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. Cautionary Statement Concerning Forward-Looking Statements See the first page of this Report for information regarding forward-looking statements. 27 Selected Financial Data The following tables set forth selected historical financial and other data of the Company at and for the years ended December 31, 2022, 2021 and 2020. The information at December 31, 2022 and 2021, and for the years ended December 31, 2022 and 2021 is derived in part from, and should be read together with, the Company's audited consolidated financial statements and notes included in this Report and should be read together therewith. The information at December 31, 2020 and for the year ended December 31, 2020 is derived in part from audited financial statements that are not included in this Report. December 31, 2022 2021 2020 (Dollars in Thousands) Selected Financial Condition Data: Assets $ 1,408,938 $ 1,425,479 $ 1,416,720 Cash and Due From Banks 103,700 119,674 160,911 Securities 190,058 224,974 145,400 Loans, Net 1,037,054 1,009,214 1,031,982 Deposits 1,268,503 1,226,613 1,224,569 Short-Term Borrowings 8,060 39,266 41,055 Other Borrowings 14,638 17,601 8,000 Stockholders’ Equity 110,155 133,124 134,530 Year Ended December 31, 2022 2021 2020 (Dollars in Thousands) Selected Operating Data: Interest and Dividend Income $ 47,716 $ 43,557 $ 47,467 Interest Expense 4,781 3,405 5,563 Net Interest and Dividend Income 42,935 40,152 41,904 Provision (Recovery) for Loan Losses 3,784 (1,125) 4,000 Net Interest and Dividend Income After Provision (Recovery) for Loan Losses 39,151 41,277 37,904 Noninterest Income 9,820 16,280 9,471 Noninterest Expense 34,891 42,862 56,767 Income (Loss) Before Income Tax Expense 14,080 14,695 (9,392) Income Tax Expense 2,833 3,125 1,248 Net Income (Loss) $ 11,247 $ 11,570 $ (10,640) At or For the Year Ended December 31, 2022 2021 2020 Per Common Share Data: Earnings (Loss) Per Common Share - Basic $ 2.19 $ 2.15 $ (1.97) Earnings (Loss) Per Common Share - Diluted 2.18 2.15 (1.97) Dividends Per Common Share 0.96 0.96 0.96 Dividend Payout Ratio (1) 44.04 % 44.65 % (48.73) % Book Value Per Common Share $ 21.60 $ 25.31 $ 24.76 Common Shares Outstanding 5,100,189 5,260,672 5,434,374 28 At or For the Year Ended December 31, 2022 2021 2020 Selected Financial Ratios: Return on Average Assets 0.80 % 0.79 % (0.77) % Return on Average Equity 9.56 8.66 (7.18) Average Interest-Earning Assets to Average Interest-Bearing Liabilities 148.00 145.44 139.89 Average Equity to Average Assets 8.36 9.12 10.75 Net Interest Rate Spread (2) 3.07 2.81 3.13 Net Interest Rate Spread (Non-GAAP) (2)(4) 3.08 2.82 3.15 Net Interest Margin (3) 3.24 2.92 3.30 Net Interest Margin (Non-GAAP) (3)(4) 3.25 2.94 3.32 Net Charge-Offs to Average Loans 0.25 0.01 0.11 Noninterest Expense to Average Assets 2.48 2.93 4.12 Efficiency Ratio (5) 66.14 75.95 110.50 Asset Quality Ratios: Allowance for Loan Losses to Total Loans 1.22 % 1.13 % 1.22 % Allowance for Loan Losses to Nonperforming Loans 221.06 159.40 88.15 Allowance for Loan Losses to Nonaccrual Loans 320.64 233.37 117.28 Delinquent and Nonaccrual Loans to Total Loans 0.81 0.78 1.50 Nonperforming Loans to Total Loans 0.55 0.71 1.39 Nonperforming Loans to Total Assets 0.41 0.51 1.02 Nonperforming Assets to Total Assets 0.41 0.51 1.04 Capital Ratios: Common Equity Tier 1 Capital to Risk-Weighted Assets (6) 12.33 % 11.95 % 11.79 % Tier 1 Capital to Risk-Weighted Assets (6) 12.33 11.95 11.79 Total Capital to Risk-Weighted Assets (6) 13.58 13.18 13.04 Tier 1 Leverage Capital to Adjusted Total Assets (6) 8.66 7.76 7.81 Other: Number of Branch Offices 13 14 22 Number of Full-Time Equivalent Employees 197 200 257 (1) Represents dividends per share divided by net income per share. (2) Represents the difference between the weighted average yield on average interest-earning assets and the weighted average cost of average interest-bearing liabilities. (3) Represents net interest income as a percentage of average interest-earning assets. (4) Fully taxable-equivalent (FTE) yield adjustments have been made for tax exempt loan and securities income utilizing a marginal federal income tax rate of 21% for the years ended December 31, 2022, 2021 and 2020. Refer to Explanation of Use of Non-GAAP Financial Measures in Item 7 of this Report for the calculation of the measure and reconciliation to the most comparable GAAP measure. . (5) Represents noninterest expense divided by the sum of net interest income and noninterest income. (6) Capital ratios are for Community Bank only. Critical Accounting Policies and Use of Critical Accounting Estimates Critical accounting policies are those that involve significant judgments, estimates 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. 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 29 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 nonaccrual 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 five-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. Our allowance is sensitive to a number of inputs, most notably the qualitative factors and historical loss experience by loan segment. Given the dynamic relationship between the inputs, it is difficult to estimate the impact of a change in any one individual variable on the allowance. Although management believes that it uses the best information available to establish the allowance, future adjustments to the allowance may be necessary and results of operations could be adversely affected if circumstances differ substantially from the assumptions used in making the determinations. Because future events affecting borrowers and collateral value cannot be predicted with certainty, there can be no assurance that the existing allowance is adequate or that increases will not be necessary should the quality of assets deteriorate as a result of the factors discussed previously. Any increase in the allowance may adversely affect our financial condition and results of operations. Changes in factors underlying the assessment could have a material impact on the amount of the allowance that is necessary and the amount of provision to be charged against earnings. 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 30 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. 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. The Company attempts to maximize observable inputs and limit the use of unobservable inputs when developing fair value measurements, Fair value measurements for assets where there exists limited or no observable market data and that are based primarily upon the Company’s or other third-party’s estimates, are often calculated based on the characteristics of the asset, the economic and competitive environment and other such factors. Therefore, the results cannot be determined with precision and may not be realized in an actual sale or immediate settlement of the asset. Additionally, there may be inherent weaknesses in any calculation technique where changes in the underlying assumptions used, including discount rates and estimates of future cash flows, could significantly affect the results of current or future valuations. 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. 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 31 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. If the Company determines a triggering event occurs in the future, changes in the judgments, assumptions and inputs noted above could result in additional goodwill 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 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 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. The Company did not have a deferred tax asset valuation allowance as of December 31, 2022 and December 31, 2021. 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. Branch Optimization and Operational Efficiency Initiative In 2021, the Company announced the implementation of branch optimization and operational efficiency strategic initiatives to improve the Bank’s financial performance and operations in order to position the Bank for continued profitable growth through the optimization of its branch network 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 evolving changes in consumer preferences, largely driven by the global pandemic, led to an acceleration of branch optimization efforts. The Bank also completed a comprehensive review of its branch network and operating environment to identify solutions to improve operating performance. This review prioritized profitability, efficiency, infrastructure and client experience improvements, automation in operations, and digital marketing and technology investments and the Bank is in process of implementing operational efficiencies related to individualized processes within its branch network and operating environment. The Bank has substantially completed these initiatives through the consolidation of six branches that was completed on June 30, 2021. In addition, CB Financial, Community Bank, and Citizens Bank of West Virginia, Inc. (“Citizens Bank”) executed a Purchase and Assumption Agreement (the “Agreement”) pursuant to which Citizens Bank agreed to purchase certain loans and other assets, and assume certain deposits and other liabilities, of the branch offices of Community Bank located in Buckhannon, West Virginia, and New Martinsville, West Virginia. The divestiture of two branches in December 2021 resulted in the sale of $102.8 million of deposits, $6.1 million of loans and $795,000 of premises and equipment and the recognition of a $5.2 million pre-tax gain on sale from a 5.0% premium paid by Citizens Bank on the assumed deposits. The branch optimization initiative reduced the Bank's branch network to 14 branches. The Company anticipates $3.0 million of ongoing pre-tax cost savings as a result of the branch optimization initiatives. 32 COVID-19 Pandemic Although many health and safety restrictions have been lifted and vaccine distribution has increased, the ongoing COVID-19 pandemic has negatively impacted local, national and global economies and financial markets since March 2020. Economic activity and demand for goods and services, alongside labor shortages and supply chain complications, has also contributed to rising inflationary pressures. The extent to which the COVID-19 pandemic continues to impact our business, financial condition, liquidity, and results of operations will depend on future developments, which are highly uncertain and are difficult to predict In response to the anticipated economic effects of COVID-19, the Board of Governors of the Federal Reserve took a number of actions that significantly affected the financial markets, including actions intended to result in substantial decreases in market interest rates. On March 15, 2020, the FRB reduced the target federal funds range by 100 basis points to 0% to 0.25% and have held the target federal funds rate in that range for the remainder of 2020 and throughout 2021. These reductions in interest rates, among other actions of the FRB and the Federal government generally, adversely affected our net interest income, compressed our margins and impacted our overall profitability. The reduction of interest rates to near zero in response to the effects of the COVID-19 pandemic were gradually reversed over the course of 2022 with increases totaling 425 bps due to FRB concerns with respect to inflation. The FRB has indicated it is committed to reducing inflation to its 2% objective. The magnitude and timing of further interest rate action is unknown. 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. Refer to the "Reconciliations of Non-GAAP Financial Measures to GAAP" within this Item 7 for further information. Comparison of Financial Condition at December 31, 2022 and 2021 Assets. Total assets decreased $16.5 million, or 1.2%, to $1.41 billion at December 31, 2022, compared to $1.43 billion at December 31, 2021. Cash and Due From Banks. Cash and due from banks decreased $16.0 million, or 13.3%, to $103.7 million at December 31, 2022, compared to $119.7 million at December 31, 2021. The change is primarily related to net funding of loans. Securities. Securities decreased $34.9 million, or 15.5%, to $190.1 million at December 31, 2022, compared to $225.0 million at December 31, 2021. The securities balance was negatively impacted by a $32.3 million decrease in market value of the debt securities portfolio, primarily due to the increase in market interest rates. The current period activity included $26.8 million of purchases, $29.2 million of paydowns, and no sales. The purchases were made to improve yield on excess cash. In addition there was a $168,000 loss in market value in the equity securities portfolio, which is primarily comprised of bank stocks. 33 Securities Portfolio. The following table sets forth the composition of our securities portfolio at the dates indicated. 2022 2021 December 31, Amortized Cost Fair Value Amortized Cost Fair Value (Dollars in Thousands) Available-for-Sale Debt Securities: U.S. Government Agencies $ 53,993 $ 44,634 $ 53,992 $ 52,561 Obligations of States and Political Subdivisions 14,053 13,342 17,951 18,955 Mortgage-Backed Securities - Government-Sponsored Enterprises 46,345 41,427 55,373 56,559 Collateralized Mortgage Obligations - Government Sponsored Enterprises 96,930 79,642 88,493 86,583 Corporate Debt 9,487 8,315 7,481 7,450 Total Available-for-Sale Debt Securities $ 220,808 187,360 $ 223,290 222,108 Equity Securities: Mutual Funds 875 990 Other 1,823 1,876 Total Equity Securities 2,698 2,866 Total Securities $ 190,058 $ 224,974 Securities Portfolio Maturities and Yields. The composition and maturities of the debt securities portfolio at December 31, 2022, are summarized in the following table. Maturities are based on the final contractual payment dates, and do not reflect the impact of prepayments or early redemptions that may occur. The weighted average yield for each security category is determined by the security's book yield and calculating the interest earned divided by the carrying value. For tax free obligations of states and political subdivision, the book yield is the tax free yield. One Year or Less More than One Year Through Five Years More than Five Years Through Ten Years More than Ten Years Total Fair Value Weighted Average Yield Fair Value Weighted Average Yield Fair Value Weighted Average Yield Fair Value Weighted Average Yield Fair Value Weighted Average Yield (Dollars in Thousands) U.S. Government Agencies $ — — % $ 7,849 0.96 % $ 36,785 1.24 % $ — — % $ 44,634 1.19 % Obligations of States and Political Subdivisions 244 2.61 739 3.09 11,501 3.28 858 3.18 13,342 3.25 Mortgage Backed Securities - Government-Sponsored Enterprises — — 2,971 2.80 9,282 1.96 29,174 2.11 41,427 2.12 Collateralized Mortgage Obligations - Government-Sponsored Enterprises — — — — — — 79,642 1.52 79,642 1.52 Corporate Debt Securities — — — — 3,815 3.31 4,500 6.92 8,315 5.20 Total Debt Securities $ 244 2.61 % $ 11,559 1.53 % $ 61,383 1.81 % $ 114,174 1.87 % $ 187,360 1.83 % Loans. Total loans increased $29.1 million, or 2.8%, to $1.05 billion at December 31, 2022 compared to $1.02 billion at December 31, 2021. Excluding the net decline of $24.4 million in PPP loans in the current period, loans increased $53.5 million. 2022 loan growth was experienced through net funding of $44.7 million in commercial real estate loans and $24.8 34 million in consumer loans, partially offset by the completion of $40.1 million in construction loans . Average loans for the year ended December 31, 2022 increased $4.7 million compared to the year ended December 31, 2021. Loan Portfolio Composition. The following table sets forth the composition of the Company’s loan portfolio by type of loan at the dates indicated. The Company did not have loans held for sale at the dates indicated below. 2022 2021 December 31, Amount Percent Amount Percent (Dollars in Thousands) Real Estate: Residential $ 330,725 31.5 % $ 320,798 31.4 % Commercial 436,805 41.6 392,124 38.5 Construction 44,923 4.3 85,028 8.3 Commercial and Industrial 70,044 6.7 89,010 8.7 Consumer 146,927 14.0 122,152 12.0 Other 20,449 1.9 11,684 1.1 Total Loans 1,049,873 100.0 % 1,020,796 100.0 % Allowance for Loan Losses (12,819) (11,582) Loans, Net $ 1,037,054 $ 1,009,214 Loan Portfolio Maturities and Yields. The following table summarizes the scheduled repayments of our loan portfolio at December 31, 2022. Demand loans, loans having no stated repayment schedule or maturity, and overdraft loans are reported as being due in one year or less. For construction-to-permanent loans in the construction category, the maturity date is the date the loan matures once it is in permanent repayment status. Consumer loans consist primarily of indirect automobile loans whereby a portion of the rate is prepaid to the dealer and accrued in a prepaid dealer reserve account. Therefore, the true yield for the consumer loan portfolio is significantly less than the note rate disclosed below. Real Estate Residential Commercial Construction Commercial and Industrial Amount Weighted Average Rate Amount Weighted Average Rate Amount Weighted Average Rate Amount Weighted Average Rate (Dollars in Thousands) One Year or Less $ 16,317 7.40 % $ 19,485 6.40 % $ 4,177 7.85 % $ 14,118 7.02 % After One Year Through Five Years 7,410 4.32 60,700 5.62 17,772 6.75 33,240 4.92 After Five Years Through 15 Years 112,609 4.07 345,811 4.85 13,437 4.13 22,684 4.03 After 15 Years 194,389 3.84 10,809 3.90 9,537 3.82 2 7.50 Total $ 330,725 4.10 % $ 436,805 5.00 % $ 44,923 5.44 % $ 70,044 5.05 % Consumer Other Total Amount Weighted Average Rate Amount Weighted Average Rate Amount Weighted Average Rate (Dollars in Thousands) One Year or Less $ 5,734 8.15 % $ 952 6.98 % $ 60,783 7.09 % After One Year Through Five Years 84,765 4.37 418 3.08 204,305 5.05 After Five Years Through 15 Years 54,958 5.00 16,645 3.48 566,144 4.62 After 15 Years 1,470 9.54 2,434 2.56 218,641 3.82 Total $ 146,927 4.77 % $ 20,449 3.53 % $ 1,049,873 4.68 % 35 The following table sets forth at December 31, 2022, the dollar amount of all fixed-rate and adjustable-rate loans due after December 31, 2023. Due After December 31, 2023 Fixed Adjustable Total (Dollars in Thousands) Real Estate: Residential $ 267,046 $ 47,362 $ 314,408 Commercial 238,933 178,387 417,320 Construction 30,720 10,026 40,746 Commercial and Industrial 47,021 8,905 55,926 Consumer 141,157 36 141,193 Other 16,381 3,116 19,497 Total Loans $ 741,258 $ 247,832 $ 989,090 Liabilities. Total liabilities increased $6.4 million, or 0.5%, to $1.30 billion at December 31, 2022 compared to $1.29 billion at December 31, 2021. Deposits. Total deposits increased $41.9 million to $1.27 billion as of December 31, 2022 compared to $1.23 billion at December 31, 2021. Noninterest bearing demand deposits, NOW accounts and savings accounts increased $4.6 million, $39.3 million and $8.5 million, respectively, partially offset by a decrease of $27.6 million in time deposits. The increase in interest-bearing demand deposits is primarily the result of the transition of customer deposits from securities sold under agreements to repurchase product, which are 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. The following table sets forth the distribution of our average deposit accounts, by account type, for the years indicated. 2022 2021 Year Ended December 31, Average Balance Percent Weighted Average Rate Average Balance Percent Weighted Average Rate (Dollars in Thousands) Non-Interest Bearing Demand Deposits $ 389,553 31.4 % — % $ 378,374 29.8 % — % NOW Accounts 282,850 22.8 0.48 272,256 21.4 0.09 Savings Accounts 248,334 20.0 0.04 247,864 19.5 0.04 Money Market Accounts 194,223 15.7 0.50 201,222 15.8 0.14 Time Deposits 124,817 10.1 1.28 171,805 13.5 1.46 Total Deposits $ 1,239,777 100.0 % 0.32 % $ 1,271,521 100.0 % 0.25 % The following table sets forth time deposits classified by interest rate as of the dates indicated. December 31, 2022 2021 (Dollars in Thousands) Less than 0.25% $ 43,516 $ 39,573 0.25% to 0.49% 10,732 20,568 0.50% to 0.99% 7,721 10,943 1.00% to 1.49% 5,929 11,110 1.50% to 1.99% 4,717 7,561 2.00% to 2.49% 7,379 11,841 2.49% to 2.99% 12,779 13,427 3.00% to 3.99% 16,210 21,531 4.00% or Greater 143 159 Total Time Deposits $ 109,126 $ 136,713 36 The following table sets forth, by interest rate ranges and scheduled maturity, information concerning our time deposits at the date indicated. Period to Maturity December 31, 2022 Less Than Or Equal to One Year More Than One to Two Years More Than Two to Three Years More Than Three to Four Years More Than Four to Five Years More Than Five Years Total Percent of Total (Dollars in Thousands) Less than 0.25% $ 30,789 $ 9,926 $ 1,185 $ 1,535 $ 81 $ — $ 43,516 39.9 % 0.25% to 0.49% 1,071 760 785 4,686 3,430 — 10,732 9.8 0.50% to 0.99% 514 669 3,844 138 195 2,361 7,721 7.1 1.00% to 1.49% 2,748 1,275 1,430 202 — 274 5,929 5.4 1.50% to 1.99% 1,281 836 788 1,579 129 104 4,717 4.3 2.00% to 2.49% 4,659 1,753 166 31 234 536 7,379 6.8 2.49% to 2.99% 12,298 95 386 — — — 12,779 11.7 3.00% to 3.99% 15,852 285 73 — — — 16,210 14.9 4.00% or Greater 143 — — — — — 143 0.1 Total $ 69,355 $ 15,599 $ 8,657 $ 8,171 $ 4,069 $ 3,275 $ 109,126 100.0 % As of December 31, 2022 and 2021, the aggregate estimated amount of outstanding deposits in amounts uninsured by the FDIC, or that were not secured by the Bank through the pledging of securities, FHLB letters of credit or other means, was approximately $368.1 million and $337.9 million, respectively. The estimates are based on the same methodologies and assumptions used for the Bank's regulatory reporting requirements. Of the amount at December 31, 2022, an estimated $6.5 million are uninsured time deposits and the following table sets forth their maturity. December 31, 2022 (Dollars in Thousands) Three Months or Less $ 348 Over Three Months to Six Months 1,345 Over Six Months to One Year 1,847 Over One Year 2,968 Total $ 6,508 Borrowed Funds ◦ Short-term borrowings. Short-term borrowings decreased $31.2 million, or 79.5%, to $8.1 million at December 31, 2022, compared to $39.3 million at December 31, 2021. At December 31, 2022 and December 31, 2021, short-term borrowings were comprised entirely of securities sold under agreements to repurchase, which are 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. A majority of the decrease was due to accounts that were transitioned into other deposit products and account for most of the interest-bearing demand deposit increase. ◦ Other borrowed funds. Other borrowed funds decreased $3.0 million to $14.6 million at December 31, 2022 due to $3.0 million of Federal Home Loan Bank borrowings that matured in the current period. The Company intends to utilize the subordinated debt proceeds to continue to proactively repurchase shares or for other general corporate matters. Stockholders’ Equity. Stockholders’ equity decreased $23.0 million, or 17.3%, to $110.2 million at December 31, 2022, compared to $133.1 million at December 31, 2021. • Accumulated other comprehensive loss increased $25.3 million primarily due to market interest rate conditions in the current period on the Bank’s available-for-sale debt securities. • Net income was $11.2 million for the year ended December 31, 2022. • The Company paid $4.9 million in dividends to common stockholders in the current year. 37 • Primarily as part of the Company’s $10.0 million stock repurchase program previously announced in April 2022, and the completion of the $7.5 million repurchase program announced in June 2021, the Company repurchased 195,033 shares of common stock totaling $4.8 million in the current year. In connection with the current program, the Company purchased a total of 62,178 shares of the Company’s common stock at an average price of $22.47 per share, with $8.6 million remaining in the program. • Book value per share was $21.60 at December 31, 2022 compared to $25.31 at December 31, 2021, a decrease of $3.71. Tangible book value per share (Non-GAAP) decreased $3.45, or 15.4%, to $19.00 compared to $22.45 at December 31, 2021. 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, 2022 and 2021 Overview. 2022 Annual Results were impacted by the following significant items: • Recurring Fed interest rate increases during 2022 resulted in an increase in net interest income of $2.8 million. • There was a commercial loan charge off in the second quarter and resulted in a $3.8 million provision. 2021 Annual Results were impacted by the following significant non-recurring items: • The branch optimization and operational efficiency initiatives resulted in $7.5 million of restructuring-related and other expenses for the year ended December 31, 2021. The non-recurring expenses include a $2.3 million writedown on premises and equipment and $1.2 million impairment of intangible assets associated with the branch sales. The Company also incurred $4.1 million of expenses related to contracted services, employee severance costs, branch lease impairment, professional fees, data processing fees, charitable donations, legal and other expenses for the year ended December 31, 2021 related to these initiatives. • The Company recognized a $5.2 million pre-tax gain on sale of branches related to the 5.0% premium paid by Citizens Bank on the assumed deposits. Net Interest Income. Net interest income increased $2.8 million, or 6.9%, to $42.9 million for the year ended December 31, 2022 compared to $40.2 million for the year ended December 31, 2021. Net interest margin (Non-GAAP FTE) increased 31 bps to 3.25% for the year ended December 31, 2022 compared to 2.94% the year ended December 31, 2021. Net interest margin (GAAP) increased to 3.24% for the year ended December 31, 2022 compared to 2.92% for the year ended December 31, 2021. The net interest margin increased primarily due to the higher interest rate environment increasing yields on loans more than the yield on interest-bearing deposits. Interest and dividend income increased $4.2 million, or 9.5%, to $47.7 million for the year ended December 31, 2022 compared to $43.6 million for the year ended December 31, 2021. • Interest income on loans increased $2.2 million, or 5.6%, to $41.9 million for the year ended December 31, 2022 compared to $39.7 million for the year ended December 31, 2021. Average loans increased $4.7 million while the loan yield for the year ended December 31, 2022 increased 20 bps to 4.12% for the year ended December 31, 2022 compared to 3.92% for the year ended December 31, 2021 due to the increases of market interest rates this year compared to a full year impact of the COVID-19 pandemic-related declines in market interest rates beginning in March 2020. Interest and fee income on PPP loans was $734,000 for the year ended December 31, 2022 and contributed 5 bps to loan yield, compared to $2.2 million for the year ended December 31, 2021, which contributed loan yield 4 bps in the prior period. The impact of the accretion of the credit mark on acquired loan portfolios was $239,000 for the year ended December 31, 2022 compared to $468,000 for the year ended December 31, 2021, or 2 bps in the current period compared to 4 bps in the prior period. • Interest income on taxable investment securities increased $862,000, or 28.8%, to $3.9 million for the year ended December 31, 2022 compared to $3.0 million for the year ended December 31, 2021. While average investment securities increased $57.8 million, there was a 9 bps decrease in average yield. There were sales of securities in 2021 that were higher-interest securities, which were replaced by lower-interest securities that decreased the yield year over year. • Interest income on tax-exempt investment securities decreased $76,000, or 26.3%, to $213,000 for the year ended December 31, 2022 compared to $289,000 for the year ended December 31, 2021 primarily driven by a decrease of $3.4 million in average balance from municipal securities calls. • Interest from other interest-earning assets, which primarily consists of interest-earning cash, increased $1.1 million, or 232.0% for the year ended December 31, 2022 compared to the year ended December 31, 2021. Interest and dividend income earned on other interest-earning assets, which is primarily composed of restricted stock, decreased $32,000. Average interest bearing deposits at other banks decreased $107.0 million, primarily related to funds received from deposit and loan activity, there was however a $1.1 million increase in interest income due to an increase in Fed interest rates that resulted in a 191 bps increase in average yield. 38 Interest expense increased $1.4 million, or 40.4%, to $4.8 million for the year ended December 31, 2022 compared to $3.4 million for the year ended December 31, 2021. • Interest expense on deposits increased $900,000, or 28.8%, to $4.0 million for the year ended December 31, 2022 compared to $3.1 million for the year ended December 31, 2021. While average interest-bearing deposits decreased $42.9 million, interest rate increases for all products driven by post-pandemic Fed interest rate increases resulting in a 12 bps increase in average cost compared to the year ended December 31, 2021. • Interest expense on short-term borrowings decreased $35,000, or 35.7%, to $63,000 for the year ended December 31, 2022 compared to $98,000 for the year ended December 31, 2021 primarily due to the transition of sweep accounts into other deposit products. • Interest expense on other borrowed funds increased $511,000, or 280.8%, to $693,000 for the year ended December 31, 2022 compared to $182,000 for the year ended December 31, 2021 primarily due to the issuance of $15.0 million in subordinated debt, partially offset by a $3.0 million payoff of an FHLB borrowing, which resulted in a $10.4 million increase in average balances. Provision for Loan Losses. The provision for loan losses was $3.8 million for the year ended December 31, 2022, compared to a $1.1 million recovery for the year ended December 31, 2021. Net charge-offs for the year ended December 31, 2022 were $2.5 million primarily from one commercial and industrial loan that impacted the loss history for the category. The prior year recovery was the result of improvement in overall economic conditions thereby improving corresponding qualitative factors that were previously negatively impacted by the COVID-19 pandemic. Noninterest Income . The breakdown of noninterest income for the year ended December 31, 2022 compared to year ended December 31, 2021 is as follows: Year Ended December 31, 2022 2021 Dollar Change Percent Change (Dollars in Thousands) Service Fees $ 2,160 $ 2,331 $ (171) (7.3) % Insurance Commissions 5,934 5,616 318 5.7 % Other Commissions 669 521 148 28.4 % Net Gain on Sales of Loans — 1,143 (1,143) (100.0) % Net (Loss) Gain on Securities (168) 526 (694) (131.9) % Net Gain on Purchased Tax Credits 57 70 (13) (18.6) % Gain on Sale of Branches — 5,203 (5,203) (100.0) % Net Gain (Loss) on Disposal of Fixed Assets 431 (3) 434 14466.7 % Income from Bank-Owned Life Insurance 561 553 8 1.4 % Other Income 176 320 (144) (45.0) % Total Noninterest Income $ 9,820 $ 16,280 $ (6,460) (39.7) % Noninterest income decreased $6.5 million, or 39.7%, to $9.8 million for the year ended December 31, 2022, compared to $16.3 million for the year ended December 31, 2021. • Insurance commissions increased $318,000, or 5.7%, to $5.9 million for the year ended December 31, 2022, compared to $5.6 million for the year ended December 31, 2021 due to an increase in core business, including both personal and commercial lines. • There was no net gain on sales of loans for the year ended December 31, 2022 compared to $1.1 million for the year ended December 31, 2021 due to a change in strategy to keep all loans made in 2022. There were no gains from sales of mortgage loans for the year ended December 31, 2022 compared to $1.1 million for the year ended December 31, 2021. • Net loss on securities was $168,000 for the year ended December 31, 2022, compared to a gain of $526,000 for the year ended December 31, 2021. There were no sales of securities in the current period compared to sales that resulted in a gain of $231,000 in the prior period. The Company’s equity securities, which are primarily comprised of bank 39 stocks, reflected a decline in value of $168,000 for the current period compared to a gain of $295,000 in value in the prior period primarily from a change in market value of these securities as a result of changes in interest rates. • The Company recorded a $431,000 net gain on disposal of fixed assets in the current year, resulting from the sale of two former branch locations. • The Company recognized a $5.2 million pre-tax gain on sale of branches in the prior period related to the 5.0% premium paid by Citizens Bank on the assumed deposits. • There was a $144,000 decrease in other income primarily due to a $99,000 valuation allowance adjustment on mortgage servicing rights in the current period as a result of a decrease in prepayment speeds resulting in an increase in the fair value of the serviced mortgage portfolio. Noninterest Expense. The breakdown of noninterest expense for the year ended December 31, 2022 compared to year ended December 31, 2021 is as follows: Year Ended December 31, 2022 2021 Dollar Change Percent Change (Dollars in Thousands) Salaries and Employee Benefits $ 18,469 $ 19,938 $ (1,469) (7.4) % Occupancy 3,047 2,968 79 2.7 % Equipment 739 1,034 (295) (28.5) % Data Processing 2,152 2,154 (2) (0.1) % FDIC Assessment 638 1,014 (376) (37.1) % PA Shares Tax 979 887 92 10.4 % Contracted Services 1,628 4,011 (2,383) (59.4) % Legal and Professional Fees 1,237 994 243 24.4 % Advertising 527 749 (222) (29.6) % Other Real Estate Owned (Income) (151) (183) 32 (17.5) % Amortization of Intangible Assets 1,782 1,926 (144) (7.5) % Intangible Assets and Goodwill Impairment — 1,178 (1,178) (100.0) % Writedown of Premises and Equipment — 2,293 (2,293) (100.0) % Other 3,844 3,899 (55) (1.4) % Total Noninterest Expense $ 34,891 $ 42,862 $ (7,971) (18.6) % Noninterest expense decreased $8.0 million, or 18.6%, to $34.9 million for the year ended December 31, 2022 compared to $42.9 million for the year ended December 31, 2021. This was primarily impacted by $7.5 million of expenses associated with the branch optimization and operational efficiency initiatives in the prior year, which included writedown on premises and equipment of $2.3 million and intangible asset impairment of $1.2 million. • Salaries and employee benefits decreased $1.5 million to $18.5 million for the year ended December 31, 2022 compared to $19.9 million for the year ended December 31, 2021. The decrease was primarily related to the branch optimization that included the consolidation of six branches and the divestiture of two in the prior year. • Occupancy expense increased $79,000 to remain constant at $3.0 million for the years ended December 31, 2022 and 2021 respectively. The increase was related to building maintenance costs and utilities, partially offset by the prior year recognition of a $227,000 lease impairment related to the branch optimization initiative. • Equipment expense decreased $295,000 to $739,000 for the year ended December 31, 2022 compared to $1.0 million for the year ended December 31, 2021 as the result of a decrease in repairs and maintenance. • FDIC assessment expense decreased $376,000 to $638,000 for the year ended December 31, 2022 compared to $1.0 million for the year ended December 31, 2021. The decrease in assessment was due to an increase in nonperforming loans negatively impacting the quarterly assessment rates in the prior period. • Contracted services decreased $2.4 million to $1.6 million for the year ended December 31, 2022 compared to $4.0 million for the year ended December 31, 2021. The prior period had activity of $2.8 million, and included expense 40 related to the engagement of a third-party expert to improve workflow as well as implement more effective sales management techniques designed to improve operational efficiencies in the near and long-term and engagement of other third party specialists to assist in core platform improvements and efficiencies.. This was partially offset by $319,000 of employee recruiter fees and $203,000 of core conversion consultant fees. • Legal fees and professional fees increased $243,000 to $1.2 million for the year ended December 31, 2022 compared to $994,000 for the year ended December 31, 2021 due to increases in consultant services related to regulatory reporting and validation of the CECL model, and the FDICIA control project to strengthen the Company's internal control structure. • Advertising decreased $222,000 to $527,000 for the year ended December 31, 2022 compared to $749,000 for the year ended December 31, 2021 due to a decrease in marketing initiatives in the prior year during the pandemic. • Other real estate owned income decreased $32,000 to $151,000 for the year ended December 31, 2022 compared to $183,000 for the year ended December 31, 2021 primarily due to an $80,000 gain on sale of a property sold in the prior period. • Amortization of intangible assets decreased $144,000 to $1.8 million for the year ended December 31, 2022 compared to $1.9 million for the year ended December 31, 2021 primarily due to current period impairment in core deposit intangible asset from the branch sales, which reduced the remaining amount of intangible assets to amortize. • Within other noninterest expense, charitable contributions decreased $150,000 due to the prior year donation of a former branch office location. Loan expenses increased $148,000 primarily due to appraisal fees and credit reports related to an increase in indirect loan volume in the current period. Income Tax Expense. Income tax expense decreased $292,000 to $2.8 million for the year ended December 31, 2022, compared to $3.1 million for the year ended December 31, 2021 and is primarily attributed to a write down in premises and equipment and intangible assets. 41 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 2022 and 2021. 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. 2022 2021 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) $ 1,019,124 $ 42,010 4.12 % $ 1,014,405 $ 39,799 3.92 % Securities Taxable 220,818 3,852 1.74 162,987 2,990 1.83 Tax Exempt 8,383 270 3.22 11,829 366 3.09 Equity Securities 2,693 91 3.38 2,657 84 3.16 Interest Bearing Deposits at Other Banks 70,765 1,473 2.08 177,768 304 0.17 Other Interest-Earning Assets 3,092 154 4.98 3,733 186 4.98 Total Interest-Earning Assets 1,324,875 47,850 3.61 1,373,379 43,729 3.18 Noninterest-Earning Assets 81,553 91,075 Total Assets $ 1,406,428 $ 1,464,454 Liabilities and Stockholders' equity: Interest-Bearing Liabilities: Interest-Bearing Demand Deposits $ 282,850 $ 1,362 0.48 % $ 272,256 $ 232 0.09 % Savings 248,334 88 0.04 247,864 98 0.04 Money Market 194,223 976 0.50 201,222 281 0.14 Time Deposits 124,817 1,599 1.28 171,805 2,514 1.46 Total Interest-Bearing Deposits 850,224 4,025 0.47 893,147 3,125 0.35 Short-term Borrowings: Securities Sold Under Agreement to Repurchase 27,360 63 0.23 43,988 98 0.22 Other Borrowed Funds 17,609 693 3.94 7,172 182 2.54 Total Interest-Bearing Liabilities 895,193 4,781 0.53 944,307 3,405 0.36 Noninterest-Bearing Demand Deposits 389,553 378,374 Other Liabilities 4,072 8,168 Total Liabilities 1,288,818 1,330,849 Stockholders' Equity 117,610 133,605 Total Liabilities and Stockholders' Equity $ 1,406,428 $ 1,464,454 Net Interest Income (FTE) (Non-GAAP) (2) $ 43,069 $ 40,324 Net Interest Rate Spread (FTE) (Non-GAAP) (2)(3) 3.08 2.82 Net Interest-Earning Assets (4) $ 429,682 $ 429,072 Net Interest Margin (FTE) (Non-GAAP) (2)(5) 3.25 2.94 Return on Average Assets 0.80 0.79 Return on Average Equity 9.56 8.66 Average Equity to Average Assets 8.36 9.12 Average Interest-Earning Assets to Average Interest-Bearing Liabilities 148.00 145.44 PPP Loans $ 5,666 $ 734 12.95 $ 45,905 $ 2,189 4.77 (1) Net of the allowance for loan losses and includes nonaccrual loans with a zero yield (2) 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. (3) 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. Net interest rate spread (GAAP) was 3.07% and 2.81% for the year ended December 31, 2022 and 2021, respectively (4) Net interest-earning assets represent total interest-earning assets less total interest-bearing liabilities. (5) Net interest margin represents net interest income divided by average total interest-earning assets. Net interest margin (GAAP) was 3.24% and 2.92% for the year ended December 31, 2022 and 2021, respectively 42 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. There were no out of period items that occurred this past year. Year Ended December 31, 2022 Compared To Year Ended December 31, 2021 Increase (Decrease) Due to Volume Rate Total (Dollars in Thousands) Interest and Dividend Income: Loans, net $ 174 $ 2,037 $ 2,211 Securities: Taxable 1,015 (153) 862 Tax-Exempt (111) 15 (96) Equity Securities 1 6 7 Interest Bearing Deposits at Other Banks (286) 1,455 1,169 Other Interest-Earning Assets (32) — (32) Total Interest-Earning Assets 761 3,360 4,121 Interest Expense: Deposits (126) 1,026 900 Short-Term Borrowings: Securities Sold Under Agreements to Repurchase (39) 4 (35) Other Borrowed Funds 371 140 511 Total Interest-Bearing Liabilities 206 1,170 1,376 Change in Net Interest Income $ 555 $ 2,190 $ 2,745 Asset Quality Nonperforming Assets and Delinquent Loans. The Company reviews its loans on a regular basis and generally places loans on nonaccrual status when either principal or interest is 90 days or more past due. In addition, the Company places loans on nonaccrual status when we do not expect to receive full payment of interest, principal or both. Interest accrued and unpaid at the time a loan is placed on nonaccrual status is reversed from interest income. Loans that are 90 days or more past due may still accrue interest if they are well secured and in the process of collection. Payments received on nonaccrual loans are applied against principal. Loans are returned to accrual status when all the principal and interest amounts contractually due are brought current, and current and future payments are reasonably assured. Management monitors all past due loans and nonperforming assets. Such loans are placed under close supervision, with consideration given to the need for additions to the allowance for loan losses and (if appropriate) partial or full charge-off. Management believes the volume of nonperforming assets can be partially attributed to unique borrower circumstances as well as the economy in general. We have an experienced chief credit officer, collections and credit departments that monitor the loan portfolio and seek to prevent any deterioration of asset quality. Real estate acquired through foreclosure or by deed-in-lieu of foreclosure is classified as real estate owned until such time as it is sold. When real estate owned is acquired, it is recorded at the lower of the unpaid principal balance of the related loan, or its fair market value, less estimated selling expenses. Any further write-down of real estate owned is charged against earnings. 43 Nonaccrual Loans and Nonperforming Assets. The following table sets forth the amounts and categories of our nonperforming assets at the dates indicated. Included in nonperforming loans and assets are troubled debt restructurings, which are loans whose contractual terms have been restructured in a manner that grants a concession to a borrower experiencing financial difficulties. December 31, 2022 2021 (Dollars in Thousands) Nonaccrual loans: Real Estate: Residential $ 1,649 $ 1,393 Commercial 1,814 2,058 Commercial and Industrial 415 1,496 Consumer 120 16 Total Nonaccrual Loans 3,998 4,963 Accruing Loans Past Due 90 Days or More: Consumer — — Total Accruing Loans 90 Days or More Past Due — — Total Nonaccrual Loans and Accruing Loans 90 Days or More Past Due 3,998 4,963 Troubled Debt Restructurings, Accruing Real Estate Residential 534 613 Commercial 1,260 1,674 Commercial and Industrial 7 16 Total Troubled Debt Restructurings, Accruing 1,801 2,303 Total Nonperforming Loans 5,799 7,266 Real Estate Owned: Residential — 36 Commercial — — Total Real Estate Owned — 36 Total Nonperforming Assets $ 5,799 $ 7,302 Nonaccrual Loans to Total Loans 0.38 % 0.49 % Nonperforming Loans to Total Loans 0.55 0.71 Nonperforming Assets to Total Assets 0.41 0.51 At December 31, 2022, we had no loans 90 days or more past due that were still accruing interest. At December 31, 2022, we had no loans that were not classified as nonaccrual, 90 days past due or troubled debt restructurings where known information about possible credit problems of borrowers caused management to have serious concerns as to the ability of the borrowers to comply with present loan repayment terms and that may result in disclosure as nonaccrual, 90 days past due or troubled debt restructurings. Nonperforming assets decreased $1.5 million to $5.8 million at December 31, 2022, compared to $7.3 million at December 31, 2021. Nonperforming loans decreased $1.5 million to $5.8 million at December 31, 2022 compared to $7.3 million at December 31, 2021. The respective decreases are primarily attributable to the full payoff in the current year of one of the Bank’s larger nonperforming commercial and industrial relationships. 44 The following table presents the components of the ratio of nonaccrual loans to total loans at the dates indicated. 2022 2021 December 31, Nonaccrual Loans Total Loans Nonaccrual Loans to Total Loans Nonaccrual Loans Total Loans Nonaccrual Loans to Total Loans (Dollars in Thousands) Real Estate: Residential $ 1,649 $ 330,725 0.50 % $ 1,393 $ 320,798 0.43 % Commercial 1,814 436,805 0.42 2,058 392,124 0.52 Construction — 44,923 — — 85,028 — Commercial and Industrial 415 70,044 0.59 1,496 89,010 1.68 Consumer 120 146,927 0.08 16 122,152 0.01 Other — 20,449 — — 11,684 — Total $ 3,998 $ 1,049,873 0.38 % $ 4,963 $ 1,020,796 0.49 % Nonaccrual loans decreased $1.0 million to $4.0 million at December 31, 2022 compared to $5.0 million at December 31, 2021. Nonaccrual commercial real estate loans decreased $244,000 to $1.8 million at December 31, 2022 compared to $2.1 million at December 31, 2021 primarily related to the full payoff in the current year of one of the Bank’s nonperforming commercial and industrial relationships. Loans in Forbearance. 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 worked with its borrowers impacted by COVID-19 to defer payments. The Bank provided borrower support and relief through short-term loan forbearance options by primarily allowing: (a) deferral of three- to six-months of payments; 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. There were no loans in forbearance as of December 31, 2022. At December 31, 2021, there was one loan in forbearance for a $1.9 million commercial real estate loan secured by a hotel, which was considered a troubled debt restructuring upon providing an additional forbearance period and modified payment terms. The loan was substandard rated at December 31, 2022 and 2021, respectively, and designated as a nonaccrual loan in 2021. Classified Assets. Federal regulations provide that loans and other assets of lesser quality should be classified as “substandard,” “doubtful” or “loss” assets. An asset is considered “substandard” if it is inadequately protected by the current net worth and paying capacity of the obligor or of the collateral pledged, if any. Substandard assets include those characterized by the “distinct possibility” that the Company will sustain “some loss” if the deficiencies are not corrected. Assets classified as “doubtful” have all of the weaknesses inherent in those classified “substandard,” with the added characteristic that the weaknesses present make “collection or liquidation in full,” on the basis of currently existing facts, conditions, and values, “highly questionable and improbable.” Assets classified as “loss” are those considered “uncollectible” and of such little value that their continuance as assets is not warranted. The Company designates an asset as “special mention” if the asset has a potential weakness that warrants management’s close attention. The Company uses an eight-point internal risk rating system to monitor the credit quality of the overall loan portfolio. The first four categories are not considered criticized and are aggregated as “pass” rated. The criticized rating categories used by management generally follow bank regulatory definitions. The special mention category includes assets that are currently protected but are below average quality, resulting in an undue credit risk, but not to the point of justifying a substandard classification. Loans in the substandard category have well-defined weaknesses that jeopardize the liquidation of the debt and have a distinct possibility that some loss will be sustained if the weaknesses are not corrected. Loans classified as doubtful have all the weaknesses inherent in loans classified as substandard with the added characteristic that collection or liquidation in full, on the basis of current conditions and facts, is highly improbable. Loans classified as loss are considered uncollectible and of such little value that continuance as an asset is not warranted. 45 As part of the periodic exams of the Bank by the FDIC and the Pennsylvania Department of Banking and Securities, the staff of such agencies reviews our classifications and determines whether such classifications are adequate. Such agencies have, in the past, and may in the future require us to classify certain assets which management has not otherwise classified or require a classification more severe than established by management. The following table shows the principal amount of special mention and classified loans at December 31, 2022 and 2021. December 31, 2022 2021 (Dollars in Thousands) Special Mention $ 43,804 $ 55,579 Substandard 14,499 15,069 Doubtful 415 512 Loss — — Total $ 58,718 $ 71,160 The total amount of special mention and classified loans decreased $12.4 million, or 17.5%, to $58.7 million at December 31, 2022, compared to $71.2 million at December 31, 2021. The decrease of $570,000 in the substandard category as of December 31, 2022 compared to December 31, 2021 was mainly from the full payoff in the current year of one of the Bank’s nonperforming commercial and industrial loan relationships. The decrease of $11.8 million in the special mention loan category is primarily due to commercial real estate and commercial and industrial loan upgrades and payoffs, and a $2.7 million commercial and industrial charge-off. Allowance for Loan Losses. The allowance for loan losses 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 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. Although we maintain our allowance for loan losses at a level that we consider to be adequate to provide for potential losses, there can be no assurance that such losses will not exceed the estimated amounts or that we will not be required to make additions to the allowance for loan losses in the future. Future additions to our allowance for loan losses and changes in the related ratio of the allowance for loan losses to nonperforming loans are dependent upon the economy, changes in real estate values and interest rates, the view of the regulatory authorities toward adequate loan loss reserve levels, and inflation. Management will continue to periodically review the entire loan portfolio to determine the extent, if any, to which further additional loan loss provisions may be deemed necessary. 46 Analysis of the Allowance for Loan Losses. The following table summarizes changes in the allowance for loan losses by loan categories for each year indicated and additions to the allowance for loan losses, which have been charged to operations. Loans acquired in connection with mergers were recorded at their estimated fair value at the acquisition date and did not include a carryover of the pre-merger allowance for loan losses. Year Ended December 31, 2022 2021 (Dollars in Thousands) Balance at Beginning of Year $ 11,582 $ 12,771 Provision for Loan Losses 3,784 (1,125) Charge-offs: Real Estate: Residential (32) (13) Commercial — (40) Construction — — Commercial and Industrial (2,712) — Consumer (151) (213) Other — — Total Charge-offs (2,895) (266) Recoveries: Real estate: Residential 145 17 Commercial — — Construction — — Commercial and Industrial 117 43 Consumer 86 142 Other — — Total Recoveries 348 202 Net Charge-offs (2,547) (64) Balance at End of Year $ 12,819 $ 11,582 Allowance for Loan Losses to Total Loans 1.22 % 1.13 % Allowance for Loan Losses to Nonaccrual Loans 320.64 233.37 Allowance for Loan Losses to Nonperforming Loans 221.06 159.40 Net Charge-offs to Average Loans 0.25 0.01 The allowance for loan losses increased $1.2 million, or 10.7%, to $12.8 million at December 31, 2022, compared to $11.6 million at December 31, 2021. Allowance for loan losses to total loans increased 9 basis points to 1.22% at December 31, 2022 compared to 1.13% at December 31, 2021. There was a large charge-off of one loan in the commercial and industrial pool that affected the loss rates, and caused an additional provision to be recorded. These factors primarily resulted in a $3.8 million of provision for loan losses for the year ended December 31, 2022 compared to a $1.1 million recovery for loan losses for the year ended December 31, 2021. The ratio of allowance for loan losses to nonaccrual loans ratio increased to 320.64% at December 31, 2022, compared to 233.37% at December 31, 2021. Nonaccrual loans decreased $1.0 million to $4.0 million at December 31, 2022 compared to $5.0 million at December 31, 2021. Nonaccrual commercial real estate loans decreased $244,000 to $1.8 million at December 31, 2022 compared to $2.1 million at December 31, 2021 primarily related to the full payoff in the current year of one of the Bank’s nonperforming commercial and industrial loan relationships. 47 Net charge-offs were $2.5 million or 0.25% to average loans, during 2022 compared to $64,000, or 0.01% to average loans, during 2021. The decrease was primarily related to the $2.9 million commercial and industrial loan charge-off in the current year. The following table presents the ratio of net charge-offs (recoveries) as a percent of average loans for the periods indicated. Year Ended December 31, 2022 2021 Real Estate: Residential (0.03) % — % Commercial — 0.01 Construction — — Commercial and Industrial 3.90 (0.04) Consumer 0.04 0.06 Other — — Total Loans 0.25 % 0.01 % Allocation of Allowance for Loan Losses. The following table sets forth the allocation of allowance for loan losses by loan category at the dates indicated. The table reflects the allowance for loan losses as a percentage of total loans receivable. Management believes that the allowance can be allocated by category only on an approximate basis. The allocation of the allowance by category is not necessarily indicative of future losses and does not restrict the use of the allowance to absorb losses in any category. 2022 2021 December 31, Amount Percent of Total Loans (1) Amount Percent of Total Loans (1) (Dollars in Thousands) Real Estate: Residential $ 2,074 31.5 % $ 1,420 31.4 % Commercial 5,810 41.6 5,960 38.5 Construction 502 4.3 1,249 8.3 Commercial and Industrial 2,313 6.7 1,151 8.7 Consumer 1,517 14.0 1,050 12.0 Other — 1.9 — 1.1 Total Allocated Allowance 12,216 100.0 10,830 100.0 Unallocated 603 — 752 — Total Allowance for Loan Losses $ 12,819 100.0 % $ 11,582 100.0 % (1) Represents percentage of loans in each category to total loans Reconciliations of Non-GAAP Financial Measures to GAAP Reconciliations of non-GAAP financial measures discussed in this Report to the most directly comparable GAAP financial measures are included in the following tables. Interest income on interest-earning assets, net interest rate spread and net interest margin are presented on a 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. 48 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. 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, 2022 2021 (Dollars in Thousands) Interest Income per Consolidated Statements of Income (GAAP) $ 47,716 $ 43,557 Adjustment to FTE Basis 134 172 Interest Income (FTE) (Non-GAAP) 47,850 43,729 Interest Expense per Consolidated Statements of Income (GAAP) 4,781 3,405 Net Interest Income (FTE) (Non-GAAP) $ 43,069 $ 40,324 Net Interest Income (GAAP) $ 42,935 $ 40,152 Divided by : Average Interest Earning Assets $ 1,324,875 $ 1,373,379 Net Interest Margin (GAAP) 3.24 % 2.92 % Adjustment to FTE Basis 0.01 0.02 Net Interest Margin (FTE) (Non-GAAP) 3.25 % 2.94 % Net Interest Rate Spread (GAAP) 3.07 % 2.81 % Adjustment to FTE Basis 0.01 0.01 Net Interest Rate Spread (FTE) (Non-GAAP) 3.08 % 2.82 % 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, 2022 2021 (Dollars in Thousands, Except Share and Per Share Data) Stockholders' Equity (GAAP) (Numerator) $ 110,155 $ 133,124 Goodwill and Other Intangible Assets, Net (13,245) (15,027) Tangible Common Equity or Tangible Book Value (Non-GAAP) (Numerator) $ 96,910 $ 118,097 Common Shares Outstanding (Denominator) 5,100,189 5,260,672 Book Value per Common Share (GAAP) $ 21.60 $ 25.31 Tangible Book Value per Common Share (Non-GAAP) $ 19.00 $ 22.45 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 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, 2022, 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 $103.7 million at December 31, 2022. Unpledged securities, which provide an additional source of liquidity, totaled $14.4 million. In addition, the Bank maintains a 49 credit arrangement with the FHLB with a maximum borrowing limit of approximately $435.3 million and available borrowing capacity of $407.4 million as of December 31, 2022. $26.2 million was utilized toward standby letters of credit to collateralize public deposits in excess of the level insured by the FDIC. This arrangement is subject to annual renewal, incurs no service charge, and is secured by a blanket security agreement on $602.5 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 $119.0 million that requires monthly certification of collateral, is subject to annual renewal, incurs no service charge and is secured by $172.9 million of commercial and consumer indirect auto loans. The Bank also maintains multiple line of credit arrangements with various unaffiliated banks totaling $50.0 million as of December 31, 2022. At December 31, 2022, the Bank had funding commitments totaling $156.7 million, consisting primarily of commitments to originate loans, unused lines of credit and letters of credit. At December 31, 2022, certificates of deposit due within one year of that date totaled $69.4 million, or 63.6% of total certificates of deposit. While liquidity levels at December 31, 2022 are currently sufficient, if these certificates of deposit do not remain with the Bank, the Bank may 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. For the year ended December 31, 2022 the Bank had net loan originations of $31.4 million. The Company is a separate legal entity from the Bank and must provide for its own liquidity to pay dividends to stockholders, to pay principal and interest on its subordinated debt and for other corporate purposes. At December 31, 2022, the Company (on an unconsolidated basis) had liquid assets of $16.3 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. 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, 2022. 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 $ 109,126 $ 69,355 $ 24,256 $ 12,240 $ 3,275 Other Borrowed Funds 14,638 — — — 14,638 Operating Lease Obligations 2,339 358 627 466 888 Total $ 126,103 $ 69,713 $ 24,883 $ 12,706 $ 18,801 Capital Resources At December 31, 2022 and 2021, respectively, the Bank was considered "well capitalized" under the regulatory framework for prompt corrective action. 50 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. 2022 2021 December 31, Amount Ratio Amount Ratio (Dollars in Thousands) Common Equity Tier 1 Capital (to Risk-Weighted Assets) Actual $ 121,188 12.33 % $ 113,086 11.95 % For Capital Adequacy Purposes 44,221 4.50 42,571 4.50 To Be Well Capitalized 63,875 6.50 61,491 6.50 Tier I Capital (to Risk-Weighted Assets) Actual 121,188 12.33 113,086 11.95 For Capital Adequacy Purposes 58,961 6.00 56,761 6.00 To Be Well Capitalized 78,615 8.00 75,682 8.00 Total Capital (to Risk-Weighted Assets) Actual 133,478 13.58 124,668 13.18 For Capital Adequacy Purposes 78,615 8.00 75,682 8.00 To Be Well Capitalized 98,269 10.00 94,602 10.00 Tier I Leverage Capital (to Adjusted Total Assets) Actual 121,188 8.66 113,086 7.76 For Capital Adequacy Purposes 55,969 4.00 58,307 4.00 To Be Well Capitalized 69,962 5.00 72,884 5.00 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.