# Fidelity D & D Bancorp Inc: Form 10-Q for the period ended Mar 31, 2021

- Company: [Fidelity D & D Bancorp Inc](/companies/fdbc.md) (CIK 1098151)
- Form: 10-Q
- Filed: 2021-05-14
- Accepted by EDGAR: May 14, 2021, 14:52 ET
- Period: 2021-03-31
- Accession: 0001098151-21-000024
- Inline XBRL: yes
- Main document: https://www.sec.gov/Archives/edgar/data/1098151/000109815121000024/fdbc-20210331x10q.htm
- All documents and exhibits: https://www.sec.gov/Archives/edgar/data/1098151/000109815121000024/

## Figures reported in this filing

Standardized XBRL line items for the period ended 2021-03-31.

| Line item | Period | Value | XBRL concept |
| --- | --- | ---: | --- |
| Interest expense | 3 months, 2021-01-01 to 2021-03-31 | $890.0k | us-gaap:InterestExpense |
| Income tax | 3 months, 2021-01-01 to 2021-03-31 | $1.0m | us-gaap:IncomeTaxExpenseBenefit |
| Net income | 3 months, 2021-01-01 to 2021-03-31 | $5.7m | us-gaap:NetIncomeLoss |
| Diluted EPS | 3 months, 2021-01-01 to 2021-03-31 | $1.13 | us-gaap:EarningsPerShareDiluted |
| Basic EPS | 3 months, 2021-01-01 to 2021-03-31 | $1.14 | us-gaap:EarningsPerShareBasic |
| Diluted shares (weighted) | 3 months, 2021-01-01 to 2021-03-31 | 5,033,577 shares | us-gaap:WeightedAverageNumberOfDilutedSharesOutstanding |
| Operating cash flow | 3 months, 2021-01-01 to 2021-03-31 | $25.7m | us-gaap:NetCashProvidedByUsedInOperatingActivities |
| Capital expenditure | 3 months, 2021-01-01 to 2021-03-31 | $286.0k | us-gaap:PaymentsToAcquirePropertyPlantAndEquipment |
| Dividends paid | 3 months, 2021-01-01 to 2021-03-31 | $1.5m | us-gaap:PaymentsOfDividends |
| Cash and equivalents | at 2021-03-31 | $223.0m | us-gaap:CashAndCashEquivalentsAtCarryingValue |
| Total assets | at 2021-03-31 | $1.91bn | us-gaap:Assets |
| Total liabilities | at 2021-03-31 | $1.75bn | us-gaap:Liabilities |
| Shareholders' equity | at 2021-03-31 | $163.6m | us-gaap:StockholdersEquity |

## Management's discussion and analysis

As filed, 96,233 characters.

The following is management's discussion and analysis of the significant changes in the consolidated financial condition of the Company as of March 31, 2021 compared to December 31, 2020 and a comparison of the results of operations for the three months ended March 31, 2021 and 2020. Current performance may not be indicative of future results. This discussion should be read in conjunction with the Company’s 2020 Annual Report filed on Form 10-K.

### Forward-looking statements

Certain of the matters discussed in this Quarterly Report on Form 10-Q may constitute forward-looking statements for purposes of the Securities Act of 1933, as amended, and the Securities Exchange Act of 1934, as amended, and as such may involve known and unknown risks, uncertainties and other factors which may cause the actual results, performance or achievements of the Company to be materially different from future results, performance or achievements expressed or implied by such forward-looking statements. The words “expect,” “anticipate,” “intend,” “plan,” “believe,” “estimate,” and similar expressions are intended to identify such forward-looking statements.

The Company’s actual results may differ materially from the results anticipated in these forward-looking statements due to a variety of factors, including, without limitation:

the effects of economic conditions particularly with regard to the negative impact of severe, wide-ranging and continuing disruptions caused by the spread of Coronavirus Disease 2019 (COVID-19) and responses thereto on current customers and the operations of the Company, specifically the effect of the economy on loan customers’ ability to repay loans;

acquisitions and integration of acquired businesses, including but not limited to, the recent acquisition of MNB Corporation (“MNB”) and its wholly-owned bank subsidiary;

the costs and effects of litigation and of unexpected or adverse outcomes in such litigation;

the impact of new or changes in existing laws and regulations, including the Tax Cuts and Jobs Act and Dodd-Frank Wall Street Reform and Consumer Protection Act of 2010 and the regulations promulgated there under;

impacts of the capital and liquidity requirements of the Basel III standards and other regulatory pronouncements, regulations and rules;

governmental monetary and fiscal policies, as well as legislative and regulatory changes;

effects of short- and long-term federal budget and tax negotiations and their effect on economic and business conditions;

the effect of changes in accounting policies and practices, as may be adopted by the regulatory agencies, as well as the Financial Accounting Standards Board and other accounting standard setters;

the risks of changes in interest rates on the level and composition of deposits, loan demand, and the values of loan collateral, securities and interest rate protection agreements, as well as interest rate risks;

the effects of competition from other commercial banks, thrifts, mortgage banking firms, consumer finance companies, credit unions, securities brokerage firms, insurance companies, money market and other mutual funds and other financial institutions operating in our market area and elsewhere, including institutions operating locally, regionally, nationally and internationally, together with such competitors offering banking products and services by mail, telephone, computer and the internet;

technological changes;

the interruption or breach in security of our information systems and other technological risks and attacks resulting in failures or disruptions in customer account management, general ledger processing and loan or deposit updates and potential impacts resulting therefrom including additional costs, reputational damage, regulatory penalties, and financial losses;

acquisitions and integration of acquired businesses;

the failure of assumptions underlying the establishment of reserves for loan losses and estimations of values of collateral and various financial assets and liabilities;

volatilities in the securities markets;

acts of war or terrorism;

disruption of credit and equity markets; and

the risk that our analyses of these risks and forces could be incorrect and/or that the strategies developed to address them could be unsuccessful.

The Company cautions readers not to place undue reliance on forward-looking statements, which reflect analyses only as of the date of this document. The Company has no obligation to update any forward-looking statements to reflect events or circumstances after the date of this document.

Readers should review the risk factors described in other documents that we file or furnish, from time to time, with the Securities and Exchange Commission, including Annual Reports to Shareholders, Annual Reports filed on Form 10-K and other current reports filed or furnished on Form 8-K.

### Executive Summary

The Company is a Pennsylvania corporation and a bank holding company, whose wholly-owned state chartered commercial bank is The Fidelity Deposit and Discount Bank. The Company is headquartered in Dunmore, Pennsylvania. We consider Lackawanna, Northampton and Luzerne Counties our primary marketplace.

As a leading Northeastern Pennsylvania community bank, our goals are to enhance shareholder value while continuing to build a full-service community bank. We focus on growing our core business of retail and business lending and deposit gathering while maintaining strong asset quality and controlling operating expenses. We continue to implement strategies to diversify earning assets (see “Funds Deployed” section of this management’s discussion and analysis) and to increase low cost core deposits (see “Funds Provided” section of this management’s discussion and analysis). These strategies include a greater level of commercial lending and the ancillary business products and services supporting our commercial customers’ needs as well as residential lending strategies and an array of consumer products. We focus on developing a full banking relationship with existing, as well as new business prospects. The Bank has a personal and corporate trust department and also provides alternative financial and insurance products with asset management services. In addition, we explore opportunities to selectively expand our franchise footprint, consisting presently of our 20-branch network.

We are impacted by both national and regional economic factors, with commercial, commercial real estate and residential mortgage loans concentrated in Northeastern Pennsylvania, primarily in Lackawanna and Luzerne counties, and Eastern Pennsylvania, primarily Northampton County. The Federal Open Market Committee (FOMC) began increasing interest rates at the end of 2015 in an attempt to return to a “normal” stance. Rate cuts of 50 and 100 basis points during the first quarter of 2020 at the start of the pandemic completely reversed the increases initiated by the FOMC at the end of 2015. According to the U.S. Bureau of Labor Statistics, the national unemployment rate for March 2021 was 6.0%, down 0.7 percentage points from December 2020. However, the unemployment rates in the Scranton - Wilkes-Barre - Hazleton and the Allentown – Bethlehem - Easton Metropolitan Statistical Areas (local) increased and remained at a higher level than the national unemployment rate. The local unemployment rates at March 31, 2021 were 9.0% and 7.3%, respectively, an increase of 1.0 and 0.7 percentage points from the 8.0% and 6.6%, respectively, at December 31, 2020. The local unemployment rates have risen as a result of the effects of the pandemic. The increase in unemployment and business restrictions has had an effect on spending in our market area and unemployment is expected to remain above the pre-pandemic levels for the next few months. Stimulus payments and enhanced unemployment benefits have supported the economy throughout 2020 and the first quarter of 2021 and the government could continue to provide this support throughout 2021. The median home values in the Scranton-Wilkes-Barre-Hazleton metro and Allentown-Bethlehem-Easton metro increased 13.6% and 14.2% from a year ago, according to Zillow, an online database advertising firm providing access to its real estate search engines to various media outlets, and values are expected to grow 6.7% and 9.8% in the next year. In light of these expectations, we will continue to monitor the economic climate in our region and scrutinize growth prospects with credit quality as a principal consideration.

On May 1, 2020, the Company completed its previously announced acquisition of MNB Corporation (“MNB”) and its wholly-owned bank subsidiary. The merger expanded the Company’s full-service footprint into Northampton County, PA and the Lehigh Valley. Non-recurring costs to facilitate the merger and integrate systems of $2.5 million were incurred during 2020.

On February 26, 2021, the Company announced an agreement to acquire Landmark Bancorp, Inc. (“Landmark”). The Company expects to complete the merger with Landmark during the third quarter of 2021. The Company expects non-recurring costs to facilitate the anticipated merger and integrate systems in 2021 incurred by the Company to be $3.7 million, of which $0.5 million was recognized in the first quarter. The Company remains committed to selectively expanding branch banking and wealth management locations in Northeastern and Eastern Pennsylvania as opportunities arrive going forward.

For the first quarter of 2021, net income was $5.7 million, or $1.13 diluted earnings per share, compared to $2.6 million, or $0.69 diluted earnings per share, for the first quarter of 2020. Non-recurring merger-related costs and a FHLB prepayment penalty incurred during the first quarter of 2021 are not a part of the Company’s normal operations. If these expenses had not occurred, adjusted net income (non-GAAP) for the three months ended March 31, 2021 and 2020 would have been $6.5 million and $2.9 million, respectively. Adjusted diluted EPS (non-GAAP) would have been $1.29 and $0.76 for the three months ended March 31, 2021 and 2020, respectively.

For the quarters ended March 31, 2021 and 2020, tangible common book value per share (non-GAAP) was $31.00 and $29.47, respectively. These non-GAAP measures should be reviewed in connection with the reconciliation of these non-GAAP ratios. See “Non-GAAP Financial Measures” located below within this management’s discussion and analysis.

Branch managers, relationship bankers, mortgage originators and our business service partners are all focused on developing a mutually profitable full banking relationship. We understand our markets, offer products and services along with financial advice that is appropriate for our community, clients and prospects. The Company continues to focus on the trusted financial advisor model by utilizing the team approach of experienced bankers that are fully engaged and dedicated towards maintaining and growing profitable relationships.

In addition to the challenging economic environment in which we compete, the regulation and oversight of our business has changed significantly in recent years. As described more fully in Part II, Item 1A, “Risk Factors” below, as well as Part I, Item 1A, “Risk

Factors,” and in the “Supervisory and Regulation” section of management’s discussion and analysis of financial condition and results of operations in our 2020 Annual Report filed on Form 10-K, certain aspects of the Dodd-Frank Wall Street Reform Act (Dodd-Frank Act) continue to have a significant impact on us. In addition, final rules to implement Basel III regulatory capital reform, approved by the federal bank regulatory agencies in 2013, subject many banks including the Company, to capital requirements which became effective for the Company on January 1, 2015 and were fully phased in on January 1, 2019. The rules also revise the minimum risk-based and leverage capital ratio requirements applicable to the Company and revise the calculation of risk-weighted assets to enhance their risk sensitivity. We will continue to prepare for the impacts of the continuing implementation of the Dodd-Frank Act and the Basel III capital standards, and related rulemaking will have on our business, financial condition and results of operations.

### Non-GAAP Financial Measures

The following are non-GAAP financial measures which provide useful insight to the reader of the consolidated financial statements but should be supplemental to GAAP used to prepare the Company’s financial statements and should not be read in isolation or relied upon as a substitute for GAAP measures. In addition, the Company’s non-GAAP measures may not be comparable to non-GAAP measures of other companies. The Company’s tax rate used to calculate the fully-taxable equivalent (FTE) adjustment was 21% at March 31, 2021 and 2020.

The following table reconciles the non-GAAP financial measures of FTE net interest income:

*(dollars in thousands)*

|  | March 31, 2021 | March 31, 2020 |
| --- | ---: | ---: |
| Interest income (GAAP) | **$14,340** | $9,711 |
| Adjustment to FTE | **416** | 191 |
| Interest income adjusted to FTE (non-GAAP) | **14,756** | 9,902 |
| Interest expense (GAAP) | **890** | 1,705 |
| Net interest income adjusted to FTE (non-GAAP) | **$13,866** | $8,197 |

The efficiency ratio is non-interest expenses as a percentage of FTE net interest income plus non-interest income. The following table reconciles the non-GAAP financial measures of the efficiency ratio to GAAP:

*(dollars in thousands)*

| Efficiency Ratio (non-GAAP) | March 31, 2021 | March 31, 2020 |
| --- | ---: | ---: |
| Non-interest expenses (GAAP) | **$11,456** | $7,304 |
| Net interest income (GAAP) | **13,450** | 8,006 |
| Plus: taxable equivalent adjustment | **416** | 191 |
| Non-interest income (GAAP) | **5,516** | 2,755 |
| Net interest income (FTE) plus non-interest income (non-GAAP) | **$19,382** | $10,952 |
| Efficiency ratio (non-GAAP) | **59.11%** | 66.69% |

The following table provides a reconciliation of the tangible common equity (non-GAAP) and the calculation of tangible book value per share:

*(dollars in thousands)*

| Tangible Book Value per Share (non-GAAP) | March 31, 2021 | March 31, 2020 |
| --- | ---: | ---: |
| Total assets (GAAP) | **$1,913,092** | $1,062,495 |
| Less: Intangible assets, primarily goodwill | **(8,697)** | (209) |
| Tangible assets | **1,904,395** | 1,062,286 |
| Total shareholders' equity (GAAP) | **163,582** | 112,140 |
| Less: Intangible assets, primarily goodwill | **(8,697)** | (209) |
| Tangible common equity | **$154,884** | $111,931 |
| Common shares outstanding, end of period | **4,995,547** | 3,797,646 |
| Tangible Common Book Value per Share | **$31.00** | $29.47 |

The following table provides a reconciliation of the Company’s earnings results under GAAP to comparative non-GAAP results excluding merger-related expenses:

*(dollars in thousands except per share data)*

|  | March 31, 2021 Income before ‎income taxes | Provision for ‎income taxes | Net income | Diluted earnings ‎per share | March 31, 2020 Income before ‎income taxes | Provision for ‎income taxes | Net income | Diluted earnings ‎per share |
| --- | ---: | ---: | ---: | ---: | ---: | ---: | ---: | ---: |
| Results of operations (GAAP) | **$6,710** | **$1,043** | **$5,667** | **$1.13** | $3,157 | $523 | $2,634 | $0.69 |
| Add: Merger-related expenses | **523** | **8** | **515** | **0.10** | 271 | 9 | 262 | 0.07 |
| Add: FHLB prepayment penalty | **369** | **78** | **291** | **0.06** | - | - | - | - |
| Adjusted earnings (non-GAAP) | **$7,602** | **$1,129** | **$6,473** | **$1.29** | $3,428 | $532 | $2,896 | $0.76 |

### General

The Company’s earnings depend primarily on net interest income. Net interest income is the difference between interest income and interest expense. Interest income is generated from yields earned on interest-earning assets, which consist principally of loans and investment securities. Interest expense is incurred from rates paid on interest-bearing liabilities, which consist of deposits and borrowings. Net interest income is determined by the Company’s interest rate spread (the difference between the yields earned on its interest-earning assets and the rates paid on its interest-bearing liabilities) and the relative amounts of interest-earning assets and interest-bearing liabilities. Interest rate spread is significantly impacted by: changes in interest rates and market yield curves and their related impact on cash flows; the composition and characteristics of interest-earning assets and interest-bearing liabilities; differences in the maturity and re-pricing characteristics of assets compared to the maturity and re-pricing characteristics of the liabilities that fund them and by the competition in the marketplace.

The Company’s earnings are also affected by the level of its non-interest income and expenses and by the provisions for loan losses and income taxes. Non-interest income mainly consists of: service charges on the Company’s loan and deposit products; interchange fees; trust and asset management service fees; increases in the cash surrender value of the bank owned life insurance and from net gains or losses from sales of loans and securities. Non-interest expense consists of: compensation and related employee benefit costs; occupancy; equipment; data processing; advertising and marketing; FDIC insurance premiums; professional fees; loan collection; net other real estate owned (ORE) expenses; supplies and other operating overhead.

Net interest income, net interest rate margin, net interest rate spread and the efficiency ratio are presented in the MD&A on a fully-taxable equivalent (FTE) basis. The Company believes this presentation to be the preferred industry measurement of net interest income as it provides a relevant comparison between taxable and non-taxable amounts.

### Comparison of the results of operations

### Three months ended March 31, 2021 and 2020

### Overview

For the first quarter of 2021, the Company generated net income of $5.7 million, or $1.13 per diluted share, compared to $2.6 million, or $0.69 per diluted share, for the first quarter of 2020. The $3.1 million, or 115%, increase in net income was primarily the result of $5.4 million higher net interest income and $2.8 million more non-interest income partially offset by a $4.2 million rise in non-interest expenses and $0.5 million increase in the provision for loan losses. The increase in non-interest expenses was driven by the impact of adding the operations of MNB along with merger-related expenses incurred in connection with the acquisitions of MNB and Landmark.

Return on average assets (ROA) was 1.29% and 1.04% for the first quarters of 2021 and 2020. During the same time periods, return on average shareholders’ equity (ROE) was 13.75% and 9.74%, respectively. ROA and ROE both increased due to the growth in net income relative to the increase in average assets and equity.

#### Net interest income and interest sensitive assets / liabilities

For the first quarter of 2021, net interest income increased $5.4 million, or 68%, to $13.4 million from $8.0 million for the first quarter of 2020. The $4.6 million growth in interest income was produced by the addition of $707.6 million in average interest-earning assets partially offset by the effect of a 58 basis point decline in FTE yield earned on those assets. The loan portfolio drove this interest income growth due to $405.9 million more in average loans, primarily from the MNB acquisition and PPP lending. In the investment portfolio, an increase in the average balances of municipal securities was the biggest driver of interest income growth. The average balance of total securities grew $223.1 million producing $0.7 million in additional FTE interest income despite a decrease of 93 basis points in yields earned on investments. On the liability side, total interest-bearing liabilities grew $454.3 million, on average, with a 67 basis point decrease in rates paid thereon. A 61 basis point decrease in rates paid on deposits offset the effect of $482.0 million higher average interest-bearing deposits resulting in $0.6 million less interest expense from deposits for the first quarter of 2021 compared to the 2020 like period. There was also $0.2 million less in interest expense on borrowings due to lower rates paid on a lower balance of average borrowings.

The FTE net interest rate spread increased by nine basis points and margin decreased by eight basis points, respectively, for the three months ended March 31, 2021 compared to the same 2020 period. The yields earned on interest-earning assets declined slower than the rates paid on interest-bearing liabilities causing the improvement in net interest rate spread. The decrease in net interest rate margin was due to the higher average balance of interest-bearing cash. The overall 23 basis point cost of funds, which includes the impact of non-interest bearing deposits, decreased 54 basis points for the three months ended March 31, 2021 compared to the same 2020 periods. The primary reason for the decline was the reduction in rates paid on deposits compared to the same 2020 periods.

For the remainder of 2021, the Company expects to operate in a relatively low interest rate environment. A rate environment with falling interest rates positions the Company to reduce its interest income performance from new and maturing earning assets. Until there is a sustained period of yield curve steepening, with rates rising more sharply at the long end, the interest rate margin may experience compression. The FOMC began easing the federal funds rate during the second half of 2019 and continued through the first quarter of 2020 which reduced rates paid on interest-bearing liabilities. On the asset side, the prime interest rate, the benchmark rate that banks use as a base rate for adjustable rate loans was cut 75 basis points in the second half of 2019 and another 150 basis points in the first quarter of 2020. The Blue-Chip Financial Forecasts’ consensus forecasts are predicting a steepening yield curve, with basically flat short-term rates and rising long-term rates. The 2021 focus is to manage net interest income through a relatively flat forecasted rate cycle by controlling loan and deposit pricing to maintain a reasonable spread. Interest income is projected to increase for the remainder of 2021. Management expects to actively reduce the cost of funds to partially mitigate spread compression throughout this flat rate cycle. Continued growth in the loan portfolios complemented with investment security growth is expected to boost interest income, and when coupled with a proactive relationship approach to deposit cost setting strategies should help mitigate spread compression and contain the interest rate margin at acceptable levels.

The Company’s cost of interest-bearing liabilities was 0.31% for the three months ended March 31, 2021, or 67 basis points lower than the cost for the same 2020 periods. The decrease in interest paid on both deposits and borrowings contributed to the lower cost of interest-bearing liabilities. The FOMC is not expected to cut the federal funds rate further, but the Company has the opportunity to reduce rates paid on deposits as higher-priced promotional rates and negotiated rates reprice into products with lower rates. To help mitigate the impact of the imminent change to the economic landscape, the Company has successfully developed and will continue to strengthen its association with existing customers, develop new business relationships, generate new loan volumes, and retain and generate higher levels of average non-interest bearing deposit balances. Strategically deploying no- and low-cost deposits into interest earning-assets is an effective margin-preserving strategy that the Company expects to continue to pursue and expand to help stabilize net interest margin.

The Company’s Asset Liability Management (ALM) team meets regularly to discuss among other things, interest rate risk and when deemed necessary adjusts interest rates. ALM is actively addressing the Company's sensitivity to a changing rate environment to ensure interest rate risks are contained within acceptable levels. ALM also discusses revenue enhancing strategies to help combat the potential for a decline in net interest income. The Company’s marketing department, together with ALM, lenders and deposit gatherers, continue to develop prudent strategies that will grow the loan portfolio and accumulate low-cost deposits to improve net interest income performance.

The table that follows sets forth a comparison of average balances of assets and liabilities and their related net tax equivalent yields and rates for the periods indicated. Within the table, interest income was FTE adjusted, using the corporate federal tax rate of 21% for March 31, 2021 and 2020 to recognize the income from tax-exempt interest-earning assets as if the interest was taxable. See “Non-GAAP Financial Measures” within this management’s discussion and analysis for the FTE adjustments. This treatment allows a uniform comparison among yields on interest-earning assets. Loans include loans held-for-sale (HFS) and non-accrual loans but exclude the allowance for loan losses. Home equity lines of credit (HELOC) are included in the residential real estate category since they are secured by real estate. Net deferred loan fee/(cost) amortization of $1.4 million and ($0.2 million) during the first quarters of 2021 and 2020, respectively, are included in interest income from loans. MNB loan fair value purchase accounting adjustments of $455 thousand are included in interest income from loans and $30 thousand reduced interest expense on deposits for the three months ended March 31, 2021. Fair value purchase accounting adjustments are preliminary and subject to refinement. Average balances are based on amortized cost and do not reflect net unrealized gains or losses. Residual values for direct finance leases are included in the average balances for consumer loans. Net interest margin is calculated by dividing net interest income-FTE by total average interest-earning assets. Cost of funds includes the effect of average non-interest bearing deposits as a funding source:

*(dollars in thousands)*

| Assets Interest-earning assets | Three months ended March 31, 2021 Average balance | Interest | Yield / rate | March 31, 2020 Average balance | Interest | Yield / rate |
| --- | ---: | ---: | ---: | ---: | ---: | ---: |
| Interest-bearing deposits | **$85,985** | **$21** | **0.10%** | $6,853 | $12 | 0.72% |
| Restricted investments in bank stock | **2,892** | **33** | **4.56** | 3,434 | 65 | 7.61 |
| Investments: |  |  |  |  |  |  |
| Agency - GSE | **53,068** | **181** | **1.38** | 5,943 | 40 | 2.70 |
| MBS - GSE residential | **146,487** | **519** | **1.44** | 125,504 | 806 | 2.58 |
| State and municipal (nontaxable) | **157,508** | **1,186** | **3.05** | 51,313 | 535 | 4.19 |
| State and municipal (taxable) | **49,414** | **224** | **1.84** | 641 | 5 | 2.97 |
| Total investments | **406,477** | **2,110** | **2.11** | 183,401 | 1,386 | 3.04 |
| Loans and leases: |  |  |  |  |  |  |
| C&I and CRE (taxable) | **645,596** | **7,805** | **4.90** | 320,019 | 3,985 | 5.01 |
| C&I and CRE (nontaxable) | **42,294** | **404** | **3.87** | 36,675 | 376 | 4.13 |
| Consumer | **162,325** | **1,574** | **3.93** | 163,376 | 1,611 | 3.97 |
| Residential real estate | **311,897** | **2,809** | **3.65** | 236,138 | 2,467 | 4.20 |
| Total loans and leases | **1,162,112** | **12,592** | **4.39** | 756,208 | 8,439 | 4.49 |
| Total interest-earning assets | **1,657,466** | **14,756** | **3.61%** | 949,896 | 9,902 | 4.19% |
| Non-interest earning assets | **121,813** |  |  | 69,656 |  |  |
| **Total assets** | **$1,779,279** |  |  | $1,019,552 |  |  |
| **Liabilities and shareholders' equity** |  |  |  |  |  |  |
| **Interest-bearing liabilities** |  |  |  |  |  |  |
| Deposits: |  |  |  |  |  |  |
| Interest-bearing checking | **$484,245** | **$376** | **0.31%** | $248,364 | $372 | 0.60% |
| Savings and clubs | **186,473** | **32** | **0.07** | 104,309 | 26 | 0.10 |
| MMDA | **361,446** | **266** | **0.30** | 199,078 | 595 | 1.20 |
| Certificates of deposit | **119,691** | **190** | **0.64** | 118,116 | 523 | 1.78 |
| Total interest-bearing deposits | **1,151,855** | **864** | **0.30** | 669,867 | 1,516 | 0.91 |
| Short-term borrowings | **144** | **-** | **0.51** | 16,174 | 75 | 1.87 |
| FHLB advances | **3,389** | **26** | **3.12** | 15,000 | 114 | 3.06 |
| Total interest-bearing liabilities | **1,155,388** | **890** | **0.31%** | 701,041 | 1,705 | 0.98% |
| Non-interest bearing deposits | **437,740** |  |  | 194,847 |  |  |
| Non-interest bearing liabilities | **18,944** |  |  | 14,891 |  |  |
| Total liabilities | **1,612,072** |  |  | 910,779 |  |  |
| Shareholders' equity | **167,207** |  |  | 108,773 |  |  |
| **Total liabilities and shareholders' equity** | **$1,779,279** |  |  | $1,019,552 |  |  |
| Net interest income - FTE |  | **$13,866** |  |  | $8,197 |  |
| Net interest spread |  |  | **3.30%** |  |  | 3.21% |
| Net interest margin |  |  | **3.39%** |  |  | 3.47% |
| Cost of funds |  |  | **0.23%** |  |  | 0.77% |

Changes in net interest income are a function of both changes in interest rates and changes in volume of interest-earning assets and interest-bearing liabilities. The following table presents the extent to which changes in interest rates and changes in volumes of interest-earning assets and interest-bearing liabilities have affected the Company’s interest income and interest expense during the periods indicated. Information is provided in each category with respect to (1) the changes attributable to changes in volume (changes in volume multiplied by the prior period rate), (2) the changes attributable to changes in interest rates (changes in rates multiplied by prior period volume) and (3) the net change. The combined effect of changes in both volume and rate has been allocated proportionately to the change due to volume and the change due to rate. Tax-exempt income was not converted to a tax-equivalent basis on the rate/volume analysis:

*(dollars in thousands)*

| Interest income: | Three months ended March 31, 2021 compared to 2020 Increase (decrease) due to Volume | Rate | Total | 2020 compared to 2019 Volume | Rate | Total |
| --- | ---: | ---: | ---: | ---: | ---: | ---: |
| Interest-bearing deposits | **$28** | **$(19)** | **$9** | $13 | $(16) | $(3) |
| Restricted investments in bank stock | **(9)** | **(23)** | **(32)** | (24) | (11) | (35) |
| Investments: |  |  |  |  |  |  |
| Agency - GSE | **169** | **(28)** | **141** | 1 | - | 1 |
| MBS - GSE residential | **116** | **(403)** | **(287)** | (10) | (105) | (115) |
| State and municipal | **853** | **(203)** | **650** | 39 | (33) | 6 |
| Total investments | **1,138** | **(634)** | **504** | 30 | (138) | (108) |
| Loans and leases: |  |  |  |  |  |  |
| Residential real estate | **697** | **(355)** | **342** | 254 | (166) | 88 |
| C&I and CRE | **3,877** | **(34)** | **3,843** | 110 | (106) | 4 |
| Consumer | **(16)** | **(21)** | **(37)** | 63 | 47 | 110 |
| Total loans and leases | **4,558** | **(410)** | **4,148** | 427 | (225) | 202 |
| Total interest income | **5,715** | **(1,086)** | **4,629** | 446 | (390) | 56 |
| Interest expense: |  |  |  |  |  |  |
| Deposits: |  |  |  |  |  |  |
| Interest-bearing checking | **237** | **(233)** | **4** | 38 | (6) | 32 |
| Savings and clubs | **16** | **(10)** | **6** | (4) | (6) | (10) |
| Money market | **290** | **(619)** | **(329)** | 196 | (87) | 109 |
| Certificates of deposit | **7** | **(340)** | **(333)** | - | 54 | 54 |
| Total deposits | **550** | **(1,202)** | **(652)** | 230 | (45) | 185 |
| Overnight borrowings | **(43)** | **(32)** | **(75)** | (129) | (67) | (196) |
| FHLB advances | **(90)** | **2** | **(88)** | (59) | 30 | (29) |
| Total interest expense | **417** | **(1,232)** | **(815)** | 42 | (82) | (40) |
| Net interest income | **$5,298** | **$146** | **$5,444** | $404 | $(308) | $96 |

#### Provision for loan losses

The provision for loan losses represents the necessary amount to charge against current earnings, the purpose of which is to increase the allowance for loan losses (the allowance) to a level that represents management’s best estimate of known and inherent losses in the Company’s loan portfolio. Loans determined to be uncollectible are charged off against the allowance. The required amount of the provision for loan losses, based upon the adequate level of the allowance, is subject to the ongoing analysis of the loan portfolio. The Company’s Special Assets Committee meets periodically to review problem loans. The committee is comprised of management, including credit administration officers, loan officers, loan workout officers and collection personnel. The committee reports quarterly to the Credit Administration Committee of the board of directors.

Management continuously reviews the risks inherent in the loan portfolio. Specific factors used to evaluate the adequacy of the loan loss provision during the formal process include:

- specific loans that could have loss potential;
- levels of and trends in delinquencies and non-accrual loans;
- levels of and trends in charge-offs and recoveries;
- trends in volume and terms of loans;
- changes in risk selection and underwriting standards;
- changes in lending policies and legal and regulatory requirements;
- experience, ability and depth of lending management;
- national and local economic trends and conditions; and
- changes in credit concentrations.

For the three months ended March 31, 2021 and 2020, the Company recorded a provision for loan losses of $0.8 million and $0.3 million, respectively, a $0.5 million, or 167%, increase. The increase in the provision for loan losses from the year earlier period was primarily attributed to higher credit losses inherent within the loan portfolio that were a result of the COVID-19 crisis and its effects.

See the discussion of the qualitative factors within the “Allowance for loan losses” section of this management’s discussion and analysis. Although uncertainty over COVID’s duration and severity complicates management’s ability to render a more precise estimate of credit losses, management currently believes the level of provisioning for the three months ended March 31, 2021 was adequate based on the information that was available as of the reporting date and subsequent period up to the filing date.

The provision for loan losses derives from the reserve required from the allowance for loan losses calculation. The Company continued provisioning for the three months ended March 31, 2021 to maintain an allowance level that management deemed adequate.

For a discussion on the allowance for loan losses, see “Allowance for loan losses,” located in the comparison of financial condition section of management’s discussion and analysis contained herein.

#### Other income

For the first quarter of 2021, non-interest income amounted to $5.5 million, an increase of $2.7 million, or 100%, compared to $2.8 million recorded for the same 2020 period. Heightened mortgage activity caused gains on loan sales to increase $2.1 million and service charges on loans to increase $0.1 million. Interchange fees were $0.4 million higher than the first quarter of 2020 with more debit cards issued after the merger with MNB. Additionally, earnings on bank-owned life insurance grew $0.1 million and fees from trust fiduciary activities increased $0.1 million partially offset by a $0.1 million reduction in other income from increased mortgage servicing rights amortization.

#### Operating expenses

For the quarter ended March 31, 2021, total non-interest operating expenses were $11.5 million, an increase of $4.2 million, or 57%, compared to $7.3 million for the same 2020 quarter. Salary and employee benefits rose $2.0 million, or 50%, to $5.9 million for the first quarter of 2021 from $3.9 million for the first quarter of 2020. The increase was primarily due to salaries and benefits from additional employees resulting from the merger. Premises and equipment expenses increased $0.5 million, or 47%, primarily due to property and equipment acquired from the merger. Professional fees increased $0.5 million due to expenses related to the pandemic, higher legal and audit expenses, and expenses after the merger with MNB. Advertising and marketing expense increased $0.5 million due to additional donations and more advertising. The Company incurred a $0.4 million FHLB prepayment penalty during the three months ended March 31, 2021. Merger-related expenses during the first quarter of 2021 were $0.3 million higher than in the first quarter of 2020 due to the timing of the pending merger. Data processing and communications expenses and the FDIC assessment also both increased $0.1 million. Partially offsetting these increases was a $0.3 million reduction in other expenses due to higher loan origination cost deferrals from PPP lending and mortgage activity.

The ratios of non-interest expense less non-interest income to average assets, known as the expense ratio, were 1.35% and 1.79% for the three months ended March 31, 2021 and 2020. The expense ratio decreased because of increased levels of average assets. The efficiency ratio (non-GAAP) decreased from 66.69% at March 31, 2020 to 59.11% at March 31, 2021 due to revenue increasing faster than expenses. For more information on the calculation of the efficiency ratio, see “Non-GAAP Financial Measures” located within this management’s discussion and analysis.

Merger related expenses expected to be incurred by the Company of $3.2 million are anticipated over the remainder of 2021 for legal, investment banking, audit, data processing, regulatory filings, shareholder conversion and severance costs for the pending merger with Landmark Bancorp, Inc.

#### Provision for income taxes

The provision for income taxes increased $0.5 million for the three months ended March 31, 2021 compared to the same 2020 period due to higher pre-tax income. The Company's effective tax rate was 15.5% at March 31, 2021 compared to 16.6% at March 31, 2020. The difference between the effective rate and the enacted statutory corporate rate of 21% is due mostly to the effect of tax-exempt income in relation to the level of pre-tax income. The decrease in the effective tax rate was primarily due to higher tax-exempt interest income. Due to challenges relating to current market conditions, the Company may not have the ability to make a reliable estimate of all or part of its ordinary income. If the federal corporate tax rate is increased, the Company’s net deferred tax liabilities will be re-valued upon adoption of the new tax rate. A federal tax rate increase will increase net deferred tax liabilities with a corresponding increase to provision for income taxes.

### Comparison of financial condition at

### March 31, 2021 and December 31, 2020

#### Overview

Consolidated assets increased $213.6 million, or 13%, to $1.9 billion as of March 31, 2021 from $1.7 billion as of December 31, 2020. The increase in assets occurred primarily in cash and cash equivalents and the investment portfolio primarily from growth in deposits. As explained in greater detail below, growth in deposits occurred because of seasonal tax cycles, PPP loan proceeds, business activity, government relief due to the pandemic and increases in personal account balances. Cash inflow from growth in deposits of $213.4 million was used to purchase investment securities and pay down borrowings.

### Funds Deployed:

#### Investment securities

At the time of purchase, management classifies investment securities into one of three categories: trading, available-for-sale (AFS) or held-to-maturity (HTM). To date, management has not purchased any securities for trading purposes. All of the securities the Company purchases are classified as AFS even though there is no immediate intent to sell them. The AFS designation affords management the flexibility to sell securities and position the balance sheet in response to capital levels, liquidity needs or changes in market conditions. Debt securities AFS are carried at fair value on the consolidated balance sheets with unrealized gains and losses, net of deferred income taxes, reported separately within shareholders’ equity as a component of accumulated other comprehensive income (AOCI). Securities designated as HTM are carried at amortized cost and represent debt securities that the Company has the ability and intent to hold until maturity.

As of March 31, 2021, the carrying value of investment securities amounted to $436.6 million, or 23% of total assets, compared to $392.4 million, or 23% of total assets, at December 31, 2020. As of March 31, 2021, 35% of the carrying value of the investment portfolio was comprised of U.S. Government Sponsored Enterprise residential mortgage-backed securities (MBS – GSE residential or mortgage-backed securities) that amortize and provide monthly cash flow that the Company can use for reinvestment, loan demand, unexpected deposit outflow, facility expansion or operations.

Investment securities were comprised of AFS securities as of March 31, 2021 and December 31, 2020. The AFS securities were recorded with a net unrealized gain of $1.5 million as of March 31, 2021 and a net unrealized gain of $11.3 million as of December 31, 2020. Of the net decline in the unrealized gain position of $9.8 million, $5.6 million was attributable to municipal securities, $2.0 million was attributable to mortgage-backed securities and $2.2 million was attributable to agency securities. The direction and magnitude of the change in value of the Company’s investment portfolio is attributable to the direction and magnitude of the change in interest rates along the treasury yield curve. Generally, the values of debt securities move in the opposite direction of the changes in interest rates. As interest rates along the treasury yield curve rise, especially at the intermediate and long end, the values of debt securities tend to decline. Whether or not the value of the Company’s investment portfolio will continue to change above or below its amortized cost will be largely dependent on the direction and magnitude of interest rate movements and the duration of the debt securities within the Company’s investment portfolio. Management does not consider the reduction in value attributable to changes in credit quality. Correspondingly, when interest rates decline, the market values of the Company’s debt securities portfolio could be subject to market value increases.

As of March 31, 2021, the Company had $331.2 million in public deposits, or 19% of total deposits. Pennsylvania state law requires the Company to maintain pledged securities on these public deposits or otherwise obtain a FHLB letter of credit or FDIC insurance for these customers. As of March 31, 2021, the balance of pledged securities required for deposit accounts was $341.2 million, or 78% of total securities.

Quarterly, management performs a review of the investment portfolio to determine the causes of declines in the fair value of each security. The Company uses inputs provided by independent third parties to determine the fair value of its investment securities portfolio. Inputs provided by the third parties are reviewed and corroborated by management. Evaluations of the causes of the unrealized losses are performed to determine whether impairment exists and whether the impairment is temporary or other-than-temporary. Considerations such as the Company’s intent and ability to hold the securities until or sell prior to maturity, recoverability of the invested amounts over the intended holding period, the length of time and the severity in pricing decline below cost, the interest rate environment, the receipt of amounts contractually due and whether or not there is an active market for the securities, for example, are applied, along with an analysis of the financial condition of the issuer for management to make a realistic judgment of the probability that the Company will be unable to collect all amounts (principal and interest) due in determining whether a security is other-than-temporarily impaired. If a decline in value is deemed to be other-than-temporary, the amortized cost of the security is reduced by the credit impairment amount and a corresponding charge to current earnings is recognized. During the quarter ended March 31, 2021, the Company did not incur other-than-temporary impairment charges from its investment securities portfolio.

During the three months ended March 31, 2021, the carrying value of total investments increased $44.2 million, or 11%. The Company attempts to maintain a well-diversified and proportionate investment portfolio that is structured to complement the strategic direction of the Company. Its growth typically supplements the lending activities but also considers the current and forecasted economic conditions, the Company’s liquidity needs and interest rate risk profile.

A comparison of investment securities at March 31, 2021 and December 31, 2020 is as follows:

*(dollars in thousands)*

|  | March 31, 2021 Amount% |  | December 31, 2020 Amount% |  |
| --- | ---: | ---: | ---: | ---: |
| MBS - GSE residential | **$151,611** | **34.7%** | $147,260 | 37.5% |
| State & municipal subdivisions | **228,161** | **52.3** | 199,713 | 50.9 |
| Agency - GSE | **56,850** | **13.0** | 45,447 | 11.6 |
| Total | **$436,622** | **100.0%** | $392,420 | 100.0% |

45

As of March 31, 2021, there were no investments from any one issuer with an aggregate book value that exceeded 10% of the Company’s shareholders’ equity.

The distribution of debt securities by stated maturity and tax-equivalent yield at March 31, 2021 are as follows:

*(dollars in thousands)*

|  | One year or less $% |  | More than one year to five years $% |  | More than five years to ten years $% |  | More than ten years $% |  | Total $% |  |
| --- | ---: | ---: | ---: | ---: | ---: | ---: | ---: | ---: | ---: | ---: |
| MBS - GSE residential | $- | -% | $172 | 4.16% | $5,011 | 3.44% | $146,428 | 2.59% | $151,611 | 2.62% |
| State & municipal subdivisions | 1,007 | 6.02 | - | - | 24,063 | 1.69 | 203,091 | 3.47 | 228,161 | 3.29 |
| Agency - GSE | - | - | 6,298 | 2.70 | 46,535 | 1.17 | 4,017 | 1.55 | 56,850 | 1.35 |
| Total debt securities | $1,007 | 6.02% | $6,470 | 2.73% | $75,609 | 1.48% | $353,536 | 3.08% | $436,622 | 2.80% |

In the above table, the book yields on state & municipal subdivisions were adjusted to a tax-equivalent basis using the corporate federal tax rate of 21%. In addition, average yields on securities AFS are based on amortized cost and do not reflect unrealized gains or losses.

#### Restricted investments in bank stock

Investment in Federal Home Loan Bank (FHLB) stock is required for membership in the organization and is carried at cost since there is no market value available. The amount the Company is required to invest is dependent upon the relative size of outstanding borrowings the Company has with the FHLB of Pittsburgh. Excess stock is repurchased from the Company at par if the amount of borrowings decline to a predetermined level. In addition, the Company earns a return or dividend based on the amount invested. Atlantic Community Bankers Bank (ACBB) stock totaling $45 thousand was acquired from the merger with MNB in 2020. The dividends received from the FHLB totaled $35 thousand and $70 thousand for the three months ended March 31, 2021 and 2020, respectively. The balance in FHLB and ACBB stock was $2.9 million and $2.8 million as of March 31, 2021 and December 31, 2020, respectively.

#### Loans held-for-sale (HFS)

Upon origination, most residential mortgages and certain Small Business Administration (SBA) guaranteed loans may be classified as held-for-sale (HFS). In the event of market rate increases, fixed-rate loans and loans not immediately scheduled to re-price would no longer produce yields consistent with the current market. In declining interest rate environments, the Company would be exposed to prepayment risk as rates on fixed-rate loans decrease, and customers look to refinance loans. Consideration is given to the Company’s current liquidity position and projected future liquidity needs. To better manage prepayment and interest rate risk, loans that meet these conditions may be classified as HFS. Occasionally, residential mortgage and/or other nonmortgage loans may be transferred from the loan portfolio to HFS. The carrying value of loans HFS is based on the lower of cost or estimated fair value. If the fair values of these loans decline below their original cost, the difference is written down and charged to current earnings. Subsequent appreciation in the portfolio is credited to current earnings but only to the extent of previous write-downs.

As of March 31, 2021 and December 31, 2020, loans HFS consisted of residential mortgages with carrying amounts of $11.0 million and $29.8 million, respectively, which approximated their fair values. During the three months ended March 31, 2021, residential mortgage loans with principal balances of $80.7 million were sold into the secondary market and the Company recognized net gains of $2.3 million, compared to $12.9 million and $0.2 million, respectively, during the three months ended March 31, 2020.

The Company retains mortgage servicing rights (MSRs) on loans sold into the secondary market. MSRs are retained so that the Company can foster personal relationships. At March 31, 2021 and December 31, 2020, the servicing portfolio balance of sold residential mortgage loans was $420.5 million and $366.5 million, respectively, with mortgage servicing rights of $1.8 million and $1.3 million for the same periods, respectively.

#### Loans and leases

As of March 31, 2021, the Company had gross loans and leases, including Company-originated loans, MNB-acquired loans, and PPP loans, totaling $1.14 billion compared to $1.12 billion at December 31, 2020, an increase of $22 million, or 2%.

The increase resulted primarily from $15 million growth in PPP loans, net of deferred fees, that occurred during the quarter. The increase in PPP loans was the result of $71 million in second round PPP loans originated, net of deferred fees, partially offset by $56 million in SBA forgiveness and customer loan payments received from PPP loans originated in 2020, net of deferred fees, during the first quarter of 2021.

As of March 31, 2021, Company-originated loans, excluding the PPP loans and MNB-acquired loans, totaled $801 million compared with $781 million as of December 31, 2020, an increase of $20 million, or 3%, with growth primarily attributed to the commercial real estate portfolio, resulting from the origination of several large commercial real estate loans during the quarter.

The composition of the loan portfolio at March 31, 2021 and December 31, 2020 is summarized as follows:

*(dollars in thousands)*

|  | March 31, 2021 Amount% |  | December 31, 2020 Amount% |  |
| --- | ---: | ---: | ---: | ---: |
| Commercial and industrial | **$295,595** | **25.8%** | $280,757 | 25.0% |
| Commercial real estate: |  |  |  |  |
| Non-owner occupied | **202,500** | **17.7** | 192,143 | 17.1 |
| Owner occupied | **179,932** | **15.7** | 179,923 | 16.1 |
| Construction | **11,721** | **1.0** | 10,231 | 0.9 |
| Consumer: |  |  |  |  |
| Home equity installment | **38,425** | **3.4** | 40,147 | 3.6 |
| Home equity line of credit | **47,675** | **4.2** | 49,725 | 4.4 |
| Auto | **96,841** | **8.5** | 98,386 | 8.8 |
| Direct finance leases | **20,421** | **1.8** | 20,095 | 1.8 |
| Other | **6,098** | **0.5** | 7,602 | 0.7 |
| Residential: |  |  |  |  |
| Real estate | **221,766** | **19.4** | 218,445 | 19.5 |
| Construction | **22,340** | **2.0** | 23,357 | 2.1 |
| Gross loans | **1,143,314** | **100.0%** | 1,120,811 | 100.0% |
| Less: |  |  |  |  |
| Allowance for loan losses | **(14,839)** |  | (14,202) |  |
| Unearned lease revenue | **(1,155)** |  | (1,159) |  |
| Net loans | **$1,127,320** |  | $1,105,450 |  |
| Loans held-for-sale | **$11,001** |  | $29,786 |  |

### Commercial & industrial and commercial real estate

As of March 31, 2021, the commercial loan portfolio grew by $27 million to $690 million over the December 31, 2020 balance of $663 million, a 4% increase for the quarter. First quarter growth was attributed to $15 million net growth in PPP loans and $12 million in commercial real estate (CRE) loans from new relationships in the Lehigh Valley.

The commercial loan portfolio consisted of $536 million company-originated loans, including $145 million in PPP loans, and $154 million in loans acquired from MNB.

#### Paycheck Protection Program Loans

The Coronavirus Aid, Relief, and Economic Security Act, or CARES Act, was signed into law on March 27, 2020, and provided over $2.0 trillion in emergency economic relief to individuals and businesses impacted by the COVID-19 pandemic. The CARES Act authorized the Small Business Administration (SBA) to temporarily guarantee loans under a new 7(a) loan program called the Paycheck Protection Program (“PPP”).

As a qualified SBA lender, the Company was automatically authorized to originate PPP loans, and during the second and third quarter of 2020, the Company originated 1,551 loans totaling $159 million under the Paycheck Protection Program.

Under the PPP, the entire principal amount of the borrower’s loan, including any accrued interest, is eligible to be reduced by the loan forgiveness amount, so long as the employer maintains or quickly rehires employees and maintains salary levels and 60% of the loan proceeds are used for payroll expenses, with the remaining 40% of the loan proceeds used for other qualifying expenses.

Beginning in the fourth quarter of 2020 and continuing during the first quarter of 2021 and subsequent period up to the filing date, the Company submitted PPP forgiveness applications totaling $159 million to the SBA and received approval for $84 million with $75 million awaiting approval as of March 31, 2021.

As part of the Economic Relief Act, which became law on December 27, 2020, an additional $284 billion was allocated to a reauthorized and revised PPP. On January 19, 2021, the Company began processing and originating PPP loans for this second round, and as of March 31, 2021, the Company originated 895 loans totaling $74 million.

As a PPP lender, the Company expects to recognize fee income of approximately $9.6 million with $5.1 million recognized to date, including $3.3 million of PPP fee income recognized during 2020 and $1.8 million recognized during the first quarter of 2021. Unearned fees attributed to PPP loans, net of $0.2 million in fees paid to referral sources as prescribed by the SBA under the PPP, were $4.3 million as of March 31, 2021.

The PPP loans originated by size were as follows as of March 31, 2021:

*(dollars in thousands)*

|  | Balance originated | Current balance | Total SBA fee | SBA fee recognized |
| --- | ---: | ---: | ---: | ---: |
| $150,000 or less | **$74,018** | **$41,976** | **$4,553** | **$2,145** |
| Greater than $150,000 but less than $2,000,000 | **127,541** | **75,449** | **4,745** | **2,709** |
| $2,000,000 or higher | **31,656** | **31,656** | **316** | **193** |
| Total PPP loans originated | **$233,215** | **$149,081** | **$9,614** | **$5,047** |

### Consumer

As of March 31, 2021, the consumer loan portfolio decreased by $6 million to $210 million over the December 31, 2020 balance of $216 million, a 3% decrease for the quarter. The first quarter decrease was attributed to pay downs in debt resulting from the availability of COVID-related government stimulus, mortgage refinancing paying off home equity loans and less demand for home equity products.

The consumer loan portfolio consisted of home equity installment, home equity line of credit, auto, direct finance leases and other consumer loans.

### Residential

As of March 31, 2021, the residential loan portfolio increased by $2 million to $244 million over the December 31, 2020 balance of $242 million, a 1% increase for the quarter. With most of the mortgage origination activity conforming and sold in the secondary market, mortgages held-for-investment grew 1%.

The residential loan portfolio consisted primarily of held-for-investment residential loans for primary residences. Company-originated loans totaled $210 million and acquired loans from MNB totaled $34 million as of March 31. 2021 compared to Company-originated loans of $203 million and acquired loans of $38 million as of December 31, 2020.

The Company’s service team is experienced, knowledgeable, and dedicated to servicing the community and its clients. The Company will continue to provide products and services that benefit our clients as well as the community which is very important to our success. There is much uncertainty regarding the effects COVID-19 may have on demand for loans and leases. The Company has been proactively trying to reach out to customers to understand their needs during this crisis.

#### Allowance for loan losses

Management evaluates the credit quality of the Company’s loan portfolio and performs a formal review of the adequacy of the allowance for loan losses (allowance) on a quarterly basis. The allowance reflects management’s best estimate of the amount of credit losses in the loan portfolio. Management’s judgment is based on the evaluation of individual loans, experience, the assessment of current economic conditions and other relevant factors including the amounts and timing of cash flows expected to be received on impaired loans. Those estimates may be susceptible to significant change. The provision for loan losses represents the amount necessary to maintain an appropriate allowance. Loan losses are charged directly against the allowance when loans are deemed to be uncollectible. Recoveries from previously charged-off loans are added to the allowance when received.

Management applies two primary components during the loan review process to determine proper allowance levels. The two components are a specific loan loss allocation for loans that are deemed impaired and a general loan loss allocation for those loans not specifically allocated. The methodology to analyze the adequacy of the allowance for loan losses is as follows:

identification of specific impaired loans by loan category;

calculation of specific allowances where required for the impaired loans based on collateral and other objective and quantifiable evidence;

determination of loans with similar credit characteristics within each class of the loan portfolio segment and eliminating the impaired loans;

application of historical loss percentages (trailing twelve-quarter average) to pools to determine the allowance allocation;

application of qualitative factor adjustment percentages to historical losses for trends or changes in the loan portfolio, regulations, and/or current economic conditions.

A key element of the methodology to determine the allowance is the Company’s credit risk evaluation process, which includes credit risk grading of individual commercial loans. Commercial loans are assigned credit risk grades based on the Company’s assessment of conditions that affect the borrower’s ability to meet its contractual obligations under the loan agreement. That process includes reviewing borrowers’ current financial information, historical payment experience, credit documentation, public information and other information specific to each individual borrower. Upon review, the commercial loan credit risk grade is revised or reaffirmed. The credit risk grades may be changed at any time management determines an upgrade or downgrade may be warranted. The credit risk grades for the commercial loan portfolio are considered in the reserve methodology and loss factors are applied based upon the credit risk grades. The loss factors applied are based upon the Company’s historical experience as well as what management believes to be best practices and within common industry standards. Historical experience reveals there is a direct correlation between the credit risk grades and loan charge-offs. The changes in allocations in the commercial loan portfolio from period-to-period are based upon the credit risk grading system and from periodic reviews of the loan portfolio.

Acquired loans are initially recorded at their acquisition date fair values with no carryover of the existing related allowance for loan losses. Fair values are based on a discounted cash flow methodology that involves assumptions and judgements as to credit risk, expected lifetime losses, environmental factors, collateral values, discount rates, expected payments and expected prepayments. Upon acquisition, in accordance with GAAP, the Company has individually determined whether each acquired loan is within the scope of ASC 310-30. These loans are deemed purchased credit impaired loans and the excess of cash flows expected at acquisition over the estimated fair value is referred to as the accretable discount and is recognized into interest income over the remaining life of the loan. The difference between contractually required payments at acquisition and the cash flows expected to be collected at acquisition is referred to as the non accretable discount.

Acquired ASC 310-20 loans, which are loans that did not meet the criteria of ASC 310-30, were pooled into groups of similar loans based on various factors including borrower type, loan purpose, and collateral type. These loans are initially recorded at fair value and include credit and interest rate marks associated with purchase accounting adjustments. Purchase premiums or discounts are subsequently amortized as an adjustment to yield over the estimated contractual lives of the loans. There is no allowance for loan losses established at the acquisition date for acquired performing loans. An allowance for loan losses is recorded for any credit deterioration in these loans after acquisition. As of March 31, 2021, no allowance was recorded for credit deterioration in acquired loans.

Each quarter, management performs an assessment of the allowance for loan losses. The Company’s Special Assets Committee meets quarterly, and the applicable lenders discuss each relationship under review and reach a consensus on the appropriate estimated loss amount, if applicable, based on current accounting guidance. The Special Assets Committee’s focus is on ensuring the pertinent facts are considered regarding not only loans considered for specific reserves, but also the collectability of loans that may be past due. The assessment process also includes the review of all loans on non-accrual status as well as a review of certain loans to which the lenders or the Credit Administration function have assigned a criticized or classified risk rating.

The following tables set forth the activity in the allowance for loan losses and certain key ratios for the period indicated:

*(dollars in thousands)*

|  | As of and for the three months ended March 31, 2021 | As of and for the twelve months ended December 31, 2020 | As of and for the three months ended March 31, 2020 |
| --- | ---: | ---: | ---: |
| Balance at beginning of period | **$14,202** | $9,747 | $9,747 |
| Charge-offs: |  |  |  |
| Commercial and industrial | **(7)** | (372) | (64) |
| Commercial real estate | **(124)** | (465) | (163) |
| Consumer | **(28)** | (296) | (43) |
| Residential | **(43)** | (35) | (31) |
| Total | **(202)** | (1,168) | (301) |
| Recoveries: |  |  |  |
| Commercial and industrial | **4** | 26 | 12 |
| Commercial real estate | **11** | 30 | 2 |
| Consumer | **24** | 120 | 64 |
| Residential | **-** | 197 | 193 |
| Total | **39** | 373 | 271 |
| Net charge-offs | **(163)** | (795) | (30) |
| Provision for loan losses | **800** | 5,250 | 300 |
| Balance at end of period | **$14,839** | $14,202 | $10,017 |
| Allowance for loan losses to total loans | **1.30%** | 1.27% | 1.34% |
| Net charge-offs to average total loans outstanding | **0.06%** | 0.08% | 0.02% |
| Average total loans | **$1,162,112** | $1,019,373 | $756,208 |
| Loans 30 - 89 days past due and accruing | **$912** | $1,598 | $8,308 |
| Loans 90 days or more past due and accruing | **$59** | $61 | $- |
| Non-accrual loans | **$3,929** | $3,769 | $3,654 |
| Allowance for loan losses to non-accrual loans | **3.78** **x** | 3.77 x | 2.74 x |
| Allowance for loan losses to non-performing loans | **3.72** **x** | 3.71 x | 2.74 x |

49

For the three months ended March 31, 2021, the allowance increased $0.6 million, or 4%, to $14.8 million from $14.2 million at December 31, 2020 due to provisioning of $0.8 million partially offset by $0.2 million in net charge-offs. The allowance for loan and lease losses increased slightly as a percentage of total loans to 1.30% from 1.27% at December 31, 2020 as the loan portfolio increased by 2% while the allowance for loan losses increased by 4% during the same period.

Loans acquired from the MNB merger (performing and non-performing) were initially recorded at their acquisition-date fair values. Because there is no initial credit valuation allowance recorded under this method, the Company establishes a post-acquisition allowance of loan losses to record losses which may subsequently arise on the acquired loans. Since no deterioration was noted for any such loans following acquisition, no allowance for loan and lease losses was provided at this time.

PPP loans made to eligible borrowers have a 100% SBA guarantee. Given this guarantee, no allowance for loan and lease losses was recorded for these loans.

Management believes that the current balance in the allowance for loan losses is sufficient to meet the identified potential credit quality issues that may arise and other issues unidentified but inherent to the portfolio. Potential problem loans are those where there is known information that leads management to believe repayment of principal and/or interest is in jeopardy and the loans are currently neither on non-accrual status nor past due 90 days or more.

During the first quarter of 2021, management increased the qualitative factors associated with its commercial, consumer, and residential portfolios related to the rise in rates that occurred during the quarter, and the adverse impact that these increased rates are anticipated to have on estimated credit losses.

Management will continue to monitor the potential for increased risk exposure due to the adverse economic impact of a prolonged COVID-19 pandemic. Should the duration and/or severity of the pandemic’s economic impact increase, management will take measures commensurate with the then observed risk to increase the provision for loan losses and, by extension, the allowance for loan and lease losses as appropriate.

The allocation of net charge-offs among major categories of loans are as follows for the periods indicated:

*(dollars in thousands)*

| Net charge-offs | For the three months ended March 31, 2021 | % of Total Net Charge-offs | For the three months ended March 31, 2020 | % of Total Net Charge-offs |
| --- | ---: | ---: | ---: | ---: |
| Commercial and industrial | **$(3)** | **2%** | $(52) | 173% |
| Commercial real estate | **(113)** | **69** | (161) | 537 |
| Consumer | **(4)** | **3** | 21 | (70) |
| Residential | **(43)** | **26** | 162 | (540) |
| Total net charge-offs | $(163) | **100%** | $(30) | 100% |

For the three months ended March 31, 2021, net charge-offs against the allowance totaled $163 thousand compared with net charge-offs of $30 thousand for the three months ended March 31, 2020, representing a $133 thousand increase. The increase was attributed to a $192 thousand one-time recovery during the first quarter of 2020 in the form of a reimbursement from the Federal National Mortgage Association (“FNMA”) for previously sold mortgages that were charged-off. Excluding the one-time FNMA recovery in 2020, net charge-offs for the three months ended March 31, 2021 would have shown an improvement, decreasing by $59 thousand, or 36%, compared to the prior period.

For a discussion on the provision for loan losses, see the “Provision for loan losses,” located in the results of operations section of management’s discussion and analysis contained herein.

The allowance for loan losses can generally absorb losses throughout the loan portfolio. However, in some instances an allocation is made for specific loans or groups of loans. Allocation of the allowance for loan losses for different categories of loans is based on the methodology used by the Company, as previously explained. The changes in the allocations from period-to-period are based upon quarter-end reviews of the loan portfolio.

Allocation of the allowance among major categories of loans for the periods indicated, as well as the percentage of loans in each category to total loans, is summarized in the following table. This table should not be interpreted as an indication that charge-offs in future periods will occur in these amounts or proportions, or that the allocation indicates future charge-off trends. When present, the portion of the allowance designated as unallocated is within the Company’s guidelines:

*(dollars in thousands)*

| Category | March 31, 2021 Allowance | Category % of Loans | December 31, 2020 Allowance | Category % of Loans | March 31, 2020 Allowance | Category % of Loans |
| --- | ---: | ---: | ---: | ---: | ---: | ---: |
| Commercial real estate | **$7,080** | **35%** | $6,383 | 34% | $3,943 | 30% |
| Commercial and industrial | **2,342** | **26** | 2,407 | 25 | 1,553 | 16 |
| Consumer | **2,415** | **18** | 2,552 | 19 | 2,094 | 28 |
| Residential real estate | **2,915** | **21** | 2,781 | 22 | 2,393 | 26 |
| Unallocated | **87** | **-** | 79 | - | 34 | - |
| Total | **$14,839** | **100%** | $14,202 | 100% | $10,017 | 100% |

The allocation of the allowance for the commercial loan portfolio, which is comprised of CRE and C&I loans, accounted for approximately 63% of the total allowance for loan losses at March 31, 2021, which represents a one percentage point increase from 62% of the total allowance for loan losses at December 31, 2020 and a eight percentage point increase from the 55% of the total allowance for loan and lease losses at March 31, 2020.

The increase in the allowance allocated to the commercial portfolio was attributed to the recognition of increased inherent risk due to the economic impact of the COVID-19 pandemic.

The allocation of the allowance for the consumer loan portfolio, accounted for approximately 16% of the total allowance for loan losses at March 31, 2021, which represents a two percentage point decrease from 18% of the total allowance for loan losses at December 31, 2020 and a five percentage point decrease from 21% of the total allowance for loan losses at March 31, 2020.

The decrease in the allowance allocated to the consumer loan portfolio was attributed to the relative decrease in the percentage of consumer loans in the portfolio.

The allocation of the allowance for the residential real estate portfolio, accounted for approximately 20% of the total allowance for loan losses at March 31, 2021 unchanged from 20% of the total allowance for loan losses at December 31, 2020 and a four percentage point decrease from 24% of the total allowance for loan losses at March 31, 2020.

The year-over-year decrease in the allowance allocated to the residential real estate portfolio was attributed to the relative decrease in the percentage of residential loans in the portfolio.

The unallocated amount represents the portion of the allowance not specifically identified with a loan or groups of loans. The unallocated reserve was less than 1% of the total allowance for loan losses at March 31, 2021, unchanged from less than 1% of the total allowance for loan losses at December 31, 2020 and March 31, 2020.

#### Non-performing assets

The Company defines non-performing assets as accruing loans past due 90 days or more, non-accrual loans, troubled debt restructurings (TDRs), other real estate owned (ORE) and repossessed assets.

The following table sets forth non-performing assets data as of the period indicated:

*(dollars in thousands)*

|  | March 31, 2021 | December 31, 2020 | March 31, 2020 |
| --- | ---: | ---: | ---: |
| Loans past due 90 days or more and accruing | **$59** | $61 | $- |
| Non-accrual loans \* | **3,929** | 3,769 | 3,654 |
| Total non-performing loans | **3,988** | 3,830 | 3,654 |
| Troubled debt restructurings | **2,489** | 2,571 | 988 |
| Other real estate owned and repossessed assets | **413** | 256 | 116 |
| Total non-performing assets | **$6,890** | $6,657 | $4,758 |
| Total loans, including loans held-for-sale | **$1,153,160** | $1,149,438 | $746,715 |
| Total assets | **$1,913,092** | $1,699,510 | $1,062,495 |
| Non-accrual loans to total loans | **0.34%** | 0.33% | 0.49% |
| Non-performing loans to total loans | **0.35%** | 0.33% | 0.49% |
| Non-performing assets to total assets | **0.36%** | 0.39% | 0.45% |

\* In the table above, the amount includes non-accrual TDRs of $0.7 million as of March 31, 2021, $0.7 million as of December 31, 2020 and $0.6 million as of March 31, 2020.

In the review of loans for both delinquency and collateral sufficiency, management concluded that there were several loans that lacked the ability to repay in accordance with contractual terms. The decision to place loans on non-accrual status is made on an individual basis after considering factors pertaining to each specific loan. Generally, commercial loans are placed on non-accrual status when management has determined that payment of all contractual principal and interest is in doubt or the loan is past due 90 days or more as to principal and interest, unless well-secured and in the process of collection. Consumer loans secured by residential real estate and residential mortgage loans are placed on non-accrual status at 90 days past due as to principal and interest, and unsecured consumer loans are charged-off when the loan is 90 days or more past due as to principal and interest. Uncollected interest income accrued on all loans placed on non-accrual is reversed and charged to interest income.

Non-performing assets represented 0.36% of total assets at March 31, 2021 compared with 0.39% at December 31, 2020 and 0.45% at March 31, 2020. The year-to-date improvement in the non-performing assets ratio was the result of the $214 million, or 13%, increase in total assets to $1.9 billion at March 31, 2021 outpacing the $0.2 million, or 4%, increase in non-performing assets, and the year-over-year improvement in the non-performing assets ratio was the result of the $851 million, or 80%, increase in total assets outpacing the $2.1 million, or 45%, increase in non-performing assets.

For the three months ended March 31, 2021, non-performing assets increased to $6.9 million from $6.7 million at December 31, 2020. The $0.2 million increase resulted from a $0.1 million increase in non-accrual loans and a $0.1 million increase in other real estate owned and repossessed assets.

From December 31, 2020 to March 31, 2021, non-accrual loans increased $0.1 million, or 4%, from $3.8 million to $3.9 million. The $0.1 million increase in non-accrual loans was the result of $0.6 million in new non-accruals, offset by $0.3 million in payments and $0.1 million in charge-offs. At March 31, 2021, there were a total of 40 loans to 34 unrelated borrowers with balances that ranged from less than $1 thousand to $0.5 million. At December 31, 2020, there were a total of 46 loans to 38 unrelated borrowers with balances that ranged from less than $1 thousand to $0.5 million.

There was one direct finance lease totaling $27 thousand and two auto loans totaling $32 thousand that were over 90 days past due as of March 31, 2021 compared to two direct finance leases totaling $61 thousand that were over 90 days past due as of December 31, 2020. The Company seeks payments from all past due customers through an aggressive customer communication process. A past due loan will be placed on non-accrual at the 90-day point when it is deemed that a customer is non-responsive and uncooperative to collection efforts.

The composition of non-performing loans as of March 31, 2021 is as follows:

*(dollars in thousands)*

|  | Gross loan balances | Past due 90 days or more and still accruing | Non- accrual loans | Total non- performing loans | % of gross loans |
| --- | ---: | ---: | ---: | ---: | ---: |
| Commercial and industrial | **$295,595** | **$-** | **$507** | **$507** | **0.17%** |
| Commercial real estate: |  |  |  |  |  |
| Non-owner occupied | **202,500** | **-** | **821** | **821** | **0.41%** |
| Owner occupied | **179,932** | **-** | **1,560** | **1,560** | **0.87%** |
| Construction | **11,721** | **-** | **-** | **-** | **-** |
| Consumer: |  |  |  |  |  |
| Home equity installment | **38,425** | **-** | **26** | **26** | **0.07%** |
| Home equity line of credit | **47,675** | **-** | **287** | **287** | **0.60%** |
| Auto loans | **96,841** | **32** | **14** | **46** | **0.05%** |
| Direct finance leases \* | **19,266** | **27** | **-** | **27** | **0.14%** |
| Other | **6,098** | **-** | **-** | **-** | **-** |
| Residential: |  |  |  |  |  |
| Real estate | **221,766** | **-** | **714** | **714** | **0.32%** |
| Construction | **22,340** | **-** | **-** | **-** | **-** |
| Loans held-for-sale | **11,001** | **-** | **-** | **-** | **-** |
| Total | **$1,153,160** | **$59** | **$3,929** | **$3,988** | **0.35%** |

\*Net of unearned lease revenue of $1.2 million.

Payments received from non-accrual loans are recognized on a cost recovery method. Payments are first applied to the outstanding principal balance, then to the recovery of any charged-off loan amounts. Any excess is treated as a recovery of interest income. If the non-accrual loans that were outstanding as of March 31, 2021 had been performing in accordance with their original terms, the Company would have recognized interest income with respect to such loans of $78 thousand.

The following tables set forth the activity in TDRs for the periods indicated:

*(dollars in thousands)*

| As of and for the three months ended March 31, 2021 Troubled Debt Restructures: | Accruing Commercial real estate | Non-accruing Commercial real estate | Commercial & industrial | Total |
| --- | ---: | ---: | ---: | ---: |
| Beginning balance | **$2,571** | **$456** | **$206** | **$3,233** |
| Additions | **2** | **-** | **-** | **2** |
| Pay downs / payoffs | **(84)** | **(1)** | **(6)** | **(91)** |
| Ending balance | **$2,489** | **$455** | **$200** | **$3,144** |
| Number of loans | **7** | **1** | **2** | **10** |

*(dollars in thousands)*

| As of and for the year ended December 31, 2020 Troubled Debt Restructures: | Accruing Commercial real estate | Non-accruing Commercial real estate | Commercial & industrial | Total |
| --- | ---: | ---: | ---: | ---: |
| Beginning balance | $991 | $561 | $- | $1,552 |
| Additions | 1,600 | 2 | 206 | 1,808 |
| Pay downs / payoffs | (20) | (8) | - | (28) |
| Charge offs | - | (99) | - | (99) |
| Ending balance | $2,571 | $456 | $206 | $3,233 |
| Number of loans | 8 | 2 | 2 | 12 |

The Company, on a regular basis, reviews changes to loans to determine if they meet the definition of a TDR. TDRs arise when a borrower experiences financial difficulty and the Company grants a concession that it would not otherwise grant based on current underwriting standards in order to maximize the Company’s recovery.

Consistent with Section 4013 and the Revised Statement of Section 4013 of the CARES Act, specifically “Temporary Relief From Troubled Debt Restructurings”, the Company approved requests by borrowers to modify loan terms and defer principal and/or interest payment for loans. U.S. GAAP permits the temporary suspension of TDR determination defined under ASC 310-40 provided that such modifications are made on a good faith basis in response to COVID-19 to borrowers who were current prior to any relief. This includes short-term (i.e. six months) modifications such as payment deferrals, fee waivers, extensions of repayment terms, or delays in payment that are insignificant. Borrowers considered current for purposes of Section 4013 are those that are less than 30 days past due on their contractual payments at the time the modification program is implemented.

From December 31, 2020 to March 31, 2021, TDRs decreased $0.1 million, or 3%, primarily due to the payoff of a $0.1 million accruing commercial real estate TDR. At December 31, 2020, there were a total of 12 TDRs by 9 unrelated borrowers with balances that ranged from $1 thousand to $1.3 million, and at March 31, 2021, there were a total of 10 TDRs by 7 unrelated borrowers with balances that ranged from $91 thousand to $1.3 million.

Loans modified in a TDR may or may not be placed on non-accrual status. At March 31, 2021, there were three TDRs totaling $0.7 million that were on non-accrual status compared to four TDRs totaling $0.7 million at December 31, 2020.

Beginning the week of March 16, 2020, the Company began receiving requests for temporary modifications to the repayment structure for borrower loans. Modification terms included interest only or full payment deferral for up to 6 months. As of March 31, 2021, the Company had 5 temporary modifications with principal balances totaling $0.7 million outstanding, which included 3 additional deferral requests for temporary forbearance modifications totaling $0.3 million and 2 first requests for temporary forbearance modifications totaling $0.2 million.

Details with respect to the actual loan modifications are as follows:

| Types of Loans | Number of Loans | Deferral Period | Balance | Percentage of Tier 1 Capital |
| --- | ---: | --- | ---: | ---: |
| Commercial Purpose | **5** | **Up to 6 months** | **$717** | **0.5%** |

The following table provides information with respect to the Company’s commercial COVID-19 accommodations by sector at March 31, 2021.

*(dollars in thousands)*

|  | Count | Balance |
| --- | ---: | ---: |
| Real Estate Rental and Leasing | 3 | $445 |
| Construction | 2 | 272 |
| **Total commercial accommodations** | **5** | **$717** |

The global pandemic referred to as COVID-19, and the government responses thereafter, have created many impediments to loan production relative to the measures taken to slow the spread. These measures have put a large strain on a wide variety of industries within the global economy generally, and the Company’s market specifically. The overall economic impact and effect of the measures is yet to be fully understood as its effects will most likely lag while businesses and governments inject resources to help lessen the impact. Despite efforts to lessen the impact, it is the Company’s current belief that the pandemic will temporarily, or in some cases permanently, damage our borrower’s ability to repay loans and comply with terms.

#### Foreclosed assets held-for-sale

From December 31, 2020 to March 31, 2021, foreclosed assets held-for-sale (ORE) increased from $256 thousand to $413 thousand, a $157 thousand, or 62%, increase. During the first quarter, two properties to two unrelated borrowers for $248 thousand were added; two properties for $90 thousand were sold; and one foreclosed asset was written down by $1 thousand to fair market value.

The following table sets forth the activity in the ORE component of foreclosed assets held-for-sale:

*(dollars in thousands)*

|  | March 31, 2021 Amount | # | December 31, 2020 Amount | # |
| --- | ---: | ---: | ---: | ---: |
| Balance at beginning of period | **$256** | **6** | $349 | 7 |
| Additions | **248** | **2** | 770 | 10 |
| Pay downs | **-** |  | (1) |  |
| Write downs | **(1)** |  | (36) |  |
| Sold | **(90)** | **(2)** | (826) | (11) |
| Balance at end of period | **$413** | **6** | $256 | 6 |

As of March 31, 2021, ORE consisted of six properties securing loans to six unrelated borrowers totaling $413 thousand. Two properties ($248 thousand) to two unrelated borrowers were added in 2021; two properties ($133 thousand) to two unrelated borrowers were added in 2020; one property ($31 thousand) was added in 2019; one property ($1 thousand) was added in 2017. Of the six properties, three properties are under agreement of sale and three properties are listed for sale.

As of March 31, 2021 and December 31, 2020, the Company had no other repossessed assets held-for-sale.

#### Cash surrender value of bank owned life insurance

The Company maintains bank owned life insurance (BOLI) for a chosen group of employees at the time of purchase, namely its officers, where the Company is the owner and sole beneficiary of the policies. BOLI is classified as a non-interest earning asset. Increases in the cash surrender value are recorded as components of non-interest income. The BOLI is profitable from the appreciation of the cash surrender values of the pool of insurance and its tax-free advantage to the Company. This profitability is used to offset a portion of current and future employee benefit costs. In March 2019, the Company invested $2.0 million in additional BOLI as a source of funding for additional life insurance benefits that provides for payments upon death for officers and employee benefit expenses related to the Company’s non-qualified SERP implemented for certain executive officers. In December 2020, the Company invested in $6 million in BOLI and $5 million in BOLI with annuity rider investments. The BOLI can be liquidated if necessary, with associated tax costs. However, the Company intends to hold this pool of insurance, because it provides income that enhances the Company’s capital position. Therefore, the Company has not provided for deferred income taxes on the earnings from the increase in cash surrender value.

#### Premises and equipment

Net of depreciation, premises and equipment decreased $0.3 million during the first three months of 2021. The Company added $0.2 million in fixed assets which was offset by $0.5 million in depreciation expense. The Company expects to begin branch remodeling and corporate center planning which may increase construction in process by approximately $2.5 million in 2021. On December 23, 2020, the Commonwealth of Pennsylvania authorized the release of $2.0 million in Redevelopment Assistance Capital Program (RACP) funding for the Company’s headquarters project in Lackawanna County. Although the Company was awarded the grant, funds will not be available until a final project is selected and certain requirements are met.

#### Other assets

During the first three months of 2021, the $12.7 million increase in other assets was due mostly to $7.9 million of municipal security settlements pending and $1.9 million in SBA fees receivable from loans originated under the second round of PPP.

### Funds Provided:

#### Deposits

The Company is a community based commercial depository financial institution, member FDIC, which offers a variety of deposit products with varying ranges of interest rates and terms. Generally, deposits are obtained from consumers, businesses and public entities within the communities that surround the Company’s 20 branch offices and all deposits are insured by the FDIC up to the full extent permitted by law. Deposit products consist of transaction accounts including: savings; clubs; interest-bearing checking; money market and non-interest bearing checking (DDA). The Company also offers short- and long-term time deposits or certificates of deposit (CDs). CDs are deposits with stated maturities which can range from seven days to ten years. Cash flow from deposits is influenced by economic conditions, changes in the interest rate environment, pricing and competition. To determine interest rates on its deposit products, the Company considers local competition, spreads to earning-asset yields, liquidity position and rates charged for alternative sources of funding such as short-term borrowings and FHLB advances.

The following table represents the components of deposits as of the date indicated:

*(dollars in thousands)*

|  | March 31, 2021 Amount% |  | December 31, 2020 Amount% |  |
| --- | ---: | ---: | ---: | ---: |
| Interest-bearing checking | **$513,735** | **29.8%** | $453,896 | 30.0% |
| Savings and clubs | **197,138** | **11.4** | 179,676 | 11.9 |
| Money market | **381,808** | **22.2** | 340,654 | 22.6 |
| Certificates of deposit | **111,867** | **6.5** | 127,783 | 8.5 |
| Total interest-bearing | **1,204,548** | **69.9** | 1,102,009 | 73.0 |
| Non-interest bearing | **518,352** | **30.1** | 407,496 | 27.0 |
| Total deposits | **$1,722,900** | **100.0%** | $1,509,505 | 100.0% |

Total deposits increased $213.4 million, or 14%, from $1.5 billion at December 31, 2020 to $1.7 billion at March 31, 2021. Non-interest bearing and interest-bearing checking accounts contributed the most to the deposit growth with increases of $110.9 million and $59.8 million, respectively. Of the growth in non-interest bearing checking accounts, $43.4 million was seasonal deposits from one public customer which flowed out of the bank on April 1, 2021. Tax deposits are usually received mid-quarter and retained for a short period of time with disbursements occurring shortly after they are received. The remaining growth of over $67 million was primarily due to an increase in business deposit account balances from second round PPP proceeds. The increase in interest-bearing checking accounts was primarily due to seasonal tax cycles, business activity, government relief due to the pandemic and shifts from maturing CDs. Money market accounts also increased $41.2 million mostly due to seasonal college tuition cycles, higher balances of personal and business accounts and shifts from other types of deposit accounts. The Company focuses on obtaining a full-banking relationship with existing checking account customers as well as forming new customer relationships. Savings accounts increased $17.5 million due to an increase in personal account balances. The Company will continue to execute on its relationship development strategy, explore the demographics within its marketplace and develop creative programs for its customers. For 2021, the Company expects deposit growth to fund asset growth with expansion in the new Lehigh Valley market and the pending acquisition of Landmark. The Company expects business deposits to continue growing during the second quarter of 2021 as PPP loan proceeds flow into deposit accounts and pandemic-related government relief is distributed. When pandemic-related restrictions are fully lifted, the Company anticipates personal and business spending to increase and therefore average deposit balances to decline. Seasonal public deposit fluctuations are usual, and at times may partially offset this deposit growth.

During the first quarter of 2021, CDs also decreased $15.9 million as rates dropped during 2020 and previous years' promotional CDs reached maturity. Most of the maturing CD balances were transferred to interest-bearing checking and money market accounts. The Company will continue to pursue strategies to grow and retain retail and business customers with an emphasis on deepening and broadening existing and creating new relationships.

The Company uses the Certificate of Deposit Account Registry Service (CDARS) reciprocal program and Insured Cash Sweep (ICS) reciprocal program to obtain FDIC insurance protection for customers who have large deposits that at times may exceed the FDIC maximum insured amount of $250,000. In the CDARS program, deposits with varying terms and interest rates, originated in the Company’s own markets, are exchanged for deposits of other financial institutions that are members in the CDARS network. By placing the deposits in other participating institutions, the deposits of our customers are fully insured by the FDIC. In return for deposits placed with network institutions, the Company receives from network institutions deposits that are approximately equal in amount and are comprised of terms similar to those placed for our customers. Deposits the Company receives from other institutions are considered reciprocal deposits by regulatory definitions. The Company did not have any CDARs as of March 31, 2021 and December 31, 2020. As of March 31, 2021 and December 31, 2020, ICS reciprocal deposits represented $5.7 million and $46.2 million, or less than 1% and 3%, of total deposits which are included in interest-bearing checking accounts in the table above. The $40.5 million decrease in ICS deposits is primarily due to public funds deposit transfers from ICS accounts to other interest-bearing checking accounts.

The maturity distribution of certificates of deposit at March 31, 2021 is as follows:

*(dollars in thousands)*

|  | Three months or less | More than three months to six months | More than six months to twelve months | More than twelve months | Total |
| --- | ---: | ---: | ---: | ---: | ---: |
| CDs of $100,000 or more | $11,304 | $16,803 | $18,566 | $10,081 | $56,754 |
| CDs of less than $100,000 | 10,992 | 7,176 | 14,997 | 21,936 | 55,101 |
| Total CDs | $22,296 | $23,979 | $33,563 | $32,017 | $111,855 |

There is a remaining time deposit premium of $12 thousand that will be amortized into income on a level yield amortization method over the contractual life of the deposits.

Certificates of deposit of $250,000 or more amounted to $32.5 million and $41.1 million as of March 31, 2021 and December 31,

2020, respectively.

Approximately 53% of the CDs, with a weighted-average interest rate of 0.62%, are scheduled to mature during 2021 and an additional 34%, with a weighted-average interest rate of 0.54%, are scheduled to mature during 2022. Renewing CDs are currently expected to re-price to lower market rates depending on the rate on the maturing CD, the pace and direction of interest rate movements, the shape of the yield curve, competition, the rate profile of the maturing accounts and depositor preference for alternative, non-term products. The Company plans to address repricing CDs in the ordinary course of business on a relationship basis and is prepared to match rates when prudent to maintain relationships. Growth in CD accounts is challenged by the current and expected rate environment and clients’ preference for short-term rates, as well as aggressive competitor rates. The Company is not currently offering any CD promotions but may resume promotions in the future. The Company will consider the needs of the customers and simultaneously be mindful of the liquidity levels, borrowing rates and the interest rate sensitivity exposure of the Company.

#### Borrowings

Borrowings are used as a complement to deposit generation as an alternative funding source whereby the Company will borrow under advances from the FHLB of Pittsburgh and other correspondent banks for asset growth and liquidity needs.

Short-term borrowings may include overnight balances with FHLB line of credit and/or correspondent bank’s federal funds lines which the Company may require to fund daily liquidity needs such as deposit outflow, loan demand and operations. There were no short-term borrowings as of March 31, 2021 and December 31, 2020 as growth in deposits funded asset growth.

During the first quarter of 2021, the Company paid off $5 million in FHLB advances with a weighted average interest rate of 3.07%. As of March 31, 2021, the Company had the ability to borrow an additional $447.5 million from the FHLB.

## Market risk

As filed, 27,258 characters.

#### Management of interest rate risk and market risk analysis.

The adequacy and effectiveness of an institution’s interest rate risk management process and the level of its exposures are critical factors in the regulatory evaluation of an institution’s sensitivity to changes in interest rates and capital adequacy. Management believes the Company’s interest rate risk measurement framework is sound and provides an effective means to measure, monitor, analyze, identify and control interest rate risk in the balance sheet.

The Company is subject to the interest rate risks inherent in its lending, investing and financing activities. Fluctuations of interest rates will impact interest income and interest expense along with affecting market values of all interest-earning assets and interest-bearing liabilities, except for those assets or liabilities with a short term remaining to maturity. Interest rate risk management is an integral part of the asset/liability management process. The Company has instituted certain procedures and policy guidelines to manage the interest rate risk position. Those internal policies enable the Company to react to changes in market rates to protect net interest income from significant fluctuations. The primary objective in managing interest rate risk is to minimize the adverse impact of changes in interest rates on net interest income along with creating an asset/liability structure that maximizes earnings.

*Asset/Liability Management.* One major objective of the Company when managing the rate sensitivity of its assets and liabilities is to stabilize net interest income. The management of and authority to assume interest rate risk is the responsibility of the Company’s Asset/Liability Committee (ALCO), which is comprised of senior management and members of the board of directors. ALCO meets quarterly to monitor the relationship of interest sensitive assets to interest sensitive liabilities. The process to review interest rate risk is a regular part of managing the Company. Consistent policies and practices of measuring and reporting interest rate risk exposure, particularly regarding the treatment of non-contractual assets and liabilities, are in effect. In addition, there is an annual process to review the interest rate risk policy with the board of directors which includes limits on the impact to earnings from shifts in interest rates.

*Interest Rate Risk Measurement.* Interest rate risk is monitored through the use of three complementary measures: static gap analysis, earnings at risk simulation and economic value at risk simulation. While each of the interest rate risk measurements has limitations, collectively, they represent a reasonably comprehensive view of the magnitude of interest rate risk in the Company and the distribution of risk along the yield curve, the level of risk through time and the amount of exposure to changes in certain interest rate relationships.

*Static Gap*. The ratio between assets and liabilities re-pricing in specific time intervals is referred to as an interest rate sensitivity gap. Interest rate sensitivity gaps can be managed to take advantage of the slope of the yield curve as well as forecasted changes in the level of interest rate changes.

To manage this interest rate sensitivity gap position, an asset/liability model commonly known as cumulative gap analysis is used to monitor the difference in the volume of the Company’s interest sensitive assets and liabilities that mature or re-price within given time intervals. A positive gap (asset sensitive) indicates that more assets will re-price during a given period compared to liabilities, while a negative gap (liability sensitive) indicates the opposite effect. The Company employs computerized net interest income simulation modeling to assist in quantifying interest rate risk exposure. This process measures and quantifies the impact on net interest income through varying interest rate changes and balance sheet compositions. The use of this model assists the ALCO to gauge the effects of the interest rate changes on interest-sensitive assets and liabilities in order to determine what impact these rate changes will have upon the net interest spread. At March 31, 2021, the Company maintained a one-year cumulative gap of positive (asset sensitive) $311.1 million, or 16%, of total assets. The effect of this positive gap position provided a mismatch of assets and liabilities which may expose the Company to interest rate risk during periods of falling interest rates. Conversely, in an increasing interest rate environment, net interest income could be positively impacted because more assets than liabilities will re-price upward during the one-year period.

Certain shortcomings are inherent in the method of analysis discussed above and presented in the next table. Although certain assets and liabilities may have similar maturities or periods of re-pricing, they may react in different degrees to changes in market interest rates. The interest rates on certain types of assets and liabilities may fluctuate in advance of changes in market interest rates, while interest rates on other types of assets and liabilities may lag behind changes in market interest rates. Certain assets, such as adjustable-rate mortgages, have features which restrict changes in interest rates on a short-term basis and over the life of the asset. In the event of a change in interest rates, prepayment and early withdrawal levels may deviate significantly from those assumed in calculating the table amounts. The ability of many borrowers to service their adjustable-rate debt may decrease in the event of an interest rate increase.

The following table illustrates the Company’s interest sensitivity gap position at March 31, 2021:

*(dollars in thousands)*

|  | Three months or less | More than three months to twelve months | More than one year to three years | More than three years | Total |
| --- | ---: | ---: | ---: | ---: | ---: |
| Cash and cash equivalents | $183,989 | $- | $- | $38,964 | $222,953 |
| Investment securities (1)(2) | 9,799 | 19,993 | 78,398 | 331,363 | 439,553 |
| Loans and leases(2) | 397,441 | 199,112 | 315,142 | 226,626 | 1,138,321 |
| Fixed and other assets | - | 44,582 | - | 67,683 | 112,265 |
| Total assets | $591,229 | $263,687 | $393,540 | $664,636 | $1,913,092 |
| Total cumulative assets | $591,229 | $854,916 | $1,248,456 | $1,913,092 |  |
| Non-interest-bearing transaction deposits (3) | $- | $51,887 | $142,443 | $324,022 | $518,352 |
| Interest-bearing transaction deposits (3) | 412,057 | - | 272,250 | 408,374 | 1,092,681 |
| Certificates of deposit | 22,296 | 57,613 | 24,286 | 7,672 | 111,867 |
| Short-term borrowings | - | - | - |  | - |
| FHLB advances | - | - | - | - | - |
| Other liabilities | - | - | - | 26,610 | 26,610 |
| Total liabilities | $434,353 | $109,500 | $438,979 | $766,678 | $1,749,510 |
| Total cumulative liabilities | $434,353 | $543,853 | $982,832 | $1,749,510 |  |
| Interest sensitivity gap | $156,876 | $154,187 | $(45,439) | $(102,042) |  |
| Cumulative gap | $156,876 | $311,063 | $265,624 | $163,582 |  |
| Cumulative gap to total assets | 8.2% | 16.3% | 13.9% | 8.6% |  |

(1) Includes restricted investments in bank stock and the net unrealized gains/losses on available-for-sale securities.

(2) Investments and loans are included in the earlier of the period in which interest rates were next scheduled to adjust or the period in which they are due. In addition, loans were included in the periods in which they are scheduled to be repaid based on scheduled amortization. For amortizing loans and MBS – GSE residential, annual prepayment rates are assumed reflecting historical experience as well as management’s knowledge and experience of its loan products.

(3) The Company’s demand and savings accounts were generally subject to immediate withdrawal. However, management considers a certain amount of such accounts to be core accounts having significantly longer effective maturities based on the retention experiences of such deposits in changing interest rate environments. The effective maturities presented are the recommended maturity distribution limits for non-maturing deposits based on historical deposit studies.

*Earnings at Risk and Economic Value at Risk Simulations*. The Company recognizes that more sophisticated tools exist for measuring the interest rate risk in the balance sheet that extend beyond static re-pricing gap analysis. Although it will continue to measure its re-pricing gap position, the Company utilizes additional modeling for identifying and measuring the interest rate risk in the overall balance sheet. The ALCO is responsible for focusing on “earnings at risk” and “economic value at risk”, and how both relate to the risk-based capital position when analyzing the interest rate risk.

*Earnings at Risk*. An earnings at risk simulation measures the change in net interest income and net income should interest rates rise and fall. The simulation recognizes that not all assets and liabilities re-price one-for-one with market rates (e.g., savings rate). The ALCO looks at “earnings at risk” to determine income changes from a base case scenario under an increase and decrease of 200 basis points in interest rate simulation models.

*Economic Value at Risk.* An earnings at risk simulation measures the short-term risk in the balance sheet. Economic value (or portfolio equity) at risk measures the long-term risk by finding the net present value of the future cash flows from the Company’s existing assets and liabilities. The ALCO examines this ratio quarterly utilizing an increase and decrease of 200 basis points in interest rate simulation models. The ALCO recognizes that, in some instances, this ratio may contradict the “earnings at risk” ratio.

The following table illustrates the simulated impact of an immediate 200 basis points upward or downward movement in interest rates on net interest income, net income and the change in the economic value (portfolio equity). This analysis assumed that the adjusted interest-earning asset and interest-bearing liability levels at March 31, 2021 remained constant. The impact of the rate movements was developed by simulating the effect of the rate change over a twelve-month period from the March 31, 2021 levels:

| Earnings at risk: | % change Rates +200 | Rates -200 |
| --- | ---: | ---: |
| Net interest income | 3.4% | (2.0)% |
| Net income | 8.2 | (4.3) |
| Economic value at risk: |  |  |
| Economic value of equity | 8.5 | (27.9) |
| Economic value of equity as a percent of total assets | 1.1 | (3.7) |

Economic value has the most meaning when viewed within the context of risk-based capital. Therefore, the economic value may normally change beyond the Company’s policy guideline for a short period of time as long as the risk-based capital ratio (after adjusting for the excess equity exposure) is greater than 10%. At March 31, 2021, the Company’s risk-based capital ratio was 16.47%.

The table below summarizes estimated changes in net interest income over a twelve-month period beginning April 1, 2021, under alternate interest rate scenarios using the income simulation model described above:

*(dollars in thousands)*

| Simulated change in interest rates | Net interest income | $% variance | variance |
| --- | ---: | ---: | ---: |
| +200 basis points | $53,029 | $1,722 | 3.4% |
| +100 basis points | 51,868 | 561 | 1.1 |
| Flat rate | 51,307 | - | - |
| -100 basis points | 51,265 | (42) | (0.1) |
| -200 basis points | 50,277 | (1,030) | (2.0) |

Simulation models require assumptions about certain categories of assets and liabilities. The models schedule existing assets and liabilities by their contractual maturity, estimated likely call date or earliest re-pricing opportunity. MBS – GSE residential securities and amortizing loans are scheduled based on their anticipated cash flow including estimated prepayments. For investment securities, the Company uses a third-party service to provide cash flow estimates in the various rate environments. Savings, money market and interest-bearing checking accounts do not have stated maturities or re-pricing terms and can be withdrawn or re-price at any time. This may impact the margin if more expensive alternative sources of deposits are required to fund loans or deposit runoff. Management projects the re-pricing characteristics of these accounts based on historical performance and assumptions that it believes reflect their rate sensitivity. The model reinvests all maturities, repayments and prepayments for each type of asset or liability into the same product for a new like term at current product interest rates. As a result, the mix of interest-earning assets and interest bearing-liabilities is held constant.

#### Liquidity

Liquidity management ensures that adequate funds will be available to meet customers’ needs for borrowings, deposit withdrawals and maturities, facility expansion and normal operating expenses. Sources of liquidity are cash and cash equivalents, asset maturities and pay-downs within one year, loans HFS, investments AFS, growth of core deposits, utilization of borrowing capacities from the FHLB, correspondent banks, ICS and CDARs, the Discount Window of the Federal Reserve Bank of Philadelphia (FRB), Atlantic Community Bankers Bank (ACBB) and proceeds from the issuance of capital stock. Though regularly scheduled investment and loan payments are dependable sources of daily liquidity, sales of both loans HFS and investments AFS, deposit activity and investment and loan prepayments are significantly influenced by general economic conditions including the interest rate environment. During low and declining interest rate environments, prepayments from interest-sensitive assets tend to accelerate and provide significant liquidity that can be used to invest in other interest-earning assets but at lower market rates. Conversely, in periods of high or rising interest rates, prepayments from interest-sensitive assets tend to decelerate causing prepayment cash flows from mortgage loans and mortgage-backed securities to decrease. Rising interest rates may also cause deposit inflow but priced at higher market interest rates or could also cause deposit outflow due to higher rates offered by the Company’s competition for similar products. The Company closely monitors activity in the capital markets and takes appropriate action to ensure that the liquidity levels are adequate for funding, investing and operating activities.

The Company’s contingency funding plan (CFP) sets a framework for handling liquidity issues in the event circumstances arise which the Company deems to be less than normal. The Company established guidelines for identifying, measuring, monitoring and managing the resolution of potentially serious liquidity crises. The CFP outlines required monitoring tools, acceptable alternative funding sources and required actions during various liquidity scenarios. Thus, the Company has implemented a proactive means for the measurement and resolution for handling potentially significant adverse liquidity conditions. At least quarterly, the CFP monitoring tools, current liquidity position and monthly projected liquidity sources and uses are presented and reviewed by the Company’s Asset/Liability Committee. As of March 31, 2021, the Company had not experienced any adverse issues that would give rise to its inability to raise liquidity in an emergency situation.

During the three months ended March 31, 2021, the Company generated $153.6 million of cash. During the period, the Company’s operations provided approximately $25.5 million mostly from $13.7 million of net cash inflow from the components of net interest income and $21.9 million of proceeds over originations of loans held for sale, partially offset by net non-interest expense/income related payments of $10.0 million. Cash inflow from interest-earning assets, deposits, loan payments and the sale of securities were used to purchase investment securities and replace maturing and cash runoff of securities, fund the loan portfolio, pay down borrowings, invest in bank premises and equipment and make net dividend payments. The Company received a large amount of public deposits over the past five years. The seasonal nature of deposits from municipalities and other public funding sources requires the Company to be prepared for the inherent volatility and the unpredictable timing of cash outflow from this customer base, including maintaining the requirements to pledge investment securities. Accordingly, the use of short-term overnight borrowings could be used to fulfill funding gap needs. The CFP is a tool to help the Company ensure that alternative funding sources are available to meet its liquidity needs.

During 2020 and the first quarter of 2021, the Company also experienced deposit inflow resulting from businesses and municipalities that received relief from the CARES Act, normal seasonal tax activity and less consumer spending along with the third round of economic impact payments. There is uncertainty about the length of time that these deposits will remain which could require the Company to maintain elevated cash balances. The Company will continue to monitor deposit fluctuation for significant changes.

The Company is a party to financial instruments with off-balance sheet risk in the normal course of business in order to meet the financing needs of its customers and in connection with the overall interest rate management strategy. These instruments involve, to a varying degree, elements of credit, interest rate and liquidity risk. In accordance with GAAP, these instruments are either not recorded in the consolidated financial statements or are recorded in amounts that differ from the notional amounts. Such instruments primarily include lending commitments.

Lending commitments include commitments to originate loans and commitments to fund unused lines of credit. Commitments to extend credit are agreements to lend to a customer as long as there is no violation of any condition established in the contract. Commitments generally have fixed expiration dates or other termination clauses and may require payment of a fee. Since some of the commitments are expected to expire without being drawn upon, the total commitment amounts do not necessarily represent future cash requirements.

As of March 31, 2021, the Company maintained $223.0 million in cash and cash equivalents and $447.6 million of investments AFS and loans HFS. Also as of March 31, 2021, the Company had approximately $447.5 million available to borrow from the FHLB, $31.0 million from correspondent banks, $87.3 million from the FRB and $255.7 million from the Promontory One-Way Buy program. The combined total of $1.5 billion represented 78% of total assets at March 31, 2021. Management believes this level of liquidity to be strong and adequate to support current operations.

#### Capital

During the three months ended March 31, 2021, total shareholders' equity decreased $3.1 million, or 2%, due principally to the $7.8 million after tax reduction in the net unrealized gain position in the Company’s investment portfolio which was partially offset by $5.7 million in net income added into retained earnings. Capital was enhanced by $0.3 million from investments in the Company’s common stock via the Employee Stock Purchase Plan (ESPP) and $0.3 million from stock-based compensation expense from the ESPP and restricted stock and SSARs. These items were offset by $1.5 million of cash dividends declared on the Company’s common stock. The Company’s dividend payout ratio, defined as the rate at which current earnings are paid to shareholders, was 26.7% for the three months ended March 31, 2021. The balance of earnings is retained to further strengthen the Company’s capital position.

As of March 31, 2021, the Company reported a net unrealized gain position of $1.2 million, net of tax, from the securities AFS portfolio compared to a net unrealized gain of $9.0 million as of December 31, 2020. The reduction during the first quarter of 2021 was from the $7.8 million reduction in net unrealized gains on AFS securities, net of tax. Lower net unrealized gains on municipal and mortgage-backed securities and net unrealized losses on agency securities contributed to the lower total net unrealized gains in investment portfolio. Management believes that changes in fair value of the Company’s securities are due to changes in interest rates and not in the creditworthiness of the issuers. Generally, when U.S. Treasury rates rise, investment securities’ pricing declines and fair values of investment securities also decline. While volatility has existed in the yield curve within the past twelve months, an improving rate environment is expected and during the period of increasing rates, the Company expects pricing in the bond portfolio to decline. There is no assurance that future realized and unrealized losses will not be recognized from the Company’s portfolio of investment securities. To help maintain a healthy capital position, the Company can issue stock to participants in the DRP and ESPP plans. The DRP affords the Company the option to acquire shares in open market purchases and/or issue shares directly from the Company to plan participants. During the first three months of 2021, the Company acquired shares in the open market to fulfill the needs of the DRP. Both the DRP and the ESPP plans have been a consistent source of capital from the Company’s loyal employees and shareholders and their participation in these plans will continue to help strengthen the Company’s balance sheet.

The Company (on a consolidated basis) and the Bank are subject to various regulatory capital requirements administered by the federal banking agencies. Failure to meet minimum capital requirements can initiate certain mandatory and possible additional discretionary actions by regulators that, if undertaken, could have a direct material effect on the Company’s and the Bank’s financial statements. Under capital adequacy guidelines and the regulatory framework for prompt corrective action, the Company and the Bank must meet specific capital guidelines that involve quantitative measures of their assets, liabilities and certain off-balance-sheet items as calculated under regulatory accounting practices. The capital amounts and classification are also subject to qualitative judgments by the regulators about components, risk-weightings and other factors. Prompt corrective action provisions are not applicable to bank holding companies.

Under these guidelines, assets and certain off-balance sheet items are assigned to broad risk categories, each with appropriate weights. The resulting capital ratios represent capital as a percentage of total risk-weighted assets. The guidelines require all banks and bank holding companies to maintain a minimum ratio of total risk-based capital to total risk-weighted assets (Total Risk Adjusted Capital) of 8%, including Tier I common equity to total risk-weighted assets (Tier I Common Equity) of 4.5%, Tier I capital to total risk-weighted assets (Tier I Capital) of 6% and Tier I capital to average total assets (Leverage Ratio) of at least 4%. A capital conservation buffer, comprised of common equity Tier I capital, is also established above the regulatory minimum capital requirements of 2.50%. As of March 31, 2021 and December 31, 2020, the Company and the Bank exceeded all capital adequacy requirements to which it was subject.

The Company continues to closely monitor and evaluate alternatives to enhance its capital ratios as the regulatory and economic environments change. The following table depicts the capital amounts and ratios of the Company, on a consolidated basis, and the Bank as of March 31, 2021 and December 31, 2020:

*(dollars in thousands)*

| As of March 31, 2021: Total capital (to risk-weighted assets) | Actual Amount | Ratio | For capital adequacy purposes Amount |  | Ratio |  | For capital adequacy purposes with capital conservation buffer\* Amount | Ratio | To be well capitalized under prompt corrective action provisions Amount |  | Ratio |
| --- | ---: | ---: | --- | ---: | ---: | --- | ---: | ---: | --- | ---: | ---: |
| Consolidated | **$166,381** | **16.5%** | **≥** | **$80,840** | **8.0%** | **≥** | **$106,102** | **10.5%** |  | **N/A** | **N/A** |
| Bank | **$166,344** | **16.5%** | **≥** | **$80,834** | **8.0%** | **≥** | **$106,095** | **10.5%** | **≥** | **$101,043** | **10.0%** |
| Tier 1 common equity (to risk-weighted assets) |  |  |  |  |  |  |  |  |  |  |  |
| Consolidated | **$153,722** | **15.2%** | **≥** | **$45,472** | **4.5%** | **≥** | **$70,735** | **7.0%** |  | **N/A** | **N/A** |
| Bank | **$153,686** | **15.2%** | **≥** | **$45,469** | **4.5%** | **≥** | **$70,730** | **7.0%** | **≥** | **$65,678** | **6.5%** |
| Tier I capital (to risk-weighted assets) |  |  |  |  |  |  |  |  |  |  |  |
| Consolidated | **$153,722** | **15.2%** | **≥** | **$60,630** | **6.0%** | **≥** | **$85,892** | **8.5%** |  | **N/A** | **N/A** |
| Bank | **$153,686** | **15.2%** | **≥** | **$60,626** | **6.0%** | **≥** | **$85,886** | **8.5%** | **≥** | **$80,834** | **8.0%** |
| Tier I capital (to average assets) |  |  |  |  |  |  |  |  |  |  |  |
| Consolidated | **$153,722** | **8.7%** | **≥** | **$70,487** | **4.0%** | **≥** | **$70,487** | **4.0%** |  | **N/A** | **N/A** |
| Bank | **$153,686** | **8.7%** | **≥** | **$70,487** | **4.0%** | **≥** | **$70,487** | **4.0%** | **≥** | **$88,109** | **5.0%** |

| As of December 31, 2020: Total capital (to risk-weighted assets) |  |  |  |  |  |  |  |  |  |  |  |
| --- | ---: | ---: | --- | ---: | ---: | --- | ---: | ---: | --- | ---: | ---: |
| Consolidated | $161,199 | 16.5% | ≥ | $78,356 | 8.0% | ≥ | $102,842 | 10.5% |  | N/A | N/A |
| Bank | $161,145 | 16.5% | ≥ | $78,342 | 8.0% | ≥ | $102,823 | 10.5% | ≥ | $97,927 | 10.0% |
| Tier 1 common equity (to risk-weighted assets) |  |  |  |  |  |  |  |  |  |  |  |
| Consolidated | $148,931 | 15.2% | ≥ | $44,075 | 4.5% | ≥ | $68,562 | 7.0% |  | N/A | N/A |
| Bank | $148,879 | 15.2% | ≥ | $44,067 | 4.5% | ≥ | $68,549 | 7.0% | ≥ | $63,653 | 6.5% |
| Tier I capital (to risk-weighted assets) |  |  |  |  |  |  |  |  |  |  |  |
| Consolidated | $148,931 | 15.2% | ≥ | $58,767 | 6.0% | ≥ | $83,253 | 8.5% |  | N/A | N/A |
| Bank | $148,879 | 15.2% | ≥ | $58,756 | 6.0% | ≥ | $83,238 | 8.5% | ≥ | $78,342 | 8.0% |
| Tier I capital (to average assets) |  |  |  |  |  |  |  |  |  |  |  |
| Consolidated | $148,931 | 8.8% | ≥ | $67,584 | 4.0% | ≥ | $67,584 | 4.0% |  | N/A | N/A |
| Bank | $148,879 | 8.8% | ≥ | $67,584 | 4.0% | ≥ | $67,584 | 4.0% | ≥ | $84,479 | 5.0% |

\* The minimums under Basel III increased by 0.625% (the capital conservation buffer) annually until 2019.

The Company advises readers to refer to the Supervision and Regulation section of Management’s Discussion and Analysis of Financial Condition and Results of Operation, of its 2020 Form 10-K for a discussion on the regulatory environment and recent legislation and rulemaking.

## Controls and procedures

As filed, 1,065 characters.

As of the end of the period covered by this Quarterly Report on Form 10-Q, an evaluation was carried out by the Company’s management, with the participation of its President and Chief Executive Officer and Chief Financial Officer, of the effectiveness of the Company’s disclosure controls and procedures, as defined in Rule 13a-15(e) under the Securities Exchange Act of 1934. Based on such evaluation, the President and Chief Executive Officer and Chief Financial Officer concluded that the Company’s disclosure controls and procedures are designed to ensure that information required to be disclosed in the reports the Company files or furnishes under the Securities Exchange Act of 1934 is recorded, processed, summarized and reported within the time periods specified in the SEC’s rules and regulations, and are effective. The Company made no changes in its internal controls over financial reporting or in other factors that materially affected, or are reasonably likely to materially affect, these controls during the last fiscal quarter ended March 31, 2021.

## Risk factors

As filed, 210 characters.

Management of the Company does not believe there have been any material changes to the risk factors that were disclosed in the 2020 Form 10-K filed with the Securities and Exchange Commission on March 19, 2021.

Filed May 14, 2021.
Source: SEC EDGAR, the filing index for accession 0001098151-21-000024. Last ingested by Listed: Nov 6, 2026, 18:40 ET. No prices; not investment advice.