OHIO VALLEY BANC CORP 10-Q

ITEM 2. MANAGEMENT’S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS OF OPERATIONS (dollars in thousands, except share and per share data) Forward Looking Statements Certain statements contained in this report and other publicly available documents incorporated herein by reference constitute "forward looking statements" within the meaning of Section 27A of the Securities Act of 1933, as amended, and Section 21E of the Securities Act of 1934, as amended, and as defined in the Private Securities Litigation Reform Act of 1995. Such statements are often, but not always, identified by the use of such words as “believes,” “anticipates,” “expects,” “intends,” “plan,” “goal,” “seek,” “project,” “estimate,” “strategy,” “future,” “likely,” “may,” “should,” “will,” and similar expressions. Such statements involve various important assumptions, risks, uncertainties, and other factors, many of which are beyond our control, particularly with regard to developments related to COVID-19, and which could cause actual results to differ materially from those expressed in such forward looking statements. These factors include, but are not limited to: the effects of COVID-19 on our business, operations, customers and capital position; higher default rates on loans made to our customers related to COVID-19 and its impact on our customers’ operations and financial condition; the impact of COVID-19 on local, national and global economic conditions; unexpected changes in interest rates or disruptions in the mortgage market related to COVID-19 or responses to the health crisis; the effects of various governmental responses to COVID-19; political uncertainty caused by, among other things, political parties, tensions surrounding the current socioeconomic landscape, and the 2020 U.S. Presidential election; changes in political, economic or other factors, such as inflation rates, recessionary or expansive trends, taxes, the effects of implementation of legislation and the continuing economic uncertainty in various parts of the world; competitive pressures; fluctuations in interest rates; the level of defaults and prepayment on loans made by the Company; unanticipated litigation, claims, or assessments; fluctuations in the cost of obtaining funds to make loans; and regulatory changes. Additional detailed information concerning such factors is available in the Company’s filings with the Securities and Exchange Commission, under the Securities Exchange Act of 1934, including the disclosure under the heading “Item 1A. Risk Factors” of Part II of the Quarterly Report on Form 10-Q for the quarter ended March 31, 2020, and Part I of the Company’s Annual Report on Form 10-K for the fiscal year ended December 31, 2019. Readers are cautioned not to place undue reliance on such forward looking statements, which speak only as of the date hereof. The Company undertakes no obligation and disclaims any intention to republish revised or updated forward looking statements, whether as a result of new information, unanticipated future events or otherwise. Financial Overview BUSINESS OVERVIEW: The Company is primarily engaged in commercial and retail banking, offering a blend of commercial and consumer banking services within southeastern Ohio as well as western West Virginia. The banking services offered by the Bank include the acceptance of deposits in checking, savings, time and money market accounts; the making and servicing of personal, commercial, floor plan and student loans; the making of construction and real estate loans; and credit card services. The Bank also offers individual retirement accounts, safe deposit boxes, wire transfers and other standard banking products and services. In January 2020, the Bank began offering Tax Refund Advance Loans (“TALs”) to Loan Central tax customers. A TAL represents a short-term loan offered by the Bank to tax preparation customers of Loan Central. Previously, Loan Central offered and originated tax refund anticipation loans that represented a large composition of its annual earnings. However, new Ohio laws that became effective in April 2019 placed numerous restrictions on short-term and small loans extended by certain non-bank lenders in Ohio. As a result, Loan Central is no longer able to directly offer the service to its tax preparation customers, but it is able to do so through the Bank. After Loan Central prepares a customer’s tax return, the customer is offered the opportunity to have immediate access to a portion of the anticipated tax refund by entering into a TAL with the Bank. As part of the process, the tax customer completes a loan application and authorizes the expected tax refund to be deposited with the Bank once it is issued by the IRS. Once the Bank receives the tax refund, the refund is used to repay the TAL and Loan Central’s tax preparation fees, then the remainder of the refund is remitted to Loan Central’s tax customer. IMPACT of COVID-19: COVID-19 has continued to cause significant disruption in the United States and international economies and financial markets. The primary markets served by the Company in southeastern Ohio and western West Virginia have been significantly impacted by COVID-19, which has changed the way we live and work. The actions taken by the Governors of the States of Ohio and West Virginia beginning in March of 2020 were imposed to mitigate the spread and lessen the public health impact of COVID-19. During this time, the Bank’s primary channels of serving our customers have primarily consisted of drive-thru, mobile, and online banking services and appointment-only lobby services. Beginning in September 2020, the Bank re-opened lobby services to customers within all of our banking centers. In doing so, the Bank has followed all state mandates to provide a safe environment for all of our customers. While the Bank is excited to be able to fully open its doors to its customers, we understand the accommodations will likely continue to have a negative impact on the Company’s results of operations for the duration of the pandemic, and, depending on how quickly the businesses of our customers rebound after the same, could lead to an increase in nonperforming assets. The Company has also continued to support its clients who have experienced financial hardship due to COVID-19 through participation in the PPP, assistance with expedited deposits of CARES Act stimulus payments, and loan modifications, as needed. 29 FINANCIAL RESULTS OVERVIEW: Net income totaled $2,294 during the third quarter of 2020, an increase of $157, or 7.3%, compared to $2,137 during the third quarter of 2019. Earnings per share for the third quarter of 2020 finished at $.48 per share, compared to $.45 per share during the third quarter of 2019. The Company’s net income during the nine months ended September 30, 2020 totaled $5,559, a decrease of $850, or 13.3%, compared to $6,409 during the nine months ended September 30, 2019. Earnings per share during the first nine months of 2020 finished at $1.16 per share, compared to $1.35 per share during the first nine months of 2019. Quarterly earnings improved largely due to lower provision expense and higher noninterest revenue being partially offset by a decrease in net interest income and an increase in noninterest expense. The decline in year-to-date earnings continues to be impacted by a decrease in interest and fee loan revenue and higher provision expense, being partially offset by higher noninterest revenue and reduced noninterest expenses. The negative impact of lower net earnings during the first nine months of 2020 also had a direct impact to the Company’s annualized net income to average asset ratio, or return on assets, which decreased to 0.69% at September 30, 2020, compared to 0.83% at September 30, 2019. The Company’s net income to average equity ratio, or return on equity, also decreased to 5.70% at September 30, 2020, compared to 7.07% at September 30, 2019. During the three months ended September 30, 2020, net interest income decreased $544, or 5.1%, from the same period in 2019. During the nine months ended September 30, 2020, net interest income decreased $2,785, or 8.5%, from the same period in 2019. The decreases were mostly attributable to continued net interest margin compression in relation to decreases in market rates that contributed to lower earning asset yields during the first nine months of 2020. During the second half of 2019, the Federal Reserve reduced interest rates by 75 basis points, followed by another reduction of 150 basis points in March 2020 due to concerns about the impact of COVID-19 on the economy. Although the effects of lower market rates have reduced earning asset yields, the effects have not yet fully impacted the Company’s interest-bearing deposit costs. The Company’s interest rates on time deposits have repriced downward, which will continue to have an impact of lowering interest expense when new time deposits are issued going forward. Furthermore, certain interest-bearing deposits were already at or near their interest rate floors, which also limited the Company’s ability to reduce deposit costs during the first nine months of 2020. Due to this lagging effect of deposit cost reduction combined with a more rate-sensitive earning asset portfolio, the Company’s net interest margin decreased 53 basis points during both the three and nine months ended September 30, 2020, as compared to the same periods in 2019. Net interest income was also affected by lower loan fees impacted by the change in the Company’s business model for Loan Central’s assessment of fees for TALs as described above. This resulted in a $727 decrease in loan fees during the first nine months of 2020, as compared to the same period in 2019. Loan Central’s tax preparation fee income from TAL offerings during the first nine months of 2020 was recorded to noninterest income, as discussed below. Since the tax refund business is seasonal, there was minimal impact from fee revenue during the third quarter of 2020. Partially offsetting the negative impact from lower asset yields and fee revenue was growth in average earning assets, up $78,298 during the third quarter of 2020 and $33,172 during the first nine months of 2020, as compared to the same periods in 2019, respectively. The growth came largely from the impact of $35,114 in PPP loans that were originated mostly during the end of the second quarter of 2020, contributing to higher commercial and industrial loans at September 30, 2020. Average earning asset growth also came from the Company’s interest-bearing deposit account at the Federal Reserve Bank, driven by heightened deposit balances received during the second quarter of 2020. During the three months ended September 30, 2020, the Company experienced negative provision for loan loss, which contributed to a $446 decrease in provision expense when compared to the same period in 2019. The quarterly improvement came primarily from lower net charge-offs partially offset by the changes in general allocations during the three months ended September 30, 2020, as compared to the same period in 2019. During the nine months ended September 30, 2020, Company’s provision expense increased $1,436 compared to the same period in 2019 . The increase in provision expense during the first nine months of 2020 was largely impacted by the economic effects of COVID-19, which resulted in a higher general allocation of the allowance for loan losses during the first quarter of 2020. Based on declining economic conditions and increasing unemployment levels, management increased general reserves by $2,287 to reflect higher anticipated losses due to the expected financial impact of COVID-19 on its customers. The Company will continue to closely monitor COVID-19 and make the appropriate adjustments within the allowance for loan losses in response to the pandemic as the situation evolves. 30 Total noninterest income during the three and nine months ended September 30, 2020 increased $327 and $3,169 compared to the same respective periods in 2019. The year-over-year improvement in noninterest revenue came primarily from proceeds of $2,000 received in a litigation settlement with a third-party, while further growth also came from tax preparation fee income, which was up $643 over the prior year. Tax preparation fee income was the result of the Company changing its business model in 2020 from assessing TAL fees to now assessing tax preparation fees in response to a state law enacted in 2019. Noninterest revenue was also impacted by surging growth in mortgage banking income, which was up $365 and $739 during the three and nine months ended September 30, 2020, as compared to the same periods in 2019. Mortgage banking income has grown in response to the record low mortgage rates that have generated a significant volume of mortgages being refinanced in 2020. Partially offsetting these factors was lower service charges on deposit accounts, which decreased $130 and $324 during the three and nine months ended September 30, 2020, as compared to the same periods in 2019, respectively. The decline came mostly from overdraft fees. Although noninterest expense increased $153 during the third quarter of 2020, the Company still benefited from having lower noninterest expense for the year, which was down $85 during the nine months ended September 30, 2020, as compared to the same period in 2019. The quarterly increase was mostly impacted by salaries and employee benefit expense, which increased $321 over the third quarter of 2019. The increase was primarily related to the expense associated with the severance package payout of an employee, as well as costs associated with select non-qualified benefit plans. The expense required to maintain the benefit plan accruals continues to increase in association with the decrease in market interest rates. Salaries and employee benefit expense for the year was up $139 over the nine months ended September 30, 2020, compared to the same period in 2019. This increase was offset by expense savings associated with a lower number of employees from the sale of two branches in December 2019 and the voluntary severance program that was completed during the fourth quarter of 2019. These expense savings also more than offset the expense increase associated with annual merit increases in 2020. Changes in noninterest expense were impacted by p rofessional fees, which decreased $73 and $363 during the three and nine months ended September 30, 2020, as compared to the same periods in 2019. This expense savings is attributable to lower audit expense and litigation-related legal fees. Further impacting noninterest costs in 2020 was data processing expense, which was stable during the third quarter of 2020 and up $212 over 2019. The increase was primarily from costs associated with the platform used to facilitate PPP loans, credit card processing and website maintenance costs. The Company’s provision for income taxes decreased $81 and $117 during the three and nine months ended September 30, 2020, as compared to the same periods in 2019. This is largely due to the changes in taxable income affected by the factors mentioned above. At September 30, 2020, total assets were $1,137,938, an increase of $124,666 from total assets of $1,013,272 at year-end 2019. Higher assets were impacted mostly by increases in loans, cash and cash equivalents, and investment securities, which were collectively up $116,134, or 12.3%, from year-end 2019. The Company’s loan portfolio increased $80,264, finishing at $853,038 at September 30, 2020, compared to $772,774 at year-end 2019. The commercial loan segment experienced a 26.7% increase from year-end 2019, which was partially related to the origination of $35,114 in PPP loans. The residential real estate segment grew 0.9% from year-end 2019, while the consumer loan segment decreased 6.2% from year-end 2019. The increase in both cash and cash equivalents and securities was related to the investment of the heightened deposit balances received primarily during the second quarter of 2020. Further asset increases came from bank owned life insurance (“BOLI”) and annuity assets, which increased $5,200 from year-end 2019, impacted by new BOLI plan purchases in the second quarter of 2020. Premises and equipment also increased $2,103 from year-end 2019, impacted by the construction of the Company’s new Second and State Street facility in Gallipolis, Ohio. The facility officially opened in the first quarter of 2020 and consists mostly of executive offices and areas for loan processing. Total liabilities were $1,005,040 at September 30, 2020, up $119,947 from year-end 2019. This increase is mostly attributable to higher deposit balances, which increased $123,513 from year-end 2019, which were largely impacted by customers receiving stimulus funds. Partially offsetting the growth in deposits were reduced borrowings of $4,670 from the continued principal repayments of long-term advances with the FHLB. 31 At September 30, 2020, total shareholders' equity was $132,898, up $4,719 since December 31, 2019. Regulatory capital ratios of the Company remained higher than the "well capitalized" minimums. Comparison of Financial Condition at September 30, 2020 and December 31, 2019 The following discussion focuses, in more detail, on the consolidated financial condition of the Company at September 30, 2020, compared to December 31, 2019. This discussion should be read in conjunction with the interim consolidated financial statements and the footnotes included in this Form 10‑Q. Cash and Cash Equivalents At September 30, 2020, cash and cash equivalents were $83,554, an increase of $31,198 from $52,356 at December 31, 2019. The increase in cash and cash equivalents came mostly from higher interest-bearing deposits on hand with correspondent banks. Over 80% of cash and cash equivalents consist of the Company’s interest-bearing Federal Reserve Bank clearing account. The Company utilizes its interest-bearing Federal Reserve Bank clearing account to manage excess funds, as well as to assist in funding earning asset growth. The interest rate paid on both the required and excess reserve balances of the Federal Reserve Bank account is based on the targeted federal funds rate established by the Federal Open Market Committee. During the second half of 2019, the rate associated with the Company’s Federal Reserve Bank clearing account decreased 75 basis points to 1.75% as a result of the Federal Reserve’s action to decrease short-term market rates. The Federal Reserve again reduced short-term rates by 150 basis points in March 2020 due to concerns about the impact of COVID-19 on the economy, resulting in a target federal funds rate range of 0% to 0.25%. Although interest-bearing deposits in the Federal Reserve Bank are the Company's lowest-yielding interest-earning asset, the investment rate is higher than the rate the Company would have received from its investments in federal funds sold. Furthermore, Federal Reserve Bank balances are 100% secured. The Company’s focus during periods of heightened liquidity will be to invest excess funds in longer-term, higher-yielding assets, primarily loans, when the opportunities arise. As liquidity levels vary continuously based on consumer activities, amounts of cash and cash equivalents can vary widely at any given point in time. As previously mentioned, the Bank settled a lawsuit filed against a third-party tax refund provider for breach of contract in March 2020. In addition, the Bank entered into a new agreement with the third-party to process future electronic refund checks and deposits presented for payment on behalf of taxpayers through accounts containing taxpayer refunds. The new agreement provides that the Bank will process refunds for five tax seasons, beginning with the 2021 tax season and continuing through the 2025 tax season. As a result, the Bank anticipates this new tax agreement will materially impact its liquidity levels during the term of the agreement beginning in 2021. Certificates of deposit At September 30, 2020, the Company had $2,745 in certificates of deposit owned by the Captive, up from $2,360 at year-end 2019. The deposits on hand at September 30, 2020 consist of twelve certificates with remaining maturity terms ranging from less than 3 months up to 32 months. Securities The balance of total securities increased $4,672, or 4.0%, compared to year-end 2019. The Company’s investment securities portfolio is made up mostly of U.S. Government agency (“Agency”) mortgage-backed securities, which increased $6,261, or 7.1%, from year-end 2019 and represented 77.7% of total investments at September 30, 2020. During the first nine months of 2020, the Company invested $25,884 in new Agency mortgage-backed securities, while receiving principal repayments of $21,873. The monthly repayment of principal has been the primary advantage of Agency mortgage-backed securities as compared to other types of investment securities, which deliver proceeds upon maturity or call date. 32 In addition, decreasing market rates during 2020 led to a $2,755 decrease in the net unrealized loss position associated with the Company’s available for sale securities, which increased the fair value of securities at September 30, 2020. The fair value of an investment security moves inversely to interest rates, so as rates decreased, the unrealized loss in the portfolio was reduced. These changes in rates are typical and do not impact earnings of the Company as long as the securities are held to full maturity. Loans The loan portfolio represents the Company’s largest asset category and is its most significant source of interest income. Gross loan balances grew to $853,038 at September 30, 2020, representing an increase of $80,264, or 10.4%, as compared to $772,774 at December 31, 2019. Loan growth has been largely influenced by PPP loan originations within the commercial and industrial loan segment. Additional growth also came from the commercial and residential real estate portfolios, which were partially offset by decreases in the consumer loan portfolio from year-end 2019. The majority of the Company’s increase in loans from year-end 2019 came from the commercial and industrial portfolio, which increased $58,810, or 58.8%, from year-end 2019. Commercial and industrial loans consist of loans to corporate borrowers primarily in small to mid-sized industrial and commercial companies that include service, retail and wholesale merchants. Collateral securing these loans includes equipment, inventory, and stock. Furthermore, in response to COVID-19 during the first quarter of 2020, the Company was authorized to originate PPP loans under the CARES Act. PPP loans are guaranteed by the Small Business Administration (“SBA”) and have an interest rate of 1.0%, a two-year loan term to maturity, and principal and interest payments are deferred for six months from the date of disbursement. As long as the small business borrower meets certain criteria on the use of loan proceeds, the entire principal and accrued interest is eligible to be forgiven by the SBA. As of September 30, 2020, the Company had 362 PPP loans outstanding that totaled $35,114. Additional loan growth came from the commercial real estate loan portfolio, which increased $27,259, or 12.3%, from year-end 2019. The commercial real estate segment comprised the largest portion of the Company’s total commercial loan portfolio at September 30, 2020, at 61.1%. Leading the growth in commercial real estate were increases in nonowner-occupied loan originations, with balances up $30,536, or 23.2%, from year-end 2019, primarily due to continued demand from new customers. While management believes lending opportunities exist in the Company’s markets, future commercial lending activities will depend upon economic and other related conditions, such as general demand for loans in the Company’s primary markets, interest rates offered by the Company, the effects of competitive pressure and normal underwriting considerations. Management will continue to place emphasis on its commercial lending, which generally yields a higher return on investment as compared to other types of loans. Further loan growth also came from the Company’s residential real estate loan segment, which increased $2,837, or 0.9%, from year-end 2019. The residential real estate loan segment comprises the largest portion of the Company’s overall loan portfolio at 36.7% and consists primarily of one- to four-family residential mortgages, carrying many of the same customer and industry risks as the commercial loan portfolio. The growth in residential real estate loans came largely from the Bank's warehouse lending volume. Warehouse lending consists of a line of credit provided by the Bank to another mortgage lender that makes loans for the purchase of one- to four-family residential real estate properties. The mortgage lender eventually sells the loans and repays the Bank. With record low mortgage rates during 2020, real estate refinancings began to significantly increase during the second quarter of 2020. This not only contributed to the rise in warehouse lending volume, but also impacted an increase in volume of long-term fixed-rate mortgages being sold to the secondary market. Partially offsetting the increases in both the commercial and residential real estate loan portfolios were consumer loan balances, which were down $8,642, or 6.2%, from year-end 2019, finishing at $131,720. This change was primarily impacted by a decline in automobile loan balances from year-end 2019. Automobile loans represent the Company’s largest consumer loan segment at 42.8% of total consumer loans. Automobile loans decreased primarily as a result of COVID-19 and the stay-at-home orders that limited automobile sales within the Company’s market areas. Further limiting the volume of automobile loan originations are heightened incentives being offered from the captive auto finance companies in response to the pandemic. 33 Allowance for Loan Losses The Company established a $7,730 allowance for loan losses at September 30, 2020, which represents an increase from the $6,272 allowance at year-end 2019. The allowance was impacted by an increase of $2,222 in general allocations from year-end 2019. As part of the Company’s quarterly analysis of the allowance for loan losses, management will review various factors that directly impact the general allocation needs of the allowance, which include: historical loan losses, loan delinquency levels, local economic conditions and unemployment rates, criticized/classified asset coverage levels and loan loss recoveries. During the first quarter of 2020, the Company added a new risk factor to the evaluation of the allowance for loan losses pertaining to COVID-19. The risk factor was necessary to account for the changes in economic conditions resulting from increases in unemployment that would produce higher anticipated losses as a result of COVID-19. Given that the economic scenarios had deteriorated significantly since the pandemic was declared in early March, it was determined the credit risk in the loan portfolio had increased, resulting in the need for an additional reserve for credit loss. As a result, the general reserve allocation related to COVID-19 totaled $2,287 at September 30, 2020, which had a corresponding impact to provision expense during the first nine months of 2020. While the Company has yet to experience any significant charge-offs related to COVID-19, the continued uncertainty regarding the severity and duration of the pandemic and related economic effects will continue to impact the Company’s estimate of its allowance for loan losses and resulting provision expense. Excluding the risk factors from COVID-19, the Company also experienced increases in general allocations from its historical loan loss factor, which grew from 0.23% at year-end 2019 to 0.25% at September 30, 2020. Increases also came from higher unemployment rates within the Company’s market areas, as well as lower annualized loan recoveries at September 30, 2020 compared to year-end 2019. The impact from these risk factors were offset by a lower classified asset risk factor from year-end 2019, impacted by various commercial loan upgrades as a result of improvements in the financial performance of certain borrowers’ ability to repay their loans. This contributed to lower classified assets from year-end 2019, particularly within the commercial nonowner-occupied and commercial and industrial loan segments. Furthermore, the Company’s delinquency levels decreased from year-end 2019, with nonperforming loans to total loans of 0.75% at September 30, 2020, compared to 1.30% at December 31, 2019, and lower nonperforming assets to total assets of 0.57% at September 30, 2020, compared to 1.04% at year-end 2019. The large increase in PPP loans during the first nine months of 2020 will have minimal to no impact on the general allocations of the allowance for loan losses due to these loans being fully guaranteed by the SBA. Increases in general allocations were partially offset by a $764 decrease in specific allocations from year-end 2019. Specific allocations of the allowance for loan losses identify loan impairment by measuring fair value of the underlying collateral and the present value of estimated future cash flows. The change in specific reserves from year-end 2019 was primarily related to the loan payoff of one commercial borrower during the first quarter of 2020. The Company’s allowance for loan losses to total loans ratio finished at 0.91% at September 30, 2020, and 0.81% at year-end 2019. Management believes that the allowance for loan losses at September 30, 2020 was adequate and reflected probable incurred losses in the loan portfolio. There can be no assurance, however, that adjustments to the allowance for loan losses will not be required in the future. Changes in the circumstances of particular borrowers, as well as adverse developments in the economy, particularly with respect to COVID-19, could cause further increases in the required allowance for loan losses and require additional provision expense. Asset quality will continue to remain a key focus, as management continues to stress not just loan growth, but quality in loan underwriting as well. Deposits Deposits continue to be the most significant source of funds used by the Company to meet obligations for depositor withdrawals, to fund the borrowing needs of loan customers, and to fund ongoing operations. Total deposits at September 30, 2020 increased $123,513, or 15.0%, from year-end 2019. This change in deposits came primarily from interest-bearing deposit balances, which were up by $76,034, or 12.7%, from year-end 2019, while noninterest-bearing deposits increased $47,479, or 21.3%, from year-end 2019. The significant increase in deposits was largely impacted by funds from government stimulus programs such as the PPP and consumer economic impact payments received. 34 The increase in interest-bearing deposits came mostly from money market balances from year-end 2019, which increased $35,532, or 27.3%, primarily from a shift in consumer preference to more competitive, higher-costing deposit accounts. This increase was partially offset by a decrease in brokered money market balances due to a favorable liquidity position from elevated retail deposits. Growth in interest-bearing deposits also came from higher interest-bearing NOW account balances from year-end 2019, which increased $26,429, or 16.7%. This increase was largely driven by higher municipal NOW product balances, particularly within the Gallia County, Ohio, and Mason County, West Virginia market areas. Savings deposits also increased $15,297, or 15.3%, from year-end 2019, primarily from higher statement savings account balances impacted by the government stimulus proceeds previously mentioned. Partially offsetting the increases in interest-bearing deposits were time deposit balances, which decreased $1,225, or 0.6%, from year-end 2019. The decrease was a result of reduced demand for retail time deposits from year-end 2019 due to the decline in product rate offerings, while wholesale certificates of deposit issuances were relatively stable from year-end 2019. The increase in noninterest-bearing deposits came mostly from the Company’s business and incentive-based checking account balances from year-end 2019. While facing increased competition for deposits in its market areas, the Company will continue to emphasize growth and retention in its core deposit relationships during the remainder of 2020, reflecting the Company’s efforts to reduce its reliance on higher cost funding and improve net interest income. Other Borrowed Funds Other borrowed funds were $29,321 at September 30, 2020, a decrease of $4,670, or 13.7%, from year-end 2019. The decrease was related primarily to the principal repayments applied to various FHLB advances during the first nine months of 2020. Particularly, the Company took advantage of its heightened liquidity position in the second quarter of 2020 to apply an additional $1,195 in principal prepayments to various FHLB advances to further reduce interest expense on higher-cost funding sources. While deposits continue to be the primary source of funding for growth in earning assets, management will continue to utilize FHLB advances and promissory notes to help manage interest rate sensitivity and liquidity. Shareholders’ Equity Total shareholders' equity at September 30, 2020 increased $4,719, or 3.7%, to finish at $132,898, as compared to $128,179 at December 31, 2019. Net unrealized gains on available for sale securities increased $2,176 from year-end 2019, as market rate decreases continued during the first nine months of 2020, causing an increase in the fair value of the Company’s investment portfolio. Comparison of Results of Operations For the Three and Nine Months Ended September 30, 2020 and 2019 The following discussion focuses, in more detail, on the consolidated results of operations of the Company for the three and nine months ended September 30, 2020, compared to the same periods in 2019. This discussion should be read in conjunction with the interim consolidated financial statements and the footnotes included in this Form 10‑Q. Net Interest Income The most significant portion of the Company's revenue, net interest income, results from properly managing the spread between interest income on earning assets and interest expense incurred on interest-bearing liabilities. During the three months ended September 30, 2020, net interest income decreased $544, or 5.1%, as compared to the same period in 2019. During the nine months ended September 30, 2020, net interest income decreased $2,785, or 8.5%, as compared to the same period in 2019. The decreases during both periods were mostly attributable to a net interest margin compression in relation to decreases in market rates that contributed to lower earning asset yields during the first nine months of 2020. 35 Total interest and fee income recognized on the Company’s earning assets decreased $947, or 7.6%, during the third quarter of 2020, and decreased $3,304, or 8.7%, during the first nine months of 2020, as compared to the same periods in 2019. The quarterly and year-to-date decreases were impacted by interest and fees on loans, which decreased $485, or 4.3%, and $2,187, or 6.3%, during the three and nine months ended September 30, 2020, as compared to the same periods in 2019. These results are directly related to the decline in loan yields, which decreased from 5.86% to 5.24% when comparing the third quarters of 2019 to 2020, and decreased from 5.99% to 5.46% when comparing the first nine months of 2019 to 2020, respectively. Loan yields were impacted by interest rate reductions from the Federal Reserve Bank in the second half of 2019 and in March 2020. This trend of decreasing market rates led to lower yields on the Company’s loan portfolio and lower loan interest revenue. Partially offsetting the effects from lower loan yields was average growth in loans. Average loans for the quarter ended September 30, 2020, compared to the quarter ended September 30, 2019, increased $58,428, or 7.5%. Average loans for the first nine months of 2020, compared to the first nine months of 2019, increased $21,874, or 2.8%. The increase in average loans for both the quarterly and year-to-date periods came mostly from the origination of $35,114 in PPP loans primarily during the end of the second quarter of 2020. While PPP loans contributed to higher earning asset balances, they also had a dilutive effect on loan yields as a result of the 1% interest rate associated with each loan. These factors contributed to decreases of $661 and $2,038 in loan interest income during the three and nine months ended September 30, 2020, as compared to the same periods in 2019. Loan revenue was also impacted by loan fees, which increased $176 during the three months ended September 30, 2020, but decreased $149 during the nine months ended September 30, 2020, as compared to the same periods in 2019. The quarterly increase was largely impacted by $126 in loan fees earned on the origination of government-guaranteed PPP loans. The year-to-date change came mostly from lower fees associated with TALs. As previously mentioned, beginning in 2020, the Company changed its business model for Loan Central’s assessment of fees from assessing TAL fees to now assessing tax preparation fees. This fundamental change in the fee structure was necessary to comply with new Ohio lending regulations. As a result, TAL fees decreased $727 during the first nine months of 2020 from the same period last year, with minimal impact during the third quarters of both 2020 and 2019. During the three and nine months ended September 30, 2020, interest income from interest-bearing deposits with banks decreased $313, or 94.0%, and $777, or 79.5%, when compared to the same periods in 2019, respectively. These changes in interest revenue come primarily from the Company’s interest-bearing Federal Reserve Bank clearing account. The quarterly and year-to-date decreases in interest income was primarily due to the interest rate tied to this interest-bearing clearing account, which was 0.25% at September 30, 2020, compared to 2.0% at September 30, 2019. The increase in liquidity from the surge in deposit liabilities allowed the Company to maintain higher average balances within the account, which increased $17,823 during the third quarter of 2020, and $10,349 during the first nine months of 2020, as compared to the same periods in 2019, respectively. 36 Total interest expense incurred on the Company’s interest-bearing liabilities decreased $403, or 21.3%, during the third quarter of 2020, and decreased $519, or 9.6%, during the first nine months of 2020, as compared to the same periods in 2019. Interest expense decreased during both periods despite an increase in average interest-bearing deposits of $49,296 during the third quarter of 2020 and an increase of $25,010 during the first nine months of 2020, as compared to the same periods in 2019, respectively. The converse relationship between increasing average interest-bearing liabilities to lower interest expense is related to the repricing efforts in a lower rate environment which drove down average costs during 2020. The Company also continues to experience a composition shift to a higher-costing money market account that has generated more interest expense during 2020. However, the pace of interest expense savings has been slowed due to a lag in repricing on deposits. Given the Company’s asset-sensitivity, decreases in short-term interest rates have had a negative impact on net interest income in that interest-earning assets have repriced faster than interest-bearing liabilities. This has caused a lagging effect to the impact that decreasing market rates have had on reducing deposit expense, particularly with CDs. As CD rates reprice downward, the Company will benefit from lower interest expense only to the extent that new CDs at lower rates are issued. As CDs continued to rollover into lower rates during the second and third quarters of 2020, along with the rate reductions of other interest-bearing deposit products, the interest expense on deposits decreased $318, or 20.0%, during the three months ended September 30, 2020, as compared to the same period in 2019. This is compared to a $145 decrease in deposit interest during the three months ended June 30, 2020, and a $167 increase in deposit interest during the three months ended March 31, 2020, as compared to the same periods in 2019. As a result, the Company’s total weighted average costs on interest-bearing deposits has decreased by 10 basis points from 0.97% at September 30, 2019 to 0.87% at September 30, 2020. The Company’s net interest margin is defined as fully tax-equivalent net interest income as a percentage of average earning assets. During 2020, the Company’s third quarter net interest margin finished at 3.88%, compared to 2019’s third quarter net interest margin of 4.41%. The year-to-date net interest margin at September 30, 2020 finished at 4.04%, compared to 4.57% at September 30, 2019. The decrease in margin was largely impacted by the decreasing market rates that contributed to lower earning asset yields during 2020. Interest rates were reduced in the first quarter of 2020 primarily as a result of the growing concern that COVID-19 would have a significant negative impact on the economy. Furthermore, the Company’s ability to reduce deposit expenses in a low rate environment has been limited by a lagging effect in CD rates, along with an increased composition of higher-costing deposits, such as time deposits and money market accounts. The Company’s primary focus is to invest its funds into higher yielding assets, particularly loans, as opportunities arise. However, if loan balances do not continue to expand and remain a larger component of overall earning assets, the Company will face pressure within its net interest income and margin improvement. Provision for Loan Losses For the three months ended September 30, 2020, the Company’s provision expense decreased $446, and for the nine months ended September 30, 2020, provision expense increased $1,436, over the same respective periods in 2019. The quarterly improvement came primarily from a decrease of $1,443 in net charge-offs during the three months ended September 30, 2020, as compared to the same period in 2019. This was primarily related to the charge-offs recorded on one commercial and industrial loan relationship in September 2019. The impact of lower net charge-offs was partially offset by the changes in general reserve allocations. During the third quarter of 2020, the Company decreased its general allocation from $7,981 at June 30, 2020 to $7,687 at September 30, 2020. This is compared to a $1,214 general allocation decrease during the same period in 2019. The release of general reserves during the third quarters of 2020 and 2019 were caused by various improvements within the economic risk factor calculation that included: lower criticized and classified assets, lower delinquency levels, and lower unemployment rates. Provision expense during the nine months ended September 30, 2020 increased in large part to the addition of a new risk reserve allocation. As previously discussed, the Company’s general reserves during the first quarter of 2020 were significantly impacted by a $1,942 allocation of the allowance for loan losses as a result of the expected financial impact of COVID-19. The allocation resulted in a corresponding entry to provision expense. Due to growing risk concerns impacted by rising unemployment trends related to COVID-19, this allocation has grown to $2,287 at September 30, 2020. The impact from this new risk factor was partially offset by the release of general reserves associated with lower classified assets. 37 Future provisions to the allowance for loan losses will continue to be based on management’s quarterly in-depth evaluation that is discussed in further detail under the caption “Critical Accounting Policies - Allowance for Loan Losses” within this Management’s Discussion and Analysis. Noninterest Income Noninterest income for the three months ended September 30, 2020 increased $327, or 15.5%, when compared to the three months ended September 30, 2019. Noninterest income for the nine months ended September 30, 2020 increased $3,169, or 53.2%, when compared to the nine months ended September 30, 2019. The key contributor to the yearly improvement in noninterest revenue was from proceeds received in a litigation settlement with a third-party. During the first quarter of 2020, the Bank entered into a settlement agreement related to the previously disclosed litigation the Bank had filed against a third-party tax software product provider for breach of contract. Under the settlement agreement, the third-party paid a $2,000 settlement payment to the Bank, which was recorded as noninterest income. Further growth in noninterest revenue for the year came from tax preparation fee income. As previously discussed, the Company changed its business model in 2020 for assessing fees related to TALs. By charging for the tax preparation services, the Company recorded $643 in tax preparation fee income for the first nine months of 2020, which includes $9 in tax preparation fee income recorded during the third quarter of 2020. Mortgage banking income also contributed to the increase in noninterest revenue. Mortgage banking income is highly influenced by mortgage interest rates and housing market conditions. With mortgage rates at record lows as a result of COVID-19, the consumer demand to refinance long-term, fixed-rate real estate mortgages significantly increased. This led to increased sales of loans to the secondary market, which generated increases of $365 and $739 in mortgage banking income during the three and nine months ended September 30, 2020, when compared to the same periods in 2019. Partially offsetting growth in noninterest income was less service charge fees recorded in 2020. During the three months ended September 30, 2020, service charges on deposit accounts decreased $130, or 23.5%, while also decreasing $324, or 20.6%, during the first nine months of 2020, as compared to the same periods in 2019. This was largely due to lower overdraft fees impacted by economic stimulus proceeds received by customers, along with growing uncertainties of COVID-19 that has disrupted consumer spending. The remaining noninterest income categories increased $83, or 5.6%, during the third quarter of 2020, and $111, or 2.7%, during the first nine months of 2020, as compared to the same periods in 2019, respectively. This income growth came mostly from interest rate swap agreements and debit and credit interchange income during both periods, partially offset by losses incurred on the sale of other real estate owned during the first nine months of 2020. Noninterest Expense Noninterest expense during the third quarter of 2020 increased $153, or 1.6%, as compared to the same period in 2019. Noninterest expense during the first nine months of 2020 decreased $85, or 0.3%, as compared to the same period in 2019. Contributing most to higher noninterest expense during the quarter were salaries and employee benefits, which increased $321, or 5.7%, during the three months ended September 30, 2020, as compared to the same period in 2019. As previously mentioned, the quarterly increase was primarily related to a severance package payout and higher non-qualified benefit plan costs that have been impacted by lower market rates. These quarter-to-date factors contributed to a year-to-date increase in salaries and employee benefits of $139, or 0.8%, when comparing the nine months ended September 30, 2020 to the same period in 2019. Limiting the cost increase to salaries and employee benefits has been the expense savings associated with a lower number of employees from the sale of two branches in December 2019 and the voluntary severance program that was completed during the fourth quarter of 2019. The Bank’s average full-time equivalent employee base at September 30, 2020 was 243 employees, down from an average full-time equivalent employee base of 265 employees at September 30, 2019. The impact of a lower employee base has more than offset the expense increases associated with annual merit increases in 2020. 38 Further impacting overhead costs were higher data processing expenses, which decreased $2, or 0.4%, during the third quarter of 2020, but increased $212, or 13.0%, during the first nine months of 2020, as compared to the same periods in 2019. The increase during the year-to-date period was primarily due to a $186 expense associated with the platform used to facilitate PPP loans during the second quarter of 2020. Further expenses also came from the processing of credit cards, as well as website maintenance costs to improve the quality of the Company’s internet-based technology. Partially offsetting increases in overhead costs were professional fees, which decreased $73, or 12.2%, during the third quarter of 2020, and $363, or 18.5%, during the first nine months of 2020, as compared to the same periods in 2019. These decreases include lower litigation costs associated with the Bank’s lawsuit against the third-party tax software product provider. As previously discussed, a settlement was reached with the third-party during the first quarter of 2020, which contributed to lower legal costs. Furthermore, the number of bankruptcy-related loan cases has decreased significantly due to the effects of COVID-19, which has shut down municipal courts at various times during the pandemic. Additionally, the Company incurred lower audit-related expenses during the quarterly and year-to-date periods ended September 30, 2020. This was related to costs from 2019 associated with the “expected loss” allowance model that the Company was prepared to adopt in 2020. In the fourth quarter of 2019, it was announced this required accounting guidance would be delayed until 2023. The remaining noninterest expense categories decreased $93, or 3.2%, during the third quarter of 2020, and $73, or 0.8%, during the first nine months of 2020, as compared to the same periods in 2019. These decreases were impacted mostly from expense savings related to lower software, foreclosure, travel and seminar costs. Efficiency The Company’s efficiency ratio is defined as noninterest expense as a percentage of fully tax-equivalent net interest income plus noninterest income. The effects from provision expense are excluded from the efficiency ratio. Management continues to place emphasis on managing its balance sheet mix and interest rate sensitivity as well as developing more innovative ways to generate noninterest revenue. Comparing the third quarters of 2020 and 2019, the Company’s asset yields were negatively impacted by market rate reductions related to COVID-19, which led to a 5.1% decrease in net interest income. This more than offset the positive effects of a 15.5% improvement in noninterest income less a 1.6% increase in overhead costs for the quarter. As a result, the Company’s efficiency number increased to 78.3% during the quarterly period ended September 30, 2020, as compared to 75.8% during the same period in 2019. Comparing the first nine months of 2020 to the first nine months of 2019, average earning asset yields remained lower due to the reduction in market rates. This, combined with the $727 decrease in TAL fees, caused the Company’s net interest income to decrease by 8.5%. However, this was completely offset by a $3,169 increase in noninterest revenue, which was impacted by $2,000 in income from a litigation settlement and $643 in tax preparation fee income. Furthermore, the severance package offering and the sale of two branch offices in December 2019 has helped to minimize the growth in salaries and employee benefit costs in 2020. As a result, the Company’s efficiency number decreased to 73.8% during the first nine months of September 30, 2020, as compared to 74.7% during the same period in 2019. Provision for income taxes The Company’s income tax provision decreased $81, or 19.6%, during the three months ended September 30, 2020, while also decreasing $117, or 10.6%, during the nine months ended September 30, 2020, as compared to the same periods in 2019. The change in tax expense corresponded directly to the change in associated taxable income during 2020 and 2019. Capital Resources Federal regulators have classified and defined capital into the following components: (i) Tier 1 capital, which includes tangible shareholders’ equity for common stock, qualifying preferred stock and certain qualifying hybrid instruments, and (ii) Tier 2 capital, which includes a portion of the allowance for loan losses, certain qualifying long-term debt, preferred stock and hybrid instruments which do not qualify as Tier 1 capital. 39 In September 2019, consistent with Section 201 of the Economic Growth, Regulatory Relief, and Consumer Protection Act, the federal banking agencies issued a final rule providing simplified capital requirements for certain community banking organizations (banks and holding companies). Under the rule, a qualifying community banking organization (“QCBO”) is eligible to opt into the Community Bank Leverage Ratio (“CBLR”) framework in lieu of the Basel III capital requirements if it has less than $10 billion in total consolidated assets, limited amounts of certain trading assets and liabilities, limited amounts of off-balance sheet exposure and a leverage ratio greater than 9.0%. The new rule took effect January 1, 2020, and QCBOs were allowed to opt into the new CBLR framework in their call report beginning the first quarter of 2020. A QCBO opting into the CBLR framework must maintain a CBLR of 9.0%, subject to a two quarter grace period to come back into compliance, provided that the QCBO maintains a leverage ratio of more than 8.0% during the grace period. A QCBO failing to satisfy these requirements must comply with the existing Basel III capital requirements as implemented by the banking regulators in July 2013. The numerator of the CBLR is Tier 1 capital, as calculated under present rules. The denominator of the CBLR is the QCBO’s average assets, calculated in accordance with the QCBO’s Call Report instructions and less assets deducted from Tier 1 capital. The Bank has opted into the CBLR, and will therefore not be required to comply with the Basel III capital requirements. As of September 30, 2020, the Bank’s CBLR was 10.70%, and the Company’s CBLR was 11.74%. Pursuant to the CARES Act, the federal banking regulators in April 2020 issued interim final rules to set the CBLR at 8% beginning in the second quarter of 2020 through the end of 2020. Beginning in 2021, the CBLR will increase to 8.5% for the calendar year. QCBOs will have until January 1, 2022 before the CBLR requirement will return to 9%. Cash dividends paid by the Company were $3,016 during the first nine months of 2020. The year-to-date dividends paid totaled $0.63 per share. Liquidity Liquidity relates to the Company's ability to meet the cash demands and credit needs of its customers and is provided by the ability to readily convert assets to cash and raise funds in the marketplace. Total cash and cash equivalents, held to maturity securities maturing within one year and available for sale securities, totaling $195,720, represented 17.2% of total assets at September 30, 2020. In addition, the FHLB offers advances to the Bank, which further enhances the Bank's ability to meet liquidity demands. At September 30, 2020, the Bank could borrow an additional $109,189 from the FHLB, of which $80,000 could be used for short-term, cash management advances. Furthermore, the Bank has established a borrowing line with the Federal Reserve. At September 30, 2020, this line had total availability of $58,804. Lastly, the Bank also has the ability to purchase federal funds from a correspondent bank. Off-Balance Sheet Arrangements As discussed in Note 5 – Financial Instruments with Off-Balance Sheet Risk, the Company engages in certain off-balance sheet credit-related activities, including commitments to extend credit and standby letters of credit, which could require the Company to make cash payments in the event that specified future events occur. Commitments to extend credit are agreements to lend to a customer as long as there is no violation of any condition established in the contract. Commitments generally have fixed expiration dates or other termination clauses and may require payment of a fee. Standby letters of credit are conditional commitments to guarantee the performance of a customer to a third party. While these commitments are necessary to meet the financing needs of the Company’s customers, many of these commitments are expected to expire without being drawn upon. Therefore, the total amount of commitments does not necessarily represent future cash requirements. 40 Critical Accounting Policies The most significant accounting policies followed by the Company are presented in Note A to the financial statements in the Company’s 2019 Annual Report to Shareholders. These policies, along with the disclosures presented in the other financial statement notes, provide information on how significant assets and liabilities are valued in the financial statements and how those values are determined. Management views critical accounting policies to be those which are highly dependent on subjective or complex judgments, estimates and assumptions, and where changes in those estimates and assumptions could have a significant impact on the financial statements. Management currently views the adequacy of the allowance for loan losses to be a critical accounting policy. Allowance for loan losses The allowance for loan losses is a valuation allowance for probable incurred credit losses. 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. 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 other factors. 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. The allowance consists of specific and general components. The specific component relates to loans that are individually classified as impaired. A loan is impaired when, based on current information and events, it is probable that the Company will be unable to collect all amounts due according to the contractual terms of the loan agreement. Impaired loans generally consist of loans with balances of $200 or more on nonaccrual status or nonperforming in nature. Loans for which the terms have been modified, and for which the borrower is experiencing financial difficulties, are considered TDRs and classified as impaired. Factors considered by management in determining impairment include payment status, collateral value, and the probability of collecting scheduled principal and interest payments when due. Loans that experience insignificant payment delays and payment shortfalls generally are not classified as impaired. Management determines the significance of payment delays and payment shortfalls on a case-by-case basis, taking into consideration all of the circumstances surrounding the loan and the borrower, including the length and reasons for the delay, the borrower’s prior payment record, and the amount of shortfall in relation to the principal and interest owed. Commercial and commercial real estate loans are individually evaluated for impairment. If a loan is impaired, a portion of the allowance is allocated so that the loan is reported, net, at the present value of estimated future cash flows using the loan’s existing rate or at the fair value of collateral if repayment is expected solely from the collateral. Smaller balance homogeneous loans, such as consumer and most residential real estate, are collectively evaluated for impairment, and accordingly, they are not separately identified for impairment disclosure. TDRs are measured at the present value of estimated future cash flows using the loan’s effective rate at inception. If a TDR is considered to be a collateral dependent loan, the loan is reported, net, at the fair value of the collateral. For TDRs that subsequently default, the Company determines the amount of reserve in accordance with the accounting policy for the allowance for loan losses. The general component covers non-impaired loans and impaired loans that are not individually reviewed for impairment and is based on historical loss experience adjusted for current factors. The historical loss experience is determined by portfolio segment and is based on the actual loss history experienced by the Company over the most recent three years for the consumer and real estate portfolio segment and five years for the commercial portfolio segment. The total loan portfolio’s actual loss experience is supplemented with other economic factors based on the risks present for each portfolio segment. These economic factors include consideration of the following: levels of and trends in delinquencies and impaired loans; levels of and trends in charge-offs and recoveries; trends in volume and terms of loans; effects of any changes in risk selection and underwriting standards; other changes in lending policies, procedures, and practices; experience, ability, and depth of lending management and other relevant staff; national and local economic trends and conditions; industry conditions; and effects of changes in credit concentrations. The following portfolio segments have been identified: Commercial Real Estate, Commercial and Industrial, Residential Real Estate, and Consumer. 41 Commercial and industrial loans consist of borrowings for commercial purposes by individuals, corporations, partnerships, sole proprietorships, and other business enterprises. Commercial and industrial loans are generally secured by business assets such as equipment, accounts receivable, inventory, or any other asset excluding real estate and generally made to finance capital expenditures or operations. The Company’s risk exposure is related to deterioration in the value of collateral securing the loan should foreclosure become necessary. Generally, business assets used or produced in operations do not maintain their value upon foreclosure, which may require the Company to write down the value significantly to sell. Commercial real estate consists of nonfarm, nonresidential loans secured by owner-occupied and nonowner-occupied commercial real estate as well as commercial construction loans. An owner-occupied loan relates to a borrower purchased building or space for which the repayment of principal is dependent upon cash flows from the ongoing business operations conducted by the party, or an affiliate of the party, who owns the property. Owner-occupied loans that are dependent on cash flows from operations can be adversely affected by current market conditions for their product or service. A nonowner-occupied loan is a property loan for which the repayment of principal is dependent upon rental income associated with the property or the subsequent sale of the property. Nonowner-occupied loans that are dependent upon rental income are primarily impacted by local economic conditions which dictate occupancy rates and the amount of rent charged. Commercial construction loans consist of borrowings to purchase and develop raw land into one- to four-family residential properties. Construction loans are extended to individuals as well as corporations for the construction of an individual or multiple properties and are secured by raw land and the subsequent improvements. Repayment of the loans to real estate developers is dependent upon the sale of properties to third parties in a timely fashion upon completion. Should there be delays in construction or a downturn in the market for those properties, there may be significant erosion in value which may be absorbed by the Company. Residential real estate loans consist of loans to individuals for the purchase of one- to four-family primary residences with repayment primarily through wage or other income sources of the individual borrower. The Company’s loss exposure to these loans is dependent on local market conditions for residential properties as loan amounts are determined, in part, by the fair value of the property at origination. Consumer loans are comprised of loans to individuals secured by automobiles, open-end home equity loans and other loans to individuals for household, family, and other personal expenditures, both secured and unsecured. These loans typically have maturities of six years or less with repayment dependent on individual wages and income. The risk of loss on consumer loans is elevated as the collateral securing these loans, if any, rapidly depreciate in value or may be worthless and/or difficult to locate if repossession is necessary. During the last several years, one of the most significant portions of the Company’s net loan charge-offs have been from consumer loans. Nevertheless, the Company has allocated the highest percentage of its allowance for loan losses as a percentage of loans to the other identified loan portfolio segments due to the larger dollar balances and inherent risk associated with such portfolios. Concentration of Credit Risk The Company maintains a diversified credit portfolio, with residential real estate loans currently comprising the most significant portion. Credit risk is primarily subject to loans made to businesses and individuals in southeastern Ohio and western West Virginia. Management believes this risk to be general in nature, as there are no material concentrations of loans to any industry or consumer group. To the extent possible, the Company diversifies its loan portfolio to limit credit risk by avoiding industry concentrations. ITEM 3. QUANTITATIVE AND QUALITATIVE DISCLOSURES ABOUT MARKET RISK Not applicable. 42