PCSB Financial Corp - Quarter Report: 2020 September (Form 10-Q)

UNITED STATES

SECURITIES AND EXCHANGE COMMISSION

WASHINGTON, DC 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

For the transition period from _____ to _____

Commission File Number: 001-38065

PCSB Financial Corporation

(Exact Name of Registrant as Specified in its Charter)

Maryland	81-4710738
(State or other jurisdiction of incorporation or organization)	(I.R.S. Employer Identification No.)
2651 Strang Blvd, Suite 100 Yorktown Heights, NY	10598
(Address of principal executive offices)	(Zip Code)

Registrant’s telephone number, including area code: (914) 248-7272

N/A

(Former name, former address and former fiscal year, if changed since last report)

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

Title of each class

Trading

Symbol(s)

Name of each exchange on which registered

Common Stock, $0.01 par value per share

PCSB

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 (or for such shorter period that the registrant was required to file such reports), and (2) has been subject to such filing requirements for the past 90 days. Yes ☒ 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 ☒ 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 the definitions 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	☐	Small 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 completing with any 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 ☒

16,417,737 shares of the Registrant’s common stock, par value $0.01 per share, were outstanding as of November 4, 2020.

Table of Contents

		Page
PART I.	FINANCIAL INFORMATION
Item 1.	Financial Statements (Unaudited)	3
	Consolidated Balance Sheets	3
	Consolidated Statements of Operations	4
	Consolidated Statements of Comprehensive Income	5
	Consolidated Statements of Changes in Shareholders’ Equity	6
	Consolidated Statements of Cash Flows	7
	Notes to Unaudited Consolidated Financial Statements	8
Item 2.	Management’s Discussion and Analysis of Financial Condition and Results of Operations	30
Item 3.	Quantitative and Qualitative Disclosures About Market Risk	38
Item 4.	Controls and Procedures	38
PART II.	OTHER INFORMATION
Item 1.	Legal Proceedings	39
Item 1A.	Risk Factors	39
Item 2.	Unregistered Sales of Equity Securities and Use of Proceeds	39
Item 3.	Defaults Upon Senior Securities	39
Item 4.	Mine Safety Disclosures	39
Item 5.	Other Information	39
Item 6.	Exhibits	40
Signatures		41

PART I—FINANCIAL INFORMATION

Item 1. Financial Statements.

PCSB Financial Corporation and Subsidiaries

Consolidated Balance Sheets (unaudited)

(amounts in thousands, except share and per share data)

	September 30,			June 30,
	2020			2020
ASSETS
Cash and due from banks	$	161,387		$	135,045
Federal funds sold		1,352			1,257
Total cash and cash equivalents		162,739			136,302
Investment securities:
Held to maturity debt securities, at amortized cost (fair value of $293,810, and $281,497, respectively)		287,370			275,772
Available for sale debt securities, at fair value		31,139			37,426
Total investment securities		318,509			313,198
Loans receivable, net of allowance for loan losses of $8,672 and $8,639, respectively		1,227,913			1,260,947
Accrued interest receivable		6,729			6,880
FHLB stock		6,307			6,308
Premises and equipment, net		20,195			20,853
Deferred tax asset, net		3,400			3,129
Bank-owned life insurance		25,151			25,019
Goodwill		6,106			6,106
Other intangible assets		209			229
Other assets		13,817			12,958
Total assets	$	1,791,075		$	1,791,929
LIABILITIES AND SHAREHOLDERS' EQUITY
Interest bearing deposits	$	1,193,168		$	1,181,357
Non-interest bearing deposits		183,844			191,898
Total deposits		1,377,012			1,373,255
Mortgage escrow funds		6,420			10,123
Advances from FHLB		106,056			106,089
Other liabilities		27,908			28,749
Total liabilities		1,517,396			1,518,216
Commitments and contingencies		-			-
Shareholders' equity:
Preferred stock ($0.01 par value, 10,000,000 shares authorized, no shares issued or outstanding as of September 30, 2020 and June 30, 2020)		-			-
Common stock ($0.01 par value, 200,000,000 shares authorized, 18,712,295 shares issued as of September 30, 2020 and June 30, 2020, respectively, and 16,634,237 and 16,898,137 shares outstanding as of September 30, 2020 and June 30, 2020, respectively)		187			187
Additional paid in capital		187,026			186,200
Retained earnings		143,386			141,288
Unearned compensation - ESOP		(10,901	)		(11,145	)
Accumulated other comprehensive loss, net of income taxes		(6,216	)		(6,403	)
Treasury stock, at cost (2,078,058 and 1,814,158 shares as of September 30, 2020 and June 30, 2020, respectively)		(39,803	)		(36,414	)
Total shareholders' equity		273,679			273,713
Total liabilities and shareholders' equity	$	1,791,075		$	1,791,929

See accompanying notes to the consolidated financial statements (unaudited)

PCSB Financial Corporation and Subsidiaries

Consolidated Statements of Operations (unaudited)

(amounts in thousands, except share and per share data)

	Three Months Ended September 30,
	2020		2019
Interest and dividend income
Loans receivable	$	12,547	$	13,036
Investment securities		1,856		2,692
Federal funds and other		125		298
Total interest and dividend income		14,528		16,026
Interest expense
Deposits and escrow interest		2,432		3,301
FHLB advances		519		727
Total interest expense		2,951		4,028
Net interest income		11,577		11,998
Provision for loan losses		109		335
Net interest income after provision for loan losses		11,468		11,663
Noninterest income
Fees and service charges		322		402
Bank-owned life insurance		132		137
Swap income		129		170
Other		11		56
Total noninterest income		594		765
Noninterest expense
Salaries and employee benefits		5,607		5,764
Occupancy and equipment		1,318		1,315
Communication and data processing		576		531
Professional fees		400		404
Postage, printing, stationary and supplies		139		140
FDIC assessment		113		-
Advertising		100		100
Amortization of intangible assets		20		24
Other operating expenses		351		509
Total noninterest expense		8,624		8,787
Net income before income tax expense		3,438		3,641
Income tax expense		710		812
Net income	$	2,728	$	2,829
Earnings per common share:
Basic	$	0.18	$	0.18
Diluted	$	0.18	$	0.18
Weighted average common shares outstanding:
Basic		15,302,838		15,979,762
Diluted		15,302,949		16,082,276

See accompanying notes to the consolidated financial statements (unaudited)

PCSB Financial Corporation and Subsidiaries

Consolidated Statements of Comprehensive Income (unaudited)

(amounts in thousands)

	Three Months Ended September 30,
	2020			2019
Net income	$	2,728		$	2,829

Other comprehensive income :
Unrealized (losses) gains on available for sale debt securities:
Net change in unrealized gains/losses before reclassification adjustment		(16	)		181
Reclassification adjustment for gains realized in net income		-			-
Net change in unrealized gains/losses		(16	)		181
Tax effect		3			(38	)
Net of tax		(13	)		143

Defined benefit pension plan:
Net gain (loss) arising during the period		-			-
Reclassification adjustment for amortization of prior service cost and net gain included in net periodic pension cost		240			133
Tax effect		(51	)		(29	)
Net of tax		189			104

Supplemental retirement plans:
Net gain (loss) arising during the period		-			-
Reclassification adjustment for amortization of prior service cost and net gain included in net periodic pension cost		14			11
Tax effect		(3	)		(2	)
Net of tax		11			9

Total other comprehensive income		187			256

Comprehensive income	$	2,915		$	3,085

See accompanying notes to the consolidated financial statements (unaudited)

PCSB Financial Corporation and Subsidiaries

Consolidated Statements of Changes in Shareholders’ Equity (unaudited)

(amounts in thousands, except share and per share data)

																		Accumulated
	Number of					Additional						Unallocated			Treasury			Other
	Common			Common		Paid-In			Retained			Common Stock			Stock,			Comprehensive			Total
	Shares			Stock		Capital			Earnings			of ESOP			at cost			Loss			Equity
Balance at July 1, 2020		16,898,137		$	187	$	186,200		$	141,288		$	(11,145	)	$	(36,414	)	$	(6,403	)	$	273,713
Net income		-			-		-			2,728			-			-						2,728
Other comprehensive income		-			-		-			-			-			-			187			187
Common stock dividends declared ($0.04 per share)		-			-		-			(630	)		-			-			-			(630	)
Repurchase of common stock		(266,900	)		-		-			-			-			(3,449	)		-			(3,449	)
Restricted stock awards granted		3,000			-		(60	)		-			-			60						-
Stock-based compensation		-			-		829			-			-			-			-			829
ESOP shares committed to be released (24,419 shares)		-			-		57			-			244			-			-			301
Balance at September 30, 2020		16,634,237		$	187	$	187,026		$	143,386		$	(10,901	)	$	(39,803	)	$	(6,216	)	$	273,679

Balance at July 1, 2019		17,804,039		$	187	$	182,129		$	134,500		$	(12,114	)	$	(18,305	)	$	(5,090	)	$	281,307
Net income		-			-		-			2,829			-			-			-			2,829
Other comprehensive income		-			-		-			-			-			-			256			256
Common stock dividends declared ($0.04 per share)		-			-		-			(659	)		-			-			-			(659	)
Repurchase of common stock		(179,800	)		-		-			-			-			(3,524	)		-			(3,524	)
Stock-based compensation		-			-		830			-			-			-			-			830
ESOP shares committed to be released (24,419 shares)		-			-		239			-			244			-			-			483
Balance at September 30, 2019		17,624,239		$	187	$	183,198		$	136,670		$	(11,870	)	$	(21,829	)	$	(4,834	)	$	281,522

See accompanying notes to the consolidated financial statements (unaudited)

PCSB Financial Corporation and Subsidiaries

Consolidated Statements of Cash Flows (unaudited)

(amounts in thousands)

	Three Months Ended September 30,
	2020			2019
OPERATING ACTIVITIES
Net income	$	2,728		$	2,829
Adjustments to reconcile net income to net cash provided by operating activities:
Provision for loan loss		109			335
Depreciation and amortization		748			695
Amortization of net premiums on securities and net deferred loan origination costs		206			494
Net decrease (increase) in accrued interest receivable		151			(697	)
Net gains on sales of foreclosed real estate		-			(47	)
Stock-based compensation		829			830
ESOP compensation		301			483
Earnings from cash surrender value of BOLI		(132	)		(137	)
Net accretion of purchase accounting adjustments		(75	)		(198	)
Other adjustments, principally net changes in other assets and liabilities		(2,986	)		680
Net cash provided by operating activities		1,879			5,267
INVESTING ACTIVITIES
Purchases of investment securities:
Held to maturity		(27,894	)		-
Maturities, calls and amortization of investment securities:
Held to maturity		17,289			33,185
Available for sale		6,202			7,492
Loan principal repayments (disbursements), net		33,088			(26,762	)
Purchase of loans		-			(44,065	)
Net redemption of FHLB stock		1			1
Purchase of bank premises and equipment, net of sales		(70	)		(127	)
Proceeds from sales of foreclosed real estate		-			709
Net cash provided by (used in) investing activities		28,616			(29,567	)
FINANCING ACTIVITIES
Net increase in deposits		3,757			8,084
Repayment of long-term FHLB advances		(33	)		(31	)
Net decrease in mortgage escrow funds		(3,703	)		(1,802	)
Common stock dividends paid		(630	)		(659	)
Repurchase of common stock		(3,449	)		(3,524	)
Net cash (used in) provided by financing activities		(4,058	)		2,068
Net increase (decrease) in cash and cash equivalents		26,437			(22,232	)
Cash and cash equivalents at beginning of period		136,302			60,029
Cash and cash equivalents at end of period	$	162,739		$	37,797

Supplemental information:
Cash paid for:
Interest	$	2,908		$	3,883
Income taxes (net of refunds)		2,625			821
Loans transferred to foreclosed real estate and other assets		-			360
Establishment of right to use lease asset (ASU 2016-13)		-			12,687

See accompanying notes to the consolidated financial statements (unaudited)

PCSB Financial Corporation and Subsidiaries

Notes to Consolidated Financial Statements (unaudited)

Note 1. Basis of Presentation

Nature of Operations: PCSB Financial Corporation (the “Holding Company” and together with its direct and indirect subsidiaries, the “Company”) is a Maryland corporation organized by PCSB Bank (the “Bank”) for the purpose of acquiring all of the capital stock of the Bank issued in the Bank's conversion to stock ownership on April 20, 2017. At September 30, 2020, the significant assets of the Holding Company were the capital stock of the Bank, cash deposited in the Bank, and a loan to the PCSB Bank Employee Stock Ownership Plan (“ESOP”). The liabilities of the Holding Company were insignificant. The Company is subject to the financial reporting requirements of the Securities Exchange Act of 1934, as amended, and regulation and examination by the Board of Governors of the Federal Reserve System (the “Federal Reserve Board”) and the New York State Department of Financial Services (the “NYSDFS”).

PCSB Bank is a community-oriented financial institution that provides financial services to individuals and businesses within its market area of Putnam, Southern Dutchess, Rockland and Westchester Counties in New York. The Bank is a state-chartered commercial bank and its deposits are insured up to applicable limits by the Deposit Insurance Fund of the Federal Deposit Insurance Corporation (“FDIC”). The Bank’s primary regulators are the FDIC and the NYSDFS.

Basis of Presentation: The unaudited consolidated financial statements have been prepared in conformity with accounting principles generally accepted in the United States of America (“GAAP”), and include the accounts of the Holding Company, the Bank and the Bank's two subsidiaries – PCSB Funding Corp. and UpCounty Realty Corp. (formerly PCSB Realty Ltd.). PCSB Funding Corp. is a real estate investment trust that holds certain mortgage assets. UpCounty Realty Corp. is a corporation that holds certain properties foreclosed upon by the Bank. All intercompany transactions and balances have been eliminated in consolidation.

The unaudited consolidated financial statements contained herein reflect all normal recurring adjustments that are, in the opinion of management, necessary for a fair presentation of the results for the interim periods presented. Such adjustments are the only adjustments reflected in the consolidated financial statements contained herein. The results of operations for the current period presented are not necessarily indicative of the results of operations that may be expected for the entire current fiscal year. Certain information and note disclosures normally included in financial statements prepared in accordance with GAAP have been condensed or omitted pursuant to the rules and regulations of the Securities and Exchange Commission. The accompanying unaudited consolidated financial statements should be read in conjunction with the audited consolidated financial statements and notes thereto for the year ended June 30, 2020, included in the Company's Annual Report on Form 10-K.

Certain prior period amounts have been reclassified to conform to the current presentation. Reclassifications had no effect on prior period net income or equity.

Risks and Uncertainties:

The COVID-19 pandemic has created extensive disruptions to the global and U.S. economies and to the lives of individuals throughout the world. The New York City Metropolitan area and environs have had the highest incidence of COVID-19 in the nation, and the neighboring Tri-State area of New Jersey and Connecticut also has been particularly affected by COVID-19. Governments, businesses, and the public are taking unprecedented actions to contain the spread of COVID-19 and to mitigate its effects, including quarantines, travel bans, shelter-in-place orders, closures of businesses and schools, fiscal and monetary stimulus, and legislation designed to deliver financial aid and other relief. While the scope, duration, and full effects of COVID-19 are rapidly evolving and not fully known, the pandemic and the efforts to contain it have disrupted global economic activity, adversely affected the functioning of financial markets, impacted market interest rates, increased economic and market uncertainty, and disrupted trade and supply chains.

The ultimate financial impact is unknown at this time. However, if these actions are sustained, it may adversely impact several industries within our geographic footprint and impair the ability of the Company’s customers to fulfill their contractual obligations to the Company. This could cause the Company to experience a material adverse effect on our business operations, asset valuations, financial condition, and results of operations. Material adverse impacts may include all or a combination of valuation impairments of the Company’s intangible assets, investments, loans, or deferred tax assets.

As it relates to the allowance for loan losses, the Company continues to assess the economic impacts the COVID-19 pandemic has had on our local economy and loan portfolio. The Company has taken actions to identify, assess and address its COVID-19 related credit exposure. Many factors are unknown, including the length of the resulting economic shutdown imposed by New York State and other neighboring states, the impacts of the government’s fiscal and monetary relief measures, including payment deferral programs, as well as the long-term impacts COVID-19 may have on our consumer and commercial borrowers. It is reasonably possible that the Company’s allowance for loan loss estimate as of September 30, 2020 will change in the near term and could result in a material change to the Company’s provision for loan losses, earnings and capital.

Use of Estimates: To prepare financial statements in conformity with GAAP management makes estimates and assumptions based on available information. These estimates and assumptions affect the amounts reported in the financial statements and the disclosures provided, and actual results could differ.

Note 2. Recent Accounting Pronouncements

The pronouncements discussed below are not intended to be an all-inclusive list, but rather only those pronouncements that could potentially have a material impact on our financial position, results of operations or disclosures.

There were no accounting standards adopted in the current period

Future Application of Accounting Pronouncements Previously Issued

In June 2016, the FASB issued ASU 2016-13 “Measurement of Credit Losses on Financial Instruments.” ASU 2016-13 affects entities holding financial assets that are not accounted for at fair value through net income, including loans, debt securities, and other financial assets. The ASU requires financial assets measured at amortized cost basis to be presented at the net amount expected to be collected by recording an allowance for current expected credit losses. In October 2019, the FASB unanimously voted to delay the implementation of the standard for three years for certain companies, including small reporting companies (as defined by the SEC), non-SEC public companies and private companies. The Company currently qualifies as a small reporting company and is subject to the delayed implementation. Therefore, the amendments in this update will be effective for the Company for the fiscal year beginning on July 1, 2023, including interim periods within that fiscal year. The Company is actively working through the provisions of the Update. Management has established a steering committee which is identifying the methodologies and the additional data requirements necessary to implement the Update and has engaged a third-party software service provider to assist in the Company's implementation. Management is currently evaluating the impact that ASU 2016-13 will have on the Company’s consolidated financial position, results of operations and disclosures.

Note 3. Investment Securities

The amortized cost, gross unrealized/unrecognized gains and losses and fair value of available for sale and held to maturity debt securities at September 30, 2020 and June 30, 2020 were as follows:

	September 30, 2020
	Amortized		Gross Unrealized/Unrecognized					Fair
	Cost		Gains		Losses			Value
			(in thousands)
Available for sale:
U.S. Government and agency obligations	$	7,000	$	17	$	-		$	7,017
Corporate and other debt securities		5,031		90		-			5,121
Mortgage-backed securities – residential		18,582		432		(13	)		19,001
Total available for sale	$	30,613	$	539	$	(13	)	$	31,139
Held to maturity:
U.S. Government and agency obligations	$	38,001	$	391	$	(1	)	$	38,391
Corporate and other debt securities		73,994		798		(1,266	)		73,526
Mortgage-backed securities – residential		112,035		4,316		(10	)		116,341
Mortgage-backed securities – collateralized mortgage obligations		44,621		1,488		(9	)		46,100
Mortgage-backed securities – commercial		18,719		733		-			19,452
Total held to maturity	$	287,370	$	7,726	$	(1,286	)	$	293,810

	June 30, 2020
	Amortized		Gross Unrealized/Unrecognized					Fair
	Cost		Gains		Losses			Value
			(in thousands)
Available for sale:
U.S. Government and agency obligations	$	11,002	$	47	$	-		$	11,049
Corporate and other debt securities		5,038		82		-			5,120
Mortgage-backed securities – residential		20,844		428		(15	)		21,257
Total available for sale	$	36,884	$	557	$	(15	)	$	37,426
Held to maturity:
U.S. Government and agency obligations	$	42,001	$	454	$	(5	)	$	42,450
Corporate and other debt securities		52,790		332		(1,510	)		51,612
Mortgage-backed securities – residential		117,160		4,291		(17	)		121,434
Mortgage-backed securities – collateralized mortgage obligations		45,047		1,487		(31	)		46,503
Mortgage-backed securities – commercial		18,774		724		-			19,498
Total held to maturity	$	275,772	$	7,288	$	(1,563	)	$	281,497

No securities were sold during the three months ended September 30, 2020 or 2019.

The following table presents the fair value and carrying amount of debt securities at September 30, 2020, by contractual maturity (in thousands). Expected maturities may differ from contractual maturities if borrowers have the right to call or prepay obligations with or without call or prepayment penalties. Securities not due at a single maturity date, primarily mortgage-backed securities, are shown separately.

	Held to maturity				Available for sale
	Carrying		Fair		Amortized		Fair
	Amount		Value		Cost		Value
1 year or less	$	11,037	$	11,089	$	7,000	$	7,018
1 to 5 years		32,165		32,266		5,031		5,120
5 to 10 years		38,716		38,487		-		-
over 10 years		26,121		25,894
Mortgage-backed securities and other		179,331		186,074		18,582		19,001
Total	$	287,370	$	293,810	$	30,613	$	31,139

Securities pledged had carrying amounts of $164.1 million and $182.2 million at September 30, 2020 and June 30, 2020, respectively, and were pledged principally to secure FHLB advances and public deposits.

The following table provides information regarding investment securities with unrealized/unrecognized losses, aggregated by investment category and length of time that individual securities had been in a continuous unrealized loss position at September 30, 2020 and June 30, 2020:

	September 30, 2020
	Less than 12 months					12 months or greater					Total
			Unrealized/					Unrealized/					Unrealized/
	Fair		Unrecognized			Fair		Unrecognized			Fair		Unrecognized
	Value		Loss			Value		Loss			Value		Loss
	(in thousands)
Available for sale:
Mortgage-backed securities – residential	$	662	$	(9	)	$	760	$	(4	)	$	1,422	$	(13	)
Total available for sale	$	662	$	(9	)	$	760	$	(4	)	$	1,422	$	(13	)
Held to maturity:
U.S. Government and agency obligations	$	2,500	$	(1	)	$	-	$	-		$	2,500	$	(1	)
Corporate and other debt securities		30,144		(738	)		16,972		(528	)		47,116		(1,266	)
Mortgage-backed securities – residential		2,062		(10	)		-		-			2,062		(10	)
Mortgage-backed securities – collateralized mortgage obligations		5,302		(9	)		-		-			5,302		(9	)
Total held to maturity	$	40,008	$	(758	)	$	16,972	$	(528	)	$	56,980	$	(1,286	)

	June 30, 2020
	Less than 12 months					12 months or greater					Total
			Unrealized/					Unrealized/					Unrealized/
	Fair		Unrecognized			Fair		Unrecognized			Fair		Unrecognized
	Value		Loss			Value		Loss			Value		Loss
	(in thousands)
Available for sale
Mortgage-backed securities – residential	$	1,450	$	(15	)	$	-	$	-		$	1,450	$	(15	)
Total available for sale	$	1,450	$	(15	)	$	-	$	-		$	1,450	$	(15	)
Held to maturity
U.S. Government and agency obligations	$	11,995	$	(5	)	$	-	$	-		$	11,995	$	(5	)
Corporate and other debt securities		30,751		(1,055	)		12,045		(455	)		42,796		(1,510	)
Mortgage-backed securities – residential		5,130		(17	)		-		-			5,130		(17	)
Mortgage-backed securities – collateralized mortgage obligations		2,627		(31	)		-		-			2,627		(31	)
Total held to maturity	$	50,503	$	(1,108	)	$	12,045	$	(455	)	$	62,548	$	(1,563	)

As of September 30, 2020, the Company’s securities portfolio consisted of $318.5 million in securities, of which 24 securities with a fair value of $58.4 million were in an unrealized loss position. The majority of unrealized losses are related to the Company’s corporate and other debt securities, mortgage-backed securities and U.S. Government and agency obligations. Corporate and other debt securities are internally pass rated and are subject to quarterly credit monitoring.

At September 30, 2020 and June 30, 2020 there were no holdings of securities of any one issuer, other than the U.S. government and its agencies, in an amount greater than 10% of shareholders’ equity.

There were no securities as of September 30, 2020 or June 30, 2020 for which the Company believes it is not probable that it will collect all amounts due according to the contractual terms of the security. Management believes the unrealized losses are primarily a result of changes in interest rates and credit spreads. The Company has determined that it does not intend to sell, or it is not more likely than not that it will be required to sell, its securities that are in an unrealized loss position prior to the recovery of its amortized cost basis. Therefore, the Company did not consider any securities to be other-than-temporarily impaired as of September 30, 2020 or June 30, 2020.

Note 4. Loans Receivable

Loans receivable are summarized as follows (in thousands):

	September 30,			June 30,
	2020			2020
Mortgage loans:
Residential	$	245,008		$	255,382
Commercial		794,248			807,106
Construction		11,512			11,053
Net deferred loan origination costs		666			739
Total mortgage loans		1,051,434			1,074,280
Commercial and consumer loans:
Commercial loans		155,569			164,257
Home equity lines of credit		29,249			29,838
Consumer and overdrafts		308			481
Net deferred loan origination costs		25			730
Total commercial and consumer loans		185,151			195,306
Total loans receivable		1,236,585			1,269,586
Allowance for loan losses		(8,672	)		(8,639	)
Loans receivable, net	$	1,227,913		$	1,260,947

The following tables present the activity in the allowance for loan losses by portfolio segment for the three months ended September 30, 2020 and 2019 (in thousands):

	Three Months Ended September 30, 2020
	Beginning Allowance		Provision (credit)			Charge-offs			Recoveries		Ending Allowance
Residential	$	373	$	(33	)	$	-		$	2	$	342
Commercial		6,913		53			-			-		6,966
Construction		165		8			-			-		173
Commercial loans		1,124		71			(105	)		31		1,121
Home equity lines of credit		60		1		-				2		63
Consumer and overdrafts		4		9			(8	)		2		7
Total	$	8,639	$	109		$	(113	)	$	37	$	8,672

	Three Months Ended September 30, 2019
	Beginning Allowance		Provision (credit)			Charge-offs			Recoveries		Ending Allowance
Residential	$	446	$	(106	)	$	-		$	3	$	343
Commercial		3,853		461			-			-		4,314
Construction		159		63			-			-		222
Commercial loans		1,130		(89	)		-			-		1,041
Home equity lines of credit		65		(9	)		-			5		61
Consumer and overdrafts		11		15			(18	)		4		12
Total	$	5,664	$	335		$	(18	)	$	12	$	5,993

The following tables present the balance in the allowance for loan losses and the recorded investment in loans, excluding net deferred fees and accrued interest, by portfolio segment, and based on impairment method as of September 30, 2020 and June 30, 2020 (in thousands):

	September 30, 2020
	Loans								Allowance for Loan Losses
	Individually Evaluated for Impairment		Collectively Evaluated for Impairment		Acquired With Deteriorated Credit Quality		Total		Individually Evaluated for Impairment		Collectively Evaluated for Impairment		Acquired With Deteriorated Credit Quality		Total
Residential	$	2,440	$	241,837	$	731	$	245,008	$	115	$	227	$	-	$	342
Commercial		-		793,362		886		794,248		-		6,966		-		6,966
Construction		-		11,512		-		11,512		-		173		-		173
Commercial loans		1,804		153,765		-		155,569		-		1,121		-		1,121
Home equity lines of credit		365		28,749		135		29,249		8		55		-		63
Consumer and overdrafts		-		308		-		308		-		7		-		7
Total	$	4,609	$	1,229,533	$	1,752	$	1,235,894	$	123	$	8,549	$	-	$	8,672

	June 30, 2020
	Loans								Allowance for Loan Losses
	Individually Evaluated for Impairment		Collectively Evaluated for Impairment		Acquired With Deteriorated Credit Quality		Total		Individually Evaluated for Impairment		Collectively Evaluated for Impairment		Acquired With Deteriorated Credit Quality		Total
Residential	$	2,448	$	252,195	$	739	$	255,382	$	118	$	255	$	-	$	373
Commercial		-		806,224		882		807,106		-		6,913		-		6,913
Construction		-		11,053		-		11,053		-		165		-		165
Commercial loans		1,921		162,336		-		164,257		1		1,123		-		1,124
Home equity lines of credit		350		29,349		139		29,838		4		56		-		60
Consumer and overdrafts		-		481		-		481		-		4		-		4
Total	$	4,719	$	1,261,638	$	1,760	$	1,268,117	$	123	$	8,516	$	-	$	8,639

The following tables present information related to loans individually evaluated for impairment (excluding loans acquired with deteriorated credit quality) by portfolio segment as of September 30, 2020 and June 30, 2020 (in thousands):


	September 30, 2020						June 30, 2020
	Unpaid Principal Balance		Recorded Investment		Allowance for Loan Losses		Unpaid Principal Balance		Recorded Investment		Allowance for Loan Losses
With no related allowance recorded:
Residential	$	2,114	$	2,007	$	-	$	2,123	$	2,013	$	-
Commercial loans		1,960		1,789		-		2,067		1,897		-
Home equity lines of credit		326		338		-		326		339		-
With an allowance recorded:
Residential		370		433		115		372		435		118
Commercial loans		15		15		-		24		24		1
Home equity lines of credit		27		27		8		11		11		4
Total	$	4,812	$	4,609	$	123	$	4,923	$	4,719	$	123

The tables below present the average recorded investment and interest income recognized on loans individually evaluated for impairment, by portfolio segment, for the three months ended September 30, 2020 and 2019 (in thousands):

	Three months ended				Three months ended
	September 30, 2020				September 30, 2019
	Average Recorded Investment		Interest Income Recognized		Average Recorded Investment		Interest Income Recognized
With no related allowance recorded:
Residential	$	2,015	$	8	$	1,735	$	6
Commercial		-		-		1,411		12
Commercial loans		1,809		49		1,825		50
Home equity lines of credit		339		-		680		-
With an allowance recorded:
Residential		434		3		738		3
Commercial loans		15		-		180		1
Home equity lines of credit		16		-		11		-
Total	$	4,628	$	60	$	6,580	$	72

The following table presents the recorded investment in nonaccrual loans and in loans past due over 90 days and still on accrual status, by portfolio segment, as of September 30, 2020 and June 30, 2020 (in thousands):

					Loans Past Due Over 90 Days
	Nonaccrual				and Still Accruing
	September 30,		June 30,		September 30,		June 30,
	2020		2020		2020		2020
Residential	$	1,454	$	1,457	$	-	$	-
Commercial loans		247		-		-		-
Home equity lines of credit		383		338		-		-
Total	$	2,084	$	1,795	$	-	$	-

Nonperforming loans include both smaller-balance homogeneous loans that are collectively evaluated for impairment and individually classified impaired loans. The table above excludes acquired loans that are accounted for as purchased credit impaired loans totaling $383,000 and $392,000 as of September 30, 2020 and June 30, 2020, respectively. Such loans are excluded because the loans are in pools that are considered performing. The discounts arising from recording these loans at fair value upon acquisition were due in part to credit quality and the accretable yield is being recognized as interest income over the life of the loans based on expected cash flows.

The following tables present the aging of the recorded investment in past due loans by portfolio segment as of September 30, 2020 and June 30, 2020 (in thousands):

	September 30, 2020
	30-59		60-89		90 Days or
	Days Past		Days Past		More Past		Total Past
	Due		Due		Due		Due		Current ⁽¹⁾		Total
Residential	$	-	$	286	$	813	$	1,099	$	243,909	$	245,008
Commercial		-		-		-		-		794,248		794,248
Construction		-		-		-		-		11,512		11,512
Commercial loans		83		226		247		556		155,013		155,569
Home equity lines of credit		-		-		383		383		28,866		29,249
Consumer and overdrafts		-		-		-		-		308		308
Total	$	83	$	512	$	1,443	$	2,038	$	1,233,856	$	1,235,894

	June 30, 2020
	30-59		60-89		90 Days or
	Days Past		Days Past		More Past		Total Past
	Due		Due		Due		Due		Current ⁽¹⁾		Total
Residential	$	495	$	10	$	806	$	1,311	$	254,071	$	255,382
Commercial		-		-		-		-		807,106		807,106
Construction		-		-		-		-		11,053		11,053
Commercial loans		76		-		-		76		164,181		164,257
Home equity lines of credit		44		-		338		382		29,456		29,838
Consumer and overdrafts		-		-		-		-		481		481
Total	$	615	$	10	$	1,144	$	1,769	$	1,266,348	$	1,268,117

⁽¹⁾

As of September 30, 2020 and June 30, 2020, loans on a COVID-19-related payment deferral are considered current.

Troubled Debt Restructurings

The terms of certain loans have been modified as troubled debt restructurings (“TDR”). The modification of the terms of such loans included one or a combination of the following: a reduction of the stated interest rate of the loan; an extension of the maturity date at a stated rate of interest lower than the current market rate for new debt with similar risk; or a permanent reduction of the recorded investment in the loan. All TDRs are considered impaired loans.

As of both September 30, 2020 and June 30, 2020, the Company had 14 loans, classified as TDRs totaling $3.2 million and $3.3 million, including $2.8 million and $2.9 million, respectively, of loans still accruing interest. The Company has allocated $124,000 and $123,000, of specific reserves to customers whose loan terms have been modified in TDRs as of September 30, 2020 and June 30, 2020, respectively. As of September 30, 2020, the Company has committed to lend an additional $10,000 to customers with outstanding loans that are classified as TDRs.

The Company did not modify any loans during the three months ended September 30, 2020 or 2019 that were classified as TDRs.

There were no defaults of troubled debt restructurings occurring in the three months ended September 30, 2020 that were modified in the twelve months prior to default. The Company had one TDR, a residential mortgage with a carrying amount of $370,000 as of September 30, 2019, default in the three months ended September 30, 2019 that

was modified in the twelve months prior to default. This default did not result in a charge-off nor an increase to the allowance for loan losses.

In order to determine whether a borrower is experiencing financial difficulty, an evaluation is performed of the probability that the borrower will be in payment default on any of its debt in the foreseeable future without the modification. This evaluation is performed under the Company’s internal underwriting policy.

On March 27, 2020, the Coronavirus Aid, Relief, and Economic Security Act (“CARES Act”) was signed into law. Section 4013 of the CARES Act, “Temporary Relief From Troubled Debt Restructurings,” provides banks the option to temporarily suspend certain requirements under U.S. GAAP related to TDRs for a limited period of time to account for the effects of COVID-19. Additionally, on April 7, 2020, the banking agencies, including the Board of Governors of the Federal Reserve System and the Federal Deposit Insurance Corporation, issued a statement, “Interagency Statement on Loan Modifications and Reporting for Financial Institutions Working With Customers Affected by the Coronavirus (Revised)” (“Interagency Statement”), to encourage banks to work prudently with borrowers and to describe the agencies’ interpretation of how accounting rules under ASC 310-40, “Troubled Debt Restructurings by Creditors,” apply to certain COVID-19-related modifications.

During the three months ended September 30, 2020, the Company granted or extended loan payment deferrals for 21 residential mortgage loans and home equity lines of credit totaling $7.4 million, as well as 20 commercial mortgage and commercial loans totaling $26.0 million. In accordance with either the CARES Act or Interagency Statement, these modifications are not considered troubled debt restructurings. The Company had 28 and 320 loans totaling $21.8 million and $216.2 million on loan payment deferral as of September 30, 2020 and June 30, 2020, respectively.

Credit Quality Indicators

The Company categorizes loans into risk categories based on relevant information about the ability of borrowers to service their debt such as: current financial information, historical payment experience, credit documentation, public information, and current economic trends, among other factors. The Company analyzes loans individually by classifying the loans as to credit risk. This analysis includes non-homogeneous loans, such as commercial and commercial real estate loans. This analysis is performed on a monthly basis. The Company utilizes the same grading process for acquired loans as it does for originated loans. The Company uses the following definitions for risk ratings:

Special Mention – Loans classified as special mention have a potential weakness that deserves management's close attention. If left uncorrected, these potential weaknesses may result in deterioration of the repayment prospects for the loan or of the institution's credit position at some future date.

Substandard – Loans classified as substandard are inadequately protected by the current net worth and paying capacity of the obligor or of the collateral pledged, if any. Loans so classified have a well-defined weakness or weaknesses that jeopardize the liquidation of the debt. They are characterized by the distinct possibility that the institution will sustain some loss if the deficiencies are not corrected.

Doubtful – Loans classified as doubtful have all the weaknesses inherent in those classified as substandard, with the added characteristic that the weaknesses make collection or liquidation in full, on the basis of currently existing facts, conditions, and values, highly questionable and improbable.

Loans not meeting the criteria above that are analyzed individually as part of the above-described process and loans in groups of homogenous loans are considered to be pass rated loans. These loans are monitored based on delinquency and performance. Based on the most recent analysis performed, the risk category of loans by portfolio segment is as follows (in thousands):

	September 30, 2020
	Pass		Special Mention		Substandard		Total
Residential	$	242,366	$	563	$	2,079	$	245,008
Commercial		780,620		12,742		886		794,248
Construction		11,512		-		-		11,512
Commercial loans		151,189		463		3,917		155,569
Home equity lines of credit		28,357		449		443		29,249
Consumer and overdrafts		308		-		-		308
Total	$	1,214,352	$	14,217	$	7,325	$	1,235,894

	June 30, 2020
	Pass		Special Mention		Substandard		Total
Residential	$	252,604	$	687	$	2,091	$	255,382
Commercial		803,048		3,176		882		807,106
Construction		11,053		-		-		11,053
Commercial loans		160,137		201		3,919		164,257
Home equity lines of credit		28,894		498		446		29,838
Consumer and overdrafts		481		-		-		481
Total	$	1,256,217	$	4,562	$	7,338	$	1,268,117

As of September 30, 2020, of the $21.8 million in loans granted COVID-19 related payment deferrals, $11.9 million were pass-rated, with $9.6 million and $221,000 rated special mention and substandard, respectively. As of June 30, 2020, of the $216.2 million in loans granted COVID-19 related payment deferrals, $211.0 million were pass-rated, with $198,000 and $4.9 million rated special mention and substandard, respectively.

Purchased Credit Impaired Loans

The Company has acquired loans for which there was, at acquisition, evidence of deterioration of credit quality since origination and it was probable, at acquisition, that all contractually required payments would not be collected. The carrying amount of those loans as of September 30, 2020 and June 30, 2020 is as follows (in thousands):

	September 30,		June 30,
	2020		2020
Residential	$	731	$	739
Commercial		886		882
Home equity lines of credit		135		139
Carrying amount, net of allowance of $0	$	1,752	$	1,760

The allowance for loan losses on purchased credit impaired loans decreased $0 and $83,000 during the three months ended September 30, 2020 and 2019, respectively.

Accretable yield, or income expected to be collected, for acquired loans is as follows (in thousands):

	Three Months Ended September 30,
	2020			2019
Beginning balance	$	156		$	192
New loans acquired		-			-
Accretion income		(5	)		(10	)
Reclassification from non-accretable difference		-			-
Disposals		-			-
Ending balance	$	151		$	182

Note 5. Other Comprehensive Income (Loss)

The following is a summary of the accumulated other comprehensive income (loss) balances, net of tax (in thousands):

	Net unrealized gain (loss) on available for sale securities			Unrealized loss on pension benefits			Unrealized loss on SERP benefits			Total
Balance at July 1, 2020	$	428		$	(6,605	)	$	(226	)	$	(6,403	)
Other comprehensive (loss) income before reclassifications		(16	)		-			-			(16	)
Amounts reclassified from accumulated other comprehensive income		-			240			14			254
Less tax effect		3			(51	)		(3	)		(51	)
Net other comprehensive (loss) income		(13	)		189			11			187
Balance at September 30, 2020	$	415		$	(6,416	)	$	(215	)	$	(6,216	)

	Net unrealized gain (loss) on available for sale securities			Unrealized loss on pension benefits			Unrealized loss on SERP benefits			Total
Balance at July 1, 2019	$	(209	)	$	(4,631	)	$	(250	)	$	(5,090	)
Other comprehensive income before reclassifications		181			-			-			181
Amounts reclassified from accumulated other comprehensive income		-			133			11			144
Less tax effect		(38	)		(29	)		(2	)		(69	)
Net other comprehensive income		143			104			9			256
Balance at September 30, 2019	$	(66	)	$	(4,527	)	$	(241	)	$	(4,834	)

Note 6. Post-Retirement Benefits

Employee Pension Plan

The Company maintains a non-contributory defined benefit pension plan that covers employees meeting specific requirements as to age and length of service. The Company’s contributions to this qualified plan are determined on the basis of (i) the maximum amount that can be deducted for federal income tax purposes, and (ii) the amount determined by a consulting actuary as necessary to avoid an accumulated funding deficiency as defined by the Employee Retirement Income Security Act of 1974 (“ERISA”). Contributions are intended to provide for benefits attributed to service to date but also those expected to be earned in the future. On February 15, 2017, the Board of Directors approved the freezing of the defined benefit pension plan effective May 1, 2017.

Supplemental Executive Retirement Plans

The Company also maintains unfunded and non-qualified supplemental executive retirement plans ("SERP") to provide pension benefits in addition to those provided under the qualified pension plan.

Net periodic benefit cost and other amounts recognized in other comprehensive income for the three months ended September 30, 2020 and 2019 (in thousands):

	Three Months Ended					Three Months Ended
	September 30, 2020					September 30, 2019
	Defined Benefit Plan			Supplemental Retirement Plans		Defined Benefit Plan			Supplemental Retirement Plans
Service cost	$	-		$	90	$	-		$	79
Interest cost		136			24		180			31
Expected return on plan assets		(456	)		-		(479	)		-
Amortization of prior net loss		240			14		133			11
Net periodic cost (benefit)	$	(80	)	$	128	$	(166	)	$	121

The Company made no contributions to the defined benefit plan during the three months ended September 30, 2020.

Employee Stock Ownership Plan

On January 1, 2017, the Company established an Employee Stock Ownership Plan (“ESOP”) to provide eligible employees the opportunity to own Company stock. The ESOP is a tax-qualified retirement plan for the benefit of Company employees. On April 20, 2017, the Company granted a loan to the ESOP for the purchase of 1,453,209 shares of the Company’s common stock at a price of $10.00 per share. The loan obtained by the ESOP from the Company to purchase the common stock is payable annually over 15 years at a rate per annum equal to the Prime Rate, reset annually on January 1st (4.75% for 2020). Loan payments are principally funded by cash contributions from the Bank. The loan is secured by the shares purchased, which are held in a suspense account for allocation among participants as the loan is repaid. The balance of the ESOP loan at September 30, 2020 was $11.6 million. Contributions are allocated to eligible participants on the basis of compensation, subject to federal tax limits. The number of shares committed to be released annually is 96,881 through 2032. Dividends on allocated shares increase participant accounts and are used to purchase additional shares of stock. Participants receive the shares at the end of employment.

Shares held by the ESOP include the following (dollars in thousands):

	September 30, 2020		June 30, 2020
Allocated to participants		352,463		327,206
Unearned		1,090,110		1,114,529
Total ESOP shares		1,442,573		1,441,735

Fair value of unearned shares	$	13,158	$	14,132

Total compensation expense recognized in connection with the ESOP for the three months ended September 30, 2020 and 2019 was $301,000 and $483,000, respectively.

Note 7. Fair Value of Financial Instruments

Fair value is the exchange price that would be received for an asset or paid to transfer a liability (exit price) in the principal or most advantageous market for the asset or liability in an orderly transaction between market participants on the measurement date. There are three levels of inputs that may be used to measure fair values:

Level 1: Quoted prices (unadjusted) for identical assets or liabilities in active markets that the entity has the ability to access as of the measurement date.

Level 2: Significant other observable inputs other than Level 1 prices such as quoted prices for similar assets or liabilities; quoted prices in markets that are not active; or other inputs that are observable or can be corroborated by observable market data.

Level 3: Significant unobservable inputs that reflect a reporting entity’s own assumptions about the assumptions that market participants would use in pricing an asset or liability.

A description of the valuation methodologies used for assets and liabilities measured at fair value, as well as general classification of such instruments pursuant to the valuation hierarchy, is set forth below. While management believes the Company’s valuation methodologies are appropriate and consistent with other financial institutions, the use of different methodologies or assumptions to determine the fair value of certain financial instruments could result in a different estimate of fair value at the reporting date.

Investment Securities: The fair values of securities available for sale are determined by obtaining quoted prices on nationally recognized securities exchanges (Level 1 inputs), matrix pricing, which is a mathematical technique widely used in the industry to value debt securities without relying exclusively on quoted prices for the specific securities but rather by relying on the securities’ relationship to other benchmark quoted securities (Level 2 inputs), or a broker's opinion of value (Level 3 inputs).

Impaired Loans: The fair value of collateral-dependent impaired loans with specific allocations of the allowance for loan losses is generally based on recent real estate appraisals. Appraisals are generally obtained annually and may utilize a single valuation approach or a combination of approaches including comparable sales and the income approach. Adjustments are routinely made in the appraisal process by the appraisers to adjust for differences between the comparable sales and income data available. Such adjustments are typically significant and result in a Level 3 classification of the inputs for determining fair value. Management performs a review of all appraisals, including any such adjustments. The fair value of uncollateralized or non-collateral-dependent loans are generally based on discounted cash flows which utilize management’s assumption of discount rates and expected future cash flows, resulting in a Level 3 classification.

Foreclosed Real Estate: Assets acquired through or instead of loan foreclosure are initially recorded at fair value, less estimated costs to sell, when acquired, establishing a new cost basis. These assets are subsequently accounted for at the lower of cost or fair value, less estimated costs to sell. Fair value is commonly based on recent real estate appraisals which are updated no less frequently than annually. These appraisals may utilize a single valuation approach or a combination of approaches including comparable sales and the income approach. Adjustments are routinely made in the appraisal process by the independent appraisers to adjust for differences between the comparable sales and income data available. Such adjustments are usually significant and typically result in a Level 3 classification of the inputs for determining fair value.

Foreclosed properties are evaluated on a quarterly basis for additional impairment and adjusted accordingly.

Appraisals for both collateral-dependent impaired loans and real estate owned are performed by certified general appraisers (for commercial properties) or certified residential appraisers (for residential properties) whose qualifications and licenses have been reviewed and verified by the Company. Once received, a member of the Credit Department, as well as a third-party specialist, where deemed appropriate, reviews the assumptions and approaches utilized in the appraisal as well as the overall resulting fair value in comparison with independent data sources such as recent market data or industry-wide statistics. Once appraisals are considered appropriate, management discounts the appraised value for estimated selling costs, such as legal, broker, and property maintenance and insurance costs. The most recent analysis performed indicated discount rates ranging between 10% and 20% should be applied to properties with appraisals performed.

Derivatives: The Company’s derivative assets and liabilities consist of transactions undertaken as part of management’s strategy to manage interest rate risk. The valuation of the Company’s interest rate swaps is obtained from a third-party pricing service and is determined using a discounted cash flow analysis on the expected cash flows of each derivative. The pricing analysis is based on observable inputs for the contractual terms of the derivatives, including the period to maturity and interest rate curves. The Company has determined that the majority of the inputs used to value its interest rate derivatives fall within Level 2 of the fair value hierarchy.

Assets and liabilities measured at fair value are summarized below (in thousands):

	Fair Value Measurements
	Level 1		Level 2		Level 3		Total
September 30, 2020

Measured on a recurring basis:
Available for sale securities:
U.S. Government and agency obligations	$	-	$	7,017	$	-	$	7,017
Corporate and other debt securities		-		5,121		-		5,121
Mortgage-backed securities – residential		-		19,001		-		19,001
Derivatives – interest rate contracts		-		8,094		-		8,094
Total assets at fair value	$	-	$	39,233	$	-	$	39,233

Derivatives – interest rate contracts	$	-	$	8,094	$	-	$	8,094
Total liabilities at fair value	$	-	$	8,094	$	-	$	8,094

Measured on a non-recurring basis:
Impaired loans:
Residential mortgages	$	-	$	-	$	318	$	318
Commercial loans		-		-		15		15
Home equity lines of credit		-		-		18		18
Total assets at fair value	$	-	$	-	$	351	$	351


	Fair Value Measurements
	Level 1		Level 2		Level 3		Total
June 30, 2020
Measured on a recurring basis:
Available for sale securities:
U.S. Government and agency obligations	$	-	$	11,049	$	-	$	11,049
Corporate and other debt securities		-		5,120		-		5,120
Mortgage-backed securities – residential		-		21,257		-		21,257
Derivatives – interest rate contracts		-		8,305		-		8,305
Total assets at fair value	$	-	$	45,731	$	-	$	45,731

Derivatives – interest rate contracts	$	-	$	8,305	$	-	$	8,305
Total liabilities at fair value	$	-	$	8,305	$	-	$	8,305

Measured on a non-recurring basis:
Impaired loans:
Residential mortgages	$	-	$	-	$	316	$	316
Commercial loans		-		-		100		100
Home equity lines of credit		-		-		8		8
Total assets at fair value	$	-	$	-	$	424	$	424

There were no transfers between levels within the fair value hierarchy during the three months ended September 30, 2020 and 2019.

Impaired loans in the preceding table had a carrying amount of $475,000 and a remaining valuation allowance of $124,000, at September 30, 2020, as compared to $547,000 and 123,000, respectively, as of June 30, 2020. Impaired loans measured at fair value incurred net recoveries of $4,000 and resulted in a credit for loan losses of $3,000 during the three months ended September 30, 2020. Impaired loans measured at fair value as of September 30, 2019 incurred no net charge-offs and resulted in an additional credit for loan losses of $6,000 during the three months ended September 30, 2019.

The following tables present quantitative information about Level 3 fair value measurements for selected financial instruments measured at fair value on a non-recurring basis at September 30, 2020 and June 30, 2020 (dollars in thousands):

Valuation

Unobservable

Range or

Fair Value

Technique(s)

Input(s)

Rate Used

September 30, 2020

Impaired loans - residential mortgages

318

Discounted cash flow

Discount rate

5.4% to 6.3%

Impaired loans - home equity lines of credit

Discounted cash flow

Discount rate

3.3% to 6.3%

Impaired loans - commercial loans

Discounted cash flow

Discount rate

7.0%

June 30, 2020

Impaired loans - residential mortgages

316

Discounted cash flow

Discount rate

5.4% to 6.3%

Impaired loans - home equity lines of credit

Discounted cash flow

Discount rate

6.3%

Impaired loans - commercial loans

100

Discounted cash flow

Discount rate

6.8% to 7.5%

The following is a summary of the carrying amounts and estimated fair values of the Company’s financial assets and liabilities, none of which are held for trading purposes (in thousands):

	Carrying		Fair Value Measurements
	Amount		Level 1		Level 2		Level 3		Total
September 30, 2020
Financial assets:
Cash and cash equivalents	$	162,739	$	162,739	$	-	$	-	$	162,739
Investment securities held to maturity		287,370		-		289,010		4,800		293,810
Investment securities available for sale		31,139		-		31,139		-		31,139
Loans receivable, net		1,227,913		-		-		1,207,943		1,207,943
Accrued interest receivable		6,729		-		1,310		5,419		6,729
FHLB stock		6,307	N/A		N/A		N/A		N/A
Derivative assets - interest rate contracts		8,094		-		8,094		-		8,094
Financial liabilities:
Demand, NOW, money market deposits and savings accounts		935,001		935,001		-		-		935,001
Time deposits		442,011		-		451,034		-		451,034
Mortgage escrow funds		6,420		6,420		-		-		6,420
Accrued interest payable		252		2		250		-		252
FHLB advances		106,056		-		110,762		-		110,762
Derivative liabilities - interest rate contracts		8,094		-		8,094		-		8,094

	Carrying		Fair Value Measurements
	Amount		Level 1		Level 2		Level 3		Total
June 30, 2020
Financial assets:
Cash and cash equivalents	$	136,302	$	136,302	$	-	$	-	$	136,302
Investment securities held to maturity		275,772		-		276,847		4,650		281,497
Investment securities available for sale		37,426		-		37,426		-		37,426
Loans receivable, net		1,260,947		-		-		1,240,440		1,240,440
Accrued interest receivable		6,880		-		997		5,883		6,880
FHLB stock		6,308	N/A		N/A		N/A		N/A
Derivative assets - interest rate contracts		8,305		-		8,305		-		8,305
Financial liabilities:
Demand, NOW, money market deposits and savings accounts		926,989		926,989		-		-		926,989
Time deposits		446,246		-		456,109		-		456,109
Mortgage escrow funds		10,123		10,123		-		-		10,123
Accrued interest payable		246		1		245				246
FHLB advances		106,089		-		110,937		-		110,937
Derivative liabilities - interest rate contracts		8,305		-		8,305		-		8,305

The methods of determining the fair value of assets and liabilities presented in the table above are consistent with our methodologies disclosed in the Company's Consolidated Financial Statements included in the Annual Report on Form 10-K.

Note 8. Regulatory Matters

The following is a summary of the Bank’s actual capital amounts and ratios as of September 30, 2020 and June 30, 2020, compared to the required ratios for minimum capital adequacy and for classification as well capitalized (dollars in thousands).

											To Be Well Capitalized
						For Capital					Under Prompt
						Adequacy					Corrective Action
	Bank Actual					Purposes					Provisions
	Amount		Ratio			Amount		Ratio			Amount		Ratio
September 30, 2020
PCSB Bank
Leverage (Tier 1)	$	223,304		12.4	%	$	72,002		4.0	%	$	90,003		5.0	%
Risk-based:
Common Tier 1		223,304		17.6			57,228		4.5			82,662		6.5
Tier 1		223,304		17.6			76,304		6.0			101,738		8.0
Total		231,976		18.2			101,738		8.0			127,173		10.0

June 30, 2020
PCSB Bank
Leverage (Tier 1)	$	220,310		12.5	%	$	70,432		4.0	%	$	88,040		5.0	%
Risk-based:
Common Tier 1		220,310		17.0			58,389		4.5			84,339		6.5
Tier 1		220,310		17.0			77,852		6.0			103,802		8.0
Total		228,949		17.0			103,802		8.0			129,753		10.0

In addition to the ratios above, the Basel III Capital Rules have established that community banking institutions must maintain a capital conservation buffer of common equity Tier 1 capital in an amount greater than 2.5% of total risk-weighted assets to avoid being subject to limitations on capital distributions and discretionary bonus payments to executive officers.

Management believes that as of September 30, 2020 and June 30, 2020, the Bank met all capital adequacy requirements to which it was subject, including the capital conservation buffer of 2.5%, as of September 30, 2020 and June 30, 2020, respectively. Further, the most recent FDIC notification categorized the Bank as a well-capitalized institution under the prompt corrective action regulations. There have been no conditions or events since that notification that management believes have changed the Bank’s capital classification.

Note 9. Earnings Per Share (“EPS”)

Basic EPS is calculated by dividing net income available to common shareholders by the weighted average number of common shares outstanding during the period.

Diluted EPS is calculated in a similar matter, except that the denominator includes the number of additional common shares that would have been outstanding if potentially dilutive common shares were issued using the treasury stock method. Dilutive financial instruments include stock options and unvested restricted stock.

The following table provides factors used in the earnings per share computation for the three months ended September 30^th.

	2020			2019
	(amounts in thousands, except share and per share data)
Net income applicable to common stock	$	2,728		$	2,829

Average number of common shares outstanding		16,404,886			17,178,824
Less: Average unallocated ESOP shares		(1,102,048	)		(1,199,062	)
Average number of common shares outstanding used to calculate basic earnings per common share		15,302,838			15,979,762

Effect of equity-based awards		111			102,514
Average number of common shares outstanding used to calculate diluted earnings per common share		15,302,949			16,082,276

Earnings per common share:
Basic	$	0.18		$	0.18
Diluted	$	0.18		$	0.18

Stock options for 1,345,293 and 1,339,293 shares of common stock were not considered in computing diluted earnings per common share for the three months ended September 30, 2020 and 2019, respectively because they were antidilutive.

Note 10. Derivatives and Hedging

Derivatives not designated as hedges may be used to manage the Company’s exposure to interest rate movements or to provide service to customers. The Company executes interest rate swaps with commercial lending customers to facilitate their respective risk management strategies. These interest rate swaps with customers are simultaneously offset by interest rate swaps that the Company executes with a third party in order to minimize the net risk exposure resulting from such transactions. These interest rate swap agreements do not qualify for hedge accounting treatment, and therefore changes in fair value are reported in current period earnings.

The following table presents summary information about the interest rate swaps as of September 30, 2020 and June 30, 2020.

	September 30,			June 30,
	2020			2020
	(dollars in thousands)
Notional amounts	$	168,462		$	159,242
Weighted average pay rates		2.53	%		2.54	%
Weighted average receive rates		2.53	%		2.54	%
Weighted average maturity	9.10 years			9.31 years
Fair value of combined interest rate swaps	$	-		$	-

Note 11. Revenue From Contracts With Customers

In accordance with ASC 606, revenue is recognized when a customer obtains control of promised services. The amount of revenue recognized reflects the consideration to which the Company expects to be entitled to receive in exchange for these services. The Company applies the following five steps to properly recognize revenue:

Identify the contract with a customer.

Identify the performance obligations in the contract.

Determine the transaction price.

Allocate the transaction price to performance obligations in the contract.

Recognize revenue when (or as) the Company satisfies a performance obligation.

The following table presents summary information about sources of revenue from contracts with customers as of September 30^th.

	2020		2019
	(in thousands)
Noninterest income:
Service charges on deposits	$	162	$	256
Interchange fees		131		117
Other ⁽¹⁾		29		29
Fees and service charges		322		402

Bank-owned life insurance⁽¹⁾		132		137
Swap income ⁽¹⁾		129		170

Net gain on sale of foreclosed real estate		-		47
Other ⁽¹⁾		11		9
Other noninterest income		11		56
Total noninterest income	$	594	$	765

⁽¹⁾Not within the scope of ASC 606.

Fees and Service Charges on Deposit Accounts. The Company earns fees from its deposit customers for transaction-based, account maintenance, and overdraft services. Transaction-based fees, which include services such as ATM use fees, stop payments, statement rendering, and ACH fees, are recognized at the time the transaction is executed as that is the point in time the Company fulfills the customer’s request. Account maintenance fees, which relate primarily to monthly maintenance, are earned over the course of the month, representing the period over which the Company satisfied the performance obligation. Overdraft fees are recognized at the point in time that the overdraft occurs. Service charges on deposits are withdrawn from the customer’s account balance.

Interchange Income. The Company earns interchange fees from debit cardholder transactions conducted through various payment networks. Interchange fees from cardholder transactions represent a percentage of the underlying transaction value and are recognized daily, concurrently with the transaction processing services provided to the cardholder.

Gain on Sales of Foreclosed Real Estate. The Company records a gain or loss from the sale of foreclosed real estate when control of the property transfers to the buyer, which generally occurs at the time of an executed deed. When the Company finances the sale of foreclosed real estate to the buyer, the Company assesses whether the buyer is committed to perform their obligations under the contract and whether collectability of the transaction price is probable. Once these criteria are met, the foreclosed real estate asset is derecognized and the gain or loss on sale is recorded upon the transfer of control of the property to the buyer. In determining the gain or loss on the sale, the Company adjusts the transaction price and related gain (loss) on sale if a significant financing component is present.

Note 12. Stock-Based Compensation

On October 24, 2018, the Company’s shareholders approved the PCSB Financial Corporation 2018 Equity Incentive Plan (the “Plan”), which permits the grant of stock options and restricted stock and/or restricted stock units. The total number of shares that may be granted under the Plan is 2,543,115, of which 1,816,511 shares may be granted as stock options and 726,604 shares may be granted as restricted stock and restricted stock units. Total compensation cost that has been charged against income for the Plan was $829,000 and $830,000 for the three months ended September 30, 2020 and 2019, respectively.

Restricted Stock Awards (“RSAs”)

RSAs provide for the issuance of shares to both employees and non-employee directors. These awards generally vest over a 5-year period, with 20% vesting each year on the anniversary of the award. All awards were made at the fair value of common stock on the grant date. Compensation expense is recognized over the vesting period of the awards based on the fair value of the stock at grant date. The fair value of the stock was determined to be the closing price of the stock on the NASDAQ exchange. Total shares available for grant under the Plan are 726,604, of which 550,185 shares were granted as of September 30, 2020.

The following table presents a summary of RSA activity during the period ended September 30, 2020.

	Number of Shares		Weighted-Average Grant Date Fair Value
Unvested granted shares outstanding at July 1, 2020		437,737	$	19.02
Shares granted		3,000		12.34
Shares vested		-		-
Shares forfeited		-		-
Unvested granted shares at September 30, 2020		440,737	$	18.97

As of September 30, 2020, there was $6.5 million of total unrecognized compensation cost related to non-vested shares granted under the Plan. The cost is expected to be recognized over a weighted-average period of 3.2 years.

Stock Option Awards

Stock options awarded to employees under the Plan are considered incentive stock options (ISOs), up to applicable limits. Option awards are generally granted with an exercise price equal to the market price of the Company’s common stock at the date of grant. Those issued to non-employee directors, as well as those exceeding ISO limitations, are considered non-qualified stock options (NQSOs). Options generally vest over a 5-year period, with 20% vesting each year on the anniversary of the award, however, may not vest more rapidly than over a three-year period, and have a contractual term of 10 years. The Company has a policy of using shares held as a treasury stock to satisfy share option exercises. Currently, the Company has a sufficient number of treasury shares to satisfy the current level of exercisable share options.

The fair value of each option award is estimated on the date of grant using a closed form option valuation (Black-Scholes) model that uses the assumptions noted in the following table. Expected volatilities are based on the historical volatilities of a peer group of publicly traded financial institutions. The expected term of options granted is based on the simplified “mid-point” approach which utilizes the weighted average vesting period and contractual term. The risk-free interest rate for the expected term of the option is based on the U.S. Treasury yield curve in effect at the time of the grant.

The fair value of options granted during the three months ended September 30, 2020, was determined using the following weighted-average assumptions as of grant date.

Risk-free interest rate		0.39	%
Expected term (in years)		6.25
Expected stock price volatility		35.75	%
Dividend yield		1.30	%
Weighted average fair value of options granted	$	3.72

As of September 30, 2020, there was $3.8 million of total unrecognized compensation cost related to non-vested stock options granted under the Plan. The cost is expected to be recognized over a weighted-average period of 3.2 years.

Total shares available for grant under the Plan are 1,816,511, of which 1,345,293 shares were granted as of September 30, 2020. The following table presents a summary of activity related to stock options granted under the Plan, and changes during the period then ended:

	Number of Options		Weighted- Average Exercise Price		Weighted- Average Remaining Contractual Years		Aggregate Intrinsic Value
	(dollars in thousands, except share and per share data)
Options outstanding at July 1, 2020		1,339,293	$	19.04			$	-
Options granted		6,000		12.34
Options expired		-		-
Options exercised		-		-
Options outstanding at September 30, 2020		1,345,293	$	19.01		8.1	$	-

Exercisable at September 30, 2020		267,859	$	19.04		8.1	$	-

Note 13. Leases

As of September 30, 2020, the Company leases real estate for eleven branch offices and one administrative office, including its corporate headquarters, under various operating lease agreements. The Company’s leases have maturities which range from 2021 to 2041, some of which include lessee options to extend the lease term. The weighted average remaining life of the lease terms for these leases was 9.9 years as of September 30, 2020.

The operating lease asset and lease liability are determined at the commencement date of the lease based on the present value of the lease payments. As most of our leases do not provide an implicit rate, the Company used its incremental borrowing rate, the rate of interest to borrow on a collateralized basis for a similar term, at the lease commencement date. The Company utilized a weighted average discount rate of 2.43% in determining the lease liability as of September 30, 2020.

The Company made a policy election to exclude the recognition requirements of ASC 842 to short-term leases, those leases with original terms of 12 months or less. Short-term lease payments are recognized in the income statement on a straight-line basis over the lease term. The Company had no short-term lease cost for the three months ended September 30, 2020 or 2019. Certain leases may include one or more options to renew. The exercise of lease renewal options is typically at the Company’s discretion and are included in the operating lease liability if it is reasonably certain that the renewal option will be exercised. Certain real estate leases may contain lease and non-lease components, such as common area maintenance charges, real estate taxes, and insurance, which are generally

accounted for separately and are not included in the measurement of the lease liability since they are generally able to be segregated. The Company does not sublease any of its leased properties. There were no sale and leaseback transactions, leveraged leases or lease transactions with related parties during the three months ended September 30, 2020 or 2019.

For the three months ended September 30, 2020 and 2019, total operating lease cost was $504,000 and $497,000, respectively, and is included in occupancy and equipment expense. The right-of-use asset, included in premises and equipment, net, was $10.6 million and the corresponding lease liability, included in other liabilities was $10.8 million as of September 30, 2020.

Future minimum lease payments for the fiscal years ending June 30 and a reconciliation of undiscounted lease cash flows and the lease liability recognized in the consolidated balance sheet as of September 30, 2020 is shown below:

(dollars in thousands)
2021	$	1,486
2022		1,937
2023		1,850
2024		1,479
2025		1,186
Thereafter		4,475
Total future minimum lease payments (undiscounted)		12,413
Discounting effect on cash flows		(1,622	)
Lease liability (discounted)	$	10,791

Note 14. Subsequent Events

Subsequent to September 30, 2020, and through November 4, 2020, the Company repurchased 216,500 shares of common stock, at an average cost of $13.18 per share.

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

General

Management’s discussion and analysis of financial condition at September 30, 2020 and June 30, 2020, and results of operations for the three months ended September 30, 2020 and 2019 is intended to assist in understanding the consolidated financial condition and results of operations of the Company. The information contained in this section should be read in conjunction with the unaudited consolidated financial statements and the notes thereto appearing in Part I, Item 1, of this quarterly report on Form 10-Q and with the audited consolidated financial statements included in the annual report on Form 10-K for the fiscal year ended June 30, 2020.

Cautionary Note Regarding Forward-Looking Statements

This quarterly report contains forward-looking statements, which can be identified by the use of words such as “estimate,” “project,” “believe,” “intend,” “anticipate,” “plan,” “seek,” “expect,” “will,” “may” and words of similar meaning. These forward-looking statements include, but are not limited to:

•

statements of our goals, intentions and expectations;

•

statements regarding our business plans, prospects, growth and operating strategies;

•

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

•

estimates of our risks and future costs and benefits.

These forward-looking statements are based on current beliefs and expectations of our management and are inherently subject to significant business, economic and competitive uncertainties and contingencies, many of which are beyond our control. In addition, these forward-looking statements are subject to assumptions with respect to future business strategies and decisions that are subject to change.

The following factors, among others, could cause actual results to differ materially from the anticipated results or other expectations expressed in the forward-looking statements:

•

extent and severity of the recent COVID-19 pandemic, including its impact on our business and operations, including the impact on lost fee revenue and operating expenses, as well as its effects on our customers and issuers of securities, including their ability to make timely payments on obligations, service providers, and on economies and markets more generally;

•

general economic conditions, either nationally or in our market areas, that are worse than expected;

•

changes in the level and direction of loan delinquencies and charge-offs and changes in estimates of the adequacy of the allowance for loan losses;

•

our ability to access cost-effective funding;

•

fluctuations in real estate values and both residential and commercial real estate market conditions;

•

demand for loans and deposits in our market area;

•

our ability to continue to implement our business strategies;

•

competition among depository and other financial institutions;

•

inflation and changes in the interest rate environment that reduce our margins and yields, reduce the fair value of financial instruments or reduce the origination levels in our lending business, or increase the level of defaults, losses and prepayments on loans we have made and make whether held in portfolio or sold in the secondary markets;

•

adverse changes in the securities or credit markets;

•

changes in laws or government regulations or policies affecting financial institutions, including changes in regulatory fees and capital requirements;

•

our ability to manage market risk, credit risk and operational risk in the current economic conditions;

•

our ability to enter new markets successfully and capitalize on growth opportunities;

•

our ability to successfully integrate any assets, liabilities, customers, systems and management personnel we may acquire into our operations and our ability to realize related revenue synergies and cost savings within expected time frames and any goodwill charges related thereto;

•

changes in consumer spending, borrowing and savings habits;

•

changes in accounting policies and practices, as may be adopted by the bank regulatory agencies, the Financial Accounting Standards Board, or the Securities and Exchange Commission;

•

our ability to retain key employees;

•

our compensation expense associated with equity allocated or awarded to our employees; and

•

changes in the financial condition, results of operations or future prospects of issuers of securities that we own.

Additional factors that may affect our results are discussed in the annual report on Form 10-K for the fiscal year ended June 30, 2020, under the heading “Risk Factors.”

Because of these and other uncertainties, our actual future results may be materially different from the results indicated by these forward-looking statements. The Company assumes no obligation to update any forward-looking statements except as may be required by applicable law or regulation.

Critical Accounting Policies

Critical accounting estimates are necessary in the application of certain accounting policies and procedures and are particularly susceptible to significant change. Critical accounting policies are defined as those involving significant judgments and assumptions by management that could have a material impact on the carrying value of certain assets or on income under different assumptions or conditions. For additional information regarding critical accounting policies, refer to the section captioned “Critical Accounting Policies” in Management’s Discussion and Analysis of Financial Condition and Results of Operations included in the June 30, 2020 Form 10-K. There have been no significant changes in our application of critical accounting policies for the three months ended September 30, 2020.

Comparison of Financial Condition at September 30, 2020 and June 30, 2020

Total Assets. Total assets were unchanged at $1.79 billion at September 30, 2020. However, the mix of assets changed due to a decrease of $33.0 million in net loans receivable, partially offset by increases of $26.4 million in cash and cash equivalents and $5.3 million in total investment securities.

Cash and Cash Equivalents. Cash and cash equivalents increased $26.4 million, or 19.4%, to $162.7 million at September 30, 2020 from $136.3 million at June 30, 2020. The increase is primarily due to a $33.0 million decrease in loans receivable and a $3.8 million increase in deposits, partially offset by a $5.3 million increase in total investment securities and a $3.7 million decrease in mortgage escrow funds. The increase in cash and cash equivalents is a result of an increase in deposits and reduced loan originations experienced during the quarter, most likely due to reduced economic activity resulting from the COVID-19 pandemic.

Securities Held to Maturity. Total securities held to maturity increased $11.6 million, or 4.2%, to $287.4 million at September 30, 2020 from $275.8 million at June 30, 2020. This increase was caused primarily by purchases of $21.3 million in corporate and other bonds and $7.8 million in mortgage-backed securities, partially offset by $4.0 million of maturities of U.S. government and agency obligations and $5.6 million of amortization of mortgage-backed securities.

Securities Available for Sale. Total securities available for sale decreased $6.3 million, or 16.8%, to $31.1 million at September 30, 2020 from $37.4 million at June 30, 2020. This decrease was primarily due to $4.0 million in maturities of U.S. government and agency obligations, and amortization, net of purchases, of mortgage-backed securities of $2.3 million.

Net Loans Receivable. Net loans receivable decreased $33.0 million, or 2.6%, to $1.23 billion at September 30, 2020 from $1.26 billion at June 30, 2020. The decrease was the result of decreases in commercial mortgages of

$12.9 million, residential mortgages of $10.4 million and commercial loans of $8.7 million, which included a decrease in PPP loans of $13.9 million.

Deposits. Total deposits increased $3.8 million, or 0.3%, to $1.38 billion at September 30, 2020 as compared to $1.37 billion at June 30, 2020. This increase primarily reflects increases of $13.2 million in money market accounts and $6.5 million in savings accounts, partially offset by decreases of $8.0 million in demand deposits, $4.3 million in time deposits and $3.6 million in NOW accounts. The Company continued to experience deposit inflows in the current quarter, likely the result of numerous economic trends associated with COVID-19, including reduced consumer and commercial spending, and various forms of government stimulus.

Federal Home Loan Bank Advances. FHLB advances decreased $33,000 to $106.1 million at September 30, 2020 as compared to June 30, 2020. This decrease is due to repayments of long-term amortizing advances.

Total Shareholder’s Equity. Total shareholders’ equity decreased $34,000 to $273.7 million at September 30, 2020. This decrease was primarily due to the repurchase of $3.4 million of common stock and $630,000 of cash dividends declared and paid, partially offset by net income of $2.7 million and $1.1 million of stock-based compensation and reduction in unearned ESOP shares for plan shares earned during the period. During the quarter-ended September 30, 2020, the Company repurchased 266,900 shares of common stock at an average price of $12.92 per share. At September 30, 2020, the Company’s book value per share was $16.45 compared to $16.20 at June 30, 2020. At September 30, 2020, the Bank was considered “well capitalized” under applicable regulatory guidelines.

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

General. Net income decreased $101,000, or 3.6%, to $2.7 million for the three months ended September 30, 2020 compared to $2.8 million for the three months ended September 30, 2019. The decrease was primarily due to decreases of $421,000 in net interest income and $171,000 in noninterest income, partially offset by decreases of $226,000 million in the provision for loan losses, $163,000 in noninterest expenses and $102,000 in income tax expense.

Net Interest Income. Net interest income decreased $421,000, or 3.5%, to $11.6 million for the three months ended September 30, 2020 compared to $12.0 million for the three months ended September 30, 2019. The decrease primarily reflects a 34 basis point decrease in net interest margin to 2.69% compared to 3.03% for the same period last year, partially offset by an increase in average interest-earning assets of $138.8 million, or 8.7%. The increase in average interest-earning assets reflects a $112.1 million increase in average other interest earning assets and a $110.6 million increase in average loans receivable, partially offset by a $83.9 million decrease in average investment securities. Despite continued asset growth along with a decrease in funding costs, margin compression has resulted from significant decreases in market interest rates over the past year, stemming from decreases in Fed Funds rates throughout the last year, which has disproportionally reduced asset yields compared to funding costs. The reduction in funding costs has continued in the current quarter, however, the significant increase in cash and cash equivalents, driven by the significant increase in deposits experienced in the prior quarter, has resulted in a less profitable asset mix and continued pressure on net interest margin.

Interest and Dividend Income. Interest and dividend income decreased $1.5 million, or 9.3%, to $14.5 million for the three months ended September 30, 2020 compared to $16.0 million for the three months ended September 30, 2019. The decrease primarily reflects a 68 basis point decrease in the yield on total interest-earning assets, partially offset by a $138.8 million increase in total average interest-earning assets.

Interest income on loans receivable decreased $489,000, or 3.8%, primarily due to a 56 basis point decrease in the average yield on loans to 4.00% for the three months ended September 30, 2020 from 4.56% for the same period last year, partially offset by a $110.6 million increase in the average balance of loans receivable to $1.25 billion for the three months ended September 30, 2020 from $1.14 billion for the same period last year. Decreases in market interest rates driven most significantly by the Fed Funds rate cuts throughout the last year, as well as the origination of lower yielding PPP loans, has resulted in a decreased yield on loans.

Interest income on investment securities decreased $836,000, or 31.1%, primarily due to a 35 basis point decrease in the average yield on investment securities to 2.35% for the three months ended September 30, 2020 from 2.70% for

the same period last year and a $83.9 million decrease in the average balance of investment securities to $315.3 million for the three months ended September 30, 2020 from $399.2 million for the same period last year and. The decrease in yield is a result of lower market rates, as well as prepayment income earned in the prior year quarter. The decrease in the average balance of investment securities is the result of the Company utilizing securities portfolio runoff to fund loan growth.

Interest income on other interest-earning assets, primarily consisting of cash balances at correspondent banks including the Federal Reserve, decreased $173,000, or 58.1%, primarily due to a 227 basis point decrease in the average yield on other interest-earning assets to 0.31% for the three months ended September 30, 2020, from 2.58% for the same period last year, partially offset by a $112.1 million increase in the average balance of other interest-earning assets to $158.0 million for the three months ended September 30, 2020 compared to $45.9 million for the three months ended September 30, 2019. The decrease in the yield on other interest-earning assets was primarily due to a decrease in market interest rates, specifically Fed Funds.

Interest Expense. Interest expense decreased $1.0 million, or 26.7%, to $3.0 million for the three months ended September 30, 2020 compared to $4.0 million for the three months ended September 30, 2019. The decrease primarily reflects a 43 basis point decrease in the average cost of interest-bearing liabilities to 0.89% for the three months ended September 30, 2020 from 1.32% for the same period last year, partially offset by a $95.9 million increase in the average balance of interest-bearing liabilities to $1.31 billion for the three months ended September 30, 2020 from $1.21 billion for the same period last year.

Interest expense on interest-bearing deposits decreased $869,000, or 26.3%, primarily due to a 40 basis point decrease in the average cost of interest-bearing deposits to 0.80% for the three months ended September 30, 2020 from 1.20% for the same period last year, partially offset by a $111.7 million increase in the average balance to $1.20 billion for the three months ended September 30, 2020 from a $1.09 billion for the three months ended September 30, 2019. The decrease in the average rate paid on interest-bearing deposits was primarily caused by a decrease in market interest rates, primarily decrease in the Fed Funds rate. At September 30, 2020, the weighted average cost of interest-bearing deposits was 0.66%.

Interest expense on FHLB advances decreased $208,000, or 28.6%, primarily due to a 43 basis point decrease in the average cost to 1.94% for the three months ended September 30, 2020 from 2.37% for the same period last year, and due to a $15.8 million decrease in the average balance to $106.1 million for the three months ended September 30, 2020 from a $121.9 million for the three months ended September 30, 2019. The decrease in the cost of FHLB funds is primarily due to a decrease in the Fed Funds interest rate.

Over the remainder of the current fiscal year, the Company has $77.5 million of wholesale funding maturing, including FHLB advances and brokered time deposits, with a weighted average cost of 2.29%.

Provision for Loan Losses. The provision for loan losses was $109,000 for the three months ended September 30, 2020, compared to $335,000 for the three months ended September 30, 2019. The decrease is primarily due to a decrease in loan portfolio growth. Loans classified as substandard or doubtful totaled $7.3 million, a decrease of $3.9 million, or 35.0%, from September 30, 2019. Non-performing loans as a percent of total loans receivable was 0.17% as of September 30, 2020, a decrease from 0.29% as of September 30, 2019. Charge-offs, net of recoveries, were $76,000 and $6,000 for the three months ended September 30, 2020 and 2019, respectively.

Noninterest Income. Noninterest income decreased $171,000, or 22.4%, to $594,000 for the three months ended September 30, 2020 compared to $765,000 for the three months ended September 30, 2019. The decrease was caused primarily due to decreases of $80,000 in fees and service charges, $41,000 in swap income and $47,000 in gains on the sale of foreclosed real estate. The reduction in fees and service charge income compared to the prior year quarter was due to the combined effects of reduced customer transaction activity since the start of the COVID-19 pandemic and our waiver of certain overdraft fees, ATM usage fees, wire and CD early withdrawal fees in response to COVID-19, as required by emergency regulations promulgated by the New York State Department of Financial Services. The Company began waiving such fees in accordance with these regulations on or about March 20, 2020 and reinstituted these fees on July 15, 2020, however, we expect to continue to be subject to some level of reduced customer activity and waivers based on customer-specific circumstances.

Noninterest Expense. Noninterest expense decreased $163,000, or 1.9%, to $8.6 million for the three months ended September 30, 2020 compared to $8.8 million for the three months ended September 30, 2019. The

decrease compared to the prior year quarter was caused primarily by decreases of $256,000 in retirement costs and $65,000 in all other expenses, partially offset by increases in FDIC insurance premiums of $113,000 and communications and data processing fees of $45,000. The Bank applied small bank assessment credits of $98,000 which fully offset its FDIC assessment for the prior year quarter. All available credits were applied as of June 30, 2020.

Income Tax Expense. Income tax expense decreased $102,000, or 12.6%, for the three months ended September 30, 2020 in comparison to the three months ended September 30, 2019. The decrease was caused by lower pre-tax income, as well as a lower effective tax rate. The effective income tax rate was 20.7% for the three months ended September 30, 2020 as compared to 22.3% for the three months ended September 30, 2019. The Company expects an effective tax rate of approximately 22.0% for the year ending June 30, 2021.

Average Balance Sheet and Interest Rates.

The following table presents information regarding average balances of assets and liabilities, the total dollar amounts of interest income and dividends from average interest-earning assets, the total dollar amounts of interest expense on average interest-bearing liabilities, and the resulting annualized average yields and costs. The yields and costs for the periods indicated are derived by dividing income or expense by the average balances of assets or liabilities, respectively, for the periods presented. Average balances have been calculated using daily balances. Nonaccrual loans are included in average balances only. Loan fees are included in interest income on loans and are not material.

	Three Months Ended September 30,
	2020								2019
	Average Balance			Interest/ Dividends		Average Rate			Average Balance			Interest/ Dividends		Average Rate
	(dollars in thousands)
Assets:
Loans receivable	$	1,252,595		$	12,547		4.00	%	$	1,142,025		$	13,036		4.56	%
Investment securities		315,292			1,856		2.35			399,190			2,692		2.70
Other interest-earning assets		158,038			125		0.31			45,914			298		2.58
Total interest-earning assets		1,725,925			14,528		3.36			1,587,129			16,026		4.04
Non-interest-earning assets		71,926								70,266
Total assets	$	1,797,851							$	1,657,395

Liabilities and equity:
NOW accounts	$	149,466			89		0.24		$	119,852			57		0.19
Money market accounts		250,297			238		0.38			149,880			463		1.23
Savings accounts and escrow		360,091			202		0.22			362,569			232		0.25
Time deposits		443,487			1,903		1.70			459,348			2,549		2.20
Total interest-bearing deposits		1,203,341			2,432		0.80			1,091,649			3,301		1.20
FHLB advances		106,067			519		1.94			121,855			727		2.37
Total interest-bearing liabilities		1,309,408			2,951		0.89			1,213,504			4,028		1.32
Non-interest-bearing deposits		184,085								140,627
Other non-interest-bearing liabilities		28,958								21,210
Total liabilities		1,522,451								1,375,341
Total equity		275,400								282,054
Total liabilities and equity	$	1,797,851							$	1,657,395

Net interest income				$	11,577							$	11,998
Interest rate spread ⁽¹⁾							2.47								2.72
Net interest margin ⁽²⁾							2.69								3.03
Average interest-earning assets to interest-bearing liabilities		131.81	%							130.79	%

⁽¹⁾	Net interest rate spread represents the difference between the average yield on average interest-earning assets and the average cost of average interest-bearing liabilities.

⁽²⁾	Net interest margin represents annualized net interest income divided by average interest-earning assets.

Rate/Volume Analysis. The following table sets forth the effects of changing rates and volumes on our net interest income. The rate column shows the effects attributable to changes in rate (changes in rate multiplied by prior volume). The volume column shows the effects attributable to changes in volume (changes in volume multiplied by prior rate). The net column represents the sum of the prior columns. Changes attributable to changes in both rate and volume that cannot be segregated have been allocated proportionally based on the changes due to rate and the changes due to volume.

	Three Months Ended September 30,
	2020 versus 2019
	Rate			Volume			Net
	(in thousands)
Interest income:
Loans receivable	$	(1,568	)	$	1,079		$	(489	)
Investment securities		(525	)		(311	)		(836	)
Other interest-earning assets		(427	)		254			(173	)
Total interest-earning assets		(2,520	)		1,022			(1,498	)

Interest expense:
NOW accounts		16			16			32
Money market accounts		(430	)		205			(225	)
Savings and escrow accounts		(21	)		(9	)		(30	)
Time deposits		(561	)		(85	)		(646	)
FHLB advances		(120	)		(88	)		(208	)
Total interest-bearing liabilities		(1,116	)		39			(1,077	)

Net (decrease) increase in net interest income	$	(1,404	)	$	983		$	(421	)

Management of Market Risk

General. The majority of our assets and liabilities are monetary in nature. Consequently, our most significant form of market risk is interest rate risk. Our assets, consisting primarily of loans, have longer maturities than our liabilities, consisting primarily of deposits. As a result, a principal part of our business strategy is to manage our exposure to changes in market interest rates. Accordingly, we have established a management-level Asset/Liability Management Committee, which takes initial responsibility for developing an asset/liability management process and related procedures, establishing and monitoring reporting systems and developing asset/liability strategies. On at least a quarterly basis, the Asset/Liability Management Committee reviews asset/liability management with the Investment Asset/Liability Committee of the Board of Directors. This Committee also reviews any changes in strategies as well as the performance of any specific asset/liability management actions that have been implemented previously. On a quarterly basis, an outside consulting firm provides us with detailed information and analysis as to asset/liability management, including our interest rate risk profile. Ultimate responsibility for effective asset/liability management rests with our Board of Directors.

We have sought to manage our interest rate risk in order to minimize the exposure of our earnings and capital to changes in interest rates. We have implemented the following strategies to manage our interest rate risk: originating loans with adjustable interest rates; utilizing interest rate swaps, promoting core deposit products; and adjusting the interest rates and maturities of funding sources, as necessary. By following these strategies, we believe that we are better positioned to react to changes in market interest rates.

Net Portfolio Value Simulation. We analyze our sensitivity to changes in interest rates through a net portfolio value of equity (“NPV”) model. NPV represents the present value of the expected cash flows from our assets less the present value of the expected cash flows arising from our liabilities. The NPV ratio represents the dollar amount of our NPV divided by the present value of our total assets for a given interest rate scenario. NPV attempts to quantify our economic value using a discounted cash flow methodology while the NPV ratio reflects that value as a form of equity ratio. We estimate what our NPV would be at a specific date. We then calculate what the NPV would be at the same date throughout a series of interest rate scenarios representing immediate and permanent, parallel shifts in the yield curve. We currently calculate NPV under the assumptions that interest rates increase 100 and 200

basis points from current market rates and that interest rates decrease 50 and 100 basis points from current market rates.

The following table presents the estimated changes in our NPV that would result from changes in market interest rates at September 30, 2020 and June 30, 2020. All estimated changes presented in the table are within the policy limits approved by our Board of Directors.

	NPV									NPV as Percent of Portfolio Value of Assets
	(dollars in thousands)
Basis Point Change in Interest Rates	Dollar Amount		Dollar Change			Percent Change				NPV Ratio			Change (in bps)
September 30, 2020:
200	$	272,110	$	(20,318	)		(6.9	)	%		15.74	%		(43	)
100		289,991		(2,437	)		(0.8	)			16.37			20
-		292,428	-				-				16.17			-
(50)		299,184		6,756			2.3				16.38			21
(100)		298,595		6,167			2.1				16.32			15

June 30, 2020:
200	$	285,720	$	(20,631	)		(6.7	)	%		16.42	%		(40	)
100		304,004		(2,347	)		0.8				17.03			21
-		306,351		-			-				16.82			-
(50)		312,596		6,245			2.0				16.99			17
(100)		323,494		17,143			5.6				17.44			62

Certain shortcomings are inherent in the methodologies used in the above interest rate risk measurements. Modeling changes require making certain assumptions that may or may not reflect the manner in which actual yields and costs respond to changes in market interest rates. The above table assumes that the composition of our interest-sensitive assets and liabilities existing at the date indicated remains constant uniformly across the yield curve regardless of the duration or repricing of specific assets and liabilities. Accordingly, although the table provides an indication of our interest rate risk exposure at a particular point in time, such measurements are not intended to and do not provide a precise forecast of the effect of changes in market interest rates on our NPV and will differ from actual results.

Liquidity and Capital Resources

Liquidity. Liquidity is the ability to meet current and future financial obligations of a short-term nature. Our primary sources of funds consist of deposit inflows, loan repayments and maturities and sales of securities. While maturities and scheduled amortization of loans and securities are predictable sources of funds, deposit flows and mortgage prepayments are greatly influenced by general interest rates, economic conditions and competition.

We regularly review the need to adjust our investments in liquid assets based upon our assessment of: (1) expected loan demand, (2) expected deposit flows, (3) yields available on interest-earning deposits and securities, and (4) the objectives of our asset/liability management program. Excess liquid assets are invested generally in interest-earning deposits and short- and intermediate-term securities.

Our most liquid assets are cash and cash equivalents. The levels of these assets are dependent on our operating, financing, lending and investing activities during any given period. At September 30, 2020, cash and cash equivalents totaled $162.7 million, an increase from $136.3 million as of June 30, 2020. Securities classified as available for sale that are not pledged to support borrowings, which provide an additional source of liquidity, totaled $12.9 million at September 30, 2020, a decrease from $13.9 million as of June 30, 2020.

We had the ability to borrow up to $209.3 million and $218.4 million from the FHLB of New York, at September 30, 2020 and June 30, 2020, respectively, of which $106.1 million was outstanding as of both September 30, 2020 and June 30, 2020. Additionally, as of September 30, 2020, we had an available line of credit with the Federal Reserve Bank of New York’s discount window program of $103.0 million, as well as $25.0 million of fed funds lines of credit, neither of which had outstanding balances as of September 30, 2020.

We have no material commitments or demands that are likely to affect our liquidity other than as set forth below. If loan demand was to increase faster than expected, or any unforeseen demand or commitment was to occur, we could access our borrowing capacity with the FHLB of New York or Federal Reserve Bank of New York.

We had $54.1 million of loan commitments outstanding as of September 30, 2020 and $147.7 million of approved, but unadvanced, funds to borrowers. We also had $1.6 million in outstanding letters of credit at September 30, 2020.

Time deposits due within one year of September 30, 2020 totaled $276.6 million, an increase of $6.1 million from $270.5 million as of June 30, 2020. If these deposits do not remain with us, we will be required to seek other sources of funds, including other time deposits and FHLB of New York advances. Depending on market conditions, we may be required to pay higher rates on such deposits or other borrowings than we currently pay on the time deposits at September 30, 2020. We believe, however, based on past experience that a significant portion of our time deposits will remain with us. We have the ability to attract and retain deposits by adjusting the interest rates offered.

The Holding Company is a separate legal entity from the Bank and must provide for its own liquidity to pay any dividends to its shareholders, to repurchase shares of its common stock and for other corporate purposes. The Holding Company’s primary source of liquidity is dividend payments it may receive from the Bank. The Bank’s ability to pay dividends to the Holding Company is governed by applicable law and regulations. At September 30, 2020, the Holding Company (on an unconsolidated, stand-alone basis) had liquid assets of $37.9 million.

Capital Resources. The Bank is subject to various regulatory capital requirements administered by the NYSDFS and the FDIC. At September 30, 2020, the Bank exceeded all applicable regulatory capital requirements, and the Bank was considered “well capitalized” under applicable regulatory guidelines. See Note 8 to the accompanying unaudited consolidated financial statements.

Item 3. Quantitative and Qualitative Disclosures About Market Risk.

The information required by this item is included in Part I, Item 2 of this report under "Management of Market Risk."

Item 4. Controls and Procedures

An evaluation was performed under the supervision and with the participation of the Company’s management, including the Chief Executive Officer and the Chief Financial Officer, of the effectiveness of the design and operation of the Company’s disclosure controls and procedures (as defined in Rule 13a-15(e) promulgated under the Securities and Exchange Act of 1934, as amended) as of September 30, 2020. Based on that evaluation, the Company’s management, including the Chief Executive Officer and the Chief Financial Officer, concluded that the Company’s disclosure controls and procedures were effective.

During the quarter ended September 30, 2020, there have been no changes in the Company’s internal controls over financial reporting that have materially affected, or are reasonably likely to materially affect, the Company’s internal control over financial reporting.

PART II – OTHER INFORMATION

Item 1. Legal Proceedings

The Company is not involved in any pending legal proceedings as a plaintiff or a defendant other than routine legal proceedings occurring in the ordinary course of business. At September 30, 2020, the Company was not involved in any legal proceedings the outcome of which it believes would be material to its consolidated financial condition or results of operations.

Item 1A. Risk Factors

For information regarding the Company’s risk factors, see Part 1, Item 1A “Risk Factors” in the Company’s Annual Report on Form 10-K for the year ended June 30, 2020, filed with the Securities and Exchange Commission. As of September 30, 2020, the risk factors of the Company have not changed materially from those disclosed in the Annual Report on Form 10-K for the year ended June 30, 2020.

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

(a)

Not applicable

(b)

Not applicable

(c)

On August 20, 2020, a third repurchase program was authorized by the Board of Directors to repurchase up to 844,907 shares, or 5.0% of the Company’s common stock. Subsequent to September 30, 2020, and through November 4, 2020, the Company repurchased 216,500 shares of common stock at an average cost of $13.18 per share.

The following table presents information regarding stock repurchases by the Company during the quarter ended September 30, 2020.

	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
July 1, 2020 through July 31, 2020		-	$	-		-		844,907
August 1, 2020 through August 31, 2020		60,000		13.01		60,000		784,907
September 1, 2020 through September 30, 2020		206,900		12.90		206,900		578,007
Total		266,900	$	12.92		266,900

Item 3. Defaults Upon Senior Securities

None.

Item 4. Mine Safety Disclosures

Not applicable.

Item 5. Other Information

None.

Item 6. Exhibits

Exhibit Number		Description

3.1		Articles of Incorporation of PCSB Financial Corporation ⁽¹⁾

3.2		Bylaws of PCSB Financial Corporation ⁽²⁾

31.1		Certification of Chief Executive Officer pursuant to Section 302 of the Sarbanes-Oxley Act of 2002

31.2		Certification of Principal Financial Officer pursuant to Section 302 of the Sarbanes-Oxley Act of 2002

32		Certification of Chief Executive Officer and Principal Financial Officer pursuant to Section 906 of the Sarbanes-Oxley Act of 2002

101		The following materials for the quarter ended September 30, 2020, formatted in Inline XBRL (Extensible Business Reporting Language): (i) Consolidated Statements of Financial Condition, (ii) the Consolidated Statements of Operations, (iii) Consolidated Statements of Comprehensive Income, (iv) Consolidated Statements of Changes in Shareholders’ Equity, (v) Consolidated Statements of Cash Flows, and (vi) Notes to Consolidated Financial Statements

104		Cover Page Interactive Data File (embedded within the Inline XBRL document and included in Exhibit 101.

(1)	Incorporated by reference to Exhibit 3.1 to the Company’s Registration Statement on Form S-1, as amended (Commission File No. 333-215052).

(2)	Incorporated by reference to Exhibit 3.2 to the Company’s Registration Statement on Form S-1, as amended (Commission File No. 333-215052).

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.

		PCSB FINANCIAL CORPORATION

Date: November 6, 2020		/s/ Joseph D. Roberto
		Joseph D. Roberto
		Chairman, President and Chief Executive Officer

Date: November 6, 2020		/s/ Jeffrey M. Helf
		Jeffrey M. Helf
		Senior Vice President and Chief Financial Officer