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 (the “Exchange Act”), 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 other 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 the Coronavirus (“COVID-19”) pandemic, 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; the effects of various governmental responses to COVID-19; unexpected changes in interest rates or disruptions in the mortgage market; the effects of various governmental responses to COVID-19; 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 Ohio Valley Banc Corp. (“Ohio Valley”) and its direct and indirect subsidiaries (collectively, 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 Exchange Act, including the disclosure under the heading “Item 1A. Risk Factors” of Part I of the Company’s Annual Report on Form 10-K for the fiscal year ended December 31, 2021. 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. BUSINESS OVERVIEW: The following discussion on consolidated financial statements include the accounts of Ohio Valley and its wholly-owned subsidiaries, The Ohio Valley Bank Company (the “Bank”), Loan Central, Inc., a consumer finance company (“Loan Central”), Ohio Valley Financial Services Agency, LLC, an insurance agency, and OVBC Captive, Inc., a limited purpose property and casualty insurance company (“the Captive”). The Bank has two wholly-owned subsidiaries, Race Day Mortgage, Inc., an Ohio corporation that provides online consumer mortgages (“Race Day”), and Ohio Valley REO, LLC, an Ohio limited liability company. Ohio Valley and its subsidiaries are collectively referred to as the “Company.” 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. Furthermore, the Bank offers 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. IMPACT of COVID-19: COVID-19 has caused 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 continued effects of COVID-19 on the economy, supply chains, financial markets, unemployment levels, businesses and our customers are unknown and unpredictable. On March 27, 2020, the Coronavirus Aid, Relief, and Economic Security Act ("CARES Act") was signed into law. The CARES Act provided assistance to small businesses through the establishment of the Paycheck Protection Program ("PPP"). The PPP provided small businesses with funds to use for payroll and certain other expenses. The funds were provided in the form of loans that would be fully forgiven if certain criteria were met. In 2021, Congress amended the PPP 28 by extending the authority of the Small Business Administration (“SBA”) to guarantee loans and the ability of PPP lenders to disburse PPP loans until May 31, 2021. The Company supported its clients who 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. FINANCIAL RESULTS OVERVIEW: Net income totaled $1,999 during the second quarter of 2022, a decrease of $862 from the same period of 2021. Earnings per share for the second quarter of 2022 finished at $.42 per share, compared to $.60 per share during the second quarter of 2021. Net income totaled $6,124 during the six months ended June 30, 2022, a decrease of $268 from the same period of 2021. Earnings per share during the first six months of 2022 finished at $1.29 per share, compared to $1.34 per share during the first six months of 2021. Q uarterly earnings were negatively impacted by increases in both provision and noninterest expense, being partially offset by growth in net interest and noninterest income. Earnings during the first six months of 2022 were negatively impacted by higher noninterest expense, being partially offset by improved net interest and noninterest income and lower provision expense. The impact of lower net earnings during 2022 also had a direct impact to the Company’s annualized net income to average asset ratio, or return on assets, which decreased to 0.98% for the six months ended June 30, 2022, compared to 1.06% for the six months ended June 30, 2021. The Company’s net income to average equity ratio, or return on equity, also decreased to 8.87% for the six months ended June 30, 2022, compared to 9.39% for the six months ended June 30, 2021. During the three months ended June 30, 2022, net interest income increased $338, or 3.3%, over the same period in 2021. During the six months ended June 30, 2022, net interest income increased $280, or 1.4%, over the same period in 2021. Growth in net interest income was generated by higher average earning assets, which increased by 1.5% during the second quarter of 2022, and 3.5% during the first half of 2022, compared to the same periods in 2021. The increases were primarily due to growth in average investment securities in relation to higher average deposit balances. Partially offsetting growth in securities were lower average loans, which decreased 1.2% during the second quarter of 2022, and 1.7% during the first half of 2022, compared to the same periods in 2021. The decreases in average loans were largely the result of decreased residential real estate loans and payoffs of PPP loans. While average Federal Reserve balances were down, the Federal Reserve’s actions in increasing rates by 150 basis points during the first half of 2022 contributed to higher associated interest income on those balances during the second quarter and year-to-date. Net interest income growth was further impacted by lower interest expense on deposits, decreasing 36.5% and 39.0% during both the quarterly and year-to-date periods ended June 30, 2022, respectively, compared to the same periods in 2021. This is largely the result of a lower average cost of funds, as well as a composition shift from higher-costing time deposits to lower-costing demand and savings account balances. During the three months ended June 30, 2022, the Company’s provision for loan loss was $813, which contributed to a $786 increase in provision expense when compared to the same period in 2021. This increase in provision expense was impacted by a $752 increase in quarterly net charge offs, related primarily to a single loan relationship. During the six months ended June 30, 2022, the Company experienced negative provision for loan loss, which contributed to a $288 decrease in provision expense when compared to the same period in 2021. The decrease from the prior year was related to improved economic risk factors impacted by lower net charge-offs and criticized and classified loans, as well as the partial release of the COVID-19 reserve for the pandemic environment. During the three months ended June 30, 2022, noninterest income increased $130, or 5.2%, from the same period in 2021. This increase came largely from increases in service charges on deposit accounts. During the six months ended June 30, 2022, noninterest income increased $511, or 8.7%, from the same period in 2021. This increase came largely from increases in service charges on deposit accounts, interchange income on debit and credit card transactions, and mortgage banking income in relation to Race Day, the Company’s new online mortgage company. During the three months ended June 30, 2022, noninterest expense increased $726, or 7.8%, over the same period in 2021. During the six months ended June 30, 2022, noninterest expense increased $1,327, or 7.2%, over the same period in 2021. The increases during both periods were primarily related to higher salaries and employee benefit costs impacted by the staffing of Race Day, as well as higher annual merit expenses. The Company also experienced increases in data processing costs, professional fees, and software expense, as well as various other overhead costs from Race Day. The Company’s provision for income taxes decreased $182, or 34.0%, during the three months ended June 30, 2022, and increased $20, or 1.6%, during the six months ended June 30, 2022, compared to the same periods in 2021. This was largely due to the changes in taxable income affected by the factors mentioned above. At June 30, 2022, total assets were $1,253,886, an increase of $4,117 from year-end 2021. Higher assets were primarily impacted by increases in loans and investment securities, which were collectively up $55,119, or 5.4%, from year-end 2021. This was largely the result of the deployment of a portion of the Company’s heightened cash balance to higher yielding earning assets during the first half of 2022 and resulted in a decrease of $58,012 in Federal Reserve Bank balances from year-end 2021. The Company’s loan portfolio experienced increases in the residential real estate segment (+12.3%), the commercial segment (+0.4%) and the consumer loan segment (+2.7%). 29 At June 30, 2022, total liabilities were $1,121,316, up $12,903 from year-end 2021. Contributing most to this increase were higher deposit balances, which increased $13,446 from year-end 2021. The increase was impacted mostly from higher interest-bearing demand deposits, partially offset by lower time deposits and noninterest bearing demand deposits. At June 30, 2022, total shareholders' equity was $132,570, down $8,786 since December 31, 2021. This was largely the result of cash dividends paid and a decrease in net unrealized gains on available for sale securities being partially offset by improved quarterly net income. Regulatory capital ratios of the Company remained higher than the "well capitalized" minimums. Comparison of Financial Condition at June 30, 2022 and December 31, 2021 The following discussion focuses, in more detail, on the consolidated financial condition of the Company at June 30, 2022 compared to December 31, 2021. 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 June 30, 2022, cash and cash equivalents were $94,094, a decrease of $57,940, or 38.1%, from December 31, 2021. The decrease in cash and cash equivalents came mostly from lower interest-bearing deposits on hand with correspondent banks. Over 82% of cash and cash equivalents consisted of the Company’s interest-bearing Federal Reserve Bank clearing account, which decreased $58,012, or 42.7%, from year-end 2021. 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. During the first half of 2022, the Company utilized a portion of its clearing account balances to reinvest in higher-yielding loans and investment securities. This shift into higher-yielding earning assets not only helped to minimize the dilutive effect that higher clearing account balances had on the net interest margin during the year, but also contributed to an increase in the net interest margin during the second quarter of 2022 over the second quarter of 2021. 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 first half of 2022, the rate associated with the Company’s Federal Reserve Bank clearing account increased 150 basis points due to rising inflationary concerns, resulting in a target federal funds rate range of 1.50% to 1.75%. 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 balances are 100% secured by the U.S. Government. As liquidity levels continuously vary based on consumer activities, amounts of cash and cash equivalents can vary widely at any given point in time. The Company’s focus during periods of heightened liquidity will be to invest excess funds into longer-term, higher-yielding assets, primarily loans, when opportunities arise. Certificates of Deposit At June 30, 2022, the Company had $1,873 in certificates of deposit owned by the Captive, down from $2,329 at year-end 2021. The deposits on hand at June 30, 2022 consist of eight certificates with remaining maturity terms ranging from less than 10 months up to 15 months. 30 Securities The balance of total securities increased $16,058, or 8.6%, compared to year-end 2021. The increase was primarily the result of investment security purchases funded by excess funds being maintained within the Federal Reserve Bank clearing account. The Company’s investment securities portfolio is made up mostly of U.S. Government agency (“Agency”) mortgage-backed securities, which represented 66.6% of total investments at June 30, 2022. During the first half of 2022, the Company invested $29,470 in new Agency mortgage-backed securities, while receiving principal repayments of $12,412. 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. The Company also redeployed a portion of its heightened excess funds to purchase $19,801 in U.S. Government securities during the first half of 2022. In addition, the continued increases in long-term reinvestment rates during 2022 led to a $16,164 decrease in the fair value of the Company’s available for sale securities. The fair value of an investment security moves inversely to interest rates, so as rates increased, the unrealized gain in the portfolio decreased. 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 increased to $870,252 at June 30, 2022, representing an increase of $39,061, or 4.7%, as compared to $831,191 at December 31, 2021. The increase in loans came primarily from the residential real estate portfolio, with other increases coming from the total commercial and consumer loan portfolios from year-end 2021. The Company’s residential real estate loan portfolio increased $33,716, or 12.3%, from year-end 2021. The residential real estate loan segment comprises the largest portion of the Company’s overall loan portfolio at 35.4% and consists primarily of one- to four-family residential mortgages and carries many of the same customer and industry risks as the commercial loan portfolio. The increase in residential real estate loans was largely related to the funding of a warehouse line of credit by the Bank for a mortgage lender. The warehouse lending line is used by the mortgage lender to make loans for the purchase of one- to four-family residential real estate properties. The mortgage lender eventually sells the loan and repays the Bank. From year-end 2021, warehouse lending balances increased $37,236. Partially offsetting the increase in warehouse lending balances were the principal repayments and payoffs in both long-term fixed-rate and short-term adjustable-rate mortgages. A decrease in refinancing volume and an increase in long-term reinvestment rates have led to a slower demand for mortgage loans during 2022. Further increases in loans came from the Company’s total commercial loan portfolio, which increased $1,790, or 0.4%, from year-end 2021. Contributing most to this increase were higher loan balances within the commercial and industrial portfolio, up $7,052, or 5.0%, from year-end 2021. The growth was impacted by an increase in larger loan originations during the year. 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. The commercial and industrial segment also includes PPP loan balances that had a significant impact on average earning asset growth in 2021. The Company’s remaining PPP loans of $446 that were outstanding at year-end 2021 were paid off during the first quarter of 2022. Increases in commercial and industrial loans were partially offset by a $5,262, or 1.9%, decrease in the commercial real estate portfolio from year-end 2021. The commercial real estate segment comprised the largest portion of the Company’s total commercial loan portfolio at June 30, 2022 at 65.0%. Decreases came primarily from the principal payoffs of a limited number of large nonowner-occupied loan balances from year-end 2021. 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, and 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. The Company’s loan portfolio at June 30, 2022 was also impacted by higher consumer loan balances from year-end 2021, increasing $3,555, or 2.7%. This change was impacted by a $2,583, or 11.5%, increase in home equity lines of credit. The remaining consumer loan portfolio increased $972, or 0.9%, from year-end 2021, mostly from automobile loans. 31 Allowance for Loan Losses The Company established a $5,214 allowance for loan losses at June 30, 2022, which represents a decrease from the $6,483 allowance at year-end 2021. 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 half of 2022, the Company experienced a $1,556 decrease in its general allocations of the allowance for loan losses. Contributing to this decrease were lower reserves associated with the COVID-19 risk factor. The Company added a COVID-19 risk factor in 2020 due to the negative economic outlook of the pandemic. Based on positive asset quality trends and lower net charge offs, management released $645 of the reserve related to the COVID-19 risk factor during the first half of 2022, resulting in a corresponding decrease in both provision expense and general allocations of the allowance for loan loss. Excluding the impact from the COVID-19 risk factor, the Company experienced a $1,059 decrease in general allocations of the allowance for loan losses related to improvements in various economic risk factors, including those associated with criticized and classified assets. During the second quarter of 2022, the Company experienced a payoff on one commercial loan relationship that had $6,500 in loans and committed balances, which reduced classified assets and released general reserves during the first half of 2022. Furthermore, the Company upgraded a single commercial loan relationship during the first quarter of 2022 totaling $2,232 from a classified to a criticized loan status, which also contributed to the release of general reserves during the first half of 2022. The loan upgrade came as a result of improvements in the borrower’s financial performance and ability to repay their loans. Additionally, the Company’s delinquency levels decreased from year-end 2021, with nonperforming loans to total loans of 0.46% at June 30, 2022, compared to 0.56% at December 31, 2021, and lower nonperforming assets to total assets of 0.32% at June 30, 2022, compared to 0.37% at year-end 2021. Lower general allocations during the first half of 2022 were also impacted by higher loan recoveries, while the historical loan loss factor remained at 0.18% at June 30, 2022, and year-end 2021. Decreases in general allocations were partially offset by a $287 increase in specific allocations from year-end 2021. 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 was primarily related to the loan impairments of one borrower relationship during the first half of 2022. The Company’s allowance for loan losses to total loans ratio finished at 0.60% at June 30, 2022, and 0.78% at year-end 2021. Management believes that the allowance for loan losses at June 30, 2022 was adequate and reflected probable incurred losses in the loan portfolio. Changes in the circumstances of particular borrowers, as well as adverse developments in the economy, particularly with respect to COVID-19, are factors that could change, and management will make adjustments to the allowance for loan losses as needed. Asset quality will continue to remain a key focus of the Company, as management continues to stress not just loan growth, but quality in loan underwriting. Deposits Deposits continue to be the most significant source of funds used by the Company to meet obligations for depositor withdrawals, fund the borrowing needs of loan customers, and fund ongoing operations. Total deposits at June 30, 2022 increased $13,446, or 1.3%, from year-end 2021. This change in deposits came primarily from interest-bearing deposit balances, which were up by $20,880, or 3.0%, from year-end 2021, while noninterest-bearing deposits decreased $7,434, or 2.1%, from year-end 2021. The increase in interest-bearing deposits was primarily a result of higher interest-bearing NOW account balances from year-end 2021, which increased $25,418, or 12.4%. This increase was largely driven by higher municipal NOW product balances, particularly within the Gallia County, Ohio, and Mason County, West Virginia, market areas. Growth in interest-bearing deposits also came from savings deposits, which increased $6,632, or 4.5%, from year-end 2021, primarily from higher statement savings account balances. Interest-bearing deposit growth was further impacted by higher money market balances from year-end 2021, which increased $7,203, or 4.3%. Partially offsetting the increases in interest-bearing deposits were time deposit balances, which decreased $18,373, or 9.7%, from year-end 2021. The decrease came primarily from the Company’s retail time deposits, which decreased $12,891 from year-end 2021 due to the consumer shift to savings and money market products. Time deposits were also impacted by lower brokered and internet CD issuances, down collectively by $5,482, as a result of the heightened liquidity position from year-end 2021. 32 The decrease in noninterest-bearing deposits was primarily in the Company’s business and incentive-based checking account balances from year-end 2021. 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 2022, 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 $18,484 at June 30, 2022, a decrease of $1,130, or 5.8%, from year-end 2021. The decrease was related primarily to the principal repayments applied to various FHLB advances during the first quarter of 2022. 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 June 30, 2022 decreased $8,786, or 6.2%, to finish at $132,570, as compared to $141,356 at December 31, 2021. This was from quarterly net income being completely offset by cash dividends paid and a decrease in the fair value of available for sale securities. The after-tax change in fair value totaled $12,769 from year-end 2021, as market rate increases continued during the first half of 2022, causing a decrease in the fair value of the Company’s available for sale investment portfolio. Comparison of Results of Operations For the Three and Six Months Ended June 30, 2022 and 2021 The following discussion focuses, in more detail, on the consolidated results of operations of the Company for the three and six months ended June 30, 2022, compared to the same period in 2021. 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 June 30, 2022, net interest income increased $338, or 3.3%, compared to the same period in 2021. During the six months ended June 30, 2022, net interest income increased $280, or 1.4%, compared to the same period in 2021. The improvement during both periods was mostly attributable to an increase in average earning assets combined with a decrease in the average costs paid on deposits, being partially offset by lower earning asset yields and lower loan fees. Total interest and fee income recognized on the Company’s earning assets increased just $22, or 0.2%, during the second quarter of 2022, and decreased $447, or 2.0%, during the first half of 2022, compared to the same periods in 2021. The limited to lower earnings during both periods was impacted by interest and fees on loans, which decreased $542, or 5.1%, during the second quarter of 2022, and $1,309, or 6.2%, during the first half of 2022, compared to the same periods in 2021. This was largely related to the decline in loan fees, which were down $310 and $649 during the quarterly and year-to-date periods ended June 30, 2022, compared to the same periods in 2021. The decrease in loan fees was primarily a result of decreased PPP fees during both periods as a result of the payoffs of all PPP loans by the end of the first quarter of 2022. Interest on loans decreased $233 and $661 during the quarterly and year-to-date periods ended June 30, 2022, compared to the same periods in 2021, as a result of lower loan yields and lower average balances. The average interest rate yield on loans decreased 5 basis points during the second quarter of 2022, and decreased 8 basis points during the first half of 2022, compared to the same periods in 2021. While average loan rates were down, the actions taken by the Federal Reserve to increase rates during the first half of 2022 have had a positive impact on average loan yields. On a linked quarter basis, the average interest rate yield on loans was 4.55% during the second quarter of 2022 compared to 4.55% for the first quarter of 2022 and 4.59% for the fourth quarter of 2021. Average loans decreased $10,269 during the second quarter of 2022, and $14,184 during the first half of 2022, compared to the same periods in 2021. The decrease came mostly from the payoffs of all the Company’s PPP loans during 2021 and 2022, while a decrease in average real estate loan balances impacted by principal repayments and payoffs, combined with a lower volume of new originations, also contributed to the decrease. 33 Total interest income from interest-bearing deposits with banks increased $199, or 603.0%, during the second quarter of 2022, and increased $225, or 368.9%, during the first half of 2022, compared to the same periods in 2021. The increases during both periods were largely from the rate increases associated with the Company’s interest-bearing Federal Reserve Bank clearing account. As previously mentioned, the Federal Reserve took action during the first half of 2022 to increase the target federal funds rate by 150 basis points due to rising inflationary concerns. This had a corresponding effect to the interest rate tied to the Federal Reserve clearing account, which also increased by 150 basis points. The impact from higher rates was partially offset by lower average Federal Reserve Bank balances, which decreased $17,673 during the second quarter of 2022, and $3,343 during the first half of 2022, compared to the same periods in 2021. The Company utilized Federal Reserve Bank balances to help fund new loans and security purchases during the first half of 2022. Total interest on securities increased $357, or 66.2%, during the second quarter of 2022, and increased $635, or 63.3%, during the first half of 2022, compared to the same periods in 2021. Due to the surge in deposits and proceeds from PPP loan payoffs, the Company has taken opportunities to reinvest a portion of these excess funds into new U.S. Government, Agency and Agency mortgage-backed securities. This contributed to average security balance increases of $47,173 during the second quarter of 2022 and $58,104 during the first half of 2022, compared to the same periods in 2021. The average yield on securities also increased 38 basis points during the second quarter of 2022 and 23 basis points during the first half of 2022, which contributed to growth in interest income. This change was partly impacted by the Company’s decision to sell $48,732 in lower yielding securities during the fourth quarter of 2021 that carried an average yield of 0.89% and replace them with similar securities at an average yield of 1.30%. Total interest expense incurred on the Company’s interest-bearing liabilities decreased $316, or 32.1%, during the second quarter of 2022, and decreased $727, or 32.3%, during the first half of 2022, compared to the same periods in 2021. Interest expense decreased despite increases in average interest-bearing deposits of $11,169 during the second quarter of 2022, and $21,321 during the first half of 2022, compared to the same periods in 2021. 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 and 2021. Lower deposit expense was mostly impacted by the continued decline in CD rates, which contributed to a $296 decrease in time deposit interest expense during the second quarter of 2022, and a $646 decrease during the first half of 2022, compared to the same periods in 2021. As CD rates have repriced downward, the Company has benefited from lower interest expense on newly issued CDs at lower rates. As a result of the rate repricings on time deposits, the Company’s total weighted average costs on interest-bearing deposits has decreased by 19 basis points from 0.48% at June 30, 2021, to 0.29% at June 30, 2022. The Company’s net interest margin is defined as fully tax-equivalent net interest income as a percentage of average earning assets. During 2022, the Company’s second quarter net interest margin improved to 3.64%, compared to 2021’s second quarter net interest margin of 3.58%. The Company’s year-to-date net interest margin finished at 3.58% at June 30, 2022, compared to 2021’s year-to-date net interest margin of 3.65%. The year-to-date margin decrease was largely impacted by the decrease in PPP loan fees and a low interest rate environment that impacted lower earning asset yields during 2022 combined with decreases in average loan balances. The quarterly margin increase was impacted by the redeployment of lower yielding Federal Reserve Bank balances into higher yielding loans and securities. This composition shift from lower yielding Federal Reserve clearing account balances limited the dilutive effect to the net interest margin during the second quarter of 2022. Furthermore, the actions taken by the Federal Reserve to increase rates by 125 basis points during the second quarter of 2022 had a direct impact to the rate repricings of the Federal Reserve Bank account and a portion of the loan portfolio, which had a positive impact on the margin. 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 June 30, 2022, the Company’s provision expense increased $786 over the same period in 2021. The increase was directly related to a $752 increase in net charge offs during the second quarter of 2022 compared to the same period in 2021. In June 2022, the Company charged off two commercial and industrial loans totaling $613 as part of a single borrower relationship, which required a corresponding increase to provision expense. For the six months ended June 30, 2022, the Company’s provision expense decreased $288 from the same period in 2021. The year-to-date improvement came primarily from a decrease in general allocations. As previously discussed, the Company’s general allocations of the allowance for loan losses were impacted by the release of $645 in COVID-19 general reserves during the first quarter of 2022. The Company removed a portion of its COVID-19 reserves due to positive asset quality trends and lower net charge offs, which resulted in a corresponding decrease of $645 to provision expense during the first half of 2022. Further contributing to lower provision expense were the impacts of the Company’s other general reserve allocations. During the first half of 2022, the Company decreased its general allocations, excluding the COVID-19 risk factor, from $3,840 at December 31, 2021, to $2,781 at June 30, 2022. Lower general reserves were a result of various improvements within the economic risk factor calculation that included: lower criticized and classified assets, lower delinquency levels, and higher annualized level of loan recoveries. Decreases in provision expense were partially offset by increases in net charge offs and specific allocations during the year, which required corresponding increases to provision expense. During the first half of 2022, net charge offs increased $620 compared to the same period in 2021, due in large part to the charge off of a single borrower relationship discussed above. An increase in specific allocations also increased provision expense during the first half of 2022 to $297 at June 30, 2022, compared to $60 in specific allocations at June 30, 2021. 34 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 increased $130, or 5.2%, during the three months ended June 30, 2022, and increased $511, or 8.7%, during the six months ended June 30, 2022, when compared to the same periods in 2021. Higher noninterest revenue was largely impacted by increases in service charges on deposit accounts, which were up $205 and $358 during the three and six months ended June 30, 2022, compared to the same periods in 2021, respectively. This included a higher volume of overdraft transactions during both the quarterly and year-to-date periods of 2022. Further impacting growth in noninterest revenue was mortgage banking income, which increased $34 and $90 during the three and six months ended June 30, 2022, compared to the same periods in 2021, respectively. Mortgage banking income increased largely due to Race Day. Race Day was formed in April 2021 and began conducting business during the third quarter of 2021. During the second quarter of 2022, Race Day experienced loan sales that yielded $127 in mortgage banking revenue, which contributed to $223 in mortgage banking revenue during the first half of 2022. These increases were partially offset by decreases in the Bank’s secondary market income due to less volume of mortgage refinancings. Increases in noninterest revenue also came from interchange income, which increased $4 during the second quarter of 2022, and increased $89 during the first half of 2022, compared to the same periods in 2021. This was impacted by an increase in consumer spending that led to a higher volume of transactions associated with the Company’s debit and credit card products. Partially offsetting increases to noninterest income were decreases in other noninterest income. During the second quarter of 2022, other noninterest income decreased $119, or 40.1%, compared to the same period in 2021. During the first half of 2022, other noninterest income decreased $67, or 15.0%, compared to the same period in 2021. The decreases were largely impacted by a $70 non-recurring gain on the sale of a branch building in Jackson, Ohio, that was sold in June 2021. The building had been acquired as part of the merger with the Milton Banking Company in 2016. The remaining noninterest income categories increased $6, or 1.3%, during the second quarter of 2022, and $41, or 2.0%, during the first half of 2022, compared to the same periods in 2021. The increases came primarily from growth in trust division income and higher earnings on bank owned life insurance and annuity assets. Noninterest Expense Noninterest expense increased $726, or 7.8%, during the three months ended June 30, 2022, and increased $1,327, or 7.2%, during the six months ended June 30, 2022, compared to the same periods in 2021. Contributing most to the increase in noninterest expense were salaries and employee benefits, which increased $404 and $704 during the three and six months ended June 30, 2022, compared to the same periods in 2021, respectively. The e xpense increase was largely from the staffing of Race Day employees in 2021, which led to higher salaries expense in 2022. Other expense increases in this category also came from annual merit increases and higher retirement plan costs in 2022. Higher noninterest expense also came from software costs, which increased $122 and $176 during the three and six months ended June 30, 2022, compared to the same periods in 2021, respectively. The increases were largely impacted by the associated software costs from Race Day, which included various software platforms and resources that were necessary to begin conducting business. 35 Further impacting higher overhead costs were professional fees, which increased $71 and $130 during the three and six months ended June 30, 2022, compared to the same periods in 2021, respectively. Professional fees were impacted by higher accounting expenses associated with adhering to regulatory guidance. Data processing expenses increased $28 and $125 during the three and six months ended June 30, 2022, compared to the same periods in 2021, respectively. Higher costs in this category were the direct result of the volume increase in debit and credit card transactions, which increased processing costs. Other noninterest expense also increased $138 and $300 during the three and six months ended June 30, 2022, compared to the same periods in 2021, respectively. This was primarily impacted by various other overhead costs associated with Race Day, including loan expenses and employee recruiting costs. The remaining noninterest expense categories decreased $37 and $108 during the three and six months ended June 30, 2022, compared to the same periods in 2021, respectively. These decreases were impacted mostly from expense savings related to lower marketing and furniture and equipment 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 three and six months ended June 30, 2022, to the same periods in 2021, the Company continues to benefit from a larger decrease in the average cost on interest-bearing liabilities than the decrease on earning asset yields. The composition shift from lower yielding Federal Reserve Bank balances to higher yielding loans and securities, combined with the Federal Reserve’s rate increases during the first half of 2022 has had a positive impact to the net interest margin. These factors more than offset the decrease in PPP loan fees that were more impactful during 2021 than 2022. As a result, net interest income during the three and six months ended June 30, 2022, has outperformed the net interest income results during the same periods in 2021. However, it has been the increases in overhead costs that have completely offset the benefits of higher net interest earnings. Increases in overhead costs associated with Race Day have contributed to higher noninterest expense, which have increased over 7.0% during both the three and six months ended June 30, 2022, compared to the same periods in 2021. Furthermore, the Company’s increases in quarterly and year-to-date overhead expense were only partially offset by increases in noninterest income during both periods. As a result, the Company’s quarterly efficiency number increased (regressed) to 75.3% during the three months ended June 30, 2022 from 72.4% during the same period in 2021. The Company’s year-to-date efficiency number also increased (regressed) to 73.0% during the first half of 2022 from 70.2% during the same period in 2021. Provision for income taxes The Company’s income tax provision decreased $182 during the three months ended June 30, 2022, and increased $20 during the six months ended June 30, 2022, when compared to the same periods in 2021. The changes in tax expense corresponded directly to the change in associated taxable income during 2022 and 2021. 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. 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. 36 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 opted into the CBLR, and will, therefore, not be required to comply with the Basel III capital requirements. As of June 30, 2022, the Bank’s CBLR was 10.43%. 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. The CBLR was then increased to 8.5% in 2021 until it was returned to 9% for all community banks beginning January 1, 2022. Cash dividends paid by the Company were $2,716 during the first half of 2022. The year-to-date dividends paid totaled $0.57 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 market place. Total cash and cash equivalents, held to maturity securities maturing within one year, and available for sale securities, which totaled $288,145, represented 23.0% of total assets at June 30, 2022 compared to $329,264 and 26.3% of total assets at December 31, 2021. To further enhance the Bank’s ability to meet liquidity demands, the FHLB offers advances to the Bank. At June 30, 2022, the Bank could borrow an additional $116,069 from the FHLB. Furthermore, the Bank has established a borrowing line with the Federal Reserve. At June 30, 2022, this line had total availability of $51,567. Lastly, the Bank also has the ability to purchase federal funds from a correspondent bank. For further cash flow information, see the condensed consolidated statement of cash flows above. Management does not rely on any single source of liquidity and monitors the level of liquidity based on many factors affecting the Company’s financial condition. 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. 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 2021 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. 37 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 3 years for the consumer and real estate portfolio segment and 5 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. During the second quarter of 2022, the Company established a new economic risk factor for certain risks that may impact the loan portfolio, such as elevated inflation, increasing interest rates, slowing housing starts, declining GDP, and negative employment trends. The following portfolio segments have been identified: Commercial Real Estate, Commercial and Industrial, Residential Real Estate, and Consumer. 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. 38 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 6 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.