What changed in this filing

/stocks — the workspaceLOADING

Item 1. Financial Statements

2023-05-11 compared with 2022-11-04 · 772 added, 755 removed, 882 unchanged (63% of the section changed)

3 unchanged sentences

(Dollars in thousands, except share and per share data)

September 30,

Cash and due from banks

1 unchanged sentence

Total cash and cash equivalents

Time deposits with other banks

Debt securities available-for-sale, at fair value

2 unchanged sentences

Loans held for sale

Allowance for loan losses

Allowance for credit losses

Premises and equipment, net

12 unchanged sentences

Accrued interest payable

Deferred income taxes

Other liabilities

2 unchanged sentences

Preferred stock, par value $ 2.00 per share;

authorized 1,000,000 shares as of September 30, 2022 and December 31, 2021;

issued 0 as of September 30, 2022 and December 31, 2021

authorized 1,000,000 shares as of March 31, 2023 and December 31, 2022;

issued 0 as of March 31, 2023 and December 31, 2022

Common stock, par value $ 2.00 per share;

authorized 20,000,000 shares as of September 30, 2022 and December 31, 2021;

issued 6,232,056 as of September 30, 2022 and 6,178,835 as of December 31, 2021;

outstanding 6,000,445 as of September 30, 2022 and 5,947,223 as of December 31, 2021

authorized 20,000,000 shares as of March 31, 2023 and December 31, 2022;

issued 6,271,550 as of March 31, 2023 and 6,250,763 as of December 31, 2022;

outstanding 6,039,939 as of March 31, 2023 and 6,019,152 as of December 31, 2022

Retained earnings

Accumulated other comprehensive (loss) income

Treasury stock, at cost, 231,611 shares as of September 30, 2022 and 231,612 shares as of December 31, 2021

Accumulated other comprehensive loss

Treasury stock, at cost, 231,611 shares as of March 31, 2023 and December 31, 2022

TOTAL STOCKHOLDERS’ EQUITY

3 unchanged sentences

CONSOLIDATED STATEMENTS OF INCOME

THREE AND NINE MONTHS ENDED SEPTEMBER 30, 2022 AND 2021

(Dollars in thousands, except per share data)

Three Months Ended

Nine Months Ended

September 30,

INTEREST INCOME

11 unchanged sentences

Net interest income

Provision for loan losses

Net interest income after provision for loan losses

Provision for credit losses

Net interest income after provision for credit losses

NON-INTEREST INCOME

3 unchanged sentences

ATM fees and debit card income

Net (losses) gains on sales of mortgage loans

Net securities (losses) gains

Net gains (losses) on sales of mortgage loans

Net securities losses

Total non-interest income

9 unchanged sentences

Data processing fees

Foreclosed assets held for resale expense, net

Total non-interest expense

6 unchanged sentences

FIRST KEYSTONE CORPORATION AND SUBSIDIARY

CONSOLIDATED STATEMENTS OF COMPREHENSIVE (LOSS) INCOME

THREE AND NINE MONTHS ENDED SEPTEMBER 30, 2022 AND 2021

CONSOLIDATED STATEMENTS OF COMPREHENSIVE INCOME (LOSS)

(Dollars in thousands)

Three Months Ended

September 30,

Other comprehensive loss:

Unrealized net holding losses on debt securities available-for-sale arising during the period, net of income taxes of $( 3,243 ) and $( 654 ), respectively

Less reclassification adjustment for net gains included in net income, net of income taxes of $( 0 ) and $( 1 ), respectively (a) (b)

Total other comprehensive loss

Total Comprehensive (Loss) Income

(Dollars in thousands)

Nine Months Ended

September 30,

Other comprehensive loss:

Unrealized net holding losses on debt securities available-for-sale arising during the period, net of income taxes of $( 10,688 ) and $( 1,113 ), respectively

Other comprehensive income (loss):

Unrealized net holding gains (losses) on debt securities available-for-sale arising during the period, net of income taxes of $ 1,025 and $( 4,594 ), respectively

Less reclassification adjustment for net gains included in net income, net of income taxes of $( 21 ) and $( 0 ), respectively (a) (b)

Total other comprehensive loss

Total Comprehensive (Loss) Income

Total other comprehensive income (loss)

Total Comprehensive Income (Loss)

______________________________

(a) Gross amounts are included in net securities (losses) gains on the consolidated statements of income in non-interest income.

(a) Gross amounts are included in net securities losses on the consolidated statements of income in non-interest income.

(b) Income tax amounts are included in income tax expense on the consolidated statements of income.

2 unchanged sentences

CONSOLIDATED STATEMENTS OF CHANGES IN STOCKHOLDERS’ EQUITY

NINE MONTHS ENDED SEPTEMBER 30, 2022 AND 2021

THREE MONTHS ENDED MARCH 31, 2023 AND 2022

(Dollars in thousands, except

2 unchanged sentences

Stockholders’

(Loss) Income

Balance at January 1, 2023

Other comprehensive loss, net of taxes

Cumulative effect of adoption of ASU No.

Other comprehensive income, net of taxes

Issuance of common stock under dividend reinvestment plan

1 unchanged sentence

Balance at March 31, 2023

Other comprehensive loss, net of taxes

Issuance of common stock under dividend reinvestment plan

Dividends - $ 0.28 per share

Balance at June 30, 2022

Other comprehensive loss, net of taxes

Issuance of common stock under dividend reinvestment plan

Dividends - $ 0.28 per share

Balance at September 30, 2022

(Dollars in thousands, except

per share data)

Comprehensive

Stockholders’

Balance at January 1, 2022

3 unchanged sentences

Balance at March 31, 2022

Other comprehensive income, net of taxes

Issuance of common stock under dividend reinvestment plan

Dividends - $ 0.27 per share

Balance at June 30, 2021

Other comprehensive income, net of taxes

Issuance of common stock under dividend reinvestment plan

Dividends - $ 0.28 per share

Balance at September 30, 2021

See accompanying notes to consolidated financial statements.

1 unchanged sentence

CONSOLIDATED STATEMENTS OF CASH FLOWS

NINE MONTHS ENDED SEPTEMBER 30, 2022 AND 2021

THREE MONTHS ENDED MARCH 31, 2023 AND 2022

(Dollars in thousands)

CASH FLOWS FROM OPERATING ACTIVITIES:

Adjustments to reconcile net income to net cash provided by operating activities:

Provision for loan losses

Adjustments to reconcile net income to net cash (used in) provided by operating activities:

Provision for credit losses

Depreciation and amortization

Net premium amortization on securities

Deferred income tax benefit

Net losses (gains) on sales of mortgage loans

Deferred income tax (benefit) expense

Net (gains) losses on sales of mortgage loans

Proceeds from sales of mortgage loans originated for sale

Originations of mortgage loans originated for sale

Net securities losses (gains)

(Increase) decrease in accrued interest receivable

Net securities losses

Decrease in accrued interest receivable

Increase in cash surrender value of bank owned life insurance

3 unchanged sentences

Increase in accrued interest payable

(Decrease) increase in other liabilities

NET CASH PROVIDED BY OPERATING ACTIVITIES

Decrease in other liabilities

NET CASH (USED IN) PROVIDED BY OPERATING ACTIVITIES

CASH FLOWS FROM INVESTING ACTIVITIES:

7 unchanged sentences

Purchase of investment in real estate venture

Proceeds from sales of foreclosed assets held for resale

NET CASH USED IN INVESTING ACTIVITIES

NET CASH PROVIDED BY (USED IN) INVESTING ACTIVITIES

CASH FLOWS FROM FINANCING ACTIVITIES:

Net (decrease) increase in deposits

Net decrease in deposits

Net increase in short-term borrowings

Repayment of finance lease obligations

Repayment of long-term borrowings

Common stock issued

Dividends paid

NET CASH PROVIDED BY FINANCING ACTIVITIES

(DECREASE) INCREASE IN CASH AND CASH EQUIVALENTS

NET CASH USED IN FINANCING ACTIVITIES

INCREASE (DECREASE) IN CASH AND CASH EQUIVALENTS

CASH AND CASH EQUIVALENTS, BEGINNING

2 unchanged sentences

Interest paid

Income taxes paid

SUPPLEMENTAL DISCLOSURE OF NON-CASH ACTIVITIES

Loans transferred from held for sale to held for investment portfolio

Common stock subscription receivable

11 unchanged sentences

In the opinion of management, all adjustments considered necessary for fair presentation have been included.

Operating results for the three and nine months ended September 30, 2022, are not necessarily indicative of the results for the year ending December 31, 2022.

Operating results for the three months ended March 31, 2023, are not necessarily indicative of the results for the year ending December 31, 2023.

For further information, refer to the consolidated financial statements and notes thereto included in First Keystone Corporation’s Annual Report on Form 10-K for the year ended December 31, 2022.

Subsequent Events

The Company has evaluated events and transactions occurring subsequent to the consolidated balance sheet date of September 30, 2022 for items that should potentially be recognized or disclosed in these consolidated financial statements.

The Company has evaluated events and transactions occurring subsequent to the consolidated balance sheet date of March 31, 2023 for items that should potentially be recognized or disclosed in these consolidated financial statements.

The evaluation was conducted through the date these consolidated financial statements were issued.

On October 21, 2022, the Company completed the purchase of an office building located in Bethlehem, Pennsylvania, with a total cost of $ 1,107,000 .

The Company intends to complete property renovations and utilize the building as a full-service banking facility.

NOTE 2 ― RECENT ACCOUNTING STANDARDS UPDATES (“ASU”)

Recently adopted ASUs:

There were no ASUs adopted during the first three quarters of 2022.

Pending ASUs:

In June 2016, the FASB issued ASU 2016-13, Financial Instruments-Credit Losses (Topic 326):

Adopted ASUs:

In January of 2023, the Corporation adopted ASU No.

2016-13, Financial Instruments-Credit Losses (Topic 326):

Measurement of Credit Losses on Financial Instruments .

ASU 2016-13 requires financial assets measured at amortized cost to be presented at the net amount expected to be collected, through an allowance for credit losses that is deducted from the amortized cost basis.

2016-13 required financial assets measured at amortized cost to be presented at the net amount expected to be collected, through an allowance for credit losses that is deducted from the amortized cost basis.

The measurement of expected credit losses is based on relevant information about past events, including historical experience, current conditions, and reasonable and supportable forecasts that affect the collectability of the reported amount.

ASU 2016-13 is effective for annual periods and interim periods within those annual periods beginning after December 15, 2019.

In November 2019, the FASB issued ASU 2019-10, Financial Instruments-Credit Losses (Topic 326), Derivatives and Hedging (Topic 815), and Leases (Topic 842), to delay the effective date for smaller reporting companies to fiscal years, and interim periods within those fiscal years, beginning after December 15, 2022.

It is currently unclear how the adoption of this standard will impact the Company’s consolidated financial statements, but the Company is currently evaluating the provisions of ASU 2016-13 to determine the potential impact that the adoption of the standard may have on the Company.

The Company has taken steps to prepare for the implementation when it becomes effective, such as:

The Corporation took steps to prepare for the implementation over the past several years, such as:

forming an internal committee, gathering pertinent data, consulting with outside professionals, subscribing to a new software system, and running existing and new methodologies concurrently through the period of implementation.

In March 2022, the FASB issued ASU 2022-02, Financial Instruments-Credit Losses (Topic 326):

Troubled Debt Restructurings and Vintage Disclosures , which eliminates the accounting guidance on troubled debt restructurings (“TDRs”) by creditors that have adopted the current expected credit losses (“CECL”) model and enhances disclosure requirements for certain loan refinancing and restructurings by creditors made to borrowers experiencing financial difficulty.

The ASU also amends the guidance on “vintage disclosures” to require disclosure of current-period gross charge-offs by year of origination.

For entities that have not yet adopted ASU 2016-13, the amendments in ASU 2022-02 are effective upon adoption of ASU 2016-13.

Entities may elect to apply the guidance on TDR recognition and measurement by using a modified retrospective transition method, which would result in a cumulative-effect adjustment to retained earnings, or to adopt the amendments prospectively.

If an entity elects to adopt the updated guidance on TDR recognition and measurement prospectively, the guidance should be applied to modifications occurring after the date of adoption.

The amendments on TDR disclosures and vintage disclosures should be adopted prospectively.

The Company plans to adopt ASU 2022-02 upon the adoption of ASU 2016-13 and is currently evaluating the provisions of ASU 2022-02 and ASU 2016-13 to determine the potential impact the new standard will have on the Company’s consolidated financial statements.

The Corporation also completed a data and model validation analysis and prepared policies related to the adoption process.

The Corporation adopted the ASU’s provisions using the modified retrospective method and evaluated the impact the current expected credit loss (“CECL”) model had on the accounting for credit losses, and recognized a one-time, cumulative-effect adjustment to retained earnings at the beginning of the first reporting period in which the new standard became effective.

The cumulative-effect adjustment resulted in an increase to retained earnings of $ 768,000 , an additional reserve for unfunded commitments of $ 147,000 , a decrease in the allowance for credit losses of $ 1,119,000 , and a decrease in deferred tax assets of $ 204,000 , as outlined in the table on the next page.

There was no impact on the securities portfolio upon adoption.

This adoption method is considered a change in accounting principle requiring additional disclosure of the nature of and reason for the change, which is solely a result of the adoption of the required standard.

January 1, 2023

As Reported Under ASU

2016-13 Adoption

Allowance For Credit Losses

Deferred Income Taxes

Other Liabilities

Retained Earnings

Effect on deferred tax assets related to the adjustment to the allowance for credit losses and reserve for unfunded lending commitments from the adoption of ASU 2016-13 using a 21 % tax rate

Adjustment to the reserve for unfunded lending commitments related to the adoption of ASU 2016-13

Adjustment to undistributed profits related to the adoption of ASU 2016-13

In January of 2023, the Corporation adopted ASU No.

2022-02, Financial Instruments-Credit Losses (Topic 326):

Troubled Debt Restructurings and Vintage Disclosures , which eliminated the accounting guidance on troubled debt restructurings (“TDRs”) by creditors that have adopted the CECL model and enhances disclosure requirements for certain loan refinancing and restructurings by creditors made to borrowers experiencing financial difficulty.

The ASU also amended the guidance on “vintage disclosures” to require disclosure of current-period gross charge-offs by year of origination.

The Corporation adopted the ASU’s provisions using the modified retrospective method in conjunction with the CECL adoption.

The adoption of ASU 2022-02 did not have a material impact on the Corporation’s consolidated financial statements.

Pending ASUs:

In March of 2023, the Financial Accounting Standards Board (“FASB”) issued ASU No.

2023-02, Investments- Equity Method and Joint Ventures (Topic 323):

Accounting for Investments in Tax Credit Structures Using the Proportional Amortization Method .

ASU 2023-02 allows for standardization of accounting methodology for tax credit equity investments when certain requirements are met.

The standard provides the ability for both current and prospective tax credit investors to avoid the complexities of accounting for tax credits outside of the proportional amortization method.

To qualify for the proportional amortization method, the following conditions must be met:

it is probable that the income tax credits allocable to the investor will be available, 2.

the investor does not have the ability to exercise significant influence over the operating and financial policies of the underlying project, 3.

substantially all of the projected benefits are from income tax credits and other income tax benefits, 4.

the investor’s projected yield based solely on the cash flows from the income tax credits and other income tax benefits is positive, and 5.

the investor is a limited liability investor in the limited liability entity for both legal and tax purposes and the investor’s liability is limited to its capital investment.

The amendments in this ASU will be applied either on a modified retrospective basis or a retrospective basis.

The amendments in this update are effective for public business entities for fiscal years, and interim periods within those fiscal years beginning after December 15, 2023.

Early adoption is permitted for all entities in any interim period.

The Corporation is currently evaluating the provisions of ASU 2023-02 and does not expect the adoption of the standard to have a material impact on the Corporation’s financial statements.

NOTE 3 — SECURITIES

Debt Securities

The Company classifies its securities as either “Held-to-Maturity” or “Available-for-Sale” at the time of purchase.

5 unchanged sentences

Management’s decision to sell Available-for-Sale securities is based on changes in economic conditions, controlling the sources and applications of funds, terms, availability of and yield of alternative investments, interest rate risk and the need for liquidity.

Equity securities with readily determinable fair values are stated at fair value with realized and unrealized gains and losses reported in income.

Equity securities without readily determinable fair values are recorded at cost less impairment, if any.

The cost of debt securities classified as Held-to-Maturity or Available-for-Sale is adjusted for amortization of premiums to the earliest call date and accretion of discounts to expected maturity.

2 unchanged sentences

The cost of securities sold, redeemed or matured is based on the specific identification method.

The amortized cost, related estimated fair value, and unrealized gains and losses for debt securities classified as Available-For-Sale were as follows at September 30, 2022 and December 31, 2021:

The Corporation invests in various forms of agency debt including residential and commercial mortgage-backed

securities and callable debt.

The mortgage-backed agency securities are issued by Federal Home Loan Mortgage

Corporation (“FHLMC”), Federal National Mortgage Association (“FNMA”), Government National Mortgage

Association (“GNMA”) or Small Business Administration (“SBA”).

The other mortgage-backed securities consist of private (non-agency) residential and commercial mortgage-backed securities.

The municipal securities consist of general obligations and revenue bonds.

Asset-backed securities consist of private (non-agency) student loan pools backed by the Federal Family Education LoanProgram (“FFELP”) which carry a 97% federal government guarantee.

Corporate debt securities consist of senior debt and subordinated debt holdings.

There was no allowance for credit losses for Available-For-Sale debt securities as of March 31, 2023;

therefore, it is not present in the table below.

The amortized cost, related estimated fair value, and unrealized gains and losses for debt securities classified as Available-For-Sale were as follows at March 31, 2023 and December 31, 2022:

Debt Securities Available-for-Sale

(Dollars in thousands)

September 30, 2022:

March 31, 2023:

Treasury securities

17 unchanged sentences

Corporate debt securities

Securities Available-for-Sale with an aggregate fair value of $ 355,786,000 at September 30, 2022 and $ 401,861,000 at December 31, 2021, were pledged to secure public funds, trust funds, securities sold under agreements to repurchase and the Federal Discount Window aggregating $ 300,452,000 at September 30, 2022 and $ 318,074,000 at December 31, 2021.

The amortized cost and estimated fair value of debt securities, by contractual maturity, are shown below at September 30, 2022.

Securities Available-for-Sale with an aggregate fair value of $ 254,601,000 at March 31, 2023 and $ 315,836,000 at December 31, 2022, were pledged to secure public funds, trust funds, securities sold under agreements to repurchase and the Federal Discount Window aggregating $ 202,659,000 at March 31, 2023 and $ 241,385,000 at December 31, 2022.

The amortized cost and estimated fair value of debt securities, by contractual maturity, are shown below at March 31, 2023.

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.

September 30, 2022

March 31, 2023

Debt Securities Available-For-Sale

11 unchanged sentences

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

There were no aggregate securities with a single issuer (excluding the U.S.

At March 31, 2023, the Corporation had holdings of securities from one issuer in excess of ten percent of consolidated stockholders’ equity, other than the U.S.

Government and U.S.

Government Agencies and Corporations) which exceeded ten percent of consolidated stockholders’ equity at September 30, 2022.

Government Agencies and Corporations.

Holdings in Sallie Mae Bank securities had a fair value of $ 16,601,000 as of March 31, 2023.

There were no aggregate holdings of securities with a single issuer (excluding the U.S.

Government and U.S.

Government Agencies and Corporations) which exceeded ten percent of consolidated stockholders’ equity at March 31, 2022.

The quality rating of the obligations of state and political subdivisions are generally investment grade, as rated by Moody’s, Standard and Poor’s or Fitch.

The typical exceptions are local issues which are not rated, but are secured by the full faith and credit obligations of the communities that issued these securities.

There were no proceeds from sales of Debt Securities Available-For-Sale for the three months ended September 30, 2022 and 2021.

Therefore, there were no gains or losses realized during these periods.

There were no impairment losses realized on Debt Securities Available-For-Sale during the three months ended September 30, 2022 or 2021.

There were no proceeds from sales of Debt Securities Available-For-Sale for the nine months ended September 30, 2022 and 2021.

Therefore, there were no gains or losses realized during these periods.

There were no impairment losses realized on Debt Securities Available-For-Sale during the nine months ended September 30, 2022 or 2021.

At September 30, 2022 and December 31, 2021, the Company had $ 1,612,000 and $ 1,962,000 , respectively, in equity securities recorded at fair value.

The following is a summary of realized gains and losses recognized in net income on equity securities during the nine months ended September 30, 2022 and 2021:

(Dollars in thousands)

Nine months ended

September 30, 2022

September 30, 2021

Net (losses) and gains recognized during the period on equity securities

Net gains recognized during the period on equity securities sold during the period

Net (losses) and gains recognized during the reporting period on equity securities still held at the reporting date

There were no proceeds from sales of investments in Held-to-Maturity debt securities during the three and nine months ended September 30, 2022 or 2021.

Therefore, there were no gains or losses realized during these periods.

Management evaluates securities for other-than-temporary impairment (“OTTI”) at least on a quarterly basis, and more frequently when economic or market conditions warrant such an evaluation.

Securities classified as Available-for-Sale or Held-to-Maturity are generally evaluated for OTTI under FASB ASC 320, Investments - Debt and Equity Securities .

In determining OTTI under the FASB ASC 320 model, management considers many factors, including (1) the length of time and the extent to which the fair value has been less than cost, (2) the financial condition and near-term prospects of the issuer, (3) whether the market decline was affected by macroeconomic conditions, and (4) whether the entity has the intent to sell the debt security or more likely than not will be required to sell the debt security before its anticipated recovery.

The assessment of whether an other-than-temporary decline exists involves a high degree of subjectivity and judgment and is based on the information available to management at a point in time.

When OTTI occurs on debt securities, the amount of the OTTI recognized in earnings depends on whether an entity intends to sell the security or more likely than not will be required to sell the security before recovery of its amortized cost basis less any current-period credit loss.

If an entity intends to sell or more likely than not will be required to sell the security before recovery of its amortized cost basis less any current-period credit loss, the OTTI shall be recognized in earnings equal to the entire difference between the investment’s amortized cost basis and its fair value at the balance sheet date.

If an entity does not intend to sell the security and it is not more likely than not that the entity will be required to sell the security before recovery of its amortized cost basis less any current-period loss, the OTTI shall be separated into the amount representing the credit loss and the amount related to all other factors.

The amount of the total OTTI related to the credit loss is determined based on the present value of cash flows expected to be collected, and the realized loss is recognized as impairment charges on securities on the consolidated statements of income.

The amount of the total OTTI related to the other factors shall be recognized in other comprehensive (loss) income, net of applicable taxes.

The previous amortized cost basis less the OTTI recognized in earnings becomes the new amortized cost basis of the security.

The Company and its investment advisors monitor the entire portfolio monthly with particular attention given to securities in a continuous loss position of at least ten percent for over twelve months.

Based on the factors described above, management did not consider any securities to be other-than-temporarily impaired at September 30, 2022 or December 31, 2021.

Proceeds from sales of Debt Securities Available-For-Sale for the three months ended March 31, 2023 and 2022 were $ 23,230,000 and $ 0 , respectively.

Gross gains realized on these sales were $ 447,000 and $ 0 , respectively.

Gross losses on these sales were $ 348,000 and $ 0 respectively.

The summary below shows the gross unrealized losses and fair value of the Company’s debt securities.

Totals are aggregated by investment category where individual securities have been in a continuous loss position for less than 12 months or 12 months or more as of September 30, 2022 and December 31, 2021:

September 30, 2022

Totals are aggregated by investment category where individual securities have been in a continuous loss position for less than 12 months or 12 months or more as of March 31, 2023 and December 31, 2022:

March 31, 2023

(Dollars in thousands)

23 unchanged sentences

Corporate debt securities

The Company invests in various forms of agency debt including residential and commercial mortgage-backed securities and callable debt.

The mortgage-backed agency securities are issued by Federal Home Loan Mortgage Corporation (“FHLMC”), Federal National Mortgage Association (“FNMA”), Government National Mortgage Association (“GNMA”) or Small Business Administration (“SBA”).

The other mortgage-backed securities consist of private (non-agency) residential and commercial mortgage backed securities.

The municipal securities consist of general obligations and revenue bonds.

Asset backed securities consist of bonds backed by consumer loans.

Corporate debt securities consist of senior debt and subordinated debt holdings.

The fair market value of the above securities is influenced by market interest rates, prepayment speeds on mortgage securities, bid-offer spreads in the market place and credit premiums for various types of agency debt.

These factors change continuously and therefore the market value of these securities may be higher or lower than the Company’s carrying value at any measurement date.

Management does not believe any of their 156 debt securities with a less than one year unrealized loss position, or any of their 61 debt securities with a one year or greater unrealized loss position as of September 30, 2022, represent an other-than-temporary impairment, as the unrealized losses relate principally to changes in interest rates subsequent to the acquisition of the specific securities.

The Company expects to collect all principal and interest payments defined under the original terms as all contracted payments on securities in the portfolio are current as of September 30, 2022.

NOTE 4 — LOANS AND ALLOWANCE FOR LOAN LOSSES

Net loans are stated at their outstanding recorded investment, net of deferred fees and costs, unearned income and the allowance for loan losses.

There were 173 individual debt securities in an unrealized loss position as of March 31, 2023, with a combined depreciation in value representing 8.61 % of the debt securities portfolio.

There were 183 individual debt securities in an unrealized loss position as of December 31, 2022, with their combined depreciation in value representing 9.11 % of the debt securities portfolio.

Available-for-sale debt securities are required to be individually evaluated for impairment in accordance with ASC 326, Financial Instruments – Credit Losses.

Management evaluates debt securities for impairment where there has been a decline in fair value below the amortized cost basis of a debt security to determine whether there is a credit loss associated with the decline in fair value on at least a quarterly basis, and more frequently when economic or market concerns warrant such evaluation.

Credit losses are calculated individually, rather than collectively, using a discounted cash flow method, whereby Management compares the present value of expected cash flows with the amortized cost basis of the debt security.

The credit loss component would be recognized through the provision for credit losses and the creation of an allowance for credit losses.

Consideration is given to (1) the financial condition and near-term prospects of the issuer, (2) the outlook for receiving the contractual cash flows of the investments, (3) the length of time and the extent to which the fair value has been less than cost, (4) our intent and ability to retain its investment in the issuer for a period of time sufficient to allow for any anticipated recovery in fair value or whether it is more-likely-than-not that we will be required to sell the debt security prior to recovering its fair value, (5) the anticipated outlook for changes in the general level of interest rates, (6) credit ratings, (7) third party guarantees, and (8) collateral values.

In analyzing an

issuer’s financial condition, management considers whether the debt securities are issued by the federal government or its agencies, whether downgrades by bond rating agencies have occurred, the results of reviews of the issuer’s financial condition, and the issuer’s anticipated ability to pay the contractual cash flows of the debt securities.

All issues of U.S.

Treasury and Agency-Backed debt securities have the full faith and credit backing of the United States Government or one of its agencies.

All other debt securities that do not have a zero expected credit loss are evaluated quarterly to determine whether there is a credit loss associated with a decline in fair value.

The Company made a policy election to exclude accrued interest receivable from the amortized cost basis of debt securities available for sale.

Accrued interest receivable on debt securities available for sale is reported as a component of accrued interest receivable on the Company’s consolidated balance sheet and totaled $ 2,122,000 as of March 31, 2023.

Accrued interest receivable on debt securities available for sale is excluded from the estimate of credit losses.

All debt securities available for sale in an unrealized loss position as of March 31, 2023, continue to perform as scheduled and we do not believe that there is a credit loss or that a provision for credit losses is necessary.

Also, as part of our evaluation of our intent and ability to hold debt securities for a period of time sufficient to allow for any anticipated recovery in the market, we consider our investment strategies, cash flow needs, liquidity position, capital adequacy and interest rate risk position.

We do not currently intend to sell the debt securities within the portfolio and it is not more-likely-than-not that we will be required to sell the debt securities.

Management continues to monitor all of our debt securities with a high degree of scrutiny.

There can be no assurance that we will not conclude in future periods that conditions existing at that time indicate some or all of its debt securities may be sold or would require a charge to earnings as a provision for credit losses in such periods.

Equity Securities

Equity securities with readily determinable fair values are stated at fair value with realized and unrealized gains and losses reported in income.

Equity securities without readily determinable fair values are recorded at cost less impairment, if any.

At March 31, 2023 and December 31, 2022, the Company had $ 1,544,000 and $ 1,699,000 , respectively, in equity securities recorded at fair value.

The following is a summary of realized gains and losses recognized in net income on equity securities during the three months ended March 31, 2023 and 2022:

(Dollars in thousands)

Three months ended

March 31, 2023

March 31, 2022

Net losses from market value fluctuations recognized during the period on equity securities

Net gains recognized during the period on equity securities sold during the period

Net losses recognized during the reporting period on equity securities still held at the reporting date

Management evaluates equity securities for other-than-temporary impairment (“OTTI”) at least on a quarterly basis, and more frequently when economic or market conditions warrant such an evaluation.

Equity securities are generally evaluated for OTTI under FASB ASC 320, Investments - Debt and Equity Securities.

In determining OTTI under the FASB ASC 320 model, management considers many factors, including (1) the length of time and the extent to which the fair value has been less than cost, (2) the financial condition and near-term prospects of the issuer, (3) whether the market decline was affected by macroeconomic conditions, and (4) whether the entity has the intent to sell the equity security or more likely than not will be required to sell the equity security before its anticipated recovery.

The assessment of whether an other-than-temporary decline exists involves a high degree of subjectivity and judgment and is based on the information available to management at a point in time.

If an impairment loss on an equity security is considered to be other-than-temporary, a loss in the amount of the difference between the cost and fair value of the

security is recognized.

Once the impairment is recorded, this becomes the new cost basis of the equity security and cannot be adjusted upward if there is a subsequent recovery in the fair value of the security.

The Company monitors the equity securities portfolio monthly with particular attention given to securities in a continuous loss position of at least ten percent for over twelve months.

Based on the factors described above, management did not consider any equity securities to be other-than-temporarily impaired at March 31, 2023 or December 31, 2022.

NOTE 4 — LOANS AND ALLOWANCE FOR CREDIT LOSSES

Net loans are stated at their outstanding recorded investment, net of deferred fees and costs, unearned income and the allowance for credit losses.

Interest on loans is recognized as income over the term of each loan, generally, by the accrual method.

Loan origination fees and certain direct loan origination costs have been deferred with the net amount amortized using the straight line method or the interest method over the contractual life of the related loans as an interest yield adjustment.

The loans receivable portfolio is segmented into commercial, residential and consumer loans.

Commercial loans consist of the following classes:

Commercial and Industrial, and Commercial Real Estate.

The loans receivable portfolio is segmented into the following segments:

Real Estate (including both commercial and residential loans), Agricultrual, Commercial and Industrial, Consumer, and State and Political Subdivisions.

Real Estate Lending

The Company engages in real estate lending to commercial borrowers in its primary market area and surrounding areas.

The commercial component of the Company’s Real Estate portfolio is secured primarily by commercial retail space, commercial office buildings, residential housing and hotels.

Generally, these loans have terms that do not exceed twenty years , have loan-to-value ratios of up to eighty percent of the value of the collateral property, and are typically supported by personal guarantees of the borrowers.

In underwriting these loans, the Company performs a thorough analysis of the financial condition of the borrower, the borrower’s credit history, and the reliability and predictability of the cash flow generated by the property securing the loan.

The value of the property is determined by either independent appraisers or internal evaluations performed by Bank officers.

Real estate loans secured by commercial properties generally present a higher level of risk than loans secured by residential real estate.

Repayment of loans secured by commercial real estate is typically dependent upon the successful operation of the related real estate project and/or the effect of the general economic conditions on income producing properties.

The residential component of the Company’s Real Estate portfolio is comprised of one-to-four family residential mortgage loan originations, home equity term loans and home equity lines of credit.

These loans are generated by the Company’s marketing efforts, its present customers, walk-in customers and referrals.

These loans are originated primarily with customers from the Company’s market area.

The Company’s one-to-four family residential mortgage originations are secured principally by properties located in its primary market area and surrounding areas.

The Company offers fixed-rate mortgage loans with terms up to a maximum of thirty years for both permanent structures and those under construction.

Loans with terms of thirty years are normally held for sale and sold without recourse;

most of the residential mortgages held in the Company’s residential real estate portfolio have maximum terms of twenty years .

Generally, the majority of the Company’s residential mortgage loans originate with a loan-to-value of eighty percent or less, or those with private mortgage insurance at ninety-five percent or less.

Home equity term loans are secured by the borrower’s primary residence and typically have a maximum loan-to-value of eighty percent and a maximum term of fifteen years .

In general, home equity

lines of credit are secured by the borrower’s primary residence with a maximum loan-to-value of eighty percent and a maximum term of twenty years .

In underwriting one-to-four family residential mortgage loans, the Company evaluates the borrower’s ability to make monthly payments, the borrower’s prior loan repayment history and the value of the property securing the loan.

The ability and willingness to repay is assessed based upon the borrower’s employment history, current financial conditions and credit background.

A majority of the properties securing residential real estate loans made by the Company are appraised by independent appraisers.

The Company generally requires mortgage loan borrowers to obtain an attorney’s title opinion or title insurance and fire and property insurance, including flood insurance, if applicable.

Residential mortgage loans, home equity term loans and home equity lines of credit generally present a lower level of risk than consumer loans because they are secured by the borrower’s primary residence.

Risk is increased when the Company is in a subordinate position, especially to another lender, for the loan collateral.

Residential mortgage loans held for sale are carried at the lower of cost or market on an aggregate basis determined by independent pricing from appropriate federal or state agency investors.

These loans are sold without recourse.

Loans held for sale amounted to $ 115,000 and $ 71,000 at March 31, 2023 and December 31, 2022, respectively.

Agricultural Lending

The Company originates agricultural loans to individuals in the farming industry for funding the production of crops or to purchase or refinance capital assets such as farmland, livestock, machinery, equipment, and farm real estate improvements.

Agricultural loans are typical secured by collateral related to the farming activities.

These loans originate from customers within our primary market area or the surrounding areas.

In underwriting agricultural loans, an analysis is performed regarding the borrower’s ability to repay the loan, the borrower’s capital and collateral, and the past, present, and future cash flows of the borrower, as well as the agricultural industry as a whole.

In general, these loans would be secured by cropland, pastureland, orchardland, or timberland that is committed to ongoing management and agricultural production, with a maximum loan-to-value ratio of 70 % and a maximum term of ten years .

Commercial and Industrial Lending

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Evaluation of the borrower’s past, present and future cash flows is also an important aspect of the Company’s analysis of the borrower’s ability to repay.

SBA Paycheck Protection Program (“PPP”) loans that have been issued by the Company as a result of the enactment of the Coronavirus Aid Relief and Economic Security Act (“CARES Act”) in response to the economic impact of the COVID-19 pandemic are included in the Company’s Commercial and Industrial portfolio and are underwritten according to all terms and conditions pursuant to the PPP as administered by the SBA under the CARES Act.

See the Coronavirus Pandemic Impact on the Loan Portfolio section on page 16 for more information regarding the Company’s underwriting of these loans.

Commercial and industrial loans generally present a higher level of risk than other types of loans due primarily to the effect of general economic conditions.

Commercial and industrial loans are typically made on the basis of the borrower’s ability to make repayment from cash flows from the borrower’s primary business activities.

Commercial and industrial loans are typically made on the basis of the

borrower’s ability to make repayment from cash flows from the borrower’s primary business activities.

As a result, the availability of funds for the repayment of commercial and industrial loans is dependent on the success of the business itself, which in turn, is likely to be dependent upon the general economic environment.

The PPP loans have 1.00% interest rates, lender fees, two or five-year terms (depending on date of origination), and may qualify for forgiveness.

These loans funded by the Company are subject to the terms and conditions applicable to all loans made pursuant to the PPP, as administered by the SBA under the CARES Act.

The PPP calls for these loans to be fully guaranteed by the SBA.

PPP loan origination fees and certain loan origination costs have been deferred with the net amount accreted using the straight line method over the contractual life of the related loans as an interest yield adjustment.

If a loan is forgiven pursuant to the terms and conditions applicable to the PPP, the remaining origination fees and costs are recognized at the time of forgiveness.

As of March 31, 2023, the Company held 2 PPP loans in its Commercial and Industrial portfolio carrying an aggregate balance of $ 101,000 which were granted during the first round of PPP issuance and did not qualify for forgiveness.

At December 31, 2022, the Company held 2 PPP loans in its Commercial and Industrial portfolio carrying an aggregate balance of $ 113,000 which were granted during the first round of PPP issuance and did not qualify for forgiveness.

As an addition to the commercial loans receivable portfolio, the Company may purchase the guaranteed portion of loans secured by the U.S.

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Government) on all principal and the balance of interest accruing through ninety days beyond the date that demand is made to the originating bank for repurchase of the loan.

As of September 30, 2022, the Company's balance of GGLs was $ 4,660,000 , compared to $ 3,829,000 at December 31, 2021.

Commercial Real Estate Lending

The Company engages in commercial real estate lending in its primary market area and surrounding areas.

The Company’s Commercial Real Estate portfolio is secured primarily by commercial retail space, commercial office buildings, residential housing and hotels.

Generally, commercial real estate loans have terms that do not exceed twenty years , have loan-to-value ratios of up to eighty percent of the value of the collateral property, and are typically supported by personal guarantees of the borrowers.

The value of the property is determined by either independent appraisers or internal evaluations performed by Bank officers.

Commercial real estate loans generally present a higher level of risk than residential real estate secured loans.

Residential Real Estate Lending (Including Home Equity)

The Company’s Residential Real Estate portfolio is comprised of one-to-four family residential mortgage loan originations, home equity term loans and home equity lines of credit.

These loans are generated by the Company’s marketing efforts, its present customers, walk-in customers and referrals.

These loans are originated primarily with customers from the Company’s market area.

The Company’s one-to-four family residential mortgage originations are secured principally by properties located in its primary market area and surrounding areas.

The Company offers fixed-rate mortgage loans with terms up to a maximum of thirty years for both permanent structures and those under construction.

Loans with terms of thirty years are normally held for sale and sold without recourse;

most of the residential mortgages held in the Company’s residential real estate portfolio have maximum terms of twenty years .

Generally, the majority of the Company’s residential mortgage loans originate with a loan-to-value of eighty percent or less, or those with primary mortgage insurance at ninety-five percent or less.

Home equity term loans are secured by the borrower’s primary residence and typically have a maximum loan-to-value of eighty percent and a maximum term of fifteen years .

In general, home equity lines of credit are secured by the borrower’s primary residence with a maximum loan-to-value of eighty percent and a maximum term of twenty years .

The ability and willingness to repay is assessed based upon the borrower’s employment history, current financial conditions and credit background.

A majority of the properties securing residential real estate loans made by the Company are appraised by independent appraisers.

The Company generally requires mortgage loan borrowers to obtain an attorney’s title opinion or title insurance and fire and property insurance, including flood insurance, if applicable.

Risk is increased when the Company is in a subordinate position, especially to another lender, for the loan collateral.

Residential mortgage loans held for sale are carried at the lower of cost or market on an aggregate basis determined by independent pricing from appropriate federal or state agency investors.

These loans are sold without recourse.

Loans held for sale amounted to $ 691,000 and $ 6,006,000 at September 30, 2022 and December 31, 2021, respectively.

As of March 31, 2023, the Company's balance of GGLs was $ 4,595,000 , compared to $ 4,631,000 at December 31, 2022.

Consumer Lending

The Company offers a variety of secured and unsecured consumer loans, including vehicle loans, stock secured loans and loans secured by financial institution deposits.

These loans originate primarily within or with customers from the Company’s market area.

These loans originate primarily with customers from the Company’s market area.

Consumer loan terms vary according to the type and value of collateral and creditworthiness of the borrower.

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Furthermore, the application of various federal and state laws, including bankruptcy and insolvency laws, may limit the amount which can be recovered on such loans.

Coronavirus Pandemic Impact on the Loan Portfolio

As a result of the economic impact of the COVID-19 coronavirus pandemic, the CARES Act was enacted in the United States on March 27, 2020.

The Company was approved by the SBA to fund loans under the SBA’s Paycheck Protection Program created as part of the CARES Act.

The PPP loans have 1.00 % interest rates, lender fees, two or five-year terms (depending on date of origination), and may qualify for forgiveness.

These loans funded by the Company are subject to the terms and conditions applicable to all loans made pursuant to the PPP, as administered by the SBA under the CARES Act.

The PPP calls for these loans to be fully guaranteed by the SBA.

If a loan is forgiven pursuant to the terms and conditions applicable to the PPP, the remaining origination fees and costs are recognized at the time of forgiveness.

All PPP loans are carried in the Company’s Commercial and Industrial loan portfolio.

As of September 30, 2022, the Company held 2 PPP loans in its Commercial and Industrial portfolio carrying an aggregate balance of $ 125,000 which were granted during the first round of PPP issuance and did not qualify for forgiveness.

At December 31, 2021, the Company held 122 PPP loans in its Commercial and Industrial portfolio, which carried an aggregate balance of $ 4,894,000 , of which 2 loans carrying an aggregate balance of $ 160,000 were granted during the first round of PPP issuance and 120 loans carrying an aggregate balance of $ 4,734,000 were granted during the second round of PPP issuance.

An additional provision of the CARES Act, Section 4013 provides financial institutions the option to suspend requirements to categorize certain loan modifications as troubled debt restructurings as long as specific criteria are met.

To qualify, the loan modifications must have been made on a good-faith basis in response to the COVID-19 pandemic, must have occurred between March 1, 2020 and the earlier of September 30, 2021 or the termination date of the national emergency related to the COVID-19 pandemic as declared by the President of the United States, and the loans must have been paid current (less than 30 days past due prior to any relief) as of December 31, 2019.

In compliance with Section 4013 of the CARES Act, the Company granted modification requests to defer principal and/or interest payments or modify interest rates on various loans across all portfolio segments.

Of the loan modifications that were granted in compliance with Section 4013 of the CARES Act, there were no loan modifications still actively on deferral as of September 30, 2022, compared to December 31, 2021 when there was 1 loan modification still actively on deferral carrying a balance of $ 9,423,000 .

See page 25 for additional information regarding the Section 4013 CARES Act modifications.

State and Political Subdivisions Lending

The Company, from time to time, may originate loans to state and political subdivisions that are within the Bank’s primary market area or surrounding areas.

These loans may be either taxable or tax-free.

These loans may be issued for the purpose of land improvement, infrastructure changes, bond refinances, or the purchase of equipment.

State and political loans are typically secured by the taxing power of the borrowing entity.

In some cases, the loans may also

be secured by the property/item being purchased.

Audited financial statements are required as part of the underwriting for all state and political loans and a full analysis of all components of the audited statements is performed.

If the loan is to be classified as tax-free, a letter from the entity’s solicitor stating such is required, as well.

The risk associated with these types of loans is considerably less than commercial loan transactions.

Repayment is based on the full faith, credit, and ability of the borrowing entity to tax and then collect the payments.

Delinquency or loss on these types of loans is de minimus.

Delinquent Loans

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Past-due loans are continually evaluated with the determination for charge-off being made when no reasonable chance remains that the status of the loan can be improved.

Commercial and industrial and commercial real estate loans are charged off in whole or in part when they become sufficiently delinquent based upon the terms of the underlying loan contract and when a collateral deficiency exists.

Commercial and industrial loans and real estate loans issued for commercial purpose are charged off in whole or in part when they become sufficiently delinquent based upon the terms of the underlying loan contract and when a collateral deficiency exists.

Because all or part of the contractual cash flows are not expected to be collected, the loan is considered to be impaired, and the Company estimates the impairment based on its analysis of the cash flows or collateral estimated at fair value less cost to sell.

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If the originating bank does not repurchase the loan, demand for repurchase is then made to the appropriate government agency which has provided the guarantee for the loan.

Residential real estate and consumer loans are charged off when they become sufficiently delinquent based upon the terms of the underlying loan contract and when the value of the underlying collateral is not sufficient to support the loan balance and a loss is expected.

Real estate loans issued for residential purposes and consumer loans are charged off when they become sufficiently delinquent based upon the terms of the underlying loan contract and when the value of the underlying collateral is not sufficient to support the loan balance and a loss is expected.

At that time, the amount of estimated collateral deficiency, if any, is charged off for loans secured by collateral, and all other loans are charged off in full.

Loans with collateral are written down to the estimated fair value of the collateral less cost to sell.

Existing loans in which the borrower has declared bankruptcy are considered on a case by case basis to determine whether repayment is likely to occur (eg.

Existing loans in which the borrower has declared bankruptcy are considered on a case by case basis to determine whether repayment is likely to occur (e.g.

reaffirmation by the borrower with demonstrated repayment ability).

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These loans remain under constant scrutiny, and if performance continues, interest income may be recorded on a cash basis based on management's judgment regarding the collectability of principal.

Allowance for Loan Losses

The allowance for loan losses is established through provisions for loan losses charged against income.

Loans deemed to be uncollectible are charged against the allowance for loan losses and subsequent recoveries, if any, are credited to the allowance.

The allowance for loan losses is maintained at a level estimated by management to be adequate to absorb potential loan losses.

Management’s periodic evaluation of the adequacy of the allowance for loan losses is based on the Company’s past loan loss experience, known and inherent risks in the portfolio, adverse situations that may affect the borrower’s ability to repay (including the timing of future payments), the estimated value of any underlying collateral, composition of the loan portfolio, current economic conditions, and other relevant factors.

This evaluation is inherently subjective as it requires material estimates including the amounts and timing of future cash flows expected to be received on impaired loans that may be susceptible to significant change.

The allowance consists of specific, general and unallocated components.

The specific component relates to loans that are individually classified as impaired.

Select loans are not aggregated for collective impairment evaluation, as such;

all loans are subject to individual impairment evaluation should the facts and circumstances pertinent to a particular loan suggest that such evaluation is necessary.

Allowance for Credit Losses - Loans

The allowance for credit losses (“ACL”) is an estimate of losses arising from borrowers’ inability to make loan payments as required, which is calculated via a valuation account that is deducted from the amortized cost basis to present the net amount expected to be collected on the loan portfolio.

The Company completed a one-time adjustment to decrease the ACL at the adoption of ASU 2016-13 through retained earnings, but all subsequent adjustments will be established through provisions for credit losses charged against income.

Loans deemed to be uncollectible are charged against the ACL and subsequent recoveries, if any, are credited to the allowance.

The ACL is maintained at a level estimated by management to be adequate to absorb potential loan losses.

Management’s periodic evaluation of the adequacy of the ACL is based on specific expectations for the future economic

environment that are incorporated in the projection, with loss expectations to revert to the long-run historical mean after such time as management can make or obtain a reasonable and supportable forecast.

Management also considers the Company’s past loan loss experience, known and inherent risks in the portfolio, adverse situations that may impact the borrower’s ability to repay (including the timing of future payments), the estimated value of any underlying collateral (if the loan is collateral dependent), composition of the loan portfolio, and other relevant factors.

This evaluation is inherently subjective as it requires material estimates based on management’s judgment regarding the projection of expected credit losses over the contractual lifetime of the loans.

Modeling of the ACL uses sophisticated statistical techniques to arrive at reasonable and supportable forecasts of expected losses.

The Company has contracted with a third-party vendor to assist in developing models for the ACL related to the Company’s loan portfolio under ASU 2016-13.

The Company has opted to utilize the Weighted Average Remaining Maturity (“WARM”) method to calculate the ACL which uses an average annual charge-off rate.

This average annual charge-off rate contains loss content over several vintages and is used as a foundation for estimating the credit loss content for loans by segmented pools at the balance sheet date and is used to determine a historical charge-off rate.

When estimating expected credit losses, the Company considers forward-looking information that is both reasonable, supportable, and relevant to assessing the collectability of cash flows.

Reasonable and supportable forecasts may extend over the entire contractual term of a loan or a period shorter than the contractual term.

Reasonable and supportable forecasts may vary by portfolio segment or individual forecast input.

These forecasts may include data from internal sources, external sources, or a combination of both.

When the contractual term of a loan extends beyond the reasonable and supportable period, ASC Topic 326 requires reverting to historical loss information, or an appropriate proxy, for those periods beyond the reasonable and supportable forecast period (often referred to as the reversion period).

The Company may revert to historical loss information for each individual forecast input or based on the entire estimate of loss.

Reversion to historical loss information may be immediate, occur on a straight-line basis, or use any systematic/rational method.

Management may apply different reversion techniques depending on the economic environment or applicable loan portfolio.

The methodology used to determine the ACL also includes a qualitative component in which the Company adjusts expected credit loss estimates for information not already captured in the loss estimation process.

These qualitative factor adjustments may increase or decrease management’s estimate of expected credit losses.

Changes in the level of the Company’s ACL may not always be directionally consistent with changes in the level of qualitative factor adjustments due to the incorporation of reasonable and supportable forecasts in estimating expected losses.

Management considers qualitative factors that are relevant to the Company as of the reporting date, which may include but are not limited to:

1) changes in lending policies and procedures, including changes in underwriting standards and collection, charge-off, and recovery practices not considered elsewhere;

2) changes in international, national, regional, and local economic and business conditions and developments that affect the collectability of the loan portfolio, including the condition of various market segments;

3) changes in the nature and volume of the loan portfolio;

4) changes in the experience, ability, and depth of management and other relevant staff;

5) changes in the volume and severity of past due loans, the volume of non-accrual loans, and the volume and severity of adversely classified or graded loans;

6) changes in the quality of the Company’s loan review system;

7) changes in the value of underlying collateral for collateral dependent loans;

8) the existence and effect of any concentrations of credit and changes in the level of such concentrations;

and 9) the effect of other external factors such as competition and legal and regulatory requirements on the level of estimated credit losses in the Company’s existing loan portfolio.

The Company’s ACL is calculated by collectively evaluating and individually evaluating loans.

The Company collectively evaluates applicable loans based on segments according to their homogeneous characteristics, aligned with the segmentation of the FDIC Bank Call Report.

The Company collectively evaluates loans and determines applicable loss rates based on the following segments/classes:

◾ Construction, land development, and other land loans

◾ Residential construction (loans to build homes, both speculative and owner-occupied, and 1-4 family lot loans)

◾ Agribusiness, farmland, or secured by farmland

◾ Revolving, open-end, 1-4 family residential properties (and extended under lines of credit)

◾ Loans secured by first liens

◾ Loans secured by junior liens

◾ Secured by multifamily (5 or more) residential properties

◾ Loans secured by owner occupied, non-farm, non-residential properties

◾ Loans secured by other non-farm, non-residential properties

◾ Loans to finance agricultural production and other loans for farmers

Commercial and Industrial

◾ Commercial and industrial loans

◾ Other revolving credit plans

◾ Automobile loans

◾ Other consumer loans

State and Political Subdivisions

◾ Obligations (other than securities or leases) of states and political subdivisions in the U.S.

In accordance with ASC 326-20-30-2, the Company will evaluate individual loans for expected credit losses when the loans do not share similar risk characteristics with loans evaluated using the collective method.

Management may evaluate loans on an individual basis even when no specific expectation of collectability is in place.

Loans deemed to be impaired are specifically identified and measured for impairment.

A loan is deemed to be impaired when, based on current information and events, it is probable that the Company will be unable to collect all amounts due according to the loan agreement.

Loans to be considered for impairment include all non-accrual loans or any other selected loans where full collection is unlikely.

Factors considered by management in determining impairment include payment status and the probability of collecting scheduled principal and interest payments when due.

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Management determines the significance of payment delays and payment shortfalls on a case-by-case basis, taking into consideration all of the circumstances surrounding the loan and the borrower, including the length of the delay, the reasons for the delay, the borrower’s prior payment record, and the amount of the shortfall in relation to the principal and interest owed.

If a loan is impaired, a portion of the allowance may be allocated so that the loan is reported, net, at the present value of estimated future cash flows using the loan’s existing rate or at the fair value of collateral if repayment is expected solely from collateral.

TDRs are separately identified for impairment disclosures and are measured at the present value of estimated future cash flows using the loan’s contractual rate at inception.

If a TDR is considered to be a collateral dependent loan, the loan may be reported at the net realizable value of the collateral.

For TDRs that subsequently default, the Company determines the amount of reserve in accordance with the accounting policy for the allowance for loan losses.

The general component covers all other loans not identified as impaired (aside from GGLs, which do not require an allowance) and is based on historical losses and qualitative factors.

The historical loss component of the allowance is determined by losses recognized by portfolio segment over an eight quarter lookback period that management has determined best represents the current credit cycle.

Qualitative factors impacting each portfolio segment may include:

delinquency trends, loan volume trends, Bank policy changes, management processes and oversight, economic trends (including change in consumer and business disposable incomes, unemployment and under-employment levels, and other conditions), concentrations by industry or product, internal and external loan review processes, collateral value and market conditions, and external factors including regulatory issues and competition.

GGLs do not require an associated allowance for loan losses due to the underlying irrevocable and unconditional guarantee, which is supported by the full faith and credit of the U.S.

Should a GGL default, the loan will be repurchased by the originating bank or the appropriate government agency that has provided the guarantee for the loan.

Although PPP loans do not require an associated allowance for loan losses due to the program’s call for a full guarantee by the SBA, the Company has calculated a qualitative allocation for the PPP loans under the general component of the allowance for the Commercial and Industrial portfolio.

The unallocated component of the allowance is maintained to cover uncertainties that could affect management’s estimate of probable losses.

The unallocated component of the allowance reflects the margin of imprecision inherent in the underlying assumptions used in the methodologies for estimating specific and general losses in the portfolio.

Once identified as impaired, the loans are measured individually for impairment based on one of the following methods:

The present value of expected cash flows, discounted at the loan’s effective interest rate (i.e.

the contractual interest rate adjusted for any net deferred loan fees or costs, premium, or discount existing at the origination or acquisition of the loan)

The loan’s observable market price

The fair value of the collateral if the loan is deemed to be collateral dependent.

A loan is collateral dependent if the repayment of the loan is expected to be provided solely by the liquidation of the underlying collateral and there are no other available and reliable sources of repayment.

Management will consider estimated costs to sell, on a discounted basis, in the measurement of impairment if these costs are expected to reduce the cash flows available to repay the loan.

Any portion of the recorded investment for a collateral dependent loan (including any capitalized accrued interest, net deferred loan fees or costs, and unamortized premium or discount) exceeding the fair value of the collateral that can be identified as uncollectible is deemed a confirmed loss and will be charged off against the ACL

Loans that have been individually measured for impairment may have a portion of the allowance allocated to cover the calculated amount of impairment as determined by the methods listed above, referred to as a specific allocation.

Loans individually evaluated for impairment may also have a zero specific allocation if the loans are deemed to have no impairment, or if the amount of the impairment will be charged off.

From time to time, the Company may agree to modify or restructure the contractual terms of loans to borrowers experiencing financial difficulties.

The most common types of concessions granted upon modification of a loan to a borrower experiencing financial difficulties include:

(a) a reduction in the interest rate for the remaining life of the debt, (b) an extension of the maturity date at an interest rate lower than the current market rate for new debt with similar risk, (c) a temporary period of interest-only payments, and (d) a reduction in the contractual payment amount for either a short period or for the remaining term of the loan.

A less common concession would be forgiveness of a portion of the loan’s principal.

Loans so modified remain collectively evaluated for determination of expected credit losses, unless, during the process of evaluation, it is determined that the loan should be placed on non-accrual status until the Company determines that future collection of principal and interest is reasonably assured or the loan is otherwise deemed to be collateral dependent.

Any modifications of loans to borrowers experiencing financial difficulty that are classified as non-accrual or are otherwise designated as collateral dependent are individually evaluated for determination of expected credit losses.

There may be certain types of loans for which the expectation of credit loss is zero after evaluating historical loss information, making necessary adjustments for current conditions and reasonable and supportable forecasts, and considering any collateral or guarantee arrangements that are not free-standing contracts.

Factors considered by management when evaluating whether expectations of zero credit loss are appropriate may include, but are not limited to:

1) a long history of zero credit loss;

2) full securitization by cash or cash equivalents;

3) high credit ratings from rating agencies with no expected future downgrade;

4) principal and interest payments that are guaranteed by the U.S.

5) the issuer, guarantor, or sponsor can print its own currency and the currency is held by other central banks as reserve currency;

and 6) the interest rate on the security is recognized as a risk-free rate.

A loan that is fully secured by cash or cash equivalents, such as a certificate of deposit issued by the lending institution, would likely have zero credit loss expectations.

Similarly, the guaranteed portion of an SBA loan purchased on the secondary market through the SBA’s fiscal and transfer agent would likely have zero credit loss expectations because these financial assets are unconditionally guaranteed by the U.S.

ASC Topic 326 introduces the concept of purchased credit deteriorated (“PCD”) assets.

PCD assets are acquired financial assets that, at acquisition, have experienced more-than-insignificant deterioration in credit quality since origination, as determined by the Company’s assessment.

The Company does not possess loans classified as purchased credit deterioration at this time.

Should the Company acquire purchased loans, these loans will be evaluated to determine if they are PCD.

A reserve for unfunded lending commitments is provided for possible credit losses on off-balance sheet credit exposures.

Off-balance sheet credit exposures primarily include undrawn portions of revolving lines of credit and standby letters of credit.

The reserve for unfunded lending commitments represents management’s estimate of losses inherent in its unfunded loan commitments and, if necessary, is recorded in other liabilities on the consolidated balance sheets.

As of September 30, 2022 and December 31, 2021, the amount of the reserve for unfunded lending commitments was $ 75,000 and $ 177,000 , respectively.

The Company is subject to periodic examination by its federal and state examiners, and may be required by such regulators to recognize additions to the allowance for loan losses based on their assessment of credit information available to them at the time of their examinations.

A loan is considered impaired when, based on current information and events, it is probable that the Company will be unable to collect all amounts due according to the contractual terms of the existing loan agreement.

Under current accounting standards, the allowance for loan losses related to impaired loans is based on discounted cash flows using the loan’s contractual interest rate at inception or the net realizable value of the collateral for certain collateral dependent loans.

From time to time, the Company may agree to modify/restructure the contractual terms of a borrower's loan.

The restructuring of a loan is considered a TDR if both the following conditions are met:

(i) the borrower is experiencing financial difficulties, and (ii) the Company has granted a concession.

The most common concessions granted include one or more modifications to the terms of the debt, such as (a) a reduction in the interest rate for the remaining life of the debt, (b) an extension of the maturity date at an interest rate lower than the current market rate for new debt with similar risk, (c) a temporary period of interest-only payments, and (d) a reduction in the contractual payment amount for either a short period or remaining term of the loan.

A less common concession is the forgiveness of a portion of the principal.

The determination of whether a borrower is experiencing financial difficulties takes into account not only the current financial condition of the borrower, but also the potential financial condition of the borrower were a concession not granted.

Similarly, the determination of whether a concession has been granted is subjective in nature.

For example, simply extending the term of a loan at its original interest rate or even at a higher interest rate could be interpreted as a concession unless the borrower could readily obtain similar credit terms from a different lender.

Loans modified in a TDR are considered impaired and may or may not be placed on non-accrual status until the Company determines the future collection of principal and interest is reasonably assured, which generally requires that the borrower demonstrates a period of performance according to the restructured terms of six months.

Any loan modifications that were made in response to the COVID-19 pandemic were not considered TDRs as long as the criteria set forth in Section 4013 of the CARES Act were met.

See page 25 for further discussion of the Section 4013 CARES Act modifications.

The Company utilizes a risk grading matrix as a tool for managing credit risk in the loan portfolio and assigns an asset quality rating (risk grade) to all commercial and industrial, commercial real estate, residential real estate and consumer loans.

As of March 31, 2023 and December 31, 2022, the amount of the reserve for unfunded lending commitments was $ 237,000 and $ 68,000 , respectively.

The Company made a policy election to exclude accrued interest receivable from the amortized cost basis of loans.

Accrued interest receivable on loans is reported as a component of accrued interest receivable on the Company’s consolidated balance sheet and totaled $ 1,762,000 as of March 31, 2023.

Accrued interest receivable on loans is excluded from the estimate of credit losses.

The Company is subject to periodic examination by its federal and state examiners, and may be required by such regulators to recognize additions to the ACL based on their assessment of credit information available to them at the time of their examinations.

The Company utilizes a risk grading matrix as a tool for managing credit risk in the loan portfolio and assigns an asset quality rating (risk grade) to all loans.

An asset quality rating is assigned using the guidance provided in the Company’s loan policy.

5 unchanged sentences

as well as other variables such as liquidity, cash flow, revenue/earnings trends, management strengths or weaknesses, quality of financial information, and credit history.

The loan grading system for Residential Real Estate and Consumer loans focuses on the borrower’s credit score and credit history, debt-to-income ratio and income sources, collateral position and loan-to-value ratio.

The loan grading system for residential real estate secured and consumer loans focuses on the borrower’s credit score and credit history, debt-to-income ratio and income sources, collateral position and loan-to-value ratio.

Risk grade characteristics are as follows:

25 unchanged sentences

Generally, loans graded doubtful have all the weaknesses inherent in a substandard loan with the added factor that the weaknesses are pronounced to a point whereby the basis of current information, conditions, and values, collection or liquidation in full is deemed to be highly improbable.

The possibility of loss is extremely high, but because of certain important and reasonably specific pending factors that may work to strengthen the asset, its classification is deferred until, for example, a proposed merger, acquisition, liquidation procedure, capital injection, perfection of liens on additional collateral and/or refinancing plan is completed.

on additional collateral and/or refinancing plan is completed.

Loans are graded doubtful if they contain weaknesses so serious that collection or liquidation in full is questionable.

The following table presents the classes of the loan portfolio summarized by risk rating as of September 30, 2022 and December 31, 2021:

Commercial and

The following table presents the classes of the loan portfolio summarized by risk rating and year of origination and gross charge offs by loan portfolio summarized by year of origination as of March 31, 2023:

(Dollars in thousands)

Commercial Real Estate

September 30,

7 Special Mention

8 Substandard

Add (deduct):

Unearned discount and

Unearned discount

Net deferred loan fees and costs

Residential Real Estate

Including Home Equity

September 30,

Total Real Estate Loans

Agricultural:

7 Special Mention

8 Substandard

Add (deduct):

Unearned discount and

Unearned discount

Net deferred loan fees and costs

September 30,

Total Agricultural Loans

Commercial and Industrial:

7 Special Mention

8 Substandard

Add (deduct):

Unearned discount and

Unearned discount

Net deferred loan fees and costs

Commercial and Industrial and Commercial Real Estate include loans categorized as tax-free in the amounts of $ 28,995,000 and $ 1,538,000 at September 30, 2022 and $ 24,647,000 and $ 1,671,000 at December 31, 2021.

Commercial and industrial loans also included $ 4,660,000 and $ 3,829,000 of GGLs and $ 125,000 and $ 4,894,000 of PPP loans as of September 30, 2022 and December 31, 2021, respectively.

Loans held for sale amounted to $ 691,000 at September 30, 2022 and $ 6,006,000 at December 31, 2021.

During the nine months ended September 30, 2022, $ 7,900,000 in loans that had previously been classified as held for sale were transferred to held for investment status, as the Company no longer had the intent to sell these loans.

The activity in the allowance for loan losses, by loan class, is summarized below for the periods indicated.

(Dollars in thousands)

and Industrial

As of and for the three months ended September 30, 2022:

Allowance for Loan Losses:

Beginning balance

Provision (credit)

Ending Balance

Total Commercial and

Industrial Loans

7 Special Mention

8 Substandard

Unearned discount

Net deferred loan fees and costs

Total Consumer Loans

State and Political Subdivisions:

7 Special Mention

8 Substandard

Unearned discount

Net deferred loan fees and costs

Total State and Political Subdivision Loans

7 Special Mention

8 Substandard

Unearned discount

Net deferred loan fees and costs

Gross Charge Offs:

Commercial and Industrial

State and Political Subdivisions

Total Gross Charge Offs

Commercial and Industrial Loans include loans categorized as tax-free in the amount of $ 10,000 and State and Political Subdivision Loans include loans categorized as tax-free in the amount of $ 29,454,000 as of March 31, 2023.

Commercial and Industrial Loans also include $ 4,595,000 of GGLs and $ 101,000 of PPP loans as of March 31, 2023.

Loans held for sale amounted to $ 115,000 at March 31, 2023 and are included in the Real Estate Loans category.

The activity in the allowance for credit losses by loan class (post adoption of ASU No.

2016-13), is summarized below for the three months ended March 31, 2023.

(Dollars in thousands)

and Industrial

As of and for the nine months ended September 30, 2022:

Allowance for Loan Losses:

Beginning balance

Provision (credit)

As of and for the three months ended March 31, 2023:

Allowance for Credit Losses:

Balance at December 31, 2022

CECL adoption adjustment

Beginning balance January 1, 2023

(Credit) Provision

Ending Balance

3 unchanged sentences

evaluated for impairment

Reserve for Unfunded Lending Commitments

Loans Receivable:

4 unchanged sentences

evaluated for impairment

The Company's activity in the allowance for credit losses on unfunded commitments for the period ended March 31, 2023 was as follows:

(Dollars in thousands)

and Industrial

As of and for the three months ended September 30, 2021:

Allowance for Loan Losses:

Beginning balance

(Credit) provision

Ending Balance

Balance at December 31, 2022

CECL adoption adjustment

Provision for credit losses

Balance at March 31, 2023

The recorded investment, unpaid principal balance, and the related allowance of the Company’s individually evaluated loans are summarized below at March 31, 2023:

(Dollars in thousands)

March 31, 2023

With no related allowance recorded:

Commercial and Industrial

With an allowance recorded:

Commercial and Industrial

Total consists of:

Commercial and Industrial

The recorded investment represents the loan balance reflected on the consolidated balance sheets net of any charge-offs.

The unpaid balance is equal to the gross amount due on the loan.

The average recorded investment and interest income recognized for the Company’s individually evaluated loans are summarized below for the three months ended March 31, 2023:

(Dollars in thousands)

For the Three Months Ended

March 31, 2023

With no related allowance recorded:

Commercial and Industrial

With an allowance recorded:

Commercial and Industrial

Total consists of:

Commercial and Industrial

Of the $ 6,000 in interest income recognized on individually evaluated loans for the three months ended March 31, 2023, $ 0 in interest income was recognized with respect to non-accrual loans.

The following table presents collateral-dependent loans by segment for the period ended March 31, 2023.

(Dollars in thousands)

March 31, 2023

Commercial and Industrial

At March 31, 2023, there were no commitments to lend additional funds with respect to individually evaluated loans.

Total non-performing assets (which includes loans receivable on non-accrual status, foreclosed assets held for resale and loans past-due 90 days or more and still accruing interest) as of March 31, 2023 and December 31, 2022 were as follows:

(Dollars in thousands)

Commercial and Industrial

State and Political Subdivisions

Total non-accrual loans

Foreclosed assets held for resale

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

Total non-performing assets

There were no foreclosed assets held for resale at March 31, 2023 or December 31, 2022.

Consumer mortgage loans secured by residential real estate for which the Company has entered into formal foreclosure proceedings but for which physical possession has yet to be obtained amounted to $ 41,000 at both March 31, 2023 and December 31, 2022.

These balances were not included in foreclosed assets held for resale at March 31, 2023 or December 31, 2022.

The following tables present the classes of the loan portfolio, including individually evaluated loans, summarized by past-due status at March 31, 2023 and December 31, 2022:

(Dollars in thousands)

March 31, 2023:

Commercial and Industrial

State and Political Subdivisions

(Dollars in thousands)

December 31, 2022:

Commercial and Industrial

State and Political Subdivisions

2016-13 Disclosures:

For periods prior to the adoption of ASU No.

2016-13, when management deemed the collection of contractual cashlows was unlikely for a specific instrument (mainly non-accrual loans and TDRs, then referred to as impaired loans), a specific reserve was calculated under ASC 310-10.

Management further calculated a general reserve for performing assets under its previous methodology, following ASC 450-20 which utilized historical loss experience and qualitative factor adjustments to arrive at a calculated allowance for credit losses.

Upon adoption of ASU No.

2016-13, the classes of the loan portfolio were updated to match the segmentation used under the CECL model and have been updated from Commercial and Industrial, Commercial Real Estate, Residential Real Estate, and Consumer to Real Estate, Agricultural, Commercial and Industrial, Consumer, and State and Political Subdivisions.

Comparative, pre-ASU No.

2016-13 adoption data has not been updated to reflect the new loan classes/segmentation utilized under the CECL model.

The following table presents the classes of the loan portfolio summarized by risk rating as of December 31,

Commercial and

(Dollars in thousands)

Commercial Real Estate

7 Special Mention

8 Substandard

Add (deduct):

Unearned discount

Net deferred loan fees and costs

Residential Real Estate

Including Home Equity

7 Special Mention

8 Substandard

Add (deduct):

Unearned discount

Net deferred loan fees and costs

7 Special Mention

8 Substandard

Add (deduct):

Unearned discount

Net deferred loan fees and costs

The activity in the allowance for credit losses by loan class (prior to adoption of ASU No.

2016-13), is summarized below for the three months ended March 31, 2022 and the year ended December 31, 2022.

(Dollars in thousands)

and Industrial

As of and for the nine months ended September 30, 2021:

Allowance for Loan Losses:

As of and for the three months ended March 31, 2022:

Allowance for Credit Losses:

Beginning balance

14 unchanged sentences

As of and for the year ended December 31, 2022:

Allowance for Loan Losses:

Allowance for Credit Losses:

Beginning balance

11 unchanged sentences

evaluated for impairment

The outstanding recorded investment of TDRs as of September 30, 2022 and December 31, 2021 was $ 7,589,000 and $ 8,020,000 , respectively.

The decrease in TDRs at September 30, 2022 as compared to December 31, 2021 is mainly attributable to regular principal payments and paydowns on existing TDRs that were completed during the nine months ended September 30, 2022.

There were no unfunded commitments on TDRs at September 30, 2022 and December 31, 2021.

During the three months ended September 30, 2022, one loan with a post modification balance of $ 143,000 was modified as a TDR, compared to the three months ended September 30, 2021 when one loan with a post modification recorded balance of $ 59,000 was modified as a TDR.

During the nine months ended September 30, 2022, two loans with a combined post modification recorded investment of $ 515,000 were modified as TDRs, compared to the nine months ended September 30, 2021 when four loans with a combined post modification recorded investment of $ 360,000 were modified as TDRs.

The loan modifications for the nine months ended September 30, 2022 consisted of two payment modifications, compared to the loan modifications for the nine months ended September 30, 2021 which consisted of two term modifications and two payment modifications.

The outstanding recorded investment of TDRs as of December 31, 2022 $ 7,480,000 .

There were no unfunded commitments on TDRs at December 31, 2022.

The following table presents the outstanding recorded investment of TDRs at the dates indicated:

(Dollars in thousands)

September 30,

Non-accrual TDRs

Accruing TDRs

At September 30, 2022, three commercial and industrial loans classified as TDRs with a combined recorded investment of $ 670,000 and four commercial real estate loans classified as TDRs with a combined recorded investment of $ 107,000 were not in compliance with the terms of their restructure, compared to September 30, 2021 when three commercial and industrial loans classified as TDRs with a combined recorded investment of $ 724,000 , eight commercial real estate loans classified as TDRs with a combined recorded investment of $ 541,000 , and one residential real estate loan classified as a TDR with a recorded investment of $ 15,000 were not in compliance with the terms of their restructure.

Of the loans that were modified as TDRs within the twelve months preceding September 30, 2022, no loans experienced payment defaults during the three or nine months ended September 30, 2022.

Of the loans that were modified as TDRs during the twelve months preceding September 30, 2021, three commercial real estate loans totaling $ 291,000 experienced payment defaults during the nine months ended September 30, 2021.

No loans that were modified as TDRs during the twelve months preceding September 30, 2021 experienced payment defaults during the three months ended September 30, 2021.

The following table presents information regarding the loan modifications categorized as TDRs during the three and nine months ended September 30, 2022 and 2021.

(Dollars in thousands)

For the Three Months Ended September 30, 2022

Pre-Modification

Post-Modification

Commercial Real Estate

(Dollars in thousands)

For the Nine Months Ended September 30, 2022

Pre-Modification

Post-Modification

Commercial Real Estate

(Dollars in thousands)

For the Three Months Ended September 30, 2021

Pre-Modification

Post-Modification

Commercial Real Estate

(Dollars in thousands)

For the Nine Months Ended September 30, 2021

Pre-Modification

Post-Modification

Commercial Real Estate

The following table provides detail regarding the types of loan modifications made for loans categorized as TDRs during the three and nine months ended September 30, 2022 and 2021 with the total number of each type of modification performed.

For the Three Months Ended September 30, 2022

Commercial Real Estate

For the Nine Months Ended September 30, 2022

Commercial Real Estate

For the Three Months Ended September 30, 2021

Commercial Real Estate

For the Nine Months Ended September 30, 2021

Commercial Real Estate

In the wake of the COVID-19 pandemic, during the second quarter of 2020, the Company began granting loan modification requests to defer principal and/or interest payments or modify interest rates.

These loans are not classified as TDRs according to Section 4013 of the CARES Act, as long as the specific criteria set forth in the Act are met.

As of September 30, 2022, there were no loan modifications in compliance with Section 4013 of the CARES Act that were still actively on deferral, compared to December 31, 2021 when there was one loan in the amount of $ 9,423,000 that was still actively on deferral, which was returned to normal payment status during the first quarter of 2022.

The recorded investment, unpaid principal balance, and the related allowance of the Company’s impaired loans are summarized below at September 30, 2022 and December 31, 2022.

At March 31, 2022, three commercial and industrial loans classified as TDRs with a combined recorded investment of $ 696,000 , six commercial real estate loans classified as TDRs with a combined recorded investment of $ 431,000 , and one residential real estate loan classified as a TDR with a recorded investment of $ 13,000 were not in compliance with the terms of their restructure.

Of the loans that were modified as TDRs during the twelve months preceding March 31, 2022, one commercial real estate loan experienced a payment default during the three months ended March 31, 2022, but the loan was subsequently paid off prior to the end of the quarter.

No loans were modified as TDRs during the three months ended March 31, 2022.

The recorded investment, unpaid principal balance, and the related allowance of the Company’s impaired loans are summarized below at December 31, 2022.

(Dollars in thousands)

September 30, 2022

December 31, 2022

11 unchanged sentences

Residential Real Estate

At September 30, 2022 and December 31, 2021, $ 7,589,000 and $ 8,020,000 of loans classified as TDRs were included in impaired loans with a total allocated allowance of $ 0 at both September 30, 2022 and December 31, 2021.

At December 31, 2022, $ 7,480,000 of loans classified as TDRs were included in impaired loans with a total allocated allowance of $ 0 at December 31, 2022.

The recorded investment represents the loan balance reflected on the consolidated balance sheets net of any charge-offs.

The unpaid balance is equal to the gross amount due on the loan.

The average recorded investment and interest income recognized for the Company’s impaired loans are summarized below for the three and nine months ended September 30, 2022 and 2021.

The average recorded investment and interest income recognized for the Company’s impaired loans are summarized below for the three months ended March 31, 2022.

(Dollars in thousands)

For the Three Months Ended

September 30, 2022

September 30, 2021

With no related allowance recorded:

Commercial and Industrial

Commercial Real Estate

Residential Real Estate

With an allowance recorded:

Commercial and Industrial

Commercial Real Estate

Residential Real Estate

Total consists of:

Commercial and Industrial

Commercial Real Estate

Residential Real Estate

Of the $ 75,000 and $ 84,000 in interest income recognized on impaired loans for the three months ended September 30, 2022 and 2021 respectively, $ 0 in interest income was recognized with respect to non-accrual loans for each respective period.

(Dollars in thousands)

For the Nine Months Ended

September 30, 2022

September 30, 2021

March 31, 2022

With no related allowance recorded:

10 unchanged sentences

Residential Real Estate

Of the $ 222,000 and $ 278,000 in interest income recognized on impaired loans for the nine months ended September 30, 2022 and 2021 respectively, $ 0 and $ 3,000 in interest income was recognized with respect to non-accrual loans for each respective period.

Total non-performing assets (which includes loans receivable on non-accrual status, foreclosed assets held for resale and loans past-due 90 days or more and still accruing interest) as of September 30, 2022 and December 31, 2021 were as follows:

(Dollars in thousands)

September 30,

Commercial and Industrial

Commercial Real Estate

Residential Real Estate

Total non-accrual loans

Foreclosed assets held for resale

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

Total non-performing assets

There were no foreclosed assets held for resale at September 30, 2022 or December 31, 2021.

These balances were not included in foreclosed assets held for resale at September 30, 2022 or December 31, 2021.

The following tables present the classes of the loan portfolio, including non-accrual loans and TDRs, summarized by past-due status at September 30, 2022 and December 31, 2021:

(Dollars in thousands)

September 30, 2022:

Commercial and Industrial

Commercial Real Estate

Residential Real Estate

(Dollars in thousands)

December 31, 2021:

Commercial and Industrial

Commercial Real Estate

Residential Real Estate

At September 30, 2022 and December 31, 2021, commitments to lend additional funds with respect to impaired loans consisted of one irrevocable letter of credit totaling $ 1,249,000 that was associated with a loan to a developer of a residential sub-division.

Of the $ 74,000 in interest income recognized on impaired loans for the three months ended March 31, 2022, $ 0 in interest income was recognized with respect to non-accrual loans.

NOTE 5 — DEPOSITS

Major classifications of deposits at September 30, 2022 and December 31, 2021 consisted of:

Major classifications of deposits at March 31, 2023 and December 31, 2022 consisted of:

(Dollars in thousands)

September 30,

Non-interest bearing demand

3 unchanged sentences

Total deposits

Total deposits decreased $ 19,660,000 to $ 1,058,309,000 as of September 30, 2022 due to decreases in interest bearing demand and time deposits.

The decrease in deposits was mainly the result of a $ 84,608,000 decrease in municipal deposits and other normal fluctuations in deposits during the nine months ended September 30, 2022.

Total deposits decreased $ 45,584,000 to $ 947,915,000 as of March 31, 2023 due to decreases in non-interest bearing demand, interest bearing demand and savings deposits.

The decrease in deposits was mainly the result of a $ 38,711,000 decrease in municipal deposits and other normal fluctuations in deposits during the three months ended March 31, 2023.

NOTE 6 — BORROWINGS

1 unchanged sentence

Short-term borrowings include federal funds purchased, securities sold under agreements to repurchase, the Federal Discount Window, and Federal Home Loan Bank of Pittsburgh (“FHLB”) advances, which generally represent overnight or less than 30-day borrowings.

Short-term borrowings and weighted–average interest rates at September 30, 2022 and December 31, 2021 are as follows:

Short-term borrowings and weighted–average interest rates at March 31, 2023 and December 31, 2022 are as follows:

(Dollars in thousands)

September 30, 2022

March 31, 2023

December 31, 2022

13 unchanged sentences

The counterparty has the right to sell or repledge the investment securities.

The following table presents the short-term borrowings subject to an enforceable master netting arrangement or repurchase agreements as of September 30, 2022 and December 31, 2021.

The following table presents the short-term borrowings subject to an enforceable master netting arrangement or repurchase agreements as of March 31, 2023 and December 31, 2022.

(Dollars in thousands)

of Liabilities

September 30, 2022

March 31, 2023

Repurchase agreements (a)

1 unchanged sentence

Repurchase agreements (a)

(a) As of September 30, 2022 and December 31, 2021, the fair value of securities pledged in connection with repurchase agreements was $ 36,062,000 and $ 37,735,000 , respectively.

The following table presents the remaining contractual maturity of the master netting arrangement or repurchase agreements as of September 30, 2022:

(a) As of March 31, 2023 and December 31, 2022, the fair value of securities pledged in connection with repurchase agreements was $ 26,188,000 and $ 34,160,000 , respectively.

The following table presents the remaining contractual maturity of the master netting arrangement or repurchase agreements as of March 31, 2023:

(Dollars in thousands)

Remaining Contractual Maturity of the Agreements

September 30, 2022:

March 31, 2023:

Repurchase agreements and repurchase-to-maturity transactions:

5 unchanged sentences

The Company began utilizing this service offered by the FHLB during the second quarter of 2021.

There were no irrevocable standby letters of credit which could be drawn on through FHLB’s close of business on September 30, 2022.

There were no irrevocable standby letters of credit which could be drawn on through FHLB’s close of business on March 31, 2023.

Any irrevocable standby letters of credit are issued as necessary in an amount appropriate to secure specific public/municipal unit deposits.

1 unchanged sentence

Principal qualifying assets are certain real estate mortgages and investment securities.

As of September 30, 2022, loans of $ 664,778,000 were pledged to FHLB which resulted in a FHLB maximum borrowing capacity of $ 468,873,000 .

As of September 30, 2022, no securities were pledged as collateral to FHLB to secure FHLB loans and letters of credit.

As of March 31, 2023, loans of $ 714,475,000 were pledged to FHLB which resulted in a FHLB maximum borrowing capacity of $ 504,375,900 .

As of March 31, 2023, no securities were pledged as collateral to FHLB to secure FHLB loans and letters of credit.

NOTE 7 — SUBORDINATED DEBT

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

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

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

regulatory capital purposes.

The Company utilized the net proceeds it received from the sale of the 2020 Notes to support organic growth and for general corporate purposes.

7 unchanged sentences

Management does not believe the outcome of these actions and proceedings will have a material effect on the consolidated financial position or results of operations of the Company.

The Company currently leases four branch banking facilities and one parcel of land under operating leases.

At September 30, 2022, right-of-use assets and lease liabilities were recorded related to these operating leases totaling $ 999,000 and $ 1,484,000 , respectively.

At December 31, 2021, right-of-use assets and lease liabilities stood at $ 1,025,000 and $ 1,499,000 , respectively.

Further options to extend or terminate the lease are not applicable for any of the five leases.

The Company currently leases three branch banking facilities and one parcel of land under operating leases.

At March 31, 2023, right-of-use assets and lease liabilities were recorded related to these operating leases totaling $ 1,548,000 and $ 2,041,000 , respectively.

At December 31, 2022, right-of-use assets and lease liabilities stood at $ 1,541,000 and $ 2,029,000 , respectively, in the consolidated balance sheets.

Options to extend or terminate a lease may be included in our lease agreements.

When it is reasonably certain that we will exercise those options, the right-of-use asset and lease liability will reflect the renewal or termination option.

No significant assumptions or judgements were made in determining whether a contract contained a lease or in the consideration of lease versus non-lease components.

1 unchanged sentence

therefore, our incremental borrowing rate was used for each of the leases.

The Company recognized total operating lease costs for the nine months ended September 30, 2022 and 2021 of $ 135,000 and $ 133,000 , respectively.

The Company recognized total operating lease costs for the three months ended March 31, 2023 and 2022 of $ 58,000 and $ 45,000 , respectively.

Operating lease costs are included in occupancy, net in the accompanying statements of income.

Cash payments totaled $ 125,000 and $ 116,000 , respectively, for the nine months ended September 30, 2022 and 2021.

Cash payments totaled $ 55,000 and $ 41,000 , respectively, for the three months ended March 31, 2023 and 2022.

The Company currently has one finance lease for equipment.

At September 30, 2022, right-of-use assets and lease liabilities were recorded related to the finance lease totaling $ 34,000 and $ 9,000 , respectively.

At March 31, 2023, right-of-use assets and lease liabilities were recorded related to the finance lease totaling $ 34,000 and $ 4,000 , respectively.

At December 31, 2022, right-of-use assets and lease liabilities stood at $ 34,000 and $ 6,000 , respectively.

4 unchanged sentences

therefore, our incremental borrowing rate was used.

Total finance lease costs that were recognized by the Company for the nine months ended September 30, 2022 and 2021 were immaterial.

Cash payments totaled $ 7,000 for the nine months ended September 30, 2022 and 2021.

The following table displays the weighted-average term and discount rates for operating and finance leases outstanding as of September 30, 2022 and December 31, 2021.

September 30,

Total finance lease costs that were recognized by the Company for the three months ended March 31, 2023 and 2022 were immaterial.

Cash payments totaled $ 2,000 for the three months ended March 31, 2023 and 2022.

The following table displays the weighted-average term and discount rates for operating and finance leases outstanding as of March 31, 2023 and December 31, 2022.

Weighted-average term (years)

2 unchanged sentences

(Dollars in thousands)

September 30,

Minimum Lease Payments due:

18 unchanged sentences

The Company may require collateral or other security to support financial instruments with off-balance sheet credit risk.

The contract or notional amounts at September 30, 2022 and December 31, 2021 were as follows:

The contract or notional amounts at March 31, 2023 and December 31, 2022 were as follows:

(Dollars in thousands)

September 30, 2022

March 31, 2023

December 31, 2022

8 unchanged sentences

The amount of collateral obtained, if deemed necessary by the Company upon extension of credit, is based on management’s credit evaluation of the borrower.

Collateral held varies but may include

accounts receivable, inventory, property, plant and equipment, owner-occupied income-producing commercial properties, and residential real estate.

Collateral held varies but may include accounts receivable, inventory, property, plant and equipment, owner-occupied income-producing commercial properties, and residential real estate.

Standby letters of credit are conditional commitments issued by the Company to guarantee payment to a third party when a customer either fails to repay an obligation or fails to perform some non-financial obligation.

2 unchanged sentences

Financial Instruments with Concentrations of Credit Risk

The Company originates primarily commercial and residential real estate loans to customers in northeastern Pennsylvania.

The Company originates primarily commercial and residential real estate loans to customers predominately in the Company’s primary five county, Pennsylvania market area.

The ability of the majority of the Company’s customers to honor their contractual loan obligations is dependent on the economy and real estate market in this area.

At September 30, 2022, the Company had $ 754,392,000 in loans secured by real estate, which represented 89.2 % of total loans.

At March 31, 2023, the Company had $ 767,060,000 in loans secured by real estate, which represented 89.0 % of total loans.

The real estate loan portfolio is largely secured by lessors of residential buildings and dwellings, lessors of non-residential buildings, and lessors of hotels/motels.

As of September 30, 2022 and December 31, 2021, management is of the opinion that there were no concentrations exceeding 10% of total loans with regard to loans to borrowers who were engaged in similar activities that were similarly impacted by economic or other conditions.

As of March 31, 2023 and December 31, 2022, management is of the opinion that there were no concentrations exceeding 10% of total loans with regard to loans to borrowers who were engaged in similar activities that were similarly impacted by economic or other conditions.

As all financial instruments are subject to some level of credit risk, the Company requires collateral and/or guarantees for all loans.

1 unchanged sentence

In the event of a borrower’s default, the collateral supporting the loan may be seized in order to recoup losses associated with the loan.

The Company also establishes an allowance for loan losses that constitutes the amount available to absorb losses within the loan portfolio that may exist due to deficiencies in collateral values.

The Company also establishes an allowance for credit losses that constitutes the amount available to absorb losses within the loan portfolio that may exist due to deficiencies in collateral values.

NOTE 10 — FAIR VALUE MEASUREMENTS

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Fair value measurement and disclosure guidance provides a list of factors that a reporting entity should evaluate to determine whether there has been a significant decrease in the volume and level of activity for the asset or liability in relation to normal market activity for the asset or liability.

When the reporting entity concludes there has been a significant decrease in the volume and level of activity for the asset or liability, further analysis of the information from that market is needed and significant adjustments to the related prices may be necessary to estimate fair value in accordance with the fair value measurement and disclosure guidance.

When the reporting entity concludes there has been a significant decrease in the volume and level of activity for the asset or liability, further analysis of the information from

that market is needed and significant adjustments to the related prices may be necessary to estimate fair value in accordance with the fair value measurement and disclosure guidance.

This guidance clarifies that when there has been a significant decrease in the volume and level of activity for the asset or liability, some transactions may not be orderly.

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Inputs may be observable, meaning those that reflect the assumptions market participants would use in pricing the asset or liability developed based on market data obtained from independent sources, or unobservable, meaning those that reflect the reporting entity’s own belief about the assumptions market participants would use in pricing the asset or liability based upon the best information available.

value measurement and disclosure guidance establishes a fair value hierarchy for valuation inputs that gives the highest priority to quoted prices in active markets for identical assets or liabilities and the lowest priority to unobservable inputs.

Fair value measurement and disclosure guidance establishes a fair value hierarchy for valuation inputs that gives the highest priority to quoted prices in active markets for identical assets or liabilities and the lowest priority to unobservable inputs.

The fair value hierarchy is as follows:

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Financial Assets Measured at Fair Value on a Recurring Basis

At September 30, 2022 and December 31, 2021, securities measured at fair value on a recurring basis and the valuation methods used are as follows:

At March 31, 2023 and December 31, 2022, securities measured at fair value on a recurring basis and the valuation methods used are as follows:

(Dollars in thousands)

September 30, 2022

March 31, 2023

Debt Securities Available-for-Sale:

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Financial Assets Measured at Fair Value on a Nonrecurring Basis

At September 30, 2022 and December 31, 2021, impaired loans measured at fair value on a nonrecurring basis are as follows:

Periodically, non-recurring adjustments may be applied to the carrying value of loans based on the fair value measurements for partial charge-offs of the uncollectible portions of those loans.

Non-recurring adjustments can also include certain specific allocation amounts for individually evaluated collateral-dependent loans as calculated when establishing the allowance for credit losses.

The Company’s valuation procedure for any individually evaluated 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 Company.

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 individually evaluated loans less than $250,000 upon classification and annually at year end, the Company completes a Certificate of Inspection, which includes an onsite inspection, and considers value indicators such as insured values, tax assessed values, recent sales comparisons and a review of the previous evaluations.These assets are included as Level 3 fair values, based upon the lowest level that is significant to the fair value measurements.

The fair value consists of the individually evaluated loan balances less the valuation allowance and/or charge-offs.

There were no transfers between valuation levels in 2023 and 2022.

Following the adoption of ASU No.

2016-13, at March 31, 2023, individually evaluated loans measured at fair value on a nonrecurring basis are as follows:

(Dollars in thousands)

Assets at September 30, 2022

Impaired loans:

Assets at March 31, 2023

Individually evaluated loans:

Commercial Real Estate

Residential Real Estate

Total impaired loans

Total individually evaluated loans

Prior to the adoption of ASU No.

2016-13, at December 31, 2022, impaired loans measured at fair value on a nonrecurring basis were as follows:

(Dollars in thousands)

4 unchanged sentences

Total impaired loans

The Company’s impaired 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 Company.

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 impaired loans less than $ 250,000 upon classification and annually at year end, the Company completes a Certificate of Inspection, which includes an onsite inspection, and considers value indicators such as insured values, tax assessed values, recent sales comparisons and a review of the previous evaluations.These assets are included as Level 3 fair values, based upon the lowest level that is

significant to the fair value measurements.

The fair value consists of the impaired loan balances less the valuation allowance and/or charge-offs.

There were no transfers between valuation levels in 2022 and 2021.

Nonfinancial Assets Measured at Fair Value on a Nonrecurring Basis

There were no foreclosed assets held for resale measured at fair value on a nonrecurring basis at September 30, 2022 and December 31, 2021.

There were no foreclosed assets held for resale measured at fair value on a nonrecurring basis at March 31, 2023 and December 31, 2022.

The Company’s foreclosed asset valuation procedure requires an appraisal or a Certificate of Inspection, which considers the sales prices of similar properties in the proximate vicinity, to be completed periodically with the exception of those cases in which the Bank has obtained a sales agreement.

4 unchanged sentences

Quantitative Information about Level 3 Fair Value Measurements

September 30, 2022

2016-13 Adoption:

March 31, 2023

Valuation Technique

Unobservable Input

Impaired loans - collateral dependent

Individually evaluated loans - collateral dependent

Appraisal of collateral 1,3

3 unchanged sentences

( 0 %) – ( 5 %)

Impaired loans - other

Discounted cash flow

Discount rate

( 7 % ) – ( 7 % )

2016-13 Adoption:

December 31, 2022

16 unchanged sentences

(Dollars in thousands)

Fair Value Measurements at September 30, 2022

Fair Value Measurements at March 31, 2023

FINANCIAL ASSETS:

1 unchanged sentence

Interest-bearing deposits in other banks

Time deposits with other banks

Restricted investment in bank stocks

14 unchanged sentences

Interest-bearing deposits in other banks

Time deposits with other banks

Restricted investment in bank stocks

24 unchanged sentences

Wealth management fees are included within non-interest income in the consolidated statements of income.

As of September 30, 2022 and December 31, 2021, the fair value of trust assets under management was $ 114,030,000 and $ 108,339,000 , respectively.

As of March 31, 2023 and December 31, 2022, the fair value of trust assets under management was $ 113,687,000 and $ 111,172,000 , respectively.

The costs of acquiring asset management customers are incremental and recognized within non-interest expense in the consolidated statements of income.

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Diluted EPS reflects the potential dilution that could occur if securities or other contracts to issue common stock were exercised or converted into common stock or resulted in the issuance of common stock that then shared in the earnings of the Corporation.

At September 30, 2022 and 2021, there were no potential common shares outstanding.

At March 31, 2023 and 2022, there were no potential common shares outstanding.

The following table sets forth the computation of basic and diluted earnings per share.

1 unchanged sentence

Three Months Ended

September 30,

Weighted-average common shares outstanding

Basic and diluted earnings per share

(In thousands, except earnings per share)

Nine Months Ended

September 30,

Weighted-average common shares outstanding

Basic and diluted earnings per share

NOTE 13 — GOODWILL

2 unchanged sentences

In accordance with current accounting standards, goodwill is not amortized.

Goodwill totaled $ 19,133,000 at September 30, 2022 and December 31, 2021.

Goodwill totaled $ 19,133,000 at March 31, 2023 and December 31, 2022.

Impairment testing is performed on an annual basis, using either a qualitative or quantitative approach.

2 unchanged sentences

Goodwill was evaluated for impairment at December 31, 2022, and it was determined that goodwill was not impaired.

Management evaluated the need for an interim goodwill impairment analysis and determined that there were no triggering events or negative factors affecting goodwill since the previous test that would indicate goodwill was impaired as of September 30, 2022.

First Keystone Corporation Management’s Discussion and Analysis of Financial Condition and Results of Operation

3 unchanged sentences

Although management believes the expectations reflected in such forward-looking statements are reasonable, actual results may differ materially.

CRITICAL ACCOUNTING ESTIMATES

CRITICAL ACCOUNTING POLICIES

The Company has chosen accounting policies that it believes are appropriate to accurately and fairly report its operating results and financial position, and the Company applies those accounting policies in a consistent manner.

The Significant Accounting Policies are summarized in Note 1 to the consolidated financial statements included in the 2022 Annual Report on Form 10-K.

There have been no changes to the Critical Accounting Estimates since the Company filed its Annual Report on Form 10-K for the year ended December 31, 2021.

Effective January 1, 2023, the Company elected to adopt ASU No.

2016-13, referred to as CECL.

Please refer to Note 2- Recent Accounting Standards Updates, Note 3- Securities, and Note 4- Loans and Allowance for Credit Losses for updates reflecting the adoption of ASU No.

These Notes supplement updates to the accounting policies previously disclosed in Note 1- Summary of Significant Accounting Policies of the Company’s Annual Report on Form 10-K for the year ended December 31, 2022.

RESULTS OF OPERATIONS

Quarter ended September 30, 2022 compared to quarter ended September 30, 2021

First Keystone Corporation realized earnings for the three months ended September 30, 2022 of $3,504,000, a decrease of $519,000, or 12.9% from the third quarter of 2021.

The decrease in net income for the three months ended September 30, 2022 was primarily due to increases in interest paid on deposits, interest paid on short-term borrowings through the Federal Home Loan Bank, and salaries and employee benefits expenses, as well as a reduction in net gains on sales of mortgage loans, and less PPP fees.

On a per share basis, for the three months ended September 30, 2022, net income was $0.58 versus $0.68 for the same three month period of 2021.

Cash dividends amounted to $0.28 per share for the three months ended September 30, 2022 and 2021.

Quarter ended March 31, 2023 compared to quarter ended March 31, 2022

First Keystone Corporation realized earnings for the three months ended March 31, 2023 of $1,357,000, a decrease of $2,186,000, or 61.7% from the first quarter of 2022.

The decrease in net income for the three months ended March 31, 2023 was primarily due to increases in interest paid on deposits, interest paid on short-term borrowings through the Federal Home Loan Bank, and salaries and employee benefits expenses, as well as a reduction in PPP fees.

On a per share basis, for the three months ended March 31, 2023, net income was $0.23 versus $0.60 for the same three month period of 2022.

Cash dividends amounted to $0.28 per share for the three months ended March 31, 2023 and 2022.

NET INTEREST INCOME

The major source of operating income for the Company is net interest income, defined as interest and loan fee income less interest expense.

In the three months ended September 30, 2022, interest income amounted to $11,897,000, an increase of $1,181,000 or 11.0% from the three months ended September 30, 2021, while interest expense amounted to $2,378,000 in the three months ended September 30, 2022, an increase of $1,095,000 or 85.3% from the three months ended September 30, 2021.

As a result, net interest income increased $86,000 or 0.9% to $9,519,000 from $9,433,000 for the same period in 2021.

The Company’s net interest margin for the three months ended September 30, 2022 was 3.24% compared to 3.18% for same period in 2021.

The increase in net interest margin was primarily a result of increases in yields earned on commercial and consumer loans and restricted stocks.

PROVISION FOR LOAN LOSSES

The provision for loan losses for the three months ended September 30, 2022 and 2021 was $219,000 and $185,000, respectively.

The increase in the provision for loan losses resulted from the Company’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 three months ended September 30, 2022 is also reflective of management’s assessment of the continued credit risk associated with the uncertainty surrounding geopolitical and

economic concerns.

Charge-off and recovery activity in the allowance for loan losses resulted in net charge-offs of $168,000 and $21,000 for the the three months ended September 30, 2022 and 2021, respectively.

See Allowance for Loan Losses on page 46 for further discussion.

In the three months ended March 31, 2023, interest income amounted to $13,307,000, an increase of $2,678,000 or 25.2% from the three months ended March 31, 2022, while interest expense amounted to $5,503,000 in the three months ended March 31, 2023, an increase of $4,330,000 or 369.1% from the three months ended March 31, 2022.

As a result, net interest income decreased $1,652,000 or 17.5% to $7,804,000 from $9,456,000 for the same period in 2022.

The Company’s net interest margin for the three months ended March 31, 2023 was 2.61% compared to 3.19% for same period in 2022.

The decrease in net interest margin was primarily a result of increased rates paid on deposit products and short-term borrowings.

PROVISION FOR CREDIT LOSSES

The provision for credit losses for the three months ended March 31, 2023 and 2022 was $0 and $219,000, respectively.

The decrease in the provision for credit losses resulted from the Company’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 credit losses for the three months ended March 31, 2023 is also reflective of management’s assessment of the continued credit risk associated with the uncertainty surrounding geopolitical and economic concerns.

Charge-off and recovery activity in the allowance for credit losses resulted in net charge-offs of $13,000 for the three months ended March 31, 2023 and net recoveries of $38,000 for the the three months ended March 31, 2022.

See Allowance for Credit Losses on page 45 for further discussion.

NON-INTEREST INCOME

Total non-interest income was $1,493,000 for the three months ended September 30, 2022, as compared to $1,697,000 for the same period in 2021, a decrease of $204,000, or 12.0%.

Net securities (losses) gains decreased $72,000 to ($50,000) for the three months ended September 30, 2022 as compared to the three months ended September 30, 2021.

This decrease was mainly due to the Company recognizing $50,000 in net losses on held equity securities in the third quarter of 2022 as compared to recognizing $18,000 in net gains on held equity securities in the same quarter of 2021.

Trust department income decreased $7,000 or 2.9% to $236,000 for the three months ended September 30, 2022 as compared to the same period in 2021.

Total non-interest income was $1,452,000 for the three months ended March 31, 2023, as compared to $1,389,000 for the same period in 2022, an increase of $63,000, or 4.5%.

Net securities losses decreased $7,000 to ($56,000) for the three months ended March 31, 2023 as compared to the three months ended March 31, 2022.

This decrease was mainly due to to the Company recognizing $63,000 in net losses on held equity securities in the first quarter of 2022 as compared to recognizing $155,000 in net losses on held equity securities and $99,000 in net gains on the sales of taxable municipal debt securities in the first quarter of 2023.

Trust department income decreased $20,000 or 8.0% to $230,000 for the three months ended March 31, 2023 as compared to the same period in 2022.

Service charges and fee income increased $16,000 or 3.1%.

The increase was mainly due to increases in overdraft fees as compared to the same period in 2022.

ATM fees and debit card income decreased $24,000 or 4.3% to $531,000 for the three months ended September 30, 2022.

Net (losses) gains on sales of mortgage loans decreased $143,000 or 102.9% to ($4,000) due to the repurchase of two loans originally sold to Fannie Mae and no sales of mortgage loans in the third quarter of 2022 as the rate environment has led to many loans being sold at a loss and there have been fewer mortgages originated with intent to sell.

Other non-interest income decreased $37,000 or 39.8% to $56,000 for the three months ended September 30, 2022.

The decrease was due to lower retail investment income as income from annuities was lower in the third quarter of 2022 as compared to the same period in 2021.

NON-INTEREST EXPENSE

Total non-interest expense was $6,711,000 for the three months ended September 30, 2022, as compared to $6,267,000 for the three months ended September 30, 2021.

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

Salaries and benefits amounted to $3,677,000 or 54.8% of total non-interest expense for the three months ended September 30, 2022, as compared to $3,303,000 or 52.7% for the three months ended September 30, 2021.

The increase was mainly due to increased costs associated with medical insurance plus normal merit increases for employees and new hires as compared to the same period in 2021.

Net occupancy, furniture and equipment, and computer expense amounted to $977,000 for the three months ended September 30, 2022, an increase of $64,000 or 7.0% which was due to the implementation of several new software programs throughout 2021 and early 2022 to increase security and efficiency.

Professional services increased $51,000 or 20.9% to $295,000 as of September 30, 2022.

The increase was mainly the result of an increase in consulting expense as the result of strategic planning and consulting services associated with implementing new internal systems contracts.

Pennsylvania shares tax expense amounted to $312,000 for the three months ended September 30, 2022, an increase of $3,000 or 1.0% as compared to the three months ended September 30, 2021.

Federal Deposit Insurance Corporation (“FDIC”) insurance expense amounted to $116,000 for the three months ended September 30, 2022, an increase of $13,000 or 12.6% as compared to the same period in 2021.

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

ATM and debit card fees expense amounted to $274,000 for the three months ended September 30, 2022, a decrease of $7,000 or 2.5% as compared to the three months ended September 30, 2021.

Data processing expenses amounted to $205,000 for the three months ended September 30, 2022 as compared to $295,000 for the same period of 2021, a decrease of $90,000 or 30.5%.

This decrease was the result of negotiations of new internal systems contracts resulting in some lower fees and vendor relationship credits that were applied to the expenses related to those systems.

Advertising expense amounted to $96,000 in the third quarter of 2022, a decrease of $5,000 or 5.0% as compared to the three months ended September 30, 2021.

Other non-interest expense amounted to $759,000 for the three months ended September 30, 2022, an increase of $41,000 or 5.7% as compared to 2021 mainly due to a fraud settlement related to a customer’s deposit relationship in the third quarter of 2022.

Income tax expense amounted to $578,000 for the three months ended September 30, 2022, as compared to $655,000 for the three months ended September 30, 2021, a decrease of $77,000.

The effective total income tax rate was 14.2% for the three months ended September 30, 2022 as compared to 14.0% for the three months ended September 30, 2021.

The increase in the effective tax rate was mainly due to fewer tax credits from low-income housing partnerships.

The Company recognized $58,000 and $101,000 of tax credits from low-income housing partnerships in the three months ended September 30, 2022 and 2021, respectively.

Nine months ended September 30, 2022 compared to nine months ended September 30, 2021

First Keystone Corporation realized earnings for the nine months ended September 30, 2022 of $10,869,000, a decrease of $637,000, or 5.5% from the same period in 2021.

The decrease in net income for the nine months ended September 30, 2022 was primarily due to less PPP loan fees, an increase in interest expense, and a decrease in non-interest income, mainly due to fewer sales of mortgage loans and net securities losses.

On a per share basis, net income was $1.82 for the nine months ended September 30, 2022 versus $1.95 for the same period in 2021.

Cash dividends amounted to $0.84 and $0.83 per share for the nine months ended September 30, 2022 and 2021, respectively.

NET INTEREST INCOME

The major source of operating income for the Company is net interest income, defined as interest and loan fee income less interest expense.

For the nine months ended September 30, 2022, interest income amounted to $33,637,000, an increase of $2,387,000 or 7.6% from the nine months ended September 30, 2021, while interest expense amounted to $4,881,000 in the nine months ended September 30, 2022 an increase of $1,005,000 or 25.9% from the nine months ended September 30, 2021.

As a result, net interest income increased $1,382,000 or 5.0% to $28,756,000 from $27,374,000 for the same period in 2021.

The Company’s net interest margin for the nine months ended September 30, 2022 was 3.26% compared to 3.25% for same period in 2021.

The increase in net interest margin was a result of an increase in yield earned on securities and restricted stock.

PROVISION FOR LOAN LOSSES

The provision for loan losses for the nine months ended September 30, 2022 and 2021 was $656,000 and $455,000, respectively.

The provision for loan losses for the nine months ended September 30, 2022 is also reflective of management’s assessment of the continued credit risk associated with the uncertainty surrounding geopolitical and economic concerns.

Charge-off and recovery activity in the allowance for loan losses resulted in net charge-offs of $125,000 and 100,000 for the nine months ended September 30, 2022 and 2021, respectively.

See Allowance for Loan Losses on page 46 for further discussion.

NON-INTEREST INCOME

Total non-interest income was $4,396,000 for the nine months ended September 30, 2022, as compared to $5,437,000 for the same period in 2021, a decrease of $1,041,000, or 19.1%.

The decrease was due to recognizing net

losses on the sales of mortgage loans and net securities losses on held equity securities during the first nine months of 2022 as compared to recognizing net gains on both during the same period of 2021.

ATM fees and debit card income decreased $41,000 or 2.5% to $1,598,000 for the nine months ended September 30, 2022 due to decreased ATM surcharge fees as the result of decreased transaction volume.

Service charges and fee income increased $279,000 for the nine months ended September 30, 2022.

The increase was mainly due to increased overdraft fees on DDA accounts.

Gains on sales of mortgage loans decreased $839,000 or 104.7% due to a low number of individual loans sold in the first nine months of 2022 and many of the loans sold in 2022 being sold at a loss.

These factors were due to the current rate environment and fewer loans being originated with the intent to sell in 2022.

Trust department income was $754,000 for the nine months ended September 30, 2022 a decrease of $7,000 or 0.9% as compared to the same period in 2021.

Net securities (losses) gains decreased $346,000 or 209.7% to ($181,000) for the nine months ended September 30, 2022 as compared to the nine months ended September 30, 2021.

The decrease was due to the Company recognizing $181,000 in net losses on held equity securities in the first nine months of 2022 as compared to recognizing $161,000 in net gains on held equity securities in the same period in 2021.

ATM fees and debit card income increased $23,000 or 4.5% to $532,000 for the three months ended March 31, 2023 due to increased transaction volume.

Net gains (losses) on sales of mortgage loans increased $51,000 or 150.0% to $17,000.

In the prior year, many of the loans sold in the first quarter were sold at a loss.

Other non-interest income decreased $15,000 or 21.4% to $55,000 for the three months ended March 31, 2023.

The decrease was due to lower retail investment income as income from annuities was lower in the first quarter of 2023 as compared to the same period in 2022.

NON-INTEREST EXPENSE

Total non-interest expense was $19,822,000 for the nine months ended September 30, 2022, as compared to $19,011,000 for the nine months ended September 30, 2021.

Non-interest expense increased $811,000 or 4.3%.

Total non-interest expense was $7,753,000 for the three months ended March 31, 2023, as compared to $6,516,000 for the three months ended March 31, 2022.

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

Salaries and benefits amounted to $10,693,000 or 53.9% of total non-interest expense for the nine months ended September 30, 2022, as compared to $10,064,000 or 52.9% for the nine months ended September 30, 2021.

The increase was mainly due to normal merit increases and new hires along with an increase in medical insurance costs as compared to the first nine months of 2021.

Net occupancy, furniture and equipment, and computer expense amounted to $2,977,000 for the nine months ended September 30, 2022, an increase of $219,000 or 7.9%.

The increase is the result of the implementation of several new software programs in 2022 to increase security and efficiency.

Professional services increased $187,000 or 24.1% to $963,000 for the nine months ended September 30, 2022.

The increase was mainly the result of an increase in consulting expense as the result of strategic planning and consulting services associated with implementing new internal systems contracts along with normal increases in annual audit expenses.

Pennsylvania shares tax expense amounted to $960,000 for the nine months ended September 30, 2022, an increase of $25,000 or 2.7% as compared to the nine months ended September 30, 2021.

FDIC insurance expense increased $63,000 or 20.3% for the nine months ended September 30, 2022.

Salaries and benefits amounted to $4,386,000 or 56.6% of total non-interest expense for the three months ended March 31, 2023, as compared to $3,554,000 or 54.5% for the three months ended March 31, 2022.

The increase was mainly due to increased costs associated with medical insurance plus normal merit increases for employees, filling existing open positions, plus new hires as compared to the same period in 2022.

Net occupancy, furniture and equipment, and computer expense amounted to $1,043,000 for the three months ended March 31, 2023, an increase of $26,000 or 2.6% which was mainly due to higher rent costs associated with a new leased branch location and higher utility costs.

Professional services increased $137,000 or 46.0% to $435,000 as of March 31, 2023.

The increase was mainly the result increased accounting expense related to the adoption of ASU 2016-13 along with an increase in legal fees related to a customer’s estate.

Pennsylvania shares tax expense amounted to $241,000 for the three months ended March 31, 2023, a decrease of $83,000 or 25.6% as compared to the three months ended March 31, 2022.

This increase was due to lower equity due to the unrealized loss position in the securities portfolio at December 31, 2022.

Federal Deposit Insurance Corporation (“FDIC”) insurance expense amounted to $176,000 for the three months ended March 31, 2023, an increase of $39,000 or 28.5% as compared to the same period in 2022.

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

ATM and debit card fees expense amounted to $644,000 for the nine months ended September 30, 2022, a decrease of $120,000 or 15.7% as compared to the nine months ended September 30, 2021.

The decrease was the result of negotiations of new internal systems contracts resulting in some lower fees and vendor relationship credits that were applied to the expenses related to those systems.

Data processing expenses amounted to $714,000 for the nine months ended September 30, 2022, a decrease of $198,000 or 21.7% as compared to the nine months ended September 30, 2021.

This decrease was also the result of the negotiations of new systems contracts.

Advertising expense increased $4,000 or 1.4% during the nine months ended September 30, 2022.

Other non-interest expense amounted to $2,212,000 for the nine months ended September 30, 2022, an increase of $5,000 or 0.2% as compared to the nine months ended September 30, 2021.

Income tax expense amounted to $1,805,000 for the nine months ended September 30, 2022, as compared to $1,839,000 for the nine months ended September 30, 2021, a decrease of $34,000.

The effective total income tax rate

was 14.2% for the nine months ended September 30, 2022 as compared to 13.8% for the nine months ended September 30, 2021.

The increase in the effective tax rate was mainly due to fewer tax credits from low-income housing partnerships in the current year.

The Company recognized $191,000 and $303,000 of tax credits from low-income housing partnerships in the nine months ended September 30, 2022 and 2021, respectively.

ATM and debit card fees expense amounted to $307,000 for the three months ended March 31, 2023, an increase of $179,000 or 139.8% as compared to the three months ended March 31, 2022.

This increase was result of third party pricing increases, increased debit card transaction volume, increased ATM fraud and credits that were used to lower third party costs in the first quarter of 2022.

Data processing expenses amounted to $312,000 for the three months ended March 31, 2023 as compared to $258,000 for the same period of 2022, an increase of $54,000 or 20.9%.

This increase was mainly the result of third party pricing increases and credits used to lower third party costs in the first quarter of 2022.

Advertising expense amounted to $74,000 in the first quarter of 2023, an increase of $2,000 or 2.8% as compared to the three months ended March 31, 2023.

Other non-interest expense amounted to $779,000 for the three months ended March 31, 2023, an increase of $51,000 or 7.0% as compared to 2022 mainly due to an increase in the provision for unfunded commitments as a result of increased funding and loss rates utilized in the methodology upon the adoption of ASU 2016-13 in 2023.

Income tax expense amounted to $146,000 for the three months ended March 31, 2023, as compared to $567,000 for the three months ended March 31, 2022, a decrease of $421,000.

The effective total income tax rate was 9.7% for the three months ended March 31, 2023 as compared to 13.8% for the three months ended March 31, 2022.

The decrease in the effective tax rate was mainly due to lower overall income.

The Company recognized $58,000 and $74,000 of tax credits from low-income housing partnerships in the three months ended March 31, 2023 and 2022, respectively.

FINANCIAL CONDITION

Total assets increased to $1,324,250,000 as of September 30, 2022, an increase of $3,900,000 from year-end 2021.

Total assets decreased to $1,310,647,000 as of March 31, 2023, a decrease of $18,547,000 from year-end 2022.

Total assets as of December 31, 2022 amounted to $1,329,194,000.

Total debt securities available-for-sale decreased $51,347,000 or 11.7% to $386,569,000 as of September 30, 2022 from December 31, 2021.

The decrease was mainly due to a decrease in the market value of the portfolio as a result of the current interest rate environment and principal paydowns.

Total loans increased $92,834,000 or 12.3% to $845,675,000 as of September 30, 2022 from December 31, 2021.

Loan demand grew in the nine months ended September 30, 2022 as the Bank has realized an increase in loan originations, primarily in the Commercial Real Estate portfolio.

Total deposits decreased $19,660,000 or 1.8% to $1,058,309,000 as of September 30, 2022 from December 31, 2021.

The decrease was mainly due to a decrease in highly rate sensitive deposits and other normal fluctuations.

Total debt securities available-for-sale decreased $27,174,000 or 7.3% to $346,270,000 as of March 31, 2023 from December 31, 2022.

The decrease was mainly due to the sales of tax-exempt municipals and principal paydowns.

Total loans increased $3,714,000 or 0.4% to $862,183,000 as of March 31, 2023 from December 31, 2022.

Loan demand grew slightly in the three months ended March 31, 2023 as the Bank has realized an increase in loan originations, primarily in the Real Estate portfolio.

Total deposits decreased $45,584,000 or 4.6% to $947,915,000 as of March 31, 2023 from December 31, 2022.

The decrease was mainly due to a decrease in both non-interest and interest bearing deposits, primarily municipal deposits.

The Company continues to maintain and manage its asset growth.

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

Total borrowings increased in the nine months ended September 30, 2022 by $57,371,000 to $119,748,000 from $62,377,000 as of December 31, 2021.

Total borrowings increased in the three months ended March 31, 2023 by $26,489,000 to $204,907,000 from $178,418,000 as of December 31, 2022.

Borrowings increased mainly due to decreased deposit balances and growth in the loan portfolio.

Total stockholders’ equity amounted to $115,423,000 at September 30, 2022, a decrease of $33,132,000 or 22.3% from December 31, 2021 due to a decrease in the market value of the securities portfolio resulting in a tax-effected accumulated other comprehensive loss position.

Total stockholders’ equity amounted to $125,026,000 at March 31, 2023, an increase of $4,640,000 or 3.9% from December 31, 2022 due to an increase in the market value of the securities portfolio.

SEGMENT REPORTING

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

The earning asset ratio (average interest earning assets divided by average total assets) equaled 94.0% at September 30, 2022 and 94.1% at September 30, 2021.

The earning asset ratio (average interest earning assets divided by average total assets) equaled 93.3% at March 31, 2023 and 94.4% at March 31, 2022.

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.

Our primary earning asset, total loans, increased to $845,675,000 as of September 30, 2022, up $92,834,000, or 12.3% since year-end 2021.

Our primary earning asset, total loans, increased to $862,183,000 as of March 31, 2023, up $3,714,000, or 0.4% since year-end 2022.

The loan portfolio continues to be well diversified.

Non-performing assets decreased since year-end 2022, and overall asset quality has remained consistent.

Total non-performing assets were $6,082,000 as of September 30, 2022, a decrease of $984,000, or 13.9% from $7,066,000 reported in non-performing assets as of December 31, 2021.

Total allowance for loan losses to total non-performing assets was 151.45% as of September 30, 2022 and 122.84% at December 31, 2021.

Total non-performing assets were $5,169,000 as of March 31, 2023, a decrease of $190,000, or 3.5% from $5,359,000 reported in non-performing assets as of December 31, 2022.

Total allowance for credit losses to total non-performing assets was 138.14% as of March 31, 2023 and 154.39% at December 31, 2022.

See the Non-Performing Assets section on page 48 for more information.

In addition to loans, another primary earning asset is our overall securities portfolio, which decreased in size from December 31, 2021 to September 30, 2022.

Debt securities available-for-sale amounted to $386,569,000 as of September 30, 2022, a decrease of $51,347,000 from year-end 2021.

The decrease in debt securities available-for-sale is mainly due to a $50,924,000 decrease in the market value of the portfolio as a result of the current interest rate environment and $29,444,000 in principal paydowns on debt securities, offset by the deployment of $38,349,000 in cash to purchase debt securities, along with other portfolio activity.

Interest-bearing deposits in other banks decreased as of September 30, 2022, to $1,803,000 from $51,738,000 at year-end 2021 due to decreased cash held at the Federal Reserve Bank.

Time deposits with other banks were $0 at September 30, 2022 and $247,000 at December 31, 2021 due to the maturity of the one remaining time deposit.

Total loans increased to $845,675,000 as of September 30, 2022 as compared to $752,841,000 as of December 31, 2021.

In addition to loans, another primary earning asset is our overall securities portfolio, which decreased in size from December 31, 2022 to March 31, 2023.

Debt securities available-for-sale amounted to $346,270,000 as of March 31, 2023, a decrease of $27,174,000 from year-end 2022.

The decrease in debt securities available-for-sale is mainly due to the sales of $23,131,000 of tax-exempt municipals during the first quarter of 2023.

There were also principal paydowns on debt securities of $7,665,000 offset by an increase in the market value of the portfolio of $4,782,000 during the quarter ended March 31, 2023.

Interest-bearing deposits in other banks decreased as of March 31, 2023, to $1,035,000 from $1,297,000 at year-end 2022 due to decreased cash held at the Federal Home Loan Bank.

Total loans increased to $862,183,000 as of March 31, 2023 as compared to $858,469,000 as of December 31, 2022.

The table on page 21 provides data relating to the composition of the Company’s loan portfolio on the dates indicated.

Total loans increased by $3,714,000 or 0.4%.

Steady demand for borrowing by businesses accounted for the 12.3% increase in the loan portfolio from December 31, 2021 to September 30, 2022.

Overall, the Commercial and Industrial portfolio (which includes tax-free commercial and industrial loans) increased $3,329,000 or 4.0% from $82,526,000 at December 31, 2021 to $85,855,000 at September 30, 2022.

The increase in the Commercial and Industrial portfolio during the nine months ended September 30, 2022 was mainly attributable to the portion of the Commercial and Industrial portfolio excluding SBA PPP loans which increased $8,098,000 during the nine months ended September 30, 2022, mainly resulting from $15,100,000 in new loan originations for the nine months ended September 30, 2022 and an increase in utilization of existing Commercial and Industrial lines of credit of $3,361,000, offset by loan payoffs of $5,054,000 and regular principal payments and other typical fluctuations in the Commercial and Industrial portfolio during the nine months ended September 30, 2022.

This was offset by a reduction of $4,769,000 in the portion of the Commercial and Industrial portfolio attributable to SBA PPP loans, the balance of which decreased from $4,894,000 at December 31, 2021 to $125,000 at September 30, 2022, as a result of loan forgiveness.

The Commercial Real Estate portfolio (which includes tax-free commercial real estate loans) increased $78,414,000 or 15.0% from $521,654,000 at December 31, 2021 to $600,068,000 at September 30, 2022.

The increase is mainly attributable to new loan originations of $137,509,000 for the nine months ended September 30, 2022, offset by loan payoffs of $52,118,000, offset by a decrease in utilization of existing Commercial Real Estate lines of credit of $591,000 and regular principal payments and other typical amortization in the Commercial Real Estate portfolio during the nine months ended September 30, 2022.

Residential Real Estate loans increased $10,941,000 or 7.6% from $143,383,000 at December 31, 2021 to $154,324,000 at September 30, 2022.

The increase was mainly the result of $26,129,000 in new loan originations and an increase in utilization of existing Residential Real Estate (Home Equity) lines of credit of $2,255,000, offset by net loans sold of $2,719,000, loan payoffs of $12,821,000 (of which $4,154,000 was refinanced with the Bank during the nine months ended September 30, 2022 with the new refinanced loan balances included in the new loan origination total), and regular principal payments and other typical amortization in the Residential Real Estate portfolio during the nine months ended September 30, 2022.

Net loans sold for the nine months ended September 30, 2022 consisted of total loans sold during the nine months ended September 30, 2022 of $4,463,000, offset with loans opened and sold in the same quarter during the first three quarters of 2022 which amounted to $1,744,000.

Steady demand for borrowing by businesses accounted for the 0.4% increase in the loan portfolio from December 31, 2022 to March 31, 2023.

The Real Estate portfolio increased $2,180,000 or 0.30% from $764,880,000 at December 31, 2022 to $767,060,000 at March 31, 2023.

The increase in the Real Estate portfolio for the three months ended March 31, 2023 was mainly the result of $16,448,000 in new loan originations, which were offset by loan payoffs of $8,449,000 and a decrease of $1,447,000 in utilization of existing real estate lines of credit, along with regular principal payments and other typical fluctuations in the Real Estate portfolio.

The Agricultural portfolio decreased $77,000 or 9.0% from $860,000 at December 31, 2022 to $783,000 at March 31, 2023.

The decrease in the Agricultural portfolio was mainly the result of a decrease of $71,000 in utilization of existing agricultural-related lines of credit during the three months ended March 31, 2023, along with regular principal payments.

There were no new agricultural loans originated during the three months ended March 31, 2023 and payoffs of agricultural loans for the three months ended March 31, 2023 did not have a material impact on the change in the portfolio balance.

Overall, the Commercial and Industrial portfolio increased $2,203,000 from $56,077,000 or 3.9% from December 31, 2022 to $58,280,000 at March 31, 2023.

The increase in the Commercial and Industrial portfolio during the three months ended March 31, 2023 was mainly attributable to the portion of the Commercial and Industrial portfolio excluding PPP loans which increased $2,215,000 during the three months ended March 31, 2023.

The increase was attributable to $4,088,000 in new loan originations, offset by loan payoffs of $422,000 and a decrease of $200,000 in utilization of existing commercial and industrial lines of credit, as well as regular principal payments and other typical amortization in the Commercial and

Industrial portfolio.

The portion of the Commercial and Industrial portfolio attributable to PPP loans decreased $12,000 from December 31, 2022 to March 31, 2023.

Consumer loans increased $137,000 or 2.4% from $5,707,000 at December 31, 2022 to $5,844,000 at March 31, 2023.

The increase is mainly attributable to new loan originations of $921,000, offset by loan payoffs of $415,000 and a decrease of $31,000 in utilization of existing consumer lines of credit, along with regular principal payments.

The State and Political Subdivisions portfolio decreased $729,000 or 2.40% from $30,945,00 at December 31, 2022 to $30,216,000 at March 31, 2023.

The decrease is mainly the result of $630,000 in loan payoffs for the three months ended March 31, 2023 along with regular principal payments.

There were no new state and political loans originated during the three months ended March 31, 2023.

The Company continues to originate and sell certain long-term fixed rate residential mortgage loans, which conform to secondary market requirements, when the market pricing is favorable.

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The Company continues its efforts to lend to creditworthy borrowers.Management believes that the loan portfolio is well diversified.

The total commercial portfolio was $685,923,000 at September 30, 2022.

Of total loans, $600,068,000 or 71.0% were secured by commercial real estate, primarily lessors of residential buildings and dwellings and lessors of non-residential buildings.

The Company continues to monitor these portfolios.

Overall, the portfolio risk profile as measured by loan grade is considered low risk, as $840,346,000 or 97.6% of gross loans are graded Pass;

2 unchanged sentences

and $0 are graded Doubtful.

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

Bank, credit history and lender knowledge of the borrower.

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

Overall, non-pass grades decreased to $21,997,000 at September 30, 2022, as compared to $24,737,000 at December 31, 2021.

Commercial and Industrial non-pass grades decreased to $736,000 as of September 30, 2022 as compared to $796,000 as of December 31, 2021.

Commercial Real Estate non-pass grades decreased to $20,224,000 as of September 30, 2022 as compared to $22,346,000 as of December 31, 2021.

The Residential Real Estate and Consumer loan non-pass grades decreased to $1,037,000 as of September 30, 2022 as compared to $1,595,000 as of December 31, 2021.

The decrease in Commercial Real Estate non-pass grades from December 31, 2021 to September 30, 2022 is mainly the result of a payoff that was completed during the second quarter of 2022 on a Substandard non-accrual loan to a contractor specializing in modular construction that carried a balance of $1,000,000 at December 31, 2021.

Four loans to the owners/operators of an indoor family entertainment complex that carried an aggregate balance of $753,000 at December 31, 2021 were also upgraded from Substandard to pass-grade status during the nine months ended September 30, 2022.

There were also $256,000 in principal payments and paydowns completed during the nine months ended September 30, 2022 on a loan to the owner/operator of a multi-unit apartment building that was classified as Special Mention status at both December 31, 2021 and September 30, 2022.

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

Overall, non-pass grades decreased to $20,678,000 at March 31, 2023, as compared to $20,935,000 at December 31, 2022.

Commercial and Industrial non-pass grades decreased to $716,000 as of March 31, 2023 as compared to $725,000 as of December 31, 2022.

Real Estate non-pass grades decreased to $19,962,000 as of March 31, 2023 as compared to $20,210,000 as of December 31, 2022.

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

(Dollars in thousands)

September 30,

Commercial and Industrial

Commercial Real Estate

Residential Real Estate

ALLOWANCE FOR LOAN LOSSES

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

As of September 30, 2022, the allowance for loan losses was $9,211,000 as compared to $8,680,000 as of December 31, 2021.

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.

State and Political Subdivisions

ALLOWANCE FOR CREDIT LOSSES

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

As of March 31, 2023, the allowance for credit losses was $7,142,000 as compared to $8,274,000 as of December 31, 2022.

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

Loans are charged against the allowance for possible credit 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 performs a quarterly analysis to determine the adequacy of the allowance for credit losses.

The methodology in determining adequacy incorporates quantitative and qualitative 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.

On a quarterly basis, management evaluates the qualitative factors utilized in the calculation of the Company’s allowance for loan losses and various adjustments are made to these factors as deemed necessary at the time of evaluation.

The uncertain economic climate has played a large

role in the qualitative factor adjustments that have been implemented throughout 2021 and the first nine months of 2022.

Qualitative factors remained unchanged during the first quarter of 2021, as the economy and unemployment levels showed marked improvement over the prior quarter.

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 Company’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 an artificial increase in market values in the real estate sector as individuals’ willingness to pay above-average market prices has sparked uncertainty surrounding collateral values in the real estate market.

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 increased inflation rates, 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 would be.

The qualitative factors related to collateral values were also increased by one basis point across all loan segments during the fourth quarter of 2021, as collateral values continued to artificially increase as individuals were willing to pay above-average market prices in all sectors.

During the first quarter of 2022, the qualitative factors related to the local/regional economy were increased by one basis point across all loan segments due to ongoing economic uncertainty resulting from supply chain disruptions caused by the COVID-19 pandemic, conflicts in foreign countries causing inflationary pressures due to reductions/disruptions in the production of the commodities controlled by these countries, increased interest rates, and the overall inflation rate continuing to rise.

During the second quarter of 2022, the qualitative factors remained unchanged.

During the third quarter of 2022, the qualitative factors related to the management and review systems components were each decreased by two basis points across all loan segments due to consistency and experience within the Company’s management and satisfactory exam results related to the Company’s loan review process.

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 uncertainty related to the lagging economic effects of the COVID-19 pandemic, especially in relation to this segment of the Company’s loan portfolio.

See Allowance for Loan Losses on page 17 for further discussion.

The Analysis of Allowance for Loan Losses table contains an analysis of the allowance for loan losses indicating charge-offs and recoveries for the nine months ended September 30, 2022 and 2021.

Net charge-offs as a percentage of average loans was 0.02% and 0.01% for the nine months ended September 30, 2022 and 2021, respectively.

Net charge-offs amounted to $125,000 the nine months ended September 30, 2022 as compared to $100,000 for the nine months ended September 30, 2021.

For the nine months ended September 30, 2022, the provision for loan losses was $656,000 as compared to $455,000 for the nine months ended September 30, 2021.

The provision, net of charge-offs and recoveries, resulted in the quarter end allowance for loan losses of $9,211,000 of which 7.8% was attributed to the Commercial and Industrial component;

65.7% attributed to the Commercial Real Estate component;

17.5% attributed to the Residential Real Estate component;

0.8% attributed to the Consumer component;

and 8.2% being the unallocated component (refer to the activity in Note 4 – Loans and Allowance for Loan Losses on page 14).

The Company determined that the provision for loan losses made during the current quarter was sufficient to maintain the allowance for loan losses at a level necessary for the probable losses inherent in the loan portfolio as of September 30, 2022.

Analysis of Allowance for Loan Losses

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

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

On a quarterly basis, management evaluates the qualitative factors utilized in the calculation of the Company’s allowance for credit losses and various adjustments are made to these factors as deemed necessary at the time of evaluation.

Upon adoption of ASU No.

2016-13 in the first quarter of 2023, the qualitative factors used in the allowance calculation were adjusted from five loan pools utilized under previous methodology to fifteen loan segmentation pools aligning with the segmentation of the quarterly call report.

There were no material increases or decreases in the qualitative factors arising from the realigning of the qualitative factor pools/segments and no additional qualitative factor adjustments were deemed necessary for the first quarter of 2023.

The Analysis of Allowance for Credit Losses table contains an analysis of the allowance for credit losses indicating charge-offs and recoveries for the three months ended March 31, 2023 and 2022.

Net charge-offs as a percentage of average loans was 0.002% for the three months ended March 31, 2023 and net recoveries as a percentage of average loans was 0.005% as of March 31, 2022.

Net charge-offs amounted to $13,000 the three months ended March 31, 2023 as compared to net recoveries of $38,000 for the three months ended March 31, 2022.

For the three months ended March 31, 2023, the provision for credit losses was $0 as compared to $219,000 for the three months ended March 31, 2022.

The provision, net of charge-offs and recoveries, resulted in the quarter end allowance for credit losses of $7,142,000 of which 3.7% was attributed to the Commercial and Industrial component;

94.3% attributed to the Real Estate component;

0.7% attributed to the State and Political Subdivision component;

and 1.3% attributed to the Consumer component (refer to the activity in Note 4 – Loans and Allowance for Credit Losses on page 13).

The Company determined that the balance of the allowance for credit losses during the current quarter was sufficient to cover the estimated potential credit losses for the remaining balance of financial assets in the loan portfolio as of March 31, 2023 which resulted in no additional provision for credit losses for the three months ended March 31, 2023.

Analysis of Allowance for Credit Losses (Post-Adoption of ASU No.

(Dollars in thousands)

September 30,

As of and for the nine months ended:

As of and for the three months ended:

Balance at prior year-end

CECL adoption adjustment

Beginning balance

Commercial and Industrial

State and Political Subdivisions

Commercial and Industrial

State and Political Subdivisions

Net charge-offs

Additions charged to operations

Balance at end of period

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

Allowance for credit losses to average loans outstanding during the period

Analysis of Allowance for Credit Losses (Pre-Adoption of ASU No.

(Dollars in thousands)

As of and for the three months ended:

Beginning balance

Commercial and Industrial

Commercial Real Estate

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Residential Real Estate

Net charge-offs

Net recoveries

Additions charged to operations

Balance at end of period

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

Allowance for loan losses to average loans outstanding during the period

Ratio of net recoveries during the period to average loans outstanding during the period

Allowance for credit losses to average loans outstanding during the period

It is the policy of management and the Company’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.

A provision for credi 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 Company’s allowance for loan losses is reviewed by the Board of Directors.

With the Bank’s manageable level of net charge-offs and recoveries along with the additions to the reserve from the provision out of operations, the allowance for loan losses as a percentage of year-to-date average loans amounted to 1.16% and 1.13% at September 30, 2022 and 2021, respectively.

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

With the Bank’s manageable level of net charge-offs and recoveries along with the additions to the reserve from the provision out of operations, the allowance for credit losses as a percentage of year-to-date average loans amounted to 0.831% and 1.167% at March 31, 2023 and 2022, respectively.

NON-PERFORMING ASSETS

The table on page 51 details the Company’s non-performing assets and impaired loans as of the dates indicated.

The table on page 51 details the Company’s non-performing assets and individually evaluated 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 TDR when a borrower is experiencing financial difficulty and the modification constitutes a concession that the Company 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

were not considered TDRs as long as the criteria set forth in Section 4013 of the CARES Act were met.

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

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

Total non-performing assets amounted to $6,082,000 as of September 30, 2022, as compared to $7,066,000 as of December 31, 2021.

The economy is very unstable.

Inflation is at a four-decade high.

The war between Ukraine and Russia is creating worldwide turmoil.

The unemployment rate has dropped significantly compared to the beginning of the COVID-19 pandemic, but the labor force participation rate has also fallen.

Total non-performing assets amounted to $5,169,000 as of March 31, 2023, as compared to $5,359,000 as of December 31, 2022.

The economy remains unstable.

Inflation has receded in recent months but remains at a high level, and is well above the Federal Reserve’s target rate of 2%.

The war between Ukraine and Russia continues to produce worldwide consternation.

The continued backing by the United States, both monetary and weapons, to Ukraine to support the NATO initiative has been a strain on the economy.

The unemployment rate is still low even though it has begun to slowly increase over the last two quarters, and the labor force participation rate remains low.

The need for workers has driven wages up in most sectors.

Inflation is causing extreme concerns in all areas of the economy.

The war abroad and its effects on various commodities are pushing inflationary concerns.

Values of new and used homes and automobiles continue to climb.

The Federal Reserve has indicated a plan to continue to raise interest rates at an accelerated level throughout the year.

There has also been a resurgence of the COVID-19 pandemic in some areas of the country and world.

Attempting to rein in inflation has proven to be a very difficult task.

The OPEC nations slashing the daily output of oil, and the recent failures of two very large banks have proven to be large factors in the attempts to control inflation.

Values of new and used homes and automobiles have come back down, but higher interest rates have greatly curtailed borrowing.

The Federal Reserve has indicated a plan to potentially further raise interest rates if inflation does not continue to decrease, but expects at a minimum to hold rates steady through the end of the year.

These forces have had a direct effect on the Company’s non-performing assets.

The Company is closely monitoring all segments of its loan portfolio because of the current uncertain economic environment.

Non-accrual loans totaled $5,917,000 as of September 30, 2022, as compared to $7,066,000 as of December 31, 2021.

The decrease in non-accrual loans from December 31, 2021 to September 30, 2022 was mainly the result of the payoff of one non-accrual loan to a contractor specializing in modular construction which carried a balance of $1,000,000 at December 31, 2021.

There were no foreclosed assets held for resale as of September 30, 2022 and December 31, 2021.

There was one loan past-due 90 days or more and still accruing interest at September 30, 2022 that carried a balance of $165,000 and was well-secured by residential real estate and in the process of collection.

There were no loans past-due 90 days or more and still accruing interest as of December 31, 2021.

Non-performing assets to total loans was 0.72% at September 30, 2022 and 0.94% at December 31, 2021.

Non-performing assets to total assets was 0.46% at September 30, 2022 and 0.54% at December 31, 2021.

The allowance for loan losses to total non-performing assets was 151.45% as of September 30, 2022 as compared to 122.84% as of December 31, 2021.

Additional detail can be found on page 51 in the Non-Performing Assets and Impaired Loans table and page 27 in the Non-Performing Assets table.

Asset quality is a priority and the Company 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 $10,645,000 at September 30, 2022, compared to $10,463,000 at December 31, 2021.

Impaired loans were $12,177,000 at September 30, 2022 and $13,673,000 at December 31, 2021.

The largest impaired loan relationship at September 30, 2022 and December 31, 2021 consisted of a non-performing loan to a student housing holding company which is secured by commercial real estate.

At September 30, 2022, 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, 2021 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 September 30, 2022 and December 31, 2021 consisted of one performing loan to a student housing holding company, which is classified as a TDR.

The loan is secured by commercial real estate and carried a balance of $2,812,000 as of September 30, 2022, net of $943,000 that had been charged off to date, compared to December 31, 2021 when the loan carried a balance of $2,864,000, net of $943,000 that had been charged off to date.

The third largest impaired loan relationship at September 30, 2022 and December 31, 2021 consisted of five non-performing loans to a plastic processing company focused on non-post-consumer recycling.

Three loans are classified in the Commercial and Industrial portfolio and modified as TDRs and two loans are secured by commercial real estate.

The loans carried an aggregate balance of $1,096,000 at September 30, 2022, compared to December 31, 2021 when the loans carried an aggregate balance of $1,176,000.

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

Non-accrual loans totaled $5,037,000 as of March 31, 2023, as compared to $5,051,000 as of December 31, 2022.

There were no foreclosed assets held for resale as of March 31, 2023 and December 31, 2022.

There was one loan past-due 90 days or more and still accruing interest at March 31, 2023 that carried a balance of $132,000 which was well-secured by residential real estate and in the process of collection, compared to December 31, 2022 when there were three loans carrying an aggregate balance of $308,000 that were past-due 90 days or more and still accruing interest.

The loan past-due 90 days or more and still accruing interest as of December 31, 2022 consisted of three real estate loans, all of which were well secured and in the process of collection.

Non-performing assets to total loans was 0.60% at March 31, 2023 and 0.62% at December 31, 2022.

Non-performing assets to total assets was 0.39% at March 31, 2023 and 0.40% at December 31, 2022.

The allowance for credit losses to total non-performing assets was 138.14% as of March 31, 2023 as compared to 154.39% as of December 31, 2022.

Additional detail can be found on page 51 in the Non-Performing Assets and Individually Evaluated Loans (Post-Adoption of ASU No.

20016-13) and Non-Performing Assets to Impaired Loans (Pre-Adoption of ASU No.

2016-13) tables and page 25 in the Non-Performing Assets table.

Performing substandard loans which have not been designated for individual impairment 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 designated for individual impairment amounted to $15,007,000 at March 31, 2023.

Individually evaluated loans were $5,346,000 at March 31, 2023 and $11,207,000 at December 31, 2022.

The largest individually evaluated loan relationship at March 31, 2023 consisted of a non-performing loan to a student housing holding company which is secured by commercial real estate.

At March 31, 2023, the loan carried a balance of $2,340,000, net of $1,989,000 that had been charged off to date.

The second largest individually evaluated loan relationship at March 31, 2023 consisted of five non-performing loans to a plastic processing company focused on non-post-consumer recycling.

Three loans are classified in the Commercial and Industrial portfolio and two loans are secured by commercial real estate.

The loans carried an aggregate balance of $1,081,000 at March 31, 2023.

The third largest individually evaluated loan relationship at March 31, 2023 consisted of a non-performing loan to the owner of a golf course and catering venue which is secured by commercial real estate.

At March 31, 2023, the loan carried a balance of $582,000.

The Company determines the need for individual evaluation of loans 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 $12,177,000 in impaired loans at September 30, 2022, none were located outside of the Company’s primary market area.

The outstanding recorded investment of TDRs as of September 30, 2022 and December 31, 2021 was $7,589,000 and $8,020,000, respectively.

Of the thirty restructured loans at September 30, 2022, four loans were classified in the Commercial and Industrial portfolio, twenty-five loans were classified in the Commercial Real Estate portfolio, and one loan was classified in the Residential Real Estate portfolio.

Troubled debt restructurings at September 30, 2022 consisted of ten term modifications beyond the original stated term, three rate modifications, and sixteen payment modifications.

There was also one troubled debt restructuring that experienced all three types of modifications—payment, rate, and term.

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

There were no specific allocations attributable to the TDRs at September 30, 2022 or December 31, 2021.

There were no unfunded commitments attributable to the TDRs at September 30, 2022 and December 31, 2021.

At September 30, 2022, three commercial and industrial loans classified as TDRs with a combined recorded investment of $670,000 and four commercial real estate loans classified as TDRs with a combined recorded investment of $107,000 were not in compliance with the terms of their restructure, compared to September 30, 2021 when three commercial and industrial loans classified as TDRs with a combined recorded investment of $724,000, eight commercial real estate loans classified as TDRs with a combined recorded investment of $541,000, and one residential real estate loan classified as a TDR with a recorded investment of $15,000 were not in compliance with the terms of their restructure.

Of the loans that were modified as TDRs within the twelve months preceding September 30, 2022, no loans experienced payment defaults during the three or nine months ended September 30, 2022.

Of the loans that were modified as TDRs during the twelve months preceding September 30, 2021, three commercial real estate loans totaling $291,000 experienced payment defaults during the nine months ended September 30, 2021.

No loans that were modified as TDRs during the twelve months preceding September 30, 2021 experienced payment defaults during the three months ended September 30, 2021.

Of the $5,346,000 in individually evaluated loans at March 31, 2023, none were located outside of the Company’s primary market area.

The Company’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 Company.

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The Company actively works with borrowers to resolve credit problems and will continue its close monitoring efforts in 2023.

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

Excluding the assets disclosed in the Non-Performing Assets and Individually Evaluated Loans (Post-Adoption of ASU No.

2016-13) and Non-Performign Assets and Impaired Loans (Pre-Adoption of ASU No.

2016-13) tables below, 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.

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The economic climate remains in a very frail state.

The war between Ukraine and Russia has exacerbated the difficulties in the national and state economy and experts at all levels are attempting to calculate the intermediate or long term affects.

The Company 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 Company’s allowance for loan losses could be required.

The extent of the impact of these stressors on the Company’s operational and financial

performance will depend on certain developments including inflationary controls enacted, the labor force, supply bottlenecks, the longevity of the war, and the effectiveness in controlling the lingering effects of the COVID-19 outbreak, etc.

The war between Ukraine and Russia, inflationary pressures, OPEC cutting the oil supply, large bank failures, a slow increase in the unemployment rate, and recission concerns has exacerbated the difficulties in the national and state economy, and experts at all levels are attempting to calculate the intermediate or long term affects.

The Company 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 individually evaluated loans, non-performing assets, charge-offs, and delinquencies.

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

The extent of the impact of these stressors on the Company’s operational and financial performance will depend on certain developments including inflationary controls enacted, the labor force, supply bottlenecks, the longevity of the war, and the effectiveness in controlling the lingering effects of the COVID-19 outbreak, etc.

and any after-effects of these factors.

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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 September 30, 2022 and December 31, 2021, management is of the opinion that there were no loan concentrations exceeding 10% of total loans.

Non-Performing Assets and Impaired Loans

As of March 31, 2023 and December 31, 2022, management is of the opinion that there were no loan concentrations exceeding 10% of total loans.

Non-Performing Assets and Individually Evaluated Loans (Post-Adoption of ASU No.

(Dollars in thousands)

September 30,

Non-performing assets

3 unchanged sentences

Total non-performing assets

Individually evaluated loans

Non-accrual loans

Other Individually Evaluated loans

Total individually evaluated loans

Allocated allowance for credit losses

Net investment in individually evaluated loans

Individually evaluated loans with a valuation allowance

Individually evaluated loans without a valuation allowance

Total individually evaluated loans

Allocated valuation allowance as a percent of individually evaluated loans

Individually evaluated loans to total loans

Non-performing assets to total loans

Non-performing assets to total assets

Allowance for credit losses to individually evaluated loans

Allowance for credit losses to total non-performing assets

Non-Performing Assets and Impaired Loans (Pre-Adoption of ASU No.

(Dollars in thousands)

Non-performing assets

Non-accrual loans

Foreclosed assets held for resale

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

Total non-performing assets

Impaired loans

2 unchanged sentences

Total impaired loans

Allocated allowance for loan losses

Allocated allowance for credit losses

Net investment in impaired loans

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Non-performing assets to total assets

Allowance for loan losses to impaired loans

Allowance for loan losses to total non-performing assets

Real estate mortgages comprise 89.2% of the loan portfolio as of September 30, 2022, as compared to 88.3% as of December 31, 2021.

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

Allowance for credit losses to impaired loans

Allowance for credit losses to total non-performing assets

Real estate mortgages comprise 89.0% of the loan portfolio as of March 31, 2023, as compared to 89.1% as of December 31, 2022.

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

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.

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

The real estate loans are concentrated primarily in the Company’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 Company’s market area.

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

The Company’s loss exposure on its individually evaluated loans continues to be mitigated by collateral positions on these loans.

The allocated allowance for credit losses associated with individually evaluated 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 Bank’s eighteen full service office locations, one loan production office and through its internet banking presence.

The Bank offers a broad selection of

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

Consumer and commercial retail deposits are attracted primarily by the Bank’s nineteen full service office locations and through its internet banking presence.

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

The Bank regularly reviews competing financial institutions’ interest rates, especially when establishing interest rates on certificates of deposit and municipal deposits.

Total deposits decreased $19,660,000 to $1,058,309,000 as of September 30, 2022 as non-interest bearing deposits increased by $2,854,000 and interest bearing deposits decreased by $22,514,000 from year-end 2021.

Total deposits decreased $45,584,000 to $947,915,000 as of March 31, 2023 as non-interest bearing deposits decreased by $2,133,000 and interest bearing deposits decreased by $43,451,000 from year-end 2022.

The decrease in deposits was the result of a $38,711,000 decrease in municipal deposits and other normal fluctuations.

Total short-term and long-term borrowings increased to $119,748,000 as of September 30, 2022, from $62,377,000 at year-end 2021, an increase of $57,371,000 or 92.0%.

Total short-term and long-term borrowings increased to $204,907,000 as of March 31, 2023, from $178,418,000 at year-end 2022, an increase of $26,489,000 or 14.8%.

The increase in total borrowings was mainly the result of increased short-term borrowings due to decreased deposits and growth in the loan portfolio.

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

During the nine months ended September 30, 2022, net income less dividends paid increased capital by $5,860,000.

During the three months ended March 31, 2023, net income less dividends paid decreased capital by $328,000.

The decrease was offset by a one-time cumulative effect adjustment to retained earnings in the amount of $728,000 upon the adoption of ASU 2016-13.

Accumulated other comprehensive (loss) income derived from net unrealized gains on debt securities available-for-sale also impacts capital.

At December 31, 2021 accumulated other comprehensive income was $7,588,000.

Accumulated other comprehensive loss stood at $32,642,000 at September 30, 2022, a decrease of $40,230,000.

At December 31, 2022 accumulated other comprehensive loss was ($29,558,000).

Accumulated other comprehensive loss stood at ($25,780,000) at March 31, 2023, an increase of $3,778,000.

Fluctuations in interest rates have regularly impacted the gain/loss position in the Bank’s securities portfolio, as well as its decision to sell securities at a gain or loss.

The fluctuations from net unrealized gains on debt securities available-for-sale do not affect regulatory capital, as the Bank elected to opt-out of the inclusion of this item with the filing of the March 31, 2015 Call Report.

The Company held 231,611 and 231,612 shares of common stock as treasury stock at September 30, 2022 and December 31, 2021, respectively.

This had an effect of reducing our total stockholders’ equity by $5,709,000 as of September 30, 2022 and December 31, 2021.

Total stockholders’ equity was $115,423,000 as of September 30, 2022, and $148,555,000 as of December 31, 2021.

At September 30, 2022 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 September 30, 2022 and December 31, 2021:

September 30,

The Company held 231,611 shares of common stock as treasury stock at March 31, 2023 and December 31, 2022, respectively.

This had an effect of reducing our total stockholders’ equity by $5,709,000 as of March 31, 2023 and December 31, 2022.

Total stockholders’ equity was $125,026,000 as of March 31, 2023, and $120,386,000 as of December 31, 2022.

At March 31, 2023 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 March 31, 2023 and December 31, 2022:

Corrective Action

6 unchanged sentences

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

The capital buffer requirement effectively raises the minimum required common equity Tier 1 capital ratio to 7.0%, the Tier 1 capital ratio to 8.5%, and the total capital ratio

to 10.5% on a fully phased-in basis as of January 1, 2019.

As of September 30, 2022, the Bank meets all capital adequacy requirements under the Basel III Capital Rules on a fully phased-in basis.

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

As of March 31, 2023, 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.

8 unchanged sentences

● Brokered CDs.

At September 30, 2022 the Company had $468,873,000 in maximum 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);

At March 31, 2023 the Company had $504,376,000 in maximum 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 $9,749,000.

2 unchanged sentences

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 $28,519,000 at September 30, 2022.

Securities sold under agreements to repurchase were $20,734,000 at March 31, 2023.

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.

2 unchanged sentences

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

Net cash flows provided by operating activities were $11,392,000 and $11,261,000 at September 30, 2022 and 2021, respectively.

Net income amounted to $10,869,000 for the nine months ended September 30, 2022 and $11,506,000 for the nine months ended September 30, 2021.

During the nine months ended September 30, 2022 and 2021, net premium amortization on securities amounted to $2,346,000 and $2,124,000, respectively.

Net losses on sales of mortgage loans amounted to $38,000 for the nine months ended September 30, 2022, compared to net gains on sales of mortgage loans of $801,000 for the nine months ended September 30, 2021.

Originations from sales of mortgage loans originated for resale exceeded proceeds (net of gains/losses) from sales of mortgage loans originated for resale by $2,819,000 for the nine months ended September 30, 2022 and $1,383,000 for the nine months ended September 30, 2021.

Net securities losses amounted to $181,000 for the nine months ended September 30, 2022, compared to net securities gains of $165,000 for the nine months ended September 30, 2021.

Accrued interest receivable increased by $118,000 and decreased by $261,000 during the nine months ended September 30, 2022 and 2021, respectively.

Other assets increased by $85,000 and $1,422,000 during the nine months ended September 30, 2022 and 2021, respectively.

Other liabilities decreased by $363,000 during the nine months ended September 30, 2022 and increased by $44,000 during the nine months ended September 30, 2021.

Investing activities used cash of $96,167,000 and $107,970,000 during the nine months ended September 30, 2022 and 2021, respectively.

Net activity in the available-for-sale securities portfolio (including proceeds from sale, maturities, and redemptions, net against purchases) used cash of $1,924,000 during the nine months ended September 30, 2022, compared to $73,548,000 for the nine months ended September 30, 2021.

Changes in restricted investment in bank stocks used cash of $2,489,000 and $57,000 during the nine months ended September 30, 2022 and 2021, respectively.

Net cash used to originate loans amounted to $90,178,000 for the nine months ended September 30, 2022, compared to $34,091,000 for the nine months ended September 30, 2021.

Purchase of investment in real estate ventures used cash of $1,548,000 during the nine months ended September 30, 2022, compared to $0 for the nine months ended September 30, 2021.

Financing activities provided cash of $33,917,000 and $204,577,000 during the nine months ended September 30, 2022 and 2021, respectively.

Deposits decreased by $19,660,000 during the nine months ended September 30, 2022, compared to an increase of $208,016,000 during the nine months ended September 30, 2021.

Short-term borrowings increased by $67,371,000 and $10,359,000 during the nine months ended September 30, 2022 and 2021, respectively.

Repayment of long-term borrowings used cash of $10,000,000 at both September 30, 2022 and 2021, respectively.

Dividends paid amounted to $5,009,000 for the nine months ended September 30, 2022, compared to $4,897,000 for the nine months ended September 30, 2021.

Net cash flows used in operating activities were $2,827,000 for the three months ended March 31, 2023, compared to net cash flows provided by operating activities of $5,448,000 for the three months ended March 31, 2022.

Net income amounted to $1,357,000 for the three months ended March 31, 2023 and $3,543,000 for the three months ended March 31, 2022.

During the three months ended March 31, 2023 and 2022, net premium amortization on securities amounted to $400,000 and $838,000, respectively.

Net gains on sales of mortgage loans amounted to $17,000 for the three months ended March 31, 2023, compared to net losses on sales of mortgage loans of $34,000 for the three months ended March 31, 2022.

Originations of mortgage loans originated for resale exceeded proceeds (net of gains/losses) from sales of mortgage loans originated for resale by $27,000 for the three months ended March 31, 2023, compared to the three months ended March 31, 2022 when proceeds (net of gains/losses) from sales of mortgage loans exceeded originations of mortgage loans originated for resale by $1,228,000.

Net securities losses amounted to $56,000 and $63,000 for the three months ended March 31, 2023 and 2022, respectively.

Accrued interest receivable decreased by $356,000 and $40,000 during the three months ended March 31, 2023 and 2022, respectively.

Other assets increased by $706,000 and $655,000 during the three months ended March 31, 2023 and 2022, respectively.

Accrued interest payable increased by $726,000 during the three months ended March 31, 2023, compared to an increase of $255,000 during the three months ended March 31, 2022.

Other liabilities decreased by $5,125,000 during the three months ended March 31, 2023 and decreased by $347,000 during the three months ended March 31, 2022.

Investing activities provided cash of $24,775,000 during the three months ended March 31, 2023, compared to the three months ended March 31, 2022 when investing activities used cash of $48,070,000.

Net activity in the available-for-sale securities portfolio (including proceeds from sale, maturities, and redemptions, net against purchases) provided cash of $31,655,000 during the three months ended March 31, 2023 and used cash of $19,679,000 during the three months ended March 31, 2022.

Changes in restricted investment in bank stocks used cash of $1,216,000 and $1,130,000 during the three months ended March 31, 2023 and 2022, respectively.

Net cash used to originate loans amounted to $3,683,000 for the three months ended March 31, 2023, compared to $27,411,000 for the three months ended March 31, 2022.

Purchases of premises and equipment used cash of $868,000 and $97,000 during the three months ended March 31, 2023 and 2022, respectively.

Purchase of investment in real estate ventures used cash of $1,113,000 during the three months ended March 31, 2023, compared to $0 for the three months ended March 31, 2022.

Financing activities used cash of $20,373,000 and $8,817,000 during the three months ended March 31, 2023 and 2022, respectively.

Deposits decreased by $45,584,000 during the three months ended March 31, 2023, compared to a decrease of $32,492,000 during the three months ended March 31, 2022.

Short-term borrowings increased by $26,489,000 and $24,954,000 during the three months ended March 31, 2023 and 2022, respectively.

Dividends paid amounted to $1,685,000 for the three months ended March 31, 2023, compared to $1,665,000 for the three months ended March 31, 2022.

Managing liquidity remains an important segment of asset/liability management.

10 unchanged sentences

Generally, the fair value of fixed-rate instruments fluctuates inversely with changes in interest rates.

As a result, increases in interest rates have and could result in further decreases in the fair value of the Company’s interest-earning assets, which could adversely affect the Company’s results of operations if sold, or, in the case of interest-earning assets classified as available-for-sale, the Company’s stockholders’ equity, if retained.

As a result, increases in interest rates could result in further decreases in the fair value of the Company’s interest-earning assets, which could adversely affect the Company’s results of operations if sold, or, in the case of interest-earning assets classified as available-for-sale, the Company’s stockholders’ equity, if retained.

Under FASB ASC 320-10, Investments – Debt Securities , changes in the unrealized gains and losses, net of taxes, on debt securities classified as available-for-sale are reflected in the Company’s stockholders’ equity.

9 unchanged sentences

position would contribute positively to net interest income in a falling rate environment.

The Company’s cumulative gap at one year indicates the Company is liability sensitive at September 30, 2022.

The Company’s cumulative gap at one year indicates the Company is liability sensitive at March 31, 2023.

Earnings at Risk

14 unchanged sentences

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.

The table on the next page 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 table below 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.

1 unchanged sentence

In addition, the earnings simulation model projects net interest income would increase 11.89% and 22.88% in the 100 and 200 basis point decreasing rate scenarios presented.

All of these forecasts are within the Company’s one year policy guidelines, aside from the 300 basis point immediate increase scenario at (28.01)% vs.

the policy limit of (25.00)%.

The analysis and model used to quantify the sensitivity of net interest income becomes less reliable in a decreasing rate scenario given the current interest rate environment with federal funds trading in the 300 - 325 basis point range and many deposit accounts still lagging at lower rates.

All of these forecasts are within the Company’s one year policy guidelines, aside from the 200 basis point immediate increase scenario at (28.36)% and the 300 basis point immediate increase scenario at (40.90)% vs.

the policy limits of (20.00)% and (25.00)%, respectively.

The analysis and model used to quantify the sensitivity of net interest income becomes less reliable in a decreasing rate scenario given the current interest rate environment with federal funds trading in the 475-500 basis point range and many deposit accounts still lagging at markedly lower rates.

Results of the decreasing basis point declining scenarios are affected by the fact that many of the Company’s interest-bearing liabilities are at rates below 1% and therefore likely may not decline 100 or more basis points.

However, the Company’s interest-sensitive assets are able to decline by these amounts.

For the nine months ended September 30, 2022, the cost of interest-bearing liabilities averaged 0.70%, and the yield on interest-earning assets, on a fully taxable equivalent basis, averaged 3.79%.

For the three months ended March 31, 2023, the cost of interest-bearing liabilities averaged 2.29%, and the yield on interest-earning assets, on a fully taxable equivalent basis, averaged 4.40%.

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 September 30, 2022, net present value is projected to decrease 3.56%, 10.68%,

and 19.38% in the 100, 200, and 300 basis point immediate increase scenarios, respectively.

Additionally, the 100 and 200 basis point immediate decrease scenarios are estimated to affect net present value with a decrease of 2.77% and 16.15%, respectively.

All of these scenarios presented are within the Company’s policy limits.

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 March 31, 2023, net present value is projected to decrease 2.71%, 8.61%, and 16.25% 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 3.75% and 16.10%, respectively.

All scenarios presented are within the Company’s policy limits.

The computation of the effects of hypothetical interest rate changes are based on many assumptions.

19 unchanged sentences

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

What changed 10-Q

Item 1. Financial Statements