unallocated component of the allowance reflects the margin of imprecision inherent in the underlying assumptions used in the methodologies for estimating specific and general losses in the portfolio.
In addition, various regulatory agencies periodically review the allowance for loan losses. As a result of such reviews, we may have to adjust our allowance for loan losses. However, regulatory agencies are not directly involved in the process of establishing the allowance for loan losses as the process is the responsibility of Seneca Savings and any increase or decrease in the allowance is the responsibility of management. Income Taxes. Income taxes are provided for the tax effects of certain transactions reported in the consolidated financial statements. Income taxes consist of taxes currently due plus deferred taxes related primarily to temporary differences between the financial reporting and income tax basis of the allowance for loan losses, premises and equipment, certain state tax credits, and deferred loan origination costs. The deferred tax assets and liabilities represent the future tax return consequences of the temporary differences, which will either be taxable or deductible when the assets and liabilities are recovered or settled. Deferred tax assets are reduced by a valuation allowance when, in the opinion of management, it is more likely than not that some portion of the deferred tax assets will not be realized. Deferred tax assets and liabilities are reflected at income tax rates applicable to the period in which the deferred tax assets and liabilities are expected to be realized or settled. As changes in tax laws or rates are enacted, deferred tax assets and liabilities are adjusted through the provision for income taxes. Estimation of Fair Values. Fair values for securities available-for-sale are obtained from an independent third party pricing service. Where available, fair values are based on quoted prices on a nationally recognized securities exchange. If quoted prices are not available, fair values are measured using quoted market prices for similar benchmark securities. Management generally makes no adjustments to the fair value quotes provided by the pricing source. The fair values of foreclosed real estate and the underlying collateral value of impaired loans are typically determined based on evaluations by third parties, less estimated costs to sell. When necessary, appraisals are updated to reflect changes in market conditions. Pension Plans. Seneca Savings sponsors a qualified defined benefit pension plan. The qualified defined benefit pension plan is funded with trust assets invested in a diversified portfolio of debt and equity securities. Accounting for pensions involves estimating the cost of benefits to be provided well into the future and attributing that cost over the time period each employee works. To accomplish this, we make extensive use of assumptions about inflation, investment returns, mortality, turnover, and discount rates. We have established a process by which management reviews and selects these assumptions annually. Among other factors, changes in interest rates, investment return and the market value of plan assets can (i) affect the level of plan funding; (ii) cause volatility in the net periodic pension cost; and (iii) increase our future contribution requirements. A significant decrease in investment returns or the market value of plan assets or a significant decrease in interest rates could increase our net periodic pension costs and adversely affect our results of operations. A significant increase in our contribution requirements with respect to our qualified defined benefit pension plan could have an adverse impact on our cash flow. Changes in the key actuarial plan assumptions would impact net periodic benefit expense and the projected benefit obligation for our defined benefit pension plan. See Note 10 to the Audited Consolidated Financial Statements, "Employee Benefit Plans," for information on this plan and the
assumptions used.
39
Average balances and yields. The following table sets forth average balance
sheets, average yields and costs, and certain other information for the years
indicated. No tax-equivalent yield adjustments were made, as the effect thereof
was not material. All average balances are daily average balances. Non-accrual
loans were included in the computation of average balances but have been
reflected in the table as loans carrying a zero yield. The yields set forth
below include the effect of deferred fees, discounts and premiums that are
amortized or accreted to interest income or interest expense.
For the Years Ended December 31,
2019 2018 2017
Average Average Average
Outstanding Yield/ Outstanding Yield/ Outstanding Yield/
Balance Interest Rate Balance Interest Rate Balance Interest Rate
(In Thousands)
Interest-earning assets:
Loans $ 163,901 $ 7,862 4.80 % $ 148,129 $ 6,889 4.65 % $ 138,185 $ 6,284 4.55 %
Available-for-sale securities 26,804 694 2.59 % 26,453 611 2.31 % 21,453 407 1.90 %
FHLB Stock 2,967 189 6.37 % 2,600 168 6.46 % 2,126 116 5.46 %
Other interest-earning assets 1,559 24 1.54 % 1,899 34 1.79 % 1,687 21 1.24 %
Total interest-earning assets 195,231 8,769 4.49 % 179,081 7,702 4.30 % 163,451 6,828 4.18 %
Noninterest-earning assets 9,787 6,986 7,258
Total assets $ 205,018 $ 186,067 $ 170,709
Interest-bearing liabilities:
NOW accounts $ 14,469 $ 23 0.16 % $ 13,892 $ 24 0.17 % $ 11,944 $ 18 0.15 %
Regular savings and demand
club accounts 22,189 20 0.09 % 21,417 15 0.07 % 22,888 14 0.06 %
Money market accounts 16,817 169 1.00 % 13,554 76 0.56 % 13,822 78 0.56 %
Certificates of deposit and
retirement accounts 76,320 1,509 1.98 % 73,034 1,149 1.57 % 69,553 876 1.26 %
Total interest-bearing
deposits 129,795 1,721 1.33 % 121,897 1,264 1.04 % 118,207 986 0.83 %
FHLB Borrowings 35,497 852 2.40 % 30,112 654 2.17 % 24,045 451 1.88 %
Total interest-bearing
liabilities 165,292 2,573 1.56% 152,009 1,918 1.26 % 142,252
1,437 1.01 % Noninterest-bearing deposits 16,291 13,269 15,228 Other non-interest bearing liabilities 4,039 2,569 559 Total liabilities 185,622 167,847 158,039 Stockholders' equity 19,396 18,220 12,670 Total liabilities and stockholders' equity$ 205,018 $ 186,067 $ 170,709 Net interest income$ 6,196 $ 5,784 $ 5,391 Net interest rate spread (1) 2.93 % 3.04 % 3.17 % Net interest-earning assets (2)$ 29,939 $ 27,072 $ 27,072 Net interest margin (3) 3.17 % 3.23 % 3.30 % Average interest-earning assets to average interest-bearing liabilities 118 % 118 % 118 %
(1) Interest rate spread represents the difference between the average yield on
average interest-earning assets and the average cost of average
interest-bearing liabilities.
(2) Net interest-earning assets represents total interest-earning assets less
total interest-bearing liabilities.
(3) Net interest margin represents net interest income divided by total
interest-earning assets.
40
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.
Year Ended December 31, Year Ended December 31,
2019 vs. 2018 2018 vs. 2017
Total Total
Increase Increase
Increase (Decrease) Due to (Decrease) Increase (Decrease) Due to (Decrease)
Volume Rate Volume Rate
(In thousands)
Interest-earning assets:
Loans $ 733 $ 240 $ 973 $ 863 $ (36 ) $ 827
Available-for-sale securities 8 75 83 25 72 97
FHLB Stock 24 (3 ) 21 22 22 44
Other interest-earning assets (6 ) (4 ) (10 ) 2 14 16
Total interest-earning assets $ 759 $ 308 $ 1,067 $ 912 $ 72 $ 984
Interest-bearing liabilities:
NOW accounts $ - $ (1 ) $ (1 ) $ 3 $ 1 $ 4
Regular savings and demand club
accounts - 5 5 - 2 2
Money market accounts 1 92 93 3 (2 ) 1
Certificates of deposit and
retirement accounts 1 359 360 118 188 306
Total deposits 2 455 457 124 189 313
FHLB Borrowings 117 81 198 50 82 132
Total interest-bearing liabilities 119 536 655 175 271 445
Change in net interest income $ 640 $ (228 ) $ 412 $ 738 $ (199 ) $ 539
41
Comparison of Financial Condition at
Total assets increased$14.9 million , or 7.6%, to$210.2 million atDecember 31, 2019 from$195.3 million atDecember 31, 2018 . The increase in assets was due to increases in loans, securities available-for-sale, fixed assets and pension assets. Loans net of allowance for loan losses increased$9.7 million , or 6.3%, to$164.4 million atDecember 31, 2019 from$154.7 million atDecember 31, 2018 , reflecting increases in commercial loans. One- to four-family residential real estate mortgage loans decreased$3.4 million , or 3.3%, to$99.2 million atDecember 31, 2019 from$102.6 million atDecember 31, 2018 as principal payments outpaced originations during the twelve months endedDecember 31, 2019 . Commercial real estate loans increased$11.0 million , or 47.1%, to$34.4 million atDecember 31, 2019 from$23.4 million atDecember 31, 2018 . Commercial and industrial loans increased$2.7 million , or 19.0%, to$16.8 million atDecember 31, 2019 from$14.1 million atDecember 31, 2018 . Throughout the year of 2019, we increased our portfolio of commercial loans to increase earnings and to continue to manage interest rate risk. Securities available-for-sale increased by$1.8 million , or 6.8%, to$28.0 million atDecember 31, 2019 from$26.2 million atDecember 31, 2018 . The increase was primarily due to the purchase of securities of$9.7 million , partially offset by principal repayments, amortization of premiums of$1.0 million , maturity and calls of$780,000 , and proceeds from sales of$5.9 million . The growth in securities was to conform to our asset composition policy of 10% of securities to total assets. A portion of our securities portfolio is used to collateralize FHLB advances. Total deposits increased$7.9 million , or 5.5%, to$151.9 million atDecember 31, 2019 from$144.0 million atDecember 31, 2018 . The increase was primarily due to increases in demand deposits and money market accounts. Demand deposits increased$3.5 million , or 26.7% to$16.7 million atDecember 31, 2019 from$13.2 million atDecember 31, 2018 . The increased in demand deposits was due to our marketing efforts to increase transaction accounts in our primary market area and the opening of ourBridgeport location. We are offering products and services to attract new commercial checking accounts. Business online internet banking, ACH origination and wire services, remote deposit capture, mobility business services, check free small business bill payment and delivery and mobile source capture are products targeting the growth of our business deposit accounts. Money market accounts increased$5.6 million , or 37.1% to$20.7 million atDecember 31, 2019 from$15.1 million atDecember 31, 2018 . The increase in money market accounts was the result of our continued focus on commercial deposit relationships. Certificates of deposit decreased$2.0 million as we reduced our dependence on jumbo certificates of deposit. Total borrowings from the FHLB ofNew York increased$4.5 million , or 16.0%, from$28.4 million atDecember 31, 2018 to$32.9 million atDecember 31, 2019 to fund loan growth. Total stockholders' equity increased$1.6 million , or 8.5%, to$21.1 million atDecember 31, 2019 from$19.4 million atDecember 31, 2018 . The increase was due to the combined effect of our net income of$1.1 million and decreases in accumulated other comprehensive loss of$1.1 million and stock-based compensation valuation of$12,000 , partially offset by an increase in treasury stock of$579,000 resulting from our stock repurchase program. Comparison of Operating Results for the Years EndedDecember 31, 2019 and 2018 General. Net income increased$267,000 , or 31.4%, to$1.1 million for the year endedDecember 31, 2019 , compared to$850,000 for the year endedDecember 31, 2018 . The increase was due to an increase in net interest income and an increase in non-interest income partially offset by increases in the provision for loan losses, the provision for income tax, and non-interest expense. Interest Income. Interest income increased$1.1 million , or 13.9%, to$8.8 million for the year endedDecember 31, 2019 from$7.7 million for the year endedDecember 31, 2018 . Our average balance of interest-earning assets increased$16.2 million , or 9.0%, to$195.2 million for the year endedDecember 31, 2019 from$179.1 million for the year endedDecember 31, 2018 due primarily to the increase in the average balance of loans. Our average yield of interest-earning assets increased 19 basis points to 4.49% for the year endedDecember 31, 2019 from 4.30% for the year endedDecember 31, 2018 . Interest income on loans increased$973,000 , or 14.1%, to$7.9 million for the year endedDecember 31, 2019 from$6.9 million for the year endedDecember 31, 2018 due primarily to the increase in the average balance of loans. Our average balance of loans increased$15.8 million , or 10.6%, to$163.9 million for the year endedDecember 31, 2019 from$148.1 million for the year endedDecember 31, 2018 . The increase in the average balance of loans resulted from our continued focus on commercial lending. Our average yield on loans increased by 15 basis points to 4.80% for the year endedDecember 31, 2019 from 4.65% for the year endedDecember 31, 2018 , as higher-yielding commercial loans have been originated during the year. Interest income on securities increased$104,000 , or 13.4%, to$883,000 for the year endedDecember 31, 2019 from$779,000 for the year endedDecember 31, 2018 . The average balance of available-for-sale securities increased$351,000 , or 1.3%, to$26.8 million in 2019 from$26.5 million in 2018 due to securities purchases. The average yield we earned on available-for-sale securities increased by 28 basis points to 2.59% for the year endedDecember 31, 2019 from 2.31% for the year endedDecember 31, 2018 as yields on available-for- sale securities increased with new purchases at higher yields. 42 Interest Expense. Interest expense increased$655,000 , or 34.2%, to$2.6
million for the year endedDecember 31, 2019 from$1.9 million for the year endedDecember 31, 2018 , due to increases in interest expense on deposits of$457,000 and$198,000 in interest expense on borrowings. Our average balance of interest-bearing liabilities increased$13.3 million , or 8.7%, to$165.3 million for the year endedDecember 31, 2019 from$152.0 million for the year endedDecember 31, 2018 due primarily to increases in the average balances of certificates of deposit, money market accounts and FHLB ofNew York borrowings. Our average rate on interest-bearing liabilities increased 30 basis points to 1.56% for the year endedDecember 31, 2019 from 1.26% for the year endedDecember 31, 2018 as a result of increases in the average rates on certificates of deposit, money market accounts and FHLB ofNew York borrowings. Interest expense on deposits increased$457,000 , or 36.2%, to$1.7 million for 2019 from$1.3 million for 2018 due to increases in the average rate paid on deposits and the average balance of deposits. The average rate paid on deposits increased to 1.33% for 2019 from 1.04% for 2018, primarily reflecting higher rates paid on promotional money market accounts, certificates of deposit and CDARS certificates of deposit. The average rate of money market deposits increased by 44 basis points to 1.00% in 2019 from 0.56% in 2018. Certificates of deposit increased by 41 basis points to 1.98% in 2019 from 1.57% in 2018. In addition, the average balance of certificates of deposit increased by$3.3 million to$76.3 million in 2019 from$73.0 million in 2018, and the average balance of money market accounts increased by$3.3 million to$16.8 million in 2019 from$13.6 million in 2018 which reflected the majority of the growth in the average balance of deposits. Interest expense on borrowings increased$198,000 , or 30.3%, to$852,000 for the year endedDecember 31, 2019 from$654,000 for the year endedDecember 31, 2018 . The increase in interest expense on borrowings reflected a$5.4 million increase in our average balance of borrowings with the FHLB ofNew York to$35.5 million for 2019 from$30.1 million for 2018, and an increase in the average rate of these borrowings to 2.40% in 2019 from 2.17% in 2018. The average balance on borrowings with the FHLB ofNew York increased in 2019 as compared to 2018 due to increased borrowings throughout the year to fund loan growth. The average rate on borrowings increased due to extending the FHLB ofNew York borrowing terms in order to manage interest rate risk. Net Interest Income. Net interest income increased$412,000 , or 7.1%, to$6.2 million for the year endedDecember 31, 2019 from$5.8 million for the year endedDecember 31, 2018 , primarily as a result of the greater growth in the average balance of our interest-earning assets as compared to our interest-bearing liabilities and the purchase of higher yielding securities. Our net interest-earning assets increased 2.9% to$29.9 million for the year endedDecember 31, 2019 , from$27.1 million for the year endedDecember 31, 2018 , due to the increase in the average balance of loans and securities. Our net interest rate spread decreased by 11 basis points to 2.93% for the year endedDecember 31, 2019 from 3.04% for the year endedDecember 31, 2018 , and our net interest margin decreased by six basis points to 3.17% for the year endedDecember 31, 2019 from 3.23% for the year endedDecember 31, 2018 as the percentage increase of interest expense on interest bearing liabilities outpaced the percentage increase of interest income on interest earning assets. Provision for Loan Losses. We establish a provision for loan losses which is charged to operations in order to maintain the allowance for loan losses at a level we consider necessary to absorb credit losses inherent in the loan portfolio that are both probable and reasonably estimable at the consolidated balance sheet date. In determining the level of the allowance for loan losses, we consider past and current loss experience, evaluations of real estate collateral, current economic conditions, volume and type of lending, adverse situations that may affect a borrower's ability to repay a loan, and the levels of non-performing and other classified loans. The amount of the allowance is based on estimates and the ultimate losses may vary from such estimates as more information becomes available or conditions change. We assess the allowance for loan losses on a quarterly basis and make provisions for loan losses in order to maintain the allowance. Based on our evaluation of the above factors, we recorded a$242,000 provision to the allowance for loan losses for the year endedDecember 31, 2019 compared to a$10,000 provision for loan losses for the year endedDecember 31, 2018 . The increase in the provision for 2019 was the result of increased net charge-offs. Net charge-offs increased to$235,000 in 2019 as compared to$17,000 in 2018. The increase in charge-offs were due to residential real-estate loans foreclosed and sold during the year and were provisioned in our allowance for loan losses. The allowance for loan losses was$1.2 million , or 0.75% of net loans outstanding atDecember 31, 2019 as compared to$1.2 million , and 0.79% of net loans outstanding atDecember 31, 2018 . 43 To the best of our knowledge, we have recorded all loan losses that are both probable and reasonable to estimate atDecember 31, 2019 andDecember 31, 2018 . However, future changes in the factors described above, including, but not limited to, actual loss experience with respect to our loan portfolio, could result in material increases in our provision for loan losses. In addition, theOffice of the Comptroller of the Currency , as an integral part of its examination process, will periodically review our allowance for loan losses, and as a result of such reviews, we may have to adjust our allowance for loan losses. However, regulatory agencies are not directly involved in establishing the allowance for loan losses as the process is our responsibility and any increase or decrease in the allowance is the responsibility of management. Non-Interest Income. Non-interest income increased$183,000 , or 27.2%, to$855,000 for the year endedDecember 31, 2019 from$672,000 for the year endedDecember 31, 2018 . The increase was primarily due to increased income of$32,000 from financial services and$110,000 in deposit related fees. The increase in financial services income of$32,000 was due to an increase in assets under management and an increase in commission on annuity sales. Our insufficient fund fees increased$84,000 due to an increase in transaction accounts. We sold and serviced approximately 40% of the residential mortgages we originated in 2019 to mitigate interest rate risk and to increase non-interest income. During the year 2019, we disposed of a fully depreciated bank own truck and had a gain on the sale of$9,000 . Non-Interest Expense. Non-interest expense increased by$5,000 , or 0.1%, to$5.4 million for the year endedDecember 31, 2019 as compared to$5.4 million for the year endedDecember 31, 2018 . The increase was due primarily to an increase in premises and equipment of$73,000 , an increase in advertising expense of$19,000 , and an increase in professional fees of$18,000 . Nearly offsetting the increase in non-interest expense was a decrease in core processing expense of$10,000 , a decrease in postage and office supplies of$9,000 , a decrease inFDIC insurance of$12,000 and a decrease in compensation and employee benefits of$69,000 . The decrease in compensation and employee benefits expense was due to a reduction in our net periodic pension cost. Core processing decreased as we received a credit from our outsourced call center. Premises and equipment increased as we updated and modernized our offices and equipment and opened our fourth office inBridgeport, N.Y. Advertising expense increased due to printed advertising campaigns in our local market and an increased focus of advertising on social media. Professional fees increased due to the adoption of our stock-based compensation plan and other corporate matters.FDIC insurance expense decreased due to the credit received from theFDIC . Mortgage recording tax decreased due to a tax credit for the year 2019 as compared to 2018. Income Tax Expense. We incurred income tax expense of$272,000 and$181,000 for the years endedDecember 31, 2019 and 2018, respectively, resulting in effective tax rates of 19.58% and 17.56%, respectively. The increase in income tax expense resulted from the increase in income before tax.
Liquidity and Capital Resources
Liquidity describes our ability to meet the financial obligations that arise in the ordinary course of business. Liquidity is primarily needed to meet the borrowing and deposit withdrawal requirements of our customers and to fund current and planned expenditures. Our primary sources of funds are deposits, principal and interest payments on loans and securities, proceeds from the sale of loans, and proceeds from calls, maturities and sales of securities. We also are able to borrow from the FHLB ofNew York . AtDecember 31, 2019 , we had a$89.8 million line of credit with the FHLB ofNew York and$2.5 million line of credit withZions Bank . AtDecember 31, 2019 , we had outstanding borrowings of$32.9 million from the FHLB ofNew York . We have not borrowed against the line of credit withZions Bank during the years endedDecember 31, 2019 , and 2018. 44 The board of directors is responsible for establishing and monitoring our liquidity targets and strategies in order to ensure that sufficient liquidity exists for meeting the borrowing needs and deposit withdrawals of our customers as well as unanticipated contingencies. We believe that we have enough sources of liquidity to satisfy our short and long-term liquidity needs as ofDecember 31, 2019 . While maturities and scheduled amortization of loans and securities are predictable sources of funds, deposit flows and loan prepayments are greatly influenced by general interest rates, economic conditions, and competition. Our most liquid assets are cash and cash equivalents, which includes cash and due from banks. The levels of these assets are dependent on our operating, financing, lending and investing activities during any given period. AtDecember 31, 2019 , cash and cash equivalents from banks totaled$3.1 million . Securities classified as available-for-sale, which provide additional sources of liquidity, had a total market value of$28.0 million atDecember 31, 2019 . We are committed to maintaining a strong liquidity position. We monitor our liquidity position on a daily basis. We anticipate that we will have sufficient funds to meet our current funding commitments. Certificates of deposit due within one year ofDecember 31, 2019 , totaled$60.0 million , or 39.5%, of total deposits. If these deposits do not remain with us, we will be required to seek other sources of funds, including other deposits and FHLB ofNew York advances. Depending on market conditions, we may be required to pay higher rates on such deposits or borrowings than we currently pay. We believe, however, based on past experience that a significant portion of such deposits will remain with us. We have the ability to attract and retain deposits by adjusting the interest rates offered.
We have obtained an irrevocable letter of credit with theFederal Home Loan Bank of New York to collateralizeNew York state deposits for theNew York Banking Development District program.The Banking Development District program through incentives encourages banks to open branches in communities that are underserved in banking services. The program has approved our new location inBridgeport , located in Madison County.New York State will deposit a below market rate, certificate of deposit in the new location after the branch is completed. The Bank will in turn make loans to small businesses located in the market area with the proceeds. The branch was opened in the fourth quarter of 2019. AtDecember 31, 2019 , we exceeded all of our regulatory capital requirements, and we were categorized as well capitalized atDecember 31, 2019 and atDecember 31, 2018 . Management is not aware of any conditions or events since the most recent notification that would change our category. See Note 13 to our consolidated financial statements for more information.
Off-Balance Sheet Arrangements and Contractual Obligations
Commitments. As a financial services provider, we routinely are a party to various financial instruments with off-balance-sheet risks, such as commitments to extend credit and unused lines of credit. While these contractual obligations represent our future cash requirements, a significant portion of commitments to extend credit may expire without being drawn upon. Such commitments are subject to the same credit policies and approval process accorded to loans we make. AtDecember 31, 2019 , we had outstanding commitments to originate loans of$816,000 . We anticipate that we will have sufficient funds available to meet our current lending commitments. Contractual Obligations. In the ordinary course of our operations, we enter into certain contractual obligations. Such obligations include data processing services, operating leases for premises and equipment, agreements with respect to borrowed funds and deposit liabilities.
Recent Accounting Pronouncements
Please refer to Note 2 to our consolidated financial statements for a description of recent accounting pronouncements that may affect our financial condition and results of operations.
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Impact of Inflation and Changing Price
The financial statements and related data presented herein have been prepared in accordance withU.S. GAAP, which requires the measurement of financial position and operating results in terms of historical dollars without considering changes in the relative purchasing power of money over time due to inflation. The primary impact of inflation on our operations is reflected in increased operating costs. Unlike most industrial companies, virtually all of the assets and liabilities of a financial institution are monetary in nature. As a result, interest rates, generally, have a more significant impact on a financial institution's performance than does inflation. Interest rates do not necessarily move in the same direction or to the same extent as the prices of goods and
services.
Coronavirus Disease 2019
The outbreak of Coronavirus Disease 2019 ("COVID-19") could adversely impact a
broad range of industries in which the Company's customers operate and impair
their ability to fulfill their obligations to the Company. The World Health
Organization has declared Covid-19 to be a global pandemic indicating that
almost all public commerce and related business activities must be, to varying
degrees, curtailed with the goal of decreasing the rate of new infections.
The spread of the outbreak will likely cause disruptions in the U.S. economy and
is highly likely to disrupt banking and other financial activity in the areas in
which the Company operates and could potentially create widespread business
continuity issues for the Company.
The Company's business is dependent upon the willingness and ability of its
employees and customers to conduct banking and other financial transactions. If
the global response to contain COVID-19 escalates or is unsuccessful, the
Company could experience a material adverse effect on its business, financial
condition, results of operations and cash flows.
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