What changed in this filing

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Item 2. Management’s Discussion and Analysis

2021-08-05 compared with 2021-05-06 · 336 added, 256 removed, 495 unchanged (54% of the section changed)

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This Form 10- Q includes forward-looking statements that involve inherent risks and uncertainties.

Words such as “expects”, “anticipates”, “believes”, “projects”, and “estimates” or variations of such words and similar expressions are intended to identify forward-looking statements.

These statements are based on certain underlying assumptions and are not guarantees of future performance, as they could be impacted by a several potential risks and developments that cannot be predicted with any degree of certainty.

These forward-looking statements are within the meaning of Section 27A of the Securities Act of 1933 (“1933 Act”), as amended and Section 21E of the Securities Exchange Act of 1934 (“1934 Act”), as amended.

Those sections of the 1933 Act and 1934 Act provide a “safe harbor” for forward-looking statements in order to encourage companies to provide prospective information about their financial performance as long as important factors that could cause actual results to differ significantly from projected results are identified with meaningful cautionary statements.

Words such as “expects”, “anticipates”, “believes”, “projects”, “intends”, and “estimates” or variations of such words and similar expressions, as well as future or conditional verbs preceded by “will”, “would”, “should”, “could” or “may” are intended to identify forward-looking statements.

These forward-looking statements are based on certain underlying assumptions and are not guarantees of future performance, as they could be impacted by a several potential risks and developments that cannot be predicted with any degree of certainty.

These statements are based on management’s current expectations regarding economic, legislative, regulatory and other environmental issues that may affect our earnings in future periods.

Therefore, actual outcomes and results may differ materially from what is expressed, forecast in, or implied by such forward-looking statements.

A variety of factors could have a material adverse impact on the Company’s financial condition or results of operations, and should be considered when evaluating the Company’s potential future financial performance.

They include, but are not limited to, the risk of unfavorable economic conditions in the Company’s market areas;

risks associated with the current national emergency with respect to COVID-19 including the impact that national, state, and local responses, including shelter-at-home orders and limitations on business and personal activity as well as any stimulus or relief efforts, have on customers’ ability to repay loans or to resume normal payments following the end of COVID-19 related deferrals granted by the Bank;

They include, but are not limited to:

● the risk of unfavorable economic conditions in the Company’s market areas;

● risks associated with the current national emergency with respect to COVID-19 and its variants, including the impact that national, state, and local responses, including limitations on business and personal activity as well as any stimulus or relief efforts, have on customers’ continued ability to repay loans or to resume normal payments following the end of COVID-19 related deferrals granted by the Bank;

● the Company’s delayed implementation of CECL;

the ability for the Company to serve its customers with modified branch operations as well as social distancing guidelines and mandates under state and local stay-at-home orders;

● risks associated with fluctuations in interest rates or a sustained low interest rate environment;

liquidity risks;

● liquidity risks, including the ability to effectively manage the additional liquidity from the significant increase in deposits during the COVID-19 pandemic including managing the potential loss of a portion of such deposits;

● increases in nonperforming assets and credit losses that could occur, particularly in times of weak economic conditions or rising interest rates;

● reductions in the market value of available-for-sale securities that could result if interest rates increase substantially or an issuer has real or perceived financial difficulties;

● the Company’s ability to diversify and grow its loan portfolio;

● the Company’s ability to attract and retain skilled employees;

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● the Company’s ability to receive regulatory approval for acquisitions or branch expansion while having a less than satisfactory rating under the Community Reinvestment Act;

the success of acquisitions or branch expansion, closure or consolidation;

and risks associated with the multitude of current and prospective laws and regulations to which the Company is and will be subject.

Risk factors that could cause actual results to differ materially from results that might be implied by forward-looking statements include the risk factors disclosed in the Company’s Form 10-K for the fiscal year ended December 31, 2020 and in Item 1A, herein.

● the success of acquisitions or branch expansions, closures or consolidations;

● risks associated with the multitude of current and prospective laws and regulations to which the Company is and will be subject.

Risk factors that could cause actual results to differ materially from results that might be implied by forward-looking statements include the risk factors detailed in the Company’s Form 10-K for the fiscal year ended December 31, 2020 and in Item 1A, herein.

We do not update forward-looking statements to reflect circumstances or events that occur after the date the forward-looking statements are made or to reflect the occurrence of unanticipated events.

CRITICAL ACCOUNTING POLICIES

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● income taxes and related deferred tax assets and liabilities, especially with regard to the ability of the Company to recover deferred tax assets as discussed in the “Provision for Income Taxes” and “Other Assets” sections of this discussion and analysis;

and goodwill and other intangible assets, which are evaluated annually for impairment and for which we have determined that no impairment

exists, as discussed in the “Other Assets” section of this discussion and analysis.

● goodwill and other intangible assets, which are evaluated annually for impairment and for which we have determined that no impairment exists, as discussed in the “Other Assets” section of this discussion and analysis.

Critical accounting areas are evaluated on an ongoing basis to ensure that the Company’s financial statements incorporate our most recent expectations regarding those areas.

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RESULTS OF OPERATIONS SUMMARY

First Quarter 2021 compared to First Quarter 2020

First quarter 2021 net income was $11.1 million, or $0.72 per diluted share, compared to $7.8 million, or $0.51 per diluted share in the first quarter of 2020.

The Company’s annualized return on average equity was 12.94% and annualized return on average assets was 1.40% for the quarter ended March 31, 2021, compared to 9.97% and 1.23%, respectively, for the same quarter in 2020.

The primary drivers behind the variance in first quarter net income are as follows:

● The $4.8 million, or 20%, increase in net interest income is due mostly to a $3.4 million increase in interest income resulting primarily from higher loan volumes as compared to March 31, 2020, accelerated fee income recognition from the forgiveness of SBA PPP loans, partially offset by lower rates.

In addition, there was a $1.4 million favorable decline in interest expense due to a higher mix of noninterest bearing deposits and lower rates on the remaining deposits and borrowed funds.

The provision for loan & lease losses is $1.6 million lower as a result of higher economic uncertainty as the primary driver for provision, offset by net loan recoveries and lower historical loss rates used in the calculation.

● The $0.7 million, or 12%, favorable increase in noninterest income is due to a $0.4 million favorable change in the annual fair market value adjustment of restricted equity investments, and fluctuations in income on bank- owned life insurance (BOLI) associated with deferred compensation plans.

Customer service charges on deposit accounts were lower in the quarterly comparison, but were partially offset by increases in debit card interchange income.

● The efficiency ratio improved to 56.43% from 58.88%.

Although there was a $2.5 million increase in noninterest expense, net interest income increased $4.8 million as described above.

The largest expense item with an increase was salaries and benefits, with a $1.0 million increase due to lower deferred loan costs and higher bonus expense in the first quarter of 2021 as compared to the same period in 2020.

Second Quarter 2021 compared to Second Quarter 2020

Second quarter 2021 net income was $11.7 million, or $0.76 per diluted share, compared to $8.3 million, or $0.54 per diluted share in the second quarter of 2020.

The Company’s annualized return on average equity was 13.29% and annualized return on average assets was 1.42% for the quarter ended June 30, 2021, compared to 10.30% and 1.19%, respectively, for the same quarter in 2020.

The primary drivers behind the variance in second quarter net income are as follows:

● A $2.1 million negative provision for loan and lease losses.

This favorable impact was precipitated by continued improvements in the overall economy, lower historical loss rates, net recoveries during the past two quarters, and a $272.7 million decrease in average balances of net loan and leases.

● The $3.0 million, or 13%, increase in net interest income is due to a $3.6 million increase in interest income resulting primarily from higher real estate secured loan volumes as compared to June 30, 2020, partially offset

by lower rates on interest earning assets.

In addition, there was a favorable decline in interest expense due to a higher mix of noninterest bearing deposits and lower rates on the interest bearing deposits and borrowed funds.

● An increase of $2.2 million, or 12% in noninterest expense partially offset the positive variances mentioned above.

The increase was due mostly due a $1.2 increase in salaries and benefits, $0.5 million increase in data processing, and $0.4 million increase in legal expenses.

First Half 2021 compared to First Half 2020

Net income for the first half of 2021 was $22.8 million, or $1.48 per diluted share, compared to $16.1 million, or $1.05 per diluted share for the same period in 2020.

The Company’s annualized return on average equity was 13.11% and annualized return on average assets was 1.41% for the six months ended June 30, 2021, compared to a return on equity of 10.14% and return on assets of 1.21% for the six months ended June 30, 2020.

The primary drivers behind the variance in year-to-date net income are as follows:

● A $1.9 million negative provision for loan and lease losses, relative to $4.0 million provision for loan and lease losses in the first half of 2020, for the same reasons outlined above in the quarterly comparison.

● Net interest income increased by $7.8 million or 16% as declines in loan yields were offset by higher balances and lower interest expense.

● The above year-to-date increases were partially offset by an increase in noninterest expense of $4.7 million, or 13%, due mostly to a $2.1 million increase in salaries and benefits, $1.4 million increase in professional services, and $0.8 million increase in data processing expense.

FINANCIAL CONDITION SUMMARY

March 31, 2021 relative to December 31, 2020

The Company’s assets totaled $3.3 billion at March 31, 2021 relative to $3.2 billion at December 31, 2020.

The following provides a summary of key balance sheet changes during the first three months of 2021:

June 30, 2021 relative to December 31, 2020

The Company’s assets totaled $3.3 billion at June 30, 2021 relative to $3.2 billion at December 31, 2020.

The following provides a summary of key balance sheet changes during the first six months of 2021:

● The Company’s balance of cash and cash equivalents was up by $302.5 million, or 424% from December 31, 2020.

The overall increase in cash balances was due primarily to increases in deposit accounts and decreases in loan balances during the first quarter 2021.

● Securities available-for-sale were $552.9 million at March 31, 2021, an increase of $9.0 million, or 2% from December 31, 2020.

The Company purchased $45.2 million in various Government Agency sponsored mortgage-backed securities and municipal securities.

● The year-to-date 2021 loan balance decline of $175.2 million, or 7%, was highlighted by declines in outstanding balances on mortgage warehouse lines of $119.7 million, as well as a $19.3 million decline in SBA Paycheck Protection Program (PPP) loans.

During the first quarter of 2021 the Bank had $33.2 million in SBA PPP loan originations, but overall SBA balances declined due to SBA forgiveness of $52.8 million in PPP loans during the same period.

The remainder of the decline was primarily in real estate secured loans with an increased strategic focus of building our commercial & industrial loans, including owner-occupied CRE loans

and small business lending.

The Company’s regulatory commercial real estate concentration ratio decreased to 352% at March 31, 2021 as compared to 378% at December 31, 2020.

● Deposits increased by $229.3 million, or 9%, in the first quarter of 2021.

The growth in deposits came primarily from noninterest bearing or low-cost transaction, and savings accounts, while higher-cost time deposits decreased slightly.

● Short-term borrowings decreased by $125.5 million during the first quarter of 2021 to $56.5 million at March 31, 2021.

The decrease was due to a decrease in Federal Home Loan Bank (FHLB) overnight borrowings due to an increase in deposit balances.

● Total shareholders’ equity of $348.0 million at March 31, 2021 reflects an increase of $4.1 million, or 1%, relative to year-end 2020 due to capital from the $11.1 million addition of net income, a $4.1 million unfavorable swing in accumulated other comprehensive income/loss, stock options exercised, restricted stock compensation, net of $3.2 million in dividends paid.

The overall increase in cash balances was due primarily to increases in deposit accounts and decreases in loan balances during the first half 2021.

● Securities available-for-sale were $607.5 million at June 30, 2021, an increase of $63.5 million, or 12% from December 31, 2020.

The Company purchased $119.3 million in various government agency sponsored mortgage-backed securities, municipal securities, and corporate bonds.

● The year-to-date 2021 loan balance decline of $318.3 million, or 13%, was mostly due to declines in outstanding balances on mortgage warehouse lines of $157.3 million, as well as a $100.0 million decline in real estate loans, mostly in commercial real estate (CRE) loan balances, and a $49.0 million decline in SBA Paycheck Protection Program (PPP) loans.

During the second quarter of 2021 the Bank had $16.1 million in SBA PPP loan originations, but overall SBA PPP loan balances declined due to SBA forgiveness of $45.5 million in PPP loans during the same period.

During the first half of 2021, the Company changed its strategic loan origination focus to better diversify our portfolio by adding commercial & industrial loans, including owner-occupied CRE loans and small business lending.

Most of the decline in CRE loan balances were from construction loan balance declines.

The Company’s regulatory commercial real estate concentration ratio decreased to 335% at June 30, 2021 as compared to 378% at December 31, 2020 and remains well within our acceptable risk tolerance for CRE concentration.

● Deposits increased by $151.3 million, or 6%, in the first half of 2021.

The growth in deposits came primarily from noninterest bearing or low-cost transaction, and savings accounts, while higher-cost time deposits

decreased as the Company chose not to renew certain time-deposits or to seek alternative time-deposits for those that matured.

● All short-term borrowings paid off in full, resulting in a decrease of $142.9 million during the first half of 2021.

This included fed funds purchased, Federal Home Loan Bank (FHLB) overnight, and term borrowings and was a direct result of an increase in deposit balances combined by softened loan demand.

Customer repurchase agreements increased $31.4 million to $70.5 million.

● Total shareholders’ equity of $357.7 million at June 30, 2021 reflects an increase of $13.8 million, or 4%, relative to year-end 2020 due to additional capital from the $22.8 million addition of net income, a $3.0 million unfavorable swing in accumulated other comprehensive income/loss, stock options exercised, restricted stock compensation, net of $6.5 million in dividends paid.

IMPACT OF CORONAVIRUS DISEASE 2019 (COVID-19) PANDEMIC ON THE COMPANY’S OPERATIONS

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This was followed by extensions of these orders in April and many local municipalities in which the Company operates issued orders mandating additional requirements to protect their citizens.

Although many counties in California began phased reopening

plans, due to recent increases in cases effective July 13, 2020, the Governor ordered that dine-in restaurants, wineries and tasting rooms, movie theaters, family entertainment centers, zoos and museums, and cardrooms immediately close all indoor operations.

Although many counties in California began phased reopening plans, due to recent increases in cases effective July 13, 2020, the Governor ordered that dine-in restaurants, wineries and tasting rooms, movie theaters, family entertainment centers, zoos and museums, and cardrooms immediately close all indoor operations.

Effective August 31, 2020, a new simplified, four-tier guideline was implemented for counties to reopen.

Counties must remain in a tier for at least three weeks before moving to the next tier.

However, most counties remained in partially or fully closed states through

On June 15, 2021, the state of California effectively removed most remaining restrictions for fully vaccinated individuals.

● On March 22, 2020, the federal financial institution regulatory agencies (the agencies) issued guidance to financial institutions to suspend the requirements to classify certain loan modifications as troubled debt restructurings (TDRs).

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● In 2021, COVID-19 vaccinations began rolling out across the country and in California.

In early April 2021, with over 20 million vaccines administered in California, a Blueprint for a Safer Economy was announced to fully reopen the California economy on June 15, 2021, subject to certain health requirements, if two criteria are met regarding equitable vaccine availability and a consistently low burden of disease.

In early April 2021, with over 20 million vaccines administered in California, a Blueprint for a Safer Economy was announced to fully reopen the California economy on June 15, 2021, subject to certain health requirements, if two criteria were met regarding equitable vaccine availability and a consistently low burden of disease.

● On June 15, 2021, the Governor of California terminated the executive orders that put into place the Stay Home Order and the Blueprint for a Safer Economy.

He also phased out the vast majority of executive actions put in place since March 2020 as part of the pandemic response, leaving a subset of provisions that facilitate the ongoing recovery.

Impact of COVID-19 on the Company’s Operations

● The Company had $10.4 million in classified assets at March 31, 2021, from loans modified under the Interagency Guidance or CARES Act, as amended, that are either not expected to make all principal and interest payments in a timely manner, or will need further modifications or assistance.

● The Company had $10.4 million in classified assets at June 30, 2021, from loans modified under the CARES Act, as amended, that are either not expected to make all principal and interest payments in a timely manner, or will need further modifications or assistance.

Starting in April 2020, the Company took actions to mitigate the impact on credit losses including permitting short-term payment deferrals to current customers, as well as providing bridge loans and SBA Paycheck Protection Program (PPP) loans.

For further information on the principal and interest deferrals, please see the “Nonperforming Assets” section below.

● The uncertainty of national and local economic conditions had an impact on our provision for loan and lease losses in 2020 and continuing into 2021.

● The uncertainty of national and local economic conditions had an impact on our provision for loan and lease losses in 2020 and early 2021.

The Company elected under Section 4014 of the CARES Act to defer the implementation of CECL until the earlier of when the national emergency related to the outbreak of COVID-19 ends or December 31, 2020.

In December 2020, the Consolidated Appropriations Act, 2021, extended the deferral of implementation of CECL from December 31, 2020, to the earlier of the first day of the fiscal year, beginning after the national emergency terminates or January 1, 2022.

Although this deferral will

still require CECL to be implemented as of January 1, 2022, the Company believes that the deferral will provide time to better assess the impact of the COVID-19 pandemic on the expected lifetime credit losses in our loan and lease portfolio.

The most significant unknown factor is how long economic activity will be impacted by COVID-19, and in turn how deeply that will impact the markets in which we operate.

Therefore, more time was needed to assess the impact of this economic uncertainty and related actions taken such as the stimulus provisions of the CARES Act on the Company’s allowance for loan and lease losses under the CECL methodology.

In December 2020, the Consolidated Appropriations Act, 2021, extended the deferral of implementation of CECL from December 31, 2020, to the earlier of the first day of the fiscal year,

beginning after the national emergency terminates or January 1, 2022.

The Company’s decision to defer the adoption of CECL was done primarily to provide additional time to assess better the impact of the COVID-19 pandemic on the expected lifetime credit losses in our loan and lease portfolio.

At the time the decision was made, there was a significant change in economic uncertainty on the local, regional, and national levels as a result of local and state stay-at-home orders, as well as relief measures provided at a national, state, and local level.

● The Company expects that net interest income will continue to be adversely impacted over time given pressure on net interest margin as a result of the current interest rate environment.

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These lower rates impacted our net interest margin.

Our net interest margin for the three months ended March 31, 2021, was 3.93%, compared to a net interest margin of 4.13% for the same period in 2020.

New loans booked in 2021 have been at lower rates and although deposit costs have also declined, deposit costs were already low or at their floors.

● The COVID-19 pandemic has not adversely affected our capital or financial resources as of March 31, 2021.

During the first three months of 2021, total shareholders’ equity increased by $4.1 million, or 1%, to $348.0 million.

The Company earned $11.1 million in net income in the first three months of 2021, but had a $4.1 million decrease in accumulated other comprehensive income as a result of decreases in the value of our investment portfolio due to an uptick in interest rates.

The Company also paid dividends of $3.2 million during the first quarter of 2021.

On April 15, 2021, the Company declared a twenty-one cent per share dividend to be paid on May 12, 2021.

Our net interest margin for the three months ended June 30, 2021, was 3.60%, compared to a net interest margin of 3.81% for the same period in 2020.

Additional liquidity from significant deposit growth in 2021 coupled with lower loan balances has negatively impacted our net interest margin.

This additional liquidity was mostly deployed in overnight funding at an average rate of 11 basis points for the second quarter and six-months ending June 30, 2021.

In addition, investment and new loan yields have continued to decline given the overall rate environment in 2021.

● The COVID-19 pandemic has not adversely affected our capital or financial resources as of June 30, 2021.

During the first half of 2021, total shareholders’ equity increased by $13.8 million, or 4%, to $357.7 million.

The Company earned $22.8 million in net income in the first half of 2021, but had a $3.0 million decrease in accumulated other comprehensive income as a result of decreases in the value of our investment portfolio due to an uptick in interest rates.

The Company also paid dividends of $6.5 million during the first half of 2021.

On July 15, 2021, the Company declared a twenty-two cent per share dividend to be paid on August 12, 2021.

Although presently not expected, if the Company were to incur significant credit losses as a result of COVID-19’s impact on our customers’ ability to repay loans, capital could be adversely impacted.

With respect to liquidity, the Company maintains strong primary and secondary liquidity sources as further described under “Liquidity and Market Risk Management” below.

● While we do not expect COVID-19 to affect our ability to account timely for the assets on our balance sheet, this could change in future periods.

● We do not expect COVID-19 to affect our ability to account timely for the assets on our balance sheet.

Certain valuation assumptions and judgments continue to change to account for pandemic-related circumstances such as widening credit spreads.

However, we do not anticipate any significant changes in methodology used to determine the fair value of assets measured in accordance with GAAP.

As of March 31, 2021, our goodwill was not impaired.

As of June 30, 2021, our goodwill was not impaired.

The Company last performed an assessment of potential impairment to its goodwill at December 31, 2020 and concluded that it was not more likely than not that a goodwill impairment exists.

The Company continues to monitor its goodwill recorded on the balance sheet for potential impairment and did not believe there was any event that would trigger a potential impairment in the first quarter of 2021.

In the event that we conclude that all or a portion of our goodwill is impaired, a non-cash charge for the amount of such impairment would be recorded to earnings.

At March 31, 2021, we had goodwill of $27.4 million which represented 8% of total equity.

At June 30, 2021, we had goodwill of $27.4 million which represented 8% of total equity.

● The Company continues to serve its customers.

Out of our 40 branch locations, four are open with drive-up only access, and five branches are currently closed except by appointment.

Approximately 45% of our back-office and corporate employees are working remotely and it has not adversely affected our operations.

In addition, none of our internal controls have changed or are expected to change as a result of the remote work arrangements other than the use of remote approvals.

The Company is preparing to bring all the branch locations back to normal operating hours in the next 30 days and is analyzing the return of the corporate office staff over the next 90 days.

As a result of a change in customer behaviors brought about by the COVID-19 pandemic along with an efficiency review, the Company has decided to permanently close five branch locations effective June 18, 2021.

Several of our branch locations, were closed due to the pandemic, however all of our branch lobbies are now fully open, with the exception of five branch locations that the Company decided to permanently close in June 2021.

This decision to close these branches was made as a result of a change in customer behaviors brought about by the COVID-19 pandemic along with an efficiency review.

All of the five closed locations were located outside of Tulare County, the Bank’s primary market area.

Many of our customers have found an added convenience and ease of transacting business through online and mobile banking services which precipitated our decision to close locations where in-person transaction volumes no longer warranted a traditional brick-and-mortar branch.

The acceleration of leasehold improvements for these locations increased depreciation expense by $0.1 million in the first quarter of 2021 and is expected to increase depreciation expense by an additional $0.4 million in the second quarter of 2021.

Further, it is anticipated that there will be additional amortization expense of $0.2 million related to the

right of use asset from lease cancellations.

Overall deposits at these five closed branches increased during the period of time from announcement to closure and consolidation into a nearby branch.

The acceleration of amortization of leasehold improvements for these locations increased depreciation expense by $0.4 million in the second quarter of 2021 and by $0.5 million year-to-date 2021.

Most of the staff at these five locations were relocated to existing branches with position vacancies however, four

individuals elected to leave the Company.

It is projected that closing these five branch locations will result in annual noninterest expense savings of between $0.8 and $1.0 million.

● All of our back office and corporate office staff have returned to normal work arrangements, although remote and hybrid work provisions are now defined as “normal” work arrangements for certain corporate and back office employees, depending on the nature of the position.

In addition, none of our internal controls have changed or are expected to change as a result of these work arrangements other than the use of remote approvals.

● To date, the Company did not experience any challenges in implementing its business continuity plans.

The Company’s Risk Management team began preparing in early 2020, with ordering of supplies such as hand sanitizer, masks and cleaning supplies, as well as laptops for those who did not have one.

The Company’s Risk Management team began preparing in early 2020, with ordering of supplies such as hand sanitizer, masks cleaning supplies, as well as laptops for those who did not have one.

This enabled the Company to immediately communicate and implement plans to continue operations in our banking facilities while enabling those non-customer facing employees to immediately begin working remotely.

The Company did not face any material resource constraints in implementing these plans.

● As a financial institution providing essential services, the Company expects continued demand for loans and deposits, albeit at a much slower pace than in 2020 for mortgage warehouse utilization and SBA PPP loan demand.

In addition, it is expected that the Company’s strategic shift to focus more on loan categories other than non-owner occupied real estate will result in lower overall loan originations in 2021 than in 2020.

It is further expected that certain services may see continued declines in demand for certain deposit services, such as debit and credit card interchange, given lower consumer spending.

● As a financial institution providing essential services, the Company expects continued demand for loans and deposits, albeit at a much slower pace than in 2020.

In addition, mortgage warehouse utilization that resulted from the low rate environment is expected to remain at a lower level than 2020.

Further, it is expected that SBA PPP loans will continue to be forgiven, with most expected to be forgiven in 2021.

● The Company loosened its vacation and sick-time policies to accommodate our employees who were affected by COVID-19.

The Company has hired an additional 28 temporary employees throughout the pandemic related to higher demand for loan processing and forgiveness, and to provide enhanced customer service.

It is expected that the number of temporary employees will begin to decline through the second and third quarters of 2021.

The Company hired an additional 28 temporary employees throughout the pandemic related to higher demand for loan processing and forgiveness, and to provide enhanced customer service.

Those temporary assignments ended in the second quarter of 2021, although many of those employees have been redeployed within other areas of the Company.

EARNINGS PERFORMANCE

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NET INTEREST INCOME AND NET INTEREST MARGIN

Net interest income increased $4.8 million to $28.6 million, for the first quarter of 2021 over the first quarter of 2020.

For the first quarter of 2021 as compared to the same quarter in 2020, average loan balances increased $658.5 million, primarily due to increases in real estate loans of $484.4 million, mortgage warehouse lines of $98.2 million and SBA PPP loans of $109.7 million contributing to the $4.3 million increase in loan interest income, however the volume increase was offset by lower yields.

Overall, there was a decline of 68 bps in loan yield for the quarter ending March 31, 2021 as compared to the same period in 2020.

Offsetting declines in yield on earnings assets, there was a 40 bps decrease in the cost of interest-bearing liabilities for the same period.

Net interest income increased $3.0 million to $27.2 million, for the second quarter of 2021 over the second quarter of 2020 and increased $7.8 million, or 16% to $55.7 million for the first six months of 2021 in comparison to the first six months of 2020.

For the second quarter of 2021 as compared to the same quarter in 2020, average loan balances increased $272.7 million, or 14%, primarily due to increases in real estate loans of $348.2 million, or 24%, offset by a $64.3 million, or 31%, decrease in the utilization of mortgage warehouse lines.

The increase in average commercial real estate loan balances was the primary contributor to the $3.2 million increase in loan interest income, as the average yield on the overall loan portfolio was relatively flat.

There was a 11 bps favorable decrease in the cost of interest-bearing liabilities for the second quarter of 2021 as compared to the same quarter in 2020.

For the first half of 2021 as compared to the same period in 2020, average loan balances increased $465.1 million or 26%, primarily due to increases in real estate loans of $416.2 million or 29%, $100.4 million in SBA PPP loans and $16.7 million in mortgage warehouse line utilization.

The increase in the aforementioned average loan balances were the

major driver in the increase in net interest income with a 31 bps decrease in loan yield partially offsetting the increase in volume.

There was a 25 bps favorable decrease in the yield on interest bearing liabilities driven by an increase in lower or no cost core deposits and a decrease in higher cost time deposits for the first half of 2021 as compared to the same period in 2020.

The level of net interest income we recognize in any given period depends on a combination of factors including the average volume and yield for interest earning assets, the average volume and cost of interest-bearing liabilities, and the mix of products which comprise the Company’s earning assets, deposits, and other interest-bearing liabilities.

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For the three months ended

March 31, 2021

March 31, 2020

June 30, 2021

June 30, 2020

Rate/Yield (2)

Federal funds sold/due from time

Interest-earning due from banks

Total investments

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Loan fees have been included in the calculation of interest income.

Net loan fees and loan acquisition FMV amortization were $1.4 million and $(0.1) million for the quarters ended March 31, 2021 and 2020, respectively.

Net loan fees and loan acquisition FMV amortization were $1.0 million and $(0.2) million for the quarters ended June 30, 2021 and 2020, respectively.

(4) Non-accrual loans have been included in total loans for purposes of computing total earning assets.

(5) Net interest margin represents net interest income as a percentage of average interest earning assets.

Average Balances and Rates

(Dollars in Thousands, Unaudited)

For the six months ended

June 30, 2021

June 30, 2020

Rate/Yield (2)

Interest-earning due from banks

Total investments

Loans and leases:

Mortgage warehouse lines

Total loans and leases

Total interest earning assets (4)

Other earning assets

Non-earning assets

Liabilities and shareholders' equity

Interest bearing deposits:

Demand deposits

Savings accounts

Certificates of deposit, under $100,000

Certificates of deposit, $100,000 or more

Brokered deposits

Total interest bearing deposits

Borrowed funds:

Federal funds purchased

Repurchase agreements

Short term borrowings

Total borrowed funds

Total interest bearing liabilities

Demand deposits - noninterest bearing

Other liabilities

Shareholders' equity

Total liabilities and shareholders' equity

Interest income/interest earning assets

Interest expense/interest earning assets

Net interest income and margin (5)

(1) Average balances are obtained from the best available daily or monthly data and are net of deferred fees and related direct costs.

(2) Yields and net interest margin have been computed on a tax equivalent basis utilizing a 21% effective tax rate.

(3) Loans are gross of the allowance for possible loan losses.

Loan fees have been included in the calculation of interest income.

Net loan fees and loan acquisition FMV amortization were $2.4 million and $(0.4) million for the six months ended June 30, 2021 and 2020, respectively.

(4) Non-accrual loans have been included in total loans for purposes of computing total earning assets.

(5) Net interest margin represents net interest income as a percentage of average interest-earning assets.

The Volume and Rate Variances table below sets forth the dollar difference for the comparative periods in interest earned or paid for each major category of interest earning assets and interest-bearing liabilities, and the amount of such change attributable to fluctuations in average balances (volume) or differences in average interest rates.

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(dollars in thousands, unaudited)

Three months ended March 31,

Three months ended June 30,

Six months ended June 30,

2021 over 2020

Increase (decrease) due to

Federal funds sold/due from time

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Net interest income (1)

The volume variance calculated for the first three months of 2021 relative to the first three months of 2020 was a favorable $7.6 million due to higher average balances of interest earning assets, resulting from organic growth in commercial real estate loans, growth in commercial loans due to our participation in the SBA PPP program and higher utilization of mortgage warehouse lines.

(1) Subtotals are a sum of the categories above and are not recalculated on the portfolio totals.

The volume variance calculated for the second quarter of 2021 relative to the second quarter of 2020 was a favorable $3.5 million due to higher average balances of interest earning assets, resulting from organic growth in commercial real estate loans.

There was an unfavorable rate variance of $0.5 million for the comparative quarters since the weighted average yield on interest earning assets fell by 30 basis points and the weighted average cost of interest-bearing liabil ities decreased by 11 basis points.

The rate variance was negatively impacted by the following factors:

rate cuts by the FOMC in March 2020 and resulting lower rates and yields given the uncertainty of the pandemic, new loans and investments having lower yields overall, including an increase in low-yielding SBA PPP loans.

These negative factors were partially offset by an increase in loans overall as a percent of overall earning assets, as well as lower costs of time-deposits and other interest-bearing liabilities.

high average balances of cash and due from banks earning on average 11 bps, new loans and investments having lower yields overall, including low-yielding SBA PPP loans.

These negative factors were partially offset by an increase in loans as a percent of overall earning assets, as well as lower costs of time-deposits and other interest-bearing liabilities.

The average fees on the SBA PPP loans was approximately 5.5%.

These fees, net of loan costs, are being accreted over the stated life of the loan (generally two years for PPP loans generated in 2020 and 5 years for PPP loans generated in 2021), net of loan costs.

These fees, net of loan costs, are being accreted over the stated life of

the loan (generally two years for PPP loans generated in 2020 and 5 years for PPP loans generated in 2021), net of loan costs.

Our customers with an SBA PPP loan are generally eligible to apply for loan forgiveness after 24 weeks.

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The decrease in rate on interest earning assets was less than the net volume/rate decrease in interest bearing liabilities and resulted in a favorable $3.0 million net volume/rate difference.

The Company’s net interest margin for the first three months of 2021 was 3.93%, as compared to 4.13% in the first three months of 2020.

The Company’s net interest margin for the second quarter of 2021 was 3.60%, as compared to 3.81% for the second quarter of 2020.

The volume variance calculated for the first six months of 2021 relative to the first six months of 2020 reflects a favorable variance of $11.1 million and an unfavorable rate variance of $3.2 million, resulting from organic growth in commercial real estate loans, growth in commercial loans due to our participation in the SBA PPP program and higher utilization of mortgage warehouse lines.

The growth in interest earning assets was more than offset by the 37 basis point decrease in yield while interest bearing liabilities increased $274.4 million with a 25 basis point drop in cost.

Since the volume variances outweighed the declines in yield there was a favorable $7.8 million net volume/rate difference.

The Company’s net interest margin for the first half of 2021 was 3.76%, as compared to 3.97% in the first half of 2020.

As described above, a lower rate environment precipitated by two interest rate cuts by the Federal Open Market Committee totaling 150 bps in March 2020 and other economic uncertainty negatively impacted our yield on existing adjustable and variable rate portfolio loans and created a lower initial interest rate for new loan volumes.

At March 31, 2021, approximately 10% of our total portfolio, or $226.2 million, consists of variable rate loans.

At June 30, 2021, approximately 9% of our total portfolio, or $199.3 million, consists of variable rate loans.

Of these variable rate loans, approximately $74 million have floors that limited the overall reduction in rates.

At March 31, 2021, our outstanding fixed rate loans represented 22% of our loan portfolio.

The remaining 68% of our loan portfolio at March 31, 2021 consists of adjustable rate loans.

However, the majority of these loans (approximately $1.2 billion) will not begin adjusting for at least another 3 years.

Approximately $70.1 million of these adjustable rate loans will reprice in the next quarter.

Cash balances have increased on March 31, 2021 as compared to December 31, 2020 due to the increase in deposit balances and lower loan balances in the first quarter of 2021.

For the quarterly comparisons, there was an unfavorable net volume rate variance since cash balances earned considerably lower yields than other earning assets.

Overall average investment securities decreased by $60.2 million for the quarter ending March 31, 2021 as compared to March 31, 2020.

For the three months ending March 31, 2021 over the same period for 2020, average non-taxable securities increased $31.4 million and taxable securities decreased $91.6 million.

The overall investment portfolio had a tax-equivalent yield of 2.66% at March 31, 2021, with an average life of 4.5 years.

Interest expense was $0.9 million in the first quarter of 2021, a decline of $1.4 million, or 60%, compared to the first quarter of 2020.

The significant decline in interest expense for the quarterly comparisons is attributable to a favorable shift in deposit mix as average noninterest bearing demand deposits increased $298.5 million in the first quarter of 2021 as compared to the same quarter in 2020.

Lower cost transaction, savings and money market accounts increased $267.2 million in the first quarter of 2021 as compared to the same quarter in 2020.

The average cost of interest-bearing deposits declined by 36 basis points, or 72%, to 14 basis points for the first quarter of 2021 compared to the first quarter of 2020.

At June 30, 2021, our outstanding fixed rate loans represented 19% of our loan portfolio.

The remaining 71% of our loan portfolio at June 30, 2021 consists of adjustable rate loans.

However, the majority of these loans (approximately $1.3 billion) will not begin adjusting for at least another 3 years, but up to 10 years.

Approximately $66.0 million of these adjustable rate loans have the ability to reprice next quarter.

Cash balances for the quarter and year to date comparisons continue to increase and have a negative impact on our net interest margin since cash balances earn considerably lower yields than other earning assets.

Average cash and due from banks was $308.4 million, an increase of $255.2 million or 480% for the second quarter of 2021 as compared to the second quarter of 2020 and was $148.0 million or 328% higher for the first half of 2021 as compared to the same period in 2020.

Overall average investment securities decreased by $36.1 million for the second quarter of June 30, 2021 as compared to June 30, 2020 and decreased by $48.0 million for the first half of 2021 as compared to the same period in 2020.

For the quarter ending June 30, 2021 over the same period for 2020, average non-taxable securities increased $26.7 million and taxable securities decreased $62.8 million.

For the first half of 2021 over the same period for 2020, average non-taxable securities increased $29.0 million and taxable securities decreased $77.0 million.

The overall investment portfolio had a tax-equivalent yield of 2.49% at June 30, 2021, with an average life of 4.6 years.

Interest expense was $0.9 million in the second quarter of 2021, a decline of $0.3 million, or 27%, compared to the second quarter of 2020 and was $1.8 million in the first six-months of 2021, a decline of $1.7 million or 49%.

The decline in interest expense for both the quarter and the half is attributable to a favorable shift in deposit mix as average total time deposits declined by $33.0 million in the second quarter of 2020 as compared to the same quarter in 2019 and by $11.2 million for the first half of 2021 as compared to the same period in 2020.

The average cost of interest-bearing deposits declined by 9 basis points to 14 basis points for the second quarter of 2021 compared to the second quarter of 2020, and by 23 basis points for the first six-months of 2021 as compared to the same period in 2020.

Non-interest bearing demand deposits increased $222.2 million or 27% for the second quarter of 2021 as compared to the second quarter of 2020 and increased $260.6 million or 35% for the first six-months of 2021 as compared to the same period in 2020.

PROVISION FOR LOAN AND LEASE LOSSES

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The Company sets aside an allowance for loan and lease losses, a contra-asset account, through periodic charges to earnings which are reflected in the income statement as the provision for loan and lease losses.

The Company recorded a loan loss provision of $0.3 million in the first quarter of 2021 compared to $1.8 million in the first quarter of 2020.

The decrease in provision for loan and lease losses is due to a decrease in loan balances and the receipt of net loan recoveries for the first three months of 2021.

The Company recorded a net benefit related to loan and lease loss provision of $2.1 million in the second quarter of 2021 relative to a loan and lease loss provision expense of $2.2 million in the second quarter of 2020, and a year-to-date net benefit for loan and lease loss provision of $1.9 million in 2021 as compared to $4.0 million loan and lease loss provision expense for the same period in 2020.

The Company's $4.3 million, or 195%, favorable decline in provision for loan and lease losses in the second quarter of 2021 as compared to the second quarter of 2020, and the $5.9 million favorable decrease, or 146% in the first six months of 2021 compared to the same period in 2020 is due mostly to lower historical loan loss rates, lower average balances on loans, net recoveries of previously charged-off loan balances, and changes to qualitative factors.

Management adjusted its qualitative risk factors under our current incurred loss model for improved economic conditions, improvements in the severity and volume of past due loans, enhancements in the quality of the Company’s loan review system, and a reduction in the level of concentrations of credit in non-owner occupied real estate loans.

There was no provision for loan and lease losses, or related allowance for loan and leases losses, associated with the SBA PPP loans as those loans carry a full guarantee by the SBA, subject to the financial institution meetings its Bank Secrecy Act obligations and other diligence requirements in making such loans.

Management also evaluated its qualitative risk factors under our current incurred loss model and adjusted for changes as deemed appropriate in the current environment.

These qualitative risk factors accounted for the majority of the provision expense in both the first quarter of 2020 and in the first quarter of 2021.

As described above, the Company was subject to the adoption of the CECL accounting method under Financial Accounting Standards Board (FASB) Accounting Standards Update 2016-13 and related amendments, Financial Instruments – Credit Losses (Topic 326).

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The Company has elected this deferral to provide time to better assess the impact of the COVID-19 pandemic and changing economic forecasts on the expected lifetime credit losses.

It is expected that the Company’s Allowance for Credit Loss under CECL will be approximately 50% higher than the current Allowance for Loan and Lease Losses, with the initial adjustment being recorded as an adjustment to equity, as previously disclosed in the Company’s Form 10-K for the fiscal year ended December 31, 2020.

If the CECL adjustment is to increase the current Allowance for Loan and Lease Losses by 50% at 1/1/2022, the adjustment to equity will also be adjusted for income taxes, causing a net decrease to equity of approximately $5.8 million to $6.5 million.

This adjustment is not expected to immediately impact our regulatory capital ratios given the Interagency Guidance to phase-in the CECL adjustment as adopted in 2020.

At this time, the Company is not anticipating any need to raise capital due to the CECL implementation.

The impact of adoption of CECL has not yet been definitively determined, due in part to changing economic forecasts and further to evaluate model inputs in advance of our planned implementation on January 1, 2022.

This adjustment, however, is not expected to immediately impact our regulatory capital ratios given the Interagency Guidance to phase-in the CECL adjustment as adopted in 2020.

Even if the entire adjustment immediately impacted regulatory capital ratios, the Company would have a regulatory leverage ratio in excess of 9% as required by the community bank leverage ratio framework.

The Company has taken actions to mitigate the impact on credit losses including permitting short-term payment deferrals to current customers, as well as providing bridge loans and SBA PPP loans.

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These modifications generally provided for a six-month deferral of both interest and principal and the vast majority of the customers on deferral resumed making scheduled payments upon the expiration of the deferral.

As of March 31, 2021, the Company had $22.4 million in remaining loan modifications;

all but two small balance consumer loans are fully secured by real estate.

As of June 30, 2021, the Company had $10.4 million in remaining loan modifications;

all loans are fully secured by real estate.

The Company expects that all customers show an ability and willingness to pay full principal and interest upon maturity of their deferment period.

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Specifically identifiable and quantifiable loan losses are immediately charged off against the allowance, with subsequent recoveries reflected as an increase to the allowance.

The Company recorded net recoveries of $0.3 million in the first quarter of 2021 as compared to net charge-offs of $0.3 million for the comparative period of 2020.

The Company recorded net recoveries of $0.2 million in the second quarter of 2021 as compared to net charge-offs of $0.1 million for the comparative period of 2020.

For the first six months of 2021, net recoveries were $0.5 million as compared to $0.4 million in net charge-offs for the same period of 2020.

The allowance for loan and lease losses is at a level that, in Management’s judgment, is adequate to absorb probable loan losses related to specifically identified impaired loans as well as probable incurred losses in the remaining loan portfolio.

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NONINTEREST INCOME AND NONINTEREST EXPENSE

The following table provides details on the Company’s noninterest income and noninterest expense for the three periods ended March 31, 2021 and 2020:

The following table provides details on the Company’s noninterest income and noninterest expense for the three and six month periods ended June 30, 2021 and 2020:

Noninterest Income/Expense

(dollars in thousands, unaudited)

For the three months ended March 31,

For the three months ended June 30,

For the six months ended June 30,

Noninterest income:

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Legal & accounting

Acquisition costs

Other professional service

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Noninterest Income:

Total noninterest income reflected an increase of $0.7 million, or 12%, for the quarter ended March 31, 2021 as compared to the same quarter in 2020 due mostly to higher BOLI income and an increase in the other noninterest income category.

BOLI income increased by $0.5 million as compared to the same quarter of 2020.

This BOLI variance was due mostly to fluctuations in underlying values of assets in the specific account BOLI policies that are designed to have similar assets to those in the deferred compensation plans.

Thus, the higher values in BOLI policies are offset by higher deferred compensation expense reflected primarily in director fees expense.

At March 31, 2021, there was $43.5 million in BOLI policies associated with the deferred compensation plans and $9.8 million in separate account BOLI policies.

Additionally, in the “other” category of noninterest income the Company reflected a $0.4 million increase in the first quarter of 2021 as compared to the first quarter of 2020 the valuation of restricted stock held by the Company as required under FASB ASU 2016-01.

Total noninterest income reflects a decrease of $0.3 million, or 4%, for the quarterly comparison and reflects a $0.4 million increase, or 3% for the year-to-date comparison.

Service charges on deposit accounts increased by $0.1 million or 4%, for the quarterly comparison and decreased $0.3 million or 5%, for the year to date comparison.

The positive and negative variances were mostly in returned items on overdrafts for both periods under comparison.

Other service charges and fees increased $0.5 million or 22% for the second quarter of 2021 $0.7 million or 14% for the first half of 2021 as compared to the same periods in 2020.

For both the quarter and the half the positive variance was due to increased check-card interchange fees due to increased usage of customer debit cards.

The Company recognized a $0.4 million gain from the sale of debt securities in the second quarter of 2020, with no corresponding like sales in 2021 thus resulting in a negative variance of $0.4 million for both the second quarter and first half of 2021 as compared to the same periods in 2020.

BOLI income increased by $0.2 million as compared to the second quarter of 2021 and $0.7 million for the first half of 2021 as compared to the same period in 2020.

These variances are due mostly to fluctuations in underlying values of assets in the specific account BOLI policies that are designed to have similar assets to those in the deferred compensation plans.

Thus, the higher quarterly values in BOLI policies are offset by higher deferred compensation expense reflected primarily in director fees expense.

At June 30, 2021, there was $43.7 million in BOLI policies associated with the deferred compensation plans and $10.2 million in separate account BOLI policies.

In the “other” category of noninterest income the Company reflected a $0.7 million decrease in the second quarter of 2021 as compared to the second quarter of 2020 and a $0.3 million decrease in the first half of 2021 as compared to the same period in 2020.

The quarterly and year-to-date comparison includes a $0.7 million non-recurring gain resulting from the wrap-up of a low-income housing tax credit fund investment and a $0.4 million gain from the sale of debt securities which occurred in the second quarter of 2020.

Additionally in the “other” category of noninterest income for the 2021 year-to-date comparison over the same period in 2020, the Company reflected a $0.4 million increase in the valuation of restricted stock held by the Company as required under FASB ASU 2016-01.

The valuation of restricted stock held by the Company as required under FASB ASU 2016-01.

This stock is related to an equity investment in Pacific Coast Bankers’ Bank and is adjusted when financial information and an updated valuation report becomes available, generally in the late first quarter of each year.

Offsetting the above increases, there was a $0.4 million decrease in service charges on deposit accounts mostly from lower returned items and overdraft fees for the quarter ending March 31, 2021 over the comparable period in 2020.

Customer spending behaviors have changed since the onset of the COVID-19 pandemic, reducing disbursement activity that creates overdrafts.

It is unknown how long this trend will continue.

Noninterest Expense:

Total noninterest expense increased by $2.5 million, or 14%, in the first quarter of 2021 relative to the first quarter of 2020.

Noninterest expense dropped to 2.8% of average earning assets in the first quarter of 2021 from 3.1% for the first quarter of 2020 and the tax-equivalent efficiency ratio improved to 56.43 % in the first quarter of 2021 as compared to 58.88% in the same quarter of 2020.

Total noninterest expense increased by $2.2 million, or 12%, in the second quarter of 2021 relative to the second quarter of 2020, and increased $4.7 million or 13% in the first half of 2021 as compared to the same period in 2020.

Noninterest expense dropped to 2.6% of average earning assets in the second quarter of 2021 from 2.8% for the second quarter of 2020 and was 2.68% of average earning assets for the first six months of 2021 relative to 2.92% for the same period in 2020.

The tax-equivalent efficiency ratio was 58.79% in the second quarter of 2021 as compared to 57.78% in the same quarter of 2020 but improved to 57.58% for the first half of 2021 as compared to 58.33% for the same period in 2020.

The efficiency ratio represents total noninterest expense divided by the sum of fully tax-equivalent net interest and noninterest income;

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The Company continues to actively consider a wide variety of operational efficiency opportunities, however with softening loan demand and reduced noninterest income further improvement of the efficiency ratio is difficult to predict.

Salaries and Benefits were $1.0 million, or 10%, higher in the first quarter of 2021 as compared to the same quarter in 2020.

The reason for the increase is merit increases for employees due to annual performance evaluations for 2021 and the addition of and a focus on hiring higher-level staff and management.

Salary expense deferrals related to loan originations were $0.4 million lower in the first quarter of 2021 as compared to the same quarter in 2020.

Occupancy expenses were $0.2 million higher for the first quarter of 2021 as compared to the first quarter of 2020.

We experienced higher depreciation expense related to an acceleration of expense associated with the branch closures as described further below.

In addition, we incurred higher janitorial costs due to intermittent COVID-19 sanitization of facilities.

Further, other noninterest expense categories were $1.3 million higher for the first quarter 2021 as compared to the first quarter in 2020.

The Company experienced increases in every expense category except advertising and marketing.

Advertising and marketing declined due to the COVID-19 pandemic as much of our in-person marketing efforts were temporarily suspended.

The principal increases were in data processing for $0.3 million due to increased network security and additional software required for the efficient processing of SBA PPP loans, a $0.3 million increase in debit card processing costs, $0.1 million increase in foreclosed asset expenses, an increase in FDIC assessments for $0.2 million, as the first quarter of 2020 included Small Bank Assessment credits applied against the FDIC deposit insurance assessment, a $0.3 million increase in directors deferred compensation expense, which is linked to changes in BOLI income, a $0.1 million increase in debit card losses, and other costs associated with five branch closures scheduled for June 2021 as discussed in the paragraph below.

As a result of an ongoing COVID-19 pandemic, several of our branch lobbies were closed throughout the pandemic.

Many of these lobbies have reopened, but a few remain closed.

As a result a change in customer behaviors brought about by the COVID-19 pandemic along with an efficiency review, the Company has decided to permanently close five branch locations outside of our primary market area, effective June 18, 2021.

Many of our customers have found an added convenience and ease of transacting business through online and mobile banking services which precipitated our

decision to close locations where in-person transaction volumes no longer warranted a traditional brick-and-mortar branch.

The acceleration of amortization of leasehold improvements for these locations increased depreciation expense by $0.1 million in the first quarter of 2021 and is expected to increase depreciation expense by an additional $0.4 million in the second quarter of 2021.

Further, it is anticipated that there will be additional lease expense of $0.2 million related to right of use asset due to lease cancellations.

It is projected that closing these five branch locations will result in annual noninterest expense savings, realized fully by the end of the fourth quarter 2021, of between $0.8 and $1.0 million.

Salaries and Benefits were $1.2 million, or 13%, higher in the second quarter of 2021 as compared to the second quarter of 2020 and $2.1 million, or 11% higher for the first six months of 2021 compared to the same period in 2020.

The reason for this increase is primarily due to lower salary expense deferrals related to the decrease in loan originations for both the quarterly and year-to-date comparisons.

Occupancy expenses were $0.1 million higher for the second quarter of 2021 as compared to the same quarter in 2020 and $0.3 million higher for the first half of 2021 as compared to the same period in 2020.

The primary reason for this increase was an acceleration of leasehold improvement amortization for two leased branch facilities that were closed during the second quarter of 2021.

See the discussion of branch closures below.

Other noninterest expense increased $0.9 million, or 15% for the second quarter 2021 as compared to the second quarter in 2020, and increased $2.2 million, or 19% for the first half of 2021 as compared to the same period in 2020.

The negative variance for second quarter of 2021 compared to the same period in 2020 was primarily driven by an increase of $0.5 million or 45% in data processing costs, most of which was due mostly to increases in core processor costs, price increases in loan processing software and additional software to compliment the Company’s digital strategy.

We also had a $0.2 million increase in data communication costs, a $0.3 million increase in legal costs and a $0.3 million increase in other professional services costs.

Other professional services variances include a $0.1 million increase in FDIC assessments, and a $0.1 million increase in deferred compensation expense for directors, which is linked to the changes in BOLI income.

For the year-over-year comparison the categories of increase were the same as with the quarterly comparison, along with a $0.4 million increase in check-card processing costs.

As previously mentioned, the Company decided to permanently close five branch locations in June 2021, as a result of a change in customer behaviors brought about by the COVID-19 pandemic along with an efficiency review.

The acceleration of amortization of leasehold improvements for these locations increased depreciation expense by $0.4 million in the second quarter of 2021 and by $0.5 million year-to-date 2021.

It is projected that closing these five branch locations will result in annual noninterest expense savings of between $0.8 and $1.0 million.

PROVISION FOR INCOME TAXES

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Our tax credits consist primarily of those generated by investments in low-income housing tax credit funds.

The Company’s provision for income taxes was 25.47% of pre-tax income in the first quarter of 2021 relative to 24.02% in the first quarter of 2020.

The increase in the effective tax rate for the first quarter of 2021 is due to tax credits and tax-exempt income representing a smaller percentage of total taxable income.

The Company’s provision for income taxes was 25.3% of pre-tax income in the second quarter of 2021 relative to 23.2% in the second quarter of 2020, and 25.4% of pre-tax income for the first half of 2021, relative to 23.6% for the same period in 2020.

The increases in the effective tax rates for the second quarter and first half of 2021 were due to tax credits and tax-exempt income representing a smaller percentage of total taxable income.

BALANCE SHEET ANALYSIS

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Investments are analyzed in the section immediately below, while the loan and lease portfolio and other factors affecting earning assets are discussed in the sections following investments.

The Company’s investments may at any given time consist of debt securities and marketable equity securities (together, the “investment portfolio”), investments in the time deposits of other banks, surplus interest earning balances in our Federal Reserve Bank account, and overnight fed funds sold.

Federal Reserve Bank account, and overnight fed funds sold.

The Company’s investments can serve several purposes, including the following:

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and 5) they can provide partially tax exempt income.

The investment portfolio is reflected on the balance sheet as investment securities and totaled $552.9 million, or 17% of total assets at March 31, 2021, and $544.0 million, or 17% of total assets at December 31, 2020.

In addition, within the Cash and Due from Banks account on the balance sheet was $268.4 million of surplus interest earning balances in our Federal Reserve Bank account at March 31, 2021, as compared to $3.5 million at December 31, 2020.

The investment portfolio is reflected on the balance sheet as investment securities and totaled $607.5 million, or 19% of total assets at June 30, 2021, and $544.0 million, or 17% of total assets at December 31, 2020.

In addition, within the Cash and Due from Banks account on the balance sheet was $294.1 million of surplus interest earning balances in our Federal Reserve Bank account at June 30, 2021, as compared to $3.5 million at December 31, 2020.

Surplus balances in our Federal Reserve Bank account and fed funds sold to correspondent banks typically represent the temporary investment of excess liquidity.

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We currently have the intent and ability to hold our investment securities to maturity, but the securities are all marketable and are classified as “available for sale” to allow maximum flexibility with regard to interest rate risk and liquidity management.

The expected average life for bonds in

our investment portfolio was 4.5 years and their average effective duration was 3.0 years at March 31, 2021, up from an expected average life of 4.2 years and an average effective duration of 2.4 years at year-end 2020.

The expected average life for bonds in our investment portfolio was 4.6 years and their average effective duration was 3.1 years at June 30, 2021, up from an expected average life of 4.2 years and an average effective duration of 2.4 years at year-end 2020.

The following table sets forth the amortized cost and fair market value of Company’s investment portfolio by investment type as of the dates noted:

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(dollars in thousands, unaudited)

March 31, 2021

June 30, 2021

December 31, 2020

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State and political subdivisions

Corporate bonds

Total securities

The net unrealized gain on our investment portfolio, or the amount by which aggregate fair market values exceeded amortized cost, was $20.4 million at March 31, 2021, a $5.7 million decrease relative to the net unrealized gain of $26.1 million at December 31, 2020.

The net unrealized gain on our investment portfolio, or the amount by which aggregate fair market values exceeded amortized cost, was $21.9 million at June 30, 2021, a $4.2 million decrease relative to the net unrealized gain of $26.1 million at December 31, 2020.

The change was caused by increased long-term market interest rates on fixed-rate bond values.

Municipal bond balances comprise 42% of our total securities portfolio at March 31, 2021, as compared to 42% at December 31, 2020.

Municipal bond balances comprise 42% of our total securities portfolio at June 30, 2021, and December 31, 2020.

Municipal bonds purchased have strong underlying ratings, and we review all municipal bonds in our portfolio every quarter for potential impairment.

Investment securities that were pledged as collateral for borrowings and/or potential borrowings from the Federal Home Loan Bank and the Federal Reserve Bank, customer repurchase agreements, and other purposes as required or permitted by law totaled $246.7 million at March 31, 2021 and $232.0 million at December 31, 2020, leaving $306.3 million in unpledged debt securities at March 31, 2021 and $312.0 million at December 31, 2020.

Securities that were pledged in excess of actual pledging needs and were thus available for liquidity purposes, if needed, totaled $53.8 million at March 31, 2021 and $52.9 million at December 31, 2020.

In addition, the newly purchased corporate bonds are exclusively subordinated debentures of bank holding companies.

These purchases were underwritten by the credit administration department prior to acquisition and will be subject to quarterly potential impairment reviews similar to municipal bonds.

Investment securities that were pledged as collateral for borrowings and/or potential borrowings from the Federal Home Loan Bank and the Federal Reserve Bank, customer repurchase agreements, and other purposes as required or permitted by law totaled $125.4 million at June 30, 2021 and $232.0 million at December 31, 2020, leaving $482.1 million in unpledged debt securities at June 30, 2021 and $312.0 million at December 31, 2020.

Securities that were pledged in excess of actual pledging needs and were thus available for liquidity purposes, if needed, totaled $44.3 million at June 30, 2021 and $52.9 million at December 31, 2020.

LOAN AND LEASE PORTFOLIO

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(dollars in thousands, unaudited)

March 31, 2021

June 30, 2021

December 31, 2020

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Total loans and leases

Gross loans and leases at $2.3 billion, reflected a decrease of $174.6 million, or 7%, at March 31, 2021 from $2.5 billion at December 31, 2020 due mostly to declines in outstanding balances on mortgage warehouse lines, as well as the forgiveness of PPP loans.

Balances on mortgage warehouse lines were down $119.7 million or 39% during the first quarter of 2021, due to seasonal fluctuations and a decline in mortgage refinancing activity.

Mortgage warehouse utilization was 51% at March 31, 2021, as compared to 71% at December 31, 2020.

Utilization of mortgage warehouse lines in the future could be impacted by fluctuations in interest rates and from economic uncertainty including the impact of the COVID-19 pandemic.

Non-agricultural real estate loan balances decreased due to a deliberate decision to supplement the Company’s core commercial real estate franchise with an increased strategic focus of building our commercial and industrial lending, including loans for owner-occupied commercial real estate and small business.

At March 31, 2021 the Bank’s regulatory credit concentration of commercial real estate loans (CRE), as defined in the Interagency Guidance dated, December 12, 2006, was 352%, down from 378% at December 31, 2020.

Management employs heightened risk management practices with respect to CRE lending, including board and management oversight, strategic planning, development and underwriting standards, risk assessment and monitoring through market

analysis, and stress testing.

At March 31, 2021 we have concluded that we have an acceptable and well-managed concentration in CRE lending under the foregoing standards, however, given the current level of CRE, and potential increased regulatory scrutiny it could bring, we are actively monitoring this segment of the loan portfolio.

The 12% decrease in Commercial and Industrial loans from $209.0 million at December 31, 2020 to $183.8 million was primarily driven by loan forgiveness precipitated by the Company’s participation in the Small Business Administration’s PPP as authorized by the CARES Act.

Gross loans and leases at $2.1 billion, reflected a decrease of $318.3 million, or 13%, at June 30, 2021 from $2.5 billion at December 31, 2020 due mostly to declines in commercial real estate loan balances, outstanding balances on mortgage warehouse lines, as well as the forgiveness of SBA PPP loans.

Balances on mortgage warehouse lines were down $157.3 million or 51% during the first half of 2021.

Mortgage warehouse utilization was 43% at June 30, 2021, as compared to 71% at December 31, 2020.

Utilization of mortgage warehouse lines in the future could be impacted by fluctuations in interest rates, seasonality, and other factors affecting home purchasing or refinancing demand including economic uncertainty.

There was a net decrease of $100.0 million in real estate secured loans, primarily from construction and other commercial real estate loans as the Company strategically lowered its regulatory commercial real estate concentration ratio from 378% at December 31, 2020 to 335% at June 30, 2021.

Management believes that a regulatory commercial real estate loan ratio of 335% is well within its overall risk appetite given that the Company employs heightened risk management practices with respect to CRE lending, including board and management oversight, strategic planning, development and underwriting standards, risk assessment and monitoring through market analysis, and stress testing.

At June 30, 2021 we have concluded that we have an acceptable and well-managed concentration in CRE lending as defined in the Interagency Guidance dated December 12, 2006.

The 28% decrease in Commercial and Industrial loans from $209.0 million at December 31, 2020 to $150.6 million at June 30, 2021 was primarily driven by loan forgiveness precipitated by the Company’s participation in the Small Business Administration’s PPP as authorized by the CARES Act.

The Company began accepting and funding loans under this program in April 2020.

There were 1,070 loans for $97.3 million outstanding at March 31, 2021, compared to 1,274 loans for $117.2 million at December 31, 2020.

During the first quarter of 2021, the Bank originated, and the SBA approved, funding for $33.2 million in PPP loans while the SBA forgave $52.8 million of PPP loans.

There were 943 loans for $68.0 million outstanding at June 30, 2021, compared to 1,274 loans for $117.2 million at December 31, 2020.

During the first half of 2021, the Bank originated, and the SBA approved, funding for $49.3 million in PPP loans while the SBA forgave $98.3 million of PPP loans.

The Company is working to buildout a more robust Commercial and Industrial loan origination group and platform, including small business loans, in order to complement its commitment to serving its commercial real estate customers.

NONPERFORMING ASSETS

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If the Company grants a concession to a borrower in financial difficulty, the loan falls into the category of a TDR, unless the modification was granted under section 4013 of the CARES Act or the April 7, 2020 Interagency Statement.

TDRs may be classified as either nonperforming or performing loans depending on their underlying characteristics and circumstances.

TDRs may be classified as either nonperforming or performing loans depending on their underlying characteristics and

circumstances.

The following table presents comparative data for the Company’s nonperforming assets and performing TDRs as of the dates noted:

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(dollars in thousands, unaudited)

March 31, 2021

June 30, 2021

December 31, 2020

March 31, 2020

June 30, 2020

NON-ACCRUAL LOANS:

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(1) Performing TDRs are not included in nonperforming loans above, nor are they included in the numerators used to calculate the ratios disclosed in this table.

Total nonperforming assets increased by $1.0 million, or 11%, during the first three months of 2021.

The increase resulted from two loans to one borrower.

None of these increases were due to COVID-19.

As a result of the decrease in the gross loan portfolio, the Company’s ratio of nonperforming assets to loans increased to 0.42% at March 31, 2021, from 0.35% at December 31, 2020.

All of the Company’s impaired assets are periodically reviewed and are either well-

reserved based on current loss expectations, or are carried at the fair value of the underlying collateral net of expected disposition costs.

As shown in the table, we also had $10.6 million in loans classified as performing TDRs on which we were still accruing interest as of March 31, 2021, a decrease of $0.8 million, or 7%, relative to December 31, 2020.

Foreclosed assets had a carrying value of $0.9 million at March 31, 2021 comprised of 7 properties classified as OREO as compared to 7 properties for $1.0 million at December 31, 2020.

Total nonperforming assets decreased by $0.5 million, or 6%, during the first six months of 2021.

The Company's ratio of nonperforming loans to gross loans increased to 0.34% at June 30, 2021 from 0.31% at December 31, 2020;

this was due to a decrease in the gross loan and lease portfolio, since nonperforming loans decreased $0.3 million during the same period.

All of the Company's impaired assets are periodically reviewed and are either well-reserved based on current loss expectations or are carried at the fair value of the underlying collateral, net of expected disposition costs.

As shown in the table, we also had $10.8 million in loans classified as performing TDRs on which we were still accruing interest as of June 30, 2021, a decrease of $0.6 million, or 5%, relative to December 31, 2020.

Foreclosed assets had a carrying value of $0.8 million at June 30, 2021 comprised of 6 properties classified as OREO as compared to 7 properties for $1.0 million at December 31, 2020.

All foreclosed assets are periodically evaluated and written down to their fair value less expected disposition costs, if lower than the then-current carrying value.

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Collection efforts are continuously pursued for all nonperforming loans, but we cannot provide assurance that they will be resolved in a timely manner or that nonperforming balances will not increase.

The Company had $4.2 million in loans past due 30-59 days at March 31, 2021.

The Company had $3.2 million in loans past due 30-59 days at June 30, 2021.

This is an increase of $1.1 million over the balance at December 31, 2020.

All of these past due loans are under management supervision and every effort is being taken to assist the borrowers and manage credit risk in this regard.

As described above, the Company is providing loan modifications to certain customers and taking advantage of either Section 4013 of the CARES Act or the April 7, 2020 Interagency Statement, which provides that such modifications do not result in treatment of such loan as a TDR.

not result in treatment of such loan as a TDR.

Since April 2020, the Company modified approximately $426 million of its loans under this guidance.

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For lines of credit, the borrower must repay the accrued interest at the end of the deferral period or take out a second credit facility to repay the accrued interest.

As of March 31, 2021, the Company had $22.4 million remaining in loan modification under Section 4013 of the CARES Act.

All but one small consumer relationship are fully secured by real estate collateral.

We expect all customers to show an ability and willingness to pay full principal and interest upon maturity of their deferment periods.

As of June 30, 2021, the Company had $10.4 million remaining in loan modification under Section 4013 of the CARES Act.

All loans are fully secured by real estate collateral.

We monitor these loans during the deferral period and if circumstances change, we may downgrade the loan to a criticized asset.

An additional modification, if necessary, could also result in the loan being treated as a TDR or classified asset.

If some portion of the customers are not able to resume payments after the deferral period, it likely could result in higher classified and/or nonperforming assets, reversals of interest income, and/or higher charge-offs.

At March 31, 2020, approximately $10.4 million of the $22.4 million in outstanding modification already are internally graded as a classified asset.

If some of the customers are not able to resume payments after the deferral period, it likely could result in higher classified and/or nonperforming assets, reversals of interest income, and/or higher charge-offs.

At June 30, 2021, all of the $10.4 million in outstanding modifications already are internally graded as classified assets.

ALLOWANCE FOR LOAN AND LEASE LOSSES

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The Company made this election as it believed that the deferral provided additional time to better assess the impact of the COVID-19 pandemic and related stimulus and relief efforts on the expected lifetime credit losses.

The Company’s allowance for loan and lease losses was $18.3 million at March 31,2021, an increase of $0.6 million, or 3%, relative to December 31, 2020 resulting from a $0.3 million loan loss provision recorded during the first three months of 2021, plus a $0.3 million in net recoveries during the same period.

The loan loss provision in the first three months of 2021 was precipitated primarily by the decrease in loan balances as well as the impact of loan recoveries.

No allowance for loan and lease losses was considered necessary for the SBA PPP loans as those loans carry a 100 percent guarantee under the “Paycheck Protection Program”, subject to certain diligence requirements by the issuing financial institution.

For further information regarding the Company's decision to defer the implementation of CECL under Section 4014 of the CARES Act, as well as further detail on the increase in provision during the first quarter of 2021, please see the discussion above under Provision for Loan and Lease Losses.

The allowance for loan and lease losses was 0.80% of total loans at March 31, 2021, 0.72% at December 31, 2020 and 0.64% at March 31, 2020.

The ratio of the allowance for loan and lease losses to nonperforming loans was 213.0% at March 31, 2021, relative to 233.5% at December 31, 2020 and 155.8% for March 31, 2020.

Management's detailed analysis indicates that the Company's allowance for loan and lease losses should be sufficient to cover credit losses inherent in loan and lease balances outstanding as of March 31, 2021, but no assurance can be given that the Company will not experience substantial future losses relative to the size of the allowance.

A separate allowance of $0.3 million for potential losses inherent in unused commitments is included in other liabilities at March 31, 2021.

The Company’s allowance for loan and lease losses was $16.4 million at June 30, 2021, a decrease of $1.3 million, or 7%, relative to December 31, 2020 resulting from a $1.9 million loan loss benefit recorded during the first six months of 2021, plus a $0.5 million in net recoveries during the same period.

The loan loss benefit in the first six months of 2021 was precipitated primarily by the decrease in loan balances, the impact of loan recoveries and improved historical loan loss rates.

No allowance for loan and lease losses was considered necessary for the SBA PPP loans as those loans carry a 100% guarantee under the “Paycheck Protection Program”, subject to certain diligence requirements by the issuing financial institution.

For further information regarding the Company's decision to defer the implementation of CECL under Section 4014 of the CARES Act, as well as further detail on the increase in provision during the first half of 2021, please see the discussion above under Provision for Loan and Lease Losses.

The allowance for loan and lease losses was 0.77% of total loans at June 30, 2021, 0.72% at December 31, 2020 and 0.61% at June 30, 2020.

The ratio of the allowance for loan and lease losses to nonperforming loans was 225.7% at June 30, 2021, relative to 233.5% at December 31, 2020 and 233.5% for June 30, 2020.

Management's detailed analysis indicates that the Company's allowance for loan and lease losses should be sufficient to cover credit losses inherent in loan and lease balances outstanding as of June 30, 2021, but no assurance can be given that the Company will not experience substantial future losses relative to the size of the allowance.

A separate allowance of $0.2 million for potential losses inherent in unused commitments is included in other liabilities at June 30, 2021.

The following table summarizes activity in the allowance for loan and lease losses for the noted periods:

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(1) Average balances are obtained from the best available daily or monthly data and are net of deferred fees and related direct costs.

The Company’s allowance for loan and lease losses at March 31, 2021 represents Management’s best estimate of probable losses in the loan portfolio as of that date, but no assurance can be given that the Company will not experience substantial losses relative to the size of the allowance.

The Company’s allowance for loan and lease losses at June 30, 2021 represents Management’s best estimate of probable losses in the loan portfolio as of that date, but no assurance can be given that the Company will not experience substantial losses relative to the size of the allowance.

Furthermore, fluctuations in credit quality, changes in economic conditions, updated accounting or regulatory requirements, and/or other factors could induce us to augment or reduce the allowance.

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It is unlikely that all unused commitments will ultimately be drawn down.

Unused commitments to extend credit, which included standby letters of credit, totaled $485.3 million at March 31, 2021 and $449.9 million at December 31, 2020, representing approximately 21% of gross loans outstanding at March 31, 2021 and 18% at December 31, 2020.

Unused commitments to extend credit, which included standby letters of credit, totaled $488.6 million at June 30, 2021 and $449.9 million at December 31, 2020, representing approximately 23% of gross loans outstanding at June 30, 2021 and 18% at December 31, 2020.

The increase in unused commitments is due in large part to the increase in unfunded commitments on mortgage warehouse lines.

The Company also had undrawn letters of credit issued to customers totaling $8.4 million at March 31, 2021 and $8.1 million at December 31, 2020.

The Company also had undrawn FHLB letters of credit issued to customers totaling $4.9 million at both June 30, 2021 and December 31, 2020.

The effect on the Company’s revenues, expenses, cash flows and liquidity from the unused portion of commitments to provide credit cannot be reasonably predicted because there is no guarantee that the lines of credit will ever be used.

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If a “long” position is prevalent, we could let brokered deposits or other wholesale borrowings roll off as they mature, or we might invest excess liquidity into longer-term, higher-yielding bonds.

The Company’s balance of non-earning cash and due from banks was $77.8 million at March 31, 2021 relative to $67.9 million at December 31, 2020.

The increase is primarily due to maintaining higher amounts of cash on hand due to the COVID-19 pandemic specifically government stimulus payments and customer needs for higher amounts of cash.

Foreclosed assets are discussed above in the section titled “Nonperforming Assets.” Net premises and equipment decreased by $0.7 million during the first three months of 2021, to $26.8 million.

Goodwill was $27 million at March 31, 2021, unchanged during the first three months of 2021.

The Company’s balance of non-earning cash and due from banks was $78.7 million at June 30, 2021 relative to $67.9 million at December 31, 2020.

The increase is primarily due to maintaining higher amounts of cash on hand due to fully reopening of all branches in the second quarter 2021 and to meet customer needs for higher amounts of cash.

Foreclosed assets are discussed above in the section titled “Nonperforming Assets.” Net premises and equipment decreased by $1.6 million during the first six months of 2021, to $25.9 million.

Goodwill was $27 million at June 30, 2021, unchanged during the first six months of 2021.

As mentioned above, the Company performed a qualitative assessment of goodwill impairment during the fourth quarter 2020 and determined that a quantitative analysis was not required.

There have been no triggering events in the first quarter of 2021 that would require The Company to perform a Goodwill impairment test, however the Company will continue to monitor its Goodwill for potential impairment given the COVID-19 pandemic.

Bank-owned life insurance, with a balance of $53.3 million at March 31, 2021, is discussed in detail above in the “Noninterest Income and Noninterest Expense” section.

There have been no triggering events in the first half of 2021 that would require the Company to perform a Goodwill impairment test, however the Company will continue to monitor its Goodwill for potential impairment.

Bank-owned life insurance, with a balance of $54.0 million at June 30, 2021, is discussed in detail above in the “Noninterest Income and Noninterest Expense” section.

DEPOSITS AND INTEREST BEARING LIABILITIES

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Deposits provide liquidity to fund growth in earning assets, and the Company’s net interest margin is improved to the extent that growth in deposits is concentrated in less volatile and typically less costly non-maturity accounts such as demand deposit accounts, NOW accounts, savings accounts, and money market demand accounts.

Information concerning average balances and rates paid by deposit type is included in the Average Balances and Rates tables appearing above, in the section titled “Net Interest Income and Net Interest Margin.” A distribution of the Company’s deposits by type, showing the period-end balance and percentage of total deposits, is presented as of the dates indicated in the following table.

Information concerning average balances and rates paid by deposit type is included in the Average Balances and Rates tables appearing above, in the section titled “Net

Interest Income and Net Interest Margin.” A distribution of the Company’s deposits by type, showing the period-end balance and percentage of total deposits, is presented as of the dates indicated in the following table.

Deposit Distribution

(dollars in thousands, unaudited)

March 31, 2021

June 30, 2021

December 31, 2020

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Interest bearing demand deposits

Time, under $250,000

Time, $250,000 or more

Brokered deposits

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Interest bearing demand deposits

Time, under $250,000

Time, $250,000 or more

Brokered deposits

Deposit balances reflect net growth of $229.3 million, or 9%, during the first three months of 2021.

Time deposits were $511.4 million at March 31, 2021 as compared to $512.9 million at December 31, 2020.

Brokered deposits were flat for the same period.

Non-maturity deposit growth of $230.8 million for the first three months of 2021was primarily the result of increases in balances of existing customers as the total number of customers increased by less than 1%.

Deposit balances reflect net growth of $151.3 million, or 6%, during the first half of 2021.

Time deposits were $380.9 million at June 30, 2021 as compared to $512.9 million at December 31, 2020.

Brokered deposits decreased $15.0 million at June 30, 2021 to $85.0 million as compared to $100.0 million at December 31, 2020.

Time deposits declined $117.1 million for the first six months of 2021 due mostly to the non-renewal of $120.0 million in public time deposits.

Non-maturity deposit growth of $283.4 million for the first six months of 2021 was primarily the result of increases in balances of existing customers as the total number of customers was relatively unchanged.

Management is of the opinion that a relatively high level of core customer deposits is one of the Company’s key strengths, and we continue to strive for core deposit retention and growth.

In particular, the Company’s ratio of noninterest-bearing deposits to total deposits was 35.8% at March 31, 2021 as compared to 36.0% at December 31, 2020.

In particular, the Company’s ratio of noninterest-bearing deposits to total deposits was 38.7% at June 30, 2021 as compared to 36.0% at December 31, 2020.

OTHER INTEREST-BEARING LIABILITIES

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The FHLB line is committed, but the amount of available credit depends on the level of pledged collateral.

Total non-deposit interest-bearing liabilities decreased by $125.5 million, or 58%, during the first three months of 2021 primarily due to a decrease in federal funds purchased and borrowings from the FHLB, due to the increase in deposits.

Repurchase agreements totaled $51.5 million at March 31, 2021 relative to a balance of $39.1 million at year-end 2020.

Repurchase agreements represent “sweep accounts”, where commercial deposit balances above a specified threshold are transferred at the close of each business day into non-deposit accounts secured by investment securities.

The Company had junior subordinated debentures totaling $35.2 million and $35.1 million at March 31, 2021 and December 31, 2020, respectively, in the form of long-term borrowings from trust subsidiaries formed specifically to issue trust preferred securities.

Total non-deposit interest-bearing liabilities decreased by $111.5 million, or 51%, during the first six months of 2021 primarily due to a decrease in federal funds purchased and borrowings from the FHLB.

Repurchase agreements totaled $70.5 million at June 30, 2021 relative to a balance of $39.1 million at year-end 2020.

Repurchase agreements represent “sweep accounts”, where certain customers have elected to have their commercial deposit balances above a specified threshold transferred at the close of each business day into non-deposit investments accounts.

The balance in the investment account is used to have the customer purchase securities or a perfected interest in specifically identified pledged securities from the bank, which are then repurchased by the bank from the customer the next business day.

The Company had junior subordinated debentures totaling $35.2 million and $35.1 million at June 30, 2021 and December 31, 2020, respectively, in the form of long-term borrowings from trust subsidiaries formed specifically to issue trust preferred securities.

OTHER NONINTEREST BEARING LIABILITIES

Other liabilities are principally comprised of operating lease right-of-use liabilities, accrued interest payable, other accrued but unpaid expenses, and certain clearing amounts.

The Company’s balance of other liabilities was $32.5 million at March 31, 2021 as compared to $35.1 million at December 31, 2020.

The Company’s balance of other liabilities was $32.7 million at June 30, 2021 as compared to $35.1 million at December 31, 2020.

LIQUIDITY AND MARKET RISK MANAGEMENT

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To meet these short-term needs, we can borrow overnight funds from other financial institutions, draw advances via Federal Home Loan Bank lines of credit, or solicit brokered deposits if customer deposits are not immediately obtainable from local sources.

At March 31, 2021 and December 31, 2020, the Company had the following sources of primary and secondary liquidity ($ in thousands):

At June 30, 2021 and December 31, 2020, the Company had the following sources of primary and secondary liquidity ($ in thousands):

Primary and secondary liquidity sources

March 31, 2021

June 30, 2021

December 31, 2020

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In addition to the above sources, the Company could obtain brokered deposits, obtain deposits via deposit listing services, or offer higher rate time deposits within our market.

At March 31, 2021, the Company had previously applied for and received approval to borrow $99.8 million from the Federal Reserve Bank for a Paycheck Protection Program Lending Facility (PPPLF) through June 30, 2021.

The PPPLF provides the Company with the ability to pledge any PPP loan to the Federal Reserve Bank and obtain funding at 35 basis points.

Further, any loans pledged to the PPPLF will be excluded from the regulatory leverage capital ratio.

Due to the Company’s liquidity throughout the first three months of 2021 it elected not to utilize the PPPLF during the quarter.

The Company will continue to evaluate whether it should utilize the PPPLF in the second quarter 2021.

The significant increase in cash and cash equivalents during 2021 is due mostly to continued deposit growth coupled with decreases in loans, but partially offset by increases in investments.

Utilization of this excess liquidity is expected to come from a combination of new loans, including potential loan purchases;

new investment purchases;

and anticipated declines in a portion of the deposits built-up during the COVID-19 pandemic.

When looking to reduce these low-yielding cash balances with earning assets other than loans, management considers interest rate risk, including duration and extension risk;

and the liquidity risk of such alternative assets.

The Company performs regular stress tests on its liquidity and at this time, believes that we have sufficient primary and secondary liquidity sources for operations.

The Company has a higher level of actual balance sheet liquidity than might otherwise be the case, since we utilize a letter of credit from the FHLB rather than investment securities for certain pledging requirements.

That letter of credit, which is backed by loans pledged to the FHLB by the Company, totaled $100 million at March 31, 2021 and December 31, 2020.

That letter of credit, which is backed by loans pledged to the FHLB by the Company, totaled $100 million at June 30, 2021 and December

Other sources of liquidity included the brokered deposit market, deposit listing services, and the ability to offer local time-deposit campaigns.

Management is of the opinion that available investments and other potentially liquid assets, along with standby funding sources it has arranged, are more than sufficient to meet the Company’s current and anticipated short-term liquidity needs and that its liquidity has not been adversely impacted by COVID-19.

The Company’s net loans to assets and available investments to assets ratios were 68.7% and 18.9%, respectively, at March 31, 2021, as compared to internal policy guidelines of “less than 78%” and “greater than 3%.” Other liquidity ratios reviewed periodically by Management and the Board include net loans to total deposits and wholesale funding to total assets, including ratios and sub-limits for the various components comprising wholesale funding, which were all well within policy guidelines at March 31, 2021.

The Company’s net loans to assets and available investments to assets ratios were 65.4% and 25.1%, respectively, at June 30, 2021, as compared to internal policy guidelines of “less than 78%” and “greater than 3%.” Other liquidity ratios reviewed periodically by Management and the Board include net loans to total deposits and wholesale funding to total assets, including ratios and sub-limits for the various components comprising wholesale funding, which were all well within policy guidelines at June 30, 2021.

The Company has been able to maintain a robust liquidity position in recent periods, but no assurance can be provided that our liquidity position will continue at current strong levels.

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Its primary source of funds is dividends from the Bank, since the holding company does not conduct regular banking operations.

As of March 31, 2021, the holding company maintained a cash balance of $12.4 million.

As of June 30, 2021, the holding company maintained a cash balance of $8.7 million.

Management anticipates that with the available cash and the continued ability for the Bank to provide dividends to the holding company, that the holding company has sufficient liquidity to meet its funding requirements for the foreseeable future.

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The rate projections can be shocked (an immediate and parallel change in all base rates, up or down), ramped (an incremental increase or decrease in rates over a specified time period), economic (based on current trends and econometric models) or stable (unchanged from current actual levels).

In addition to a stable rate scenario, which presumes that there are no changes in interest rates, we typically use at least six other interest rate scenarios in conducting our rolling 12-month net interest income simulations:

In addition to a stable rate scenario, which presumes that there are no changes in interest rates, we typically use at least eight other interest rate scenarios in conducting our rolling 12-month net interest income simulations:

upward shocks of 100, 200, 300, and 400 basis points, and downward shocks of 100, 200, and 300 basis points.

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Given the current near zero interest rate environment it is unlikely that rates could decline much further beyond the downward shock of 100 basis points, therefore the downward shock scenarios of 200,300, and 400 basis points are temporarily being suspended after concurrence by the Company’s Board of Directors.

We currently utilize an additional upward rate shock scenario of 400 basis points.

Pursuant to policy guidelines, we generally attempt to limit the projected decline in net interest income relative to the

stable rate scenario to no more than 5% for a 100 basis point (bp) interest rate shock, 10% for a 200 bp shock, 15% for a 300 bp shock, and 20% for a 400 bp shock.

Pursuant to policy guidelines, we generally attempt to limit the projected decline in net interest income relative to the stable rate scenario to no more than 5% for a 100 basis point (bp) interest rate shock, 10% for a 200 bp shock, 15% for a 300 bp shock, and 20% for a 400 bp shock.

The Company had the following estimated net interest income sensitivity profiles over one-year, without factoring in any potential negative impact on spreads resulting from competitive pressures or credit quality deterioration:

March 31, 2021

March 31, 2020

June 30, 2021

June 30, 2020

Immediate change in Interest Rates (basis points)

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$ Change in Net Interest Income

For the periods ended March 31, 2021 and 2020, the Company was asset sensitive, with net income increasing in a rising rate environment in all scenarios but declining considerably in the down shocks.

The simulation for the period ending March 31, 2020 indicates that the Company’s net interest income will increase over the next 12 months in a rising rate environment in all scenarios, but a continued drop in interest rates could have a substantial negative impact.

However the rate of increase is not as pronounced as in the March 31, 2021 scenario due to considerably less cash on hand and the impact of interest rate reductions and balance sheet changes including an increase in loans with variable rate characteristics (mortgage warehouse loans), the runoff of loans which had rates fixed for periods in excess of a year, and a projected slight shift in our deposit mix toward time deposits over time.

In the up 400 basis point shock scenario, expected net interest income over the next twelve months increases $7.7 million, or 7%, to $115.7 million at March 31, 2021 compared to a 5% increase or $5.0 million for the same period in 2020.

For the periods ended June 30, 2021 and 2020, the Company was asset sensitive, with net income increasing in a rising rate environment in all scenarios but declining considerably in the down shocks.

The simulation for the period ending June 30, 2020 indicates that the Company’s net interest income will increase over the next 12 months in a rising rate environment in all scenarios, but a continued drop in interest rates could have a substantial negative impact.

However the rate of increase is not as pronounced as in the June 30, 2021 scenario due to considerably more cash on hand, and to a lesser extent the impact of interest rate increases on loans with variable and adjustable rate characteristics.

In the up 400 basis point shock scenario, expected net interest income over the next twelve months increases $11.6 million, or 11%, to $114.8 million at June 30, 2021 compared to a 5% increase or $5.0 million for the same period in 2020.

The primary reason for the increase in expected net interest income despite a lower rate environment, was the increase in surplus interest-bearing cash in other banks.

In an instantaneous parallel rate shock the entire balance of surplus cash would reprice immediately.

Over the next twelve months, surplus cash is projected to remain at higher levels than prior years as the Company shifts from non-owner occupied commercial real estate to other types of lending.

Although the cost of interest-bearing liabilities will also increase, the deposit betas utilized in the model mitigate the magnitude of a deposit rate increase.

Over the next twelve months, surplus cash is projected to decline due to asset purchases;

core loan growth as mortgage warehouse utilization stabilized and our pipelines begin to increase;

and expected declines in a portion of the build-up in deposits during the COVID-19 pandemic.

Although the cost of interest-bearing liabilities will also increase in a rate shock, the deposit betas utilized in the interest rate model mitigate the magnitude of a deposit rate increase.

The change in net interest income is similar for the up 100, 200, and 300 basis point scenarios.

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If there was an immediate downward adjustment of 100 basis points in interest rates, net interest income would drop $8.3 million or a negative variance of 8%.

Since many of deposit products are at their natural floors as reflected in our current cost of deposits of.14% for the first quarter of 2021, the unfavorable variances increase as interest rates decline because non-floored variable-rate loans continue to drop.

This effect is further exacerbated by accelerated prepayments on fixed-rate loans and mortgage- backed securities when rates decline.

While we view material interest rate reductions as unlikely in the near term, the potential percentage drop in net interest income in the “down 100 basis points” interest rate scenario exceeds our internal policy guidelines and we will continue to monitor our interest rate risk profile and implement remedial changes as deemed appropriate.

The reason for the drop in net interest income is, most deposit products are at or below their modeled floors of 0.10% and cannot be re-priced lower, while non-floored interest earning assets such as loans and securities can theoretically still be re-priced lower in a falling rate environment.

Due to the historically low current rate environment, we view any material interest rate reductions as unlikely in the near term.

However, the potential percentage drop in net interest income in the “down 100 basis points” interest rate scenario exceeds our internal policy guidelines and we will continue to monitor our interest rate risk profile and implement remedial changes if deemed appropriate.

If there was an immediate downward adjustment of 100 basis points in interest rates, net interest income would drop $8.3 million or a negative variance of 8%.

The reason for the drop in net interest income is, most deposit products are at their floors of 0.10% and cannot be re-priced lower, while non-floored interest earning assets such as loans and securities can theoretically still be re-priced lower in a falling rate environment.

Due to the historically low current rate environment, we view any material interest rate reductions as unlikely in the near term.

In addition to the net interest income simulations shown above, we run stress scenarios for the unconsolidated Bank modeling the possibility of no balance sheet growth, the potential runoff of “surge” core deposits which flowed into the Bank in the most recent economic cycle, and unfavorable movement in deposit rates relative to yields on earning assets (i.e., higher deposit betas).

When a static balance sheet and a stable interest rate environment are assumed, projected annual net interest income is more than $3 million lower than in our standard simulation.

When a static balance sheet and a stable interest rate environment are assumed, projected annual net interest income is $5 million lower than in our standard simulation.

The economic value (or “fair value”) of financial instruments on the Company’s balance sheet will also vary under the interest rate scenarios previously discussed.

The difference between the projected fair value of the Company’s financial assets and the fair value of its financial liabilities is referred to as the economic value of equity (“EVE”), and changes in EVE under different interest rate scenarios are effectively a gauge of the Company’s longer-term exposure to interest rate fluctuations.

rate fluctuations.

Fair values for financial instruments are estimated by discounting projected cash flows (principal and interest) at anticipated replacement interest rates for each account type, while the fair value of non-financial accounts is assumed to equal their book value for all rate scenarios.

An economic value simulation is a static measure utilizing balance sheet accounts at a given point in time, and the measurement can change substantially over time, as is evident in the tables below for the periods ending March 31, 2021 and 2020, respectively, as the Company’s balance sheet evolves and interest rate and yield curve assumptions are updated.

An economic value simulation is a static measure utilizing balance sheet accounts at a given point in time, and the measurement can change substantially over time, as is evident in the tables below for the periods ending June 30, 2021 and 2020, respectively, as the Company’s balance sheet evolves and interest rate and yield curve assumptions are updated.

The change in economic value under different interest rate scenarios depends on the characteristics of each class of financial instrument, including stated interest rates or spreads relative to current or projected market-level interest rates or spreads, the likelihood of principal prepayments, whether contractual interest rates are fixed or floating, and the average remaining time to maturity.

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The tables below show estimated changes in the Company’s EVE, under different interest rate scenarios relative to a base case of current interest rates:

March 31, 2021

March 31, 2020

June 30, 2021

June 30, 2020

Immediate change in Interest Rates (basis points)

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CAPITAL RESOURCES

The Company had total shareholders’ equity of $348.0 million at March 31, 2021, comprised of $113.5 million in common stock, $4.0 million in additional paid-in capital, $216.2 million in retained earnings, and accumulated other comprehensive income of $14.3 million.

The Company had total shareholders’ equity of $357.7 million at June 30, 2021, comprised of $113.5 million in common stock, $4.2 million in additional paid-in capital, $224.7 million in retained earnings, and accumulated other comprehensive income of $15.4 million.

At the end of 2020, total shareholders’ equity was $343.9 million.

The increase during the first three months of 2021 is due to the addition of capital from net income, stock options exercised and restricted stock accrued.

The increase during the first half of 2021 is due to the addition of capital from net income, stock options exercised and restricted stock accrued.

These positive changes were partially offset by a $3.0 million unfavorable swing in accumulated other comprehensive income, net and the impact of cash dividends paid.

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Tier 1 Capital to Adjusted Average Assets ("Leverage Ratio")

(1) Current data is not applicable as the Bank adopted the Community Bank Leverage Ratio Framework as of the first quarter of 2020.

(1) The minimum required Community Bank Leverage Ratio is 9.00%, but the CARES Act temporarily lowers this to 8.5% as described below.

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The federal bank regulatory agencies adopted an interim final rule to implement this change from the CARES Act.

At March 31, 2021, the Company and the Bank met the criteria outlined in the final rule and the interim final rule and elected to measure capital adequacy under the CBLR framework.

At June 30, 2021, the Company and the Bank met the criteria outlined in the final rule and the interim final rule and elected to measure capital adequacy under the CBLR framework.

PART I – FINANCIAL INFORMATION

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Compared sentence by sentence after normalising whitespace, quotation marks, case and digits, so re-formatting and restated figures do not read as changed language. Wording changes appear as one removal and one addition. The current filing and the prior one are authoritative.

What changed 10-Q

Item 2. Management’s Discussion and Analysis