GERMAN AMERICAN BANCORP, INC. 10-Q

Item 2. Management’s Discussion and Analysis of Financial Condition and Results of Operations GERMAN AMERICAN BANCORP, INC. MANAGEMENT’S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS OF OPERATIONS German American Bancorp, Inc. is a Nasdaq-traded (symbol: GABC) financial holding company based in Jasper, Indiana. German American, through its banking subsidiary German American Bank, operates 73 banking offices in 20 contiguous southern Indiana counties and eight Kentucky counties. The Company also owns an investment brokerage subsidiary (German American Investment Services, Inc.) and a full line property and casualty insurance agency (German American Insurance, Inc.). Throughout this Management’s Discussion and Analysis, as elsewhere in this Report, when we use the term “Company,” we will usually be referring to the business and affairs (financial and otherwise) of German American Bancorp, Inc. and its subsidiaries and affiliates as a whole. Occasionally, we will refer to the term “parent company” or “holding company” when we mean to refer to only German American Bancorp, Inc. This section presents an analysis of the consolidated financial condition of the Company as of June 30, 2020 and December 31, 2019 and the consolidated results of operations for the three and six months ended June 30, 2020 and 2019. This discussion should be read in conjunction with the consolidated financial statements and other financial data presented elsewhere herein and with the financial statements and other financial data, as well as the Management’s Discussion and Analysis of Financial Condition and Results of Operations, included in the Company’s Annual Report on Form 10-K for the year ended December 31, 2019. SIGNIFICANT BUSINESS DEVELOPMENTS RELATING TO COVID-19 Impact of COVID-19 On January 30, 2020, the World Health Organization (“WHO”) announced that the outbreak of the novel coronavirus disease 2019 (COVID-19) constituted a public health emergency of international concern. On March 11, 2020, WHO declared COVID-19 to be a global pandemic and, on March 13, 2020, the President of the United States declared the COVID-19 outbreak a national emergency. The health concerns relating to the COVID-19 outbreak and related governmental actions taken to reduce the spread of the virus have significantly impacted the global economy (including the states and local economies in which we operate), disrupted supply chains, lowered equity market valuations, and created significant volatility and disruption in financial markets. The outbreak has resulted in authorities implementing numerous measures to try to contain the virus, such as travel bans and restrictions, quarantines, shelter in place or total lock-down orders and business limitations and shutdowns. Such measures have significantly contributed to rising unemployment and negatively impacted consumer and business spending. While many states have lifted quarantine and lock-down orders on a limited basis and with certain social distancing restrictions, commercial activity has not yet returned to the levels existing prior to the pandemic outbreak. A s a result, the demand for the Company’s products and services has been, and will continue to be, significantly impacted. Interest Rates On March 3, 2020, the Federal Open Market Committee reduced the target federal funds rate by 50 basis points to 1.00% to 1.25%. This rate was further reduced to a target range of 0% to 0.25% on March 16, 2020. These reductions in interest rates and other effects of the COVID-19 outbreak are likely to negatively impact the Company’s net interest income and noninterest income. The CARES Act and the Paycheck Protection Program On March 27, 2020, the Coronavirus Aid, Relief and Economic Security Act (the “CARES Act”) was signed into law, providing an approximately $2 trillion stimulus package that includes direct payments to individual taxpayers, economic stimulus to significantly impacted industry sectors, emergency funding for hospitals and providers, small business loans, increased unemployment benefits, and a variety of tax incentives. For small businesses, eligible nonprofits and certain others, the CARES Act established a Paycheck Protection Program (“PPP”), which is administered by the Small Business Administration (“SBA”). On April 24, 2020, the Paycheck Protection Program and Health Care Enhancement Act was enacted. Among other things, this legislation amends the initial CARES Act program by raising the appropriation level for PPP loans from $349 billion to $670 billion. The PPP was further modified on June 5, 2020 with the adoption of the Paycheck Protection Program Flexibility Act (the “Flexibility Act”), which extended the maturity date for PPP loans from two years to five years for loans disbursed on or after the date of enactment of the Flexibility Act. For PPP loans disbursed prior to such enactment, the Flexibility Act permits the borrower and lender to mutually agree to extend the term of the 50 loan to five years. The vast majority of the Company's PPP loans have two-year maturities. PPP loans earn interest at a fixed rate of 1%. The Bank is actively participating in assisting its customers with applications for resources through the program. The Company anticipates that the majority of these loans will ultimately be forgiven by the SBA in accordance with the terms of the program. As of June 30, 2020, the Bank has committed approximately $349.5 million, on 2,998 loan relationships, under this program with processing fees estimated to total approximately $12.6 million ($12.0 million net of processing costs). Under the terms of the PPP program, the loans are fully guaranteed by the U.S. government. Paycheck Protection Program Liquidity Facility To provide liquidity to small business lenders and the broader credit markets, to help stabilize the financial system, and to provide economic relief to small businesses nationwide, the Board of Governors of the Federal Reserve System (the "FRB") authorized each of the Federal Reserve Banks to participate in the Paycheck Protection Program Liquidity Facility (the “PPPL Facility”), pursuant to the Federal Reserve Act. Under the PPPL Facility, each of the Federal Reserve Banks will extend non-recourse loans to eligible financial institutions such as the Bank to fund loans guaranteed by the SBA under the PPP. The Bank has until September 30, 2020 to access funds under the PPPL Facility, unless otherwise extended by the FRB and the Department of the Treasury. The Company is continuing to assess the PPPL Facility and whether it will utilize the facility as a source of liquidity for its PPP lending. Loan Modifications and Troubled Debt Restructurings On April 7, 2020, the FRB, the Office of the Comptroller of the Currency (the “OCC”), and the Federal Deposit Insurance Corporation (the “FDIC” and, together with the FRB and OCC, the “federal banking regulators”) issued a revised Interagency Statement on Loan Modifications and Reporting for Financial Institutions, which, among other things, encouraged financial institutions to work prudently with borrowers who are or may be unable to meet their contractual payment obligations because of the effects of COVID-19, and stated that institutions generally do not need to categorize COVID-19-related modifications as troubled debt restructurings and that the agencies will not direct supervised institutions to automatically categorize all COVID-19 related loan modifications as troubled debt restructurings. Similarly, under the CARES Act, provisions were included that allow for loan modifications to not be classified as TDRs if certain criteria are met. In response to requests from borrowers who have experienced pandemic-related business or personal cash flow interruptions, and in accordance with the recently issued regulatory guidance, the Company has made short-term loan modifications involving both interest-only and full payment deferrals. As of June 30, 2020 the following payment modifications have been made: Type of Loans Number of Loans Loan Balance % of Loan Type (excludes PPP Loans) (dollars in thousands) Commercial & Industrial Loans 257 $ 54,300 10.8 % Commercial Real Estate Loans 392 224,664 15.3 % Agricultural Loans 8 1,175 0.3 % Consumer Loans 80 1,115 0.4 % Residential Mortgage Loans 110 23,103 8.2 % Total 847 $ 304,357 10.4 % To date, the Company has not experienced significant customer requests for additional loan modifications, within the commercial and industrial loan and commercial real estate loan portfolios, after the initial short-term modifications granted for those customers during the second quarter of 2020. Lending Exposure to Potentially Impacted Industry Segments The Company tracks lending exposure by industry classification to determine potential risk associated with industry concentrations, if any, that could lead to additional credit loss exposure. As a result of the COVID-19 pandemic, the Company has initially identified loan segments that could represent a potentially higher level of credit risk, as many of these customers may have incurred a significant negative impact to their businesses as a result of governmental stay-at-home orders and travel restrictions. At June 30, 2020, the Company had the following exposure to these potentially sensitive COVID-19 identified loan segments: 51 Industry Segment Number of Loans Outstanding Balance % of Total Loans (dollars in thousands) Lodging / Hotels 51 $ 130,112 4.0 % Student Housing 107 94,226 2.9 % Retail Shopping / Strip Centers 61 93,172 2.9 % Restaurants 190 50,724 1.6 % Regulatory Capital Current Expected Credit Loss (CECL) Model . As part of the CARES Act, banking organizations are permitted to temporarily defer implementation of Accounting Standards Update (“ASU”) No. 2016-13, Financial Instruments - Credit Losses (Topic 326) . As discussed under Note 2 (Recent Accounting Pronouncement) in the Notes to the Consolidated Financial Statements in Item 1 of this Report, ASU 2016-13 provides for the replacement of the incurred loss model for recording the allowance for credit losses with an expected loss model, which is referred to as the current expected credit loss (“CECL”) model. However, in an action related to the CARES Act, federal banking regulators issued, on March 27, 2020, an interim final rule that allows banking organizations to mitigate the effects of the CECL accounting standard on their regulatory capital. Banking organizations that are required under GAAP to adopt CECL, and do not elect to defer adoption under the CARES Act during 2020, can elect to mitigate the estimated cumulative regulatory capital effects of CECL for up to two years. This two-year delay is in addition to the three-year transition period that federal banking regulators had already made available. The Company has elected to adopt the option provided by the interim final rule, which will largely delay the effects of CECL on its regulatory capital through December 31, 2021. Beginning on January 1, 2022, we will be required to phase in 25% of the previously deferred estimated capital impact of CECL, with an additional 25% to be phased in at the beginning of each subsequent year until fully phased in by January 1, 2025. Under the interim final rule, the amount of adjustments to regulatory capital that can be deferred until the phase-in period includes both the initial impact of our adoption of CECL at January 1, 2020 and 25% of subsequent changes in our allowance for credit losses during each quarter of the two-year period ended December 31, 2021. Community Bank Leverage Ratio . On April 6, 2020, federal banking regulators issued two interim final rules that make changes to the community bank leverage ratio (“CBLR”) framework and implementing certain directives of the CARES Act. Under the existing CBLR framework, which became effective as of January 1, 2020, community banks and holding companies (which would include the Bank and the Company) that satisfy certain qualifying criteria, including having less than $10 billion in average total consolidated assets and a leverage ratio (referred to as the “community bank leverage ratio”) of greater than 9%, were eligible to opt-in to the CBLR framework. The community bank leverage ratio is the ratio of a banking organization’s Tier 1 capital to its average total consolidated assets, both as reported on the banking organization’s applicable regulatory filings. The first of the April 2020 interim final rules provides that, as of the second quarter 2020, banking organizations with leverage ratios of 8% or greater (and that meet the other existing qualifying criteria) may elect to use the CBLR framework. It also establishes a two-quarter grace period for qualifying community banking organizations whose leverage ratios fall below the 8% CBLR requirement, so long as the banking organization maintains a leverage ratio of 7% or greater. The second interim final rule provides a transition from the temporary 8% CBLR requirement to a 9% CBLR requirement. It establishes a minimum CBLR of 8% for the second through fourth quarters of 2020, 8.5% for 2021, and 9% thereafter, and maintains a two-quarter grace period for qualifying community banking organizations whose leverage ratios fall no more than 100 basis points below the applicable CBLR requirement. Notwithstanding these changes, the Company intends to continue with the existing layered ratio structure. Under either framework, the Company and the Bank would be considered well-capitalized under the applicable guidelines. PPP Loans and PPPL Facility . On April 9, 2020, federal banking regulators issued an interim final rule to modify the Basel III regulatory capital rules applicable to banking organizations to allow those organizations participating in the PPP to neutralize the regulatory capital effects of participating in the program. Specifically, the agencies have clarified that banking organizations, including the Company and the Bank, are permitted to assign a zero percent risk weight to PPP loans for purposes of determining risk-weighted assets and risk-based capital ratios. Additionally, in order to facilitate use of the PPPL Facility, the agencies further clarified that, for purposes of determining leverage ratios, a banking organization is permitted to exclude from total average assets PPP loans that have been pledged as collateral for a PPPL Facility. 52 MANAGEMENT OVERVIEW This updated discussion should be read in conjunction with the Management Overview that was included in our Management’s Discussion and Analysis of Financial Condition and Results of Operations in the Company’s Annual Report on Form 10-K for the year ended December 31, 2019. Net income for the quarter ended June 30, 2020 totaled $14,255,000, or $0.54 per share, a decline of 11% on a per share basis compared with the second quarter 2019 net income of $15,271,000, or $0.61 per share. Net income for the six months ended June 30, 2020 totaled $26,727,000, or $1.01 per share, a decline of 17% on a per share basis compared with the first half of 2019 net income of $30,338,000, or $1.21 per share. The decline in net income and earnings per share during the second quarter of 2020 and first six months of 2020 was largely attributable to an increased level of provision for credit losses related to economic uncertainties and stress related to the COVID-19 pandemic. The Company adopted ASU No. 2016-13, Financial Instruments - Credit Losses (Topic 326) ("CECL") on January 1, 2020. As a result, the Company recognized a one-time cumulative adjustment to the allowance for credit losses of $15.7 million. The increase was primarily related to the Company's acquired loan portfolio which totaled approximately $851.1 million at the time of adoption. On July 1, 2019, the Company completed the acquisition of Citizens First Corporation (“Citizens First”) through the merger of Citizens First with and into the Company. Immediately following completion of the Citizens First holding company merger, Citizens First's subsidiary bank, Citizen First Bank, Inc., was merged with and into the Company’s subsidiary bank, German American Bank. Citizens First, headquartered in Bowling Green, Kentucky operated eight retail banking offices through Citizens First Bank, Inc. in Barren, Hart, Simpson and Warren Counties in Kentucky. As of the closing of the transaction, Citizens First had total assets of approximately $456.0 million, total loans of approximately $364.6 million, and total deposits of approximately $370.8 million. The Company issued approximately 1.7 million shares of its common stock, and paid approximately $15.5 million in cash, in exchange for all of the issued and outstanding shares of common stock of Citizens First. CRITICAL ACCOUNTING POLICIES AND ESTIMATES The financial condition and results of operations for the Company presented in the Consolidated Financial Statements, accompanying Notes to the Consolidated Financial Statements, and selected financial data appearing elsewhere within this Report, are, to a large degree, dependent upon the Company’s accounting policies. The selection of and application of these policies involve estimates, judgments, and uncertainties that are subject to change. The critical accounting policies and estimates that the Company has determined to be the most susceptible to change in the near term relate to the determination of the allowance for credit losses, the valuation of securities available for sale, income tax expense, and the valuation of goodwill and other intangible assets. Allowance for Credit Losses The Company maintains an allowance for credit losses to cover the estimated expected credit losses over the expected contractual life of the loan portfolio. Loan losses are charged against the allowance when management believes the uncollectibility of a loan balance is confirmed. Subsequent recoveries, if any, are credited to the allowance. Allocations of the allowance may be made for specific loans, but the entire allowance is available for any loan that, in management’s judgment, should be charged-off. A provision for credit losses is charged to operations based on management’s periodic evaluation of the necessary allowance balance. Evaluations are conducted at least quarterly and more often if deemed necessary. The ultimate recovery of all loans is susceptible to future market factors beyond the Company’s control. The Company has an established process to determine the adequacy of the allowance for credit losses. The determination of the allowance is inherently subjective, as it requires significant estimates, including the amounts and timing of expected future cash flows on individually analyzed loans, estimated losses on other classified loans and pools of homogeneous loans, and consideration of past loan loss experience, the nature and volume of the portfolio, information about specific borrower situations and estimated collateral values, economic conditions, reasonable and supportable forecasts and other factors, all of which may be susceptible to significant change. The allowance consists of two components of allocations, specific and general. These two components represent the total allowance for credit losses deemed adequate to cover expected credit losses over the expected life of the loan portfolio. Commercial and agricultural loans are subject to a standardized grading process administered by an internal loan review function. The need for specific reserves is considered for credits when: (a) the customer’s cash flow or net worth appears insufficient to repay the loan; (b) the loan has been criticized in a regulatory examination; (c) the loan is on non-accrual; or (d) other reasons where the ultimate collectability of the loan is in question, or the loan characteristics require special monitoring. 53 Specific reserves on individually analyzed loans are determined by comparing the loan balance to the present value of expected cash flows or expected collateral proceeds. Allocations are also applied to categories of loans not individually analyzed but for which the rate of loss is expected to be greater than other similar type loans, including non-performing consumer or residential real estate loans. Such allocations are based on past loss experience, reasonable and supportable forecasts and information about specific borrower situations and estimated collateral values. General allocations are made for commercial and agricultural loans that are graded as substandard and special mention, but are not individually analyzed for specific reserves as well as other pools of loans, including non-classified loans, homogeneous portfolios of consumer and residential real estate loans, and loans within certain industry categories believed to present unique risk of loss. General allocations of the allowance are primarily made based on historical averages for loan losses for these portfolios along with reasonable and supportable forecasts, judgmentally adjusted for economic, external and internal quantitative and qualitative factors and portfolio trends. Economic factors include evaluating changes in international, national, regional and local economic and business conditions that affect the collectability of the loan portfolio. Internal factors include evaluating changes in lending policies and procedures; changes in the nature and volume of the loan portfolio; and changes in experience, ability and depth of lending management and staff. The allowance for credit losses for loans represents management’s estimate of all expected credit losses over the expected contractual life of the loan portfolio. Determining the appropriateness and adequacy of the allowance is complex and requires judgment by management about the effect of matters that are inherently uncertain. Subsequent evaluations of the loan portfolio may result in significant changes in the allowance for credit losses in future periods. Securities Valuation Available-for-sale debt securities in unrealized loss positions are evaluated for impairment related to credit losses at least quarterly. For available-for-sale debt securities in an unrealized loss position, the Company assesses whether we intend to sell, or it is more likely than not that we will be required to sell the security before recovery of its amortized cost basis. If either of the criteria regarding intent or requirement to sell is met, the security’s amortized cost basis is written down to fair value through income. For available-for sale debt securities that do not meet the criteria, the Company evaluates whether the decline in fair value has resulted from credit losses or other factors. In making this assessment, management considers the extent to which fair value is less than amortized cost, any changes to the rating of the security by a rating agency, and adverse conditions specifically related to the security and the issuer, among other factors. If this assessment indicates that a credit loss exists, the Company compares the present value of cash flows expected to be collected from the security with the amortized cost basis of the security. If the present value of cash flows expected to be collected is less than the amortized cost basis for the security, a credit loss exists and an allowance for credit losses is recorded, limited to the amount that the fair value of the security is less than its amortized cost basis. Any impairment that has not been recorded through an allowance for credit losses is recognized in other comprehensive income, net of applicable taxes. No allowance for credit losses for available-for-sale debt securities was needed at June 30, 2020. Accrued interest receivable on available-for-sale debt securities is excluded from the estimate of credit losses. As of June 30, 2020, gross unrealized gains on the securities available-for-sale portfolio totaled approximately $40,506,000 and gross unrealized losses totaled approximately $126,000 net of applicable taxes is included in other comprehensive income. Equity securities that do not have readily determinable fair values are carried at cost, less impairment with observable price changes being recognized in earnings. Income Tax Expense Income tax expense involves estimates related to the valuation allowance on deferred tax assets and loss contingencies related to exposure from tax examinations presumed to occur. A valuation allowance reduces deferred tax assets to the amount management believes is more likely than not to be realized. In evaluating the realization of deferred tax assets, management considers the likelihood that sufficient taxable income of appropriate character will be generated within carry-back and carry-forward periods, including consideration of available tax planning strategies. Tax-related loss contingencies, including assessments arising from tax examinations and tax strategies, are recorded as liabilities when the likelihood of loss is probable and an amount or range of loss can be reasonably estimated. In considering the likelihood of loss, management considers the nature of the contingency, the progress of any examination or related protest or appeal, the views of legal counsel and other advisors, experience of the Company or other enterprises in similar matters, if any, and management’s intended response to any assessment. 54 Goodwill and Other Intangible Assets Goodwill resulting from business combinations represents the excess of the purchase price over the fair value of the net assets of businesses acquired. Goodwill resulting from business combinations is generally determined as the excess of the fair value of the consideration transferred, plus the fair value of any noncontrolling interests in the acquiree, over the fair value of the net assets acquired and liabilities assumed as of the acquisition date. Goodwill and intangible assets acquired in a purchase business combination and determined to have an indefinite useful life are not amortized, but tested for impairment at least annually. The Company has selected December 31 as the date to perform the annual impairment test. Goodwill is the only intangible asset with an indefinite life on the Company’s balance sheet. Based on recent economic developments related to the COVID-19 pandemic, the Company tested Goodwill for impairment as of the June 30, 2020 balance sheet date. No impairment to Goodwill was indicated based on this interim period testing. Intangible assets with definite useful lives are amortized over their estimated useful lives to their estimated residual values. Other intangible assets consist of core deposit and acquired customer relationship intangible assets. They are initially measured at fair value and then are amortized over their estimated useful lives, which range from 6 to 10 years. RESULTS OF OPERATIONS Net Income: Net income for the quarter ended June 30, 2020 totaled $14,255,000, or $0.54 per share, a decline of 11% on a per share basis compared with the second quarter 2019 net income of $15,271,000, or $0.61 per share. Net income for the six months ended June 30, 2020 totaled $26,727,000, or $1.01 per share, a decline of 17% on a per share basis compared with the first half of 2019 net income of $30,338,000, or $1.21 per share. The decline in net income and earnings per share during the second quarter of 2020 and first six months of 2020 was largely attributable to an increased level of provision for credit losses related to economic uncertainties and stress related to the COVID-19 pandemic. Net Interest Income: Net interest income is the Company’s single largest source of earnings, and represents the difference between interest and fees realized on earning assets, less interest paid on deposits and borrowed funds. Several factors contribute to the determination of net interest income and net interest margin, including the volume and mix of earning assets, interest rates, and income taxes. Many factors affecting net interest income are subject to control by management policies and actions. Factors beyond the control of management include the general level of credit and deposit demand, Federal Reserve Board monetary policy, and changes in tax laws. 55 The following table summarizes net interest income (on a tax-equivalent basis) for the three months ended June 30, 2020 and 2019. For tax-equivalent adjustments, an effective tax rate of 21% was used for both periods (1) . Average Balance Sheet (Tax-equivalent basis / dollars in thousands) Three Months Ended June 30, 2020 Three Months Ended June 30, 2019 Principal Balance Income / Expense Yield / Rate Principal Balance Income / Expense Yield / Rate ASSETS Federal Funds Sold and Other Short-term Investments $ 239,164 $ 84 0.14 % $ 21,257 $ 85 1.62 % Securities: Taxable 538,881 2,706 2.01 % 547,775 3,555 2.60 % Non-taxable 358,312 3,381 3.77 % 294,507 2,974 4.04 % Total Loans and Leases (2) 3,253,169 38,154 4.71 % 2,721,630 35,135 5.18 % TOTAL INTEREST EARNING ASSETS 4,389,526 44,325 4.06 % 3,585,169 41,749 4.67 % Other Assets 399,369 339,969 Less: Allowance for Credit Losses (37,123 ) (16,469 ) TOTAL ASSETS $ 4,751,772 $ 3,908,669 LIABILITIES AND SHAREHOLDERS’ EQUITY Interest-bearing Demand, Savings and Money Market Deposits $ 2,220,549 $ 1,535 0.28 % $ 1,797,228 $ 2,945 0.66 % Time Deposits 586,179 2,208 1.51 % 631,174 2,814 1.79 % FHLB Advances and Other Borrowings 227,562 1,339 2.37 % 246,229 1,636 2.67 % TOTAL INTEREST-BEARING LIABILITIES 3,034,290 5,082 0.67 % 2,674,631 7,395 1.11 % Demand Deposit Accounts 1,074,739 715,681 Other Liabilities 55,271 33,466 TOTAL LIABILITIES 4,164,300 3,423,778 Shareholders’ Equity 587,472 484,891 TOTAL LIBABILITIES AND SHAREHOLDERS' EQUITY $ 4,751,772 $ 3,908,669 COST OF FUNDS 0.47 % 0.83 % NET INTEREST INCOME $ 39,243 $ 34,354 NET INTEREST MARGIN 3.59 % 3.84 % (1) Effective tax rates were determined as though interest earned on the Company’s investments in municipal bonds and loans was fully taxable. (2) Loans held-for-sale and non-accruing loans have been included in average loans. During the second quarter of 2020, net interest income totaled $38,459,000, an increase of $4,818,000, or 14%, compared to the second quarter of 2019 net interest income of $33,641,000. The increase in net interest income during the second quarter of 2020 compared with the second quarter of 2019 was largely attributable to acquisition of Citizens First and an increased level of loans related to the PPP, with a corresponding increase in interest income and fees. The average balance of PPP loans during the second quarter of 2020 was approximately $276 million while the net fees recognized through interest income on those loans totaled approximately $1.1 million. The net interest margin represents tax-equivalent net interest income expressed as a percentage of average earning assets. The tax equivalent net interest margin was 3.59% for the second quarter of 2020 compared to 3.84% during the second quarter of 2019. The tax equivalent yield on earning assets was 4.06% during the quarter ended June 30, 2020 compared to 4.67% in the same period of 2019, while the cost of funds (expressed as a percentage of average earning assets) was 0.47% during the quarter ended June 30, 2020 compared to 0.83% in the same period of 2019. The lower net interest margin during the second quarter of 2020 compared with the second quarter of 2019 was attributable to lower market interest rates, excess liquidity on the balance sheet that resulted from significant deposit growth during the second quarter of 2020 and the 1% interest rate applicable to the PPP loans. Accretion of loan discounts on acquired loans contributed approximately 19 basis points to the net interest margin on an annualized basis in the second quarter of 2020 and 12 basis points in the second quarter of 2019. 56 The following table summarizes net interest income (on a tax-equivalent basis) for the six months ended June 30, 2020 and 2019. For tax-equivalent adjustments, an effective tax rate of 21% was used for both periods (1) . Average Balance Sheet (Tax-equivalent basis / dollars in thousands) Six Months Ended June 30, 2020 Six Months Ended June 30, 2019 Principal Balance Income / Expense Yield / Rate Principal Balance Income / Expense Yield / Rate ASSETS Federal Funds Sold and Other Short-term Investments $ 142,425 $ 242 0.34 % $ 22,888 $ 226 1.99 % Securities: Taxable 542,537 5,816 2.14 % 541,957 7,154 2.64 % Non-taxable 341,044 6,476 3.80 % 292,043 5,924 4.06 % Total Loans and Leases (2) 3,156,284 76,090 4.85 % 2,720,227 70,342 5.21 % TOTAL INTEREST EARNING ASSETS 4,182,290 88,624 4.26 % 3,577,115 83,646 4.71 % Other Assets 396,256 336,905 Less: Allowance for Credit Losses (34,742 ) (16,263 ) TOTAL ASSETS $ 4,543,804 $ 3,897,757 LIABILITIES AND SHAREHOLDERS’ EQUITY Interest-bearing Demand, Savings and Money Market Deposits $ 2,106,860 $ 4,491 0.43 % $ 1,764,356 $ 5,640 0.64 % Time Deposits 612,320 4,909 1.61 % 638,907 5,535 1.75 % FHLB Advances and Other Borrowings 231,855 2,997 2.60 % 288,113 3,818 2.67 % TOTAL INTEREST-BEARING LIABILITIES 2,951,035 12,397 0.84 % 2,691,376 14,993 1.12 % Demand Deposit Accounts 961,315 703,462 Other Liabilities 49,721 28,300 TOTAL LIABILITIES 3,962,071 3,423,138 Shareholders’ Equity 581,733 474,619 TOTAL LIBABILITIES AND SHAREHOLDERS' EQUITY $ 4,543,804 $ 3,897,757 COST OF FUNDS 0.60 % 0.85 % NET INTEREST INCOME $ 76,227 $ 68,653 NET INTEREST MARGIN 3.66 % 3.86 % (1) Effective tax rates were determined as though interest earned on the Company’s investments in municipal bonds and loans was fully taxable. (2) Loans held-for-sale and non-accruing loans have been included in average loans. Net interest income increased $7,483,000, or 11%, for the six months ended June 30, 2020 compared with the same period of 2019. The increased level of net interest income during the first half of 2020 compared with the first half of 2019 was driven primarily by a higher level of average earning assets resulting from the acquisition of Citizens First. The tax equivalent net interest margin was 3.66% during the first half of 2020 compared to 3.86% during the first half of 2019. The tax equivalent yield on earning assets was 4.26% during the six months ended June 30, 2020 compared to 4.71% in the same period of 2019, while the cost of funds was 0.60% during the first half of 2020 compared to 0.85% in the same period of 2019. The lower net interest margin during the first half of 2020 compared with the first half of 2019 was attributable to lower market interest rates, excess liquidity on the balance sheet that resulted from significant deposit growth during the second quarter of 2020 and the 1% interest rate applicable to the PPP loans. Accretion of loan discounts on acquired loans contributed approximately 17 basis points to the net interest margin on an annualized basis in the six months ended June 30, 2020 and 14 basis points in the same period of 2019. 57 Provision for Credit Losses: The Company provides for credit losses through regular provisions to the allowance for credit losses. The provision is affected by net charge-offs on loans and changes in specific and general allocations of the allowance. During the quarter ended June 30, 2020, the provision for credit losses totaled $5,900,000 under the CECL methodology adopted during the first quarter of 2020 compared with a $250,000 provision for loan losses during the second quarter of 2019 under the incurred loss model. The provision for credit losses losses represented approximately 73 basis points of average loans on an annualized basis in the second quarter of 2020 compared a provision for loan losses of 4 basis points of average loans on an annualized basis in the second quarter of 2019. During the six months ended June 30, 2020, the provision for credit losses totaled $11,050,000 under the CECL methodology compared with a $925,000 provision for loan losses during the same period of 2019 under the incurred loss model. The provision for credit losses losses represented approximately 70 basis points of average loans on an annualized basis in the first six months of 2020 compared a provision for loan losses of 7 basis points of average loans on an annualized basis in the same period of 2019. The increase in the provision for credit losses during the three and six months ended June 30, 2020 compared to the provision for loan losses during the same periods of 2019 was primarily due to the recent developments related to the COVID-19 pandemic and the resulting impact on the economic assumptions used in the Company's CECL model. Net charge-offs totaled $110,000 or 1 basis point on an annualized basis of average loans outstanding during the three months ended June 30, 2020, compared with $254,000 or 4 basis points on an annualized basis of average loans outstanding during the same period of 2019. Net charge-offs totaled $550,000 or 3 basis point on an annualized basis of average loans outstanding during the first half of 2020, compared with $509,000 or 4 basis points on an annualized basis of average loans outstanding during the same period of 2019. The provision for credit losses losses made during the three and six months ended June 30, 2020 was made at a level deemed necessary by management to absorb estimated losses in the loan portfolio. A detailed evaluation of the adequacy of the allowance for credit losses is completed quarterly by management, the results of which are used to determine provision for credit losses. Management estimates the allowance balance required using past loan loss experience, the nature and volume of the portfolio, information about specific borrower situations and estimated collateral values, economic conditions and reasonable and supportable forecasts along with other qualitative and quantitative factors. Non-interest Income: During the quarter ended June 30, 2020, non-interest income totaled $12,423,000, an increase of $1,914,000, or 18%, compared with the second quarter of 2019. Non-interest Income (dollars in thousands) Three Months Ended June 30, Change From Prior Period Amount Percent 2020 2019 Change Change Trust and Investment Product Fees $ 1,867 $ 1,913 $ (46 ) (2 )% Service Charges on Deposit Accounts 1,365 2,024 (659 ) (33 ) Insurance Revenues 1,830 1,929 (99 ) (5 ) Company Owned Life Insurance 356 304 52 17 Interchange Fee Income 2,476 2,332 144 6 Other Operating Income 882 461 421 91 Subtotal 8,776 8,963 (187 ) (2 ) Net Gains on Sales of Loans 2,654 1,030 1,624 158 Net Gains on Securities 993 516 477 92 Total Non-interest Income $ 12,423 $ 10,509 $ 1,914 18 Service charges on deposit accounts declined $659,000, or 33%, during the second quarter of 2020 compared with the second quarter of 2019. The decline during the second quarter of 2020 was largely related to the economic impacts of the COVID-19 pandemic and resulting change in deposit customer activity. Other operating income increased $421,000, or 91%, during the quarter ended June 30, 2020 compared with the second quarter of 2019. The increase during the second quarter of 2020 was largely attributable to lower fair value adjustments on interest rate swap transactions and the acquisition of Citizens First. 58 Net gains on sales of loans increased $1,624,000, or 158%, during the second quarter of 2020 compared with the second quarter of 2019. The increase during the second quarter of 2020 was generally attributable to a higher sales volume, higher pricing levels on loans sold and an increased level of commitments to originate loans which resulted in a higher fair value adjustment on those commitments. Loan sales totaled $79.7 million during the second quarter of 2020, compared with $39.6 million during the second quarter of 2019. The Company realized $993,000 in gains on sales of securities during the second quarter of 2020 compared with $516,000 during the second quarter of 2019. The sales of securities in both periods was done as part of modest shifts in the allocations within the securities portfolio. During the six months ended June 30, 2020, non-interest income totaled $26,504,000, an increase of $4,337,000, or 20%, compared with the first half of 2019. Non-interest Income (dollars in thousands) Six Months Ended June 30, Change From Prior Period Amount Percent 2020 2019 Change Change Trust and Investment Product Fees $ 3,898 $ 3,480 $ 418 12 % Service Charges on Deposit Accounts 3,602 3,924 (322 ) (8 ) Insurance Revenues 5,059 5,134 (75 ) (1 ) Company Owned Life Insurance 1,578 1,188 390 33 Interchange Fee Income 4,958 4,427 531 12 Other Operating Income 1,309 1,332 (23 ) (2 ) Subtotal 20,404 19,485 919 5 Net Gains on Sales of Loans 4,517 2,011 2,506 125 Net Gains on Securities 1,583 671 912 136 Total Non-interest Income $ 26,504 $ 22,167 $ 4,337 20 Trust and investment product fees increased $418,000, or 12%, during the first half of 2020 compared with the first half of 2019. The increase was primarily attributable to fees generated from increased assets under management in the Company's wealth management group. Service charges on deposit accounts declined $322,000, or 8%, during the first quarter of 2020 compared with the first half of 2019. The decline during the the first half of 2020 compared with first half of 2019 was largely related to the economic impacts of the COVID-19 pandemic and resulting change in deposit customer activity, partially mitigated by the acquisition of Citizens First. Company owned life insurance revenue increased $390,000, or 33%, during the six months ended June 30, 2020, compared with the first half of 2019. The increase was largely related to death benefits received from life insurance policies. Interchange fees increased $531,000, or 12%, during the first half of 2020 compared with the first half of 2019. The increase during the first half of 2020 compared with the first half of 2019 was largely attributable to the acquisition of Citizens First and increased card utilization by customers. Net gains on sales of loans increased $2,506,000, or 125%, during the first half of 2020 compared with the first half of 2019. The increase in the net gain on sales of loans during the first half of 2020 compared with 2019 was generally attributable to a higher sales volume, higher pricing levels on loans sold and an increased level of commitments to originate loans which resulted in a higher fair value adjustment on those commitments. Loan sales totaled $136.0 million during the first half of 2020 and $68.4 million during the first half of 2019. The Company realized $1,583,000 in gains on sales of securities during first six months of 2020 compared with $671,000 during the same period of 2019. The sales of securities in both periods was done as part of modest shifts in the allocations within the securities portfolio. 59 Non-interest Expense: During the quarter ended June 30, 2020, non-interest expense totaled $28,088,000, an increase of $2,470,000, or 10%, compared with the second quarter of 2019. Non-interest Expense (dollars in thousands) Three Months Ended June 30, Change From Prior Period Amount Percent 2020 2019 Change Change Salaries and Employee Benefits $ 15,882 $ 14,117 $ 1,765 13 % Occupancy, Furniture and Equipment Expense 3,481 3,212 269 8 FDIC Premiums 123 245 (122 ) (50 ) Data Processing Fees 1,763 1,803 (40 ) (2 ) Professional Fees 1,082 1,174 (92 ) (8 ) Advertising and Promotion 882 936 (54 ) (6 ) Intangible Amortization 909 802 107 13 Other Operating Expenses 3,966 3,329 637 19 Total Non-interest Expense $ 28,088 $ 25,618 $ 2,470 10 Salaries and benefits increased $1,765,000, or 13%, during the quarter ended June 30, 2020 compared with the second quarter of 2019. The increase in salaries and benefits during the second quarter of 2020 compared with the second quarter of 2019 was primarily attributable to the acquisition of Citizens First. Occupancy, furniture and equipment expense increased $269,000, or 8%, during the second quarter of 2020 compared with the second quarter of 2019. The increase during the second quarter of 2020 compared with the second quarter of 2019 was primarily due to the operating costs of the Citizens First branch network. FDIC premiums declined $122,000, or 50%, during the second quarter of 2020 compared with the second quarter of 2019. The decline in FDIC premiums is attributable to credits received from the FDIC during the second quarter of 2020. The credits received were due to the reserve ratio of the deposit insurance fund exceeding the FDIC targeted levels. Intangible amortization increased $107,000, or 13%, during the quarter ended June 30, 2020 compared with the second quarter of 2019. The increase in intangible amortization in the second quarter of 2020 was attributable to the Citizens First acquisition completed during 2019. Other operating expenses increased $637,000, or 19%, during the second quarter of 2020 compared with the second quarter of 2019. The increase in the second quarter of 2020 compared with second quarter of 2019 was largely attributable to the Citizens First acquisition. During the six months ended June 30, 2020, non-interest expense totaled $58,416,000, an increase of $6,039,000, or 12%, compared with the first half of 2019. The increase in the first half of 2019 was largely impacted by the inclusion of operating expenses related to the acquisition of Citizens First. Non-interest Expense (dollars in thousands) Six Months Ended June 30, Change From Prior Period Amount Percent 2020 2019 Change Change Salaries and Employee Benefits $ 33,282 $ 29,161 $ 4,121 14 % Occupancy, Furniture and Equipment Expense 7,062 6,431 631 10 FDIC Premiums 123 533 (410 ) (77 ) Data Processing Fees 3,449 3,386 63 2 Professional Fees 2,166 2,501 (335 ) (13 ) Advertising and Promotion 1,953 1,806 147 8 Intangible Amortization 1,869 1,645 224 14 Other Operating Expenses 8,512 6,914 1,598 23 Total Non-interest Expense $ 58,416 $ 52,377 $ 6,039 12 60 Salaries and benefits increased $4,121,000, or 14%, during the six months ended June 30, 2020 compared with the first half of 2019. The increase in salaries and benefits during the first half of 2020 compared with the first half of 2019 was largely attributable to an increased number of full-time equivalent employees due in part to the acquisition of Citizens First. Occupancy, furniture and equipment expense increased $631,000, or 10%, during the first half of 2020 compared with the first half of 2019. The increase during the first half of 2020 compared with the first half of 2019 was primarily due to operating costs related to the Citizens First acquisition. FDIC premiums declined $410,000, or 77%, during the first half of 2020 compared with the first half of 2019. The decline in FDIC premiums is attributable to credits received from the FDIC during the first half of 2020. The credits received were due to the reserve ratio of the deposit insurance fund exceeding the FDIC targeted levels. Professional fees declined $335,000, or 13%, during the first half of 2020 compared with the first half of 2019. The first half of 2019 included significant acquisition professional fees related to the Citizens First acquisition which resulted in the overall decline in professional fees when comparing the first half of 2020 with the first half of 2019. Intangible amortization increased $224,000, or 14%, during the six months ended June 30, 2020 compared with the first half of 2019. The increase in intangible amortization was attributable to the previously discussed Citizens First acquisition. Other operating expenses increased $1,598,000, or 23%, during the first half of 2020 compared with the first half of 2019. The increase during the first half of 2020 compared with the first half of 2019 was largely impacted by the recent acquisition activity. Income Taxes: The Company’s effective income tax rate was 15.6% and 16.5%, respectively, during the three months ended June 30, 2020 and 2019. The Company’s effective income tax rate was 15.8% and 16.0%, respectively, during the six months ended June 30, 2020 and 2019. The effective tax rate in all periods presented was lower than the blended statutory rate resulting primarily from the Company’s tax-exempt investment income on securities, loans and company-owned life insurance, income tax credits generated from affordable housing projects, and income generated by subsidiaries domiciled in a state with no state or local income tax. FINANCIAL CONDITION Total assets for the Company totaled $4.851 billion at June 30, 2020, representing an increase of $453.4 million, or 21% on an annualized basis, compared with December 31, 2019. The increase in total assets during the first half of 2020 has been impacted by the Company's participation in the PPP and by significant growth of deposits during the second quarter of 2020. As of June 30, 2020 compared with December 31, 2019, federal funds sold and other short-term investments increased by $181.4 million and the Company's securities available for sale portfolio increased by $107.4 million. These increases were largely driven by the increased level of deposits during the second quarter of 2020. In addition, loans increased $189.0 million as of the end of June 30, 2020 compared with December 31, 2019 impacted primarily by the Company's participation in the PPP. June 30, 2020 total loans increased $189.0 million, or 12% on an annualized basis, compared with December 31, 2019. The increase in loans during the first half of 2020 compared with year-end 2019 was primarily the result in the Company's participation in the PPP. Excluding the $349.5 million in PPP loans ($338.7 million net of deferred fees) at June 30, 2020, total loans declined by $149.7 million, or 10% on an annualized basis, during the first half of 2020 compared with year-end 2019. The decline in total loans, excluding the PPP loans, was impacted by continued elevated pay-offs within the commercial real estate loan portfolio, reduced line utilization within the commercial loan portfolio partially attributable to the PPP loan originations during the second quarter of 2020, and continued pay-downs in the Company's residential and home equity loan portfolios related to the current interest rate environment. 61 End of Period Loan Balances: (dollars in thousands) June 30, 2020 December 31, 2019 Current Period Change Commercial and Industrial Loans and Leases $ 852,416 $ 589,758 $ 262,658 Commercial Real Estate Loans 1,473,234 1,495,862 (22,628 ) Agricultural Loans 373,483 384,526 (11,043 ) Home Equity and Consumer Loans 291,555 306,972 (15,417 ) Residential Mortgage Loans 280,246 304,855 (24,609 ) Total Loans $ 3,270,934 $ 3,081,973 $ 188,961 The following table indicates the breakdown of the allowance for credit losses for the periods indicated (dollars in thousands): June 30, 2020 December 31, 2019 Commercial and Industrial Loans and Leases $ 8,989 $ 4,799 Commercial Real Estate Loans 22,369 4,692 Agricultural Loans 7,030 5,315 Home Equity and Consumer Loans 1,683 634 Residential Mortgage Loans 2,360 333 Unallocated — 505 Total Allowance for Credit Losses $ 42,431 $ 16,278 The Company’s allowance for credit losses totaled $42.4 million at June 30, 2020 compared to $16.3 million at December 31, 2019. The allowance for credit losses represented 1.30% of period-end loans at June 30, 2020 compared with 0.53% of period-end loans at December 31, 2019. Total PPP loans included in the Commercial and Industrial Loan category totaled $349.5 million at June 30, 2020. These loans are guaranteed by the SBA and have minimal impact on the allowance for credit losses. The Company adopted ASU No. 2016-13, Financial Instruments - Credit Losses (Topic 326) ("CECL") on January 1, 2020. As a result, the Company recognized a one-time cumulative adjustment to the allowance for credit losses of $15.7 million. The increase was primarily related to the Company's acquired loan portfolio which totaled approximately $851.1 million at the time of adoption. The increase included $6.9 million in non-accretable credit marks allocated to purchased credit deteriorated loans which were grossed up between loans and the allowance for credit losses. Under the CECL model, certain acquired loans continue to carry a fair value discount as well as an allowance for credit losses. As of June 30, 2020, the Company held net discounts on acquired loans of $9.8 million. In addition, the allowance for credit losses increased during the six months ended June 30, 2020, as a result of the Company recording an $11.1 million provision for credit losses while recording net charge-offs of approximately $550,000. The provision for credit losses was elevated in the first half of 2020 primarily due to the recent developments related to the COVID-19 pandemic and the resulting impact on the economic assumptions used in the CECL model. The following is an analysis of the Company’s non-performing assets at June 30, 2020 and December 31, 2019: Non-performing Assets: (dollars in thousands) June 30, 2020 December 31, 2019 Non-accrual Loans $ 16,183 $ 13,802 Past Due Loans (90 days or more) 2,948 190 Total Non-performing Loans 19,131 13,992 Other Real Estate 425 425 Total Non-performing Assets $ 19,556 $ 14,417 Restructured Loans $ 114 $ 116 Non-performing Loans to Total Loans 0.59 % 0.45 % Allowance for Loan Loss to Non-performing Loans 221.79 % 116.34 % 62 The following table presents non-accrual loans and loans past due 90 days or more still on accrual by class of loans: Non-Accrual Loans Loans Past Due 90 Days or More & Still Accruing June 30, 2020 December 31, 2019 June 30, 2020 December 31, 2019 Commercial and Industrial Loans and Leases $ 7,194 $ 4,940 $ — $ 190 Commercial Real Estate Loans 4,540 3,433 354 — Agricultural Loans 2,715 2,739 2,594 — Home Equity Loans 258 79 — — Consumer Loans 305 115 — — Residential Mortgage Loans 1,171 2,496 — — Total $ 16,183 $ 13,802 $ 2,948 $ 190 Non-performing assets totaled $19.6 million at June 30, 2020 compared to $14.4 million at December 31, 2019. Non-performing assets represented 0.40% of total assets at June 30, 2020 and 0.33% at December 31, 2019. Non-performing loans totaled $19.1 million at June 30, 2020 compared to $14.0 million at December 31, 2019. Non-performing loans represented 0.59% of total loans at June 30, 2020 compared to 0.45% at December 31, 2019. The increase in the level of non-performing assets and non-performing loans at June 30, 2020 compared with year-end 2019 was attributable to the $6.9 million gross-up of purchase credit deteriorated loans upon the adoption of the CECL standard. June 30, 2020 total deposits increased $549.4 million, or 32% on an annualized basis, compared to December 31, 2019. The increase in total deposits at June 30, 2020 compared with year-end 2019 was partially attributable the Company's participation in the PPP and a seasonal increase in public fund operating deposits as well as an overall inflow of customer deposits during the second quarter of 2020. End of Period Deposit Balances: (dollars in thousands) June 30, 2020 December 31, 2019 Current Period Change Non-interest-bearing Demand Deposits $ 1,139,928 $ 832,985 $ 306,943 Interest-bearing Demand, Savings, & Money Market Accounts 2,267,092 1,965,640 301,452 Time Deposits < $100,000 293,059 314,789 (21,730 ) Time Deposits of $100,000 or more 279,354 316,607 (37,253 ) Total Deposits $ 3,979,433 $ 3,430,021 $ 549,412 Capital Resources: On January 27, 2020, the Company’s Board of Directors approved a plan to repurchase up to one million shares of the Company’s outstanding common stock. On a share basis, the amount of common stock subject to the repurchase plan represents approximately 4% of the Company’s outstanding shares. The Company is not obligated to purchase any shares under the plan, and the plan may be discontinued at any time. The actual timing, number and share price of shares purchased under the repurchase plan will be determined by the Company at its discretion and will depend upon such factors as the market price of the stock, general market and economic conditions and applicable legal requirements. At the time it approved the new plan, the Board also terminated a similar program that had been adopted in 2001. At the time of its termination, the Company had been authorized to purchase up to 409,184 shares of common stock under the 2001 program. The Company repurchased 44,166 shares of common stock under the 2020 repurchase plan during the second quarter of 2020 at an average price of $26.46 per share. The Company repurchased 217,255 shares of common stock under the 2020 repurchase plan during the first half of 2020 at an average price of $26.07 per share. As of June 30, 2020, shareholders’ equity increased by $20.9 million to $594.7 million compared with $573.8 million at year-end 2019. The increase in shareholders' equity was largely attributable to an increase of $16.0 million in accumulated other comprehensive income primarily related to the increase in value of the Company's available-for-sale securities portfolio. In addition, retained earnings increased $9.9 million due to first half of 2020 net income of $26.7 which was partially offset by the payment of $10.1 million in shareholder dividends and a $6.7 million charge relating to the implementation of CECL on January 1, 2020. Also impacting total shareholders' equity was the repurchase of common stock under the Company's share repurchase plan which totaled $5.7 million during the first half of 2020. 63 Shareholders’ equity represented 12.3% of total assets at June 30, 2020 and 13.0% of total assets at December 31, 2019. Shareholders’ equity included $132.7 million of goodwill and other intangible assets at June 30, 2020 compared to $134.0 million of goodwill and other intangible assets at December 31, 2019. Federal banking regulations provide guidelines for determining the capital adequacy of bank holding companies and banks. These guidelines provide for a more narrow definition of core capital and assign a measure of risk to the various categories of assets. The Company is required to maintain minimum levels of capital in proportion to total risk-weighted assets and off-balance sheet exposures. As of January 1, 2015, the Company and its subsidiary bank adopted the new Basel III regulatory capital framework. The adoption of this new framework modified the regulatory capital calculations, minimum capital levels and well-capitalized thresholds and added the new Common Equity Tier 1 capital ratio. Additionally, under the new rules, in order to avoid limitations on capital distributions, including dividend payments, the Company is required to maintain a capital conservation buffer above the adequately capitalized regulatory capital ratios. The capital conservation buffer was phased in from 0.00% in 2015 to 2.50% in 2019. For both June 30, 2020 and December 31, 2019, the capital conservation buffer was 2.50%. At June 30, 2020, the capital levels for the Company and its subsidiary bank remained well in excess of the minimum amounts needed for capital adequacy purposes and the Bank's capital levels met the necessary requirements to be considered well-capitalized. The table below presents the Company’s consolidated and the subsidiary bank's capital ratios under regulatory guidelines: 6/30/2020 Ratio 12/31/2019 Ratio Minimum for Capital Adequacy Purposes (1) Well-Capitalized Guidelines Total Capital (to Risk Weighted Assets) Consolidated 15.22 % 14.28 % 8.00 % N/A Bank 13.03 % 12.82 % 8.00 % 10.00 % Tier 1 (Core) Capital (to Risk Weighted Assets) Consolidated 13.35 % 12.67 % 6.00 % N/A Bank 12.33 % 12.35 % 6.00 % 8.00 % Common Tier 1, (CET 1) Capital Ratio (to Risk Weighted Assets) Consolidated 12.90 % 12.23 % 4.50 % N/A Bank 12.33 % 12.35 % 4.50 % 6.50 % Tier 1 Capital (to Average Assets) Consolidated 9.97 % 10.53 % 4.00 % N/A Bank 9.21 % 10.27 % 4.00 % 5.00 % (1) Excludes capital conservation buffer. In December 2018, the federal banking regulators approved a final rule to address changes to credit loss accounting under GAAP, including banking organizations’ implementation of CECL. The final rule provides banking organizations the option to phase in over a three-year period the day-one adverse effects on regulatory capital that may result from the adoption of the new accounting standard. On March 27, 2020, in an action related to the CARES Act, the federal banking regulators announced an interim final rule to delay the estimated impact on regulatory capital stemming from the implementation of CECL. The interim final rule maintains the three-year transition option in the previous rule and provides banks the option to delay for two years an estimate of CECL’s effect on regulatory capital, relative to the incurred loss methodology’s effect on regulatory capital, followed by a three-year transition period (five-year transition option). The Company is adopting the capital transition relief over the permissible five-year period. On April 6, 2020, federal banking regulators issued two interim final rules that make changes to the community bank leverage ratio (“CBLR”) framework and implementing certain directives of the CARES Act. Under the existing CBLR framework, which became effective as of January 1, 2020, community banks and holding companies (which would include the Bank and the Company) that satisfy certain qualifying criteria, including having less than $10 billion in average total consolidated assets and a leverage ratio (referred to as the “community bank leverage ratio”) of greater than 9%, were eligible to opt-in to the CBLR framework. The first of the April 2020 interim final rules provides that, as of the second quarter 2020, banking organizations with leverage ratios of 8% or greater (and that meet the other existing qualifying criteria) may elect to use the CBLR framework. It also establishes a two-quarter grace period for qualifying community banking organizations whose leverage ratios fall below the 8% CBLR 64 requirement, so long as the banking organization maintains a leverage ratio of 7% or greater. The second interim final rule provides a transition from the temporary 8% CBLR requirement to a 9% CBLR requirement. It establishes a minimum CBLR of 8% for the second through fourth quarters of 2020, 8.5% for 2021, and 9% thereafter, and maintains a two-quarter grace period for qualifying community banking organizations whose leverage ratios fall no more than 100 basis points below the applicable CBLR requirement. Notwithstanding these changes, the Company intends to continue with the existing layered ratio structure. Under either framework, the Company and the Bank would be considered well-capitalized under the applicable guidelines. On April 9, 2020, federal banking regulators issued an interim final rule to modify the Basel III regulatory capital rules applicable to banking organizations to allow those organizations participating in the PPP to neutralize the regulatory capital effects of participating in the program. Specifically, the agencies have clarified that banking organizations, including the Company and the Bank, are permitted to assign a zero percent risk weight to PPP loans for purposes of determining risk-weighted assets and risk-based capital ratios. Additionally, in order to facilitate use of the PPPL Facility, the agencies further clarified that, for purposes of determining leverage ratios, a banking organization is permitted to exclude from total average assets PPP loans that have been pledged as collateral for a PPPL Facility. Liquidity: The Consolidated Statement of Cash Flows details the elements of changes in the Company’s consolidated cash and cash equivalents. Total cash and cash equivalents increased $174.5 million during the six months ended June 30, 2020 ending at $278.4 million. During the six months ended June 30, 2020, operating activities resulted in net cash inflows of $42.7 million. Investing activities resulted in net cash outflows of $272.0 million during the six months months ended June 30, 2020 primarily resulting from the investment of excess liquidity into the available for sale securities portfolio and loan portfolio growth resulting from the Company's participation in the PPP. Financing activities resulted in net cash inflows for the six months ended June 30, 2020 of $403.8 million primarily related to growth in the Company's deposit portfolio. The parent company is a corporation separate and distinct from its bank and other subsidiaries. The Company uses funds at the parent-company level to pay dividends to its shareholders, to acquire or make other investments in other businesses or their securities or assets, to repurchase its stock from time to time, and for other general corporate purposes including debt service. The parent company does not have access at the parent-company level to the deposits and certain other sources of funds that are available to its bank subsidiary to support its operations. Instead, the parent company has historically derived most of its revenues from dividends paid to the parent company by its bank subsidiary. The Company’s banking subsidiary is subject to statutory restrictions on its ability to pay dividends to the parent company. The parent company has in recent years supplemented the dividends received from its subsidiaries with borrowings. As of June 30, 2020, the parent company had approximately $65.1 million of cash and cash equivalents available to meet its cash flow needs. FORWARD-LOOKING STATEMENTS AND ASSOCIATED RISKS The Company from time to time in its oral and written communications makes statements relating to its expectations regarding the future. These types of statements are considered “forward-looking statements” within the meaning of the Private Securities Litigation Reform Act of 1995. The Company may include forward-looking statements in filings with the Securities and Exchange Commission (“SEC”), such as this Form 10-Q, in other written materials, and in oral statements made by senior management to analysts, investors, representatives of the media, and others. Such forward looking statements can include statements about the Company’s net interest income or net interest margin; its adequacy of allowance for loan losses, levels of provisions for loan losses, and the quality of the Company’s loans, investment securities and other assets; simulations of changes in interest rates; expected results from mergers with or acquisitions of other businesses; litigation results; tax estimates and recognition; dividend policy; parent company cash resources and cash requirements, and parent company capital resources; estimated cost savings, plans and objectives for future operations; and expectations about the Company’s financial and business performance and other business matters as well as economic and market conditions and trends. They often can be identified by the use of words like “plan,” “expect,” “can,” “might,” “may,” “will,” “would,” “could,” “should,” “intend,” “project,” “estimate,” “believe” or “anticipate,” or similar expressions. Forward-looking statements speak only as of the date they are made, and the Company undertakes no obligation to update any forward-looking statement to reflect events or circumstances after the date on which the forward-looking statement is made. Readers are cautioned that, by their nature, all forward-looking statements are based on assumptions and are subject to risks, uncertainties, and other factors. Actual results may differ materially and adversely from the expectations of the Company that are expressed or implied by any forward-looking statement. The discussions in this Item 2 list some of the factors that could cause the Company’s actual results to vary materially from those expressed or implied by any forward-looking statements. Other risks, uncertainties, and factors that could cause the Company’s actual results to vary materially from those expressed or implied by any 65 forward-looking statement include the unknown future direction of interest rates and the timing and magnitude of any changes in interest rates; changes in competitive conditions; the introduction, withdrawal, success and timing of asset/liability management strategies or of mergers and acquisitions and other business initiatives and strategies; changes in customer borrowing, repayment, investment and deposit practices; changes in fiscal, monetary and tax policies; changes in financial and capital markets; deterioration in general economic conditions, either nationally or locally, resulting in, among other things, credit quality deterioration; the severity and duration of the COVID-19 pandemic and its impact on general economic and financial market conditions and our business, results of operations, and financial condition; our participation as a lender in the PPP; capital management activities, including possible future sales of new securities, or possible repurchases or redemptions by the Company of outstanding debt or equity securities; risks of expansion through acquisitions and mergers, such as unexpected credit quality problems of the acquired loans or other assets, unexpected attrition of the customer base of the acquired institution or branches, and difficulties in integration of the acquired operations; factors driving impairment charges on investments; the impact, extent and timing of technological changes; potential cyber-attacks, information security breaches and other criminal activities; litigation liabilities, including related costs, expenses, settlements and judgments, or the outcome of matters before regulatory agencies, whether pending or commencing in the future; actions of the Federal Reserve Board; changes in accounting principles and interpretations; potential increases of federal deposit insurance premium expense, and possible future special assessments of FDIC premiums, either industry wide or specific to the Company’s banking subsidiary; actions of the regulatory authorities under the Dodd-Frank Wall Street Reform and Consumer Protection Act (the "Dodd-Frank Act") and the Federal Deposit Insurance Act and other possible legislative and regulatory actions and reforms; impacts resulting from possible amendments or revisions to the Dodd-Frank Act and the regulations promulgated thereunder, or to Consumer Financial Protection Bureau rules and regulations; and the continued availability of earnings and excess capital sufficient for the lawful and prudent declaration and payment of cash dividends. Such statements reflect our views with respect to future events and are subject to these and other risks, uncertainties and assumptions relating to the operations, results of operations, growth strategy and liquidity of the Company. Readers are cautioned not to place undue reliance on these forward-looking statements. Investors should consider these risks, uncertainties, and other factors, in addition to those mentioned by the Company in its Annual Report on Form 10-K for its fiscal year ended December 31, 2019, this Quarterly Report on Form 10-Q, and other SEC filings from time to time, when considering any forward-looking statement. 66