What changed in this filing

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Item 2. Management’s Discussion and Analysis

2021-11-04 compared with 2021-08-05 · 289 added, 261 removed, 570 unchanged (49% of the section changed)

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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 forward-looking statements are based on certain underlying assumptions and are not guarantees of future performance, as they could be impacted by 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.

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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 outcome of any existing or future legal action for which the Company or Bank is a defendant;

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

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RESULTS OF OPERATIONS SUMMARY

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.

Third Quarter 2021 compared to Third Quarter 2020

Third quarter 2021 net income was $10.6 million, or $0.69 per diluted share, compared to $10.4 million, or $0.68 per diluted share in the third quarter of 2020.

The Company’s annualized return on average equity was 11.62% and annualized return on average assets was 1.26% for the quarter ended September 30, 2021, compared to 12.34% and 1.34%, respectively, for the same quarter in 2020.

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

● A $0.6 million negative provision for loan and lease losses as compared to a provision for loan and lease losses of $2.4 million in the same quarter in 2020.

This favorable impact was attributed to continued improvements in the overall economy and lower uncertainty, a reduction in historical loss rates, a decline in specific reserves on

impaired loans, net loan recoveries in 2021, and a change in the mix of loans, and lower outstanding balances of net loans and leases.

● Net interest income decreased by $1.4 million mostly due to a 54 bps decline in the yield on earning assets and a shift in mix due to higher levels of average cash invested overnight with the Federal Reserve Bank and lower average loan balances.

● Noninterest income increased $0.4 million or 6% primarily due to increases in checkcard interchange fees from increased usage.

● Noninterest expense increased by $1.6 million, due mostly to a $0.9 million increase in salaries, a $0.4 million increase in deposit servicing costs, and a $0.5 million increase in legal expenses.

Year-to-Date Changes 2021 compared to First Nine-Months of 2020

Net income for the first nine months of 2021 was $33.4 million, or $2.17 per diluted share, compared to $26.5 million, or $1.73 per diluted share for the same period in 2020.

The Company’s annualized return on average equity was 12.60% and annualized return on average assets was 1.36% for the nine months ended September 30, 2021, compared to a return on equity of 10.90% and return on assets of 1.26% for the nine months ended September 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.

● A $2.5 million negative provision for loan and lease losses, relative to $6.4 million provision for loan and lease losses in the first nine months of 2020, for the same reasons outlined above in the quarterly comparison.

● Net interest income increased by $6.5 million or 8% due mostly to higher average loan balances and a continued favorable deposit mix, partially offset by a lower net interest margin.

● Noninterest income increased by $0.9 million, or 4%, due to checkcard interchange fees, increases in BOLI income, and increases in the fair market value of equity securities partially offset by the fact that the third quarter of 2020 had certain nonrecurring gains on the sales of investments, and other assets that did not reoccur in the third quarter of 2021.

● Noninterest expense increased $6.2 million, or 11% due mostly to the increases in salary expense, data processing, checkcard processing costs, and professional services expense, including legal costs.

FINANCIAL CONDITION SUMMARY

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 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.

September 30, 2021 relative to December 31, 2020

The Company’s assets totaled $3.4 billion at September 30, 2021 relative to $3.2 billion at December 31, 2020.

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

● Cash and due from banks increased $350.9 million, to $422.4 million during the first nine months of the year due mostly to higher deposit balances coupled with lower loan balances.

● Investment securities increased 35% to $732.3 million from $544.0 million at December 31, 2020, primarily due to bond purchases.

● Gross loans declined $323.3 million due predominantly to a $181.2 million decline in mortgage warehouse line utilization, a $63.0 million decline in real estate loans mostly due to lower commercial real estate and construction loan balances, and a $76.8 million decrease in commercial and industrial loans, which was mostly Small Business Administration Paycheck Protection Program (“SBA PPP”) loan forgiveness.

● Deposits totaled $2.8 billion at September 30, 2021, representing a year-to-date increase of $196.0 million, or 7%.

The growth in deposits came primarily from core transaction and savings accounts, while higher-cost time and wholesale brokered deposits decreased.

● Long-term debt increased to $49.2 million from the issuance of $50 million in ten year 3.25% fixed to floating subordinated notes, net of issuance costs.

● Total shareholders’ equity of $364.5 million at September 30, 2021 reflects an increase of $20.6 million, or 6%, relative to year-end 2020 due to additional capital from the $33.4 million addition of net income, a $3.4 million unfavorable swing in accumulated other comprehensive income/loss, stock options exercised, and restricted stock compensation, net of $9.8 million in dividends paid.

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

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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 were 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.

● 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.

● On September 9, 2021, President Biden announced as part of his six-pronged, comprehensive national strategy to combat COVID-19.

The “Path out of the Pandemic” includes a rule requiring all employers with 100+ employees to ensure their workforce is fully vaccinated or require any workers who remain unvaccinated to produce a negative test result on at least a weekly basis before coming to work.

This Emergency Temporary Standard is currently under White House review.

It is anticipated that this rule will become effective in November 2021 with enforcement actions beginning around January 1, 2022.

Fines for non-compliance are up to $14,000 per violation.

Impact of COVID-19 on the Company’s Operations

● 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.

The Company had $10.4 million in classified assets at September 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.

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

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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.

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.

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

As described above, in March 2020, the FOMC cut short-term rates by 150 basis points to near zero.

The uncertainty with COVID-19 and the lower targeted fed funds rates also impacted other rates including the Prime Rate and treasury yields.

The uncertainty with COVID-19 and the lower targeted fed funds rates also impacted other rates including the Prime Rate and treasury yields, which the Company uses to price many of its loans.

These lower rates impacted our net interest margin.

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.

Our net interest margin for the three months ended September 30, 2021, was 3.46%, compared to a net interest margin of 3.98% 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.

This additional liquidity was mostly deployed in overnight funding resulting in $380.0 million in average overnight cash during the third quarter of 2021 and $256.0 in average balances for the year-to-date period ending September 30,2021.

This overnight funding earned an average rate of 15 and 13 basis points, respectively, for the third quarter and nine-months ending September 30, 2021.

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

The overall impact of a lower net interest margin was more than offset by higher earning assets in 2021 as compared to 2020 for the year-to-date comparisons.

However, for the third quarter of 2021 as compared to the same quarter in 2020, the $267.0 million increase in average interest earning balances did not fully offset the impact of the 54 bps decline in yield.

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

During the first nine months of 2021, total shareholders’ equity increased by $20.6 million, or 6%, to $364.5 million.

The Company earned $33.4 million in net income in the first nine months of 2021, but had a $3.4 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 $9.8 million during the first nine months of 2021.

On October 21, 2021, the Company declared a twenty-two cent per share dividend to be paid on November 11, 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.

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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 June 30, 2021, our goodwill was not impaired.

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

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

● The Company continues to serve its customers.

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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.

The acceleration of amortization of leasehold improvements for these locations increased depreciation expense 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 in June 2021 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.

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NET INTEREST INCOME AND NET INTEREST MARGIN

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.

Net interest income decreased $1.4 million to $26.7 million, for the third quarter of 2021 over the third quarter of 2020 and increased $6.5 million, or 8% to $82.5 million for the first nine months of 2021 in comparison to the first nine months of 2020.

For the third quarter of 2021 as compared to the same quarter in 2020, average loan balances decreased $161.9 million, or 7%, primarily due to $144.6 million, or a 55% decrease in the utilization of mortgage warehouse lines, and a $86.4 million, or 38% decrease in commercial loans, from the forgiveness of SBA PPP loans.

These decreases were partially offset by a $75.4 million increase in real estate loan balances, primarily from the purchase of $121.6 million in mortgage loan pools, later in the third quarter of 2021.

The average yield on the overall loan portfolio increased 5 basis points, while there was a 2 bps favorable decrease in the cost of interest-bearing liabilities for the third quarter of 2021 as compared to the same quarter in 2020.

For the first nine months of 2021 as compared to the same period in 2020, average loan balances increased $254.3 million or 13%, primarily due to increases in real estate loans of $301.7 million or 20%.

The increase in the aforementioned average loan balances were the major driver in the increase in net interest income with a 18 bps decrease in loan yield partially offsetting the increase in volume.

There was a 17 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 nine months 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

June 30, 2021

June 30, 2020

September 30, 2021

September 30, 2020

Rate/Yield (2)

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Short term borrowings

Long-term debt

Subordinated debentures

Total borrowed funds

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

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

Net loan fees and loan acquisition FMV amortization were $1.0 million and $1.3 million for the quarters ended September 30, 2021 and 2020, respectively.

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

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(Dollars in Thousands, Unaudited)

For the six months ended

June 30, 2021

June 30, 2020

For the nine months ended

September 30, 2021

September 30, 2020

Rate/Yield (2)

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Short term borrowings

Long-term debt

Subordinated debentures

Total borrowed funds

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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.

Net loan fees and loan acquisition FMV amortization were $3.4 million and $0.9 million for the nine months ended September 30, 2021 and 2020, respectively.

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

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(dollars in thousands, unaudited)

Three months ended June 30,

Six months ended June 30,

Three months ended September 30,

Nine months ended September 30,

2021 over 2020

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Borrowed funds:

Federal funds purchased

Repurchase agreements

Short term borrowings

Long-term debt

Subordinated debt

Total borrowed funds (1)

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(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 volume variance calculated for the third quarter of 2021 relative to the third quarter of 2020 was an unfavorable $0.8 million due to lower average balances of interest earning assets, resulting from a decrease in mortgage warehouse line utilization coupled with a decrease in commercial loans, mostly from the forgiveness of SBA PPP loans, partially offset by an increase in real estate loans.

There was an unfavorable rate variance of $0.6 million for the comparative quarters

since the weighted average yield on interest earning assets fell by 54 basis points and the weighted average cost of interest-bearing liabil ities decreased by 2 basis points.

The rate variance was negatively impacted by the following factors:

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.

high average balances of cash and due from banks earning on average 15 bps, new loans and investments having lower yields overall, including low-yielding 1-4 SFD mortgage loans and SBA PPP loans.

These negative factors were slightly offset by an increase in 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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If a loan is forgiven, upon repayment of principal and interest by the SBA, any unaccreted fee income, net of unamortized costs, would be recognized as interest income at such time.

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 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.

The decrease in rate on interest earning assets was more than the net volume/rate decrease in interest bearing liabilities and resulted in an unfavorable $1.4 million net volume/rate difference.

The Company’s net interest margin for the third quarter of 2021 was 3.46%, as compared to 3.98% for the third quarter of 2020.

The volume variance calculated for the first nine months of 2021 relative to the first nine months of 2020 reflects a favorable volume variance of $10.9 million and an unfavorable rate variance of $4.4 million, resulting from organic growth in commercial real estate loans.

The growth in interest earning assets was partially offset by the 43 basis point decrease in yield while interest bearing liabilities increased $174.4 million with a 17 basis point drop in cost.

Since the volume variances outweighed the declines in yield there was a favorable $6.5 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.

The Company’s net interest margin for the first nine months of 2021 was 3.66%, as compared to 3.97% in the first nine months 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 June 30, 2021, approximately 9% of our total portfolio, or $199.3 million, consists of variable rate loans.

At September 30, 2021, approximately 9% of our total portfolio, or $192.7 million, consists of variable rate loans.

Of these variable rate loans, approximately $69.9 million have floors that limited the overall reduction in rates.

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.

At September 30, 2021, our outstanding fixed rate loans represented 22% of our loan portfolio.

The remaining 69% of our loan portfolio at September 30, 2021 consists of adjustable-rate loans;

60% of these loans (approximately $883 million) will not begin adjusting for at least another 3 years, but up to 10 years.

These loans are typically adjustable every five years after the initial adjustment.

Approximately $54.3 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.

Average cash and due from banks was $379.6 million, an increase of $372.7 million for the third quarter of 2021 as compared to the third quarter of 2020 and was $256.0 million, an increase of $223.6 million for the first nine months of 2021 as compared to the same period in 2020.

Overall average investment securities increased by $56.2 million for the third quarter of September 30, 2021 as compared to September 30, 2020 and decreased by $12.9 million for the first nine months of 2021 as compared to the same period in 2020.

For the quarter ending September 30, 2021 over the same period for 2020, average non-taxable securities increased $32.7 million and taxable securities increased $23.5 million.

For the first nine months of 2021 over the same period for 2020, average non-taxable securities increased $28.6 million and taxable securities decreased $41.5 million due mostly to prepayments on mortgage-backed securities.

Partially offsetting the decrease to taxable securities were purchases of subordinated debentures of bank holding companies and collateralized loan obligations.

The overall investment portfolio had a tax-equivalent yield of 2.44% at September 30, 2021, with an average life of 4.9 years.

Interest expense was $0.9 million in the third quarter of 2021, a decline of $0.1 million, or 6%, compared to the third quarter of 2020 and was $2.7 million in the first nine-months of 2021, a decline of $1.8 million or 39%.

The decline in interest expense for both the quarter and the nine months is attributable to a favorable shift in deposit mix as average total time deposits declined by $134.8 million, or 31%, in the third quarter of 2021 as compared to the same quarter in 2020 and by $96.5 million, or 22% for the first nine months of 2021 as compared to the same period in 2020.

The average cost of interest-bearing deposits declined by 2 basis points to 14 basis points for the third quarter of 2021

compared to the third quarter of 2020, and by 15 basis points to 14 basis points for the first nine-months of 2021 as compared to the same period in 2020.

Non-interest bearing demand deposits increased $146.3 million or 15% for the third quarter of 2021 as compared to the third quarter of 2020 and increased $222.3 million or 27% for the first nine-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 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.

The Company recorded a net benefit related to loan and lease loss provision of $0.6 million in the third quarter of 2021 relative to a provision of $2.4 million in the third quarter of 2020, and a year-to-date net benefit for loan and lease loss provision of $2.5 million in 2021 as compared to $6.4 million loan and lease loss provision expense for the same period in 2020.

The Company's $3.0 million, or 126%, favorable decline in provision for loan and lease losses in the third quarter of 2021 as compared to the third quarter of 2020, and the $8.8 million favorable decrease, or 139% in the first nine months of 2021 compared to the same period in 2020 is due mostly to lower historical loan loss rates, a decline in outstanding balances on loans, a change in the mix of loans, and net year-to-date 2021 recoveries of previously charged-off loan balances.

During the first nine months of 2021, 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, 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.

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).

However, 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.

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

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.

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.

As described above, the Company was subject to the adoption in the first quarter of 2020 of the Current Expected Credit Loss ("CECL") accounting method under Financial Accounting Standards Board (FASB) Accounting Standards Update 2016-03 and related amendments, Financial Instruments – Credit Losses (Topic 326).

Prior to the close of the first quarter of 2020, the Company elected under Section 4014 of the Coronavirus Aid, Relief, and Economic Security (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.

Later in 2020, the Consolidated Appropriations Act, 2021 extended the deferral of implementation of CECL 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 better assess the impact of the COVID-19 pandemic on the expected lifetime credit losses.

Further, the Company has taken actions to serve our communities during the pandemic, including permitting short-term payment deferrals to current customers, as well as originating bridge loans and SBA PPP loans.

Upon the adoption of CECL on January 1, 2022, the Company is expected to record the anticipated increase in the allowance for credit losses as an adjustment to equity, net of deferred taxes.

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

As of September, 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.

These deferrals had an impact on how the Company internally grades its loans and as such had an impact on the overall provision under the incurred loss method.

The performance on these loans after the end of the deferral period could impact future provision.

The continued performance on these loans after the end of the deferral period could impact future provision.

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 $0.2 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 Company recorded net charge-offs of $0.2 million in the third quarter of 2021 as compared to $0.3 million for the comparative period of 2020.

For the first nine months of 2021, the Company recorded net recoveries of $0.3 million as compared to net charge-offs of $0.7 million 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 and six month periods ended June 30, 2021 and 2020:

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

Noninterest Income/Expense

(dollars in thousands, unaudited)

For the three months ended June 30,

For the six months ended June 30,

For the three months ended September 30,

For the nine months ended September 30,

Noninterest income:

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Noninterest Income:

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.

Total noninterest income reflects increases of $0.4 million, or 6%, for the quarter ended September 30, 2021 as compared to the same quarter in 2020, and $0.9 million, or 4% for the year-to-date period ended September 30, 2021 as compared to the same period in 2020.

Service charges on deposit accounts increased by $0.2 million or 8%, for the quarterly comparison and decreased $0.1 million or 1%, 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.

The variances for both periods were due to increases and decreases, respectively in overdraft fees, due to volume fluctuations.

Other service charges and fees increased $0.4 million or 15% for the third quarter of 2021 and $1.1 million or 15% for the first nine months of 2021 as compared to the same period in 2020.

For both the quarter and the year-to-date comparisons 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.

The same gain in 2021 was very minor, thus resulting in a negative variance of $0.4 million for the first nine months of 2021 as compared to the same period in 2020.

BOLI income decreased by $0.3 million as compared to the third quarter of 2021 and increased $0.4 million for the first nine months 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.

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

At September 30, 2021, there was $44.0 million in BOLI policies and $11.0 million in separate account BOLI policies associated with the deferred compensation plans.

In the “other” category of noninterest income the Company reflected a $0.1 million increase in the third quarter of 2021 as compared to the third quarter of 2020 and a $0.2 million decrease in the first nine months of 2021 as compared to the same period in 2020.

The quarterly comparison includes a $0.8 million non-recurring gain resulting from the wrap-up of a low-income housing tax credit fund investment in the third quarter of 2020, partially offset by a $0.6 million favorable change in costs of the same low-income housing tax credit fund investment.

A recovery of legal expenses from a prior year for $0.2 million also was recorded in the third quarter of 2021.

The year-to-date comparisons were impacted by a $0.6 million favorable variance in low-income housing tax credit fund investments offset by $1.5 million in non-recurring gains in the first nine months of 2020 from the wrap up of low-income housing tax credit fund investments.

The year-to-date comparison was also favorably impacted by a $0.4 million increase in the valuation of the Company’s equity investment in Pacific Coast Bankers’ Bank.

Noninterest Expense:

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.

Total noninterest expense increased by $1.6 million, or 8%, in the third quarter of 2021 relative to the third quarter of 2020, and by $6.2 million, or 11%, in the first nine months of 2021 as compared to the same period in 2020.

Noninterest expense dropped to 2.66% of average earning assets in the third quarter of 2021 down from 2.70% for the third quarter of 2020 and was 2.67% of average earning assets for the first nine months of 2021 relative to 2.85% for the same period in 2020.

The tax-equivalent efficiency ratio was 59.75% in the third quarter of 2021 as compared to 53.74% in the same quarter of 2020 and was 58.30% for the first nine months of 2021 as compared to 56.64% 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;

the provision for loan losses and investment gains/losses are excluded from the equation.

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 $1.2 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.

The Company continues to actively consider a wide variety of operational efficiency opportunities, and noninterest income enhancements, however challenges in net interest income from softening loan demand make it difficult to predict further improvements of the efficiency ratio.

Salaries and Benefits were $0.9 million, or 9%, higher in the third quarter of 2021 as compared to the third quarter of 2020 and $3.1 million, or 10%, higher for the first nine months of 2021 compared to the same period in 2020.

expense deferrals related to the decrease in loan originations were primarily responsible for the negative variance;

there was a decrease in salary deferrals of $0.5 million for the quarterly comparison and $2.2 million for the year-to-date comparison.

There were 482 full-time equivalent employees at September 30, 2021 as compared to 491 at September 30, 2020.

Occupancy expenses were $0.2 million lower for the third quarter of 2021 as compared to the same quarter in 2020 and $0.1 million higher for the first nine months of 2021 as compared to the same period in 2020.

The primary reason for decrease in the quarterly comparison was the closure of five branch facilities earlier in the year, which included the early termination of two leases immediately.

The acceleration of leasehold improvements was responsible for the slight increase in the year-to-date comparison.

Other noninterest expense increased $0.9 million, or 12% for the third quarter 2021 as compared to the third quarter in 2020, and increased $3.1 million, or 17% for the first nine months of 2021 as compared to the same period in 2020.

The variance for the third quarter of 2021 compared to the same period in 2020 was primarily driven by an increase of $0.6 million in legal and accounting costs due mostly to an increase in litigation costs.

Additionally, there were increases of $0.3 million in data processing costs resulting from increases in core banking system expenses, and $0.4 million in increase in checkcard processing costs due to higher debit card usage.

These higher costs were partially offset by a $0.4 million decrease in foreclosed assets costs, due to the sale of all but two bank owned properties.

For the year-over-year comparison the categories of increase were the same as with the quarterly comparison, along with a $0.3 million increase in FDIC assessments and a $0.3 million increase in deferred compensation expense for directors, which is linked to the changes in BOLI income.

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 25.3% 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.

The Company's provision for income taxes was 24.1% of pre-tax income in the third quarter of 2021 relative to 23.4% in the third quarter of 2020, and 25.0% of pre-tax income for the first nine months of 2021 relative to 23.5% for the same period in 2020.

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

BALANCE SHEET ANALYSIS

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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 $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.

The investment portfolio is reflected on the balance sheet as investment securities and totaled $732.3 million, or 21% of total assets at September 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 $356.2 million of surplus interest earning balances in our Federal Reserve Bank account at September 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 4.6 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 expected average life for bonds in our investment portfolio was 4.9 years and their average effective duration was 3.2 years at September 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:

1 unchanged sentence

(dollars in thousands, unaudited)

June 30, 2021

September 30, 2021

December 31, 2020

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Corporate bonds

Collateralized loan obligations

Total securities

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 net unrealized gain on our investment portfolio, or the amount by which aggregate fair market values exceeded amortized cost, was $21.3 million at September 30, 2021, a $4.9 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 June 30, 2021, and December 31, 2020.

Municipal bond balances comprise 40% of our total securities portfolio (fair value) at September 30, 2021, and 42% at December 31, 2020.

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

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.

The corporate bonds purchased in 2021 are exclusively subordinated debentures of bank holding companies.

These bonds were subject to a credit review by the credit administration department prior to their purchase and are subject to quarterly potential impairment reviews.

The purchases of collateralized loan obligations (“CLOs”) in the third quarter of 2021 is were exclusively AAA and AA rated tranches.

Each purchase is subject to a credit and structure review by the credit administration department prior to their purchase and are subject to quarterly potential impairment reviews.

The AAA and AA-rated CLO purchases were primarily a balance sheet diversification strategy as management continues to utilize available liquidity.

In addition to

providing asset class diversification given the high level of real estate backed earning assets on the balance sheet, these floating rate CLOs are more asset sensitive which complements the longer-term fixed-rate earning assets.

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 $148.2 million at September 30, 2021 and $232.0 million at December 31, 2020, leaving $584.1 million in unpledged debt securities at September 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 $43.2 million at September 30, 2021 and $52.9 million at December 31, 2020.

LOAN AND LEASE PORTFOLIO

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(dollars in thousands, unaudited)

June 30, 2021

September 30, 2021

December 31, 2020

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Total loans and leases

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.

Gross loans and leases at $2.1 billion, reflected a decrease of $323.3 million, or 13%, at September 30, 2021 from $2.5 billion at December 31, 2020 due mostly to declines in commercial real estate and construction loan balances, outstanding balances on mortgage warehouse lines, as well as the forgiveness of SBA PPP loans.

Balances on mortgage warehouse lines were down $181.2 million or 59% during the first nine months of 2021.

Mortgage warehouse utilization was 33% at September 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.

There was a net decrease of $63.0 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 308% at September 30, 2021, although it is expected to moderately increase this concentration ratio during the fourth quarter of 2021 and into 2022.

At September 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 overall decline in real estate secured loans during 2021 was partially offset by an increase of $80.4 million in 1-4 family residential real estate loans due to the $121.6 million purchase of high quality jumbo mortgage loans during the third quarter of 2021.

These loan purchases were designed as a bridge to organic loan growth as the Bank’s core loan pipeline continues to improve and the hiring of one or more loan teams that is expected to occur during the fourth quarter of 2021.

If successfully hired, the loan teams are anticipated to further diversify the loan portfolio by specializing in various categories of commercial and industrial loans.

The 37% decrease in Commercial and Industrial loans from $209.0 million at December 31, 2020 to $132.3 million at September 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 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.

There were 642 loans for $50.7 million outstanding at September 30, 2021, compared to 1,274 loans for $117.2 million at December 31, 2020.

During the first nine months of 2021, the SBA forgave $117.9 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.

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(dollars in thousands, unaudited)

June 30, 2021

September 30, 2021

December 31, 2020

June 30, 2020

September 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 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;

Total nonperforming assets decreased by $1.7 million, or 20%, to $6.9 million during the first nine months of 2021.

The Company's ratio of nonperforming loans to gross loans increased to 0.32% at September 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 $0.8 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.

As shown in the table, we also had $5.5 million in loans classified as performing TDRs on which we were still accruing interest as of September 30, 2021, a decrease of $5.9 million, or 52%, relative to December 31, 2020.

Foreclosed assets had a carrying value of $0.1 million at September 30, 2021 comprised of 2 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 $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.

The Company had $1.3 million in loans past due 30-59 days at September 30, 2021.

This is a decrease of $0.8 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.

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 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.

As of September 30, 2021, the Company had $10.4 million for one customer relationship remaining in loan modifications under Section 4013 of the CARES Act.

The $10.4 million remaining on deferral is 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.

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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.

At September 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 $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.

The Company’s allowance for loan and lease losses was $15.6 million at September 30, 2021, a decrease of $2.1 million, or 12%, relative to December 31, 2020 resulting from a $2.5 million loan loss benefit recorded during the first nine months of 2021, plus a $0.3 million in net recoveries during the same period.

The loan loss benefit in the first nine 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.

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 decrease in the provision for loan and lease losses during the first nine months of 2021, please see the discussion above under Provision for Loan and Lease Losses.

The allowance for loan and lease losses was 0.73% of total loans at September 30, 2021, 0.72% at December 31, 2020 and 0.65% at September 30, 2020.

The ratio of the allowance for loan and lease losses to nonperforming loans was 230.1% at September 30, 2021, relative to 233.5% at December 31, 2020 and 216.9% for September 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 September 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 September 30, 2021, as compared to $0.3 million at December 31, 2020 and September 30, 2020.

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

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For the year ended

September 30,

Average gross loans and leases outstanding during period (1)

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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 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.

The Company’s allowance for loan and lease losses at September 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.

OFF-BALANCE SHEET ARRANGEMENTS

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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 $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.

Unused commitments to extend credit, which included standby letters of credit, totaled $540.0 million at September 30, 2021 and $449.9 million at December 31, 2020, representing approximately 25% of gross loans outstanding at September 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 FHLB letters of credit issued to customers totaling $4.9 million at both June 30, 2021 and December 31, 2020.

The Company also had undrawn FHLB letters of credit issued to customers totaling $4.9 million at both September 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.

However, the “Liquidity” section in this Form 10-Q outlines resources available to draw upon should we be required to fund a significant portion of unused commitments.

In addition to unused commitments to provide credit, the Company is utilizing a $100 million letter of credit issued by the Federal Home Loan Bank on the Company’s behalf as security for certain local agency deposits.

That letter of credit is backed by loans that are pledged to the FHLB by the Company.

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Should a large “short” overnight position persist for any length of time, the Company typically raises money through focused retail deposit gathering efforts or by adding brokered time deposits.

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 $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.

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 investments or loans, subject to the bank’s risk tolerances.

The Company’s balance of non-earning cash and due from banks was $66.2 million at September 30, 2021 relative to $67.9 million at December 31, 2020.

Foreclosed assets are discussed above in the section titled “Nonperforming Assets.” Net premises and equipment decreased by $3.0 million during the first nine months of 2021, to $24.5 million.

This decline was primarily a result of the closure of five branch locations in the second quarter of 2021.

Goodwill was $27 million at September 30, 2021, unchanged during the first nine 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 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.

There have been no triggering events in the first nine months 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 $55.0 million at September 30, 2021, is discussed in detail above in the “Noninterest Income and Noninterest Expense” section.

DEPOSITS AND INTEREST BEARING LIABILITIES

Deposits represent another key balance sheet category impacting the Company’s net interest income and profitability metrics.

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.

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.

Deposit Distribution

(dollars in thousands, unaudited)

June 30, 2021

September 30, 2021

December 31, 2020

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Brokered deposits

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.

Deposit balances reflect net growth of $196.0 million, or 7%, during the first nine months of 2021.

Time deposits were $290.8 million at September 30, 2021 as compared to $412.9 million at December 31, 2020.

Brokered deposits decreased $40.0 million at September 30, 2021 to $60.0 million as compared to $100.0 million at December 31, 2020.

Time deposits declined $122.1 million for the first nine months of 2021 due mostly to the non-renewal of $120.0 million in public time deposits.

Non-maturity deposit growth of $358.2 million for the first nine 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 38.7% at June 30, 2021 as compared to 36.0% at December 31, 2020.

In particular, the Company’s ratio of noninterest-bearing deposits to total deposits was 39.4% at September 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 $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.

Total non-deposit interest-bearing liabilities decreased by $40.1 million, or 18%, during the first nine months of 2021 primarily due to a decrease in federal funds purchased and borrowings from the FHLB.

Repurchase agreements totaled $92.6 million at September 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.

Long term debt increased to $49.2 million from the issuance of $50 million in 3.25% fixed – floating subordinated debt with a ten-year maturity in the third quarter of 2021.

The Company’s Board approved a $25 million contribution of additional capital to the Bank in the fourth quarter of 2021.

The Company plans to utilize the remainder of the funds for general corporate purposes, which may include repurchasing shares, among other things.

The Company had junior subordinated debentures totaling $35.3 million and $35.1 million at September 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 $32.7 million at June 30, 2021 as compared to $35.1 million at December 31, 2020.

The Company’s balance of other liabilities was $80.6 million at September 30, 2021 as compared to $35.1 million at December 31, 2020.

The $45.5 million increase in the first nine months of 2021 was attributed to a forward settling investment securities accrual.

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

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

Primary and secondary liquidity sources

June 30, 2021

September 30, 2021

December 31, 2020

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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;

Utilization of this excess liquidity is expected to

come from a combination of new loans, including loan purchases, and new investment purchases.

In addition, it is possible that a portion of the deposits built-up during the COVID-19 pandemic could be withdrawn by customers.

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

and the liquidity risk of such alternative assets.

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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 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.

That letter of credit, which is backed by loans pledged to the FHLB by the Company, totaled $100 million at September 30, 2021 and December 31, 2020.

Other sources of liquidity include 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 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’s net loans to assets and available investments to assets ratios were 62.08% and 28.57%, respectively, at September 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 September 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.

The holding company’s primary uses of funds include operating expenses incurred in the normal course of business, interest on trust preferred securities, shareholder dividends, and stock repurchases.

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

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.

The holding company’s primary uses of funds include operating expenses incurred in the normal course of business, interest on trust preferred securities and subordinated debt, shareholder dividends, and share repurchases.

Its primary source of funds is dividends from the Bank, since the holding company does not conduct regular banking operations, however the holding company did raise $50 million in cash from the issuance of subordinated debt in the third quarter of 2021.

As of September 30, 2021, the holding company maintained a cash balance of $53.7 million, but expects to contribute $25.0 million in capital to the Bank in the fourth quarter of 2021.

Management anticipates that with the available cash on hand remaining after the capital infusion to the Bank, the holding company still has sufficient liquidity to meet its funding requirements for the foreseeable future.

Both the holding company and the Bank are subject to legal and regulatory limitations on dividend payments, as outlined in Item 5(c) Dividends in the Company’s Annual Report on Form 10-K for the year ended December 31, 2020 which was filed with the SEC.

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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:

June 30, 2021

June 30, 2020

September 30, 2021

September 30, 2020

Immediate change in Interest Rates (basis points)

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$ Change in Net Interest Income

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 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.

For the period ended September 30, 2021, management believes that the Company was asset sensitive, with net income increasing in a rising rate environment in all scenarios but declining considerably in the down shocks.

For period ended September 30, 2020, management believed that the Company was generally asset sensitive, with overall sensitivity declining with larger rate shocks and declining overall in the down shock and up 400 basis point shock.

The change in the magnitude of the Company’s asset sensitivity based on its interest rate risk model at September 30, 2021 as compared to September 30, 2020, is due mostly to the level of overnight cash held as an interest bearing deposit at the Federal Reserve Bank.

At September 30, 2021, the Company had $356.2 million in overnight cash with the Federal Reserve Bank compared to $3.5 million at September 30, 2020.

As this cash is held overnight, any change in interest rate in the model would increase the yield on such overnight cash immediately, therefore, increasing the Company’s asset sensitivity.

The simulation for the period ending September 30, 2021 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.

As described above, the rate of increase is significantly greater than the September 30, 2020 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 $17.4 million, or 16%, to $125.5 million at September 30, 2021 compared to a 0.4% decrease or $0.4 million for the same period in 2020.

The reason that the modeled asset level of asset sensitivity declined at September 30, 2020 with each increase in the parallel rate shock is because of the level of overnight borrowing at such date.

With each subsequently larger rate shock, the cost of overnight borrowing increased more than the modeled increase in earning asset rates which caused the level of sensitivity to decline as the rate shocks increased in magnitude at September 30, 2020.

Over the next twelve months, surplus cash is projected to decline due to expected earning asset purchases and core loan growth as our pipelines begin to increase.

Further, a portion of the significant increase in deposits during the COVID-19 pandemic could be withdrawn by customers.

These expected changes in earnings assets, including overnight cash, are not modeled in the immediate rate shock model described above.

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.

If there were an immediate and sustained upward adjustment of 100 basis points in interest rates, all else being equal, net interest income over the next 12 months is projected to improve by $4.2 million, or 4%, relative to a stable interest rate scenario, with the favorable variance increasing marginally as interest rates rise higher.

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 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.

If there was an immediate downward adjustment, it is anticipated that interest income would decline.

The reason for the drop in net interest income is because 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.

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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.

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).

In addition to the net interest income simulations shown above, we run stress scenarios for the unconsolidated Bank where we model 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 $13.4 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.

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

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 June 30, 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 September 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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In our economic value simulations, estimated prepayments are factored in for financial instruments with stated maturity dates, and decay rates for non-maturity deposits are projected based on historical patterns and Management’s best estimates.

Our EVE increased in the past twelve months due to asset growth, but that trend slowed in the first quarter of 2021 as loan growth decelerated.

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:

June 30, 2021

June 30, 2020

Our EVE increased in the past twelve months due to asset and deposit growth.

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

September 30, 2021

September 30, 2020

Immediate change in Interest Rates (basis points)

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$ Change in Fair Value of Equity

The table shows that our EVE will deteriorate in moderate declining rate scenarios but should benefit from a parallel shift upward in the yield curve.

The table shows that our EVE is modeled to deteriorate in moderate declining rate scenarios but should benefit from a parallel shift upward in the yield curve.

The rate of increase in EVE accelerates the higher interest rates rise.

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Model results are highly sensitive to changes in assumed decay rates for non-maturity deposits, in particular, with material unfavorable variances occurring relative to the standard simulations shown above as decay rates are increased.

Furthermore, while not as extreme as the variances produced by increasing non-maturity deposit decay rates, EVE also displays a relatively high level of sensitivity to unfavorable changes in deposit rate betas in rising interest rate scenarios.

Furthermore, while not as

extreme as the variances produced by increasing non-maturity deposit decay rates, EVE also displays a relatively high level of sensitivity to unfavorable changes in deposit rate betas in rising interest rate scenarios.

CAPITAL RESOURCES

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.

The Company had total shareholders’ equity of $364.5 million at September 30, 2021, comprised of $114.1 million in common stock, $3.7 million in additional paid-in capital, $231.7 million in retained earnings, and accumulated other comprehensive income of $15.0 million.

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

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.

The increase during the first nine months 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 $3.4 million unfavorable swing in accumulated other comprehensive income, net and the impact of cash dividends paid.

The Company has 268,301 shares authorized to repurchase under the current repurchase program.

The Company suspended its stock repurchase program on March 16, 2020 and continues to evaluate when or if we will restart repurchasing shares.

The Company approved a new share repurchase program (the 2021 Share Repurchase Plan) on October 21, 2021 and authorized one million shares to be repurchased under this plan.

The previous 2003 Share Repurchase Plan was cancelled and the 268,301 shares remaining in that plan were incorporated into the 2021 Share Repurchase Plan.

No shares have been repurchased year-to-date under either plan.

The Company uses a variety of measures to evaluate its capital adequacy, including the leverage ratio which is calculated separately for the Company and the Bank.

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Regulatory Capital Ratios

September 30,

Community Bank

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

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.

At September 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