FIRST KEYSTONE CORP 10-K

ITEM 7. 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. 22 Table of Contents RESULTS OF OPERATIONS Year Ended December 31, 2021 Versus Year Ended December 31, 2020 Net income increased to $14,688,000 for the year ended December 31, 2021, as compared to $11,837,000 for the prior year, an increase of 24.1%. Earnings per share, both basic and diluted, for 2021 was $2.49 as compared to $2.03 in 2020, an increase of 22.7%. Dividends per share for 2021 and 2020 were $1.12 and $1.08, respectively, representing a 3.7% increase. The Corporation’s return on average assets was 1.15% in 2021 and 1.09% in 2020. Return on average equity increased to 9.93% in 2021 from 8.61% in 2020. Total interest income in 2021 amounted to $42,048,000, an increase of $2,481,000 or 6.3% from 2020. The increase in interest income reflects an additional $934,000 in servicing fees earned from the SBA related to the origination of PPP loans for a total of $1,544,000 throughout 2021, plus an increase in interest earned on commercial real estate loans. Total interest expense of $5,148,000 decreased $1,212,000 or 19.1% from 2020. The majority of this decrease related to a decrease in interest paid on deposits and short-term borrowings in 2021. Selected financial data and performance ratios of the Corporation for the past five years are presented below in Table 1. Table 1 — Selected Financial Data ​ ​ ​ ​ ​ ​ ​ ​ ​ ​ ​ ​ ​ ​ ​ ​ ​ (Dollars in thousands, except per share data) ​ For the Year Ended December 31, ​ ​ 2021 2020 2019 2018 2017 ​ SELECTED FINANCIAL DATA AT YEAR END: ​ ​ ​ ​ ​ ​ Total assets ​ $ 1,320,350 ​ $ 1,179,047 ​ $ 1,007,226 ​ $ 1,012,000 ​ $ 990,121 ​ Total securities ​ 439,878 ​ 368,357 ​ 279,861 ​ 317,614 ​ 350,218 ​ Net loans ​ 744,161 ​ 712,677 ​ 640,727 ​ 599,647 ​ 551,910 ​ Total deposits ​ 1,077,969 ​ 937,488 ​ 761,628 ​ 671,553 ​ 778,146 ​ Total long-term borrowings ​ 35,000 ​ 45,000 ​ 55,000 ​ 45,000 ​ 65,000 ​ Total stockholders’ equity ​ 148,555 ​ 144,242 ​ 128,752 ​ 116,756 ​ 116,719 ​ SELECTED OPERATING DATA: ​ ​ ​ ​ ​ ​ Interest income ​ $ 42,048 ​ $ 39,567 ​ $ 38,527 ​ $ 35,573 ​ $ 32,268 ​ Interest expense ​ 5,148 ​ 6,360 ​ 10,243 ​ 8,620 ​ 6,548 ​ Net interest income ​ 36,900 ​ 33,207 ​ 28,284 ​ 26,953 ​ 25,720 ​ Provision for loan losses ​ 860 ​ 1,200 ​ 450 ​ 200 ​ 267 ​ Net interest income after provision for loan losses ​ 36,040 ​ 32,007 ​ 27,834 ​ 26,753 ​ 25,453 ​ Non-interest income ​ 7,323 ​ 6,012 ​ 6,929 ​ 5,562 ​ 6,171 ​ Non-interest expense ​ 26,354 ​ 24,605 ​ 23,422 ​ 22,645 ​ 21,521 ​ Income before income tax expense ​ 17,009 ​ 13,414 ​ 11,341 ​ 9,670 ​ 10,103 ​ Income tax expense ​ 2,321 ​ 1,577 ​ 1,114 ​ 459 ​ 1,455 ​ Net income ​ $ 14,688 ​ $ 11,837 ​ $ 10,227 ​ $ 9,211 ​ $ 8,648 ​ ​ ​ ​ ​ ​ ​ ​ ​ ​ ​ ​ ​ ​ ​ ​ ​ ​ PER SHARE DATA: ​ ​ ​ ​ ​ ​ Net income ​ $ 2.49 ​ $ 2.03 ​ $ 1.77 ​ $ 1.60 ​ $ 1.52 ​ Dividends ​ 1.12 ​ 1.08 ​ 1.08 ​ 1.08 ​ 1.08 ​ ​ ​ ​ ​ ​ ​ ​ ​ ​ ​ ​ ​ ​ ​ ​ ​ ​ PERFORMANCE RATIOS: ​ ​ ​ ​ ​ ​ Return on average assets ​ 1.15 % 1.09 % 1.02 % 0.92 % 0.86 % Return on average equity ​ 9.93 % 8.61 % 8.17 % 8.05 % 7.54 % Dividend payout ​ 45.05 % 53.29 % 61.08 % 67.26 % 71.05 % Average equity to average assets ​ 11.57 % 12.72 % 12.42 % 11.39 % 11.45 % ​ 23 Table of Contents Net interest income, as indicated below in Table 2, increased by $3,693,000 or 11.1% to $36,900,000 for the year ended December 31, 2021. The Corporation’s net interest income on a fully tax equivalent basis increased by $3,934,000, or 11.3% to $38,800,000 in 2021 as compared to $34,866,000 in 2020. Table 2 — Reconciliation of Taxable Equivalent Net Interest Income (Dollars in thousands) ​ ​ ​ ​ ​ ​ ​ ​ ​ ​ ​ ​ ​ ​ 2021/2020 ​ ​ Increase/(Decrease) ​ 2021 Amount % 2020 Interest Income ​ $ 42,048 ​ $ 2,481 6.3 ​ $ 39,567 Interest Expense ​ 5,148 ​ (1,212) (19.1) ​ 6,360 Net Interest Income ​ 36,900 ​ 3,693 11.1 ​ 33,207 Tax Equivalent Adjustment ​ 1,900 ​ 241 14.5 ​ 1,659 Net Interest Income (fully tax equivalent) ​ $ 38,800 ​ $ 3,934 11.3 ​ $ 34,866 ​ 24 Table of Contents Table 3 — Average Balances, Rates and Interest Income and Expense (Dollars in thousands) ​ ​ ​ ​ ​ ​ ​ ​ ​ ​ ​ ​ ​ ​ ​ ​ ​ ​ ​ 2021 2020 ​ ​ Average ​ ​ ​ ​ Yield/ ​ Average ​ ​ ​ ​ Yield/ ​ ​ ​ Balance ​ Interest ​ Rate ​ Balance ​ Interest ​ Rate ​ Interest Earning Assets: ​ ​ ​ ​ ​ Loans: ​ ​ ​ ​ ​ Commercial, net 1,2,4 ​ $ 94,377 ​ $ 2,681 2.84 % $ 97,418 ​ $ 3,096 3.18 % Real Estate 1,2 ​ 637,461 ​ 27,427 4.30 % 581,404 ​ 26,590 4.57 % Consumer, net 1,4 ​ 5,001 ​ 395 7.91 % 5,310 ​ 440 8.30 % Fees on Loans ​ ― ​ 2,545 — % ― ​ 1,554 — % Total Loans 5 ​ 736,839 ​ 33,048 4.49 % 684,132 ​ 31,680 4.63 % ​ ​ ​ ​ ​ ​ ​ ​ ​ ​ ​ ​ ​ ​ ​ ​ ​ ​ Securities: ​ ​ ​ ​ ​ Taxable ​ 281,742 ​ 5,640 2.00 % 205,236 ​ 4,792 2.33 % Tax-Exempt 1,3 ​ 129,870 ​ 5,084 3.91 % 103,696 ​ 4,528 4.37 % Total Investment Securities ​ 411,612 ​ 10,724 2.61 % 308,932 ​ 9,320 3.02 % Restricted Investment in Bank Stocks ​ 2,193 ​ 96 4.38 % 3,605 ​ 210 5.84 % Interest-Bearing Deposits in Other Banks ​ 53,622 ​ 80 0.15 % 10,508 ​ 16 0.15 % Total Other Interest Earning Assets ​ 55,815 ​ 176 0.32 % 14,113 ​ 226 1.61 % Total Interest Earning Assets ​ 1,204,266 ​ 43,948 3.65 % 1,007,177 ​ 41,226 4.09 % ​ ​ ​ ​ ​ ​ ​ ​ ​ ​ ​ ​ ​ ​ ​ ​ ​ ​ Non-Interest Earning Assets: ​ ​ ​ ​ ​ Cash and Due From Banks ​ 9,218 ​ ​ 8,292 ​ ​ Allowance for Loan Losses ​ (8,144) ​ ​ (7,330) ​ ​ Premises and Equipment ​ 19,448 ​ ​ 20,309 ​ ​ Other Assets ​ 53,569 ​ ​ 52,550 ​ ​ Total Non-Interest Earning Assets ​ 74,091 ​ ​ 73,821 ​ ​ Total Assets ​ $ 1,278,357 ​ ​ $ 1,080,998 ​ ​ ​ ​ ​ ​ ​ ​ ​ ​ ​ ​ ​ ​ ​ ​ ​ ​ ​ ​ ​ ​ ​ ​ ​ ​ ​ ​ ​ ​ ​ ​ ​ ​ ​ ​ ​ ​ Interest Bearing Liabilities: ​ ​ ​ ​ ​ Savings, NOW, Money Markets and Interest Checking ​ $ 626,511 ​ $ 1,454 0.23 % $ 452,323 ​ $ 1,717 0.38 % Time Deposits ​ 181,459 ​ 1,689 0.93 % 206,566 ​ 3,229 1.56 % Securities Sold U/A to Repurchase ​ 26,352 ​ 92 0.35 % 18,350 ​ 105 0.58 % Short-Term Borrowings ​ 553 ​ 2 0.34 % 25,396 ​ 254 1.00 % Long-Term Borrowings ​ ​ 38,013 ​ ​ 817 ​ 2.15 % ​ 50,587 ​ ​ 991 ​ 1.96 % Subordinated Debentures ​ 25,000 ​ 1,094 4.38 % 1,458 ​ 64 4.37 % Total Interest Bearing Liabilities ​ 897,888 ​ 5,148 0.57 % 754,680 ​ 6,360 0.84 % ​ ​ ​ ​ ​ ​ ​ ​ ​ ​ ​ ​ ​ ​ ​ ​ ​ ​ ​ ​ ​ ​ ​ ​ ​ ​ ​ ​ ​ ​ ​ ​ ​ ​ ​ ​ Non-Interest Bearing Liabilities: ​ ​ ​ ​ ​ Demand Deposits ​ 220,615 ​ ​ 177,691 ​ ​ Other Liabilities ​ 11,888 ​ ​ 11,172 ​ ​ Stockholders’ Equity ​ 147,966 ​ ​ 137,455 ​ ​ Total Liabilities/Stockholders’ Equity ​ $ 1,278,357 ​ ​ $ 1,080,998 ​ ​ ​ ​ ​ ​ ​ ​ ​ ​ ​ ​ ​ ​ ​ ​ ​ ​ ​ ​ ​ ​ ​ ​ ​ ​ ​ ​ ​ ​ ​ ​ ​ ​ ​ ​ ​ ​ Net Interest Income Tax Equivalent ​ ​ $ 38,800 ​ ​ $ 34,866 ​ ​ ​ ​ ​ ​ ​ ​ ​ ​ ​ ​ ​ ​ ​ ​ ​ ​ ​ Net Interest Spread ​ ​ 3.08 % ​ 3.25 % ​ ​ ​ ​ ​ ​ ​ ​ ​ ​ ​ ​ ​ ​ ​ ​ ​ ​ Net Interest Margin ​ ​ 3.22 % ​ 3.46 % 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 $188,000 and $150,000 for years 2021 and 2020, respectively. 3 Includes tax equivalent adjustments on tax-free municipal securities of $1,712,000 and $1,509,000 for years 2021 and 2020, respectively. 4 Installment loans are stated net of unearned interest. 5 Average loan balances include non-accrual loans. Interest income on non-accrual loans is not included. ​ 25 Table of Contents 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 amount of interest income is dependent upon both the volume of earning assets and the level of interest rates. 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 3 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 2021 and 2020. The yield on earning assets was 3.65% in 2021 and 4.09% in 2020. The rate paid on interest bearing liabilities was 0.57% in 2021 and 0.84% in 2020. This resulted in a decrease in our net interest spread to 3.08% in 2021, as compared to 3.25% in 2020. As Table 3 illustrates, net interest margin, which is interest income less interest expense divided by average earning assets, was 3.22% in 2021 as compared to 3.46% in 2020. Net interest margins are presented on a tax-equivalent basis. In 2021, the yield on earning assets decreased by 0.44% and the rate paid on interest bearing liabilities decreased by 0.27%. Yields decreased across all segments of interest earning assets and interest bearing liabilities during 2021, mainly as a result of the current low interest rate environment precipitated by rate cuts that occurred in the latter part of 2020 and into 2021 as a result of the COVID-19 pandemic. The yield on loans decreased from 4.63% in 2020 to 4.49% in 2021 mainly due to loans repaid or refinanced that were reinvested and new loan volume 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 2.61% in 2021 as compared to 3.02% in 2020. The decrease was mainly the result of reduced yield on tax-exempt securities which declined from 4.37% in 2020 to 3.91% in 2021 due to maturities and calls of securities that were reinvested along with new funding at lower rates. The average rate paid on short-term borrowings decreased 0.66% from 1.00% in 2020 to 0.34% in 2021. The rate paid on savings, NOW, money market, and interest checking accounts decreased 0.15% from 0.38% to 0.23% and the average rate paid on time deposits decreased 0.63% from 1.56% to 0.93%. Interest income exempt from federal tax was $3,743,000 in 2021 and $3,319,000 in 2020. Interest income exempt from federal tax increased due to the purchases of tax-exempt securities and originations of tax-exempt loans. Tax-exempt income has been adjusted to a tax-equivalent basis using an incremental rate of 21%. The decrease in net interest margin at December 31, 2021 compared to December 31, 2020 was primarily due to decreased yields on interest bearing assets in 2021, as compared to 2020. Fully tax equivalent net interest income increased by $3,934,000 or 11.3% to $38,800,000 at December 31, 2021 compared to $34,866,000 at December 31, 2020. During 2020, the Federal Reserve decreased the federal-funds rate by 1.5%, resulting in a target range of 0.00% - 0.25%. The federal-funds rate remained the throughout 2021 at the target range of 0.00% - 0.25%. 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 organic loan growth and 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 2022, as well as the slope and position of the yield curve. Table 4 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). 26 Table of Contents In 2021, the increase in net interest income on a fully tax equivalent basis of $3,934,000 resulted from an increase in volume of $4,500,000 and a decrease of $566,000 due to changes in rate. Table 4 — Rate/Volume Analysis (Dollars in thousands) ​ ​ ​ ​ ​ ​ ​ ​ ​ ​ ​ ​ 2021 COMPARED TO 2020 ​ VOLUME RATE NET Interest Income: ​ ​ ​ ​ Loans, Net ​ $ 2,441 ​ $ (1,073) ​ $ 1,368 Taxable Securities ​ 1,786 ​ (938) ​ 848 Tax-Exempt Securities ​ 1,143 ​ (587) ​ 556 Restricted Investment in Bank Stocks ​ (82) ​ (32) ​ (114) Other ​ 66 ​ (2) ​ 64 Total Interest Income ​ $ 5,354 ​ $ (2,632) ​ $ 2,722 ​ ​ ​ ​ ​ ​ ​ ​ ​ ​ Interest Expense ​ ​ ​ Savings, NOW and Money Markets ​ $ 661 ​ $ (924) ​ $ (263) Time Deposits ​ (392) ​ (1,148) ​ (1,540) Securities Sold U/A to Repurchase ​ 46 ​ (59) ​ (13) Short-Term Borrowings ​ (248) ​ (4) ​ (252) Long-Term Borrowings ​ ​ (246) ​ ​ 72 ​ ​ (174) Subordinated Debentures ​ 1,033 ​ (3) ​ 1,030 Total Interest Expense ​ 854 ​ (2,066) ​ (1,212) Net Interest Income ​ $ 4,500 ​ $ (566) ​ $ 3,934 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 LOSSES For the year ended December 31, 2021, the provision for loan losses was $860,000 as compared to $1,200,000 for the year ended December 31, 2020. The decrease in the provision for loan losses in 2021 as compared to 2020 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, 2021 is also reflective of management’s assessment of the continued 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 $113,000 and $272,000 for the years ended December 31, 2021 and 2020, respectively. See Allowance for Loan Losses on page 35 for further discussion. Gross charge-offs amounted to $158,000 at December 31, 2021, as compared to $301,000 at December 31, 2020. The increased level of charge-offs for the year ended December 31, 2020 was mainly due to three charge-offs totaling $137,000 that were completed during the fourth quarter of 2020. One charge-off in the amount of $86,000 was completed in the Commercial Real Estate portfolio on a loan to a student housing holding company 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 to be insufficient to cover the loan balance. Two charge-offs totaling $51,000 were completed in the Commercial and Industrial portfolio on loans to the former owner of a residential investment property, as the property was deemed to be uninhabitable and was sold for less than the amount owed by the borrower on the aggregate balance of all loans related to the project and the borrower failed to pay the outstanding balances due after the sale of the property. These charge-offs contributed to the increased balance of net charge-offs in 2020 over 2021 but were not indicative of a significant change in asset quality in the overall loan portfolio. See Table 11 – Analysis of Allowance for Loan Losses for further details. 27 Table of Contents The allowance for loan losses as a percentage of average loans outstanding was 1.18% as of December 31, 2021 and 1.16% as of December 31, 2020. 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 fees and debit card income, trust department revenue, increases in the cash surrender value of 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 5 provides the yearly non-interest income by category, along with the amount, dollar changes, and percentage of change comparing the last two years. Non-interest income through December 31, 2021 was $7,323,000, an increase of 21.8%, or $1,311,000, from 2020. The increase was due to increases in net securities gains, gains on sales of mortgage loans, ATM and debit card fees and service charges and fees. During 2021, net securities gains increased $381,000 to a net gain of $323,000. The increase was due to the Corporation recognizing $319,000 in net gains on held equity securities in 2021, as compared to recognizing $287,000 in net losses on held equity securities in 2020. The Corporation also recognized $229,000 in net gains on the sales of debt and equity securities during 2020 as compared to $4,000 in 2021. Gains on sales of mortgage loans provided income of $980,000 in 2021 as compared to $604,000 in 2020. The increase in gains on sales of mortgage loans in 2021 was due to more mortgage loans being sold in 2021 as compared to 2020. 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 $221,000 or 13.1% in 2021 as compared to 2020. The increase was mainly due to higher 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 more prepayment penalties earned on commercial loan payoffs during 2021. ATM fees and debit card income increased by $334,000 or 18.1% in 2021 as compared to 2020 due to increased debit card interchange fees as the result of increased transaction volume in 2021. Other income, consisting primarily of safe deposit box rentals, income from the sale of non-deposit investment products, and miscellaneous fees, decreased $1,000, or 0.3% in 2021 as compared to 2020. 28 Table of Contents Table 5 — Non-Interest Income ​ ​ ​ ​ ​ ​ ​ ​ ​ ​ ​ ​ (Dollars in thousands) ​ 2021/2020 ​ ​ Increase/(Decrease) ​ 2021 Amount % ​ 2020 Trust department ​ $ 1,008 ​ $ 13 1.3 ​ $ 995 Service charges and fees ​ 1,914 ​ 221 13.1 ​ 1,693 Increase in cash surrender value of life insurance ​ 598 ​ (13) (2.1) ​ 611 ATM fees and debit card income ​ 2,183 ​ 334 18.1 ​ 1,849 Gains on sales of mortgage loans ​ 980 ​ 376 62.3 ​ 604 Other ​ 317 ​ (1) (0.3) ​ 318 Subtotal ​ 7,000 ​ 930 15.3 ​ 6,070 Net securities gains (losses) ​ 323 ​ 381 656.9 ​ (58) Total ​ $ 7,323 ​ $ 1,311 21.8 ​ $ 6,012 ​ NON-INTEREST EXPENSE Total non-interest expense amounted to $26,354,000, an increase of $1,749,000, or 7.1% in 2021. Expenses associated with employees (salaries and employee benefits) continue to be the largest non-interest expenditure. Salaries and employee benefits amounted to $14,148,000 or 53.7% of total non-interest expense in 2021 and $13,687,000 or 55.6% in 2020. Salaries and employee benefits increased $461,000, or 3.4% in 2021. The increase in 2021 was due to normal merit increases, new position hires and filling vacant positions. The number of full-time equivalent employees was 198 as of December 31, 2021 and 195 as of December 31, 2020. Net occupancy expense decreased $124,000, or 6.2% in 2021 as compared to 2020, mainly due to an increase in 2020 for rent expense associated with the new leasing standard. Net furniture and equipment and computer expense increased $210,000, or 13.3% in 2021 compared to 2020. The increase in 2021 was due to several new software contracts that were implemented in late 2020 and early 2021 as the Corporation has continued to invest in new technology. Professional services increased $69,000, or 7.0% in 2021 as compared to 2020. The higher expense in 2021 was mainly due to amortization of consulting expense due to broker fees resulting from the Corporation’s subordinated debt issuance. Pennsylvania shares tax expense increased $335,000, or 38.6% in 2021 as compared to 2020. The increase was the result of an increase in total equity. FDIC insurance expense increased $255,000, or 151.8% in 2021 as compared to 2020. This increase was primarily due to small bank assessment credits received from the FDIC effectively reducing the expense in 2020. FDIC insurance expense varies with changes in net asset size, risk ratings, and FDIC derived assessment rates. ATM and debit card fees expense increased $185,000, or 20.4% in 2021 as compared to 2020 due to increased electronic funds transfer fees as the result of increased customer transaction volume. Data processing fees increased $34,000, or 2.9% in 2021 as compared to 2020 as the result of annual contracted pricing increases from our main third-party data processor. Foreclosed assets held for resale expense amounted to $3,000 in 2021 as compared to $50,000 in 2020, a decrease of $47,000, or 94.0%. The Corporation incurred costs associated with the maintenance and sale of one foreclosed property in 2021 and four foreclosed properties in 2020. Advertising expense increased $53,000, or 15.0% in 2021 as compared to 2020. The increase was due to an increase in digital and social media, business development, radio, civic sponsorships and events, and billboard advertising in 2021 as compared to 2020. In addition, newspaper advertising was down due to utilizing more digitally focused advertising mediums. 29 Table of Contents Other non-interest expense increased $318,000, or 11.2% in 2021 as compared to 2020. This increase included the Corporation pledging $75,000 in donations to local community organizations as well as fraud losses due to an isolated incident and increased check fraud. 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 2.06% of average assets in 2021 and 2.28% in 2020, which places the Corporation among the leaders in its peer financial institution categories in controlling non-interest expense. Table 6 — Non-Interest Expense ​ ​ ​ ​ ​ ​ ​ ​ ​ ​ ​ ​ (Dollars in thousands) 2021/2020 ​ ​ Increase/(Decrease) ​ 2021 Amount % 2020 Salaries and employee benefits ​ $ 14,148 ​ $ 461 3.4 ​ $ 13,687 Occupancy, net ​ 1,885 ​ (124) (6.2) ​ 2,009 Furniture and equipment ​ 570 ​ (20) (3.4) ​ 590 Computer expense ​ 1,220 ​ 230 23.2 ​ 990 Professional services ​ 1,050 ​ 69 7.0 ​ 981 Pennsylvania shares tax ​ 1,202 ​ 335 38.6 ​ 867 FDIC Insurance ​ 423 ​ 255 151.8 ​ 168 ATM and debit card fees ​ 1,091 ​ 185 20.4 ​ 906 Data processing fees ​ 1,200 ​ 34 2.9 ​ 1,166 Foreclosed assets held for resale ​ 3 ​ (47) (94.0) ​ 50 Advertising ​ 407 ​ 53 15.0 ​ 354 Other ​ 3,155 ​ 318 11.2 ​ 2,837 Total ​ $ 26,354 ​ $ 1,749 7.1 ​ $ 24,605 ​ INCOME TAX EXPENSE Income tax expense for the year ended December 31, 2021, was $2,321,000 as compared to $1,577,000 for the year ended December 31, 2020. The effective income tax rate was 13.6% in 2021 and 11.8% in 2020. The increase in the effective tax rate for 2021 was due to higher overall operating income. The Corporation recognized $405,000 of tax credits from low-income housing partnerships for the year ended December 31, 2021. FINANCIAL CONDITION GENERAL Total assets increased to $1,320,350,000 at year-end 2021, an increase of 12.0% from year-end 2020. Total debt securities available-for-sale increased $71,205,000 or 19.4% to $437,916,000 as of December 31, 2021. Net loans increased in 2021 from $712,677,000 to $744,161,000, a 4.4% increase. Loan demand grew in 2021 as the Bank has realized an increase in loan originations, primarily in the commercial real estate portfolio. The cash surrender value of bank owned life insurance totaled $24,792,000 at December 31, 2021, an increase of $598,000 or 2.5% from 2020. This increase represents tax-free income included in non-interest income on the consolidated statements of income. Investments in low-income housing partnerships were $1,530,000 at year-end 2021, an increase of 4.4% from year-end 2020. The Corporation became a limited partner in a new real estate venture during 2021 with an initial 30 Table of Contents investment of $435,000. 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, 2021, total deposits amounted to $1,077,969,000, an increase of 15.0% from 2020. The increase in 2021 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, a $73,000,000 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 2021 by $2,117,000, mainly due to the maturity of long-term notes with the FHLB. Total stockholders’ equity increased to $148,555,000 at December 31, 2021, an increase of $4,313,000, primarily due to an increase in retained earnings. SEGMENT REPORTING 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 94.2% for 2021 compared to 93.2% for 2020. 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 securities. 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 increased $71,205,000 or 19.4% to $437,916,000 in 2021. At December 31, 2021, the net unrealized gain, net of the tax effect, on these securities was $7,588,000 and was included in stockholders’ equity as accumulated other comprehensive income. Table 7 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, 2021, the securities portfolio does not contain any off-balance sheet derivatives or trust preferred investments. 31 Table of Contents ​ ​ Table 7 — Securities ​ ​ ​ ​ ​ ​ ​ (Dollars in thousands) ​ Available-For-Sale ​ December 31, 2021 December 31, 2020 U.S. Treasury securities ​ $ 7,729 ​ $ — U. S. Government corporations and agencies ​ 122,487 ​ 88,003 Other mortgage-backed debt securities ​ 39,550 ​ 39,844 Obligations of state and political subdivisions ​ 186,176 ​ 165,101 Asset backed securities ​ 36,542 ​ 44,821 Corporate debt securities ​ 45,432 ​ 28,942 Total ​ $ 437,916 ​ $ 366,711 ​ The amortized cost and fair value of securities, by contractual maturity, are shown below at December 31, 2021. 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 8 — Securities Maturity Table ​ ​ ​ ​ ​ ​ ​ ​ ​ ​ ​ ​ ​ ​ ​ ​ ​ ​ ​ (Dollars in thousands) ​ December 31, 2021 ​ ​ Debt Securities Available-For-Sale ​ ​ ​ ​ ​ U.S. Government ​ Other ​ Obligations ​ ​ ​ ​ ​ ​ ​ ​ ​ ​ ​ Corporations & ​ Mortgage ​ of State ​ Asset ​ Corporate ​ U.S. Treasury Agencies Backed Debt & Political Backed Debt ​ Securities Obligations 1 Securities 1 Subdivisions Securities Securities Within 1 Year: ​ ​ ​ ​ ​ ​ Amortized cost ​ $ — ​ $ — ​ $ — ​ $ 6,104 ​ $ — ​ $ 1,583 Fair value ​ — ​ — ​ — ​ 6,163 ​ — ​ 1,616 ​ ​ ​ ​ ​ ​ ​ ​ ​ ​ ​ ​ ​ ​ ​ ​ ​ ​ ​ 1 - 5 Years: ​ ​ ​ ​ ​ ​ ​ ​ ​ ​ ​ ​ ​ ​ ​ ​ ​ Amortized cost ​ — ​ 659 ​ 9,259 ​ 19,443 ​ 697 ​ 13,281 Fair value ​ — ​ 661 ​ 9,256 ​ 20,291 ​ 699 ​ 13,523 ​ ​ ​ ​ ​ ​ ​ ​ ​ ​ ​ ​ ​ ​ ​ ​ ​ ​ ​ 5 - 10 Years: ​ ​ ​ ​ ​ ​ ​ ​ ​ ​ ​ ​ ​ ​ ​ ​ ​ Amortized cost ​ 7,825 ​ 16,335 ​ 3,297 ​ 23,066 ​ — ​ 30,490 Fair value ​ 7,729 ​ 16,319 ​ 3,275 ​ 24,460 ​ — ​ 30,293 ​ ​ ​ ​ ​ ​ ​ ​ ​ ​ ​ ​ ​ ​ ​ ​ ​ ​ ​ After 10 Years: ​ ​ ​ ​ ​ ​ ​ ​ ​ ​ ​ ​ ​ ​ ​ ​ ​ Amortized cost ​ — ​ 106,681 ​ 27,325 ​ 126,408 ​ 35,858 ​ — Fair value ​ — ​ 105,507 ​ 27,019 ​ 135,262 ​ 35,843 ​ — ​ ​ ​ ​ ​ ​ ​ ​ ​ ​ ​ ​ ​ ​ ​ ​ ​ ​ ​ Total: ​ ​ ​ ​ ​ ​ Amortized cost ​ $ 7,825 ​ $ 123,675 ​ $ 39,881 ​ $ 175,021 ​ $ 36,555 ​ $ 45,354 Fair value ​ 7,729 ​ 122,487 ​ 39,550 ​ 186,176 ​ 36,542 ​ 45,432 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, 2021 and 2020, the Corporation had $1,962,000 and $1,646,000, respectively, in equity securities recorded at fair value, an increase of $316,000 or 19.2%. ​ 32 Table of Contents LOANS Total loans increased to $752,841,000 as of December 31, 2021, compared to a balance of $720,610,000 as of December 31, 2020. Table 9 provides data relating to the composition of the Corporation’s loan portfolio on the dates indicated. Total loans increased $32,231,000, or 4.5% in 2021 compared to an increase of $72,878,000, or 11.3% in 2020. Steady demand for borrowing by businesses accounted for the 4.5% increase in the loan portfolio from December 31, 2020 to December 31, 2021. Overall, the Commercial and Industrial portfolio (which includes tax-free Commercial and Industrial loans) decreased $9,349,000 or 10.2% from $91,875,000 at December 31, 2020 to $82,526,000 at December 31, 2021. The decrease in the Commercial and Industrial portfolio during the year ended December 31, 2021 was mainly attributable to a reduction of $18,082,000 in the portion of the Commercial and Industrial portfolio attributable to SBA PPP loans, the balance of which decreased from $22,967,000 at December 31, 2020 to $4,894,000 at December 31, 2021 as a result of loan forgiveness. The $18,082,000 reduction in the balance of SBA PPP loans during the year ended December 31, 2021 was the result of $16,844,000 in new SBA PPP loan originations offset by $34,926,000 in SBA PPP loan forgiveness. The portion of the Commercial and Industrial portfolio excluding PPP loans increased by $8,733,000 during the year ended December 31, 2021, mainly resulting from $24,317,000 in new loan originations for the year ended December 31, 2021, offset by loan payoffs of $8,337,000 and a decrease in utilization of existing Commercial and Industrial lines of credit of $3,559,000, as well as regular principal payments and other typical fluctuations in the Commercial and Industrial portfolio during the year ended December 31, 2021. The Commercial Real Estate portfolio (which includes tax-free Commercial Real Estate loans) increased $54,926,000 or 11.8% from $466,728,000 at December 31, 2020 to $521,654,000 at December 31, 2021. The increase is mainly attributable to $137,056,000 in new loan originations for the year ended December 31, 2021 and an increase of $8,143,000 in utilization of existing Commercial Real Estate lines of credit, offset by $69,177,000 in loan payoffs, in addition to regular principal payments and other typical amortization in the Commercial Real Estate portfolio during the year ended December 31, 2021. Residential Real Estate loans decreased $13,600,000 or 8.7% from $156,983,000 at December 31, 2020 to $143,383,000 at December 31, 2021. The decrease was mainly the result of $54,180,000 in new loan originations and an increase of $83,000 in utilization of existing Residential Real Estate (Home Equity) lines of credit, offset by $47,277,000 in loan payoffs, net loans sold of $15,061,000, and regular principal payments and other typical amortization in the Residential Real Estate portfolio during the year ended December 31, 2021. Net loans sold for the year ended December 31, 2021 consisted of total loans sold during the year ended December 31, 2021 of $29,741,000, offset with loans opened and sold in the same quarter during each quarter of 2021 which amounted to $14,680,000. 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 $604,180,000 at December 31, 2021. Of total loans, $521,654,000 or 69.3% 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 $727,319,000 or 96.7% of gross loans are graded Pass; $1,668,000 or 0.2% are graded Special Mention; $23,069,000 or 3.1% 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 3 — Loans and Allowance for Loan Losses for risk grading tables. ​ 33 Table of Contents Overall, non-pass grades increased to $24,737,000 at December 31, 2021, as compared to $24,137,000 at December 31, 2020. Commercial and Industrial non-pass grades decreased to $796,000 as of December 31, 2021, compared to $919,000 as of December 31, 2020. Commercial Real Estate non-pass grades increased to $22,346,000 as of December 31, 2021 as compared to $21,789,000 as of December 31, 2020. Residential Real Estate and Consumer non-pass grades increased to $1,595,000 as of December 31, 2021, as compared to $1,429,000 as of December 31, 2020. The increase in the Commercial Real Estate non-pass grade portfolio during the year ended December 31, 2021 is mainly due to the downgrade of one loan to a contractor specializing in modular construction in the amount of $1,000,000. The loan was downgraded to substandard and placed on non-accrual status during the second quarter of 2021 as a result of the borrower’s inability to make payments as scheduled, as the business has ceased operations and has entered into bankruptcy proceedings. 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 9. Table 9 — Loans ​ ​ ​ ​ ​ ​ ​ ​ ​ ​ ​ ​ ​ ​ ​ ​ (Dollars in thousands) ​ December 31, ​ 2021 2020 2019 2018 2017 Commercial and Industrial ​ $ 82,526 $ 91,875 $ 86,712 $ 92,220 $ 99,337 Commercial Real Estate ​ 521,654 ​ 466,728 ​ 395,801 ​ 348,476 ​ 290,970 Residential Real Estate ​ 143,383 ​ 156,983 ​ 159,350 ​ 159,741 ​ 162,925 Consumer ​ 5,278 ​ 5,024 ​ 5,869 ​ 5,955 ​ 6,165 Total Loans ​ $ 752,841 ​ $ 720,610 ​ $ 647,732 ​ $ 606,392 ​ $ 559,397 ​ The Corporation’s maturity and interest rate sensitivity information related to the loan portfolio is summarized in Table 10. Table 10 — Loan Maturity and Interest Sensitivity ​ ​ ​ ​ ​ ​ ​ ​ ​ ​ ​ ​ ​ Loans by Maturity ​ ​ ​ ​ ​ ​ ​ ​ ​ ​ ​ ​ ​ ​ December 31, 2021 (Dollars in thousands) ​ One Year ​ After One Year ​ After ​ ​ ​ ​ and Less Through Five Years Five Years Total Commercial and Industrial ​ $ 18,523 $ 28,371 $ 35,632 $ 82,526 Commercial Real Estate ​ 38,915 ​ 115,688 ​ 367,051 ​ 521,654 Residential Real Estate ​ 14,114 ​ 32,374 ​ 96,895 ​ 143,383 Consumer ​ 1,634 ​ 3,057 ​ 587 ​ 5,278 Total ​ $ 73,186 ​ $ 179,490 ​ $ 500,165 ​ $ 752,841 The above data represents the amount of loans receivable at December 31, 2021 which, based on remaining scheduled repayments of principal, are due in the periods indicated. ​ ​ ​ ​ ​ ​ ​ ​ ​ ​ ​ ​ ​ ​ 34 Table of Contents ​ ​ ​ ​ ​ ​ ​ ​ ​ ​ ​ ​ ​ ​ ​ Loans by Repricing ​ ​ ​ ​ ​ ​ ​ ​ ​ ​ ​ ​ ​ ​ December 31, 2021 (Dollars in thousands) ​ One Year ​ After One Year ​ After ​ ​ ​ ​ and Less Through Five Years Five Years Total Commercial and Industrial ​ $ 31,223 $ 37,596 $ 13,707 $ 82,526 Commercial Real Estate ​ 88,250 ​ 406,676 ​ 26,728 ​ 521,654 Residential Real Estate ​ 23,189 ​ 29,203 ​ 90,991 ​ 143,383 Consumer ​ 2,422 ​ 2,785 ​ 71 ​ 5,278 Total ​ $ 145,084 ​ $ 476,260 ​ $ 131,497 ​ $ 752,841 ​ ​ ​ ​ ​ ​ ​ ​ ​ ​ ​ ​ ​ Loans with a fixed interest rate ​ $ 40,466 ​ $ 60,707 ​ $ 102,283 ​ $ 203,456 Loans with a variable interest rate ​ 104,618 ​ 415,553 ​ 29,214 ​ 549,385 Total ​ $ 145,084 ​ $ 476,260 ​ $ 131,497 ​ $ 752,841 The above data represents the amount of loans receivable at December 31, 2021 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, 2021, the allowance for loan losses was $8,680,000 as compared to $7,933,000 as of December 31, 2020. 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. 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. Qualitative factors remained unchanged during the first quarter of 2021. During the second quarter of 2021, the qualitative factors related to the local/regional economy were decreased by one basis point across all loan segments, as the economy and job growth in the Corporation’s market areas demonstrated marked improvement over the prior quarter, and the qualitative factor related to collateral values was increased by one basis point for both the Commercial Real Estate and Residential Real Estate portfolio segments due to increasing market values in the real estate sector. Qualitative factors remained unchanged during the third quarter of 2021. During the fourth quarter of 2021, the qualitative factors related to external factors/conditions were increased by one basis point across all loan segments due to current economic uncertainty caused by the COVID-19 pandemic including increased inflation, as well as elevated unemployment levels (although improved from 2020 and early 2021) and the uncertainty of how broad the changes implemented by the Federal Reserve may be, and the qualitative factors 35 Table of Contents related to collateral values were increased by one basis point across all loan segments, as collateral values have continued to artificially increase as individuals have been willing to pay above-average market prices in all sectors. Modifications granted in compliance with Section 4013 of the CARES Act were 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 11 contains an analysis of the allowance for loan losses indicating charge-offs and recoveries by year. In 2021, net charge-offs as a percentage of average loans were 0.02% as compared to 0.04% in 2020. Net charge-offs amounted to $113,000 in 2021 and $272,000 in 2020. Net charge-offs were higher in 2020 than in 2021, mainly due to three charge-offs totaling $137,000 that were completed during the fourth quarter of 2020. One charge-off in the amount of $86,000 was completed in the Commercial Real Estate portfolio on a loan to a student housing holding company 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 to be insufficient to cover the loan balance. Two charge-offs totaling $51,000 were completed in the Commercial and Industrial portfolio on loans to the former owner of a residential investment property, as the property was deemed to be uninhabitable, was sold for less than the amount owed by the borrower on the aggregate balance of all loans related to the project, and the borrower failed to pay the outstanding balances due after the sale of the property. For the year ended December 31, 2021, the provision for loan losses was $860,000 as compared to $1,200,000 for the year ended December 31, 2020. The net effect of the provision, charge-offs and recoveries resulted in the year-end allowance for loan losses of $8,680,000 of which 7.8% was attributed to the Commercial and Industrial component, 62.3% attributed to the Commercial Real Estate component, 17.7% attributed to the Residential Real Estate component, 1.0% attributed to the Consumer component, and 11.2% being the unallocated component (refer to the activity in Note 3 — Loans and Allowance for Loan Losses on page 73.) The Corporation determined that the provision for loan losses made during 2021 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, 2021. Table 11 — Analysis of Allowance for Loan Losses ​ ​ ​ ​ ​ ​ ​ ​ ​ ​ ​ ​ ​ ​ ​ ​ ​ (Dollars in thousands) ​ Years Ended December 31, ​ ​ 2021 2020 2019 2018 2017 Balance at beginning of period ​ $ 7,933 $ 7,005 $ 6,745 $ 7,487 $ 7,357 ​ Charge-offs: ​ ​ ​ ​ ​ ​ Commercial and Industrial ​ 13 ​ 90 ​ ― ​ 18 ​ — ​ Commercial Real Estate ​ 29 ​ 141 ​ 64 ​ 783 ​ 189 ​ Residential Real Estate ​ 80 ​ 33 ​ 69 ​ 181 ​ 62 ​ Consumer ​ 36 ​ 37 ​ 71 ​ 57 ​ 82 ​ ​ ​ 158 ​ 301 ​ 204 ​ 1,039 ​ 333 ​ Recoveries: ​ ​ ​ ​ ​ ​ Commercial and Industrial ​ — ​ 14 ​ 6 ​ 31 ​ 74 ​ Commercial Real Estate ​ 30 ​ ― ​ ― ​ 60 ​ 103 ​ Residential Real Estate ​ 4 ​ 8 ​ 2 ​ — ​ 9 ​ Consumer ​ 11 ​ 7 ​ 6 ​ 6 ​ 10 ​ ​ ​ 45 ​ 29 ​ 14 ​ 97 ​ 196 ​ ​ ​ ​ ​ ​ ​ ​ ​ ​ ​ ​ ​ ​ ​ ​ ​ ​ Net charge-offs ​ 113 ​ 272 ​ 190 ​ 942 ​ 137 ​ Additions charged to operations ​ 860 ​ 1,200 ​ 450 ​ 200 ​ 267 ​ Balance at end of period ​ $ 8,680 ​ $ 7,933 ​ $ 7,005 ​ $ 6,745 ​ $ 7,487 ​ ​ ​ ​ ​ ​ ​ ​ ​ ​ ​ ​ ​ ​ ​ ​ ​ ​ Ratio of net charge-offs during the period to average loans outstanding during the period ​ 0.02 % 0.04 % 0.03 % 0.16 % 0.03 % Allowance for loan losses to average loans outstanding during the period ​ 1.18 % 1.16 % 1.13 % 1.15 % 1.40 % ​ 36 Table of Contents ​ 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. 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 1.18% in 2021 and 1.16% in 2020. Table 12 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 12 — Allocation of Allowance for Loan Losses (Dollars in thousands) ​ ​ ​ ​ ​ ​ ​ ​ ​ ​ ​ ​ ​ ​ ​ ​ ​ ​ ​ ​ ​ ​ ​ ​ ​ ​ ​ ​ December 31, ​ 2021 %* 2020 %* 2019 %* 2018 %* 2017 %* Commercial and Industrial ​ $ 681 8.8 $ 787 10.8 $ 634 9.7 $ 724 11.7 $ 949 14.0 Commercial Real Estate ​ 5,408 ​ 70.1 ​ 4,762 ​ 65.4 ​ 4,116 ​ 63.0 ​ 3,700 ​ 59.8 ​ 4,067 ​ 60.0 Residential Real Estate ​ 1,539 ​ 20.0 ​ 1,643 ​ 22.5 ​ 1,665 ​ 25.5 ​ 1,650 ​ 26.6 ​ 1,656 ​ 24.4 Consumer ​ 84 ​ 1.1 ​ 94 ​ 1.3 ​ 114 ​ 1.8 ​ 117 ​ 1.9 ​ 111 ​ 1.6 Unallocated ​ 968 ​ N/A ​ 647 ​ N/A ​ 476 ​ N/A ​ 554 ​ N/A ​ 704 ​ N/A ​ ​ $ 8,680 ​ 100.0 ​ $ 7,933 ​ 100.0 ​ $ 7,005 ​ 100.0 ​ $ 6,745 ​ 100.0 ​ $ 7,487 ​ 100.0 *Percentage of allocation in each category to total allocations in the Allowance for Loan Loss Analysis, excluding unallocated. NON-PERFORMING ASSETS Table 13 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. A loan may remain on accrual status if it is in the process of collection and is either guaranteed or well secured. 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. Any loan modifications made in response to the COVID-19 pandemic are not considered TDRs 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. 37 Table of Contents Total non-performing assets amounted to $7,066,000 as of December 31, 2021, as compared to $7,119,000 as of December 31, 2020. The economy is still in flux. Businesses have reopened to find customers wanting to return, but employees, in many cases, wanting to continue to work from home or remain unemployed. The work force has dwindled, inflationary pressures have caused prices to increase, the vaccination debate continues, and political unrest has reached an unprecedented level. These forces have 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 $7,066,000 as of December 31, 2021 as compared to $7,078,000 as of December 31, 2020. There were no foreclosed assets held for resale as of December 31, 2021, compared to $28,000 as of December 31, 2020. There were no loans past-due 90 days or more and still accruing interest as of December 31, 2021, compared to $13,000 in loans past-due 90 days or more and still accruing interest at December 31, 2020. Non-performing assets to total loans was 0.94% as of December 31, 2021 compared to 0.99% at December 31, 2020. Non-performing assets to total assets was 0.54% as of December 31, 2021 compared to 0.60% at December 31, 2020. The allowance for loan losses to total non-performing assets was 122.84% as of December 31, 2021 as compared to 111.43% as of December 31, 2020. Additional detail can be found in Table 13 – Non-Performing Assets and Impaired Loans and the Loans Receivable on Non-Accrual Status table in Note 3 — 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 $10,463,000 at December 31, 2021 and $9,992,000 at December 31, 2020. Impaired loans were $13,673,000 at December 31, 2021 and $15,054,000 at December 31, 2020. The largest impaired loan relationship at December 31, 2021 consisted of a non-performing loan to a student housing holding company which was secured by commercial real estate. At December 31, 2021, the loan carried a balance of $3,090,000, net of $1,989,000 that had been charged off to date, compared to December 31, 2020 when 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, 2021 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 $2,864,000 as of December 31, 2021, net of $943,000 that had been charged off to date, compared to December 31, 2020 when the loan carried a balance of $2,929,000, net of $943,000 that had been charged-off to date. The third largest impaired loan relationship at December 31, 2021 consisted of five non-performing loans to a plastic processing company focused on non-post-consumer recycling. Three loans were classified in the Commercial and Industrial portfolio and modified as TDRs and two loans were secured by commercial real estate. The loans carried an aggregate balance of $1,176,000 as of December 31, 2021, compared to December 31, 2020 when the loans carried an aggregate balance of $1,262,000. 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 appraisal or other qualitative 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 $13,673,000 in impaired loans at December 31, 2021, none were located outside the Corporation’s primary market area. The outstanding recorded investment of loans categorized as TDRs as of December 31, 2021 and December 31, 2020 was $8,020,000 and $9,563,000, respectively. The decrease in TDRs at December 31, 2021 as compared to December 31, 2020 is mainly attributable to the payoff of a Commercial Real Estate TDR to a real estate holding company which was completed during the third quarter of 2021 in the amount of $1,010,000, as well as regular principal payments on existing TDRs during the year ended December 31, 2021. Of the thirty-three restructured loans at December 31, 2021, six loans were classified in the Commercial and Industrial portfolio, twenty-six loans were classified in the Commercial Real Estate portfolio, and one loan was classified in the Residential Real Estate portfolio. TDRs at December 31, 2021 consisted of thirteen term modifications beyond the original stated term, three interest rate modifications, and sixteen payment modifications. At December 31, 2021, there was also one troubled debt restructuring that experienced all three types of modification—payment, rate, and term. TDRs are separately evaluated for impairment 38 Table of Contents disclosures, and if necessary, a specific allocation is established. As of December 31, 2021 and 2020, there were no specific allocations attributable to the TDRs. There were no unfunded commitments on TDRs at December 31, 2021 and 2020. At December 31, 2021, three Commercial and Industrial loans classified as TDRs with a combined recorded investment of $708,000, ten Commercial Real Estate loans classified as TDRs with a combined recorded investment of $590,000, and one Residential Real Estate loan classified as a TDR with a recorded investment of $14,000 were not in compliance with the terms of their restructure, compared to December 31, 2020 when 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. Three Commercial Real Estate loans totaling $285,000 that were modified as TDRs within the twelve months preceding December 31, 2021 experienced payment defaults during the year ended December 31, 2021. Of the loans that were modified as TDRs during the twelve months preceding December 31, 2020, two Commercial Real Estate loans totaling $57,000 experienced payment defaults during the year ended December 31, 2020. 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. The Corporation actively works with borrowers to resolve credit problems and will continue its close monitoring efforts in 2022. Excluding the assets disclosed in Table 13 – Non-Performing Assets and Impaired Loans and the Troubled Debt Restructurings section in Note 3 — 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 in flux at this time. The COVID-19 pandemic has caused much upheaval and uncertainty in the national and state economy. Experts at all levels are attempting to calculate the intermediate or long term affects that may arise. The Corporation may experience difficulties collecting payments on time from its borrowers, 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 inflationary pressures, the labor force, supply bottlenecks, the government’s ability to respond to foreign and domestic issues, and the effectiveness in controlling the spread of the outbreak, etc. and the after-effects of these factors. These factors may not immediately impact the Corporation’s operational and financial performance, as the effects of these factors may lag into the future. The Corporation is also susceptible to the impact of economic and fiscal policy factors that may evolve in the post-pandemic environment. 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, 2021 and 2020 management is of the opinion that there were no loan concentrations exceeding 10% of total loans. 39 Table of Contents Table 13 — Non-Performing Assets and Impaired Loans ​ ​ ​ ​ ​ ​ ​ ​ (Dollars in thousands) ​ December 31, ​ ​ 2021 2020 Non-performing assets ​ ​ Non-accrual loans ​ $ 7,066 ​ $ 7,078 ​ Foreclosed assets held for resale ​ — ​ 28 ​ Loans past-due 90 days or more and still accruing interest ​ — ​ 13 ​ Total non-performing assets ​ $ 7,066 ​ $ 7,119 ​ ​ ​ ​ ​ ​ ​ ​ ​ Impaired loans ​ ​ ​ Non-accrual loans ​ $ 7,066 ​ $ 7,078 ​ Accruing TDRs ​ 6,607 ​ 7,976 ​ Total impaired loans ​ 13,673 ​ 15,054 ​ Allocated allowance for loan losses ​ — ​ (8) ​ Net investment in impaired loans ​ $ 13,673 ​ $ 15,046 ​ ​ ​ ​ ​ ​ ​ ​ ​ Impaired loans with a valuation allowance ​ $ — ​ $ 486 ​ Impaired loans without a valuation allowance ​ 13,673 ​ 14,568 ​ Total impaired loans ​ $ 13,673 ​ $ 15,054 ​ ​ ​ ​ ​ ​ ​ ​ ​ Allocated valuation allowance as a percent of impaired loans ​ — % 0.05 % Impaired loans to total loans ​ 1.81 % 2.09 % Non-performing assets to total loans ​ 0.94 % 0.99 % Non-performing assets to total assets ​ 0.54 % 0.60 % Allowance for loan losses to impaired loans ​ 63.48 % 52.70 % Allowance for loan losses to total non-performing assets ​ 122.84 % 111.43 % ​ Real estate mortgages comprise 88.3% of the loan portfolio as of December 31, 2021, as compared to 86.6% as of December 31, 2020. 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 $140,481,000, or 15.0% for the year ending December 31, 2021 as compared to December 31, 2020. The increase in deposits in 2021 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, a $73,000,000 increase in highly rate sensitive deposits and other normal fluctuations in deposits during 2021. 40 Table of Contents The following schedule reflects the remaining maturities of time deposits and other time open deposits of $100,000 or more at December 31, 2021. ​ ​ ​ ​ ​ ​ ​ (Dollars in thousands) ​ Time Other Time Open ​ ​ Deposits ​ Deposits ​ ≥$100,000 ≥$100,000 Less than or equal to 3 months ​ $ 9,237 ​ $ — Over 3 months through 6 months ​ 12,308 ​ — Over 6 months through 12 months ​ 18,343 ​ 855 Over 12 months ​ 20,390 ​ — ​ ​ $ 60,278 ​ $ 855 ​ Total borrowings were $62,377,000 as of December 31, 2021, compared to $64,494,000 at December 31, 2020. During 2021, long-term borrowings decreased from $45,000,000 to $35,000,000. The decrease in long-term borrowings in 2021 was the result of the maturity of two individual term notes with FHLB. Short-term debt increased from $19,494,000 in 2020 to $27,377,000 as of December 31, 2021 as a result of increased balances of repurchase agreements. 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, 2021 and 2020. Table 14 — Short-Term Borrowings (Dollars in thousands) ​ ​ ​ ​ ​ ​ ​ ​ ​ ​ ​ ​ ​ ​ ​ 2021 ​ ​ ​ ​ ​ ​ ​ ​ Maximum ​ ​ ​ ​ Month End ​ Average ​ Month End ​ Average ​ Balance Balance Balance Rate Federal funds purchased ​ $ — $ — $ — 0.36 % Securities sold under agreements to repurchase ​ 27,377 ​ 26,352 ​ 29,853 ​ 0.35 % Federal Discount Window ​ ― ​ — ​ ― ​ 0.36 % Federal Home Loan Bank ​ — ​ 553 ​ 770 ​ 0.34 % ​ ​ $ 27,377 ​ $ 26,905 ​ $ 30,623 ​ 0.35 % ​ (Dollars in thousands) ​ ​ ​ ​ ​ ​ ​ ​ ​ ​ ​ ​ ​ ​ ​ 2020 ​ ​ ​ ​ ​ ​ ​ ​ Maximum ​ ​ ​ ​ Month End ​ Average ​ Month End ​ Average ​ Balance Balance Balance Rate Federal funds purchased ​ $ — $ — $ — 0.37 % Securities sold under agreements to repurchase ​ 19,494 ​ 18,350 ​ 23,453 ​ 0.58 % Federal Discount Window ​ ― ​ — ​ ― ​ 0.37 % Federal Home Loan Bank ​ — ​ 25,396 ​ 54,434 ​ 1.00 % ​ ​ $ 19,494 ​ $ 43,746 ​ $ 77,887 ​ 0.82 % ​ 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). ​ 41 Table of Contents 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 $4,313,000 in 2021 after an increase of $15,490,000 in 2020. The increase in equity capital in 2021 was due to the retention of $8,071,000 in earnings and the issuance of new shares through the Corporation’s Dividend Reinvestment Program (“DRIP”) amounting to $1,524,000. Accumulated other comprehensive income decreased $5,282,000 in 2021 as a result of market fluctuations in the investment portfolio. The Corporation had 231,612 shares of common stock as of December 31, 2021 and December 31, 2020, 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 9.93% for 2021 and 8.61% for 2020. Adequate capitalization of banks and bank holding companies is required and monitored by regulatory authorities. Table 15 reflects risk-based capital ratios and the leverage ratio for the Bank. The Bank’s leverage ratio was 10.14% at December 31, 2021 and 10.81% at December 31, 2020. 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 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. Table 15 — Capital Ratios At December 31, 2021, 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, 2021 and December 31, 2020: ​ ​ ​ ​ ​ ​ ​ ​ ​ ​ ​ ​ ​ ​ ​ ​ ​ ​ To Be Well ​ ​ ​ ​ ​ ​ Capitalized ​ ​ ​ ​ ​ ​ Under Prompt ​ ​ December 31, ​ December 31, ​ Corrective Action ​ ​ 2021 2020 Regulations Tier 1 leverage ratio (to average assets) 10.14 % 10.81 % 5.00 % Common Equity Tier 1 capital ratio (to risk-weighted assets) 15.52 % 15.99 % 6.50 % Tier 1 risk-based capital ratio (to risk-weighted assets) 15.52 % 15.99 % 8.00 % Total risk-based capital ratio 16.57 % 17.05 % 10.00 % ​ In 2020, there was an increase in the Bank’s capital ratios 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 42 Table of Contents 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, 2021, 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 securities; ● Payments received on loans and mortgage-backed and asset-backed securities ; ● Overnight correspondent bank borrowings on various credit lines, notes, etc., with various levels of capacity; ● Securities sold under agreements to repurchase; and ● Brokered CDs. At December 31, 2021, the Corporation had $433,394,000 in available borrowing capacity at FHLB (inclusive of the outstanding balances of FHLB long-term notes, FHLB short-term borrowings and irrevocable standby letters of credit issued by FHLB); the maximum borrowing capacity at ACBB was $15,000,000 and the maximum borrowing capacity of the Federal Discount Window was $3,162,000. 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 $27,377,000 at December 31, 2021. Asset liquidity is provided by 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. Net cash flows provided by operating activities were $15,255,000 as of December 31, 2021, compared to cash used in operating activities of $1,957,000 as of December 31, 2020. Net income amounted to $14,688,000 for the year ended December 31, 2021 and $11,837,000 for the year ended December 31, 2020. During the years ended December 31, 2021 and 2020, net premium amortization on securities amounted to $2,930,000 and $2,003,000, respectively. Gains on sales of mortgage loans were $980,000 as of December 31, 2021, compared to $604,000 as of December 31, 2020. Originations of mortgage loans originated for resale exceeded proceeds (including gains) from sales of mortgage loans originated for resale by $1,404,000 and $15,115,000 for the years ended December 31, 2021 and 2020, respectively. Net securities gains were $323,000 for the year ended December 31, 2021, compared to net securities losses of $58,000 for the year ended December 31, 2020. Accrued interest receivable decreased by $183,000 during the year ended December 31, 2021 and increased by $1,139,000 during the year ended December 31, 2020. Other assets increased by $1,554,000 during the year ended December 31, 2021 and decreased by $550,000 during the year ended December 31, 2020. Other liabilities increased by $305,000 during the year ended December 31, 2021 and decreased by $867,000 during the year ended December 31, 2020. 43 Table of Contents Investing activities used cash of $111,345,000 and $135,264,000 during the years ended December 31, 2021 and 2020, respectively. Net activity in the available-for-sale securities portfolio (including proceeds from sale, maturities, and redemptions, net against purchases) used cash of $80,814,000 during the year ended December 31, 2021, compared to $79,609,000 during the year ended December 31, 2020. Net cash used to originate loans amounted to $29,960,000 and $57,415,000 during the years ended December 31, 2021 and 2020, respectively. Financing activities provided cash of $133,248,000 and $150,677,000 during the years ended December 31, 2021 and 2020, respectively. Deposits increased by $140,481,000 during the year ended December 31, 2021 and increased by $175,860,000 during the year ended December 31, 2020. Short-term borrowings increased by $7,883,000 during the year ended December 31, 2021 and decreased by $35,169,000 during the year ended December 31, 2020. Repayment of long-term borrowings amounted to $10,000,000 for both the years ended December 31, 2021 and 2020, respectively. Dividends paid amounted to $6,617,000 for the year ended December 31, 2021, compared to $6,308,000 for the year ended December 31, 2020. 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. 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. Table 16 represents scheduled maturities of the Corporation’s contractual obligations by time remaining until maturity as of December 31, 2021. Table 16 — Contractual Obligations (Dollars in thousands) ​ ​ ​ ​ ​ ​ ​ ​ ​ ​ ​ ​ ​ ​ ​ ​ ​ Less than 1 - 3 4 -5 Over ​ December 31, 2021 ​ 1 Year ​ Years ​ Years ​ 5 Years ​ Total Time deposits ​ $ 98,618 ​ $ 56,301 ​ $ 18,145 ​ $ 28 ​ $ 173,092 Securities sold under agreement to repurchase ​ 27,377 ​ — ​ — ​ — ​ 27,377 Long-term borrowings ​ 10,000 ​ 23,000 ​ — ​ 2,000 ​ 35,000 Subordinated debentures ​ ​ — ​ ​ — ​ ​ — ​ ​ 25,000 ​ ​ 25,000 Operating lease obligations ​ ​ 120 ​ ​ 136 ​ ​ 136 ​ ​ 2,190 ​ ​ 2,582 Financing lease obligations ​ 10 ​ 7 ​ ​ — ​ — ​ 17 ​ ​ $ 136,125 ​ $ 79,444 ​ $ 18,281 ​ $ 29,218 ​ $ 263,068 ​ 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, 2021, the Corporation had outstanding unfunded commitments to extend credit of $142,335,000 and outstanding standby letters of credit of $5,727,000. 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. 44 Table of Contents MARKET RISK 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 Accounting Standards Codification (“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. Table 16 presents an interest sensitivity analysis of assets and liabilities as of December 31, 2021. 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. 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 17 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, 2021 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 sensitive at December 31, 2021. Table 17 — Interest Rate Sensitivity Analysis (Dollars in thousands) ​ ​ ​ ​ ​ ​ ​ ​ ​ ​ ​ ​ ​ ​ ​ ​ ​ ​ ​ December 31, 2021 ​ One 1 - 5 Beyond Not Rate ​ ​ ​ Year ​ Years ​ 5 Years ​ Sensitive ​ Total Assets ​ $ 250,935 ​ $ 484,352 ​ $ 497,009 ​ $ 88,054 ​ $ 1,320,350 ​ ​ ​ ​ ​ ​ ​ ​ ​ ​ ​ ​ ​ ​ ​ ​ Liabilities/Stockholders’ Equity ​ 290,439 ​ 190,919 ​ 668,827 ​ 170,165 ​ 1,320,350 ​ ​ ​ ​ ​ ​ ​ ​ ​ ​ ​ ​ ​ ​ ​ ​ Interest Rate Sensitivity Gap ​ $ (39,504) ​ $ 293,433 ​ $ (171,818) ​ $ (82,111) ​ ​ ​ ​ ​ ​ ​ ​ ​ ​ ​ ​ ​ ​ ​ ​ ​ ​ Cumulative Gap ​ $ (39,504) ​ $ 253,929 ​ $ 82,111 ​ — ​ ​ ​ ​ 45 Table of Contents 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 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. Net income is also subject to changes in the shape of the yield curve. 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 and liability 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. 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 18 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 6.05%, 11.81% and 17.31% in the 100, 200 and 300 basis point increasing rate scenarios presented. In addition, the earnings simulation model projects net interest income would decrease 2.06% and 7.72% 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, 2021 and 2020, the cost of interest-bearing liabilities averaged 0.57% and 0.84%, respectively, and the yield on average interest-earning assets, on a fully taxable equivalent basis, averaged 3.65% and 4.09%, 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, 2021, net present value is projected to increase 12.89%, 16.27%, and 13.25% in the 100, 200 and 300 basis point immediate increase scenarios, respectively. Additionally, the 100 and 200 basis point immediate decreases in rates are estimated to affect net present value with a decrease of 29.25% and 84.75%, respectively. All scenarios presented are within the Corporation’s policy limits, aside from the 100 basis point 46 Table of Contents immediate decrease scenario at (29.25)% vs. a policy limit of (20)% and the 200 basis point immediate decrease scenario at (84.75)% 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. Table 18 — Effect of Change in Interest Rates ​ ​ ​ ​ ​ ​ Projected Change Effect on Net Interest Income ​ ​ ​ 1-Year Net Income Simulation Projection ​ +300 bp Shock vs. Stable Rate (17.31) % +200 bp Shock vs. Stable Rate (11.81) % +100 bp Shock vs. Stable Rate (6.05) % Flat rate ​ ‒100 bp Shock vs. Stable Rate (2.06) % ‒200 bp Shock vs. Stable Rate (7.72) % ​ ​ ​ ​ Effect on Net Present Value of Balance Sheet ​ Static Net Present Value Change ​ +300 bp Shock vs. Stable Rate 13.25 % +200 bp Shock vs. Stable Rate 16.27 % +100 bp Shock vs. Stable Rate 12.89 % Flat rate ​ ‒100 bp Shock vs. Stable Rate (29.25) % ‒200 bp Shock vs. Stable Rate (84.75) % ​ Table 19 shows the quarterly results of operations for the Corporation for the years ended December 31, 2021 and 2020: Table 19 — Quarterly Results of Operations (Unaudited) ​ ​ ​ ​ ​ ​ ​ ​ ​ ​ ​ ​ ​ (Dollars in thousands, except per share data) ​ ​ ​ ​ ​ ​ ​ ​ ​ ​ ​ ​ ​ Three Months Ended 2021 March 31 June 30 September 30 December 31 Interest income ​ $ 10,275 ​ $ 10,259 ​ $ 10,716 ​ $ 10,798 Interest expense ​ 1,305 ​ 1,288 ​ 1,283 ​ 1,272 Net interest income ​ 8,970 ​ 8,971 ​ 9,433 ​ 9,526 Provision for loan losses ​ 135 ​ 135 ​ 185 ​ 405 Non-interest income ​ 1,875 ​ 1,865 ​ 1,697 ​ 1,886 Non-interest expense ​ 6,197 ​ 6,547 ​ 6,267 ​ 7,343 Income before income tax expense ​ 4,513 ​ 4,154 ​ 4,678 ​ 3,664 Income tax expense ​ 635 ​ 549 ​ ​ 655 ​ 482 Net income ​ $ 3,878 ​ $ 3,605 ​ $ 4,023 ​ $ 3,182 ​ ​ ​ ​ ​ ​ ​ ​ ​ ​ ​ ​ ​ Basic and diluted earnings per share ​ $ 0.66 ​ $ 0.61 ​ $ 0.68 ​ $ 0.54 ​ ​ ​ ​ 47 Table of Contents ​ ​ ​ ​ ​ ​ ​ ​ ​ ​ ​ ​ ​ (Dollars in thousands, except per share data) ​ ​ ​ ​ ​ ​ ​ ​ ​ ​ ​ ​ ​ Three Months Ended 2020 ​ March 31 ​ June 30 ​ September 30 ​ December 31 Interest income ​ $ 9,768 ​ $ 9,631 ​ $ 9,852 ​ $ 10,316 Interest expense ​ 2,392 ​ 1,513 ​ 1,231 ​ 1,224 Net interest income ​ 7,376 ​ 8,118 ​ 8,621 ​ 9,092 Provision for loan losses ​ 194 ​ 194 ​ 294 ​ 518 Non-interest income ​ 983 ​ 1,621 ​ 1,515 ​ 1,893 Non-interest expense ​ 5,915 ​ 5,655 ​ 6,256 ​ 6,779 Income before income tax expense ​ 2,250 ​ 3,890 ​ 3,586 ​ 3,688 Income tax expense ​ 197 ​ 509 ​ ​ 449 ​ 422 Net income ​ $ 2,053 ​ $ 3,381 ​ $ 3,137 ​ $ 3,266 ​ ​ ​ ​ ​ ​ ​ ​ ​ ​ ​ ​ ​ Basic and diluted earnings per share ​ $ 0.35 ​ $ 0.58 ​ $ 0.54 ​ $ 0.56 ​ 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 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. 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. 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. 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 December 31 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. 48 Table of Contents ITEM 7A. QUANTITATIVE AND QUALITATIVE DISCLOSURES ABOUT MARKET RISK Not required. ​ ​