What changed in this filing

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Item 2. Management’s Discussion and Analysis

2021-11-09 compared with 2021-08-12 · 247 added, 248 removed, 520 unchanged (49% of the section changed)

26 unchanged sentences

The Bank has two consumer finance company subsidiaries - OakFirst Loan Center, Inc., a West Virginia corporation, and OakFirst Loan Center, LLC, a Maryland limited liability company - and two subsidiaries that it uses to hold real estate acquired through foreclosure or by deed in lieu of foreclosure - First OREO Trust, a Maryland statutory trust, and FUBT OREO I, LLC, a Maryland limited liability company.

In addition, the Bank owns 99.9% of the limited partnership interests in Liberty Mews Limited Partnership;

a Maryland limited partnership formed for the purpose of acquiring, developing and operating low-income housing units in Garrett County, Maryland, and 99.9% of the membership interests in MCC FUBT Fund, LC, an Ohio limited liability company formed for the purpose of acquiring, developing and operating low-income housing units in Allegany County, Maryland.

At June 30, 2021, the Corporation’s total assets were $1.8 billion, net loans were $1.1 billion, and deposits were $1.5 billion.

Shareholders’ equity at June 30, 2021 was $130.6 million.

In addition, the Bank owns 99.9% of the limited partnership interests in Liberty Mews Limited Partnership, a Maryland limited partnership formed for the purpose of acquiring, developing and operating low-income housing units in Garrett County, Maryland, and a 99.9% non-voting membership interest in MCC FUBT Fund, LC, an Ohio limited liability company formed for the purpose of acquiring, developing and operating low-income housing units in Allegany County, Maryland.

At September 30, 2021, the Corporation’s total assets were $1.7 billion, net loans were $1.1 billion, and deposits were $1.4 billion.

Shareholders’ equity at September 30, 2021 was $133.8 million.

The Corporation maintains an Internet site at www.mybank.com on which it makes available, free of charge, its Annual Report on Form 10-K, Quarterly Reports on Form 10-Q, Current Reports on Form 8-K, and all amendments to the foregoing as soon as reasonably practicable after these reports are electronically filed with, or furnished to, the SEC.

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Also, the Consolidated Appropriations Act (the “CAA”) passed on December 27, 2020, which, among other things, extended the provisions of Section 4013 of the CARES Act to January 1, 2022.

The Federal Reserve also took actions to mitigate the economic impact of the COVID-19 pandemic, including cutting the federal funds rate 150 basis points and targeting a 0 to 25 basis point rate.

In addition to the general impact of the COVID-19 pandemic, certain provisions of the CARES Act as well as other legislative and regulatory relief efforts are expected to have a material impact on the Company’s operations.

During the first six months of 2021, we continued to assist our business customers with the PPP loan forgiveness process and to originate additional PPP loans.

The Federal Reserve’s actions have included cutting the federal funds rate 150 basis points and targeting a 0 to 25 basis point rate.

During the first nine months of 2021, we continued to assist our business customers with the PPP loan forgiveness process and to originate additional PPP loans through the third round of funding.

We remained diligent in protecting our associates and customers from the lingering effects of the pandemic, delaying opening our lobbies until April 1, 2021.

During the third quarter, we made the decision to reclose our lobbies as COVID cases increased in most of our markets and staffing was at reduced levels.

Many of our sales and support employees continue to work remotely as we have adjusted to a hybrid work environment.

We have continued to monitor our market areas, maintaining travel protocols and utilizing safety precautions while continuing to provide full banking services to our customers.

Paycheck Protection Program

The Corporation actively participated in the PPP.

On January 19, 2021, the SBA implemented a second round of funding for PPP loans.

The Corporation originated $66.1 million in PPP loans during the first six months of 2021, consisting of 870 loans with an average loan size of $80 thousand.

New PPP loans are no longer available.

A total of 1,174 loans totaling $148.5 million were originated in 2020.

As of June 30, 2021, approximately $140.5 million have been forgiven with a remaining balance of $74.1 million.

The Corporation continues to actively participate in the PPP.

On January 19, 2021, the SBA implemented a third round of funding for PPP loans.

During 2020, the Corporation originated a total of $148.5 million in PPP loans under the first and second rounds of funding, consisting of 1,174 loans with an average loan size of $162 thousand.

During 2021, the Corporation originated a total of $66.1 million in PPP loans under the third round of funding, consisting of 870 loans with an average loan size of $80 thousand.

Net PPP origination fees recognized in the first nine months of 2021 were $3.2 million due to amortization and forgiveness, compared to $2.4 million in 2020.

During 2020, 290 PPP loans, totaling $34.5 million were forgiven, resulting in 885 loans with a remaining balance of $114.0 million at December 31, 2020.

During the first nine months of 2021, an additional 1,384 PPP loans originated under all three rounds, with an aggregate principal balance of $150.0 million, were forgiven, resulting in 371 PPP loans with a total remaining balance of $30.3 million at September 30, 2021.

Of the 2,046 PPP loans originated by the Corporation since the PPP’s inception, 1,675 loans, totaling $184.9 million, have been forgiven through the end of third quarter 2021, representing 86% of the number of loans originated and 82% of originated principal balances.

COVID Modifications

While the COVID-19 pandemic has had an impact on most industries, some have been more affected than others.

In accordance with Section 4013 of the CARES Act and related regulatory pronouncements, we have not accounted for modifications of loans affected by the pandemic as troubled debt restructurings nor have we designated them as past due or nonaccrual.

As of July 16, 2021, there were six commercial loans totaling $7.3 million in total loan modifications related to the real estate rental and health care sectors.

In accordance with Section 4013 of the CARES Act and related regulatory pronouncements, we have not accounted for modifications of loans affected by the pandemic as troubled debt restructurings (“TDRs”) nor have we designated them as past due or nonaccrual.

As of October 15, 2021, modified loans not treated as TDRs consisted of eleven commercial loans relating to real estate rental, food services and health care sectors and one mortgage loan, with an aggregate balance of $9.9 million.

These loans are scheduled to return to contractual payment terms within the next quarter.

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Management has reviewed its Liquidity Contingency Funding Plan in preparation of funding needs as it relates to the COVID-19 pandemic.

As of June 30, 2021, the Corporation had approximately $130.0 million in unsecured lines of credit with its correspondent banks, $1.0 million with the Federal Reserve Discount Window, and approximately $122.2 million of secured borrowings with the Federal Home Loan Bank of Atlanta (“FHLB”).

As of September 30, 2021, the Corporation had approximately $130.0 million in unsecured lines of credit with its correspondent banks, $1.0 million with the Federal Reserve Discount Window, and approximately $189.0 million of secured borrowings with the Federal Home Loan Bank of Atlanta (“FHLB”).

Additionally, the Corporation has access to the brokered certificates of deposit market.

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SELECTED FINANCIAL DATA

The following table sets forth certain selected financial data for the six month periods ended June 30, 2021 and 2020 and is qualified in its entirety by the detailed information and unaudited financial statements, including the notes thereto, included elsewhere in this quarterly report.

As of the six months ended

The following table sets forth certain selected financial data for the nine month periods ended September 30, 2021 and 2020 and is qualified in its entirety by the detailed information and unaudited financial statements, including the notes thereto, included elsewhere in this quarterly report.

As of the nine months ended

September 30,

Per Share Data

4 unchanged sentences

Basic book value per common share (1) - as reported

Basic book value per common share (1) - non-GAAP

Diluted book value per common share (1) - as reported

Diluted book value per common share (1) - non-GAAP

Significant Ratios:

Return on Average Assets (1) - as reported

Settlement expenses, net of income tax

Adjusted Return on Average Assets (1) (non-GAAP)

Return on Average Equity (1) - as reported

Settlement expenses

Income tax effect of adjustment

Adjusted Return on Average Equity (1) (non-GAAP)

Return on Average Assets (a) (1) - as reported

Settlement and FHLB expenses, net of income tax

Adjusted Return on Average Assets (a) (1) (non-GAAP)

Return on Average Equity (a) (1) - as reported

Settlement and FHLB expenses, net of income tax

Adjusted Return on Average Equity (a) (1) (non-GAAP)

Average Equity to Average Assets

Capital Ratios:

Consolidated Total Capital (to risk weighted assets) - as reported

Consolidated Total Capital (to risk weighted assets) - (non-GAAP)

Consolidated Tier 1 Capital (to risk weighted assets) - as reported

Consolidated Tier 1 Capital (to risk weighted assets) - (non-GAAP)

Consolidated Common Equity Tier 1 Capital (to risk weighted assets) - as reported

Consolidated Common Equity Tier 1 Capital (to risk weighted assets) - (non-GAAP)

Consolidated Tier 1 Capital (to average assets) - as reported

Consolidated Tier 1 Capital (to average assets) - (non-GAAP)

(1) See reconciliation of this non-GAAP financial measure provided elsewhere herein associated with settlement expenses incurred during the first quarter of 2021.

Consolidated Total Capital (to risk weighted assets)

Consolidated Tier 1 Capital (to risk weighted assets)

Consolidated Common Equity Tier 1 Capital (to risk weighted assets)

Consolidated Tier 1 Capital (to average assets)

(1) See reconciliation of this non-GAAP financial measure provided elsewhere herein associated with settlement expenses incurred during the first quarter of 2021 and prepayment penalties incurred during the third quarter of 2021.

(a) Annualized

RESULTS OF OPERATIONS

Consolidated net income was $7.8 million, inclusive of litigation settlement expenses of $3.3 million, for the six months ended June 30, 2021 compared to $4.3 million for the six months ended June 30, 2020.

Basic and diluted net income per share for

the first six months of 2021 were both $1.15, compared to basic and diluted net income per share of $0.62 for the same period of 2020, an 85.5% increase.

The increase in earnings for the first six months of 2021 was attributable to an increase in net interest income of $0.5 million, an increase in other operating income, including gains, of $1.8 million and a decrease in provision expense of $4.2 million, partially offset by an increase in other operating expenses of $1.5 million, inclusive of the $3.3 million in litigation settlement expenses.

The provision for loan losses was $0.7 million for the six month period ended June 30, 2021 and $4.8 million for the six month period ended June 30, 2020.

Net charge-offs of $83 thousand were recorded for the first six months of 2021, compared to net charge offs of $0.3 million for first six months of 2020.

The higher provision expense recorded in 2021 was driven by an increase in the qualitative factors reflecting the uncertainty of the economic environment related to the COVID-19 pandemic and its impact on our borrowers.

The ratio of the ALL to loans outstanding, including PPP loan balances, was 1.49% at June 30, 2021 compared to 1.43% at June 30, 2020 and 1.41% at December 31, 2020.

The ratio of ALL to loans outstanding, on a non-GAAP basis, excluding PPP loan balances of $74.1 million, was 1.59% at June 30, 2021.

Net interest income, on a non-GAAP, fully-taxable equivalent (“FTE”) basis, increased by $0.5 million (1.9%) during the six months ended June 30, 2021 when compared with the six months ended June 30, 2020, driven by a $1.7 million (32.4%) decrease in interest expense, partially offset by a decrease in interest income of $1.2 million.

The net interest margin, on a FTE basis, declined for the six months ended June 30, 2021 to 3.13% compared to 3.61% for the same period of 2020.

The decrease in interest income was driven by a slight decrease in interest and fees on loans and reduced income on the investment portfolio.

While the average balance of the investment portfolio increased by $65.8 million, bonds at higher yielding rates were called and replaced with lower yielding investments, resulting in a decrease in average yield on the investment portfolio of 118 basis points.

The increase in the average balance of investments is due to a strategic decision in December 2020 to invest $70.0 million of excess cash into the investment portfolio.

Significantly higher cash levels invested at an average yield on Fed Funds of 0.08% for the first six months of 2021, compared to 0.52% for the first six months of 2020, also negatively impacted the margin for the first six months of 2021.

The increase in average balance of loans of $82.8 million, primarily driven by PPP loans, offset the declining yield in the portfolio leading to slightly reduced interest and fees on loans when comparing the first six months of 2021 to the first six months of 2020.

The average balances of PPP loans of approximately $126.6 million generated $2.6 million of interest and fees but had a negative impact on the margin.

The average loan yield was also negatively impacted by the low-rate environment, which resulted in loan production and loans repricing at lower rates.

These factors resulted in a decrease of approximately 38 basis points in average loan yield when compared with the six months ended June 30, 2020.

The decrease in interest expense of $1.7 million, despite an increase in average interest-bearing liabilities of $117.9 million, was a direct result of a reduction in the cost of deposits of 28 basis points, a 3 basis point decrease in the cost of our short-term borrowings and a 67 basis point decrease in the cost of long-term borrowings.

The decrease in the rate on long-term borrowings was primarily due to the restructuring of three long-term FHLB advances late in the fourth quarter of 2020 that resulted in a reduced weighted average rate of 80 basis points on the $70.0 million portfolio.

The average balance on our interest-bearing money market accounts increased $49.1 million, while the rate on these accounts decreased by 43 basis points.

Average growth of $140.9 million in our non-interest-bearing accounts benefited our overall cost of deposits.

Other operating income, including net gains, increased $1.8 million for the six months ended June 30, 2021 when compared to the six months ended June 30, 2020.

Gains on the sale of mortgages to the secondary market, which we have utilized in lieu of retaining long-term fixed rate loans in our portfolio, increased $0.1 million related to continued refinancing activity.

Trust and brokerage income increased $0.9 million year-over-year due to continued growth in new client relationships and assets under management.

Debit card income increased $0.4 million for the six months ended June 30, 2021 when compared with the same period of 2020 as we continued to grow our deposit relationships and our customers increase use of our electronic services.

Consolidated net income for the nine months ended September 30, 2021 was $12.2 million, inclusive of litigation settlement expenses of $3.3 million and FHLB prepayment penalties of $2.4 million, compared to $9.3 million for the nine months ended September 30, 2020.

Basic and diluted net income per share for the first nine months of 2021 were both $1.81, a 37.1% increase when compared to basic and diluted net income per share of $1.32 for the same period of 2020.

The increase in earnings for the first nine months of 2021 was attributable to an increase in net interest income of $2.2 million, reduced provision expense of $4.9 million and an increase in other operating income, including gains on sales of mortgage loans and securities’ of $1.3 million.

These changes were partially offset by an increase in other operating expenses of $4.0 million, inclusive of the $3.3 million in litigation settlement expenses and the $2.4 million FHLB prepayment penalty.

Net interest income, on a non-GAAP, FTE basis, increased by $2.2 million (5.9%) during the nine months ended September 30, 2021 when compared to the nine months ended September 30, 2020 driven by a $2.7 million (36.5%) decrease in interest expense, partially offset by a decrease in interest income of $0.5 million.

The decrease in interest expense resulted from proactive efforts to reduce the cost of funds by further reductions to rates on deposit accounts throughout 2021, the runoff of balances in the time deposits of $100,000 or more, including brokered deposits, and the expiration of empowered rates on money market accounts.

The prepayment of the FHLB advances in the third quarter should significantly reduce interest expense in the fourth quarter and future years.

The net interest margin, on an FTE basis, declined to 3.21% for the nine months ended September 30, 2021 compared to 3.43% for the same period of 2020.

Excluding the average balance of PPP loans of $100.6 million and interest and fees of $4.0 million, the net interest margin for the nine months ended September 2021 was 3.07%.

Other operating income, including net gains on sales of mortgage loans and sales of investment securities, increased $1.3 million for the nine months ended September 30, 2021 when compared to the nine months ended September 30, 2020.

Gains on the sale of mortgage loans to the secondary market decreased $0.5 million due to refinancing activity occurring at a slower pace than the pace experienced in 2020.

Trust and brokerage income increased $1.2 million year-over-year due to growth in new client relationships and assets under management.

Debit card income increased $0.6 million for the nine months ended September 30, 2021 when compared to the same period of 2020 due to growth in deposit relationships and increased customer usage of our electronic services.

Other income increased $0.5 million, due primarily to the receipt of insurance proceeds related to litigation claims recorded in the first quarter of 2021.

Service charge income remained stable when comparing the six months of 2021 to the same time period of 2020.

Other operating expenses increased $1.5 million, inclusive of litigation settlement expenses, for the six months ended June 30, 2021 when compared with the same period of 2020.

Salaries and benefits decreased $0.4 million when compared to the six months of 2020, primarily due to reductions of $0.2 million in life and health insurance costs, a $0.5 million offset in salary expense

from deferred loan origination costs primarily attributable to PPP loans and $0.1 million of reduced executive equity compensation due to a timing difference in long-term incentive grants.

These decreases were offset by an increase of $0.4 million in salaries, incentives and related payroll costs.

Service charge income remained stable when comparing the first nine months of 2021 to the same time period of 2020.

Other operating expenses increased $4.0 million for the nine months ended September 30, 2021 when compared to the same period of 2020.

This increase was driven by $3.3 million of litigation settlement expenses recorded in the first quarter of 2021 and a $2.4 million penalty on the prepayment of $70.0 million FHLB advances in the third quarter of 2021.

Salaries and benefits remained stable when compared to the first nine months of 2020, as increases in salaries, incentive pay and stock compensation were offset by decreases in pension and life and health insurance costs, a $0.3 million offset in salary expense from deferred loan origination costs primarily attributable to PPP loans and $0.1 million of reduced executive equity compensation due to a timing difference in long-term incentive grants.

Federal Deposit Insurance Corporation premiums increased slightly by $0.2 million due to credits received on quarterly assessments in 2020.

Equipment, occupancy and technology expenses decreased $0.6 million when compared to the six months of 2020 as we began to realize cost savings from our core processor related to a new contract negotiated in the fourth quarter of 2020.

OREO expenses were a net credit in the first six months of 2021 due to $0.8 million in gains attributable to the sale of OREO properties.

Professional services increased $0.8 million as a result of increased legal and professional fees, partially offset by decreased investor relations expenses related to the 2021 annual meeting of shareholders and related litigation.

Consolidated net income was $4.4 million for the second quarter of 2021 compared to $2.6 million for the second quarter of 2020.

Basic and diluted net income per common share for the second quarter of 2021 were both $0.66, compared to basic and diluted net income per common share of $0.37 for the second quarter of 2020, an 78.4% increase.

The increase in earnings for the second quarter of 2021 was due to stable net interest income (inclusive of PPP origination fee accretion), an increase in other operating income, including gains, of approximately $0.5 million, a decrease in provision expense of $1.6 million and a decrease in other operating expenses of $0.4 million.

The provision for loan losses was $0.6 million for the three month period ended June 30, 2021 and $2.2 million for the three month period ended June 30, 2020.

Net interest income, on a non-GAAP, FTE basis, increased $0.1 million (0.9%) during the second quarter of 2021 over the same period in 2020 and was driven by a decrease in interest expense of approximately $0.8 million (31.7%), offset by a $0.7 million (4.4%) decrease in interest income.

The net interest margin for the second quarter of 2021 was 3.15%, compared to 3.53% for the second quarter of 2020.

Participation in the PPP, with an average outstanding loan balance of $110.7 million and a loan rate of 1.0% at June 30, 2021, negatively impacted the margin for the second quarter of 2021 by 12 basis points.

However, deferred fees of approximately $1.3 million recognized during the second quarter of 2021 positively impacted the margin by 28 basis points, with a net positive impact of 16 basis points.

Continued elevated cash levels have also negatively impacted the margin.

We expect to see continued margin compression during the remainder of 2021 as deposit rates approach floors and loans continue to reprice to lower rates.

The decrease in interest income was driven by a slight decrease in interest and fees on loans and reduced income on the investment portfolio.

While the average balance of the investment portfolio increased by $72.3 million, bonds at higher yielding rates were called and replaced with lower yielding investments, resulting in a decrease in average yield on the investment portfolio of 128 basis points.

The increase in the average balance of investments is due to a strategic decision in December 2020 to invest $70.0 million of excess cash into the investment portfolio.

Significantly higher cash levels invested also negatively impacted the margin for the second quarter of 2021 when compared to the second quarter of 2020.

The increase in average balance of loans of $9.0 million, primarily driven by PPP loans, offset the declining yield in the portfolio leading to slightly reduced interest and fees on loans when comparing the second quarter of 2021 to the second quarter of 2020.

The average loan yield was also negatively impacted by the low-rate environment, which resulted in loan production and loans repricing at lower rates.

These factors resulted in a decrease of approximately 12 basis points in average loan yield when compared with the second quarter of 2020.

The decrease in interest expense of $0.8 million, despite an increase in average interest-bearing liabilities of $81.3 million, was a direct result of a reduction in the cost of deposits of 23 basis points, a 1 basis point decrease in the cost of our short-term borrowings and a 68 basis point decrease in the cost of long-term borrowings.

The decrease in the rate on long-term borrowings is primarily due to the restructuring of three long-term FHLB advances late in the fourth quarter of 2020 that resulted in a reduced weighted average rate of 80 basis points on the $70.0 million portfolio.

The average balance on our interest-bearing money market accounts increased $7.9 million, while the rate on these accounts decreased by 33 basis points.

Average growth of $105.4 million in our non-interest-bearing accounts benefited our overall cost of deposits.

Other operating income, including gains, for the second quarter of 2021 increased by approximately $0.5 million when compared with the same period of 2020.

Service charge income increased by $0.2 million during the second quarter of 2021 when compared with the second quarter of 2020.

Trust and brokerage income increased $0.5 million due to increased production and

market values on assets under management.

Net gains decreased $0.4 million when comparing the second quarter of 2021 to the second quarter of 2020.

While the refinancing activity continued into the second quarter of 2021, the pace of activity slowed when compared to the second quarter of 2020, which resulted in reduced gains on the sale of mortgages.

Other operating expenses decreased by $0.4 million when comparing the second quarter of 2021 to the second quarter of 2020.

This decrease was driven by reduced occupancy, equipment and technology service during the second quarter of 2021 when compared with the second quarter of 2020 as we began to see reduced costs associated with our core processor due to contract negotiations during 2020.

Investor relations costs decreased by $0.7 million during the second quarter of 2021 when compared with the second quarter of 2020 due to costs associated with the 2020 annual meeting of shareholders.

These changes were partially offset by increased salaries and benefits related to a reduction in deferred loan origination costs and an increase in professional services related to final legal expenses associated with litigation that was settled in April 2021.

Other miscellaneous expenses, such as contributions, consulting, Visa processing fees, office supplies, travel and lodging, schools and seminars, and business-related meals declined.

Most of the expense reductions are related to limited operations as a result of the pandemic and management’s continued focus on cost savings and efficiencies.

The decreases were offset by increases in mileage, line rentals and contract labor.

The effective income tax rates as a percentage of income for the six-month periods ended June 30, 2021 and 2020 were 25.2% and 22.2%, respectively.

The increase in the tax rate was primarily due to the reduction in tax exempt income as well as the reduction in tax credits related to the expiration of a low-income housing tax credit in June 2021.

Equipment, occupancy and technology expenses decreased $0.9 million when compared to the first nine months of 2020 as we began to realize cost savings from our core processor related to a new contract negotiated in the fourth quarter of 2020.

Other real estate owned (“OREO”) expenses were a net credit in the first nine months of 2021 due to $0.8 million in gains attributable to the sale of OREO properties.

Professional services increased $0.8 million as a result of increased legal and professional fees related to shareholder litigation early in 2021, partially offset by decreased investor relations expenses.

The provision for loan losses was $0.1 million for the nine months ended September 30, 2021 and $5.0 million for the nine months ended September 30, 2020.

The higher provision expense recorded in the first nine months of 2020 was driven by an increase in the qualitative factors reflecting the uncertainty of the economic environment related to the COVID-19 pandemic.

Net recoveries of $0.4 million were recorded for the nine months ended September 30, 2021, compared to net charge offs of $1.3 million for the same period of 2020.

The ratio of the ALL to loans outstanding, including PPP loan balances, was 1.46% at September 30, 2021 compared to 1.36% at September 30, 2020 and 1.41% at December 31, 2020.

The ALL to loans outstanding, excluding PPP loan balances of $30.3 million and $148.9 million, was 1.49% at September 30, 2021 and 1.55% at September 30, 2020 and December 31, 2020, non-GAAP.

Consolidated net income was $4.4 million for the third quarter of 2021 compared to $5.0 million for the third quarter of 2020.

Basic and diluted net income per share for the third quarter of 2021 were both $0.66, a 5.7% decrease when compared to basic and diluted net income per share of $0.70 for the third quarter of 2020.

The decline in earnings in the third quarter of 2021 was due to an increase in net interest income, a credit to provision expense, and increased wealth management income, offset by increased non-interest expenses, including the prepayment penalty of $2.4 million on FHLB borrowings.

Net interest income, on a non-GAAP, FTE basis, increased by $1.7 million (14.2%) for the third quarter 2021 when compared to the third quarter of 2020.

This increase resulted from an increase in interest income of $0.7 million and a decrease in interest expense of $1.1 million.

The increase in interest income on loans was a result of increased interest on consumer loans related to the purchase of a loan pool in the second quarter as well as an increase in the unearned fees related to the PPP forgiveness during

The reduction of interest expense resulted from the further reduction of deposit rates early in the third quarter and the declining balances in the higher cost CD portfolio.

The prepayment of the FHLB advances should positively impact interest expense for the remainder of 2021 and future years.

The weighted rate on the $70.0 million FHLB long-term borrowings was 1.90%.

The net interest margin for the third quarter of 2021 was 3.38%, compared to 3.12% for the third quarter of 2020.

Excluding the average balance of PPP loans of $48.5 million and interest and fees of $1.4 million, the net interest margin for the third quarter of 2021 was 3.12%.

Other operating income, including gains, for the third quarter of 2021 decreased by approximately $0.6 million when compared to the same period of 2020.

Service charge income remained stable during the third quarter of 2021 when compared to the third quarter of 2020.

Trust and brokerage income increased $0.3 million due to increased production and market values on assets under management.

Net gains decreased $1.1 million when comparing the third quarter of 2021 to the third quarter of 2020.

This decrease was due to the slowing of refinancing activity in the mortgage portfolio, which resulted in less gains on sales as well as no sales activity in the investment portfolio during the third quarter of 2021.

Bank Owned Life Insurance (“BOLI”) income decreased by $0.1 million when comparing the third quarter of 2021 to the third quarter of 2020 due to the receipt of policy proceeds in the third quarter of 2020.

Other operating expenses increased by $2.5 million when comparing the third quarter of 2021 to the third quarter of 2020.

This increase was driven by an increase in salaries and benefits of $0.3 million related to a reduction in deferred loan origination costs in 2021 (primarily related to PPP activities) and the $2.4 million prepayment penalties incurred in connection with the prepayment of the FHLB advances.

As noted above, the prepayment was a strategic decision to use $70.0 million of cash for the purpose of reducing the cost of funds for the remainder of 2021 and future years.

Occupancy, equipment and technology service expenses were stable during the third quarter of 2021 when compared to the third quarter of 2020.

Investor relations and professional services costs were also stable during the third quarter of 2021 when compared to the third quarter of 2020.

Other miscellaneous expenses, such as Visa processing fees, contract labor, schools and seminars, dues and licenses, in-house training, trust department expense, debit card expense and other personnel related expenses, declined.

The decreases were offset by increases in marketing, contributions and consulting expenses.

The effective income tax rates as a percentage of income for the nine-month periods ended September 30, 2021 and 2020 were 24.9% and 22.1%, respectively.

The increase in the tax rate for the first nine months of 2021 was primarily due to the reduction in tax exempt income as well as the reduction in tax credits related to the expiration of a low-income housing tax credit in June 2021.

A new 2021 investment in low-income housing is expected to provide tax benefits in 2022 and beyond.

Non-GAAP Financial Measures

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This non-GAAP disclosure has limitations as an analytical tool, should not be viewed as a substitute for performance and financial condition measures determined in accordance with GAAP, and should not be considered in isolation or as a substitute for analysis of results as reported under GAAP, nor is it necessarily comparable to non-GAAP performance measures that may be presented by other companies.

The following table presents a reconciliation of net income and basic and diluted earnings per share (as reported) to adjusted net income and adjusted basic and diluted earnings per share excluding settlement expense:

Six months ended June 30,

Nine months ended September 30,

(in thousands, except for per share amount)

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The following table presents a reconciliation of basic and diluted book value per share (as reported) to adjusted basic and diluted book value per share excluding settlement expense:

Six months ended June 30,

Nine months ended September 30,

(in thousands, except for per share amount)

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Outstanding shares

Basic book value per share - as reported

Equity without net settlement expenses

Outstanding shares

Adjusted basic book value per share (non-GAAP)

Basic book value per share

Diluted book value per share

Outstanding shares

Diluted book value per share - as reported

Equity without net settlement expenses

Outstanding shares

Adjusted diluted book value per share (non-GAAP)

The following table presents a reconciliation of capital ratios (as reported) to adjusted ratios excluding settlement expense:

(in thousands)

Retained Earnings - as reported

Settlement Expense

Income tax effect of adjustment

Adjusted Retained Earnings (non-GAAP)

Total Capital - as reported

Retained Earnings adjustment

Changes to capital due to retained earnings adjustment

Total Capital (non-GAAP)

Average Assets used for calculation

Consolidated Tier 1 Capital (to average assets) - as reported

Consolidated Tier 1 Capital (to average assets) - non-GAAP

Total risk weighted assets used for calculation

Consolidated Total Capital (to risk weighted assets) - as reported

Consolidated Total Capital (to risk weighted assets) - (non-GAAP)

Consolidated Tier 1 Capital (to risk weighted assets) - as reported

Consolidated Tier 1 Capital (to risk weighted assets) - (non-GAAP)

Consolidated Common Equity Tier 1 Capital (to risk weighted assets) - as reported

Consolidated Common Equity Tier 1 Capital (to risk weighted assets) - (non-GAAP)

Diluted book value per share

Net Interest Income

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This is a non-GAAP disclosure and management believes it is not materially different than the corresponding GAAP disclosure.

The table below summarizes net interest income for the six months ended June 30, 2021 and 2020.

The tables below summarizes net interest income for the nine and three month periods ended September 30, 2021 and 2020.

Non-GAAP - FTE

Six Months Ended

Nine Months Ended

September 30,

(dollars in thousands)

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Net interest margin %

The following tables set forth the average balances, net interest income and expense, and average yields and rates of our interest-earning assets and interest-bearing liabilities for the six and three month periods ended June 30, 2021 and 2020:

Six Months Ended

Three Months Ended

September 30,

(dollars in thousands)

Interest income

Interest expense

Net interest income

Net interest margin %

The following tables set forth the average balances, net interest income and expense, and average yields and rates of our interest-earning assets and interest-bearing liabilities for the nine and three month periods ended September 30, 2021 and 2020:

Nine Months Ended

September 30,

(dollars in thousands)

Investment Securities:

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(3) The average yields on investments are based on amortized cost.

Net interest income, on a non-GAAP, FTE basis, increased $0.5 million (1.9%) for the six months ended June 30, 2021 when compared with the same period of 2020, driven by a $1.7 million (32.4%) decrease in interest expense, partially offset by a decrease in interest income of $1.2 million.

The net interest margin, on an FTE basis, declined for the six months ended June 30, 2021 to 3.13% compared to 3.61% for the same period of 2020.

The decrease in interest income was driven by a slight decrease in interest and fees on loans and reduced income on the investment portfolio.

of 118 basis points.

The prepayment of the FHLB advances in the third quarter should significantly reduce interest expense in the fourth quarter and future years.

The net interest margin, on an FTE basis, declined to 3.21% for the nine months ended September 30, 2021 compared to 3.43% for the same period of 2020.

Excluding the average balances of PPP loans of $100.6 million and interest and fees of $4.0 million, the net interest margin for the nine months ended September 2021 was 3.07%.

The decrease in interest income was driven by a slight increase in interest and fees on loans offset by reduced income on the investment portfolio.

While the average balance of the investment portfolio increased by $69.9 million, bonds at higher yielding rates were called and replaced with lower yielding investments, resulting in a decrease in average yield on the investment portfolio of 106 basis points.

The increase in the average balance of investments is due to a strategic decision in December 2020 to invest $70.0 million of excess cash into the investment portfolio.

Significantly higher cash levels invested at an average yield on Fed Funds of 0.11% for the first nine months of 2021, compared to 0.31% for the first nine months of 2020, also negatively impacted the margin for the first nine months of 2021.

The increase in average balance of loans of $42.7 million, driven by PPP loans and the purchase of a $20.0 million consumer loan pool during the second quarter of 2021, offset the declining yield in the portfolio.

Interest and fees on loans increased slightly when comparing the first nine months of 2021 to the first nine months of 2020.

The average balances of PPP loans of approximately $100.6 million generated $3.2 million of interest and fees but had a negative impact on the margin.

The average loan yield was also negatively impacted by the low-rate environment, which resulted in loan production and loans repricing at lower rates.

These factors resulted in a decrease of approximately 38 basis points in average loan yield when compared with the six months ended June 30, 2020.

These factors resulted in a decrease of approximately 12 basis points in average loan yield when compared to the nine months ended September 30, 2020.

The decrease in interest expense of $2.7 million, despite an increase in average interest-bearing liabilities of $84.9 million, was a direct result of a reduction in the cost of deposits of 27 basis points, a 5 basis point decrease in the cost of our short-term borrowings and a 61 basis point decrease in the cost of long-term borrowings.

The decrease in the rate on long-term borrowings is primarily due to the restructuring of three long-term Federal Home Loan Bank advances late in the fourth quarter of 2020 that resulted in a reduced weighted average rate of 80 basis points on the $70.0 million portfolio.

The decrease in the rate on long-term borrowings was primarily due to the restructuring of three long-term Federal Home Loan Bank advances late in the fourth quarter of 2020 that resulted in a reduced weighted average rate of 80 basis points on the $70.0 million portfolio.

The rate on the long-term borrowings will be reduced further as the $70.0 million of FHLB advances were repaid late in the third quarter of 2021.

These advances had a weighted rate of 1.90%.

The average balance on our interest-bearing money market accounts increased $34.6 million, while the rate on these accounts decreased by 39 basis points.

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Three Months Ended

September 30,

(dollars in thousands)

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(3)The average yields on investments are based on amortized cost.

The net interest margin for the second quarter of 2021 was 3.15%, compared to 3.53% for the second quarter of 2020.

Participation in the PPP, with an average outstanding loan balance of $110.7 million and a loan rate of 1.0%, negatively impacted the margin for the second quarter of 2021 by 12 basis points.