ESSA BANCORP, INC. Management’s Discussion and Analysis of Financial Condition and Results of Operations (Form 10-Q)


Forward-looking statements

This Quarterly Report on Form 10-Q contains forward-looking statements, which can be identified by the use of words such as estimate, project, believe, intend, anticipate, plan, seek, expect similar expressions. These forward-looking statements include:

• statements of our objectives, intentions and expectations;

• statements regarding our business plans, prospects and growth and

      operating strategies;

   •  statements regarding the asset quality of our loan and investment
      portfolios; and

  • estimates of our risks and future costs and benefits.

By identifying these forward-looking statements for you in this manner, we are
alerting you to the possibility that our actual results and financial condition
may differ, possibly materially, from the anticipated results and financial
condition indicated in these forward-looking statements. Important factors that
could cause our actual results and financial condition to differ from those
indicated in the forward-looking statements include, among others, those
discussed under "Risk Factors" in Part I, Item 1A of the Company's Annual Report
on Form 10-K and Part II, Item 1A of this and any previous Quarterly Report on
Form 10-Q filed since our most recent Annual Report on Form 10-K, as well as the
following factors:

• significantly increased competition between custodians and other


• inflation and changes in the interest rate environment that reduce our

margins or reduce the fair value of financial instruments;

• general economic conditions, either nationally or in our market areas, which

      are worse than expected;

  • adverse changes in the securities markets;

  • legislative or regulatory changes that adversely affect our business;

• our ability to successfully enter new markets and take advantage of growth

opportunities, and the potential short-term dilutive effect of

      acquisitions or de novo branches, if any;

  • changes in consumer spending, borrowing and savings habits;

• changes in accounting policies and practices, as adopted by the bank

      regulatory agencies and the FASB; and

  • changes in our organization, compensation and benefit plans.

Further, the COVID-19 pandemic has caused local and national economic disruption
and has had and may continue to have an impact on the Company's operations and
financial results. Given its ongoing and dynamic nature, it is difficult to
predict what effects the pandemic will have on our business and results of
operations in the future. The pandemic and related local and national economic
disruption may, among other effects, result in a decline in demand for our
products and services; increased levels of loan delinquencies, problem assets
and foreclosures; branch closures, work stoppages and unavailability of
personnel; and increased cybersecurity risks, as employees increasingly work

These risks and uncertainties should be considered when evaluating forward-looking statements and undue reliance should not be placed on such statements.

Comparison of the financial situation at December 31, 2021 and September 30, 2021

Total Assets. Total assets increased by $6.9 million, or 0.4%, to $1.87 billion
at December 31, 2021 from $1.86 billion at September 30, 2021 due primarily to
increases in cash and due from banks and investments securities held to maturity
partially offset by decreases in investment securities available for sale and
loans receivable. At the onset of the pandemic, the Company moved quickly to
build its liquidity as an offset to the economic uncertainty caused by the
resulting economic slowdown.  The Company has and will continue to maintain a
strong liquidity position against the changing economic forecasts through daily

Total Cash and Cash Equivalents. Total cash and cash equivalents increased $39.5
million, or 24.8%, to $198.4 million at December 31, 2021 from $158.9 million at
September 30, 2021. Decreases in investment and loan balances outstanding
accounted for the majority of the increase. The Company built the majority of
its cash position in the fiscal second quarter of 2020 and has maintained that
position through the first quarter of fiscal 2022 to remain prepared for ongoing
economic uncertainties.


Net Loans. Net loans decreased $1.6 million, or 0.1%, to $1.34 billion at
December 31, 2021. During this period, residential loans decreased $21,000 to
$580.3 million, construction loans increased $4.0 million to $18.0 million,
commercial real estate loans increased $24.5 million to $615.6 million,
commercial loans decreased $7.0 million to $56.5 million partially due to the
repayment and forgiveness of $9.4 million in PPP loans carried in the commercial
loan portfolio, obligations of states and political subdivisions decreased $18.4
million to $37.8 million, home equity loans and lines of credit decreased $1.0
million to $37.4 million, auto loans decreased $3.5 million to $10.3 million
reflecting expected runoff of the portfolio following the Company's previously
announced discontinuation of indirect auto lending in July 2018, and other loans
decreased $48,000 to $1.5 million. The Company sold $12.8 million in residential
mortgage loans to the Federal Home Loan Bank of Pittsburgh during the three
month period ended December 31, 2021, recording gains on the sale of these loans
in noninterest income.

Investment Securities Available for Sale. Investment securities available for
sale decreased $68.4 million, or 28.4%, to $172.2 million at December 31, 2021
from $240.6 million at September 30, 2021 due primarily to the maturity of
securities in the portfolio. The Company has continued to maintain a liquid
position in cash and cash equivalents and has limited its investment purchases.

Investment Securities Held to Maturity. Investment securities held to maturity
increased to $55.7 million at December 31, 2021 from $21.5 million at September
30, 2021. The Company carries some investment as held to maturity to manage
fluctuations in comprehensive loss caused by interest rate changes.

Deposits. Deposits decreased $1.4 million, or 0.1%, to $1.63 billion at December
31, 2021 from $1.64 billion at September 30, 2021. Decreases in interest bearing
demand accounts of $42.9 million and certificates of deposit of $10.3 million
were offset in part by increases in money market accounts of $30.5 million,
savings and club accounts of $4.0 million and non-interest bearing demand
accounts of $17.3 million. The overall decrease in certificates of deposit
reflected a decrease in brokered certificates of $15.0 million.

Stockholders' Equity. Stockholders' equity increased by $5.8 million, or 2.9%,
to $207.6 million at December 31, 2021 from $201.8 million at September 30,
2021. The increase in stockholders' equity was primarily due to net income of
$4.6 million and other comprehensive income of $1.9 million which was partially
offset by regular cash dividends of $0.12 per share, which reduced stockholders'
equity by $1.2 million.


Average balance sheets for the three months 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. 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.

                                                                                  For the Three Months Ended December 31,
                                                                    2021                                                           2020
                                                                Interest Income/                                               Interest Income/
                                          Average Balance           Expense            Yield/Cost        Average Balance           Expense            Yield/Cost
                                                                                          (dollars in thousands)
Interest-earning assets:
Loans(1)                                 $       1,363,548     $           13,259              3.87 %   $       1,419,348     $           13,760              3.86 %
Investment Securities
Taxable(2)                                         130,338                    597              1.82 %              94,568                    632              2.66 %
Exempt from federal income
  tax(2)(3)                                          3,956                     19              2.42 %               8,474                     40              2.38 %
Total investment securities                        134,294                    616              1.84 %             103,042                    672              2.64 %
Mortgage-backed securities                         103,046                    414              1.60 %             100,070                    365              1.45 %
Federal Home Loan Bank stock                         4,707                     54              4.56 %               5,428                     77              5.64 %
Other                                              172,678                     65              0.15 %             178,228                     38              0.08 %
Total interest-earning assets                    1,778,273                 14,408                               1,806,116                 14,912
Allowance for loan losses                          (18,162 )                                   3.22 %             (15,678 )                                   3.29 %
Noninterest-earning assets                         111,107                                                        118,985
Total assets                             $       1,871,218                                              $       1,909,423
Interest-bearing liabilities:
NOW accounts                             $         305,440     $               36              0.05 %   $         261,026     $               97              0.15 %
Money market accounts                              449,909                    141              0.12 %             412,381                    201              0.19 %
Savings and club accounts                          192,111                     25              0.05 %             163,805                     22              0.05 %
Certificates of deposit                            422,867                    644              0.61 %             536,021                  1,452              1.08 %
Borrowed funds                                           -                      -                 -                64,471                    228              1.41 %
Total interest-bearing liabilities               1,370,327                    846              0.24 %           1,437,704                  2,000              0.55 %
Non-interest-bearing NOW
  accounts                                         270,111                                                        247,345
Non-interest-bearing liabilities                    25,252                                                         30,269
Total liabilities                                1,665,690                                                      1,715,318
Equity                                             205,528                                                        194,105
Total liabilities and equity             $       1,871,218                                              $       1,909,423
Net interest income                                            $           13,562                                             $           12,912
Interest rate spread                                                                           2.98 %                                                         2.74 %
Net interest-earning assets              $         407,946                                              $         368,412
Net interest margin(4)                                                                         3.03 %                                                         2.84 %
Average interest-earning assets to
  average interest-bearing liabilities                                     129.77 %                                                       125.63 %


(1) Unmatured loans are included in outstanding loans.

(2) Securities available for sale are recognized at fair value.

(3) Returns on tax-exempt securities were calculated on an entirely

equivalent basis assuming a tax rate of 21.00% for the three months ended

December 31, 2021 and 2020.

(4) Represents the difference between interest earned and interest paid, divided

    by average total interest earning assets.


Comparison of operating results for the three months ended December 31, 2021 and
December 31, 2020

Net Income. Net income increased $478,000, or 11.6%, to $4.6 million for the
three months ended December 31, 2021 compared to net income of $4.1 million for
the comparable period in 2020. The increase was primarily due to an increase in
net interest income and a decline in the provision for loan losses partially
offset by increases in non-interest expense and the income tax provision and a
decrease in non-interest income.

Net Interest Income. Net interest income increased $650,000, or 5.0%, to $13.6
million for the three months ended December 31, 2021 compared to $12.9 million
for the comparable period in 2020.

Interest Income. Total interest income was $14.4 million for the three months
ended December 31, 2021 compared with $14.9 million for the three months ended
December 31, 2020 reflecting a decline in interest rates and a decrease in the
total yield on average interest earning assets from 3.29% for the quarter ended
December 31, 2020 to 3.22% for the quarter ended December 31, 2021. A decline of
$27.8 million in average interest earning assets also contributed to the decline
in interest income.

Interest Expense. Interest expense was $846,000 for the quarter ended December
31, 2021 compared to $2.0 million for the same period in 2020. The cost of
interest-bearing liabilities declined to 0.24% in the quarter ended December 31,
2021 from 0.55% a year earlier, reflecting lower interest rates, timely
repricing of deposits and roll-off of higher-cost borrowings. Average
interest-bearing liabilities decreased $67.4 million year-over-year.

Provision for Loan Losses. 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 a
borrower's ability to repay, the estimated value of any underlying collateral,
peer group information and prevailing economic conditions. This evaluation is
inherently subjective as it requires estimates that are subject to
interpretation and revision as more information becomes available or as future
events occur. After an evaluation of these factors, management made no provision
for loan losses for the three month period ended December 31, 2021 compared to
$900,000 for the three month period ended December 31, 2020. The allowance for
loan losses was $18.2 million, or 1.34% of loans outstanding, at December 31,
2021, compared to $18.1 million, or 1.33% of loans outstanding, at September 30,
2021. As the economic impact of the COVID-19 pandemic continues to evolve, our
customers may experience decreased cash flows, which may correlate to an
inability to make timely loan payments. This, in turn may require increases in
our allowance for loan losses and increases in the level of charge-offs in our
loan portfolio.

Non-interest Income. Noninterest income decreased 25.7% to $2.3 million for the
three months ended December 31, 2021, compared with $3.1 million for the three
months ended December 31, 2020. Decreases in loan swap fees of $64,000, earnings
on bank-owned life insurance of $150,000, other income of $48,000 and gains on
sales of residential mortgages of $599,000 were partially offset by an increase
in trust and investment fees of $95,000 in the quarter ended December 31, 2021
compared with the comparable period in 2020.

Non-interest Expense. Noninterest expense increased $126,000 or 1.2% to $10.3
million for the three months ended December 31, 2021 compared with $10.2 million
for the comparable period a year earlier primarily reflecting increases in
professional fees of $162,000, occupancy and equipment of $27,000, data
processing of $98,000 and other expenses of $31,000 which were partially offset
by decreases in Federal Deposit Insurance Corporation premiums of $109,000,
compensation and employee benefits of $62,000 and gains on foreclosed real
estate of $12,000.

Income Taxes. Income tax expense increased $139,000 to $973,000 for the three
months ended December 31, 2021 from $834,000 for the comparable 2020 period. The
effective tax rate for the three months ended December 31, 2021 was 17.4%
compared to 16.8% for the 2020 period.


The following table provides information on the Bank’s non-performing assets as of the dates indicated (in thousands of dollars).

                                                                                September 30,
                                                         December 31, 2021           2021
Non-performing assets:
Non-accruing loans                                      $            18,921     $       15,864
Non-accruing purchased credit impaired loans                              3                  3
Total non-performing loans                                           18,924             15,867
Foreclosed real estate                                                  193                461
Total non-performing assets                             $            19,117     $       16,328
Ratio of non-performing loans to total loans                           1.39 %             1.17 %
Ratio of non-performing loans to total assets                          1.01 %             0.85 %
Ratio of non-performing assets to total assets                         1.02 %             0.88 %
Ratio of allowance for loan losses to total loans                      1.34 %             1.33 %

Loans are reviewed on a regular basis and are placed on non-accrual status when
they become 90 days delinquent. When loans are placed on non-accrual status,
unpaid accrued interest is fully reserved, and further income is recognized only
to the extent received. Non-performing assets increased $2.8 million from
September 30, 2021 to December 31, 2021. The primary reason for the increase in
nonperforming assets at December 31, 2021 as compared to September 30, 2021 was
the addition of one non-performing commercial loan relationship of $3.9
million. Also included in non-performing assets are two nonperforming commercial
real estate loans totaling $8.8 million. These loans are well collateralized and
carry personal guarantees. The number of nonperforming residential loans was 31
at December 31, 2021 compared to 38 at September 30, 2021. The $18.9 million of
non-accruing loans at December 31, 2021 included 31 residential loans with an
aggregate outstanding balance of $2.3 million, 20 commercial and commercial real
estate loans with aggregate outstanding balances of $16.2 million and 27
consumer loans with aggregate balances of $489,000. Within the residential loan
balance were $788,000 of loans past due less than 90 days. In the quarter ended
December 31, 2021, the Company identified eight residential loans which,
although paying as agreed, have a high probability of default. Foreclosed real
estate decreased $268,000 to $193,000 at December 31, 2021. Foreclosed real
estate consists of five residential properties and one commercial property.

AT December 31, 2021the main balance of distressed debt restructurings (“TDR”) was $9.5 million compared to $9.7 million at September 30, 2021. The whole of the $9.5 million distressed debt restructurings December 31, 2021 are outstanding loans.

As of December 31, 2021, TDRs were comprised of nine residential loans totaling
$1.1 million, seven commercial and commercial real estate loans totaling $8.3
million and four consumer loans (home equity loans, home equity lines and
credit, indirect auto and other loans) totaling $53,000.

For the three-month period ended December 31, 2021two loans were canceled due to the completion of a consecutive year of one-time payments.

The Company continues to closely monitor all customer credit positions,
particularly loans requesting payment relief. As of December 31, 2021,
approximately eight of our commercial clients had requested loan payment
deferrals or payments of interest only on loans totaling $19.2 million. In
accordance with interagency guidance issued in March 2020, these short-term
deferrals are not considered TDRs unless the borrower was previously
experiencing financial difficulty. As the economic impact of the COVID-19
pandemic continues to evolve, our customers may experience decreased cash flows,
which may correlate to an inability to make timely loan payments. This, in turn
may require increases in our allowance for loan losses and increases in the
level of chargeoffs in our loan portfolio.

Cash and capital resources

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

Our primary sources of liquidity are deposits, prepayment and repayment 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 borrowing sources. While scheduled
principal repayments on loans and mortgage-backed securities are a relatively



predictable source of funds, deposit flows and loan 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.

A portion of our liquidity consists of cash and cash equivalents and borrowings,
which are a product of our operating, investing and financing activities. At
December 31, 2021, $198.4 million of our assets were invested in cash and cash
equivalents. Our primary sources of cash are principal repayments on loans,
proceeds from the maturities of investment securities, principal repayments of
mortgage-backed securities and increases in deposit accounts and borrowings. As
of December 31, 2021, we had no borrowings outstanding from the Pittsburgh FHLB.
We have access to total FHLB advances of up to approximately $723.4 million.

At December 31, 2021, we had $352.8 million in loan commitments outstanding,
which included, in part, $165.3 million in undisbursed construction loans and
land development loans, $51.3 million in unused home equity lines of credit,
$103.3 million in commercial lines of credit and commitments to originate
commercial loans, $16.9 million in performance standby letters of credit and
$16.0 million in other unused commitments which are primarily to originate
residential mortgage loans and multifamily loans. Certificates of deposit due
within one year of December 31, 2021 totaled $145.3 million, or 72.8% of
certificates of deposit. If these maturing deposits do not remain with us, we
will be required to seek other sources of funds, including other certificates of
deposit and borrowings. 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 due on or before December 31, 2022. We believe,
however, based on past experience that a significant portion of our certificates
of deposit will remain with us. We have the ability to attract and retain
deposits by adjusting the interest rates offered.

As reported in the Consolidated Statements of Cash Flow, our cash flows are
classified for financial reporting purposes as operating, investing or financing
cash flows. Net cash provided by operating activities was $3.6 million and $3.9
million for the three months 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 provided by investing activities was $34.6 million and $83.5 million for
the three months ended December 31, 2021 and 2020, respectively, principally
reflecting our loan and investment security activities. Deposit and borrowing
cash flows have comprised most of our financing activities, which resulted in
net cash provided by (used for), of $1.3 million and $(26.1) million for the
three months ended December 31, 2021 and 2020, respectively.

Critical accounting policies

We consider accounting policies that require management to exercise significant
judgment or discretion or make significant assumptions that have, or could have,
a material impact on the carrying value of certain assets or on income, to be
critical accounting policies. We consider the following to be our critical
accounting policies:

Allowance for Loan Losses. 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. 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 changes in the economic environment
that could result in changes to the amount of the recorded allowance for loan

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 loans. Assumptions for appraisals and discounted
cash flow 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 and discounted
cash flow valuations are carefully reviewed by management to determine that the
resulting values reasonably reflect amounts realizable on the related loans.

Management performs a quarterly evaluation of the adequacy of the allowance for
loan losses. Consideration is given to a variety of factors in establishing this
estimate 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.

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,
risk weighting (if applicable) and payment



history. We also analyze historical loss experience, delinquency trends, general
economic conditions and geographic and industry concentrations. This analysis
establishes factors that are applied to the loan groups to determine the amount
of the general allocations. 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.

Goodwill and Intangible Assets. 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. If the estimated current fair value of a
reporting unit exceeds its carrying value, no additional testing is required and
an impairment loss is not recorded. The Company uses market capitalization and
multiples of tangible book value methods to determine the estimated current fair
value of its reporting unit. Based on this analysis, no impairment was recorded
in 2021 or 2020.

The other intangibles assets are assigned useful lives, which are amortized on
an accelerated basis over their weighted-average lives. The Company periodically
reviews the intangible assets for impairment as events or changes in
circumstances indicate that the carrying amount of such asset may not be
recoverable. Based on these reviews, no impairment was recorded in 2021 or 2020.

Derivative Instruments and Hedging Activities. The Company records all
derivatives on the balance sheet at fair value.  The accounting for changes in
the fair value of derivatives depends on the intended use of the derivative,
whether the Company has elected to designate a derivative in a hedging
relationship and apply hedge accounting and whether the hedging relationship has
satisfied the criteria necessary to apply hedge accounting. Derivatives
designated and qualifying as a hedge of the exposure to changes in the fair
value of an asset, liability, or firm commitment attributable to a particular
risk, such as interest rate risk, are considered fair value hedges. Derivatives
designated and qualifying as a hedge of the exposure to variability in expected
future cash flows, or other types of forecasted transactions, are considered
cash flow hedges. Derivatives may also be designated as hedges of the foreign
currency exposure of a net investment in a foreign operation. Hedge accounting
generally provides for the matching of the timing of gain or loss recognition on
the hedging instrument with the recognition of the changes in the fair value of
the hedged asset or liability that are attributable to the hedged risk in a fair
value hedge or the earnings effect of the hedged forecasted transactions in a
cash flow hedge. The Company may enter into derivative contracts that are
intended to economically hedge certain of its risk, even though hedge accounting
does not apply or the Company elects not to apply hedge accounting.

Fair value valuations. We group our assets at fair value into three levels, depending on the markets in which the assets are traded and the reliability of the assumptions used to determine fair value. These levels are:

• Level I – Valuation is based on quoted prices for identical instruments

traded in active markets.

• Level II – Valuation is based on quoted prices for similar instruments in

active markets, quoted prices for identical or similar instruments in

markets that are not active and model-based valuation techniques for which

all material assumptions are observable in the market.

• Level III – The valuation is generated from model-based techniques that use

significant assumptions not observable in the market. These unobservables

assumptions reflect the Company’s own estimates of assumptions that the market

participants would use to set the price of the asset.

We base our fair values on the price that would be received to sell an asset or
paid to transfer a liability in an orderly transaction between market
participants at the measurement date. It is our policy to maximize the use of
observable inputs and minimize the use of unobservable inputs when developing
fair value measurements, in accordance with the fair value hierarchy in
generally accepted accounting principles.

Fair value measurements for most of our assets are obtained from independent
pricing services that we have engaged for this purpose. When available, we, or
our independent pricing service, use quoted market prices to measure fair value.
If market prices are not available, fair value measurement is based upon models
that incorporate available trade, bid, and other market information.
Subsequently, all of our financial instruments use either of the foregoing
methodologies to determine fair value adjustments recorded to our financial
statements. In certain cases, however, when market observable inputs for
model-based valuation techniques may not be readily available, we are required
to make judgments about assumptions market participants would use in estimating
the fair value of financial instruments. The degree of management judgment
involved in determining the fair value of a financial instrument is dependent
upon the availability of quoted market prices or observable market parameters.
For financial instruments that trade actively and have quoted market prices or
observable market parameters, there is minimal subjectivity involved in
measuring fair value. When observable market prices and parameters are not fully
available, management judgment is necessary to estimate fair value. In addition,
changes in the market conditions may reduce the availability of quoted prices or
observable data. When market data is not available, we use valuation techniques
requiring more management judgment to estimate the appropriate fair value
measurement. Therefore, the results cannot be determined with precision and may
not be realized in an actual sale or immediate settlement of the asset.



Additionally, there may be inherent weaknesses in any calculation technique, and
changes in the underlying assumptions used, including discount rates and
estimates of future cash flows, that could significantly affect the results of
current or future valuations.

Other-than-Temporary Investment Security Impairment. Securities are evaluated
periodically to determine whether a decline in their value is
other-than-temporary. Management utilizes criteria such as the magnitude and
duration of the decline, in addition to the reasons underlying the decline, to
determine whether the loss in value is other-than-temporary. The term
"other-than-temporary" is not intended to indicate that the decline is
permanent, but indicates that the prospect for a near-term recovery of value is
not necessarily favorable, or that there is a lack of evidence to support a
realizable value equal to or greater than the carrying value of the investment.
Once a decline in value is determined to be other-than-temporary, the value of
the security is reduced and a corresponding charge to earnings is recognized.

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
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. 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 that would adversely affect our operating results.

Off-balance sheet arrangements

We do not have any off-balance sheet arrangements (as such term is defined in
applicable Securities and Exchange Commission rules) that are reasonably likely
to have a current or future material effect on our financial condition, results
of operations, liquidity, capital expenditures or capital resources.

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