NORWOOD FINANCIAL CORP 10-Q

Item 2. Management’s Discussion and Analysis of Financial Condition and Results of Operations Forward-Looking Statements The Private Securities Litigation Reform Act of 1995 contains safe harbor provisions regarding forward-looking statements. When used in this discussion, the words “believes,” “anticipates,” “contemplates,” “expects,” and similar expressions are intended to identify forward-looking statements. Such statements are subject to certain risks and uncertainties which could cause actual results to differ materially from those projected. Those risks and uncertainties include:  possible future impairment of intangible assets  our ability to effectively manage future growth  loan losses in excess of our allowance  the impact of the COVID-19 pandemic on us  risk of litigation from participation in the PPP loan program  risks inherent in the COVID-19 loan forbearance programs under the CARES Act  risks inherent in commercial lending  real estate collateral which is subject to declines in value  potential other-than-temporary impairments  soundness of other financial institutions  interest rate risks  potential liquidity risk  deposits acquired through competitive bidding  availability of capital  regional economic factors  loss of senior officers  comparatively low legal lending limits  risks of new capital requirements  potential impact of Tax Cuts and Jobs Act  limited market for the Company’s stock  restrictions on ability to pay dividends  common stock may lose value  insider ownership  issuing additional shares may dilute ownership  competitive environment  certain anti-takeover provisions  extensive and complex governmental regulation and associated cost  cybersecurity The Company undertakes no obligation to publicly release the results of any revisions to those forward-looking statements which may be made to reflect events or circumstances after the date hereof or to reflect the occurrence of unanticipated events. Critical Accounting Policies Note 2 to the Company’s consolidated financial statements for the year ended December 31, 2019 (incorporated by reference in Item 8 of the Annual Report on Form 10-K for the fiscal year ended December 31, 2019) lists significant accounting policies used in the development and presentation of its financial statements. This discussion and analysis, the significant accounting policies, and other financial statement disclosures identify and address key variables and other qualitative and quantitative factors that are necessary for an understanding and evaluation of the Company and its results of operations. Material estimates that are particularly susceptible to significant change in the near term relate to the determination of the allowance for loan losses, the valuation of deferred tax assets, the fair value of financial instruments, the determination of other-than- 35 temporary impairment on securities and the determination of goodwill impairment. Please refer to the discussion of the allowance for loan losses calculation under “Loans” in the “Changes in Financial Condition” section. The Company uses the modified prospective transition method to account for stock options. Under this method companies are required to record compensation expense, based on the fair value of options over the vesting period. Restricted shares vest over a five-year period. The product of the number of shares granted and the grant date market price of the Company’s common stock determines the fair value of restricted stock. Deferred income taxes reflect temporary differences in the recognition of the revenue and expenses for tax reporting and financial statement purposes, principally because certain items are recognized in different periods for financial reporting and tax return purposes. Although realization is not assured, the Company believes that it is more likely than not that all deferred tax assets will be realized. The fair value of financial instruments is based upon quoted market prices, when available. For those instances where a quoted price is not available, fair values are based upon observable market based parameters as well as unobservable parameters. Any such valuation is applied consistently over time. Management determines the appropriate classification of debt securities at the time of purchase and re-evaluates such designation as of each Consolidated Balance Sheet date. Declines in the fair value of available for sale securities below their cost that are deemed to be other than temporary are reflected in earnings as realized losses. In estimating other-than-temporary impairment losses, the Company considers (1) the length of time and the extent to which the fair value has been less than cost, (2) the financial condition and near-term prospects of the issuer, and (3) the intent of the Company to not sell the securities and whether it is more likely than not that it will not have to sell the securities before recovery of their cost basis. The Company believes that all unrealized losses on securities at September 30, 2020 and December 31, 2019 represent temporary impairment of the securities, related to changes in interest rates. In connection with acquisitions, the Company recorded goodwill in the amount of $30.2 million, representing the excess of amounts paid over the fair value of net assets of the institutions acquired in purchase transactions, at its fair value at the date of acquisition. Goodwill is tested and deemed impaired when the carrying value of goodwill exceeds its implied fair value. The value of the goodwill can change in the future. We expect the value of the goodwill to decrease if there is a significant decrease in the franchise value of the Company or the Bank. If an impairment loss is determined in the future, we will reflect the loss as an expense for the period in which the impairment is determined, leading to a reduction of our net income for that period by the amount of the impairment loss. Changes in Financial Condition General Total assets as of September 30, 2020 were $1.842 billion compared to $1.231 billion as of December 31, 2019. The increase was due primarily to the $456.1 million of assets acquired in the UpState merger. The increase in total assets and loans outstanding is also due in part to the Company’s participation in the PPP and other related economic stimulus programs. Securities The fair value of securities available for sale as of September 30, 2020 was $197.4 million compared to $210.2 million as of December 31, 2019. The decrease in the securities portfolio is the result of sales, calls, maturities and principal reductions of securities with the proceeds utilized to fund loan growth. The carrying value of the Company’s securities portfolio (Available-for Sale) consisted of the following: September 30, 2020 December 31, 2019 (dollars in thousands) Amount % of portfolio Amount % of portfolio States and political subdivisions $ 53,065 26.9 % $ 71,305 33.9 % Corporate obligations 3,063 1.5 4,100 2.0 Mortgage-backed securities- government sponsored entities 141,308 71.6 134,800 64.1 Total $ 197,436 100.0 % $ 210,205 100.0 % 36 The Company has securities in an unrealized loss position. In management’s opinion, the unrealized losses reflect changes in interest rates subsequent to the acquisition of specific securities. Management believes that the unrealized losses on all holdings represent temporary impairment of the securities, as the Company has the intent and ability to hold these investments until maturity or market price recovery. Loans Loans receivable totaled $1.415 billion at September 30, 2020 compared to $924.6 million as of December 31, 2019. The increase in loans receivable includes $402.2 million of loans acquired in the UpState merger. The loan growth recorded during the first nine months of 2020 also includes $95.0 million of PPP loans. Organic loan growth for the nine-month period ended September 30, 2020 was negatively impacted by the effects of the COVID-19 pandemic as social distancing constraints and business closures resulted in a significant slowing of new loan originations. The allowance for loan losses totaled $11,674,000 as of September 30, 2020, and represented 0.83% of total loans outstanding, compared to $8.5 million, or 0.92% of total loans, at December 31, 2019. The Company had net charge-offs for the nine months ended September 30, 2020 of $685,000 compared to $1,097,000 in the corresponding period in 2019. The Company’s management assesses the adequacy of the allowance for loan losses on a quarterly basis. The process includes an analysis of the risks inherent in the loan portfolio. It includes an analysis of impaired loans and a historical review of credit losses by loan type. Other factors considered include concentration of credit in specific industries, economic and industry conditions, trends in delinquencies and loan classifications, and loan growth. In addition, management has included qualitative factors during 2020 which are specifically related to the economic impact of the COVID-19 pandemic. Management considers the allowance adequate at September 30, 2020 based on the Company’s criteria. However, there can be no assurance that the allowance for loan losses will be adequate to cover significant losses, if any, that might be incurred in the future. As of September 30, 2020, non-performing loans totaled $12.6 million, or 0.89% of total loans compared to $795,000, or 0.09%, of total loans at December 31, 2019. The increase reflects loans acquired in the UpState merger. At September 30, 2020, non-performing assets totaled $13.6 million, or 0.74%, of total assets, compared to $2.4 million, or 0.19%, of total assets at December 31, 2019. The following table sets forth information regarding non-performing loans and foreclosed real estate at the dates indicated: (dollars in thousands) September 30, 2020 December 31, 2019 Loans accounted for on a non-accrual basis: Real Estate Residential $ 663 $ 567 Commercial 1,280 99 Agricultural 676 Construction — — Commercial and financial loans 23 50 Other agricultural loans 263 Consumer loans to individuals 139 79 Total non-accrual loans * 3,044 795 Accruing loans which are contractually past due 90 days or more 1,000 — Total non-performing loans 4,044 795 Foreclosed real estate 965 1,556 Total non-performing assets $ 5,009 $ 2,351 Purchased credit impaired loans (a) $ 8,586 $ 696 Allowance for loans losses $ 11,674 $ 8,509 Coverage of non-performing loans (a) (b) 289% % 1,070% % Non-performing loans to total loans(a) 0.29 % 0.09 % Non-performing loans to total assets(a) 0.22 % 0.06 % Non-performing assets to total assets(a) 0.27 % 0.19 % *Includes non-accrual TDRs of $91,000 as of September 30, 2020 and $99,000 as of December 31, 2019. There were no accruing TDRs as of September 30, 2020 or as of December 31, 2019. 37 (a) Purchased impaired loans are loans obtained in acquisition transactions that as of the acquisition date were specifically identified as displaying signs of credit deterioration and for which the Company did not expect to collect all contractually required principal and interest payments. Those loans were impaired at the date of acquisition, were recorded at estimated fair value and were generally delinquent in payments. The Company estimated the timing and amount of expected cash flows in excess of the estimated fair value and established an accretable discount on the acquisition date relating to these impaired loans that is recognized in interest income. (b) For loans acquired with specific evidence of deterioration in credit quality, a specific credit fair value adjustment is established at the date of acquisition and will not impact the allowance for loan losses unless actual losses exceed the established fair value adjustment. During the nine-months ended September 30, 2020, over 1,100 of our loan customers had requested loan payment deferrals or payments of interest only on loans totaling $273.4 million. In accordance with interagency guidance issued in March 2020, these short-term deferrals are not considered troubled debt restructurings (“TDRs”) unless the borrower was previously experiencing financial difficulty. In addition, the risk-rating on COVID-19 modified loans did not change, and these loans will not be considered past due until after the deferral period is over and scheduled payments resume. The credit quality of these loans will be reevaluated after the deferral period ends. Deposits During the nine-month period ended September 30, 2020, total deposits increased $558.4 million due primarily to the $414.1 million of deposits acquired in the UpState merger. The increase during the 2020 period also includes the impact from the PPP and other economic stimulus programs. The following table sets forth deposit balances as of the dates indicated: (dollars in thousands) September 30, 2020 December 31, 2019 Non-interest bearing demand $ 372,237 $ 207,299 Interest-bearing demand 157,927 99,366 Money market deposit accounts 229,941 128,441 Savings 220,640 161,705 Time deposits <$100,000 205,671 143,940 Time deposits >$100,000 329,506 216,778 Total $ 1,515,922 $ 957,529 Borrowings Other borrowings as of September 30, 2020, totaled $46.4 million compared to $56.4 million as of December 31, 2019. Short-term borrowings, which consist of securities sold under agreements to repurchase and overnight borrowings from the FHLB, increased $7.0 million due to a $38.8 million increase in repurchase agreements, which was partially offset by a $31.8 million reduction in overnight borrowings. 38 Other borrowings consisted of the following: (dollars in thousands) September 30, 2020 December 31, 2019 Notes with the FHLB: Fixed rate term borrowing due May 2020 at 1.85% $ — $ 5,000 Amortizing fixed rate borrowing due June 2020 at 1.490% — 1,034 Amortizing fixed rate borrowing due July 2020 at 2.77% — 2,974 Amortizing fixed rate borrowing due December 2020 at 1.706% 260 2,538 Amortizing fixed rate borrowing due December 2020 at 3.06% 642 1,034 Amortizing fixed rate borrowing due March 2022 at 1.748% 1,348 2,009 Amortizing fixed rate borrowing due August 2022 at 1.94% 3,874 5,351 Amortizing fixed rate borrowing due October 2022 at 1.88% 3,425 4,626 Amortizing fixed rate borrowing due October 2023 at 3.24% 6,357 7,809 Amortizing fixed rate borrowing due December 2023 at 3.22% 3,341 4,063 Fixed rate term borrowing due December 2023 at 1.95% 10,000 10,000 Amortizing fixed rate borrowing due December 2023 at 1.73% 8,216 10,000 Amortizing fixed rate borrowing due April 2024 at 0.91% 8,975 — $ 46,438 $ 56,438 Stockholders’ Equity and Capital Ratios As of September 30, 2020, stockholders’ equity totaled $190.5 million, compared to $137.4 million as of December 31, 2019. The net change in stockholders’ equity included $45.3 million resulting from the UpState merger and $9.6 million of net income, which was partially offset by $5.7 million of dividends declared. In addition, total equity increased $3.5 million due to an increase in the fair value of securities in the available for sale portfolio, net of tax. This increase in fair value is the result of a change in interest rates and spreads, which may impact the value of the securities. Because of interest rate volatility, the Company’s accumulated other comprehensive income could materially fluctuate for each interim and year-end period. A comparison of the Company’s consolidated regulatory capital ratios is as follows: September 30, 2020 December 31, 2019 Tier 1 Capital (To average assets) 8.80% 10.18% Tier 1 Capital (To risk-weighted assets) 11.52% 13.11% Common Equity Tier 1 Capital (To risk-weighted assets) 11.52% 13.11% Total Capital (To risk-weighted assets) 12.40% 14.01% Effective January 1, 2015, the Company and the Bank became subject to new regulatory capital rules, which, among other things, impose a new common equity Tier 1 minimum capital requirement (4.5% of risk-weighted assets), set the minimum leverage ratio for all banking organizations at a uniform 4% of total assets, increase the minimum Tier 1 capital to risk-based assets requirement (from 4% to 6% of risk-weighted assets) and assign a higher risk weight (150%) to exposures that are more than 90 days past due or are on nonaccrual status and to certain commercial real estate facilities that finance the acquisition, development or construction of real property. The new rules also require unrealized gains and losses on certain “available-for-sale” securities holdings to be included for purposes of calculating regulatory capital requirements unless a one-time opt out is exercised which the Company and the Bank have done. The final rule limits a banking organization’s dividends, stock repurchases and other capital distributions, and certain discretionary bonus payments to executive officers, if the banking organization does not hold a “capital conservation buffer” consisting of 2.5% of common equity Tier 1 capital to risk-weighted assets above regulatory minimum risk-based requirements. The capital conservation buffer requirement was phased in beginning January 1, 2016 and ending January 1, 2019, when the full capital conservation buffer requirement became effective. The Company and the Bank are in compliance with their respective new capital requirements, including the capital conservation buffer, as of September 30, 2020. 39 Liquidity As of September 30, 2020, the Company had cash and cash equivalents of $124.4 million in the form of cash, due from banks and short-term deposits with other institutions. In addition, the Company had total securities available for sale of $197.4 million which could be used for liquidity needs. This totals $321.9 million of liquidity and represents 17.5% of total assets compared to $225.6 million and 18.3% of total assets as of December 31, 2019. The Company also monitors other liquidity measures, all of which were within the Company’s policy guidelines as of September 30, 2020 and December 31, 2019. Based upon these measures, the Company believes its liquidity is adequate. Capital Resources The Company has a line of credit commitment from Atlantic Community Bankers Bank for $7,000,000 which expires June 30, 2021. There were no borrowings under this line as of September 30, 2020 and December 31, 2019. The Company has a line of credit commitment available which has no stated expiration date from PNC Bank for $16,000,000. There were no borrowings under this line as of September 30, 2020 and December 31, 2019. The Company has a line of credit commitment available which has no stated expiration date from Zions Bank for $17,000,000. There were no borrowings under this line as of September 30, 2020 and December 31, 2019. The Bank’s maximum borrowing capacity with the Federal Home Loan Bank was approximately $429,045,000 as of September 30, 2020, of which $46,437,000 was outstanding in the form of borrowings. As of December 31, 2019, the maximum borrowing capacity was $425,226,000, of which $88,189,000 of borrowings was outstanding. Additionally, as of September 30, 2020, the Bank had secured Letters of Credit from the Federal Home Loan Bank in the amount of $152.4 million as collateral for specific municipal deposits. These Letters of Credit reduce the availability under the maximum borrowing capacity. There was $56,000,000 outstanding in the form of Letters of Credit as of December 31, 2019. Advances and Letters of Credit from the Federal Home Loan Bank are secured by qualifying assets of the Bank. Non-GAAP Financial Measures This report contains or references fully taxable-equivalent (fte) interest income and net interest income, which are non-GAAP financial measures. Interest income (fte) and net interest income (fte) are derived from GAAP interest income and net interest income using an assumed tax rate of 21%. We believe the presentation of interest income (fte) and net interest income (fte) ensures comparability of interest income and net interest income arising from both taxable and tax-exempt sources and is consistent with industry practice. Interest income (fte) and Net interest income (fte) is reconciled to GAAP interest income and net interest income on pages 41 and 45. Although the Company believes that these non-GAAP financial measures enhance investors’ understanding of our business and performance, these non-GAAP financial measures should not be considered an alternative to GAAP measures. 40 Results of Operations NORWOOD FINANCIAL CORP Consolidated Average Balance Sheets with Resultant Interest and Rates (Tax-Equivalent Basis, Three Months Ended September 30, dollars in thousands) 2020 2019 Average Average Average Average Balance Interest Rate Balance Interest Rate (2) (1) (3) (2) (1) (3) Assets Interest-earning assets: Interest-bearing deposits with banks $ 78,525 $ 18 0.09% $ 693 $ 5 2.89% Securities available for sale: Taxable 147,864 687 1.86 147,079 798 2.17 Tax-exempt (1) 50,543 436 3.45 80,099 608 3.04 Total securities available for sale (1) 198,407 1,123 2.26 227,178 1,406 2.48 Loans receivable (1) (4) (5) 1,391,012 16,385 4.71 897,850 10,890 4.85 Total interest-earning assets 1,667,944 17,526 4.20 1,125,721 12,301 4.37 Non-interest earning assets: Cash and due from banks 23,036 14,968 Allowance for loan losses (10,894) (8,344) Other assets 106,437 83,474 Total non-interest earning assets 118,579 90,098 Total Assets $ 1,786,523 $ 1,215,819 Liabilities and Stockholders&apos; Equity Interest-bearing liabilities: Interest-bearing demand and money market $ 360,183 $ 192 0.21 $ 232,893 $ 173 0.30 Savings 219,441 34 0.06 168,972 26 0.06 Time 537,146 1,450 1.08 348,890 1,588 1.82 Total interest-bearing deposits 1,116,770 1,676 0.60 750,755 1,787 0.95 Short-term borrowings 58,527 61 0.42 56,136 135 0.96 Other borrowings 48,415 242 2.00 39,349 246 2.50 Total interest-bearing liabilities 1,223,712 1,979 0.65 846,240 2,168 1.02 Non-interest bearing liabilities: Demand deposits 356,827 218,893 Other liabilities 21,859 16,649 Total non-interest bearing liabilities 378,686 235,542 Stockholders&apos; equity 184,125 134,037 Total Liabilities and Stockholders&apos; Equity $ 1,786,523 $ 1,215,819 Net interest income/spread (tax equivalent basis) 15,547 3.55% 10,133 3.35% Tax-equivalent basis adjustment (217) (242) Net interest income $ 15,330 $ 9,891 Net interest margin (tax equivalent basis) 3.73% 3.60% (1) Interest and yields are presented on a tax-equivalent basis using a marginal tax rate of 21%. (2) Average balances have been calculated based on daily balances. (3) Annualized (4) Loan balances include non-accrual loans and are net of unearned income. (5) Loan yields include the effect of amortization of deferred fees, net of costs. 41 Rate/Volume Analysis. The following table shows the fully taxable equivalent effect of changes in volumes and rates on interest income and interest expense. Increase/(Decrease) Three months ended September 30, 2020 Compared to Three months ended September 30, 2019 Variance due to Volume Rate Net (dollars in thousands) Interest-earning assets: Interest-bearing deposits with banks $ 35 $ (22) $ 13 Securities available for sale: Taxable 4 (115) (111) Tax-exempt securities (229) 57 (172) Total securities (225) (58) (283) Loans receivable 5,968 (473) 5,495 Total interest-earning assets 5,778 (553) 5,225 Interest-bearing liabilities: Interest-bearing demand and money market 82 (63) 19 Savings 8 — 8 Time 631 (769) (138) Total interest-bearing deposits 721 (832) (111) Short-term borrowings 3 (77) (74) Other borrowings 51 (55) (4) Total interest-bearing liabilities 775 (964) (189) Net interest income (tax-equivalent basis) $ 5,003 $ 411 $ 5,414 Changes in net interest income that could not be specifically identified as either a rate or volume change were allocated proportionately to changes in volume and changes in rate. ‎ 42 Comparison of Operating Results for the Three Months Ended September 30, 2020 to September 30, 2019 General For the three months ended September 30, 2020, net income totaled $4,999,000 compared to $3,907,000 earned in the similar period in 2019. The increase in net income for the three months ended September 30, 2020 was due primarily to a $5,439,000 million improvement in net interest income which reflects the benefits realized from the merger of UpState. This increase was partially offset by an increase in the provision for loan losses and $386,000 of merger related expenses. Earnings per share for the three-months ended September 30, 2020 were $0.62 per share for basic shares and fully diluted shares compared to $0.62 per share for basic shares and fully diluted shares for the three months ended September 30, 2019. The resulting annualized return on average assets and annualized return on average equity for the three months ended September 30, 2020 were 1.11% and 10.64%, respectively, compared to 1.27% and 11.56%, respectively, for the same period in 2019. The following table sets forth changes in net income: (dollars in thousands) Three months ended September 30, 2020 to September 30, 2019 Net income three months ended September 30, 2019 $ 3,907 Change due to: Net interest income 5,439 Provision for loan losses (1,550) Net gains on sales 13 Other income 177 Salaries and employee benefits (1,145) Occupancy, furniture and equipment (193) Data processing related (266) FDIC insurance assessment (149) Merger related (386) All other expenses (450) Income tax expense (398) Net income three months ended September 30, 2020 $ 4,999 Net Interest Income Net interest income on a fully taxable equivalent basis (fte) for the three months ended September 30, 2020 totaled $15,547,000 which was $5,414,000 higher than the comparable period in 2019. The increase in net interest income was due primarily to a $5,495,000 increase in interest income (fte) on loans resulting from the acquisition of UpState. Tax-equivalent interest income was negatively impacted by a $283,000 decrease in securities income. The fte net interest spread and net interest margin were 3.55% and 3.73%, respectively, for the three months ended September 30, 2020 compared to 3.35% and 3.60%, respectively, for the same period in 2019. The increase in the net interest spread reflects the growth in average interest-earning assets. For the three-months ended September 30, 2020, interest income (fte) totaled $17,526,000 with a yield on average earning assets of 4.20% compared to $12,301,000 and 4.37% for the 2019 period. Average loans increased $493.2 million during the three-months ended September 30, 2020, over the comparable period of 2019, while average securities decreased $28.8 million as portfolio runoff was utilized to fund loan growth. Average earning assets totaled $1.668 billion for the three months ended September 30, 2020, an increase of $542.2 million over the average for the same period in 2019. All increases reflect growth resulting from the merger with UpState. Interest expense for the three months ended September 30, 2020 totaled $1,979,000 at an average cost of 0.65% compared to $2,168,000 and 1.02% for the same period in 2019. The decrease in average cost during the 2020 quarter reflects the overall lower level of interest rates. The average cost of time deposits, which is the most significant component of funding, decreased 0.74% during the period. Provision for Loan Losses The Company’s provision for loan losses for the three months ended September 30, 2020 was $1,850,000 compared to $300,000 for the three months ended September 30, 2019. The increased provision includes the increased risk related to the economic impact of the COVID-19 pandemic. The Company makes provisions for loan losses in an amount necessary to maintain the 43 allowance for loan losses at an acceptable level. Net charge-offs were $488,000 for the quarter ended September 30, 2020, compared to $123,000 for the similar period in 2019. At September 30, 2020, the allowance for loan losses represented 0.83% of loans receivable. Additionally, the allowance for loan losses represented 289% of non-performing loans, excluding loans acquired with credit quality deterioration. Other Income Other income totaled $2,072,000 for the three months ended September 30, 2020, compared to $1,882,000 for the same period in 2019. The increase was due primarily to a $101,000 increase in service charges and fees. Net gains from the sale of securities totaled $33,000 for the three-months ended September 30, 2020, compared to $169,000 in the three-months ended September 30, 2019. Net gains on the sale of loans totaled $164,000 for the three-months ended September 30, 2020 compared to $15,000 in the three-months ended September 30, 2019. Other Expense Other expense for the three months ended September 30, 2020 totaled $9,380,000, which was $2,589,000 higher than the same period of 2019, due primarily to the $386,000 of merger related expenses and costs associated with the operation of four community offices acquired in the UpState merger. Income Tax Expense Income tax expense totaled $1,173,000 for an effective tax rate of 19.0% for the period ended September 30, 2020 compared to $775,000 for an effective tax rate of 16.6% for the similar period in 2019. The increase in the effective tax rate in the 2020 period reflects the merger costs and the related tax-deductions. ‎ 44 Results of Operations NORWOOD FINANCIAL CORP Consolidated Average Balance Sheets with Resultant Interest and Rates (Tax-Equivalent Basis, Nine Months Ended September 30, dollars in thousands) 2020 2019 Average Average Average Average Balance Interest Rate Balance Interest Rate (2) (1) (3) (2) (1) (3) Assets Interest-earning assets: Interest bearing deposits with banks $ 51,705 $ 43 0.11% $ 3,853 $ 70 2.42% Securities available for sale: Taxable 144,582 2,182 2.01 152,404 2,545 2.23 Tax-exempt (1) 55,002 1,380 3.35 89,369 2,038 3.04 Total securities available for sale (1) 199,584 3,562 2.38 241,773 4,583 2.53 Loans receivable (1) (4) (5) 1,099,586 38,097 4.62 877,283 31,419 4.78 Total interest-earning assets 1,350,875 41,702 4.12 1,122,909 36,072 4.28 Non-interest earning assets: Cash and due from banks 17,752 14,473 Allowance for loan losses (9,692) (8,472) Other assets 93,351 79,743 Total non-interest earning assets 101,411 85,744 Total Assets $ 1,452,286 $ 1,208,653 Liabilities and Stockholders&apos; Equity Interest-bearing liabilities: Interest-bearing demand and money market $ 277,606 $ 468 0.22 $ 230,748 $ 486 0.28 Savings 191,164 81 0.06 172,148 77 0.06 Time 427,351 4,547 1.42 356,222 4,792 1.79 Total interest-bearing deposits 896,121 5,096 0.76 759,118 5,355 0.94 Short-term borrowings 54,957 244 0.59 48,957 344 0.94 Other borrowings 52,287 824 2.10 45,059 827 2.45 Total interest-bearing liabilities 1,003,365 6,164 0.82 853,134 6,526 1.02 Non-interest bearing liabilities: Demand deposits 274,297 210,900 Other liabilities 18,336 15,252 Total non-interest bearing liabilities 292,633 226,152 Stockholders&apos; equity 156,288 129,367 Total Liabilities and Stockholders&apos; Equity $ 1,452,286 $ 1,208,653 Net interest income/spread (tax equivalent basis) 35,538 3.30% 29,546 3.26% Tax-equivalent basis adjustment (676) (773) Net interest income $ 34,862 $ 28,773 Net interest margin (tax equivalent basis) 3.51% 3.51% (1) Interest and yields are presented on a tax-equivalent basis using a marginal tax rate of 21%. (2) Average balances have been calculated based on daily balances. (3) Annualized (4) Loan balances include non-accrual loans and are net of unearned income. (5) Loan yields include the effect of amortization of deferred fees, net of costs. 45 Rate/Volume Analysis. The following table shows the fully taxable equivalent effect of changes in volumes and rates on interest income and interest expense Increase/(Decrease) Nine months ended September 30, 2020 Compared to Nine months ended September 30, 2019 Variance due to Volume Rate Net (dollars in thousands) Interest-earning assets: Interest-bearing deposits with banks $ 75 $ (102) $ (27) Securities available for sale: Taxable (120) (243) (363) Tax-exempt securities (722) 64 (658) Total securities (842) (179) (1,021) Loans receivable 6,998 (320) 6,678 Total interest-earning assets 6,231 (601) 5,630 Interest-bearing liabilities: Interest-bearing demand and money market 88 (106) (18) Savings 4 — 4 Time 826 (1,071) (245) Total interest-bearing deposits 918 (1,177) (259) Short-term borrowings 29 (129) (100) Other borrowings 123 (126) (3) Total interest-bearing liabilities 1,070 (1,432) (362) Net interest income (tax-equivalent basis) $ 5,161 $ 831 $ 5,992 Comparison of Operating Results for the Nine Months Ended September 30, 2020 to September 30, 2019 General For the nine months ended September 30, 2020, net income totaled $9,567,000 compared to $10,619,000 earned in the similar period in 2019. The decrease in net income for the nine months ended September 30, 2020 was due primarily to a $2,800,000 increase in the provision for loan losses and $1,983,000 of merger related expenses. Earnings per share for the current period were $1.39 per share for basic shares and fully diluted shares compared to $1.70 per share for basic shares and $1.68 per share for fully diluted shares for the nine months ended September 30, 2019. The resulting annualized return on average assets and annualized return on average equity for the nine months ended September 30, 2020 were 0.88% and 8.13%, respectively, compared to 1.17% and 10.97%, respectively, for the similar period in 2019. The following table sets forth changes in net income: (dollars in thousands) Nine months ended September 30, 2020 to September 30, 2019 Net income nine months ended September 30, 2019 $ 10,619 Change due to: Net interest income 6,089 Provision for loan losses (2,800) Net gains on sales (2) Other income 38 Salaries and employee benefits (963) Occupancy, furniture and equipment (203) Data processing related (249) FDIC insurance assessment (36) Merger related (1,983) All other expenses (873) Income tax expense (70) Net income nine months ended September 30, 2020 $ 9,567 46 Net Interest Income Net interest income on a fully taxable equivalent basis (fte) for the nine months ended September 30, 2020 totaled $35,538,000 which was $5,992,000 higher than the comparable period in 2019. The increase in net interest income was due primarily to a $6,678,000 increase in interest income (fte) on loans resulting from the merger with UpState. Tax-equivalent interest income was negatively impacted by a $1,021,000 decrease in securities income. The fte net interest spread and net interest margin were 3.30% and 3.51%, respectively, for the nine months ended September 30, 2020 compared to 3.26% and 3.51%, respectively, for the similar period in 2019. The increase in the net interest spread reflects the growth in loans resulting from the UpState merger. Interest income (fte) totaled $41,702,000 with a yield on average earning assets of 4.12% compared to $36,072,000 and 4.28% for the 2019 period. Average loans increased $222.3 million over the comparable period of last year, while average securities decreased $42.2 million as portfolio runoff was utilized to fund loan growth. Average earning assets totaled $1.351 billion for the nine months ended September 30, 2020, an increase of $228.0 million over the average for the similar period in 2019. All increases reflect assets acquired from UpState. Interest expense for the nine months ended September 30, 2020 totaled $6,164,000 at an average cost of 0.82% compared to $6,526,000 and 1.02% for the similar period in 2019. The decrease in average cost reflects the overall lower level of interest rates. The average cost of time deposits, which is the most significant component of funding, decreased to 1.42 % from 1.79% for the similar period in the prior year. Provision for Loan Losses The Company’s provision for loan losses for the nine months ended September 30, 2020 was $3,850,000 compared to $1,050,000 for the nine months ended September 30, 2019. The increased provision includes the increased risk related to the economic impact of the COVID-19 pandemic. The Company makes provisions for loan losses in an amount necessary to maintain the allowance for loan losses at an acceptable level. Net charge-offs were $685,000 for the nine months ended September 30, 2020 compared to $1,097,000 for the similar period in 2019. At September 30, 2020, the allowance for loan losses represented 0.83% of loans receivable. Additionally, the allowance for loan losses represented 289% of non-performing loans, excluding loans acquired with credit quality deterioration. Other Income Other income totaled $5,119,000 for the nine months ended September 30, 2020 compared to $5,083,000 for the similar period in 2019. The increase was due primarily to a $79,000 increase related to fiduciary activities. All other items included in other income decreased $43,000, net. Net gains from the sale of securities totaled $71,000 for the nine-months ended September 30, 2020, compared to $233,000 in the nine-months ended September 30, 2019. Net gains on the sale of loans totaled $285,000 for the nine-months ended September 30, 2020 compared to $125,000 in the nine-months ended September 30, 2019. Other Expense Other expense for the nine months ended September 30, 2020 totaled $24,531,000 which was $4,307,000 higher than the same period of 2019 due primarily to $1,983,00 of merger related expenses and costs associated with the operation of four community offices acquired in the UpState merger. Income Tax Expense Income tax expense totaled $2,033,000 for an effective tax rate of 17.5% for the nine months ended September 30, 2020 compared to $1,963,000 for an effective tax rate of 15.6% for the similar period in 2019.