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Item 7. Management’s Discussion and Analysis

2021-03-15 compared with 2020-03-13 · 563 added, 963 removed, 210 unchanged (88% of the section changed)

MANAGEMENT’S DISCUSSION AND

ANALYSIS OF FINANCIAL CONDITION AND RESULTS OF OPERATIONS

The purpose of Management’s Discussion

and Analysis of First Keystone Corporation, a bank holding company (the “Corporation”), and its wholly owned subsidiary,

First Keystone Community Bank (the “Bank”), is to assist the reader in reviewing the financial information presented

and should be read in conjunction with the consolidated financial statements and other financial data contained herein.

to Forward-Looking Statements on page 1 for detailed information.

MANAGEMENT’S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS OF OPERATIONS

The purpose of Management’s Discussion and Analysis of First Keystone Corporation, a bank holding company (the “Corporation”), and its wholly owned subsidiary, First Keystone Community Bank (the “Bank”), is to assist the reader in reviewing the financial information presented and should be read in conjunction with the consolidated financial statements and other financial data contained herein.

Refer to Forward-Looking Statements on page 1 for detailed information.

RESULTS OF OPERATIONS

Year Ended December 31, 2020 Versus Year Ended December 31, 2019

Net income increased to $10,227,000 for

the year ended December 31, 2019, as compared to $9,211,000 for the prior year, an increase of 11.0%.

Earnings per share, both

basic and diluted, for 2019 was $1.77 as compared to $1.60 in 2018, an increase of 10.6%.

Dividends per share for 2019 and 2018

Net income increased to $11,837,000 for the year ended December 31, 2020, as compared to $10,227,000 for the prior year, an increase of 15.7%.

Earnings per share, both basic and diluted, for 2020 was $2.03 as compared to $1.77 in 2019, an increase of 14.7%.

Dividends per share for 2020 and 2019 were $1.08.

The Corporation’s return on average assets was 1.09% in 2020 and 1.02% in 2019.

Return on average equity increased

to 8.17% in 2019 from 8.05% in 2018.

Total interest income in 2019 amounted to $38,527,000, an increase of $2,954,000 or 8.3%

Total interest expense of $10,243,000 increased $1,623,000 or 18.8% from 2018.

The majority of this increase related

to an increase in interest paid on deposits in 2019.

Net interest income, as indicated below

in Table 1, increased by $1,331,000 or 4.9% to $28,284,000 for the year ended December 31, 2019.

The Corporation’s net interest

income on a fully tax equivalent basis increased by $531,000, or 1.8% to $30,105,000 in 2019 as compared to $29,574,000 in 2018.

Table 1 — Reconciliation of Taxable Equivalent Net

Interest Income

Return on average equity increased to 8.61% in 2020 from 8.17% in 2019.

Total interest income in 2020 amounted to $39,567,000, an increase of $1,040,000 or 2.7% from 2019.

The increase in interest income reflects $610,000 in servicing fees earned from the SBA related to the origination of PPP loans throughout 2020.

Total interest expense of $6,360,000 decreased $3,883,000 or 37.9% from 2019.

The majority of this decrease related to a decrease in interest paid on deposits and short-term borrowings in 2020.

Net interest income, as indicated below in Table 1, increased by $4,923,000 or 17.4% to $33,207,000 for the year ended December 31, 2020.

The Corporation’s net interest income on a fully tax equivalent basis increased by $4,761,000, or 15.8% to $34,866,000 in 2020 as compared to $30,105,000 in 2019.

Table 1 — Reconciliation of Taxable Equivalent Net Interest Income

(Dollars in thousands)

4 unchanged sentences

Tax Equivalent Adjustment

Net Interest Income (fully tax

Table 2 — Average Balances, Rates and Interest Income

Net Interest Income (fully tax equivalent)

Table 2 — Average Balances, Rates and Interest Income and Expense

(Dollars in thousands)

Interest Earning Assets:

Commercial, net 1,2,4

Real Estate 1,2

Consumer, net 1,4

Fees on Loans

Total Loans 5

Tax-Exempt 1,3

Total Investment

Total Investment Securities

Restricted Investment in Bank Stocks

Interest-Bearing Deposits in Other

Interest Earning Assets

Total Interest

Earning Assets

Interest-Bearing Deposits in Other Banks

Total Other Interest Earning Assets

Total Interest Earning Assets

Non-Interest Earning Assets:

2 unchanged sentences

Premises and Equipment

Total Non-Interest

Earning Assets

Total Non-Interest Earning Assets

Interest Bearing Liabilities:

Savings, NOW Accounts, and Money Markets

Savings, NOW, Money Markets and Interest Checking

Time Deposits

2 unchanged sentences

Long-Term Borrowings

Total Interest

Bearing Liabilities

Subordinated Debentures

Total Interest Bearing Liabilities

Non-Interest Bearing Liabilities:

1 unchanged sentence

Other Liabilities

Stockholders’

Liabilities/Stockholders’

Income Tax Equivalent

Stockholders’ Equity

Total Liabilities/Stockholders’ Equity

Net Interest Income Tax Equivalent

Net Interest Spread

Net Interest Margin

1 Tax-exempt income has been adjusted to a tax equivalent

basis using an incremental rate of 21% and statutory interest expense disallowance.

2 Includes tax equivalent adjustments on tax-free

municipal loans of $269,000 and $395,000 for years 2019 and 2018, respectively.

3 Includes tax equivalent adjustments on tax-free

municipal securities of $1,552,000 and $2,226,000 for years 2019 and 2018, respectively.

1 Tax-exempt income has been adjusted to a tax equivalent basis using an incremental rate of 21% and statutory interest expense disallowance.

2 Includes tax equivalent adjustments on tax-free municipal loans of $150,000 and $269,000 for years 2020 and 2019, respectively.

3 Includes tax equivalent adjustments on tax-free municipal securities of $1,509,000 and $1,552,000 for years 2020 and 2019, respectively.

4 Installment loans are stated net of unearned interest.

2 unchanged sentences

NET INTEREST INCOME

The major source of operating income for

the Corporation is net interest income.

Net interest income is the difference between interest income on earning assets, such

as loans and securities, and the interest expense on liabilities used to fund those assets, including deposits and other borrowings.

The major source of operating income for the Corporation is net interest income.

Net interest income is the difference between interest income on earning assets, such as loans and securities, and the interest expense on liabilities used to fund those assets, including deposits and other borrowings.

The amount of interest income is dependent upon both the volume of earning assets and the level of interest rates.

the volume of non-performing loans affects interest income.

The amount of interest expense varies with the amount of funds needed

to support earning assets, interest rates paid on deposits and borrowed funds, and finally, the level of interest free deposits.

Table 2 on the preceding page provides

a summary of average outstanding balances of earning assets and interest bearing liabilities with the associated interest income

and interest expense as well as average tax equivalent rates earned and paid as of year-end 2019 and 2018.

The yield on earning assets was 4.33% in

2019 and 4.11% in 2018.

In addition, the volume of non-performing loans affects interest income.

The amount of interest expense varies with the amount of funds needed to support earning assets, interest rates paid on deposits and borrowed funds, and finally, the level of interest free deposits.

Table 2 on the preceding page provides a summary of average outstanding balances of earning assets and interest bearing liabilities with the associated interest income and interest expense as well as average tax equivalent rates earned and paid as of year-end 2020 and 2019.

The yield on earning assets was 4.09% in 2020 and 4.33% in 2019.

The rate paid on interest bearing liabilities was 0.84% in 2020 and 1.38% in 2019.

This resulted in a

decrease in our net interest spread to 2.95% in 2019, as compared to 2.98% in 2018.

As Table 2 illustrates, net interest margin,

which is interest income less interest expense divided by average earning assets, was 3.23% in 2019 as compared to 3.18% in 2018.

This resulted in an increase in our net interest spread to 3.25% in 2020, as compared to 2.95% in 2019.

As Table 2 illustrates, net interest margin, which is interest income less interest expense divided by average earning assets was 3.46% in 2020 as compared to 3.23% in 2019.

Net interest margins are presented on a tax-equivalent basis.

In 2019, the yield on earning assets increased by 0.22%, while the

rate paid on interest bearing liabilities increased 0.25%.

As loans were repaid and refinanced, the principal balances were reinvested

at higher, current rates.

This was the primary cause of the higher yield on loans.

The investment portfolio yield decreased slightly

in 2019 to 3.36% due to decreased volume from the sale of tax-exempt securities.

The average rate paid on short-term borrowings

increased 0.31% from 2.28% to 2.59%.

The rate paid on savings, NOW accounts and money market accounts increased from 0.54% to

0.75% while the average rate paid on time deposits increased 0.33% to 1.82% in 2019.

Interest income exempt from federal tax was

$3,766,000 in 2019 and $5,387,000 in 2018.

Interest income exempt from federal tax decreased due to the sales of tax-exempt securities

and payoff of tax exempt loans.

In 2020, the yield on earning assets decreased by 0.24% and the rate paid on interest bearing liabilities decreased by 0.54%.

Yields decreased across all segments of interest earning assets and interest bearing liabilities during 2020, mainly as a result of the current low interest rate environment precipitated by rate cuts that occurred in 2020 as a result of the COVID-19 pandemic.

The yield on loans decreased from 4.78% in 2019 to 4.63% in 2020 mainly due to loans repaid or refinanced that were reinvested at lower interest rates, as well as the Bank’s origination of SBA Paycheck Protection Program loans that have interest rates of 1.00%.

The securities portfolio yield decreased to 3.02% in 2020 as compared to 3.36% in 2019.

The decrease was mainly the result of reduced yield on taxable securities which declined from 2.78% in 2019 to 2.33% in 2020 due to maturities, calls, and sales of investment securities that were reinvested at lower rates.

The average rate paid on short-term borrowings decreased 1.59% from 2.59% in 2019 to 1.00% in 2020.

The rate paid on savings, NOW, money market, and interest checking accounts decreased 0.37% from 0.75% to 0.38% and the average rate paid on time deposits decreased 0.26% from 1.82% to 1.56%.

Interest income exempt from federal tax was $3,319,000 in 2020 and $3,766,000 in 2019.

Interest income exempt from federal tax decreased due to the sales and calls of tax-exempt securities and payoffs of tax-exempt loans.

Tax-exempt income has been adjusted to a tax-equivalent basis using an incremental rate of 21%.

The increase in net interest margin at

December 31, 2019, compared to December 31, 2018 was primarily due to increases in loan volumes and yields.

Fully tax equivalent

net interest income increased by $531,000 or 1.8% to $30,105,000 at December 31, 2019, compared to $29,574,000 at December 31,

The increase in net interest margin at December 31, 2020 compared to December 31, 2019 was primarily due to decreased yields on interest bearing liabilities resulting in lower interest expense in 2020, as compared to 2019.

Fully tax equivalent net interest income increased by $4,761,000 or 15.8% to $34,866,000 at December 31, 2020 compared to $30,105,000 at December 31, 2019.

Throughout 2020, the Federal Reserve decreased the federal-funds rate by 1.5%, resulting in a target range of 0.00% - 0.25%.

The Corporation could experience a decrease in net interest income if the market interest rates continue to decline, as the Corporation

continues to be liability sensitive.

To negate the potential impact of a decreasing net interest margin, the Corporation will

continue to focus on attracting lower cost core deposits such as checking, savings, and money market accounts, thereby reducing

its dependence on higher priced certificates of deposit and short-term borrowings.

The Corporation is actively monitoring and

restructuring its portfolios to become more asset sensitive, which will allow for better performance in a rates-down environment.

The Corporation will continue to evaluate the potential impact of short-term rate fluctuations in 2020, as well as the slope and

position of the yield curve.

Table 3 sets forth changes in interest

income and interest expense for the periods indicated for each category of interest earning assets and interest bearing liabilities.

The Corporation could experience a decrease in net interest income if market rates remain static or continue to decline, as the Corporation’s net interest income continues to be liability sensitive.

To negate the potential impact of a decreasing net interest margin, the Corporation will continue to focus on attracting lower cost core deposits such as checking, savings, and money market accounts, thereby further reducing its dependence on higher priced certificates of deposit and short-term borrowings.

The Corporation is actively monitoring and restructuring its portfolios to become more asset sensitive, which will allow for better performance in a static or rates-down environment.

The Corporation will continue to evaluate the potential impact of short-term rate fluctuations in 2021, as well as the slope and position of the yield curve.

Table 3 sets forth changes in interest income and interest expense for the periods indicated for each category of interest earning assets and interest bearing liabilities.

Information is provided on changes attributable to (i) changes in volume (changes in average volume multiplied by prior rate);

(ii) changes in rate (changes in average rate multiplied by prior average volume);

and, (iii) changes in rate and volume (changes

in average volume multiplied by change in average rate).

In 2019, the increase in net interest income

on a fully tax equivalent basis of $531,000 resulted from an increase in volume of $77,000 and an increase of $454,000 due to

changes in rate.

and, (iii) changes in rate and volume (changes in average volume multiplied by change in average rate).

In 2020, the increase in net interest income on a fully tax equivalent basis of $4,761,000 resulted from an increase in volume of $4,244,000 and an increase of $517,000 due to changes in rate.

Table 3 — Rate/Volume Analysis

5 unchanged sentences

Restricted Investment in Bank Stocks

Interest Income

Total Interest Income

Interest Expense

4 unchanged sentences

Long-Term Borrowings

Total Interest

Interest Income

The change in interest due to both volume

and yield/rate has been allocated to change due to volume and change due to yield/rate in proportion to the absolute value of

the change in each.

Subordinated Debentures

Total Interest Expense

Net Interest Income

The change in interest due to both volume and yield/rate has been allocated to change due to volume and change due to yield/rate in proportion to the absolute value of the change in each.

Balances on non-accrual loans are included for computational purposes.

Interest income on non-accrual loans

is not included.

PROVISION FOR LOAN

For the year ended December 31, 2019, the

provision for loan losses was $450,000 as compared to $200,000 for the year ended December 31, 2018.

The increase in the provision

for loan losses in 2019 as compared to 2018 resulted from the Corporation’s analysis of the current loan portfolio, including

historic losses, past-due trends, current economic conditions, loan portfolio growth, and other relevant factors.

Net charge-offs

by the Corporation for the fiscal years ended December 31, 2019 and 2018 were $190,000 and $942,000, respectively.

See Allowance

for Loan Losses on page 32 for further discussion.

Gross charge-offs amounted to $204,000

at December 31, 2019, as compared to $1,039,000 at December 31, 2018.

The decreased level of charge-offs for the year ended December

31, 2019 was mainly due to two large charge-offs totaling $548,000 on a non-accrual participation loan to a student housing holding

company that were completed during the year ended December 31, 2018.

A charge-off in the amount of $342,000 was completed during

the second quarter of 2018 and an additional charge-off in the amount of $206,000 was completed during the fourth quarter of 2018.

Other large items impacting the decreased level of charge-offs in 2019 compared to 2018 included a charge-off in the amount of

$106,000 that was completed during the first quarter of 2018 on a loan to a retailer of recreational vehicles and a charge-off

in the amount of $111,000 that was completed during the third quarter of 2018 on a loan to the owner of a restaurant/bar that

is no longer in operation.

All of these charge-offs were completed to charge the respective loan balances down to the net realizable

value of the supporting collateral less cost to sell, as the underlying value of the collateral was deemed to be insufficient

to cover the respective loan balances.

The large charge-offs completed in the prior year contributed to the decreased balance

of net charge-offs in 2019 but was not indicative of a significant change in asset quality in the overall loan portfolio.

Table 10 – Analysis of Allowance for Loan Losses for further details.

The allowance for loan losses as a percentage

of average loans outstanding was 1.13% as of December 31, 2019 and 1.15% as of December 31, 2018.

On a quarterly basis, management performs,

and the Corporation’s Audit Committee and the Board of Directors review a detailed analysis of the adequacy of the allowance

for loan losses.

This analysis includes an evaluation of credit risk concentration, delinquency trends, past loss experience,

current economic conditions, composition of the loan portfolio, classified loans and other relevant factors.

The Corporation will continue to monitor

its allowance for loan losses and make future adjustments to the allowance through the provision for loan losses as conditions

Although the Corporation believes that the allowance for loan losses is adequate to provide for losses inherent in the

loan portfolio, there can be no assurance that future losses will not exceed the estimated amounts or that additional provisions

will not be required in the future.

The Corporation is subject to periodic

regulatory examination by the Pennsylvania Department of Banking and Securities and the FDIC.

As part of the examination, the

regulators will assess the adequacy of the Corporation’s allowance for loan losses and may include factors not considered

by the Corporation.

In the event that a regulatory examination results in a conclusion that the Corporation’s allowance

for loan losses is not adequate, the Corporation may be required to increase its provision for loan losses.

Interest income on non-accrual loans is not included.

PROVISION FOR LOAN LOSSES

For the year ended December 31, 2020, the provision for loan losses was $1,200,000 as compared to $450,000 for the year ended December 31, 2019.

The increase in the provision for loan losses in 2020 as compared to 2019 resulted from the Corporation’s analysis of the current loan portfolio, including historic losses, past-due trends, current economic conditions, loan portfolio growth, and other relevant factors.

The provision for loan losses for the year ended December 31, 2020 is also reflective of management’s assessment of the increased risk associated with the economic uncertainty surrounding the COVID-19 pandemic.

Charge-off and recovery activity in the allowance for loan losses resulted in net charge-offs of $272,000 and $190,000 for the years ended December 31, 2020 and 2019, respectively.

See Allowance for Loan Losses on page 36 for further discussion.

Gross charge-offs amounted to $301,000 at December 31, 2020, as compared to $204,000 at December 31, 2019.

The increased level of charge-offs for the year ended December 31, 2020 was mainly due to one charge-off totaling $86,000 completed during the fourth quarter of 2020 on a non-accrual loan to a student housing holding company.

The charge-off was completed to charge the loan balance down to the net realizable value of the supporting collateral less cost to sell, as the underlying value of the collateral was deemed to be insufficient to cover the loan balance.

This charge-off contributed to the increased balance of net charge-offs in 2020 vs.

2019, but was not indicative of a significant change in asset quality in the overall loan portfolio.

See Table 10 – Analysis of Allowance for Loan Losses for further details.

The allowance for loan losses as a percentage of average loans outstanding was 1.16% as of December 31, 2020 and 1.13% as of December 31, 2019.

On a quarterly basis, management performs, and the Corporation’s Audit Committee and the Board of Directors review a detailed analysis of the adequacy of the allowance for loan losses.

This analysis includes an evaluation of credit risk concentration, delinquency trends, past loss experience, current economic conditions, composition of the loan portfolio, classified loans and other relevant factors.

The Corporation will continue to monitor its allowance for loan losses and make future adjustments to the allowance through the provision for loan losses as conditions warrant.

Although the Corporation believes that the allowance for loan losses is adequate to provide for losses inherent in the loan portfolio, there can be no assurance that future losses will not exceed the estimated amounts or that additional provisions will not be required in the future.

The Corporation is subject to periodic regulatory examination by the Pennsylvania Department of Banking and Securities and the FDIC.

As part of the examination, the regulators will assess the adequacy of the Corporation’s allowance for loan losses and may include factors not considered by the Corporation.

In the event that a regulatory examination results in a conclusion that the Corporation’s allowance for loan losses is not adequate, the Corporation may be required to increase its provision for loan losses.

NON-INTEREST INCOME

Non-interest income is derived primarily

from service charges and fees, ATM and debit card income, trust department revenue, income on bank owned life insurance, gains

on sales of mortgage loans and other miscellaneous income.

In addition, net securities gains and losses also impact total non-interest

Table 4 provides the yearly non-interest income by category, along with the amount, dollar changes, and percentage of

Non-interest income through December 31,

2019 was $6,929,000, an increase of 24.6%, or $1,367,000, from 2018.

The increase was due primarily to an increase in net securities

Non-interest income is derived primarily from service charges and fees, ATM and debit card income, trust department revenue, income on bank owned life insurance, gains on sales of mortgage loans and other miscellaneous income.

In addition, net securities gains and losses also impact total non-interest income.

Table 4 provides the yearly non-interest income by category, along with the amount, dollar changes, and percentage of change.

Non-interest income through December 31, 2020 was $6,012,000, a decrease of 13.2%, or $917,000, from 2019.

The decrease was due primarily to a decrease in net securities gains and a decrease in service charges and fees.

Table 4 provides the major categories of non-interest income and each respective change comparing the last two years.

During 2019, net securities gains increased

$976,000 to a net gain of $911,000.

The Corporation has taken gains and losses in the portfolio in 2019 due to a strategic movement

to sell underperforming securities to fund loan growth and replace the remainder with better performing securities in various

rate scenarios while having a balanced approach to total return and interest rate risk.

Gains on sales of mortgage loans provided

income of $277,000 in 2019 as compared to $188,000 in 2018.

The increase in gains on sales of mortgage loans in 2019 was due to

higher average gains on individual mortgage loan sales.

In 2019, the Corporation originated $25,592,000 in residential mortgage

loans, of which $12,447,000 were originated with the intent to sell.

This compared favorably to 2018 when the Corporation originated

$23,918,000 in residential mortgage loans, of which $8,926,000 were originated with the intent to sell.

The Corporation continues

to service the majority of mortgages which are sold.

This servicing income provides an additional source of non-interest income

on an ongoing basis.

Service charges and fees increased by $165,000

or 8.0% in 2019 as compared to 2018, largely due to prepayment penalties earned on commercial loan payoffs.

In addition, ATM and

debit card income increased $83,000 or 5.3%, in 2019 as compared to 2018.

Other income, consisting primarily of safe

deposit box rentals, income from the sale of non-deposit investment products, and miscellaneous fees, increased $15,000, or 5.7%

in 2019 as compared to 2018.

During 2020, net securities gains decreased $969,000 to a net loss of $(58,000).

The decrease was due to the Corporation recognizing $287,000 in net losses on held equity securities in 2020, as compared to recognizing $373,000 in net gains on held equity securities in 2019.

The Corporation also recognized $309,000 less in net gains on the sales of debt securities during 2020 as compared to 2019.

Gains on sales of mortgage loans provided income of $604,000 in 2020 as compared to $277,000 in 2019.

The increase in gains on sales of mortgage loans in 2020 was due to more mortgage loans being sold and higher average gains on individual mortgage loan sales in 2020 as compared to 2019.

In 2020, the Corporation originated $44,485,000 in residential mortgage loans, of which $30,480,000 were originated with the intent to sell.

This compared favorably to 2019 when the Corporation originated $25,592,000 in residential mortgage loans, of which $12,447,000 were originated with the intent to sell.

The Corporation continues to service the majority of mortgages which are sold.

This servicing income provides an additional source of non-interest income on an ongoing basis.

Service charges and fees decreased by $531,000 or 23.9% in 2020 as compared to 2019.

The decrease was mainly due to fewer customers in overdraft status and lower fees earned on deposit accounts, as overdraft fees and several other deposit account service charges were waived during the second quarter of 2020 due to the COVID-19 pandemic.

In addition, there were fewer prepayment penalties earned on commercial loan payoffs during 2020.

ATM fees and debit card income increased by $199,000 or 12.1% in 2020 as compared to 2019 due to an increase in transaction volume.

Other income, consisting primarily of safe deposit box rentals, income from the sale of non-deposit investment products, and miscellaneous fees, increased $42,000, or 15.2% in 2020 as compared to 2019.

Table 4 — Non-Interest Income

6 unchanged sentences

Gains on sales of mortgage loans

Net securities gains (losses)

Net securities (losses) gains

NON-INTEREST EXPENSE

Total non-interest

expense amounted to $23,422,000, an increase of $777,000, or 3.4% in 2019.

Expenses associated with employees (salaries and

employee benefits) continue to be the largest non-interest expenditure.

Salaries and employee benefits amounted to

$12,457,000 or 53.2% of total non-interest expense in 2019 and $11,770,000 or 52.0% in 2018.

Salaries and employee benefits

increased $687,000, or 5.8% in 2019.

The increase in 2019 was due to performance salaries increases, an increase in

commissions and referral fees associated with loan growth and retail non-deposit activity and increased healthcare costs.

Corporation experienced a 12.4% increase in medical insurance for its employees in 2019.

In 2018 there was a $318,000

reversal of a retirement benefit as the result of the resignation of an executive officer of the Bank.

The number of full

time equivalent employees was 196 as of December 31, 2019 and 195 as of December 31, 2018.

Net occupancy expense increased $78,000,

or 4.5% in 2019 as compared to 2018, mainly due to an increase in rent expense associated with operating leases after the adoption

of the new lease accounting standard.

Net furniture and equipment and computer expense increased $74,000, or 4.6% in 2019 compared

The increase in 2019 was due to annual, contracted price increases on several software licenses, as well as one-time

implementation fees for new products including online account opening.

Professional services decreased $119,000,

or 11.3% in 2019 as compared to 2018.

The higher expense in 2018 was the result of additional accounting fees for 2017 out of

scope audit work and additional engagements for the form S-3 consent for the Bank’s dividend reinvestment plan and 2017

There were also higher engagement fees related to income generation consulting, higher legal fees relating to the

resignation of an executive officer of the Bank and additional legal expenses associated with the dividend reinvestment plan rescission

offer and form S-3 filing.

Pennsylvania shares tax expense decreased

$14,000, or 1.8% in 2019 as compared to 2018.

FDIC insurance expense decreased $174,000, or 55.9% in 2019 as compared to 2018.

This decrease was due to small bank assessment credits received from the FDIC in the third and fourth quarters of 2019.

FDIC insurance

expense varies with changes in net asset size, risk ratings, and FDIC derived assessment rates.

ATM and debit card fees expense increased

$86,000, or 10.7% in 2019 as compared to 2018.

The increase in 2019 was due to an increase in client card usage causing higher

electronic funds transfer fees plus additional expenses incurred to deploy instant issue debit cards.

Data processing fees increased

$79,000, or 7.7% in 2019 as compared to 2018 as the result of an annual, contracted price increase and an increase in fees assessed

based on the number of customer accounts.

Foreclosed assets

held for resale expense amounted to $295,000 in 2019 as compared to $148,000 in 2018.

The Corporation incurred costs associated

with the maintenance and sales of thirteen foreclosed properties in 2018 and nine foreclosed properties in 2019.

was primarily the result of a write down to the agreed upon lead bank repurchase price of a foreclosed asset in 2019.

Advertising expense increased $106,000,

or 20.9% in 2019 as compared to 2018.

The increase in 2019 was primarily due to more newspaper advertising and an increase in

digital and social media advertising.

Other non-interest expense decreased $173,000,

or 6.0% in 2019 as compared to 2018.

The decrease in 2019 was primarily due to a decrease in amortization costs on one of the

Corporation’s low income housing investment properties.

The overall level of non-interest expense

remains low, relative to the Corporation’s peers (community banks from $500 million to $1 billion in assets).

Corporation’s total non-interest expense was 2.33% of average assets in 2019 and 2.25% in 2018.

The Corporation’s

non-interest expense as a percentage of average assets places the Corporation among the leaders in its peer financial institution

categories in controlling non-interest expense.

Total non-interest expense amounted to $24,605,000, an increase of $1,183,000, or 5.1% in 2020.

Expenses associated with employees (salaries and employee benefits) continue to be the largest non-interest expenditure.

Salaries and employee benefits amounted to $13,687,000 or 55.6% of total non-interest expense in 2020 and $12,457,000 or 53.2% in 2019.

Salaries and employee benefits increased $1,230,000, or 9.9% in 2020.

The increase in 2020 was due to an increase in commissions associated with loan growth and retail non-deposit activity, bonuses paid to all employees for working through the COVID-19 pandemic and increased healthcare costs.

The Corporation experienced a 30.0% increase in healthcare costs for its employees in 2020 as compared to 2019.

The number of full time equivalent employees was 195 as of December 31, 2020 and 196 as of December 31, 2019.

Net occupancy expense increased $190,000, or 10.4% in 2020 as compared to 2019, mainly due to an increase in rent expense associated with the new leasing standard.

Net furniture and equipment and computer expense decreased $109,000, or 6.5% in 2020 compared to 2019.

The decrease in 2020 was due to several software items fully depreciating in 2019 which were still being utilized throughout 2020.

Professional services increased $49,000, or 5.3% in 2020 as compared to 2019.

The higher expense in 2020 was the result of higher legal fees related to the issuance of subordinated debt and additional consulting and accounting fees related to the review of the Corporation’s goodwill.

Pennsylvania shares tax expense increased $101,000, or 13.2% in 2020 as compared to 2019.

The increase was the result of an increase in total equity.

FDIC insurance expense increased $31,000, or 22.6% in 2020 as compared to 2019.

This increase was due to small bank assessment credits received from the FDIC effectively reducing the expense in 2019.

FDIC insurance expense varies with changes in net asset size, risk ratings, and FDIC derived assessment rates.

ATM and debit card fees expense increased $14,000, or 1.6% in 2020 as compared to 2019.

Data processing fees increased $55,000, or 5.0% in 2020 as compared to 2019 as the result of annual contracted pricing increases from our main third-party data processor.

Foreclosed assets held for resale expense amounted to $50,000 in 2020 as compared to $295,000 in 2019, a decrease of $245,000, or 83.1%.

The Corporation incurred costs associated with the maintenance and sales of four foreclosed properties in 2020 and nine foreclosed properties in 2019.

The majority of the decrease was the result of a write down to the agreed upon lead bank repurchase price of a foreclosed asset in 2019.

Advertising expense decreased $259,000, or 42.3% in 2020 as compared to 2019.

The decrease was due to a less aggressive advertising approach in 2020 due to the COVID-19 pandemic, as 2020 saw less newspaper, billboard, digital and civic advertising.

Advertising for 2020 was geared mostly towards social media and keeping customers informed and educated on the events created due to COVID-19.

This advertising was significantly less expensive than

the Bank’s traditional campaign driven messages.

Civic advertising was affected by the COVID-19 pandemic as many events that the Bank would normally sponsor were canceled.

Other non-interest expense increased $126,000, or 4.6% in 2020 as compared to 2019.

The increase in 2020 was primarily due to higher promotional expenses for free appraisals given by the Bank.

The overall level of non-interest expense remains low, relative to the Corporation’s peers (community banks from $500 million to $1 billion in assets).

The Corporation’s total non-interest expense was 2.28% of average assets in 2020 and 2.33% in 2019, which places the Corporation among the leaders in its peer financial institution categories in controlling non-interest expense.

Table 5 — Non-Interest Expense

12 unchanged sentences

INCOME TAX EXPENSE

Income tax expense for the year ended December

31, 2019, was $1,114,000 as compared to $459,000 for the year ended December 31, 2018.

The effective income tax rate was 9.8%

in 2019 and 4.7% in 2018.

The increase in the effective tax rate for 2019 was due to a net decrease in tax-exempt investments

in and loans to state and local units of government.

Income tax expense for the year ended December 31, 2020, was $1,577,000 as compared to $1,114,000 for the year ended December 31, 2019.

The effective income tax rate was 11.8% in 2020 and 9.8% in 2019.

The increase in the effective tax rate for 2020 was due to a net decrease in tax-exempt investments in and loans to state and local units of government, plus higher overall operating income.

FINANCIAL CONDITION

Total assets decreased to $1,007,226,000

at year-end 2019, a decrease of 0.5% from year-end 2018.

Total debt securities available-for-sale

decreased $38,126,000 or 12.1% to $277,928,000 as of December 31, 2019.

Net loans increased in 2019 from $599,647,000

to $640,727,000, a 6.9% increase.

Loan demand grew in 2019 as the Bank added loans in the commercial real estate category.

The cash surrender value of bank owned

life insurance totaled $23,583,000 at December 31, 2019, an increase of $620,000 or 2.7% from 2018.

This increase represents tax-free

income included in non-interest income on the consolidated statements of income.

Investments in low-income housing partnerships

were $1,828,000 at year-end 2019, a decrease of 12.8% from year-end 2018.

The Corporation became a limited partner in a new real

estate venture during 2015 with an initial investment of $590,000, a second installment of $1,178,000 in 2016, third and fourth

installments in 2017 of $168,000 and $84,000, respectively, and a fifth and final installment of $85,000 in 2019.

in low-income housing real estate ventures enables the Corporation to recognize tax credits and satisfy Community Reinvestment

Act initiatives.

As of December 31, 2019, total deposits

amounted to $761,628,000, an increase of 13.4% from 2018.

The increase in 2019 was primarily due to the Corporation accepting

$40,000,000 in brokered CDs during 2019, plus higher balances in the accounts of municipal depositors.

Core deposits, which include

demand deposits and interest bearing demand deposits (NOWs), money market accounts, savings accounts, and time deposits of individuals,

continue to be the Corporation’s most significant source of funds.

The Corporation continues to maintain and

manage its asset growth.

The Corporation’s strong equity capital position provides an opportunity to further leverage its

asset growth.

Borrowings decreased in 2019 by $109,782,000, mainly due to increased deposit balances and a strategic decrease

in the balance of the securities portfolio.

Total stockholders’ equity increased

to $128,752,000 at December 31, 2019, an increase of $11,996,000.

Total assets increased to $1,179,047,000 at year-end 2020, an increase of 17.1% from year-end 2019.

Total debt securities available-for-sale increased $88,783,000 or 31.9% to $366,711,000 as of December 31, 2020.

Net loans increased in 2020 from $640,727,000 to $712,677,000, an 11.2% increase.

Loan demand grew in 2020 as the Bank has realized an increase in loan originations, primarily in the commercial real estate and commercial and industrial portfolios.

The increase was partially due to the origination of PPP loans, which carried a balance of $22,976,000 at December 31, 2020.

Interest receivable increased $1,139,000 or 33.5% to $4,544,000 as of December 31, 2020.

This increase was mainly due to the full payment deferrals of several loans that were modified in response to the COVID-19 pandemic under Section 4013 of the CARES act, plus the impact of growth in the loan portfolio.

The cash surrender value of bank owned life insurance totaled $24,194,000 at December 31, 2020, an increase of $611,000 or 2.6% from 2019.

This increase represents tax-free income included in non-interest income on the consolidated statements of income.

Investments in low-income housing partnerships were $1,466,000 at year-end 2020, a decrease of 19.8% from year-end 2019.

The Corporation became a limited partner in a new real estate venture during 2015 with an initial investment of $590,000, a second installment of $1,178,000 in 2016, third and fourth installments in 2017 of $168,000 and $84,000, respectively, and a fifth and final installment of $85,000 in 2019.

Investing in low-income housing real estate ventures enables the Corporation to recognize tax credits and satisfy Community Reinvestment Act initiatives.

As of December 31, 2020, total deposits amounted to $937,488,000, an increase of 23.1% from 2019.

The increase in 2020 was due to many different factors including the deposit of stimulus funds via check or ACH, the deposit of PPP loan proceeds, less consumer spending, an $83,000,000 increase in highly rate sensitive deposits and other normal fluctuations.

Core deposits, which include demand deposits and interest bearing demand deposits (NOWs), money market accounts, savings accounts, and time deposits of individuals, continue to be the Corporation’s most significant source of funds.

The Corporation continues to maintain and manage its asset growth.

The Corporation’s strong equity capital position provides an opportunity to further leverage its asset growth.

Short and long-term borrowings decreased in 2020 by $45,169,000, mainly due to increased deposit balances.

The Corporation issued $25,000,000 in subordinated debentures in the fourth quarter of 2020.

Total stockholders’ equity increased to $144,242,000 at December 31, 2020, an increase of $15,490,000, primarily due to an increase in accumulated other comprehensive income and retained earnings.

SEGMENT REPORTING

Currently, management measures the performance

and allocates the resources of the Corporation as a single segment.

Currently, management measures the performance and allocates the resources of the Corporation as a single segment.

EARNING ASSETS

Earning assets are defined as those assets

that produce interest income.

By maintaining a healthy asset utilization rate, i.e., the volume of earning assets as a percentage

of total assets, the Corporation maximizes income.

The earning asset ratio (average interest earning assets divided by average

total assets) equaled 92.4% for 2019 compared to 92.5% for 2018.

This indicates that the management of earning assets is a priority

and non-earning assets, primarily cash and due from banks, fixed assets and other assets, are maintained at minimal levels.

primary earning assets are loans and investment securities.

The Corporation uses securities to not

only generate interest and dividend revenue, but also to help manage interest rate risk and to provide liquidity to meet operating

The securities portfolio consists of debt

securities available-for-sale.

Earning assets are defined as those assets that produce interest income.

By maintaining a healthy asset utilization rate, i.e., the volume of earning assets as a percentage of total assets, the Corporation maximizes income.

The earning asset ratio (average interest earning assets divided by average total assets) equaled 93.2% for 2020 compared to 92.4% for 2019.

This indicates that the management of earning assets is a priority and non-earning assets, primarily cash and due from banks, fixed assets and other assets, are maintained at minimal levels.

The primary earning assets are loans and investment securities.

The Corporation uses securities to not only generate interest and dividend revenue, but also to help manage interest rate risk and to provide liquidity to meet operating cash needs.

The securities portfolio consists of debt securities available-for-sale.

No securities were established in a trading account.

Debt securities available-for-sale decreased

$38,126,000 or 12.1% to $277,928,000 in 2019.

At December 31, 2019, the net unrealized gain, net of the tax effect, on these securities

was $4,221,000 and was included in stockholders’ equity as accumulated other comprehensive income (loss).

Table 6 provides

data on the fair value of the Corporation’s securities portfolio on the dates indicated.

The vast majority of security purchases

are allocated as available-for-sale.

This provides the Corporation with increased flexibility should there be a need or desire

to liquidate a security.

Debt securities available-for-sale increased $88,783,000 or 31.9% to $366,711,000 in 2020.

At December 31, 2020, the net unrealized gain, net of the tax effect, on these securities was $12,870,000 and was included in stockholders’ equity as accumulated other comprehensive income.

Table 6 provides data on the fair value of the Corporation’s securities portfolio on the dates indicated.

The vast majority of security purchases are allocated as available-for-sale.

This provides the Corporation with increased flexibility should there be a need or desire to liquidate a security.

The securities portfolio includes, U.S.

treasuries, U.S.

government corporations and agencies, corporate debt obligations, mortgage-backed securities, asset backed securities,

and obligations of state and political subdivisions, both tax-exempt and taxable.

Debt securities available-for-sale may

be sold as part of the overall asset and liability management process.

Realized gains and losses are reflected in the results

of operations on the Corporation’s Consolidated Statements of Income.

As of December 31, 2019, the securities portfolio

does not contain any off-balance sheet derivatives or trust preferred investments.

government corporations and agencies, corporate debt obligations, mortgage-backed securities, asset backed securities, and obligations of state and political subdivisions, both tax-exempt and taxable.

Debt securities available-for-sale may be sold as part of the overall asset and liability management process.

Realized gains and losses are reflected in the results of operations on the Corporation’s Consolidated Statements of Income.

As of December 31, 2020, the securities portfolio does not contain any off-balance sheet derivatives or trust preferred investments.

Table 6 — Securities

(Dollars in thousands)

Available-For-Sale

December 31, 2020

December 31, 2019

Treasury securities

4 unchanged sentences

Corporate debt securities

The amortized cost and fair value of securities,

by contractual maturity, are shown below at December 31, 2019.

Expected maturities will differ from contractual maturities because

borrowers may have the right to call or prepay obligations with or without call or prepayment penalties.

The amortized cost and fair value of securities, by contractual maturity, are shown below at December 31, 2020.

Expected maturities will differ from contractual maturities because borrowers may have the right to call or prepay obligations with or without call or prepayment penalties.

Table 7 — Securities Maturity Table

(Dollars in thousands)

Securities Available-For-Sale

December 31, 2020

Debt Securities Available-For-Sale

Corporations &

8 unchanged sentences

Amortized cost

1 Mortgage-backed securities are allocated for maturity

reporting at their original maturity date.

Marketable equity securities consist of

common stock investments in other commercial banks and bank holding companies.

At December 31, 2019 and 2018, the Corporation

had $1,933,000 and $1,560,000, respectively, in equity securities recorded at fair value, an increase of $373,000 or 23.9%.

to January 1, 2018 equity securities were stated at fair value with unrealized gains and losses reported as a separate component

of accumulated other comprehensive income (AOCI), net of tax.

At December 31, 2017, net unrealized gains, net of tax, of $634,000

had been recognized in AOCI.

On January 1, 2018, the unrealized gains and losses were reclassified out of AOCI and into retained

earnings with subsequent changes in fair value being recognized in net income.

Total loans increased to $647,732,000 as

of December 31, 2019, as compared to a balance of $606,392,000 as of December 31, 2018.

Table 8 provides data relating to the

composition of the Corporation’s loan portfolio on the dates indicated.

Total loans increased $41,340,000, or 6.8% in 2019

compared to an increase of $46,995,000, or 8.4% in 2018.

Steady demand for borrowing by businesses

accounted for the 6.8% increase in total loans in 2019 and the 8.4% increase in total loans in 2018.

The Commercial and Industrial

portfolio decreased $5,508,000 to $86,712,000 as of December 31, 2019, as compared to $92,220,000 at December 31, 2018.

in the Commercial and Industrial portfolio (which includes tax-free Commercial and Industrial loans) was attributed to new loan

originations totaling $13,360,000 offset by a decrease of $3,746,000 in utilization of existing Commercial and Industrial lines

of credit and loan payoffs of $12,629,000, as well as regular principal payments.

The Commercial Real Estate loan portfolio (which

includes tax-free Commercial Real Estate loans) increased $47,325,000 to $395,801,000 as of December 31, 2019, as compared to

$348,476,000 at December 31, 2018.

The increase was mainly the result of $92,389,000 in new loan originations and an increase

of $3,082,000 in utilization of existing Commercial Real Estate lines of credit offset by $39,024,000 in loan payoffs in addition

to regular principal payments and other typical amortization in the Commercial Real Estate loan portfolio during the year ended

December 31, 2019.

Residential Real Estate loans decreased $391,000 to $159,350,000 as of December 31, 2019, as compared to $159,741,000

at December 31, 2018.

The decrease was the result of new loan originations totaling $21,396,000, offset by loan payoffs of $13,544,000,

net loans sold of $1,318,000 as well as regular principal payments and other typical amortization in the Residential Real Estate

loan portfolio during the year ended December 31, 2019.

Net loans sold in the Residential Real Estate portfolio for the year ended

December 31, 2019 consisted of total loans sold during the year ended December 31, 2019 of $10,506,000, offset with loans opened

and sold in the same quarter during any quarter of 2019 which amounted to $9,188,000.

The Corporation continues to originate and

sell certain long-term fixed rate residential mortgage loans which conform to secondary market requirements.

The Corporation derives

ongoing income from the servicing of mortgages sold in the secondary market.

The Corporation continues its efforts to lend to

creditworthy borrowers.

Management believes that the loan portfolio

is well diversified.

1 Mortgage-backed securities are allocated for maturity reporting at their original maturity date.

Marketable equity securities consist of common stock investments in other commercial banks and bank holding companies.

At December 31, 2020 and 2019, the Corporation had $1,646,000 and $1,933,000, respectively, in equity securities recorded at fair value, a decrease of $287,000 or 14.8%.

Total loans increased to $720,610,000 as of December 31, 2020, as compared to a balance of $647,732,000 as of December 31, 2019.

Table 8 provides data relating to the composition of the Corporation’s loan portfolio on the dates indicated.

Total loans increased $72,878,000, or 11.3% in 2020 compared to an increase of $41,340,000, or 6.8% in 2019.

Steady demand for borrowing by businesses (including loans issued through the Bank’s participation in the SBA’s Paycheck Protection Program) accounted for the 11.3% increase in the loan portfolio from December 31, 2019 to December 31, 2020.

Overall, the Commercial and Industrial portfolio (which includes tax-free Commercial and Industrial loans) increased 6.0% or $5,163,000 to $91,875,000 at December 31, 2020 compared to $86,712,000 at December 31, 2019.

The increase in the Commercial and Industrial portfolio was mainly attributable to originations of Paycheck Protection Program loans which amounted to $22,976,000 as of December 31, 2020.

The portion of the Commercial and Industrial portfolio not attributable to the Paycheck Protection Program loans decreased $17,813,000 during the year ended December 31, 2020.

The decrease was mainly attributable to $11,102,000 in new loan originations offset by a $5,522,000 decrease in utilization of existing Commercial and Industrial lines of credit and loan payoffs of $17,965,000, as well as regular principal payments and other typical fluctuations in the Commercial and Industrial portfolio.

The Commercial Real Estate portfolio (which includes tax-free Commercial Real Estate loans) increased 17.9% or $70,927,000 to $466,728,000 at December 31, 2020 compared to $395,801,000 at December 31, 2019.

The increase was mainly the result of $117,952,000 in new loan originations net against a $2,067,000 decrease in utilization of existing Commercial Real Estate lines of credit and $38,793,000 in loan payoffs, in addition to regular principal payments and other typical amortization in the Commercial Real Estate portfolio.

Residential Real Estate loans decreased 1.5% or $2,367,000 to $156,983,000 at December 31, 2020 compared to $159,350,000 at December 31, 2019.

The decrease was the result of $33,481,000 in new loan originations and a $206,000 increase in utilization of existing Residential Real Estate (Home Equity) lines of credit, offset by loan payoffs of $24,784,000, net loans sold of $7,019,000 and regular principal payments and other typical amortization in the Residential Real Estate portfolio.

Net loans sold for the year ended December 31, 2020 consisted of total loans sold during the year ended December 31, 2020 of $14,760,000, offset with loans opened and sold in the same quarter during each quarter of 2020 which amounted to $7,741,000.

The Corporation continues to originate and sell certain long-term fixed rate residential mortgage loans which conform to secondary market requirements.

The Corporation derives ongoing income from the servicing of mortgages sold in the secondary market.

The Corporation continues its efforts to lend to creditworthy borrowers.

Management believes that the loan portfolio is well diversified.

The total commercial portfolio was $558,603,000 at December 31, 2020.

Of total loans, $395,801,000 or 61.1%

were secured by commercial real estate, primarily lessors of residential buildings and dwellings and lessors of non-residential

Of total loans, $466,728,000 or 64.8% were secured by commercial real estate, primarily lessors of residential buildings and dwellings and lessors of non-residential buildings.

The Corporation continues to monitor these portfolios.

All loan relationships in excess of $1,500,000

are reviewed internally and/or externally through a loan review process on an annual basis.

Such review is based upon analysis

of current financial statements of the borrower, co-borrowers/guarantors, payment history, and economic conditions.

Overall, the portfolio risk profile as

measured by loan grade is considered low risk, as $631,472,000 or 97.7% of gross loans are graded Pass;

$1,146,000 or 0.2% are

graded Special Mention;

All loan relationships in excess of $1,500,000 are reviewed internally and/or externally through a loan review process on an annual basis.

Such review is based upon analysis of current financial statements of the borrower, co-borrowers/guarantors, payment history, and economic conditions.

Overall, the portfolio risk profile as measured by loan grade is considered low risk, as $695,657,000 or 96.7% of gross loans are graded Pass;

$1,039,000 or 0.1% are graded Special Mention;

$23,098,000 or 3.2% are graded Substandard;

and $0 are graded Doubtful.

The rating is intended to represent

the best assessment of risk available at a given point in time, based upon a review of the borrower’s financial statements,

credit analysis, payment history with the Bank, credit history and lender knowledge of the borrower.

See Note 4 — Loans

and Allowance for Loan Losses for risk grading tables.

Overall, non-pass grades decreased to $14,887,000

at December 31, 2019, as compared to $20,949,000 at December 31, 2018.

Commercial and Industrial non-pass grades decreased to

$1,070,000 as of December 31, 2019, compared to $1,225,000 as of December 31, 2018.

Commercial Real Estate non-pass grades decreased

to $12,534,000 as of December 31, 2019 as compared to $18,652,000 as of December 31, 2018.

Residential Real Estate and Consumer

non-pass grades increased to $1,283,000 as of December 31, 2019, as compared to $1,072,000 as of December 31, 2018.

The decrease in the Commercial Real Estate

non-pass grade portfolio during the year ended December 31, 2019 was mainly attributable to a pay-off in the amount of $4,296,000

on a performing Substandard purchased participation loan to a real estate developer specializing in commercial office space.

large fluctuations in the Commercial Real Estate non-pass grade portfolio during the year ended December 31, 2019 consisted of

a loan to golf course and related facilities in the amount of $1,014,000 that was returned to pass-grade status due to exemplary

payment history by the borrower, as well as an increase in membership in 2019, $558,000 in payments and pay-offs related to three

performing Substandard loans to a developer of a residential sub-division and payments of $330,000 on a performing Substandard

loan to the owner of a recreation facility, net against a loan in the amount of $195,000 to a beer distributor/retailer and restaurant

operator that was downgraded to Substandard and placed on non-accrual status during the year ended December 31, 2019 due to slow

payment performance and cash flow challenges.

The remainder of the fluctuation in the balance of Commercial Real Estate non-pass

grades from December 31, 2018 to December 31, 2019 is attributable to other normal activity in the Commercial Real Estate non-pass

grade portfolio (including additions of smaller loans to non-pass grade status, regular principal payments on existing non-pass

grade loans, etc.) during the year ended December 31, 2019.

The Corporation continues to internally

underwrite each of its loans to comply with prescribed policies and approval levels established by its Board of Directors.

The classes of the Corporation’s

loan portfolio net of unearned discount and net deferred loan fees and costs are summarized in Table 8.

The rating is intended to represent the best assessment of risk available at a given point in time, based upon a review of the borrower’s financial statements, credit analysis, payment history with the Bank, credit history and lender knowledge of the borrower.

See Note 4 — Loans and Allowance for Loan Losses for risk grading tables.

Overall, non-pass grades increased to $24,137,000 at December 31, 2020, as compared to $14,887,000 at December 31, 2019.

Commercial and Industrial non-pass grades decreased to $919,000 as of December 31, 2020,

compared to $1,070,000 as of December 31, 2019.

Commercial Real Estate non-pass grades increased to $21,789,000 as of December 31, 2020 as compared to $12,534,000 as of December 31, 2019.

Residential Real Estate and Consumer non-pass grades increased to $1,429,000 as of December 31, 2020, as compared to $1,283,000 as of December 31, 2019.

The increase in the Commercial Real Estate non-pass grade portfolio during the year ended December 31, 2020 was mainly due to the downgrade of various large loans/loan relationships to Special Mention or Substandard during the year.

One Commercial Real Estate loan to a real estate developer that carried a balance of $814,000 as of December 31, 2020 was downgraded to Special Mention during the third quarter of 2020, as the borrower was unable to pay off the loan or refinance through another institution at maturity;

the Bank has agreed to extend the maturity date of the loan for one year in conjunction with a principal paydown that was financed by partial release of the mortgaged premises.

One Commercial Real Estate loan to the owner/operator of a hotel that carried a balance of $9,423,000 as of December 31, 2020 was downgraded to Special Mention during the third quarter of 2020 and subsequently downgraded to Substandard during the fourth quarter of 2020, as occupancy levels have been adversely impacted by the COVID-19 coronavirus pandemic, but the business remains operational.

Four Commercial Real Estate loans to the owners/operators of an indoor family entertainment complex that carried a balance of $792,000 as of December 31, 2020 were downgraded to Special Mention during the third quarter of 2020 and subsequently downgraded to Substandard during the fourth quarter of 2020, as the business was adversely impacted by the COVID-19 coronavirus pandemic.

Net against the large additions to Special Mention and Substandard status, there was also one Commercial Real Estate loan to the owner of a recreation facility that was classified as Substandard and carried a balance of $2,640,000 as of December 31, 2019 which was paid off during the second quarter of 2020.

The Corporation continues to internally underwrite each of its loans to comply with prescribed policies and approval levels established by its Board of Directors.

The classes of the Corporation’s loan portfolio net of unearned discount and net deferred loan fees and costs are summarized in Table 8.

Table 8 — Loans

3 unchanged sentences

Residential Real Estate

The Corporation’s maturity and rate

sensitivity information related to the loan portfolio is summarized in Table 9.

The Corporation’s maturity and rate sensitivity information related to the loan portfolio is summarized in Table 9.

Table 9 — Loan Maturity and Interest Sensitivity

Loans by Maturity

December 31, 2020

(Dollars in thousands)

After One Year

Through Five Years

Commercial and Industrial

1 unchanged sentence

Residential Real Estate

The above data represents the amount of loans receivable at

December 31, 2019 which, based on remaining scheduled repayments of principal, are due in the periods indicated.

Loans by Repricing Opportunity

The above data represents the amount of loans receivable at December 31, 2020 which, based on remaining scheduled repayments of principal, are due in the periods indicated.

Loans by Repricing

December 31, 2020

(Dollars in thousands)

After One Year

Through Five Years

Commercial and Industrial

2 unchanged sentences

Loans with a fixed interest rate

Loans with a variable interest

The above data represents the amount of loans receivable at

December 31, 2019 which are due or have the opportunity to reprice in the periods indicated, based on remaining scheduled repayments

of principal for fixed rate loans or date of next repricing opportunity for variable rate loans.

The fixed and variable portions

of the amounts of loans receivable due or repricing in the periods indicated are also summarized above.

ALLOWANCE FOR LOAN

The allowance for loan losses constitutes

the amount available to absorb losses within the loan portfolio.

As of December 31, 2019, the allowance for loan losses was $7,005,000

as compared to $6,745,000 as of December 31, 2018.

The allowance for loan losses is established through a provision for loan losses

charged to expenses.

Loans are charged against the allowance for possible loan losses when management believes that the collectability

of the principal is unlikely.

The risk characteristics of the loan portfolio are managed through various control processes, including

credit evaluations of individual borrowers, periodic reviews, and diversification by industry.

Risk is further mitigated through

the application of lending procedures such as the holding of adequate collateral and the establishment of contractual guarantees.

Management performs a quarterly analysis

to determine the adequacy of the allowance for loan losses.

The methodology in determining adequacy incorporates specific and

general allocations together with a risk/loss analysis on various segments of the portfolio according to an internal loan review

Loans with a variable interest rate

The above data represents the amount of loans receivable at December 31, 2020 which are due or have the opportunity to reprice in the periods indicated, based on remaining scheduled repayments of principal for fixed rate loans or date of next repricing opportunity for variable rate loans.

The fixed and variable portions of the amounts of loans receivable due or repricing in the periods indicated are also summarized above.

ALLOWANCE FOR LOAN LOSSES

The allowance for loan losses constitutes the amount available to absorb losses within the loan portfolio.

As of December 31, 2020, the allowance for loan losses was $7,933,000 as compared to $7,005,000 as of December 31, 2019.

The allowance for loan losses is established through a provision for loan losses charged to expenses.

Loans are charged against the allowance for possible loan losses when management believes that the collectability of the principal is unlikely.

The risk characteristics of the loan portfolio are managed through various control processes, including credit evaluations of individual borrowers, periodic reviews, and diversification by industry.

Risk is further mitigated through the application of lending procedures such as the holding of adequate collateral and the establishment of contractual guarantees.

Management performs a quarterly analysis to determine the adequacy of the allowance for loan losses.

The methodology in determining adequacy incorporates specific and general allocations together with a risk/loss analysis on various segments of the portfolio according to an internal loan review process.

This assessment results in an allocated allowance.

Management maintains its loan review and loan classification standards

consistent with those of its regulatory supervisory authority.

Management considers, based upon its methodology,

that the allowance for loan losses is adequate to cover foreseeable future losses.

However, there can be no assurance that the

allowance for loan losses will be adequate to cover significant losses, if any, that might be incurred in the future.

Table 10 contains an analysis of the allowance

for loan losses indicating charge-offs and recoveries by year.

In 2019, net charge-offs as a percentage of average loans were

0.03% as compared to 0.16% in 2018.

Management maintains its loan review and loan classification standards consistent with those of its regulatory supervisory authority.

Management considers, based upon its methodology, that the allowance for loan losses is adequate to cover foreseeable future losses.

However, there can be no assurance that the allowance for loan losses will be adequate to cover significant losses, if any, that might be incurred in the future.

In response to the COVID-19 pandemic and its impact on the current economy, the qualitative factors related to the local/regional economy were increased by two basis points across all loan segments during the first quarter of 2020, and increased by an additional basis point across all loan segments during the second quarter of 2020.

The qualitative factor relating to the impact of external factors/conditions for the Commercial Real Estate portfolio segment was increased by an additional basis point during the third quarter of 2020.

The qualitative factors relating to the impact of external factors/conditions were increased by two additional basis points across all loan segments during the fourth quarter of 2020.

Modifications granted in compliance with Section 4013 of the CARES Act are highest in the Commercial Real Estate portfolio segment, the long-term effects of which are still very unclear, as there is still economic uncertainty related to the COVID-19 pandemic, especially in relation to this segment of the Corporation’s loan portfolio.

Table 10 contains an analysis of the allowance for loan losses indicating charge-offs and recoveries by year.

In 2020, net charge-offs as a percentage of average loans were 0.04% as compared to 0.03% in 2019.

Net charge-offs amounted to $272,000 in 2020 and $190,000 in 2019.

Net charge-offs were significantly

less in 2019 than in 2018 mainly due to four charge-offs in the Commercial Real Estate portfolio that were completed during the

year ended December 31, 2018.

Two charge-offs totaling $548,000 were completed on a non-accrual Commercial Real Estate participation

loan to a student housing holding company, of which, a charge-off in the amount of $342,000 was completed during the second quarter

of 2018, and an additional charge-off in the amount of $206,000 was completed during the fourth quarter of 2018.

in the amount of $106,000 was completed on a Commercial Real Estate loan to a retailer of recreational vehicles during the first

quarter of 2018 and a charge-off in the amount of $111,000 was completed during the third quarter of 2018 on a Commercial Real

Estate loan to the owner of a restaurant/bar that is no longer in operation.

All of the charge-offs were completed to charge the

respective loan balances down to the net realizable value of the collateral less cost to sell, as the underlying value of the

collateral was deemed insufficient to cover the respective loan balances.

For the year ended December 31, 2019, the

provision for loan losses was $450,000 as compared to $200,000 for the year ended December 31, 2018.

The net effect of the provision,

charge-offs and recoveries resulted in the year-end allowance for loan losses of $7,005,000 of which 9.0% was attributed to the

Commercial and Industrial component, 58.8% attributed to the Commercial Real Estate component, 23.8% attributed to the Residential

Real Estate component, 1.6% attributed to the Consumer component, and 6.8% being the unallocated component (refer to the activity

in Note 4 ― Loans and Allowance for Loan Losses on page 68.) The Corporation determined that the provision for loan losses

made during 2019 was sufficient to maintain the allowance for loan losses at a level necessary for the probable losses inherent

in the loan portfolio as of December 31, 2019.

Net charge-offs were greater in 2020 than in 2019 mainly due to one charge-off totaling $86,000 in the Commercial Real Estate portfolio that was completed during the fourth quarter of 2020 on a non-accrual loan to a student housing holding company.

The charge-off was completed to charge the loan

balance down to the net realizable value of the collateral less cost to sell, as the underlying value of the collateral was deemed insufficient to cover the loan balance.

For the year ended December 31, 2020, the provision for loan losses was $1,200,000 as compared to $450,000 for the year ended December 31, 2019.

The net effect of the provision, charge-offs and recoveries resulted in the year-end allowance for loan losses of $7,933,000 of which 9.9% was attributed to the Commercial and Industrial component, 60.0% attributed to the Commercial Real Estate component, 20.7% attributed to the Residential Real Estate component, 1.2% attributed to the Consumer component, and 8.2% being the unallocated component (refer to the activity in Note 4 — Loans and Allowance for Loan Losses on page 75.) The Corporation determined that the provision for loan losses made during 2020 was sufficient to maintain the allowance for loan losses at a level necessary for the probable losses inherent in the loan portfolio as of December 31, 2020.

Table 10 — Analysis of Allowance for Loan Losses

(Dollars in thousands)

Ended December 31,

Years Ended December 31,

Balance at beginning of period

8 unchanged sentences

Balance at end of period

of net charge-offs during the period to average loans outstanding during the period

Allowance for loan losses to average loans outstanding

during the period

It is the policy of management and the

Corporation’s Board of Directors to make a provision for both identified and unidentified losses inherent in its loan portfolio.

Ratio of net charge-offs during the period to average loans outstanding during the period

Allowance for loan losses to average loans outstanding during the period

It is the policy of management and the Corporation’s Board of Directors to make a provision for both identified and unidentified losses inherent in its loan portfolio.

A provision for loan losses is charged to operations based upon an evaluation of the potential losses in the loan portfolio.

evaluation takes into account such factors as portfolio concentrations, delinquency trends, trends of non-accrual and classified

loans, economic conditions, and other relevant factors.

The loan review process, which is conducted

quarterly, is an integral part of the Bank’s evaluation of the loan portfolio.

A detailed quarterly analysis to determine

the adequacy of the Corporation’s allowance for loan losses is reviewed by the Board of Directors.

With the Bank’s manageable level

of net charge-offs and the additions to the reserve from the provision out of operations, the allowance for loan losses as a percentage

of average loans amounted to 1.13% in 2019 and 1.15% in 2018.

Table 11 sets forth the allocation of the

Bank’s allowance for loan losses by loan category and the percentage of loans in each category to the total allowance for

loan losses at the dates indicated.

The portion of the allowance for loan losses allocated to each loan category does not represent

the total available for future losses that may occur within the loan category, since the total loan loss allowance is a valuation

reserve applicable to the entire loan portfolio.

This evaluation takes into account such factors as portfolio concentrations, delinquency trends, trends of non-accrual and classified loans, economic conditions, and other relevant factors.

The loan review process, which is conducted quarterly, is an integral part of the Bank’s evaluation of the loan portfolio.

A detailed quarterly analysis to determine the adequacy of the Corporation’s allowance for loan losses is reviewed by the Board of Directors.

With the Bank’s manageable level of net charge-offs and the additions to the reserve from the provision out of operations, the allowance for loan losses as a percentage of average loans amounted to 1.16% in 2020 and 1.13% in 2019.

Table 11 sets forth the allocation of the Bank’s allowance for loan losses by loan category and the percentage of loans in each category to the total allowance for loan losses at the dates indicated.

The portion of the allowance for loan losses allocated to each loan category does not represent the total available for future losses that may occur within the loan category, since the total loan loss allowance is a valuation reserve applicable to the entire loan portfolio.

Table 11 — Allocation of Allowance for Loan Losses

(Dollars in thousands)

and Industrial

*Percentage of allocation in each category to total allocations

in the Allowance for Loan Loss Analysis, excluding unallocated.

Commercial and Industrial

Commercial Real Estate

Residential Real Estate

*Percentage of allocation in each category to total allocations in the Allowance for Loan Loss Analysis, excluding unallocated.

NON-PERFORMING ASSETS

Table 12 details the Corporation’s

non-performing assets and impaired loans as of the dates indicated.

Generally, a loan is classified as non-accrual and the accrual

of interest on such a loan is discontinued when the contractual payment of principal or interest has become 90 days past due or

management has serious doubts about further collectability of principal or interest, even though the loan currently is performing.

Table 12 details the Corporation’s non-performing assets and impaired loans as of the dates indicated.

Generally, a loan is classified as non-accrual and the accrual of interest on such a loan is discontinued when the contractual payment of principal or interest has become 90 days past due or management has serious doubts about further collectability of principal or interest, even though the loan currently is performing.

A loan may remain on accrual status if it is in the process of collection and is either guaranteed or well secured.

is placed on non-accrual status, unpaid interest credited to income in the current year is reversed and unpaid interest accrued

in prior years is charged against current period income.

A modification of a loan constitutes a troubled debt restructuring (“TDR”)

when a borrower is experiencing financial difficulty and the modification constitutes a concession that the Corporation would

not otherwise consider.

Modifications to loans classified as TDRs generally include reductions in contractual interest rates,

principal deferments and extensions of maturity dates at a stated interest rate lower than the current market for a new loan with

similar risk characteristics.

When a loan is placed on non-accrual status, unpaid interest credited to income in the current year is reversed and unpaid interest accrued in prior years is charged against current period income.

A modification of a loan constitutes a troubled debt restructuring (“TDR”) when a borrower is experiencing financial difficulty and the modification constitutes a concession that the Corporation would not otherwise consider.

Modifications to loans classified as TDRs generally include reductions in contractual interest rates, principal deferments and extensions of maturity dates at a stated interest rate lower than the current market for a new loan with similar risk characteristics.

While unusual, there may be instances of loan principal forgiveness.

Foreclosed assets held for

resale represent property acquired through foreclosure, or considered to be an in-substance foreclosure.

Total non-performing assets amounted to

$4,607,000 as of December 31, 2019, as compared to $5,400,000 as of December 31, 2018.

The economy, in particular, the political

unrest both domestic and abroad, the looming presidential election, the various tariffs both imposed and threatened, the concerns

and discussion of a potential recession, the recent rate cuts by the Fed, and the continued slowness in the housing industry in

our market areas had a direct effect on the Corporation’s non-performing assets.

The Corporation is closely monitoring its

Commercial Real Estate portfolio because of the current economic environment.

In particular, housing starts have declined, while

bankruptcy filings have increased.

Non-accrual loans totaled $4,388,000 as of December 31, 2019 as compared to $3,896,000 as of

December 31, 2018.

The increase in non-accrual loans at December 31, 2019 compared to December

31, 2018 is mainly due to two loans with a combined outstanding recorded investment of $374,000 to a beer distributor/retailer

and restaurant owner that were moved to non-accrual status during the second quarter of 2019 due to slow payment performance and

cash flow challenges and two loans with a combined outstanding recorded investment of $123,000 to a defunct supplier of equipment

and equipment repair services to building restoration companies that were moved to non-accrual status during the second quarter

of 2019 due to nonpayment.

Foreclosed assets held for resale decreased to $119,000 as of December 31, 2019, compared to $1,163,000

as of December 31, 2018, mainly due to the repurchase of a foreclosed property by the lead participating bank that took place

during the fourth quarter of 2019.

Loans past-due 90 days or more and still accruing interest amounted to $100,000 at December

31, 2019, as compared to $341,000 as of December 31, 2018.

At December 31, 2019, loans past-due 90 days or more and still accruing

interest consisted of one Residential Real Estate loan which was well secured and in the process of collection.

Non-performing assets to total loans was

0.71% as of December 31, 2019 compared to 0.89% at December 31, 2018.

Non-performing assets to total assets was 0.46% as of December

31, 2019 compared to 0.53% at December 31, 2018.

The allowance for loan losses to total non-performing assets was 152.05% as of

December 31, 2019 as compared to 124.91% as of December 31, 2018.

Additional detail can be found in Table 12 – Non-Performing

Assets and Impaired Loans and the Loans Receivable on Non-Accrual Status table in Note 4 ― Loans and Allowance for Loan

Asset quality is a priority and the Corporation retains a full-time loan review officer to closely track and monitor overall

loan quality, along with a full-time workout department to manage collection and liquidation efforts.

Potential problem loans are defined as

performing substandard loans which are not deemed to be impaired.

These loans have characteristics that cause management to have

doubts regarding the ability of the borrower to perform under present loan repayment terms and which may result in reporting these

loans as non-performing loans in the future.

Potential problem loans amounted to $4,074,000 at December 31, 2019 and $6,100,000

at December 31, 2018.

Impaired loans were $12,954,000 at December

31, 2019 and $17,593,000 at December 31, 2018.

The largest impaired loan relationship at December 31, 2019 consisted of a non-performing

participation loan to a student housing holding company which was secured by commercial real estate.

The Corporation’s share

of the loan at December 31, 2019 was $3,176,000, net of $1,904,000 that had been charged off to date.

The second largest impaired

loan relationship at December 31, 2019 consisted of one performing loan to a student housing holding company, which was classified

The loan was secured by commercial real estate and carried a balance of $2,992,000 as of December 31, 2019, net of $943,000

that had been charged off to date.

The third largest impaired loan relationship at December 31, 2019 consisted of a substandard

performing loan to a developer of a residential sub-division in the amount of $1,474,000, which was secured by commercial real

estate and classified as a TDR.

The Bank estimates impairment based on

its analysis of the cash flows or collateral estimated at fair value less cost to sell.

For collateral dependent loans, the estimated

appraisal adjustments and cost to sell percentages are determined based on the market area in which the real estate securing the

loan is located, among other factors, and therefore, can differ from one loan to another.

Of the $12,954,000 in impaired loans

at December 31, 2019, none were located outside the Corporation’s primary market area.

The outstanding recorded investment of

loans categorized as TDRs was $8,678,000 as of December 31, 2019, compared to $13,777,000 as of December 31, 2018.

in TDRs at December 31, 2019 as compared to December 31, 2018 is mainly attributable to a large loan to a real estate developer

specializing in commercial office space that carried a value of $4,296,000 and was modified as a TDR during the fourth quarter

the loan was subsequently paid off during the year ended December 31, 2019.

Of the thirty-four restructured loans at

December 31, 2019, seven loans are classified in the Commercial and Industrial portfolio, twenty-five loans are classified in

the Commercial Real Estate portfolio, and two loans are classified in the Residential Real Estate portfolio.

Troubled debt restructurings

at December 31, 2019 consisted of sixteen term modifications beyond the original stated term, three interest rate modifications,

and fourteen payment modifications.

At December 31, 2019, there was also one troubled debt restructuring that experienced all

three types of modification – payment, rate, and term.

TDRs are separately evaluated for impairment disclosures, and if

necessary, a specific allocation is established.

As of December 31, 2019 and 2018, there were $1,000, respectively, in specific

allocations attributable to the TDRs.

There were no unused commitments on TDRs at December 31, 2019 and 2018.

At December 31, 2019, six Commercial Real

Estate loans classified as TDRs with a combined recorded investment of $464,000 were not in compliance with the terms of their

restructure, compared to December 31, 2018 when eight Commercial Real Estate loans classified as TDRs with a combined recorded

investment of $499,000 and one Commercial and Industrial loan classified as a TDR with a recorded investment of $6,000 were not

in compliance with the terms of their restructure.

No loans were modified as TDRs within the

twelve months preceding December 31, 2019, as compared to the year ended December 31, 2018 when four Commercial Real Estate loans

totaling $163,000 that were modified as TDRs within the twelve months preceding December 31, 2018 had experienced payment defaults.

The Corporation’s non-accrual loan

valuation procedure for any loans greater than $250,000 requires an appraisal to be obtained and reviewed annually at year end.

A quarterly collateral evaluation is performed which may include a site visit, property pictures and discussions with realtors

and other similar business professionals to ascertain current values.

For non-accrual loans less than $250,000

upon classification and typically at year end, the Corporation completes a Certificate of Inspection, which includes the results

of an onsite inspection, insured values, tax assessed values, recent sales comparisons and a review of the previous evaluations.

Any loan modifications made in response to the COVID-19 pandemic are not considered troubled debt restructurings as long as the criteria set forth in Section 4013 of the CARES Act are met.

Foreclosed assets held for resale represent property acquired through foreclosure, or considered to be an in-substance foreclosure.

Total non-performing assets amounted to $7,119,000 as of December 31, 2020, as compared to $4,607,000 as of December 31, 2019.

The economy, in particular, the political unrest both domestic and abroad, the recent presidential election, the partial and full shutdowns of various government offices, the recession resulting from the COVID-19 pandemic, the large unemployment totals, and the continued slowness in the housing industries in our market areas has had a direct effect on the Corporation’s non-performing assets.

The Corporation is closely monitoring its Commercial Real Estate portfolio because of the current uncertain economic environment.

Non-accrual loans totaled $7,078,000 as of December 31, 2020 as compared to $4,388,000 as of December 31, 2019.

Foreclosed assets held for resale decreased to $28,000 as of December 31, 2020, compared to $119,000 as of December 31, 2019.

Loans past-due 90 days or more and still accruing interest amounted to $13,000 at December 31, 2020, as compared to $100,000 as of December 31, 2019.

At December 31, 2020, loans past-due 90 days or more and still accruing interest consisted of one Residential Real Estate loan which was well secured and in the process of collection.

The increase in non-accrual loans at December 31, 2020, as compared to December 31, 2019 is mainly due to the addition of several large loans/loan relationships to non-accrual status during the year ended December 31, 2020.

Five loans to a plastic processing company focused on non-post-consumer recycling totaling $1,262,000 were moved to

non-accrual status during the first quarter of 2020 due to strained liquidity and the borrower’s inability to make required payments.

A loan in the amount of $762,000 to a golf course and catering venue was moved to non-accrual status during the first quarter of 2020 due to the borrower’s inability to make monthly payments due to cash flow challenges exacerbated by the seasonality of the industry.

A residential mortgage in the amount of $356,000 to the owner of a manufacturing company was also moved to non-accrual status during the first quarter of 2020, as poor payment performance has led to foreclosure proceedings related to the associated property.

A loan in the amount of $485,000 to an agricultural producer was moved to non-accrual status during the fourth quarter of 2020 due to cash flow challenges that have led to payment delinquency, as well as issues with additional liens on the real estate collateral which are impeding efforts to sell the property and pay off the loan.

Non-performing assets to total loans was 0.99% as of December 31, 2020 compared to 0.71% at December 31, 2019.

Non-performing assets to total assets was 0.60% as of December 31, 2020 compared to 0.46% at December 31, 2019.

The allowance for loan losses to total non-performing assets was 111.43% as of December 31, 2020 as compared to 152.05% as of December 31, 2019.

Additional detail can be found in Table 12 – Non-Performing Assets and Impaired Loans and the Loans Receivable on Non-Accrual Status table in Note 4 — Loans and Allowance for Loan Losses.

Asset quality is a priority and the Corporation retains a full-time loan review officer to closely track and monitor overall loan quality, along with a full-time loan workout department to manage collection and liquidation efforts.

Performing substandard loans which are not deemed to be impaired have characteristics that cause management to have doubts regarding the ability of the borrower to perform under present loan repayment terms and which may result in reporting these loans as non-performing loans in the future.

Performing substandard loans not deemed to be impaired amounted to $9,992,000 at December 31, 2020 and $4,074,000 at December 31, 2019.

Impaired loans were $15,054,000 at December 31, 2020 and $12,954,000 at December 31, 2019.

The largest impaired loan relationship at December 31, 2020 consisted of a non-performing loan to a student housing holding company which was secured by commercial real estate.

At December 31, 2020, the loan carried a balance of $3,090,000, net of $1,989,000 that had been charged off to date.

The second largest impaired loan relationship at December 31, 2020 consisted of one performing loan to a student housing holding company, which was classified as a TDR.

The loan was secured by commercial real estate and carried a balance of $2,929,000 as of December 31, 2020, net of $943,000 that had been charged off to date.

The third largest impaired loan relationship at December 31, 2020 consisted of a substandard performing loan to a developer of a residential sub-division in the amount of $1,326,000, which was secured by commercial real estate and classified as a TDR.

The Corporation estimates impairment based on its analysis of the cash flows or collateral estimated at fair value less cost to sell.

For collateral dependent loans, the estimated valuation adjustments and cost to sell percentages are determined based on the market area in which the real estate securing the loan is located, among other factors, and therefore, can differ from one loan to another.

Of the $15,054,000 in impaired loans at December 31, 2020, none were located outside the Corporation’s primary market area.

The outstanding recorded investment of loans categorized as TDRs as of December 31, 2020 and December 31, 2019 was $9,563,000 and $8,678,000, respectively.

The increase in TDRs at December 31, 2020 as compared to December 31, 2019 is mainly attributable to eight loans that were modified as TDRs during the year ended December 31, 2020, net against payments, payoffs, and charge-offs on existing TDRs that were completed during the year ended December 31, 2020.

Of the thirty-four restructured loans at December 31, 2020, eight loans were classified in the Commercial and Industrial portfolio, twenty-five loans were classified in the Commercial Real Estate portfolio, and one loan was classified in the Residential Real Estate portfolio.

Troubled debt restructurings at December 31, 2020 consisted of thirteen term modifications beyond the original stated term, three interest rate modifications, and seventeen payment modifications.

At December 31, 2020, there was also one troubled debt restructuring that experienced all three types of modification—payment, rate, and term.

TDRs are separately evaluated for impairment disclosures, and if necessary, a specific allocation is established.

As of December 31, 2020, there were no specific allocations attributable to the TDRs, compared to December 31, 2019 when there were $1,000 in specific allocations attributable to the TDRs.

There were no unfunded commitments on TDRs at December 31, 2020 and 2019.

At December 31, 2020, three Commercial and Industrial loans classified as TDRs with a combined recorded investment of $745,000, seven Commercial Real Estate loans classified as TDRs with a combined recorded investment of $984,000, and one Residential Real Estate loan classified as a TDR with a recorded investment of $18,000 were not in compliance with the terms of their restructure, compared to December 31, 2019 when six Commercial Real Estate loans classified as TDRs with a combined recorded investment of $464,000 were not in compliance with the terms of their restructure.

Two Commercial Real Estate loans totaling $57,000 that were modified as TDRs within the twelve months preceding December 31, 2020 experienced payment defaults during the year ended December 31, 2020.

No loans were modified as TDRs within the twelve months preceding December 31, 2019.

The Corporation’s non-accrual loan valuation procedure for any loans greater than $250,000 requires an appraisal to be obtained and reviewed annually at year end, unless the Board of Directors waives such requirement for a specific loan, in favor of obtaining a Certificate of Inspection instead, defined as an internal evaluation completed by the Corporation.

A quarterly collateral evaluation is performed which may include a site visit, property pictures and discussions with realtors and other similar business professionals to ascertain current values.

For non-accrual loans less than $250,000 upon classification and typically at year end, the Corporation completes a Certificate of Inspection, which includes the results of an onsite inspection, and may consider value indicators such as insured values, tax assessed values, recent sales comparisons and a review of the previous evaluations.

Improving loan quality is a priority.

Corporation actively works with borrowers to resolve credit problems and will continue its close monitoring efforts in 2020.

the assets disclosed in Table 12 – Non-Performing Assets and Impaired Loans and the Troubled Debt Restructurings section

in Note 4 — Loans and Allowance for Loan Losses, management is not aware of any information about borrowers’ possible

credit problems which cause serious doubt as to their ability to comply with present loan repayment terms.

Should the economic climate no longer continue

to be stable or deteriorate further, borrowers may experience difficulty, and the level of impaired loans and non-performing assets,

charge-offs and delinquencies could rise and possibly require additional increases in the Corporation’s allowance for loan

In addition, regulatory authorities, as

an integral part of their examinations, periodically review the allowance for possible loan losses.

They may require additions

to allowances based upon their judgments about information available to them at the time of examination.

A concentration of credit exists when the

total amount of loans to borrowers, who are engaged in similar activities that are similarly impacted by economic or other conditions,

exceed 10% of total loans.

As of December 31, 2019 and 2018 management is of the opinion that there were no loan concentrations

exceeding 10% of total loans.

The Corporation actively works with borrowers to resolve credit problems and will continue its close monitoring efforts in 2021.

Excluding the assets disclosed in Table 12 – Non-Performing Assets and Impaired Loans and the Troubled Debt Restructurings section in Note 4 — Loans and Allowance for Loan Losses, management is not aware of any information about borrowers’ possible credit problems which cause serious doubt as to their ability to comply with present loan repayment terms.

In addition, regulatory authorities, as an integral part of their examinations, periodically review the allowance for possible loan losses.

They may require additions to allowances based upon their judgments about information available to them at the time of examination.

The economic climate is unclear at this time.

The COVID-19 pandemic has caused much upheaval and uncertainty in the national and state economy.

Experts at all levels are uncertain as to the intermediate or long term affects that may arise.

The Corporation may experience difficulties collecting monthly payments on time from its borrowers, property values may decline, and certain types of loans may need to be modified, which could cause a rise in the level of impaired loans, non-performing assets, charge-offs, and delinquencies.

Should such metrics increase, additions to the balance of the Corporation’s allowance for loan losses could be required.

The extent of the impact of the COVID-19 pandemic on the Corporation’s operational and financial performance will depend on certain developments including the duration and spread of the outbreak.

A concentration of credit exists when the total amount of loans to borrowers, who are engaged in similar activities that are similarly impacted by economic or other conditions, exceed 10% of total loans.

As of December 31, 2020 and 2019 management is of the opinion that there were no loan concentrations exceeding 10% of total loans.

Table 12 — Non-Performing Assets and Impaired Loans

in thousands)

Non-performing

assets held for resale

past-due 90 days or more and still accruing interest

(Dollars in thousands)

Non-performing assets

impaired loans

allowance for loan losses

investment in impaired loans

loans with a valuation allowance

loans without a valuation allowance

Non-accrual loans

Foreclosed assets held for resale

Loans past-due 90 days or more and still accruing interest

Total non-performing assets

Impaired loans

valuation allowance as a percent of impaired loans

loans to total loans

Non-performing

assets to total loans

Non-performing

assets to total assets

for loan losses to impaired loans

for loan losses to total non-performing assets

estate mortgages comprise 85.7% of the loan portfolio as of December 31, 2019, as compared to 83.8% as of December 31, 2018.

estate mortgages consist of both residential and commercial real estate loans.

The real estate loan portfolio is well diversified

in terms of borrowers, collateral, interest rates, and maturities.

Also, the residential real estate loan portfolio is largely

comprised of fixed rate mortgages.

The real estate loans are concentrated primarily in the Corporation’s market area and

are subject to risks associated with the local economy.

The commercial real estate loans typically reprice approximately every

three to five years and are also concentrated in the Corporation’s market area.

The Corporation’s loss exposure on

its impaired loans continues to be mitigated by collateral positions on these loans.

The allocated allowance for loan losses associated

with impaired loans is generally computed based upon the related collateral value of the loans.

The collateral values are determined

by recent appraisals, but are generally discounted by management based on historical dispositions, changes in market conditions

since the last valuation and management’s expertise and knowledge of the borrower and the borrower’s business.

AND OTHER BORROWED FUNDS

and commercial retail deposits are attracted primarily by the Corporation’s eighteen full service office locations, one

loan production office, and through its internet banking presence.

The Corporation offers a broad selection of deposit products

and continually evaluates its interest rates and fees on deposit products.

The Corporation regularly reviews competing financial

institutions’ interest rates, especially when establishing interest rates on certificates of deposit.

increased by $90,075,000, or 13.4% for the year ending December 31, 2019 as compared to December 31, 2018.

The increase in deposits

in 2019 can be attributed to increases in non-interest bearing, interest bearing and savings deposits.

In addition, time deposits

experienced the largest increase in 2019 due to the Corporation accepting $40,000,000 in brokered CDs.

following schedule reflects the remaining maturities of time deposits and other time open deposits of $100,000 or more at December

in thousands)

than or equal to 3 months

3 months through 6 months

6 months through 12 months

borrowings were $109,663,000 as of December 31, 2019, compared to $219,445,000 at December 31, 2018.

During 2019, long-term borrowings

increased from $45,000,000 to $55,000,000.

The increase in long-term borrowings in 2019 primarily resulted from borrowing additional

FHLB notes to sustain growth in the Corporation’s loan portfolio and to secure financing at low market rates.

debt decreased from $174,445,000 in 2018 to $54,663,000 as of December 31, 2019 as a result of increased deposit balances and

increased cash provided by investment activity.

Short-term borrowings are comprised of federal funds purchased, securities sold

under agreements to repurchase, Federal Discount Window and short-term borrowings from FHLB.

Short-term borrowings from FHLB are

commonly used to offset seasonal fluctuations in deposits.

connection with FHLB borrowings, Federal Discount Window, and securities sold under agreements to repurchase, the Corporation

maintains certain eligible assets as collateral.

following table shows information about the Corporation’s short-term borrowings as of December 31, 2019 and 2018.

13 ― Short-Term Borrowings

in thousands)

funds purchased

sold under agreements to repurchase

Discount Window

Home Loan Bank

in thousands)

funds purchased

sold under agreements to repurchase

Discount Window

Home Loan Bank

increases in capital are generated by net income, less cash dividends paid out.

Also, the net unrealized gains or losses on debt

securities available-for-sale, net of taxes, referred to as accumulated other comprehensive income, may increase or decrease total

equity capital.

Non-accrual loans

Accruing TDRs

Total impaired loans

Allocated allowance for loan losses

Net investment in impaired loans

Impaired loans with a valuation allowance

Impaired loans without a valuation allowance

Total impaired loans

Allocated valuation allowance as a percent of impaired loans

Impaired loans to total loans

Non-performing assets to total loans

Non-performing assets to total assets

Allowance for loan losses to impaired loans

Allowance for loan losses to total non-performing assets

Real estate mortgages comprise 86.6% of the loan portfolio as of December 31, 2020, as compared to 85.7% as of December 31, 2019.

Real estate mortgages consist of both residential and commercial real estate loans.

The real estate loan portfolio is well diversified in terms of borrowers, collateral, interest rates, and maturities.

Also, the residential real estate loan portfolio is largely comprised of fixed rate mortgages.

The real estate loans are concentrated primarily in the Corporation’s market area and are subject to risks associated with the local economy.

The commercial real estate loans typically reprice approximately every three to five years and are also concentrated in the Corporation’s market area.

The Corporation’s loss exposure on its impaired loans continues to be mitigated by collateral positions on these loans.

The allocated allowance for loan losses associated with impaired loans is generally computed based upon the related collateral value of the loans.

The collateral values are determined by recent appraisals or Certificates of Inspection, but are generally discounted by management based on historical dispositions, changes in market conditions since the last valuation and management’s expertise and knowledge of the borrower and the borrower’s business.

DEPOSITS, OTHER BORROWED FUNDS AND SUBORDINATED DEBT

Consumer and commercial retail deposits are attracted primarily by the Corporation’s eighteen full service office locations, one loan production office, and through its internet banking presence.

The Corporation offers a broad selection of deposit products and continually evaluates its interest rates and fees on deposit products.

The Corporation regularly reviews competing financial institutions’ interest rates, especially when establishing interest rates on certificates of deposit.

Deposits increased by $175,860,000, or 23.1% for the year ending December 31, 2020 as compared to December 31, 2019.

The increase in deposits in 2020 can be attributed to increases in non-interest bearing, interest bearing and savings deposits.

The increase in deposits was the result of many different factors including the deposit of stimulus funds, PPP loan proceeds, an $83,000,000 increase in highly rate sensitive deposits and other normal fluctuations in deposits during 2020.

The following schedule reflects the remaining maturities of time deposits and other time open deposits of $100,000 or more at December 31, 2020.

(Dollars in thousands)

Other Time Open

Less than or equal to 3 months

Over 3 months through 6 months

Over 6 months through 12 months

Over 12 months

Total borrowings were $64,494,000 as of December 31, 2020, compared to $109,663,000 at December 31, 2019.

During 2020, long-term borrowings decreased from $55,000,000 to $45,000,000.

The decrease in long-term borrowings in 2020 was the result of the maturity of two individual term notes with FHLB.

Short-term debt decreased from $54,663,000 in 2019 to $19,494,000 as of December 31, 2020 as a result of increased deposit balances.

Short-term borrowings are comprised of federal funds purchased, securities sold under agreements to repurchase, Federal Discount Window and short-term borrowings from FHLB.

Short-term borrowings from FHLB are commonly used to offset seasonal fluctuations in deposits.

In connection with FHLB borrowings, Federal Discount Window, and securities sold under agreements to repurchase, the Corporation maintains certain eligible assets as collateral.

The following table shows information about the Corporation’s short-term borrowings as of December 31, 2020 and 2019.

Table 13 — Short-Term Borrowings

(Dollars in thousands)

Federal funds purchased

Securities sold under agreements to repurchase

Federal Discount Window

Federal Home Loan Bank

(Dollars in thousands)

Federal funds purchased

Securities sold under agreements to repurchase

Federal Discount Window

Federal Home Loan Bank

On December 10, 2020, the Corporation issued $25,000,000 aggregate principal amount of Subordinated Notes due December 31, 2030 (the “2020 Notes”).

The 2020 Notes are intended to be treated as Tier 2 capital for regulatory capital purposes.

The 2020 Notes bear a fixed interest rate of 4.375% per year for the first five years and then float based on a benchmark rate (as defined).

CAPITAL STRENGTH

Normal increases in capital are generated by net income, less cash dividends paid out.

Also, the net unrealized gains or losses on debt securities available-for-sale, net of taxes, referred to as accumulated other comprehensive income, may increase or decrease total equity capital.

The total net increase in capital was $15,490,000 in 2020 after an increase of $11,996,000 in 2019.

The increase in

equity capital in 2019 was due to the retention of $3,980,000 in earnings and the issuance of new shares through the Corporation’s

Dividend Reinvestment Program (“DRIP”) amounting to $1,214,000.

Accumulated other comprehensive income increased $6,802,000

in 2019 as a result of market fluctuations in the investment portfolio.

Corporation had 231,612 shares of common stock as of December 31, 2019 and December 31, 2018, at a cost of $5,709,000, as treasury

stock, authorized and issued but not outstanding.

on average equity (“ROE”) is computed by dividing net income by average stockholders’ equity.

This ratio was

8.17% for 2019 and 8.05% for 2018.

Refer to Performance Ratios on page 21 — Selected Financial Data for a more expanded

listing of the ROE.

capitalization of banks and bank holding companies is required and monitored by regulatory authorities.

Table 14 reflects risk-based

capital ratios and the leverage ratio for the Bank.

The Bank’s leverage ratio was 9.42% at December 31, 2019 and 9.01% at

December 31, 2018.

Bank has consistently maintained regulatory capital ratios at or above the “well capitalized” standards.

To be categorized

as “well capitalized”, the Bank must maintain minimum tier 1 risk-based capital, common equity tier 1 risk based capital,

total risk-based capital and tier 1 leverage ratios of 8.0%, 6.5%, 10.0% and 5.0%, respectively.

For additional information on

capital ratios, see Note 13 — Regulatory Matters.

The risk-based capital calculation assigns various levels of risk to different

categories of bank assets, requiring higher levels of capital for assets with more risk.

Also measured in the risk-based capital

ratio is credit risk exposure associated with off-balance sheet contracts and commitments.

14 — Capital Ratios

December 31, 2019, the Bank met the definition of a “well-capitalized” institution under the regulatory framework

for prompt corrective action and the minimum capital requirements under Basel III.

The following table presents the Bank’s

capital ratios as of December 31, 2019 and December 31, 2018:

1 leverage ratio (to average assets)

Equity Tier 1 capital ratio (to risk-weighted assets)

1 risk-based capital ratio (to risk-weighted assets)

risk-based capital ratio

the final capital rules that became effective on January 1, 2015, there was a requirement for a common equity tier 1 capital conservation

buffer of 2.5% of risk-weighted assets which is in addition to the other minimum risk-based capital standards in the rule.

that do not maintain this required capital buffer will become subject to progressively more stringent limitations on the percentage

of earnings that can be paid out in dividends or used for stock repurchases and on the payment of discretionary bonuses to senior

executive management.

The capital buffer requirement was phased in over three years beginning in 2016.

The capital buffer requirement

effectively raises the minimum required common equity tier 1 capital ratio to 7.0%, the tier 1 capital ratio to 8.5%, and the

total capital ratio to 10.5% on a fully phased-in basis on January 1, 2019.

As of December 31, 2019, the Bank meets all capital

adequacy requirements under the Basel III Capital Rules on a fully phased-in basis.

Corporation’s capital ratios are not materially different than those of the Bank.

Corporation’s objective is to maintain adequate liquidity to meet funding needs at a reasonable cost and provide contingency

plans to meet unanticipated funding needs or a loss of funding sources, while minimizing interest rate risk.

Adequate liquidity

is needed to provide the funding requirements of depositors’ withdrawals, loan growth, and other operational needs.

of liquidity are as follows:

in the core deposit base;

from sales or maturities of investment securities;

received on loans and mortgage-backed securities;

correspondent bank borrowings on various credit lines, notes, etc., with various levels

sold under agreements to repurchase;

December 31, 2019, the Corporation had $353,426,000 in available borrowing capacity at FHLB (which takes into account FHLB long-term

notes and FHLB short-term borrowings);

the maximum borrowing capacity at ACBB was $15,000,000 and the maximum borrowing capacity

of the Federal Discount Window was $4,805,000.

Corporation enters into “Repurchase Agreements” in which it agrees to sell securities subject to an obligation to

repurchase the same or similar securities.

Because the agreement both entitles and obligates the Corporation to repurchase the

assets, the Corporation may transfer legal control of the securities while still retaining effective control.

As a result, the

repurchase agreements are accounted for as collateralized financing agreements (secured borrowings) and act as an additional source

of liquidity.

The increase in equity capital in 2020 was due to the retention of $5,529,000 in earnings and the issuance of new shares through the Corporation’s Dividend Reinvestment Program (“DRIP”) amounting to $1,312,000.

Accumulated other comprehensive income increased $8,649,000 in 2020 as a result of market fluctuations in the investment portfolio.

The Corporation had 231,612 shares of common stock as of December 31, 2020 and December 31, 2019, at a cost of $5,709,000, as treasury stock, authorized and issued but not outstanding.

Return on average equity (“ROE”) is computed by dividing net income by average stockholders’ equity.

This ratio was 8.61% for 2020 and 8.17% for 2019.

Refer to Performance Ratios on page 24 — Selected Financial Data for a more expanded listing of the ROE.

Adequate capitalization of banks and bank holding companies is required and monitored by regulatory authorities.

Table 14 reflects risk-based capital ratios and the leverage ratio for the Bank.

The Bank’s leverage ratio was 10.81% at December 31, 2020 and 9.42% at December 31, 2019.

The Bank has consistently maintained regulatory capital ratios at or above the “well capitalized” standards.

To be categorized as “well capitalized”, the Bank must maintain minimum tier 1 risk-based capital, common equity tier 1 risk based capital, total risk-based capital and tier 1 leverage ratios of 8.0%, 6.5%, 10.0% and 5.0%, respectively.

For additional information on capital ratios, see Note 14 — Regulatory Matters.

The risk-based capital calculation assigns various levels of risk to different categories of bank assets, requiring higher levels of capital for assets with more risk.

Also measured in the risk-based capital ratio is credit risk exposure associated with off-balance sheet contracts and commitments.

Table 14 — Capital Ratios

At December 31, 2020, the Bank met the definition of a “well-capitalized” institution under the regulatory framework for prompt corrective action and the minimum capital requirements under Basel III.

The following table presents the Bank’s capital ratios as of December 31, 2020 and December 31, 2019:

Corrective Action

Tier 1 leverage ratio (to average assets)

Common Equity Tier 1 capital ratio (to risk-weighted assets)

Tier 1 risk-based capital ratio (to risk-weighted assets)

Total risk-based capital ratio

The increase in the Bank’s capital ratios was mainly due to $22,500,000 contributed by the Corporation from proceeds of a $25,000,000 subordinated debt issuance.

The subordinated debt is treated as tier 1 capital at the Bank level and tier 2 capital at the Corporation level for regulatory capital purposes.

Under the final capital rules that became effective on January 1, 2015, there was a requirement for a common equity tier 1 capital conservation buffer of 2.5% of risk-weighted assets which is in addition to the other minimum risk-based capital standards in the rule.

Institutions that do not maintain this required capital buffer will become subject to progressively more stringent limitations on the percentage of earnings that can be paid out in dividends or used for stock repurchases and on the payment of discretionary bonuses to senior executive management.

The capital buffer

requirement was phased in over three years beginning in 2016.

The capital buffer requirement effectively raises the minimum required common equity tier 1 capital ratio to 7.0%, the tier 1 capital ratio to 8.5%, and the total capital ratio to 10.5% on a fully phased-in basis on January 1, 2019.

As of December 31, 2020, the Bank meets all capital adequacy requirements under the Basel III Capital Rules on a fully phased-in basis.

The Corporation’s capital ratios are not materially different than those of the Bank.

LIQUIDITY MANAGEMENT

The Corporation’s objective is to maintain adequate liquidity to meet funding needs at a reasonable cost and provide contingency plans to meet unanticipated funding needs or a loss of funding sources, while minimizing interest rate risk.

Adequate liquidity is needed to provide the funding requirements of depositors’ withdrawals, loan growth, and other operational needs.

Sources of liquidity are as follows:

● Growth in the core deposit base;

● Proceeds from sales or maturities of investment securities;

● Payments received on loans and mortgage-backed securities;

● Overnight correspondent bank borrowings on various credit lines, notes, etc., with various levels of capacity;

● Securities sold under agreements to repurchase;

● Brokered CDs.

At December 31, 2020, the Corporation had $402,240,000 in available borrowing capacity at FHLB (which takes into account FHLB long-term notes and FHLB short-term borrowings);

the maximum borrowing capacity at ACBB was $15,000,000 and the maximum borrowing capacity of the Federal Discount Window was $4,215,000.

The Corporation enters into “Repurchase Agreements” in which it agrees to sell securities subject to an obligation to repurchase the same or similar securities.

Because the agreement both entitles and obligates the Corporation to repurchase the assets, the Corporation may transfer legal control of the securities while still retaining effective control.

As a result, the repurchase agreements are accounted for as collateralized financing agreements (secured borrowings) and act as an additional source of liquidity.

Securities sold under agreements to repurchase were $19,494,000 at December 31, 2020.

liquidity is provided by investment securities maturing in one year or less, other short-term investments, federal funds sold,

and cash and due from banks.

The liquidity is augmented by repayment of loans and cash flows from mortgage-backed and asset-backed

Liability liquidity is accomplished primarily by maintaining a core deposit base, acquired by attracting new deposits

and retaining maturing deposits.

Asset liquidity is provided by investment securities maturing in one year or less, other short-term investments, federal funds sold, and cash and due from banks.

The liquidity is augmented by repayment of loans and cash flows from mortgage-backed and asset-backed securities.

Liability liquidity is accomplished primarily by maintaining a core deposit base, acquired by attracting new deposits and retaining maturing deposits.

Also, short-term borrowings provide funds to meet liquidity needs.

cash flows provided by operating activities were $12,539,000 and $14,741,000 at December 31, 2019 and 2018, respectively.

income amounted to $10,227,000 for the year ended December 31, 2019 and $9,211,000 for the year ended December 31, 2018.

the years ended December 31, 2019 and 2018, net premium amortization on investment securities amounted to $2,624,000 and $3,343,000,

respectively.

Cash utilized for originations of mortgage loans originated for resale exceeded proceeds (including gains) from

sales of mortgage loans originated for resale by $1,664,000 for the year ended December 31, 2019, and proceeds (including gains)

from sales of mortgage loans originated for resale exceeded cash utilized for originations of mortgage loans originated for resale

by $22,000 for the year ended December 31, 2018.

Net securities gains were $911,000 for the year ended December 31, 2019, compared

to net securities losses of $65,000 for the year ended December 31, 2018.

Other assets increased by $916,000 and $81,000 during

the years ended December 31, 2019 and 2018, respectively.

Other liabilities increased by $1,667,000 during the year ended December

31, 2019 and decreased by $17,000 during the year ended December 31, 2018.

activities provided cash of $11,986,000 during the year ended December 31, 2019 and used cash of $29,045,000 during the year ended

December 31, 2018.

Net activity associated with the debt securities available-for-sale portfolio (including proceeds from sale,

maturities, and redemptions net against purchases) provided cash of $45,660,000 and $23,964,000 during the years ended December

31, 2019 and 2018, respectively.

Net cash used to originate loans amounted to $39,504,000 during the year ended December 31, 2019

and $48,203,000 during the year ended December 31, 2018.

activities used cash of $24,751,000 during the year ended December 31, 2019 and provided cash of $16,515,000 during the year ended

December 31, 2018.

Deposits increased by $90,075,000 during the year ended December 31, 2019 and decreased by $106,593,000 during

the year ended December 31, 2018.

Short-term borrowings decreased by $119,782,000 during the year ended December 31, 2019 and

increased by $148,149,000 during the year ended December 31, 2018.

Proceeds from long-term borrowings amounted to $30,000,000

during the year ended December 31, 2019 and $3,000,000 during the year ended December 31, 2018.

Repayment of long-term borrowings

amounted to $20,000,000 at December 31, 2019 and $23,000,000 at December 31, 2018.

Dividends paid amounted to $6,247,000 and $6,194,000

during the years ended December 31, 2019 and 2018, respectively.

liquidity remains an important segment of asset/liability management.

The overall liquidity position of the Corporation is maintained

by an active asset/liability management committee.

The Corporation believes that its core deposit base is stable even in periods

of changing interest rates.

Net cash flows used in operating activities were $1,957,000 as of December 31, 2020, compared to net cash flows provided by operating activities of $12,539,000 as of December 31, 2019.

Net income amounted to $11,837,000 for the year ended December 31, 2020 and $10,227,000 for the year ended December 31, 2019.

During the years ended December 31, 2020 and 2019, net premium amortization on investment securities amounted to $2,003,000 and $2,624,000, respectively.

Originations of mortgage loans originated for resale exceeded proceeds (including gains) from sales of mortgage loans originated for resale by $15,115,000 and $1,664,000 for the years ended December 31, 2020 and 2019, respectively.

Net securities losses were $58,000 for the year ended December 31, 2020, compared to net securities gains of $911,000 for the year ended December 31, 2019.

Accrued interest receivable increased by $1,139,000 during the year ended December 31, 2020 and decreased by $636,000 during the year ended December 31, 2019.

Other assets decreased by $550,000 during the year ended December 31, 2020 and increased by $916,000 during the year ended December 31, 2019.

Other liabilities decreased by $867,000 during the year ended December 31, 2020, compared to an increase of $1,667,000 during the year ended December 31, 2019.

Investing activities used cash of $135,264,000 during the year ended December 31, 2020 and provided cash of $11,986,000 during the year ended December 31, 2019.

Net activity in the available-for-sale securities portfolio (including proceeds from sale, maturities, and redemptions net against purchases) used cash of $79,609,000 during the year ended December 31, 2020 and provided cash of $45,660,000 during the year ended December 31, 2019.

Net cash used to originate loans amounted to $57,415,000 and $39,504,000 during the years ended December 31, 2020 and 2019, respectively.

Financing activities provided cash of $150,677,000 during the year ended December 31, 2020 and used cash of $24,751,000 during the year ended December 31, 2019.

Deposits increased by $175,860,000 and $90,075,000 during the years ended December 31, 2020 and 2019, respectively.

Short-term borrowings decreased by $35,169,000 and $119,782,000 during the years ended December 31, 2020 and 2019, respectively.

There were no proceeds from long-term borrowings during the year ended December 31, 2020, compared to proceeds from long-term borrowings of $30,000,000 for the year ended December 31, 2019.

Repayment of long-term borrowings amounted to $10,000,000 for the year ended December 31, 2020 and $20,000,000 for the year ended December 31, 2019.

Proceeds from issuance of subordinated debentures amounted to $25,000,000 for the year ended December 31, 2020, compared to the year ended December 31, 2019 when there were no issuances of subordinated debentures.

Dividends paid amounted to $6,308,000 and $6,247,000 during the years ended December 31, 2020 and 2019, respectively.

Managing liquidity remains an important segment of asset/liability management.

The overall liquidity position of the Corporation is maintained by an active asset/liability management committee.

The Corporation believes that its core deposit base is stable even in periods of changing interest rates.

Liquidity and funds management are governed by policies and measured on a monthly basis.

These measurements

indicate that liquidity generally remains stable and exceeds the Corporation’s minimum defined levels of adequacy.

than the trends of continued competitive pressures and volatile interest rates, there are no known demands, commitments, events

or uncertainties that will result in, or that are reasonably likely to result in, liquidity increasing or decreasing in any material

15 represents scheduled maturities of the Corporation’s contractual obligations by time remaining until maturity as of December

15 — Contractual Obligations

in thousands)

sold under agreement to repurchase

lease obligations

Sheet Arrangements

The Corporation is party to financial instruments

with off-balance sheet risk in the normal course of business to meet the financing needs of its customers.

These financial instruments

include commitments to extend credit and, to a lesser extent, standby letters of credit.

At December 31, 2019, the Corporation

had outstanding unfunded commitments to extend credit of $122,082,000 and outstanding standby letters of credit of $3,565,000.

Because these commitments generally have fixed expiration dates and many will expire without being drawn upon, the total commitment

level does not necessarily represent future cash requirements.

Please refer to Note 14 — Financial Instruments with

Off-Balance Sheet Risk and Concentrations of Credit Risk for a discussion of the nature, business purpose, and importance of the

Corporation’s off-balance sheet arrangements.

Market risk is the risk of loss arising

from adverse changes in the fair value of financial instruments due to changes in interest rates, exchange rates and equity prices.

These measurements indicate that liquidity generally remains stable and exceeds the Corporation’s minimum defined levels of adequacy.

Other than the trends of continued competitive pressures and volatile interest rates, there are no known demands, commitments, events or uncertainties that will result in, or that are reasonably likely to result in, liquidity increasing or decreasing in any material way.

Given our financial strength, we expect to be able to maintain adequate liquidity as we manage through the current environment, utilizing current funding options and possibly exploring new options, such as the Federal Reserve’s Paycheck Protection Program Liquidity Facility (“PPPLF”).

Table 15 represents scheduled maturities of the Corporation’s contractual obligations by time remaining until maturity as of December 31, 2020.

Table 15 — Contractual Obligations

(Dollars in thousands)

December 31, 2020

Time deposits

Securities sold under agreement to repurchase

Long-term borrowings

Subordinated debentures

Operating lease obligations

Financing lease obligations

Off-Balance Sheet Arrangements

The Corporation is party to financial instruments with off-balance sheet risk in the normal course of business to meet the financing needs of its customers.

These financial instruments include commitments to extend credit and, to a lesser extent, standby letters of credit.

At December 31, 2020, the Corporation had outstanding unfunded commitments to extend credit of $114,836,000 and outstanding standby letters of credit of $4,623,000.

Because these commitments generally have fixed expiration dates and many will expire without being drawn upon, the total commitment level does not necessarily represent future cash requirements.

Please refer to Note 15 — Financial Instruments with Off-Balance

Sheet Risk and Concentrations of Credit Risk for a discussion of the nature, business purpose, and importance of the Corporation’s off-balance sheet arrangements.

Market risk is the risk of loss arising from adverse changes in the fair value of financial instruments due to changes in interest rates, exchange rates and equity prices.

The Corporation’s market risk is composed primarily of interest rate risk.

The Corporation’s interest rate risk results

from timing differences in the repricing of assets, liabilities, off-balance sheet instruments, and changes in relationships between

rate indices and the potential exercise of explicit or embedded options.

Increases in the level of interest rates

also may adversely affect the fair value of the Corporation’s securities and other earning assets.

Generally, the fair value

of fixed-rate instruments fluctuates inversely with changes in interest rates.

As a result, increases in interest rates could

result in decreases in the fair value of the Corporation’s interest-earning assets, which could adversely affect the Corporation’s

results of operations if sold, or, in the case of interest-earning assets classified as available-for-sale, the Corporation’s

stockholders’ equity, if retained.

Under FASB ASC 320-10, Investments – Debt Securities , changes in the unrealized

gains and losses, net of taxes, on debt securities classified as available-for-sale are reflected in the Corporation’s stockholders’

The Corporation’s interest rate risk results from timing differences in the repricing of assets, liabilities, off-balance sheet instruments, and changes in relationships between rate indices and the potential exercise of explicit or embedded options.

Increases in the level of interest rates also may adversely affect the fair value of the Corporation’s securities and other earning assets.

Generally, the fair value of fixed-rate instruments fluctuates inversely with changes in interest rates.

As a result, increases in interest rates could result in decreases in the fair value of the Corporation’s interest-earning assets, which could adversely affect the Corporation’s results of operations if sold, or, in the case of interest-earning assets classified as available-for-sale, the Corporation’s stockholders’ equity, if retained.

Under FASB ASC 320-10, Investments – Debt Securities , changes in the unrealized gains and losses, net of taxes, on debt securities classified as available-for-sale are reflected in the Corporation’s stockholders’ equity.

The Corporation does not own any trading assets.

Asset/Liability Management

The principal objective of asset/liability

management is to manage the sensitivity of the net interest margin to potential movements in interest rates and to enhance profitability

through returns from managed levels of interest rate risk.

The Corporation actively manages the interest rate sensitivity of its

assets and liabilities.

The principal objective of asset/liability management is to manage the sensitivity of the net interest margin to potential movements in interest rates and to enhance profitability through returns from managed levels of interest rate risk.

The Corporation actively manages the interest rate sensitivity of its assets and liabilities.

Table 16 presents an interest sensitivity analysis of assets and liabilities as of December 31, 2020.

Several techniques are used for measuring interest rate sensitivity.

Interest rate risk arises from the mismatches in the repricing

of assets and liabilities within a given time period, referred to as a rate sensitivity gap.

If more assets than liabilities mature

or reprice within the time frame, the Corporation is asset sensitive.

This position would contribute positively to net interest

income in a rising rate environment.

Interest rate risk arises from the mismatches in the repricing of assets and liabilities within a given time period, referred to as a rate sensitivity gap.

If more assets than liabilities mature or reprice within the time frame, the Corporation is asset sensitive.

This position would contribute positively to net interest income in a rising rate environment.

Conversely, if more liabilities mature or reprice, the Corporation is liability sensitive.

This position would contribute positively to net interest income in a falling rate environment.

Limitations of interest rate sensitivity

gap analysis as illustrated in Table 16 include:

a) assets and liabilities which contractually reprice within the same period

may not, in fact, reprice at the same time or to the same extent;

b) changes in market interest rates do not affect all assets

and liabilities to the same extent or at the same time, and c) interest rate sensitivity gaps reflect the Corporation’s

position on a single day (December 31, 2019 in the case of the following schedule) while the Corporation continually adjusts its

interest sensitivity throughout the year.

The Corporation’s cumulative gap at one year indicates the Corporation is liability

Limitations of interest rate sensitivity gap analysis as illustrated in Table 16 include:

a) assets and liabilities which contractually reprice within the same period may not, in fact, reprice at the same time or to the same extent;

b) changes in market interest rates do not affect all assets and liabilities to the same extent or at the same time, and c) interest rate sensitivity gaps reflect the Corporation’s position on a single day (December 31, 2020 in the case of the following schedule) while the Corporation continually adjusts its interest sensitivity throughout the year.

The Corporation’s cumulative gap at one year indicates the Corporation is asset sensitive at December 31, 2020.

Table 16 — Interest Rate Sensitivity Analysis

(Dollars in thousands)

Liabilities/Stockholders’

December 31, 2020

Liabilities/Stockholders’ Equity

Interest Rate Sensitivity Gap

1 unchanged sentence

Earnings at Risk

The Bank’s Asset/Liability Committee

(“ALCO”) is responsible for reviewing the interest rate sensitivity position and establishing policies to monitor

and limit exposure to interest rate risk.

The guidelines established by ALCO are reviewed by the Corporation’s Board of

The Corporation recognizes that more sophisticated tools exist for measuring the interest rate risk in the balance

sheet beyond interest rate sensitivity gap.

Although the Corporation continues to measure its interest rate sensitivity gap, the

Corporation utilizes additional modeling for interest rate risk in the overall balance sheet.

Earnings at risk and economic values

at risk are analyzed.

Earnings simulation modeling addresses

earnings at risk and net present value estimation addresses economic value at risk.

While each of these interest rate risk measurements

has limitations, taken together they represent a reasonably comprehensive view of the magnitude of interest rate risk to the Corporation.

The Bank’s Asset/Liability Committee (“ALCO”) is responsible for reviewing the interest rate sensitivity position and establishing policies to monitor and limit exposure to interest rate risk.

The guidelines established by ALCO are reviewed by the Corporation’s Board of Directors.

The Corporation recognizes that more sophisticated tools exist for measuring the interest rate risk in the balance sheet beyond interest rate sensitivity gap.

Although the Corporation continues to measure its interest rate sensitivity gap, the Corporation utilizes additional modeling for interest rate risk in the overall balance sheet.

Earnings at risk and economic values at risk are analyzed.

Earnings simulation modeling addresses earnings at risk and net present value estimation addresses economic value at risk.

While each of these interest rate risk measurements has limitations, taken together they represent a reasonably comprehensive view of the magnitude of interest rate risk to the Corporation.

Earnings Simulation Modeling

The Corporation’s net income is affected

by changes in the level of interest rates.

The Corporation’s net income is affected by changes in the level of interest rates.

Net income is also subject to changes in the shape of the yield curve.

a flattening of the yield curve would result in a decline in earnings due to the compression of earning asset yields and increased

liability rates, while a steepening would result in increased earnings as earning asset yields widen.

Earnings simulation modeling is the primary

mechanism used in assessing the impact of changes in interest rates on net interest income.

The model reflects management’s

assumptions related to asset yields and rates paid on liabilities, deposit sensitivity, size and composition of the balance sheet.

For example, a flattening of the yield curve would result in a decline in earnings due to the compression of earning asset yields and increased liability rates, while a steepening would result in increased earnings as earning asset yields widen.

Earnings simulation modeling is the primary mechanism used in assessing the impact of changes in interest rates on net interest income.

The model reflects management’s assumptions related to asset yields and rates paid on liabilities, deposit sensitivity, size and composition of the balance sheet.

The assumptions are based on what management believes at that time to be the most likely interest rate environment.

risk is the change in net interest income from a base case scenario under various scenarios of rate shock increases and decreases

in the interest rate earnings simulation model.

Table 17 presents an analysis of the changes

in net interest income and net present value of the balance sheet resulting from various increases or decreases in the level of

interest rates, such as two percentage points (200 basis points) in the level of interest rates.

The calculated estimates of change

in net interest income and net present value of the balance sheet are compared to current limits approved by ALCO and the Board

of Directors.

The earnings simulation model projects net interest income would decrease 5.7%, 10.8% and 15.3% in the 100, 200

and 300 basis point increasing rate scenarios presented.

In addition, the earnings simulation model projects net interest income

would increase 1.9% and decrease 0.5% in the 100 and 200 basis point decreasing rate scenarios presented, respectively.

these forecasts are within the Corporation’s one year policy guidelines.

The analysis and model used to quantify

the sensitivity of net interest income becomes less reliable in a decreasing rate scenario given the current unprecedented low

interest rate environment with federal funds trading in the 150 – 175 basis point range.

Results of the decreasing basis

point declining scenarios are affected by the fact that many of the Corporation’s interest-bearing liabilities are at rates

below 1% and therefore likely may not decline 100 or more basis points.

However, the Corporation’s interest-sensitive assets

are able to decline by these amounts.

For the years ended December 31, 2019 and 2018, the cost of interest-bearing liabilities

averaged 1.38% and 1.13%, respectively, and the yield on average interest-earning assets, on a fully taxable equivalent basis,

averaged 4.33% and 4.11%, respectively.

Earnings at risk is the change in net interest income from a base case scenario under various scenarios of rate shock increases and decreases in the interest rate earnings simulation model.

Table 17 presents an analysis of the changes in net interest income and net present value of the balance sheet resulting from various increases or decreases in the level of interest rates, such as two percentage points (200 basis points) in the level of interest rates.

The calculated estimates of change in net interest income and net present value of the balance sheet are compared to current limits approved by ALCO and the Board of Directors.

The earnings simulation model projects net interest income would decrease 3.62%, 7.76% and 11.61% in the 100, 200 and 300 basis point increasing rate scenarios presented.

In addition, the earnings simulation model projects net interest income would decrease 2.52% and 7.79% in the 100 and 200 basis point decreasing rate scenarios presented, respectively.

All of these forecasts are within the Corporation’s one year policy guidelines.

The analysis and model used to quantify the sensitivity of net interest income becomes less reliable in a decreasing rate scenario given the current unprecedented low interest rate environment with federal funds trading in the 0 – 25 basis point range.

Results of the decreasing basis point declining scenarios are affected by the fact that many of the Corporation’s interest-bearing liabilities are at rates below 1% and therefore likely may not decline 100 or more basis points.

However, the Corporation’s interest-sensitive assets are able to decline by these amounts.

For the years ended December 31, 2020 and 2019, the cost of interest-bearing liabilities averaged 0.84% and 1.38%, respectively, and the yield on average interest-earning assets, on a fully taxable equivalent basis, averaged 4.09% and 4.33%, respectively.

Net Present Value Estimation

The net present value measures economic

value at risk and is used for helping to determine levels of risk at a point in time present in the balance sheet that might not

be taken into account in the earnings simulation model.

The net present value of the balance sheet is defined as the discounted

present value of asset cash flows minus the discounted present value of liability cash flows.

At December 31, 2019, the 100 and

200 basis point immediate decreases in rates are estimated to affect net present value with a decrease of 21.7% and 62.1%, respectively.

Additionally, net present value is projected to increase 10.2%, 13.5%, and 13.4% in the 100, 200 and 300 basis point immediate

increase scenarios, respectively.

All scenarios presented are within the Corporation’s policy limits, aside from the 100

basis point immediate decrease scenario at (21.7)% vs.

a policy limit of (20.0)% and the 200 basis point immediate decrease scenario

at (62.1)% vs.

The net present value measures economic value at risk and is used for helping to determine levels of risk at a point in time present in the balance sheet that might not be taken into account in the earnings simulation model.

The net present value of the balance sheet is defined as the discounted present value of asset cash flows minus the discounted present value of liability cash flows.

At December 31, 2020, the 100 and 200 basis point immediate decreases in rates are estimated to affect net present value with a decrease of 46.58% and 117.55%, respectively.

Additionally, net present value is projected to increase 26.71%, 40.95%, and 46.03% in the 100, 200 and 300 basis point immediate increase scenarios, respectively.

All scenarios presented are within the Corporation’s policy limits, aside from the 100 basis point

immediate decrease scenario at (46.58)% vs.

a policy limit of (20)% and the 200 basis point immediate decrease scenario at (117.55)% vs.

a policy limit of (30)%.

The computation of the effects of hypothetical

interest rate changes are based on many assumptions.

They should not be relied upon solely as being indicative of actual results,

since the computations do not account for actions management could undertake in response to changes in interest rates.

The computation of the effects of hypothetical interest rate changes are based on many assumptions.

They should not be relied upon solely as being indicative of actual results, since the computations do not account for actions management could undertake in response to changes in interest rates.

Table 17 — Effect of Change in Interest Rates

Projected Change

Effect on Net Interest Income

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‒200 bp Shock vs.

Table 18 shows the quarterly results of operations

for the Corporation for the years ended December 31, 2019 and 2018:

Table 18 shows the quarterly results of operations for the Corporation for the years ended December 31, 2020 and 2019:

Table 18 — Quarterly Results of Operations (Unaudited)

(Dollars in thousands, except per share data)

Three Months Ended

Interest income

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(Dollars in thousands, except per share data)

Three Months Ended

Interest income

8 unchanged sentences

Critical Accounting Estimates

The Corporation has chosen accounting policies

that it believes are appropriate to accurately and fairly report its operating results and financial position, and the Corporation

has applied those policies in a consistent manner.

The preparation of financial statements

in conformity with accounting principles generally accepted in the United States of America require that the Corporation make

estimates and assumptions that affect the reported amounts of assets, liabilities, revenues and expenses.

These estimates and

assumptions are based on historical or other factors believed to be reasonable under the circumstances.

The Corporation evaluates

these estimates and assumptions on an ongoing basis and may retain outside consultants, lawyers and actuaries to assist in its

These estimates, assumptions and judgments are based on information available as of the date of the consolidated financial

accordingly, as this information changes, the consolidated financial statements could reflect different estimates,

assumptions and judgments.

The Corporation considers two accounting

policies to be critical because they involve the most significant judgments and estimates used in preparation of its consolidated

financial statements.

The two policies are the determination of other-than-temporary impairment of securities and the determination

of the allowance for loan losses.

Other-Than-Temporary Impairment of

The Corporation has chosen accounting policies that it believes are appropriate to accurately and fairly report its operating results and financial position, and the Corporation has applied those policies in a consistent manner.

The preparation of financial statements in conformity with accounting principles generally accepted in the United States of America require that the Corporation make estimates and assumptions that affect the reported amounts of assets, liabilities, revenues and expenses.

These estimates and assumptions are based on historical or other factors believed to be reasonable under the circumstances.

The Corporation evaluates these estimates and assumptions on an ongoing basis and may retain outside consultants, lawyers and actuaries to assist in its evaluation.

These estimates, assumptions and judgments are based on information available as of the date of the consolidated financial statements;

accordingly, as this information changes, the consolidated financial statements could reflect different estimates, assumptions and judgments.

The Corporation considers three accounting policies to be critical because they involve the most significant judgments and estimates used in preparation of its consolidated financial statements.

The three policies are the determination of other-than-temporary impairment of securities, the determination of the allowance for loan losses, and the assessment of goodwill for possible impairment.

Other-Than-Temporary Impairment of Securities.

Valuations for the securities portfolio are determined using quoted market prices, where available.

market prices are not available, securities valuation is based on pricing models, quotes for similar securities, and observable

yield curves and spreads.

In addition to valuation, management must assess whether there are any declines in value below the carrying

value of the securites that should be considered other than temporary or otherwise require an adjustment in carrying value and

recognition of the loss in the Corporation’s Consolidated Statements of Income.

If quoted market prices are not available, securities valuation is based on pricing models, quotes for similar securities, and observable yield curves and spreads.

In addition to valuation, management must assess whether there are any declines in value below the carrying value of the securities that should be considered other than temporary or otherwise require an adjustment in carrying value and recognition of the loss in the Corporation’s Consolidated Statements of Income.

Allowance for Loan Losses.

allowance for loan losses represents management’s estimate of probable credit losses inherent in the loan portfolio.

the amount of the allowance for loan losses is considered a critical accounting estimate because it requires significant judgment

and the use of estimates related to the amount and timing of expected future cash flows on impaired loans, estimated losses on

pools of homogeneous loans based on historical loss experience, and consideration of current economic trends and conditions, all

of which may be susceptible to significant change.

The loan portfolio also represents the largest asset type on the Corporation’s

Consolidated Balance Sheets.

The allowance for loan losses represents management’s estimate of probable credit losses inherent in the loan portfolio.

Determining the amount of the allowance for loan losses is considered a critical accounting estimate because it requires significant judgment and the use of estimates related to the amount and timing of expected future cash flows on impaired loans, estimated losses on pools of homogeneous loans based on historical loss experience, and consideration of current economic trends and conditions, all of which may be susceptible to significant change.

The loan portfolio also represents the largest asset type on the Corporation’s Consolidated Balance Sheets.

Goodwill represents the excess purchase consideration over the fair value of net assets acquired in connection with acquisitions.

Goodwill is not amortized but is periodically evaluated for impairment.

Impairment testing is performed using either a qualitative or quantitative approach.

The Corporation has selected September 30 as the date to perform the annual goodwill impairment test.

Additionally, a goodwill impairment evaluation is performed on an interim basis when events or circumstances indicate impairment potentially exists.

QUANTITATIVE AND QUALITATIVE DISCLOSURES ABOUT MARKET RISK

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What changed 10-K

Item 7. Management’s Discussion and Analysis