Magyar Bancorp (MGYR) Risk Analysis

Federal law requires that a holding company act as a source of financial and managerial strength to its subsidiary bank and to commit resources to support such subsidiary bank. Under the "source of strength" doctrine, the Federal Reserve Board may require a holding company to make capital injections into a troubled subsidiary bank and may charge the holding company with engaging in unsafe and unsound practices for failure to commit resources to a subsidiary bank. A capital injection may be required at times when the holding company may not have the resources to provide it and therefore may be required to borrow the funds or raise capital. Any loans by a holding company to its subsidiary bank are subordinate in right of payment to deposits and to certain other indebtedness of such subsidiary bank. In the event of a holding company's bankruptcy, the bankruptcy trustee will assume any commitment by the holding company to a federal bank regulatory agency to maintain the capital of a subsidiary bank. Thus, any borrowing that must be done by Magyar Bancorp to make a required capital injection becomes more difficult and expensive and could have an adverse effect on our business, financial condition and results of operations.

Our allowance for loan losses may not be sufficient to cover losses inherent in our loan portfolio, requiring additions to our allowance, which could materially decrease our net income. The allowance for loan losses decreased by $103,000 during the year ended September 30, 2023 to $8.3 million from $8.4 million for the year ended September 30, 2022. The allowance for loan losses as a percentage of non-performing loans decreased to 163.9% at September 30, 2023 compared with 297.5% at September 30, 2022. At September 30, 2023 our allowance for loan losses as a percentage of total loans was 1.19%, compared with 1.34% at September 30, 2022. Future increases in the allowance for loan losses may be necessary based on possible future increases in total loans receivable, increases in non-performing loans and charge-offs, deterioration of collateral values securing impaired real estate loans, and deterioration of the current economic environment. We make various assumptions and judgments about the collectability of our loan portfolio, including the creditworthiness of our borrowers and the value of the real estate and other assets serving as collateral for the repayment of many of our loans. In determining the amount of the allowance for loan losses, we review our loans and our loss and delinquency experience, and we evaluate economic conditions. Based on this review, we believe our allowance for loan losses is adequate to absorb losses in our loan portfolio as of September 30, 2023. Bank regulators periodically review our allowance for loan losses and may require us to increase our provision for loan losses or recognize further loan charge-offs. Any increase in our allowance for loan losses or loan charge-offs as required by these regulatory authorities will have a material adverse effect on our financial condition and results of operations. The Financial Accounting Standards Board has adopted a new accounting standard that is referred to as Current Expected Credit Loss, or CECL. The implementation of CECL has been delayed for smaller reporting companies, such as the Company, until January 2023 (effective October 1, 2023 for the Company). CECL will require financial institutions to determine periodic estimates of lifetime expected credit losses on loans, and recognize the expected credit losses as allowances for loan losses. This will change the current method of providing allowances for loan losses that are probable, which may require us to increase our allowance for loan losses, and to greatly increase the types of data we will need to collect and review to determine the appropriate level of the allowance for loan losses. Any increase in our allowance for loan losses or expenses incurred to determine the appropriate level of the allowance for loan losses may have a material adverse effect on our financial condition and results of operations.

At September 30, 2023, our portfolio of commercial real estate and commercial business loans totaled $419.3 million, or 60.1% of our total loans, compared to $377.5 million, or 60.0% of our total loans at September 30, 2022 and $349.6 million, or 58.8% of our total loans at September 30, 2021. It is our intent to continue to emphasize the origination of commercial business and commercial real estate loans. Commercial business and commercial real estate loans generally have more risk than one-to four-family residential mortgage loans. At September 30, 2023, there was one non-performing commercial real estate loan totaling $2.2 million and no non-performing commercial business loans compared with no non-performing commercial real estate or commercial business loans at September 30, 2022. Because the repayment of commercial business and commercial real estate loans depends on the successful management and operation of the borrower's properties or related businesses, repayment of these loans has been and may continue to be affected by adverse conditions in the real estate market or the local economy. Further, these loans typically have larger loan balances, and several of our borrowers have more than one commercial business and commercial real estate loan outstanding with us. Consequently, an adverse development with respect to one loan or one credit relationship can expose us to significantly greater risk of loss compared to an adverse development with respect to a one- to four-family residential mortgage loan. Finally, if we foreclose on a commercial business or commercial real estate loan, our holding period for the collateral, if any, typically is longer than for one-to four-family residential mortgage loans because there are fewer potential purchasers of the collateral. Because we plan to continue to emphasize the origination of these loans, it may be necessary to increase our allowance for loan losses because of the increased credit risk associated with these types of loans. Any increase to our allowance for loan losses would adversely affect our earnings.

Our earnings largely depend on our net interest income, which could be negatively affected by changes in interest rates. Net interest income is the difference between: - the interest income we earn on our interest-earning assets, such as loans and securities; and - the interest expense we pay on our interest-bearing liabilities, such as deposits and borrowings. The rates we earn on our assets and the rates we pay on our liabilities are generally fixed for a contractual period of time. While we have taken steps to attempt to reduce our exposure to increases in interest rates, historically our liabilities generally have shorter contractual maturities than our assets. This imbalance can create significant earnings volatility, because market interest rates change over time. In a period of rising interest rates, the interest income earned on our assets may not increase as rapidly as the interest paid on our liabilities. Likewise, in a period of falling interest rates, the interest expense paid on our liabilities may not decrease as rapidly as the interest income received on our assets. See "Management's Discussion and Analysis of Financial Condition and Results of Operations-Management of Market Risk." In addition, changes in interest rates can affect the average life of loans and mortgage-backed securities. A reduction in interest rates causes increased prepayments of loans and mortgage-backed securities as borrowers tend to refinance their debt to reduce their borrowing costs. This creates reinvestment risk, which is the risk that we may not be able to reinvest the funds from faster prepayments at rates that are comparable to the rates we earned on the prepaid loans or securities. Additionally, increases in interest rates may decrease loan demand and/or make it more difficult for borrowers to repay adjustable-rate loans. Changes in interest rates also affect the current market value of our interest-earning securities portfolio. Generally, the value of securities moves inversely with changes in interest rates. At September 30, 2023, the fair value of our total securities portfolio was $83.9 million. The unrealized net loss on securities totaled $14.1 million on a pre-tax basis at September 30, 2023. We evaluate interest rate sensitivity using models that estimate the change in Magyar Bank's net interest income over a range of interest rate scenarios. At September 30, 2023, in the event of an immediate 200 basis point increase in interest rates, the model projects that we would experience a $391,000, or 1.3%, increase in net interest income in the first year following the change in interest rates, and a $1.8 million, or 5.3%, increase in net interest income in the second year following the change in interest rates. At September 30, 2023, in the event of an immediate 200 basis point decrease in interest rates, the model projects that we would experience a $661,000, or 2.1%, decrease in net interest income in the first year following the change in interest rates, and a $2.3 million, or 6.9%, decrease in net interest income in the second year following the change in interest rates. At September 30, 2023, our available-for-sale securities portfolio at fair value totaled $10.1 million, which consisted entirely of mortgage-backed securities. To the extent interest rates increase and the value of our available-for-sale portfolio increases, our stockholders' equity will be affected accordingly.