Rhinebeck Bancorp, Inc. (RBKB) FY 2021 MD&A

Item 7.    Management’s Discussion and Analysis of Financial Condition and Results of Operations

This discussion and analysis reflects information contained in our audited consolidated financial statements and other relevant statistical data, and is intended to enhance your understanding of our financial condition and results of operations. The information in this section has been derived from the audited consolidated financial statements of this Form 10-K.

Overview

Net Interest Income. Our primary source of income is net interest income. Net interest income is the difference between interest income, which is the income we earn on our loans and investments, and interest expense, which is the interest we pay on our deposits and borrowings.

Provision for Loan Losses. The allowance for loan losses is a valuation allowance for probable incurred credit losses. The allowance for loan losses is increased through charges to the provision for loan losses. Loans are charged against the allowance when management believes that the collectability of the principal loan amount is not probable. Recoveries on loans previously charged-off, if any, are credited to the allowance for loan losses when realized.

Non-interest Income. Our primary sources of non-interest income are mortgage banking income, service charges on deposit accounts, investment advisory income and net gains in the cash surrender value of bank owned life insurance and other income.

Non-Interest Expenses. Our non-interest expenses consist of salaries and employee benefits, net occupancy and equipment, data processing, professional fees, marketing expenses and other general and administrative expenses, including premium payments we make to the FDIC for insurance of our deposits.

Income Tax Expense. Our income tax expense is the total of the current year income tax due or refundable and the change in deferred tax assets and liabilities. Deferred tax assets and liabilities are the expected future tax amounts for the temporary differences between the carrying amounts and the tax basis of assets and liabilities, computed using enacted tax rates. A valuation allowance, if needed, reduces deferred tax assets to the amounts expected to be realized.

Impact of COVID-19

During 2021, the United States’ economy began to recover from the COVID-19 pandemic, as the distribution of COVID-19 vaccines allowed for the easing of restrictive measures that had previously been imposed by state and local governments. While progress has been made to combat the COVID-19 pandemic, the pandemic is not over and may continue to have a complex and significant adverse impact on the economy, the banking industry and the Company in future periods, all subject to a high degree of uncertainty, particularly if new variants of the virus continue to emerge.

Effects on Our Market Areas.

Our commercial and consumer banking products and services are offered primarily in the Hudson Valley of New York, where individual and governmental responses to the COVID-19 pandemic led to a broad curtailment of economic activity beginning in March 2020. In 2020, the Governor announced a statewide stay-at-home order, also known as the “NYS on PAUSE Program,” with a mandate that all non-essential workers work from home and only businesses declared as essential by the program were allowed to stay open. As cases of COVID-19 declined, New York began a phased-in reopening with the Hudson Valley reaching Phase 1 reopening on May 26, 2020 and reaching the final Phase 4 on July 7, 2020. Even with the Phase 4 reopening business operations remained limited and many people still engaged in limited activities. As vaccines became available in 2021, more pandemic related restrictions eased and New York is gradually returning to normal. The recent surge of the Omicron variant has been a setback, and certain previously-relaxed social distancing and safety protocols have been reinstated, however, the state is hesitant to enact strict restrictions with vaccines and masking remaining the best public health measures in protecting people from COVID-19. Statewide unemployment levels have decreased but remain higher than pre-pandemic levels, from an average of 3.7% in December 2019 to 6.2% in December 2021.

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Pandemic Operational Preparations and Status.

Various operational measures remain in effect to encourage social distancing and enhanced cleaning and sanitizing procedures continue at all offices, drive-thru locations and ATM terminals. We maintain a workplace safety program to provide employees a safe and healthy workplace. By September 30, 2021, the majority of our employees had returned to the office. On September 6, 2021, New York Governor Kathy Hochul announced the designation of COVID-19 as an airborne infectious disease under the New York Health and Essential Rights Act (“HERO Act”). This designation requires all private employers to implement workplace safety plans. The key change to current safety protocol followed by the Bank is that all employees, regardless of vaccination status must be masked while in common areas. We continue to watch the latest COVID-19 developments and are following guidance provided by the Centers for Disease Control, as well as federal, state and local agencies.

Effects on Our Business.

With regard to our December 31, 2021 financial condition and results of operations, improving conditions around COVID-19 had a material impact on our provision for loan losses as the provision is significantly impacted by changes in economic conditions. Given that the economic conditions have improved significantly since December 31, 2020, we recorded a credit to the provision for loan losses for the year ended December 31, 2021. Should economic conditions worsen as a result of a resurgence in the virus and resulting measures to curtail its spread, we could experience increases in our required provision.

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The Company’s interest income could be reduced due to COVID-19. In keeping with guidance from regulators, the Company continues to work with COVID-19 affected borrowers to defer their payments, interest, and fees. While interest and fees continue to accrue to income, should eventual credit losses on these deferred payments emerge, the related loans would be placed on nonaccrual status and interest income and fees accrued would be reversed. In such a scenario, interest income in future periods could be negatively impacted.

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U.S. Small Business Administration Paycheck Protection Program.

Section 1102 of the CARES Act created the PPP, a program administered by the Small Business Administration (“SBA”) to provide loans to small businesses for payroll and other basic expenses during the COVID-19 pandemic. We participated in the PPP as a lender. These loans are eligible to be forgiven if certain conditions are satisfied and are fully guaranteed by the SBA. Additionally, loan payments will also be deferred for the first ten months of the loan term. During 2020, we received SBA approval for 674 applications totaling $92.0 million all of which were funded.

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On December 27, 2020, President Trump signed into law the Consolidated Appropriations Act, 2021 (the “CAA”). The CAA, among other things, extends the life of the PPP, creating a second round of PPP loans for eligible businesses. We participated in the CAA’s second round of PPP lending. During the year ended December 31, 2021, we received SBA approval for 376 applications totaling $48.2 million and all had been funded. At December 31, 2021, we had $29.5 million of PPP loans outstanding

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Deferred loan origination fees related to the PPP loans, net of deferred loan origination costs, totaled $3.3 million at December 31, 2021. We recorded amortization of net deferred loan origination fees of $2.4 million and $2.1 million on PPP loans for the years ended December 31, 2021 and 2020, respectively. The remaining net deferred loan origination fees will be amortized over the life of the respective loans, or until forgiven by the SBA, and will be recognized in interest income.

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To assure adequate funding of the additional loan demand, the Bank became a participant in the Federal Reserve’s Payroll Protection Program Lending Facility (“PPPLF”), which allowed us to present these loans as collateral for 100% principal credit at the Federal Reserve’s discount window. The term of these loans mirrored the actual maturity of the underlying collateral and had a fixed interest rate of 0.35%. In April 2020, we borrowed $70.1 million which was repaid in full on July 2, 2020. The Bank did not utilize the PPPLF to fund its second round of PPP loans.

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COVID-19 Loan Forbearance Programs

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Section 4013 of the CARES Act provides that a qualified loan modification is exempt by law from classification as a TDR pursuant to GAAP.  In addition, the Office of the Comptroller of the Currency (“OCC”) in coordination with other federal agencies and in consultation with state financial regulators, issued OCC Bulletin 2020-35, which provided more limited circumstances in which a loan modification is not subject to classification as a TDR.

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For consumer borrowers, the Bank deferred payments for indirect and direct automobile loans for up to 60 days and an additional 30 days, if needed. We also provided forbearance to our residential real estate borrowers which allowed them to defer their principal and interest payments for up to 90 days and an option for an additional 90 days, if needed. In addition, for commercial borrowers we provided deferment and forbearance options that include interest-only and tax escrow only payments. Some borrowers that met the Bank’s underwriting criteria were granted working capital loans to provide financial assistance. These deferrals were maintained within the CARES Act guidance and did not exceed twelve consecutive months of deferred payment.

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Throughout 2020, the Bank had approved 2,095 loan deferrals totaling $122.6 million. During 2021, the Bank had approved 120 loan deferrals totaling $1.9 million. As of December 31, 2021, all of the modifications granted to customers had expired and there were no deferrals outstanding.

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Business Strategy

Based on an extensive review of the current opportunities in our primary market area as well as our resources and capabilities, we are pursuing the following business strategies:

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Terms of Critical Accounting Policies

Our most significant accounting policies are described in Note 1 to the consolidated financial statements.  Certain of these accounting policies require management to use significant judgment and estimates, which can have a material impact on the carrying value of certain assets and liabilities, and we consider these policies to be our critical accounting estimates.  The judgment and assumptions made are based upon historical experience, future forecasts, or other factors that management believes to be reasonable under the circumstances.  Because of the nature of the judgment and assumptions, actual results could differ from estimates, which could have a material effect on our financial condition and results of operations.

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The following accounting policies materially affect our reported earnings and financial condition and require significant judgments and estimates.

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Allowance for loan losses

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The allowance for loan losses is the estimated amount considered necessary to cover credit losses inherent in the loan portfolio at the balance sheet date. The allowance is established through the provision for loan losses which is charged against income. Determining the appropriateness of the allowance is complex and requires judgment by management about the effect of matters that are inherently uncertain. Subsequent evaluations of the then-existing loan portfolio, in light of the factors then prevailing, may result in significant changes in the allowance in those future periods.

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In determining the allowance for loan losses, management makes significant estimates and has identified this policy as one of our most critical. The methodology for determining the allowance for loan losses is considered a critical accounting policy by management due to the high degree of judgment involved, the subjectivity of the assumptions utilized and the potential for unanticipated changes in the economic environment that could result in changes to the amount of the recorded allowance for loan losses.

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As a substantial amount of our loan portfolio is collateralized by real estate, appraisals of the underlying value of property securing loans and discounted cash flow valuations of properties are critical in determining the amount of the allowance required for specific impaired loans. Assumptions for appraisals and discounted cash flow valuations are instrumental in determining the value of properties.

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Management performs a quarterly evaluation of the adequacy of the allowance for loan losses. Consideration is given to a variety of factors in establishing the allowance including, but not limited to, current economic conditions, delinquency statistics, geographic and industry concentrations, the adequacy of the underlying collateral, the financial strength of the borrower, results of internal and external loan reviews and other relevant factors. This evaluation is inherently subjective, as it requires material estimates that may be susceptible to significant revision based on changes in economic and real estate market conditions.

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The analysis of the allowance for loan losses has two components: specific and general allocations. Specific allocations are made for loans that are determined to be impaired. Impairment is measured by determining the present value of expected future cash flows or, for collateral-dependent loans, the fair value of the collateral adjusted for market conditions and selling expenses. The general allocation is determined by segregating the remaining loans by type of loan and using applicable historical loss experience plus qualitative factors including, but not limited to, delinquency trends, general economic conditions and geographic and industry concentrations.

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The allowance represents management’s best estimate, but significant downturns in circumstances relating to loan quality and economic conditions could result in a requirement for additional allowance.  Likewise, external events could potentially cause an upturn in loan quality and improved economic conditions may allow a reduction in the required allowance.  In either instance, unanticipated and unforeseeable changes could have a significant impact on results of operations.

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Overly optimistic assumptions or negative changes to assumptions could significantly impact the valuation of a property securing a loan and the related allowance determined. The assumptions supporting such appraisals and discounted cash flow valuations are carefully reviewed by management to determine that the resulting values reasonably reflect amounts realizable on the related loans. Actual loan losses may be significantly more than the allowance for loan losses we have established, which could have a material negative effect on our financial results. In addition, our banking regulators, as an integral part of their examination process, periodically review our allowance for loan losses. Our banking regulators may require us to recognize adjustments to the allowance based on judgments about information available to them at the time of its examination.

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Goodwill and Intangible Assets

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The assets (including identifiable intangible assets) and liabilities acquired in a business combination are recorded at fair value at the date of acquisition. Goodwill is recognized as the excess of the acquisition cost over the fair values of the net assets acquired and is not subsequently amortized. Identifiable intangible assets include customer lists and core deposit intangibles and are being amortized on a straight-line basis over their estimated lives. Goodwill is not amortized, but it is tested at least annually for impairment in the fourth quarter, or more frequently if indicators of impairment are present.

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The determination of fair values is based on valuations using management’s assumptions of future growth rates, future attrition, discount rates, multiples of earnings or other relevant factors. In evaluating whether it is more likely than not that the fair value is less than its carrying amount, management assessed seven qualitative factors including, but not limited to, macroeconomic conditions, industry and market considerations, overall financial performance and other relevant company-specific events.

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Changes in these factors, as well as downturns in economic or business conditions, could have a significant adverse impact on the carrying value of goodwill and could result in impairment losses affecting our financial statements. A prolonged economic downturn or deterioration in the economic outlook may lead management to conclude that an interim quantitative impairment test of our goodwill is required prior to the annual impairment test. Based on our impairment tests, no impairment was recorded in 2021 or 2020.

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Income Taxes

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We are subject to the income tax laws of the United States, New York State, and the municipalities in which we operate.  These tax laws are complex and subject to different interpretations by the taxpayer and the relevant government taxing authorities.  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.  See Note 9 to the Consolidated Financial Statements for a further description of our provision and related income tax assets and liabilities.

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In establishing a provision for income tax expense, we must make judgments and interpretations about the application of these inherently complex tax laws.  We must also make estimates about when in the future certain items will affect taxable income.  Disputes over interpretations of the tax laws may be subject to review/adjudication by the court systems of the various tax jurisdictions or may be settled with the taxing authority upon examination or audit.

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If current available information raises doubt as to the realization of the deferred tax assets, a valuation allowance is established. We consider the determination of this valuation allowance to be a critical accounting policy because of the need to exercise significant judgment in evaluating the amount and timing of recognition of deferred tax liabilities and assets, including projections of future taxable income. These judgments and estimates are reviewed on a continual basis as regulatory and business factors change.

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A valuation allowance for deferred tax assets may be required if the amount of taxes recoverable through loss carryback declines, or if we project lower levels of future taxable income. Such a valuation allowance would be established through a charge to income tax expense which would adversely affect our operating results.

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Although management believes that the judgments and estimates used are reasonable, actual results could differ and we may be exposed to losses or gains that could be material.   An unfavorable tax settlement would result in an increase in our effective income tax rate in the period of resolution.  A favorable tax settlement would result in a reduction in our effective income tax rate in the period of resolution.

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Selected Financial Data

The following selected consolidated financial data sets forth certain financial highlights of the Company and should be read in conjunction with the audited consolidated financial statements and related notes included elsewhere in this Annual Report on Form 10-K for 2021 and 2020.

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NON-GAAP FINANCIAL INFORMATION

This Report contains financial information determined by methods other than in accordance with generally accepted accounting principles (“GAAP”). Such non-GAAP financial information includes the following measure: “tangible book value per common share.” Management uses this non-GAAP measure because we believe that it may provide useful supplemental information for evaluating our operations and performance, as well as in managing and evaluating our business and in discussions about our operations and performance. Management believes this non-GAAP measure may also provide users of our financial information with a meaningful measure for assessing our financial results, as well as a comparison to financial results for prior periods. This non-GAAP measure should be viewed in addition to, and not as an alternative to or substitute for, measures determined in accordance with GAAP and are not necessarily comparable to other similarly titled measures used by other companies. To the extent applicable, reconciliations of these non-GAAP measures to the most directly comparable measures as reported in accordance with GAAP are included below.

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

Total Assets.  Total assets were $1.28 billion at December 31, 2021, representing an increase of $152.3 million, or 13.5%, compared to $1.13 billion at December 31, 2020. The increase was primarily related to an increase in available for sale securities, which increased $177.4 million, or 172.3% and an increase of $10.3 million, or 54.3%, in the cash surrender value of life insurance. These increases were partially offset by a decrease in cash and due from banks of $21.4 million, or 22.9%, and a decrease in net loans receivable of $18.8 million, or 2.2%.

Cash and Due from Banks.  Cash and due from banks decreased $21.4 million, or 22.9%, to $72.1 million at December 31, 2021 from $93.5 million at December 31, 2020, primarily due to a decrease in deposits held at the Federal Reserve Bank of New York, as excess cash was used to purchase investment securities.

Investment Securities Available for Sale.  Investment securities available for sale increased $177.4 million, or 172.3%, to $280.3 million at December 31, 2021 from $102.9 million at December 31, 2020. The increase was primarily due to $244.7 million of new purchases, primarily of mortgage-backed securities and U.S. Treasury and government agency securities, as we deployed excess cash received mostly from PPP borrower-related accounts and government stimulus actions and the additional deposits acquired in our 2021 branch acquisition. The increase in available for sale securities was partially offset by paydowns, calls and maturities of $62.6 million and $4.7 million in unrealized market losses.

Net Loans.  Net loans receivable were $855.0 million at December 31, 2021, a decrease of $18.8 million, or 2.2%, when compared to December 31, 2020. The decrease was primarily due a decrease in PPP loans. Net PPP loans decreased $45.6 million, or 61.5%, reflecting the improvement in the economy as our customers showed signs of recovering from the pandemic. Excluding PPP loans, commercial loans decreased $3.8 million primarily on production shortfalls. Residential real estate loans decreased $3.6 million, or 9.2%, while non-residential real estate and home equity loans decreased $2.8 million and $2.3 million, respectively. These decreases were partially offset by an increase in multi-family real estate of $25.5 million, or 84.1%, an increase in our indirect automobile portfolio of $5.8 million, or 1.5%, and an increase in commercial real estate construction loans of $4.7 million, or 87.2%. During the year, our allowance for loan losses decreased $4.1 million, or 35.0%, to reflect the decrease in our portfolio and the improving economic conditions.

Cash Surrender Value of Life Insurance. Cash surrender value of life insurance increased $10.3 million, or 54.3%, as the Bank purchased $10.0 million in split-dollar life insurance policies for key employees.

Total Liabilities.  Total liabilities increased $142.9 million in 2021 primarily due to an increase in deposits of $172.6 million, or 18.6%, and partially offset by a decrease of $32.6 million, or 64.4%, in FHLB advances.

Deposits.  Deposits increased $172.6 million, or 18.6%, to $1.10 billion at December 31, 2021. Interest bearing accounts grew 14.9%, or $102.2 million, to $787.2 million. NOW accounts increased $17.0 million, or 12.0%, savings accounts increased $25.2 million, or 16.0%, and money market accounts increased $103.7 million, or 56.0%. Certificates of deposit decreased $43.7 million, or 21.8%, to $156.9 million at December 31, 2021. Non-interest bearing balances increased 28.8%, or $70.5 million, finishing the year at $314.8 million. Mortgagors’ escrow accounts increased 7.5% to $9.1 million at December 31, 2021.

Borrowed Funds.  Advances from the FHLB decreased $32.6 million, or 64.4%, from $50.7 million at December 31, 2020 to $18.0 million at December 31, 2021 as there was no need to replace maturing advances due to deposit growth.

Stockholders’ Equity. Stockholders' equity increased $9.5 million to $126.0 million at December 31, 2021, primarily due to net income of $11.6 million, partially offset by a $3.7 million increase in accumulated other comprehensive loss on available for sale securities, as a net unrealized gain turned to a net unrealized loss. The Company's ratio of average equity to average assets was 10.02% for the year ended December 31, 2021 and 10.56% for the year ended December 31, 2020. Book value per share was $11.15 and $10.31 for the years ended December 31, 2021

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and 2020, respectively. Tangible book value per share was $10.92 and $10.16 for the years ended December 31, 2021 and 2020, respectively (see reconciliation of Non-GAAP Financial Information shown above).

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

Net Income.  Net income for the year ended December 31, 2021 was $11.6 million ($1.07 per basic and $1.06 per diluted share), compared with $5.9 million ($0.55 per basic and diluted share) for the year ended December 31, 2020, an increase of $5.6 million, or 95.3%. Interest and dividend income decreased $695,000, or 1.6%, interest expense decreased $3.7 million, or 46.5%, and the provision for loan losses decreased $10.8 million, or 151.4%, ending the year with a credit balance. Noninterest income decreased $880,000, or 10.6%, while other expenses and taxes increased $7.3 million, or 23.2%, as compared to 2020. The increase in net income came largely from a credit to the provision for loan losses of $3.7 million in 2021 as compared to a provision for loan losses of $7.1 million for 2020.

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Net Interest Income.  Net interest income increased $3.0 million, or 8.3%, to $39.4 million for the year ended December 31, 2021, as compared to $36.4 million in 2020. The increase was primarily driven by higher interest-earning asset balances and the favorable impact of lower rates on deposit costs, which were partially offset by lower yields on earning assets. An increase in lower yielding available for sale securities was the primary reason our net interest margin decline of 11 basis points to 3.45% for the year ended December 31, 2021 compared to 3.56% for 2020. The ratio of average interest-earning assets to average interest-bearing liabilities improved 3.2% to 144.89%. The yield on interest earning assets decreased 52 basis points to 3.82% in 2021 from 4.34%, primarily due to the large addition of lower yielding available for sale securities, while deposit and borrowing costs decreased 56 basis points to 0.54% in 2021 from 1.10% for 2020 driven by decreases in general market rates, a change in the composition of the deposit portfolio to more transaction accounts and less certificates of deposit, and efforts to maintain our margin.

Interest Income.  Interest income decreased $695,000, or 1.6%, to $43.7 million for fiscal year 2021 from $44.4 million for fiscal year 2020. The decrease resulted primarily from decreased yields and, to a lesser extent, a lower average loan balance, partially offset by a higher average balance of lower yielding available for sale securities. The average yield on loans decreased to 4.80% for the fiscal year 2021, from 4.86% for the fiscal year 2020. The average yields on investment securities decreased to 1.12% for the fiscal year 2021 from 1.88% for 2020. Average interest earning assets increased $120.0 million from $1.02 billion at December 31, 2020 to $1.14 billion at December 31, 2021. The increase in average interest earning assets during 2021 compared to 2020 included increases in available for sale securities of $85.6 million and an increase in average interest bearing depository accounts of $42.6 million, partially offset by a decrease of $8.2 million in average loan balances.

Interest Expense.  Interest expense decreased $3.7 million, or 46.5%, to $4.3 million for fiscal year 2021 from $8.0 million for fiscal year 2020. This was primarily due to a 56 basis point decrease in the overall cost of interest bearing liabilities to 0.54% for fiscal 2021 from 1.10% for fiscal 2020 partially offset by an increase in average interest bearing liability balances of $60.1 million, or 8.3%, year over year.

Provision for Loan Losses.  The Company establishes provisions for loan losses, which are charged to earnings, at a level necessary to absorb known and inherent losses that are both probable and reasonably estimable at the date of the financial statements. In evaluating the level of the allowance for loan losses, management considers historical loss experience, the types of loans and the amount of loans in the loan portfolio, adverse situations that may affect the borrower’s ability to repay, the estimated value of any underlying collateral, peer group information and prevailing economic conditions, among other qualitative factors. This evaluation is inherently subjective as it requires estimates that are susceptible to significant revision as more information becomes available or as future events occur.

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The Company recorded a credit to the provision of $3.7 million for the year ended December 31, 2021, a decrease of $10.8 million, or 151.4%, as compared to the year ended December 31, 2020. The credit to the provision was mainly attributable to the positive impact of the change in both quantitative and qualitative factors reflecting the improved economic environment and the resultant decreased financial risk for the Bank’s borrowers. The decrease in our loan loss allowance related to the economic environment was based, in major part, on the number of loans that had their payments deferred in fiscal year 2020 which increased the risk of defaults. There were no deferrals remaining at December 31, 2021. Net charge-offs for the year ended December 31, 2021 totaled $407,000, compared to $1.5 million, for the year

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ended 2020. The decrease was primarily due to an improvement in the overall economic environment and pricing gains on the sales of repossessed vehicles as used car prices have risen significantly.

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Although we believe that we use the best information available to establish the allowance for loan losses, future additions to the allowance may be necessary, based on estimates that are susceptible to change as a result of changes in economic conditions and other factors. In addition, the FDIC and NYSDFS, as an integral part of their examination process, will periodically review our allowance for loan losses. These agencies may require us to recognize adjustments to the allowance, based on their judgments about information available to them at the time of their examination.

Non-Interest Income. Non-interest income decreased $880,000, or 10.6%, to $7.4 million for the year ended December 31, 2021 as compared to $8.3 million in 2020. For the year ended December 31, 2021, the gain on sales of mortgage loans decreased $1.2 million, or 31.4%, and the net gain from sales of other real estate owned decreased $489,000, or 98.2%. The Company sold $72.9 million of residential mortgage loans in 2021 as compared to $95.0 million in 2020. Investment advisory income decreased $158,000, or 12.3%. These decreases were partially offset by service charges on deposit accounts, which increased $308,000, or 13.5%, as transaction volume increased, while the cash surrender value of life insurance increased $191,000. A gain related to the collection of life insurance proceeds of $195,000 and an increase in various other non-interest income items of $224,000 also served to reduce the overall decline in non-interest income.

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Non-Interest Expense.  For the year ended December 31, 2021, non-interest expense increased $5.4 million, or 18.1%, to $35.5 million from $30.1 million for 2020. The increase was primarily due to an increase in salaries and benefits of $3.3 million, or 19.7%, due to new branch employees as well as annual merit increases, production incentives and employee benefit increases. Occupancy increased $579,000, or 16.3%, data processing increased $345,000, or 24.7%, marketing fees increased $202,000 and professional fees increased $194,000. Other non-interest expenses increased $935,000, or 18.1%, and included an additional estimated reserve of $600,000 for potential consumer compliance issues in the Bank’s indirect automobile portfolio. Additional reserves in the future may be required but cannot be estimated at this time.

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Income Taxes.  Income tax provision increased by $1.9 million, or 120.2%, to $3.4 million for the year ended December 31, 2021 as compared to 2020. Our effective tax rate for the year ended December 31, 2021 was 22.9% compared to 20.9% in 2020.

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Average Balance Sheets for the Years Ended December 31, 2021 and 2020

The following tables set forth average balance sheets, average yields and costs, and certain other information for the periods indicated. No tax-equivalent yield adjustments have been made, as the effects would be immaterial. All average balances are daily average balances. The yields set forth below include the effect of deferred fees and discounts and premiums that are amortized or accreted to interest income. Loan balances include loans held for sale. Deferred loan fees included in interest income totaled $2.7 million and $1.7 million for the years ended December 31, 2021 and 2020, respectively.

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Rate/Volume Analysis

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The following table presents the effects of changing rates and volumes on our net interest income for the years indicated. The rate column shows the effects attributable to changes in rate (changes in rate multiplied by prior volume). The volume column shows the effects attributable to changes in volume (changes in volume multiplied by prior rate). The net column represents the sum of the prior columns. For purposes of this table, changes attributable to both rate and volume, which cannot be segregated, have been allocated proportionately based on the changes due to rate and the changes due to volume. The Company does not have any excludable out-of-period items or adjustments.

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Management of Market Risk

General.  The majority of our assets and liabilities are monetary in nature. Consequently, our most significant form of market risk is interest rate risk. Our assets, consisting primarily of loans, have longer maturities than our liabilities, consisting primarily of deposits. As a result, a principal part of our business strategy is to manage our exposure to changes in market interest rates. Accordingly, the Board of Directors maintains a management-level Asset/Liability Management Committee (the “ALCO”), which takes initial responsibility for reviewing the asset/liability management process and related procedures, establishing and monitoring reporting systems and ascertaining that established asset/liability strategies are being maintained. On at least a quarterly basis, the ALCO reviews and reports asset/liability management outcomes with the Board of Directors. This committee also implements any changes in strategies and reviews the performance of any specific asset/liability management actions that have been implemented.

We try to manage our interest rate risk to minimize the exposure of our earnings and capital to changes in market interest rates. We have implemented the following strategies to manage our interest rate risk: originating loans with adjustable interest rates, selling longer-term fixed-rate residential mortgage loans, promoting core deposit products and adjusting the interest rates and maturities of funding sources, as necessary. By following these strategies, we believe that we are better positioned to react to changes in market interest rates.

Net Economic Value Simulation.  We analyze our sensitivity to changes in interest rates through a net economic value of equity (“EVE”) model. EVE represents the present value of the expected cash flows from our assets less the present value of the expected cash flows arising from our liabilities adjusted for the value of off-balance sheet contracts. The EVE ratio represents the dollar amount of our EVE divided by the present value of our total assets for a given interest rate scenario. EVE attempts to quantify our economic value using a discounted cash flow methodology while the EVE ratio reflects that value as a form of capital ratio. We estimate what our EVE would be at a specific date. We then calculate what the EVE would be at the same date throughout a series of interest rate scenarios representing immediate and permanent, parallel shifts in the yield curve. We currently calculate EVE under the assumptions that interest rates

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increase 100, 200, 300 and 400 basis points from current market rates and that interest rates decrease 100 basis points from current market rates.

The following table presents the estimated changes in our EVE that would result from changes in market interest rates at December 31, 2021. All estimated changes presented in the table are within the policy limits approved by our Board of Directors.

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Certain shortcomings are inherent in the methodologies used in the above interest rate risk measurements. Modeling changes require making certain assumptions that may or may not reflect the manner in which actual yields and costs respond to changes in market interest rates. The above table assumes that the composition of our interest-sensitive assets and liabilities existing at the date indicated remains constant uniformly across the yield curve regardless of the duration or repricing of specific assets and liabilities. Accordingly, although the table provides 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 EVE and will differ from actual results.

Liquidity Management

We maintain liquid assets at levels we consider adequate to meet both our short-term and long-term liquidity needs. We adjust our liquidity levels to fund deposit outflows, repay our borrowings and to fund loan commitments. We also adjust liquidity as appropriate to meet asset and liability management objectives.

Our primary sources of liquidity are deposits, loan sales, amortization and prepayment of loans and mortgage-backed securities, maturities of investment securities and other short-term investments, and earnings and funds provided from operations, as well as access to FHLB advances and other borrowings. While scheduled principal repayments on loans and mortgage-backed securities are a relatively predictable source of funds, deposit flows and loan sales and prepayments are greatly influenced by market interest rates, economic conditions, and rates offered by our competition. We set the interest rates on our deposits to maintain a desired level of total deposits.

As reported in the Consolidated Statements of Cash Flows, our cash flows are classified for financial reporting purposes as operating, investing, or financing cash flows. Net cash provided by operating activities was $7.7 million and $14.8 million for the years ended December 31, 2021 and 2020, respectively. These amounts differ from our net income because of a variety of cash receipts and disbursements that did not affect net income for the respective periods. Net cash used for investing activities was $135.7 million and $74.1 million in fiscal years 2021 and 2020, respectively, principally reflecting our investment security and loan activities in the respective periods. We also received $32.8 million in cash from the acquisition of two branches in 2021. Cash outlays for the purchase of securities increased from $39.2 million for the year ended December 31, 2020 to $244.6 million for the year ended December 31, 2020. Cash proceeds from principal repayments, maturities and sales of investment securities amounted to $62.2 million and $52.0 million in the years ended December 31, 2021 and 2020, respectively. We had cash flows from a net decrease in loans of $23.7 million in 2021 compared to a net increase of $89.3 million in 2020. Deposit and borrowing cash flows have traditionally comprised most of our financing activities which resulted in net cash provided of $106.7 million in fiscal year 2021, and $140.8 million in fiscal year 2020.

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At December 31, 2021, we had the following main sources of availability of liquid funds and borrowings:

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The following table summarizes our main contractual obligations and other commitments to make future payments as of December 31, 2021. The amount of the obligations presented in the table reflect principal amounts only and exclude the amount of interest we are obligated to pay. Also excluded from the table are a number of obligations to be settled in cash. These excluded items are reflected in our consolidated balance sheet and include deposits with no stated maturity, trade payables, and accrued interest payable.

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Off-Balance Sheet Arrangements.  In the normal course of operations, we engage in a variety of financial transactions that, in accordance with generally accepted accounting principles are not recorded in our financial statements. These transactions involve, to varying degrees, elements of credit, interest rate and liquidity risk. Such transactions are used primarily to manage customers’ requests for funding and take the form of loan commitments and lines of credit. For information about our loan commitments, letters of credit and unused lines of credit, see Note 12 to the Consolidated Financial Statements. For fiscal year 2021, we did not engage in any off-balance-sheet transactions other than loan origination commitments and standby letters of credit in the normal course of our lending activities.

Impact of Inflation and Changing Prices

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

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