LAKE SHORE BANCORP, INC. Management's Discussion and Analysis of Financial Condition and Results
of Operations. (form 10-K)
LAKE SHORE BANCORP, INC. Management’s Discussion and Analysis of Financial Condition and Results
of Operations. (form 10-K)

This discussion and analysis reflects our consolidated financial statements and
other relevant statistical data and is intended to enhance your understanding of
our consolidated financial condition and results of operations. You should read
the information in this section in conjunction with our audited consolidated
financial statements and accompanying notes to the audited consolidated
financial statements beginning on page F-1 of this Form 10-K, and the other
statistical data provided in this Form 10-K.

General Overview of the Company’s Activities and Risks

Our results of operations depend primarily on our net interest income, which is
the difference between the interest income we earn on loans and investments and
the interest expense we pay on deposits, borrowings and other interest-bearing
liabilities. Net interest income is affected by the relative amounts of
interest-earning assets and interest-bearing liabilities and the interest rates
we earn or pay on these balances.

Our operations are also affected by non-interest income, such as service charges
and fees, debit card fees, earnings on bank owned life insurance and gains and
losses on interest rate swaps and the sales of securities and loans, by
provision for loan losses and by non-interest expenses which include salaries
and employee benefits, occupancy and equipment costs, data processing,
professional services, advertising and other general and administrative
expenses.

Financial institutions like us, in general, are significantly affected by
economic conditions, competition, and the monetary and fiscal policies of the
federal government. Lending activities are influenced by the demand for and
supply of housing and commercial real estate, competition among lenders,
interest rate conditions, and funds availability. Our operations and lending are
principally concentrated in the Western New York area, and our operations and
earnings are influenced by local economic conditions. Deposit balances and cost
of funds are influenced by prevailing market rates on competing investments,
customer preferences, and levels of personal income and savings in our primary
market area. Operations are also significantly impacted by government policies
and actions of regulatory authorities. Future changes in applicable law,
regulations or government policies may materially impact the Company.

To operate successfully, we must manage various types of risk, including but not
limited to, interest rate risk, credit risk, liquidity risk, operational and
information technology risks, strategic risk, reputation risk and compliance
risk. A significant form of market risk for the Company is interest rate risk,
as the Company’s assets and liabilities are sensitive to changes in interest
rates. Interest rate risk is the exposure of our net interest income to adverse
movements in interest rates. Net interest income is our primary source of
revenue and interest rate risk is a significant non-credit related risk to which
our Company is exposed. Net interest income is affected by changes in interest
rates as well as fluctuations in the level and duration of our assets and
liabilities. In addition to directly impacting net interest income, changes in
interest rates can also affect the amount of new loan originations, the ability
of borrowers and debt issuers to repay loans and debt securities, the volume of
loan repayments and refinancings, the flow and mix of deposits and the fair
value of available for sale securities.

In recent years, the Company has adjusted its strategies to manage interest rate
risk by originating a greater volume of shorter-term, adjustable rate commercial
real estate and commercial business loans and increasing its concentration of
core deposits, which are less interest rate sensitive. The Company has entered
into two interest rate swap arrangements with a total notional amount of $6.0
million
to convert a portion of its interest earning assets into fixed or
adjustable rate interest-earning assets, as applicable, to better manage its
exposure to movements in interest rates.

Credit risk is the risk to our earnings and stockholders’ equity that results
from customers, to whom loans have been made, and from issuers of debt
securities in which the Company has invested, failing to repay


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their obligations. The magnitude of risk depends on the capacity and willingness
of borrowers and debt issuers to repay and the sufficiency of the value of
collateral obtained to secure the loans made or investments purchased. This risk
is managed by policies approved by the Company’s Board of Directors, review of
compliance with the policies and periodic reporting and evaluation of loans or
securities that are non-performing or demonstrate other characteristics of
potential loss.

RECENT MARKET CONDITIONS, RELATED RISKS AND UNCERTAINTIES

During the first quarter of 2020, an outbreak of a novel strain of coronavirus
(“COVID-19”), which was originally identified in Wuhan, China, and has since
spread to a number of countries around the world, including the United States.
The World Health Organization declared COVID-19 to be a global pandemic. In
response to the COVID-19 pandemic, the federal government, New York State
governor and state agencies, along with national, state and local health
agencies have taken and continue to take actions designed to mitigate the effect
of the virus on public health and to address the economic impact of the
pandemic. The Federal Reserve reduced the overnight federal funds rate by 150
basis points in March 2020 and announced the resumption of quantitative easing.
Congress passed a number of measures in 2020 and 2021, designed to infuse cash
into the economy to offset the negative impacts of business closings and
restrictions.

The Company quickly responded to the changing environment at the onset of the
pandemic by successfully executing its business continuity plan, including
implementing work from home arrangements and limiting branch activities. Once
the branches received the resources necessary to implement appropriate social
distancing protocols, along with enhanced cleaning services, in-person customer
service activities resumed.

The direct and indirect effects of COVID-19 and its associated impacts on
business activities, retail, restaurants and bars, travel, productivity, labor
shortages, supply chain constraints and other activities have had, are currently
having and may for some time continue to have an adverse impact on financial
markets and economic activity. The extent of the impact of COVID-19 on our
operational and financial performance is currently uncertain, cannot be
predicted and will depend on future developments, including, among others, the
effectiveness of vaccination, the ability to sustainably limit the spread of
COVID-19 and/or its variants, and sustained recovery of economic activity in our
market areas as pandemic restrictions are relaxed. Refer to Part I. Item 1.
Business and Part I. Item 1A. Risk Factors for additional details on the related
risks and the impact of the pandemic.

As of December 31, 2021, the Bank’s capital ratios were in excess of all
regulatory requirements. While management believes we have sufficient capital to
withstand potential losses that may occur as a result of the COVID-19 pandemic,
our regulatory capital ratios could be adversely impacted by further credit
losses. The Company maintains access to multiple sources of liquidity which
could be used to support capital ratios.

Management Strategy

Our Reputation. Our primary management strategy has been to maintain our
position as an authentic community bank, locally headquartered in Western New
York
, with more than 130 years of service to our community. Our management team
strives to accomplish this goal by continuing to emphasize our exceptional
individualized customer service and financial strength, continued community
involvement, effective risk management, strong capital levels, multi-channel
banking services and penetration in our market areas via organic growth of loans
and deposits.

Branding and Marketing. We currently operate eleven full-service branch offices
throughout Western New York, where our branch teams initiate and develop both
consumer and commercial customer relationships in and around the surrounding
market areas. We offer concierge banking services, together with our online and
mobile customer conveniences, creating a truly individualized approach for
customers to manage their finances whenever, wherever and however they wish. As
a true local bank, we pride ourselves on offering competitive products delivered
with the individualized service our customers have come to expect.


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Our experienced team of commercial bankers can meet the needs of nearly any type
of business through a variety of checking and credit products, and banking
services. The retail banking team located in our branch offices focuses on
meeting the deposit and lending needs of all consumers through-out various life
stages. Our team members live and work right here in our Western New York
communities and can fully understand the specific challenges and opportunities
our customers face daily. As the banking industry continues to rapidly evolve in
terms of technological conveniences, we remain proactive in our efforts to
provide e-banking services that our customers expect. From local
decision-making, responding quickly and efficiently to customer needs, and
utilizing technology to level the playing field with our competitors, we are
committed to developing long-term relationships with our customers. Staying true
to our local roots and mission of “Putting People First” continues to uniquely
position us as a bank of choice in Western New York.

Technology. An important strategic objective is to continue to evaluate and
enhance the technology supporting our customer service. We are committed to
making investments in technology and we believe that it represents an efficient
way to deploy a portion of our capital. To this end, the Company has developed a
five year plan for the implementation of cost effective and efficient digital
services to meet our customer’s technology needs, to focus on attracting new
customers, and to improve our operational efficiencies. Although we remain
committed to expanding our retail branch footprint whenever it makes strategic
sense, we will be concentrating our near term efforts on expanding our digital
footprint. As part of this initiative, we converted a portion of our banking
systems to a new provider in the third quarter of 2021, which improved our
ability to efficiently serve our customers and provides our customers with
updated e-banking services for their convenience.

Our People. A large part of our success is related to customer service and
customer satisfaction. Having employees who understand and value our clientele
and their business is a key component to our success. We believe that our
present staff is one of our competitive strengths, and thus the retention of
such persons and our ability to continue to attract quality personnel is a high
priority.

Lending. Our strategy is to grow our loan portfolio with emphasis on the
origination of short-term adjustable rate commercial real estate, commercial
business and home equity loans, while maintaining strong underwriting and asset
quality.

Due to the interest rate risk inherent in holding long-term, fixed rate one- to
four-family real estate loans in our portfolio, we have been strategically
focused on increasing the originations of commercial real estate loans to
finance the purchase of real property, which generally consists of developed
real estate. We have also focused on commercial business lending to small
businesses, including business installment loans, lines of credit and other
commercial loans. These types of commercial loans are generally made at higher
interest rates and for shorter terms than one- to four-family real estate loans,
which reduces the Bank’s interest rate risk. At December 31, 2021 and 2020, our
commercial real estate loan portfolio (including loans to finance the
construction of commercial real estate) represented the largest holdings in our
loan portfolio at 55.5% and 54.4%, respectively, of total loans.

At December 31, 2021 and 2020, residential one- to four-family mortgage loans
(including loans to finance the construction of one- to four-family homes)
represented the second largest holding in our loan portfolio at 30.6% and 28.6%,
respectively. We may sell low-yielding long-term conforming fixed rate one- to
four-family residential loans that we originate on the secondary market, as part
of our interest rate risk strategy and asset/liability management, if it is
deemed appropriate. During the years ended December 31, 2021 and 2020, we sold
$13.3 million and $19.1 million, respectively, of low-rate one- to four- family
residential loans in the secondary market. We typically retain servicing rights
when we sell one- to four-family residential mortgage loans.

Commercial business loans, home equity loans and consumer loans provide
diversification to our loan portfolio while meeting the needs of our customers.
As of December 31, 2021 and 2020, our commercial business loan portfolio
represented 4.5% and 7.7%, respectively, of total loans, while the home equity
loan portfolio represented 9.2% and 9.0%, of total loans, respectively.


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Asset Quality. We remain committed to maintaining prudent underwriting standards
and aggressively monitoring our loan portfolio to maintain asset quality. We
introduce loan products only when we are confident that our staff has the
necessary expertise to originate and administer such loans, and that sound
underwriting and collection procedures are in place. Our goal is to continue to
improve our asset quality through prudent underwriting standards and the
diligence of our loan collection personnel.

Critical Accounting Estimates


It is management's opinion that accounting estimates covering certain aspects of
our business have more significance than others due to the relative importance
of those areas to overall performance, or the level of subjectivity required in
making such estimates.
Allowance for loan losses. Management considers the accounting policy relating
to the allowance for loan losses to be a critical accounting policy given the
significant subjectivity and uncertainty in evaluating the level of the
allowance for loan losses required for probable credit losses and the material
effect that such judgments can have on the results of operations. Management's
monthly evaluation of the adequacy of the allowance considers our historical
loan loss experience, review of specific loans that are past due or where
management has knowledge of possible credit problems, current economic
conditions, and such other factors considered appropriate to estimate loan
losses. Management uses presently available information to estimate probable
losses on loans; however, future additions to the allowance may be necessary
based on changes in estimates, assumptions, or economic conditions. Significant
factors that could give rise to changes in these estimates include, but are not
limited to, changes in economic conditions in our local market areas,
concentrations of risk or a decline in local property values. During 2020, the
Company adjusted certain qualitative factors to take into account the uncertain
impacts of COVID-19 on economic conditions and borrowers' ability to repay
loans. The Company's determination as to the amount of its allowance for loan
losses is subject to review by its bank regulators, which can require the
establishment of additional loss allowances. Refer to Note 6 of the notes to our
audited consolidated financial statements for more information on the allowance
for loan losses.
This critical accounting estimate and its application is reviewed periodically
by our Audit/Risk Committee and our Board of Directors. All accounting policies
are important, and as such, we encourage the reader to review each of the
policies included in the notes to the audited consolidated financial statements
to better understand how our financial performance is reported.

Analysis of Net Interest Income

Net interest income represents the difference between the interest we earn on
our interest-earning assets, such as commercial and residential mortgage loans
and investment securities, and the expense we pay on interest-bearing
liabilities, such as deposits and borrowings. Net interest income depends on
both the volume of our interest-earning assets and interest-bearing liabilities
and the interest rates we earn or pay on them.

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Average Balances, Interest and Average Yields. The following table sets forth
certain information relating to our average balance sheets and reflects the
average yield on interest-earning assets and average cost of interest-bearing
liabilities, interest earned and interest paid for the years indicated. Such
yields and costs are derived by dividing income or expense by the average
balance of interest-earning assets or interest-bearing liabilities,
respectively, for the years presented. Average balances are derived from daily
balances over the years indicated. The average balances for loans are net of
allowance for loan losses, but include non-accrual loans. The loan yields
include net amortization of certain deferred fees and costs that are considered
adjustments to yields. The net amortization of deferred loan fees and costs were
$509,000 and $566,000 for the years ended December 31, 2021 and 2020,
respectively. Interest income on securities does not include a tax equivalent
adjustment for bank qualified municipal bonds.

                                    For the Year Ended                   For the Year Ended
                                    December 31, 2021                    December 31, 2020
                                          Interest                             Interest
                             Average      Income/      Yield/     Average      Income/      Yield/
                             Balance      Expense       Rate      Balance      Expense       Rate
                                                    (Dollars in thousands)
Interest-earning assets:
Interest-earning deposits
& federal funds sold        $  42,875    $      35       0.08%   $  51,419     $    104       0.20%
Securities(1)                  81,212        1,872       2.31%      77,290        2,163       2.80%
Loans                         532,665       22,752       4.27%     487,888       22,069       4.52%
Total interest-earning
assets                        656,752       24,659       3.75%     616,597       24,336       3.95%
Other assets                   48,139                               44,150
Total assets                $ 704,891                            $ 660,747

Interest-bearing
liabilities
Demand & NOW accounts       $  85,132    $      75       0.09%   $  76,313     $    105       0.14%
Money market accounts         165,393          347       0.21%     152,682          919       0.60%
Savings accounts               72,433           38       0.05%      60,350           35       0.06%
Time deposits                 150,274        1,634       1.09%     163,838        2,609       1.59%
Borrowed funds & other
interest-bearing
liabilities                    26,403          571       2.16%      33,649          736       2.19%
Total interest-bearing
liabilities                   499,635        2,665       0.53%     486,832        4,404       0.90%
Other non-interest
bearing liabilities           118,125                               89,007
Stockholders' equity      87,131                               84,908
Total liabilities &
stockholders' equity   $ 704,891                            $ 660,747
Net interest income                      $  21,994                            $  19,932
Interest rate spread                                     3.22%                                3.05%
Net interest margin                                      3.35%                                3.23%

(1)The tax equivalent adjustment for bank qualified municipal securities results
in rates of 2.68% and 3.21% for the years ended December 31, 2021 and 2020,
respectively.


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Rate Volume Analysis. The following table analyzes the dollar amount of changes
in interest income and interest expense for major components of interest-earning
assets and interest-bearing liabilities. The table shows the amount of the
change in interest income or expense caused by either changes in outstanding
balances (volume) or changes in interest rates. The effect of a change in volume
is measured by applying the average rate during the first year to the volume
change between the two years. The effect of changes in rate is measured by
applying the change in rate between the two years to the average volume during
the first year. Changes attributable to both rate and volume, which cannot be
segregated, have been allocated proportionately to the absolute value of the
change due to volume and the change due to rate.

                                                        Year Ended December 31, 2021
                                                                 Compared to
                                                        Year Ended December 31, 2020
                                                        Rate       Volume     Net Change
                                                           (Dollars in thousands)
Interest-earning assets:
Interest-earning deposits & federal funds sold       $      (54)  $   (15)  $       (69)
Securities                                                 (396)      105          (291)
Loans, including fees                                    (1,272)    1,955           683
Total interest-earning assets                            (1,722)    2,045           323
Interest-bearing liabilities:
Demand & NOW accounts                                       (41)       11           (30)
Money market accounts                                      (643)       71          (572)
Savings accounts                                             (4)        7             3
Time deposits                                              (773)     (202)         (975)
Total deposits                                           (1,461)     (113)       (1,574)

Other interest-bearing liabilities:
Borrowed funds & other interest-bearing liabilities (17) (148) (165)
Total interest-bearing liabilities

                       (1,478)     (261)       (1,739)
Total change in net interest income                  $     (244)  $ 2,306   $     2,062


As shown in the above table, the increase in net interest income for the year
ended December 31, 2021 was primarily due to the decrease in average interest
rates paid on interest-bearing liabilities (specifically average interest rates
paid on deposit products) and the increase in the average volume of loans,
partially offset by a decrease in the average yield earned on interest-earning
assets. Net interest rate spread increased by 17 basis points to 3.22% for the
year ended December 31, 2021 as compared to 3.05% for the year ended December
31, 2020
. Net interest margin increased by 12 basis points to 3.35% for the year
ended December 31, 2021 as compared to 3.23% for the prior year. The increase in
net interest spread and net interest margin were primarily due to a 37 basis
points decrease in average rates paid on interest-bearing liabilities, which was
partially offset by a 20 basis points decrease in average yield earned on
interest-earnings assets.

Comparison of Financial Condition at December 31, 2021 and December 31, 2020

Total assets at December 31, 2021 were $713.7 million, an increase of $27.5
million
, or 4.0%, from $686.2 million at December 31, 2020. The increase in
total assets was primarily due to a $24.6 million increase in cash and cash
equivalents driven by deposit growth and a $9.5 million increase in securities,
partially offset by a $6.9 million decrease in loans receivable, net.

Cash and cash equivalents increased by $24.6 million, or 57.3%, from $43.0
million
at December 31, 2020 to $67.6 million at December 31, 2021. The increase
was primarily due to a $32.9 million increase in


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deposits and a $5.6 million cash inflow related to an overall decrease in loans
receivable, net, partially offset by a $11.2 million net cash outflow for the
purchases of securities available for sale and a $7.8 million cash outflow to
pay down long-term debt.

Securities increased by $9.5 million, or 12.0%, from $79.3 million at December
31, 2020
to $88.8 million at December 31, 2021. The increase was primarily due
to $30.0 million of securities purchases which was partially offset by $18.8
million
in securities paydowns, as a result of maturities, calls and
prepayments, and a $1.5 million decrease in unrealized mark to market gains
during the year ended December 31, 2021.


Net loans receivable decreased during the year ended December 31, 2021, as shown
in the table below:

                                        At December 31,             Change
                                        2021        2020         $          %
                                                (Dollars in thousands)
Real Estate Loans:
Residential, one- to four-family(1)  $ 158,826   $ 150,660   $   8,166      5.4 %
Home equity                             48,071      47,603         468      1.0 %
Commercial                             266,525     257,321       9,204      3.6 %
Construction - Commercial               21,824      28,923      (7,099)  (24.5) %
Total real estate loans                495,246     484,507      10,739      2.2 %
Other Loans:
Commercial                              23,216      40,772     (17,556)  (43.1) %
Consumer                                 1,317       1,353         (36)   (2.7) %
Total gross loans                      519,779     526,632      (6,853)   (1.3) %
Allowance for loan losses               (6,118)     (5,857)       (261)     4.5 %
Net deferred loan costs                  3,545       3,368         177      5.3 %
Loans receivable, net                $ 517,206   $ 524,143   $  (6,937)   (1.3) %

(1)Includes one- to four-family construction loans.

Loans receivable, net decreased $6.9 million, or 1.3%, primarily due to
construction – commercial and commercial business loan pay-downs, which included
PPP loan forgiveness, that was partially offset by new loan originations. The
decrease was primarily due to a $17.6 million decrease in commercial business
loans resulting from forgiveness of $24.9 million of PPP loans originated during
2020 and 2021, partially offset by loan originations during 2021. The
outstanding balance of PPP loans was $4.6 million at December 31, 2021 as
compared to $18.1 million as of December 31, 2020. During the year ended
December 31, 2021, commercial real estate loans, including commercial real
estate construction loans, increased by a net amount of $2.1 million, driven by
$68.7 million of loan originations which was partially offset by $66.6 million
of loan payoffs. The Bank experienced an unexpected increase in loan payoff
during the current year as a result of competitive low interest rates being
offered by non-bank lenders. During the year ended December 31, 2021, we
remained strategically focused on originating shorter duration, adjustable-rate
commercial real estate loans and commercial business loans to diversify our
asset mix and to properly manage interest rate risk.


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Asset Quality. The following table presents information regarding activity in
our allowance for loan losses and our asset quality ratios at or for the years
ended December 31, 2021 and 2020.

                                                At or for the Year Ended December 31,
                                                     2021                   2020
                                                        (Dollars in thousands)
Balance at beginning of year                  $            5,857     $            4,267
Provision for loan losses                                    650                  1,625
Charge-offs:
Real estate loans:
Residential, one- to four-family                             (12)                   (26)
Home equity                                                     -                    (6)
Commercial                                                  (427)                      -
Construction - Commercial and Residential,
one- to four-family                                             -                      -
Other loans:
Commercial                                                      -                    (5)
Consumer                                                     (39)                   (42)
Total charge-offs                                           (478)                   (79)
Recoveries:
Real estate loans:
Residential, one- to four-family                              49                     23
Home equity                                                    2                      2
Commercial                                                     6                      1
Construction - Commercial and Residential,
one- to four-family                                             -                      -
Other loans:
Commercial                                                    23                      4
Consumer                                                       9                     14
Total recoveries                                              89                     44
Net charge-offs                                             (389)                   (35)
Balance at end of period                      $            6,118     $            5,857

Average loans outstanding                     $          532,665     $          487,888
Allowance for loan losses as a percent of
total net loans                                             1.18  %                1.12  %
Allowance for loan losses as a percent of
non-performing loans                                       63.50  %              188.75  %

Ratio of net charge-offs to average loans
outstanding by loan type:
Real estate loans:
Residential, one- to four-family                            0.02  %                    - %
Home equity                                                     - %               (0.01) %
Commercial                                                 (0.16) %                    - %
Construction - Commercial                                       - %                    - %
Other loans:
Commercial                                                  0.06  %                    - %
Consumer                                                   (2.31) %               (2.22) %
Ratio of total net charge-offs to total
average loans outstanding                                  (0.07) %               (0.01) %

Non-performing loans as a percent of total
net loans:                                                  1.86  %                0.59  %
Non-performing assets as a percent of total
assets:                                                     1.37  %                0.46  %


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Total non-performing assets increased by $6.6 million, or 208.7%, to $9.8
million
at December 31, 2021 from $3.2 million at December 31, 2020, primarily
due to one commercial real estate loan with a balance of $7.0 million being
placed into non-accrual status during 2021. The loan was restructured and
classified as a TDR during the year ended December 31, 2021, which resulted in a
$423,000 charge-off, as well as receipt of a significant payment by the borrower
to reduce the remaining outstanding principal balance. Management continues to
closely monitor the performance of this loan, which is well supported by
collateral and is currently in compliance with its contractual monthly payments.

The table below shows changes in deposit balances by type of deposit account
between December 31, 2021 and December 31, 2020:


                                      At December 31,             Change
                                      2021        2020         $          %
                                              (Dollars in thousands)
Core Deposits
Demand deposits and NOW accounts:
Non-interest bearing               $ 110,676   $  91,946   $  18,730    20.4  %
Interest bearing                      95,104      84,839      10,265    12.1  %
Money market                         175,886     158,505      17,381    11.0  %
Savings                               74,155      65,643       8,512    13.0  %
Total core deposits                  455,821     400,933      54,888    13.7  %
Non-core Deposits
Time deposits                        137,363     159,326     (21,963)  (13.8) %
Total deposits                     $ 593,184   $ 560,259   $  32,925     5.9  %

The increase in total deposits was primarily due to an overall increase in net
core deposits, partially offset by a decrease in time deposits. A majority of
the growth in core deposits during the year ended December 31, 2021 was
primarily due to organic growth and the deposit of PPP funds and government
stimulus payments into our customers’ deposit accounts. The Company’s strategic
focus continues to be centered on organic growth of low-cost core deposits among
its retail and commercial customers in an effort to manage interest expense and
strengthen customer relationships.

Long-term debt consisting of advances from the FHLBNY, decreased by $7.8
million
, or 26.2%, from $29.8 million at December 31, 2020 to $22.0 million at
December 31, 2021. The decrease was due to the Company paying off maturing debt
with excess cash on hand.

Total stockholders’ equity increased $2.1 million, or 2.4%, to $88.0 million at
December 31, 2021 from $85.9 million at December 31, 2020. Stockholders’ equity
as of December 31, 2021 reflected net income of $6.2 million, which was
partially offset by a $1.1 million decrease in accumulated other comprehensive
income, a $2.1 million increase in treasury stock and by $1.1 million of
dividends paid during the year ended December 31, 2021.

Comparison of Results of Operations for the Years Ended December 31, 2021 and
2020

General. Net income was $6.2 million for the year ended December 31, 2021, or
$1.05 per diluted share, an increase of $1.6 million, or 35.7%, compared to net
income of $4.6 million, or $0.77 per diluted share, for the year ended December
31, 2020
. Net income for the year ended December 31, 2021 reflected a $2.1
million
increase in net interest income, a $1.0 million decrease in provision
for loans losses and a $196,000 increase in non-interest income which was
partially offset by a $1.1 million increase in non-interest expense and a
$464,000 increase in income tax expense when compared to the year ended December
31, 2020
.


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Net Interest Income. Net interest income increased by $2.1 million, or 10.3%, to
$22.0 million for the year ended December 31, 2021 compared to $19.9 million for
the year ended December 31, 2020. Interest income increased by 1.3%, while
interest expense decreased by 39.5% for the year ended December 31, 2021 when
compared to the year ended December 31, 2020. Interest rate spread and net
interest margin were 3.22% and 3.35%, respectively, for the year ended December
31, 2021
compared to 3.05% and 3.23%, respectively, for the year ended December
31, 2020
.

Interest Income. Interest income increased by $323,000, or 1.3%, to $24.7
million
for the year ended December 31, 2021 when compared to the year ended
December 31, 2020 primarily due to an increase in loan interest income. Loan
interest income increased $683,000, or 3.1%, to $22.8 million for the year ended
December 31, 2021 when compared to the year ended December 31, 2020. The
increase was primarily due to an increase in the average balance of the loan
portfolio of $44.8 million, or 9.2%, from $487.9 million for the year ended
December 31, 2020 to $532.7 million for the year ended December 31, 2021. The
increase in the average balance of loans was primarily due to growth in the
average balance of commercial real estate, commercial construction and one-to
four-family real estate loans. The increase in loan interest income was also
impacted by a $338,000 increase in prepayment penalties and a $119,000 increase
in PPP loan fees during the year ended December 31, 2021 when compared to the
prior year. The increase in loan interest income was partially offset by a 25
basis points decrease in the average yield on loans to 4.27% for the year ended
December 31, 2021 as compared to 4.52% for the year ended December 31, 2020. The
decrease in average yield on loans was primarily due to a decrease in market
interest rates. It was also due to the portfolio of PPP loans, which have an
interest rate of 1.00% as per the SBA guidelines. The net yield on the PPP
loans, when including the deferred origination fee income and cost, averaged
2.04%, which is well below traditional loan yields.

Investment interest income decreased $291,000, or 13.5%, to $1.9 million for the
year ended December 31, 2021 compared to the year ended December 31, 2020, due
to a 49 basis points decrease in the average yield of the investment portfolio.
The average yield was 2.80% for the year ended December 31, 2020 as compared to
2.31% for the year ended December 31, 2021. The decrease in the average yield
was due to a decrease in market interest rates since December 31, 2020 and
purchases of new securities at lower interest rates. The average balance of the
investment portfolio increased from $77.3 million for the year ended December
31, 2020
to $81.2 million for the year ended December 31, 2021 primarily due to
securities purchases which largely consisted of municipal bond and mortgage
backed securities, partially offset by securities paydowns and redemptions of
“callable” municipal bonds.

Other interest income decreased by $69,000, or 66.3%, to $35,000 for the year
ended December 31, 2021 as compared to the year ended December 31, 2020. The
average yield on other interest income decreased 12 basis points to 0.08% for
the year ended December 31, 2021 from 0.20% for the year ended December 31, 2020
and the average balance of other interest earning assets decreased from $51.4
million
for the year ended December 31, 2020 to $42.9 million for the year ended
December 31, 2021. The decrease in the average yield was primarily due to the
150 basis points decrease in short term market interest rates during the first
quarter of 2020 as a response to the economic impact of the COVID-19 pandemic.
The decrease in the average balance of other interest earning assets was
primarily due to a decrease in the average balance of interest earning deposits
held by the Company as excess funds were used to fund loan originations,
purchase securities available for sale and pay-off long-term debt.

Interest Expense. Interest expense decreased $1.7 million, or 39.5%, to $2.7
million
for the year ended December 31, 2021 compared to $4.4 million for the
year ended December 31, 2020 primarily due to a decrease in interest paid on
deposits. Interest paid on deposits decreased by $1.6 million, or 42.9%, to $2.1
million
for the year ended December 31, 2021 when compared to the year ended
December 31, 2020. The decrease in interest expense on deposits was primarily
due to a 37 basis points decrease in the average rate paid on deposits due to a
decrease in market interest rates compared to the year ended December 31, 2020.
The decrease was partially offset by a $20.0 million, or 4.4%, increase in
average deposit balances for the year ended December 31, 2021 as compared to the
year ended December 31, 2020. The average balance of deposits for the year ended
December 31, 2021 was $473.2 million with an average rate of 0.44% compared to
the


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average balance of deposits of $453.2 million and an average rate of 0.81% for
the year ended December 31, 2020. The increase in the average balance of
interest-bearing deposits was due to an increase in core deposit accounts
primarily through organic growth and the deposit of PPP funds and government
stimulus payments into our customers’ deposit accounts.

Interest expense on long-term debt decreased by $160,000, or 24.0%, to $508,000
for the year ended December 31, 2021 when compared to the year ended December
31, 2020
primarily due to a decrease in the average balance of advances from the
FHLBNY. The average balance of advances from the FHLBNY for the year ended
December 31, 2021 was $25.7 million with an average rate of 1.97% compared to an
average balance of $32.9 million with an average rate of 2.03% for the year
ended December 31, 2020. The decrease in average balance was due to the Company
paying off maturing debt with excess cash on hand since December 31, 2020.

Provision for Loan Losses. A $650,000 provision to the allowance for loan losses
was recorded during the year ended December 31, 2021 compared to $1.6 million
for the year ended December 31, 2020. During the year ended December 31, 2020,
the Company’s provision for loan losses included an adjustment of certain
qualitative factors to take into account the uncertainty surrounding the impact
of COVID-19 and related economic conditions on borrowers’ ability to repay
loans. The provision for the year ended December 31, 2021 was primarily due to a
charge-off associated with the downgrade and impairment of one commercial real
estate loan and general reserves for loan originations during the year.

We complete a comprehensive quarterly evaluation to determine our provision for
loan losses. The evaluation reflects analyses of individual borrowers and
historical loss experience, supplemented as necessary by credit judgment that
considers observable trends, conditions, and other relevant environmental and
economic factors.

During the year ended December 31, 2021, the Company recorded a $672,000 net
provision for commercial real estate and construction – commercial loans. This
consisted of a $423,000 provision for a charge-off related to one commercial
real estate loan during the year. The remaining provision was primarily related
to adjustments to certain qualitative factors for commercial real estate and
construction – commercial loans during the year ended December 31, 2021. A
$72,000 net provision was recorded for one-to four-family, home equity and
consumer loans that primarily reflected adjustments to certain qualitative
factors for these loan types, partially offset by net loan recoveries for these
loan types during the year ended December 31, 2021. A $168,000 net credit
provision was recorded for commercial business loans which reflected a $116,000
credit allowance to account for a $125,000 decrease in criticized and classified
commercial business loans and adjustments to certain qualitative factors.
Furthermore, a $52,000 credit allowance to account for a $4.0 million decrease
in outstanding commercial business loans, excluding PPP loans, during the year
ended December 31, 2021 was recorded. A $74,000 unallocated provision was
recorded to reflect the margin of imprecision inherent in the underlying
assumptions used in the methodologies for estimating allocated and general
losses in the loan portfolio.

During the year ended December 31, 2020, the Company recorded a $1.4 million net
provision for commercial real estate and construction – commercial loans. This
consisted of a $693,000 provision to reflect an adjustment of certain
qualitative factors to take into account the uncertain impact of COVID-19 on
economic conditions and borrowers’ ability to repay loans and a $638,000 general
allowance to reflect inherent losses within the portfolio due to $42.7 million
of organic growth during 2020. It also included an $84,000 provision to reflect
the $11.6 million increase in criticized and classified commercial real estate
loans, which consists primarily of one loan relationship which is
well-collateralized. A $199,000 net provision was recorded for commercial
business loans which reflected adjustments to certain qualitative factors
relating to the COVID-19 impact on economic conditions and an increase in
classified loans. The provision also reflected a credit allowance to account for
a $4.0 million decrease in outstanding commercial business loans, excluding PPP
loans, during the year ended December 31, 2020. An $11,000 credit provision was
recorded for one-to four-family, home equity and consumer loans primarily to
reflect a decrease in classified loans during the year ended December 31, 2020.
A $22,000 unallocated provision was recorded to reflect the margin of
imprecision


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inherent in the underlying assumptions used in the methodologies for estimating
allocated and general losses in the loan portfolio.

Refer to Note 6 of the Notes to the Consolidated Financial Statements for
additional details on the provision for loan losses.

Non-Interest Income. Non-interest income increased by $196,000, or 6.6%, to $3.2
million
for the year ended December 31, 2021 as compared to $3.0 million for the
year ended December 31, 2020. The increase was primarily due to a $331,000
increase in unrealized gains on interest rate swaps due to an increase in
long-term interest rates during the year ended December 31, 2021. Non-interest
income was also positively impacted by a $171,000 increase in service charges
and fees and a $110,000 increase in debit card fee income. During the prior
year, the Company waived certain ATM fees and other service charges to provide
relief to customers during the onset of the COVID-19 pandemic. The increase in
non-interest income was partially offset by a $297,000 decrease in gains on the
sale of residential mortgage loans due to impact of increased market competition
on the pricing of residential mortgage loan products in our market area,
resulting in less income earned per loan at time of sale during the year ended
December 31, 2021. Offsetting the increase in non-interest income was a $76,000
decrease in earnings on bank owned life insurance during the year ended December
31, 2021
as compared to the year ended December 31, 2020.

Non-Interest Expense. Non-interest expense increased by $1.1 million, or 7.2%,
to $17.1 million for the year ended December 31, 2021 as compared to $15.9
million
for the year ended December 31, 2020. Professional services increased
$592,000, or 61.2%, primarily due to one-time costs of $509,000 associated with
the Company’s undertaking of a core processing system upgrade which was
completed during the third quarter of 2021. Salary and employee benefits expense
increased $364,000, or 4.2%, primarily due to an increase in annual salaries and
the creation of an officer position for retail, sales and marketing which was
filled in August 2020. Occupancy and equipment expenses increased $268,000, or
10.4%, primarily due to increases in building maintenance and repairs, purchases
of new equipment related to the core conversion and also additional cleaning
expense related to the COVID-19 pandemic. FDIC Insurance expense increased
$59,000, or 47.6%, due to the receipt of small bank assessment credits during
the year ended December 31, 2020. These increases were partially offset by a
decrease in data processing expenses of $126,000, or 8.5%, primarily due to a
decrease in core system processing costs and activity. Advertising expense
decreased $69,000, or 10.3%, primarily due to changes in the structure of our
marketing activities.

Income Taxes Expense. Income tax expense was $1.3 million for the year ended
December 31, 2021, an increase of $464,000, or 56.3%, as compared to $824,000
for the year ended December 31, 2020. The increase in income tax expense was
primarily due to an increase in income before taxes and an increase in the
effective tax rate. The effective tax rate for the year ended December 31, 2021
and 2020 was 17.2% and 15.3%, respectively. The increase in the effective tax
rate was primarily due to a decrease in the mix of tax-exempt income derived
from our municipal bond portfolio in relation to our pre-tax income.

Liquidity and Capital Resources

Liquidity describes our ability to meet the financial obligations that arise
during the ordinary course of business. Liquidity is primarily needed to fund
loan commitments, to pay the deposit withdrawal requirements of our customers as
well as to fund current and planned expenditures. Our primary sources of funds
consist of deposits, scheduled amortization and prepayments of loans and
securities, maturities and sales of investments and loans, excess cash, interest
earning deposits at other financial institutions and funds provided from
operations. We have written agreements with the FHLBNY, which allows us to
borrow the maximum lending values designated by the type of collateral pledged.
As of December 31, 2021, the maximum amount that we could borrow from the FHLBNY
was $114.3 million and was collateralized by a pledge of certain fixed-rate
residential, one- to four-family loans. At December 31, 2021, we had outstanding
advances under this agreement of $22.0 million. We have a written agreement with
the Federal Reserve Bank discount window for overnight borrowings which is
collateralized by a pledge of our securities, and allows us to borrow up to the


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value of the securities pledged, which was equal to a book value of $10.6
million
and a fair value of $11.0 million as of December 31, 2021. There were no
balances outstanding with the Federal Reserve Bank at December 31, 2021. We have
also established lines of credits with correspondent banks for $42.0 million, of
which $40.0 million is unsecured and the remaining $2.0 million will be secured
by a pledge of our securities when a draw is made. There were no borrowings on
these lines as of December 31, 2021.

While maturities and scheduled amortization of loans and securities are
predictable sources of funds, deposit outflows, calls of investment securities,
and prepayments of loans and mortgage-backed securities are strongly influenced
by interest rates, general and local economic conditions, and competition in the
marketplace. These factors reduce the predictability of the timing of these
sources of funds. We have not experienced any unusual pressure on our deposit
balances or our liquidity position as a result of the COVID-19 pandemic.

Our primary investing activities include the origination of loans and the
purchase of investment securities. For the year ended December 31, 2021, we
originated loans of approximately $168.6 million as compared to approximately
$188.5 million of loans originated during the year ended December 31, 2020.
Principal repayments and other deductions exceeded loan originations in 2021 by
$5.6 million. Purchases of investment securities totaled $30.0 million and $28.0
million
for the years ended December 31, 2021 and 2020, respectively. These
activities were funded primarily through deposit growth, principal payments
received on loans and securities, borrowings and cash reserves.

As described elsewhere in this report, the Company has loan commitments to
borrowers and borrowers have unused overdraft lines of protection, unused home
equity lines of credit and unused commercial lines of credit that may require
funding at a future date. The Company believes it has sufficient funds to
fulfill these commitments, including sources of funds available through the use
of FHLBNY advances or other liquidity sources. Total deposits were $593.2
million
at December 31, 2021, as compared to $560.3 million at December 31,
2020
. Approximately $72.6 million of time deposit accounts are scheduled to
mature within one year as of December 31, 2021. Based on our deposit retention
experience, current pricing strategy, and competitive pricing policies, we
anticipate that a significant portion of these time deposits will remain with us
following their maturity.

We are committed to maintaining a strong liquidity position; therefore, we
monitor our liquidity position on a daily basis. We anticipate that we will have
sufficient funds to meet our current funding commitments. The marginal cost of
new funding, however, whether from deposits or borrowings from the FHLBNY, will
be carefully considered as we monitor our liquidity needs. Therefore, in order
to minimize our cost of funds, we may consider additional borrowings from the
FHLBNY in the future.

We do not anticipate any material capital expenditures in 2022. We do not have
any balloon or other payments due on any long-term obligations, other than the
borrowing agreements noted above.

Off-Balance Sheet Arrangements

Our off-balance sheet items include loan commitments as described in Note 17 in
the notes to our consolidated financial statements and interest rate swap
agreements for a notional amount of $6.0 million, which is not designated as a
hedging instrument and does not have a material impact on our Consolidated
Statements of Income. At December 31, 2021, we had loan commitments to borrowers
of approximately $61.2 million and overdraft lines of credit, unused home equity
lines of credit, and unused commercial lines of credit of approximately $73.4
million
. We do not have any other off-balance sheet arrangements that have or
are reasonably likely to have a current or future effect on our financial
condition, revenues or expenses, results of operations, liquidity, capital
expenditures, or capital resources that is material to investors.


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Accounting Polices, Standards and Pronouncements

Refer to Note 2 in the notes to our consolidated financial statements for a
discussion of significant accounting policies, the impact of the adoption of new
accounting standards and recent accounting pronouncements.

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