Northfield Bancorp, Inc. (NFBK) FY 2021 MD&A

ITEM 7.    MANAGEMENT’S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS OF OPERATIONS

The following discussion should be read in conjunction with the Consolidated Financial Statements of Northfield Bancorp, Inc. and the Notes thereto included elsewhere in this report (collectively, the “Financial Statements”).

Overview

Net income was $70.7 million, or $1.45 per diluted common share, and $37.0 million, or $0.76 per diluted common share, for the years ended December 31, 2021 and 2020, respectively. Net income for the year ended December 31, 2021 included $4.0 million, after tax, ($0.08 per share) of income generated from the accelerated accretion of fees related to the forgiveness of PPP loans, $1.4 million, after tax, ($0.03 per share) of accretable income related to the payoffs of PCD loans, $1.0 million, after tax, ($0.02 per share) in gains on loans sold, and $677,000 ($0.01 per share) of tax-exempt income from bank-owned life insurance proceeds in excess of the cash surrender value of the policies. Net income for the year ended December 31, 2020 reflected $5.8 million after tax ($0.12 per share) in incremental loan loss provisions related to an increase in estimated loss factors associated with the COVID-19 pandemic, $3.3 million after tax ($0.07) in merger-related expenses associated with the acquisition of Victory, and $1.6 million after-tax ($0.03 per share) in occupancy costs related to branch consolidations; partially offset by $479,000 after tax ($0.01 per share) in gains on loans sold, and a $445,000 after-tax reduction ($0.01 per share) in the allowance for loan losses related to the sale of loans.

Assets decreased by $84.0 million, or 1.5%, to $5.43 billion at December 31, 2021, from $5.51 billion at December 31, 2020, primarily as a result of decreases in available-for sale debt securities of $56.6 million, or 4.5%, total loans of $36.5 million, or 1.0%, and FHLBNY stock of $6.3 million, or 22.0%. Partially offsetting these decreases were increases in other assets of $11.8 million, or 46.6%, and cash and cash equivalents of $3.5 million, or 4.0%. Liabilities decreased by $69.9 million, or 1.5%, primarily as a result of a decrease in borrowings of $170.0 million, or 28.7%, to $421.8 million at December 31, 2021, from $591.8 million, partially offset by a $92.8 million, or 2.3%, increase in deposits to $4.17 billion at December 31, 2021, from $4.08 billion at December 31, 2020.

Stockholders’ equity decreased by $14.1 million to $739.9 million at December 31, 2021, from $754.0 million at December 31, 2020. The decrease was attributable to $53.2 million in stock repurchases, $24.3 million in dividend payments, and an $11.1 million decrease in accumulated other comprehensive income associated with a reduction in unrealized gains on our debt securities available-for-sale portfolio, partially offset by net income of $70.7 million for year ended December 31, 2021, and a $6.9 million increase in equity award activity. In connection with the adoption of the CECL methodology, effective January 1, 2021, the Company recognized a cumulative effect adjustment that reduced stockholders’ equity by $3.1 million, net of tax, to adjust opening allowances against credit losses on loans and off-balance sheet credit exposures.

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Selected Financial Data

The summary information presented below at the dates or for each of the years presented is derived in part from our consolidated financial statements.  The following information is only a summary, and should be read in conjunction with our consolidated financial statements and notes included in this Annual Report on Form 10-K.

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Critical Accounting Policies

Critical accounting policies are defined as those that involve significant judgments and uncertainties, and could potentially result in materially different results under different assumptions and conditions. We believe that the most critical accounting policies upon which our financial condition and results of operation depend, and which involve the most complex subjective decisions or assessments, are the following:

Allowance for Credit Losses on Loans. Effective January 1, 2021, the Company adopted new accounting guidance, which requires entities to estimate and recognize an allowance for lifetime expected credit losses for loans and other financial assets measured at amortized cost. Previously, an allowance for credit losses on loans was recognized based on probable and reasonably estimable incurred losses inherent in the loan portfolio at the balance sheet date. See Note 1 to the Company's Consolidated Financial Statements for further discussion of the Company's accounting policies and methodologies for establishing the allowance for credit losses. We identified our policy on the allowance for credit losses on loans to be a critical accounting policy because management makes subjective and/or complex judgments about matters that are inherently uncertain and because it is likely that materially different amounts would be reported under different conditions or using different assumptions.

The allowance for credit losses on loans is a critical accounting estimate for the following reasons:

•    Changes in the provision for credit losses can materially affect our financial results;

•    Estimates relating to the allowance for credit losses require us to utilize a reasonable and supportable forecast period based upon forward-looking economic scenarios in order to estimate probability of default and loss given default rates which our CECL methodology encompasses;

•    The allowance for credit losses on loans is influenced by factors outside of our control such as industry and business trends, as well as economic conditions such as trends in housing prices, interest rates, gross domestic product, inflation, and unemployment; and

•    Judgment is required to determine whether the models used to generate the allowance for credit losses on loans produce an estimate that is sufficient to encompass the current view of lifetime expected credit losses.

The allowance for credit losses on loans has been determined in accordance with U.S. GAAP. We are responsible for the timely and periodic determination of the amount of the allowance required. We believe that our allowance for credit losses is adequate to cover identifiable losses, as well as estimated losses inherent in our portfolio for which certain losses are probable but not specifically identifiable.

Management performs a quarterly evaluation of the adequacy of the allowance for credit losses on loans. This quarterly process is performed by the accounting department, in conjunction with the credit administration department, and approved by the Allowance Committee. The Chief Financial Officer performs a final review of the calculation. All supporting documentation with regard to the evaluation process is maintained by the accounting department. Each quarter a summary of the allowance for credit losses is presented by the Chief Financial Officer to the Audit Committee of the Board of Directors.

Under the CECL methodology, the allowance for credit losses on loans has two components. (1) a collective reserve component for estimated expected credit losses for pools of loans that share common risk characteristics and (2) an individual reserve component for loans that do not share risk characteristics, consisting of collateral-dependent and TDR loans.

Allowance for Collectively Evaluated Loans Held-for-Investment

The Company estimates the collective reserve using a risk rating migration model which calculates an expected life of loan loss percentage for each loan by generating probability of default and loss given default metrics. These metrics are multiplied by the exposure at default, taking into consideration prepayments, to calculate the quantitative component of the collective reserve. The metrics are based on the migration of loans from performing to loss by credit risk rating or delinquency categories using historical life-of-loan analysis periods for each loan portfolio pool, and the severity of loss, based on the aggregate net lifetime losses incurred using the Company's own historical loss experience and comparable peer data loss history. The model's expected losses based on loss history are adjusted for qualitative adjustments. Among other things, these adjustments include and account for differences in: (i) changes in lending policies and procedures; (ii) changes in local, regional, national, and international economic and business conditions and developments that affect the collectability of our portfolio, including the condition of various market segments; (iii) changes in the experience, ability and depth of lending management and other relevant staff; (iv) changes in the quality of our loan review system; (v) the existence and effect of any concentrations of credit, and changes in the level of such concentrations; and (vi) the effect of other external factors such as competition and legal and regulatory requirements on the level of estimated credit losses in our existing portfolio.

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The Company utilizes a two-year reasonable and supportable forecast period after which estimated losses revert to historical loss experience immediately for the remaining life of the loan. In establishing its estimate of expected credit losses, the Company utilizes five externally-sourced forward-looking economic scenarios developed by Moody's Analytics (“Moody's”).

Management utilizes five different Moody's scenarios so as to incorporate uncertainties related to the economic environment arising from the COVID-19 pandemic. These scenarios, which range from more benign to more severe economic outlooks, include a ‘most likely outcome’ (the “Baseline” scenario) and four less likely scenarios referred to as the “Upside” and “Downside” scenarios. Each scenario is assigned a weighting with a majority of the weighting placed on the Baseline scenario and lower weights placed on both the Upside and Downside scenarios. The weighting assigned by management is based on the economic outlook and available information at the reporting date. The model projects economic variables under each scenario based on detailed statistical analyses. The Company has identified and selected key variables that most closely correlated to its historical credit performance, which include: gross domestic product, unemployment, and three collateral indices: the Commercial Property Price Index, the Commercial Property Price Apartment Index and the Case-Shiller Home Price Index.

Because management's estimates of the allowance for credit losses on loans involves a high degree of judgement, the subjectivity of the assumptions used and the potential for changes in the forecasted economic environment that could result in changes to the amount of the allowance recorded, there is uncertainty inherent in such estimates. Changes in these estimates could significantly impact the allowance for credit losses on loans.

Allowance for Individually Evaluated Loans

The Company measures specific reserves for individual loans that do not share common risk characteristics with other loans, consisting of all TDRs and non-accrual loans with an outstanding balance of $500,000 or greater. Loans individually evaluated for impairment are assessed to determine that the loan’s carrying value is not in excess of the estimated fair value of the collateral less cost to sell, if the loan is collateral-dependent, or the present value of the expected future cash flows, if the loan is not collateral-dependent. Management performs an evaluation of each impaired loan and generally obtains updated appraisals as part of the evaluation. In addition, management adjusts estimated fair values down to appropriately consider recent market conditions, our willingness to accept a lower sales price to effect a quick sale, and costs to dispose of any supporting collateral. Determining the estimated fair value of underlying collateral (and related costs to sell) can be difficult in illiquid real estate markets and is subject to significant assumptions and estimates. Management employs an independent third-party management firm that specializes in appraisal preparation and review to ascertain the reasonableness of updated appraisals. Projecting the expected cash flows under troubled debt restructurings which are not collateral-dependent is inherently subjective and requires, among other things, an evaluation of the borrower’s current and projected financial condition. Actual results may be significantly different than our projections and our established allowance for credit losses on these loans, which could have a material effect on our financial results. Individually impaired loans that have no impairment losses are not considered for collective allowances described earlier.

We have a concentration of loans secured by real property located in New York City, New Jersey, and, to a lesser extent, eastern Pennsylvania. As a substantial amount of our loan portfolio is collateralized by real estate, appraisals of the underlying value of property securing loans are critical in determining the amount of the allowance required for specific loans. Assumptions for appraisal valuations are instrumental in determining the value of properties. Overly optimistic assumptions or negative changes to assumptions could significantly impact the valuation of a property securing a loan and the related allowance determined. The assumptions supporting such appraisals are reviewed by management and an independent third-party appraiser to determine that the resulting values reasonably reflect amounts realizable on the collateral. Based on the composition of our loan portfolio, we believe the primary risks are increases in interest rates, a decline in the economy generally, or a decline in real estate market values in New York, New Jersey, or eastern Pennsylvania. Any one or a combination of these events may adversely affect our loan portfolio resulting in delinquencies, increased loan losses, and increased loan loss provisions.

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Although we believe we have established and maintained the allowance for credit losses at adequate levels, changes may be necessary if future economic or other conditions differ substantially from our estimation of the current operating environment. Although management uses the information available, the level of the allowance for credit losses remains an estimate that is subject to significant judgment and short-term change. In addition, the OCC, as an integral part of their examination process, will review our allowance for credit losses on loans and may require us to recognize adjustments to the allowance based on their judgments about information available to them at the time of their examination.

We also maintain an allowance for estimated losses on off-balance sheet credit risks related to loan commitments and standby letters of credit. The reserve for off-balance sheet exposures is determined using the CECL reserve factor in the related funded loan segment, adjusted for an average historical funding rate. The allowance for credit losses for off-balance sheet credit exposures is recorded in other liabilities on the consolidated balance sheets and the corresponding provision is included in other non-interest expense.

Deferred Income Taxes. We use the asset and liability method of accounting for income taxes. Under this method, deferred tax assets and liabilities are recognized for the future tax consequences attributable to differences between the financial statement carrying amounts of existing assets and liabilities and their respective tax bases. Deferred tax assets and liabilities are measured using enacted tax rates expected to apply to taxable income in the years in which those temporary differences are expected to be recovered or settled. If it is determined that it is more likely than not that the deferred tax assets will not be realized, a valuation allowance is established. We consider the determination of this valuation allowance to be a critical accounting policy because of the need to exercise significant judgment in evaluating the amount and timing of recognition of deferred tax liabilities and assets, including projections of future taxable income. These judgments and estimates are reviewed quarterly as regulatory and business factors change. A valuation allowance for deferred tax assets may be required if the amounts of taxes recoverable through loss carry backs decline, or if we project lower levels of future taxable income. Such a valuation allowance would be established and any subsequent changes to such allowance would require an adjustment to income tax expense that could adversely affect our operating results.

Other New Accounting Standards Issued but Not Yet Effective

ASU No. 2020-04. On March 12, 2020, FASB issued ASU No. 2020-04, “Reference Rate Reform ("ASC 848"): Facilitation of the Effects of Reference Rate Reform on Financial Reporting”, which provides temporary optional guidance to ease the potential burden in accounting for reference rate reform. The ASU provides optional expedients and exceptions for applying generally accepted accounting principles to contract modifications and hedging relationships, subject to meeting certain criteria, that reference the London Inter-Bank Offered Rate (“LIBOR”) or another reference rate expected to be discontinued. It is intended to help stakeholders during the global market-wide reference rate transition period. The guidance is effective for all entities as of March 12, 2020 through December 31, 2022. The Company is implementing a transition plan to identify and modify its loans and other financial instruments that are either directly or indirectly influenced by LIBOR. The Company is in the process of evaluating ASU No. 2020-04 and its impact on the Company’s transition away from LIBOR for its loan and other financial instruments, with no material expected impact on the Company's Consolidated Financial Statements.

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Comparison of Financial Condition at December 31, 2021 and 2020

Total assets decreased $84.0 million, or 1.5%, to $5.43 billion at December 31, 2021, from $5.51 billion at December 31, 2020. The decrease was primarily due to decreases in available-for sale debt securities of $56.6 million, or 4.5%, total loans of $36.5 million, or 1.0%, and FHLBNY stock of $6.3 million, or 22.0%, partially offset by an increase in other assets of $11.8 million, or 46.6%, and an increase in cash and cash equivalents of $3.5 million, or 4.0%.

Cash and cash equivalents increased by $3.5 million, or 4.0%, to $91.1 million at December 31, 2021, from $87.5 million at December 31, 2020. Balances fluctuate based on the timing of receipt of security and loan repayments and the redeployment of cash into higher-yielding assets such as loans and securities, or the funding of deposit outflows or borrowing maturities or repayments.

The Company’s available-for-sale debt securities portfolio decreased by $56.6 million, or 4.5%, to $1.21 billion at December 31, 2021, from $1.26 billion at December 31, 2020. The decrease was primarily attributable to paydowns, maturities, calls, and sales. At December 31, 2021, $973.1 million of the portfolio consisted of residential mortgage-backed securities issued or guaranteed by Fannie Mae, Freddie Mac, or Ginnie Mae. In addition, the Company held $232.8 million in corporate bonds, all of which were considered investment grade at December 31, 2021, $2.3 million in U.S. Government agency securities, and $72,000 in municipal bonds. The effective duration of the securities portfolio at December 31, 2021 was 1.19 years.

Equity securities increased by $5.1 million to $5.3 million at December 31, 2021, from $253,000 at December 31, 2020, due to the purchase of an investment in an SBA Loan Fund. This investment is utilized by the Bank as part of its Community Reinvestment Act program.

As of December 31, 2021, our non-owner occupied commercial real estate concentration (as defined by regulatory guidance) to total risk-based capital was approximately 443.5%. Management believes that the Bank has implemented appropriate risk management practices including risk assessments, board-approved underwriting policies and related procedures, which include monitoring Bank portfolio performance, performing market analysis (economic and real estate), and stressing of the Bank’s commercial real estate portfolio under severe, adverse economic conditions. Although management believes the Bank has implemented appropriate policies and procedures to manage its commercial real estate concentration risk, the Bank’s regulators could require it to implement additional policies and procedures or could require it to maintain higher levels of regulatory capital, which might adversely affect its loan originations, ability to pay dividends, and profitability.

Loans held-for-investment, net, decreased by $16.6 million to $3.81 billion at December 31, 2021, from $3.82 billion at December 31, 2020. The decrease was primarily due to the $126.3 million sale of a portfolio of multifamily loans, loan prepayments, and PPP loan forgiveness, partially offset by loan growth. Construction and land loans decreased by $46.8 million, or 63.0%, to $27.5 million at December 31, 2021 from $74.3 million at December 31, 2020, one-to-four family residential loans decreased by $27.2 million, or 12.9%, to $183.7 million at December 31, 2021, from $210.8 million at December 31, 2020, and PPP loans decreased by $86.0 million, or 68.0%, to $40.5 million at December 31, 2021, from $126.5 million at December 31, 2020. Through December 31, 2021, 1,964 borrowers have received forgiveness payments totaling approximately $187.2 million. The decreases were primarily offset by increases in commercial real estate loans of $91.6 million, or 12.8%, to $808.6 million at December 31, 2021 from $717.0 million at December 31, 2020, and commercial and industrial loans (excluding PPP loans) of $32.7 million, or 48.2%, to $100.5 million at December 31, 2021 from $67.8 million at December 31, 2020, and, to a lesser extent, increases in home equity loans of $18.8 million and multifamily real estate loans of $8.8 million.

Loans originated under the PPP are authorized by the CARES Act. The PPP loans are administered by the SBA which provides 100% federally guaranteed loans for small businesses to cover payroll, utilities, rent and interest. These small business loans may be forgiven if borrowers maintain their payrolls and satisfy certain other conditions for a period of time during the COVID-19 pandemic. The Company began accepting and funding loans under this program in April 2020. There were 377 PPP loans outstanding totaling $40.5 million at December 31, 2021, compared to 1,275 loans outstanding totaling $126.5 million at December 31, 2020. During the year ended December 31, 2021, the Company originated and the SBA approved funding for $81.4 million of PPP loans. The PPP provides for lender processing fees that range from 1% to 5% of the final disbursement made to individual borrowers. As of December 31, 2021, we have received loan processing fees of $9.5 million, of which $7.4 million has been recognized in earnings, including $5.6 million recognized in the year ended December 31, 2021. The remaining unearned fees will be recognized in income over the remaining term of the loans.

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The following tables detail our multifamily real estate originations for the years ended December 31, 2021 and 2020 (dollars in thousands):

There were no loans held-for-sale at December 31, 2021 compared to $19.9 million at December 31, 2020. At December 31, 2020, loans held-for-sale were comprised of commercial real estate and multifamily loans, primarily accommodation loans that were modified in the form of interest and/or principal payment deferrals due to COVID-19 related hardships, and had not returned to contractual payments after 180 days of relief. The sale of these loans was completed in March 2021.

PCD loans totaled $15.8 million at December 31, 2021, and $18.5 million at December 31, 2020. Upon adoption of the CECL accounting standard on January 1, 2021, the allowance for credit losses related to PCD loans was recorded through a gross-up that increased the amortized cost-basis of PCD loans by $6.8 million with a corresponding increase to the allowance for credit losses. The decrease in the PCD loan balance at December 31, 2021 was due to PCD loans being sold and paid off during the period. The majority of the remaining PCD loan balance consists of loans acquired as part of a Federal Deposit Insurance Corporation-assisted transaction. The Company accreted interest income of $324,000 and $3.7 million attributable to PCD loans for the quarter and year ended December 31, 2021, respectively, as compared to $689,000 and $2.9 million for the quarter and year ended December 31, 2020, respectively. The increase in income accreted for the year ended December 31, 2021, was related to the payoff of PCD loans. PCD loans had an allowance for credit losses of approximately $4.7 million at December 31, 2021.

Bank-owned life insurance increased $2.6 million, or 1.6%, to $164.5 million at December 31, 2021, as compared to $161.9 million at December 31, 2020. The increase resulted from income earned on bank-owned life insurance for the year ended December 31, 2021.

Other assets increased $11.8 million, or 46.6%, to $37.2 million at December 31, 2021, from $25.4 million at December 31, 2020. The increase was primarily attributable to an increase in net deferred tax assets.

FHLBNY stock decreased by $6.3 million, or 22.0%, to $22.3 million at December 31, 2021, from $28.6 million at December 31, 2020. The decrease in FHLBNY stock directly correlates with lower short-term borrowing balances at December 31, 2021, as compared to December 31, 2020.

Total liabilities decreased $69.9 million, or 1.5%, to $4.69 billion at December 31, 2021, from $4.76 billion at December 31, 2020. The decrease was primarily attributable to a decrease in Federal Home Loan Bank and other borrowings of $145.0 million and a decrease in securities sold under agreements to repurchase of $25.0 million, partially offset by an increase in deposits of $92.8 million, an increase in advance payments by borrowers for taxes and insurance of $5.2 million and an increase in accrued expenses and other liabilities of $5.0 million.

Deposits increased $92.8 million, or 2.28%, to $4.17 billion at December 31, 2021, as compared to $4.08 billion at December 31, 2020. The increase was attributable to increases of $409.7 million in transaction accounts and $26.0 million in savings accounts, partially offset by decreases of $203.7 million in money market accounts and $139.3 million in certificates of deposit. We continue to see balance runoff from high-cost money market and certificates of deposit categories as we strategically chose not to compete on rate at this time during the year.

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Borrowings and securities sold under agreements to repurchase decreased to $421.8 million at December 31, 2021, from $591.8 million at December 31, 2020. The decrease in borrowings for the period was largely due to the maturity and replacement of FHLB borrowings with lower cost deposits. Management utilizes borrowings to mitigate interest rate risk, for short-term liquidity, and to a lesser extent as part of leverage strategies.

Total stockholders’ equity decreased by $14.1 million to $739.9 million at December 31, 2021, from $754.0 million at December 31, 2020. The decrease was attributable to $53.2 million in stock repurchases, $24.3 million in dividend payments, and an $11.1 million decrease in accumulated other comprehensive income associated with a reduction in unrealized gains on our debt securities available-for-sale portfolio, partially offset by net income of $70.7 million for year ended December 31, 2021, and a $6.9 million increase in equity award activity. The Company repurchased 3,342,700 shares of its common stock outstanding at an average price of $15.91 for a total of $53.2 million during the year ended December 31, 2021, pursuant to approved stock repurchase plans. As of December 31, 2021, the Company had approximately $8.3 million in remaining capacity under its current repurchase program. In connection with the adoption of CECL, effective January 1, 2021, the Company recognized a cumulative effect adjustment that reduced stockholders’ equity by $3.1 million, net of tax, to adjust opening allowances against credit losses on loans and off-balance sheet credit exposures.

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

Net Income. Net income was $70.7 million and $37.0 million for the years ended December 31, 2021 and December 31, 2020, respectively. Significant variances from the prior year are as follows: a $25.8 million increase in net interest income, an $18.9 million decrease in the provision for credit losses on loans, a $3.0 million increase in non-interest income, and a $646,000 increase in non-interest expense.

Interest Income. Interest income increased $4.2 million, or 2.5%, to $172.3 million for the year ended December 31, 2021, from $168.1 million for the year ended December 31, 2020, due to an increase in the average balance of interest-earning assets of $211.3 million, or 4.3%, largely attributable to assets acquired in the Victory acquisition on July 1, 2020. The increase was due primarily to increases in the average balance of loans outstanding of $239.5 million and the average balance of other securities of $19.7 million, partially offset by decreases in the average balance of mortgage-backed securities of $39.8 million, the average balance of FHLBNY stock of $4.6 million, and the average balance of interest-earning deposits in financial institutions of $3.5 million. Partially offsetting the increase in the average balance of interest-earning assets was a five basis point decrease in the yields earned on interest-earning assets to 3.33% for the year ended December 31, 2021, from 3.38% for the comparative prior year. The decrease in earning asset yields was due to decreases in market interest rates coupled with PPP loan originations, which have lower yields than other loans. The Company accreted interest income related to its PCD/PCI loans of $3.7 million and $2.9 million for the years ended December 31, 2021 and 2020, respectively. The increase in accretable interest income was primarily related to payoffs of PCD loans in the first quarter of 2021. Interest income for the year ended December 31, 2021, included loan prepayment income of $5.1 million as compared to $2.2 million for the year ended December 31, 2020. Also contributing to the increase in net interest income was the recognition of fees related to PPP loans paid-off. Fees recognized from PPP loans totaled $5.6 million for the year ended December 31, 2021, as compared to $1.9 million for the year ended December 31, 2020.

Interest Expense. Interest expense decreased $21.7 million, or 56.6%, to $16.6 million for the year ended December 31, 2021, as compared to $38.3 million for the year ended December 31, 2020. The decrease was due to a decrease in interest expense on deposits of $19.0 million, or 75.4%, as well as a decrease in interest expense on borrowings of $2.7 million, or 20.3%. The decrease in interest expense on deposits was attributable to a 58 basis point decrease in the cost of interest-bearing deposits to 0.19% for the year ended December 31, 2021, partially offset by a $49.9 million, or 1.5% increase in the average balance of interest-bearing deposit accounts. The decrease in the cost of interest-bearing deposits was primarily due to the lower interest rate environment and a change in the composition of the deposit portfolio as the average balance of transaction accounts increased and the average balance of certificates of deposit decreased. The decrease in interest expense on borrowings was primarily attributable to a $143.8 million, or 22.3%, decrease in average borrowings outstanding, which was partially offset by a five basis point increase in the average cost of borrowings.

Net Interest Income. Net interest income for the year ended December 31, 2021, increased $25.8 million, or 19.9%, to $155.6 million, from $129.8 million for the year ended December 31, 2020, primarily due to a $211.3 million, or 4.3%, increase in average interest-earning assets as well as a 40 basis point increase in net interest margin to 3.01% from 2.61%. The increase in net interest margin was primarily due to the decrease in the cost of interest-bearing liabilities outpacing the decrease in yields on interest-earning assets. Yields on interest-earning assets decreased five basis points to 3.33% for the year ended December 31, 2021, from 3.38% for the comparative prior year. The cost of interest-bearing liabilities decreased by 54 basis points to 0.44% for the year ended December 31, 2021, from 0.98% for the year ended December 31, 2020, driven by a lower cost of deposits.

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Provision for Credit Losses. The provision for credit losses on loans decreased by $18.9 million to a benefit of $6.2 million for the year ended December 31, 2021, compared to a provision of $12.7 million for the year ended December 31, 2020. The decrease in the provision for credit losses was primarily the result of improvements in the economic forecast and asset quality. The improvement in asset quality was primarily attributable to an improvement in risk ratings as loans previously modified for COVID-19 relief returned to consistent payment status. The higher provision for loan losses in 2020 was primarily due to increases in qualitative adjustments used in determining the adequacy of the allowance for credit losses related to unemployment, loan risk rating changes and increased risks related to loans on forbearance, resulting from economic uncertainty attributable to the COVID-19 pandemic under the incurred loss methodology. Net charge-offs were $2.8 million for the year ended December 31, 2021, primarily related to PCD loans, as compared to net charge-offs of $3.8 million for the year ended December 31, 2020.

On January 1, 2021, the Company adopted ASU 2016-13, Financial Instruments- Credit Losses (Topic 326): Measurement of Credit Losses on Financial Instruments. CECL requires the measurement of all expected credit losses over the life of financial instruments held at the reporting date based on historical experience, current conditions, and reasonable and supportable forecasts. In connection with the adoption of CECL, the Company recognized a cumulative effect adjustment that reduced stockholders’ equity by $3.1 million, net of tax. At adoption, the Company increased its allowance for credit losses by $11.1 million, comprised of $10.4 million and $737,000, respectively, for loans and unfunded commitments, including $6.8 million related to PCD loans. For PCD loans, the allowance for credit losses recorded is recognized through a gross-up that increases the amortized cost basis of loans with a corresponding increase to the allowance for credit losses, and therefore results in no impact to shareholders' equity.

Non-interest Income. Non-interest income increased $3.0 million to $14.5 million for the year ended December 31, 2021, from $11.5 million for the year ended December 31, 2020, due primarily to: an increase of $1.4 million in fees and service charges for customer services, as the prior year reflected fees waived and fewer transactions related to lower consumer spending in the early part of the pandemic; an increase of $1.2 million in gains on sales of available-for-sale debt securities, net; a $736,000 increase in gains on sales of loans; and a $329,000 increase in income on bank-owned life insurance income related to an increase in benefit claims. The increase in gains on sales of loans resulted from the sales of approximately $126.3 million of multifamily loans for gains of $1.4 million in the second quarter of 2021, compared to sales of $47.5 million of multifamily loans for gains of $665,000 in the second quarter of 2020. The Company periodically considers the sale of loans to manage its overall risk profile, including consideration of interest rate risk, concentration risk and capital deployment opportunities. Partially offsetting the increases was a $781,000 decrease in other income primarily due to a decrease in fees on loan swap transactions for the year ended December 31, 2021, compared to the year ended December 31, 2020, due to a lower volume of such transactions in 2021.

Non-interest Expense. Non-interest expense increased $646,000, or 0.8%, to $79.2 million for the year ended December 31, 2021, compared to $78.5 million for the year ended December 31, 2020. Employee compensation and benefits expense increased by $2.2 million, primarily due to increases in salary and medical benefit expenses associated with the addition of former Victory employees, combined with annual merit increases and an increase in the employee stock option plan expense, partially offset by a decrease in change-in-control and severance compensation paid to former Victory employees in the prior year. FDIC insurance premiums increased by $480,000 due to an increase in the insurance assessment rate and the receipt of a small bank assessment credit in the prior year that was not available in 2021. Other expense increased by $518,000, primarily due to an increase in the reserve for unfunded commitments as well as an increase in other operating expenses. Partially offsetting the increases was a $1.2 million decrease in occupancy expense, primarily due to a $2.2 million charge in the prior year associated with branch consolidations, which was partially offset by higher maintenance costs related to additional branches from the Victory acquisition, renovation of existing branches, and higher snow removal costs in the current year. Additionally, there was a $1.3 million decrease in data processing costs as the prior year included a contract termination penalty of $1.3 million on the completion of Victory's core system conversion, and a $545,000 decrease in professional fees due to a reduction in merger-related costs.

Income Tax Expense. The Company recorded income tax expense of $26.5 million for the year ended December 31, 2021, compared to $13.0 million for the year ended December 31, 2020. The effective tax rate for the year ended December 31, 2021, was 27.3% compared to 26.1% for the year ended December 31, 2020. The higher effective tax rate was primarily due to higher taxable income. Additionally, on April 19, 2021, the Governor of New York signed into law an increase in the tax rate from 6.5% to 7.25%.

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Comparison of Operating Results for the Years Ended December 31, 2020 and 2019

Net Income. Net income was $37.0 million and $40.2 million for the years ended December 31, 2020 and December 31, 2019, respectively. Significant variances from the prior year are as follows: an $18.0 million increase in net interest income, a $12.7 million increase in the provision for loan losses, a $3.3 million decrease in non-interest income, and a $5.0 million increase in non-interest expense.

Interest Income. Interest income increased by $3.0 million, or 1.8%, to $168.1 million for the year ended December 31, 2020, as compared to $165.1 million for the year ended December 31, 2019. The increase was primarily due to an increase in the average balance of interest-earning assets of $580.5 million, or 13.2%.The increase in the average balance of interest-earning assets was primarily attributable to increases in average loans of $324.9 million, average mortgage-backed securities of $237.3 million, and average interest-earning deposits in financial institutions of $100.7 million, partially offset by a decrease in average other securities of $84.3 million. This was partially offset by a 38 basis point increase in the yields earned on interest-earning assets to 3.38% for the year ended December 31, 2020, from 3.76% for the prior year. The decrease in interest-earning asset yields was due to decreases in market interest rates coupled with PPP loan originations, which have lower yields than other loans. The Company accreted interest income related to its PCI loans of $2.9 million for the year ended December 31, 2020, as compared to $4.1 million for the year ended December 31, 2019. Interest income for the year ended December 31, 2020, included loan prepayment income of $2.2 million as compared to $1.6 million for the year ended December 31, 2019. Also included in net interest income for the year ended December 31, 2020, were PPP fees of approximately $1.9 million. Included in net interest income for the year ended December 31, 2019, was $314,000 of interest income recorded on the pay-off of a non-accrual loan.

Interest Expense. Interest expense decreased $15.0 million, or 28.2%, to $38.3 million for the year ended December 31, 2020, from $53.4 million for the year ended December 31, 2019. The decrease was attributable to a decrease in interest expense on deposits of $16.1 million, or 39.0%, partially offset by an increase in interest expense on borrowings of $1.1 million, or 9.0%. The decrease in interest expense on deposits was primarily attributable to a 63 basis point decrease in the cost of interest-bearing deposits to 0.77% for the year ended December 31, 2020, from 1.40% for the prior year, partially offset by an increase in the average balance of interest-bearing deposits of $318.4 million, or 10.8%, due to the Victory acquisition as well as organic deposit growth. The decrease in the cost of interest-bearing deposits was primarily due to the Federal Reserve's reductions in the targeted federal funds rate and a shift in the composition of the deposit portfolio towards more core deposits. The increase in interest expense on borrowings was attributable to a $69.0 million, or 12.0%, increase in average borrowings outstanding, partially offset by a six basis point decrease in the cost of borrowings to 2.03% for the year ended December 31, 2020.

Net Interest Income. Net interest income for the year ended December 31, 2020, increased $18.0 million, or 16.1%, to $129.8 million, from $111.8 million for the year ended December 31, 2019, primarily due to a $580.5 million, or 13.2%, increase in average interest-earning assets as well as a six basis point increase in net interest margin to 2.61% from 2.55%. The increase in net interest margin was primarily due to the decrease in the cost of interest-bearing liabilities outpacing the decrease in yields on interest earning assets. Yields earned on interest-earning assets decreased 38 basis points to 3.38% for the year ended December 31, 2020, from 3.76% for the prior year. The cost of interest-bearing liabilities decreased 53 basis points to 0.98% for the year ended December 31, 2020, from 1.51% for the prior year, driven by lower cost of deposits and borrowed funds.

Provision for Loan Losses. The provision for loan losses increased by $12.7 million for the year ended December 31, 2020, compared to a provision of $22,000 for the year ended December 31, 2019. The increase in the provision for loan losses was primarily due to increases in the qualitative adjustments used in determining the adequacy of the allowance for loan losses related to unemployment, loan risk rating changes and increased risks related to loans on forbearance, resulting from economic uncertainty attributable to the COVID-19 pandemic, and higher charge-offs. Year-over-year loan growth also contributed to the increase in the provision. Net charge-offs were $3.8 million for the year ended December 31, 2020, as compared to net recoveries of $1.2 million for the year ended December 31, 2019.

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Non-interest Income. Non-interest income decreased $3.3 million, or 22.5%, to $11.5 million for the year ended December 31, 2020, from $14.8 million for the year ended December 31, 2019, primarily due to decreases of: (i) $914,000 in fees and service charges for customer services, related to fees waived due to the COVID-19 pandemic, as well as a decline in overdrafts due to lower consumer spending; (ii) $3.2 million in income on bank owned life insurance, attributable to lower insurance proceeds received in excess of the related cash surrender value of the policies; and (iii) $387,000 in gains on trading securities, net. For the year ended December 31, 2020, gains on trading securities were $1.6 million as compared to gains of $2.0 million for the year ended December 31, 2019. The trading portfolio is utilized to fund the Company’s deferred compensation obligation to certain employees and directors of the Company's deferred compensation plan (the “Plan”). The participants of this Plan, at their election, defer a portion of their compensation. Gains and losses on trading securities have no effect on net income since participants benefit from, and bear the full risk of, changes in the trading securities market values. Therefore, the Company records an equal and offsetting amount in compensation expense, reflecting the change in the Company’s obligations under the Plan. Partially offsetting the decreases was a $665,000 gain on the sale of a portfolio of $47.5 million in multifamily loans in the quarter ended June 30, 2020, and an increase in other income of $1.4 million, primarily attributable to an increase in swap fee income.

Non-interest Expense. Non-interest expense increased $5.0 million, or 6.7%, to $78.5 million for the year ended December 31, 2020, compared to $73.5 million for the year ended December 31, 2019. This was due primarily to a $1.9 million increase in employee compensation and benefits, related to change-in-control and severance compensation associated with the Victory acquisition, increased salary and benefit expenses due to the addition of Victory personnel, and increased medical benefit costs. Partially offsetting the increase was a decrease in expense related to the Company's deferred compensation plan, which is described above and has no effect on net income, and a decrease in equity award expense related to equity awards that fully vested in June 2019. Additionally, there was a $1.5 million increase in occupancy costs primarily attributable to costs associated with the branch consolidations, and to a lesser extent, higher rent expense associated with additional branches from the Victory acquisition, and a $2.4 million increase in data processing costs, $1.3 million of which relates to a contract termination penalty associated with the completion of Victory's core systems conversion. Partially offsetting the increases was a $1.4 million decrease in advertising expense, due to fewer marketing campaigns in 2020, and an $820,000 decrease in other non-interest expense, primarily related to a decrease in directors' equity award expense associated with awards that fully vested in June 2019.

Income Tax Expense. The Company recorded income tax expense of $13.0 million for the year ended December 31, 2020, compared to $12.8 million for the year ended December 31, 2019. The effective tax rate for the year ended December 31, 2020, was 26.1% compared to 24.1% for the year ended December 31, 2019. The higher effective tax rate for the year ended December 31, 2020, was primarily attributable to lower tax exempt income of $2.4 million from bank owned life insurance proceeds in excess of the cash surrender value of the policies received, compared to the prior year, and non-deductible merger-related expenses for the year ended December 31, 2020.

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Average Balances and Yields

The following tables set forth average balance sheets, average yields and costs, and certain other information for the years indicated.  No tax-equivalent yield adjustments have been made, as we had no tax-free interest-earning assets during the years.  All average balances are daily average balances based upon amortized costs.  Non-accrual loans are included in the computation of average balances. 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.

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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 total 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.

Asset Quality

PCD Loans (Held-for-Investment)

Based on its detailed review of PCD loans and experience in loan workouts, management believes it has a reasonable expectation about the amount and timing of future cash flows and accordingly has classified PCD loans of $15.8 million at December 31, 2021 and $18.5 million at December 31, 2020 as accruing, even though they may be contractually past due. At December 31, 2021, 10.5% of PCD loans were past due 30 to 89 days, and 19.2% were past due 90 days or more, as compared to 9.6% and 35.2%, respectively, at December 31, 2020.

Loans

General.  Maintaining loan quality historically has been, and will continue to be, a key element of our business strategy. We employ conservative underwriting standards for new loan originations and maintain sound credit administration practices while the loans are outstanding. In addition, substantially all of our loans are secured, predominantly by real estate. At December 31, 2021, our non-performing loans totaled $8.0 million, or 0.21%, of total loans. Net charge-offs for the year ended December 31, 2021, were $2.8 million, or 0.07%, of average loans outstanding. For the year ended December 31, 2020, the Company had net charge-offs of $3.8 million, or 0.11%, of average loans outstanding, and for the year ended December 31, 2019, net recoveries were $1.2 million.

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Non-performing Assets and Delinquent Loans.  The following table details non-performing assets consisting of non-performing loans held-for-investment and non-performing loans held-for-sale at December 31, 2021 and 2020 (in thousands):

The following table details non-performing loans by loan type at December 31, 2021 and 2020 (in thousands):

Other real estate owned is comprised of one property acquired during the year ended December 31, 2021, as a result of foreclosure. The property is located in New Jersey and had a carrying value of approximately $100,000. It is included in other assets on the consolidated balance sheet as of December 31, 2021.

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Non-performing loans held-for-sale at December 31, 2020 totaled $19.9 million and were comprised of high risk commercial real estate and multifamily loans, primarily accommodation loans that were modified in the form of interest and/or principal payment deferrals due to COVID-19 related hardships, and had not returned to contractual payments after 180 days of relief. The sale of these loans was completed in the first quarter of 2021.

Generally, loans, excluding PCD loans, are placed on non-accruing status when they become 90 days or more delinquent, and remain on non-accrual status until they are brought current, have six consecutive months of performance under the loan terms, and factors indicating reasonable doubt about the timely collection of payments no longer exist. Therefore, loans may be current in accordance with their loan terms, or may be less than 90 days delinquent and still be on a non-accruing status.

The following table sets forth the total amounts of delinquencies for accruing loans that were 30 to 89 days past due by type and by amount at the dates indicated (in thousands):

The decrease in accruing loans 30 to 89 days delinquent from December 31, 2020 was primarily due to a decrease in delinquencies associated with the improvement of economic conditions in 2021.

Included in non-accruing loans held-for-investment are TDR loans totaling $3.2 million and $3.7 million at December 31, 2021, and December 31, 2020, respectively. At December 31, 2021, one of the non-accruing TDRs totaling $368,000 was not performing in accordance with its restructured terms, and is collateralized by real estate with an appraised value of $620,000. At December 31, 2020, two of the non-accruing TDRs totaling $462,500 were not performing in accordance with their restructured terms, and are collateralized by real estate with an appraised value of $620,000.

The Company also holds loans held-for-investment subject to restructuring agreements that are on accrual status, which totaled $5.8 million and $7.7 million at December 31, 2021, and December 31, 2020, respectively. At December 31, 2021, $5.7 million, or 97.5%, of the $5.8 million of accruing loans subject to restructuring agreements were performing in accordance with their restructured terms. At December 31, 2020, $6.5 million, or 84.1%, of the $7.7 million of accruing loans subject to restructuring agreements were performing in accordance with their restructured terms. Generally, the types of concessions that we make to troubled borrowers include both temporary and permanent reductions to interest rates, extensions of payment terms, and, to a lesser extent, forgiveness of principal and interest.

The table below sets forth the amounts and categories of TDRs as of December 31, 2021, and December 31, 2020 (in thousands):

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COVID-19 Exposure

Management continues to evaluate the Company's exposure to increased loan losses related to the COVID-19 pandemic, in particular the commercial real estate and multifamily loan portfolios. During the second quarter of 2020, the Company implemented a customer relief program to assist borrowers that were experiencing financial hardship due to COVID-19 related challenges. The relief program grants principal and/or interest payment deferrals typically for a period of 90 days, which management may choose to extend for additional 90 day periods. At the peak of forbearance in June 2020, the Company had 286 loans approved for payment deferral representing $360.2 million, or approximately 10% of the Company's loan portfolio. As of December 31, 2021, substantially all of the borrowers who had requested relief have returned to contractual payments. Two borrowers with loans totaling $774,000 did not return to their contractual status; however, they are making partial payments.

Loans in deferment status (“COVID-19 Modified Loans”) have continued to accrue interest during the deferment period unless otherwise classified as non-performing. COVID-19 Modified Loans are required to make escrow payments for real estate taxes and insurance, if applicable. The COVID-19 Modified Loan agreements also require loans to be brought back to their fully contractual terms within 12 to 18 months and include covenants that prohibit distributions, bonuses, or payments of management fees to related entities until all deferred payments are made. Consistent with industry regulatory guidance, borrowers who were otherwise current on loan payments and were granted COVID-19 related financial hardship payment deferrals will continue to be reported as current loans throughout the agreed upon deferral period. Borrowers who were delinquent in their payments to the Bank prior to requesting a COVID-19 related financial hardship payment deferral are reviewed on a case by case basis for TDR classification and non-performing loan status.

Other

During the fourth quarter of 2021, we downgraded a lending relationship with an outstanding principal balance at December 31, 2021 of approximately $15.6 million to substandard, which is comprised of two commercial real estate loans with balances of $10.9 million, and a commercial line of credit secured by all unencumbered business assets with a balance of $4.7 million. In addition, the Bank has a commitment to fund $1.8 million under the line of credit with one of the entities in the relationship and all draws on the line are at the discretion of the Bank.

The commercial real estate loans are secured by two commercial properties with a current appraised value of $19.2 million. The lending relationship was downgraded as a result of legal matters against certain officers of the borrowing entities, including certain individuals who are guarantors to the loans, and the impact such legal matters may have on future operations of the entities.

All loans under the lending relationship are current as of February 28, 2022, and the entities continue to operate. We continue to evaluate the financial condition, operating results and cash flows of the related entities and guarantors. At December 31, 2021, approximately $1.9 million of the allowance for credit losses has been designated to this lending relationship. Based on information available, the loan has not been designated as impaired and remains on accrual status. However, there can be no assurances that one or more of the loans under the relationship will not migrate to non-accrual status in the future or require the establishment of additional loan losses reserves.

During 2022, the Bank received paydowns of approximately $3.0 million on the commercial line of credit, reducing the outstanding balance to approximately $1.7 million.

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Allowance for Credit Losses

On January 1, 2021, the Company adopted the CECL standard and as a result of the adoption recorded a $10.4 million increase to its allowance for credit losses on loans, including $6.8 million related to PCD loans.

The allowance for credit losses to non-performing loans increased from 127.38% at December 31, 2020 to 486.80% at December 31, 2021. This increase was primarily attributable to a decrease in non-performing loans of $21.5 million, from $29.5 million at December 31, 2020 to $8.0 million at December 31, 2021. During the fourth quarter of 2020, the Company transferred $19.9 million of certain high risk, primarily commercial real estate accommodation (hotel/motel) loans that were modified in the form of interest and/or principal payment deferrals due to COVID-19 related hardships, and had not returned to contractual payments after 180 days of relief, to held-for-sale. These loans were sold in the first quarter of 2021.

The Company utilizes external appraisals to determine the fair value of the underlying collateral in its analysis of impaired loans. A third-party appraisal is generally ordered as soon as a loan is designated as an impaired loan and updated annually, or more frequently if required. Generally, non-performing loans are charged down to the appraised value of collateral less costs to sell for collateral-dependent loans and to the present value of the expected future cash flows for non-collateral dependent loans, which reduces the ratio of the allowance for loan losses to non-performing loans. Downward adjustments to appraisal values, primarily to reflect “quick sale” discounts, are generally recorded as specific reserves within the allowance for loan losses.

The allowance for credit losses to total loans held-for-investment, net, was 1.02% (1.03% excluding PPP loans which are fully government guaranteed and do not carry any allowance for loan losses) at December 31, 2021, as compared to 0.98% and 1.00%, respectively, at December 31, 2020. The increase in the loan coverage ratio from December 31, 2020 was primarily attributable to the Company's Day 1 CECL adoption adjustment of $10.4 million recorded, $6.8 million of which related to PCD loans. For PCD loans, the allowance for credit losses recorded is recognized through a gross-up that increases the amortized cost basis of loans with a corresponding increase to the allowance for credit losses and therefore results in no impact to shareholders' equity. The increase in the allowance for credit losses on loans attributable to the CECL adoption adjustment was partially offset by a decrease in the provision for 2021, primarily due to improvements in the economic forecast and asset quality. The improvement in asset quality was largely attributable to an improvement in risk ratings as loans previously modified for COVID-19 relief returned to consistent payment status. Net charge-offs were $2.8 million for the year ended December 31, 2021, compared to net charge-offs of $3.8 million for the year ended December 31, 2020, and net recoveries of $1.2 million for the year ended December 31, 2019. Net charge-offs for the year ended December 31, 2021, were primarily related to PCD loans transferred from held-for-investment to held-for-sale at fair value, and subsequently sold in the first quarter of 2021. Net charge-offs for the year ended December 31, 2020, included $3.6 million related to higher risk commercial real estate and multifamily loans transferred to held-for-sale at estimated net realizable value in the fourth quarter of 2020. The benefit for credit losses on loans was $6.2 million for the year ended December 31, 2021. The provision for credit losses on loans was $12.7 million and $22,000 for the years ended December 31, 2020 and 2019, respectively.

Specific reserves on loans individually evaluated for impairment decreased by $43,000, or 59%, from $73,000 at December 31, 2020, to $30,000 at December 31, 2021. At December 31, 2021, the Company had 25 loans classified as individually impaired and recorded $30,000 of specific reserves on four of the 25 impaired loans. At December 31, 2020, the Company had 26 loans classified as impaired and recorded $73,000 of specific reserves on four of the 26 impaired loans.

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The following table sets forth activity in our allowance for credit losses, by loan type, at December 31, for the years indicated (in thousands):

During the year ended December 31, 2021, the Company recorded net charge-offs of $2.8 million, as compared to net charge-offs of $3.8 million for the year ended December 31, 2020, and net recoveries of $1.2 million for the year ended December 31, 2019. Charge-offs in 2021 are primarily related to PCD loans. Charge-offs in 2020 were primarily related to high risk, commercial real estate accommodation (hotel/motel) loans on COVID-19 forbearance that were transferred to held-for-sale. The net recoveries in 2019 were primarily due to a $1.8 million recovery on a multifamily loan previously charged-off, partially offset by a $521,000 charge-off on an impaired commercial real estate loan. The increase in the allowance for credit losses from 2020 to 2021 for one-to-four family residential loans, home equity loans and lines of credit, commercial and industrial loans, and PCD loans was primarily attributable to the Day 1 CECL adoption adjustment. The decrease in the allowance for credit losses for commercial loans, construction and land loans, and other loans was primarily due to a benefit in the provision for credit losses attributable to the improved forecast and asset quality, as well as a benefit from the Day 1 CECL adoption adjustment.

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Management of Market Risk

General.  A majority of our assets and liabilities are monetary in nature. Consequently, our most significant form of market risk is interest rate risk. Our assets, consisting primarily of mortgage-related securities and loans, generally have longer maturities than our liabilities, which consist primarily of deposits and wholesale borrowings. As a result, a principal part of our business strategy involves managing interest rate risk and limiting the exposure of our net interest income to changes in market interest rates. Accordingly, our Board of Directors has established a Management Asset-Liability Committee, comprised of our Senior Vice President ("SVP") & Chief Investment Officer and Treasurer, who chairs this Committee, our President and Chief Executive Officer, our Executive Vice President ("EVP") & Chief Risk Officer, our EVP & Chief Financial Officer, our SVP and Chief Credit Officer and our SVP & Director of Marketing, and other officers and staff as necessary or appropriate. This committee is responsible for, among other things, evaluating the interest rate risk inherent in our assets and liabilities, for recommending to the risk management committee of our Board of Directors the level of risk that is appropriate given our business strategy, operating environment, capital, liquidity and performance objectives, and for managing this risk consistent with the guidelines approved by the Board of Directors.

We seek to manage our interest rate risk in order to minimize the exposure of our earnings and capital to changes in interest rates. As part of our ongoing asset-liability management, we currently use the following strategies to manage our interest rate risk:

•originating multifamily loans and commercial real estate loans that generally have shorter maturities than one-to-four family residential real estate loans and have higher interest rates that generally reset from five to ten years;

•investing in investment grade corporate securities and mortgage-backed securities; and

•obtaining general financing through lower-cost core deposits, brokered deposits, and longer-term FHLB advances and repurchase agreements.

Shortening the average term of our interest-earning assets by increasing our investments in shorter-term assets, as well as originating loans with variable interest rates, helps to match the maturities and interest rates of our assets and liabilities better, thereby reducing the exposure of our net interest income to changes in market interest rates.

Net Portfolio Value Analysis. We compute amounts by which the net present value of our assets and liabilities (net portfolio value or NPV) would change in the event market interest rates changed over an assumed range of rates. Our simulation model uses a discounted cash flow analysis to measure the interest rate sensitivity of our NPV. Depending on current market interest rates, we estimate the economic value of these assets and liabilities under the assumption that interest rates experience an instantaneous and sustained increase of 100, 200, 300, or 400 basis points, or a decrease of 100 and 200 basis points, which is based on the current interest rate environment. A basis point equals one-hundredth of one percent, and 100 basis points equals one percent. An increase in interest rates from 3% to 4% would mean, for example, a 100 basis point increase in the “Change in Interest Rates” column below.

Net Interest Income Analysis.  In addition to NPV calculations, we analyze our sensitivity to changes in interest rates through our net interest income model. Net interest income is the difference between the interest income we earn on our interest-earning assets, such as loans and securities, and the interest we pay on our interest-bearing liabilities, such as deposits and borrowings. In our model, we estimate what our net interest income would be for a twelve-month period. Depending on current market interest rates we then calculate what the net interest income would be for the same period under the assumption that interest rates experience an instantaneous and sustained increase or decrease of 100, 200, 300, or 400 basis points, or a decrease of 100 and 200 basis points, which is based on the current interest rate environment.

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The following tables set forth, as of December 31, 2021 and December 31, 2020, our calculation of the estimated changes in our NPV, NPV ratio, and percent change in net interest income that would result from the designated instantaneous and sustained changes in interest rates (dollars in thousands). Computations of prospective effects of hypothetical interest rate changes are based on numerous assumptions, including relative levels of market interest rates, loan prepayments and deposit repricing characteristics including decay rates, and correlations to movements in interest rates, and should not be relied on as indicative of actual results.

The table above indicates that at December 31, 2021, in the event of a 200 basis point decrease in interest rates, we would experience a 2.79% decrease in estimated net portfolio value, a 6.02% decrease in net interest income in year one, and an 11.42% decrease in net income in year two. In the event of a 400 basis point increase in interest rates, we would experience a 13.48% decrease in estimated net portfolio value, a 14.49% decrease in net interest income in year one and a 4.48% increase in net interest income in year two. During the fourth quarter of 2021, the Company revised certain assumptions in the modelling as a result of a new non-maturity deposit study which resulted in a decrease in the duration of these instruments.

The table above indicates that at December 31, 2020, in the event of a 200 basis point decrease in interest rates, we would experience a 19.65% increase in estimated net portfolio value, a 3.70% decrease in net interest income in year one and a 7.89% decrease in net income in year two. In the event of a 400 basis point increase in interest rates, we would experience a 3.41% decrease in estimated net portfolio value, a 1.52% increase in net interest income in year one and a 20.02% increase in net interest income in year two.

Our policies provide that, in the event of a 200 basis point decrease or less in interest rates, our net present value ratio should decrease by no more than 300 basis points and 10%, and in the event of a 400 basis point increase or less, our net present value should decrease by no more than 475 basis points and 35%. In the event of a 200 basis point decrease or less, our projected net interest income should decrease by no more than 10% in year one and 10% in year two, and in the event of a 400 basis point increase or less, our projected net interest income should decrease by no more than 30% in year one and 20% in year two. However, when the federal funds rate is low and negative rate shocks do not produce meaningful results, management may temporarily suspend use of guidelines for negative interest rate shocks. At December 31, 2021 and December 31, 2020, we were in compliance with all Board-approved policies with respect to interest rate risk management.

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Certain shortcomings are inherent in the methodologies used in determining interest rate risk through changes in net portfolio value and net interest income. Our model requires us to make certain assumptions that may or may not reflect the manner in which actual yields and costs respond to changes in market interest rates. However, we also apply consistent parallel yield curve shifts (in both directions) to determine possible changes in net interest income if the theoretical yield curve shifts occurred gradually. Net interest income analysis also adjusts the asset and liability repricing analysis based on changes in prepayment rates resulting from the parallel yield curve shifts. In addition, the net portfolio value and net interest income information presented assume that the composition of our interest-sensitive assets and liabilities existing at the beginning of a period remains constant over the period being measured and assume that a particular change in interest rates is reflected uniformly across the yield curve regardless of the duration or repricing of specific assets and liabilities. Accordingly, although interest rate risk calculations provide an indication of our interest rate risk exposure at a particular point in time, such measurements are not intended to and do not provide a precise forecast of the effect of changes in market interest rates on our net portfolio value or net interest income and will differ from actual results.

Liquidity and Capital Resources

Liquidity is the ability to fund assets and meet obligations as they come due. Our primary sources of funds consist of deposit inflows, loan repayments, borrowings through repurchase agreements, advances from money center banks and the FHLBNY, and repayments, maturities and sales of securities. While maturities and scheduled amortization of loans and securities are reasonably predictable sources of funds, deposit flows and mortgage prepayments are greatly influenced by general interest rates, economic conditions, and competition. Our Board Risk Committee 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 withdrawals of deposits by our customers as well as unanticipated contingencies. We seek to maintain a ratio of liquid assets (not subject to pledge or encumbered) as a percentage of deposits and borrowings of 35% or greater. At December 31, 2021, this ratio was 56.31%.  We believe that we had sufficient sources of liquidity to satisfy our short- and long-term liquidity needs at December 31, 2021.

We regularly adjust our investments in liquid assets based on our assessment of:

•expected loan demand;

•expected deposit flows;

•yields available on interest-earning deposits and securities; and

•the objectives of our asset/liability management program.

Our most liquid assets are cash and cash equivalents, corporate bonds, and unpledged mortgage-related securities issued or guaranteed by the U.S. Government, Fannie Mae, or Freddie Mac, that we can either borrow against or sell. We also have the ability to surrender bank-owned life insurance contracts. The surrender of these contracts would subject the Company to income taxes and penalties for increases in the cash surrender values over the original premium payments. We also have the ability to obtain additional funding from the FHLB and Federal Reserve Bank utilizing unencumbered and unpledged securities and multifamily loans. Any amount pledged for such deposits under the line of credit reduces the Company's available borrowing amount under the FHLB advance agreement. The Company continues to maintain a strong liquidity position, despite the economic uncertainties presented by the COVID-19 pandemic and expects to have sufficient funds available to meet current commitments in the normal course of business.

The Company had the following primary sources of liquidity at December 31, 2021 (in thousands):

(1) Excludes $18.2 million of cash at Northfield Bank.

(2) Represents remaining borrowing potential.

70

At December 31, 2021, we had $159.4 million in outstanding loan commitments. In addition, we had $245.9 million in unused lines of credit to borrowers. Certificates of deposit due within one year of December 31, 2021, totaled $295.8 million, or 7.1% of total deposits. If these deposits do not remain with us, we will be required to seek other sources of funds, including loan sales, securities sales, other deposit products, including replacement certificates of deposit, securities sold under agreements to repurchase (repurchase agreements), and advances from the FHLBNY and other borrowing sources. Depending on market conditions, we may be required to pay higher rates on such deposits or other borrowings than we currently pay on the certificates of deposit. Based on experience, we believe that a significant portion of such deposits will remain with us, and we have the ability to attract and retain deposits by adjusting the interest rates offered.

We have a detailed contingency funding plan that is reviewed and reported to the Board Risk Committee at least quarterly. This plan includes monitoring cash on a daily basis to determine the liquidity needs of Northfield Bank. Additionally, management performs a stress test on Northfield Bank’s retail deposits and wholesale funding sources in several scenarios on a quarterly basis. The stress scenarios include deposit attrition of up to 50%, and selling our securities available-for-sale portfolio at a discount of 20% to its current estimated fair value. Northfield Bank continues to maintain significant liquidity under all stress scenarios.

Northfield Bancorp, Inc. is a separate legal entity from Northfield Bank and must provide for its own liquidity to fund dividend payments, stock repurchases, and other corporate risk factors. The Company’s primary source of liquidity is the receipt of dividend payments from the Bank in accordance with applicable regulatory requirements. At December 31, 2021, Northfield Bancorp, Inc. (unconsolidated) had liquid assets of $14.4 million.

Northfield Bank and Northfield Bancorp, Inc. are both subject to various regulatory capital requirements, including a risk-based capital measure. The risk-based capital guidelines include both a definition of capital and a framework for calculating risk-weighted assets by assigning assets and off-balance sheet items to broad risk categories. At December 31, 2021, both Northfield Bank and Northfield Bancorp, Inc. exceeded all regulatory capital requirements and are considered “well capitalized” under regulatory guidelines.  See “Item 1. Business - Supervision and Regulation” and Note 15 of the Notes to the Consolidated Financial Statements.

Off-Balance Sheet Arrangements and Aggregate 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 potential 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 applicable to loans we originate. In addition, we routinely enter into commitments to sell mortgage loans; such amounts are not significant to our operations. For additional information, see Note 14 of the Notes to the Consolidated Financial Statements.

Impact of Inflation and Changing Prices

Our Consolidated Financial Statements and related notes have been prepared in accordance with U.S. GAAP. U.S. GAAP generally requires the measurement of financial position and operating results in terms of historical dollars without consideration for changes in the relative purchasing power of money over time due to inflation. The effect of inflation is reflected in the increased cost of our operations. Unlike industrial companies, our assets and liabilities are primarily monetary in nature. As a result, changes in market interest rates have a greater effect on our performance than inflation.