CB Financial Services, Inc. 10-K

ITEM 7. Management’s Discussion and Analysis of Financial Condition and Results of Operations This discussion and analysis reflects our consolidated financial statements and other relevant statistical data, and is intended to enhance your understanding of our financial condition and results of operations. The information in this section has been derived from the audited consolidated financial statements, which appear in this Report. You should read the information in this section in conjunction with the business and financial information the Company provided in this Report. Critical Accounting Policies and Use of Estimates Critical accounting policies are those that involve significant judgments and assumptions by management and that have, or could have, a material impact on the Company’s income or the carrying value of its assets. 39 Allowance for Loan Losses. The allowance for loan losses (“allowance”) is maintained at a level considered adequate to provide for losses that can be reasonably anticipated. Management performs a quarterly evaluation of the adequacy of the allowance based on potential losses in the current loan portfolio, which includes an assessment of economic conditions, changes in the nature and volume of the loan portfolio, loan loss experience, volume and severity of past due, classified and nonaccrual loans as well as other loan modifications, quality of the Company’s loan review system, the degree of oversight by the Company’s Board, existence and effect of any concentrations of credit and changes in the level of such concentrations, effect of external factors, such as competition and legal and regulatory requirements, and other relevant factors. While management uses the best information available to make such evaluations, future adjustments to the allowance may be necessary if economic conditions differ substantially from the assumptions used in making evaluations. Additions are made to the allowance through periodic provisions charged to income and recovery of principal and interest on loans previously charged-off. Losses of principal are charged directly to the allowance when a loss occurs or when a determination is made that the specific loss is probable. This evaluation is inherently subjective as it requires estimates that are susceptible to significant revisions as more information becomes available. The allowance consists of specific and general components. The specific component relates to loans that are classified as impaired. A loan is considered impaired when, based upon current information and events, it is probable that the Company will be unable to collect all amounts due for principal and interest according to the original contractual terms of the loan agreement. Generally, management considers all substandard-, doubtful-, and loss-rated loans, nonaccrual loans, and TDRs for impairment. Management determines the significance of payment delays and payment shortfalls on a case-by-case basis, taking into consideration all of the circumstances surrounding the loan and the borrower, including the length of the delay, the reasons for the delay, the borrower’s prior payment record, and the amount of the shortfall in relation to the principal and interest owed. The maximum period without payment that typically can occur before a loan is considered for impairment is 90 days. Impairment is measured based on the present value of expected future cash flows discounted at a loan’s effective interest rate, or as a practical expedient, the observable market price, or, if the loan is collateral dependent, the fair value of the underlying collateral. When the measurement of an impaired loan is less than the recorded investment in the loan, the impairment is recorded in a specific valuation allowance. This specific valuation allowance is periodically adjusted for significant changes in the amount or timing of expected future cash flows, observable market price or fair value of the collateral. The specific valuation allowance, or allowance for impaired loans, is part of the total allowance for loan losses. Cash payments received on impaired loans that are considered non-accrual are recorded as a direct reduction of the recorded investment in the loan. When the recorded investment has been fully collected, receipts are recorded as recoveries to the allowance for loan losses until the previously charged-off principal is fully recovered. Subsequent amounts collected are recognized as interest income. If no charge-off exists, then once the recorded investment has been fully collected, any future amounts collected would be recognized as interest income. Impaired loans are not returned to accrual status until all amounts due, both principal and interest, are current and a sustained payment history has been demonstrated. The general allowance component covers pools of homogeneous loans by loan class. Management determines historical loss experience for each segment of loans using the two-year rolling average of the net charge-off data within each segment. Qualitative and environmental factors are also considered that are likely to cause estimated credit losses associated with the Bank’s existing portfolio to differ from historical loss experience, and include levels and trends in delinquency and impaired loans; levels and trends in net charge-offs, trends in volume and terms of loans; change in underwriting, policies, procedures, practices and key personnel; national and local economic trends; industry conditions, and effects of changes in high-risk credit circumstances. The qualitative and environmental factors are reviewed on a quarterly basis to ensure they are reflective of current conditions in the portfolio and economy. An unallocated component, which is a part of the general allowance component, is maintained to cover uncertainties that could affect the Company’s estimate of probable losses. Fair Value Measurements. Fair value is defined as the price that would be received for an asset or paid to transfer a liability in an orderly transaction between market participants in the principal or most advantageous market for the asset or liability at the transaction date. Valuation techniques used to measure fair value must maximize the use of observable inputs and minimize the use of unobservable inputs. A three-level of fair value hierarchy prioritizes the inputs used to measure fair value: Level 1 – Fair value is based on unadjusted quoted prices in active markets that are accessible to the Company for identical assets. These generally provide the most reliable evidence and are used to measure fair value whenever available. Level 2 – Fair value is based on significant inputs, other than Level 1 inputs, that are observable either directly or indirectly for substantially the full term of the asset through corroboration with observable market data. Level 2 inputs include quoted market prices in active markets for similar assets, quoted market prices in markets that are not active for identical or similar assets, and other observable inputs. Level 3 – Fair value is based on significant unobservable inputs. Examples of valuation methodologies that would result in Level 3 classification include option pricing models, discounted cash flows, and other similar techniques. 40 This hierarchy requires the use of observable market data when available. The level in the fair value hierarchy within which the fair value measurement falls is determined based on the lowest level input that is significant to the fair value measurement. Goodwill. Goodwill represents the excess of the cost of an acquisition over the fair value of the net assets acquired. Deemed to have an indefinite life and not subject to amortization, goodwill is instead tested for impairment at the reporting unit level at least annually on October 31 or more frequently if triggering events occur or impairment indicators exist. The Company operates two reporting units – Community Banking segment and Insurance Brokerage Services segment. The Company has assigned 100% of the goodwill to the Community Banking reporting unit. Determining the fair value of a reporting unit under the goodwill impairment test is judgmental and often involves the use of significant estimates and assumptions. In 2019, the Company adopted Accounting Standards Update (“ASU”) 2017-04 whereby the Company applies a one-step quantitative test and records the amount of goodwill impairment as the excess of a reporting unit's carrying amount over its fair value, not to exceed the total amount of goodwill allocated to the reporting unit. The Company has the option to first assess qualitative factors to determine whether the existence of events or circumstances leads to a determination that it is more likely than not that the fair value of a reporting unit is less than its carrying amount. If, after assessing the totality of events or circumstances, an entity determines it is not more likely than not that the fair value of a reporting unit is less than its carrying amount, then performing a step one impairment test is unnecessary. An entity also has the option to bypass the qualitative assessment for any reporting unit and proceed directly to the first step of impairment testing. Two basic approaches to determine the fair value of an entity are the income approach and market approach or a combination of the two. The income approach uses valuation techniques to convert future earnings or cash flows to present value to arrive at a value that is indicated by market expectations about future amounts. The market approach uses observable prices and other relevant information that is generated by market transactions involving identical or comparable assets or liabilities. The fair value measure is based on the value that those transactions indicate. These approaches involve significant estimates and assumptions In the application of the income approach, fair value of a reporting unit is determined using a discounted cash flow (“DCF”) analysis. The income approach relies on Level 3 inputs along with a market-derived cost of capital when measuring fair value. Fair value is determined by converting anticipated benefits into a present single value. Once the benefit or benefits are selected, an appropriate discount or capitalization rate is applied to each benefit. These rates are calculated using the appropriate measure for the size and type of company, using financial models and market data as required. A discount rate may be derived based on a modified capital asset pricing model. which is comprised of a risk-free rate of return, an equity risk premium, a size premium and a factor covering the systemic market risk and a company specific risk premium. The values for the factors applied are determined primarily using external sources of information. The DCF model also uses prospective financial information. Estimating future earnings and capital requirements involves judgment and the consideration of past and current performance and overall macroeconomic and regulatory environments. Under the market approach, Level 1 and 2 inputs are used when measuring fair value. In the application of the market approach, the Guideline Public Company ("GPC") method of appraisal is based on the premise that pricing multiples of publicly traded companies can be used as a tool to be applied in valuing a closely held entity. A value multiple or ratio relates a stock’s market price to the reported accounting data such as revenue, earnings, and book value. These ratios provide an objective basis for measuring the market’s perception of a stock’s fair value. Value ratios generally reflect the trends in growth, performance and stability of the financial results of operations. In this way, the business and financial risks exhibited by an industry or group of companies can be viewed in relation to market values. Value ratios also reflect the market’s outlook for the economy as a whole. Guideline companies provide a reasonable basis for comparison to the relative investment characteristics of the company being valued. The Company analyzes the relationships between the guideline companies' asset size, profitability, asset quality and capital ratios and applies a control premium to the selected guideline company multiples. The control premium is management's estimate of how much a market participant would be willing to pay over the fair market value in consideration of synergies and other benefits that flow from control of the entity. The GPC method using trading activity of publicly traded companies that are most similar to the Company may also be considered when the banking industry has a sufficient level of mergers and acquisitions activity The results of the income and market approaches may be weighted to determine the concluded fair value of the reporting unit. The weighting is judgmental and is based on the perceived level of appropriateness of the valuation methodology. Estimating the fair value involves the use of estimates and significant judgments that are based on a number of factors including actual operating results. If current conditions change from those expected, it is reasonably possible that the judgments and estimates described above could change in future periods and require management to further evaluate goodwill for impairment. Other-Than-Temporary Impairment. In estimating other-than-temporary impairment of securities, securities are evaluated on at least a quarterly basis to determine whether a decline in their value is other-than-temporary. In estimating other-than temporary impairment losses, management considers (1) the length of time and the extent to which the fair value has been less than cost, (2) the financial condition and near-term prospects of the issuer, and (3) whether or not the Company intends to sell 41 or expect that it is more likely than not that it will be required to sell the security before an anticipated recovery in fair value. Once a decline in value for a debt security is determined to be other than temporary, the other-than-temporary impairment is separated in (a) the amount of total other-than-temporary impairment related to a decrease in cash flows expected to be collected from the debt security (the credit loss) and (b) the amount of other-than-temporary impairment related to all other factors. The amount of the total other-than-temporary impairment related to credit loss is recognized in earnings. The amount of other-than-temporary impairment related to other factors is recognized in other comprehensive income (loss). Deferred Tax Assets. Deferred income tax expense results from changes in deferred tax assets and liabilities between periods. Deferred tax assets are recognized if it is more likely than not, based on the technical merits, that the tax position will be realized or sustained upon examination, the term more likely than not means a likelihood of more than 50%; the terms examined and upon examination also include resolution of the related appeals or litigation processes, if any. A tax position that meets the more-likely-than-not recognition threshold is initially and subsequently measured as the largest amount of tax benefit that has a greater than 50% likelihood of being realized upon settlement with a taxing authority that has full knowledge of all relevant information. The determination of whether a tax position has met the more-likely-than-not recognition threshold considers the facts, circumstances and information available at the reporting date, and is subject to management’s judgment. Deferred tax assets are reduced by a valuation allowance if, based on the weight of evidence available, it is more likely than not that some portion or all of a deferred tax asset will not be realized. Recent Accounting Pronouncements and Developments New accounting pronouncements that were adopted in the current period or will be adopted in a future period are discussed in Note 1 – Summary of Significant Accounting Policies in the Notes to Consolidated Financial Statements, which is included in Part IV, Item 15 of this Report. Recently Announced Branch Optimization Initiative On February 23, 2021, the Company announced the implementation of strategic initiatives to improve the Bank’s financial performance and to position the Bank for continued profitable growth. The Bank intends to optimize its current branch network through the consolidation of six branches and the possible divestiture of others, while expanding technology and infrastructure investments in its remaining locations. The decision was the result of a comprehensive internal study that measured branch performance by comparing financial and non-financial indicators to growth opportunities, while e volving changes in consumer preferences, largely driven by the global pandemic, led to an acceleration of branch optimization efforts. The Bank plans to provide affected customers with details to ensure a seamless transition with minimal disruption to their daily banking needs. Management believes this initiative is an important first step to improve the Bank’s operations, and to provide enhanced efficiency and production capabilities. The Bank has also engaged with third-party workflow optimization experts to assist in implementing a number of robotic process automations and more effective sales management that it expects will improve operational efficiencies in the near and long-term. These efforts will likely result in additional innovations designed to improve growth prospects for the Bank as customer preferences for mobile and other technology-based services evolve. In connection with the branch consolidations and the other branch optimization initiatives, the Company anticipates non-recurring pre-tax costs during 2021 of up to $6.1 million. This estimated cost excludes the impact of any premium from sale of branches, and assumes no salvage value, lease termination, severance, and other costs associated with the consolidations or sales; however, the Company does anticipate some recovery of these costs over time. The Company expects an annual reduction in pre-tax operating expenses in 2021 of approximately $1.5 million, along with $3.0 million of ongoing pre-tax cost savings as a result of the implementation of the branch optimization initiatives. COVID-19 Pandemic The ongoing COVID-19 pandemic has caused significant disruption in the local, national and global economies and financial markets. The pandemic has resulted in temporary closures of many businesses and the institution of social distancing and shelter in place requirements in the states and communities across our market. Employee Matters and Branch Offices. Throughout the COVID-19 pandemic, the Company has been committed to the health and safety of out customers and employees. As COVID-19 unfolded, specific actions were taken to protect employees through work-at-home arrangements as well as social distancing measures for those working in our offices. Branch traffic has been mostly limited to drive-thru and special appointments with minimal disruption to our customers or employee productivity. We outfitted our branches with protective barriers and continue to provide our staff with personal protective equipment. No employee layoffs occurred. In addition, a 10% premium pay program was instituted from April 2020 to June 2020 and additional paid time off was provided to employees. Our information technology infrastructure has afforded us the ability to work remotely with little interruption as we continue to service the needs of our clients. Government Response. In response to the anticipated economic effects of COVID-19, the Board of Governors of the Federal Reserve has taken a number of actions that have significantly affected the financial markets, including actions intended to result in substantial decreases in market interest rates. On March 3, 2020, the 10-year Treasury yield fell below 1.00% for the 42 first time, and the FRB reduced the target federal funds range by 50 basis points to 1.00% to 1.25%. On March 15, 2020, the FRB further reduced the target federal funds range by 100 basis points to 0% to 0.25% and announced a $700 billion quantitative easing program in response to the expected economic downturn caused by COVID-19. On March 22, 2020, the FRB announced that it would continue its quantitative easing program in amounts necessary to support the smooth functioning of markets for Treasury securities and agency MBS. We expect that these reductions in interest rates, among other actions of the FRB and the Federal government generally, especially if prolonged, could adversely affect our net interest income, compress our margins and impact our overall profitability. At the December 2020 meeting, the FRB elected to hold the target federal funds rate at 0% to 0.25% and officials expects rates to remain near zero through 2023. The Coronavirus Aid, Relief, and Economic Security Act (the “CARES Act”) was signed into law on March 27, 2020 and provided over $2.0 trillion in emergency economic relief to individuals and businesses impacted by the COVID-19 pandemic, which included authorizing the Small Business Administration (“SBA”) to temporarily guarantee loans under a new 7(a) loan program called the Paycheck Protection Program (“PPP”). On April 16, 2020, the original $349 billion funding cap was reached. On April 23, 2020, the Paycheck Protection Program and Health Care Enhancement Act (the “PPP Enhancement Act”) was signed into law and included an additional $484 billion in COVID-19 relief, including allocating an additional $310 billion to replenish the PPP. PPP was designed to help small businesses keep their workforce employed and cover expenses during the COVID-19 crisis. Under the PPP, participating SBA and other qualifying lenders originated loans to eligible businesses that are fully guaranteed by the SBA as to principal and accrued interest, have more favorable terms than traditional SBA loans and may be forgiven if the proceeds are used by the borrower for certain eligible purposes. PPP loans have an interest rate of 1% per annum. Loans issued prior to June 5, 2020 have a term to maturity of two-years and loans issued after June 5, 2020 have a term to maturity of five-years. Loan payments were deferred for six months. The Bank received a processing fee from the SBA ranging from 1% to 5% depending on the size of the loan, which was offset by a 0.75% third-party servicing agent fee. In 2020, the Bank originated 639 PPP loans totaling $71.0 million. Among the largest sectors impacted were $15.6 million in loans for health care and social assistance, $12.6 million for construction and specialty-trade contractors, $6.1 million for professional and technical services, $6.1 million for retail trade, $5.1 million for wholesale trade, $4.6 million for manufacturing and $3.4 million for restaurant and food services. Net deferred origination fees were $2.2 million, of which $1.1 million was recognized during year ended December 31, 2020. Processing of PPP loan forgiveness began in the fourth quarter of 2020 and at December 31, 2020, PPP loans totaled $55.1 million. All PPP loans are classified as commercial and industrial loans. No allowance for loan loss was allocated to the PPP loan portfolio due to the Bank complying with the lender obligations that ensure SBA guarantee. On December 27, 2020, the Consolidated Appropriations Act (2021) was enacted and provides an additional $900 billion in pandemic-related relief aimed to bolster the economy, provide relief to small businesses and the unemployed, deliver additional stimulus checks to individuals and provide funding for COVID-19 testing and the administration of vaccines while also extending certain provisions of the original CARES Act stimulus package. The SBA reopened the PPP the week of January 11, 2021 and began accepting applications for both First Draw and Second Draw PPP Loans. Second Draw PPP Loans are available for certain eligible borrowers that previously received a PPP loan. A Second Draw PPP Loan has the same general terms as the First Draw PPP Loan. A borrower is generally eligible for a Second Draw PPP Loan if the borrower previously received a First Draw PPP Loan and will or has used the full amount only for authorized uses, has no more than 300 employees, and can demonstrate at least a 25% reduction in gross receipts between comparable quarters in 2019 and 2020. For most borrowers, the maximum amount of a Second Draw PPP Loan is 2.5x average monthly 2019 or 2020 payroll costs up to $2.0 million. Loan payments will be deferred for borrowers who apply for loan forgiveness until the SBA remits the borrower's loan forgiveness amount to the lender. If a borrower does not apply for loan forgiveness, payments are deferred 10 months after the end of the covered period for the borrower’s loan forgiveness (either 8 weeks or 24 weeks). For PPP loans made on or after December 27, 2020, the lender’s processing fee from the SBA is the lesser of 50% or $2,500 for loans up to $50,000, 5% for loans greater than $50,000 and up to $350,000, 3% for loans greater than $350,000 and less than $2.0 million and 1% for loans of at least $2.0 million. As of February 28, 2021, the Bank received 181 applications totaling $26.7 million with total estimated processing fees of $1.2 million. Section 4013 of the CARES Act and regulatory guidance promulgated by federal banking regulators provides temporary relief from accounting and financial reporting requirements for TDRs regarding certain loan modifications related to COVID-19. Specifically, the CARES Act provides that the Bank may elect to suspend the requirements under GAAP for certain loan modifications that would otherwise be categorized as a TDR and suspend any determination that such loan modifications would be considered a TDR, including the related impairment for accounting purposes. As such, the applicable loans are reported as current with regard to payment status and continue to accrue interest during the payment deferral period. The Company has worked with its borrowers impacted by COVID-19 to defer payments. The Bank provides borrower support and relief through short-term loan forbearance options by primarily allowing: (a) deferral of three- to six-months of payments; 43 or (b) for consumer loans not secured by a real estate mortgage, three months of interest-only payments that also extends the maturity date of the loan by three months. In certain circumstances, additional deferral periods were granted. The following table provides details of loans in forbearance at the dates indicated. December 31, 2020 September 30, 2020 June 30, 2020 Number of Loans Amount Percent of Portfolio Number of Loans Amount Percent of Portfolio Number of Loans Amount Percent of Portfolio (Dollars in Thousands) Real Estate: Residential 4 $ 749 0.2 % 11 $ 1,242 0.4 % 163 $ 23,653 6.9 % Commercial 8 19,818 5.3 9 13,885 3.9 111 105,117 30.0 Construction 1 1,958 2.7 1 7,162 10.4 6 15,518 26.6 Commercial and Industrial 5 1,219 1.0 1 122 0.1 76 15,697 10.5 Consumer 13 356 0.3 12 295 0.3 170 3,447 2.9 Other — — — — — — 1 2,504 11.2 Total Loans in Forbearance 31 $ 24,100 2.3 % 34 $ 22,706 2.2 % 527 $ 165,936 15.9 % Loans on deferral at December 31, 2020 include the following: • Hotels - three commercial real estate loans totaling $8.2 million and a $2.0 million construction loan. • Office and retail space - two commercial real estate loans totaling $8.3 million. • One business relationship that rents equipment, supplies and other materials for events comprised three commercial real estate loans totaling $3.3 million, and five commercial and industrial loans totaling $1.2 million The majority of the commercial real estate loans, construction loans and commercial and industrial loans are on deferral for six months through July 2021. The following table sets forth details at December 31, 2020 of industries considered at higher risk and negatively impacted by the COVID-19 pandemic: Industry Forbearance Weighted Average Risk Rating (1) Industry Amount As a Percent of Total Risk Based Capital As a Percent of Loan Class Number of Loans Weighted Average Risk Rating (1) Forbearance Amount As a Percent of Industry (Dollars in Thousands) Commercial Real Estate - Owner Occupied: Retail 3.4 $ 27,240 22.6 % 7.3 % 1 4.0 $ 2,760 10.1 % Commercial Real Estate - Nonowner Occupied: Retail 3.9 68,655 57.0 18.4 — — — — Hotels 5.3 24,832 20.6 6.6 3 5.9 8,246 33.2 Construction - Commercial Real Estate: Retail 4.0 10,925 9.1 15.0 — — — — Hotels 4.7 5,798 4.8 8.0 1 6.0 1,958 33.8 Total: Retail 3.8 106,820 88.6 1 4.0 2,760 Hotels 5.2 30,630 25.4 4 5.9 10,204 (1) Loan risk ratings of 1-4 are considered a pass-rated credit, 5 is special mention, 6 is substandard, 7 is doubtful and 8 is loss. 44 Comparison of Financial Condition at December 31, 2020 and 2019 Assets. Total assets increased $95.2 million, or 7.2%, to $1.42 billion at December 31, 2020, compared to $1.32 billion at December 31, 2019. • Cash and due from banks increased $80.7 million, or 100.6%, to $160.9 million at December 31, 2020, compared to $80.2 million at December 31, 2019. • Securities decreased $52.0 million, or 26.3%, to $145.4 million at December 31, 2020, compared to $197.4 million at December 31, 2019. This was primarily the result of $104.1 million of paydowns on mortgage-backed securities and calls of U.S. government agency and municipal securities due to the market interest rate decreases that occurred in light of the COVID-19 pandemic. In addition, there was the purchase of $69.0 million of mortgage-backed securities and U.S. government agency securities partially offset by $18.0 million of mortgage-backed securities sales to recognize gains on higher-interest securities that were paying down quicker than expected. In addition, there was a $1.0 million increase in the market value of the debt securities portfolio attributed to market interest rate decreases and $267,000 loss in market value in the equity securities portfolio, which is primarily comprised of bank stocks. • Total loans increased $92.3 million to $1.04 billion at December 31, 2020 and represented 9.7% annualized growth. Loan growth was primarily due to originating PPP loans totaling $71.0 million, mainly in the second quarter of 2020, which included $2.2 million in net deferred origination fees. $1.1 million of origination fees were unearned as of December 31, 2020 and are expected to be earned ratably over the remaining life of the loan or immediately upon receipt of funds from the SBA for forgiveness. $1.1 million of net origination fees were earned in 2020. In October 2020, the SBA began processing loan forgiveness and PPP loans totaled $55.1 million at December 31, 2020. Excluding the impact of PPP loans, organic loan growth was $37.2 million and represented an annualized growth rate of 3.9% as of December 31, 2020. 2020 loan growth was experienced through net funding of $37.0 million in construction loans and $22.2 million in commercial real estate loans. Excluding the impact of PPP loans, average loans for the year ended December 31, 2020 increased $48.9 million compared to the year ended December 31, 2019. • The allowance for loan losses was $12.8 million at December 31, 2020 compared to $9.9 million at December 31, 2019. This reflects a $4.0 million 2020 provision for loan loss primarily due to a net increase in qualitative factors related to economic and industry conditions to account for the adverse economic impact of COVID-19 and an increase in historical loss factors from a $931,000 commercial real estate loan charge-off in the fourth quarter of 2020. This charge-off was related to a hotel loan. As a result, the allowance for loan losses to total loans increased from 1.04% at December 31, 2019 to 1.22% at December 31, 2020. No allowance was allocated to the PPP loan portfolio due to the Bank complying with the lender obligations that ensure SBA guarantee. The allowance for loan losses to total loans, excluding PPP loans, was 1.29% at December 31, 2020. Refer to “Explanation of Use of Non-GAAP Financial Measures” at the end of this section. • Net charge-offs were $1.1 million, or 0.11%, to average loans on an annualized basis, for the year ended December 31, 2020, due to a $931,000 commercial real estate loan charge-off noted previously. Net charge-offs were $416,000, or 0.05% to average loans on an annualized basis, for the year ended December 31, 2019, respectively. Net charge-offs were primarily attributable to indirect automobile loans in the prior period. • Nonperforming loans were $14.5 million at December 31, 2020 compared to $5.4 million at December 31, 2019. Nonperforming loans to total loans ratio was 1.39% at December 31, 2020 compared to 0.57% at December 31, 2019. Nonaccrual loans increased primarily as a result of two commercial real estate loans (hotels) with a total principal balance of $6.9 million at December 31, 2020, and one commercial and industrial loan relationship totaling $1.3 million at December 31, 2020 that were downgraded to substandard-rated. Liabilities. Total liabilities increased $111.8 million, or 9.6%, to $1.28 billion at December 31, 2020 compared to $1.17 billion at December 31, 2019. • Deposits benefited from PPP loan originations and to a lesser extent government stimulus payments and increased $106.2 million to $1.22 billion as of December 31, 2020 compared to $1.12 billion at December 31, 2019. Noninterest bearing demand deposits, NOW accounts and savings accounts increased $73.4 million, $27.8 million and $18.2 million, respectively, partially offset by a decrease of $29.7 million in time deposits. The impact of the PPP loans that were originated and the proceeds of which were initially deposited at the Bank was approximately $54.8 million. Consumer’s tendency to save and lack of spending as a result of the pandemic were also driving factors in the increase. Annualized deposit growth rate was 9.5% including PPP loan deposits and 4.6% without PPP loan deposits, representing organic deposit growth. Average total deposits increased $62.6 million for the year ended December 31, 2020 compared to the year ended December 31, 2019 primarily in noninterest-bearing demand deposits. • Short-term borrowings increased $10.5 million, or 34.3%, to $41.1 million at December 31, 2020, compared to $30.6 million at December 31, 2019. At December 31, 2020 and 2019, short-term borrowings were comprised entirely of 45 securities sold under agreements to repurchase. The increase is related to business deposit customers whose funds, above designated target balances, are transferred into an overnight interest-earning investment account by purchasing securities from the Bank’s investment portfolio under an agreement to repurchase. • Other borrowed funds decreased $6.0 million to $8.0 million at December 31, 2020 due to Federal Home Loan Bank borrowings that matured in the current period. Stockholders’ Equity. Stockholders’ equity decreased $16.6 million, or 11.0%, to $134.5 million at December 31, 2020, compared to $151.1 million at December 31, 2019. • Net loss was $10.6 million for the year ended December 31, 2020. • Accumulated other comprehensive income increased $756,000 primarily due to market interest rate conditions in the current period on the Bank’s available-for-sale debt securities. • The Company paid $5.2 million in dividends to common stockholders in the current year. • Primarily as part of the Company’s stock repurchase program, the Company repurchased 68,434 shares of common stock totaling $1.9 million in the current year. COVID-19 prompted the Company to announce on March 19, 2020 that the stock repurchase program was suspended until further notice to preserve excess capital in support of the Bank’s business of providing financial services to its customers and communities. The program expired on November 24, 2020. • Book value per share was $24.76 at December 31, 2020 compared to $27.65 at December 31, 2019, a decrease of $2.89 primarily due to goodwill impairment. Tangible book value per share (Non-GAAP) increased $0.90, or 4.4%, to $21.42 compared to $20.52 at December 31, 2019. Refer to “Explanation of Use of Non-GAAP Financial Measures” at the end of this section. Comparison of Operating Results for the Years Ended December 31, 2020 and 2019 Overview. Results of operations for the year ended December 31, 2020 compared to the year ended December 31, 2019 were as follows. Year Ended December 31, 2020 2019 (Dollars in Thousands, Except Per Share Data) Net (Loss) Income (GAAP) $ (10,640) $ 14,327 (Loss) Earnings per Common Share - Diluted (GAAP) $ (1.97) $ 2.63 Return on Average Assets (GAAP) (0.77) % 1.09 % Return on Average Equity (GAAP) (7.18) 9.89 Efficiency Ratio (GAAP) 110.50 67.57 Excluding Non-Recurring Items (Non-GAAP) (1) : Adjusted Net Income (Non-GAAP) (1) $ 8,797 $ 13,016 Adjusted Earnings per Common Share - Diluted (Non-GAAP) (1) $ 1.63 $ 2.39 Adjusted Return on Average Assets (Non-GAAP) (1) 0.64 % 0.99 % Adjusted Return on Average Equity (Non-GAAP) (1) 5.94 8.98 Adjusted Efficiency Ratio (Non-GAAP) 68.14 63.83 ( 1) Refer to Explanation of Use of Non-GAAP Financial Measures in this Report for the calculation of the measure and reconciliation to the most comparable GAAP measure. Annual results were impacted by the following significant non-recurring items: • The Company conducted a goodwill impairment analysis at September 30, 2020 and determined that $18.7 million of goodwill was deemed impaired and written off for the year ended December 31, 2020, reducing goodwill to $9.7 million at December 31, 2020. This non-cash charge was deemed non-core and had no impact on the Company’s tangible equity, cash flows, liquidity or regulatory capital. • The Company incurred a pre-tax non-cash impairment of fixed assets of $1.1 million for the year ended December 31, 2020 as a result of the previously announced Monessen branch closure. The property was written down by $884,000 to its fair value of $240,000 in the third quarter of 2020 and was subsequently donated in the fourth quarter of 2020 with the remaining $240,000 written off. • The Company recognized a one-time income tax benefit of $1.3 million for the year ended December 31, 2019 related to the reversal of a valuation allowance for an alternative minimum tax credit carryforward. 46 Net Interest Income. Net interest income decreased $1.3 million, or 2.9%, to $41.9 million for the year ended December 31, 2020 compared to $43.2 million for the year ended December 31, 2019. Interest and dividend income decreased $3.6 million, or 7.0%, to $47.5 million for the year ended December 31, 2020 compared to $51.0 million for the year ended December 31, 2019. • Interest income on loans decreased $293,000, or 0.7%, to $42.9 million for the year ended December 31, 2020 compared to $43.2 million for the year ended December 31, 2019. Although average loans increased $94.6 million, primarily driven by PPP loans, commercial loans and mortgage loans; the loan yield for the year ended December 31, 2020 decreased 47 bps compared to the year ended December 31, 2019. The current period loan yield was significantly impacted by the 150 bp decline in the Wall Street Journal Prime Rate in March 2020, which resulted in an immediate decrease in interest rates on adjustable rate loans linked to that index and further impacted new loan rates. In addition, PPP loans decreased the loan yield approximately 4 bps in the current year. $1.1 million in net origination fees and $470,000 of loan interest income were recognized in the current year on PPP loans. • Interest income on taxable investment securities decreased $2.0 million, or 35.9%, to $3.6 million for the year ended December 31, 2020 compared to $5.6 million for the year ended December 31, 2019 driven by a $58.0 million decrease in average investment securities primarily from significant calls of U.S. government agency securities and paydowns on mortgage-backed securities in a declining interest rate environment, which were replaced with lower-yielding securities. In addition, $17.9 million of securities were sold in the second quarter of 2020 to recognize gains on higher-interest mortgage-backed securities that were paying down quicker than expected. Current period yield benefited from approximately $231,000 in discount accretion from U.S. government agency calls. • Interest income on tax-exempt investment securities decreased $239,000, or 39.3%, to $369,000 for the year ended December 31, 2020 compared to $608,000 for the year ended December 31, 2019 primarily driven by a decrease of $9.1 million in average balance from municipal securities calls. • Interest from other interest-earning assets, which primarily consists of interest-earning cash, decreased $995,000, or 65.8% for the year ended December 31, 2020 compared to the year ended December 31, 2019 even though average balances increased $48.9 million primarily related to funds received from investment securities and deposit activity. The impact on interest income was primarily due to declines on interest rates earned on deposits at other financial institutions, which resulted in a 218 bp decrease in average yield. Interest expense decreased $2.3 million, or 29.2%, to $5.6 million for the year ended December 31, 2020 compared to $7.9 million for the year ended December 31, 2019. • Interest expense on deposits decreased $2.1 million, or 29.2%, to $5.2 million for the year ended December 31, 2020 compared to $7.3 million for the year ended December 31, 2019. While average interest-bearing deposits increased $16.0 million, interest rate declines for all products driven by pandemic-related interest rate cuts and efforts to control pricing resulted in a 27 bp decrease (26.7)% in average cost compared to the year ended December 31, 2019. • Interest expense on short-term borrowings decreased $50,000, or 26.7%, to $137,000 for the year ended December 31, 2020 compared to $187,000 for the year ended December 31, 2019 primarily due to a 26 bp decrease in average cost on securities sold under agreements to repurchase. • Interest expense on other borrowed funds decreased $113,000, or 30.8%, or $254,000 for the year ended December 31, 2020 compared to $367,000 for the year ended December 31, 2019 primarily due to maturity of FHLB long-term advances in the current year that were not replaced, which resulted in a $6.1 million decrease in average balance. Provision for Loan Losses. The provision for loan losses was $4.0 million for the year ended December 31, 2020, compared to $725,000 for the year ended December 31, 2019. The pandemic resulted in an increase in unemployment and recessionary economic conditions in the current year. Based on evaluation of the macroeconomic conditions, the qualitative factors used in the allowance for loan loss analysis were increased in the current year primarily related to economic trends and industry conditions as a result of the pandemic and vulnerable industries such as hospitality, retail and restaurants. In addition, an increase in commercial real estate loans and increase in the historical loss factor related to the hotel loan charge-off combined to increase commercial real estate loan reserves. Noninterest Income . Noninterest income increased $904,000, or 10.6%, to $9.5 million for the year ended December 31, 2020, compared to $8.6 million for the year ended December 31, 2019. • Service fees decreased $286,000 to $2.2 million for the year ended December 31, 2020, compared to $2.5 million for the year ended December 31, 2019 due to decreases in overdraft fees and customer usage from the pandemic. • Insurance commissions increased $354,000, or 7.8%, to $4.9 million for the year ended December 31, 2020, compared to $4.5 million for the year ended December 31, 2019 due to an increase in both commercial and personal line policies partially offset by a $48,000 decrease in contingency fees. 47 • Other commissions increased $107,000, or 28.8%, to $479,000 for the year ended December 31, 2020, compared to $372,000 for the year ended December 31, 2019 due to a vendor bonus received for reaching certain volume quotas. • Net gain on sales of loans was $1.4 million in the current period compared to $266,000 in the prior period primarily due to increased mortgage loan production from refinances driven by reduced interest rates, which were sold to reduce interest rate risk on lower yielding, long-term assets. • Net gain on securities was $233,000 for the year ended December 31, 2020, compared to $140,000 for the year ended December 31, 2019. Net gain on sales of securities was $500,000 in the current period to recognize gains on higher-interest mortgage-backed securities that were paying down quicker than expected compared to a net loss of $50,000 in the prior period. The Company’s equity securities, which are primarily comprised of bank stocks, reflected a decline in value of $267,000 for the current period primarily from the impact of COVID-19 on the banking industry. • The Company recorded a $61,000 net loss on disposal of fixed assets in the current year, of which $48,000 related to the sale of the former EU headquarters. • There was a $460,000 decrease in other (loss) income as a result of an increase in amortization on mortgage servicing rights combined with a $303,000 temporary impairment on mortgage servicing rights recognized in the current period due to a decline in the interest rate environment that caused increased prepayment speeds and resulted in a decrease in fair value of the serviced mortgage portfolio. Noninterest Expense. Noninterest expense increased $21.8 million, or 62.4%, to $56.8 million for the year ended December 31, 2020 compared to $35.0 million for the year ended December 31, 2019. This was primarily impacted by goodwill impairment of $18.7 million and writedown on fixed assets of $1.1 million as previously noted. Excluding the impact of these non-cash charges, noninterest expense increased $2.0 million, or 5.7% to $37.0 million for the year ended December 31, 2020 compared to $35.0 million for the year ended December 31, 2019. • Salaries and employee benefits increased $496,000 for the year ended December 31, 2020 compared to $19.3 million for the year ended December 31, 2019. The Company recognized approximately $560,000 of one-time payments and related taxes and benefits from the transition and retention of a permanent CEO for the year ended December 31, 2020. Additionally, the increase is related to approximately $258,000 of expense from the Community Bank Cares 10% premium pay during the pandemic and $107,000 increase in restricted stock expense in the current period related to grants in December 2019. This was partially offset by a $407,000 one-time payment that reduced employee benefits from health insurance claims exceeding our stop-loss limit for the 2019 plan year and change from a self-funded to a fully insured plan. Final calculation of the stop loss payment was completed 90 days after the end of the plan year. Also the Company benefited from deferred employee-related loan origination costs associated with PPP loans.Salaries and employee benefits increased $1.2 million to $19.3 million for the year ended December 31, 2019, primarily due to additional employees, salary increases, and employee group health insurance as a direct result of the FWVB merger. • Occupancy expense increased $112,000 to $2.8 million for the year ended December 31, 2020 compared to $2.7 million for the year ended December 31, 2019. The increase was primarily related to a one-time $84,000 early lease termination payment from the Bethlehem branch closure and an increase in property management costs. • Equipment expense decreased $167,000 to $935,000 for the year ended December 31, 2020 compared to $1.1 million for the year ended December 31, 2019 as the result of decrease in depreciation and repairs and maintenance. • Data processing increased $260,000 to $1.8 million for the year ended December 31, 2020 compared to $1.6 million for the year ended December 31, 2019 primarily due to technology investments. • FDIC assessment expense increased $426,000 to $837,000 for the year ended December 31, 2020 compared to $411,000 for the year ended December 31, 2019 due to $308,000 of deposit insurance fund credits approved for banks with less than $10 billion in assets recognized in the prior period. In addition, the net loss recognized in 2020 primarily due to goodwill impairment negatively impacted the assessment rate in the current period resulting in an increased FDIC assessment. • Contracted services increased $787,000 to $2.0 million for the year ended December 31, 2020 compared to $1.3 million for the year ended December 31, 2019, primarily due to temporary employees hired to assist with PPP loan processing and consultants used to assist in core infrastructure improvements. In addition, consulting fees in the current period associated with the search for a permanent CEO were $177,000. • Legal fees and professional fees increased $64,000 to $752,000 for the year ended December 31, 2020 compared to $688,000 for the year ended December 31, 2019 due to fees associated with the transition and retention of a permanent CEO. • Advertising decreased $67,000 to $664,000 for the year ended December 31, 2020 compared to $731,000 for the year ended December 31, 2019 due to reduced marketing initiatives during the pandemic. 48 Income Tax Expense. Income tax expense decreased $481,000 to $1.2 million for the year ended December 31, 2020, compared to $1.7 million for the year ended December 31, 2019. Excluding the impact of goodwill impairment, income before income tax expense decreased $5.6 million in the current year. While the Tax Cuts and Jobs Act (“Tax Act”) enacted in 2017 was the first major overhaul of the Internal Revenue Code (“IRC”) in the last 30 years, it had many items that were left unaddressed once certain tax deadlines passed and for which no formal regulations had been issued as of December 31, 2018. One of these unaddressed tax deadlines was the expiration of the alternative minimum tax (“AMT”) credit carryforward after the 2021 tax year. Pre–Tax Act regulations allowed for AMT credits to carryforward infinitely. As of December 31, 2018, it was determined that an AMT credit carryforward of approximately $1.3 million, acquired in the FWVB merger on April 30, 2018, would remain unutilized as of December 31, 2021 as a result of IRC Section 382 and 383 annual limitations. As a result of the uncertainty of the utilization of the AMT credit carryforwards post-2021, a valuation allowance (“VA”) was established for the AMT credit carryforward deferred tax asset (“DTA”) balance of $1.3 million, which was offset against goodwill at December 31, 2018. This is in accordance with ASC Topic 805 – Business Combinations , due to the AMT credit carryforward being realized under current tax law and minimal possibility of utilization as of the 2021 tax year, deemed to have no current value and offset into goodwill as a purchase accounting adjustment. During the fourth quarter of the year ended December 31, 2019, the IRS issued clarifying guidance under IRC Section 382(h) that provided an alternative approach to calculating unrealized built-in gains (“UBIGs”) related to the FWVB acquisition that impact annual Section 382 limitations. This approach is referred to as the “Section 338” approach and allows for the “realization” of UBIGs based on a “deemed asset acquisition” method, rather than “actual realization”, which accelerates UBIGs utilization and increases the annual Section 382 limitations. The Company performed an analysis of its built-in gains associated with the FWVB acquisition and elected to change its approach from the Section 1374 approach to the Section 338 approach in determining its annual limitations under section 382 and 383. As a result of this analysis as well as consideration of a number of factors, including the Company's current profitability, its forecast of future profitability, and evaluation of existing tax regulations related to NOL and AMT credit carryforwards, the Company concluded that it was more likely than not that it will generate sufficient taxable income within the applicable carryforward periods to realize its net operating loss (“NOL”) and AMT credit carryforwards by December 31, 2021. Therefore, the Company recognized an income tax benefit of $1.3 million related to the reversal of 100% of the VA for the AMT credit carryforward. 49 Average Balances and Yields. The following table sets forth average balance sheets, average yields and costs, and certain other information for the years indicated. Tax-equivalent yield adjustments have been made for tax exempt loan and securities income utilizing a marginal federal income tax rate of 21% for 2020, 2019 and 2018. All average balances are daily average balances. Non-accrual loans are included in the computation of average balances only. The yields set forth below include the effect of deferred fees, discounts, and premiums that are amortized or accreted to interest income or interest expense. 2020 2019 Year Ended December 31, Average Balance Interest and Dividends Yield/ Cost Average Balance Interest and Dividends Yield/ Cost (Dollars in Thousands) Assets: Interest-Earning Assets: Loans, Net $ 1,008,401 $ 43,013 4.27 % $ 913,785 $ 43,302 4.74 % Securities Taxable 138,015 3,619 2.62 196,049 5,649 2.88 Tax Exempt 14,244 450 3.16 23,342 733 3.14 Equity Securities 2,585 79 3.06 2,530 86 3.40 Other Interest-Earning Assets 105,588 517 0.49 56,665 1,512 2.67 Total Interest-Earning Assets 1,268,833 47,678 3.76 1,192,371 51,282 4.30 Noninterest-Earning Assets 109,241 119,054 Total Assets $ 1,378,074 $ 1,311,425 Liabilities and Stockholders' equity: Interest-Bearing Liabilities: Interest-Bearing Demand Deposits $ 240,372 590 0.25 % $ 222,148 1,182 0.53 % Savings 227,277 188 0.08 215,798 507 0.23 Money Market 187,095 708 0.38 181,985 1,040 0.57 Time Deposits 203,128 3,686 1.81 221,904 4,574 2.06 Total Interest-Bearing Deposits 857,872 5,172 0.60 841,835 7,303 0.87 Short-term Borrowings: Securities Sold Under Agreement to Repurchase 37,819 137 0.36 29,976 187 0.62 Other Borrowed Funds 11,328 254 2.24 17,460 367 2.10 Total Interest-Bearing Liabilities 907,019 5,563 0.61 889,271 7,857 0.88 Noninterest-Bearing Demand Deposits 313,858 267,311 Other Liabilities 9,065 9,940 Total Liabilities 1,229,942 1,166,522 Stockholders' Equity 148,132 144,903 Total Liabilities and Stockholders' Equity $ 1,378,074 $ 1,311,425 Net Interest Income $ 42,115 $ 43,425 Net Interest Rate Spread (FTE) (Non-GAAP) (1)(4) 3.15 % 3.42 % Net Interest-Earning Assets (2) $ 361,814 $ 303,100 Net Interest Margin (FTE) (Non-GAAP) (3)(4) 3.32 3.64 Average Equity to Average Assets 10.75 11.05 Average Interest-Earning Assets to Average Interest-Bearing Liabilities 139.89 134.08 (1) Net interest rate spread represents the difference between the weighted average yield on interest-earning assets and the weighted average cost of interest-bearing liabilities. (2) Net interest-earning assets represent total interest-earning assets less total interest-bearing liabilities. (3) Net interest margin represents net interest income divided by average total interest-earning assets. (4) Refer to Explanation of Use of Non-GAAP Financial Measures in this Report for the calculation of the measure and reconciliation to the most comparable GAAP measure. 50 Rate/Volume Analysis The following table presents the effects of changing rates and volumes on our net interest income for the years indicated. The rate column shows the effects attributable to changes in rate (changes in rate multiplied by prior volume). The volume column shows the effects attributable to changes in volume (changes in volume multiplied by prior rate). The total column represents the sum of the prior columns. For purposes of this table, changes attributable to both rate and volume, which cannot be segregated, have been allocated proportionately based on the changes due to rate and the changes due to volume. Year Ended December 31, 2020 Compared To Year Ended December 31, 2019 Increase (Decrease) Due to Volume Rate Total (Dollars in Thousands) Interest and Dividend Income: Loans, net $ 4,224 $ (4,513) $ (289) Securities: Taxable (1,555) (475) (2,030) Tax-Exempt (288) 5 (283) Equity Securities 2 (9) (7) Other Interest-Earning Assets 759 (1,754) (995) Total Interest-Earning Assets 3,142 (6,746) (3,604) Interest Expense: Deposits 183 (2,314) (2,131) Short-Term Borrowings: Securities Sold Under Agreements to Repurchase 40 (90) (50) Other Borrowed Funds (136) 23 (113) Total Interest-Bearing Liabilities 87 (2,381) (2,294) Change in Net Interest Income $ 3,055 $ (4,365) $ (1,310) Explanation of Use of Non-GAAP Financial Measures In addition to traditional measures presented in accordance with generally accepted accounting principles (“GAAP”), we use, and this Report contains or references, certain non-GAAP financial measures. We believe these non-GAAP financial measures provide useful information in understanding our underlying results of operations or financial position and our business and performance trends as they facilitate comparisons with the performance of other companies in the financial services industry. Although we believe that these non-GAAP financial measures enhance the understanding of our business and performance, these non-GAAP financial measures should not be considered an alternative to GAAP or considered to be more important than financial results determined in accordance with GAAP, nor are they necessarily comparable with non-GAAP measures which may be presented by other companies. Where non-GAAP financial measures are used, the comparable GAAP financial measure, as well as the reconciliation to the comparable GAAP financial measure, can be found herein. Interest income on interest-earning assets, net interest rate spread and net interest margin are presented on a fully tax-equivalent (“FTE”) basis. The FTE basis adjusts for the tax benefit of income on certain tax-exempt loans and securities using the federal statutory income tax rate of 21 percent. We believe the presentation of net interest income on a FTE basis ensures comparability of net interest income arising from both taxable and tax-exempt sources and is consistent with industry practice. 51 The following table reconciles net interest income, net interest spread and net interest margin on a FTE basis for the periods indicated: Year Ended December 31, 2020 2019 2018 (Dollars in Thousands) Interest Income per Consolidated Statement of Operations (GAAP) $ 47,467 $ 51,031 $ 43,626 Adjustment to FTE Basis 211 251 355 Interest Income (FTE) (Non-GAAP) 47,678 51,282 43,981 Interest Expense per Consolidated Statement of Operations (GAAP) 5,563 7,857 5,949 Net Interest Income (FTE) (Non-GAAP) $ 42,115 $ 43,425 $ 38,032 Net Interest Rate Spread (GAAP) 3.13 % 3.40 % 3.37 % Adjustment to FTE Basis 0.02 0.02 0.03 Net Interest Rate Spread (FTE) (Non-GAAP) 3.15 % 3.42 % 3.40 % Net Interest Margin (GAAP) 3.30 % 3.62 % 3.55 % Adjustment to FTE Basis 0.02 0.02 0.04 Net Interest Margin (FTE) (Non-GAAP) 3.32 % 3.64 % 3.59 % Non-GAAP adjusted items impacting the Company's financial performance are identified to assist investors in analyzing the Company’s operating results on the same basis as that applied by management. Non-GAAP adjusted items reflect non-cash charges related to goodwill impairment and a writedown on fixed assets from the Monessen branch closure. Year Ended December 31, 2020 2019 (Dollars in Thousands, Except Share and Per Share Data) Net Income (Loss) (GAAP) $ (10,640) $ 14,327 Non-Cash Charges: Goodwill Impairment 18,693 — Writedown on Fixed Assets 1,124 — Income Tax Valuation Allowance Reversal — (1,311) Tax Effect (380) — Adjusted Net Income (Non-GAAP) $ 8,797 $ 13,016 Weighted-Average Diluted Common Shares and Common Stock Equivalents Outstanding 5,406,290 5,448,761 Earnings (Loss) per Common Share - Diluted (GAAP) $ (1.97) $ 2.63 Goodwill Impairment 3.46 — Writedown on Fixed Assets 0.21 — Income Tax Valuation Allowance Reversal — (0.24) Tax Effect (0.07) — Adjusted Earnings per Common Share - Diluted (Non-GAAP) $ 1.63 $ 2.39 Net Income (Loss) (GAAP) (Numerator) $ (10,640) $ 14,327 Annualization Factor 1.00 1.00 Average Assets (Denominator) 1,378,074 1,311,425 Return on Average Assets (GAAP) (0.77) % 1.09 % Adjusted Net Income (Non-GAAP) (Numerator) $ 8,797 $ 13,016 Annualization Factor 1.00 1.00 Average Assets (Denominator) 1,378,074 1,311,425 Adjusted Return on Average Assets (Non-GAAP) 0.64 % 0.99 % 52 Year Ended December 31, 2020 2019 (Dollars in Thousands) Net Income (Loss) (GAAP) (Numerator) $ (10,640) $ 14,327 Annualization Factor 1.00 1.00 Average Equity (Denominator) 148,132 144,903 Adjusted Return on Average Equity (GAAP) (7.18) % 9.89 % Adjusted Net Income (Loss) (GAAP) (Numerator) $ 8,797 $ 13,016 Annualization Factor 1.00 1.00 Average Equity (Denominator) 148,132 144,903 Adjusted Return on Average Equity (Non-GAAP) 5.94 % 8.98 % Adjusted efficiency ratio excludes the effect of certain non-recurring or non-cash items and represents adjusted noninterest expense divided by adjusted operating revenue. The Company evaluates its operational efficiency based on its adjusted efficiency ratio and believes it provides additional perspective on its ongoing performance as well as peer comparability. Year Ended December 31, 2020 2019 (Dollars in Thousands) Noninterest expense (GAAP) (Numerator) $ 56,767 $ 34,960 Net Interest and Dividend Income (GAAP) 41,904 43,174 Noninterest Income (GAAP) 9,471 8,567 Operating Revenue (GAAP) (Denominator) 51,375 51,741 Efficiency Ratio (GAAP) 110.50 % 67.57 % Noninterest expense (GAAP) $ 56,767 $ 34,960 Less: Other Real Estate Owned (Income) (69) (103) Amortization of Intangible Assets 2,128 2,127 Goodwill Impairment 18,693 — Writedown on Fixed Assets 1,124 — Adjusted Noninterest Expense (Non-GAAP) (Numerator) $ 34,891 $ 32,936 Net Interest and Dividend Income (GAAP) 41,904 43,174 Noninterest Income (GAAP) 9,471 8,567 Less: Net Gain on Securities 233 140 Net (Loss) Gain on Disposal of Fixed Assets (61) 2 Adjusted Noninterest Income (Non-GAAP) 9,299 8,425 Adjusted Operating Revenue (Non-GAAP) (Denominator) 51,203 51,599 Adjusted Efficiency Ratio (Non-GAAP) 68.14 % 63.83 % 53 Allowance for loan losses to total loans, excluding PPP loans, is a non-GAAP measure that serves as a useful measurement to evaluate the allowance for loan losses without the impact of SBA guaranteed loans. December 31, 2020 2019 (Dollars in Thousands) Allowance for Loan Losses (Numerator) $ 12,771 $ 9,867 Total Loans 1,044,753 952,496 PPP Loans (55,096) — Total Loans, Excluding PPP Loans (Non-GAAP) (Denominator) $ 989,657 $ 952,496 Allowance for Loan Losses to Total Loans (GAAP) 1.22 % 1.04 % Allowance for Loan Losses to Total Loans, Excluding PPP Loans (Non-GAAP) 1.29 % 1.04 % Tangible book value per common share is a non-GAAP measure and is calculated based on tangible common equity divided by period-end common shares outstanding. Tangible common equity to tangible assets is a non-GAAP measure and is calculated based on tangible common equity divided by tangible assets. We believe these non-GAAP measures serve as useful tools to help evaluate the strength and discipline of the Company's capital management strategies and as an additional, conservative measure of the Company’s total value. December 31, 2020 2019 (Dollars in Thousands, Except Share and Per Share Data) Stockholders' Equity (GAAP) (Numerator) $ 134,530 $ 151,097 Goodwill and Other Intangible Assets, Net (18,131) (38,952) Tangible Common Equity or Tangible Book Value (Non-GAAP) (Numerator) $ 116,399 $ 112,145 Common Shares Outstanding (Denominator) 5,434,374 5,463,828 Book Value per Common Share (GAAP) $ 24.76 $ 27.65 Tangible Book Value per Common Share (Non-GAAP) $ 21.42 $ 20.52 Liquidity Liquidity is the ability to meet current and future financial obligations of a short-term nature. The Bank’s primary sources of funds consist of deposit inflows, loan repayments, and maturities and sales of securities. While maturities and scheduled amortization of loans and securities are predictable sources of funds, deposit flows and mortgage prepayments are greatly influenced by general interest rates, economic conditions and competition. The ability to predict the impact of COVID-19 on the Company’s liquidity with any precision is difficult and depends on many factors beyond our control. The market area implemented state-wide shelter-in-place orders and closed all but essential businesses and certain government restrictions remain in effect. The far-reaching consequences of these actions and the crisis is unknown and will largely depend on the extent and length of the recession combined with how quickly the economy can fully re-open. As of December 31, 2020, 85.5% of loans that were in deferral at June 30, 2020 have returned to their regular payment schedule, but any additional forbearance that may be needed could significantly impact our sources of funds from loan cash flows. The Bank regularly adjusts its investments in liquid assets based upon its assessment of expected loan demand, expected deposit flows, yields available on interest-earning deposits and securities, and the objectives of its asset/liability management program. Excess liquid assets are invested generally in interest-earning deposits with other banks and short- and intermediate-term securities. The Bank believes that it had sufficient liquidity at December 31, 2020, to satisfy its short- and long-term liquidity needs at that date. The Bank’s most liquid assets are cash and due from banks, which totaled $160.9 million at December 31, 2020. Unpledged securities, which provide an additional source of liquidity, totaled $24.2 million. In addition, the Bank maintains a credit arrangement with the FHLB with a maximum borrowing limit of approximately $421.5 million and available borrowing capacity of $320.8 million as of December 31, 2020. $90.3 million was utilized toward standby letters of credit to collateralize public deposits in excess of the level insured by the FDIC and $8.0 million was utilized for advances. This arrangement is subject to annual renewal, incurs no service charge, and is secured by a blanket security agreement on on $564.7 million of residential and commercial mortgage loans and the Bank’s investment in FHLB stock. The Bank also maintains a Borrower-In-Custody of Collateral line of credit agreement with the FRB for $91.5 million that requires monthly certification of collateral, is 54 subject to annual renewal, incurs no service charge and is secured by $133.8 million of commercial and consumer indirect auto loans. The Bank also maintains multiple line of credit arrangements with various unaffiliated banks totaling $60.0 million as of December 31, 2020. At December 31, 2020, the Bank had funding commitments totaling $168.4 million, consisting primarily of commitments to originate loans, unused lines of credit and letters of credit. At December 31, 2020, certificates of deposit due within one year of that date totaled $87.6 million, or 46.1% of total certificates of deposit. If these certificates of deposit do not remain with the Bank, the Bank will be required to seek other sources of funds. Depending on market conditions, the Bank may be required to pay higher rates on such deposits or other borrowings than it currently pays on these certificates of deposit. The Bank believes, however, based on past experience that a significant portion of its certificates of deposit will remain with it, either as certificates of deposit or as other deposit products. The Bank can attract and retain deposits by adjusting the interest rates offered. The Bank’s primary investing activities are the origination of loans and the purchase of securities. For the year ended December 31, 2020, the Bank originated $465.7 million in loans, including $71.0 million of PPP loans, compared to $357.4 million for the year ended December 31, 2019. The Company is a separate legal entity from the Bank and must provide for its own liquidity to pay dividends to stockholders and for other corporate purposes. At December 31, 2020, the Company (on an unconsolidated basis) had liquid assets of $4.9 million. We are committed to maintaining a strong liquidity position. We monitor our liquidity position daily and anticipate that we will have sufficient funds to meet our current funding commitments. Based on our deposit retention experience and current pricing strategy, we anticipate that a significant portion of maturing time deposits will be retained. Capital Resources At December 31, 2020 and 2019, respectively, the Bank was considered "well capitalized" under the regulatory framework for prompt corrective action. At December 31, 2020, the Bank's capital ratios were not affected by loans modified in accordance with Section 4013 of the CARES Act. In addition, PPP loans received a zero-percent risk weight under the regulatory capital rules regardless of whether they were pledged as collateral to the Federal Reserve Bank's PPP lending facility, but were included in the Bank's leverage ratio requirement due to the Bank not pledging the loans as collateral to the PPP lending facility. The following table presents the Bank’s regulatory capital amounts and ratios, as well as the minimum amounts and ratios required to be well capitalized at the dates indicated. 2020 2019 December 31, Amount Ratio Amount Ratio (Dollars in Thousands) Common Equity Tier 1 Capital (to Risk-Weighted Assets) Actual $ 108,950 11.79 % $ 101,703 11.43 % For Capital Adequacy Purposes 41,598 4.50 40,050 4.50 To Be Well Capitalized 60,086 6.50 57,851 6.50 Tier I Capital (to Risk-Weighted Assets) Actual 108,950 11.79 101,703 11.43 For Capital Adequacy Purposes 55,464 6.00 53,401 6.00 To Be Well Capitalized 73,952 8.00 71,201 8.00 Total Capital (to Risk-Weighted Assets) Actual 120,520 13.04 111,570 12.54 For Capital Adequacy Purposes 73,952 8.00 71,201 8.00 To Be Well Capitalized 92,440 10.00 89,001 10.00 Tier I Leverage Capital (to Adjusted Total Assets) Actual 108,950 7.81 101,703 7.85 For Capital Adequacy Purposes 55,765 4.00 51,838 4.00 To Be Well Capitalized 69,706 5.00 64,798 5.00 55 Off-Balance Sheet Arrangements and Contractual Obligations Commitments. As a financial services provider, the Company routinely is a party to various financial instruments with off-balance-sheet risks, such as commitments to extend credit, commitments under unused lines of credit, and commitments under letters of credit. While these contractual obligations represent potential future cash requirements, a significant portion of commitments to extend credit may expire without being drawn upon. Such commitments are subject to the same credit policies and approval process accorded to loans the Company makes. In addition, the Company enters into commitments to sell mortgage loans. Contractual Obligations. In the ordinary course of its operations, the Company enters into certain contractual obligations. Such obligations include operating leases for premises and equipment, agreements with respect to borrowed funds and deposit liabilities and agreements with respect to investments. The following tables present certain of our contractual obligations at December 31, 2020. Payment Due by Period Total Less Than Or Equal to One Year More Than One to Three Years More Than Three to Five Years More Than Five Years (Dollars in Thousands) Certificates of deposit $ 190,013 $ 87,638 $ 78,764 $ 19,495 $ 4,116 Other Borrowed Funds 8,000 2,000 6,000 — — Operating Lease Obligations 1,334 356 429 185 364 Total $ 199,347 $ 89,994 $ 85,193 $ 19,680 $ 4,480 Impact of Inflation and Changing Price The consolidated financial statements and related notes of the Company have been prepared in accordance with GAAP. GAAP generally requires the measurement of financial position and operating results in terms of historical dollars without consideration of changes in the relative purchasing power of money over time due to inflation. The impact of inflation is reflected in the increased cost of the Company’s operations. Unlike industrial companies, the Company’s assets and liabilities are primarily monetary in nature. As a result, changes in market interest rates have a greater impact on performance than the effects of inflation.