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Item 7. Management’s Discussion and Analysis

2024-03-15 compared with 2023-03-24 · 296 added, 266 removed, 433 unchanged (56% of the section changed)

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This discussion and analysis should be read in conjunction with the Consolidated Financial Statements and notes thereto for the years ended December 31, 2023 and 2022, which are included in Item 8 of Part II of this annual report.

First United Corporation is a bank holding company that, through the Bank and its non-bank subsidiaries, provides an array of financial products and services primarily to customers in four Western Maryland counties and four Northeastern West Virginia counties.

First United Corporation is a financial holding company that, through the Bank and its non-bank subsidiaries, provides an array of financial products and services primarily to customers in four Western Maryland counties and four Northeastern West Virginia counties.

Its principal operating subsidiary is the Bank, which consists of a community banking network of 26 branch offices located throughout its market areas.

Our primary sources of revenue are interest income earned from our loan and investment securities portfolios and fees earned from financial services provided to customers.

Consolidated net income for the year ended December 31, 2022 was $25.0 million compared to $19.8 million in 2021.

The year-over-year increase was primarily due to a $5.1 million increase in net interest income resulting from a $4.2 million increase in interest income and a decrease in interest expense of $0.9 million.

Net gains were down $1.1 million in 2022 when compared to 2021 as management made the strategic decision to book the higher rate mortgage loans in 2022 as opposed to selling them to the secondary market.

Other income declined in 2022 due to a decrease of $0.4 million in trust and brokerage income and a decrease of $1.4 million due to an insurance reimbursement received in 2021.

These declines were slightly offset by an increase of $0.2 million in service charges and debit card income.

Provision expense was up $0.2 million as compared to 2021.

Salaries and benefits increased by $2.1 million when compared to 2021 due to a lower reduction of loan origination costs of $1.0 million and a $1.1 million increase due to performance related pay and the competitive employment environment.

Other changes year-over-year included increased other real estate owned (“OREO”) expenses of $1.5 million in 2022 due to gains on sale of OREO booked during 2021, other net increases in expenses of $0.8 million and increased income taxes of $1.6 million.

Non-interest expense decreased significantly due to our payment of $3.3 million in litigation settlement expenses during the first quarter of 2021 and a $2.4 million prepayment penalty for the early repayment of $70.0 million of FHLB advances recognized in the third quarter of 2021, a reduction of $2.4 million in professional and investor relations expenses primarily related to reimbursement of $0.7 in litigation expenses, a reduction of $0.4 million in investor relations costs and a $1.3 million reduction in legal fees.

Charitable contributions also declined by $0.9 million primarily due to the decision to make a $1.0 million contribution in 2021 to fund the newly created First United Community Dreams Foundation (the “Foundation”).

The provision for loan losses was a credit of $0.6 million for the year ended December 31, 2022 and a credit of $0.8 million for the year December 31, 2021.

Net charge-offs of $0.7 million were recorded for the year ended December 31, 2022, compared to net recoveries of $0.3 million for 2021.

The ratio of the ALL to loans outstanding, including Paycheck Protection Program (“PPP”) loan balances, was 1.14% at December 31, 2022 compared to 1.38% at December 31, 2021.

The ratio of ALL to loans outstanding, excluding PPP loan balances of $0.4 million and $7.7 million, was 1.14% and 1.39% at December 31, 2022 and 2021, respectively, non-GAAP.

Other operating income, including net gains on sales of mortgage loans and sales of investment securities, decreased by approximately $2.7 million when compared to 2021.

This decrease was partially due to a $1.4 million insurance reimbursement that was received in 2021 and a decrease in net gains from the sale of residential mortgage loans of $1.1 million as refinance activity slowed considerably and due to management’s strategic decision to book new mortgage loans at higher rates to our in-house portfolio.

These decreases were partially offset by a net increase in service charge, debit card and other income of $0.2 million.

Other operating expenses decreased $4.6 million compared to the year ended December 31, 2021.

Salaries and benefits increased by $2.1 million compared to 2021 due to a lower reduction of loan origination costs of $1.0 million and a $1.1 million increase due to performance related pay and the competitive employment environment.

Other changes year-over-year included increased OREO expenses of $1.5 million in 2022 due to gains on sale of OREO booked during 2021 and other net increases in expenses of $0.8 million.

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in professional and investor relations expenses primarily related to reimbursement of $0.7 in litigation expenses, a reduction of $0.4 million in investor relations costs and a $1.3 million reduction in legal fees.

Charitable contributions also declined by $0.9 million primarily due to the funding of the Foundation at the end of 2021.

Outstanding loans of $1.3 billion at December 31, 2022 reflected a growth of $125.8 million during 2022.

Since December 31, 2021, commercial real estate loans increased by $84.5 million and acquisition and development loans decreased by $57.5 million due primarily to the payoff of one large credit early in the third quarter.

Commercial and industrial loans increased by $64.4 million for the year, primarily in new floor plan business, new commercial clients and continued expansion of existing client relationships.

Residential mortgage loans increased $39.7 million related to management’s strategic decision to book new mortgage loans at higher rates to our in-house portfolio.

The consumer loan portfolio decreased by $5.4 million due to amortization and payoffs of the existing portfolio slightly offset by new production.

Net interest income, on a non-GAAP, fully-taxable equivalent (“FTE”) basis, increased by $5.1 million.

Interest income increased by $4.2 million and interest expense decreased by $0.9 million.

The yield on earning assets increased 22 basis points to 3.85% in 2022 compared to 3.63% in 2021 in correlation with an increase in average earning assets as well as the rising interest rate environment and new loans booked at higher rates.

Interest expense on deposits decreased by $0.2 million while the average balance of deposits increased by $26.1 million and interest on long-term borrowings decreased by $0.7 million related to the prepayment of $70.0 million of FHLB advances in the third quarter of 2021.

The decreased interest expense resulted in an overall decrease of 7 basis points on the cost of interest-bearing liabilities.

We anticipate increased margin pressure in 2023 due to increasing deposit pricing demands in our market areas.

The net interest margin for the year ended December 31, 2022 was 3.56% compared to 3.28% for the year ended December 31, 2021.

For the year ended December 31, 2023, net income was $15.1 million on a GAAP basis, inclusive of a $3.3 million, net of tax, loss on the sale of securities and $0.5 million, net of tax, in increased expenses related to announced branch closures that occurred on February 29, 2024, and $18.8 million on a non-GAAP basis compared to GAAP and non-GAAP basis income of $25.0 million in 2022.

The year-over-year $10.0 million decrease in GAAP net income was driven by an increase in total operating expenses of $7.1 million.

Salaries and employee benefits increased by $3.4 due primarily to increased salary expense of $2.0 million related to new hires, the competitive environment for labor and merit increases effective April 1, 2023, increased health insurance costs of $1.0 million associated with unusually high claims and decreases of $0.4 in deferred loan costs.

Occupancy and equipment expense increased by $0.7 million due primarily to accelerated depreciation and lease termination expenses associated with the announced branch closures that occurred on February 29, 2024, data processing expense increased by $0.5 million due to the implementation of new technology, and FDIC assessments increased by $0.4 million.

Other miscellaneous expenses, such as loan service fees, dues and licenses, check fraud expenses, employee benefit plan expense, and miscellaneous expenses increased by $2.0 million and professional fees increased by $0.6 million due to the $0.8 million cash receipt related to reimbursement of litigation expenses that were previously expensed and was credited to expenses in 2022.

Provision for credit losses increased by $2.2 million when compared to prior year due to increased loan growth during 2023 and qualitative factors with the implementation of Accounting Standards Update 2016-13:

Financial Instruments- Credit Losses (“CECL”) .

Net losses on available-for-sale (“AFS”) securities increased by $4.2 million when compared to prior year due to the sale of securities in the fourth quarter of 2023.

Net interest income decreased by $0.8 million due to compression of the net interest margin as experienced industry-wide during 2023.

These increases were partially offset by increases in gains on sales of mortgages of $0.3 million, service charges on deposit accounts of $0.2 million, and $0.1 million increase in debit card income.

Income taxes were down by $3.7 million when comparing the two periods due primarily to reductions in pre-tax income.

The provision for credit losses was $1.6 million for the year ended December 31, 2023 and a credit of $0.6 million for the year ended December 31, 2022.

Net charge-offs of $0.9 million were recorded for the year ended December 31, 2023, compared to $0.7 million for 2022.

The ratio of the ACL to loans outstanding was 1.24% at December 31, 2023 compared to 1.14% at December 31, 2022.

Other operating income, including net losses/gains on sales of mortgage loans and sales of investment securities, decreased by approximately $3.6 million when compared to 2022.

This decrease was primarily related to a $4.2 million loss recognized through the sale of AFS investment securities as part of a strategic balance sheet restructuring in the fourth quarter of 2023.

This loss was partially offset by a $0.2 million in increases in service charges on deposit accounts, $0.1 million increase in wealth management income, and $0.3 million increase in gains on sales of residential mortgages.

Other operating expenses increased $7.1 million compared to the year ended December 31, 2022.

Occupancy and equipment

expense increased by $0.7 million due to the expenses related to the branch closures, data processing expense increased by $0.5 million as a result of the implementation of a new sales management system, and FDIC assessments increased by $0.4 million.

Professional fees increased by $0.6 million related to increased audit expenses in correlation to the new CECL implementation and increased legal and professional expenses due to the receipt of an $0.8 million in proceeds credited to expense in 2022 related to reimbursement of legal and professional expenses previously recorded.

Other miscellaneous expenses increased by $2.0 million primarily driven by increased check fraud related expenses of $0.5 million, increased employee benefit costs of $1.1 million, increased escrow account fees due to the rising rate environment, miscellaneous loan fees and an increase of $0.2 million in fees associated with the Intrafi Cash Service (“ICS”) product.

Outstanding loans of $1.4 billion at December 31, 2023 reflected growth of $127.2 million in 2023.

Since December 31, 2022, commercial real estate loans increased by $34.9 million, acquisition and development loans increased by $6.5 million and commercial and industrial loans increased by $29.2 million.

Growth in the commercial portfolios was driven by increased activity with existing clients as well as cultivating new business relationships.

Residential mortgage loans increased $55.5 million related to management’s strategic decision to book new mortgage loans at higher rates to our in-house portfolio during the first half of 2023 and then shifted production to sales in the secondary market during the second half of 2023.

The consumer loan portfolio increased slightly by $1.2 million.

Net interest income, on a non-GAAP, fully-taxable equivalent (“FTE”) basis, decreased by $1.1 million in 2023 compared to 2022.

Interest expense on deposits increased by $16.0 million due to an increase in balances of $102.3 million and an increase in yield of 141 basis points.

Interest expense on long-term borrowings increased $3.5 million related to $80.0 million in Federal Home Loan Bank (“FHLB”) borrowings obtained during the first quarter of 2023 and an increase in interest rates on variable rate trust preferred borrowings.

The increased interest expense resulted in an overall increase of 151 basis points on interest bearing liabilities.

This increase was partially offset by an increase of $18.4 million in interest income.

The yield on earning assets increased 78 basis points to 4.63% in 2023 compared to 3.85% in 2022 in correlation with the rising interest rate environment, new loans booked at higher rates as well as adjustable rate loans repricing.

The net interest margin was 3.26% in 2023 compared to 3.56% in 2022.

Comparing the year ended December 31, 2023 with the year ended December 31, 2022, interest income increased by $18.4 million.

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Excess cash balances during 2023 were invested at the Fed Funds rate, which also positively affected interest income for the year ended December 31, 2023 when compared to 2022.

Increases in loan interest income stemmed from the growth of core loans in 2022.

The rate earned on the loan portfolio remained stable when comparing the year ended December 31, 2022 to the year ended December 31, 2021.

Total deposits at December 31, 2022 increased by $101.4 million when compared to deposits at December 31, 2021.

Non-interest-bearing deposits increased by $5.0 million.

Interest bearing demand deposits increased by $99.5 million and traditional savings accounts increased by $14.1 million.

The increase in interest bearing demand deposits was attributable to an increase in municipality funding into a higher yielding indexed product.

Money market balances increased by $25.4 million.

Time deposits decreased by $42.7 million related to maturing balances moving to more liquid accounts, or brokerage investment accounts, due to the rising deposit rates as well as municipal funds moving to higher yielding State funding alternatives.

The decrease in interest expense for 2022 was driven by a decrease in interest rates of 7 basis points, which offset the increase in average balances of $26.1 million on interest bearing deposits, and a $46.4 million decline in average balances on long term borrowings related to the prepayment of $70.0 million in FHLB advances in the third quarter of 2021.

This decrease in average long-term borrowings help offset the increase in yields of 190 basis points on interest paid on borrowings during 2022.

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, including brokered deposits, and the expiration of empowered rates on money market accounts continued throughout early 2022.

Increases in loan interest income stemmed from the growth of core loans at higher rates in 2023.

The rate earned on the loan portfolio increased by 74 basis points when comparing the year ended December 31, 2023 to the year ended December 31, 2022.

Total deposits at December 31, 2023 decreased by $19.8 million when compared to December 31, 2022.

In March 2023, the Corporation obtained $61.1 million in new brokered deposits.

In August 2023, the Corporation obtained $30.0 million of brokered deposits to pre-fund the maturity of a $30.4 million brokered certificate of deposit that matured in September 2023.

In December 2023, $30.6 million in brokered deposits matured and were repaid.

In addition, retail certificates of deposit increased by $45.0 million due primarily to a promotional nine-month certificate of deposit product offered in 2023.

Interest-bearing demand deposits increased by $23.2 million and money market accounts increased by $20.5 million due to a shift in the deposit portfolio mix from non-interest-bearing accounts to interest-bearing accounts including the ICS product to ensure full FDIC insurance.

These increases were offset by decreases in non-interest-bearing deposits of $78.9 million and savings accounts of $59.5 million due to the shift to interest-bearing demand deposit accounts, two relationships having large, planned deposit withdrawals totaling $39.5 million during 2023 to fund business activity, the effects of consumer and commercial spending and the competitive market for deposits.

Estimates and Critical Accounting Policies

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The preparation of these financial statements requires management to make estimates and judgments that affect the reported amounts of assets, liabilities, revenues and expenses, and related disclosure of contingent liabilities.

(See Note 1 to the Consolidated Financial Statements.) On an on-going basis, management evaluates estimates and bases

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those estimates on historical experience and on various other assumptions that are believed to be reasonable under the circumstances, the results of which form the basis for making judgments about the carrying values of assets and liabilities that are not readily apparent from other sources.

(See Note 1 to the Consolidated Financial Statements.) On an on-going basis, management evaluates estimates and bases those estimates on historical experience and on various other assumptions that are believed to be reasonable under the circumstances, the results of which form the basis for making judgments about the carrying values of assets and liabilities that are not readily apparent from other sources.

Actual results may differ from these estimates under different assumptions or conditions.

The Company identifies the following critical accounting policies may affect our more significant judgments and estimates used in the preparation of the Consolidated Financial Statements.

Allowance for Loan Losses

One of our most important accounting policies is that related to the monitoring of the loan portfolio.

A variety of estimates impact the carrying value of the loan portfolio and resulting interest income, including the calculation of the ALL, the valuation of underlying collateral, and the timing of loan charge-offs.

The ALL is established and maintained at a level that is adequate to cover losses resulting from the inability of borrowers to make required payments on loans.

Estimates for loan losses are arrived at by analyzing risks associated with specific loans and the loan portfolio, current and historical trends in delinquencies and charge-offs, and changes in the size and composition of the loan portfolio.

The analysis also requires consideration of the economic climate and direction, changes in lending rates, political conditions, legislation impacting the banking industry and economic conditions specific to Western Maryland and Northeastern West Virginia.

Because the calculation of the ALL relies on management’s estimates and judgments relating to inherently uncertain events, actual results may differ from management’s estimates.

The ALL is also discussed below in Item 7 under the heading “Allowance for Loan Losses” and in Note 6 to the Consolidated Financial Statements.

The Corporation identifies the following critical accounting policies may affect our more significant judgments and estimates used in the preparation of the Consolidated Financial Statements.

Allowance for Credit Losses

The ACL represents an amount which, in management’s judgment, is adequate to absorb expected credit losses over the life of outstanding loans as of the balance sheet date based on the evaluation of current risk characteristics of the loan portfolio, past events, current conditions, reasonable and supportable forecasts of future economic conditions and prepayment experience.

The ACL is measured and recorded upon the initial recognition of a financial asset.

The ACL is reduced by charge-offs, net of recoveries of previous losses, and is increased by a provision or decreased by a recovery for credit losses, which is recorded as a current period operating expense.

Determination of an appropriate ACL is inherently complex and requires the use of significant and highly subjective estimates.

The reasonableness of the ACL is reviewed quarterly by management.

Management believes it uses relevant information available to make determinations about the ACL and it has established the existing allowance in accordance with GAAP.

However, the determination of the ACL requires significant judgment, and estimates of expected credit losses in the loan portfolio can vary from the amounts actually observed.

While management uses available information to recognize expected credit losses, future additions to the ACL may be necessary based on changes in the loans comprising the portfolio, changes in the current and forecasted economic conditions, changes to the interest rate environment which may directly impact prepayment and curtailment rate assumptions, and changes in the financial conditions of borrowers.

The ACL”base case” model is derived from various economic forecasts provided by widely recognized sources.

Management evaluates the variability of market conditions by examining the peak and trough of economic cycles.

These peaks and troughs are used to stress the base case model to develop a range of potential outcomes.

Management then determines the appropriate reserve through an evaluation of these various outcomes relative to current economic conditions and known risks in the portfolio.

The ACL is also discussed below in Item 7 under the heading “Allowance for Credit Losses” and in Note 5 to the Consolidated Financial Statements.

Liquidity Sources

As of December 31, 2023, the Corporation had approximately $140.0 million in unsecured lines of credit with its correspondent banks, $12.2 million available through a secured line of credit with the Federal Reserve Discount Window, and approximately $145.4 million of secured borrowings with the FHLB.

The Corporation also had approximately $69.5 million available through the BTFP offered by the Federal Reserve.

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

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

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The table below summarizes net interest income for 2023 and 2022.

Non-GAAP - FTE

(Dollars in thousands)

(in thousands)

Interest income

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Net interest margin %

Net interest income, on a non-GAAP, FTE basis, increased by $5.1 million (9.5%) during the year ended December 31, 2022 when compared to the year ended December 31, 2021, driven by a $4.2 million (7.0%) increase in interest income and a decrease in interest expense of $0.9 million (16.2%).

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

The net interest margin, on an FTE basis, increased to 3.56% for the year ended December 31, 2022 from 3.28% for the year ended December 31, 2021.

Net interest income, on a non-GAAP, FTE basis, decreased by $1.1 million (1.8%) during the year ended December 31, 2023 when compared to the year ended December 31, 2022, driven by a $19.5 million (407.1%) increase in interest expense, which was partially offset by an increase in interest income of $18.4 million (29.1%).

The net interest margin, on an FTE basis, decreased to 3.26% for the year ended December 31, 2023 from 3.56% for the year ended December 31, 2022.

Comparing the year ended December 31, 2023 with the year ended December 31, 2022, interest income increased by $18.4 million.

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The increase in interest on loans was primarily due to an increase of $116.7 million in average loan balance in 2023 compared to 2022.

The rate earned on the loan portfolio remained stable when comparing the year ended December 31, 2022 to the year ended December 31, 2021.

The increase in investment income was due to the increase in average balances of $77.7 million for the year ended December 31, 2022 compared to the year ended December 31, 2021 as well as an increase in interest yield of 23 basis points.

The decrease in interest expense for 2022 was driven by a decrease of $46.4 million in average balances on long term borrowings related to the prepayment of $70.0 million in FHLB advances in the third quarter of 2021.

The decrease of $0.7 million in interest expense on long-term borrowing was partially offset by the 190 basis point increase in rate paid on borrowings for the year ended December 31, 2022 compared to 2021.

Average rates paid on deposit accounts decreased slightly in 2022 compared to 2021, which was offset by the growth of $26.1 million in interest-bearing deposits during the year.

The rate earned on the loan portfolio increased by 74 basis points when comparing the year ended December 31, 2023 to the year ended December 31, 2022.

The increase in investment income was due to the 20 basis point increase in yield during 2023, which was partially offset by the $21.1 million reduction in average balances.

Other interest income increased by $3.1 million during 2023 primarily due to a 397 basis point increase in interest income of funds held at the Federal Reserve as well as an increase of $20.9 million in average balances.

The increase in interest expense for 2023 was driven by an an increase in interest expense on deposits of $16.0 million due to an increase in balances of $102.3 million and an increase in yield of 141 basis points.

Interest expense on long-term borrowings increased $3.5 million related to $80.0 million in FHLB borrowings obtained during the first quarter of 2023 and an increase in interest rates on variable rate trust preferred borrowings.

The increased interest expense resulted in an overall increase of 151 basis points on interest bearing liabilities.

As shown below, the composition of total interest income between 2023 and 2022 remained relatively stable.

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Interest on investment securities

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The following table sets forth the average balances, net interest income and expense, and average yields and rates for our interest-earning assets and interest-bearing liabilities for 2023 and 2022:

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For the Years Ended December 31

(Dollars in thousands)

(in thousands)

Investment Securities:

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Savings deposits

Time deposits

Time deposits - Retail

Time deposits - Brokered

Short-term borrowings

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The following table sets forth an analysis of volume and rate changes in interest income and interest expense of our average interest-earning assets and average interest-bearing liabilities for 2023 and 2022.

This table distinguishes between the changes related to average outstanding balances (changes in volume created by holding the interest rate constant) and the changes related to average interest rates (changes in interest income or expense attributed to average rates created by holding the outstanding balance constant).

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This table distinguishes between the changes related to average outstanding balances (changes in volume created by holding the interest rate

constant) and the changes related to average interest rates (changes in interest income or expense attributed to average rates created by holding the outstanding balance constant).

Interest Variance Analysis (1)

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Savings deposits

Time deposits

Time deposits - Retail

Time deposits - Brokered

Short-term borrowings

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(1) The change in interest income/expense due to both volume and rate has been allocated to volume and rate changes in proportion to the relationship of the absolute dollar amounts of the change in each.

Provision for Loan Losses

The provision for loan losses was a credit of $0.6 million for the year ended December 31, 2022 and a credit of $0.8 million for the year ended December 31, 2021.

Net charge-offs of $0.7 million were recorded for the year ended December 31, 2022, compared to net recoveries of $0.3 million for 2021.

The ratio of the ALL to loans outstanding was 1.14% at December 31, 2022 compared to 1.38% at December 31, 2021.

The ALL reflects a level commensurate with the risk inherent in our loan portfolio.

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Provision for Credit Losses

The provision for credit losses was $1.6 million for the year ended December 31, 2023 and a credit of $0.6 million for the year ended December 31, 2022.

Net charge-offs of $0.9 million were recorded for the year ended December 31, 2023, compared to net charge-offs of $0.7 million for 2022.

The ratio of the ACL to loans outstanding was 1.24% at December 31, 2023 compared to an ALL 1.14% at December 31, 2022.

The ACL reflects a level commensurate with the risk inherent in our loan portfolio.

For periods prior to the adoption of the CECL standard, we recognized credit losses on loans that were collectively evaluated for impairment based on an incurred loss approach, which limited our measurement of credit losses to credit events that were estimated to have already occurred.

Effective January 1, 2023, we adopted CECL, which replaced the incurred loss impairment model with an expected loss model.

Our CECL methodology introduced a modified discounted cash flow methodology based on expected cash flow changes in the future.

Other Operating Income

The following table shows the major components of other operating income for the past two years, exclusive of net gains, and the percentage changes during these years:

(Dollars in thousands)

(in thousands)

Service charges on deposit accounts

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Brokerage commissions

Insurance reimbursement

Total other operating income

Other operating income, exclusive of gains, decreased $1.6 million during the year ended December 31, 2022 when compared to the same period of 2021.

The decrease was primarily a result of a decrease of $1.4 million in insurance reimbursements and a $0.4 million decrease in trust income in 2022 when compared to 2021.

These decreases were partially offset by increased debit card income of $0.3 million for the year ended December 31, 2022 when compared to 2021 due to growth in deposit relationships and increased customer usage of our electronic services and increased service charge income of $0.2 million in 2022 when compared to 2021.

Other income decreased $0.4 million.

Net gains of $0.2 million and $1.2 million were reported through other income for the years ended December 31, 2022 and 2021, respectively.

The $1.1 million decrease in gains for 2022 was primarily attributable to the decrease in gains on the sale of mortgage loans to the secondary market of $1.1 million due to refinancing activity occurring at a slower pace than the pace experienced in 2021 and due to management’s strategic decision to book new mortgage loans at higher rates to our in-house portfolio.

Other operating income, exclusive of gains, increased $0.5 million during the year ended December 31, 2023 when compared to the same period of 2022.

The increase was primarily a result of a increase of $0.2 million in service charges on deposit accounts, an increase of $0.1 million in wealth management income, and a $0.1 million increase in debit card income.

Net losses of $3.9 million were reported for the year ended December 31, 2023 compared to net gains of $0.2 million for the same period in 2022.

The Corporation recognized a $4.2 millon loss in the sale of AFS investment securities as part of the balance sheet restructuring in the fourth quarter of 2023.

This loss was partially offset by an increase of $0.3 million in gains on sale of residential mortgages.

The following table shows the components of net losses for the year ended December 31, 2023 and net gains for the year ended December 31, 2022.

(in thousands)

Net gains/(losses):

Available-for-sale securities:

Realized gains from sales and calls

Realized losses from sales and calls

Held-to-Maturity:

Realized gains on calls

Gains on sale of loans held for sale

(Loss)/Gain on disposal of fixed assets

Net (losses)/gains

Other Operating Expense

The following table compares the major components of other operating expense for 2023 and 2022:

(Dollars in thousands)

(in thousands)

Salaries and employee benefits

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Contract labor

Total OREO expenses/(income), net

Total OREO (income)/expenses, net

Investor relations

Settlement expense

FHLB prepayment expense

Contributions

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Total other operating expense

Other operating expenses decreased $4.6 million for the year ended December 31, 2022 when compared to 2021.

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Other changes year-over-year included increased OREO expenses of $1.5 million in 2022 due to gains on sale of OREO booked during 2021 and other net increases in expenses of $0.8 million.

Charitable contributions also declined by $0.9 million primarily due to the funding of the Foundation at the end of 2021.

Other operating expenses increased $7.1 million for the year ended December 31, 2023 when compared to 2022.

Occupancy and equipment expense increased by $0.7 million due to the expenses related to the announced branch closures that occurred on February 29, 2024, data processing expense increased by $0.5 million as a result of the implementation of a new sales management system, and FDIC assessments increased by $0.4 million.

Applicable Income Taxes

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See the discussion under “Income Taxes” in Note 13 to the Consolidated Financial Statements presented elsewhere in this annual report for a detailed analysis of our deferred tax assets and liabilities.

Our effective tax rate was 24.5% in 2022 and 24.9% in 2021.

The decrease in the tax rate for 2022 was primarily due to the increase in tax credits related to a new 2021 investment in a low-income housing tax credit that began to provide tax benefits in 2022 and will continue to provide benefits in the coming years.

Our effective income tax rates as a percentage of income for the years ended December 31, 2023 and December 31, 2022 were 22.7% and 24.5%, respectively.

The decrease in the tax rate for the 2023 period was primarily related to a new low-income housing tax credit investment in 2022 that began generating tax credits during the fourth quarter of 2022.

This tax credit will continue through 2032.

At December 31, 2023, the Corporation had Maryland Net Operating Losses (“NOLs”) of $39.1 million for which a deferred tax asset of $2.6 million has been recorded.

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The valuation allowance was $2.8 million and $2.9 million at December 31, 2023 and 2022, respectively.

We have concluded that no valuation allowance is deemed necessary for our remaining federal and state deferred tax assets at December 31, 2022, as it is more likely than not that they will be realized based on the expected reversal of deferred tax liabilities, the generation of future income sufficient to realize the deferred tax assets as they reverse, and the ability to implement tax planning strategies to prevent the expiration of any carry-forward periods.

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We have concluded that no valuation allowance is deemed necessary for our remaining federal and state deferred tax assets at December 31, 2023, as it is more likely than not that they will be realized based on the expected reversal of

deferred tax liabilities, the generation of future income sufficient to realize the deferred tax assets as they reverse, and the ability to implement tax planning strategies to prevent the expiration of any carry-forward periods.

GAAP and Non-GAAP measures

The following tables sets forth certain selected financial data for the years ended December 31, 2022 and 2021 and is qualified in its entirety by the detailed information and unaudited financial statements, including the notes thereto, included elsewhere in this annual report.

The following tables sets forth certain selected financial data for the years ended December 31, 2023 and 2022 under generally accepted accounting principles (“GAAP”) (as reported) and non-GAAP.

A non-GAAP financial measure is a numerical measure of historical or future financial performance, financial position or cash flows that excludes or includes amounts that are required to be disclosed in the most directly comparable measure calculated and presented in accordance with GAAP in the United States.

The Corporation’s management believes the presentation of non-GAAP financial measures provide investors with a greater understanding of the Corporation’s operating results in addition to the results measured in accordance with GAAP.

While management uses these non-GAAP measures in its analysis of the Corporation’s performance, this information should not be viewed as a substitute for financial results determined in accordance with GAAP or considered to be more important than financial results determined in accordance with GAAP.

The following non-GAAP financial measures exclude losses on the sale of AFS securities and accelerated depreciation and lease termination expenses related to announced branch closures that occurred on February 29, 2024.

For the year ended

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Return on Average Assets (a) - as reported

Settlement, FHLB and contribution expenses, and insurance reimbursement income, net of income tax effect

Loss on sale of AFS securities, accelerated depreciation and lease termination expenses, net of income tax effect

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

Return on Average Equity (a) - as reported

Settlement, FHLB and contribution expenses, and insurance reimbursement income, net of income tax effect

Loss on sale of AFS securities, accelerated depreciation and lease termination expenses, net of income tax effect

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

(1) See reconciliation of this non-GAAP financial measure provided elsewhere herein associated with settlement, FHLB and contribution expenses, and insurance reimbursement incurred during 2021.

(in thousands, except for per share amount)

Net income - as reported

Settlement expense

Charitable contribution

Insurance reimbursement

Loss on sale of securities

Accelerated depreciation and lease termination expenses

Income tax effect of adjustment

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Basic earnings per share - as reported

Settlement expense

Charitable contribution

Insurance reimbursement

Loss on sale of securities

Accelerated depreciation and lease termination expenses

Income tax effect of adjustment

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Diluted earnings per share - as reported

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CONSOLIDATED BALANCE SHEET REVIEW

Total assets at December 31, 2022 increased by $118.3 million since December 31, 2021.

During 2022, cash and interest-bearing deposits in other banks decreased by $41.4 million, the investment portfolio increased by $18.5 million and gross loans increased by $125.8 million.

Management made strategic decisions to deploy excess cash balances in 2022.

Cash was utilized to purchase a $73.3 million in securities in 2022.

OREO balances increased by $0.3 million due to foreclosure activity in 2022.

Other assets, including deferred taxes, premises and equipment, and accrued interest receivable, increased by $3.4 million.

Total assets at December 31, 2023 increased by $57.7 million, or 3.1%, when compared to December 31, 2022.

During the year, cash balances decreased by $24.6 million, investment securities decreased by $50.1 million and gross loans increased by $127.2 million.

In the first quarter of 2023, management made the strategic decision to obtain $61.1 million in brokered certificates of deposit and $80.0 million of FHLB borrowings to strengthen on-balance sheet liquidity in light of the disruption in the banking industry.

$30.0 million of the brokered deposits were repaid in September 2023 and during the third quarter, in anticipation of increasing rates, management pre-funded the $30.7 million of brokered deposits set to mature in the fourth quarter of 2023 at the same rate in order to maintain cash balances and control interest expense.

Investment in FHLB stock increased by $4.2 million during the year related to the borrowings obtained in the first quarter.

Other assets, including OREO, deferred taxes, premises and equipment, and accrued interest receivable, increased by $3.5 million.

Total liabilities increased by $47.6 million since December 31, 2022.

Non-interest bearing deposits increased by $5.0 million.

Interest bearing demand deposits increased by $99.5 million and traditional savings accounts increased by $14.1 million.

The increase in interest bearing demand deposits was attributable to an increase in municipality funding into a higher yielding indexed product.

Money market balances increased by $25.4 million.

Time deposits decreased by $42.7 million related to maturing balances moving to more liquid accounts, or broker investment accounts, due to the rising deposit rates as well as municipal funds moving to higher yielding State funding alternatives.

Total shareholders’ equity increased by $9.9 million during the year ended December 31, 2022, as net income of $25.0 million and the issuance of $0.7 million of new shares of common stock was offset by other comprehensive losses of $11.7 million and the payment of $4.2 million in dividends.

Total deposits decreased by $19.8 million during the year.

Interest-bearing demand deposits and money market accounts increased by $23.2 million and $20.5 million, respectively, due to a shift in the deposit portfolio mix from non-interest-bearing deposits to interest-bearing accounts including the ICS product to ensure full FDIC insurance coverage, where balances grew by approximately $104.0 million.

These increases were offset by decreases in non-interest-bearing deposits of $78.9 million and savings accounts of $59.5 million as we saw businesses and consumers utilizing cash due to the rising rate and inflationary environment.

Total certificates of deposit increased by $75.0 million primarily due to an increase of $30.0 million in brokered certificates of deposits and $45.0 million in retail certificates of deposit.

Short-term borrowings decreased by $19.1 million since December 31, 2022 primarily due to one municipal customer moving funds from an overnight investment product to a non-interest bearing deposit product in 2023 as well as regular fluctuations in municipal deposit balances.

Long-term borrowings increased by $80.0 million in 2023 when compared to December 31, 2022 due to the acquisition of $80.0 million in FHLB borrowings in the first quarter of 2023.

As indicated below, the total interest-earning asset mix remained relatively constant at December 31, 2023 as compared to December 31, 2022.

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Cash and cash equivalents

The year-end total liability mix has remained consistent during the two-year period as illustrated below.

The year-end total liability mix has remained relatively consistent during the two-year period as illustrated below.

Year End Percentage

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We have policies and procedures designed to mitigate credit risk and to maintain the quality of our loan portfolio.

These policies include underwriting standards for new credits as well as continuous monitoring and reporting policies for asset quality and the adequacy of the ALL.

These policies include underwriting standards for new credits as well as continuous monitoring and reporting policies for asset quality and the adequacy of the ACL.

These policies, coupled with ongoing training efforts, have provided effective checks and balances for the risk associated with the lending process.

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Installment loans are typically collateralized, with loan-to-value ratios which are established based on the financial condition of the borrower.

We also have made unsecured consumer loans to qualified

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borrowers meeting our underwriting standards.

We also have made unsecured consumer loans to qualified borrowers meeting our underwriting standards.

Additional information about our loans and underwriting policies can be found in Item 1 of Part I of this annual report under the heading “Banking Products and Services”.

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Residential mortgage

*Includes PPP loans of $0.4 million and $7.7 million at December 31, 2022 and December 31, 2021, respectively.

Outstanding loans of $1.3 billion at December 31, 2022 reflected an increase of $125.8 million during 2022.

Commercial and industrial loans increased by $64.4 million for the year, primarily in new floor plan business, new commercial clients and continued expansion of existing client relationships.

Residential mortgage loans increased $39.7 million related to management’s strategic decision to book new mortgage loans at higher rates to our in-house portfolio.

The consumer loan portfolio decreased by $5.3 million due to amortization and payoffs of the existing portfolio slightly offset by new production.

Commercial loan production for the year ended December 31, 2022 was approximately $374.2 million, with $53.3 million originated during the fourth quarter.

Outstanding loans of $1.4 billion at December 31, 2023 reflected growth of $127.2 million in 2023.

Growth in the commercial portfolios was driven by increased activity with existing clients as well as cultivating new business relationships.

Residential mortgage loans increased $55.5 million related to management’s strategic decision to book new mortgage loans at higher rates to our in-house portfolio during the first half of 2023.

The consumer loan portfolio increased slightly by $1.2 million.

New commercial loan production for the year ended December 31, 2023 was approximately $197.0 million.

The pipeline of commercial loans as of December 31, 2023 was approximately $22.0 million.

At December 31, 2023, unfunded, committed commercial construction loans totaled approximately $29.6 million.

Commercial amortization and payoffs were approximately $282.7 million through December 31, 2022.

Consumer mortgage loan production was approximately $91.8 million through December 31, 2022.

The pipeline of in-house, portfolio loans as of December 31, 2022, consisted of $7.5 million.

The residential mortgage production level slowed in the fourth quarter of 2022 due to the increasing interest rates that occurred in 2022.

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Commercial amortization and payoffs were approximately $434.4 million through December 31, 2023 due primarily to pay-offs of short-term commercial loans as well as normal amortizations of the commercial loan portfolio.

New residential mortgage loan production for year ended December 31, 2023 was approximately $96.6 million, with most of this production comprised of in-house loans.

The pipeline of in-house, portfolio loans as of December 31, 2023 was $7.0 million.

The residential mortgage production level declined in the fourth quarter of 2023 due to the increasing interest rates and seasonality of this line of business.

Unfunded commitments related to residential construction loans totaled $17.6 million on December 31, 2023.

Beginning in the second quarter of 2023, management began shifting more activity towards the secondary market.

The following table presents loans in our commercial real estate portfolio by industry type.

(in thousands)

Non-owner-occupied

Owner-occupied

Accommodations and food services

Administration and support, waste management, and remediation services

Agriculture, forestry, fishing and hunting

Arts, entertainment and recreation

Educational services

Finance and insurance

Health care and social assistance

Management of companies and enterprises

Manufacturing

Other services (except public services)

Professional, scientific and technical services

Public administration

Commercial rental properties

Residential rental properties

Student rental properties

Mixed use rental properties

Storage units

Real estate rental and leasing- other

Transportation and warehousing

Wholesale trade

Our loan portfolio does not consist of any loans secured by office buildings located in major metropolitan areas or that are over four stories or any retail properties rented to major big box retail tenants.

The following table sets forth the maturities, based upon contractual dates, for selected loan categories as of December 31, 2023:

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Residential mortgage

* Commercial and Industrial includes $0.4 million of PPP balances at December 31, 2022

Management monitors the performance and credit quality of the loan portfolio by analyzing the age of the portfolio as determined by the length of time a required payment is past due.

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For all loan segments, the accrual of interest is discontinued when principal or interest is delinquent for 90 days or more unless the loan is well-secured and in the process of collection.

All non-accrual loans are considered to be impaired.

Interest payments received on non-accrual loans are applied as a reduction of the loan principal balance.

Loans are returned to accrual status when all principal and interest amounts contractually due are brought current and future payments are reasonably assured.

Our policy for recognizing interest income on impaired loans does not differ from our overall policy for interest recognition.

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The following sets forth the amounts of non-accrual, past-due and restructured loans for the past two years:

The following sets forth the amounts of non-accrual, past-due and modified loans for the past two years:

Risk Elements of Loan Portfolio

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Acquisition and development

Commercial and industrial

Residential mortgage

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Total non-accrual and past due 90 days or more

Restructured Loans (TDRs):

Modified Loans:

Non-accrual (included above)

Total modified loans

Other Real Estate Owned

Total Non-performing assets

Impaired loans without a valuation allowance

Impaired loans with a valuation allowance

Total impaired loans

Valuation allowance related to impaired loans

Individually evaluated loans without a valuation allowance

Individually evaluated loans with a valuation allowance

Total individually evaluated loans

Non-accrual loans to total loans (as %)

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Non-performing assets to total assets (as %)

Allowance for loan losses to non-accrual loans (as %)

Allowance for loan losses to non-performing assets (as %)

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Allowance for credit losses to non-accrual loans (as %)

Allowance for credit losses to non-performing assets (as %)

The following table sets forth the percent applicable by portfolio for non-accrual loans for the past two years:

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During 2023, we recognized, on a cash basis, $0.3 million of interest income on non-accrual loans that paid off.

Performing loans considered to be impaired (including performing troubled debt restructurings, or TDRs), as defined and identified by management, amounted to $3.0 million at December 31, 2022 and $3.3 million at December 31, 2021.

Loans are identified as impaired when, based on current information and events, management determines that we will be unable to collect all amounts due according to contractual terms.

These loans consist primarily of acquisition and development loans and CRE loans.

The fair values are generally determined based upon independent third-party appraisals of the collateral or discounted cash flows based upon the expected proceeds.

Specific allocations have been made where there is insufficient collateral to repay the loan balance if liquidated and there is no secondary source of repayment available.

The level of performing impaired loans (other than performing TDRs) decreased by $0.3 million during the year ended December 31, 2022.

The decrease in allowance for loan losses as a percentage of non-accrual loans was related to the increase in non-accrual loans in 2022 compared to 2021.

A troubled debt restructuring is the restructuring of a loan in which one or more concessions are granted to a borrower who is experiencing financial difficulties.

A loan will be classified as a TDR if the Bank restructures the loan’s terms (i.e., interest rate, payment amount, amortization period and/or maturity date) after determining that the borrower is experiencing financial difficulties.

A modified loan is considered to be a TDR when the Bank has determined that the borrower is experiencing financial difficulties.

The Bank evaluates the probability that the borrower will be in payment default on any of its debt in the foreseeable future without modification.

To make this determination, the Bank performs a global financial review of the borrower and loan guarantors to assess their current ability to meet their financial obligations.

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The following table presents the details of TDRs by loan class at December 31, 2022 and December 31, 2021:

December 31, 2022

December 31, 2021

(Dollars in thousands)

Commercial real estate

Non owner-occupied

All other CRE

Acquisition and development

1-4 family residential construction

All other A&D

Commercial and industrial

Residential mortgage

Residential mortgage – term

Residential mortgage – home equity

Total performing

Commercial real estate

Non owner-occupied

All other CRE

Acquisition and development

1-4 family residential construction

All other A&D

Commercial and industrial

Residential mortgage

Residential mortgage – term

Residential mortgage – home equity

Total non-accrual

The level of TDRs decreased by $0.3 million during the year ended December 31, 2022.

There were no new loans added to TDRs and one loan already in performing TDRs was re-modified.

Net principal payments totaling $0.3 million were received during the same time period.

At December 31, 2022, there were no additional funds committed to be advanced in connection with TDRs.

In 2022, interest income not recognized due to rate modifications of TDRs was $55 thousand and interest income recognized on all TDRs was $0.2 million.

Allowance for Loan Losses

The ALL is maintained to absorb probable incurred credit losses from the loan portfolio.

The ALL is based on management’s continuing evaluation of the quality of the loan portfolio, assessment of current economic conditions, diversification and size of the portfolio, adequacy of collateral, past and anticipated loss experience, and the amount of non-performing loans.

The ALL is also based on estimates, and actual losses will vary from current estimates.

These estimates are reviewed quarterly, and as adjustments, either positive or negative, become necessary, a corresponding increase or decrease is made in the ALL.

The methodology used to determine the adequacy of the ALL is consistent with prior years.

An estimate for probable losses related to unfunded lending commitments, such as letters of credit and binding but unfunded loan commitments is also prepared.

This estimate is computed in a manner similar to the methodology described above, adjusted for the probability of actually funding the commitment.

At December 31, 2022 and 2021, the balance for reserve

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for probable losses on unfunded commitments, included in other liabilities in the consolidated statements of financial condition was $0.1 million.

The ALL was $14.6 million at December 31, 2022 compared to $16.0 million at December 31, 2021, a decrease of 8.3% that resulted primarily from improvements in unemployment rates and a decline in total delinquencies.

Net charge-offs of $0.7 million were recorded for 2022, compared to net recoveries of $0.3 million for 2021.

The ratio of the ALL to loans outstanding was 1.14% at December 31, 2022 compared to 1.38% at December 31, 2021.

The ratio of net charge-offs to average loans for the year ended December 31, 2022 was an annualized 0.06%, compared to net recoveries to average loans of 0.02% for the year ended December 31, 2021.

The increase in net charge-offs was primarily related to increased charge-offs in our consumer loan portfolio.

Effective January 1, 2023, the Corporation adopted the accounting guidance in ASU 2022-02, which eliminated the recognition and measurement of TDRs.

Due to the removal of the TDR designation, the Corporation evaluates all loan restructurings according to the accounting guidance for loan modifications to determine if the restructuring results in a new loan or a continuation of the existing loan.

Loan modifications to borrowers experiencing financial difficulty that result in a direct change in the timing or amount of contractual cash flows include situations where there is principal forgiveness, interest rate reductions, other-than-insignificant payment delays, term extensions, and combinations of the above.

Therefore, the disclosures related to loan restructurings are only for modifications that directly affect cash flows.

A loan that is considered a non-accrual or modified loan may be subject to the individually evaluated loan analysis if the commitment is $0.1 million or greater;

otherwise, the modified loan remains in the appropriate segment in the ACL model and associated reserves are adjusted based on changes in the discounted cash flows resulting from the modification of the modified loan.

For a discussion with respect to reserve calculations regarding individually evaluated loans, refer to the “Nonrecurring Loans” section in Note 19, Fair Value Measurements.

There were no loan modifications made to borrowers facing financial difficulties in the year ending December 31, 2023.

Allowance for Credit Losses

Effective January 1, 2023, we adopted Accounting Standards Update (“ASU”) No.

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

Measurement of Credit Losses on Financial Instruments , universally referred to as CECL.

In connection with our adoption of ASU 2016-13, we made changes to our loan portfolio segments to align with the methodology of CECL.

Refer to Note 5, Loans and Related Allowance for Credit Losses, for further discussion of these portfolio segments.

The adoption of ASU 2016-13 resulted in a Day 1 adjustment of $2.9 million to our ACL, including an increase of $2.0 million to the ACL for loans and $0.9 million to the ACL for unfunded commitments.

The Corporation recorded a net decrease to retained earnings of $2.2 million as of January 1, 2023 for the cumulative effect of adopting ASU 2016-13.

The ACL is measured and recorded upon the initial recognition of a financial asset.

Determination of an appropriate ACL is inherently complex and requires the use of highly subjective estimates.

The reasonableness of the ACL is reviewed quarterly by management.

Management believes it uses relevant information available to make determination about the ACL and that it has established the existing allowance in accordance with GAAP.

However, the determination of the ACL requires significant judgment, and estimates of expected credit losses in the loan portfolio can vary from the amounts actually observed.

The ACL “base case” model is derived from various economic forecasts provided by widely recognized sources.

Management evaluates the variability of market conditions by examining the peak and trough of economic cycles.

These peaks and troughs are used to stress the base case model to develop a range of potential outcomes.

Management then determines the appropriate reserve through an evaluation of these various outcomes relative to current economic conditions and known risks in the portfolio.

Management enhances its calculation with the use of Moody’s economic forecast data to provide additional support to substantiate its ACL.

The ACL was $17.5 million at December 31, 2023 compared to an allowance for loan loss (“ALL”) of $14.6 million at December 31, 2022.

The provision for credit losses was $1.6 million for the year ended December 31, 2023, compared to a credit to provision of $0.6 million for the year ended December 31, 2022.

The provision expense recorded in 2023 was primarily related to strong loan growth and increases in qualitative risk factors related to the uncertainty of the economy, inflation levels, and rising interest rates, which was partially offset by the reduction of historical loss factors related to the strength of our overall portfolio.

Net charge-offs of $0.9 million were recorded for the year ended December 31, 2023 and $0.7 million for the year ended December 31, 2022.

The ratio of the ACL to loans outstanding was 1.24% at December 30, 2023 and 1.14% at December 31, 2022.

The ratio of net charge-offs to average loans for the year ended December 31, 2023 was an annualized 0.07%, compared to of 0.06% for the year ended December 31, 2022.

The increase in net charge-offs was primarily related to increased charge-offs in our commercial loan portfolio.

Our special assets team continues to effectively collect on charged-off loans, resulting in ongoing overall low charge-off ratios.

Accruing loans past due 30 days or more decreased to 0.16%, compared to 0.31% at December 31, 2021.

Accruing loans past due 30 days or more increased to 0.24%, compared to 0.16% at December 31, 2022.

Non-accrual loans totaled $4.0 million at December 31, 2023 compared to $3.5 million at December 31, 2022.

The increase in non-accrual balances at December 31, 2022 was primarily related to one residential real estate loan of $1.5 million added to non-accrual in 2022.

The increase in non-accrual balances at December 31, 2023 was primarily related to two commercial real estate loans with a combined balance of $0.8 million added to non-accrual in 2023.

This was partially offset by reductions in principal balance of existing non-accrual loans.

The ALL at December 31, 2022 is adequate to provide for probable losses inherent in our loan portfolio.

The ACL at December 31, 2023 is adequate to provide for probable losses inherent in our loan portfolio.

Amounts that will be recorded for the provision for loan losses in future periods will depend upon trends in the loan balances, including the composition of the loan portfolio, changes in loan quality and loss experience trends, potential recoveries on previously charged-off loans and changes in other qualitative factors.

Management also applies interest rate risk, collateral value and debt service sensitivity analyses to the CRE loan portfolio and obtains new appraisals on specific loans under defined parameters to assist in the determination of the periodic provision for loan losses.

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The following table presents the activity in the ALL by major loan category for the past two years.

Analysis of Activity in the Allowance for Loan Losses

The following table presents a summary of the activity in the ACL and ALL by major loan category for the past two years.

Analysis of Activity in the Allowance for Credit/Loan Losses

For the Years Ended December 31,

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Balance, January 1

Impact of CECL Adoption

Commercial real estate

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Total recoveries

Net credit (losses)/recoveries

Credit for loan losses

Net credit losses

Provision/credit for credit/loan losses

Balance at end of period

Allowance for loan losses to total loans (as %)

Allowance for credit/loan losses to total loans (as %)

Net (Charge-offs)/Recoveries as a % of Average Applicable Portfolio

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Residential mortgage

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The following presents management’s allocation of the ALL by major loan category in comparison to that loan category’s percentage of total loans.

Changes in the allocation over time reflect changes in the composition of the loan portfolio risk profile and refinements to the methodology of determining the ALL.

The following presents management’s allocation of the ACL by major loan category in comparison to that loan category’s percentage of total loans.

Changes in the allocation over time reflect changes in the composition of the loan portfolio risk profile and refinements to the methodology of determining the ACL.

Specific allocations in any particular category may be reallocated in the future as needed to reflect current conditions.

Accordingly, the entire ALL is considered available to absorb losses in any category.

Allocation of the Allowance for Loan Losses

Accordingly, the entire ACL is considered available to absorb losses in any category.

Allocation of the Allowance for Credit/Loan Losses

For the Years Ended December 31,

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Total held to maturity

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The fair value of investment securities available for sale decreased by $160.9 million since December 31, 2021 due to the transfer of investments from available for sale to held to maturity in the first quarter 2022.

At December 31, 2022, the securities classified as available for sale included a net unrealized loss of $24.0 million, which represents the difference between the fair value and the amortized cost of securities in the portfolio

Total AFS and HTM securities totaled $311.5 million at December 31, 2023, representing a $50.1 million decrease compared to December 31, 2022.

In the third quarter of 2023, management elected to redeem $17.8 million from a non-rated municipal TIF bond at par.

During December of 2023, management made a strategic decision to restructure the balance sheet by selling AFS investment securities totaling $20.4 million with a book value of $24.6 million, resulting in an after-tax loss of $3.2 million.

The securities had a weighted average book yield of approximately 1.3% and a weighted average life of approximately 6.65 years.

Additional decreases in the investment portfolio were primarily related to normal principal amortization.

Proceeds from sales and principal amortization during 2023 were used primarily to enhance on-balance sheet liquidity and to fund loan growth throughout the year.

The Corporation reassessed the classification of certain investments and, effective February 1, 2022, the Corporation transferred $139.0 million of callable agencies, obligation of state and political subdivisions, and collateralized mortgage obligations from available for sale to held to maturity securities.

The transferred occurred at fair value.

The transfer occurred at fair value.

The related unrealized loss of $8.4 million included in other comprehensive loss remained in other comprehensive loss, to be amortized out of other comprehensive loss with an offsetting entry to interest income as a yield adjustment over the remaining term of the securities.

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The $4.0 million in net unrealized losses associated with the CDO portfolio relates to nine pooled trust preferred securities that comprise the CDO portfolio.

Net unrealized losses of $1.7 million represent non-credit related other than temporary impairment (“OTTI”) charges on seven of the securities while $1.1 million of unrealized losses relates to two securities which have had no credit related OTTI.

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The following table sets forth the contractual or estimated maturities of the components of our investment securities portfolio as of December 31, 2023 and the weighted average yields on a tax-equivalent basis.

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The weighted average yield was calculated using historical cost balances and does not give effect to changes in fair value.

The negative weighted average yield was due to increased paydowns on mortgage-backed securities that impacted their factors and three month conditional prepayment rate.

At December 31, 2022, one Tax Increment Funding bond totaling $17.7 million exceeded 10% of shareholders’ equity.

The following table sets forth the deposit balances by major category for 2023 and 2022:

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Savings deposits

Time deposits

Time deposits - retail

Time deposits - brokered

Total Deposits

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Total deposits at December 31, 2022 increased by $101.4 million when compared to deposits at December 31, 2021.

Non-interest-bearing deposits increased by $5.0 million.

Interest bearing demand deposits increased by $99.5 million and traditional savings accounts increased by $14.1 million.

The increase in interest bearing demand deposits was attributable to an increase in municipality funding into a higher yielding indexed product.

Money market balances increased by $25.4 million.

Total deposits at December 31, 2023 decreased by $19.8 million when compared to December 31, 2022.

In March 2023, the Corporation obtained $61.1 million in new brokered deposits.

In August 2023, the Corporation obtained $30.0 million of brokered deposits to pre-fund the maturity of a $30.4 million brokered certificate of deposit that matured in September 2023.

In December 2023, $30.6 million in brokered deposits matured and were repaid.

In addition, retail certificates of deposit increased by $45.0 million due primarily to a promotional nine-month certificate of deposit product offered in 2023.

The following table summarizes the percentage of deposits that are insured by deposit insurance or otherwise fully collateralized by securities compared to uninsured deposits as of December 31, 2023 and December 31, 2022.

December 31, 2023

December 31, 2022

(in thousands)

Insured deposits

Uninsured but collateralized deposits

Uninsured and uncollateralized deposits

The following table summarizes the percentage of deposit balances from retail customers compared to business customers as of December 31, 2023 and December 31, 2022.

December 31, 2023

December 31, 2022

(in thousands)

Retail deposits

Business deposits

Borrowed Funds

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Total short-term borrowings

Long-term FHLB advances

Junior subordinated debentures

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The following is a summary of short-term borrowings at December 31 with original maturities of less than one year:

(Dollars in thousands)

(in thousands)

Securities sold under agreements to repurchase:

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Approximate weighted average rate during the year

Total borrowings increased by $6.9 million, or 7.7%, in 2022 when compared to 2021 due to increased balances in our existing accounts in our Treasury Management product.

Short-term borrowings decreased by $19.1 million when compared to December 31, 2022.

The decrease from December 31, 2022 was primarily related to one large municipal customer moving approximately $12.0 million in funds from an overnight investment sweep prodduct to a non-interest-bearing deposit product as well as regular fluctuations in other municipal customer balances.

Long-term boorowings increased by $80.0 million in 2023 due to the acquisition of $80.0 million in FHLB borrowings in the first quarter of 2023.

Management will continue to closely monitor interest rates within the context of its overall asset-liability management process.

See the discussion under the heading “Interest Rate Sensitivity” in this Item 7 for further information on this topic.

At December 31, 2022, we had additional borrowing capacity with the FHLB totaling $195.3 million, an additional $140.0 million of unused lines of credit with various financial institutions, and $9.6 million of an unused secured line of credit with the Federal Reserve Bank.

At December 31, 2023, we had additional borrowing capacity with the FHLB totaling $145.4 million, an additional $140.0 million of unused lines of credit with various financial institutions, and $12.2 million of an unused secured line of credit with the Federal Reserve Discount Window.

Additionally, we had $69.5 million available through the Federal Reserve’s BTFP.

See Note 10 to the Consolidated Financial Statements presented elsewhere in this annual report for further details about our borrowings and additional borrowing capacity, which is incorporated herein by reference.

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The credit risks inherent in loan commitments and letters of credit are essentially the same as those involved in extending loans to customers, and these arrangements are subject to our normal credit policies.

We use the same credit policies in making commitments and conditional obligations as we do for on-balance sheet instruments.

We generally require collateral or other security to support the financial

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instruments with credit risk.

We use the same credit policies in making commitments and conditional obligations

as we do for on-balance sheet instruments.

We generally require collateral or other security to support the financial instruments with credit risk.

The amount of collateral or other security is determined based on management’s credit evaluation of the counterparty.

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At December 31, 2023, the Bank had $140.0 million available through unsecured lines of credit with correspondent banks, $12.2 million available through a secured line of credit with the Federal Reserve Discount Window and approximately $145.4 million available through the FHLB.

Additionally, we had $69.5 million available through the Federal Reserve’s BTFP.

Management is not aware of any demands, commitments, events or uncertainties that are likely to materially affect our ability to meet our future capital requirements.

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The total risk-based capital ratios of the Corporation and the Bank at December 31, 2022 were 16.12% and 14.37%, respectively.

The decrease at the Bank was primarily due to dividend funding to the Corporation.

At December 31, 2023, the most recent notification from the regulators categorizes the Corporation and the Bank as “well capitalized” under the regulatory framework for prompt corrective action.

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It is our policy to manage our affairs so that liquidity needs are fully satisfied through normal Bank operations.

That is, the Bank will manage its liquidity to minimize the need to make unplanned sales of assets or to borrow funds

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under emergency conditions.

That is, the Bank will manage its liquidity to minimize the need to make unplanned sales of assets or to borrow funds under emergency conditions.

The Bank will use funding sources where the interest cost is relatively insensitive to market changes in the short run (periods of one year or less) to satisfy operating cash needs.

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Cash and various securities may also be pledged as collateral.

● Secured line of credit with the Federal Reserve Discount Window for use in borrowing funds up to 90 days, using municipal securities as collateral.

● Secured line of credit with the Federal Reserve Discount Window for use in borrowing funds up to 90 days, using municipal and corporate securities as collateral.

● Brokered deposits, including CDs and money market funds, provide a method to generate deposits quickly.

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● One Way Buy CDARS/ICS funding – a form of brokered deposits that has become a viable supplement to brokered deposits obtained directly.

● Secured line of credit with the FRB BTFP for use in borrowing funds up to 365 days using US government agency bonds as collateral.

The following table presents sources of liquidity available to the Corporation as of December 31, 2023.

(in thousands)

Total Availability

Net Availability

Internal Sources

Unpledged securities

External Sources

Federal Reserve (discount window)

Correspondent unsecured lines of credit

Bank Term Funding Program*

*Bank Term Funding Program has been established and eligible securities with a total par balance of $69.5 million have been pledged to the program as of December 31, 2023.

In January 2024, the Company borrowed $40.0 million from the Bank Term Funding Program to enhance on-balance sheet liquidity.

We have adequate liquidity available to respond to current and anticipated liquidity demands and is not aware of any trends or demands, commitments, events or uncertainties that are likely to materially affect our ability to maintain liquidity at satisfactory levels.

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Many factors, including economic and financial conditions, movements in interest rates and consumer preferences affect the difference between the interest earned on our assets and the interest paid on our liabilities.

Interest rate sensitivity refers to the degree that earnings will be impacted by changes in the prevailing level of interest rates.

Interest rate sensitivity refers to the degree that earnings will

be impacted by changes in the prevailing level of interest rates.

Interest rate risk arises from mismatches in the repricing or maturity characteristics between interest-bearing assets and liabilities.

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● Establish interest rate risk exposure limits for fluctuation in net interest income (“NII”), net income and economic value of equity.

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In order to manage interest sensitivity risk, management formulates guidelines regarding asset generation and pricing, funding sources and pricing, and off-balance sheet commitments.

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Based on the simulation analysis performed at December 31, 2023 and 2022, management estimated the following changes in net interest income, assuming the indicated rate changes:

(Dollars in thousands)

(in thousands)

+400 basis points

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-300 basis points

-400 basis points

This estimate is based on assumptions that may be affected by unforeseeable changes in the general interest rate environment and any number of unforeseeable factors.

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The concept of purchasing power is not an adequate indicator of the impact of inflation on financial institutions because it does not incorporate changes in our earnings.

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QUANTITATIVE AND QUALITATIVE DISCLOSURES ABOUT MARKET RISK

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See Item 7 of Part II of this report under the heading “Market Risk and Interest Sensitivity” for a discussion of the Corporation’s primary market risk.

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

What changed 10-K

Item 7. Management’s Discussion and Analysis