LAKE SHORE BANCORP, INC. - Quarter Report: 2020 September (Form 10-Q)

United States

Securities and Exchange Commission

Washington, D.C. 20549

FORM 10-Q

(Mark One)

☒ QUARTERLY REPORT PURSUANT TO SECTION 13 OR 15 (d) OF THE SECURITIES EXCHANGE ACT OF 1934

For the quarterly period ended September 30, 2020

☐ TRANSITION REPORT PURSUANT TO SECTION 13 OR 15 (d) OF THE SECURITIES EXCHANGE ACT OF 1934

Commission File No.: 000-51821


LAKE SHORE BANCORP, INC.
(Exact name of registrant as specified in its charter)
United States			20-4729288
(State or other jurisdiction of incorporation or organization)			(I.R.S. Employer Identification Number)
31 East Fourth Street, Dunkirk, New York			14048
(Address of principal executive offices)			(Zip code)
(716) 366-4070
(Registrant’s telephone number, including area code)

Securities registered pursuant to Section 12(b) of the Exchange Act:

Title of each class

Trading

Symbol(s)

Name of each exchange on which registered

Common stock, par value $0.01 per share

LSBK

The Nasdaq Stock Market LLC

Indicate by check mark whether the registrant (1) has filed all reports required to be filed by Section 13 or 15(d) of the Securities Exchange Act of 1934 during the preceding 12 months, and (2) has been subject to such filing requirements for the past 90 days.

Yes [X]No [ ]

Indicate by check mark whether the registrant has submitted electronically every Interactive Data File required to be submitted pursuant to Rule 405 of Regulation S-T (§232.405 of this chapter) during the preceding 12 months (or for such shorter period that the registrant was required to submit such files).

Yes [X]No [ ]

Indicate by check mark whether the registrant is a large accelerated filer, an accelerated filer, a non-accelerated filer, a smaller reporting company or an emerging growth company. See definition of “large accelerated filer,” “accelerated filer,” “smaller reporting company” and “emerging growth company” in Rule 12b-2 of the Exchange Act.


Large accelerated filer ☐	Accelerated filer ☐
Non-accelerated filer ☒	Smaller reporting company ☒
Emerging growth company ☐

If an emerging growth company, indicate by check mark if the registrant has elected not to use the extended transition period for complying with any new or revised financial accounting standards provided pursuant to Section 13(a) of the Exchange Act. ☐

Indicate by check mark whether the registrant is a shell company (as defined in Rule 12b-2 of the Exchange Act).

Yes [ ] No [X]

Indicate the number of shares outstanding of each of the issuer’s classes of common stock, as of the latest practical date:

There were 5,828,048 shares of the registrant’s common stock, $0.01 par value per share, outstanding at November 10, 2020.


		TABLE OF CONTENTS

ITEM		PART I	PAGE

1	FINANCIAL STATEMENTS
	-	Consolidated Statements of Financial Condition as of September 30, 2020 (Unaudited) and December 31, 2019	1
	-	Consolidated Statements of Income for the Three and Nine Months Ended September 30, 2020 and 2019 (Unaudited)	2
	-	Consolidated Statements of Comprehensive Income for the Three and Nine Months Ended September 30, 2020 and 2019 (Unaudited)	3
	-	Consolidated Statements of Stockholders’ Equity for the Three Months Ended March 31, June 30, and September 30, 2020 and 2019 (Unaudited)	4
	-	Consolidated Statements of Cash Flows for the Nine Months Ended September 30, 2020 and 2019 (Unaudited)	6
	-	Notes to Unaudited Consolidated Financial Statements	7
2	MANAGEMENT’S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS OF OPERATIONS		32
3	QUANTITATIVE AND QUALITATIVE DISCLOSURES ABOUT MARKET RISK		52
4	CONTROLS AND PROCEDURES		52

		PART II

1A	RISK FACTORS		52
2	UNREGISTERED SALES OF EQUITY SECURITIES AND USE OF PROCEEDS		54
6	EXHIBITS		54
SIGNATURES			55

PART I Financial Information

Item 1. Financial Statements

Lake Shore Bancorp, Inc. and Subsidiary


Consolidated Statements of Financial Condition

	September 30,		December 31,
	2020		2019
	(Unaudited)
	(Dollars in thousands, except share data)

Assets
Cash and due from banks	$	8,373	$	7,884
Interest earning deposits		62,766		22,405
Cash and Cash Equivalents		71,139		30,289
Securities available for sale		81,641		71,201
Federal Home Loan Bank stock, at cost		1,977		2,055
Loans receivable, net of allowance for loan losses 2020 $5,347; 2019 $4,267		491,268		470,816
Premises and equipment, net		9,066		9,415
Accrued interest receivable		3,145		2,153
Bank owned life insurance		22,343		21,969
Other assets		2,084		2,971
Total Assets	$	682,663	$	610,869
Liabilities and Stockholders' Equity
Liabilities
Deposits:
Interest bearing	$	464,869	$	422,247
Non-interest bearing		90,669		61,229
Total Deposits		555,538		483,476
Long-term debt		31,350		34,650
Advances from borrowers for taxes and insurance		1,972		3,233
Other liabilities		8,916		6,670
Total Liabilities		597,776		528,029
Stockholders' Equity
Common stock, $0.01 par value per share, 25,000,000 shares authorized; 6,836,514 shares issued and 5,835,237 shares outstanding at September 30, 2020 and 6,836,514 shares issued and 5,924,339 shares outstanding at December 31, 2019		68		68
Additional paid-in capital		31,169		31,078
Treasury stock, at cost (1,001,277 shares at September 30, 2020 and 912,175 shares at December 31, 2019)		(11,430)		(10,184)
Unearned shares held by ESOP		(1,300)		(1,364)
Unearned shares held by compensation plans		(147)		(39)
Retained earnings		64,501		61,950
Accumulated other comprehensive income		2,026		1,331
Total Stockholders' Equity		84,887		82,840
Total Liabilities and Stockholders' Equity	$	682,663	$	610,869

See notes to consolidated financial statements.

Lake Shore Bancorp, Inc. and Subsidiary


Consolidated Statements of Income
	Three Months Ended September 30,				Nine Months Ended September 30,
	2020			2019	2020		2019
	(Unaudited)
	(Dollars in thousands, except per share data)
Interest Income
Loans, including fees	$	5,366	$	5,653	$	16,637	$	15,676
Investment securities, taxable		239		278		746		863
Investment securities, tax-exempt		302		328		882		1,082
Other		15		60		92		312
Total Interest Income		5,922		6,319		18,357		17,933
Interest Expense
Deposits		833		1,173		2,950		3,249
Short-term borrowings		-		33		-		46
Long-term debt		164		142		513		409
Other		17		18		52		55
Total Interest Expense		1,014		1,366		3,515		3,759
Net Interest Income		4,908		4,953		14,842		14,174
Provision for Loan Losses		300		300		1,125		725
Net Interest Income after Provision for Loan Losses		4,608		4,653		13,717		13,449
Non-Interest Income
Service charges and fees		407		473		1,206		1,345
Earnings on bank owned life insurance		128		128		374		370
Unrealized (loss) gain on equity securities		(6)		22		(24)		57
Unrealized gain (loss) on interest rate swap		23		(15)		(156)		(109)
Recovery on previously impaired investment securities		20		13		48		39
Net gain on sale of loans		184		27		333		29
Other		15		21		53		73
Total Non-Interest Income		771		669		1,834		1,804
Non-Interest Expense
Salaries and employee benefits		2,172		2,111		6,311		6,509
Occupancy and equipment		647		632		1,921		1,855
Data processing		353		346		1,012		1,022
Professional services		245		239		741		735
Advertising		166		168		537		520
Postage and supplies		59		58		204		181
FDIC insurance		44		1		79		71
Other		236		364		850		976
Total Non-Interest Expense		3,922		3,919		11,655		11,869
Income before Income Taxes		1,457		1,403		3,896		3,384
Income Tax Expense		226		191		581		469
Net Income	$	1,231	$	1,212	$	3,315	$	2,915
Basic and diluted earnings per common share	$	0.21	$	0.20	$	0.56	$	0.48
Dividends declared per share	$	0.12	$	0.12	$	0.36	$	0.36

See notes to consolidated financial statements.

Lake Shore Bancorp, Inc. and Subsidiary

Consolidated Statements of Comprehensive Income


	Three Months Ended September 30,
	2020		2019
	(Unaudited)
	(Dollars in thousands)
Net Income	$	1,231		1,212
Other Comprehensive (Loss) Income, net of tax benefit (expense):
Unrealized holding (losses) gains on securities available for sale, net of tax (benefit) expense		(122)		207
Reclassification adjustments related to:
Recovery on previously impaired investment securities included in net income, net of tax expense		(16)		(10)
Total Other Comprehensive (Loss) Income		(138)		197
Total Comprehensive Income	$	1,093	$	1,409


	Nine Months Ended September 30,
	2020		2019
	(Unaudited)
	(Dollars in thousands)
Net Income	$	3,315	$	2,915
Other Comprehensive Income, net of tax expense:
Unrealized holding gains on securities available for sale, net of tax expense		733		1,471
Reclassification adjustments related to:
Recovery on previously impaired investment securities included in net income, net of tax expense		(38)		(31)
Total Other Comprehensive Income		695		1,440
Total Comprehensive Income	$	4,010	$	4,355

See notes to consolidated financial statements.

Lake Shore Bancorp, Inc. and Subsidiary

Consolidated Statements of Stockholders’ Equity

Three Months Ended March 31, June 30, and September 30, 2020 and 2019 (Unaudited)


							Unearned		Unearned Shares				Accumulated
			Additional				Shares		Held by				Other
	Common		Paid-In		Treasury		Held by		Compensation		Retained		Comprehensive
	Stock		Capital		Stock		ESOP		Plans		Earnings		Income		Total
	(Dollars in thousands, except share and per share data)

Balance - January 1, 2019	$	68	$	30,916	$	(8,805)	$	(1,449)	$	(200)	$	59,145	$	129	$	79,804
Net income		-		-		-		-		-		898		-		898
Other comprehensive income, net of tax expense of $167		-		-		-		-		-		-		628		628
Cumulative effect of adoption of ASU 2016-02 Leases (Topic 842) (net of $2 tax benefit effect)		-		-		-		-		-		(10)		-		(10)
ESOP shares earned (1,984 shares)		-		10		-		21		-		-		-		31
Stock based compensation		-		11		-		-		-		-		-		11
Compensation plan shares granted (5,186 shares)		-		-		49		-		(49)		-		-		-
Compensation plan shares earned (5,518 shares)		-		18		-		-		60		-		-		78
Purchase of treasury stock, at cost (7,300 shares)		-		-		(111)		-		-		-		-		(111)
Cash dividends declared ($0.12 per share)		-		-		-		-		-		(267)		-		(267)
Balance - March 31, 2019	$	68	$	30,955	$	(8,867)	$	(1,428)	$	(189)	$	59,766	$	757	$	81,062

Balance - April 1, 2019	$	68	$	30,955	$	(8,867)	$	(1,428)	$	(189)	$	59,766	$	757	$	81,062
Net income		-		-		-		-		-		805		-		805
Other comprehensive income, net of tax expense of $164		-		-		-		-		-		-		615		615
ESOP shares earned (1,983 shares)		-		6		-		21		-		-		-		27
Stock based compensation		-		11		-		-		-		-		-		11
Compensation plan shares forfeited (760 shares)		-		-		(8)		-		8		-		-		-
Compensation plan shares earned (6,107 shares)		-		23		-		-		58		-		-		81
Purchase of treasury stock, at cost (43,900 shares)		-		-		(672)		-		-		-		-		(672)
Cash dividends declared ($0.12 per share)		-		-		-		-		-		(265)		-		(265)
Balance - June 30, 2019	$	68	$	30,995	$	(9,547)	$	(1,407)	$	(123)	$	60,306	$	1,372	$	81,664

Balance - July 1, 2019	$	68	$	30,995	$	(9,547)	$	(1,407)	$	(123)	$	60,306	$	1,372	$	81,664
Net income		-		-		-		-		-		1,212		-		1,212
Other comprehensive income, net of tax expense of $52		-		-		-		-		-		-		197		197
Stock options exercised (17,773 shares)		-		6		-		-		-		-		-		6
ESOP shares earned (1,984 shares)		-		11		-		22		-		-		-		33
Stock based compensation		-		11		-		-		-		-		-		11
Compensation plan shares earned (4,277 shares)		-		19		-		-		52		-		-		71
Purchase of treasury stock, at cost (16,990 shares)		-		-		(255)		-		-		-		-		(255)
Cash dividends declared ($0.12 per share)		-		-		-		-		-		(480)		-		(480)
Balance - September 30, 2019	$	68	$	31,042	$	(9,802)	$	(1,385)	$	(71)	$	61,038	$	1,569	$	82,459

							Unearned		Unearned Shares				Accumulated
			Additional				Shares		Held by				Other
	Common		Paid-In		Treasury		Held by		Compensation		Retained		Comprehensive
	Stock		Capital		Stock		ESOP		Plans		Earnings		Income (Loss)		Total
	(Dollars in thousands, except share and per share data)
Balance - January 1, 2020	$	68	$	31,078	$	(10,184)	$	(1,364)	$	(39)	$	61,950	$	1,331	$	82,840
Net income		-		-		-		-		-		731		-		731
Other comprehensive income, net of tax expense of $220		-		-		-		-		-		-		828		828
ESOP shares earned (1,984 shares)		-		7		-		21		-		-		-		28
Stock based compensation		-		11		-		-		-		-		-		11
Compensation plan shares granted (20,830 shares)		-		-		196		-		(196)		-		-		-
Compensation plan shares earned (1,889 shares)		-		9		-		-		20		-		-		29
Purchase of treasury stock, at cost (26,900 shares)		-		-		(377)		-		-		-		-		(377)
Cash dividends declared ($0.12 per share)		-		-		-		-		-		(259)		-		(259)
Balance - March 31, 2020	$	68	$	31,105	$	(10,365)	$	(1,343)	$	(215)	$	62,422	$	2,159	$	83,831

Balance - April 1, 2020	$	68	$	31,105	$	(10,365)	$	(1,343)	$	(215)	$	62,422	$	2,159	$	83,831
Net income		-		-		-		-		-		1,353		-		1,353
Other comprehensive income, net of tax expense of $2		-		-		-		-		-		-		5		5
ESOP shares earned (1,984 shares)		-		2		-		21		-		-		-		23
Stock based compensation		-		11		-		-		-		-		-		11
Compensation plan shares forfeited (332 shares)		-		-		(4)		-		4		-		-		-
Compensation plan shares earned (3,299 shares)		-		19		-		-		31		-		-		50
Purchase of treasury stock, at cost (40,600 shares)		-		-		(511)		-		-		-		-		(511)
Cash dividends declared ($0.12 per share)		-		-		-		-		-		(254)		-		(254)
Balance - June 30, 2020	$	68	$	31,137	$	(10,880)	$	(1,322)	$	(180)	$	63,521	$	2,164	$	84,508

Balance - July 1, 2020	$	68	$	31,137	$	(10,880)	$	(1,322)	$	(180)	$	63,521	$	2,164	$	84,508
Net income		-		-		-		-		-		1,231		-		1,231
Other comprehensive loss, net of tax benefit of $37		-		-		-		-		-		-		(138)		(138)
ESOP shares earned (1,984 shares)		-		3		-		22		-		-		-		25
Stock based compensation		-		11		-		-		-		-		-		11
Compensation plan shares earned (3,327 shares)		-		18		-		-		33		-		-		51
Purchase of treasury stock, at cost (42,100 shares)		-		-		(550)		-		-		-		-		(550)
Cash dividends declared ($0.12 per share)		-		-		-		-		-		(251)		-		(251)
Balance - September 30, 2020	$	68	$	31,169	$	(11,430)	$	(1,300)	$	(147)	$	64,501	$	2,026	$	84,887

See notes to consolidated financial statements.

Lake Shore Bancorp, Inc. and Subsidiary

Consolidated Statements of Cash Flows


	Nine Months Ended September 30,
	2020		2019
	(Unaudited)
	(Dollars in thousands)
CASH FLOWS FROM OPERATING ACTIVITIES
Net income	$	3,315	$	2,915
Adjustments to reconcile net income to net cash provided by operating activities:
Net amortization of investment securities		31		38
Net amortization of deferred loan costs		424		436
Provision for loan losses		1,125		725
Recovery on previously impaired investment securities		(48)		(39)
Unrealized loss (gain) on equity securities		24		(57)
Unrealized loss on interest rate swap		156		109
Originations of loans held for sale		(8,452)		(1,274)
Proceeds from sales of loans held for sale		8,785		1,303
Gain on sale of loans held for sale		(333)		(29)
Depreciation and amortization		629		600
Increase in bank owned life insurance, net		(374)		(370)
ESOP shares committed to be released		76		91
Stock based compensation expense		163		263
Increase in accrued interest receivable		(992)		(323)
Decrease (increase) in other assets		36		(267)
Gains from sale of foreclosed real estate		(16)		-
(Decrease) increase in other liabilities		(109)		194
Net Cash Provided by Operating Activities		4,440		4,315
CASH FLOWS FROM INVESTING ACTIVITIES
Activity in available for sale securities:
Maturities, prepayments and calls		13,118		12,981
Purchases		(20,330)		-
Purchases of Federal Home Loan Bank Stock		(93)		(510)
Redemptions of Federal Home Loan Bank Stock		171		-
Loan origination and principal collections, net		(22,001)		(71,846)
Proceeds from sale of foreclosed real estate		526		-
Additions to premises and equipment		(280)		(507)
Net Cash Used in Investing Activities		(28,889)		(59,882)
CASH FLOWS FROM FINANCING ACTIVITIES
Net increase in deposits		72,062		38,817
Net decrease in advances from borrowers for taxes and insurance		(1,261)		(1,399)
Proceeds from issuance of long-term debt		1,200		14,050
Repayment of long-term debt		(4,500)		(4,050)
Proceeds from stock options exercised		-		6
Purchase of treasury stock		(1,438)		(1,038)
Cash dividends paid		(764)		(1,012)
Net Cash Provided by Financing Activities		65,299		45,374
Net Increase (Decrease) in Cash and Cash Equivalents		40,850		(10,193)
CASH AND CASH EQUIVALENTS - BEGINNING		30,289		30,751
CASH AND CASH EQUIVALENTS - ENDING	$	71,139	$	20,558
SUPPLEMENTARY CASH FLOWS INFORMATION
Interest paid	$	3,523	$	3,752
Income taxes paid	$	800	$	530
Right of use asset recognized	$	-	$	904
Right of use liability recognized	$	-	$	916

SUPPLEMENTARY SCHEDULE OF NONCASH INVESTING AND FINANCING ACTIVITIES
Foreclosed real estate acquired in settlement of loans	$	-	$	165
Securities purchased and not settled	$	2,355	$	-

See notes to consolidated financial statements.

Lake Shore Bancorp, Inc. and Subsidiary

Notes to Consolidated Financial Statements (Unaudited)

Note 1 – Basis of Presentation

The interim consolidated financial statements include the accounts of Lake Shore Bancorp, Inc. (the “Company”, “us”, “our”, or “we”) and Lake Shore Savings Bank (the “Bank”), its wholly owned subsidiary. All intercompany accounts and transactions of the consolidated subsidiary have been eliminated in consolidation.

The interim consolidated financial statements included herein as of September 30, 2020 and for the three and nine months ended September 30, 2020 and 2019 have been prepared by the Company, without audit, pursuant to the rules and regulations of the Securities and Exchange Commission, and therefore, do not include all information or footnotes necessary for a complete presentation of the consolidated statements of financial condition, results of operations and cash flows in conformity with accounting principles generally accepted in the United States of America (“GAAP”). The consolidated statement of financial condition at December 31, 2019 has been derived from the audited consolidated financial statements at that date, but does not include all of the information and footnotes required by GAAP for complete consolidated financial statements. The consolidated financial statements reflect all adjustments that are, in the opinion of management, necessary for a fair statement of such information and to make the financial statements not misleading. These interim consolidated financial statements should be read in conjunction with the consolidated financial statements and notes thereto included in the audited consolidated financial statements included in the Company’s Annual Report on Form 10-K for the year ended December 31, 2019. The consolidated statements of income for the three and nine months ended September 30, 2020 are not necessarily indicative of the results for any subsequent period or the entire year ending December 31, 2020.

To prepare these consolidated financial statements in conformity with GAAP, management of the Company made a number of estimates and assumptions relating to the reporting of assets and liabilities and the reporting of revenue and expenses. Actual results could differ from those estimates. Material estimates that are particularly susceptible to significant change in the near term relate to the determination of the allowance for loan losses, securities valuation estimates, evaluation of impairment of securities and income taxes.

The Company has evaluated events and transactions occurring subsequent to the statement of financial condition as of September 30, 2020 for items that should potentially be recognized or disclosed in these consolidated financial statements. The evaluation was conducted through the date these consolidated financial statements were issued.

Note 2 – New Accounting Standards

Impact of Adoption of Recent Accounting Standards and Accounting Guidance

Under Section 4013 of the Coronavirus Aid, Relief, and Economic Security Act (“CARES Act”), which was signed into law on March 27, 2020, financial institutions have the option to temporarily suspend certain requirements under U.S. generally accepted accounting principles related to troubled debt restructurings (“TDRs”) for a limited period of time to account for the effects of COVID-19. This provision allows a financial institution the option to not apply the guidance on accounting for TDRs to loan modifications, such as extensions or deferrals, related to COVID-19 made between March 1, 2020 and the earlier of (i) December 31, 2020 or (ii) 60 days after the end of the COVID-19 national emergency. The relief can only be applied to modifications for borrowers that were not more than 30 days past due as of December 31, 2019. The Company elected to adopt this provision of the CARES Act.

In addition, the Company’s banking regulators and other financial regulators, on March 22, 2020 and revised April 7, 2020, issued a joint interagency statement titled the “Interagency Statement on Loan Modifications and Reporting for Financial Institutions Working with Customers Affected by the Coronavirus” that encourages financial institutions to work prudently with borrowers who are or may be unable to meet their

contractual payment obligations due to the effects of the COVID-19 pandemic. Pursuant to the interagency statement, loan modifications that do not meet the conditions of Section 4013 of the CARES Act may still qualify as a modification that does not need to be accounted for as a TDR. Specifically, the agencies confirmed with the staff of the Financial Accounting Standards Board (“FASB”) that short-term modifications made in good faith in response to the pandemic to borrowers who were current prior to any relief are not TDRs under GAAP. This includes short-term (e.g. six months) modifications such as payment deferrals, fee waivers, extensions of repayment terms, or delays in payment that are insignificant. Borrowers considered current are those that are less than 30 days past due on their contractual payments at the time a modification program is implemented. Appropriate allowances for loan and lease losses are expected to be maintained. With regard to loans not otherwise reportable as past due, financial institutions are not expected to designate loans with deferrals granted due to the pandemic as past due because of the deferral. The interagency statement also states that during short-term pandemic-related loan modifications, these loans generally should not be reported as nonaccrual. The Company elected to adopt this interagency guidance.

The Company implemented a loan modification program for impacted customers, in line with regulatory guidance, allowing customers to defer loan payments. The majority of loan deferrals were granted for deferral of principal and interest payments for 90 days, and up to 180 days in some instances, with the loan repayment period extended by the deferral period. The requests are evaluated individually and approved modifications are based on the unique circumstances of each borrower. During the second quarter of 2020, the Company approved loan payment deferral requests of up to 90 days on 219 loans, representing $103.1 million, or 21.1%, of the Bank’s loan portfolio as of June 30, 2020. 88.2% of the loan balances with payment deferrals were for commercial real estate loans and commercial business loans, while the remaining 11.8% were for residential mortgage, home equity and consumer loans. The number of loan payment deferral requests has decreased and as of October 31, 2020, there were 25 loans, representing $20.8 million, or 4.1% of the Bank’s loan portfolio, that are deferring payments, as follows:


Loan Type	Number of Loans		Balance Outstanding	Weighted Average Interest Rate

Commercial real estate	16	$	17,608	5.06	%
Commercial business	9		3,165	5.02
	25	$	20,773	5.05	%

These loans were current at the time of modification and were not considered troubled debt restructurings based on the CARES Act and interagency guidance noted above and we have not accounted for the loans as TDRs, nor have we designated the loans as past due or non-accrual.

The adoption of these provisions under Section 4013 of the CARES Act and interagency guidance may have a material impact on the Company’s consolidated financial statements; however, the Company cannot quantify the impact at this time.

Accounting Standards to be Adopted

In June 2016, the FASB issued Accounting Standard Update (“ASU”) 2016-13, “Financial Instruments – Credit Losses (Topic 326): Measurement of Credit Losses on Financial Instruments” (“ASU 2016-13”). ASU 2016-13 requires credit losses on most financial assets measured at amortized cost and certain other instruments to be measured using an expected credit loss model (referred to as the current expected credit loss (“CECL”) model). Under the CECL model entities will estimate credit losses over the entire contractual term of the instrument (considering estimated prepayments, but not expected extensions or modifications unless reasonable expectation of a troubled debt restructuring exists) from the date of initial recognition of that instrument. Further, ASU 2016-13 made certain targeted amendments to the existing impairment standards for available for sale (“AFS”) debt securities. For an AFS debt security for which there is neither the intent nor a more-likely-than-not requirement to sell, an entity will record credit losses as an allowance rather than a write-down of the amortized cost basis. An entity will apply the amendments in ASU 2016-13 through a

cumulative-effect adjustment to retained earnings as of the beginning of the first reporting period in which the guidance is effective.

The Company has determined its data requirements and is developing its methodologies for calculating the expected credit losses under ASU 2016-13 which has allowed the Company to run parallel loss reserve calculations. Data integrity associated with these methodologies is being reviewed and enhancements to the current process are being considered. We expect that the new guidance will result in an increase to the allowance for loan losses given that the allowance will be required to cover the full remaining expected life of the portfolio, rather than the incurred loss under the current accounting standard. The extent of this increase is still being evaluated. We are also reviewing the impact of additional disclosures required under ASU 2016-13 on our ongoing financial reporting procedures.

ASU 2016-13 was originally effective for the Company in 2020. In November 2019, the FASB issued guidance to defer the effective date for smaller reporting companies such as the Company until January 1, 2023.

Note 3 – Investment Securities

Debt Securities

The amortized cost and fair value of securities are as follows:


	September 30, 2020
			Gross		Gross
	Amortized		Unrealized		Unrealized		Fair
	Cost		Gains		Losses		Value
		(Dollars in thousands)
SECURITIES AVAILABLE FOR SALE:
Debt Securities
U.S. government agencies	$	2,010	$	364	$	-	$	2,374
Municipal bonds		44,816		1,089		(32)		45,873
Mortgage-backed securities:
Collateralized mortgage obligations-private label		19		-		-		19
Collateralized mortgage obligations-government sponsored entities		25,091		674		(15)		25,750
Government National Mortgage Association		128		12		-		140
Federal National Mortgage Association		4,520		125		-		4,645
Federal Home Loan Mortgage Corporation		2,419		173		-		2,592
Asset-backed securities-private label		-		171		-		171
Asset-backed securities-government sponsored entities		31		3		-		34
Total Debt Securities	$	79,034	$	2,611	$	(47)	$	81,598
Equity Securities		22		21		-		43
Total Securities Available for Sale	$	79,056	$	2,632	$	(47)	$	81,641


	December 31, 2019
			Gross		Gross
	Amortized		Unrealized		Unrealized		Fair
	Cost		Gains		Losses		Value
		(Dollars in thousands)
SECURITIES AVAILABLE FOR SALE:
Debt Securities
U.S. government agencies	$	2,011	$	134	$	-	$	2,145
Municipal bonds		34,985		835		(1)		35,819
Mortgage-backed securities:
Collateralized mortgage obligations-private label		23		-		-		23
Collateralized mortgage obligations-government sponsored entities		27,081		393		(133)		27,341
Government National Mortgage Association		162		14		-		176
Federal National Mortgage Association		1,944		69		-		2,013
Federal Home Loan Mortgage Corporation		3,211		156		-		3,367
Asset-backed securities-private label		-		215		-		215
Asset-backed securities-government sponsored entities		33		2		-		35
Total Debt Securities	$	69,450	$	1,818	$	(134)	$	71,134
Equity Securities		22		45		-		67
Total Securities Available for Sale	$	69,472	$	1,863	$	(134)	$	71,201

Debt Securities

All of our collateralized mortgage obligations are backed by one- to four-family residential mortgages.

At September 30, 2020, thirty-two municipal bonds with a cost of $10.7 million and fair value of $11.2 million were pledged under a collateral agreement with the Federal Reserve Bank (“FRB”) of New York for liquidity borrowing. At December 31, 2019, thirty-three municipal bonds with a cost of $10.9 million and fair value of $11.2 million were pledged with the FRB. In addition, at September 30, 2020 seventeen municipal bonds with a cost of $3.9 million and fair value of $4.1 million were pledged as collateral for customer deposits in excess of the Federal Deposit Insurance Corporation (“FDIC”) insurance limits. At December 31, 2019, sixteen municipal bonds with a cost of $3.6 million and fair value of $3.7 million were pledged as collateral for customer deposits in excess of the FDIC insurance limits.

The following table sets forth the Company’s investment in securities available for sale with gross unrealized losses of less than twelve months and gross unrealized losses of twelve months or more and associated fair values as of the dates indicated:


	Less than 12 months				12 months or more				Total
			Gross				Gross				Gross
			Unrealized				Unrealized				Unrealized
	Fair Value		Losses		Fair Value		Losses		Fair Value		Losses
	(Dollars in thousands)
September 30, 2020
Municipal bonds	$	3,757		(32)	$	-	$	-	$	3,757	$	(32)
Mortgage-backed securities		2,246		(14)		152		(1)		2,398		(15)
	$	6,003	$	(46)	$	152	$	(1)	$	6,155	$	(47)


December 31, 2019
Municipal bonds	$	399		(1)	$	-	$	-	$	399	$	(1)
Mortgage-backed securities		423		(3)		10,676		(130)		11,099		(133)
	$	822	$	(4)	$	10,676	$	(130)	$	11,498	$	(134)

The Company reviews all investment securities on an ongoing basis for the presence of other-than-temporary-impairment (“OTTI”) with formal reviews performed quarterly.

At September 30, 2020, the Company’s investment portfolio included fourteen securities in the “unrealized losses less than twelve months” category and five securities in the “unrealized losses twelve months or more” category. Management has the intent and ability to hold these securities until maturity. Management believes the temporary impairments were due to declines in fair value resulting from changes in interest rates and/or increased credit liquidity spreads since the securities were purchased. The unrealized losses on debt securities shown in the previous tables were recorded as a component of other comprehensive income, net of tax expense on the Company’s consolidated statements of stockholders’ equity.

The following table presents a summary of the credit-related OTTI charges recognized as components of income:


	For the Nine Months Ended September 30,
	2020		2019
	(Dollars in thousands)
Beginning balance	$	294	$	347
Additions:
Credit loss not previously recognized		-		-
Reductions:
Losses realized during the period on OTTI previously recognized		-		-
Receipt of cash flows on previously recorded OTTI		(48)		(39)
Ending balance	$	246	$	308

A deterioration in credit quality and/or other factors that may limit the liquidity of a security in our portfolio might adversely affect the fair values of the Company’s investment portfolio and may increase the potential that certain unrealized losses will be designated as “other-than-temporary” and that the Company may incur additional write-downs in future periods.

During the nine months ended September 30, 2020 and 2019, the Company did not sell any available for sale debt securities.

Scheduled contractual maturities of available for sale debt securities are as follows:


	Amortized		Fair
	Cost		Value
	(Dollars in thousands)
September 30, 2020:
Less than one year	$	895	$	897
After one year through five years		7,416		7,472
After five years through ten years		13,684		14,221
After ten years		24,831		25,657
Mortgage-backed securities		32,177		33,146
Asset-backed securities		31		205
	$	79,034	$	81,598

Equity Securities

At September 30, 2020 and December 31, 2019, equity securities consisted of 22,368 shares of Federal Home Loan Mortgage Corporation (“FHLMC”) common stock. During the three months ended September 30, 2020 and 2019, the Company recognized an unrealized loss of $6,000 and an unrealized gain of $22,000, respectively, on the equity securities, which was recorded in non-interest income in the consolidated statements of income. During the nine months ended September 30, 2020 and 2019, the Company recognized an unrealized loss of $24,000 and an unrealized gain of $57,000, respectively, on the equity securities. There were no sales of equity securities during the three and nine months ended September 30, 2020 and 2019.

Note 4 - Allowance for Loan Losses

Management segregates the loan portfolio into loan types and analyzes the risk level for each loan type when determining its allowance for loan losses. The loan types are as follows:

Real Estate Loans:

One- to Four-Family – are loans secured by first lien collateral on residential real estate primarily held in the Western New York region. These loans can be affected by economic conditions and the value of underlying properties. Western New York’s housing market has consistently demonstrated stability in home prices despite economic conditions. Furthermore, the Company has conservative underwriting standards and its residential lending policies and procedures ensure that its one- to four-family residential mortgage loans generally conform to secondary market guidelines.

Home Equity - are loans or lines of credit secured by first or second liens on owner-occupied residential real estate primarily held in the Western New York region. These loans can also be affected by economic conditions and the values of underlying properties. Home equity loans may have increased risk of loss if the Company does not hold the first mortgage resulting in the Company being in a secondary position in the event of collateral liquidation. The Company does not originate interest only home equity loans.

Commercial Real Estate – are loans used to finance the purchase of real property, which generally consists of developed real estate that is held as first lien collateral for the loan. These loans are secured by real estate properties that are primarily held in the Western New York region. Commercial real estate lending involves additional risks compared with one- to four-family residential lending, because payments on loans secured by commercial real estate properties are often dependent on the successful operation or management of the properties, and/or the collateral value of the commercial real estate securing the loan, and repayment of such loans may be subject to adverse conditions in the real estate market or economic conditions to a greater extent than one- to four-family residential mortgage loans. Also, commercial real estate loans typically involve relatively large loan balances concentrated with single borrowers or groups of related borrowers.

Construction – are loans to finance the construction of either one- to four-family owner occupied homes or commercial real estate. At the end of the construction period, the loan automatically

converts to either a one- to four-family or commercial mortgage, as applicable. Risk of loss on a construction loan depends largely upon the accuracy of the initial estimate of the value of the property at completion compared to the actual cost of construction. The Company limits its risk during construction as disbursements are not made until the required work for each advance has been completed and an updated lien search is performed. The completion of the construction progress is verified by a Company loan officer or inspections performed by an independent appraisal firm. Construction loans also expose us to the risk of construction delays which may impair the borrower’s ability to repay the loan.

Other Loans:

Commercial – includes business installment loans, lines of credit, and other commercial loans. Most of our commercial loans have fixed interest rates, and are for terms generally not in excess of 5 years. Whenever possible, we collateralize these loans with a lien on business assets and equipment and require the personal guarantees from principals of the borrower. Commercial loans generally involve a higher degree of credit risk, as commercial loans can involve relatively large loan balances to a single borrower or groups of related borrowers, with the repayment of such loans typically dependent on the successful operation of the commercial business and the income stream of the borrower. Such risks can be significantly affected by economic conditions. Although commercial loans may be collateralized by equipment or other business assets, the liquidation of collateral in the event of a borrower default may be an insufficient source of repayment because the equipment or other business assets may be obsolete or of limited use, among other things. Accordingly, the repayment of a commercial loan depends primarily on the credit worthiness of the borrowers (and any guarantors), while liquidation of collateral is a secondary and often insufficient source of repayment.

Consumer – consist of loans secured by collateral such as an automobile or a deposit account, unsecured loans and lines of credit. Consumer loans tend to have a higher credit risk due to the loans being either unsecured or secured by rapidly depreciable assets. Furthermore, consumer loan payments are dependent on the borrower’s continuing financial stability, and therefore are more likely to be adversely affected by job loss, divorce, illness or personal bankruptcy.

The allowance for loan losses is a valuation account that reflects the Company’s evaluation of the losses inherent in its loan portfolio. In order to determine the adequacy of the allowance for loan losses, the Company estimates losses by loan type using historical loss factors, as well as other environmental factors, such as trends in loan volume and loan type, loan concentrations, changes in the experience, ability and depth of the Company’s lending management, and national and local economic conditions. The Company's determination as to the classification of loans and the amount of loss allowances are subject to review by bank regulators, which can require the establishment of additional loss allowances.

The Company also reviews all loans on which the collectability of principal may not be reasonably assured, by reviewing payment status, financial conditions and estimated value of loan collateral. These loans are assigned an internal loan grade, and the Company assigns an amount of loss allowances to these classified loans based on loan grade.

Although the allocations noted below are by loan type, the allowance for loan losses is general in nature and is available to offset losses from any loan in the Company’s portfolio. The unallocated component of the allowance for loan losses reflects the margin of imprecision inherent in the underlying assumptions used in the methodologies for existing specific and general losses in the portfolio.

The projected economic impact of COVID-19 resulted in the Company recording an $828,000 provision to allowance for loan losses during the nine months ended September 30, 2020 to account for adjustments to certain qualitative factors that reflected the uncertain aspects of the pandemic on economic conditions and borrowers’ ability to repay the loans. A general review of all commercial real estate and commercial business loans that received an initial loan payment deferral as a result of the COVID-19 impact was performed. Refer to Note 2 – New Accounting Standards for information on the loan payment deferrals granted by the Bank. At this time management has not changed its classification of these loans due to the quality knowledge our loan officers have obtained from their discussions with the borrowers and due to the strength of the collateral and guarantors. Management continues to carefully monitor those borrowers who remain on payment deferral

for additional signs of distress that would result in a downgrade in loan classification. The net provision for loan losses of $1.1 million during the nine months ended September 30, 2020 included a $297,000 provision related to additional adjustments which were made to account for, increases in classified loans, net loan charge-offs, changes in the historical loss factor, loan originations and payoffs and changes in the mix of the loan portfolio.

The Company is participating in the Small Business Administration (“SBA”) Paycheck Protection Program (“PPP”) under the CARES Act. The CARES Act authorized the SBA to guarantee loans under a new 7(a) loan program known as the PPP. As a qualified SBA lender, the Company was automatically authorized to originate PPP loans. The SBA will guarantee 100% of the PPP loans made to eligible borrowers. During the first nine months of 2020, the Bank originated 252 SBA PPP loans for our customers, which totaled $26.9 million. We funded $18.4 million of PPP loans directly with the remaining $8.5 million funded indirectly via our partnership with Pursuit, a SBA lender that operates in the northeast. At September 30, 2020, there were $18.6 million in PPP loans outstanding and recorded as commercial business loans. In accordance with the SBA terms and conditions on these PPP loans, the Company recorded approximately $247,000 in net fees associated with the processing of these loans. Upon funding the loans, the net fees were deferred and will be amortized over the life of the loans as an adjustment to yield. We are in the process of assisting borrowers who have received PPP loans with the forgiveness application phase of the program. As of September 30, 2020, we have not yet submitted any forgiveness applications with the SBA. It is expected that most customers will apply and receive PPP loan forgiveness during the next six months, upon which any unamortized deferred fees will be recognized as an adjustment to interest income.

The following tables summarize the activity in the allowance for loan losses for the three and nine months ended September 30, 2020 and 2019 and the distribution of the allowance for loan losses and loans receivable by loan portfolio class and impairment method as of September 30, 2020 and December 31, 2019:


	Real Estate Loans								Other Loans
	One- to Four-Family(2)		Home Equity		Commercial		Construction - Commercial		Commercial		Consumer		Unallocated		Total
	(Dollars in thousands)
September 30, 2020
Allowance for Loan Losses:
Balance – July 1, 2020	$	426	$	169	$	3,377	$	554	$	481	$	34	$	23	$	5,064
Charge-offs		-		(6)		-		-		-		(17)		-		(23)
Recoveries		-		-		-		-		-		6		-		6
Provision (credit)		(23)		-		67		6		179		1		70		300
Balance – September 30, 2020	$	403	$	163	$	3,444	$	560	$	660	$	24	$	93	$	5,347

Balance – January 1, 2020	$	436	$	129	$	2,682	$	388	$	478	$	26	$	128	$	4,267
Charge-offs		(26)		(6)		-		-		(5)		(27)		-		(64)
Recoveries		-		1		1		-		4		13		-		19
Provision (credit)		(7)		39		761		172		183		12		(35)		1,125
Balance – September 30, 2020	$	403	$	163	$	3,444	$	560	$	660	$	24	$	93	$	5,347
Ending balance: individually evaluated for impairment	$	-	$	-	$	-	$	-	$	-	$	-	$	-	$	-
Ending balance: collectively evaluated for impairment	$	403	$	163	$	3,444	$	560	$	660	$	24	$	93	$	5,347

Gross Loans Receivable (1):
Ending balance	$	151,356	$	47,073	$	216,571	$	37,338	$	39,673	$	1,312	$	-	$	493,323
Ending balance: individually evaluated for impairment	$	304	$	15	$	-	$	-	$	-	$	-	$	-	$	319
Ending balance: collectively evaluated for impairment	$	151,052	$	47,058	$	216,571	$	37,338	$	39,673	$	1,312	$	-	$	493,004

(1) Gross Loans Receivable does not include allowance for loan losses of $(5,347) or deferred loan costs of $3,292.

(2) Includes one- to four-family construction loans.


	Real Estate Loans								Other Loans
	One- to Four-Family(1)		Home Equity		Commercial		Construction - Commercial		Commercial		Consumer		Unallocated		Total
	(Dollars in thousands)
September 30, 2019
Allowance for Loan Losses:
Balance – July 1, 2019	$	389	$	144	$	2,777	$	379	$	133	$	30	$	11	$	3,863
Charge-offs		(2)		-		(10)		-		-		(13)		-		(25)
Recoveries		-		-		1		-		-		2		-		3
Provision (credit)		(4)		(9)		122		60		104		7		20		300
Balance – September 30, 2019	$	383	$	135	$	2,890	$	439	$	237	$	26	$	31	$	4,141

Balance – January 1, 2019	$	471	$	91	$	2,020	$	250	$	507	$	25	$	84	$	3,448
Charge-offs		(2)		(4)		(10)		-		-		(34)		-		(50)
Recoveries		8		1		3		-		-		6		-		18
Provision (credit)		(94)		47		877		189		(270)		29		(53)		725
Balance – September 30, 2019	$	383	$	135	$	2,890	$	439	$	237	$	26	$	31	$	4,141

(1) Includes one– to four-family construction loans.


	Real Estate Loans									Other Loans
	One- to Four-Family(2)		Home Equity		Commercial		Construction - Commercial		Commercial		Consumer		Unallocated		Total
	(Dollars in thousands)

December 31, 2019
Allowance for Loan Losses:
Balance – December 31, 2019	$	436	$	129	$	2,682	$	388	$	478	$	26	$	128	$	4,267
Ending balance: individually evaluated for impairment	$	-	$	-	$	-	$	-	$	-	$	-	$	-	$	-
Ending balance: collectively evaluated for impairment	$	436	$	129	$	2,682	$	388	$	478	$	26	$	128	$	4,267

Gross Loans Receivable (1):
Ending Balance	$	154,749	$	45,250	$	211,220	$	32,299	$	26,720	$	1,297	$	-	$	471,535
Ending balance: individually evaluated for impairment	$	166	$	-	$	-	$	-	$	-	$	-	$	-	$	166
Ending balance: collectively evaluated for impairment	$	154,583	$	45,250	$	211,220	$	32,299	$	26,720	$	1,297	$	-	$	471,369

(1) Gross Loans Receivable does not include allowance for loan losses of $(4,267) or deferred loan costs of $3,548.

(2) Includes one- to four-family construction loans.

A loan is considered impaired when, based on current information and events, it is probable that the Company will not be able to collect the scheduled payments of principal and interest when due according to the

contractual terms of the loan agreement. Factors considered in determining impairment include payment status, collateral value and the probability of collecting scheduled payments when due. Impairment is measured on a loan-by-loan basis for commercial real estate loans and commercial loans. Larger groups of smaller balance homogeneous loans are collectively evaluated for impairment. Accordingly, the Company does not separately identify individual consumer, home equity, or one- to four-family loans for impairment disclosure, unless they are subject to a troubled debt restructuring.

The following is a summary of information pertaining to impaired loans at or for the periods indicated:


			Unpaid				Average		Interest
	Recorded		Principal		Related		Recorded		Income
	Investment		Balance		Allowance		Investment		Recognized
							For the Nine Months Ended
	At September 30, 2020						September 30, 2020
	(Dollars in thousands)
With no related allowance recorded:
Residential, one- to four-family	$	304	$	304	$	-	$	312	$	11
Home equity		15		15		-		16		-
Total impaired loans		319		319		-		328		11


			Unpaid				Average		Interest
	Recorded		Principal		Related		Recorded		Income
	Investment		Balance		Allowance		Investment		Recognized
							For the Year Ended
	At December 31, 2019						December 31, 2019
	(Dollars in thousands)
With no related allowance recorded:
Residential, one- to four-family	$	166	$	166	$	-	$	173	$	10
Commercial real estate(1)		-		-		-		27		-
Total impaired loans with no related allowance		166		166		-		200		10

With an allowance recorded:
Commercial real estate(2)		-		-		-		260		8
Commercial loans(3)		-		-		-		31		1
Total impaired loans with an allowance		-		-		-		291		9

Total of impaired loans:
Residential, one- to four-family		166		166		-		173		10
Commercial real estate		-		-		-		287		8
Commercial loans		-		-		-		31		1
Total impaired loans	$	166	$	166	$	-	$	491	$	19

(1) This loan was paid off during the year ended December 31, 2019.

(2) This line item consisted of two commercial real estate loans with a combined recorded investment of $294,000 and a related allowance of $40,000. One commercial real estate loan was paid off in full and the other commercial real estate loan was charged off during the year ended December 31, 2019.

(3) A commercial business loan with a recorded investment of $30,000 and a related allowance of $15,000 was partially paid off during the year ended December 31, 2019, with the remaining balance being recorded as a loss.

The following tables provide an analysis of past due loans and non-accruing loans as of the dates indicated:


	30-59 Days		60-89 Days		90 Days or More		Total Past			Current	Total Loans		Loans on Non-
	Past Due		Past Due		Past Due		Due			Due	Receivable		Accrual
	(Dollars in thousands)
September 30, 2020:
Real Estate Loans:
Residential, one- to four-family(1)	$	1,000	$	203	$	1,245	$	2,448	$	148,908	$	151,356	$	2,664
Home equity		144		100		631		875		46,198		47,073		696
Commercial		-		-		253		253		216,318		216,571		-
Construction - commercial		-		-		-		-		37,338		37,338		-
Other Loans:
Commercial(2)		-		-		-		-		39,673		39,673		-
Consumer		13		-		1		14		1,298		1,312		1
Total	$	1,157	$	303	$	2,130	$	3,590	$	489,733	$	493,323	$	3,361

	30-59 Days		60-89 Days		90 Days or More		Total Past			Current	Total Loans		Loans on Non-
	Past Due		Past Due		Past Due		Due			Due	Receivable		Accrual
	(Dollars in thousands)
December 31, 2019:
Real Estate Loans:
Residential, one- to four-family(1)	$	1,245	$	672	$	1,924	$	3,841	$	150,908	$	154,749	$	2,845
Home equity		168		162		583		913		44,337		45,250		590
Commercial		-		1,133		-		1,133		210,087		211,220		-
Construction - commercial		-		-		-		-		32,299		32,299		-
Other Loans:
Commercial		-		-		-		-		26,720		26,720		-
Consumer		8		-		2		10		1,287		1,297		2
Total	$	1,421	$	1,967	$	2,509	$	5,897	$	465,638	$	471,535	$	3,437

(1) Includes one- to four-family construction loans.

(2) Includes $18.6 million of PPP loans which do not require payments for a certain amount of time under the CARES Act and are 100% guaranteed by SBA.

The accrual of interest on loans is discontinued when, in management’s opinion, the borrower may be unable to meet payments as they become due. A loan does not have to be 90 days delinquent in order to be classified as non-accrual. When interest accrual is discontinued, all unpaid accrued interest is reversed. If ultimate collection of principal is in doubt, all cash receipts on impaired loans are applied to reduce the principal balance.

The Company’s policies provide for the classification of loans as follows:

Pass/Performing;

Special Mention – does not currently expose the Company to a sufficient degree of risk but does possess credit deficiencies or potential weaknesses deserving the Company’s close attention;

Substandard – has one or more well-defined weaknesses and are characterized by the distinct possibility that the Company will sustain some loss if the deficiencies are not corrected. A substandard asset would be one inadequately protected by the current net worth and paying capacity of the obligor or pledged collateral, if applicable;

Doubtful – has all the weaknesses inherent in substandard loans with the additional characteristic that the weaknesses present make collection or liquidation in full on the basis of currently existing facts, conditions and values questionable, and there is a high possibility of loss; and

Loss – loan is considered uncollectible and continuance without the establishment of a specific valuation reserve is not warranted.

The Company’s Asset Classification Committee is responsible for monitoring risk ratings and making changes as deemed appropriate. Each commercial loan is individually assigned a loan classification. The Company’s consumer loans, including residential one- to four-family loans and home equity loans, are not classified as described above. Instead, the Company uses the delinquency status as the basis for classifying these loans. Generally, all consumer loans more than 90 days past due are classified and placed in non-accrual. Such loans that are well-secured and in the process of collection will remain in accrual status.

The following tables summarize the internal loan grades applied to the Company’s loan portfolio as of September 30, 2020 and December 31, 2019:


	Pass/Performing		Special Mention		Substandard		Doubtful		Loss		Total
	(Dollars in thousands)
September 30, 2020
Real Estate Loans:
Residential, one- to four-family(1)	$	148,727	$	-	$	2,629	$	-	$	-	$	151,356
Home equity		46,098		-		975		-		-		47,073
Commercial(2)		201,494		14,477		600		-		-		216,571
Construction - commercial		37,338		-		-		-		-		37,338
Other Loans:
Commercial(3)		34,340		1,030		4,303		-		-		39,673
Consumer		1,311		-		1		-		-		1,312
Total	$	469,308	$	15,507	$	8,508	$	-	$	-	$	493,323


	Pass/Performing		Special Mention		Substandard		Doubtful		Loss		Total
	(Dollars in thousands)
December 31, 2019
Real Estate Loans:
Residential, one- to four-family(1)	$	152,115	$	-	$	2,634	$	-	$	-	$	154,749
Home equity		44,403		-		847		-		-		45,250
Commercial		208,042		2,573		605		-		-		211,220
Construction - commercial		32,299		-		-		-		-		32,299
Other Loans:
Commercial		22,295		4,425		-		-		-		26,720
Consumer		1,295		-		2		-		-		1,297
Total	$	460,449	$	6,998	$	4,088	$	-	$	-	$	471,535

(1) Includes one- to four-family construction loans.

(2) The increase in commercial real estate loans classified as “Special Mention” was primarily due to a $13.3 million loan relationship with one borrower that is well collateralized and supported by guarantors.

(3) Includes $18.6 million of PPP loans which are 100% guaranteed by SBA and are graded as Pass/Performing loans.

TDRs occur when we grant borrowers concessions that we would not otherwise grant but for economic or legal reasons pertaining to the borrower’s financial difficulties. A concession is made when the terms of the loan modification are more favorable than the terms the borrower would have received in the current market under similar financial difficulties. These concessions may include, but are not limited to, modifications of the terms of the debt, the transfer of assets or the issuance of an equity interest by the borrower to satisfy all or part of the debt, or the addition of borrower(s). The Company identifies loans for potential TDRs primarily through direct communication with the borrower and evaluation of the borrower’s financial statements, revenue projections, tax returns, and credit reports. Even if the borrower is not presently in default, management will consider the likelihood that cash flow shortages, adverse economic conditions, and negative trends may result in a payment default in the near future. Generally, we will not return a TDR to accrual status until the borrower has demonstrated the ability to make principal and interest payments under the restructured terms for at least six consecutive months. The Company’s TDRs are impaired loans, which may result in specific allocations and subsequent charge-offs if appropriate.

Some loan modifications classified as TDRs may not ultimately result in full collection of principal and interest, as modified, which may result in potential losses. These potential losses have been factored into our overall estimate of the allowance for loan losses.

The following table summarizes the loans that were classified as TDRs as of the dates indicated:


					Non-Accruing				Accruing				TDRs That Have Defaulted on Modified Terms Year to Date
	Number of Loans		Recorded Investment		Number of Loans		Recorded Investment		Number of Loans		Recorded Investment		Number of Loans		Recorded Investment
	(Dollars in thousands)
At September 30, 2020
Real Estate Loans:
Residential, one- to four-family		8	$	304		1	$	20		7	$	284		-	$	-
Home equity		1		15		-		-		1		15		-		-
Total		9	$	319		1	$	20		8	$	299		-	$	-


At December 31, 2019
Real Estate Loans:
Residential, one- to four-family		5	$	166		1	$	28		4	$	138		-	$	-

No additional loan commitments were outstanding to these borrowers at September 30, 2020 and December 31, 2019.

The following table details the activity in loans which were first deemed to be TDRs during the nine months ended September 30, 2020.



	For the Nine Months Ended September 30, 2020
	Number of Loans		Pre-Modification Outstanding Recorded Investment		Post-Modification Outstanding Recorded Investment
	(Dollars in thousands)
Real Estate Loans:
Residential, one- to four-family		3	$	150	$	150
Home equity		1		16		16
Total		4	$	166	$	166

There were no loans restructured and classified as TDRs during the three month period ended September 30, 2020.

There were no loans restructured and classified as TDRs during the three and nine month periods ended September 30, 2019.

Foreclosed real estate consists of property acquired in settlement of loans which is carried at its fair value less estimated selling costs. Write-downs from cost to fair value less estimated selling costs are recorded at the date of acquisition or repossession and are charged to the allowance for loan losses. Foreclosed real estate was $197,000 and $779,000 at September 30, 2020 and December 31, 2019, respectively, and was included as a component of other assets on the consolidated statements of financial condition. The recorded investment of consumer mortgage loans secured by residential real estate properties for which formal foreclosure proceedings are in process according to local requirements of the applicable jurisdiction was $1.6 million and $1.8 million at September 30, 2020 and December 31, 2019, respectively.

Note 5 – Deposits

Deposits consist of the following at the dates indicated:


	At September 30, 2020		At December 31, 2019
	(Dollars in thousands)
Demand deposits:
Non-interest bearing	$	90,669	$	61,229
Interest bearing		85,718		56,703
Money market accounts		154,091		141,398
Savings accounts		63,870		53,628
Time deposits		161,190		170,518

	$	555,538	$	483,476

The increase in total deposits was primarily due to an overall increase in net core deposits, partially offset by a decrease in time deposits. A majority of the growth in core deposits during the nine months ended September 30, 2020 was due to organic growth, PPP loan proceeds and other government stimulus funds remaining on deposit at the Bank, and the impact of the COVID-19 pandemic on consumer and business spending and savings levels. The Company’s strategic focus remains on organic growth of lower-cost core deposits among its retail and commercial customers in an effort to manage interest expense and to strengthen customer relationships.

Note 6 – Earnings per Share

Earnings per share was calculated for the three and nine months ended September 30, 2020 and 2019, respectively. Basic earnings per share is based upon the weighted average number of common shares outstanding, exclusive of unearned shares held by the Employee Stock Ownership Plan of Lake Shore Bancorp, Inc. (the “ESOP”), unearned shares held by the Lake Shore Bancorp, Inc. 2006 Recognition and Retention Plan (“RRP”), and unearned shares held by the Lake Shore Bancorp, Inc. 2012 Equity Incentive Plan (“EIP”). Diluted earnings per share is based upon the weighted average number of common shares outstanding and common share equivalents that would arise from the exercise of dilutive securities. Stock options are regarded as potential common stock and are considered in the diluted earnings per share calculations to the extent they would be dilutive and computed using the treasury stock method.

The calculated basic and diluted earnings per share are as follows:


	Three Months Ended September 30,
	2020		2019
Numerator – net income	$	1,231,000	$	1,212,000
Denominator:
Basic weighted average shares outstanding		5,941,540		5,987,857
Increase in weighted average shares outstanding due to:
Stock options		-		-
Diluted weighted average shares outstanding (1)		5,941,540		5,987,857

Earnings per share:
Basic	$	0.21	$	0.20
Diluted	$	0.21	$	0.20

	Nine Months Ended September 30,
	2020		2019
Numerator – net income	$	3,315,000	$	2,915,000
Denominator:
Basic weighted average shares outstanding		5,968,348		6,011,070
Increase in weighted average shares outstanding due to:
Stock options		-		-
Diluted weighted average shares outstanding (1)		5,968,348		6,011,070

Earnings per share:
Basic	$	0.56	$	0.48
Diluted	$	0.56	$	0.48

⁽¹⁾

Stock options to purchase 64,547 shares under the Company’s 2006 Stock Option Plan and 20,000 shares under the EIP at $14.38 for each plan were outstanding during the three and nine month periods ended September 30, 2020 and 2019, respectively, but were not included in the calculation of diluted earnings per share because to do so would have been anti-dilutive.

Note 7 – Commitments to Extend Credit

The Company has commitments to extend credit with off-balance sheet risk in the normal course of business to meet the financing needs of its customers. Such commitments involve, to varying degrees, elements of credit and interest rate risk in excess of the amount recognized in the consolidated statements of financial condition.

The Company’s exposure to credit loss is represented by the contractual amount of these commitments. There were no loss reserves associated with these commitments at September 30, 2020 and December 31, 2019. The Company follows the same credit policies in making commitments as it does for on-balance sheet instruments.

The following commitments to extend credit were outstanding as of the dates specified:


	Contract Amount
	September 30,		December 31,
	2020		2019
	(Dollars in thousands)

Commitments to grant loans	$	63,447	$	26,919
Unfunded commitments under lines of credit		66,735		61,309

Commitments to extend credit are agreements to lend to a customer as long as there is no violation of any condition established in the contract. Commitments generally have fixed expiration dates or other termination clauses. The commitments for lines of credit may expire without being drawn upon. Therefore, the total commitment amounts do not necessarily represent future cash requirements. The amount of collateral obtained, if it is deemed necessary by the Company, is based on management’s credit evaluation of the customer.

Note 8 – Stock-based Compensation

As of September 30, 2020, the Company had four stock-based compensation plans, which are described below. The compensation cost that has been recorded under salary and benefits expense in the non-interest expense section of the consolidated statements of income for these plans was $87,000 and $115,000 for the three months ended September 30, 2020 and 2019, respectively. The compensation cost that has been recorded for the nine months ended September 30, 2020 and 2019 was $239,000 and $354,000, respectively.

2006 Stock Option Plan

The Company’s 2006 Stock Option Plan (the “Stock Option Plan”), which was approved by the Company’s stockholders, permitted the grant of options to its employees and non-employee directors for up to 297,562 shares of common stock. The Stock Option Plan expired on October 24, 2016, and grants of options can no longer be awarded.

Both incentive stock options and non-qualified stock options have been granted under the Stock Option Plan. The exercise price of each stock option equals the market price of the Company’s common stock on the date of grant and an option’s maximum term is ten years. The stock options generally vest over a five year period.

A summary of the status of the Stock Option Plan during the nine months ended September 30, 2020 and 2019 is presented below:


	2020				2019
	Options		Weighted Average Exercise Price	Remaining Contractual Life	Options		Weighted Average Exercise Price	Remaining Contractual Life
Outstanding at beginning of year	64,548	$	14.38		82,321	$	12.98
Granted	-		-		-		-
Exercised	-		-		(17,773)		7.88
Outstanding at end of period	64,548	$	14.38	6.0 years	64,548	$	14.38	7.1 years

Options exercisable at end of period	38,726	$	14.38	6.0 years	25,818	$	14.38	7.1 years

Fair value of options granted		$	-			$	-

At September 30, 2020, stock options had no intrinsic value and there were no remaining options available for grant under the Stock Option Plan. There were no stock options exercised during the three and nine months ended September 30, 2020. There were 17,773 stock options exercised during the three and nine months

ended September 30, 2019. Compensation expense related to the Stock Option Plan for the three month periods ended September 30, 2020 and 2019 was $8,000. Compensation expense related to the Stock Option Plan for the nine month periods ended September 30, 2020 and 2019 was $25,000. At September 30, 2020, $36,000 of unrecognized compensation cost related to the Stock Option Plan is expected to be recognized over a period of 13 months.

2006 Recognition and Retention Plan

The Company’s 2006 Recognition and Retention Plan (“RRP”), which was approved by the Company’s stockholders, permitted the grant of restricted stock awards (“Awards”) to employees and non-employee directors for up to 119,025 shares of common stock. The RRP expired on October 24, 2016, and as of October 24, 2016, all shares permitted under the plan have been granted.

As of September 30, 2020, there were 115,790 shares vested or distributed to eligible participants under the RRP. Compensation expense amounted to $6,000 and $14,000 for the three months ended September 30, 2020 and 2019, respectively. Compensation expense amounted to $18,000 and $58,000 for the nine months ended September 30, 2020 and 2019, respectively. At September 30, 2020, $25,000 of unrecognized compensation cost related to the RRP is expected to be recognized over a period of 13 months.

A summary of the status of unvested shares under the RRP for the nine months ended September 30, 2020 and 2019 is as follows:


	At September 30, 2020		Weighted Average Grant Price (per Share)	At September 30, 2019		Weighted Average Grant Price (per Share)
Unvested shares outstanding at beginning of year	3,255	$	14.37	10,188	$	13.27
Granted	-		-	-		-
Vested	(20)		13.42	(4,915)		12.17
Unvested shares outstanding at end of period	3,235	$	14.38	5,273	$	14.30

2012 Equity Incentive Plan

The Company’s 2012 Equity Incentive Plan (the “EIP”), which was approved by the Company’s stockholders on May 23, 2012, authorizes the issuance of up to 180,000 shares of common stock pursuant to grants of restricted stock awards and up to 20,000 shares of common stock pursuant to grants of incentive stock options and non-qualified stock options, subject to permitted adjustments for certain corporate transactions. Employees and directors of Lake Shore Bancorp or its subsidiaries are eligible to receive awards under the EIP, except that non-employees may not be granted incentive stock options.

The Board of Directors granted restricted stock awards under the EIP during the nine months ended September 30, 2020 as follows:


Grant Date	Number of Restricted Stock Awards	Vesting		Fair Value per Share of Award on Grant Date	Awardees

February 5, 2020	5,513	100% on December 11, 2020	$	15.51	Non-employee directors
February 26, 2020	15,317	100% on February 26, 2023 if three year performance metric is achieved		15.39	Employees

A summary of the status of unvested restricted stock awards under the EIP for the nine months ended September 30, 2020 and 2019 is as follows:


	At September 30, 2020		Weighted Average Grant Price (per Share)	At September 30, 2019		Weighted Average Grant Price (per Share)
Unvested shares outstanding at beginning of year	-	$	-	25,321	$	15.28
Granted	20,830		15.42	5,186		15.89
Vested	-		-	(4,213)		12.16
Forfeited	(332)		15.39	(760)		15.90
Unvested shares outstanding at end of period	20,498	$	15.42	25,534	$	15.90

As of September 30, 2020, there were 83,572 shares of restricted stock that vested or was distributed to eligible participants under the EIP. Compensation expense related to unvested restricted stock awards under the EIP amounted to $45,000 and $60,000 for the three months ended September 30, 2020 and 2019, respectively. Compensation expense related to unvested EIP restricted stock awards during the nine months ended September 30, 2020 and 2019 was $112,000 and $172,000, respectively. At September 30, 2020, $204,000 of unrecognized compensation cost related to unvested restricted stock awards is expected to be recognized over a period of 29 months.

A summary of the status of stock options under the EIP for the nine months ended September 30, 2020 and 2019 is presented below:


	At September 30, 2020				At September 30, 2019
	Options		Exercise Price	Remaining Contractual Life	Options		Exercise Price	Remaining Contractual Life
Outstanding at beginning of year	20,000	$	14.38		20,000	$	14.38
Granted	-		-		-		-
Exercised	-		-		-		-
Forfeited	-		-		-		-
Outstanding at end of period	20,000	$	14.38	6.0 years	20,000	$	14.38	7.1 years

Options exercisable at end of period	11,999	$	14.38	6.0 years	7,997	$	14.38	7.1 years

Fair value of options granted			-				-

At September 30, 2020, stock options had no intrinsic value and there were no remaining options available for grant under the EIP. Compensation expense related to stock options outstanding under the EIP amounted to $3,000 for the three months ended September 30, 2020 and 2019 and $8,000 for the nine months ended September 30, 2020 and 2019. At September 30, 2020, $11,000 of unrecognized compensation cost related to unvested stock options is expected to be recognized over a period of 13 months.

Employee Stock Ownership Plan (“ESOP”)

The Company established the ESOP for the benefit of eligible employees of the Company and Bank. All Company and Bank employees meeting certain age and service requirements are eligible to participate in the ESOP. Participants’ benefits become fully vested after five years of service once the employee is eligible to participate in the ESOP. The Company utilized $2.6 million of the proceeds of its 2006 stock offering to extend a loan to the ESOP and the ESOP used such proceeds to purchase 238,050 shares of stock on the open market at an average price of $10.70 per share, plus commission expenses. As a result of the purchase of shares by the ESOP, total stockholders’ equity of the Company was reduced by $2.6 million. As of September 30, 2020, the balance of the loan to the ESOP was $1.5 million and the fair value of unallocated shares was $1.7 million, respectively. As of September 30, 2020, there were 76,242 allocated shares and 126,958

unallocated shares compared to 72,582 allocated shares and 134,893 unallocated shares at September 30, 2019. The ESOP compensation expense was $25,000 for the three months ended September 30, 2020 and $30,000 for the three months ended September 30, 2019 based on 1,984 shares earned in each of those quarters. The ESOP compensation expense was $76,000 for the nine months ended September 30, 2020 and $91,000 for the nine months ended September 30, 2019 based on 5,951 shares earned in each of those periods.

Note 9 - Fair Value of Financial Instruments

Management uses its best judgment in estimating the fair value of the Company’s financial instruments; however, there are inherent weaknesses in any estimation technique. Therefore, for substantially all financial instruments, the fair value estimates herein are not necessarily indicative of the amounts the Company could have realized in a sale transaction on the dates indicated. The estimated fair value amounts have been measured as of September 30, 2020 and December 31, 2019 and have not been re-evaluated or updated for purposes of these consolidated financial statements subsequent to those respective dates. The estimated fair values of these financial instruments subsequent to the respective reporting dates may be different than the amounts reported here.

GAAP establishes a fair value hierarchy that prioritizes the inputs to valuation methods used to measure fair value. The hierarchy gives the highest priority to unadjusted quoted prices in active markets for identical assets or liabilities measurements (Level 1) and the lowest priority to unobservable input measurements (Level 3). The three levels of the fair value hierarchy are as follows:

Level 1: Unadjusted quoted prices in active markets for identical assets or liabilities that the reporting entity can access at the measurement date.

Level 2: Inputs other than quoted prices included in Level 1 that are observable for the asset or liability either directly or indirectly.

Level 3: Unobservable inputs for determining the fair values of assets or liabilities that reflect an entity’s own assumptions about the assumptions that market participants would use in pricing the assets or liabilities.

An asset’s or liability’s level within the fair value hierarchy is based on the lowest level of input that is significant to the fair value measurement.

The Company’s consolidated statements of financial condition contains investment securities available for sale and derivative instruments that are recorded at fair value on a recurring basis. For financial instruments measured at fair value on a recurring basis, the fair value measurements by level within the fair value hierarchy used at September 30, 2020 and December 31, 2019 were as follows:

	Fair Value Measurements at September 30, 2020
			Quoted Prices in Active Markets for Identical Assets		Significant Other Observable Inputs		Significant Other Unobservable Inputs
	Fair Value		(Level 1)		(Level 2)		(Level 3)
		(Dollars in thousands)
Measured at fair value on a recurring basis:
Securities available for sale:
Debt Securities
U.S. government agencies	$	2,374	$	2,374	$	-	$	-
Municipal bonds		45,873		-		45,873		-
Mortgage-backed securities:
Collateralized mortgage obligations-private label		19		-		19		-
Collateralized mortgage obligations-government sponsored entities		25,750		-		25,750		-
Government National Mortgage Association		140		-		140		-
Federal National Mortgage Association		4,645		-		4,645		-
Federal Home Loan Mortgage Corporation		2,592		-		2,592		-
Asset-backed securities:
Private label		171		-		171		-
Government sponsored entities		34		-		34		-
Total Debt Securities	$	81,598	$	2,374	$	79,224	$	-
Equity securities		43		-		43		-
Total Securities Available for Sale	$	81,641	$	2,374	$	79,267	$	-
Interest Rate Swap(1)	$	(283)	$	-	$	(283)	$	-

⁽¹⁾

Included in Other Liabilities on the consolidated statements of financial condition.


	Fair Value Measurements at December 31, 2019
			Quoted Prices in Active Markets for Identical Assets		Significant Other Observable Inputs		Significant Other Unobservable Inputs
	Fair Value		(Level 1)		(Level 2)		(Level 3)
		(Dollars in thousands)
Measured at fair value on a recurring basis:
Securities available for sale:
Debt Securities
U.S. government agencies	$	2,145	$	2,145	$	-	$	-
Municipal bonds		35,819		-		35,819		-
Mortgage-backed securities:
Collateralized mortgage obligations-private label		23		-		23		-
Collateralized mortgage obligations-government sponsored entities		27,341		-		27,341		-
Government National Mortgage Association		176		-		176		-
Federal National Mortgage Association		2,013		-		2,013		-
Federal Home Loan Mortgage Corporation		3,367		-		3,367		-
Asset-backed securities:						-
Private label		215		-		215		-
Government sponsored entities		35		-		35		-
Total Debt Securities	$	71,134	$	2,145	$	68,989	$	-
Equity securities		67		-		67		-
Total Securities Available for Sale	$	71,201	$	2,145	$	69,056	$	-
Interest Rate Swap(1)	$	(127)	$	-	$	(127)	$	-

⁽¹⁾

Included in Other Liabilities on the consolidated statements of financial condition

Level 2 inputs for assets or liabilities measured at fair value on a recurring basis might include quoted prices for similar assets or liabilities in active markets, quoted prices for identical or similar assets or liabilities in markets that are not active, inputs other than quoted prices that are observable for the asset or liability (such as interest rates, volatilities, prepayment projections, credit risks, etc.) or inputs that are derived principally from or corroborated by market data by correlation or other means. The following is a description of valuation methodologies used for financial assets recorded at fair value on a recurring basis:

Investment securities available for sale – the fair values are determined by obtaining quoted market prices on nationally recognized securities exchanges (Level 1) or matrix pricing (Level 2), which is a mathematical technique used widely in the industry to value debt securities without relying exclusively on quoted market prices for the specific securities, but rather by relying on the securities’ relationship to other benchmark quoted prices. The fair value measurements consider observable data that may include dealer quotes, market spreads, cash flows, the U.S. Treasury yield curve, live trading levels, trade execution date, market consensus prepayment projections, credit information and the security’ terms and conditions, among other things. Level 2 securities which are fixed income instruments that are not quoted on an exchange, but are traded in active markets, are valued using prices obtained from our custodian, who use third party data service providers.

Interest Rate Swap – the fair value is based on a discounted cash flow model. The model’s key assumptions include the contractual term of the derivative contract, including the period to maturity,

and the use of observable market based inputs, such as interest rates, yield curves, nonperformance risk and implied volatility.

In addition to disclosure of the fair value of assets on a recurring basis, GAAP requires disclosures for assets and liabilities measured at fair value on a non-recurring basis, such as impaired assets and foreclosed real estate. Loans are generally not recorded at fair value on a recurring basis. Periodically, the Company records non-recurring adjustments to the carrying value of loans based on fair value measurements for partial charge-offs of the uncollectible portions of these loans. Non-recurring adjustments also include certain impairment amounts for collateral-dependent loans calculated when establishing the allowance for loan losses. An impaired loan is carried at fair value based on either a recent appraisal less estimated selling costs of underlying collateral or discounted cash flows based on current market conditions.

For assets measured at fair value on a non-recurring basis, the fair value measurements by level within the fair value hierarchy used at September 30, 2020 and December 31, 2019 were as follows:


	Fair Value Measurements
			Quoted Prices in Active Markets for Identical Assets		Significant Other Observable Inputs		Significant Other Unobservable Inputs
	Fair Value		(Level 1)		(Level 2)		(Level 3)
		(Dollars in thousands)
Measured at fair value on a non-recurring basis:

At September 30, 2020
Foreclosed real estate	$	197	$	-	$	-	$	197

At December 31, 2019
Foreclosed real estate	$	170	$	-	$	-	$	170

The following table presents additional quantitative information about assets measured at fair value on a non-recurring basis and for which the Company has utilized Level 3 inputs to determine fair value:


	Quantitative Information about Level 3 Fair Value Measurements
(Dollars in thousands)	Fair Value Estimate		Valuation Technique	Unobservable Input	Range	Weighted Average
At September 30, 2020
Foreclosed real estate	$	197	Market valuation of property (1)	Direct Disposal Costs (2)	7.00-10.00%	9.21%
At December 31, 2019
Foreclosed real estate	$	170	Market valuation of property (1)	Direct Disposal Costs (2)	7.00-10.00%	9.40%

⁽¹⁾

Fair value is generally determined through independent third-party appraisals of the underlying collateral, which generally includes various Level 3 inputs which are not observable.

⁽²⁾

The fair value basis of foreclosed real estate may be adjusted to reflect management estimates of disposal costs including, but not necessarily limited to, real estate brokerage commissions, legal fees, and delinquent property taxes.

At September 30, 2020 and December 31, 2019, foreclosed real estate valued using Level 3 inputs had a carrying amount of $250,000 and $221,000, respectively. At September 30, 2020 and December 31, 2019, foreclosed real estate valued using Level 3 inputs had valuation allowances of $53,000 and $51,000, respectively.

The carrying amount and estimated fair value of the Company’s financial instruments, whether carried at cost or fair value, are as follows:


	Fair Value Measurements at September 30, 2020
	Carrying		Estimated		Quoted Prices in Active Markets for Identical Assets		Significant Other Observable Inputs		Significant Other Unobservable Inputs
	Amount		Fair Value		(Level 1)		(Level 2)		(Level 3)
	(Dollars in thousands)
Financial assets:
Cash and cash equivalents	$	71,139	$	71,139	$	71,139	$	-	$	-
Securities available for sale		81,641		81,641		2,374		79,267		-
Federal Home Loan Bank stock		1,977		1,977		-		1,977		-
Loans receivable, net		491,268		489,137		-		-		489,137
Accrued interest receivable		3,145		3,145		-		3,145		-
Interest rate swap		(283)		(283)		-		(283)		-
Financial liabilities:
Deposits		555,538		558,291		-		558,291		-
Long-term debt		31,350		32,522		-		32,522		-
Accrued interest payable		71		71		-		71		-
Off-balance-sheet financial instruments		-		-		-		-		-


	Fair Value Measurements at December 31, 2019
	Carrying		Estimated		Quoted Prices in Active Markets for Identical Assets		Significant Other Observable Inputs		Significant Other Unobservable Inputs
	Amount		Fair Value		(Level 1)		(Level 2)		(Level 3)
	(Dollars in thousands)
Financial assets:
Cash and cash equivalents	$	30,289	$	30,289	$	30,289	$	-	$	-
Securities available for sale		71,201		71,201		2,145		69,056		-
Federal Home Loan Bank stock		2,055		2,055		-		2,055		-
Loans receivable, net		470,816		461,058		-		-		461,058
Accrued interest receivable		2,153		2,153		-		2,153		-
Interest rate swap		(127)		(127)		-		(127)		-
Financial liabilities:
Deposits		483,476		486,487		-		486,487		-
Long-term debt		34,650		34,658		-		34,658		-
Accrued interest payable		79		79		-		79		-
Off-balance-sheet financial instruments		-		-		-		-		-

Note 10 – Treasury Stock

During the three months ended September 30, 2020, the Company repurchased 42,100 shares of common stock at an average cost of $13.06 per share. During the nine months ended September 30, 2020, the Company repurchased 109,600 shares of common stock at an average cost of $13.12 per share. These shares were repurchased pursuant to the Company’s publicly announced common stock repurchase program. As of September 30, 2020, there were 91,158 shares remaining to be repurchased under the existing stock repurchase program. During the nine months ended September 30, 2020, the Company transferred 20,830 shares of common stock out of treasury stock reserved for the 2012 Equity Incentive Plan, at an average cost of $9.39 per share to fund awards that had been granted under the plan. During the nine months ended

September 30, 2020, there were 332 shares transferred back into treasury stock reserved for the 2012 Equity Incentive Plan at an average cost of $9.39 per share due to forfeitures.

During the three months ended September 30, 2019, the Company repurchased 16,990 shares of common stock at an average cost of $14.99 per share. During the nine months ended September 30, 2019, the Company repurchased 68,190 shares of common stock at an average cost of $15.22 per share. These shares were repurchased pursuant to the Company’s publicly announced common stock repurchase program. As of September 30, 2019, there were 116,239 shares remaining to be repurchased under the existing stock repurchase program. During the nine months ended September 30, 2019, the Company transferred 5,186 shares of common stock out of treasury stock reserved for the 2012 Equity Incentive Plan, at an average cost of $9.39 per share to fund awards that had been granted under the plan. During the nine months ended September 30, 2019, there were 760 shares transferred back into treasury stock reserved for the 2012 Equity Incentive Plan at an average cost of $9.88 per share due to forfeitures.

Note 11 – Other Comprehensive Income

In addition to presenting the consolidated statements of comprehensive income herein, the following table shows the tax effects allocated to the Company’s single component of other comprehensive income (loss) for the periods presented:


	For the Three Months Ended September 30, 2020						For The Three Months Ended September 30, 2019
	Pre-Tax Amount		Tax Benefit/Expense		Net of Tax Amount		Pre-Tax Amount		Tax Expense		Net of Tax Amount
	(Unaudited)
	(Dollars in thousands)
Net unrealized (losses) gains on securities available for sale:
Net unrealized (losses) gains arising during the period	$	(155)	$	33	$	(122)	$	262	$	(55)	$	207
Less: reclassification adjustment related to:
Recovery on previously impaired investment securities included in net income		(20)		4		(16)		(13)		3		(10)
Total Other Comprehensive (Loss) Income	$	(175)	$	37	$	(138)	$	249	$	(52)	$	197


	For the Nine Months Ended September 30, 2020						For The Nine Months Ended September 30, 2019
	Pre-Tax Amount		Tax Expense		Net of Tax Amount		Pre-Tax Amount		Tax Expense			Net of Tax Amount
	(Dollars in thousands)
Net unrealized gains on securities available for sale:
Net unrealized gains arising during the period	$	928	$	(195)	$	733	$	1,862	$	(391)	$	1,471
Less: reclassification adjustment related to:
Recovery on previously impaired investment securities included in net income		(48)		10		(38)		(39)		8		(31)
Total Other Comprehensive Income	$	880	$	(185)	$	695	$	1,823	$	(383)	$	1,440

The following table presents the amounts reclassified out of the single component of the Company’s accumulated other comprehensive income for the indicated periods:


	Amounts Reclassified from Accumulated
Details about Accumulated Other	Other Comprehensive (Loss) Income				Affected Line Item
Comprehensive (Loss) Income	for the three months ended September 30,				on the Consolidated
Components	2020		2019		Statements of Income
	(Dollars in thousands)
Net unrealized gains on securities available for sale:
Recovery on previously impaired investment securities	$	(20)	$	(13)	Recovery on previously impaired investment securities
Provision for income tax expense		4		3	Income Tax Expense
Total reclassification for the period	$	(16)	$	(10)	Net Income


	Amounts Reclassified from Accumulated
Details about Accumulated Other	Other Comprehensive Income				Affected Line Item
Comprehensive Income	for the nine months ended September 30,				on the Consolidated
Components	2020		2019		Statements of Income
	(Dollars in thousands)
Net unrealized gains on securities available for sale:
Recovery on previously impaired investment securities	$	(48)	$	(39)	Recovery on previously impaired investment securities
Provision for income tax expense		10		8	Income Tax Expense
Total reclassification for the period	$	(38)	$	(31)	Net Income

Note 12 – Subsequent Events

On October 23, 2020, the Board of Directors declared a quarterly cash dividend of $0.13 per share on the Company’s common stock, payable on November 19, 2020 to shareholders of record as of November 5, 2020. Lake Shore, MHC (the “MHC”), which holds 3,636,875 shares, or approximately 62.4% of the Company’s total outstanding stock, has elected to waive receipt of the dividend on its shares. On February 28, 2020, the MHC received the non-objection of the Federal Reserve Bank of Philadelphia to waive its right to receive dividends paid by the Company during the twelve months ending February 5, 2021, aggregating up to $0.50 per share. The MHC waived $436,000 of dividends during the three months ended September 30, 2020 and $1.3 million of dividends during the nine months September 30, 2020. Cumulatively the MHC has waived approximately $13.7 million of cash dividends as of September 30, 2020. The dividends waived by the MHC are considered a restriction on the retained earnings of the Company.

Item 2. Management’s Discussion and Analysis of Financial Condition and Results of Operations.

Forward-Looking Statements

Safe-Harbor

This Quarterly Report on Form 10-Q contains certain forward-looking statements within the meaning of the Private Securities Litigation Reform Act of 1995, that are based on current expectations, estimates and projections about the Company’s and the Bank’s industry, and management’s beliefs and assumptions. Words such as anticipates, expects, intends, plans, believes, estimates and variations of such words and expressions

are intended to identify forward-looking statements. Such statements are not guarantees of future performance and are subject to certain risks, uncertainties and assumptions that are difficult to forecast. Therefore, actual results may differ materially from those expressed or forecast in such forward-looking statements.

Potential risks and uncertainties that could cause our actual results to differ from those anticipated in any forward-looking statements include, but are not limited to, those described in Part II, Item 1 of the Quarterly Report on Form 10-Q for the quarter ended June 30, 2020, Part II, Item 1A of the Quarterly Report on Form 10-Q for the quarter ended March 31, 2020 and in Part I, Item 1A of the Company’s Annual Report on Form 10-K for the year ended December 31, 2019 and the following:

general and local economic conditions;

changes in interest rates, deposit flows, demand for mortgages and other loans, real estate values and competition;

the ability of our customers to make loan payments;

the effect of competition on rates of deposit and loan growth and net interest margin;

our ability to continue to control costs and expenses;

changes in accounting principles, policies, or guidelines;

our success in managing the risks involved in our business;

inflation, and market and monetary fluctuations;

the impact of more stringent capital requirements being imposed by banking regulators;

changes in legislation or regulation, including the implementation of the Dodd-Frank act; and

other economic, competitive, governmental, regulatory and technological factors affecting our operations, pricing, products and services.

Any and all of our forward-looking statements in this Quarterly Report on Form 10-Q and in any other public statements we make may differ from actual outcomes. They can be affected by inaccurate assumptions we might make or known or unknown risks and uncertainties. Consequently, no forward-looking statement can be guaranteed. We undertake no obligation to publicly update any forward-looking statement, whether as a result of new information, future events or otherwise.

Overview

The following discussion and analysis is presented to assist in the understanding and evaluation of our consolidated financial condition and results of operations. It is intended to complement the unaudited consolidated financial statements and notes thereto appearing elsewhere in this Form 10-Q and should be read in conjunction therewith. The detailed discussion focuses on our consolidated financial condition as of September 30, 2020 compared to the consolidated financial condition as of December 31, 2019 and the consolidated results of operations for the three and nine months ended September 30, 2020 and 2019.

Our results of operations depend primarily on our net interest income, which is the difference between the interest income we earn on loans and investments and the interest expense we pay on deposits, borrowings and other interest-bearing liabilities. Net interest income is affected by the relative amounts of interest-earning assets and interest-bearing liabilities and the interest rates we earn or pay on these balances.

Our operations are also affected by non-interest income, such as service charges and fees and gains and losses on the sales of securities and loans, our provision for loan losses and non-interest expenses which include salaries and employee benefits, occupancy and equipment costs, data processing, professional services, advertising and other general and administrative expenses.

Financial institutions like us, in general, are significantly affected by economic conditions, competition, and the monetary and fiscal policies of the federal government. Lending activities are influenced by the demand for and supply of housing and commercial real estate, competition among lenders, interest rate conditions, and funds availability. Our operations and lending are principally concentrated in the Western New York area, and our operations and earnings are influenced by local economic conditions. Deposit balances and cost of funds are influenced by prevailing market rates on competing investments, customer preferences, and levels of personal income and savings in our primary market area. Operations are also significantly impacted by

government policies and actions of regulatory authorities. Future changes in applicable law, regulations or government policies may materially impact the Company.

To operate successfully, we must manage various types of risk, including but not limited to, interest rate risk, credit risk, liquidity risk, operational and information technology risks, strategic risk, reputation risk and compliance risk. A significant form of market risk for the Company is interest rate risk, as the Company’s assets and liabilities are sensitive to changes in interest rates. Interest rate risk is the exposure of our net interest income to adverse movements in interest rates. Net interest income is our primary source of revenue and interest rate risk is a significant non-credit related risk to which our Company is exposed. Net interest income is affected by changes in interest rates as well as fluctuations in the level and duration of our assets and liabilities. In addition to directly impacting net interest income, changes in interest rates can also affect the amount of new loan originations, the ability of borrowers and debt issuers to repay loans and debt securities, the volume of loan repayments and refinancing, the flow and mix of deposits and the fair value of available for sale securities. In recent years, the Company has adjusted its strategies to manage interest rate risk by originating a greater volume of shorter-term, adjustable rate commercial real estate and commercial business loans and increasing its concentration of core deposits, which are less interest rate sensitive. In the third quarter of 2018 and the first quarter of 2020, the Company entered into interest rate swap arrangements with a total notional amount of $6.0 million to convert portions of its interest earning assets into fixed or adjustable rate interest-earning assets, as applicable, to manage its exposure to movements in interest rates.

Credit risk is the risk to our earnings and stockholders’ equity that results from customers, to whom loans have been made, and from issuers of debt securities in which the Company has invested, failing to repay their obligations. The magnitude of this risk depends on the capacity and willingness of borrowers and debt issuers to repay and the sufficiency of the value of collateral obtained to secure the loans made or investments purchased. This risk is managed by policies approved by the Company’s Board of Directors, review of compliance with the policies and periodic reporting and evaluation of loans or securities that are non-performing or demonstrate other characteristics of potential loss.

RECENT MARKET CONDITIONS, RELATED RISKS AND UNCERTAINTIES

During the first nine months of 2020, an outbreak of a novel strain of coronavirus (“COVID-19”), which was originally identified in Wuhan, China, spread to a number of countries around the world, including the United States. COVID-19 and its associated impacts on trade (including supply chains and export levels), travel, employee productivity and other economic activities have had, are currently having and may for some time continue to have a destabilizing effect on financial markets and economic activity. The COVID-19 pandemic severely restricted the level of economic activity in the Bank’s market areas during 2020. In response to the COVID-19 pandemic, the New York State governor took several preventative and protective actions, such as imposing restrictions on travel and business operations, advising or requiring individuals to limit or forego their time outside of their homes, and ordering temporary closures of businesses that have been deemed non-essential. Since May 2020, some of these restrictions have been relaxed, resulting in certain industries being able to re-open for business, with appropriate health measures and social distancing protocols put in place. The initial and current restrictions and other consequences of the pandemic have resulted in significant adverse effects for many different types of businesses, including among others, those in the travel, hospitality and food and beverage industries, and have resulted in a significant number of layoffs and furloughs of employees in the market areas in which we operate.

The extent of the impact of COVID-19 on our operational and financial performance is currently uncertain, cannot be predicted and will depend on certain developments, including, among others, the duration and spread of COVID-19, its impact on our customers, employees and vendors, and governmental, regulatory and private sector responses to the coronavirus.

In light of the changing economic outlook as a result of COVID-19, as well as other factors, the 10-year Treasury yield has fallen to historic lows, and the equity markets have been significantly impacted and remain volatile. In response, the Federal Reserve reduced the target federal funds rate by 150 basis points during March 2020. The Federal Reserve’s actions and other effects of the COVID-19 pandemic may negatively impact our interest income and, therefore, our earnings, financial condition and results of operations. As a

result of the spread of COVID-19, economic uncertainties have arisen which are likely to negatively impact our provision for loan losses. Other financial impacts could occur though such potential impact is unknown at this time.

As of September 30, 2020, the Bank’s capital ratios were in excess of all regulatory requirements. While management believes we have sufficient capital to withstand an extended economic recession brought about by the COVID-19 pandemic, our regulatory capital ratios could be adversely impacted by further credit losses. The Company maintains access to multiple sources of liquidity which could be used to support capital ratios.

PANDEMIC RESPONSE

The Bank’s branches have remained open to serve our customers and local communities during the pandemic. The Company continues to place a high priority on ensuring the safety and health of its customers and employees and has put in place physical enhancements, strict social distancing protocols, and enhanced cleaning measures. The Company encourages its customers to use the branch drive-thru lanes, mobile banking and online banking services or one of the 1,900+ surcharge free ATM locations to promote appropriate social distancing protocols.

The Company implemented a loan modification program for impacted customers, in line with regulatory guidance, allowing customers to defer loan payments. As of June 30, 2020, we had approved loan payment deferral requests of up to 180 days on 219 loans, representing $103.1 million, or 21.1%, of the Bank’s loan portfolio. The number of loan payment deferral requests has decreased and as of September 30, 2020 there were 25 loans, representing $20.8 million, or 4.2%, of the loan portfolio, that were deferring payments. These loans were current at the time of initial modification and were not considered troubled debt restructurings under the CARES Act and the associated interagency guidance. Refer to Note 2 in the Consolidated Financial Statements for additional information.

The table below provides the outstanding loan balance as of October 31, 2020 for those loans that received additional payment deferrals under Section 4013 of the CARES Act (dollars in thousands):


Loan Type	Number of Loans		Balance Outstanding	Weighted Average Interest Rate

Commercial real estate	16	$	17,608	5.06	%
Commercial business	9		3,165	5.02
	25	$	20,773	5.05	%

Total payment deferral requests on real estate loans were primarily secured by real estate located in Western New York.

While many industries have and will continue to experience adverse impacts as a result of the COVID-19 pandemic, the Company’s management team has considered the categories below to be “at risk” of significant impact. The table below identifies these segments as well as the outstanding loan balance, committed loan balances, and current outstanding payment deferrals for each industry type.


	At September 30, 2020
	(dollars in thousands)
	Number of		Balance Outstanding	% of Total Loans			Loan	Total Outstanding with Payment Deferrals
Industry Type	Loans		($)	Outstanding			Commitments ($)	#	$

Retail (non-essential)	19	$	17,266	3.5	%	$	280	-	$	-
Eating and Drinking Establishments	41		16,457	3.3			3,250	11		9,990
Construction Trades	49		10,431	2.1			11,493	-		-
Hotels/Accommodations	17		11,169	2.3			854	4		6,903
Dental and Medical Practices and Gyms	13		3,690	0.7			2,063	1		193
	139	$	59,013	12.0	%	$	17,940	16	$	17,086

We are participating in the SBA PPP under the CARES Act. The CARES Act authorized the SBA to guarantee loans under a new 7(a) loan program known as the PPP. As a qualified SBA lender, we were automatically authorized to originate PPP loans. The SBA will guarantee 100% of the PPP loans made to eligible borrowers. During the first nine months of 2020, the Bank originated 252 SBA PPP loans for our customers, which totaled $26.9 million. We funded $18.4 million of PPP loans directly with the remaining $8.5 million funded indirectly via our partnership with Pursuit, an SBA lender that operates in the northeast. At September 30, 2020, there were $18.6 million in PPP loans outstanding. Net PPP loan fees are estimated to be $247,000 during the first nine months of 2020 based on current loan forgiveness expectations. In accordance with the SBA terms and conditions on these PPP loans, the Company recorded approximately $247,000 in net fees associated with the processing of these loans. Upon funding the loans, the net fees were deferred and will be amortized over the life of the loans as an adjustment to yield. We are in the process of assisting borrowers who have received PPP loans with the forgiveness application phase of the program. As of September 30, 2020, we have not yet submitted any applications to the SBA for loan forgiveness. It is expected that most customers will apply and receive PPP loan forgiveness during the next six months, upon which any unamortized deferred fees will be recognized as an adjustment to interest income.

Management Strategy

There have been no material changes in the Company’s management strategy from what was disclosed in the Company’s Annual Report on Form 10-K for the year ended December 31, 2019.

Critical Accounting Policies

Disclosure of the Company’s significant accounting policies is included in the notes to the consolidated financial statements of the Company’s Annual Report on Form 10-K for the year ended December 31, 2019. Some of these policies require significant judgment, estimates and assumptions to be made by management, most particularly in connection with determining the provision for loan losses and the appropriate level of the allowance for loan losses, as well as management’s evaluation of securities valuation, impairment of securities and income taxes. There have been no material changes in critical accounting policies since December 31, 2019.

Analysis of Net Interest Income

Net interest income represents the difference between the interest we earn on our interest-earning assets, such as commercial and residential mortgage loans and investment securities, and the expense we pay on interest-

bearing liabilities, such as deposits and borrowings. Net interest income depends on both the volume of our interest-earning assets and interest-bearing liabilities and the interest rates we earn or pay on them.

Average Balances, Interest and Average Yields. The following tables set forth certain information relating to our average balance sheets and reflects the average yield on interest-earning assets and average cost of interest-bearing liabilities, interest earned and interest paid for the periods indicated. Such yields and costs are derived by dividing income or expense by the average balance of interest-earning assets or interest-bearing liabilities, respectively, for the periods presented. Average balances are derived from daily balances over the periods indicated. The average balances for loans are net of allowance for loan losses, but include non-accrual loans. The loan yields include net amortization of certain deferred fees and costs that are considered adjustments to yields. Interest income on securities does not include a tax equivalent adjustment for tax exempt securities.


	For the Three Months Ended					For the Three Months Ended
	September 30, 2020					September 30, 2019
	Average		Interest Income/		Yield/	Average		Interest Income/		Yield/
	Balance		Expense		Rate(2)	Balance		Expense		Rate(2)
	(Dollars in thousands)
Interest-earning assets:
Interest-earning deposits & federal funds sold	$	69,561	$	15	0.09%	$	11,144	$	60	2.15%
Securities(1)		79,275		541	2.73%		79,153		606	3.06%
Loans		487,896		5,366	4.40%		451,459		5,653	5.01%
Total interest-earning assets		636,732		5,922	3.72%		541,756		6,319	4.67%
Other assets		43,847					43,542
Total assets	$	680,579				$	585,298

Interest-bearing liabilities
Demand & NOW accounts	$	85,413	$	34	0.16%	$	53,578	$	14	0.10%
Money market accounts		152,812		163	0.43%		124,923		374	1.20%
Savings accounts		62,842		9	0.06%		53,898		8	0.06%
Time deposits		161,928		627	1.55%		167,378		777	1.86%
Borrowed funds & other interest-bearing liabilities		33,037		181	2.19%		32,372		193	2.38%
Total interest-bearing liabilities		496,032		1,014	0.82%		432,149		1,366	1.26%
Other non-interest bearing liabilities		99,356					70,636
Stockholders' equity		85,191					82,513
Total liabilities & stockholders' equity	$	680,579				$	585,298
Net interest income			$	4,908				$	4,953
Interest rate spread					2.90%					3.41%
Net interest margin					3.08%					3.66%

⁽¹⁾

The tax equivalent adjustment for tax exempt securities results in rates of 3.13% and 3.50% for the three months ended September 30, 2020 and 2019, respectively.

⁽²⁾

Annualized.

	For the Nine Months Ended					For the Nine Months Ended
	September 30, 2020					September 30, 2019
	Average		Interest Income/		Yield/	Average		Interest Income/		Yield/
	Balance		Expense		Rate(2)	Balance		Expense		Rate(2)
	(Dollars in thousands)
Interest-earning assets:
Interest-earning deposits & federal funds sold	$	51,428	$	92	0.24%	$	18,097	$	312	2.30%
Securities(1)		75,102		1,628	2.89%		83,244		1,945	3.12%
Loans		482,448		16,637	4.60%		421,641		15,676	4.96%
Total interest-earning assets		608,978		18,357	4.02%		522,982		17,933	4.57%
Other assets		43,833					43,062
Total assets	$	652,811				$	566,044

Interest-bearing liabilities
Demand & NOW accounts	$	73,460	$	77	0.14%	$	51,351	$	40	0.10%
Money market accounts		151,012		809	0.71%		120,572		958	1.06%
Savings accounts		59,024		26	0.06%		53,627		24	0.06%
Time deposits		164,863		2,038	1.65%		165,071		2,227	1.80%
Borrowed funds & other interest-bearing liabilities		34,457		565	2.19%		28,358		510	2.40%
Total interest-bearing liabilities		482,816		3,515	0.97%		418,979		3,759	1.20%
Other non-interest bearing liabilities		85,421					65,483
Stockholders' equity		84,574					81,582
Total liabilities & stockholders' equity	$	652,811				$	566,044
Net interest income			$	14,842				$	14,174
Interest rate spread					3.05%					3.37%
Net interest margin					3.25%					3.61%

⁽¹⁾

The tax equivalent adjustment for tax exempt securities results in rates of 3.31% and 3.58% for the nine months ended September 30, 2020 and 2019, respectively.

⁽²⁾

Annualized.

Rate Volume Analysis. The following tables analyze the dollar amount of changes in interest income and interest expense for major components of interest-earning assets and interest-bearing liabilities. The tables show the amount of the change in interest income or expense caused by either changes in outstanding balances (volume) or changes in interest rates. The effect of a change in volume is measured by applying the average rate during the first period to the volume change between the two periods. The effect of changes in rate is measured by applying the change in rate between the two periods to the average volume during the first period. Changes attributable to both rate and volume, which cannot be segregated, have been allocated proportionately to the absolute value of the change due to volume and the change due to rate.


	Three Months Ended September 30, 2020
	Compared to
	Three Months Ended September 30, 2019
	Rate		Volume		Net Change
		(Dollars in thousands)
Interest-earning assets:
Interest-earning deposits & federal funds sold	$	(104)	$	59	$	(45)
Securities		(66)		1		(65)
Loans, including fees		(721)		434		(287)
Total interest-earning assets		(891)		494		(397)
Interest-bearing liabilities:
Demand & NOW accounts		9		11		20
Money market accounts		(281)		70		(211)
Savings accounts		-		1		1
Time deposits		(125)		(25)		(150)
Total deposits		(397)		57		(340)
Other interest-bearing liabilities:
Borrowed funds & other interest-bearing liabilities		(15)		3		(12)
Total interest-bearing liabilities		(412)		60		(352)
Total change in net interest income	$	(479)	$	434	$	(45)

	Nine Months Ended September 30, 2020
	Compared to
	Nine Months Ended September 30, 2019
	Rate		Volume			Net Change
	(Dollars in thousands)
Interest-earning assets:
Interest-earning deposits & federal funds sold	$	(448)	$	228	$	(220)
Securities		(135)		(182)		(317)
Loans, including fees		(1,191)		2,152		961
Total interest-earning assets		(1,774)		2,198		424
Interest-bearing liabilities:
Demand & NOW accounts		16		21		37
Money market accounts		(356)		207		(149)
Savings accounts		-		2		2
Time deposits		(186)		(3)		(189)
Total deposits		(526)		227		(299)
Other interest-bearing liabilities:
Borrowed funds & other interest-bearing liabilities		(37)		92		55
Total interest-bearing liabilities		(563)		319		(244)
Total change in net interest income	$	(1,211)	$	1,879	$	668

Net interest margin decreased 58 basis points to 3.08% for the 2020 third quarter as compared to the 2019 third quarter. The net interest margin for the 2020 third quarter was primarily impacted by a 95 basis points decrease in the average yield on interest-earning assets when compared to the prior year period primarily due to a decrease in market interest rates and to a lesser extent due to the impact of originating lower yielding PPP loans during the three months ended September 30, 2020. PPP loans have an interest rate of 1.00% under SBA guidelines which along with deferred origination fee income and cost, averaged 1.80%, which is well below traditional loan yields. The decrease in the average yield on interest-earning assets was partially offset by a $36.4 million, or 8.1%, increase in the average balance of the loan portfolio during the 2020 third quarter as compared to the prior year quarter. The increase in the average balance of the loan portfolio was primarily due to an increase in the average balance of commercial real estate and PPP loans. The decrease in net interest margin was partially offset by a decrease in the average interest rate paid on interest bearing liabilities which decreased from 1.26% during the 2019 third quarter to 0.82% during the 2020 third quarter due to the decrease in market interest rates. The decrease in the average interest rate paid on interest bearing liabilities during the three months ended September 30, 2020 was partially offset by a $63.2 million increase in the average balance of interest-bearing deposits in comparison to the three months ended September 30, 2019. The increase in the average balance of interest-bearing deposits was primarily driven by organic growth, the deposit of PPP funds and government stimulus payments into our customers’ deposit accounts and the impact of COVID-19 on consumer and business spending and savings levels.

Net interest margin decreased 36 basis points to 3.25% for the nine months ended September 30, 2020 from 3.61% for the nine months ended September 30, 2019. The net interest margin for the nine months ended September 30, 2020 was primarily impacted by a 55 basis points decrease in the average yield on interest-earning assets when compared to the prior year period primarily due to a decrease in market interest rates and to a lesser extent due to the impact of originating lower yielding PPP loans during the nine months ended September 30, 2020. PPP loans have an interest rate of 1.00% under SBA guidelines which along with deferred origination fee income and cost, averaged 1.80%, which is well below traditional loan yields. The decrease in the average yield on interest-earning assets was partially offset by a $60.8 million, or 14.4%, increase in the average balance of the loan portfolio during the nine months ended September 30, 2020 as compared to the prior year quarter. The increase in the average balance of the loan portfolio was primarily due to an increase in the average balance of commercial real estate and PPP loans. The decrease in net interest

margin was partially offset by a decrease in the average interest rate paid on interest bearing liabilities which decreased from 1.20% during the nine months ended September 30, 2019 to 0.97% during the nine months ended September 30, 2020 due to the decrease in market interest rates. The decrease in the average interest rate paid on interest bearing liabilities during the nine months ended September 30, 2020 was partially offset by a $57.7 million increase in the average balance of interest bearing deposits in comparison to the nine months ended September 30, 2019. The increase in the average balance of interest-bearing deposits was primarily driven by organic growth, the deposit of PPP funds and government stimulus payments into our customers’ deposit accounts and the impact of COVID-19 on consumer and business spending and savings levels.

Comparison of Financial Condition at September 30, 2020 and December 31, 2019

Total assets at September 30, 2020 were $682.7 million, an increase of $71.8 million, or 11.8%, from $610.9 million at December 31, 2019. The increase in total assets was primarily due to a $40.9 million increase in cash and cash equivalents driven by deposit growth, a $20.5 million increase in loans receivable, net and a $10.4 million increase in securities available for sale.

Cash and cash equivalents increased by $40.9 million, or 134.9%, from $30.3 million at December 31, 2019 to $71.1 million at September 30, 2020. The increase was primarily due to a $72.1 million increase in deposits, partially offset by a $22.0 million net cash outflow relating to net loan originations and principal collections, a $7.2 million net cash outflow related to securities available for sale purchases and paydowns and a $3.3 million net cash outflow to pay down long-term debt. The increase in deposits was primarily due to organic growth, the deposit of PPP funds and government stimulus payments into our customers’ deposit accounts and the impact of COVID-19 on consumer and business spending and savings levels.

Securities available for sale increased by $10.4 million, or 14.7%, from $71.2 million at December 31, 2019 to $81.6 million at September 30, 2020. The increase was primarily due to the purchase of securities, which was partially offset by maturities, calls and prepayments during the nine month period ended September 30, 2020.

Net loans receivable increased during the nine months ended September 30, 2020 as shown in the table below:


	At September 30,		At December 31,		Change
	2020		2019		$		%
	(Dollars in thousands)
Real Estate Loans:
Residential, one- to four-family(1)	$	151,356	$	154,749	$	(3,393)	(2.2)	%
Home equity		47,073		45,250		1,823	4.0	%
Commercial		216,571		211,220		5,351	2.5	%
Construction - Commercial		37,338		32,299		5,039	15.6	%
Total real estate loans		452,338		443,518		8,820	2.0	%
Other Loans:
Commercial		39,673		26,720		12,953	48.5	%
Consumer		1,312		1,297		15	1.2	%
Total gross loans		493,323		471,535		21,788	4.6	%
Allowance for loan losses		(5,347)		(4,267)		(1,080)	25.3	%
Net deferred loan costs		3,292		3,548		(256)	(7.2)	%
Loans receivable, net	$	491,268	$	470,816	$	20,452	4.3	%

(1)

Includes one- to four-family construction loans.

The increase in loans receivable, net was primarily due to an increase in commercial real estate, commercial construction and commercial business loans (primarily PPP loan originations). The outstanding balance of PPP loans was $18.6 million at September 30, 2020. During the first nine months of 2020, we remained strategically focused on originating shorter duration, adjustable rate commercial real estate loans and commercial business loans to diversify our asset mix and to properly manage interest rate risk. The origination of the SBA guaranteed PPP loans during this time period provided additional interest rate risk protection and shortened the duration of our loan portfolio.

Loans Past Due and Non-Performing Assets. The following table presents information regarding our non-accrual loans, accruing loans delinquent 90 days or more, non-performing loans, foreclosed real estate, and non-performing and performing loans classified as troubled debt restructurings, as of the dates indicated.


	At September 30,			At December 31,
	2020			2019
	(Dollars in thousands)
Loans past due 90 days or more but still accruing:
Real estate loans:
Residential, one- to four-family	$	13		$	71
Home equity		-			39
Commercial		-			-
Construction – Commercial and Residential, one- to four-family		254			-
Other loans:
Commercial		-			-
Consumer		-			-
Total	$	267		$	110
Loans accounted for on a non-accrual basis:
Real estate loans:
Residential, one- to four-family	$	2,664		$	2,845
Home equity		696			590
Commercial		-			-
Construction – Commercial and Residential, one- to four-family		-			-
Other loans:
Commercial		-			-
Consumer		1			2
Total non-accrual loans		3,361			3,437
Total non-performing loans		3,628			3,547
Foreclosed real estate		197			779
Total non-performing assets	$	3,825		$	4,326
Ratios:
Non-performing loans as a percent of total net loans:		0.74	%		0.75	%
Non-performing assets as a percent of total assets:		0.56	%		0.71	%
Troubled debt restructuring:
Loans accounted for on a non-accrual basis
Real estate loans:
Residential, one- to four-family	$	20		$	28
Performing loans
Real estate loans:
Residential, one- to four-family	$	284		$	138
Home equity		15			-

Total non-performing loans increased by $81,000, or 2.3%, to $3.6 million at September 30, 2020 from $3.5 million at December 31, 2019, primarily due to an increase in non-performing commercial construction and home equity loans which was partially offset by a decrease in non-performing residential, one- to four-family real estate loans during the first nine months of 2020.

The following table sets forth activity in our allowance for loan losses and other ratios at or for the dates indicated:


	At or for the Nine Months Ended September 30,
	2020		2019
	(Dollars in thousands)
Balance at beginning of year	$	4,267	$	3,448
Provision for loan losses		1,125		725
Charge-offs:
Real estate loans:
Residential, one- to four-family		(26)		(2)
Home equity		(6)		(4)
Commercial		-		(10)
Construction – Commercial and Residential, one- to four-family		-		-
Other loans:
Commercial		(5)		-
Consumer		(27)		(34)
Total charge-offs		(64)		(50)
Recoveries:
Real estate loans:
Residential, one- to four-family		-		8
Home equity		1		1
Commercial		1		3
Construction – Commercial and Residential, one- to four-family		-		-
Other loans:
Commercial		4		-
Consumer		13		6
Total recoveries		19		18
Net charge-offs		(45)		(32)
Balance at end of period	$	5,347	$	4,141
Average loans outstanding	$	482,448	$	421,641
Allowance for loan losses as a percent of total net loans		1.09%		0.89%
Allowance for loan losses as a percent of non-performing loans		147.38%		120.76%
Ratio of net charge-offs to average loans outstanding(1)		(0.01)%		(0.01)%

⁽¹⁾

Annualized

The projected economic impact of COVID-19 on the Company’s allowance for loan losses resulted in $828,000 of additional provision for loan losses for the nine months ended September 30, 2020. The additional provision was primarily due to an adjustment of certain qualitative factors in order to take into account the uncertain impact of COVID-19 on economic conditions and borrowers’ ability to repay loans. The remaining $297,000 increase in the provision for loan losses for this period was driven by net charge-offs, an increase in classified loans, growth and changes in the mix of the underlying loan portfolio and changes in the historical loss factor.

Accrued interest receivable increased $1.0 million, or 46.1%, to $3.1 million at September 30, 2020 from $2.2 million at December 31, 2019. The increase was primarily due to an increase in interest receivables on loans for borrowers who have been impacted by the pandemic and deferred principal and interest payments. At this time, it is expected that the deferred interest on these loans will be collected in full.

Other assets decreased $887,000, or 29.9%, to $2.1 million at September 30, 2020 from $3.0 million at December 31, 2019 primarily due to the sale of other real estate owned by the Bank and a decrease in current tax receivables.

The table below shows changes in deposit balances by type of deposit account between September 30, 2020 and December 31, 2019:


	At September 30,		At December 31,		Change
	2020		2019		$		%
	(Dollars in thousands)
Core Deposits
Demand deposits and NOW accounts:
Non-interest bearing	$	90,669	$	61,229	$	29,440	48.1	%
Interest bearing		85,718		56,703		29,015	51.2	%
Money market		154,091		141,398		12,693	9.0	%
Savings		63,870		53,628		10,242	19.1	%
Total core deposits		394,348		312,958		81,390	26.0	%
Non-core Deposits
Time deposits		161,190		170,518		(9,328)	(5.5)	%
Total deposits	$	555,538	$	483,476	$	72,062	14.9	%

The increase in total deposits was primarily due to an overall increase in net core deposits, partially offset by a decrease in time deposits. A majority of the growth in core deposits during the nine months ended September 30, 2020 was due to an increase in core deposit accounts primarily through organic growth, the deposit of PPP funds and government stimulus payments into our customers’ deposit accounts and the impact of COVID-19 on consumer and business spending and savings levels. The Company’s strategic focus continues to be centered on organic growth of low-cost core deposits among its retail and commercial customers in an effort to manage interest expense and strengthen customer relationships.

Long-term debt consisting of advances from the FHLBNY, decreased by $3.3 million, or 9.5%, from $34.7 million at December 31, 2019 to $31.4 million at September 30, 2020. The decrease was due to the Company paying off maturing debt with excess cash on hand.

Total stockholders’ equity increased by $2.0 million, or 2.5%, from $82.8 million at December 31, 2019 to $84.9 million at September 30, 2020. The increase in stockholders’ equity was primarily attributed to $3.3 million of net income and an increase of $695,000 in other comprehensive income, which was partially offset by stock repurchases of $1.4 million and dividends paid of $764,000 during the nine months ended September 30, 2020.

Comparison of Results of Operations for the Three Months Ended September 30, 2020 and 2019

General. Net income was $1.23 million for the three months ended September 30, 2020, or $0.21 per diluted share, an increase of $19,000, or 1.6%, compared to net income of $1.21 million, or $0.20 per diluted share, for the three months ended September 30, 2019. The increase in net income for the three months ended September 30, 2020 primarily reflected a $102,000 increase in non-interest income, partially offset by a $45,000 decrease in net interest income and a $35,000 increase in income tax expense.

Interest Income. Interest income decreased by $397,000, or 6.3%, to $5.9 million for the three months ended September 30, 2020 compared to the three months ended September 30, 2019 primarily due to a decrease in loan interest income. Loan interest income decreased by $287,000, or 5.1%, to $5.4 million for the three months ended September 30, 2020 compared to the three months ended September 30, 2019, primarily due to a decrease in the average yield on the loan portfolio by 61 basis points from 5.01% for the three months ended September 30, 2019 to 4.40% for the three months ended September 30, 2020. The decrease in the average

yield on loans was due to a decrease in market interest rates since September 30, 2019. It was also due to the origination of $26.7 million in PPP loans with an interest rate of 1.00% under SBA guidelines which along with deferred origination fee income and cost, averaged 1.80%, which is well below traditional loan yields. The decrease was partially offset by an increase in the average balance of the loan portfolio by $36.4 million, or 8.1%, from $451.5 million for the three months ended September 30, 2019 to $487.9 million for the three months ended September 30, 2020. The increase in the average balance of loans was primarily due to an increase in the average balance of commercial real estate, commercial construction and commercial business loans (primarily PPP loans).

Investment interest income decreased $65,000, or 10.7%, to $541,000 for the three months ended September 30, 2020 compared to the three months ended September 30, 2019, primarily due to a decrease in the average yield on the investment portfolio by 33 basis points from 3.06% for the three months ended September 30, 2019 to 2.73% for the three months ended September 30, 2020. The decrease in the average yield of the investment portfolio was primarily due to securities paydowns and redemptions of “callable” municipal bonds, partially offset by securities purchases since September 30, 2019 at lower average yields.

Other interest income decreased by $45,000, or 75.0%, to $15,000 for the three months ended September 30, 2020 as compared to the three months ended September 30, 2019. The average yield decreased to 0.09% for the three months ended September 30, 2020 from 2.15% for the three months ended September 30, 2019, while the average balance of other interest earning assets increased from $11.1 million for the three months ended September 30, 2019 to $69.6 million for the three months ended September 30, 2020. The decrease in the average yield on other interest earning assets was primarily due to lower average rates earned on excess funds, as a result of the decrease in short term market interest rates since September 30, 2019. The increase in the average balance of other interest earning assets was primarily due to an increase in average deposits that were only partially used to fund loan originations.

Interest Expense. Interest expense decreased $352,000, or 25.8%, to $1.0 million for the three months ended September 30, 2020 compared to $1.4 million for the three months ended September 30, 2019. Interest paid on deposits decreased by $340,000, or 29.0%, to $833,000 for the three months ended September 30, 2020 when compared to the three months ended September 30, 2019 primarily due to a decrease in interest paid on deposits. The decrease in interest expense on deposits was primarily due to a 45 basis points decrease in the average rate paid on deposits due to the decrease in market interest rates since September 30, 2019. The decrease was partially offset by a $63.2 million, or 15.3%, increase in average deposit balances for the three months ended September 30, 2020 as compared to the three months ended September 30, 2019. The average balance of deposits for the three months ended September 30, 2020 was $463.0 million with an average rate of 0.72% compared to the average balance of deposits of $399.8 million and an average rate of 1.17% for the three months ended September 30, 2019. The increase in the average balance of interest-bearing deposits was due to an increase in core deposit accounts primarily through organic growth, the deposit of PPP funds and government stimulus payments into our customers’ deposit accounts and the impact of COVID-19 on consumer and business spending and savings levels.

The interest expense on long-term debt increased $22,000, or 15.5%, to $164,000 for the three months ended September 30, 2020 when compared to the three months ended September 30, 2019 primarily due to an increase in the average balance of advances from the FHLBNY. The average balance of advances from the FHLBNY for the three months ended September 30, 2020 was $32.3 million with an average rate of 2.02% compared to an average balance of $26.5 million and an average rate of 2.13% for the three months ended September 30, 2019. The increase in the average balance of FHLBNY advances was due to additional borrowings that allowed the Bank to take advantage of long-term, low fixed-rates to fund loan growth and mitigate interest rate risk. The 11 basis points decrease in the average rate paid on FHLBNY advances was primarily due to the decrease in market interest rates since September 30, 2019.

Provision for Loan Losses. A $300,000 provision to the allowance for loan losses was recorded during the three months ended September 30, 2020 and 2019. The third quarter 2020 provision expense was primarily due to specific reserves required for changes in classification for certain commercial business loans and general reserves for loan originations in the third quarter of 2020.

We complete a comprehensive quarterly evaluation to determine our provision for loan losses. The evaluation reflects analyses of individual borrowers and historical loss experience, supplemented as necessary by credit judgment that considers observable trends, conditions, and other relevant environmental and economic factors.

During the three months ended September 30, 2020, the provision consisted of a $179,000 net provision recorded for commercial business loans. This included a $192,000 provision to reflect the $4.3 million increase in classified commercial business loans related to one borrower relationship, partially offset by a $13,000 credit related to a decrease in outstanding commercial business loans, excluding PPP loans. There was a $73,000 net provision for commercial real estate and construction – commercial loans during the three months ended September 30, 2020. This included a $104,000 provision to account for inherent losses in the commercial real estate and construction – commercial loan portfolio due to organic growth. This provision was partially offset by a $31,000 net credit related to changes in certain loss factors used in the model, offset by an increase in criticized and classified commercial real estate loans. A $22,000 net credit provision was recorded for one-to four-family, home equity and consumer loans primarily to reflect a decrease in classified loans during the three months ended September 30, 2020. During the three months ended September 30, 2020, a $70,000 unallocated provision for loan losses was recorded to reflect the margin of imprecision inherent in the underlying assumptions used in the methodologies for estimating allocated and general losses in the loan portfolio.

The third quarter 2019 provision included a net provision of $182,000 to account for inherent losses in the commercial real estate portfolio, including commercial construction loans, as a result of organic growth, as well as to account for changes in relevant environmental and economic factors. The quarterly provision also included a $104,000 net provision on the commercial business loan portfolio as a result of organic growth during the quarter, as well as to reflect changes in relevant environmental and economic factors. Additionally, a net provision of $14,000 was posted to reflect changes in classified loans on the one- to four- family, home equity and consumer loan portfolios as well as to adjust the unallocated portion of the allowance due to the margin of imprecision inherent in the underlying assumptions used in the methodologies for estimating allocated and general losses in the portfolio.

Refer to Note 4 of the Notes to the Consolidated Financial Statements for additional details on the provision for loan losses.

Non-Interest Income. Non-interest income increased by $102,000, or 15.2%, to $771,000 for the three months ended September 30, 2020 as compared to $669,000 for the three months ended September 30, 2019. The increase was primarily due to a $157,000 increase in gains on the sale of loans and a $38,000 increase in unrealized gains on derivative contracts, partially offset by a $66,000 decrease in service charges and fees and a $28,000 increase in unrealized losses on equity securities during the three months ended September 30, 2020 as compared to the prior year period. The increase in gains on the sale of loans was driven by an increase in the volume of low, fixed-rate residential mortgage loans originated for sale during the three months ended September 30, 2020 due to a decrease in market rates. We sell certain low, fixed rate mortgages into the secondary market to manage interest rate risk. The increase in unrealized gains on derivative contracts was due to net changes in the fair market value of interest rate swap products. The decrease in service charges and fees was primarily due to the waiver of certain ATM fees and other service charges to provide relief to customers during the COVID-19 pandemic.

Non-Interest Expenses. Non-interest expenses were $3.9 million for the three months ended September 30, 2020 and 2019. Other expenses decreased $128,000, or 35.2%, primarily due to a decrease in travel, foreclosure and other real estate owned expenses. Salaries and employee benefits increased $61,000, or 2.9%, primarily due to an increase in employee salaries, partially offset by an increase in deferred salary expense related to loan originations and decreases to stock-based compensation expenses and health insurance costs. FDIC Insurance expense increased $43,000 for the three months ended September 30, 2020 due to the receipt of a small bank assessment credit during the three months ended September 30, 2019. Occupancy and equipment expenses increased $15,000, or 2.4%, primarily due to increases in software and technology maintenance costs, equipment depreciation and additional cleaning expense related to COVID-19.

Income Taxes Expense. Income tax expense was $226,000 for the three months ended September 30, 2020, an increase of $35,000, or 18.3%, as compared to $191,000 for the three months ended September 30, 2019. The increase in income tax expense was primarily due to an increase in income before taxes and an increase in the effective tax rate. The effective tax rate for the three months ended September 30, 2020 and 2019 was 15.5% and 13.6%, respectively. The increase in effective tax rate was primarily due to a decrease in the mix of tax-exempt income derived from our municipal bond portfolio in relation to our pre-tax income for the current period.

Comparison of Results of Operations for the Nine Months Ended September 30, 2020 and 2019

General. Net income was $3.3 million for the nine months ended September 30, 2020, or $0.56 per diluted share, an increase of $400,000, or 13.7%, compared to net income of $2.9 million, or $0.48 per diluted share, for the nine months ended September 30, 2019. The increase in net income for the nine months ended September 30, 2020 primarily reflected a $668,000 increase in net interest income, a $214,000 decrease in non-interest expenses and a $30,000 increase in non-interest income, partially offset by a $400,000 increase in provision for loans losses and a $112,000 increase in income tax expense.

Interest Income. Interest income increased by $424,000, or 2.4%, to $18.4 million for the nine months ended September 30, 2020 compared to the nine months ended September 30, 2019 primarily due to an increase in loan interest income. Loan interest income increased by $1.0 million, or 6.1%, to $16.6 million for the nine months ended September 30, 2020 compared to the nine months ended September 30, 2019, primarily due to an increase in the average balance of the loan portfolio by $60.8 million, or 14.4%, from $421.6 million for the nine months ended September 30, 2019 to $482.4 million for the nine months ended September 30, 2020. The increase in the average balance of loans was primarily due to an increase in the average balance of commercial real estate, commercial construction and PPP commercial business loans. The average yield on the loan portfolio decreased by 36 basis points from 4.96% for the nine months ended September 30, 2019 to 4.60% for the nine months ended September 30, 2020. The decrease in the average yield on loans was due to a decrease in market interest rates since September 30, 2019. It was also due to the origination of PPP loans during the first nine months of 2020 with an interest rate of 1.00% under SBA guidelines which along with deferred origination fee income and cost averaged 1.80%, which is well below traditional loan yields.

Investment interest income decreased $317,000, or 16.3%, to $1.6 million for the nine months ended September 30, 2020 compared to the nine months ended September 30, 2019, primarily due to a decrease in the average balance of the investment portfolio from $83.2 million for the nine months ended September 30, 2019 to $75.1 million for the nine months ended September 30, 2020. The average yield on the investment portfolio decreased 23 basis points from 3.12% for the nine months ended September 30, 2019 to 2.89% for the nine months ended September 30, 2020. The decrease in the average balance and average yield of the investment portfolio was primarily due to securities paydowns and redemptions of “callable” municipal bonds, partially offset by securities purchases since September 30, 2019 at lower average yields.

Other interest income decreased by $220,000, or 70.5%, to $92,000 for the nine months ended September 30, 2020 as compared to the nine months ended September 30, 2019. The average yield decreased to 0.24% for the nine months ended September 30, 2020 from 2.30% for the nine months ended September 30, 2019, while the average balance of other interest earning assets increased from $18.1 million for the nine months ended September 30, 2019 to $51.4 million for the nine months ended September 30, 2020. The decrease in the average yield on other interest earning assets was primarily due to lower average rates earned on excess funds, as a result of the decrease in short term market interest rates since September 30, 2019. The increase in the average balance of other interest earning assets was primarily due to an increase in average deposits that were only partially used to fund loan originations.

Interest Expense. Interest expense decreased $244,000, or 6.5%, to $3.5 million for the nine months ended September 30, 2020 compared to $3.8 million for the nine months ended September 30, 2019 primarily due to a decrease in interest paid on deposits. Interest paid on deposits decreased by $299,000, or 9.2%, to $3.0 million for the nine months ended September 30, 2020 when compared to the nine months ended September 30, 2019. The decrease in interest expense on deposits was primarily due to a 23 basis points decrease in the

average rate paid on deposits due to the decrease in market interest rates since September 30, 2019. The decrease was partially offset by a $57.7 million, or 14.8%, increase in average deposit balances for the nine months ended September 30, 2020 as compared to the nine months ended September 30, 2019. The average balance of deposits for the nine months ended September 30, 2020 was $448.4 million with an average rate of 0.88% compared to the average balance of deposits of $390.6 million and an average rate of 1.11% for the nine months ended September 30, 2019. The increase in the average balance of interest-bearing deposits was due to an increase in core deposit accounts primarily through organic growth, the deposit of PPP funds and government stimulus payments into our customers’ deposit accounts and the impact of COVID-19 on consumer and business spending and savings levels.

The interest expense on long-term debt increased $104,000, or 25.4%, to $513,000 for the nine months ended September 30, 2020 when compared to the nine months ended September 30, 2019 primarily due to an increase in the average balance of advances from the FHLBNY. The average balance of advances from the FHLBNY for the nine months ended September 30, 2020 was $33.7 million with an average rate of 2.03% compared to an average balance of $25.2 million and an average rate of 2.17% for the nine months ended September 30, 2019. The increase in the average balance of FHLBNY advances was due to additional borrowings that allowed the Bank to take advantage of long term, low fixed-rates to fund loan growth and mitigate interest rate risk. The 14 basis points decrease in the average rate paid on FHLBNY advances was primarily due to the decrease in market interest rates since September 30, 2019. The increase in long-term debt was partially offset by a $46,000 decrease in short-term debt during the nine months ended September 30, 2020 due to paydowns.

Provision for Loan Losses. A $1.1 million provision to the allowance for loan losses was recorded during the nine months ended September 30, 2020 compared to $725,000 for the nine months ended September 30, 2019. The $400,000 increase in the provision expense was primarily due to an adjustment of certain qualitative factors to take into account the impact of COVID-19 and related economic conditions on borrowers’ ability to repay loans. We expect economic uncertainty to continue which may result in additional increases to the allowance for loan losses in future periods. The current period provision was also impacted by an increase in criticized commercial real estate and commercial business loans.

During the nine months ended September 30, 2020, the Company recorded a $933,000 net provision for commercial real estate and construction – commercial loans. This consisted of a $693,000 provision to reflect an adjustment of certain qualitative factors to take into account the uncertain impacts of COVID-19 on economic conditions and borrowers’ ability to repay loans and a $156,000 general allowance to reflect inherent losses within the portfolio due to organic growth. It also included an $84,000 provision to reflect the $11.9 million increase in criticized and classified commercial real estate loans, which consists primarily of one loan relationship which is well-collateralized and has strong support by its guarantors. A $183,000 net provision was recorded for commercial business loans which reflected adjustments to certain qualitative factors relating to the COVID-19 impact on economic conditions and an increase in classified loans. The provision also reflected a credit allowance to account for a $5.7 million decrease in outstanding commercial business loans, excluding PPP loans, during the nine months ended September 30, 2020. A $44,000 provision was recorded for one-to four-family, home equity and consumer loans primarily to reflect an increase in classified loans during the nine months ended September 30, 2020. A $35,000 unallocated credit provision was recorded to reflect the margin of imprecision inherent in the underlying assumptions used in the methodologies for estimating allocated and general losses in the loan portfolio.

The provision to the allowance for loan losses recorded during the nine months ended September 30, 2019 included a $1.1 million net provision to account for inherent losses in the commercial real estate portfolio, including commercial construction loans, as a result of organic growth and to account for changes in relevant environmental and economic factors, which was partially offset by a credit due to reductions in criticized and classified commercial real estate loans. A $270,000 net credit was recorded on the commercial business loan

portfolio to account for reductions in criticized and classified commercial business loans during the nine months ended September 30, 2019, changes in the related environmental factors used to qualitatively assess inherent loan losses on commercial business loans and changes in the historical average net charge-off rate, which was partially offset by a provision to account for inherent losses on the $3.8 million, or 17.3%, increase in commercial business loans since December 31, 2018. An $18,000 net credit to the provision was recorded for one-to four-family, home equity and consumer loans due to changes in the related environmental factors used to qualitatively assess inherent loan losses on these types of loans, partially offset by a provision to reflect a net increase in classified loans during the nine months ended September 30, 2019. Lastly, a $53,000 credit was recorded on the unallocated provision for loan losses, to reflect the margin of imprecision inherent in the underlying assumptions used in the methodologies for estimating allocated and general losses in the portfolio.

Refer to Note 4 of the Notes to the Consolidated Financial Statements for additional details on the provision for loan losses.

Non-Interest Income. Non-interest income increased by $30,000, or 1.7%, to $1.8 million for the nine months ended September 30, 2020 as compared to the nine months ended September 30, 2019. The increase was primarily due to a $304,000 increase in gains on the sale of loans. This was driven by an increase in the volume of residential mortgage loans originated for sale during the nine months ended September 30, 2020 due to the decrease in market rates. We sell certain low, fixed rate mortgages into the secondary market to manage interest rate risk. The increase in non-interest income was partially offset by a $139,000 decrease in service charges and fees during the nine months ended September 30, 2020 primarily due to the waiver of certain ATM fees and other service charges to provide relief to customers during the COVID-19 pandemic. The increase was also partially offset by an $81,000 increase in unrealized losses on equity securities and a $47,000 increase in unrealized losses on derivative contracts due to the decrease in market interest rates.

Non-Interest Expenses. Non-interest expenses were $11.7 million for the nine months ended September 30, 2020, a decrease of $214,000 or 1.8%, as compared to $11.9 million for the nine months ended September 30, 2019. Salaries and employee benefits decreased $198,000, or 3.0%, primarily due to an increase in deferred salary expense related to PPP loan originations and decreases in stock-based compensation expense and health insurance costs, partially offset by an increase in employee salaries. Other expenses decreased $126,000, or 12.9%, primarily due to a decrease in travel, foreclosure and other real estate owned expenses. These decreases were partially offset by an increase in occupancy and equipment expenses of $66,000, or 3.4%, primarily due to increases in software and technology maintenance costs, equipment depreciation and additional cleaning expense related to COVID-19. Advertising expense increased $17,000, or 3.3%, primarily due to an increase in promotional expenses. Postage and supplies increased $23,000, or 12.7%, during the nine months ended September 30, 2020, primarily due to additional supply purchases to protect the health and safety of customers and employees as a result of the pandemic.

Income Taxes Expense. Income tax expense was $581,000 for the nine months ended September 30, 2020, an increase of $112,000, or 23.9%, as compared to $469,000 for the nine months ended September 30, 2019. The increase in income tax expense was primarily due to an increase in income before taxes and an increase in the effective tax rate. The effective tax rate for the nine months ended September 30, 2020 and 2019 was 14.9% and 13.9%, respectively. The increase in effective tax rate was primarily due to a decrease in the mix of tax-exempt income derived from our municipal bond portfolio in relation to our pre-tax income.

Liquidity and Capital Resources

Liquidity describes our ability to meet the financial obligations that arise during the ordinary course of business. Liquidity is primarily needed to fund loan commitments, to pay the deposit withdrawal requirements of our customers as well as to fund current and planned expenditures. Our primary sources of funds consist of deposits, scheduled amortization and prepayments of loans and securities, maturities and sales of investments and loans, excess cash, interest earning deposits at other financial institutions, and funds provided from operations. We have written agreements with the FHLBNY, which allows us to borrow the maximum lending values designated by the type of collateral pledged. As of September 30, 2020, the maximum amount that we can borrow from the FHLBNY was $106.0 million and was collateralized by a pledge of certain fixed-rate

residential, one- to four-family loans. At September 30, 2020, we had outstanding advances under this agreement of $31.4 million. We have a written agreement with the Federal Reserve Bank discount window for overnight borrowings which is collateralized by a pledge of our securities, and allows us to borrow up to the value of the securities pledged, which was equal to a book value of $10.9 million and a fair value of $11.2 million as of September 30, 2020. There were no balances outstanding with the Federal Reserve Bank at September 30, 2020. We have also established lines of credits with correspondent banks for $31.0 million, of which $29.0 million is unsecured and the remaining $2.0 million will be secured by a pledge of our securities when a draw is made. There were no borrowings on these lines as of September 30, 2020.

While maturities and scheduled amortization of loans and securities are predictable sources of funds, deposit outflows, calls of investment securities, and prepayments of loans and mortgage-backed securities are strongly influenced by interest rates, general and local economic conditions, and competition in the marketplace. These factors reduce the predictability of the timing of these sources of funds. We have not experienced any unusual pressure on our deposit balances or our liquidity position as a result of the COVID-19 pandemic.

Our primary investing activities include the origination of loans and the purchase of investment securities. For the nine months ended September 30, 2020, we originated loans of approximately $117.3 million as compared to approximately $135.1 million of loans originated during the nine months ended September 30, 2019. Loan originations exceeded principal repayments and other deductions during the first nine months of 2020 by $22.0 million. Purchases of investment securities totaled $20.3 million during the nine months ended September 30, 2020. We did not purchase any investment securities during the nine months ended September 30, 2019. These activities were funded primarily through deposit growth, principal payments received on loans and securities, borrowings and cash reserves.

As described elsewhere in this report, the Company has loan commitments to borrowers and borrowers have unused overdraft lines of protection, unused home equity lines of credit and unused commercial lines of credit that may require funding at a future date. The Company believes it has sufficient funds to fulfill these commitments, including sources of funds available through the use of FHLBNY advances or other liquidity sources. Total deposits were $555.5 million at September 30, 2020, as compared to $483.5 million at December 31, 2019. Approximately $101.2 million of time deposit accounts are scheduled to mature within one year as of September 30, 2020. Based on our deposit retention experience, current pricing strategy, and competitive pricing policies, we anticipate that a significant portion of these time deposits will remain with us following their maturity.

We are committed to maintaining a strong liquidity position; therefore, we monitor our liquidity position on a daily basis. We anticipate that we will have sufficient funds to meet our current funding commitments. The marginal cost of new funding, however, whether from deposits or borrowings from the FHLBNY, will be carefully considered as we monitor our liquidity needs. Therefore, in order to minimize our cost of funds, we may consider additional borrowings from the FHLBNY in the future.

We do not anticipate any material capital expenditures in 2020. We do not have any balloon or other payments due on any long-term obligations, other than the borrowing agreements noted above.

Capital

Federal regulations require a federal savings bank to meet certain capital standards, as discussed in the “Supervision and Regulation - Federal Banking Regulation – Capital Requirements section included in our Annual Report on Form 10-K for the year ended December 31, 2019.

As a result of the recently enacted Economic Growth, Regulatory Relief, and Consumer Protection Act, the federal banking agencies have developed a “Community Bank Leverage Ratio” (bank’s tier 1 capital to average total consolidated assets) for financial institutions with assets of less than $10 billion and limited amounts of off-balance-sheet exposures and trading assets and liabilities. A “qualifying community bank” may elect to utilize the Community Bank Leverage Ratio in lieu of the general applicable risk-based capital requirements under Basel III. If the community bank exceeds this ratio it will be deemed to be in compliance

with all other capital and leverage requirements, including the capital requirements to be considered “well capitalized” under Basel III. The federal banking agencies may consider a financial institution’s risk profile when evaluating whether it qualifies as a community bank for purposes of the capital ratio requirement. The federal banking agencies set the minimum capital for the Community Bank Leverage Ratio at 9.00%. Pursuant to the CARES Act, the federal banking agencies issued final rules to set the Community Bank Leverage Ratio at 8% beginning in the second quarter of 2020 through the end of 2020. Beginning in 2021, the Community Bank Leverage Ratio will increase to 8.5% for the calendar year. Community banks will have until Jan. 1, 2022, before the Community Bank Leverage Ratio requirement will return to 9%. The Bank elected to be subject to this new definition when it became effective on January 1, 2020.

As of September 30, 2020, the Bank was considered a “qualifying community bank” and its Community Bank Leverage Ratio was 11.69% so it was deemed to be in compliance with all other capital and leverage requirements, including the capital requirements to be considered “well capitalized” under Prompt Corrective Action statutes.

Off-Balance Sheet Arrangements

Other than loan commitments and two interest rate swap agreements that are not designated as hedging instruments, as previously noted, we do not have any off-balance sheet arrangements that have or are reasonably likely to have a current or future effect on our financial condition, revenues or expenses, results of operations, liquidity, capital expenditures, or capital resources that is material to investors. Refer to Note 7 in the Notes to our Consolidated Financial Statements for a summary of loan commitments outstanding as of September 30, 2020.

Item 3. Quantitative and Qualitative Disclosures About Market Risk

Not required as the Company is a smaller reporting company.

Item 4. Controls and Procedures.

Disclosure Controls and Procedures

The Company’s management, with the participation of its Chief Executive Officer and Chief Financial Officer, evaluated the effectiveness of the Company’s disclosure controls and procedures (as defined in Rules 13(a)-15(e) and 15d-15(e) under the Securities Exchange Act of 1934) as of the end of the period covered by this report. Based upon such evaluation, the Company’s Chief Executive Officer and Chief Financial Officer have concluded that, as of the end of such period, the Company’s disclosure controls and procedures were effective.

Changes in Internal Control over Financial Reporting

There have not been any changes in the Company’s internal control over financial reporting (as such term is defined in Rules 13a-15(f) and 15d-15(f) under the Securities Exchange Act of 1934) during the quarter ended September 30, 2020 that have materially affected, or are reasonably likely to materially affect, internal control over financial reporting.

PART II

Item 1A. Risk Factors.

In addition to the other information contained in this Quarterly Report on Form 10-Q, the following risk factor represents material updates and additions to the risk factors previously disclosed in our Annual Report on Form 10-K for the year ended December 31, 2019 as filed with the SEC. Additional risks not presently known to us, or that we currently deem immaterial, may also adversely affect our business, financial condition or results of operations. Further, to the extent that any of the information contained in this Quarterly Report on Form 10-Q constitutes forward-looking statements, the risk factor set forth below also is a cautionary

statement identifying important factors that could cause our actual results to differ materially from those expressed in any forward-looking statements made by or on behalf of us.

The economic impact of the COVID-19 outbreak could adversely affect our financial condition and results of operations.

In December 2019, a coronavirus (COVID-19) was reported in China, and, in March 2020, the World Health Organization declared it a pandemic. On March 12, 2020 the President of the United States declared the COVID-19 outbreak in the United States a national emergency. The COVID-19 pandemic has caused significant economic dislocation in the United States as many state and local governments ordered non-essential businesses to close and residents to shelter in place at home. New York State was under a shelter in place at home order for most of the 2020 second quarter. This resulted in an unprecedented slow-down in economic activity, a steep, rapid increase in unemployment and stock market volatility. In response to the COVID-19 outbreak, the Federal Reserve reduced the benchmark fed funds rate to a target range of 0% to 0.25%, and the yields on 10 and 30-year treasury notes have declined to historic lows. The State of New York and certain federal agencies required lenders to provide forbearance and other relief to borrowers (e.g., waiving late payment and other fees). The federal banking agencies have encouraged financial institutions to prudently work with affected borrowers and passed legislation that has provided relief from reporting loan classifications due to modifications related to the COVID-19 outbreak. Certain industries have been particularly hard-hit, including the travel and hospitality industry, the restaurant industry and the retail industry. Finally, the spread of the coronavirus has caused us to modify our business practices, including employee travel, employee work locations, and cancellation of physical participation in meetings, events and conferences. We do have certain back-office employees working remotely to promote social distancing in our buildings and we may take further actions as may be required by government authorities or that we determine are in the best interests of our employees, customers and business partners.

Given the ongoing and dynamic nature of the circumstances, it is difficult to predict the full impact of the COVID-19 outbreak on our business. The extent of such impact will depend on future developments, which are highly uncertain, including when the coronavirus can be controlled and abated, and how to continue to safely re-open businesses and improve economic conditions. As the result of the COVID-19 pandemic and the related adverse local and national economic consequences, we could be subject to any of the following risks, any of which could have a material, adverse effect on our business, financial condition, liquidity, and results of operations:

•demand for our products and services may decline, making it difficult to grow assets and income;

•if the economy is unable to substantially reopen, and high levels of unemployment continue for an extended period of time, loan delinquencies, problem assets, and foreclosures may increase, resulting in increased charges and reduced income;

•collateral for loans, especially real estate, may decline in value, which could cause loan losses to increase;

•our allowance for loan losses may have to be increased if borrowers experience financial difficulties beyond forbearance periods, which will adversely affect our net income;

•the net worth and liquidity of loan guarantors may decline, impairing their ability to honor commitments to us;

•as the result of the decline in the Federal Reserve Board’s target federal funds rate to near 0%, the yield on our assets may decline to a greater extent than the decline in our cost of interest-bearing liabilities, reducing our net interest margin and spread and reducing net income;

•a material decrease in net income or a net loss over several quarters could result in a decrease in the rate of our quarterly cash dividend;

•our cyber security risks are increased as the result of an increase in the number of employees working remotely;

•we rely on third party vendors for certain services and the unavailability of a critical service due to the COVID-19 outbreak could have an adverse effect on us; and

•Federal Deposit Insurance Corporation premiums may increase if the agency experiences additional resolution costs.

Moreover, our future success and profitability substantially depends on the management skills of our executive officers and directors, many of whom have held officer and director positions with us for many years. The unanticipated loss or unavailability of key employees due to the outbreak could harm our ability to operate our business or execute our business strategy. We may not be successful in finding and integrating suitable successors in the event of key employee loss or unavailability.

Any one or a combination of the factors identified above could negatively impact our business, financial condition and results of operations and prospects.

Item 2. Unregistered Sales of Equity Securities and Use of Proceeds

The following table reports information regarding repurchases by Lake Shore Bancorp of its common stock in each month of the quarter ended September 30, 2020:

COMPANY PURCHASES OF EQUITY SECURITIES



Period	Total Number of Shares Purchased		Average Price Paid per Share	Total Number of Shares Purchased as Part of Publicly Announced Plans or Programs	Maximum Number of Shares that May Yet be Purchased Under the Plans or Programs (1)

July 1 through July 31, 2020	21,300	$	13.45	21,300	8,239
August 1 through August 31, 2020	4,300		11.89	4,300	107,658
September 1 through September 30, 2020	16,500		12.85	16,500	91,158
Total	42,100	$	13.06	42,100	91,158

⁽¹⁾

On August 13, 2020, our Board of Directors approved a new stock repurchase plan pursuant to which we can repurchase up to 111,958 shares of our outstanding common stock. This amount represented approximately 5% of our outstanding common stock not owned by the MHC as of August 13, 2020. The repurchase plan does not have an expiration date and superseded all of the prior stock repurchase programs.

Item 6. Exhibits



			31.1				Certification by the Chief Executive Officer Pursuant to Section 302 of the Sarbanes-Oxley Act of 2002*
			31.2				Certification by the Chief Financial Officer Pursuant to Section 302 of the Sarbanes- Oxley Act of 2002*
			32.1				Certification by the Chief Executive Officer Pursuant to 18 U.S.C. Section 1350, as Adopted Pursuant to Section 906 of the Sarbanes-Oxley Act of 2002*
			32.2				Certification by the Chief Financial Officer Pursuant to 18 U.S.C. Section 1350, as Adopted Pursuant to Section 906 of the Sarbanes-Oxley Act of 2002*
			101.INS				XBRL Instance Document*
			101.SCH				XBRL Taxonomy Extension Schema Document*
			101.CAL				XBRL Taxonomy Calculation Linkbase Document*
			101.DEF				XBRL Taxonomy Extension Definition Linkbase Document*
			101.LAB				XBRL Taxonomy Label Linkbase Document*
			101.PRE				XBRL Taxonomy Presentation Linkbase Document*

________________

*Filed herewith.

SIGNATURES

Pursuant to the requirements of the Securities Exchange Act of 1934, the Registrant has duly caused this report to be signed on its behalf by the undersigned, thereunto duly authorized.


		LAKE SHORE BANCORP, INC.
		(Registrant)

November 12, 2020	By:	/s/ Daniel P. Reininga
		Daniel P. Reininga
		President and Chief Executive Officer
		(Principal Executive Officer)

November 12, 2020	By:	/s/ Rachel A. Foley
		Rachel A. Foley
		Chief Financial Officer
		(Principal Financial Officer)

November 12, 2020	By:	/s/ Steven W. Schiavone
		Steven W. Schiavone
		Controller
		(Principal Accounting Officer)