What changed in this filing

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Item 2. Management’s Discussion and Analysis

2023-05-12 compared with 2022-11-10 · 104 added, 230 removed, 166 unchanged (67% of the section changed)

4 unchanged sentences

The actual results of the Company could differ materially from those management expectations.

This includes statements regarding general economic conditions, public health crisis such as the governmental, social and economic effects of the novel coronavirus, legislative and regulatory changes, monetary and fiscal policies of the federal government, changes in tax policies, rates and regulations of federal, state and local tax authorities and failure to integrate or profitably operate acquired businesses.

This includes statements regarding general economic conditions, public health crisis such as the governmental, social and economic effects of the COVID 19 pandemic, legislative and regulatory changes, monetary and fiscal policies of the federal government, changes in tax policies, rates and regulations of federal, state and local tax authorities and failure to integrate or profitably operate acquired businesses.

Additional potential factors include changes in interest rates, the rate of inflation, deposit flows, cost of funds, demand for loan products and financial services, competition and changes in the quality or composition of loan and investment portfolios of the Company.

operations, markets, products, services and prices.

Other factors that could cause future results to vary from current management expectations include changes in accounting principles, policies or guidelines, and other economic, competitive, governmental and technological factors affecting the Company’s operations, markets, products, services and prices, instability in the banking system, the potential for a recessionary economy and any adverse impact resulting from the COVID 19 pandemic.

Further description of the risks and uncertainties to the business are included in the Company’s other filings with the Securities and Exchange Commission.

In addition, the COVID-19 pandemic has had, and may continue to have, an adverse impact on the Company and the communities it serves.

Given its ongoing and dynamic nature, it is difficult to predict the full impact of the COVID-19 pandemic on our business.

The extent of such impact will depend on future developments, which are highly uncertain, including whether the coronavirus can continue to be controlled and abated.

As the result of the COVID-19 pandemic and the related adverse local and national economic consequences, we could be subject to any of the following risks, any of which could have a material, adverse effect on our business, financial condition, liquidity, and results of operations:

the demand for our products and services may decline, making it difficult to grow assets and income;

if the economy worsens, loan delinquencies, problem assets, and foreclosures may increase, resulting in increased charges and reduced income;

collateral for loans, especially real estate, may decline in value, which could cause loan losses to increase;

our allowance for credit losses may increase if borrowers experience financial difficulties, which will adversely affect our net income;

the net worth and liquidity of loan guarantors may decline, impairing their ability to honor commitments to us;

due to a decline in our stock price or other factors, goodwill may become impaired and be required to be written down;

and our cyber security risks are increased as the result of an increase in the number of employees working remotely.

During 2022, the Federal Reserve took unprecedented action during the year to restrain inflation and improve the stability of the economy by raising the target federal funds rate several times from 25 basis points in the beginning of the year to 75 basis points toward the end of the year and brought the benchmark interest rates up by a collective 4.50 percent.

During the first quarter 2023, the Federal Reserve increased the target federal funds rate another 0.25 percent and further increased the target federal funds rate another 0.25 percent in May 2023.

The Federal Reserve may further increase the target federal funds rate in 2023 in an attempt to reduce inflation.

Any substantial or unexpected change in market interest rates could have a material adverse effect on the Company’s financial condition and results of operations.

As inflation increases and market interest rates rise, the value of our investment securities, particularly those with longer maturities, would decrease, although this effect can be less pronounced for floating rate instruments.

In addition, inflation generally increases the cost of goods and services we use in our business operations, such as electricity and other utilities, which increases our non-interest expenses.

Furthermore, our customers are also affected by inflation and the rising costs of goods and services used in their households and businesses, which could have a negative impact on their ability to repay their loans with us.

In addition, r ecent bank failures have led to a greater focus by institutions, investors and regulators on the on-balance sheet liquidity of and funding sources for financial institutions, the composition of its deposits, including the amount of uninsured deposits, the amount of accumulated other comprehensive loss, capital levels and interest rate risk management.

If we are unable to adequately manage our liquidity, deposits, capital levels and interest rate risk, it may have a material adverse effect on our financial condition and results of operations.

The majority of the assets and liabilities of a financial institution are monetary in nature, and therefore, differ greatly from most commercial and industrial companies that have significant investments in fixed assets or inventories.

6 unchanged sentences

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-temporary impairment on securities and the determination of goodwill impairment.

Please refer to the discussion of the allowance for loan losses calculation under “Changes in Financial Condition - Loans” below.

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.

See Note 1, "Basis of Presentation"

for additional information on the adoption of ASC 326, which changes the methodology under which management calculates its reserve for loans and investment securities, now referred to as the allowance for credit losses.

Management considers the measurement of the allowance for credit losses to be a critical accounting policy.

Material estimates that are particularly susceptible to significant change in the near term relate to the determination of the allowance for credit losses, the valuation of deferred tax assets, the fair value of financial instruments, and the determination of goodwill impairment.

Please refer to the discussion of the allowance for credit losses calculation under “Changes in Financial Condition - Loans” below.

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.

3 unchanged sentences

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.

Decreases 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, 2022 and December 31, 2021 represent temporary impairment of the securities, related to changes in interest rates.

In connection with acquisitions, the Company recorded goodwill in the amount of $29.3 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.

4 unchanged sentences

Changes in Financial Condition

Total assets as of September 30, 2022 were $2.019 billion compared to $2.069 billion as of December 31, 2021.

The decrease was due primarily to a $167.8 million decrease in interest-bearing deposits with banks.

Interest-bearing balances with banks decreased as overnight liquidity was utilized to fund growth in loans and securities, and to pay off long-term borrowings.

The decrease was partially offset by a $77.4 million increase in loans receivable, and a $20.5 million increase in securities available for sale.

The fair value of securities available for sale as of September 30, 2022 was $427.3 million compared to $406.8 million as of December 31, 2021.

The increase in the securities portfolio is the result of purchases executed to invest excess liquidity and to provide pledging for public deposits.

The Company has securities in an unrealized loss position.

Total assets as of March 31, 2023 were $2.104 billion compared to $2.047 billion as of December 31, 2022.

The increase was due primarily to a $61.7 million increase in loans receivable.

The fair value of securities available for sale as of March 31, 2023 was $418.2 million compared to $418.9 million as of December 31, 2022.

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 receivable totaled $1.432 billion at September 30, 2022 compared to $1.355 billion as of December 31, 2021.

The $77.4 million increase in loans receivable during the nine months ended September 30, 2022, was due to a $15.9 million increase in commercial real estate loans, a $22.1 million increase in residential mortgage loans, and a $30.3 million increase in consumer loans.

The allowance for loan losses totaled $16,931,000 as of September 30, 2022, and represented 1.18% of total loans outstanding, compared to $16,442,000, or 1.21% of total loans outstanding, at December 31, 2021.

The Company had net charge-offs for the nine months ended September 30, 2022 of $111,000, compared to $797,000 in the corresponding period in 2021.

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 2022 which are specifically related to the economic impact of the COVID-19 pandemic.

Management considers the allowance for loan losses adequate at September 30, 2022 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, which might be incurred in the future.

As of September 30, 2022, non-performing loans totaled $618,000 or 0.04% of total loans compared to $734,000, or 0.05%, of total loans at December 31, 2021.

At September 30, 2022, non-performing assets totaled $964,000, or 0.05%, of total assets, compared to $2,476,000, or 0.12%, of total assets at December 31, 2021.

The decrease in non-performing assets during the nine month period ended September 30, 2022, was due to sales of properties included in foreclosed real estate.

The Company concluded that the decline in the value of these securities was not indicative of a credit loss.

The Company did not recognize any credit losses on these available for sale debt securities for the three months ended March 31, 2023, or other-than-temporary impairment charges for the three months ended March 31, 2022.

The Company does not have the intent to sell the securities and it is more likely than not that it will not have to sell the securities before recovery of its cost basis.

Loans receivable totaled $1.536 billion at March 31, 2023 compared to $1.474 billion as of December 31, 2022.

The $61.7 million increase in loans receivable during the three months ended March 31, 2023, was due primarily to a $16.8 million increase in commercial real estate loans, a $20.6 million increase in commercial loans and a $23.1 million increase in consumer loans.

The allowance for credit losses totaled $19,445,000 as of March 31, 2023, and represented 1.27% of total loans outstanding, compared to $16,999,000, or 1.15% of total loans outstanding, at December 31, 2022.

The Company had net charge-offs for the three months ended March 31, 2023 of $320,000, compared to $82,000 in the corresponding period in 2022.

The Company’s management assesses the adequacy of the allowance for credit losses on a quarterly basis.

Based on management’s best judgement, the qualitative factors are applied to the final adjusted loss rate each quarter.

Management considers the allowance for credit losses adequate at March 31, 2023 based on the Company’s criteria.

However, there can be no assurance that the allowance for credit losses will be adequate to cover significant losses, if any, which might be incurred in the future.

As of March 31, 2023, non-performing loans totaled $2,714,000 or 0.18% of total loans compared to $1,113,000, or 0.08%, of total loans at December 31, 2022.

At March 31, 2023, non-performing assets totaled $3,060,000, or 0.15%, of total assets, compared to $1,459,000, or 0.07%, of total assets at December 31, 2022.

The following table sets forth information regarding non-performing loans and foreclosed real estate at the dates indicated:

(dollars in thousands)

September 30, 2022

March 31, 2023

December 31, 2022

10 unchanged sentences

Purchased credit impaired loans (a)

Allowance for loans losses

Allowance for credit losses

Coverage of non-performing loans (a) (b)

3 unchanged sentences

(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.

Prior to 2023, 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, 2022, total deposits increased $12.0 million due primarily to growth in interest-bearing demand deposits.

(b) Prior to 2023, 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 three-months ended March 31, 2023, total deposits increased $28.2 million due primarily to a $78.1 million increase in certificates of deposit.

All other deposit categories decreased $49.9 million, net.

The following table sets forth deposit balances as of the dates indicated:

(dollars in thousands)

September 30, 2022

March 31, 2023

December 31, 2022

4 unchanged sentences

Time deposits >$250,000

Short-term borrowings increased $10.9 million to $71.7 million at September 30, 2022, compared to $60.8 million at December 31, 2021, due primarily to an increase in cash management account balances.

Other borrowings as of September 30, 2022, were $0 compared to $30.0 million as of December 31, 2021.

The decrease reflects the early payoff of $25.5 million Federal Home Loan Bank term borrowings.

A prepayment fee of $3,000 was recognized in other expense during the nine months ended September 30, 2022.

Short-term borrowings, which consist of securities sold under agreements to repurchase and overnight borrowings from the FHLB, increased $10.9 million due to growth in repurchase agreements.

Short-term borrowings increased $15.3 million to $108.5 million at March 31, 2023, compared to $93.2 million at December 31, 2022, due primarily to an increase in overnight borrowings to fund liquidity needs.

Other borrowings as of March 31, 2023, were $40.2 compared to $40.0 million as of December 31, 2022.

Federal Home Loan Bank borrowings decreased $9.8 million during the period due to scheduled principal reductions.

A new $10.0 million term borrowing that was initiated under the Federal Reserve Long-Term Funding Program contributed to the variance.

Other borrowings consisted of the following:

(dollars in thousands)

September 30, 2022

March 31, 2023

December 31, 2022

Notes with the FHLB:

Amortizing fixed rate borrowing due March 2022 at 1.75%

Amortizing fixed rate borrowing due August 2022 at 1.94%

Amortizing fixed rate borrowing due October 2022 at 1.88%

Amortizing fixed rate borrowing due October 2023 at 3.24%

Amortizing fixed rate borrowing due December 2023 at 5.08%

Fixed rate term borrowing due December 2023 at 1.95%

Amortizing fixed rate borrowing due December 2023 at 1.73%

Amortizing fixed rate borrowing due April 2024 at 0.91%

Notes with the Federal Reserve Bank

Fixed rate borrowing due March 2024 at 4.83%

Stockholders’ Equity and Capital Ratios

As of September 30, 2022, total stockholders’ equity was $158.8 million, compared to $205.3 million as of December 31, 2021.

Total stockholders’ equity decreased $60.3 million due to a decrease in the fair value of securities in the available-for-sale portfolio, net of tax, and $6.9 million of dividends declared.

The decrease in fair value is the result of a change in interest rates and spreads, which may impact the value of the securities.

The decrease in total stockholders’ equity was partially offset by $22.1 million of net income.

As of March 31, 2023, total stockholders’ equity was $176.4 million, compared to $167.1 million as of December 31, 2022.

Total stockholders’ equity increased $7.4 million due to an increase in the fair value of securities in the available-for-sale portfolio, net of tax, and $5.8 million of net income, offset partially by $2.4 million of dividends declared.

The increase in fair value of securities 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, 2022

March 31, 2023

December 31, 2022

10 unchanged sentences

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, 2022.

As of September 30, 2022, the Company had cash and cash equivalents of $40.9 million in the form of cash, due from banks and short-term deposits with other institutions.

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 March 31, 2022.

In December 2018, the Federal Reserve announced that a banking organization that experiences a reduction in retained earnings due to the CECL adoption as of the beginning of the fiscal year in which CECL is adopted may elect to phase in the regulatory capital impact of adopting CECL.

Transitional amounts are calculated for the following items:

retained earnings, temporary difference deferred tax assets and credit loss allowances eligible for inclusion in regulatory capital.

When calculating regulatory capital ratios, 25% of the transitional amounts are phased in during the first year.

An additional 25% of the transitional amounts are phased in over each of the next two years and at the beginning of the fourth year, the day-one effects of CECL are completely reflected in regulatory capital.

The Company adopted the transition guidance applied these effects to regulatory capital in the first quarter of 2023 upon adoption of CECL.

See Note 1, "Basis of Presentation"

for additional information on the adoption of CECL.

As of March 31, 2023, the Company had cash and cash equivalents of $29.0 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 $418.2 million which could be used for liquidity needs.

Total liquidity of $468.2 million as of September 30, 2022, represents 23.2% of total assets compared to $613.5 million and 29.7% of total assets as of December 31, 2021.

The Company also monitors other liquidity measures, all of which were within the Company’s policy guidelines as of September 30, 2022 and December 31, 2021.

Total liquidity of $447.3 million as of March 31, 2023, represents 21.3% of total assets compared to $450.8 million and 22.0% of total assets as of December 31, 2022.

The Company also monitors other liquidity measures, all of which were within the Company’s policy guidelines as of March 31, 2023 and December 31, 2022.

Based upon these measures, the Company believes its liquidity is adequate.

1 unchanged sentence

The Company has a line of credit commitment from Atlantic Community Bankers Bank for $7,000,000 which expires June 30, 2023.

There were no borrowings under this line as of September 30, 2022 and December 31, 2021.

There were no borrowings under this line as of March 31, 2023 and December 31, 2022.

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, 2022 and December 31, 2021.

There were no borrowings under this line as of March 31, 2023 and December 31, 2022.

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, 2022 and December 31, 2021.

The Bank’s maximum borrowing capacity with the Federal Home Loan Bank was approximately $642,371,000 as of September 30, 2022, of which $0 was outstanding in the form of borrowings as of September 30, 2022.

There were no borrowings under this line as of March 31, 2023 and December 31, 2022.

The Bank’s maximum borrowing capacity with the Federal Home Loan Bank was approximately $660,403,000 as of March 31, 2023, of which $93,366,000 was outstanding in the form of borrowings as of March 31, 2023.

As of December 31, 2022, the maximum borrowing capacity was $655,344,000, of which $82,264,000 of borrowings was outstanding as of December 31, 2022.

Additionally, as of September 30, 2022, the Bank had secured Letters of Credit from the Federal Home Loan Bank in the amount of $101,400,000 as collateral for specific municipal deposits.

Additionally, as of March 31, 2023, the Bank had secured Letters of Credit from the Federal Home Loan Bank in the amount of $97,450,000 as collateral for specific municipal deposits.

These Letters of Credit reduce the availability under the maximum borrowing capacity.

12 unchanged sentences

(Tax-Equivalent Basis,

Three Months Ended September 30,

Three Months Ended March 31,

dollars in thousands)

8 unchanged sentences

Cash and due from banks

Allowance for loan losses

Allowance for credit losses

Total non-interest earning assets

24 unchanged sentences

Increase/(Decrease)

Three months ended September 30, 2022 Compared to

Three months ended September 30, 2021

Three months ended March 31, 2023 Compared to

Three months ended March 31, 2022

Variance due to

15 unchanged sentences

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.

Comparison of Operating Results for the Three Months Ended September 30, 2022 to September 30, 2021

For the three months ended September 30, 2022, net income totaled $8,109,000 compared to $6,981,000 earned in the same period in 2021.

The increase in net income for the three months ended September 30, 2022 was due primarily to a $1,181,000 increase in net interest income and a $750,000 decrease in the provision for loan losses.

Earnings per share for the three-months ended September 30, 2022 were $1.00 per share for basic shares and fully diluted shares, compared to $0.85 per share for basic shares and for fully diluted shares for the three months ended September 30, 2021.

The resulting annualized return on average assets and annualized return on average equity for the three months ended September 30, 2022 were 1.57% and 17.93%, respectively, compared to 1.36% and 13.50%, respectively, for the same period in 2021.

Comparison of Operating Results for the Three Months Ended March 31, 2023 to March 31, 2022

For the three months ended March 31, 2023, net income totaled $5,782,000 compared to $7,128,000 earned in the three months ended March 31, 2022.

The decrease in net income for the three months ended March 31, 2023 was due primarily to a $1,426,000 decrease in total other income.

Earnings per share for the three-months ended March 31, 2023 were $0.71 per share for basic shares and fully diluted shares, compared to $0.87 per share for basic shares and for fully diluted shares for the three months ended March 31, 2022.

The resulting annualized return on average assets and annualized return on average equity for the three months ended March 31, 2023 were 1.13% and 13.61%, respectively, compared to 1.39% and 14.22%, respectively, for the same period in 2022.

The following table sets forth changes in net income:

1 unchanged sentence

Three months ended

September 30, 2022 to September 30, 2021

Net income three months ended September 30, 2021

Change due to:

Net interest income

Provision for loan losses

Net gains on sales of securities and loans

Service charges and fees

Earnings and proceeds on bank-owned life insurance

Salaries and employee benefits

Occupancy, furniture and equipment

All other expenses

Income tax expense

Net income three months ended September 30, 2022

Net Interest Income

Net interest income on a fully taxable equivalent basis (fte) for the three months ended September 30, 2022 totaled $18,369,000 which was $1,183,000 higher than the comparable period in 2021.

The increase in net interest income was due primarily to a $1,026,000 increase in interest income (fte) on securities due to purchases of securities.

The fte net interest spread and net interest margin were 3.61% and 3.74%, respectively, for the three months ended September 30, 2022 compared to 3.49% and 3.61%, respectively, for the same period in 2021.

See “Non-GAAP Financial Measures” described above on page 35.

For the three-months ended September 30, 2022, interest income (fte) totaled $20,031,000 with a yield on average earning assets of 4.08% compared to $18,596,000 and 3.90% for the 2021 period.

Average loans increased $36.5 million during the three-months ended September 30, 2022, over the comparable period of 2021, while average securities increased $157.7 million.

Average earning assets totaled $1.966 billion for the three months ended September 30, 2022, an increase of $59.0 million over the average for the same period in 2021.

See “Non-GAAP Financial Measures” described above on page 35.

Interest expense for the three months ended September 30, 2022 totaled $1,662,000 at an average cost of 0.47% compared to $1,410,000 and 0.41%, respectively, for the same period in 2021.

The increase in interest expense during the three-months ended September 30, 2022 reflects the overall higher level of market interest rates.

The average cost of time deposits, which is the most significant component of funding costs, increased 0.24% compared to the same three-month period of last year.

Provision for Loan Losses

The Company’s provision for loan losses for the three months ended September 30, 2022 was $0, compared to $750,000 for the three months ended September 30, 2021.

The decreased provision reflects a reduction in certain qualitative factors related to 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.

The Company recorded a net charge-off of $86,000 for the quarter ended September 30, 2022, compared to a net recovery of $13,000 for the similar period in 2021.

At September 30, 2022, the allowance for loan losses represented 1.18% of loans receivable.

Additionally, the allowance for loan losses represented 2,740% of non-performing loans, excluding loans acquired with credit quality deterioration.

Other income totaled $2,178,000 for the three months ended September 30, 2022, compared to $2,159,000 for the same period in 2021.

The increase was due primarily to a $67,000 increase in earnings and proceeds on bank-owned life insurance policies, and a $185,000 increase in other income.

Gains on sales of assets decreased $104,000, while all other categories of other income decreased $129,000, net.

Other Expense

Other expense for the three months ended September 30, 2022 totaled $10,139,000 which was $516,000, or 5.4%, higher than the same period of 2021, due primarily to a $142,000 increase in data processing costs, and a $165,000 increase in professional fees.

All other categories of other expense increased $209,000, net.

Income Tax Expense

Income tax expense totaled $2,100,000 for an effective tax rate of 20.6% for the three months ended September 30, 2022 compared to $1,794,000 for an effective tax rate of 20.5% for the three months ended September 30, 2021.

The increase in the effective tax rate in the 2022 period reflects the increased level of taxable income.

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)

Interest-earning assets:

Interest bearing deposits with banks

Securities available for sale:

Tax-exempt (1)

Total securities available for sale (1)

Loans receivable (1) (4) (5)

Total interest-earning assets

Non-interest earning assets:

Cash and due from banks

Allowance for loan losses

Total non-interest earning assets

Liabilities and Stockholders'

Interest-bearing liabilities:

Interest-bearing demand and money market

Total interest-bearing deposits

Short-term borrowings

Other borrowings

Total interest-bearing liabilities

Non-interest bearing liabilities:

Demand deposits

Other liabilities

Total non-interest bearing liabilities

Stockholders'

Total Liabilities and Stockholders'

Net interest income/spread (tax equivalent basis)

Tax-equivalent basis adjustment

Net interest income

Net interest margin (tax equivalent basis)

(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.

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, 2022 Compared to

Nine months ended September 30, 2021

Variance due to

(dollars in thousands)

Interest-earning assets:

Interest-bearing deposits with banks

Securities available for sale:

Tax-exempt securities

Total securities

Loans receivable

Total interest-earning assets

Interest-bearing liabilities:

Interest-bearing demand and money market

Total interest-bearing deposits

Short-term borrowings

Other borrowings

Total interest-bearing liabilities

Net interest income (tax-equivalent basis)

Comparison of Operating Results for the Nine Months Ended September 30, 2022 to September 30, 2021

For the nine months ended September 30, 2022, net income totaled $22,093,000 compared to $18,277,000 earned in the similar period in 2021.

The increase in net income for the nine months ended September 30, 2022 was due primarily to a $2,347,000 increase in net interest income, a $1,671,000 increase in other income, and a $3,150,000 decrease in the provision for loan losses.

Earnings per share for the nine-months ended September 30, 2022 were $2.71 per share for basic shares and fully diluted shares, compared to $2.23 per share for basic shares and for fully diluted shares for the nine months ended September 30, 2021.

The resulting annualized return on average assets and annualized return on average equity for the nine months ended September 30, 2022 were 1.44% and 15.73%, respectively, compared to 1.23% and 12.19%, respectively, for the same period in 2021.

The following table sets forth changes in net income:

(dollars in thousands)

Nine months ended

September 30, 2022 to September 30, 2021

Net income nine months ended September 30, 2021

March 31, 2023 to March 31, 2022

Net income three months ended March 31, 2022

Change due to:

Net interest income

Provision for loan losses

Service charges and fees

Net gains on sales of securities and loans

Net gains on sales of foreclosed real estate owned

Service charges and fees

Earnings and proceeds on bank-owned life insurance

1 unchanged sentence

Occupancy, furniture and equipment

Data processing related

Professional fees

All other expenses

Income tax expense

Net income nine months ended September 30, 2022

Net income three months ended March 31, 2023

Net Interest Income

Net interest income on a fully taxable equivalent basis (fte) for the nine months ended September 30, 2022 totaled $51,734,000 which was $2,305,000 higher than the comparable period in 2021.

The increase in net interest income was due primarily to a $2,691,000 increase in interest income (fte) on securities due to purchases of securities.

The fte net interest spread and net interest margin were 3.41% and 3.52%, respectively, for the nine months ended September 30, 2022 compared to 3.43% and 3.54%, respectively, for the same period in 2021.

Net interest income on a fully taxable equivalent basis (fte) for the three months ended March 31, 2023 totaled $16,275,000 which was $8,000 lower than the comparable period in 2022.

The decrease in net interest income was due primarily to a $4,372,000 increase in total interest expense, which slightly offset the $4,364,000 increase in in total interest income (fte).

The fte net interest spread and net interest margin were 2.83% and 3.25%, respectively, for the three months ended March 31, 2023 compared to 3.22% and 3.32%, respectively, for the same period in 2022.

See “Non-GAAP Financial Measures” described above on page 38.

For the nine-months ended September 30, 2022, interest income (fte) totaled $55,841,000 with a yield on average earning assets of 3.80% compared to $53,829,000 and 3.86% for the 2021 period.

Average loans decreased $14.0 million during the nine-months ended September 30, 2022, over the comparable period of 2021, while average securities increased $174.6 million.

Average earning assets totaled $1.962 billion for the nine months ended September 30, 2022, an increase of $102.2 million over the average for the same period in 2021.

For the three-months ended March 31, 2023, interest income (fte) totaled $21,893,000 with a yield on average earning assets of 4.37% compared to $17,529,000 and 3.57% for the 2022 period.

Average loans increased $151.9 million during the three-months ended March 31, 2023, over the comparable period of 2022, while average securities increased $54.0 million.

Average earning assets totaled $2.004 billion for the three months ended March 31, 2023, an increase of $42.1 million, over the average for the same period in 2022.

See “Non-GAAP Financial Measures” described above on page 38.

Interest expense for the nine months ended September 30, 2022 totaled $4,107,000 at an average cost of 0.39% compared to $4,400,000 and 0.43%, respectively, for the same period in 2021.

The decrease in interest expense during the nine-months ended September 30, 2022 reflects a higher level of average demand deposits and lower costing non-maturity interest-bearing deposits.

The average cost of time deposits, which is the most significant component of funding costs, increased .02% compared to the same nine-month period of last year.

Provision for Loan Losses

The Company’s provision for loan losses for the nine months ended September 30, 2022 was $600,000, compared to $3,750,000 for the nine months ended September 30, 2021.

The decreased provision reflects a reduction in certain qualitative factors

related to 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.

The Company recorded a net charge-off of $111,000 for the nine months ended September 30, 2022, compared to a net charge-off of $797,000 for the same period in 2021.

At September 30, 2022, the allowance for loan losses represented 1.18% of loans receivable.

Additionally, the allowance for loan losses represented 2,740% of non-performing loans, excluding loans acquired with credit quality deterioration.

Other income totaled $8,006,000 for the nine months ended September 30, 2022, compared to $6,335,000 for the same period in 2021.

The increase was due primarily to $1,104,000 of income recognized on previously acquired purchased impaired loans that were carried at a discount, and a $427,000 gain on the sale of a property carried in foreclosed real estate owned.

All other categories of other income increased $171,000, net.

Interest expense for the three months ended March 31, 2023 totaled $5,618,000 at an average cost of 1.54% compared to $1,246,000 and 0.35%, respectively, for the same period in 2022.

The increase in interest expense during the three-months ended March 31, 2023 reflects the overall higher level of market interest rates.

During the three months ended March 31, 2023, the average cost of time deposits, which is the most significant component of funding costs, increased 1.79% compared to the same three-month period of last year, while short-term borrowing costs increased 2.75% and other borrowing costs increased 3.12% compared to the same three-month period of last year.

Provision for Credit Losses

The Company’s provision for credit losses for the three months ended March 31, 2023 was $300,000, compared to $300,000 for the three months ended March 31, 2022.

The Company makes provisions for credit losses in an amount necessary to maintain the allowance for credit losses at an acceptable level.

The Company recorded a net charge-off of $320,000 for the quarter ended March 31, 2023, compared to a net charge-off of $82,000 for the similar period in 2022.

At March 31, 2023, the allowance for credit

losses related to loans receivable represented 1.27% of loans receivable.

Additionally, at March 31, 2023, the allowance for credit losses related to loans receivable represented 0.07% of non-performing loans.

Other income totaled $1,912,000 for the three months ended March 31, 2023, compared to $3,338,000 for the same period in 2022.

The decrease was due primarily to $873,000 of income recognized in 2022 on payoffs of purchased impaired loans that were carried at a discount.

Gains on sales of foreclosed real estate owned decreased $427,000, while all other categories of other income decreased $126,000, net.

Other Expense

Other expense for the nine months ended September 30, 2022 totaled $30,768,000, which was $2,201,000, or 7.7%, higher than the same period of 2021, due primarily to a $1,208,000 increase in salaries and employee benefits costs.

Other expense for the three months ended March 31, 2023 totaled $10,436,000 which was $279,000, or 2.7%, higher than the same period of 2022, due primarily to a $538,000 increase in salaries and employee benefits.

All other categories of other expense decreased $259,000, net.

Income Tax Expense

Income tax expense totaled $5,709,000 for an effective tax rate of 20.5% for the nine months ended September 30, 2022 compared to $4,558,000 for an effective tax rate of 20.0% for the nine months ended September 30, 2021.

The increase in the effective tax rate in the 2022 period reflects the increased level of taxable income.

Income tax expense totaled $1,487,000 for an effective tax rate of 20.5% for the three months ended March 31, 2023 compared to $1,854,000 for an effective tax rate of 20.7% for the three months ended March 31, 2022.

The decrease in the effective tax rate in the 2023 period reflects the decreased level of taxable income.

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What changed 10-Q

Item 2. Management’s Discussion and Analysis