COLUMBIA FINANCIAL, INC. MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS OF OPERATIONSForward-Looking Statements (form 10-Q)

Published: 2022-05-10 16:19:07 ET CLBK

Certain statements contained herein are "forward-looking statements" within the meaning of Section 27A of the Securities Act of 1933 and Section 21E of the Securities Exchange Act of 1934. Such forward-looking statements may be identified by reference to a future period or periods, or by the use of forward-looking terminology, such as "may," "will," "believe," "expect," "estimate," "project," "intend," "anticipate," "continue," or similar terms or variations on those terms, or the negative of those terms. Forward-looking statements are subject to numerous risk factors and uncertainties, including, but not limited to, those set forth in Item 1A of the Company's Annual Report on Form 10-K as supplemented by its Quarterly Reports on Form 10-Q, and those related to the economic environment, particularly in the market areas in which the Company operates, competitive products and pricing, as well as its impact on fiscal and monetary policies of the U.S. Government, changes in government regulations affecting financial institutions, including regulatory fees and capital requirements, changes in prevailing interest rates, higher inflation and its impact on national and local economic conditions, the Company's ability to successfully implement its business strategy, including the consummation of its pending acquisition of RSI Bank, acquisitions and the integration of acquired businesses, credit risk management, the effect of the COVID-19 pandemic (including its impact on our borrowers and their ability to repay their loans, and on the local and national economies), asset-liability management, the financial and securities markets, and the availability of and costs associated with sources of liquidity.

The Company cautions readers not to place undue reliance on any such forward-looking statements which speak only as of the date made. The Company also advises readers that the factors listed above could affect the Company's financial performance and could cause the Company's actual results for future periods to differ materially from any opinions or statements expressed with respect to future periods in any current statements. The Company does not have any obligation to update any forward-looking statements to reflect any subsequent events or circumstances after the date of this statement.

Comparison of Financial Condition at March 31, 2022 and December 31, 2021

Net income of $20.4 million was recorded for the quarter ended March 31, 2022, a decrease of $641,000, or 3.0%, compared to net income of $21.0 million for the quarter ended March 31, 2021. The decrease in net income was primarily attributable to a $2.7 million increase in provision for credit losses, a $1.6 million decrease in non-interest income, and a $3.0 million increase in non-interest expense, partially offset by a $6.0 million increase in net interest income and a $712,000 decrease in income tax expense.

Net interest income was $62.7 million for the quarter ended March 31, 2022, an increase of $6.0 million, or 10.5%, from $56.7 million for the quarter ended March 31, 2021. The increase in net interest income was primarily attributable to a $4.9 million decrease in interest expense, resulting from a decrease in interest expense on deposits and borrowings, coupled with a $1.1 million increase in interest income. The decrease in interest expense on deposits was driven by both an inflow of lower cost deposits and the repricing of existing deposits at reduced rates as a result of a sustained lower interest rate environment. The 25 basis point increase in interest rates announced by the Federal Reserve in March 2022 did not significantly impact first quarter results. The increase in interest income for the quarter ended March 31, 2022 was due to an increase in the average balance of interest-earning assets. Prepayment penalties, which are included in interest income on loans, totaled $1.3 million for the quarter ended March 31, 2022, compared to $968,000 for the quarter ended March 31, 2021.

The average yield on loans for the quarter ended March 31, 2022 decreased 25 basis points to 3.62%, as compared to 3.87% for the quarter ended March 31, 2021, due to the sustained lower interest rate environment. The average yield on securities for the quarter ended March 31, 2022 increased 15 basis points to 2.20%, as compared to 2.05% for the quarter ended March 31, 2021, as $47.4 million of higher yielding securities were purchased, and a number of adjustable rate securities tied to various indexes, repriced higher during the quarter. The average yield on other interest-earning assets for the quarter ended March 31, 2022 increased 214 basis points to 2.81%, as compared to 0.67% for the quarter ended March 31, 2021, as average cash balances in lower yielding bank accounts were redeployed into higher yielding loans and securities.

Total interest expense was $6.0 million for the quarter ended March 31, 2022, a decrease of $4.9 million, or 44.9%, from $10.9 million for the quarter ended March 31, 2021. The decrease in interest expense was primarily attributable to a 34 basis point decrease in the average cost of interest-bearing deposits which was partially offset by the impact of the increase in the average balance of deposits. The decrease in the cost of deposits was driven by both an inflow of lower cost deposits and the repricing of existing deposits at lower interest rates. Interest on borrowings decreased $700,000, or 34.6%, due to a decrease in the average balance of borrowings.

The Company's net interest margin for the quarter ended March 31, 2022 increased 18 basis points to 2.98%, when compared to 2.80% for the quarter ended March 31, 2021. The weighted average yield on interest-earning assets decreased 7 basis points to

3.27% for the quarter ended March 31, 2022 as compared to 3.34% for the quarter ended March 31, 2021. The average cost of interest-bearing liabilities decreased 32 basis points to 0.39% for the quarter ended March 31, 2022 as compared to 0.71% for the quarter ended March 31, 2021. The decrease in yields and costs for the quarter ended March 31, 2022 were largely driven by a continued lower interest rate environment. The net interest margin increased for the quarter ended March 31, 2022 as the cost of interest-bearing liabilities continued to reprice lower more rapidly than the yields on interest-earning assets and cash and cash equivalents were redeployed into higher yielding loans.

On January 1, 2022, the Company adopted ASU 2016-13, Financial Instruments-Credit Losses (Topic 326), also known as the Current Expected Credit Loss ("CECL") standard. 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 increased stockholders' equity by $6.2 million, net of tax. At adoption and on a gross basis, the Company decreased its allowance for credit losses ("ACL") by $16.8 million for loans, increased its ACL for unfunded commitments, included in other liabilities, by $7.7 million, and established an ACL for debt securities available for sale of $490,000. The provision for credit losses for the quarter ended March 31, 2022 was $1.5 million, an increase of $2.7 million, from a reversal of provision for loan loss of $1.3 million recorded for the quarter ended March 31, 2021. The increase in provision for credit losses during the quarter was primarily attributable to an increase in the balances of loans and the consideration of economic conditions.

Non-interest income was $7.0 million for the quarter ended March 31, 2022, a decrease of $1.6 million, or 18.1%, from $8.6 million for the quarter ended March 31, 2021. The decrease was primarily attributable to a decrease in income from the gain on the sale of loans of $2.0 million and a decrease in income from title insurance fees of $663,000, partially offset by an increase in the change in fair value of equity securities of $667,000.

Non-interest expense was $40.7 million for the quarter ended March 31, 2022, an increase of $3.0 million, or 8.1%, from $37.7 million for the quarter ended March 31, 2021. The increase was primarily attributable to an increase in compensation and employee benefits expense of $2.6 million and an increase in data processing and software expenses of $496,000. The increase in compensation and employee benefits expense was due to an increase in staff levels and related personnel benefit costs, partially due the acquisition of Freehold Bank in December 2021. The increase in data processing and software expenses was attributable to the amortization of software costs related to several digital banking and other Fintech solutions. Included in other non-interest expense for the quarter ended March 31, 2022, were three litigation settlements paid or accrued for totaling $2.2 million, including a previously disclosed award of $1.3 million in attorney's fees paid to the plaintiffs' counsel in connection with the settlement of a lawsuit involving the Company and certain of its current and former directors regarding certain 2019 equity awards granted under the Company's 2019 Equity Incentive Plan. Non-interest expense for the quarter ended March 31, 2022 also includes the provision for credit losses for unfunded commitments of $648,000 related to the CECL standard.

Income tax expense was $7.2 million for the quarter ended March 31, 2022, a decrease of $712,000, as compared to $7.9 million for the quarter ended March 31, 2021, mainly due to a decrease in pre-tax income, and to a lesser extent, a decrease in the Company's effective tax rate. The Company's effective tax rate was 26.0% and 27.2% for the quarters ended March 31, 2022 and 2021, respectively.

Comparison of Results of Operations for the Three Months Ended March 31, 2022 and March 31, 2021

Total assets increased $13.0 million, or 0.1%, with a balance of $9.2 billion at both March 31, 2022 and December 31, 2021. The increase in total assets was primarily attributable to an increase in loans receivable, net of $131.7 million, and an increase in cash and cash equivalents of $25.0 million, partially offset by decreases in debt securities available for sale of $124.4 million, debt securities held to maturity of $10.7 million, and other assets of $10.0 million.

Cash and cash equivalents increased $25.0 million, or 35.3%, to $96.0 million at March 31, 2022 from $71.0 million at December 31, 2021. The increase was primarily attributable to repayments on loans and mortgage-backed securities and growth in deposits, partially offset by $47.4 million in purchases of debt securities available for sale and $21.7 million in repurchases of common stock under our stock repurchase program.

Debt securities available for sale decreased $124.4 million, or 7.3%, to $1.6 billion at March 31, 2022 from $1.7 billion at December 31, 2021. The decrease was attributable to repayments of $89.9 million, partially offset by purchases of $47.4 million, consisting primarily of corporate debt and mortgage-backed securities. The gross unrealized gain (loss) on debt securities available for sale decreased $80.2 million, predominately due to rising interest rates, and the allowance for credit losses on debt securities available for sale increased $1.1 million during the quarter ended March 31, 2022.

Debt securities held to maturity decreased $10.7 million, or 2.5%, to $419.0 million at March 31, 2022 from $429.7 million at December 31, 2021 due to repayments of $10.7 million.

Loans receivable, net, increased $131.7 million, or 2.1%, to $6.4 billion at March 31, 2022 from $6.3 billion at December 31, 2021. One-to-four family real estate loans, multi-family real estate loans, commercial real estate loans, and commercial business loans increased $87.4 million, $36.8 million, $13.5 million, and $14.3 million, respectively, partially offset by decreases in construction loans and home equity loans and advances of $33.4 million and $5.9 million, respectively. The allowance for credit losses for loans decreased $15.5 million to $47.2 million at March 31, 2022 from $62.7 million at December 31, 2021. A $16.8 million decrease in the allowance for credit losses for loans was recorded on January 1, 2022 upon adoption of the CECL standard. During the quarter ended March 31, 2022, the allowance for credit losses increased $916,000 primarily due to an increase in the outstanding balance of loans. The March 31, 2022 methodology and impact of loss rates and qualitative factors remained consistent with those established upon initial adoption.

Other assets decreased $10.0 million, or 4.0%, to $239.6 million at March 31, 2022 from $249.6 million at December 31, 2021. The decrease in other assets consisted of a decrease of $15.0 million in the collateral balance related to our swap agreement obligations, and a decrease of $4.9 million in interest rate swap assets, partially offset by an increase in net deferred tax assets of $8.9 million. Total liabilities increased $59.6 million, or 0.7%, to $8.2 billion at March 31, 2022 from $8.1 billion at December 31, 2021. The increase was primarily attributable to an increase in total deposits of $24.8 million, or 0.3%, and an increase in borrowings of $55.4 million, or 14.7%, partially offset by a decrease in accrued expenses and other liabilities of $22.0 million, or 13.7%. The increase in total deposits consisted of increases in interest-bearing demand deposits, money market accounts, and savings and club deposits of $53.1 million, $39.0 million, and $28.6 million, respectively, partially offset by decreases in non-interest- bearings demand deposits and certificates of deposit accounts of $53.5 million, and $42.5 million, respectively. The increase in borrowings was primarily driven by a $65.5 million increase in FHLB overnight borrowings. The decrease in accrued expenses and other liabilities primarily consisted of a $9.5 million decrease in interest rate swap liabilities, a $9.3 million decrease in accrued bonus and a decrease in net deferred tax liabilities of $9.7 million, partially offset by an increase in allowance for credit losses for unfunded commitments of $8.3 million. Upon the initial adoption of the CECL standard on January 1 2022, an allowance for credit losses for unfunded commitments of $7.7 million was recorded.

Total stockholders' equity decreased $46.6 million, or 4.3%, to $1.0 billion at March 31, 2022 from $1.1 billion at December 31, 2021. The decrease was primarily attributable to an increase of $54.4 million in unrealized losses on debt securities available for sale and interest rate swap contracts, net of taxes, included in other comprehensive income, and the repurchase of 1,023,519 shares of common stock totaling $21.7 million, or $21.19 per share, under our stock repurchase program, partially offset by net income of $20.4 million.

Asset Quality

The Company's non-performing loans at March 31, 2022 totaled $4.6 million, or 0.07% of total gross loans, as compared to $3.9 million, or 0.06% of total gross loans, at December 31, 2021. The $656,000 increase in non-performing loans was primarily attributable to an increase of $1.3 million in non-performing commercial real estate loans, partially offset by decreases of $566,000 and $65,000, respectively, in non-performing commercial business loans and home equity loans and advances. The increase in non-performing commercial real estate loans was due to an increase in the number of loans from one non-performing loan at December 31, 2021 to two loans at March 31, 2022. The decrease in non-performing commercial business loans was due to a decrease in the number of loans from six non-performing loans at December 31, 2021 to one non-performing loans at March 31, 2022. Non-performing assets as a percentage of total assets totaled 0.05% at March 31, 2022 as compared to 0.04% at December 31, 2021.

For the quarter ended March 31, 2022, net recoveries totaled $111,090, as compared to $1.5 million in net charge-offs for the quarter ended March 31, 2021.

The Company's allowance for credit losses on loans was $47.2 million, or 0.73% of total gross loans, at March 31, 2022, compared to $62.7 million, or 0.99% of total gross loans, at December 31, 2021. The decrease in the allowance for credit losses for loans was primarily attributable to the impact of the initial adoption of the CECL standard on January 1, 2022, which resulted in a decrease to allowance for credit losses on loans of $16.8 million.

COVID-19

At March 31, 2022, there were two loans on deferral for $2.6 million, a decrease of $68.1 million, compared to $70.7 million at March 31, 2021, and a decrease of $21.7 million, compared to $24.3 million at December 31, 2021. These short-term loan modifications are treated in accordance with Section 4013 of the CARES Act and are not treated as troubled debt restructurings during the short-term modification period if the loan was not in arrears. The Consolidated Appropriations Act, 2021, which was enacted in late December 2020, extended certain provisions of the CARES Act through January 1, 2022, including provisions permitting loan deferral extension requests to not be treated as troubled debt restructurings. Subsequent modifications to these loans will be evaluated for troubled debt restructuring accounting treatment.

Subsequently, both of these loans are back on full repayment as the deferral period ended, and payments are current for April 2022.

Critical Accounting Policies

The Company considers certain accounting policies to be critically important to the fair presentation of its Consolidated Statements of Financial Condition and Consolidated Statements of Income. These policies require management to make significant judgments on matters which by their nature have elements of uncertainty. The sensitivity of the Company's consolidated financial statements to these critical accounting policies, and the assumptions and estimates applied, could have a significant impact on its financial condition and results of operations. These assumptions, estimates and judgments made by management can be influenced by a number of factors, including the general economic environment. The Company has identified the following as critical accounting policies:

The calculation of the allowance for credit losses is a critical accounting policy of the Company. The allowance for credit losses is a valuation account that reflects management's evaluation of the current expected credit losses in the loan portfolio. The Company maintains the allowance for credit losses through provisions for credit losses that are charged to income. Charge-offs against the allowance for credit losses are taken on loans where management determines that the collection of loan principal and interest is unlikely. Recoveries made on loans that have been charged-off are credited to the allowance for credit losses.

Management estimates the allowance balance using relevant available information, from internal and external sources, related to past events, current conditions, and a reasonable and supportable forecast. Historical credit loss experience for both the Company and peers provides the basis for the estimation of expected credit losses, where observed credit losses are converted to probability of default rate through the use of segment-specific loss given default risk factors that convert default rates to loss severity based on industry-level, observed relationships between the two variables for each segment, primarily due to the nature of the underlying collateral. These risk factors were assessed for reasonableness against the Company's own loss experience and adjusted in certain cases when the relationship between the Company's historical default and loss severity deviate from that of the wider industry. The historical probability of default ("PD") curves, together with corresponding economic conditions, establish a quantitative relationship between economic conditions and loan performance through an economic cycle.

Using the historical relationship between economic conditions and loan performance, management's expectation of future loan performance is incorporated using an externally developed economic forecast. This forecast is applied over a period that management has determined to be reasonable and supportable. Beyond the period over which management can develop or source a reasonable and supportable forecast, the model will revert to long-term average economic conditions using a straight-line, time-based methodology. The Company's current forecast period is six quarters, with a four quarter reversion period to historical average macroeconomic factors.

The allowance for credit losses is measured on a collective (pool) basis, with both a quantitative and qualitative analysis that is applied on a quarterly basis, when similar risk characteristics exist. The respective quantitative allowance for each segment is measured using an economic forecast, discounted cash flow modeling methodology in which distinct, segment-specific multi-variate regression models are applied to an external economic forecast. Under the discounted cash flows methodology, expected credit losses are estimated over the effective life of the loans by measuring the difference between the net present value of modeled cash flows and amortized cost basis. Contractual cash flows over the contractual life of the loans are the basis for modeled cash flows, adjusted for modeled defaults and expected prepayments and discounted at the loan-level effective interest rate. The contractual term excludes

expected extensions, renewals, and modifications. After quantitative considerations, management applies additional qualitative adjustments so that the allowance for credit loss is reflective of the estimate of lifetime losses that exist in the loan portfolio at the balance sheet date.

Portfolio segment is defined as the level at which an entity develops and documents a systematic methodology to determine its allowance for credit losses. Management developed segments for estimating loss based on type of borrower and collateral, which is generally based upon federal call report segmentation. The segments have been combined or sub-segmented as needed to ensure loans of similar risk profiles are appropriately pooled.

The allowance for credit losses on loans individually evaluated for impairment is based upon loans that have been identified through the Company's loan monitoring process. This process includes the review of delinquent, restructured, and charged-off loans.

Management believes the primary risks inherent in the portfolio are a general decline in the economy, a decline in real estate market values, rising unemployment, and increases in interest rates in the absence of economic improvement. Any one or a combination of these events may adversely affect a borrower's ability to repay its loan, resulting in increased delinquencies and loan losses. Accordingly, the Company has recorded loan losses at a level which is estimated to represent the current risk in its loan portfolio. Management considers it important to maintain the ratio of the allowance for credit losses to total loans at an acceptable level considering the current composition of the loan portfolio.

Although management believes that the Company has established and maintained the allowance for credit losses at appropriate levels, reserve levels may change if future economic, organizational, and portfolio conditions differ from the current operating environment. Management evaluates its estimates and assumptions on an ongoing basis, and the estimates and assumptions are adjusted when facts and circumstances necessitate a re-valuation of the estimate. As future events and their effects cannot be determined with precision, actual results could differ significantly from these estimates. In addition, regulatory agencies periodically review the adequacy of the Company's allowance for credit losses as an integral part of their examination process. Such agencies may require the Company to recognize additions to the allowance or additional write-downs based on their judgments about information available to them at the time of their examination. Although management uses the best information available, the level of the allowance for credit losses remains an estimate that is subject to significant judgment.

The determination of whether deferred tax assets will be realizable is predicated on the reversal of existing deferred tax liabilities, utilization against carry-back years, and projections of future taxable income. These estimates are subject to management's judgment. A valuation allowance is established when management is unable to conclude that it is more likely than not that it will realize deferred tax assets based on the nature and timing of these items. The effect on deferred tax assets and liabilities of a change in tax rates is recognized in income tax expense in the period enacted. Management believes, based on current facts, that it is more likely than not that there will be sufficient taxable income in future years to realize federal deferred tax assets and that it is more likely than not that the benefits from certain state temporary differences will not be realized. At March 31, 2022 and December 31, 2021, the Company's net deferred tax assets (liabilities) totaled $8.9 million and $(9.7) million, respectively, which included a valuation allowance totaling $2.0 million at both dates. Based upon projections of future taxable income and the ability to carryforward operating losses indefinitely, management believes it is more likely than not the Company will realize the remaining deferred tax assets.

The Company provides certain health care and life insurance benefits, along with a split dollar BOLI death benefit, to eligible retired employees. The cost of retiree health care and other benefits during the employees' period of active service are accrued monthly. The accounting guidance requires the following: a) recognize in the statement of financial position the over funded or underfunded status of a defined benefit post-retirement plan measured as the difference between the fair value of plan assets and the benefit obligations; b) measure a plan's assets and its obligations that determine its funded status as of the end of the Company's fiscal year (with limited exceptions); and c) recognizes a component of other comprehensive income (loss), net of tax, the actuarial gain and losses and the prior service costs and credits that arise during the period. These assets and liabilities and expenses are based upon actuarial assumptions including interest rates, rates of increase in compensation, expected rate of return on plan assets and the length of time we will have to provide those benefits. Actual results may differ from these assumptions. These assumptions are reviewed and updated at least annually and management believes the estimates are reasonable.