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Item 7. Management’s Discussion and Analysis

2022-02-22 compared with 2021-03-05 · 262 added, 250 removed, 493 unchanged (51% of the section changed)

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Factors which could have a material, adverse impact on the operations and future prospects of the Corporation include, but are not limited to, the following:

● the effect of the novel coronavirus (COVID-19) and related events

● changes in monetary and fiscal policies of the Federal Reserve Board and the U.S.

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● changes in general economic conditions

● the Corporation’s credit standards and its on-going credit assessment processes might not protect it from significant credit losses

● the effect of the novel coronavirus (COVID-19) and related events

● legislative or regulatory changes

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● technological changes and increased technology-related costs

● information security breach or other technology difficulties or failures

● changes in accounting principles, or the application of generally accepted accounting principles

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CORONAVIRUS (COVID-19) OUTBREAK

The Corporation’s Pandemic Committee has been very active since March 2020, providing frequent communication with employees and clients by telephone, video conference, email and digital tools, while substantially limiting business travel.

Since the pandemic

began, the Committee instituted measures to protect the health of employees and clients, including temporarily operating branch locations on a drive-through only basis and transitioning a significant portion of the Corporation’s employees to remote work.

Currently all branches have limited operations to drive-up and appointment-only services.

No furloughs or layoffs of employees have been made to date.

Emergency restrictions on the activities of businesses and individuals have resulted in significant adverse economic effects and a significant number of layoffs and furloughs of employees nationwide and in the regions in which the Corporation operates.

The ultimate effect of COVID-19 on the local or broader economy is not known nor is the ultimate length of the restrictions described and any accompanying effects.

In 2020, the Corporation increased the allowance for loan losses $785,000 based on an increase in qualitative factors related to potential deterioration in economic conditions.

Because of the significant uncertainties related to the ultimate duration of the COVID-19 pandemic and its economic impact, the total impact on the Corporation’s loan portfolio is not determinable.

Loan Payment Deferral Program

Section 4013 of the Coronavirus Aid, Relief, and Economic Security Act (the “CARES Act”) provides that, from the period beginning March 1, 2020 until the earlier of December 31, 2020 or the date that is 60 days after the date on which the national emergency concerning the COVID-19 pandemic declared by the President of the United States under the National Emergencies Act terminates (the “applicable period”), the Corporation may elect to suspend U.S.

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The suspension is not applicable to any adverse impact on the credit of a borrower that is not related to the pandemic.

On December 27, 2020, the President of the United States signed into law the Consolidated Appropriations Act, 2021 (the “CAA Act”), which both funds the federal government until September 30, 2021 and broadly addresses additional COVID-19 responses and relief.

Among the additional relief measures included are certain extensions to elements of the CARES Act, including extension of temporary relief from troubled debt restructurings established under Section 4013 of the CARES Act to the earlier of a) January 1, 2022, or b) the date that is 60 days after the date on which the national COVID-19 emergency terminates.

On December 27, 2020, the President of the United States signed into law the Consolidated Appropriations Act, 2021 (the “CAA”), which includes provisions that broadly address additional COVID-19 responses and relief.

Among the additional relief measures included are certain extensions to elements of the CARES Act, including extension of temporary relief from TDRs established under Section 4013 of the CARES Act to the earlier of a) January 1, 2022, or b) the date that is 60 days after the date on which the national COVID-19 emergency terminates.

In addition, the banking regulators and other financial regulators, on March 22, 2020 and revised April 7, 2020, issued a joint interagency statement titled the “Interagency Statement on Loan Modifications and Reporting for Financial Institutions Working with Customers Affected by the Coronavirus” that encourages financial institutions to work prudently with borrowers who are or may be unable to meet their contractual payment obligations due to the effects of the COVID-19 pandemic.

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The interagency statement also states that during short-term pandemic-related loan modifications, these loans generally should not be reported as nonaccrual.

To work with clients impacted by COVID-19, the Corporation is offering short-term loan modifications on a case-by-case basis to borrowers who were current in their payments at the inception of the loan modification program.

Prior to merging with the Corporation on July 1, 2020, Covenant Financial Inc.

(“Covenant”) had a similar program in place, and these modified loans have been incorporated into the Corporation’s program.

These efforts have been designed to assist borrowers as they deal with the current crisis and help the Corporation mitigate credit risk.

For loans subject to the program, each borrower is required to resume making regularly scheduled loan payments at the end of the modification period and the deferred amounts will be moved to the end of the loan term.

Consistent with Section 4013 of the CARES Act and guidance from the joint interagency statement described in the preceding paragraphs, the modified loans have not been reported as past due, nonaccrual or as TDRs at December 31, 2020.

Most of the modifications under the program became effective in March or the second quarter 2020 and provided a deferral of interest or principal and interest for 90-to-180 days.

Accordingly, most of the loans for which deferrals were granted returned to full payment status prior to December 31, 2020.

At December 31, 2020, there were 45 loans in deferral status with a total recorded investment of $37,397,000, including 27 commercial loans with a total recorded investment of $35,002,000.

A breakdown of these commercial loans by industry is as follows:

Deferrals Remaining

As of December 31, 2020

(Dollars In Thousands)

Commercial Loans Modified - Summary

Accommodation and food services - hotels

Lessors of residential buildings & dwellings

Lessors of nonresidential buildings (except miniwarehouses)

Accommodation and food services - other

Transportation and warehousing

Real estate rental and leasing - other

Religious organizations

Golf courses and country clubs

Personal care services

To work with clients impacted by COVID-19, the Corporation offered short-term loan modifications on a case-by-case basis to borrowers who were current in their payments at the inception of the loan modification program.

Prior to merging with the Corporation on July 1, 2020, Covenant had a similar program in place, and these modified loans have been incorporated into the Corporation’s program.

These efforts have been designed to assist borrowers as they deal with the crisis and help the Corporation mitigate credit risk.

For loans subject to the program, each borrower was required to resume making regularly scheduled loan payments at the end of the modification period and the deferred amounts have been moved to the end of the loan term.

Consistent with Section 4013 of the CARES Act, the modified loans have not been reported as past due, nonaccrual or as TDRs at December 31, 2021.

Most of the modifications under the program became effective in 2020 and provided a deferral of interest or principal and interest for 90-to-180 days.

At December 31, 2021, there were no loans in deferral status under the program.

In comparison, at December 31, 2020, there were 45 loans in deferral status with a total recorded investment of $37,397,000, including 27 commercial loans with a total recorded investment of $35,002,000.

Paycheck Protection Program

The Corporation began accepting and processing applications for loans under the Paycheck Protection Program (“PPP”) through the Small Business Administration (“SBA”) and Treasury Department on April 3, 2020.

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PPP loans will be forgiven subject to clients providing documentation evidencing their compliant use of funds and otherwise complying with the terms of the program.

The maximum term of PPP loans is five years, though most of the Corporation’s PPP loans have two-year terms, and the Corporation will be repaid sooner to the extent the loans are forgiven.

The maximum term of PPP loans is five years, though the Corporation will be repaid sooner to the extent the loans are forgiven.

The interest rate on PPP loans is 1%, and the Corporation has received fees from the SBA ranging between 1% and 5% per loan, depending on the size of the loan.

Fees on PPP loans, net of origination costs and a market rate adjustment on PPP loans acquired from Covenant, will be recognized in interest income as a yield adjustment over the term of the loans.

As of December 31, 2020, the recorded investment in PPP loans was $132,269,000, including contractual principal balances of $134,802,000, increased by a market rate adjustment on PPP loans acquired from Covenant of $504,000 and reduced by net deferred origination fees of $3,037,000.

Accretion of fees received on PPP loans, net of amortization of the market rate adjustment on PPP loans acquired from Covenant, was $1,945,000 for the year ended December 31, 2020.

Fees on PPP loans, net of origination costs and a market rate adjustment on PPP loans acquired from Covenant, are recognized in interest income as a yield adjustment over the term of the loans.

The recorded investment in PPP loans at December 31, 2021 was $26.9 million, with contractual principal balances totaling $27.8 million, reduced $0.9 million by the impact of net deferred loan origination fees.

The recorded investment in PPP loans at December 31, 2021 decreased $105.4 million from $132.3 million at December 31, 2020, reflecting the impact of loans forgiven and repaid by the SBA.

Interest and fees on PPP loans totaled $6.5 million in 2021 and $2.9 million in 2020.

Capital Strength

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Additional details regarding the Corporation’s and C&N Bank’s regulatory capital position are provided in the “Stockholders’ Equity and Capital Adequacy” section of Management’s Discussion and Analysis of Financial Condition and Results of Operations (“MD&A”).

ACQUISITIONS OF COVENANT FINANCIAL, INC.

AND MONUMENT BANCORP, INC

The Corporation’s acquisition of Covenant was completed July 1, 2020.

Covenant was the parent company of Covenant Bank, a commercial bank which operated a community bank office in Bucks County, Pennsylvania and another in Chester County, Pennsylvania.

Pursuant to the transaction, Covenant merged with and into the Corporation and Covenant Bank merged with and into C&N Bank.

Total purchase consideration was $63.3 million, including common stock with a fair value of $41.6 million and cash of $21.7 million.

Holders of Covenant common stock prior to the consummation of the merger held approximately 12.9% of the Corporation’s common stock outstanding immediately following the merger.

In connection with the acquisition, effective July 1, 2020, the Corporation recorded goodwill of $24.1 million and a core deposit intangible asset of $3.1 million.

Assets acquired included loans valued at $464.2 million, cash and due from banks of $97.8 million, bank-owned life insurance valued at $11.2 million and securities valued at $10.8 million.

Liabilities assumed included deposits valued at $481.8 million, borrowings valued at $64.0 million and subordinated debt valued at $10.1 million.

The assets purchased and liabilities assumed in the acquisition were recorded at their preliminary estimated fair values at the time of closing and may be adjusted for up to one year subsequent to the acquisition.

The acquisition of Covenant follows the acquisition of Monument Bancorp, Inc.

(“Monument”) on April 1, 2019.

Monument was the parent company of Monument Bank, with two community banking offices and a lending office in Bucks County, Pennsylvania.

Monument merged with and into the Corporation and Monument Bank merged with and into C&N Bank.

The total transaction value of the Monument acquisition was $42.7 million.

In 2020, the Corporation incurred pre-tax merger-related expenses related to the Covenant transaction of $7.7 million.

Merger-related expenses include severance and similar expenses as well as expenses related to conversion of Covenant’s core customer system data into the Corporation’s core system and legal and other professional expenses.

Management expects additional merger-related expenses associated with the Covenant acquisition will be insignificant.

Merger-related expenses associated with the Monument transaction totaled $3.8 million for the year ended December 31, 2019.

EARNINGS OVERVIEW

Net income for the year ended December 31, 2021 was $30,554,000, or $1.92 per diluted share as compared to 2020 net income of $19,222,000 or $1.30 per share.

Earnings for the year ended December 31, 2020 were significantly impacted by the Covenant acquisition, including the effects of merger-related expenses described earlier.

Earnings for the year ended December 31, 2020 included a pre-tax loss of $1.6 million on prepayment of long-term borrowings (Federal Home Loan Bank of Pittsburgh advances) with outstanding balances totaling $48.0 million.

Effective July 1, 2020, C&N acquired Covenant Financial, Inc.

(“Covenant”).

C&N incurred pre-tax merger-related expenses related to the Covenant transaction of $7.7 million for the year ended December 31, 2020.

In the fourth quarter 2020, C&N incurred a pre-tax loss of $1.6 million on prepayment of long-term borrowings (Federal Home Loan Bank of Pittsburgh advances) with outstanding balances totaling $48.0 million.

The borrowings included several advances maturing in 2022 through 2024 with a weighted-average interest rate of 1.77% and a weighted-average duration of 2.3 years.

Management estimated the use of excess cash to prepay borrowings would generate an improvement in the net interest margin of approximately 0.11% in 2021 over previous internal projections, and that the loss would be recovered through higher future earnings in approximately two years.

Excluding the impact of merger-related expenses, loss on prepayment of borrowings and net securities gains, adjusted (non-U.S.

GAAP) earnings for 2020 would be $26,514,000 or $1.79 per share as compared to similarly adjusted (non-GAAP) earnings of $22,756,000 or $1.70 per share for 2019.

Excluding the impact of merger-related expenses and loss on prepayment of borrowings, adjusted (non-U.S.

GAAP) earnings for 2020 would be $26,648,000 or $1.80 per share.

The following table provides a reconciliation of the Corporation’s 2021 earnings results under U.S.

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GAAP) to comparative non-U.S.

GAAP results excluding merger-related expenses, loss on prepayment of borrowings and net securities gains.

GAAP results excluding merger-related expenses and loss on prepayment of borrowings.

Management believes disclosure of 2021 and 2020 earnings results, adjusted to exclude the impact of these items, provides useful information to investors for comparative purposes.

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Year Ended December 31, 2020

Results as Presented Under U.S.

Earnings Under U.S.

Merger-Related Expenses (1)

Loss on Prepayment of Borrowings (1)

Net Gains on Available-for-Sale Debt Securities (1)

Adjusted Earnings (Non-U.S.

(1) Income tax has been allocated based on a marginal income tax rate of 21%.

The effect on the income tax provision of merger-related expenses is adjusted for the estimated nondeductible portion of the expenses.

In 2020, interest income on loans acquired from Covenant, partially offset by interest expense on deposits, borrowings and subordinated debt assumed, contributed to growth in net interest income, while costs associated with the expansion contributed to an increase in noninterest expenses.

Results for 2019 were significantly impacted by the Monument acquisition.

The effect on the income tax provision is adjusted for the estimated nondeductible portion of the expenses.

Other significant variances were as follows:

● Net interest income was up $13,077,000 (24.0%) in 2020 over 2019, reflecting the benefits of growth, particularly from the mid-year Covenant acquisition as well as the impact of former Monument activity for the full year as compared to the final nine months of 2019.

In 2020, annual average outstanding loans totaled $1.445 billion, an increase of $387.5 million over 2019, and annual average total deposits of $1.586 billion were up $372.7 million.

The net interest margin was 3.69% for 2020, down from 3.86% in 2019.

● Net interest income was up $10,374,000 (15.4%) in 2021 over 2020, reflecting growth mainly attributable to the Covenant acquisition that closed July 1, 2020.

In 2021, annual average outstanding loans totaled $1.597 billion, an increase of $151.7 million over 2020, annual average interest-bearing cash and due from banks of $156.2 million were up $75.6 million, annual average available-for-sale debt securities of $390.2 million were up $61.7 million, and annual average total deposits of $1.905 billion were up $319.0 million, while annual average borrowed funds were lower by $42.4 million.

The net interest margin was 3.69% for 2021, unchanged from 2020.

The average yield on earning assets in 2021 was down 0.22% from 2020, while the average rate on interest-bearing liabilities was down 0.28% between periods.

Accretion and amortization of purchase accounting adjustments had a net positive impact on net interest income of $3,272,000 for 2020 as compared to a net positive impact of $558,000 in 2019.

● The provision for loan losses of $3,913,000 for 2020 was higher than the 2019 provision by $3,064,000.

The provision included the impact of a charge-off of $2,219,000 on a commercial loan of $3,500,000.

In total, the 2020 provision included a net charge of $2,238,000 related to specific loans (net decrease in specific allowances on loans of $126,000 and net charge-offs of $2,364,000) and a $1,675,000 increase in the collectively determined portion of the allowance for loan losses.

The increase in the collectively determined portion of the allowance includes the impact of an increase in the net charge-off experience factor for commercial loans and an increase in qualitative factors.

In comparison, the 2019 provision of $849,000 included a net reduction in expense of $232,000 related to specific loans (net decrease in specific allowances on loans of $554,000 and net charge-offs of $322,000), a net $1,193,000 charge attributable to loan growth and a net reduction in expense of $112,000 related to changes in historical loss and qualitative factors and the unallocated portion of the allowance.

Accretion and amortization of purchase accounting adjustments had a net positive impact on net interest income of $2,659,000 for 2021 as compared to a net positive impact of $3,272,000 for 2020.

● The provision for loan losses of $3,661,000 for 2021 was lower than the 2020 provision by $252,000.

In 2021, the provision included the impact of partial charge-offs totaling $1,463,000 on a commercial loan.

At December 31, 2021, the recorded investment in this loan was $1,391,000.

In total, the provision for 2021 included a net charge of $1,324,000 related to specific loans (net charge-offs of $1,509,000 offset by a net decrease in specific allowances on loans of $185,000), an increase of $2,251,000 in the collectively determined potion of the allowance and an $86,000 increase in the unallocated allowance.

The increase in the collectively determined portion of the allowance reflected the impact of an increase in volume of commercial loans, excluding PPP loans.

In comparison, the 2020 provision of $3,913,000 included the impact of a charge-off of $2,219,000 on one commercial loan.

● Noninterest income increased $1,513,000, or 6.2% in 2021 over 2020.

Significant variances include the following:

Ø Net gains from sales of loans totaled $5,403,000 in 2020, an increase of $4,479,000 over 2019, reflecting an increase in volume of mortgage loans sold, resulting mainly from the impact of lower interest rates on the housing market and refinancing activity.

Total proceeds from sales of residential mortgage loans amounted to $163.1 million in 2020 as compared to $30.1 million in 2019.

Ø Trust revenue totaled $7,234,000 in 2021, an increase of $913,000 over 2020, reflecting the impact of growth in average trust assets under management including the impact of market value appreciation.

Ø Interchange revenue from debit card transactions totaled $3,855,000, an increase of $761,000 over 2020, reflecting an increase in transaction volumes.

Ø Loan servicing fees, net, totaled $694,000, an increase of $755,000 over the 2020 total of negative $61,000 (a decrease in revenue).

The net increase reflects growth in volume of residential mortgage loans sold with servicing retained.

Further, the fair value of servicing rights decreased $68,000 in 2021 as compared to a reduction in fair value of $576,000 in 2020 mainly due to changes in assumptions related to prepayments of mortgage loans.

Ø Service charges on deposit accounts totaled $4,633,000, an increase of $402,000 over 2020, as consumer and business activity increased.

Ø Brokerage and insurance revenue totaled $1,860,000, an increase of $374,000 over 2020, due to commissions on higher transaction volume.

Ø Other noninterest income totaled $3,580,000, an increase of $225,000 over 2020.

Income from realization of tax credits of $504,000 was $349,000 higher in 2020 as compared to 2019.

In 2020, income from a life insurance arrangement in which benefits were split between C&N and heirs of a former employee was $279,000.

Dividend income from Federal Home Loan Bank stock of $654,000 was up $167,000, reflecting a higher average balance of stock held due to increased borrowings and

credit card interchange income totaled $289,000 in 2020, an increase of $76,000 over 2019.

Fee income from credit enhancement provided on residential mortgage loans sold totaled $227,000 in 2020, an increase of $137,000 over 2019.

Ø Service charges on deposit accounts were down $1,127,000, or 21.0% in 2020 over 2019 as the volume of consumer and business overdraft activity fell.

● Noninterest expense, excluding merger-related expenses and loss on prepayment of borrowings, increased $10,171,000 in 2020 over 2019.

Within this category, significant variances included the following:

● Income from realization of tax credits of $772,000 was $268,000 higher in 2021 as compared to 2020 due to higher PA Educational Improvement Tax Credit Program donations.

● Credit card interchange income of $434,000 increased $144,000 due to higher transaction volume.

● Fee income for providing credit enhancement on mortgage loans sold of $348,000 increased $122,000.

● Other noninterest income decreased $272,000 as the Corporation recognized income of $279,000 in the third quarter 2020 from a life insurance arrangement in which benefits were split between the Corporation and heirs of a former employee.

● Dividend income from Federal Home Loan Bank stock of $514,000 decreased $140,000.

Ø Net gains from sales of loans totaled $3,428,000, a decrease of $1,975,000 from 2020, reflecting a decrease in volume of mortgage loans sold, resulting mainly from lower refinancing activity and overall market conditions.

● Noninterest expense increased $6,863,000, or 12.3% in 2021 over 2020, excluding merger-related expenses and loss on prepayment of borrowings.

Significant variances included the following:

Ø Salaries and wages and benefits expense increased $6,581,000, reflecting:

inclusion of Covenant for six months in 2020 and the former Monument operations for all of 2020 as compared to nine months in 2019;

an increase in incentive compensation mainly attributable to increases in earnings performance as compared to peers and an increase in residential mortgage origination volume;

annual merit-based salary adjustments;

an increase in overtime pay related mainly to mortgage lending activity;

a reduction in expense due to a higher proportion of payroll costs capitalized (added to the carrying value of loans) due to the high volume of PPP loans originated;

and an increase in health care expense due to higher claims on the Corporation’s partially self-insured plan.

Ø Data processing expenses increased $1,050,000, including the impact of increases in software licensing and maintenance costs associated with core banking, lending, trust and other functions as well as professional fees associated with analysis of the Corporation’s online delivery channel.

Ø Other noninterest expense increased $761,000.

Ø Salaries and employee benefits expense totaled $37,603,000, an increase of $4,541,000 over 2020, reflecting the inclusion of the former Covenant operations for twelve months in 2021 as compared to six months in 2020, as well as increases in lending, human resources, information technology and other personnel needed to accommodate growth, and increases in health care expense due to higher claims on the Corporation’s partially self-insured plan.

Ø Data processing and telecommunications expenses totaled $5,903,000, an increase of $587,000 over 2020, including the impact of growth related to the Covenant acquisition, increased costs from outsourced support services and other increases in software licensing and maintenance costs.

Ø Professional fees expense totaled $2,243,000, an increase of $551,000 over 2020, mainly due to increases in recruiting services and PPP loan processing professional fees.

Ø Net occupancy and equipment expense totaled $4,984,000, an increase of $523,000, primarily reflecting an increase due to the Covenant acquisition.

Ø Pennsylvania shares tax expense totaled $1,951,000, an increase of $262,000, reflecting the increase in in C&N Bank’s stockholder’s equity.

Ø Automated teller machine and interchange expense totaled $1,433,000, an increase of $202,000, reflecting increased volume of activity.

Ø Other noninterest expense totaled $8,355,000, an increase of $197,000 over 2020.

Within this category, significant variances included the following:

● Other operational losses increased $554,000, including estimated accruals of $340,000 for penalties related to certain information returns and an estimated accrual of $200,000 related to a state tax reporting matter.

● Donations expense increased $460,000, mainly due to an increase in donations associated with the Pennsylvania Educational Improvement Tax Credit program.

● Amortization of core deposit intangibles increased $318,000, mainly resulting from the Covenant acquisition.

● Expenses related to other real estate properties decreased $340,000.

The reduction resulted from the completion in the first quarter 2020 of a complex commercial workout situation for which a significant amount of expenses were incurred in 2019.

● Consulting expenses related to the overdraft privilege program decreased $201,000 consistent with the decrease in overdraft fees collected.

Ø Professional fee expense increased $623,000, including costs associated with a change in certain trust administrative activities to handle them on an outsourced basis.

Ø Occupancy expense increased $381,000, primarily reflecting an increase due to the Covenant acquisition.

Ø Pennsylvania shares tax expense increased $309,000 reflecting the impact of an increase in C&N Bank’s stockholder’s equity.

● FDIC insurance expense of $581,000 increased $258,000.

● Business development expenses of $452,000 increased $220,000, due primarily to an increase in public relations expense.

● Donations expense of $847,000 increased $208,000, mainly due to an increase in donations associated with the Pennsylvania Educational Improvement Tax Credit program.

● Other increases include legal fees and expenses of $83,000, bank insurance of $56,000, accounting and auditing expense of $51,000, and credit card reward redemption expense of $50,000.

● Other operational losses of $199,000 decreased $405,000, including a reduction in charges principally related to Trust Department tax compliance and preparation matters.

● Gains on other real estate properties totaled $100,000 in 2021 as compared to net losses of $146,000 in 2020.

● The allowance for SBA claim adjustments decreased, reflecting more favorable claim results than previously estimated, resulting in a reduction in expense of $236,000 in 2021 as compared to a reduction in expense of $70,000 in 2020.

● The income tax provision was $7,133,000 for the year ended December 31, 2021, up from $3,990,000 for the year ended December 31, 2020.

Pre-tax income was $197,000 lower for the year ended December 31, 2020 as compared to the year ended December 31, 2019.

The effective tax rate was 17.2% for the year ended December 31, 2020, slightly higher than the 16.7% effective tax rate for the year ended December 31, 2019.

Pre-tax income was $14,475,000 higher in 2021 as compared to 2020.

The effective tax rate was 18.9% for 2021, higher than the 17.2% effective tax rate for 2020.

The tax benefit of tax-exempt interest income was 2.4% of pre-tax income in 2021 as compared to a 3.5% benefit in 2020.

More detailed information concerning the Corporation’s earnings results are provided in other sections of Management’s Discussion and Analysis.

ACQUISITION OF COVENANT FINANCIAL, INC.

The Corporation’s acquisition of Covenant was completed July 1, 2020.

Covenant was the parent company of Covenant Bank, which operated banking offices in Bucks and Chester Counties of Pennsylvania.

Pursuant to the transaction, Covenant merged with and into the Corporation and Covenant Bank merged with and into C&N Bank.

Total purchase consideration was $63.3 million, including common stock with a fair value of $41.6 million and cash of $21.7 million.

The acquisition of Covenant followed the acquisition of Monument Bancorp, Inc.

(“Monument”) on April 1, 2019.

Monument was the parent company of Monument Bank, with banking and lending offices in Bucks County, Pennsylvania.

The total transaction value of the Monument acquisition was $42.7 million.

In connection with the Covenant acquisition, effective July 1, 2020, the Corporation recorded goodwill of $24.1 million and a core deposit intangible asset of $3.1 million.

Assets acquired included loans valued at $464.2 million, cash and due from banks of $97.8 million, bank-owned life insurance valued at $11.2 million and securities valued at $10.8 million.

Liabilities assumed included deposits valued at $481.8 million, borrowings valued at $64.0 million and subordinated debt valued at $10.1 million.

The assets purchased and liabilities assumed in the acquisition were recorded at their preliminary estimated fair values at the time of closing subject to adjustment for up to one year subsequent to the acquisition.

There were no adjustments to the fair values of assets acquired and liabilities assumed in the Covenant acquisition in the year ended December 31, 2021.

CRITICAL ACCOUNTING POLICIES

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Such agencies may require the Corporation to recognize adjustments to the allowance based on their judgments of information available to them at the time of their examination.

Business Combinations – We account for business combinations under the purchase method of accounting.

The application of this method of accounting requires the use of significant estimates and assumptions in the determination of the fair value of assets acquired and liabilities assumed in order to properly allocate purchase price consideration between assets that are amortized, accreted or depreciated from those that are recorded as goodwill.

Our estimates of the fair values of assets acquired and liabilities assumed are based upon assumptions that we believe to be reasonable.

Goodwill – Goodwill is tested at least annually at December 31 for impairment, or more often if events or circumstances indicate there may be impairment.

In 2020, the COVID-19 pandemic led to government-imposed emergency restrictions that have had significant adverse effects on macroeconomic conditions.

The ultimate effect of COVID-19 on the local or broader economy is not known nor is the ultimate length of the restrictions described and any accompanying effects.

In testing goodwill for impairment at December 31, 2020, the Corporation by-passed performing a qualitative assessment and performed a quantitative assessment based on comparison of the Corporation’s market capitalization to its stockholders’ equity, resulting in the determination that the fair value of its reporting unit, its community banking operation, exceeded its carrying amount.

Accordingly, there was no goodwill impairment at December 31, 2020.

Fair Value of Debt Securities – Another material estimate is the calculation of fair values of the Corporation’s debt securities.

Fair Value of Available-For-Sale Debt Securities – Another material estimate is the calculation of fair values of the Corporation’s debt securities.

For most of the Corporation’s debt securities, the Corporation receives estimated fair values of debt securities from an independent valuation service, or from brokers.

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interest expense was lower by $3,033,000 in comparing the same periods.

As presented in Table II, the Net Interest Margin was 3.69% in 2020 as compared to 3.86% in 2019, and the “Interest Rate Spread” (excess of average rate of return on earning assets over average cost of funds on interest-bearing liabilities) decreased to 3.49% in 2020 from 3.56% in 2019.

Income from purchase accounting-related adjustments in 2020 had a positive effect on net interest income of $3,272,000, including an increase in income on loans of $1,888,000 and reductions in interest expense on time deposits of $928,000 and on borrowed funds of $456,000.

The positive impact to the net interest margin from purchase accounting adjustments was 0.18% in 2020 and 0.04% in 2019.

As presented in Table II, the Net Interest Margin was 3.69% in 2021, unchanged from 2020, and the “Interest Rate Spread” (excess of average rate of return on earning assets over average cost of funds on interest-bearing liabilities) increased to 3.55% in 2021 from 3.49% in 2020.

The overall increase in net interest income resulted mainly from the acquisition of Covenant in the third quarter 2020 and income from the PPP loan program.

Accretion and amortization of purchase accounting adjustments related to the Covenant and Monument acquisitions had a positive effect on net interest income in 2021 of $2,659,000, including an increase in income on loans of $1,289,000 and net reductions in interest expense on time deposits and borrowed funds totaling $1,370,000.

In comparison, the net positive impact on net interest income of purchase accounting adjustments was $3,272,000 in 2020.

The net positive impact to the net interest margin from purchase accounting adjustments was 0.13% in 2021 and 0.18% in 2020.

INTEREST INCOME AND EARNING ASSETS

1 unchanged sentence

Interest and fees on loans receivable increased $7,175,000, or 10.3%, to $76,781,000 in 2021 from $69,606,000 in 2020.

Table III shows the increase in interest on loans includes $17,713,000 attributable to an increase in volume and a decrease of $3,832,000 related to a decrease in average yield.

Interest and fees on PPP loans totaled $6,530,000 in 2021, an increase of $3,606,000 over the total in 2020.

Table III shows the increase in interest on loans including $8,016,000 attributable to an increase in volume and a decrease of $841,000 related to a decrease in average yield.

The average balance of loans receivable increased $151,658,000 (10.5%) to $1,596,756,000 in 2021 from $1,445,098,000 in 2020.

The increase in average balance reflects the Corporation’s purchase of Covenant on July 1, 2020.

The average balance of loans outstanding in 2020 attributable to the former Covenant operations totaled $234,062,000, including PPP loans of $32,279,000.

Excluding Covenant, average loans outstanding increased $153,477,000, including PPP loans of $66,187,000.

The increase in average loans outstanding includes the effect of loans acquired from Monument, effective April 1, 2019, as well as subsequent loan growth over the last three quarters of 2019.

The average yield on loans in 2020 was 4.82% compared to 5.27% in 2019.

Interest income on available-for-sale debt securities totaled $8,203,000 in 2020, a reduction of $1,328,000 from the total for 2019.

As indicated in Table II, average available-for-sale debt securities (at amortized cost) totaled $328,445,000 in 2020, a decrease of $28,839,000 (8.1%) from 2019.

The average yield on available-for-sale debt securities decreased to 2.50% in 2020 from 2.67% in 2019.

Interest income from interest-bearing deposits in banks totaled $251,000 in 2020, a decrease of $263,000 from the total for 2019.

The increase in average loans outstanding includes the effect of loans acquired from Covenant, effective July 1, 2020.

The fully taxable equivalent yield on loans in 2021 was 4.81% compared to 4.82% in 2020.

In 2021, rates on variable rate loans and rates on most new loan originations decreased, and prepayments of loans increased, consistent with falling market interest rates throughout most of 2020 and 2021.

Further, yields on loans acquired from Covenant on July 1, 2020 were recorded at then-current market yields, which were lower than the Corporation’s average portfolio yield before the acquisition.

The overall yield on loans in 2021 included a benefit from the acceleration of fees recognized on PPP loans as repayments have been received from the SBA.

As shown in Table II, in 2021, the average balance of 1st Draw PPP loans was $44,735,000 with an average yield of 7.77% and the average balance of 2nd Draw PPP loans was $52,917,000 with an average yield of 5.77%.

Interest income on available-for-sale debt securities totaled $8,471,000 in 2021, an increase of $268,000 from the total for 2020.

As indicated in Table II, average available-for-sale debt securities (at amortized cost) totaled $390,163,000 in 2021, an increase of $61,718,000 (18.8%) from 2020.

The average yield on available-for-sale debt securities decreased to 2.17% in 2021 from 2.50% in 2020, reflecting acceleration of calls and prepayments of amortizing securities and purchases of lower-yielding securities at recent, lower market rates.

Interest income from interest-bearing deposits in banks totaled $318,000 in 2021, an increase of $67,000 from the total for 2020.

The most significant categories of assets within this category include interest-bearing balances held with the Federal Reserve and investments in certificates of deposit issued by other banks.

The average balance increased $58,876,000, partly due to cash received in the Covenant transaction that was not fully deployed.

The average yield on interest-bearing deposits with banks fell to 0.31% in 2020 from 2.37% in 2019, which is a result of the decreases to the rates paid on balances held at the Federal Reserve.

The average balance increased $75,565,000, as increases in deposits and funds from loan repayments outpaced uses of funds for loan originations, purchases of securities and repayments of borrowings.

The average balance of interest-bearing due from banks was 7.3% of average earning assets in 2021 as compared to 4.3% in 2020.

The average yield on interest-bearing due from banks fell to 0.20% in 2021 from 0.31% in 2020, due to a decrease in market rates.

INTEREST EXPENSE AND INTEREST-BEARING LIABILITIES

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Total average deposit balances (interest-bearing and noninterest-bearing) increased $318,991,000 to $1,905,400,000 in 2021 from $1,586,409,000 in 2020.

The average balance of deposits from the former Covenant operations totaled $225,541,000.

Excluding Covenant average deposits for 2020, deposits increased $147,181,000 over the comparative amount for 2019, reflecting the inclusion of deposits assumed from Monument for all of 2020 as compared to nine months in 2019 as well as increases in deposits related to PPP and other government stimulus programs.

Interest expense on deposits decreased $959,000 in 2020 over 2019.

The average rate on interest-bearing deposits decreased to 0.60% in 2020 from 0.89% in 2019, consistent with the reduction in market rates in 2020.

Interest expense on borrowed funds increased $271,000 in 2020 as compared to 2019.

Total average borrowed funds increased $46,553,000 to $129,265,000 in 2020 from $82,712,000 in 2019.

The increase in average borrowed funds includes the impact of borrowings originated to fund loan growth in the last three quarters of 2019 and borrowings assumed from Covenant.

The average rate on total borrowed funds was 1.83% in 2020 compared to 2.53% in 2019.

The decrease in the average rate on borrowed funds in 2020 reflects the impact of a reduction in market rates.

The increase in average deposits includes the impact of the Covenant acquisition.

The average rate on interest-bearing deposits decreased to 0.33% in 2021 from 0.60% in 2020.

The decrease in average rate on deposits includes decreases of 0.54% on time deposits, 0.12% on money market accounts, 0.09% on interest checking accounts and 0.02% on saving accounts.

The average balance of time deposits fell to 17.2% of average total deposits in 2021 from 25.1% in 2020, further contributing to the reduction in average rate on deposits.

Interest expense on short-term borrowings decreased $344,000 to $23,000 in 2021 from $367,000 in 2020.

The average balance of short-term borrowings decreased to $6,269,000 in 2021 from $34,212,000 in 2020.

The average rate on short-term borrowings decreased to 0.37% in 2021 from 1.07% in 2020.

Interest expense on long-term borrowings (FHLB advances) decreased $892,000 to $399,000 in 2021 from $1,291,000 in 2020.

The average balance of long-term borrowings was $44,026,000 in 2021, down from an average balance of $83,500,000 in 2020.

Borrowings are classified as long-term within the Tables based on their term at origination or assumption in business combinations.

The average rate on long-term borrowings was 0.91% in 2021 compared to 1.55% in 2020.

The reduction in both average balance and rate reflects the prepayment of higher cost borrowings of $48,036,000 in December 2020.

Interest expense on the senior notes issued in May 2021 totaled $293,000 in 2021.

The average balance of the senior notes was $9,129,000 in 2021 with an average rate of 3.21%.

Interest expense on subordinated debt increased $603,000 to $1,309,000 in 2021 from $706,000 in 2020.

The average balance of subordinated debt increased to $27,399,000 in 2021 from $11,553,000 in 2020 reflecting the net impact of subordinated debt agreements assumed in the Covenant transaction of $10,091,000 in July 2020, the new issue of subordinated debt of $24,437,000, net, in May 2021 and the redemption of subordinated notes totaling $8,000,000 in June 2021.

The average rate on subordinated debt decreased to 4.78% in 2021 from 6.11% in 2020.

TABLE I - ANALYSIS OF INTEREST INCOME AND EXPENSE

5 unchanged sentences

Loans receivable:

Paycheck Protection Program (Taxable)

Paycheck Protection Program - 1st Draw

Paycheck Protection Program - 2nd Draw

Total loans receivable

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Borrowed funds:

Subordinated debt

Long-term - FHLB advances

Senior notes, net

Subordinated debt, net

Total borrowed funds

7 unchanged sentences

Interest-bearing due from banks

Available-for-sale securities,

at amortized cost:

Available-for-sale debt securities, at amortized cost:

Total available-for-sale debt securities

Loans receivable:

Paycheck Protection Program (Taxable)

Paycheck Protection Program - 1st Draw

Paycheck Protection Program - 2nd Draw

Total loans receivable

1 unchanged sentence

Total Earning Assets

Unrealized gain/loss on securities

Unrealized gain on securities

Allowance for loan losses

8 unchanged sentences

Borrowed funds:

Subordinated debt

Long-term - FHLB advances

Senior notes, net

Subordinated debt, net

Total borrowed funds

3 unchanged sentences

Total Liabilities

Stockholders' equity, excluding accumulated

other comprehensive income/loss

Accumulated other comprehensive income/loss

Stockholders' equity, excluding other comprehensive income

Accumulated other comprehensive income

Total Stockholders' Equity

2 unchanged sentences

Net Interest Income/Earning Assets

Total Deposits (Interest-bearing

Total Deposits (Interest-bearing and Demand)

(1) Rates of return on tax-exempt securities and loans are presented on a fully taxable-equivalent basis, using the Corporation’s marginal federal income tax rate of 21%.

8 unchanged sentences

Loans receivable:

Paycheck Protection Program (Taxable)

Paycheck Protection Program - 1st Draw

Paycheck Protection Program - 2nd Draw

Total loans receivable

7 unchanged sentences

Borrowed funds:

Subordinated debt

Long-term - FHLB advances

Senior notes, net

Subordinated debt, net

Total borrowed funds

6 unchanged sentences

(Dollars in Thousands)

Trust and financial management revenue

Brokerage revenue

Insurance commissions, fees and premiums

Trust revenue

Brokerage and insurance revenue

Service charges on deposit accounts

Service charges and fees

Interchange revenue from debit card transactions

11 unchanged sentences

(Dollars in Thousands)

Salaries and wages

Pensions and other employee benefits

Occupancy expense, net

Furniture and equipment expense

Data processing expenses

Salaries and employee benefits

Net occupancy and equipment expense

Data processing and telecommunications expense

Automated teller machine and interchange expense

1 unchanged sentence

Professional fees

Telecommunications

Directors' fees

Other noninterest expense

3 unchanged sentences

Total noninterest expense

Total noninterest expenses increased $15,416,000 (31.1%) in 2020 as compared to 2019.

Total noninterest expenses excluding merger-related expenses and loss on prepayment of borrowings increased $10,171,000 (22.4%) in 2020 as compared to 2019.

Merger-related expenses are discussed in the Acquisitions of Covenant Financial Inc.

and Monument Bancorp, Inc.

section of Management’s Discussion

and Analysis.

Loss on prepayment of borrowings and other changes of significance are discussed in the Earnings Overview section of Management’s Discussion and Analysis.

Total noninterest expenses decreased $2,481,000 (3.8%) in 2021 as compared to 2020.

Total noninterest expenses increased $6,863,000 (12.3%) in 2021 excluding Covenant merger-related expenses and loss on prepayment of borrowings in 2020.

Changes of significance are discussed in the Earnings Overview section of Management’s Discussion and Analysis.

The effective income tax rate was 18.9% of pre-tax income in 2021, up from 17.2% in 2020.

The Corporation’s effective tax rates differed from the statutory rate of 21% mainly because of the effects of tax-exempt interest income.

The higher effective income tax rate in 2020 as compared to 2019 resulted mainly from a reduction in tax-exempt interest income and an increase in nondeductible penalties.

The Corporation’s effective tax rates differed from the federal statutory rate of 21% mainly because of the effects of tax-exempt interest income.

The higher effective income tax rate in 2021 as compared to 2020 resulted mainly from a reduction in the proportion of tax-exempt interest income to total pre-tax income.

The Corporation recognizes deferred tax assets and liabilities based on differences between the financial statement carrying amounts and the tax basis of assets and liabilities.

At December 31, 2021, the net deferred tax asset was $5,887,000, up from the balance at December 31, 2020 of $2,705,000.

The most significant changes in temporary difference components included a net increase of $2,170,000 in the deferred tax liability resulting from appreciation in available-for-sale debt securities attributable to lower interest rates as well as Covenant acquisition-related adjustments to loans, a net operating loss carryforward, core deposit intangibles, bank premises and equipment and operating leases.

The most significant changes in temporary difference components included a net decrease of $1,826,000 in the deferred tax liability resulting from a reduction in the unrealized gain on available-for-sale debt securities attributable to higher interest rates, as well as fluctuations related to bank premises and equipment, the allowance for loan losses, and acquisition-related adjustments to loans.

The Corporation regularly reviews deferred tax assets for recoverability based on history of earnings, expectations for future earnings and expected timing of reversals of temporary differences.

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Table VI shows the composition of the available-for-sale debt securities portfolio at December 31, 2021 and 2020.

The amortized cost of available-for-sale debt securities was $334,552,000 at December 31, 2020 and $342,278,000 at December 31, 2019.

Within the securities portfolio, mortgage-backed securities issued or guaranteed by U.S.

Government agencies or sponsored agencies decreased to 40.5% of the amortized cost basis of the portfolio at December 31, 2020 from 64.8% at December 31, 2019.

Investments in tax-exempt and taxable municipal bonds increased to 48.3% of the portfolio at December 31, 2020 from 30.5% at December 31, 2019.

These changes in portfolio mix were based on changes in liquidity and interest rate risk management needs and current market yields for various categories of securities.

The amortized cost of available-for-sale debt securities increased to $511,592,000 at December 31, 2021 from $334,552,000 at December 31, 2020.

The increase in the securities portfolio resulted from management’s decision to invest excess funds available from the fast growth in deposits and loan repayments throughout most of 2020 and 2021.

At December 31, 2021, the largest categories of securities held as a percentage of total amortized cost, were as follows:

(1) tax-exempt and taxable municipal bonds, 42.1%;

(2) residential mortgage-backed securities issued or guaranteed by U.S.

Government agencies or sponsored agencies, including pass-through securities and collateralized mortgage obligations, 27.8%;

and (3) commercial mortgage-backed securities issued or guaranteed by U.S.

Government sponsored agencies, 17.0%.

As reflected in Table VI, the fair value of available-for-sale securities as of December 31, 2021 was $6,087,000, or 1.2% greater than the total amortized cost basis.

In comparison, the aggregate unrealized gain position at December 31, 2020 was $14,780,000, or 4.4% of the total amortized cost basis.

The unrealized appreciation in the portfolio in 2020 resulted mainly from a decrease in interest rates.

The unrealized decrease in fair value of the portfolio in 2021 resulted from an increase in interest rates.

Management has reviewed the Corporation’s holdings as of December 31, 2021 and concluded that unrealized losses on all of the securities in an unrealized loss position are considered temporary.

6 unchanged sentences

Government agencies

Bank holding company debt securities

Obligations of states and political subdivisions:

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Government agencies

Bank holding company debt securities

Obligations of states and political subdivisions:

15 unchanged sentences

Table VII shows the composition of the loan portfolio as of the end of the years 2017 through 2021.

From December 31, 2016 through December 31, 2018, total loans outstanding increased $75.7 million (10.1%) and the overall mix by segment remained fairly constant, with residential mortgage loans of approximately 55% to 56% of the portfolio at each year-end, and commercial loans of 42% to 43% of the portfolio.

At December 31, 2019, gross loans outstanding totaled $1,182,222,000, an increase of $354.7 million (42.9%) from December 31, 2018.

At December 31, 2020, gross loans outstanding totaled $1,644,209,000, an increase of $462.0 million (39.1%) from December 31, 2019.

A significant portion of the Corporation’s loan growth in 2019 was attributable to the Monument acquisition, while, similarly, growth in 2020 is attributable to the Covenant acquisition as well as due to new loans originated in the southeastern and southcentral Pennsylvania markets.

At December 31, 2020, commercial loans represented approximately 61% of the portfolio while residential mortgage loans totaled 38% of the portfolio.

At December 31, 2021, gross loans outstanding totaled $1,564,849,000, a decrease of $79.4 million (4.8%) from December 31, 2020 as the outstanding balance of PPP loans decreased $105.4 million.

The total recorded investment in loans at December 31, 2021 was $749.1 million (92%) higher than the total at December 31, 2017, with most of the growth attributable to the Monument acquisition in 2019, Covenant acquisition in 2020 and expansion in Southcentral Pennsylvania, mainly in 2020 and 2021.

Over the period 2017-2021, the Corporation has increased the proportion of residential mortgage loans sold into the secondary market.

Consistent with these trends, commercial segment loans increased to 63% of the recorded investment in the portfolio at December 31, 2021 from 43% at December 31, 2017, while residential mortgage segment loans decreased to 36% at December 31, 2021 from 55% at December 31, 2017.

While the Corporation’s lending activities are primarily concentrated in its market areas, a portion of the Corporation’s commercial loan segment consists of participation loans.

2 unchanged sentences

Participation loans are included in the “Commercial and industrial,” “Commercial loans secured by real estate”, “Political subdivisions” and “Other commercial” classes in the loan tables presented in this Form 10-K.

Total participation loans outstanding amounted to $65,741,000 at December 31, 2020, up slightly from $64,633,000 at December 31, 2019.

Total participation loans outstanding amounted to $54,372,000 at December 31, 2021, down from $65,741,000 at December 31, 2020.

At December 31, 2021, the balance of participation loans outstanding includes a total of $30,196,000 to businesses located outside of the Corporation’s market areas.

3 unchanged sentences

Fixed-rate loans are shown in Table VIII based on their contractually scheduled principal repayments, and variable-rate loans are shown based on the date of the next change in rate.

Table VIII shows that fixed-rate loans are approximately 43% of the loan portfolio and approximately 34% of the portfolio are variable-rate loans that re-price after more than one year.

Variable-rate loans re-pricing after more than one year include residential and commercial real estate secured loans.

The Corporation’s substantial investment in long-term, fixed-rate loans and variable-rate loans with extended periods until re-pricing is one of the concerns management attempts to address through interest rate risk management practices.

Table VIII presents a well-balanced maturity and repricing mix.

Total fixed rate loans maturing within one year and variable or adjustable loans repricing within one year amount to $439,016,000 or 28% of the portfolio.

Table VIII shows that fixed-rate loans total approximately 44% of the loan portfolio and approximately 33% of the portfolio are variable-rate loans that re-price after more than one year.

Since 2009, the Corporation has originated and sold residential mortgage loans to the secondary market through the MPF Xtra program administered by the Federal Home Loan Banks of Pittsburgh and Chicago.

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The Corporation does not retain servicing rights for loans sold under the MPF Direct Program.

In 2020, the Corporation’s activity under the MPF Direct Program was minimal.

Through December 31, 2021, the Corporation’s activity under the MPF Direct Program has been minimal.

For loan sales originated under the MPF programs, the Corporation provides customary representations and warranties to investors that specify, among other things, that the loans have been underwritten to the standards established by the investor.

The Corporation may be required to repurchase a loan and reimburse a portion of fees received or reimburse the investor for a credit loss incurred on a loan, if it

is determined that the representations and warranties have not been met.

The Corporation may be required to repurchase a loan and reimburse a portion of fees received or reimburse the investor for a credit loss incurred on a loan, if it is determined that the representations and warranties have not been met.

Such repurchases or reimbursements generally result from an underwriting or documentation deficiency.

At December 31, 2020, the total outstanding balance of loans the Corporation has repurchased as a result of identified instances of noncompliance amounted to $1,714,000, and the corresponding total outstanding balance of repurchased loans at December 31, 2019 was $1,770,000.

At December 31, 2021, the total outstanding balance of loans the Corporation has

repurchased as a result of identified instances of noncompliance amounted to $1,571,000, and the corresponding total outstanding balance of repurchased loans at December 31, 2020 was $1,714,000.

At December 31, 2021, outstanding balances of loans sold and serviced through the MPF Xtra and Original programs totaled $334,741,000, including loans sold through the MPF Xtra program of $165,668,000 and loans sold through the Original program of $169,073,000.

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Income related to providing the credit enhancement (included in other noninterest income in the consolidated statements of income) totaled $348,000 in 2021 and $227,000 in 2020.

A provision for losses related to the credit enhancement obligation (included in other noninterest expense in the consolidated statements of income) of $167,000 was recorded in 2020 with no corresponding charge in 2019.

A provision for losses related to the credit enhancement obligation (included in other noninterest expense in the consolidated statements of income) of $135,000 was recorded in 2021 compared to $167,000 in 2020.

The Corporation does not provide a credit enhancement for loans sold through the Xtra program.

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Determination of the allowance was subjective in nature and was based on the Corporation’s assessment of the credit quality of the loans and the quality of the documentation supporting compliance with SBA requirements.

The Corporation’s total exposure related to SBA guarantees on loans originated by Covenant was $17,041,000 at December 31, 2020.

In the fourth quarter 2020, the Corporation recorded a reduction in other noninterest expense of $70,000 resulting from better collection experience on certain claims than had been estimated in determining the allowance at July 1, 2020.

At December 31, 2020, the allowance for SBA claim adjustments (included in accrued interest and other liabilities in the consolidated balance sheets) had a balance of $730,000.

The Corporation’s total exposure related to SBA guarantees on loans originated by Covenant was $12,856,000 at December 31, 2021 and $17,041,000 at December 31, 2020 with an allowance for SBA claim adjustments (included in accrued interest and other liabilities in the consolidated balance sheets) of $457,000 at December 31, 2021 and $730,000 at December 31, 2020.

In the year ended December 31, 2021, the Corporation recorded charges against the allowance for SBA claims totaling $37,000 and a reduction in other noninterest expense of $236,000 representing amounts realized on SBA claims in excess of prior estimates.

In comparison, in 2020, there were no charges against the allowance for SBA claims and the Corporation recognized a reduction in other noninterest expense of $70,000.

TABLE VII – Five-year Summary of Loans by Type

(Dollars In Thousands)

Residential mortgage:

Residential mortgage loans - first liens

Residential mortgage loans - junior liens

Home equity lines of credit

1-4 Family residential construction

Total residential mortgage

Commercial loans secured by real estate

Commercial and industrial

Small business administration - paycheck protection program

Paycheck Protection Program - 1st Draw

Paycheck Protection Program - 2nd Draw

Political subdivisions

5 unchanged sentences

Total commercial

Residential mortgage:

Residential mortgage loans - first liens

Residential mortgage loans - junior liens

Home equity lines of credit

1-4 Family residential construction

Total residential mortgage

allowance for loan losses

4 unchanged sentences

(In Thousands)

Commercial loans secured by real estate

Commercial and industrial

Paycheck Protection Program - 1st Draw

Paycheck Protection Program - 2nd Draw

Political subdivisions

Commercial construction and land

Loans secured by farmland

Multi-family (5 or more) residential

Agricultural loans

Other commercial loans

Total commercial

Residential mortgage:

Residential mortgage loans - first liens

Residential mortgage loans - junior liens

Home equity lines of credit

1-4 Family residential construction

Total residential mortgage

PROVISION AND ALLOWANCE FOR LOAN LOSSES

5 unchanged sentences

The allowance for loan losses was $13,537,000 at December 31, 2021, up from $11,385,000 at December 31, 2020.

Table X shows that the collectively determined portion of the allowance increased $1,675,000 across all loan classes, including an increase in the collectively determined portion of the allowance related to commercial loans of $1,632,000.

This increase was primarily due to increases in qualitative factors related to economic conditions in 2020 and an increase in the historical loss factor on commercial loans.

Table X shows that the collectively determined portion of the allowance increased by a net $2,251,000 across all loan classes, including an increase in the collectively determined portion of the allowance related to commercial loans of $2,008,000.

This increase was primarily due to an increase in loan volume, excluding PPP loans.

Table X shows total specific allowances on impaired loans decreased $185,000 to $740,000 at December 31, 2021 from $925,000 at December 31, 2020.

This net decrease included the impact of the elimination of a specific allowance of $678,000 at December 31, 2019 on a commercial loan that was repaid for less than the full principal balance resulting in a charge-off of $107,000 in the second quarter of 2020 as well as the elimination of $125,000 in specific allowances on loans no longer considered impaired at December 31, 2020.

This reduction in specific allowances on impaired loans was partially offset by allowances totaling $701,000 at December 31, 2020 related to three commercial loan relationships with an aggregate recorded investment of $7,312,000 that management identified as impaired in the second quarter 2020 and that were still considered impaired at December 31, 2020.

At December 31, 2021, there were 3 commercial loans with specific allowances.

The total recorded investment in these loans at December 31, 2021 was $6,540,000, including 2 loans secured by hotel properties with total recorded investments of $6,468,000.

Loans acquired from Covenant that were identified as having a deterioration in credit quality (purchased credit impaired, or PCI), were valued at $6,648,000 at July 1, 2020 and $6,259,000 at December 31, 2021.

The remainder of the portfolio was deemed to be the performing component of the portfolio.

The calculation of the fair value of performing loans included a discount for credit losses of $7,219,000 reduced by accretion of $1,857,000 in the third and fourth quarters of 2020 to $5,362,000 at December 31, 2020.

The discount recorded in the acquisition represented an estimate of the present value of credit losses based on market expectations at the date of acquisition.

Performing loans acquired from Covenant are presented net of a discount for credit losses of $3,059,000 at December 31, 2021 and $5,362,000 at December 31, 2020.

This discount reflects an estimate of the present value of credit losses based on market expectations at the date of acquisition of $7,219,000, subsequently reduced as accretion has been recognized based on estimated and actual principal pay-downs.

Loans acquired from Monument that were identified as having a deterioration in credit quality (PCI) were valued at $441,000 at April 1, 2019 and $299,000 at December 31, 2021.

2 unchanged sentences

This discount reflects an estimate of the present value of credit losses based on market expectations at the date of acquisition of $1,914,000, subsequently reduced as accretion has been recognized based on estimated and actual principal pay-downs.

Table XI shows the allowance for loan losses totaled 0.69% of gross loans outstanding at December 31, 2020, down from 0.83% at December 31, 2019 and down from levels in excess of 1.00% from 2016 to 2018.

Table XI also shows that the total of the allowance and the credit adjustment on purchased non-impaired loans, as a percentage of total loans plus the credit adjustment, was 1.05% at December 31, 2020, in line with ratios from the previous years.

Table XI shows the allowance for loan losses totaled 0.87% of gross loans outstanding at December 31, 2021, up from 0.69% at December 31, 2020 and 0.83% at December 31, 2019, and down from levels in excess of 1.00% prior to the Covenant and Monument acquisitions from 2017 to 2018.

Table XI also shows that the total of the allowance and the credit adjustment on purchased non-impaired loans, as a percentage of total loans plus the credit adjustment, was 1.08% at December 31, 2021, up from 1.05% at December 31, 2020 and 0.93% at December 31, 2019, and in line with ratios from the previous years.

The provision for loan losses by segment for 2021 and 2020 is as follows:

2 unchanged sentences

The provision for loan losses is further detailed as follows:

Residential mortgage segment

Commercial segment

(In Thousands)

(Decrease) increase in total specific allowance on impaired loans, adjusted for the effect of net charge-offs

(Decrease) increase in collectively determined portion of the allowance attributable to:

Loan (reduction) growth

Increase in total specific allowance on impaired loans, adjusted for the effect of net charge-offs

Increase in collectively determined portion of the allowance attributable to:

Changes in loan volume

Changes in historical loss experience factors

Changes in qualitative factors

Total provision for loan losses - Residential mortgage segment

Commercial segment

Total provision for loan losses - Commercial segment

Residential mortgage segment

(In Thousands)

Increase (decrease) in total specific allowance on impaired loans, adjusted for the effect of net charge-offs

Decrease in total specific allowance on impaired loans, adjusted for the effect of net charge-offs

Increase (decrease) in collectively determined portion of the allowance attributable to:

Changes in loan volume

Changes in historical loss experience factors

Changes in qualitative factors

Total provision for loan losses - Commercial segment

Total provision for loan losses - Residential mortgage segment

Consumer segment

1 unchanged sentence

Increase in total specific allowance on impaired loans, adjusted for the effect of net charge-offs

(Decrease) increase in collectively determined portion of the allowance attributable to:

Loan reduction

Increase (decrease) in collectively determined portion of the allowance attributable to:

Changes in loan volume

Changes in historical loss experience factors

3 unchanged sentences

(In Thousands)

Increase (decrease) increase in total specific allowance on impaired loans, adjusted for the effect of net charge-offs

Increase in total specific allowance on impaired loans, adjusted for the effect of net charge-offs

Increase (decrease) in collectively determined portion of the allowance attributable to:

Changes in loan volume

Changes in historical loss experience factors

3 unchanged sentences

This line item also includes net charge-offs or recoveries from smaller loans that had not been individually evaluated for impairment prior to charge-off.

In the tables immediately above, the portion of the net change in the collectively determined allowance attributable to loan growth was determined by applying the historical loss experience and qualitative factors used in the allowance calculation at the end of the preceding period to the net increase in loans outstanding (excluding purchased loans and loans specifically evaluated for impairment) for the period.

In the tables immediately above, the portion of the net change in the collectively determined allowance attributable to changes in loan volume was determined by applying the historical loss experience and qualitative factors used in the allowance calculation at the end of the preceding period to the net increase in loans outstanding (excluding loans specifically evaluated for impairment) for the period.

The effect on the provision of changes in historical loss experience and qualitative factors, as shown in the tables above, was determined by:

(1) calculating the net change in each factor used in determining the allowance at the end of the period as compared to the preceding period, and (2) applying the net change in each factor to the outstanding balance of loans at the end of the preceding period (excluding loans specifically evaluated for impairment).

(1) calculating the net change in each factor used in determining the allowance at the end of the period as compared to the preceding

period, and (2) applying the net change in each factor to the outstanding balance of loans at the end of the preceding period (excluding loans specifically evaluated for impairment).

In 2021, net charge-offs were $1,509,000, including charge-offs of $1,575,000 and recoveries of $66,000.

The Corporation’s overall net charge-off experience in 2020 was elevated compared to results over the past several years due to the impact of a charge-off of $2,219,000 on a commercial loan with an outstanding balance of $3,500,000 in the third quarter 2020.

In 2021, the Corporation recorded partial charge-offs totaling $1,463,000 on a commercial loan.

At December 31, 2021, the recorded investment in this loan was $1,391,000.

In 2020, the Corporation recorded a charge-off of $2,219,000 on one commercial loan for which there was no recorded investment at December 31, 2021 and 2020.

Table XII shows the average rate of net charge-offs as a percentage of loans was 0.09% in 2021, with an annual average over the five-year period ended December 31, 2021 of 0.08%, and annual average rates ranging from a high of 0.16% in 2020 to a low of 0.02% in 2018.

Table XI presents information related to past due and impaired loans, and loans that have been modified under terms that are considered troubled debt restructurings (TDRs).

Total nonperforming loans as a percentage of outstanding loans was 1.42% at December 31, 2020, up from 0.88% at December 31, 2019, and nonperforming assets as a percentage of total assets was 1.10% at December 31, 2020, up from 0.80% at December 31, 2019.

Total nonperforming loans as a percentage of outstanding loans was 1.36% at December 31, 2021, down from 1.42% at December 31, 2020, and nonperforming assets as a percentage of total assets was 0.94% at December 31, 2021, down from 1.10% at December 31, 2020.

Table XI presents data at the end of each of the years ended December 31, 2017 through 2021.

Table XI shows that total nonperforming loans as a percentage of loans of 1.42% at December 31, 2020, though up from December 31, 2019, was lower than the corresponding year-end ratio from 2016 through 2018.

Similarly, the December 31, 2020 ratio of total nonperforming assets as a percentage of assets of 1.10% was lower than the corresponding ratio from 2016 through 2018.

Total impaired loans of $17,818,000 at December 31, 2020 are up $12,332,000 from the corresponding amount at December 31, 2019 of $5,486,000.

The increase in impaired loans includes the net impact of classification as impaired of the commercial loans referred to above in the discussion of specific allowances and the loans purchased with credit impairment from Covenant.

Table XI shows that the

total balance of impaired loans at December 31, 2020 was higher than the year-end amounts over the period 2016-2019, which ranged from a low of $9,511,000 in 2017 to the high of $17,818,000 at December 31, 2020.

Total nonperforming assets of $24,729,000 at December 31, 2020 are $11,418,000 higher than the corresponding amount at December 31, 2019, summarized as follows:

● Total nonaccrual loans at December 31, 2020 of $21,416,000 was $12,198,000 higher than the corresponding December 31, 2019 total of $9,218,000.

Similar to the discussions above related to impaired loans and nonperforming assets, this increase reflects the impact of net changes in classification as impaired of the commercial loans subject to specific allowances and the loans purchased from Covenant with credit impairment described above.

Table XI shows that total nonperforming loans as a percentage of loans of 1.36% at December 31, 2021, though up from the low of 0.88% at December 31, 2019, was lower than the corresponding ratio at December 31, 2017, 2018 and 2020.

Similarly, the December 31, 2021 ratio of total nonperforming assets as a percentage of assets of 0.94% was up from the low of 0.80% at December 31, 2019, but lower than the corresponding ratio at December 31, 2017, 2018 and 2020.

Total impaired loans of $15,734,000 at December 31, 2021 are down $2,084,000 from the corresponding amount at December 31, 2020 of $17,818,000.

Table XI shows that while the total balance of impaired loans at December 31, 2021 was lower than the amount at December 31, 2020, it was higher than the amounts over the periods of 2017-2019, which ranged from a low of $5,486,000 in 2019 to the high of $9,774,000 at December 31, 2018.

The increase in total impaired loans in 2020 and 2021 includes the impact of purchased credit impaired loans acquired from Covenant and Monument.

Total nonperforming assets of $21,902,000 at December 31, 2021 are $2,827,000 lower than the corresponding amount at December 31, 2020, summarized as follows:

● Total nonaccrual loans at December 31, 2021 of $18,999,000 was $2,417,000 lower than the corresponding December 31, 2020 total of $21,416,000.

● Total loans past due 90 days or more and still accruing interest amounted to $2,219,000 at December 31, 2021, an increase of $244,000 from the total at December 31, 2020.

The increase includes $631,000 from loans secured by commercial real estate and $121,000 increase on residential.

Management has evaluated the loans within this category and determined they are well secured and in the process of collection at December 31, 2020.

● Foreclosed assets held for sale consisted of real estate, and totaled $684,000 at December 31, 2021, a decrease of $654,000 from $1,338,000 at December 31, 2020.

Within this decrease, there was a reduction of $1,134,000 related to the sale of a commercial real estate property in the first quarter of 2020.

At December 31, 2021, the Corporation held four such properties for sale, with total carrying values of $256,000 related to residential real estate and $428,000 related to commercial real estate.

At December 31, 2020, the Corporation held six such properties for sale, with total carrying values of $80,000 related to residential real estate and $1,258,000 related to commercial real estate.

At December 31, 2019, the Corporation held ten such properties for sale, with total carrying values of $292,000 related to residential real estate, $70,000 of land and $2,524,000 related to commercial real estate.

The Corporation evaluates the carrying values of foreclosed assets each quarter based on the most recent market activity or appraisals for each property.

5 unchanged sentences

Management believes it has been conservative in its decisions concerning identification of impaired loans, estimates of loss, and nonaccrual status;

however, the actual losses realized from these relationships could vary materially from the allowances calculated as of December 31, 2020.

however, the actual losses realized from these relationships could vary materially from the allowances calculated as

of December 31, 2021.

Management continues to closely monitor its commercial loan relationships for possible credit losses and will adjust its estimates of loss and decisions concerning nonaccrual status, if appropriate.

15 unchanged sentences

As of December 31,

ASC 310 - Impaired loans

ASC 450 - Collective segments:

ASC 310 - Impaired loans - individually evaluated

ASC 450 - Collectively evaluated:

Residential mortgage

21 unchanged sentences

Allowance for loan losses as a % of total loans

Credit adjustment on purchased non-impaired loans and allowance for loan losses

as a % of total loans and the credit adjustment (a)

Credit adjustment on purchased non-impaired loans and allowance for loan losses as a % of total loans and the credit adjustment (a)

Allowance for loan losses as a % of nonperforming loans

39 unchanged sentences

At December 31, 2021, the Corporation maintained overnight interest-bearing deposits with the Federal Reserve Bank of Philadelphia and other correspondent banks totaling $79,119,000.

The Corporation’s cash position throughout 2021 has been elevated in comparison to historical levels as growth in deposits and funds received from repayment of loans have outpaced loan originations, purchases of securities, repayments of borrowings and other uses of cash.

The Corporation maintains overnight borrowing facilities with several correspondent banks that provide a source of day-to-day liquidity.

9 unchanged sentences

Total credit facilities

The significant increase in credit available from the Federal Home Loan Bank of Pittsburgh in 2020 resulted from an increase in the borrowing base created by the acquisition of real estate secured loans from Covenant.

At December 31, 2021, the Corporation’s outstanding credit facilities with the Federal Home Loan Bank of Pittsburgh consisted of long-term borrowings of $27,727,000 and letters of credit totaling $5,584,000.

At December 31, 2020, the Corporation’s outstanding credit facilities with the Federal Home Loan Bank of Pittsburgh consisted of short-term borrowings of $18,000,000, long-term borrowings of $53,822,000 and a $400,000 letter of credit.

At December 31, 2019, the Corporation’s outstanding credit facilities with the Federal Home Loan Bank of Pittsburgh consisted of overnight borrowings of $64,000,000, short-term borrowings of $20,297,000 and long-term borrowings with a total amount of $52,127,000.

Additionally, the Corporation uses “RepoSweep” arrangements to borrow funds from commercial banking customers on an overnight basis.

38 unchanged sentences

The difference between amortized cost and fair value of available-for-sale debt securities, net of deferred income tax, is included in Accumulated Other Comprehensive Income within stockholders’ equity.

The balance in Accumulated Other Comprehensive Income related to unrealized gains (losses) on available-for-sale debt securities, net of deferred income tax, amounted to $11,676,000 at December 31, 2020 and $3,511,000 at December 31, 2019.

Changes in accumulated other comprehensive income (loss) are excluded from earnings and directly increase or decrease stockholders’ equity.

The balance in Accumulated Other Comprehensive Income related to unrealized gains on available-for-sale debt securities, net of deferred income tax, amounted to $4,809,000 at December 31, 2021 and $11,676,000 at December 31, 2020.

Changes in accumulated other comprehensive income are excluded from earnings and directly increase or decrease stockholders’ equity.

If available-for-sale debt securities are deemed to be other-than-temporarily impaired, unrealized losses are recorded as a charge against earnings, and amortized cost for the affected securities is reduced.

2 unchanged sentences

The balance in Accumulated Other Comprehensive Income related to defined benefit plans, net of deferred income tax, was $217,000 at December 31, 2021 and $119,000 at December 31, 2020.

Inflation affects the cost of labor, supplies and services used to provide banking services as well as interest rates.

After many years of low inflation, disruptions to labor markets and supply chains triggered by the COVID-19 pandemic and government policies have led to an annual inflation rate in 2021, based on changes in the Consumer Price Index, of 7%.

The Corporation is significantly affected by the Federal Reserve Board’s efforts to control inflation through changes in short-term interest rates.

In March of 2020, in response to significant concerns about the impact of the COVID-19 pandemic on the U.S.

economy, the Federal Reserve lowered the fed funds target rate from 1.75% to 0.25%, which it has maintained through December 31, 2021.

Also, the Federal Reserve has injected massive amounts of liquidity into the nation’s monetary system through a variety of programs.

The Federal Reserve has purchased large amounts of securities in an effort to keep interest rates low and stimulate economic growth.

The Federal Open Market Committee (FOMC) has noted in its most recent statement that indicators of economic activity and employment have continued to strengthen and that inflationary concerns may no longer be considered transitory in nature.

The Committee noted its desire to achieve maximum employment and inflation at a rate of 2 percent over the longer run and with inflation currently well above that level with a strong labor market, it expects it will soon be appropriate to raise the target range for the federal funds rate.

The Committee also decided to continue to reduce the monthly pace of its net asset purchases, bringing them to an end in early March of 2022.

Although management cannot predict future changes in the rates of inflation, management monitors the impact of economic trends, including indicators of inflationary pressures, in managing interest rate and other financial risks.

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

What changed 10-K

Item 7. Management’s Discussion and Analysis