Burke & Herbert Financial Services Corp. 10-Q

Item 2. Management’s Discussion and Analysis of Financial Condition and Results of Operations The following discussion and analysis of our consolidated financial condition and results of operations of the Company should be read in conjunction with the preceding consolidated financial statements and notes presented in Item 1. Financial Statements of this Form 10-Q, as well as with the audited consolidated financial statements and notes for the year ended December 31, 2022, included in our Registration Statement on Form 10 filed with the SEC on February 28, 2023, as amended on April 4, 2023, April 20, 2023, and April 21, 2023, and as declared as effective by the SEC on April 21, 2023 (the “Registration Statement”). Historical results of operations and the percentage relationships among any amounts included and any trends that may appear may not indicate trends in operations or results of operations for any future periods. We are a financial holding company, and we conduct all of our material business operations through the Bank. As a result, the discussion and analysis below primarily relate to activities conducted at the Bank. Disclosure Regarding Forward-Looking Statements This Form 10-Q contains statements that we believe are, or may be considered to be, “forward-looking statements”. Forward-looking statements are neither historical facts nor assurances of future performance. Instead, they are based on current beliefs, expectations, or assumptions regarding the future of the business, future plans and strategies, operational results, and other future conditions of the Company. All statements other than statements of historical fact included in this Form 10-Q regarding the prospects of our industry or our prospects, plans, financial position, or business strategy may constitute forward-looking statements. In addition, forward-looking statements generally can be identified by the use of forward-looking words such as “plans,” “expects” or “does not expect,” “is expected,” “look forward to,” “budget,” “scheduled,” “estimates,” “forecasts,” “will continue,” “intends,” “the intent of,” “have the potential,” “anticipates,” “does not anticipate,” “believes,” “should,” “should not,” or variations of such words and phrases that indicate that certain actions, events, or results “may,” “could,” “would,” “might,” or “will,” “be taken,” “occur,” or “be achieved,” or the negative of these terms or variations of them or similar terms. Furthermore, forward-looking statements may be included in various filings that we make with the SEC or press releases or oral statements made by or with the approval of one of our authorized executive officers. Although we believe that the expectations reflected in these forward-looking statements are reasonable, we cannot assure you that these expectations will prove to be correct. These forward-looking statements are subject to certain known and unknown risks and uncertainties, as well as assumptions that could cause actual results to differ materially from those reflected in these forward-looking statements. By their very nature, forward-looking statements involve inherent risks and uncertainties, both general and specific, and risks exist that predictions, forecasts, projections, and other forward-looking statements will not be achieved. We caution readers not to place undue reliance on these statements as a number of important factors could cause the actual results to differ materially from the beliefs, plans, objectives, expectations, anticipations, estimates, and intentions expressed in such forward-looking statements. Important risks, uncertainties, and other factors which may cause the actual results, performance, or achievements of the Company, as applicable, to be materially different from any expected future results, performance, or achievements expressed or implied by such forward-looking information and statements include, but are not limited to, the risks described in Item 1A, under the caption “Risk Factors” in our Registration Statement, and in Part II, Item 1A. Risk Factors in this Form 10-Q. Readers are cautioned not to place undue reliance on any forward-looking statements contained in this Form 10-Q, which reflect management’s opinions only as of the date hereof. Except as required by law, we undertake no obligation to revise or publicly release the results of any revision to any forward-looking statements. You are advised, however, to consult any additional disclosures we make in our reports to the SEC. All subsequent written and oral forward-looking statements attributable to us or persons acting on our behalf are expressly qualified in their entirety by the cautionary statements contained in this Form 10-Q. We have made, and will continue to make, various forward-looking statements with respect to financial and business matters. Comments regarding our business that are not historical facts are considered forward-looking statements that involve inherent risks and uncertainties. Actual results may differ materially from those contained in these forward-looking statements. Overview Burke & Herbert Financial Services Corp. was organized as a Virginia corporation on September 14, 2022, to serve as the holding company for the Bank. The Company commenced operations as a bank holding company on October 1, 2022, following a reorganization transaction in which it became the Bank’s holding company. This transaction was treated as an internal reorganization as all shareholders of the Bank became shareholders of the Company. In September 2023, the Company elected to become a financial holding company. As a financial holding company, the Company is subject to 43 Table of Contents regulation and supervision by the Federal Reserve. The Company has no material operations and owns 100% of the Bank. The Bank is a Virginia chartered commercial bank that commenced operations in 1852. The Bank is supervised and regulated by the FDIC and the Virginia BFI. The Bank offers a full range of business and personal financial solutions designed to meet customers’ banking, borrowing, and investment needs and has over 20 branches throughout the Northern Virginia region and commercial loan offices in Fredericksburg, Loudoun County, and Richmond, Virginia, and in Bethesda, Maryland. The Bank derives a significant portion of its income from interest received on loans and investments. The Bank’s primary source of funding is deposits, both interest-bearing and non-interest-bearing. In order to maximize the Bank’s net interest income, or the difference between the income on interest-earning assets and the expense of interest-bearing liabilities, the Bank must not only manage the volume of these balance sheet items, but also the yields earned on interest-earning assets and the rates paid on interest-bearing liabilities. To account for credit risk inherent in all loans, the Bank maintains an ACL to absorb expected credit losses on existing loans that may become uncollectible. The Bank establishes and maintains this ACL by charging a provision for credit losses against operating earnings. In order to maintain its operations and branch locations, the Bank incurs various operating expenses which are further described within the “Results of Operations” later in this section. As of September 30, 2023, we had total consolidated assets of $3.6 billion, gross loans of $2.1 billion, total deposits of $3.0 billion, and total shareholders’ equity of $270.8 million. As of September 30, 2023, we had 404 full-time employees. None of our employees are covered by a collective bargaining agreement. Pending Merger with Summit Financial Group, Inc. On August 24, 2023, the Company and Summit Financial Group, Inc. (“Summit”), entered into an Agreement and Plan of Reorganization and Plan of Merger pursuant to which Summit will merge with and into Burke & Herbert, with Burke & Herbert as the continuing corporation (the “merger”). Immediately following the merger, Summit Community Bank, Inc., a West Virginia banking corporation (“SCB”) and a wholly-owned direct subsidiary of Summit, will merge with and into Burke & Herbert Bank & Trust Company, a Virginia banking corporation and a wholly-owned direct subsidiary of Burke & Herbert, with the Bank as the continuing bank (the “bank merger,” and together with the merger, the “mergers”). In the merger, Summit shareholders will receive 0.5043 shares of Burke & Herbert common stock for each share of Summit common stock they own (the “exchange ratio”), subject to the payment of cash in lieu of fractional shares. In addition, each share of Summit series 2021 preferred stock issued and outstanding immediately prior to the effective time of the merger will be converted into the right to receive one share of a newly created series of Burke & Herbert preferred stock having rights, preferences, privileges and voting powers and limitations and restrictions thereof that are not materially less or more favorable to the holders of the Summit series 2021 preferred stock. Completion of the mergers is subject to receipt of the requisite approvals of the Company’s and Summit’s stockholders, receipt of all required regulatory approvals, and fulfillment of other customary closing conditions. Recent Events in the Financial Services Industry In response to the bank failures that occurred during March and May 2023 and the attendant stress on economic agents, including various financial stock markets, the Company took multiple proactive measures to mitigate any potential financial and operational impacts. Such measures included, but were not limited to: • dissemination of internal communication to inform the Board and employees of current events and the Company’s condition and desired market response; • testing of available liquidity sources; • real-time analysis of our deposit composition and deposit concentrations; • assessment of our investment securities portfolio; and • stress testing of liquidity and capital metrics based on observed financial conditions with particular emphasis on the causes of such risk events. 44 Table of Contents For further discussion see Item 1A, under the caption “Risk Factors” in our Registration Statement. The measures taken followed meetings convened by a subcommittee provided for in our Asset/Liability policy more fully described in Item 3.- Quantitative and Qualitative Disclosures About Market Risk – Market Risk . The Company’s key inputs and certain assumptions of the stress testing included, but were not limited to, uninsured deposits, deposit composition and deposit flows, borrowings and borrowing capacity, interest rate movements and sensitivity, unrealized losses in the investment securities portfolio, loan balances and loan demand, credit risks, and current allowances for credit losses. Results of the stress tests indicated capital levels that remained above the well-capitalized regulatory ratios and liquidity metrics remained within internal policy guidelines. For additional information related to capital, see Notes to the Consolidated Financial Statements – Note 8. Regulatory Capital Matters . The Company intends to continue conducting such stress tests on an interim basis. Critical Accounting Policies and Estimates Our accounting and reporting policies are in accordance with GAAP and follow accounting and reporting guidelines prescribed by bank regulatory and general practices within the financial services industry. Our financial position and results of operations are affected by management’s application of accounting policies, including estimates, assumptions, and judgements that affect the amounts reported in the consolidated financial statements and accompanying notes. These estimates, assumptions, and judgments affect the amounts reported in the financial statements and accompanying notes and are based on information available as of the date of the financial statements, and, as this information changes, actual results could differ from the estimates, assumptions, and judgments reflected in the financial statements. In particular, management has identified several accounting policies that, due to the estimates, assumptions, and judgments inherent in those policies, are critical in understanding our financial statements. The more critical accounting estimates include accounting for credit losses and valuation methodologies. Additional disclosures regarding the effects of new pronouncements, ASU 2016-13 and ASU 2022-02, are included in this report in Note 1, Nature of Business Activities and Significant Accounting Policies , to the consolidated financial statements under Part 1, Item 1, “Financial Information.” Liquidity Management Liquidity is the ability of the Company to convert assets into cash or cash equivalents without significant loss and to raise additional funds by increasing liabilities. Liquidity management involves maintaining the Company’s ability to meet the day-to-day cash flow requirements of its customers, whether they are depositors wishing to withdraw funds or borrowers requiring funds to meet their credit needs. Without proper liquidity management, the Company would not be able to perform the primary function of a financial intermediary and would, therefore, not be able to meet the needs of the communities it serves. The Company assesses the need for liquidity in a variety of scenarios. Those scenarios may include projected growth, credit deterioration, deposit decay, interest rate changes, and a variety of other economic scenarios that can impact the liquidity position of the Company. These analyses are performed on a quarterly basis in conjunction with the Company’s Asset/Liability meetings, and findings are reported to the Asset/Liability Committee (the “ALCO”) and to the Board. From time to time, management may change the frequency of such testing or update certain inputs as a result of abnormal market conditions. Findings as a result of the Company’s prudent liquidity modeling may result in the change of certain products offered to customers or adjust the way the Company manages its balance sheet. Such changes could include adjusting interest rates offered on certain deposit products, changes to interest rates charged in lending activities, or the suspension of certain products and activities altogether. Times of significant economic stress may cause the mix of funding to shift and increase the likelihood of changes to certain products in order to manage the Company’s overall liquidity and capital position. The asset portion of the balance sheet provides liquidity primarily through unencumbered securities available-for-sale, loan principal and interest payments, maturities and prepayments of investment securities, and, to a lesser extent, sales of investment securities available-for-sale. Other short-term investments available to the Company that could act as potential sources of liquidity are federal funds sold, securities purchased under agreements to resell, and maturing interest-bearing deposits with other banks. The liability portion of the balance sheet provides liquidity through interest-bearing and non-interest-bearing deposit accounts and through FHLB and other borrowings. Brokered deposits, federal funds purchased, securities sold under agreements to repurchase, and other short-term borrowings are additional sources of liquidity and basically represent the Company’s incremental borrowing capacity. These sources of liquidity are used as necessary to fund asset growth and meet short-term liquidity needs. 45 Table of Contents In addition to the Company’s financial performance and condition, liquidity may be impacted by the Company’s structure as a financial holding company that is a separate legal entity from the Bank. The Company requires cash for various operating needs that could include payment of dividends to its shareholders, the servicing of debt, and the payment of general corporate expenses. The primary source of liquidity for the Company is dividends paid by the Bank. Applicable federal and state statutes and regulations impose restrictions on the amount of dividends that may be paid by the Bank. In addition to the formal statutes and regulations, regulatory authorities also consider the adequacy of the Bank’s total capital in relation to its assets, deposits, and other such items. Any future dividends must be set forth in the Company’s capital plans before any dividends can be paid. Management believes that the current sources of liquidity are adequate to meet the Company’s requirements and plans for continued growth. See Note 6 - Advances and Other Borrowings and Note 10 - Commitments and Contingencies , in Notes to Consolidated Financial Statements for additional information regarding outstanding balances of sources of liquidity and contractual commitments and obligations. Capital The Company 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 consolidated financial statements. In July 2013, the Federal Reserve published the final rules that established a new comprehensive capital framework for banking organizations, commonly referred to as Basel III. These final rules substantially revised the risk-based capital requirements applicable to financial holding companies and depository institutions. The final rule became effective January 1, 2015, for smaller, non-complex banking organizations with full implementation by January 1, 2019. The Basel III Capital Rules require the Holding Company and the Bank to maintain minimum Common Equity Tier 1 (“CET 1”), Tier 1, and Total Capital ratios, along with a capital conservation buffer, effectively resulting in new minimum capital ratios. The capital conservation buffer is designed to absorb losses during periods of economic stress. Banking institutions with a ratio of CET 1 capital to risk-weighted assets above the minimum but below the conservation buffer (or below the combined capital conservation buffer and counter-cyclical capital buffer, when the latter is applied) will face constraints on dividends, equity repurchases, and compensation based on the amount of the shortfall. The Basel III Capital Rules also provide for a “counter-cyclical capital buffer” that is applicable to only certain covered institutions and does not have any current applicability to the Holding Company or the Bank. Under capital adequacy guidelines and the regulatory framework for “prompt corrective action”, the Holding Company and the Bank must meet specific capital guidelines that involve quantitative measures of assets, liabilities, and certain off-balance sheet items as calculated under regulatory accounting practices. The capital amounts and classifications are also subject to qualitative judgments by the regulators about components, risk weightings, and other factors. Additionally, federal banking laws require regulatory authorities to take “prompt corrective action” with respect to depository institutions that do not satisfy minimum capital requirements. The extent of these powers depends upon whether the institution in question is “well capitalized”, “adequately capitalized”, “undercapitalized”, “significantly undercapitalized”, or “critically undercapitalized”, as such terms are defined under federal banking agency regulations. Depository institutions that do not meet minimum capital requirements will face constraints on payment of dividends, equity repurchases, and compensation based on the amount of shortfall. A depository institution that is not “well capitalized” is generally prohibited from accepting brokered deposits and offering interest rates on deposits higher than the prevailing rate in its market, may be subject to asset growth limitations, and may be required to submit capital restoration plans. As of September 30, 2023, and December 31, 2022, the Bank complied with all regulatory capital standards and qualifies as “well capitalized”. Note 8 - Regulatory Capital Matters in Notes to Consolidated Financial Statements contains additional discussion and analysis regarding the Company and the Bank’s regulatory capital requirements. Effects of Inflation The majority of assets and liabilities of a financial institution are monetary in nature; therefore, a financial institution differs greatly from most commercial and industrial companies, which have significant investments in fixed assets or inventories that are greatly impacted by inflation. However, inflation does have an important impact on the growth of total assets in the banking industry and the resulting need to increase equity capital at higher than normal rates in order to 46 Table of Contents maintain an appropriate equity-to-assets ratio. Inflation also affects other expenses that tend to rise during periods of general inflation. Management believes the most significant potential impact of inflation on financial results is a direct result of the Company’s ability to manage the impact of changes in interest rates. Management attempts to maintain a balanced position between rate-sensitive assets and liabilities over an economic cycle in order to minimize the impact of interest rate fluctuations on net interest income. However, this goal can be difficult to completely achieve in times of rapidly changing interest rates and is one of many factors considered in determining the Company’s interest rate positioning. Key Factors Affecting Financial Performance We face a variety of risks that may impact various aspects of our financial performance from time to time. The extent of such impacts may vary depending on factors such as the current business and economic conditions, political and regulatory environment, and operational challenges. Many of these risks and our risk management strategies are described in more detail elsewhere in this Report as well as with the audited consolidated financial statements and notes for the year ended December 31, 2022, included in our Registration Statement. Our success will depend upon, among other things, the following factors that we manage or control: • Effectively managing capital and liquidity, including: • Continuing to maintain and, over time, grow our deposit base as a low-cost stable funding source, • Prudent liquidity and capital management to meet evolving regulatory capital, capital planning, stress testing, and liquidity standards, and • Actions we take within the capital and other financial markets, • Our ability to manage any material costs related to the execution of our strategic priorities, including increased employees, infrastructure, compliance, and other costs in a profitable manner over the long term, • Management of credit risk and interest rate risk in our portfolio, • Our ability to manage and implement strategic business objectives within the changing regulatory environment, • The impact of legal and regulatory-related contingencies, • The appropriateness of critical accounting estimates and related contingencies, • Our ability to manage operational risks related to new products and services, changes in processes and procedures, or the implementation of new technology, • The ability to make investments to promote compliance with existing and evolving regulatory requirements that will increase as the Company grows and will result in increased administrative expenses that we did not previously incur, which costs may materially increase our general and administrative expenses, and • The ability to execute our strategic objectives while satisfying the obligations associated with being a public company that will require significant resources and management attention and may divert management’s attention from our business operations. Our financial performance is also substantially affected by a number of external factors outside of our control, including the following: • Economic conditions, including the length and extent of the economic impacts of a pandemic, and the actions taken to mitigate and manage it, • The effect of climate change on our business and performance, including indirectly through impacts on our customers, • The actions by the Federal Reserve, U.S. Treasury, and other government agencies, including those that impact money supply and market interest rates and inflation, 47 Table of Contents • The level of, and direction, timing, and magnitude of movement in interest rates and the shape of the interest rate yield curve, • The functioning and other performance of, and availability of liquidity in U.S. and global financial markets, including capital markets, • The impact of tariffs and other trade policies of the U.S. and its global trading partners, • Changes in the competitive landscape, • Impacts of changes in federal, state, and local governmental policy, including on the regulatory landscape, capital markets, taxes, infrastructure spending, and social programs, • The impact of market credit spreads on asset valuations, • The ability of customers, counterparties, and issuers to perform in accordance with contractual terms, and the resulting impact on our asset quality, • Loan demand, utilization of credit commitments, and standby letters of credit, • The impact on customers and changes in customer behavior due to changing business and economic conditions or regulatory or legislative initiatives, • The possibility that the Summit merger will not close when expected or at all because required shareholder, regulatory or other approvals are not received or other conditions to the closing are not satisfied on a timely basis or at all, and • Our ability to eventually and successfully integrate into our operations Summit’s assets, liabilities or systems we acquired, as well as new management personnel or customers, and our ability to realize related revenue synergies and cost savings within expected time frames and any goodwill charges related thereto. The impact of these items, where material, is discussed in the applicable sections of this Management’s Discussion and Analysis of Financial Condition and Results of Operation. For additional information on the risks we face, see Part II, Item 1A. - Risk Factors. 48 Table of Contents Selected Financial Data The following table contains selected historical consolidated financial data as of the dates and for the periods shown. The selected balance sheet data as of September 30, 2023, and September 30, 2022, and the selected income statement data for the three months and nine months ended September 30, 2023, and September 30, 2022, have been derived from our consolidated financial statements included elsewhere in this Form 10-Q and should be read in conjunction with the other information contained in this Form 10-Q. As of the Three Months Ended September 30, As of the Nine Months Ended September 30, (In thousands, except ratios, share and per share data) 2023 2022 2023 2022 Selected Financial Condition Data: Total assets $ 3,585,188 $ 3,501,145 $ 3,585,188 $ 3,501,145 Total cash and cash equivalents 41,864 41,116 41,864 41,116 Total investment securities, at fair value 1,224,395 1,453,104 1,224,395 1,453,104 Net loans 2,044,505 1,730,874 2,044,505 1,730,874 Company-owned life insurance 94,213 92,703 94,213 92,703 Premises and equipment, net 57,514 56,558 57,514 56,558 Total deposits 2,985,618 2,977,660 2,985,618 2,977,660 Advances and other borrowings 299,000 243,000 299,000 243,000 Total shareholders’ equity 270,819 255,471 270,819 255,471 As of or for the Three Months Ended September 30, As of or for the Nine Months Ended September 30, 2023 2022 2023 2022 Selected Operating Data: Interest income $ 37,272 $ 29,265 $ 108,716 $ 80,059 Interest expense 14,383 2,585 37,261 4,277 Net interest income 22,889 26,680 71,455 75,782 Provision for (recapture of) credit losses 235 (2,388) 964 (7,564) Total non-interest income 4,289 4,261 13,128 12,872 Total non-interest expenses 22,423 19,952 64,136 59,485 Income before income taxes 4,520 13,377 19,483 36,733 Income tax expense 464 2,240 1,869 6,073 Net income 4,056 11,137 17,614 30,660 Per Share Data: Average shares of Common Stock outstanding, basic 7,428,710 7,425,760 7,427,817 7,424,862 Average shares of Common Stock outstanding, diluted 7,499,278 7,467,693 7,506,509 7,458,569 Total shares of Common Stock outstanding 7,428,710 7,425,760 7,428,710 7,425,760 Basic net income per share $ 0.55 $ 1.50 $ 2.37 $ 4.13 Diluted net income per share 0.55 1.49 2.35 4.11 Dividends declared per share 0.53 0.53 1.59 1.59 Dividend payout ratio (1) 96.36 % 35.57 % 67.66 % 38.69 % Book value (at period end) $ 36.46 $ 34.40 $ 36.46 $ 34.40 49 Table of Contents As of or for the Three Months Ended September 30, As of or for the Nine Months Ended September 30, 2023 2022 2023 2022 Performance Ratios: Return on average assets 0.45 % 1.23 % 0.65 % 1.15 % Return on average equity 5.60 14.99 8.22 12.59 Interest rate spread (2) 2.10 3.11 2.30 3.02 Net interest margin (3) 2.76 3.25 2.90 3.10 Efficiency ratio (4) 82.50 64.48 75.83 67.10 Capital Ratios: Common equity tier 1 (CET 1) capital to risk-weighted assets (5) 16.44 % 18.23 % 16.44 % 18.23 % Total risk-based capital to risk-weighted assets (5) 17.48 19.18 17.48 19.18 Tier 1 capital to risk-weighted assets (5) 16.44 18.23 16.44 18.23 Tier 1 capital to average assets (5) 11.32 11.03 11.32 11.03 Average equity to average assets (5) 8.02 8.23 7.96 9.10 Asset Quality Ratios: Allowance coverage ratio 1.26 % 1.20 % 1.26 % 1.20 % Allowance for credit losses as a percentage of non-performing loans 914.25 374.29 914.25 374.29 Net charge-offs to average outstanding loans during the period 0.00 0.00 0.00 0.18 Non-performing loans as a percentage of total loans 0.14 0.32 0.14 0.32 Non-performing assets as a percentage of total assets 0.08 0.16 0.08 0.16 Other Data: Number of full-service branches 23 24 23 24 Number of full-time equivalent employees 404 399 404 399 (1) The dividend payout ratio represents per share dividends declared divided by diluted earnings per share. (2) The interest rate spread represents the difference between the fully taxable-equivalent weighted-average yield on interest-earning assets and the weighted-average cost of interest-bearing liabilities for the period. (3) The net interest margin represents fully taxable-equivalent net interest income as a percent of average interest-earning assets for the period. (4) The efficiency ratio represents non-interest expense as a percentage of the sum of net interest income and non-interest income. (5) The 2023 capital ratios are for Burke & Herbert Financial Services Corp. and the 2022 capital ratios are for Burke & Herbert Bank & Trust Company. Results of Operations Results of Operations for the Nine Months Ended September 30, 2023, and 2022 General Consolidated net income for the nine months ended September 30, 2023, was $17.6 million compared to $30.7 million for the nine months ended September 30, 2022. The $13.0 million, or 42.6%, decrease in net income was primarily the result of a large recapture of provision expense in the first half of 2022 along with a decrease in net interest income and an increase in non-interest expense for the nine months ended September 30, 2023 compared to the nine months ended September 30, 2022. Net interest income decreased by $4.3 million to $71.5 million for the nine months ended September 30, 2023, compared to $75.8 million for the nine months ended September 30, 2022. The main driver for this decrease was higher deposit and borrowing interest expense, partially offset by higher interest income from growth in loans in addition to increases in interest rates on loans and securities. For the nine months ended September 30, 2023, the Company recorded credit provision expense of $1.0 million compared to a recapture of provision of $7.6 million for the nine months ended September 30, 2022. For the nine months ended 50 Table of Contents September 30, 2022, the Company was able to recapture a provision related to the initial uncertainty of the COVID-19 pandemic and the sale of a non-performing loan note. This non-performing loan had a specific reserve prior to the sale of the note. For the current period, the adoption of CECL (which requires the Company to estimate provision of credit losses using an expected life-time loss approach versus an incurred model), along with increased loan portfolio balances resulted in a higher credit expense for the nine months ended September 30, 2023, compared to the nine months ended, September 30, 2022. Non-interest income increased by $0.3 million, or 2.0%, to $13.1 million for the nine months ended September 30, 2023, as compared to $12.9 million for the nine months ended September 30, 2022. The increase in non-interest income was primarily due to increases in other non-interest income, including dividend income from FHLB stock that increased by $236 thousand and income from loan swap fees of $414 thousand, which were partially offset by a decrease in other non-interest income items of $301 thousand and a decrease in service charges and fees of $171 thousand for the nine months ended September 30, 2023, as compared to the nine months ended September 30, 2022. Non-interest expense increased by $4.7 million, or 7.8%, to $64.1 million for the nine months ended September 30, 2023, as compared to $59.5 million for the nine months ended September 30, 2022. The increase was primarily due to higher employee benefit costs and higher legal, consulting, and audit fees related to the filing of our initial Registration Statement, and merger-related filings. For the nine months ended September 30, 2023, the Company incurred $1.7 million of legal, consulting and audit fees related to the announced merger with Summit Financial Group, Inc. Net Interest Income and Net Interest Margin Net interest income is the principal component of the Company’s income stream and represents the difference, or spread, between interest and fee income generated from earning assets and the interest expense paid on deposits and borrowed funds. Net interest margin, stated as a percentage, is the yield obtained by dividing the difference between interest income generated on earning assets and the interest expense paid on all funding sources by average earning assets. Fluctuations in interest rates as well as changes in the volume and mix of earnings assets and interest-bearing liabilities can impact net interest income and net interest margin. Management closely monitors both total net interest income and the net interest margin and seeks to maximize net interest income without exposing the Company to an excessive level of interest rate risk through our asset and liability policies. Interest rate risk is managed by monitoring the pricing, maturity and repricing options of all classes of interest-bearing assets and liabilities. Net interest income totaled $71.5 million for the nine months ended September 30, 2023, compared to $75.8 million for the nine months ended September 30, 2022. The decrease in net interest income was primarily driven by higher interest rates and slightly higher average balances on interest-bearing liabilities, mostly offset by higher interest rates on interest-earning assets. A significant increase in cost of funds for both interest-bearing deposits and borrowed funds was the primary driver of the substantial increase in interest expense. Interest income from loans and securities increased substantially as well for the nine months ended September 30, 2023, driven primarily by higher interest rates and an increase in the volume of loans. However, this increase in interest income did not completely offset the increase in interest expense, which has increased due to the increased pace of rate hikes from the Federal Reserve resulting in higher deposit rates to retain depositors and increased the cost of borrowings from the FHLB and the Federal Reserve. The tax-adjusted net interest margin was 2.90% for the nine months ended September 30, 2023, compared to 3.10% for the nine months ended September 30, 2022. The decrease in tax-adjusted net interest margin was primarily driven by the increase in market rates that increased the cost of deposits and other borrowings in excess of the increase in interest income from interest-earning assets. The yield for the loan portfolio was 5.01% for the nine months ended September 30, 2023, compared to 3.99% for the nine months ended September 30, 2022. The increase was primarily the result of loan production with higher interest rates in a rising rate environment. The tax-adjusted yield on the total investment securities portfolio was 3.42% for the nine months ended September 30, 2023, compared to 2.53% for the nine months ended September 30, 2022. The increase was primarily due to higher market interest rates that increased the effective rate earned on investment securities and reduced the fair value of these investment securities. The rate paid on interest-bearing deposits increased to 1.70% during the nine months ended September 30, 2023, from 0.12% during the nine months ended September 30, 2022. The increase was a result of market and economic conditions, which led to an increase in our paid rates for selected parts of our deposit portfolio. Increases in deposit rates rose at a 51 Table of Contents faster pace due to the increases in the Federal Funds Rate that occurred in the second half of 2022. Continuing rate increases by the Federal Reserve and in the market rates may negatively impact our cost of funds rate. The rate paid on our borrowings for the nine months ended September 30, 2023, was 4.67%, compared to 1.27% for the corresponding period in 2022. The increase was due to the increase in short-term borrowing costs, driven by increases in the Federal Funds Rate during the year. Further increases in the Federal Funds Rate may continue to increase our overall borrowing costs. The following table sets forth the major components of net interest income and the related yields and rates for the nine months ended September 30, 2023, and September 30, 2022, for comparison (dollars in thousands). For the Nine Months Ended September 30, 2023 2022 Average Outstanding Balance Interest Income/Expense Rate Earned/Paid Average Outstanding Balance Interest Income/Expense Rate Earned/Paid Assets: Loans, gross (1)(2) $ 1,985,898 $ 74,485 5.01 % $ 1,758,267 $ 52,486 3.99 % Interest-earning deposits and fed funds sold 55,870 1,858 4.45 48,232 248 0.69 Taxable securities 1,040,695 28,130 3.61 1,163,840 20,100 2.31 Tax-exempt securities (3) 267,135 5,371 2.69 381,216 9,146 3.21 Total securities 1,307,830 33,501 3.42 1,545,056 29,246 2.53 Total interest-earning assets 3,349,598 109,844 4.38 3,351,555 81,980 3.27 Non-interest-earning assets 248,292 224,770 Total assets $ 3,597,890 $ 3,576,325 Liabilities and shareholders’ equity: Deposits: Non-interest-bearing demand $ 887,711 $ 965,859 Interest-bearing demand 554,724 1,520 0.37 % 583,080 106 0.02 % Savings 983,046 11,242 1.53 1,127,900 657 0.08 Time 559,453 13,946 3.33 285,577 960 0.45 Total interest-bearing deposits 2,097,223 26,708 1.70 1,996,557 1,723 0.12 Total deposits 2,984,934 26,708 1.20 2,962,416 1,723 0.08 Borrowings: FHLB advances and other 302,060 10,553 4.67 267,948 2,554 1.27 Total interest-bearing liabilities 2,399,283 37,261 2.08 2,264,505 4,277 0.25 Non-interest-bearing liabilities 24,485 20,355 Equity 286,411 325,606 Total liabilities and equity $ 3,597,890 $ 3,576,325 Taxable-equivalent net interest income /net interest spread (4) 72,583 2.30 % 77,703 3.02 % Taxable-equivalent net interest margin (5) 2.90 % 3.10 % Taxable-equivalent net adjustment (1,128) (1,921) Net interest income $ 71,455 $ 75,782 Net interest-earning assets $ 950,315 $ 1,087,050 (1) Non-accrual loans are included in average loan balances. (2) Loan fees are included in the calculation of interest income. 52 Table of Contents (3) Yields and interest income on tax-exempt assets are computed on a taxable-equivalent basis assuming a 21% tax rate. (4) The interest rate spread represents the difference between the fully taxable-equivalent weighted-average yield on interest-earning assets and the weighted-average cost of interest-bearing liabilities for the period. (5) The net interest margin represents fully taxable-equivalent net interest income as a percent of average interest-earning assets for the period. Taxable-equivalent net interest margin, as presented above, is calculated by dividing fully tax-equivalent (“FTE”) net interest income by total average earning assets. Net interest income, on an FTE basis, is a non-GAAP financial measure that the Company believes to provide a more accurate picture of the interest margin for comparative purposes. Management believes FTE net interest income is a standard practice in the banking industry, and when net interest income is adjusted on a FTE basis, yields on taxable, nontaxable, and partially taxable assets are comparable; however, the adjustment to a FTE basis has no impact on net income. FTE net interest income is calculated by adding the tax benefit on certain financial interest earning assets, whose interest is tax-exempt, to total interest income and then subtracting total interest expense. As a non-GAAP measure, FTE net interest income should not be considered as a substitute for the nearest comparable GAAP measure, net interest income. Net interest income shown elsewhere in this presentation is GAAP net interest income. The following table reconciles GAAP net interest income to FTE net interest income (in thousands). Nine Months Ended September 30, 2023 September 30, 2022 GAAP Financial Measurements Interest Income - Loans $ 74,485 $ 52,486 Interest Income - Securities taxable 28,130 20,101 Interest Income - Securities tax-exempt 4,243 7,224 Interest Income - Other interest income 1,858 248 Interest Expense - Deposits 26,708 1,723 Interest Expense - Borrowed funds 10,495 2,506 Interest Expense - Other 58 48 Total Net Interest Income $ 71,455 $ 75,782 Non-GAAP Financial Measurements Add: Tax Benefit on Tax-Exempt Interest Income - Securities $ 1,128 $ 1,921 Total Tax Benefit on Tax-Exempt Interest Income (1) 1,128 1,921 Tax-Equivalent Net Interest Income $ 72,583 $ 77,703 (1) Tax benefit was calculated using the federal statutory tax rate of 21%. Rate/Volume Analysis The following table sets forth the dollar difference in interest earned and paid for each major category of interest-earning assets and interest-bearing liabilities for the noted periods and the amount of such change attributable to changes in average balances (volume) or changes in average interest rates. Interest income and interest expense for the nine months ended September 30, 2023, and September 30, 2022, are annualized using an actual days over calendar year method. The volume variances are equal to the increase or decrease in average balance multiplied by current period rates, and rate variances are equal to the increase or decrease in rate times prior period average balances. Variances attributable to both rate and volume changes are calculated by multiplying the change in rate by the change in average balance and are allocated to the volume variance. See table below (in thousands). 53 Table of Contents Nine Months Ended September 30, 2023, compared to September 30, 2022 Dollar Increase (Decrease) Due to Change in: Average Volume Average Rate Net Change Income from the interest-earning assets: Loans, gross $ 11,356 $ 18,057 $ 29,413 Securities (1) (8,125) 13,814 5,689 Interest-bearing deposits and fed funds sold 340 1,813 2,153 Total interest income on interest-earning assets 3,571 33,684 37,255 Expense from the interest-bearing liabilities: Interest-bearing demand deposits (104) 1,994 1,890 Savings deposits (2,215) 16,367 14,152 Time deposits 9,841 7,521 17,362 Total interest expense on interest-bearing deposits 7,522 25,882 33,404 Borrowings 1,593 9,103 10,696 Total interest expense on interest-bearing liabilities 9,115 34,985 44,100 Taxable-equivalent net interest income $ (5,544) $ (1,301) $ (6,845) (1) Yields and interest income on tax-exempt securities have been computed on a taxable-equivalent basis. Interest Income Total interest income was $108.7 million for the nine months ended September 30, 2023, compared to $80.1 million for the nine months ended September 30, 2022, an increase of 35.8%. The increase in interest income was primarily driven by an increase in both higher interest rates and average volume for the loan portfolio along with increasing rates for the securities portfolio. Interest income on loans and securities increased by $22.0 million and $5.0 million, respectively, for the nine months ended September 30, 2023, compared to the nine months ended September 30, 2022. Interest Expense Total interest expense was $37.3 million for the nine months ended September 30, 2023, compared to $4.3 million for the nine months ended September 30, 2022. The increase in interest expense was primarily driven by increasing interest rates for both interest-bearing deposits and borrowed funds and by a lesser extent from balance increases in both deposits and borrowed funds. Interest expense on interest-bearing deposits and borrowed funds increased by $25.0 million and $8.0 million, respectively, for the nine months ended September 30, 2023, compared to the nine months ended September 30, 2022. Provision for (Recapture of) Credit Losses The provision for credit losses was $1.0 million for the nine months ended September 30, 2023, compared to a recapture of $7.6 million for the nine months ended September 30, 2022. The increased provision expense was partly due to the Company estimating credit losses using an expected life-time loss model versus an incurred model but primarily the result of a large recapture in 2022. The provision recapture in 2022 was a result of reassessing COVID-19 qualitative factors and the sale of a non-performing loan note. Proceeds obtained for this non-performing loan note were greater than the net of the loan note’s carrying value and specific reserve. Additionally, loan balances have risen significantly for the nine months ended September 30, 2023, versus the nine months ended September 30, 2022. See Note 4 - Allowance for Credit Losses in Notes to Consolidated Financial Statements for further information. 54 Table of Contents Non-interest Income The following table sets forth the various components of our non-interest income for the periods indicated (in thousands): Nine Months Ended September 30, Increase (Decrease) 2023 2022 Amount Percent Fiduciary and wealth management $ 3,996 $ 3,995 $ 1 0.0 % Service charges and fees 4,959 5,130 (171) (3.3) Net gains (losses) on securities (112) 63 (175) (277.8) Income from company-owned life insurance 1,720 1,634 86 5.3 Other non-interest income 2,565 2,050 515 25.1 Total $ 13,128 $ 12,872 $ 256 2.0 % Non-interest income increased 2.0% for the nine months ended September 30, 2023, compared to the nine months ended September 30, 2022. The increase was primarily driven by an increase in other non-interest income of $515 thousand when compared to the nine months ended September 30, 2022. This increase in other non-interest income was primarily due to an increase of $236 thousand in dividends from the FHLB and an increase of $414 thousand from customer swap fees compared to the nine months ended September 30, 2022. The increase in other non-interest income was partially offset by a decrease in other non-interest income items of $301 thousand for the nine months ended September 30, 2023. The increase in total non-interest income was also offset by a decrease of $175 thousand in net gains/(losses) on securities and a decrease of $171 thousand in service charges and fees when compared to the nine months ended September 30, 2022. Non-interest Expense The following table sets forth the various components of our non-interest expense for the periods indicated (in thousands): Nine Months Ended September 30, Increase (Decrease) 2023 2022 Amount Percent Salaries and wages $ 29,283 $ 29,240 $ 43 0.1 % Pensions and other employee benefits 7,116 5,957 1,159 19.5 Occupancy 4,464 4,306 158 3.7 Equipment rentals, depreciation and maintenance 4,231 4,296 (65) (1.5) Other 19,042 15,686 3,356 21.4 Total $ 64,136 $ 59,485 $ 4,651 7.8 % Non-interest expense increased 7.8% for the nine months ended September 30, 2023, compared to September 30, 2022. The main drivers for this increase included pensions and other employee benefits which increased by $1.2 million primarily due to increases in the costs of employee benefit plans and an increase of $3.4 million in other non-interest expense. The Company incurred legal and consulting expenses associated with filing its initial Registration Statement and merger-related filings. For the nine months ended September 30, 2023, the Company incurred $1.7 million of legal, consulting and audit fees related to the announced merger with Summit Financial Group, Inc. that are included in other non-interest expense for the nine months ended September 30, 2023. See Note 13 — Other Operating Expenses in Notes to Consolidated Financial Statements for further information on “Other” non-interest expense. Income Tax Expense Income tax expense was $1.9 million for the nine months ended September 30, 2023, a decrease of $4.2 million from the tax provision for the nine months ended September 30, 2022. The decrease was due to the decrease in net income for the nine months ended September 30, 2023, when compared to the nine months ended September 30, 2022. For the nine months ended September 30, 2023, and September 30, 2022, our effective tax rates were 9.6% and 16.5%, respectively. Results of Operations for the Three Months Ended September 30, 2023, and 2022 General Consolidated net income for the three months ended September 30, 2023, was $4.1 million, compared to $11.1 million earned during the three months ended September 30, 2022. The $7.1 million, or 63.6%, decrease in net income is primarily 55 Table of Contents due to a recapture of provision expense in the prior year quarter, a decrease in net interest income, and an increase in non-interest expense compared to the prior year quarter ended September 30, 2022. Net interest income decreased by $3.8 million to $22.9 million for the three months ended September 30, 2023, compared to $26.7 million for the three months ended September 30, 2022. The main driver for this decrease was higher funding costs on both our deposits and borrowings, which was partially offset by higher interest income from growth in loans in addition to increases in interest rates on loans and securities. For the three months ended September 30, 2023, the Company recorded credit loss expense of $0.2 million compared to a recapture of provision losses of $2.4 million. For the three months ended September 30, 2022, the Company was able to recapture provision that was booked to reflect the uncertainty of the COVID-19 pandemic. For the current period, the increased loan growth and the adoption of CECL, which requires the Company to estimate provision of credit losses using an expected life-time loss approach versus an incurred model, resulted in a higher credit expense for the three months ended September 30, 2023, compared to the three months ended September 30, 2022. Non-interest income slightly increased by $28 thousand, or 0.7%, to $4.3 million for the three months ended September 30, 2023, as compared to $4.3 million for the three months ended September 30, 2022. The increase in non-interest income was primarily due to small increases in most non-interest categories which were mostly offset by a decline in service charges and fees of $153 thousand in the three months ended September 30, 2023, compared to September 30, 2022. Non-interest expense increased by $2.5 million, or 12.4%, to $22.4 million for the three months ended September 30, 2023, as compared to $20.0 million for the three months ended September 30, 2022. The increase was primarily due to increases in other non-interest expenses including higher legal, consulting, and audit fees arising from merger-related filings. The increase was also driven by increases in employee benefit expenses and occupancy related expenses when compared to the quarter ended September 30, 2022. Net Interest Income and Net Interest Margin Net interest income is the principal component of the Company’s income stream and represents the difference, or spread, between interest and fee income generated from earning assets and the interest expense paid on deposits and borrowed funds. Net interest margin, stated as a percentage, is the yield obtained by dividing the difference between interest income generated on earning assets and the interest expense paid on all funding sources by average earning assets. Fluctuations in interest rates as well as changes in the volume and mix of earnings assets and interest-bearing liabilities can impact net interest income and net interest margin. Management closely monitors both total net interest income and the net interest margin and seeks to maximize net interest income without exposing the Company to an excessive level of interest rate risk through our asset and liability policies. Interest rate risk is managed by monitoring the pricing, maturity and repricing options of all classes of interest-bearing assets and liabilities. Net interest income totaled $22.9 million for the three months ended September 30, 2023, compared to $26.7 million for the three months ended September 30, 2022. The decrease in net interest income was primarily driven by both higher interest rates and higher volume of interest-bearing liabilities. The impact of higher rates on interest-bearing liabilities was partially offset by the increase in volume and rates of interest-earning assets. However, the increased pace of rate hikes from the Federal Reserve has resulted in higher deposit rates to retain depositors and increased the cost of borrowings from the FHLB and the Federal Reserve. The tax-adjusted net interest margin was 2.76% for the three months ended September 30, 2023, compared to 3.25% for the three months ended September 30, 2022. The decrease in tax-adjusted net interest margin was primarily driven by the increase in market rates that increased the cost of deposit and other borrowings in excess of the increase in the interest income from interest-earning assets. The yield for the loan portfolio was 5.15% for the three months ended September 30, 2023, compared to 4.19% for the three months ended September 30, 2022. The increase was primarily the result of increasing loan production with higher interest rates in a rising rate environment. The tax-adjusted yield on the total investment securities portfolio was 3.37% for the three months ended September 30, 2023, compared to 2.89% for the three months ended September 30, 2022. The increase was primarily due to higher market interest rates that increased the effective rate earned by reducing the fair value of the average outstanding balance of the investment securities. 56 Table of Contents The rate paid on interest-bearing deposits increased to 2.09% during the three months ended September 30, 2023, from 0.19% during the three months ended September 30, 2022. The increase was a result of market and economic conditions, which led to an increase in our offering rate for selected parts of our deposit portfolio. Increases in deposit rates rose at a faster pace due to the increases in the Federal Funds Rate that continued in the second half of 2022. Additional increases by the Federal Reserve and in the market rates may negatively impact our cost of funds rate. The rate paid on our borrowings for the three months ended September 30, 2023, was 4.69%, compared to 2.31% for the corresponding period in 2022. The increase was due to the increase in short-term borrowing costs, driven by increases in the Federal Funds Rate during the year. Further increases in the Federal Funds Rate may continue to increase our overall borrowing costs. The following table sets forth the major components of net interest income and the related yields and rates for the three months ended September 30, 2023, and September 30, 2022, for comparison (dollars in thousands). 57 Table of Contents For the Three Months Ended September 30, 2023 2022 Average Outstanding Balance Interest Income/Expense Rate Earned/Paid Average Outstanding Balance Interest Income/Expense Rate Earned/Paid Assets: Loans, gross (1)(2) $ 2,034,275 $ 26,425 5.15 % $ 1,763,540 $ 18,618 4.19 % Interest-earning deposits and fed funds sold 49,501 562 4.50 36,513 142 1.54 Taxable securities 991,170 8,909 3.57 1,153,564 8,171 2.81 Tax-exempt securities (3) 262,336 1,742 2.63 374,977 2,955 3.13 Total securities 1,253,506 10,651 3.37 1,528,541 11,126 2.89 Total interest-earning assets 3,337,282 37,638 4.47 3,328,594 29,886 3.56 Non-interest-earning assets 244,488 252,262 Total assets $ 3,581,770 $ 3,580,856 Liabilities and shareholders’ equity: Deposits: Non-interest-bearing demand $ 860,983 $ 985,203 Interest-bearing demand 537,644 757 0.56 % 557,232 36 0.03 % Savings 952,001 4,370 1.82 1,133,804 273 0.10 Time 654,952 6,150 3.73 309,106 645 0.83 Total interest-bearing deposits 2,144,597 11,277 2.09 2,000,142 954 0.19 Total deposits 3,005,580 11,277 1.49 2,985,345 954 0.13 Borrowings: FHLB advances and other 262,521 3,106 4.69 280,069 1,631 2.31 Total interest-bearing liabilities 2,407,118 14,383 2.37 2,280,211 2,585 0.45 Non-interest-bearing liabilities 26,442 20,604 Equity 287,227 294,838 Total liabilities and equity $ 3,581,770 $ 3,580,856 Taxable-equivalent net interest income /net interest spread (4) 23,255 2.10 % 27,301 3.11 % Taxable-equivalent net interest margin (5) 2.76 % 3.25 % Taxable-equivalent net adjustment (366) (621) Net interest income $ 22,889 $ 26,680 Net interest-earning assets $ 930,164 $ 1,048,383 (1) Non-accrual loans are included in average loan balances. (2) Loan fees are included in the calculation of interest income. (3) Yields and interest income on tax-exempt assets are computed on a taxable-equivalent basis assuming a 21% tax rate. (4) The interest rate spread represents the difference between the fully taxable-equivalent weighted-average yield on interest-earning assets and the weighted-average cost of interest-bearing liabilities for the period. (5) The net interest margin represents fully taxable-equivalent net interest income as a percent of average interest-earning assets for the period. Taxable-equivalent net interest margin, as presented above, is calculated by dividing FTE net interest income by total average earning assets. Net interest income, on an FTE basis, is a non-GAAP financial measure that the Company believes to provide a more accurate picture of the interest margin for comparative purposes. Management believes FTE net interest income is a standard practice in the banking industry, and when net interest income is adjusted on a FTE basis, yields on taxable, nontaxable, and partially taxable assets are comparable; however, the adjustment to a FTE basis has no impact on 58 Table of Contents net income. FTE net interest income is calculated by adding the tax benefit on certain financial interest earning assets, whose interest is tax-exempt, to total interest income then subtracting total interest expense. As a non-GAAP measure, FTE net interest income should not be considered as a substitute for the nearest comparable GAAP measure, net interest income. Net interest income shown elsewhere in this presentation is GAAP net interest income. The following table reconciles GAAP net interest income to FTE net interest income (in thousands). Three Months Ended September 30, 2023 September 30, 2022 GAAP Financial Measurements Interest Income - Loans $ 26,425 $ 18,618 Interest Income - Securities taxable 8,909 8,171 Interest Income - Securities tax-exempt 1,376 2,334 Interest Income - Other interest income 562 142 Interest Expense - Deposits 11,277 954 Interest Expense - Borrowed funds 3,078 1,614 Interest Expense - Other 28 17 Total Net Interest Income $ 22,889 $ 26,680 Non-GAAP Financial Measurements Add: Tax Benefit on Tax-Exempt Interest Income - Securities $ 366 $ 621 Total Tax Benefit on Tax-Exempt Interest Income (1) 366 621 Tax-Equivalent Net Interest Income $ 23,255 $ 27,301 (1) Tax benefit was calculated using the federal statutory tax rate of 21%. Rate/Volume Analysis The following table sets forth the dollar difference in interest earned and paid for each major category of interest-earning assets and interest-bearing liabilities for the noted periods and the amount of such change attributable to changes in average balances (volume) or changes in average interest rates. Interest income and interest expense for the three months ended September 30, 2023, and September 30, 2022, are annualized using an actual days over calendar year method. Volume variances are equal to the increase or decrease in average balance multiplied by current period rates, and rate variances are equal to the increase or decrease in rate times prior period average balances. Variances attributable to both rate and volume changes are calculated by multiplying the change in rate by the change in average balance and are allocated to the volume variance. See table below (in thousands). Three Months Ended September 30, 2023, compared to September 30, 2022 Dollar Increase (Decrease) Due to Change in: Average Volume Average Rate Net Change Income from the interest-earning assets: Loans, gross $ 14,122 $ 16,858 $ 30,980 Securities (1) (9,271) 7,385 (1,886) Interest-bearing deposits and fed funds sold 585 1,080 1,665 Total interest income on interest-earning assets 5,436 25,323 30,759 Expense from the interest-bearing liabilities: Interest-bearing demand deposits (109) 2,965 2,856 Savings deposits (3,311) 19,576 16,265 Time deposits 13,669 8,164 21,833 Total interest expense on interest-bearing deposits 10,249 30,705 40,954 Borrowings (824) 6,682 5,858 Total interest expense on interest-bearing liabilities 9,425 37,387 46,812 Taxable-equivalent net interest income $ (3,989) $ (12,064) $ (16,053) (1) Yields and interest income on tax-exempt securities have been computed on a taxable-equivalent basis. 59 Table of Contents Interest Income Total interest income was $37.3 million for the three months ended September 30, 2023, compared to $29.3 million for the three months ended September 30, 2022, an increase of 27.4%. The increase in interest income was primarily driven by an increase in both rates and volume for the loan portfolio. Interest income on loans increased by $7.8 million and interest income on securities decreased $(0.2) million, for the three months ended September 30, 2023, compared to the three months ended September 30, 2022. Interest Expense Total interest expense was $14.4 million for the three months ended September 30, 2023, compared to $2.6 million for the three months ended September 30, 2022. The increase in interest expense was primarily driven by increasing rates for both deposits and borrowed funds. The average interest-bearing balances of deposits also increased, but primarily, the increase in interest rate expense was due to higher rates. Interest expense on interest-bearing deposits and borrowed funds increased by $10.3 million and $1.5 million, respectively, for the three months ended September 30, 2023 compared to the three months ended September 30, 2022. Provision for (Recapture of) Credit Losses The provision for credit losses was $0.2 million for the three months ended September 30, 2023, compared to a recapture of $2.4 million for the three months ended September 30, 2022. The increased provision expense was primarily due to a recapture of provision that was booked to reflect the uncertainty of the COVID-19 pandemic for three months ended September 30, 2022 and the Company estimating credit losses using an expected life-time loss model versus an incurred model for the three months ended September 30, 2023. Additionally, loan balances have risen significantly for the three months ended September 30, 2023, versus the three months ended September 30, 2022. See Note 4 - Allowance for Credit Losses in Notes to Consolidated Financial Statements for further information. Non-interest Income The following table sets forth the various components of our non-interest income for the periods indicated (in thousands): Three months ended September 30, Increase (Decrease) 2023 2022 Amount Percent Fiduciary and wealth management $ 1,354 $ 1,328 $ 26 2.0 % Service charges and fees 1,583 1,736 (153) (8.8) Net gains (losses) on securities (1) (41) 40 (97.6) Income from company-owned life insurance 589 555 34 6.1 Other non-interest income 764 683 81 11.9 Total $ 4,289 $ 4,261 $ 28 0.7 % Non-interest income increased 0.7% for the three months ended September 30, 2023, compared to the three months ended September 30, 2022. The increase was primarily driven by an increase in other non-interest income of $81 thousand, and a small increase in fiduciary and wealth management income as well as small increases in income from company-owned life insurance and a decline in losses on securities. This increase was partially offset by a decline in service charges and fees in the three months ended September 30, 2023. Non-interest Expense The following table sets forth the various components of our non-interest expense for the periods indicated (in thousands): Three months ended September 30, Increase (Decrease) 2023 2022 Amount Percent Salaries and wages $ 9,867 $ 10,094 $ (227) (2.2) % Pensions and other employee benefits 2,242 2,017 225 11.2 Occupancy 1,462 1,151 311 27.0 Equipment rentals, depreciation and maintenance 1,435 1,534 (99) (6.5) Other 7,417 5,156 2,261 43.9 Total $ 22,423 $ 19,952 $ 2,471 12.4 % 60 Table of Contents Non-interest expense increased $2.5 million or 12.4% for the three months ended September 30, 2023, compared to September 30, 2022. The main drivers for this increase include an increase in employee benefit expenses, an increase in occupancy related expenses, and a large increase of $2.3 million in other non-interest expenses. For the three months ended September 30, 2023, the Company incurred $1.6 million of legal, consulting, and audit fees related to the announced merger with Summit Financial Group, Inc. that are included in other non-interest expense for the three months ended September 30, 2023. See Note 13 — Other Operating Expenses in Notes to Consolidated Financial Statements for further information on “Other” non-interest expense. Income Tax Expense Income tax expense was $0.5 million for the three months ended September 30, 2023, a decrease of $1.8 million from the tax provision for the three months ended September 30, 2022. The decrease was due to the decrease in net income for the three months ended September 30, 2023, when compared to the prior year three months ended September 30, 2022. For the three months ended September 30, 2023, and September 30, 2022, our effective tax rates were 10.3% and 16.7%, respectively. Analysis of Financial Condition for the Period Ended September 30, 2023, and December 31, 2022 Assets increased by $22.3 million to $3.59 billion as of September 30, 2023, compared to $3.56 billion as of December 31, 2022. Loans, net of ACL, increased by $178.3 million from $1.87 billion as of December 31, 2022, to $2.04 billion as of September 30, 2023. Deposits increased by $65.2 million and amounted to $2.99 billion at September 30, 2023, compared to $2.92 billion at December 31, 2022. Borrowed funds decreased by $44.1 million to $299.0 million as of September 30, 2023, compared to $343.1 million at December 31, 2022. Investment Securities Our investment policy is established and reviewed annually by the Board. We are permitted under federal law to invest in various types of liquid assets, including United States Government obligations, securities of various federal agencies and of state and municipal governments, mortgage-backed securities, time deposits of federally insured institutions, certain bankers’ acceptances, and federal funds. Our securities are all classified as AFS. Our investments provide a source of liquidity because we can pledge them to support borrowed funds or can liquidate them to generate cash proceeds. Our investment portfolio is also a resource in managing interest rate risk because the maturity and interest rate characteristics of this asset class can be modified to match changes in the loan and deposit portfolios. The majority of our AFS investment portfolio is comprised of obligations of states and municipalities and residential mortgage-backed securities. During the nine months ended September 30, 2023, the unrealized losses on our holdings increased from December 31, 2022, as the increase in long-term interest rate expectations, portfolio runoff, and rebalancing had a negative impact on the value of our AFS portfolio. On January 1, 2023, the Company adopted the new CECL standard in accordance with ASU 2016-13, which changed the accounting framework by replacing the other-than-temporary impairment (“OTTI”) assessment with the recognition of an ACL. The Company determined that the declines in market value were due to increases in interest rates and market movements and not due to credit factors. Therefore, the Company has concluded that the unrealized losses for the AFS securities do not require an ACL at September 30, 2023. Under the prior OTTI framework, the Company did not record any cumulative OTTI expense as of December 31, 2022. The Company has sufficient access to liquidity such that management does not believe it would be necessary to sell any of its investment securities at a loss to offset any unexpected deposit outflows. Management believes the structure of the Bank’s investment portfolio is appropriately aligned with the rest of the balance sheet to protect against significant and unexpected charges against earnings and capital. 61 Table of Contents The following tables reflect the amortized cost and fair market values for the total portfolio for each category of investment for September 30, 2023, and December 31, 2022 (in thousands): September 30, 2023 Amortized Cost Gross Unrealized Gains Gross Unrealized Losses Fair Value Securities Available-for-Sale U.S. Treasuries and government agencies $ 197,310 $ — $ 24,328 $ 172,982 Obligations of states and municipalities 536,885 7 107,413 429,479 Residential mortgage backed - agency 47,494 — 5,658 41,836 Residential mortgage backed - non-agency 307,763 4 25,659 282,108 Commercial mortgage backed - agency 36,874 20 1,355 35,539 Commercial mortgage backed - non-agency 181,844 — 8,500 173,344 Asset backed 82,811 11 1,650 81,172 Other 9,500 — 1,565 7,935 Total $ 1,400,481 $ 42 $ 176,128 $ 1,224,395 December 31, 2022 Amortized Cost Gross Unrealized Gains Gross Unrealized Losses Fair Value Securities Available-for-Sale U.S. Treasuries and government agencies $ 198,154 $ — $ 23,161 $ 174,993 Obligations of states and municipalities 550,590 12 96,695 453,907 Residential mortgage backed - agency 57,883 14 4,836 53,061 Residential mortgage backed - non-agency 365,983 2 26,690 339,295 Commercial mortgage backed - agency 61,810 75 1,952 59,933 Commercial mortgage backed - non-agency 191,709 10 8,420 183,299 Asset backed 101,791 49 3,214 98,626 Other 9,500 — 857 8,643 Total $ 1,537,420 $ 162 $ 165,825 $ 1,371,757 The investment maturity table below summarizes contractual maturities for our investment securities at September 30, 2023. The actual timing of principal payments may differ from remaining contractual maturities because obligors may have the right to repay certain obligations with or without penalties. The overall weighted average duration of the Company’s investment portfolio is 4.0 years at September 30, 2023. The weighted-average yield below represents the effective yield for the investment securities and is calculated based on the amortized cost of each security (dollars in thousands). Interest on securities below excludes tax-equivalent adjustments. September 30, 2023 One Year or Less One to Five Years Five to Ten Years After Ten Years Total Amortized Cost Weighted Average Yield Amortized Cost Weighted Average Yield Amortized Cost Weighted Average Yield Amortized Cost Weighted Average Yield Amortized Cost Weighted Average Yield Securities Available-for-Sale U.S. Treasuries and government agencies $ 29,802 1.61 % $ 78,123 1.23 % $ 89,385 1.38 % $ — — % $ 197,310 1.36 % Obligations of states and municipalities 370 4.10 15,989 2.47 234,600 2.11 285,926 2.08 536,885 2.11 Residential mortgage backed - agency 42 4.17 808 4.09 46,644 3.65 — — 47,494 3.66 Residential mortgage backed - non-agency 72,280 2.86 137,888 3.99 95,182 3.65 2,413 6.56 307,763 3.64 Commercial mortgage backed - agency 165 7.34 19,531 5.40 17,178 4.88 — — 36,874 5.17 Commercial mortgage backed - non-agency 13,613 7.04 163,088 4.87 5,143 1.43 — — 181,844 4.94 Asset backed 8,247 5.72 41,248 6.72 33,316 5.85 — — 82,811 6.27 Other — — — — 9,500 5.13 — — 9,500 5.13 Total $ 124,519 3.22 % $ 456,675 4.09 % $ 530,948 2.77 % $ 288,339 2.12 % $ 1,400,481 3.11 % 62 Table of Contents Lending Activities Our loan portfolio consists primarily of commercial real estate loans, but we offer a variety of products to meet the credit needs of our borrowers. The risks associated with lending activities differ among loan classes and are subject to the impact of changes in interest rates, market conditions of collateral securing the loans, and general economic conditions. Any of these factors may adversely impact a borrower’s ability to repay loans and also impact the associated collateral. Additional discussion on the classes of loans the Company makes and related risks is included in Note 3 — Loans in Notes to Consolidated Financial Statements. The following tables set forth the composition of our loan portfolio as of the dates indicated (in thousands): September 30, 2023 December 31, 2022 Commercial real estate $ 1,260,653 $ 1,109,315 Owner-occupied commercial real estate 123,496 127,114 Acquisition, construction & development 96,535 94,450 Commercial & industrial 61,571 53,514 Single family residential (1-4 units) 525,558 499,362 Consumer non-real estate and other 2,803 3,466 Loans, gross 2,070,616 1,887,221 Allowance for credit losses (26,111) (21,039) Loans, net $ 2,044,505 $ 1,866,182 The loan portfolio, excluding ACL, at September 30, 2023, increased by $183.4 million primarily due to growth in our commercial and residential real estate loan production. The Company’s organic growth has occurred in both legacy and newer markets, principally in commercial real estate. The following table shows the maturity distribution for total loans outstanding as of September 30, 2023. The maturity distribution is grouped by remaining scheduled principal payments that are due in the following periods. The principal balance of loans are indicated by both fixed and floating rate categories in the table below (in thousands). September 30, 2023 Within One Year One Year to Five Years Five Years to 15 Years After 15 Years Fixed Rates Adjustable Rates Fixed Rates Adjustable Rates Fixed Rates Adjustable Rates Fixed Rates Adjustable Rates Total Loans: Commercial real estate $ 92,343 $ 34,169 $ 538,416 $ 110,177 $ 388,283 $ 95,660 $ — $ 1,605 $ 1,260,653 Owner-occupied commercial real estate 8,403 235 54,274 5,337 53,523 579 — 1,145 123,496 Acquisition, construction & development 22,613 6,988 880 57,800 5,531 594 1,628 501 96,535 Commercial & industrial 502 10,475 38,132 6,019 5,293 1,150 — — 61,571 Total commercial loans 123,861 51,867 631,702 179,333 452,630 97,983 1,628 3,251 1,542,255 Single family residential (1-4 units) 3,674 1,901 9,889 13,326 19,636 11,568 273,931 191,633 525,558 Consumer non-real estate and other 217 277 937 549 401 — 22 400 2,803 Total loans $ 127,752 $ 54,045 $ 642,528 $ 193,208 $ 472,667 $ 109,551 $ 275,581 $ 195,284 $ 2,070,616 Asset Quality The Company maintains policies and procedures to promote sound underwriting and mitigate credit risk. The Chief Credit Officer is responsible for establishing credit risk policies and procedures, including underwriting guidelines and credit approval authority, and monitoring credit exposure and performance of the Company’s lending-related transactions. A loan is placed on non-accrual status when (i) the Company is advised by the borrower that scheduled principal or interest payments cannot be met, (ii) when management’s best judgment indicates that payment in full of principal and interest can no longer be expected, or (iii) when any such loan or obligation becomes delinquent for 90 days, unless it is both well-secured and in the process of collection. 63 Table of Contents The Company’s asset quality remained stable through the second quarter of 2023. The Company’s non-performing assets, which includes non-performing loans consisting of non-accrual loans, loans that are more than 90 days past due and still accruing, and other real estate owned as of September 30, 2023, totaled $2.9 million. The following table summarizes the Company’s non-performing assets as of September 30, 2023, and December 31, 2022 (in thousands): September 30, 2023 December 31, 2022 Non-accrual loans $ 2,856 $ 5,497 90 days past due and still accruing — — Total non-performing loans 2,856 5,497 Other real estate owned — — Total non-performing assets $ 2,856 $ 5,497 Allowance for Credit Losses Refer to the discussion in Note 1. Nature of Business Activities and Significant Accounting Policies in Notes to Consolidated Financial Statements for management’s approach to estimating the ACL. The Company maintains the ACL at a level deemed adequate by management for expected credit losses. As disclosed in Note 1 and Note 4 , on January 1, 2023, the Company implemented CECL and increased the ACL, previously the allowance for credit losses, with a cumulative-effect adjustment to the ACL for credit losses of $4.4 million, which included a cumulative-effect adjustment to the ACL for off-balance sheet exposures of $274.8 thousand. The Company’s ACL is calculated quarterly with any adjustment recorded to the provision for credit losses in the consolidated Statement of Income. Management evaluates the adequacy of the ACL utilizing a defined methodology to determine if it properly addresses the current and expected risks in the loan portfolio, which considers the performance of borrowers and specific evaluation of individually evaluated loans, including historical loss experiences, trends in delinquencies, non-performing loans and other risk assets, and qualitative factors. Risk factors are continuously reviewed and adjusted, as needed, by management when conditions support a change. Management believes its approach properly addresses relevant accounting and bank regulatory guidance for loans both collectively and individually evaluated. Gross charged-off loans were $13.0 thousand and $54.0 thousand for the three months ended September 30, 2023, and September 30, 2022, respectively, and $134.0 thousand and $3.4 million for the nine months ended September 30, 2023, and September 30, 2022, respectively. Gross recoveries totaled $5.0 thousand and $33.0 thousand for the three months ended September 30, 2023, and September 30, 2022, respectively, and $48.0 thousand and $219.0 thousand for the nine months ended September 30, 2023, and September 30, 2022, respectively. The ACL as a percentage of gross loans, net of unearned income, was 1.26% and 1.20% as of September 30, 2023, and September 30, 2022, respectively. The Company recorded a provision of $200 thousand and a provision recapture of $2.4 million for the three months ended September 30, 2023, and September 30, 2022, respectively, and a provision of $1.0 million and a provision recapture of $7.6 million for the nine months ended September 30, 2023, and September 30, 2022, respectively. The provision recapture was as a result of removing COVID-19 qualitative factors and the sale of a non-performing loan note in the first half of 2022. 64 Table of Contents The following table summarizes the changes in the Company’s credit loss experience by portfolio as of the three and nine months ended September 30, 2023, and 2022 (dollars in thousands): Three months ended Nine months ended September 30, 2023 September 30, 2022 September 30, 2023 September 30, 2022 Loans outstanding at end of period $ 2,070,616 $ 1,751,827 $ 2,070,616 $ 1,751,827 Balance of allowance at beginning of period (25,919) (23,362) (21,039) (31,709) Impact of the adoption of CECL — (4,125) — Loans charged-off: Commercial real estate — — — 3,282 Owner-occupied commercial real estate — — — — Acquisition, construction & development — — — — Commercial & industrial — — 29 20 Residential — — — — Consumer non-real estate and other 13 54 105 109 Total loans charged-off 13 54 134 3,411 Recoveries of loans charged-off: Commercial real estate (4) (27) (35) (34) Owner-occupied commercial real estate — — — — Acquisition, construction & development — — — — Commercial & industrial — — — — Residential (1) (2) (7) (166) Consumer non-real estate and other — (4) (6) (19) Total recoveries of loans charged-off (5) (33) (48) (219) Net loan charge-offs (recoveries) 8 21 86 3,192 Provision for (recapture of) credit losses for the period 200 (2,388) 1,033 (7,564) Ending allowance $ (26,111) $ (20,953) $ (26,111) $ (20,953) Average loans outstanding during the period $ 2,034,275 $ 1,763,540 $ 1,985,898 $ 1,758,267 Allowance coverage ratio (1) 1.26 % 1.20 % 1.26 % 1.20 % Net charge-offs to average outstanding loans during the period (2) 0.00 0.00 0.00 0.18 Allowance for credit losses as a percentage of non-performing loans (3) 914.25 374.29 914.25 374.29 (1) The allowance coverage ratio is calculated by dividing the ACL at the end of the period by gross loans, net of unearned income at the end of the period. (2) The Net charge-offs to average outstanding loans during the period is calculated by dividing total net loan charge-offs (recoveries) during the year by average gross loans outstanding during the year. (3) The Allowance for credit losses as a percentage of non-performing loans ratio is calculated by dividing the ACL at the end of the period by non-accrual loans at the end of the period. 65 Table of Contents The following table summarizes the ACL and the allowance for credit losses by portfolio with a comparison of the percentage composition in relation to total ACL and allowance for credit losses and total loans as of September 30, 2023, and December 31, 2022 (dollars in thousands). September 30, 2023 Allowance for credit losses Percent of Allowance in Each Category to Total Allocated ACL Percent of Loans in Each Category to Total Loans Commercial real estate $ 19,612 75.10 % 60.89 % Owner-occupied commercial real estate 785 3.01 5.96 Acquisition, construction & development 1,765 6.76 4.66 Commercial & industrial 517 1.98 2.97 Residential 3,386 12.97 25.38 Consumer non-real estate and other 46 0.18 0.14 Total $ 26,111 100.00 % 100.00 % December 31, 2022 Allowance for credit losses Percent of Allowance in Each Category to Total Allocated Allowance Percent of Loans in Each Category to Total Loans Commercial real estate $ 15,477 73.56 % 58.78 % Owner-occupied commercial real estate 635 3.02 6.74 Acquisition, construction & development 2,082 9.90 5.00 Commercial & industrial 438 2.08 2.84 Residential 2,379 11.31 26.46 Consumer non-real estate and other 28 0.13 0.18 Total $ 21,039 100.00 % 100.00 % Derivative Financial Instruments The Company utilizes interest rate swap agreements as part of its asset/liability management strategy to help manage its interest rate risk position. The Company recognizes derivative financial instruments at fair value as either other assets or other liabilities on the Consolidated Balance Sheets. The Company’s use of derivative financial instruments are described more fully in Note 9 — Derivatives in Notes to Consolidated Financial Statements. Off-Balance Sheet Arrangements The Company enters into certain off-balance sheet arrangements in the normal course of business to meet the financing needs of its customers. These off-balance sheet arrangements include commitments to extend credit, standby letters of credit, and financial guarantees which would impact the Company’s liquidity and capital resources to the extent customers accept and/or use these commitments. See Note 10 — Commitments and Contingencies in Notes to Consolidated Financial Statements for a discussion of credit extension commitments. These instruments involve, to varying degrees, elements of credit and interest rate risk in excess of the amount recognized in the balance sheet. With the exception of these off-balance sheet arrangements, the Company has no off-balance sheet arrangements that have, or are reasonably likely to have, a current or future effect on the Company’s financial condition, changes in financial condition, revenues or expenses, results of operations, liquidity, capital expenditures, or capital resources. Funding Activities The Company’s funding activities are monitored and governed through the Company’s asset/liability management process. Deposits are the primary source of funds for lending and investing activities; however, the Company will use borrowings to meet liquidity needs and for temporary funding. Sources of borrowings include advances from the FHLB of Atlanta, borrowings from correspondent banks, and the Fed Discount Window. The Company also utilizes brokered time deposits. For more discussion of brokered time deposits, see the Deposits heading below this section. 66 Table of Contents As of September 30, 2023, the Company has available unused borrowing capacity of $883.5 million through its available lines of credit with the FHLB of Atlanta and unsecured federal fund lines of credit from correspondent banking relationships. Advances on credit lines are secured by both securities and loans. The following table shows certain information regarding borrowings as of the three months ended September 30, 2023, and December 31, 2022, respectively (dollars in thousands): September 30, 2023 December 31, 2022 Balance at end of period $ 299,000 $ 343,100 Weighted average interest rate at end of period 4.83% 4.42% Deposits Total deposits increased by $65.2 million from December 31, 2022, to September 30, 2023, due to an increase in the balance of brokered time deposits. The Company has issued brokered time deposits that amounted to $389.0 million as of September 30, 2023, and $100.3 million at December 31, 2022, which are included in the table below within “Time deposits, other”. The following table sets forth the balance of each category of deposits as of the dates indicated (in thousands): September 30, 2023 December 31, 2022 Balance Balance Demand, non-interest-bearing $ 853,385 $ 960,692 Demand, interest-bearing 530,360 616,665 Money market and savings 927,035 1,044,152 Time deposits, other 674,838 298,891 Total interest-bearing 2,132,233 1,959,708 Total deposits $ 2,985,618 $ 2,920,400 The Company continues to seek organic growth in both interest-bearing and non-interest-bearing deposits consistent with our relationship-based strategy. Management evaluates its utilization of brokered deposits, taking into consideration the interest rate curve and regulatory views on non-core funding sources, and balances this funding source with its funding needs based on growth initiatives. The Company has deposits that meet or exceed the FDIC insurance limit of $250,000 in the amounts of $670.7 million and $843.4 million at September 30, 2023, and December 31, 2022, respectively. The following table sets forth maturity ranges of time deposits as of September 30, 2023, that meet or exceed the FDIC insurance limit (in thousands). September 30, 2023 Due within 3 months or less $ 8,909 Due after 3 months and within 6 months 24,287 Due after 6 months and within 12 months 27,441 Due after 12 months 4,840 Total uninsured, time deposits $ 65,477 Shareholders’ Equity Total shareholders’ equity at September 30, 2023, was $270.8 million, compared to $273.5 million at December 31, 2022. Shareholders’ equity decreased by $2.6 million in part due to an increase in unrealized losses in the AFS securities portfolio since December 31, 2022. Accumulated other comprehensive income decreased $6.7 million from December 31, 2022, to September 30, 2023, primarily as a result of an increase in unrealized losses on AFS investment securities. 67 Table of Contents