# Orrstown Financial Services Inc: Form 10-Q for the period ended Sep 30, 2023

- Company: [Orrstown Financial Services Inc](/companies/orrf.md) (CIK 826154)
- Form: 10-Q
- Filed: 2023-11-08
- Accepted by EDGAR: Nov 8, 2023, 21:08 ET
- Period: 2023-09-30
- Accession: 0000826154-23-000145
- Inline XBRL: yes
- Main document: https://www.sec.gov/Archives/edgar/data/826154/000082615423000145/orrf-20230930.htm
- All documents and exhibits: https://www.sec.gov/Archives/edgar/data/826154/000082615423000145/

## Figures reported in this filing

Standardized XBRL line items for the period ended 2023-09-30.

| Line item | Period | Value | XBRL concept |
| --- | --- | ---: | --- |
| Interest expense | 3 months, 2023-07-01 to 2023-09-30 | $12.5m | us-gaap:InterestExpense |
| Interest expense | 9 months, 2023-01-01 to 2023-09-30 | $31.0m | us-gaap:InterestExpense |
| Income tax | 3 months, 2023-07-01 to 2023-09-30 | $2.5m | us-gaap:IncomeTaxExpenseBenefit |
| Income tax | 9 months, 2023-01-01 to 2023-09-30 | $7.3m | us-gaap:IncomeTaxExpenseBenefit |
| Net income | 3 months, 2023-07-01 to 2023-09-30 | $9.0m | us-gaap:NetIncomeLoss |
| Net income | 9 months, 2023-01-01 to 2023-09-30 | $28.0m | us-gaap:NetIncomeLoss |
| Diluted EPS | 3 months, 2023-07-01 to 2023-09-30 | $0.87 | us-gaap:EarningsPerShareDiluted |
| Diluted EPS | 9 months, 2023-01-01 to 2023-09-30 | $2.68 | us-gaap:EarningsPerShareDiluted |
| Basic EPS | 3 months, 2023-07-01 to 2023-09-30 | $0.87 | us-gaap:EarningsPerShareBasic |
| Basic EPS | 9 months, 2023-01-01 to 2023-09-30 | $2.71 | us-gaap:EarningsPerShareBasic |
| Diluted shares (weighted) | 3 months, 2023-07-01 to 2023-09-30 | 10,405,000 shares | us-gaap:WeightedAverageNumberOfDilutedSharesOutstanding |
| Diluted shares (weighted) | 9 months, 2023-01-01 to 2023-09-30 | 10,440,000 shares | us-gaap:WeightedAverageNumberOfDilutedSharesOutstanding |
| Operating cash flow | 9 months, 2023-01-01 to 2023-09-30 | $30.0m | us-gaap:NetCashProvidedByUsedInOperatingActivities |
| Capital expenditure | 9 months, 2023-01-01 to 2023-09-30 | $1.8m | us-gaap:PaymentsToAcquirePropertyPlantAndEquipment |
| Dividends paid | 9 months, 2023-01-01 to 2023-09-30 | $6.4m | us-gaap:PaymentsOfDividends |
| Share repurchases | 9 months, 2023-01-01 to 2023-09-30 | $2.6m | us-gaap:PaymentsForRepurchaseOfCommonStock |
| Total assets | at 2023-09-30 | $3.05bn | us-gaap:Assets |
| Total liabilities | at 2023-09-30 | $2.81bn | us-gaap:Liabilities |
| Shareholders' equity | at 2023-09-30 | $243.1m | us-gaap:StockholdersEquity |

## Management's discussion and analysis

As filed, 126,683 characters.

The following discussion and analysis is intended to assist readers in understanding the consolidated financial condition and results of operations of Orrstown and should be read in conjunction with the preceding unaudited condensed consolidated financial statements and notes thereto included in this Quarterly Report on Form 10-Q, as well as with the audited consolidated financial statements and notes thereto for the year ended December 31, 2022, included in our Annual Report on Form 10-K. Throughout this discussion, the yield on earning assets is stated on a fully taxable-equivalent basis and balances represent average daily balances unless otherwise stated.

### Overview

The Company is a one-bank holding company that has elected status as a financial holding company. The consolidated financial information presented herein reflects the Company and its wholly-owned subsidiary, the Bank. At September 30, 2023, the Company had total assets of $3.1 billion, total liabilities of $2.8 billion and total shareholders’ equity of $243.1 million.

For the three and nine months ended September 30, 2023, the Company had net income of $9.0 million and $28.0 million, respectively. The focus for 2023 has been limiting net interest margin compression in an increasing interest rate environment and a long period of economic uncertainty while generating prudent growth. For the three and nine months ended September 30, 2022, the Company had a net loss of $4.8 million and net income of $12.4 million, respectively. During the fourth quarter of 2022, the Company agreed to settle a litigation matter, which resulted in a provision for legal settlement ("legal settlement") of $13.0 million, before the tax effect, recorded in the third quarter of 2022. In addition, during the third quarter of 2022, the Company announced strategic initiatives designed to drive long-term growth and improve operating efficiencies through planned branch closures and staffing model adjustments, which resulted in pre-tax non-interest expenses ("restructuring charge") of $3.2 million. Excluding the legal settlement and the restructuring charge, net income for the three and nine months ended September 30, 2022 totaled $7.9 million and $25.2 million, respectively. For the three months ended September 30, 2022, diluted loss per share totaled $0.47. For the nine months ended September 30, 2022, diluted earnings per share totaled $1.16. Excluding the legal settlement and restructuring charge, diluted earnings per share totaled $0.75 and $2.34 for the three and nine months ended September 30, 2022, respectively. See “Supplemental Reporting of Non-GAAP Measures.”

### Cautionary Note About Forward-Looking Statements

Certain statements appearing herein, which are not historical in nature, are forward-looking statements within the meaning of Section 27A of the Securities Act and Section 21E of the Exchange Act, and are intended to be covered by the safe harbor provisions of the Private Securities Litigation Reform Act of 1995. In addition, we may make other written and oral communications, from time to time, that contain such statements. Such forward-looking statements reflect the current views of the Company's management with respect to, among other things, future events and the Company's financial performance. These statements are often, but not always, made through the use of words or phrases such as “may,” “will,” “expect,” “estimate,” “anticipate” or similar terms, or the negative variations of those words or other comparable words of a future or forward-looking nature. Forward-looking statements are statements that include projections, predictions, expectations, estimates or beliefs about events or results or otherwise are not statements of historical facts, many of which, by their nature, are inherently uncertain and beyond the Company's control, and include, but are not limited to, statements related to new business development, new loan opportunities, growth in the balance sheet and fee-based revenue lines of business, merger and acquisition activity, cost savings initiatives, reducing risk assets, and mitigating losses in the future. Accordingly, the Company cautions you that any such forward-looking statements are not guarantees of future performance and are subject to risks, assumptions and uncertainties that are difficult to predict. Although the Company believes that the expectations reflected in these forward-looking statements are reasonable as of the date made, actual results may prove to be materially different from the results expressed or implied by the forward-looking statements and there can be no assurances that the Company will achieve the desired level of new business development and new loans, growth in the balance sheet and fee-based revenue lines of business, successful merger and acquisition activity, cost savings initiatives, continue to reduce risk assets or mitigate losses in the future. Factors that could cause actual results to differ from those expressed or implied by the forward-looking statements include, but are not limited to, the following: ineffectiveness of the Company’s strategic growth plan due to changes in current or future market conditions; the effects of competition and how it may impact our community banking model, including industry consolidation and development of competing financial products and services; the integration of the Company's strategic acquisitions; the inability to fully achieve expected savings, efficiencies or synergies from mergers and acquisitions, or taking longer than estimated for such savings, efficiencies and synergies to be realized; changes in laws and regulations; interest rate movements; changes in credit quality; inability to raise capital, if necessary, under favorable conditions; volatility in the securities markets; the demand for our products and services; deteriorating economic conditions; geopolitical tensions; operational risks including, but not limited to, cybersecurity incidents, fraud, natural disasters and future pandemics; expenses associated with pending litigation and legal proceedings; a continuation of the recent disruption in the banking industry and responsive measures to manage it; and other risks and uncertainties, including those detailed in our Annual Report on Form 10-K for the year ended December 31, 2022, and our Quarterly Reports on Form 10-Q under the sections titled “Risk Factors” and “Management’s Discussion and Analysis of Financial Condition and Results of Operations” and in other filings made with the SEC. The statements are valid only as of the date hereof and we disclaim any obligation to update this information.

### Economic Climate, Inflation and Interest Rates

Preliminary real GDP for the third quarter of 2023 increased 4.9% on an annualized basis, which is an improvement from 2.1% during the second quarter of 2023 and annualized increase of 3.2% during the third quarter of 2022. The increase in preliminary GDP during the third quarter of 2023 reflected increases in consumer spending within various services and goods, residential fixed assets and government spending, partially offset by decreases in nonresidential fixed assets. Fluctuations in real GDP in recent periods, due to inflation, credit conditions, supply chain challenges and geopolitical tensions, continues to create uncertainty in the current economic environment. The personal consumption expenditures ("PCE") price index increased by 2.9% in the third quarter of 2023, compared to an increase of 2.5% for the final estimate in the second quarter of 2023. Excluding food and energy prices, the PCE price index increased by 2.4% in the third quarter of 2023 compared to 3.7% in the second quarter of 2023, which may be a signal that inflation pressures are starting to ease.

The national unemployment rate increased slightly to 3.8% in September 2023 compared to 3.6% in June 2023, and was at 3.5% in September 2022. However, within the Company's geographic footprint, the unemployment rate has decreased considerably in Pennsylvania from 4.3% in September 2022 to 3.4% in September 2023, and decreased in Maryland from 3.2% in September 2022 to 1.6% in September 2023. These decreases in state-wide unemployment rates are consistent with those experienced by the counties in which the Company operates branches and other corporate offices. There continued to be notable job gains nationally in healthcare, leisure and hospitality, professional, scientific and technical services, and government during the third quarter of 2023.

At September 30, 2023, the 10-year Treasury bond yield was 4.59%, a considerable increase from 3.83% at both December 31, 2022 and September 30, 2022 due to current economic conditions and inflationary pressures. In an attempt to combat the impact of inflation, the rising consumer price index, supply chain disruptions, the state of the labor market and geopolitical tensions, the Federal Reserve Open Markets Committee ("FOMC") approved increases to the Fed Funds rate totaling 550 basis points since March 2022 through the date of this report.

The majority of the assets and liabilities of a financial institution are monetary in nature and, therefore, differ greatly from most commercial and industrial companies that have significant investments in fixed assets or inventories. However, inflation does have an impact on the Company, particularly with respect to the growth of total assets and noninterest expenses, which tend to rise during periods of general inflation. Risks also exist due to supply and demand imbalances, employment shortages, the interest rate environment, and geopolitical tensions. It is reasonably foreseeable that estimates made in the financial statements could be materially and adversely impacted in the near term as a result of these conditions, including expected credit losses on loans and the fair value of financial instruments that are carried at fair value.

### Recent Banking Industry Developments

Beginning in March 2023, the banking industry experienced disruption from the failures of multiple regional U.S. banking institutions, each due to unique circumstances related to risk management of liquidity, interest, and capital and associated stress on deposits and unrealized losses on investment securities. These events led to a decline of confidence in the banking industry, which has since subsided, and overall economic uncertainty, which is expected to result in increased regulatory oversight and policymaking. The industry has experienced a significant increase in competition and pricing on deposits, which has driven funding costs higher. Although the Company was not materially impacted by these events during the three and nine months ended September 30, 2023, the Company has continued to assess its funding sources and analyze its liquidity position, interest rate sensitivity and capital adequacy, while also monitoring the ongoing events and volatility in the banking industry.

### Critical Accounting Estimates

The Company’s accounting and reporting policies are in accordance with GAAP and follow accounting and reporting guidelines prescribed by bank regulatory authorities and general practices within the financial services industry in which it operates. Our financial position and results of operations are affected by management's application of accounting policies, including estimates, and assumptions and judgments that affect the amounts reported in the consolidated financial statements and accompanying notes. These estimates, assumptions, and judgments are based on information available as of the balance sheet date and through the date the financial statements are filed with the SEC. Different assumptions in the application of these policies could result in material changes in the consolidated financial position and/or consolidated results of operations and related disclosures. The more critical accounting estimates include accounting for credit losses and valuation methodologies.

Accordingly, these critical accounting estimates are discussed in detail in "Management's Discussion and Analysis of Financial Condition and Results of Operations" in our Annual Report on Form 10-K for the year ended December 31, 2022. Significant accounting policies and any changes in accounting principles and effects of new accounting pronouncements are discussed in Note 1, Summary of Significant Accounting Policies, to the Consolidated Financial Statements under Part II, Item 8, "Financial Statements and Supplementary Data," in our Annual Report on Form 10-K for the year ended December 31, 2022. Additional disclosures regarding the effects of new accounting pronouncements, ASU 2016-13 and ASU 2022-02, are included in this report in Note 1, Summary of Significant Accounting Policies, to the unaudited condensed consolidated financial statements under Part I, Item 1, "Financial Information."

### RESULTS OF OPERATIONS

### Three months ended September 30, 2023 compared with three months ended September 30, 2022

### Summary

Net income totaled $9.0 million for the three months ended September 30, 2023 compared to a net loss of $4.8 million for the same period in 2022 primarily due to the restructuring charge and provision for legal settlement. Diluted earnings per share for the three months ended September 30, 2023 totaled $0.87 compared to a diluted loss per share of $0.47 for the three months ended September 30, 2022.

Net interest income totaled $26.2 million for the three months ended September 30, 2023 compared to $25.5 million for the three months ended September 30, 2022, reflecting the deployment of cash into higher yielding commercial loans and investment securities and the impact of rising interest rates on interest-earning asset yields, partially offset by the impact of an increase in cost of funds and an increase in interest-bearing liabilities. Interest income recognized on SBA PPP loans totaled $28 thousand for the three months ended September 30, 2023 compared to $523 thousand for the three months ended September 30, 2022.

The provision for credit losses totaled $136 thousand and $1.5 million for the three months ended September 30, 2023 and 2022, respectively. During the first quarter of 2023, the Company adopted the new accounting standard for CECL, which resulted in the change from the incurred loss model based on historical loss experience to the expected loss model and reflects the expected credit losses over the expected life of financial assets and commitments.

Noninterest income totaled $5.9 million for the three months ended September 30, 2023 compared to $6.1 million for the three months ended September 30, 2022. During the third quarter of 2022, there were distributions of $964 thousand from investments in non-housing limited partnerships. This was partially offset by a reduction in losses in mortgage banking activities of $872 thousand during the third quarter of 2023.

Noninterest expenses totaled $20.4 million for the three months ended September 30, 2023 compared to $36.4 million for the three months ended September 30, 2022. The decrease of $16.0 million is primarily due to the legal settlement and the restructuring charge incurred during the third quarter of 2022.

### Net Interest Income

Net interest income increased by $764 thousand from $25.5 million for the three months ended September 30, 2022 to $26.2 million for the three months ended September 30, 2023. Interest income on loans increased by $9.5 million, from $23.2 million to $32.7 million, and interest income on investment securities increased by $1.2 million, from $4.1 million to $5.3 million, compared to the same period in the prior year. Total interest expense increased by $10.5 million from $2.0 million for the three months ended September 30, 2022 to $12.5 million for the three months ended September 30, 2023. Interest expense on deposits increased by $9.2 million from $1.4 million for the three months ended September 30, 2022 to $10.6 million for the three months ended September 30, 2023, and interest expense on borrowings increased by $1.3 million from $592 thousand from three months ended September 30, 2022 to $1.9 million for the three months ended September 30, 2023.

The following table presents net interest income, net interest spread and net interest margin for the three months ended September 30, 2023 and 2022 on a taxable-equivalent basis:

| Assets | Three Months Ended September 30, 2023 Average Balance | Taxable- Equivalent Interest | Taxable- Equivalent Rate | Three Months Ended September 30, 2022 Average Balance | Taxable- Equivalent Interest | Taxable- Equivalent Rate |
| --- | ---: | ---: | ---: | ---: | ---: | ---: |
| Federal funds sold & interest-bearing bank balances | **$57,778** | **$633** | **4.35%** | $38,068 | $200 | 2.08% |
| Investment securities (1)(2) | **521,234** | **5,548** | **4.26** | 528,988 | 4,377 | 3.31 |
| Loans (1)(3)(4) | **2,256,727** | **32,878** | **5.78** | 2,051,707 | 23,219 | 4.49 |
| Total interest-earning assets | **2,835,739** | **39,059** | **5.47** | 2,618,763 | 27,796 | 4.22 |
| Other assets | **200,447** |  |  | 196,277 |  |  |
| Total assets | **$3,036,186** |  |  | $2,815,040 |  |  |
| **Liabilities and Shareholders’ Equity** |  |  |  |  |  |  |
| Interest-bearing demand deposits | **$1,541,728** | **7,476** | **1.92** | $1,379,082 | 912 | 0.26 |
| Savings deposits | **190,817** | **164** | **0.34** | 237,462 | 90 | 0.15 |
| Time deposits | **357,194** | **2,942** | **3.27** | 265,015 | 370 | 0.55 |
| Total interest-bearing deposits | **2,089,739** | **10,582** | **2.01** | 1,881,559 | 1,372 | 0.29 |
| Securities sold under agreements to repurchase and federal funds purchased | **15,006** | **31** | **0.83** | 23,480 | 10 | 0.18 |
| FHLB advances and other borrowings | **128,131** | **1,354** | **4.19** | 10,394 | 78 | 3.02 |
| Subordinated notes | **32,066** | **505** | **6.29** | 32,000 | 504 | 6.29 |
| Total interest-bearing liabilities | **2,264,942** | **12,472** | **2.19** | 1,947,433 | 1,964 | 0.40 |
| Noninterest-bearing demand deposits | **468,628** |  |  | 575,777 |  |  |
| Other liabilities | **54,353** |  |  | 49,964 |  |  |
| Total liabilities | **2,787,923** |  |  | 2,573,174 |  |  |
| Shareholders’ equity | **248,263** |  |  | 241,866 |  |  |
| Total liabilities and shareholders' equity | **$3,036,186** |  |  | $2,815,040 |  |  |
| Taxable-equivalent net interest income /net interest spread |  | **26,587** | **3.29%** |  | 25,832 | 3.82% |
| Taxable-equivalent net interest margin |  |  | **3.73%** |  |  | 3.92% |
| Taxable-equivalent adjustment |  | **(368)** |  |  | (377) |  |
| Net interest income |  | **$26,219** |  |  | $25,455 |  |

| NOTES TO ANALYSIS OF NET INTEREST INCOME: |  |
| ---: | --- |
| (1) | Yields and interest income on tax-exempt assets have been computed on a taxable-equivalent basis assuming a 21% tax rate. |
| (2) | Average balance of investment securities is computed at fair value. |
| (3) | Average balances include nonaccrual loans. |
| (4) | Interest income on loans includes prepayment and late fees, where applicable. |

55

The following table presents changes in net interest income on a taxable-equivalent basis for the three months ended September 30, 2023 and 2022 by rate and volume components.

*(in thousands)*

| Interest Income | Three Months Ended September 30, 2023 Versus 2022 Increase (Decrease) Due to Change In Average Volume | Average Rate | Total |
| --- | ---: | ---: | ---: |
| Federal funds sold and interest-bearing bank balances | **$103** | **$330** | **$433** |
| Taxable securities | **206** | **1,345** | **1,551** |
| Tax-exempt securities | **(295)** | **(85)** | **(380)** |
| Loans | **2,307** | **7,352** | **9,659** |
| Total interest income | **2,321** | **8,942** | **11,263** |
| **Interest Expense** |  |  |  |
| Interest-bearing demand deposits | **106** | **6,458** | **6,564** |
| Savings deposits | **(18)** | **92** | **74** |
| Time deposits | **129** | **2,443** | **2,572** |
| Total interest-bearing deposits | **217** | **8,993** | **9,210** |
| Securities purchases under agreements to repurchase and federal funds purchased | **(4)** | **25** | **21** |
| FHLB advances and other | **896** | **380** | **1,276** |
| Subordinated notes | **1** | **—** | **1** |
| Total interest expense | **1,110** | **9,398** | **10,508** |
| **Taxable-Equivalent Net Interest Income** | **$1,211** | **$(456)** | **$755** |

Net interest income on a taxable-equivalent basis increased by $755 thousand to $26.6 million for the three months ended September 30, 2023 from $25.8 million for the three months ended September 30, 2022. The Company's net interest spread decreased by 53 basis points to 3.29% for the three months ended September 30, 2023 compared to 3.82% for the three months ended September 30, 2022.

Taxable-equivalent net interest margin decreased by 19 basis points to 3.73% for the three months ended September 30, 2023 from 3.92% for the three months ended September 30, 2022. The taxable-equivalent yield on interest-earning assets increased by 125 basis points from 4.22% for the three months ended September 30, 2022 to 5.47% for the three months ended September 30, 2023, reflecting the benefit of both the deployment of cash into higher yielding loans and investment securities and the impact of elevated interest rates on these interest-earning assets. This increase in yield was partially offset by the increase of 179 basis points in the cost of interest-bearing liabilities between these same periods from 0.40% during the third quarter of 2022 to 2.19% during the third quarter of 2023 due to increased funding costs from higher market interest rates, competitive pressures and an increase in higher cost borrowings.

Average loans increased by $205.0 million to $2.3 billion for the three months ended September 30, 2023 compared to $2.1 billion for the three months ended September 30, 2022. Average investment securities decreased by $7.8 million from $529.0 million for the three months ended September 30, 2022 to $521.2 million for the same period in 2023 primarily due to paydowns. Average interest-bearing liabilities increased by $317.5 million to $2.3 billion for the three months ended September 30, 2023 from $1.9 billion for the three months ended September 30, 2022. The competition for deposits increased in the latter part of 2022 and has continued throughout 2023, which was coupled with clients utilizing their funds at a higher frequency. Therefore, additional liquidity was needed to meet the credit demands of clients, which resulted in an increase in average borrowings.

The yield on loans increased by 129 basis points to 5.78% for the three months ended September 30, 2023 compared to 4.49% for the three months ended September 30, 2022. Taxable-equivalent interest income earned on loans increased by $9.7 million year-over-year due to an increase in the average balance of commercial loans, excluding SBA PPP loan forgiveness activity, home equity loans and residential mortgages and from the impact of the rising interest rate environment. The increase in interest income from loan growth and higher interest rates was partially offset by the decrease of $495 thousand in interest income from SBA PPP loans due to a lower amount of forgiveness activity during the three months ended September 30, 2023 compared to the same period in 2022.

The average balance of commercial loans, excluding SBA PPP loan forgiveness activity, increased by $179.4 million from $1.6 billion for the three months ended September 30, 2022 to $1.8 billion for the three months ended September 30, 2023. SBA PPP loans, net of deferred fees and costs, averaged $25.0 million for the three months ended September 30, 2022 compared to $6.8 million for the three months ended September 30, 2023. This decrease was due to forgiveness of SBA PPP loans. Average residential mortgage loans increased by $37.8 million from $213.6 million during the three months ended September 30, 2022 to $251.4 million during the three months ended September 30, 2023 due primarily to adjustable-rate and jumbo mortgage loans originated for the portfolio. Average home equity loans increased by $11.7 million from $179.7 million for the three months ended September 30, 2022 to $191.4 million for the three months ended September 30, 2023. Average installment and other consumer loans decreased by $5.7 million from $25.4 million for the three months ended September 30, 2022 to $19.7 million for the three months ended September 30, 2023.

For the three months ended September 30, 2023, interest income on loans includes $28 thousand of interest and net deferred fee income associated with SBA PPP loans compared to $523 thousand of such interest and fee income for the three months ended September 30, 2022. Prepayment income on commercial loans increased by $224 thousand from $129 thousand for the three months ended September 30, 2022 to $353 thousand for the three months ended September 30, 2023. Accretion of purchase accounting adjustments included in interest income was $149 thousand and $156 thousand for the three months ended September 30, 2023 and 2022, respectively. The three months ended September 30, 2023 and 2022 included $30 thousand and $64 thousand, respectively, of accelerated accretion.

Interest income on investment securities on a tax-equivalent basis increased by $1.1 million to $5.5 million for the three months ended September 30, 2023 from $4.4 million for the three months ended September 30, 2022, with the taxable equivalent yield increasing from 3.31% for the three months ended September 30, 2022 to 4.26% for the three months ended September 30, 2023. The increase of 95 basis points reflected the higher interest rate environment since March 2022 and the impact of investment security purchases at higher yields. The average balance of investment securities decreased by $7.8 million to $521.2 million for the three months ended September 30, 2023 from $529.0 million for the three months ended September 30, 2022 due to paydowns and lower investment security purchases between the comparative periods.

The average balance of federal funds sold and interest-bearing bank balances increased by $19.7 million from $38.1 million for the three months ended September 30, 2022 to $57.8 million for the same period in 2023 due primarily to the deployment of cash into loans and investment securities. However, the related interest income on a tax-equivalent basis increased by $433 thousand to $633 thousand for the three months ended September 30, 2023 from $200 thousand for the three months ended September 30, 2022. This increase was the result of multiple Federal Funds rate increases by the FOMC since March 2022.

Interest expense on interest-bearing liabilities increased by $10.5 million year-over-year due to the increase in the cost of interest-bearing liabilities by 179 basis points from 0.40% for the three months ended September 30, 2022 to 2.19% for the three months ended September 30, 2023, as funding costs increased from higher market interest rates, competitive pressures and an increase in higher cost borrowings. During the third quarter of 2023, average interest-bearing core deposits increased by $116.0 million and average time deposits increased by $92.2 million due as clients sought higher-yielding products during the rising interest rate environment.

Interest expense on borrowings increased by $1.3 million to $1.9 million for the three months ended September 30, 2023 from $592 thousand for the three months ended September 30, 2022, as the cost of borrowings increased by 69 basis points to 4.29% for the three months ended September 30, 2023 from 3.60% for the three months ended September 30, 2022. Average borrowings increased by $109.3 million from $65.9 million for the three months ended September 30, 2022 to $175.2 million for the three months ended September 30, 2023, as the Bank opted to borrow funds to provide additional liquidity to meet the credit needs of its clients.

### Provision for Credit Losses

The Company recorded a provision for credit losses of $136 thousand for the three months ended September 30, 2023 compared to $1.5 million for the same period in 2022. On January 1, 2023, the Company adopted the new accounting standard, referred to as CECL, which transitioned from the incurred loss model based on historical loss experience and economic and market conditions to the expected loss model. The CECL standard reflects expected credit losses over the expected life of the financial assets and commitments, primarily based on the discounted cash flow methodology for the majority of the loan segments, which applies the probability of default and loss given default factors to future cash flows, and adjusts to the net present value to derive the required reserve. Macroeconomic conditions are incorporated into the model for unemployment and gross domestic product, in addition to model assumptions for discount rate and prepayment and curtailment speeds.

For the three months ended September 30, 2023, the provision for credit losses was driven by loan growth of $32.4 million in loans and an increase in the *Delinquency and Classified Loan Trends* qualitative factor for the commercial & industrial and owner-occupied commercial real estate loan classes and an increase in the *Economic Conditions* qualitative factor for consumer loans. The changes in these qualitative factors were based on a recent trend of increases in loans downgraded within the previously noted loan classes and growing concerns surrounding the economic conditions related to consumer debt levels, the impact of inflationary pressures and the reinstatement of student loan repayments, which could impact consumer loans. The increases to these qualitative factors resulted in an increase to the required ACL of $1.5 million. In addition, the provision for credit losses is impacted by the change in expected loss rates under CECL. Favorable published trends in unemployment and GDP rates, which are used in correlation with historical charge-offs to predict defaults and losses, resulted in a decrease to the required ACL of $2.0 million in the third quarter of 2023. These changes to the total loss rate resulted in a net decrease to the required ACL of $547 thousand, which was more than offset by the impact of the loan production and the adjustments to the qualitative factors during the third quarter of 2023. The ALL to total loan ratio increased from 1.18% at September 30, 2022 to an ACL to total loan ratio of 1.25% at September 30, 2023, which the increase is primarily due to the cumulative effect adjustment recorded in connect with the adoption of CECL. The provision expense recorded in the three months ended September 30, 2022 was due to commercial loan growth, excluding SBA PPP loan forgiveness activity, of $125.9 million.

Net charge-offs for the three months ended September 30, 2023 totaled $241 thousand, compared to net charge-offs of $70 thousand for the three months ended September 30, 2022. The increase in net charge-offs was due primarily to one commercial and industrial loan relationship with partial charge-offs totaling $267 thousand during the third quarter of 2023. Nonaccrual loans were 0.98% of gross loans at September 30, 2023, compared with 0.25% of gross loans at September 30, 2022. Nonaccrual loans increased by $17.0 million from September 30, 2022 to September 30, 2023, primarily due to one commercial and land development construction-to-permanent ("CTP") loan being downgraded to substandard and placed on non-accrual status in the fourth quarter of 2022. While the loan had not been past due, management determined that it was appropriate to place the loan on non-accrual status due to other relevant factors. At this time, management believes that the value of the underlying collateral is sufficient to cover any potential losses on this loan. Management does not believe that this credit is indicative of overall stress in the loan portfolio. During the second quarter of 2023, the project underlying this CTP loan received its certificate of occupancy, which resulted in the recharacterization of the loan from commercial and land development to owner-occupied. The CTP loan had a current outstanding balance of $14.3 million and $15.4 million at September 30, 2023 and December 31, 2022, respectively.

Additional information is included in the "Credit Risk Management" section herein.

### Noninterest Income

The following table compares noninterest income for the three months ended September 30, 2023 and 2022:

|  | Three Months Ended September 30, 2023 | 2022 | $ Change 2023-2022 | % Change 2023-2022 |
| --- | ---: | ---: | ---: | ---: |
| Service charges on deposit accounts | **$1,020** | $977 | **$43** | **4.4%** |
| Interchange income | **963** | 1,014 | **(51)** | **(5.0)%** |
| Other service charges, commissions and fees | **240** | 239 | **1** | **0.4%** |
| Swap fee income | **255** | 197 | **58** | **29.4%** |
| Trust and investment management income | **1,853** | 2,006 | **(153)** | **(7.6)%** |
| Brokerage income | **973** | 947 | **26** | **2.7%** |
| Mortgage banking activities | **(142)** | (1,014) | **872** | **(86.0)%** |
| Income from life insurance | **620** | 583 | **37** | **6.3%** |
| Other income | **141** | 1,123 | **(982)** | **(87.4)%** |
| Investment securities losses | **2** | (14) | **16** | **114.3%** |
| Total noninterest income | **$5,925** | $6,058 | **$(133)** | **(2.2)%** |

Noninterest income decreased by $133 thousand between the three months ended September 30, 2023 and 2022. The following were significant components of this decrease:

- Swap fee income, which will fluctuate based on market conditions and client demand, increased by $58 thousand.
- Trust and investment management income decreased by $153 thousand due to market declines.
- The losses on mortgage banking activities declined from $1.0 million for the quarter ended September 30, 2022 to $142 thousand for the same quarter in 2023. Both periods had unfavorable marks on the fair values of loans held for sale, with losses during 2022 being more significant as there was greater movement in interest rates. Market conditions and elevated interest rates also continue to hinder mortgage production. Most mortgage production remains in adjustable-rate products, which are held in portfolio. Mortgage loans sold totaled $5.2 million in the third quarter of 2023 compared to $12.7 million in the third quarter of 2022.
- Other income decreased by $982 thousand due primarily to the distribution of $964 thousand from investments in non-housing limited partnerships during the third quarter of 2022.
- Other line items within noninterest income showed fluctuations attributable to normal business operations.

### Noninterest Expenses

The following table compares noninterest expenses for the three months ended September 30, 2023 and 2022:

|  | Three Months Ended September 30, 2023 | 2022 | $ Change 2023-2022 | % Change 2023-2022 |
| --- | ---: | ---: | ---: | ---: |
| Salaries and employee benefits | **$12,885** | $12,705 | **$180** | **1.4%** |
| Occupancy | **1,089** | 1,166 | **(77)** | **(6.6)%** |
| Furniture and equipment | **1,371** | 1,214 | **157** | **12.9%** |
| Data processing | **1,248** | 1,192 | **56** | **4.7%** |
| Automated teller machine and interchange fees | **314** | 329 | **(15)** | **(4.6)%** |
| Advertising and bank promotions | **332** | 278 | **54** | **19.4%** |
| FDIC insurance | **477** | 294 | **183** | **62.2%** |
| Professional services | **965** | 887 | **78** | **8.8%** |
| Directors' compensation | **199** | 213 | **(14)** | **(6.6)%** |
| Taxes other than income | **387** | 488 | **(101)** | **(20.7)%** |
| Intangible asset amortization | **228** | 272 | **(44)** | **(16.2)%** |
| Provision for legal settlement | **—** | 13,000 | **(13,000)** | **100.0%** |
| Restructuring expenses | **—** | 3,155 | **(3,155)** | **100.0%** |
| Other operating expenses | **952** | 1,219 | **(267)** | **(21.9)%** |
| Total noninterest expenses | **$20,447** | $36,412 | **$(15,965)** | **(43.8)%** |

Noninterest expense decreased by $16.0 million from $36.4 million for the three months ended September 30, 2022 to $20.4 million for the three months ended September 30, 2023. The following were significant factors in this decrease:

- Furniture and equipment expense increased by $157 thousand due to an increase in hardware and software maintenance and services to support technology and facility improvements.
- Advertising and bank promotions expense increased by $54 thousand due to an increase in digital advertising, contributions and sponsorships to continue to promote the Company.
- FDIC insurance expense increased by $183 thousand due to increases in the assessment rate caused by an annualized two-basis point increase assessed by the FDIC to increase its deposit insurance fund, as well as growth in commercial loans and overall assets.
- Taxes other than income decreased by $101 thousand due to a decrease in the Pennsylvania Bank Shares Tax expense, which was driven by a decrease in the Bank's total equity balance from the increase in unrealized losses on investment securities and charges in the third quarter of 2022 for a provision for legal settlement and restructuring expenses.
- The Company agreed to settle a litigation matter, which resulted in a provision for legal settlement of $13.0 million recorded in the third quarter of 2022.
- During the third quarter of 2022, the Company announced that five branch locations would be closing and staffing model adjustments would be made to drive long-term growth and improve operating efficiencies in 2023 and forward. As a result of these initiatives, the Company recorded a pre-tax restructuring charge of $3.2 million, which consisted of building and fixed asset write-offs of $1.9 million and early retirement/severance costs of $1.3 million.
- Other operating expenses decreased by $267 thousand primarily due to a reduction in credit valuation adjustments on derivatives of $169 thousand.
- Other line items within noninterest expenses showed fluctuations attributable to normal business operations.

### Income Tax Expense

Income tax expense totaled $2.5 million, an effective tax rate of 21.9%, for the three months ended September 30, 2023 compared with an income tax benefit of $1.6 million and an effective tax rate of 24.6% for the three months ended September 30, 2022. Excluding the impact of the legal settlement, the effective tax rate was 17.6% for the three months ended September 30, 2022. The Company's effective tax rate for the three months ended September 30, 2023 is greater than the 21% federal statutory rate primarily due to an increase in state taxes in addition to the disallowed portion of interest expense against earnings in association with the Bank's tax-exempt investments under the Tax Equity and Fiscal Responsibility Act of 1982 ("TEFRA"), partially offset by tax-exempt income, including interest earned on tax-exempt loans and securities and income from life insurance policies and tax credits. The increase in the effective tax rate from the three months ended September 30, 2022 to the three months ended September 30, 2023 was primarily due an increase in taxable income as the prior year was impacted by the restructuring charge and provision for legal settlement. In addition, the effective tax rate for the three months ended September 30, 2023 was increased by the portion of interest expense disallowed as a deduction against earnings under TEFRA and an increase in state taxes as a result of a greater percentage of taxable income earned in a state with a state income tax.

### Nine months ended September 30, 2023 compared with nine months ended September 30, 2022

### Summary

Net income totaled $28.0 million for the nine months ended September 30, 2023 compared to $12.4 million for the same period in 2022. Diluted earnings per share for the nine months ended September 30, 2023 totaled $2.68 compared to $1.16 for the nine months ended September 30, 2022.

Net interest income totaled $78.9 million for the nine months ended September 30, 2023 compared to $72.1 million for the nine months ended September 30, 2022, reflecting the deployment of cash into higher yielding commercial loans and investment securities and the impact of rising interest rates on interest-earning asset yields, partially offset by the impact of an increase in cost of funds and an increase in interest-bearing liabilities. Interest income recognized on SBA PPP loans totaled $174 thousand for the nine months ended September 30, 2023 compared to $5.9 million for the nine months ended September 30, 2022.

The provision for credit losses on loans totaled $1.3 million and $3.6 million for the nine months ended September 30, 2023 and 2022, respectively. During the first quarter of 2023, the Company adopted the new accounting standard for CECL, which resulted in the change from the incurred loss model based on historical loss experience to the expected loss model, and reflects the expected credit losses over the expected life of financial assets and commitments.

Noninterest income totaled $19.2 million and $20.7 million for the nine months ended September 30, 2023 and 2022, respectively. The decrease of $1.5 million was due to a decrease in swap fee income of $1.5 million.

Noninterest expenses totaled $61.5 million for the nine months ended September 30, 2023 compared to $74.6 million for the three months ended September 30, 2022. The decrease of $13.1 million is primarily due to restructuring charge for branch closures and other expense savings initiatives and a provision for legal settlement recorded in the third quarter of 2022.

### Net Interest Income

Net interest income increased by $6.8 million from $72.1 million for the nine months ended September 30, 2022 to $78.9 million for the nine months ended September 30, 2023. Interest income on loans increased by $26.2 million, from $66.5 million to $92.7 million, and interest income on investment securities increased by $6.3 million, from $9.5 million to $15.8 million, compared to the same period in the prior year. Total interest expense increased by $26.6 million from $4.4 million for the nine months ended September 30, 2022 to $31.0 million for the nine months ended September 30, 2023. Interest expense on deposits increased by $22.6 million from $2.8 million for the nine months ended September 30, 2022 to $25.4 million for the nine months ended September 30, 2023, and interest expense on borrowings increased by $3.9 million from $1.7 million from nine months ended September 30, 2022 to $5.6 million for the nine months ended September 30, 2023.

The following table presents net interest income, net interest spread and net interest margin for the nine months ended September 30, 2023 and 2022 on a taxable-equivalent basis:

| Assets | Nine Months Ended September 30, 2023 Average Balance | Taxable- Equivalent Interest | Taxable- Equivalent Rate | Nine Months Ended September 30, 2022 Average Balance | Taxable- Equivalent Interest | Taxable- Equivalent Rate |
| --- | ---: | ---: | ---: | ---: | ---: | ---: |
| Federal funds sold & interest-bearing bank balances | **$41,861** | **$1,349** | **4.31%** | $122,509 | $536 | 0.59% |
| Investment securities (1)(2) | **524,365** | **16,523** | **4.21** | 508,582 | 10,276 | 2.70 |
| Loans (1)(3)(4) | **2,223,701** | **93,051** | **5.59** | 2,011,881 | 66,738 | 4.43 |
| Total interest-earning assets | **2,789,927** | **110,923** | **5.31** | 2,642,972 | 77,550 | 3.92 |
| Other assets | **196,694** |  |  | 191,090 |  |  |
| Total | **$2,986,621** |  |  | $2,834,062 |  |  |
| **Liabilities and Shareholders’ Equity** |  |  |  |  |  |  |
| Interest-bearing demand deposits | **$1,519,013** | **18,611** | **1.64** | $1,399,035 | 1,470 | 0.14 |
| Savings deposits | **204,832** | **431** | **0.28** | 234,054 | 209 | 0.12 |
| Time deposits | **320,000** | **6,350** | **2.65** | 279,557 | 1,079 | 0.52 |
| Total interest-bearing deposits | **2,043,845** | **25,392** | **1.66** | 1,912,646 | 2,758 | 0.19 |
| Securities sold under agreements to repurchase and federal funds purchased | **14,190** | **84** | **0.79** | 23,685 | 24 | 0.14 |
| FHLB Advances and other borrowings | **122,300** | **3,992** | **4.36** | 4,693 | 121 | 3.44 |
| Subordinated notes | **32,049** | **1,513** | **6.29** | 31,985 | 1,510 | 6.29 |
| Total interest-bearing liabilities | **2,212,384** | **30,981** | **1.87** | 1,973,009 | 4,413 | 0.30 |
| Noninterest-bearing demand deposits | **480,006** |  |  | 562,826 |  |  |
| Other liabilities | **52,618** |  |  | 46,058 |  |  |
| Total liabilities | **2,745,008** |  |  | 2,581,893 |  |  |
| Shareholders’ equity | **241,613** |  |  | 252,169 |  |  |
| Total | **$2,986,621** |  |  | $2,834,062 |  |  |
| Taxable-equivalent net interest income / net interest spread |  | **79,942** | **3.44%** |  | 73,137 | 3.62% |
| Taxable-equivalent net interest margin |  |  | **3.83%** |  |  | 3.70% |
| Taxable-equivalent adjustment |  | **(1,054)** |  |  | (991) |  |
| Net interest income |  | **$78,888** |  |  | $72,146 |  |

| NOTES TO ANALYSIS OF NET INTEREST INCOME: |  |
| ---: | --- |
| (1) | Yields and interest income on tax-exempt assets have been computed on a taxable-equivalent basis assuming a 21% tax rate. |
| (2) | Average balance of investment securities is computed at fair value. |
| (3) | Average balances include nonaccrual loans. |
| (4) | Interest income on loans includes prepayment and late fees, where applicable. |

62

The following table presents changes in net interest income on a taxable-equivalent basis for the nine months ended September 30, 2023 and 2022 by rate and volume components.

*(in thousands)*

| Interest Income | Nine Months Ended September 30, 2023 Versus 2022 Increase (Decrease) Due to Change In Average Volume | Average Rate | Total |
| --- | ---: | ---: | ---: |
| Federal funds sold and interest-bearing bank balances | **$(353)** | **$1,166** | **$813** |
| Taxable securities | **640** | **6,142** | **6,782** |
| Tax-exempt securities | **(412)** | **(123)** | **(535)** |
| Loans | **7,003** | **19,310** | **26,313** |
| Total interest income | **6,878** | **26,495** | **33,373** |
| **Interest Expense** |  |  |  |
| Interest-bearing demand deposits | **122** | **17,019** | **17,141** |
| Savings deposits | **(26)** | **248** | **222** |
| Time deposits | **156** | **5,115** | **5,271** |
| Total interest-bearing deposits | **252** | **22,382** | **22,634** |
| Securities purchases under agreements to repurchase and federal funds purchased | **(10)** | **70** | **60** |
| FHLB advances and other | **3,022** | **849** | **3,871** |
| Subordinated notes | **3** | **—** | **3** |
| Total interest expense | **3,267** | **23,301** | **26,568** |
| **Taxable-Equivalent Net Interest Income** | **$3,611** | **$3,194** | **$6,805** |

Net interest income on a taxable-equivalent basis increased by $6.8 million to $79.9 million for the nine months ended September 30, 2023 from $73.1 million for the nine months ended September 30, 2022. The Company's net interest spread was 3.44% for the nine months ended September 30, 2023 compared to 3.62% for the nine months ended September 30, 2022.

Taxable-equivalent net interest margin increased by 13 basis points to 3.83% for the nine months ended September 30, 2023 from 3.70% for the nine months ended September 30, 2022. The taxable-equivalent yield on interest-earning assets increased by 139 basis points from 3.92% for the nine months ended September 30, 2022 to 5.31% for the nine months ended September 30, 2023 reflecting the benefit of both the deployment of cash into higher yielding loans and investment securities and the impact of rising interest rates on these interest-earning assets. This increase in yield was partially offset by the increase of 157 basis points in the cost of interest-bearing liabilities from 0.30% to 1.87% between these same periods due to increased funding costs from higher market interest rates, competitive pressures and an increase in borrowings.

Average loans increased by $211.8 million to $2.2 billion for the nine months ended September 30, 2023 compared to $2.0 billion for the nine months ended September 30, 2022. The increase in average loans was due to loan growth, partially offset by the impact of SBA PPP loan forgiveness activity. Average investment securities increased by $15.8 million from $508.6 million for the nine months ended September 30, 2022 to $524.4 million for the same period in 2023 primarily due to investment purchases, partially offset by paydowns. Average interest-bearing liabilities increased by $239.4 million to $2.2 billion for the nine months ended September 30, 2023 from $2.0 billion for the nine months ended September 30, 2022. The competition for deposits increased in the latter part of 2022 and continued throughout 2023, which was coupled with clients utilizing their funds at a higher frequency. Therefore, additional liquidity was needed to meet the credit demands of clients, which resulted in an increase in average borrowings.

The yield on loans increased by 116 basis points to 5.59% for the nine months ended September 30, 2023 compared to 4.43% for the nine months ended September 30, 2022. Taxable-equivalent interest income earned on loans increased by $26.3 million year-over-year due to an increase in the average balance of commercial loans, excluding SBA PPP loan forgiveness activity, home equity loans and residential mortgages and from the impact of the rising interest rate environment. The increase in interest income from loan growth and higher interest rates was partially offset by the decrease of $5.7 million in interest income from SBA PPP loans due to significantly less forgiveness activity during the nine months ended September 30, 2023 compared to the same period in 2022.

The average balance of commercial loans, excluding SBA PPP loan forgiveness activity, increased by $165.2 million from $1.6 billion for the nine months ended September 30, 2022 to $1.8 billion for the nine months ended September 30, 2023. SBA PPP loans, net of deferred fees and costs, averaged $83.8 million for the nine months ended September 30, 2022 compared to $9.6 million for the nine months ended September 30, 2023. This decrease was due to forgiveness of SBA PPP loans. Average residential mortgage loans increased by $36.5 million from $204.4 million during the nine months ended September 30, 2022 to $240.9 million during the nine months ended September 30, 2023, primarily due to adjustable-rate and jumbo mortgage loans originated for the portfolio. Average home equity loans increased by $16.9 million from $171.9 million for the nine months ended September 30, 2022 to $188.8 million for the nine months ended September 30, 2023. Average installment and other consumer loans decreased by $6.7 million from $27.2 million for the nine months ended September 30, 2022 to $20.5 million for the nine months ended September 30, 2023.

For the nine months ended September 30, 2023, interest income on loans includes $174 thousand of interest and net deferred fee income associated with SBA PPP loans compared to $5.9 million of such interest and fee income for the nine months ended September 30, 2022. Prepayment income on commercial loans decreased by $25 thousand from $652 thousand for the nine months ended September 30, 2022 to $627 thousand for the nine months ended September 30, 2023. Accretion of purchase accounting adjustments included in interest income was $603 thousand and $966 thousand for the nine months ended September 30, 2023 and 2022, respectively. The decrease in accretion was partially due to a decline in accelerated accretion from acquired loan payoffs or significant loan repayments. The nine months ended September 30, 2023 and 2022 included $212 thousand and $647 thousand, respectively, of accelerated accretion.

Interest income on investment securities on a tax-equivalent basis increased by $6.2 million to $16.5 million for the nine months ended September 30, 2023 from $10.3 million for the nine months ended September 30, 2022, with the taxable equivalent yield increasing from 2.70% for the nine months ended September 30, 2022 to 4.21% for the nine months ended September 30, 2023. The 151 basis point increase reflected the higher interest rate environment since March 2022, as well as higher balances from purchases. The average balance of investment securities increased by $15.8 million to $524.4 million for the nine months ended September 30, 2023 from $508.6 million for the nine months ended September 30, 2022.

The average balance of federal funds sold and interest-bearing bank balances decreased by $80.6 million from $122.5 million for the nine months ended September 30, 2022 to $41.9 million for the same period in 2023, due primarily to the deployment of cash into loans and investment securities. However, the related interest income on a tax-equivalent basis increased by $813 thousand to $1.3 million for the nine months ended September 30, 2023 from $536 thousand for the nine months ended September 30, 2022. This increase was the result of multiple Federal Funds rate increases by the FOMC since March 2022.

Interest expense on interest-bearing liabilities increased by $26.6 million year-over-year due to the increase in the cost of interest-bearing liabilities by 157 basis points from 0.30% for the nine months ended September 30, 2022 to 1.87% for the nine months ended September 30, 2023 as funding costs increased from higher market interest rates, competitive pressures and an increase in higher cost borrowings. In addition, the average balance of interest-bearing deposits increased by $131.2 million to $2.0 billion for the nine months ended September 30, 2023 from $1.9 billion for the nine months ended September 30, 2022. Average interest-bearing demand deposits increased by $100.4 million and average time deposits increased $40.4 million as clients sought higher-yielding products during the rising interest rate environment.

Interest expense on borrowings increased by $3.9 million to $5.6 million for the nine months ended September 30, 2023 from $1.7 million for the nine months ended September 30, 2022, as the cost of borrowings increased by 77 basis points to 4.43% for the nine months ended September 30, 2023 from 3.66% for the nine months ended September 30, 2022. Average borrowings increased by $108.1 million from $60.4 million for the nine months ended September 30, 2022 to $168.5 million for the nine months ended September 30, 2023, as the Bank opted to borrow funds to provide additional liquidity to meet the credit needs of its clients.

### Provision for Credit Losses

The Company recorded a provision for credit losses of $1.3 million for the nine months ended September 30, 2023 compared to $3.6 million for the same period in 2022. On January 1, 2023, the Company adopted the new accounting standard, referred to as CECL, which transitioned from the incurred loss model based on historical loss experience and economic and market conditions to the expected loss model. The CECL standard reflects expected credit losses over the expected life of the financial assets and commitments, primarily based on the discounted cash flow methodology for the majority of the loan segments, which applies the probability of default and loss given default factors to future cash flows, and adjusts to the net present value to derive the required reserve. Macroeconomic conditions are incorporated into the model for unemployment and gross domestic product, in addition to model assumptions for discount rate and prepayment and curtailment speeds.

For the nine months ended September 30, 2023, the provision for credit losses was driven by the increase of $101.2 million in commercial loans, excluding SBA PPP loan forgiveness activity, and an increase in the *Delinquency and Classified Loan Trends* qualitative factor for the commercial & industrial and owner-occupied commercial real estate loan classes and an increase in the *Economic Conditions* qualitative factor for consumer loans. The changes in these qualitative factors were based on a recent trend of increases in loans downgraded within the previously noted loan classes and growing concerns surrounding the economic conditions related to consumer debt levels, the impact of inflationary pressures and the reinstatement of student loan repayments, which could impact consumer loans. In addition, the provision for credit losses is impacted by the change in expected loss rates under CECL. Favorable published trends in unemployment and GDP rates, which are used in correlation with historical charge-offs to predict defaults and losses, resulted in a decrease to the required ACL. The ALL to total loan ratio increased from 1.18% at September 30, 2022 to an ACL to total loan ratio of 1.25% at September 30, 2023, which increase is primarily due to the cumulative effect adjustment recorded in connection with the adoption of CECL. The provision expense recorded in the nine months ended September 30, 2022 was due to commercial loan growth, excluding SBA PPP loan forgiveness activity, of $243.3 million.

Net charge-offs for the nine months ended September 30, 2023 totaled $587 thousand, compared to net charge-offs of $46 thousand for the nine months ended September 30, 2022. The increase in net charge-offs was due primarily to two commercial and industrial relationships with partial charge-offs totaling $656 thousand during 2023. Nonaccrual loans were 0.98% of gross loans at September 30, 2023, compared with 0.25% of gross loans at September 30, 2022. Nonaccrual loans increased by $17.0 million from September 30, 2022 to September 30, 2023, primarily due to one commercial and land development CTP loan being downgraded to substandard and placed on non-accrual status in the fourth quarter of 2022. While the loan had not been past due, management determined that it was appropriate to place the loan on non-accrual status due to other relevant factors. At this time, management believes that the value of the underlying collateral is sufficient to cover any potential losses on this loan. Management does not believe that this credit is indicative of overall stress in the loan portfolio. During the second quarter of 2023, the project underlying this CTP loan received its certificate of occupancy, which resulted in the recharacterization of the loan from commercial and land development to owner-occupied. The CTP loan had a current outstanding balance of $14.3 million and $15.4 million at September 30, 2023 and December 31, 2022, respectively.

Additional information is included in the "Credit Risk Management" section herein.

### Noninterest Income

The following table compares noninterest income for the nine months ended September 30, 2023 and 2022:

|  | Nine Months Ended September 30, 2023 | 2022 | $ Change 2023-2022 | % Change 2023-2022 |
| --- | ---: | ---: | ---: | ---: |
| Service charges on deposit accounts | **$2,966** | $2,861 | **$105** | **3.7%** |
| Interchange income | **2,921** | 3,059 | **(138)** | **(4.5)%** |
| Other service charges, commissions and fees | **702** | 622 | **80** | **12.9%** |
| Swap fee income | **451** | 1,935 | **(1,484)** | **(76.7)%** |
| Trust and investment management income | **5,668** | 5,852 | **(184)** | **(3.1)%** |
| Brokerage income | **2,727** | 2,864 | **(137)** | **(4.8)%** |
| Mortgage banking activities | **448** | 205 | **243** | **118.5%** |
| Income from life insurance | **1,855** | 1,742 | **113** | **6.5%** |
| Other income | **1,431** | 1,749 | **(318)** | **(18.2)%** |
| Investment securities losses | **(8)** | (163) | **155** | **95.1%** |
| Total noninterest income | **$19,161** | $20,726 | **$(1,565)** | **(7.6)%** |

Noninterest income decreased by $1.5 million from $20.7 million for the nine months ended September 30, 2022 to $19.2 million for the nine months ended September 30, 2023. The following were significant factors in this decrease:

- Swap fee income decreased $1.5 million during the nine months ended September 30, 2023, as swap fee income will fluctuate based on market conditions and client demand.
- Mortgage banking income increased by $243 thousand due to a decline in the fair value losses of $1.2 million from a fair value mark of $1.4 million during the nine months ended September 30, 2022 compared to $182 thousand during the nine months ended September 30, 2023. This change in the fair value mark was due to the significant increase in mortgage interest rates during 2022 compared to current year, and was partially offset by a reduction in sales volume between these periods. Market conditions and elevated interest rates also continue to hinder mortgage production. Most mortgage production remains in adjustable-rate products, which are held in portfolio in 2023. Mortgage loans sold totaled $19.9 million during the nine months ended September 30, 2023 compared to $67.6 million during the nine months ended September 30, 2022.
- Other income decreased by $318 thousand due to the distribution of $964 thousand from investments in non-housing limited partnerships, gains on the sales of two SBA loans totaling $306 thousand and tax credits of $102 thousand recognized from the Bank's investment in solar renewable energy partnerships during the nine months ended September 30, 2022 partially offset by a gain of $1.1 million from the sale of the Bank's Path Valley branch during the nine months ended September 30, 2023.
- Investment securities losses declined by $155 thousand due primarily to a loss of $171 thousand during 2022 recorded on one non-agency CMO security, which was called at a price below par. The loss was partially offset by a gain of $22 thousand from the sale of one security with a principal balance of $3.1 million during the nine months ended September 30, 2022.
- Other line items within noninterest income showed fluctuations attributable to normal business operations.

### Noninterest Expenses

The following table compares noninterest expenses for the nine months ended September 30, 2023 and 2022:

|  | Nine Months Ended September 30, 2023 | 2022 | $ Change 2023-2022 | % Change 2023-2022 |
| --- | ---: | ---: | ---: | ---: |
| Salaries and employee benefits | **$38,135** | $35,354 | **$2,781** | **7.9%** |
| Occupancy | **3,249** | 3,586 | **(337)** | **(9.4)%** |
| Furniture and equipment | **3,810** | 3,784 | **26** | **0.7%** |
| Data processing | **3,666** | 3,410 | **256** | **7.5%** |
| Automated teller machine and interchange fees | **920** | 952 | **(32)** | **(3.4)%** |
| Advertising and bank promotions | **1,656** | 1,514 | **142** | **9.4%** |
| FDIC insurance | **1,500** | 767 | **733** | **95.6%** |
| Professional services | **2,203** | 2,417 | **(214)** | **(8.9)%** |
| Directors' compensation | **667** | 674 | **(7)** | **(1.0)%** |
| Taxes other than income | **847** | 1,160 | **(313)** | **(27.0)%** |
| Intangible asset amortization | **717** | 845 | **(128)** | **(15.1)%** |
| Provision for legal settlement | **—** | 13,000 | **(13,000)** | **100.0%** |
| Restructuring expenses | **—** | 3,155 | **(3,155)** | **100.0%** |
| Other operating expenses | **4,081** | 3,952 | **129** | **3.3%** |
| Total noninterest expenses | **$61,451** | $74,570 | **$(13,119)** | **(17.6)%** |

Noninterest expense decreased by $13.1 million from $74.6 million for the nine months ended September 30, 2022 to $61.5 million for the nine months ended September 30, 2023. The following were significant factors in this decrease:

- Salaries and employee benefits expense increased by $2.8 million due primarily to staff additions that filled vacancies, merit and share-based compensation expense increases, higher employee benefit costs from increased claims volume and employee severance costs.
- Occupancy expenses decreased by $337 thousand due primarily to operating efficiencies from branch closures in 2022.
- Data processing increased by $256 thousand due primarily to an increase in core system costs and investments in new technology as the Company focuses on the evolving needs of its clients.
- Advertising and bank promotion expense increased by $142 thousand due to an increase in digital advertising and sponsorships to continue to promote the Company.
- FDIC insurance expense increased by $733 thousand due to increases in the assessment rate caused by an annualized two-basis point increase assessed by the FDIC to increase its deposit insurance fund and increases commercial loans and total assets.
- Professional services expense decreased by $214 thousand due primarily to a reduction in legal expenses following the settlement of outstanding litigation.
- Taxes other than income decreased by $313 thousand due to a decrease in the Pennsylvania Bank Shares Tax expense, which was driven by a decrease in the Bank's total equity balance from the increase in unrealized losses on investment securities and charges in the third quarter of 2022 for a provision for legal settlement and restructuring expenses.
- The Company agreed to settle a litigation matter, which resulted in a provision for legal settlement of $13.0 million recorded in the third quarter of 2022.
- During the third quarter of 2022, the Company announced that five branch locations would be closing and staffing model adjustments would be made to drive long-term growth and improve operating efficiencies in 2023 and forward. As a result of these initiatives, the Company recorded a pre-tax restructuring charge of $3.2 million, which consisted of building and fixed asset write-offs of $1.9 million and early retirement/severance costs of $1.3 million.
- Other operating expenses increased by $129 thousand due to an increase in credit valuation adjustments on derivatives of $66 thousand and customer fraud losses of $83 thousand.
- Other line items within noninterest expenses showed fluctuations attributable to normal business operations.

### Income Tax Expense

Income tax expense totaled $7.3 million, an effective tax rate of 20.7%, for the nine months ended September 30, 2023 compared with $2.3 million and an effective tax rate of 15.7% for the nine months ended September 30, 2022. Excluding the impact of the provision for legal settlement, the effective tax rate was 18.2% for the nine months ended September 30, 2022. The Company’s effective tax rate is less than the 21% federal statutory rate due to tax-exempt income, including interest earned on tax-exempt loans and investment securities and income from life insurance policies, as well as tax credits, partially offset by disallowed interest expense and state income taxes. The increase in the effective tax rate from the nine months ended September 30, 2022 to the nine months ended September 30, 2023 was primarily due to an increase in projected taxable income for the 2023 fiscal year compared to the prior year due to the provision for legal settlement and restructuring charge. In addition, the effective tax rate for the nine months ended September 30, 2023 was increased by the portion of interest expense disallowed as a deduction against earnings under TEFRA and an increase in state taxes as a result of a greater percentage of taxable income earned in a state with a state income tax.

### FINANCIAL CONDITION

Management devotes substantial time to overseeing the investment of funds in loans and investment securities, the costs of funds and the formulation of policies directed toward the profitability and management of the risks associated with these investments.

### Investment Securities

The Company utilizes investment securities to manage interest rate risk, enhance income through interest and dividend income, provide liquidity and collateralize certain deposits and borrowings.

The Company has established investment policies and an asset management policy to assist in administering its investment portfolio. Decisions to purchase or sell these securities are based on economic conditions and management’s strategy to respond to changes in interest rates, liquidity, pledges to secure deposits and repurchase agreements and other factors while trying to maximize return on the investments. The Company may segregate its investment portfolio into three categories: “securities available-for-sale,” “trading securities” and “securities held-to-maturity.”

At September 30, 2023 and December 31, 2022, management classified the entire investment securities portfolio as AFS, which is accounted for at current market value with non-credit losses and gains reported in OCI, net of income taxes. On January 1, 2023, the Company adopted the new CECL standard in accordance with ASU 2016-13, which changed the accounting framework by replacing the other-than-temporary impairment assessment with the recognition of an allowance for credit losses.

The Company's investment securities portfolio includes debt investments that are subject to varying degrees of credit and market risks, which arise from general market conditions, and factors impacting specific industries, as well as news that may impact specific issues. Management monitors its debt securities, using various indicators in determining whether unrealized losses on debt securities are credit related and require an ACL. These indicators include the amount of time the security has been in an unrealized loss position, the cause and extent of the unrealized loss, and the credit quality of the issuer and underlying assets. In addition, management assesses whether it is likely the Company will have to sell the security prior to recovery, or it expects to be able to hold the security until the price recovers. The Company determined that the declines in market value were due to increases in interest rates and market movements, and not due to credit factors. The Company does not intend to sell these securities with unrealized losses and it is more likely than not that the Company will not be required to sell them before recovery of their amortized cost basis, which may be maturity. Therefore, the Company has concluded that the unrealized losses for the AFS securities do not require an ACL at September 30, 2023. Under the prior OTTI framework, the Company did not record any cumulative OTTI expense as of December 31, 2022.

At September 30, 2023, AFS securities totaled $495.2 million, a decrease of $18.5 million, from $513.7 million at December 31, 2022. During the nine months ended September 30, 2023, the Company had net purchases of $19.6 million, which included $15.3 million of agency MBS and CMO, $3.3 million of non-agency CMO and $1.0 million in asset-backed securities. The balance of investment securities included net unrealized losses of $58.1 million at September 30, 2023 compared to net unrealized losses of $49.6 million at December 31, 2022 for a change of $8.5 million. This increase in net unrealized losses was primarily due to higher treasury rates and wider credit spreads during 2023. In addition, there was $26.8 million in paydowns during 2023 contributing to the decrease. The overall duration of the Company's investment securities portfolio is 4.7 years at September 30, 2023. The Company has sufficient access to liquidity such that management does not believe it would be necessary to sell any of its investment securities at a loss to offset any unexpected deposit outflows. Management believes the structure of the Company's investment portfolio is appropriately aligned with the rest of the balance sheet to protect against volatile interest rate environments and to generate steady earnings.

The following table summarizes the credit ratings and collateral associated with the Company's investment portfolio, excluding equity securities, at September 30, 2023:

| Sector | Portfolio Mix | Amortized Book Value | Fair Value | Credit Enhancement | AAA | AA | A | BBB | NR | Collateral / Guarantee Type |
| --- | ---: | ---: | ---: | ---: | ---: | ---: | ---: | ---: | ---: | --- |
| Unsecured ABS | 1% | $4,053 | $3,527 | 31% | —% | —% | —% | —% | 100% | Unsecured Consumer Debt |
| Student Loan ABS | 1 | 5,781 | 5,711 | 27 | — | — | — | — | 100 | Seasoned Student Loans |
| Federal Family Education Loan ABS | 18 | 101,486 | 100,566 | 9 | 7 | 80 | — | 13 | — | Federal Family Education Loan (1) |
| PACE Loan ABS | — | 2,362 | 1,983 | 6 | 100 | — | — | — | — | PACE Loans |
| Non-Agency CMBS | 4 | 23,349 | 23,110 | 19 | — | — | — | — | 100 |  |
| Non-Agency RMBS | 3 | 16,699 | 12,666 | 14 | 100 | — | — | — | — | Reverse Mortgages (2) |
| Municipal - General Obligation | 19 | 103,818 | 88,804 |  | 10 | 83 | 7 | — | — |  |
| Municipal - Revenue | 22 | 119,989 | 99,313 |  | — | 82 | 12 | — | 6 |  |
| SBA ReRemic | 1 | 3,855 | 3,732 |  | — | 100 | — | — | — | SBA Guarantee (3) |
| Small Business Administration | 1 | 8,562 | 9,100 |  | — | 100 | — | — | — | SBA Guarantee (3) |
| Agency MBS | 26 | 143,088 | 129,387 |  | — | 100 | — | — | — | Residential Mortgages (3) |
| U.S. Treasury securities | 4 | 20,060 | 17,143 |  | — | 100 | — | — | — | U.S. Government Guarantee (3) |
|  | 100% | $553,102 | $495,042 |  | 7% | 80% | 4% | 2% | 7% |  |
| (1) Minimum of 97% guaranteed by U.S. government |  |  |  |  |  |  |  |  |  |  |
| (2) Non-agency reverse mortgages with current structural credit enhancements |  |  |  |  |  |  |  |  |  |  |
| (3) Guaranteed by U.S. government or U.S. government agencies |  |  |  |  |  |  |  |  |  |  |
| Note : Ratings in table are the lowest of the six rating agencies (Standard & Poor's, Moody's, Fitch, Morningstar, DBRS and Kroll Bond Rating Agency). Standard & Poor's rates U.S. government obligations at AA+. |  |  |  |  |  |  |  |  |  |  |

### Loan Portfolio

The Company offers a variety of products to meet the credit needs of its borrowers, principally commercial real estate loans, commercial and industrial loans, retail loans secured by residential properties, and, to a lesser extent, installment loans. No loans are extended to non-domestic borrowers or governments.

The risks associated with lending activities differ among loan segments and classes and are subject to the impact of changes in interest rates, market conditions of collateral securing the loans and general economic conditions. Any of these factors may adversely impact a borrower’s ability to repay loans, and also impact the associated collateral. A further discussion on the Company's loan segments and classes and related risks and the Company's implementation of the new accounting standards for expected credit losses, referred to as CECL, and financial difficulty modifications are included in Note 1, Summary of Significant Accounting Policies, and Note 3, Loans and Allowance for Credit Losses, to the unaudited condensed consolidated financial statements under Part I, Item 1, "Financial Information."

The following table presents the loan portfolio, excluding residential LHFS, by segment and class at September 30, 2023 and December 31, 2022:

| Commercial real estate: | September 30, 2023 | December 31, 2022 |
| --- | ---: | ---: |
| Owner occupied | **$376,350** | $315,770 |
| Non-owner occupied | **630,514** | 608,043 |
| Multi-family | **143,437** | 138,832 |
| Non-owner occupied residential | **100,391** | 104,604 |
| Acquisition and development: |  |  |
| 1-4 family residential construction | **25,642** | 25,068 |
| Commercial and land development | **153,279** | 158,308 |
| Commercial and industrial (1) | **374,190** | 357,774 |
| Municipal | **10,334** | 12,173 |
| Residential mortgage: |  |  |
| First lien | **248,335** | 229,849 |
| Home equity - term | **5,223** | 5,505 |
| Home equity - lines of credit | **188,736** | 183,241 |
| Installment and other loans | **10,405** | 12,065 |
|  | **$2,266,836** | $2,151,232 |

(1) This balance includes $6.2 million and $13.8 million of SBA PPP loans, net of deferred fees and costs, at September 30, 2023 and December 31, 2022, respectively.

Total loans increased by $115.6 million from December 31, 2022 to September 30, 2023. This increase is due to growth in commercial loans of $101.2 million and first lien residential mortgages held in portfolio of $18.5 million, partially offset by decrease of $7.6 million in SBA PPP loans due to loan forgiveness during the nine months ended September 30, 2023.

### Asset Quality

### Risk Elements

The Company’s loan portfolio is subject to varying degrees of credit risk. Credit risk is managed through the Company's underwriting standards, on-going credit reviews, and monitoring of asset quality measures. Additionally, loan portfolio diversification, which limits exposure to a single industry or borrower, and collateral requirements also mitigate the Company's risk of credit loss.

The loan portfolio consists principally of loans to borrowers in south central Pennsylvania and the greater Baltimore, Maryland region. As the majority of loans are concentrated in these geographic regions, a substantial portion of the borrowers' ability to honor their obligations may be affected by the level of economic activity in the market areas.

Nonperforming assets include nonaccrual loans and foreclosed real estate. In addition, loan modifications to borrowers experiencing financial difficulty and loans past due 90 days or more and still accruing are also deemed to be risk assets. For all loan classes, the accrual of interest income generally ceases when principal or interest is past due 90 days or more and collateral is inadequate to cover principal and interest or immediately if, in the opinion of management, full collection is unlikely. Interest will continue to accrue on loans past due 90 days or more if the collateral is adequate to cover principal and interest, and the loan is in the process of collection. Interest accrued, but not collected, as of the date of placement on nonaccrual status, is generally reversed and charged against interest income, unless fully collateralized. Subsequent payments received are either applied to the outstanding principal balance or recorded as interest income, depending on management’s assessment of the ultimate collectability of principal. Loans are returned to accrual status, for all loan classes, when all the principal and interest amounts contractually due are brought current, the loans have performed in accordance with the contractual terms of the note for a reasonable period of time, generally six months, and the ultimate collectability of the total contractual principal and interest is reasonably assured. Past due status is based on contract terms of the loan.

Prior to the adoption of ASU 2022-02, loans, the terms of which are modified, were classified as TDRs if a concession was granted for legal or economic reasons related to a borrower’s financial difficulties. Concessions granted under a TDR typically involved a temporary deferral of scheduled loan payments, an extension of a loan’s stated maturity date, temporary reduction in interest rates, or below market rates. If a modification occurred while the loan is on accruing status, it would continue to accrue interest under the modified terms. Nonaccrual TDRs were restored to accrual status if scheduled principal and interest payments, under the modified terms, were current for six months after modification, and the borrower continues to demonstrate its ability to meet the modified terms. TDRs were evaluated individually for impairment if they have been restructured during the most recent calendar year, or if they are not performing according to their modified terms.

ASU 2022-02 eliminates the TDR accounting model, and requires that the Company evaluate, based on the accounting for loan modifications, whether the borrower is experiencing financial difficulty and the modification results in a more-than-insignificant direct change in the contractual cash flows and represents a new loan or a continuation of an existing loan, which the Company refers to these loans as "financial difficulty modifications" or "FDMs."

The following table presents the Company’s risk elements and relevant asset quality ratios at September 30, 2023 and December 31, 2022. Accruing loans meeting the criteria for FDMs are reported cumulatively on a prospective basis from the adoption of ASU 2022-02.

|  | September 30, 2023 | December 31, 2022 |
| --- | ---: | ---: |
| Nonaccrual loans | **$22,324** | $20,583 |
| OREO | **—** | — |
| Total nonperforming assets | **22,324** | 20,583 |
| FDMs still accruing / TDRs still accruing | **—** | 682 |
| Loans past due 90 days or more and still accruing (1) | **277** | 439 |
| Total nonperforming and other risk assets ("total risk assets") | **$22,601** | $21,704 |
| Loans 30-89 days past due and still accruing | **$4,816** | $7,311 |
| Asset quality ratios: |  |  |
| Total nonperforming loans to total loans | **0.98%** | 0.96% |
| Total nonperforming assets to total assets | **0.73%** | 0.70% |
| Total nonperforming assets to total loans and OREO | **0.98%** | 0.96% |
| Total risk assets to total loans and OREO | **1.00%** | 1.01% |
| Total risk assets to total assets | **0.74%** | 0.74% |
| ACL to total loans | **1.25%** | 1.17% |
| ACL to nonperforming loans | **126.67%** | 122.32% |
| ACL to nonperforming loans and FDMs still accruing / TDRs still accruing | **126.67%** | 118.40% |
| Net charge-offs to total average loans (2) | **0.04%** | 0.01% |

(1) Includes $256 thousand and $307 thousand of PCI loans at September 30, 2023 and December 31, 2022, respectively in accordance with ASU 310-30. Upon adoption of the CECL standard, PCD loans were evaluated and reported on an individual loan level under ASU 310-20, Nonrefundable Fees and Other Assets.

(2) Annualized

Nonperforming assets include nonaccrual loans and foreclosed real estate. Risk assets, which include nonperforming assets, FDMs still accruing and loans past due 90 days or more and still accruing, totaled $22.6 million at September 30, 2023, an increase of $897 thousand from December 31, 2022. Nonaccrual loans increased by $1.7 million from December 31, 2022 to September 30, 2023 due primarily to additions of $4.1 million and transfers to non-accrual of $931 thousand due to the treatment of PCD loans at the individual asset level under CECL, partially offset by payments of $2.3 million, charge-offs of $901 thousand and loans returned to accrual status of $401 thousand. For the nine months ended September 30, 2023, the Company did not have loans meeting the FDM criteria under ASU 2022-02.

The following table presents the amortized cost basis of nonaccrual loans, according to loan class, with and without reserves on individually evaluated loans at September 30, 2023, as compared to nonaccrual loans at December 31, 2022. There was no specific reserve on the nonaccrual loans and no significant changes in the collateral securing these loans at both September 30, 2023 and December 31, 2022.

| Commercial real estate: | September 30, 2023 Nonaccrual loans with a related ACL | Nonaccrual loans with no related ACL | Total nonaccrual loans | Loans Past Due 90+ Accruing | December 31, 2022 Total nonaccrual loans |
| --- | ---: | ---: | ---: | ---: | ---: |
| Owner-occupied | **$—** | **$16,800** | **$16,800** | **$—** | $2,767 |
| Non-owner occupied | **—** | **252** | **252** | **—** | — |
| Multi-family | **—** | **—** | **—** | **—** | — |
| Non-owner occupied residential | **—** | **288** | **288** | **—** | 81 |
| Acquisition and development: |  |  |  |  |  |
| 1-4 family residential construction | **—** | **—** | **—** | **—** | — |
| Commercial and land development | **—** | **1,417** | **1,417** | **—** | 15,426 |
| Commercial and industrial | **—** | **662** | **662** | **—** | 31 |
| Municipal | **—** | **—** | **—** | **—** | — |
| Residential mortgage: |  |  |  |  |  |
| First lien | **—** | **2,025** | **2,025** | **277** | 1,838 |
| Home equity – term | **—** | **3** | **3** | **—** | 5 |
| Home equity – lines of credit | **—** | **849** | **849** | **—** | 395 |
| Installment and other loans | **4** | **24** | **28** | **—** | 40 |
| Total | **$4** | **$22,320** | **$22,324** | **$277** | $20,583 |

During the second quarter of 2023, the underlying project for a CTP loan on nonaccrual status received its certificate of occupancy, which resulted in the recharacterization of the loan from commercial and land development to owner-occupied commercial real estate. The CTP loan had a current outstanding balance of $14.3 million and $15.4 million at September 30, 2023 and December 31, 2022, respectively.

The information presented above in the nonaccrual loan table and the collateral-dependent table are not required for periods prior to the adoption of CECL. The following table, which excludes accruing PCI loans, presents the most comparable required information at December 31, 2022, which summarizes impaired loans by segment and class, segregated by those for which a specific allowance was required and those for which a specific allowance was not required at December 31, 2022. The recorded investment in loans excludes accrued interest receivable. Related allowances established generally pertain to those loans in which loan forbearance agreements were in the process of being negotiated or updated appraisals were pending, and any partial charge-off will be recorded when final information is received.

| Commercial real estate: | December 31, 2022 Nonaccrual Loans | Restructured Loans Still Accruing | Total |
| --- | ---: | ---: | ---: |
| Owner occupied | $2,767 | $— | $2,767 |
| Non-owner occupied residential | 81 | — | 81 |
| Acquisition and development: |  |  |  |
| Commercial and land development | 15,426 | — | 15,426 |
| Commercial and industrial | 31 | — | 31 |
| Residential mortgage: |  |  |  |
| First lien | 1,838 | 682 | 2,520 |
| Home equity - term | 5 | — | 5 |
| Home equity - lines of credit | 395 | — | 395 |
| Installment and other loans | 40 | — | 40 |
|  | $20,583 | $682 | $21,265 |

72

The following table presents our exposure to relationships that are individually evaluated for impairment and the partial charge-offs taken to date and specific reserves established on those relationships at September 30, 2023 and December 31, 2022. Accruing PCI loans are excluded loans individually evaluated for impairment at December 31, 2022. Prior to the adoption of CECL, acquired loans that met the criteria for impairment or nonaccrual of interest prior to the acquisition may be considered performing upon acquisition, regardless of whether the client is contractually delinquent if the Company expects to fully collect the new carrying value (i.e., fair value) of the loans. As such, the Company may no longer consider the loan to be nonperforming in accordance with guidance in ASU 310-30. Upon adoption of CECL, the Company elected to account for its PCD loans under ASC 310-20, which required that acquired loans be analyzed on an individual asset level. The impact of this election resulted in loans reported as nonaccrual and individually evaluated for credit expected losses under the CECL methodology.

| September 30, 2023 | # of Relationships | Individually Evaluated Loans | Partial Charge-offs to Date | Specific Reserves |
| --- | ---: | ---: | ---: | ---: |
| Relationships greater than $1,000,000 | **3** | **$17,911** | **$—** | **$—** |
| Relationships greater than $500,000 but less than $1,000,000 | **1** | **631** | **388** | **—** |
| Relationships greater than $250,000 but less than $500,000 | **1** | **252** | **—** | **—** |
| Relationships less than $250,000 | **69** | **3,704** | **214** | **32** |
|  | **74** | **$22,498** | **$602** | **$32** |
| **December 31, 2022** |  |  |  |  |
| Relationships greater than $1,000,000 | 2 | $17,774 | $— | $— |
| Relationships greater than $500,000 but less than $1,000,000 | — | — | — | — |
| Relationships greater than $250,000 but less than $500,000 | 1 | 260 | — | — |
| Relationships less than $250,000 | 60 | 3,231 | 320 | 28 |
|  | 63 | $21,265 | $320 | $28 |

The Company takes partial charge-offs on collateral-dependent loans when carrying value exceeds estimated fair value, as determined by the most recent appraisal adjusted for current (within the quarter) conditions, less costs to dispose. Impairment reserves remain in place if updated appraisals are pending, and represent management’s estimate of potential loss.

Internal loan reviews are completed annually on all commercial relationships, secured by commercial real estate, with a committed loan balance in excess of $1.0 million, which includes confirmation of risk rating by an independent credit officer. In addition, all commercial relationships greater than $500 thousand rated Substandard, Doubtful or Loss are reviewed and corresponding risk ratings are reaffirmed by the Bank's Problem Loan Committee, with subsequent reporting to the Management ERM Committee.

In its individually evaluated loan analysis, the Company determines the extent of any full or partial charge-offs that may be required, or any reserves that may be needed. The determination of the Company’s charge-offs or impairment reserve include an evaluation of the outstanding loan balance and the related collateral securing the credit. Through a combination of collateral securing the loans and partial charge-offs taken to date, the Company believes that it has adequately provided for the potential losses that it may incur on these relationships at September 30, 2023. However, over time, additional information may result in increased reserve allocations or, alternatively, it may be deemed that the reserve allocations exceed those that are needed.

### Credit Risk Management

### Allowance for Credit Losses

The Company maintains the ACL at a level deemed adequate by management for expected credit losses. As disclosed in Note 1 and Note 3, on January 1, 2023 the Company implemented CECL and increased the ACL, previously the ALL, with a cumulative-effect adjustment to the ACL of $2.4 million. In addition, the Company recorded a cumulative-effect adjustment to the ACL for off-balance sheet exposures of $100 thousand. The Company’s ACL is calculated quarterly, with any adjustment recorded to the provision for credit losses in the consolidated statement of income. A comprehensive analysis of the ACL is performed by the Company on a quarterly basis. Management evaluates the adequacy of the ACL utilizing a defined methodology to determine if it properly addresses the current and expected risks in the loan portfolio, which considers the performance of borrowers and specific evaluation of individually evaluated loans, including historical loss experiences, trends in delinquencies, nonperforming loans and other risk assets, and the qualitative factors. Risk factors are continuously reviewed and adjusted, as needed, by management when conditions support a change. Management believes its approach properly addresses relevant accounting and bank regulatory guidance for loans both collectively and individually evaluated. The results of the comprehensive analysis, including recommended changes, are governed by the Company's Reserve Adequacy Committee, whose members were also a part of the Company's CECL Committee.

The ACL is evaluated based on a review of the collectability of loans in light of historical experience; the nature and volume of the loan portfolio; adverse situations that may affect a borrower’s ability to repay; estimated value of any underlying collateral; and prevailing economic conditions. This evaluation is inherently subjective as it requires estimates that are susceptible to significant revision as more information becomes available. A description of the methodology for establishing the allowance and provision for credit losses and related procedures in establishing the appropriate level of reserve is included in Note 1, Summary of Significant Accounting Policies, and Note 3, Loans and Allowance for Credit Losses, to the unaudited condensed consolidated financial statements under Part I, Item 1, "Financial Information."

The following table presents the amortized cost basis of the loan portfolio, by year of origination, loan class, and credit quality, as of September 30, 2023. For residential and consumer loan classes, the Company also evaluates credit quality based on the aging status of the loan and payment activity, which residential mortgage and installment and other consumer loans are presented below based on payment performance: performing or nonperforming. During the second and third quarters of 2023, commercial and land development loans totaling $46.6 million and $9.1 million, respectively, were recharacterized to a permanent commercial real estate class upon the completion of construction or receiving a certificate of occupancy.

| As of September 30, 2023 Commercial Real Estate: Owner-occupied: Risk rating | Term Loans Amortized Cost Basis by Origination Year 2023 | 2022 | 2021 | 2020 | 2019 | Prior | Revolving Loans Amortized Basis | Revolving Loans Converted to Term | Total |
| --- | ---: | ---: | ---: | ---: | ---: | ---: | ---: | ---: | ---: |
| Pass | $46,027 | $94,573 | $79,707 | $22,354 | $21,605 | $66,222 | $5,372 | $— | $335,860 |
| Special mention | — | 10,007 | 2,541 | — | — | 2,398 | — | — | 14,946 |
| Substandard - Non-IEL | — | — | — | 6,122 | — | 2,165 | 457 | — | 8,744 |
| Substandard - IEL | — | — | — | 14,321 | — | 2,479 | — | — | 16,800 |
| Total owner-occupied loans | $46,027 | $104,580 | $82,248 | $42,797 | $21,605 | $73,264 | $5,829 | $— | $376,350 |
| Current period gross charge offs - owner-occupied | $— | $— | $— | $— | $— | $— | $— | $— | $— |
| **Non-owner occupied:** |  |  |  |  |  |  |  |  |  |
| Risk rating |  |  |  |  |  |  |  |  |  |
| Pass | $36,918 | $98,722 | $206,053 | $85,808 | $63,827 | $135,331 | $510 | $871 | $628,040 |
| Special mention | — | — | — | — | — | 2,144 | — | — | 2,144 |
| Substandard - Non-IEL | — | — | — | — | — | 78 | — | — | 78 |
| Substandard - IEL | — | — | — | — | — | 252 | — | — | 252 |
| Total non-owner occupied loans | $36,918 | $98,722 | $206,053 | $85,808 | $63,827 | $137,805 | $510 | $871 | $630,514 |
| Current period gross charge offs - non-owner occupied | $— | $— | $— | $— | $— | $— | $— | $— | $— |
| **Multi-family:** |  |  |  |  |  |  |  |  |  |
| Risk rating |  |  |  |  |  |  |  |  |  |
| Pass | $2,255 | $59,413 | $8,732 | $12,765 | $7,791 | $50,300 | $150 | $— | $141,406 |
| Special mention | — | — | — | — | — | 2,031 | — | — | 2,031 |
| Substandard - Non-IEL | — | — | — | — | — | — | — | — | — |
| Substandard - IEL | — | — | — | — | — | — | — | — | — |
| Total multi-family loans | $2,255 | $59,413 | $8,732 | $12,765 | $7,791 | $52,331 | $150 | $— | $143,437 |
| Current period gross charge offs - multi-family | $— | $— | $— | $— | $— | $— | $— | $— | $— |

74

| As of September 30, 2023 Non-owner occupied residential: Risk rating | Term Loans Amortized Cost Basis by Origination Year 2023 | 2022 | 2021 | 2020 | 2019 | Prior | Revolving Loans Amortized Basis | Revolving Loans Converted to Term | Total |
| --- | ---: | ---: | ---: | ---: | ---: | ---: | ---: | ---: | ---: |
| Pass | $7,137 | $23,451 | $18,807 | $10,005 | $6,775 | $31,144 | $1,503 | $— | $98,822 |
| Special mention | — | — | — | — | — | 894 | — | — | 894 |
| Substandard - Non-IEL | — | — | — | — | — | 385 | — | — | 385 |
| Substandard - IEL | 2 | — | 192 | — | — | 96 | — | — | 290 |
| Total non-owner occupied residential loans | $7,139 | $23,451 | $18,999 | $10,005 | $6,775 | $32,519 | $1,503 | $— | $100,391 |
| Current period gross charge offs - non-owner occupied residential | $— | $— | $— | $— | $— | $12 | $— | $— | $12 |
| **Acquisition and development:** |  |  |  |  |  |  |  |  |  |
| **1-4 family residential construction:** |  |  |  |  |  |  |  |  |  |
| Risk rating |  |  |  |  |  |  |  |  |  |
| Pass | $13,111 | $12,383 | $— | $— | $— | $— | $— | $— | $25,494 |
| Special mention | — | — | 148 | — | — | — | — | — | 148 |
| Substandard - Non-IEL | — | — | — | — | — | — | — | — | — |
| Substandard - IEL | — | — | — | — | — | — | — | — | — |
| Total 1-4 family residential construction loans | $13,111 | $12,383 | $148 | $— | $— | $— | $— | $— | $25,642 |
| Current period gross charge offs - 1-4 family residential construction | $— | $— | $— | $— | $— | $— | $— | $— | $— |
| **Commercial and land development:** |  |  |  |  |  |  |  |  |  |
| Risk rating |  |  |  |  |  |  |  |  |  |
| Pass | $21,879 | $52,815 | $50,957 | $9,946 | $114 | $1,841 | $6,655 | $5,990 | $150,197 |
| Special mention | — | — | — | 1,223 | — | 442 | — | — | 1,665 |
| Substandard - Non-IEL | — | — | — | — | — | — | — | — | — |
| Substandard - IEL | — | — | — | — | — | 1,417 | — | — | 1,417 |
| Total commercial and land development loans | $21,879 | $52,815 | $50,957 | $11,169 | $114 | $3,700 | $6,655 | $5,990 | $153,279 |
| Current period gross charge offs - commercial and land development | $— | $— | $— | $— | $— | $— | $— | $— | $— |
| **Commercial and Industrial:** |  |  |  |  |  |  |  |  |  |
| Risk rating |  |  |  |  |  |  |  |  |  |
| Pass | $55,922 | $77,312 | $75,336 | $25,943 | $10,988 | $22,123 | $92,100 | $2,223 | $361,947 |
| Special mention | — | 1,387 | 3,699 | 15 | 1,248 | 386 | 3,235 | — | 9,970 |
| Substandard - Non-IEL | — | — | 1,223 | — | 9 | 287 | 92 | — | 1,611 |
| Substandard - IEL | — | — | — | 8 | — | 508 | 146 | — | 662 |
| Total commercial and industrial loans | $55,922 | $78,699 | $80,258 | $25,966 | $12,245 | $23,304 | $95,573 | $2,223 | $374,190 |
| Current period gross charge offs - commercial and industrial | $— | $161 | $106 | $— | $— | $8 | $473 | $— | $748 |
| **Municipal:** |  |  |  |  |  |  |  |  |  |
| Risk rating |  |  |  |  |  |  |  |  |  |
| Pass | $— | $4 | $3,403 | $— | $— | $6,927 | $— | $— | $10,334 |
| Total municipal loans | $— | $4 | $3,403 | $— | $— | $6,927 | $— | $— | $10,334 |
| Current period gross charge offs - municipal | $— | $— | $— | $— | $— | $— | $— | $— | $— |

75

| As of September 30, 2023 Residential mortgage: First lien: Payment performance | Term Loans Amortized Cost Basis by Origination Year 2023 | 2022 | 2021 | 2020 | 2019 | Prior | Revolving Loans Amortized Basis | Revolving Loans Converted to Term | Total |
| --- | ---: | ---: | ---: | ---: | ---: | ---: | ---: | ---: | ---: |
| Performing | $27,657 | $65,681 | $35,176 | $8,071 | $7,690 | $100,990 | $— | $642 | $245,907 |
| Nonperforming | — | — | — | — | 172 | 2,256 | — | — | 2,428 |
| Total first lien loans | $27,657 | $65,681 | $35,176 | $8,071 | $7,862 | $103,246 | $— | $642 | $248,335 |
| Current period gross charge offs - first lien | $— | $— | $— | $— | $— | $58 | $— | $— | $58 |
| **Home equity - term:** |  |  |  |  |  |  |  |  |  |
| Payment performance |  |  |  |  |  |  |  |  |  |
| Performing | $553 | $750 | $140 | $443 | $124 | $3,210 | $— | $— | $5,220 |
| Nonperforming | — | — | — | — | — | 3 | — | — | 3 |
| Total home equity - term loans | $553 | $750 | $140 | $443 | $124 | $3,213 | $— | $— | $5,223 |
| Current period gross charge offs - home equity - term | $— | $— | $— | $— | $— | $— | $— | $— | $— |
| **Home equity - lines of credit:** |  |  |  |  |  |  |  |  |  |
| Payment performance |  |  |  |  |  |  |  |  |  |
| Performing | $— | $— | $— | $— | $— | $— | $111,582 | $76,259 | $187,841 |
| Nonperforming | — | — | — | — | — | — | 877 | 18 | 895 |
| Total residential real estate - home equity - lines of credit loans | $— | $— | $— | $— | $— | $— | $112,459 | $76,277 | $188,736 |
| Current period gross charge offs - home equity - lines of credit | $— | $— | $— | $— | $— | $— | $40 | $— | $40 |
| **Installment and other loans:** |  |  |  |  |  |  |  |  |  |
| Payment performance |  |  |  |  |  |  |  |  |  |
| Performing | $718 | $457 | $357 | $118 | $861 | $1,350 | $6,516 | $— | $10,377 |
| Nonperforming | — | — | — | — | 19 | 5 | 4 | — | 28 |
| Total Installment and other loans | $718 | $457 | $357 | $118 | $880 | $1,355 | $6,520 | $— | $10,405 |
| Current period gross charge offs - installment and other | $139 | $24 | $— | $— | $4 | $10 | $21 | $— | $198 |

The information presented in the table above is not required for periods prior to the adoption of CECL. The following table summarizes the Company’s loan portfolio ratings based on its internal risk rating system at December 31, 2022, which presents the most comparable required information. Prior to the adoption of CECL, PCD loans were classified as PCI loans and accounted for under ASC 310-30. In accordance with the CECL standard, management did not reassess whether PCI assets met the criteria of PCD assets as of the adoption date. At September 30, 2023, the amortized cost of the PCD loans was $8.8 million.

| December 31, 2022 Commercial real estate: | Pass | Special Mention | Non-Impaired Substandard | Impaired - Substandard | Doubtful | PCI Loans | Total |
| --- | ---: | ---: | ---: | ---: | ---: | ---: | ---: |
| Owner occupied | $305,159 | $2,109 | $3,532 | $2,767 | $— | $2,203 | $315,770 |
| Non-owner occupied | 601,244 | 4,243 | 2,273 | — | — | 283 | 608,043 |
| Multi-family | 130,851 | 7,739 | 242 | — | — | — | 138,832 |
| Non-owner occupied residential | 102,674 | 810 | 482 | 81 | — | 557 | 104,604 |
| Acquisition and development: |  |  |  |  |  |  |  |
| 1-4 family residential construction | 25,068 | — | — | — | — | — | 25,068 |
| Commercial and land development | 142,424 | 458 | — | 15,426 | — | — | 158,308 |
| Commercial and industrial | 331,103 | 17,579 | 7,013 | 31 | — | 2,048 | 357,774 |
| Municipal | 12,173 | — | — | — | — | — | 12,173 |
| Residential mortgage: |  |  |  |  |  |  |  |
| First lien | 222,849 | — | 215 | 2,520 | — | 4,265 | 229,849 |
| Home equity - term | 5,485 | — | — | 5 | — | 15 | 5,505 |
| Home equity - lines of credit | 182,801 | — | 45 | 395 | — | — | 183,241 |
| Installment and other loans | 12,017 | — | — | 40 | — | 8 | 12,065 |
|  | $2,073,848 | $32,938 | $13,802 | $21,265 | $— | $9,379 | $2,151,232 |

The Special Mention classification is intended to be a temporary classification reflective of loans that have potential weaknesses that may, if not monitored or corrected, weaken the asset or inadequately protect the Company’s position at some future date. Special Mention loans represent an elevated risk, but their weakness does not yet justify a more severe, or classified, rating. These loans require inquiry by lenders on the cause of the potential weakness and, once analyzed, the loan classification may be downgraded to Substandard or, alternatively, could be upgraded to Pass. Special Mention loans decreased by $1.1 million from $32.9 million at December 31, 2022 to $31.8 million at September 30, 2023 due to repayments of $21.7 million partially offset by net downgrades of $20.6 million. The risk rating downgrades to Special Mention consisted of six clients spread across various commercial loan classes; however, management does not believe that other commercial loans in these categories reflect similar risk characteristics that led to these downgrades. The Substandard-IEL category increased from $21.3 million to $22.5 million from December 31, 2022 to September 30, 2023, respectively, primarily due to one commercial construction and land development loan with a balance of $1.4 million.

Classified loans totaled $33.6 million at September 30, 2023, or 1.5% of total loans outstanding, reflecting a decrease from $35.1 million, or 1.6% of loans outstanding, at December 31, 2022, due to net upgrades and repayments.

Non-impaired substandard loans are performing loans, which have characteristics that cause management concern over the ability of the borrower to perform under present loan repayment terms and which may result in the reporting of these loans as nonperforming, or individually evaluated, loans in the future. Generally, management feels that substandard loans that are currently performing and not considered individually evaluated result in some doubt as to the borrower’s ability to continue to perform under the terms of the loan, and represent potential problem loans. Substandard loans not individually evaluated totaled $11.1 million at September 30, 2023, a decrease of $2.7 million compared to $13.8 million at December 31, 2022, due primarily to net upgrades and repayments across various loan classes.

The following table presents the activity in the ACL, including the impact of adopting CECL, for the three and nine months ended September 30, 2023 and the activity in the ALL for the three and nine months ended September 30, 2022:

| Three Months Ended September 30, 2023 | Commercial Commercial Real Estate | Acquisition and Development | Commercial and Industrial | Municipal | Total | Consumer Residential Mortgage | Installment and Other | Total | Unallocated | Total |
| --- | ---: | ---: | ---: | ---: | ---: | ---: | ---: | ---: | ---: | ---: |
| Balance, beginning of period | **$16,996** | **$2,767** | **$5,854** | **$167** | **$25,784** | **$2,307** | **$292** | **$2,599** | **$—** | **$28,383** |
| Provision for credit losses | **(173)** | **125** | **(62)** | **(11)** | **(121)** | **239** | **18** | **257** | **—** | **136** |
| Charge-offs | **—** | **—** | **(267)** | **—** | **(267)** | **—** | **(75)** | **(75)** | **—** | **(342)** |
| Recoveries | **17** | **1** | **33** | **—** | **51** | **31** | **19** | **50** | **—** | **101** |
| Balance, end of period | **$16,840** | **$2,893** | **$5,558** | **$156** | **$25,447** | **$2,577** | **$254** | **$2,831** | **$—** | **$28,278** |
| **September 30, 2022** |  |  |  |  |  |  |  |  |  |  |
| Balance, beginning of period | $12,294 | $3,024 | $4,471 | $26 | $19,815 | $3,004 | $223 | $3,227 | $237 | $23,279 |
| Provision for loan losses | 551 | 342 | 296 | (1) | 1,188 | 309 | (5) | 304 | 8 | 1,500 |
| Charge-offs | — | — | (87) | — | (87) | — | (24) | (24) | — | (111) |
| Recoveries | — | 1 | 32 | — | 33 | 2 | 6 | 8 | — | 41 |
| Balance, end of period | $12,845 | $3,367 | $4,712 | $25 | $20,949 | $3,315 | $200 | $3,515 | $245 | $24,709 |
| **Nine Months Ended** |  |  |  |  |  |  |  |  |  |  |
| **September 30, 2023** |  |  |  |  |  |  |  |  |  |  |
| Balance, beginning of period prior to adopting CECL | **$13,558** | **$3,214** | **$4,505** | **$24** | **$21,301** | **$3,444** | **$188** | **$3,632** | **$245** | **$25,178** |
| Impact of adopting CECL | **2,857** | **(214)** | **928** | **169** | **3,740** | **(1,121)** | **49** | **(1,072)** | **(245)** | **2,423** |
| Provision for credit losses | **335** | **(111)** | **790** | **(37)** | **977** | **163** | **124** | **287** | **—** | **1,264** |
| Charge-offs | **(12)** | **—** | **(748)** | **—** | **(760)** | **(98)** | **(198)** | **(296)** | **—** | **(1,056)** |
| Recoveries | **102** | **4** | **83** | **—** | **189** | **189** | **91** | **280** | **—** | **469** |
| Balance, end of period | **$16,840** | **$2,893** | **$5,558** | **$156** | **$25,447** | **$2,577** | **$254** | **$2,831** | **$—** | **$28,278** |
| **September 30, 2022** |  |  |  |  |  |  |  |  |  |  |
| Balance, beginning of period | $12,037 | $2,062 | $3,814 | $30 | $17,943 | $2,785 | $215 | $3,000 | $237 | $21,180 |
| Provision for loan losses | 776 | 1,295 | 980 | (5) | 3,046 | 508 | 13 | 521 | 8 | 3,575 |
| Charge-offs | — | — | (202) | — | (202) | (10) | (42) | (52) | — | (254) |
| Recoveries | 32 | 10 | 120 | — | 162 | 32 | 14 | 46 | — | 208 |
| Balance, end of period | $12,845 | $3,367 | $4,712 | $25 | $20,949 | $3,315 | $200 | $3,515 | $245 | $24,709 |

The ACL totaled $28.3 million at September 30, 2023, an increase of $3.1 million from December 31, 2022, resulting from a cumulative-effect adjustment from the adoption of CECL of $2.4 million and the provision for credit losses of $1.3 million for the nine months ended September 30, 2023, which was inclusive of net charge-offs of $587 thousand during the nine months ended September 30, 2023. At September 30, 2023, the ACL as a percentage of the total loan portfolio was 1.25% compared to 1.18% at September 30, 2022. The ACL increased in the nine months ended September 30, 2023 primarily as a result of the impact of implementing CECL, which requires the transition from an incurred loss model based on historical loss experience to an expected credit loss model based on the life of the loan.

In addition to the specific reserve allocations on individually evaluated loans noted previously, 6 loans, with aggregate outstanding principal balances of $377 thousand, had cumulative partial charge-offs to the ACL totaling $602 thousand at September 30, 2023. As updated appraisals are received on collateral-dependent loans, partial charge-offs are taken to the extent the loans’ principal balance exceeds their fair value.

The information presented in the table below is not required for periods subsequent to the adoption of CECL. The following table summarizes the ALL allocation for loans individually and collectively evaluated for impairment by loan segment at December 31, 2022. Accruing PCI loans are excluded from loans individually evaluated for impairment.

| December 31, 2022 Loans allocated by: | Commercial Commercial Real Estate | Acquisition and Development | Commercial and Industrial | Municipal | Total | Consumer Residential Mortgage | Installment and Other | Total | Unallocated | Total |
| --- | ---: | ---: | ---: | ---: | ---: | ---: | ---: | ---: | ---: | ---: |
| Individually evaluated for impairment | $2,848 | $15,426 | $31 | $— | $18,305 | $2,920 | $40 | $2,960 | $— | $21,265 |
| Collectively evaluated for impairment | 1,164,401 | 167,950 | 357,743 | 12,173 | 1,702,267 | 415,675 | 12,025 | 427,700 | — | 2,129,967 |
|  | $1,167,249 | $183,376 | $357,774 | $12,173 | $1,720,572 | $418,595 | $12,065 | $430,660 | $— | $2,151,232 |
| ALL allocated by: |  |  |  |  |  |  |  |  |  |  |
| Individually evaluated for impairment | $— | $— | $— | $— | $— | $28 | $— | $28 | $— | $28 |
| Collectively evaluated for impairment | 13,558 | 3,214 | 4,505 | 24 | 21,301 | 3,416 | 188 | 3,604 | 245 | 25,150 |
|  | $13,558 | $3,214 | $4,505 | $24 | $21,301 | $3,444 | $188 | $3,632 | $245 | $25,178 |

Management believes the allocation of the ACL among the various loan classes adequately reflects the life expected credit losses in each loan class and is based on the methodology outlined in Note 1, Summary of Significant Accounting Policies, and Note 3, Loans and Allowance for Credit Losses, to the Consolidated Financial Statements under Part I, Item 1, "Financial Information." Management re-evaluates and makes enhancements to its reserve methodology to better reflect the risks inherent in the different segments of the portfolio, particularly in light of increased charge-offs, with noticeable differences between the different loan classes. Management believes these enhancements to the ACL methodology improve the accuracy of quantifying the expected credit losses inherent in the portfolio. Management charges actual loan losses to the reserve and bases the provision for credit losses on its overall analysis.

The recoveries on previously charged-off relationships are the result of successful loan monitoring and workout solutions. Recoveries are difficult to predict, and any additional recoveries that the Company receives will be used to replenish the ACL. Recoveries favorably impact historical charge-off factors, and contribute to changes in the loss factors used in our allowance adequacy analysis. However, as the loan portfolio continues to grow, future provisions for credit losses may be required.

Management believes the Company’s ACL is adequate based on currently available information. Future adjustments to the ACL and enhancements to the methodology may be necessary due to changes in economic conditions, regulatory guidance, or management’s assumptions as to future delinquencies or loss rates.

### Deposits

Deposits grew by $70.2 million, or 3%, remaining at $2.5 billion at both September 30, 2023 and December 31, 2022. During 2023, time deposits increased by $126.3 million, or 50%, interest-bearing demand deposits increased by $50.0 million, or 5% and money market accounts increased by $3.0 million, or 1%. These increases were partially offset by decreases in noninterest-bearing demand deposits of $30.5 million, or 7%, and savings accounts of $42.7 million, or 19%. The increase in time deposits was attributable to promotional offerings of up to 18-month terms. During the nine months ended September 30, 2023, brokered money market deposits increased by $19.0 million due to purchases. The decline in the savings and noninterest-bearing deposit categories was primarily the result of clients seeking higher-yielding products. During 2023, the Bank has been successful at retaining many of those deposits and driving inflows from new clients as well. This resulted in a shift from noninterest-bearing deposits to interest-bearing. At September 30, 2023, deposits that are uninsured and not collateralized totaled $387.5 million, or 15% of total deposits.

During the fourth quarter of 2022, the Bank announced that it had entered into a Purchase and Assumption Agreement providing for the sale of its Path Valley branch, including associated deposit liabilities, building and land. The sale was completed on May 12, 2023. This sale included deposits of approximately $18.7 million comprising of $14.4 million in interest-bearing deposits and $4.3 million in noninterest-bearing deposits. which were sold at a premium of 6%. These deposits were reported at cost as deposits held for assumption in connection with the sale of a bank branch within total deposits in the unaudited condensed consolidated balance sheets. At December 31, 2022, deposits of approximately $31.3 million were expected to be conveyed in the branch sale, are reported within total deposits at cost and were comprised of $23.5 million in interest-bearing deposits and $7.8 million in non-interest bearing deposits.

### Borrowings

In addition to deposits, the Company uses borrowing sources to meet liquidity needs and for temporary funding. Sources of short-term borrowings include the FHLB of Pittsburgh, federal funds purchased and the FRB discount window. Short-term borrowings also may include securities sold under agreements to repurchase with deposit clients, in which a client sweeps a portion of a deposit balance into a repurchase agreement, which is a secured borrowing with a pool of securities pledged against the balance.

The Company also utilizes long-term debt, consisting principally of FHLB fixed and amortizing advances, to fund its balance sheet with original maturities greater than one year. The Company evaluates its funding needs, interest rate movements, the cost of options and the availability of attractive structures when considering the timing and extent of when it enters into long-term borrowings.

FHLB advances and other borrowings increased by $51.1 million to $157.3 million at September 30, 2023 compared to $106.1 million at December 31, 2022. The increase in borrowings during 2023 includes long-term fixed-rate advances from the FHLB totaling $40.0 million. With the continued strength in loan fundings and increased competition for deposits, the Bank elected to replace some of its overnight borrowings with lower cost term advances. The Bank tested its various sources of funding during 2023 to ensure accessibility.

See Note 8, Short-Term Borrowings, and Note 9, Long-Term Borrowings, to the unaudited condensed consolidated financial statements under Part I, Item 1, "Financial Information," for a description and terms of the Company’s borrowings and access to alternative sources of liquidity.

### Shareholders' Equity, Capital Adequacy and Regulatory Matters

Capital management in a regulated financial services industry must properly balance return on equity to its shareholders while maintaining sufficient levels of capital and related risk-based regulatory capital ratios to satisfy statutory regulatory requirements. The Company’s capital management strategies have been developed to provide attractive rates of returns to its shareholders, while maintaining a “well-capitalized” position of regulatory strength.

Shareholders’ equity totaled $243.1 million at September 30, 2023, an increase of $14.2 million, or 6%, from $228.9 million at December 31, 2022. The increase was primarily attributable to net income of $28.0 million, partially offset by dividends paid of $6.4 million, other comprehensive losses of $4.4 million for the nine months ended September 30, 2023 and the cumulative-effect adjustment from the adoption of CECL that decreased retained earnings by $2.0 million. Other comprehensive losses increased due to after-tax declines of $6.6 million from net unrealized losses on investment securities, partially offset by $2.2 million in net unrealized gains from cash flow hedges. The increase in net unrealized losses was primarily caused by a decline in treasury rates and wider credit spreads during 2023.

For the nine months ended September 30, 2023, total comprehensive income totaled $23.6 million, an increase of $59.1 million, from total comprehensive losses of $35.5 million for the same period in 2022 due to an increase in net income of $15.6 million between the comparative periods. Other comprehensive losses, net of taxes, decreased by $43.5 million to $4.4 million for the nine months ended September 30, 2023 compared to other comprehensive losses, net of taxes, of $47.9 million for the nine months ended September 30, 2022. Unrealized losses were higher than prior periods due to market uncertainty resulting from inflation and higher interest rates from the time of the security purchase.

At September 30, 2023, book value per common share was $22.90 per share compared to $21.45 per share at December 31, 2022. Tangible book value per share also increased from $19.47 per share at December 31, 2022 to $20.94 per share at September 30, 2023, as a result of the increase in shareholders' equity driven by earnings during 2023. See “Supplemental Reporting of Non-GAAP Measures.”

The Company routinely evaluates its capital levels in light of its risk profile to assess its capital needs. The Company and the Bank are subject to various regulatory capital requirements administered by federal and state banking agencies. At September 30, 2023 and December 31, 2022, the Bank was considered well-capitalized under applicable banking regulations. Under capital adequacy guidelines and the regulatory framework for prompt corrective action, the Bank must meet specific guidelines that involve quantitative measures of assets, liabilities and certain off-balance sheet items as calculated under regulatory accounting practices. Prompt corrective action provisions are not applicable to bank holding companies, including financial holding companies.

Note 10, Shareholders' Equity and Regulatory Capital, to the Notes to Unaudited Condensed Consolidated Financial Statements under Part I, Item 1, "Financial Information," includes a table presenting capital amounts and ratios for the Company and the Bank at September 30, 2023 and December 31, 2022.

In addition to the minimum capital ratio requirement and minimum capital ratio to be well-capitalized presented in the referenced table in Note 10, the Bank must maintain a capital conservation buffer as more fully described in the Company's Annual Report on Form 10-K for the year ended December 31, 2022, Item 1 - Business, under the topic Basel III Capital Rules. At September 30, 2023, the Bank's capital conservation buffer, based on the most restrictive Total Capital to risk weighted assets capital ratio, was 4.5%, which is greater than the 2.5% requirement.

### Liquidity

The primary function of asset/liability management is to ensure adequate liquidity and manage the Company’s sensitivity to changing interest rates. Liquidity management involves the ability to meet the cash flow requirements of clients who may be either depositors wanting to withdraw funds or borrowers needing assurance that sufficient funds will be available to meet their credit needs. The Company's primary sources of funds consist of deposit inflows, loan repayments, maturities and sales of investment securities, the sale of mortgage loans and borrowings from the FHLB of Pittsburgh. While maturities and scheduled amortization of loans and investment securities are predictable sources of funds, deposit flows and mortgage prepayments are greatly influenced by general interest rates, economic conditions and competition.

The Company regularly adjusts its investments in liquid assets based upon its assessment of expected loan demand, expected deposit flows, yields available on interest-earning deposits and investment securities and the objectives of its asset/liability management policy. The Company's most liquid assets are cash and cash equivalents. The level of these assets depends on the Company's operating, financing, lending and investing activities during any given period. At September 30, 2023, cash and cash equivalents totaled $94.9 million, compared with $60.8 million at December 31, 2022, which increase reflects net income of $28.0 million for the nine months ended September 30, 2023, the increases in deposits and borrowings of $70.2 million and $51.9 million, respectively, and proceeds from investment securities maturities, calls and repayments, net of purchases of $10.0 million, offset primarily by the deployment of cash into higher yielding loans of $115.6 million. Unencumbered investment securities totaled $59.2 million at September 30, 2023. At September 30, 2023, the Company had $16.8 million of investment securities pledged at the FRB Discount Window, with no associated borrowings outstanding. The Company's maximum borrowing capacity from the FHLB of Pittsburgh is $1.1 billion at September 30, 2023. In addition, the Company had $30.0 million in available unsecured lines of credit with other banks at September 30, 2023. The Bank tested its various sources of funding during 2023 to ensure accessibility.

See Note 8, Short-Term Borrowings, and Note 9, Long-Term Borrowings, to the unaudited condensed consolidated financial statements under Part I, Item 1, "Financial Information," for a description and terms of the Company’s borrowings and access to alternative sources of liquidity.

### Supplemental Reporting of Non-GAAP Measures

Management believes providing certain “non-GAAP” financial information will assist investors in their understanding of the effect on recent financial results from non-recurring charges.

As a result of prior acquisitions, the Company had intangible assets consisting of goodwill and core deposit and other intangible assets totaling $21.4 million and $21.8 million at September 30, 2023 and December 31, 2022, respectively. Additionally, the Company incurred $3.2 million and $13.0 million in restructuring charges and a provision for legal settlement, respectively, during the three and nine months ended September 30, 2022.

Tangible book value per share and the impact of the legal settlement and restructuring charge on net income and diluted earnings per share, as used by the Company in this supplemental reporting presentation, is determined by methods other than in accordance with GAAP. While we believe this information is a useful supplement to GAAP-based measures presented in this Form 10-Q, readers are cautioned that this non-GAAP disclosure has limitations as an analytical tool, should not be viewed as a substitute for financial measures determined in accordance with GAAP, and should not be considered in isolation or as a substitute for analysis of our results and financial condition as reported under GAAP, nor are such measures necessarily comparable to non-GAAP performance measures that may be presented by other companies. This supplemental presentation should not be construed as an inference that our future results will be unaffected by similar adjustments to be determined in accordance with GAAP. The increase in tangible book value per share (non-GAAP) from December 31, 2022 to September 30, 2023 is primarily due to net income of $28.0 million, partially offset dividends paid of $6.4 million and an increase in other comprehensive losses, net of taxes, of $4.4 million due to net unrealized losses on AFS securities and interest rate swaps designated as hedging instruments caused by inversion of the yield curve.

The following table presents the computation of each non-GAAP based measure shown together with its most directly comparable GAAP-based measure.

*(dollars and shares in thousands)*

| Tangible Book Value per Common Share | September 30, 2023 | December 31, 2022 |
| --- | ---: | ---: |
| Shareholders' equity (most directly comparable GAAP-based measure) | **$243,080** | $228,896 |
| Less: Goodwill | **18,724** | 18,724 |
| Other intangible assets | **2,650** | 3,078 |
| Related tax effect | **(557)** | (646) |
| **Tangible common equity (non-GAAP)** | **$222,263** | $207,740 |
| Common shares outstanding | **10,613** | 10,671 |
| Book value per share (most directly comparable GAAP based measure) | **$22.90** | $21.45 |
| Intangible assets per share | **1.96** | 1.98 |
| **Tangible book value per share (non-GAAP)** | **$20.94** | $19.47 |

*(dollars and shares in thousands)*

| Adjusted Net Income and Adjusted Diluted Earnings Per Share | September 30, 2022 Three Months Ended | Nine Months Ended |
| --- | ---: | ---: |
| Net (loss) income (most directly comparable GAAP based measure) | $(4,828) | $12,411 |
| Plus: Restructuring charges | 3,155 | 3,155 |
| Plus: Provision for legal settlement | 13,000 | 13,000 |
| Less: Related tax effect | (3,393) | (3,393) |
| **Adjusted net income (non-GAAP)** | $7,934 | $25,173 |
| Weighted average shares - diluted (most directly comparable GAAP-based measure) | 10,369 | 10,758 |
| Diluted (losses) earnings per share (most directly comparable GAAP-based measure) | $(0.47) | $1.16 |
| Weighted average shares - diluted (non-GAAP) | 10,529 | 10,758 |
| **Diluted earnings per share, adjusted (non-GAAP)** | $0.75 | $2.34 |

## Market risk

As filed, 8,000 characters.

Market risk comprises exposure to interest rate risk, foreign currency exchange rate risk, commodity price risk, and other relevant market rate or price risks. In the banking industry, a major risk exposure is changing interest rates. The primary objective of monitoring our interest rate sensitivity, or risk, is to provide management the tools necessary to manage the balance sheet to minimize adverse changes in net interest income as a result of changes in the direction and level of interest rates. FRB monetary control efforts, economic uncertainty and legislative changes have been significant factors affecting the task of managing interest rate sensitivity positions in recent years.

### Interest Rate Risk

Interest rate risk is the exposure to fluctuations in the Bank’s future earnings (earnings at risk) and value (value at risk) resulting from changes in interest rates. This exposure results from differences between the amounts of interest-earning assets and interest-bearing liabilities that reprice within a specified time period as a result of scheduled maturities, scheduled and unscheduled repayments, the propensity of borrowers and depositors to react to changes in their economic interests, and loan contractual interest rate changes.

We attempt to manage the level of repricing and maturity mismatch through our asset/liability management process so that fluctuations in net interest income are maintained within policy limits across a range of market conditions, while satisfying liquidity and capital requirements. Management recognizes that a certain amount of interest rate risk is inherent, appropriate and necessary to ensure the Bank’s profitability. Thus, the goal of interest rate risk management is to evaluate the amount of reward for taking risk and adjusting both the size and composition of the balance sheet relative to the level of reward available for taking risk.

Management endeavors to control the exposure to changes in interest rates by understanding, reviewing and making decisions based on its risk position. The Bank primarily uses its securities portfolio, FHLB advances, interest rate swaps and brokered deposits to manage its interest rate risk position. Additionally, pricing, promotion and product development activities are directed in an effort to emphasize the loan and deposit term or repricing characteristics that best meet current interest rate risk objectives.

We use simulation analysis to assess earnings at risk and net present value analysis to assess value at risk. These methods allow management to regularly monitor both the direction and magnitude of our interest rate risk exposure. These analyses require numerous assumptions including, but not limited to, changes in balance sheet mix, prepayment rates on loans and securities, cash flows and repricing of all financial instruments, changes in volumes and pricing, future shapes of the yield curve, relationship of market interest rates to each other (basis risk), credit spread and deposit sensitivity. Assumptions are based on management’s best estimates but may not accurately reflect actual results under certain changes in interest rates due to the timing, magnitude and frequency of rate changes and changes in market conditions and management strategies, among other factors. However, the analyses are useful in quantifying risk and providing a relative gauge of our interest rate risk position over time.

Our asset/liability committee operates under management policies, approved by the Board of Directors, which define guidelines and limits on the level of risk. The committee meets regularly and reviews our interest rate risk position and monitors various liquidity ratios to ensure a satisfactory liquidity position. By utilizing our analyses, we can determine changes that may need to be made to the asset and liability mixes to mitigate the change in net interest income under various interest rate scenarios. Management continually evaluates the condition of the economy, the pattern of market interest rates and other economic data to inform the committee on the selection of investment securities. Regulatory authorities also monitor our interest rate risk position along with other liquidity ratios.

### Net Interest Income Sensitivity

Simulation analysis evaluates the effect of upward and downward changes in market interest rates on future net interest income. The analysis involves changing the interest rates used in determining net interest income over the next twelve months. The resulting percentage change in net interest income in various rate scenarios is an indication of the Bank's short-term interest rate risk. The analysis assumes recent pricing trends in new loan and deposit volumes will continue while balances remain constant. Additional assumptions are applied to modify pricing under the various rate scenarios.

The simulation analysis results are presented in the table below. The decrease in net interest income in the rising interest rate scenarios at September 30, 2023 is the result of the assumption that funding costs will increase faster than the yields on interest earning assets. Results in the falling interest rate scenario project a decrease in net interest income as a result of long-term fixed rate funding added to the balance sheet in 2023. Additionally, in the September 30, 2023 model, funding pressure is not expected to abate within the first twelve months of a rates falling scenario, while the model at December 31, 2022 assumed faster repricing between those periods. The Bank is currently liability sensitive according to the model as interest bearing liabilities have been repricing faster than interest earning assets. If interest bearing liabilities reprice slower than modeled, the pressure on net interest income may be reduced.

### Economic Value

Net present value analysis provides information on the risk inherent in the balance sheet that might not be considered in the simulation analysis due to the short time horizon used in that analysis. The net present value of the balance sheet incorporates the discounted present value of expected asset cash flows minus the discounted present value of expected liability cash flows. The analysis involves changing the interest rates used in determining the expected cash flows and in discounting the cash flows. The resulting percentage change in net present value in various rate scenarios is an indication of the longer term repricing risk and options embedded in the balance sheet.

The results at September 30, 2023 and December 31, 2022 reflect the impact of the FOMC's interest rate increases in effect at the end of each period. Funding cost and repricing speed will continue to be a factor in the results of the model. The behavior of the business and retail clients also varies across the rate scenarios, which is reflected in the results. For the September 30, 2023 modeling, enhancements were implemented to provide a more granular analysis, which reflects that business and retail accounts experience different rate sensitivities and average lives. To improve the comparability across periods, the Bank strives to follow best practices related to the assumption setting and maintains the size and mix of the period end balance sheet; thus, the results do not reflect actions management may take through the normal course of business that would impact results.

| Net Interest Income Change in Market Interest Rates (basis points) | % Change in Net Interest Income September 30, 2023 | December 31, 2022 | Economic Value Change in Market Interest Rates (basis points) | % Change in Market Value September 30, 2023 | December 31, 2022 |
| ---: | ---: | ---: | ---: | ---: | ---: |
| **(200)** | **(4.1)%** | 4.7% | **(200)** | **(4.4)%** | (27.7)% |
| **(100)** | **(1.5)%** | 4.8% | **(100)** | **(0.3)%** | (9.3)% |
| **100** | **(1.4)%** | (2.6)% | **100** | **(3.8)%** | 3.8% |
| **200** | **(3.5)%** | (6.1)% | **200** | **(8.2)%** | 4.0% |

## Controls and procedures

As filed, 846 characters.

Based on the evaluation required by Exchange Act Rules 13a-15(b) and 15d-15(b), the Company's management, including the Chief Executive Officer and Chief Financial Officer, conducted an evaluation of the effectiveness of its disclosure controls and procedures, as defined in Exchange Act Rules 13a-15(e) and 15d-15(e), at September 30, 2023. Based on that evaluation, our Chief Executive Officer and Chief Financial Officer concluded that the Company's disclosure controls and procedures were effective at September 30, 2023.

There were no significant changes made to the Company’s internal control over financial reporting that occurred during the period covered by this report that have materially affected, or that are reasonably likely to affect, our internal control over financial reporting during the nine months ended September 30, 2023.

## Risk factors

As filed, 142 characters.

There have been no material changes from the risk factors as disclosed in our Annual Report on Form 10-K for the year ended December 31, 2022.

Filed Nov 8, 2023.
Source: SEC EDGAR, the filing index for accession 0000826154-23-000145. Last ingested by Listed: Oct 24, 2026, 14:57 ET. No prices; not investment advice.