SB FINANCIAL GROUP, INC. 10-K

Item 8. Financial Statements and Supplementary Data. Our Consolidated Financial Statements and notes thereto and other supplementary data begin on the following page. 47 SB Financial Group, Inc. Consolidated Balance Sheets at December 31, ($ in thousands) 2020 2019 Assets Cash and due from banks $ 140,690 $ 27,064 Interest bearing time deposits 5,823 - Available-for-sale securities 149,406 100,948 Loans held for sale 7,234 7,258 Loans, net of unearned income 872,723 825,510 Allowance for loan losses (12,574 ) (8,755 ) Premises and equipment, net 23,557 23,385 Federal Reserve and Federal Home Loan Bank Stock, at cost 5,303 4,648 Foreclosed assets held for sale, net 23 305 Interest receivable 3,799 3,106 Goodwill 22,091 17,792 Cash value of life insurance 17,530 17,221 Mortgage servicing rights 7,759 11,017 Other assets 14,475 9,078 Total assets $ 1,257,839 $ 1,038,577 Liabilities and shareholders’ equity Liabilities Deposits Non interest bearing demand $ 251,649 $ 158,357 Interest bearing demand 176,785 131,084 Savings 174,864 119,359 Money market 216,164 173,666 Time deposits 229,549 257,753 Total deposits 1,049,011 840,219 Repurchase agreements 20,189 12,945 Federal Home Loan Bank advances 8,000 16,000 Trust preferred securities 10,310 10,310 Interest payable 616 1,191 Other liabilities 26,790 21,818 Total liabilities 1,114,916 902,483 Commitments & Contingent Liabilities - - Shareholders’ Equity Preferred stock, no par value; authorized 200,000 shares; 2020 - 0 shares outstanding, 2019 - 0 shares outstanding - - Common stock, no par value; authorized 10,000,000 shares; 2020 - 8,180,712 shares issued, 2019 - 8,180,712 shares issued 54,463 54,463 Additional paid-in capital 14,845 15,023 Retained earnings 84,578 72,704 Accumulated other comprehensive income 2,210 659 Treasury stock, at cost; (2020 - 808,456 common shares, 2019 - 417,785 common shares) (13,173 ) (6,755 ) Total shareholders’ equity 142,923 136,094 Total liabilities and shareholders’ equity $ 1,257,839 $ 1,038,577 See Notes to Consolidated Financial Statements F- 1 SB Financial Group, Inc. Consolidated Statements of Income Years Ended December 31, ($ in thousands, except per share data) 2020 2019 Interest Income Loans Taxable $ 39,735 $ 40,529 Tax exempt 239 300 Securities Taxable 2,328 3,226 Tax exempt 333 345 Total interest income 42,635 44,400 Interest Expense Deposits 6,070 8,660 Repurchase agreements & other 70 82 Federal Home Loan Bank advance expense 309 402 Trust preferred securities expense 256 430 Total interest expense 6,705 9,574 Net Interest Income 35,930 34,826 Provision for loan losses 4,500 800 Net interest income after provision for loan losses 31,430 34,026 Noninterest Income Wealth management fees 3,245 3,093 Customer service fees 2,807 2,761 Gain on sale of mortgage loans & OMSR 25,350 8,413 Mortgage loan servicing fees, net (5,138 ) (397 ) Gain on sale of non-mortgage loans 453 1,255 Title insurance income 1,913 1,120 Net gain on sale of securities - 206 Other income 1,466 1,565 Total noninterest income 30,096 18,016 Noninterest Expense Salaries and employee benefits 25,397 22,064 Net occupancy expense 2,891 2,603 Equipment expense 3,186 2,828 Data processing fees 3,055 1,973 Professional fees 3,307 2,476 Marketing expense 658 895 Telephone and communications 535 466 Postage and delivery expense 415 340 State, local and other taxes 1,146 1,092 Employee expense 535 795 Other expense 1,962 1,878 Total noninterest expense 43,087 37,410 Income before income tax 18,439 14,632 Provision for income taxes 3,495 2,659 Net Income $ 14,944 $ 11,973 Preferred share dividends - 950 Net income available to common shareholders $ 14,944 $ 11,023 Basic earnings per common share $ 1.96 $ 1.71 Diluted earnings per common share $ 1.96 $ 1.51 See Notes to Consolidated Financial Statements F- 2 SB Financial Group, Inc. Consolidated Statements of Comprehensive Income Years Ended December 31, ($ in thousands) 2020 2019 Net income $ 14,944 $ 11,973 Other comprehensive income Available for sale investment securities: Gross unrealized holding gain arising in the period 1,963 1,327 Related tax expense (412 ) (279 ) Less: reclassification adjustment for gain realized in income - 206 Related tax expense - (43 ) Net effect on other comprehensive income 1,551 1,211 Total comprehensive income $ 16,495 $ 13,184 See Notes to Consolidated Financial Statements F- 3 SB Financial Group, Inc. Consolidated Statements of Stockholders’ Equity Years Ended December 31, Preferred Common Additional Paid-in Retained Accumulated Other Comprehensive Treasury ($ in thousands, except per share data) Stock Stock Capital Earnings Income (Loss) Stock Total January 1, 2020 $ - $ 54,463 $ 15,023 $ 72,704 $ 659 $ (6,755 ) $ 136,094 Net income 14,944 14,944 Other comprehensive income 1,551 1,551 Dividends on common, $0.40 per share (3,070 ) (3,070 ) Restricted stock vesting (307 ) 307 - Stock options exercised (253 ) 441 188 Repurchased stock (7,166 ) (7,166 ) Stock based compensation expense 382 382 December 31, 2020 $ - $ 54,463 $ 14,845 $ 84,578 $ 2,210 $ (13,173 ) $ 142,923 Preferred Common Additional Paid-in Retained Accumulated Other Comprehensive Treasury ($ in thousands, except per share data) Stock Stock Capital Earnings Income (Loss) Stock Total January 1, 2019 $ 13,979 $ 40,485 $ 15,226 $ 64,012 $ (552 ) $ (2,715 ) $ 130,435 Net income 11,973 11,973 Other comprehensive income 1,211 1,211 Conversion of preferred to common (13,979 ) 13,978 (1 ) Stock reissue for purchase of Peak Title 22 117 139 Dividends on common, $0.36 per share (2,331 ) (2,331 ) Dividends on preferred, $0.65 per share (950 ) (950 ) Restricted stock vesting (321 ) 321 - Stock options exercised (321 ) 572 251 Repurchased stock (5,050 ) (5,050 ) Stock based compensation expense 417 417 December 31, 2019 $ - $ 54,463 $ 15,023 $ 72,704 $ 659 $ (6,755 ) $ 136,094 See Notes to Consolidated Financial Statements F- 4 SB Financial Group, Inc. Consolidated Statements of Cash Flows Years Ended December 31, ($ in thousands) 2020 2019 Operating Activities Net Income $ 14,944 $ 11,973 Items not requiring (providing) cash Depreciation and amortization 1,937 1,879 Provision for loan losses 4,500 800 Expense of share-based compensation plan 382 417 Amortization of premiums and discounts on securities 643 314 Amortization of intangible assets 46 8 Amortization of originated mortgage servicing rights 4,762 2,126 Impairment of mortgage servicing rights 3,586 1,094 Deferred income taxes (2,444 ) (279 ) Proceeds from sale of loans held for sale 603,178 368,154 Originations of loans held for sale (582,538 ) (364,472 ) Gain from sale of loans (25,803 ) (9,668 ) Loss (gain) on sales of assets (2 ) 5 Net gains on sales of securities - (206 ) Changes in Interest receivable (693 ) (284 ) Other assets (5,209 ) (3,680 ) Interest payable & other liabilities 6,618 10,648 Net cash provided by operating activities 23,907 18,829 Investing Activities Purchases of available-for-sale securities (129,796 ) (38,455 ) Proceeds from maturities of interest bearing time deposits 5,719 - Proceeds from maturities of available-for-sale securities 84,021 22,527 Proceeds from sales of available-for-sale securities - 7,375 Proceeds from sales of portfolio loans - 11,265 Net change in loans (31,706 ) (65,504 ) Purchase of premises, equipment (1,980 ) (2,043 ) Proceeds from sales of premises, equipment 301 24 Purchase of bank owned life insurance - (50 ) Purchase of Federal Reserve and Federal Home Loan Bank Stock (538 ) (525 ) Proceeds from sale of foreclosed assets 500 372 Acquisition, net of cash acquired 16,263 (2,600 ) Net cash used in investing activities (57,216 ) (67,614 ) Financing Activities Net increase in demand deposits, money market, interest checking & savings accounts 195,501 21,376 Net increase (decrease) in time deposits (37,762 ) 16,291 Net increase (decrease) in securities sold under agreements to repurchase 7,244 (2,239 ) Repayment of Federal Home Loan Bank advances (8,000 ) - Net proceeds from share-based compensation plans 188 251 Stock repurchase plan (7,166 ) (5,050 ) Issuance of common shares - 139 Conversion of preferred stock - (1 ) Dividends on common shares (3,070 ) (2,331 ) Dividends on preferred shares - (950 ) Net cash provided by financing activities 146,935 27,486 Increase (decrease) in cash and cash equivalents 113,626 (21,299 ) Cash and cash equivalents, beginning of year 27,064 48,363 Cash and cash equivalents, end of year $ 140,690 $ 27,064 Supplemental cash flow information Interest paid $ 7,280 $ 9,292 Income taxes paid $ 5,180 $ 3,084 Fair value of assets acquired - premises and equipment (Peak Title) $ - $ 1,161 Supplemental non-cash disclosure Initial recognition of right-of-use lease assets $ 248 $ 293 Transfer of loans to loans held for sale $ - $ 11,114 Transfer of loans to foreclosed assets $ 207 $ 551 In conjunction with the Edon acquisition, liabilities assumed were: Fair value of assets acquired $ 66,769 $ - Cash paid in acquisition (15,493 ) - Liabilities assumed $ 51,276 $ - See Notes to Consolidated Financial Statements F- 5 SB Financial Group, Inc. Notes to Consolidated Financial Statements Years Ended December 31, 2020 and 2019 Note 1: Organization and Summary of Significant Accounting Policies Organization and Nature of Operations SB Financial Group, Inc. (the “Company”) is a financial holding company whose principal activity is the ownership and management of its wholly-owned subsidiaries, The State Bank and Trust Company (“State Bank”), SBFG Title, LLC dba Peak Title Agency (“SBFG Title”), SB Captive, Inc. (“SB Captive”), RFCBC, Inc. (“RFCBC”), Rurbanc Data Services, Inc. dba RDSI Banking Systems (“RDSI”), and Rurban Statutory Trust II (“RST II”). State Bank owns all the outstanding stock of Rurban Mortgage Company (“RMC”), and State Bank Insurance, LLC (“SBI”). The Company is primarily engaged in providing a full range of banking and wealth management services to individual and corporate customers primarily located in Ohio, Indiana, and Michigan. The Company is subject to competition from other financial institutions, and regulated by certain federal and state agencies and undergoes periodic examinations by those regulatory authorities. Principles of Consolidation The Consolidated Financial Statements include the accounts of the Company, State Bank, SBFG Title, SB Captive, RFCBC, RDSI, RMC, RST II, and SBI. All significant intercompany accounts and transactions were eliminated in consolidation. Use of Estimates The preparation of financial statements in conformity with accounting principles generally accepted in the United States of America requires management to make estimates and assumptions that affect the reported amounts of assets and liabilities and disclosure of contingent assets and liabilities at the date of the financial statements and the reported amounts of revenues and expenses during the reporting period. Actual results could differ from those estimates. Material estimates that are particularly susceptible to significant change relate to the determination of the allowance for loan losses, loan servicing rights, and fair value of financial instruments. Cash Equivalents The Company considers all liquid investments with original maturities of three months or less to be cash equivalents. At December 31, 2020 and 2019, cash equivalents consisted primarily of interest-bearing and noninterest bearing demand deposit balances held by correspondent banks. At December 31, 2020, the Company’s correspondent cash accounts exceeded federally insured limits by $10.6 million. Additionally, the Company had approximately $115.9 million of cash held by the FRB and the FHLB, which is not federally insured. Securities Available-for-sale securities, which include any debt security for which the Company has no immediate plan to sell but which may be sold in the future, are carried at fair value. Unrealized gains and losses are recorded, net of related income tax effects, in other comprehensive income. Amortization of premiums and accretion of discounts are recorded as interest income from securities. Realized gains and losses are recorded as net security gains (losses). Gains and losses on sales of securities are determined on the specific-identification method. For debt securities with fair value below carrying value when the Company does not intend to sell the debt security, and it is more likely than not the Company will not have to sell the security before recovery of its cost basis, the Company recognizes the credit component of an other-than-temporary impairment of the debt security in earnings and the remaining portion in other comprehensive income. F- 6 Mortgage Loans Held for Sale Mortgage loans originated and intended for sale in the secondary market are carried at the lower of cost or fair value in the aggregate. Net unrealized losses, if any, are recognized through a valuation allowance by charges to noninterest income. Gains and losses on loan sales are recorded in noninterest income. The Company utilizes third-party hedges to minimize the impact of interest rate risk fluctuations, and their impact is realized through noninterest income. Loans Loans that management has the intent and ability to hold for the foreseeable future, or until maturity or payoffs, are reported at their outstanding principal balances adjusted for any charge offs, the allowance for loan losses, any deferred fees or costs on originated loans and unamortized premiums or discounts on purchased loans. Interest income is reported on the interest method and includes amortization of net deferred loan fees and costs over the loan term. Generally, loans are placed on nonaccrual status not later than 90 days past due. Past due status is based on the contractual terms of the loan. All interest accrued, but not collected for loans that are placed on nonaccrual or charged off, is reversed against interest income. The interest on these loans is accounted for on the cash-basis or cost-recovery method, until qualifying for return to accrual. Loans are returned to accrual status when all the principal and interest amounts contractually due are brought current and future payments are reasonably assured. Allowance for Loan Losses The allowance for loan losses is established as losses are estimated to have occurred through a provision for loan losses charged to income. Loan losses are charged against the allowance when management believes the non-collectability of a loan balance is probable. Subsequent recoveries, if any, are credited to the allowance. The allowance for loan losses is evaluated on a regular basis by management and is based upon management’s periodic review of the collectability of the loans in light of historical experience, the nature and volume of the loan portfolio, adverse situations that may affect the borrower’s ability to repay, estimated value of any underlying collateral and prevailing economic conditions. This evaluation is inherently subjective as it requires estimates that are susceptible to significant revision as new information becomes available. The allowance consists of allocated and general components. The allocated component relates to loans that are classified as impaired. For those loans that are classified as impaired, an allowance is established when the discounted cash flows (or collateral value or observable market price) of the impaired loan is lower than the carrying value of that loan. The general component covers non-classified loans and is based on historical charge off experience and expected loss given default derived from the Company’s internal risk rating process. Other adjustments may be made to the allowance for pools of loans after an assessment of internal or external influences on credit quality that are not fully reflected on the historical loss or risk rating data. A loan is considered impaired when, based on current information and events, it is probable that the Company will be unable to collect the scheduled payments of principal or interest when due according to the contractual terms of the loan agreement. 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 each of the circumstances surrounding the loan and the borrower, including the length of the delay, the reasons for the delay, the borrower’s prior payment record and the amount of the shortfall in relation to the principal and interest owed. Impairment is measured on a loan-by-loan basis for commercial, agricultural, and construction loans by either the present value of expected future cash flows discounted at the loan’s effective interest rate, the loan’s obtainable market price or the fair value of the collateral if the loan is collateral dependent. F- 7 When a loan moves to nonaccrual status, total unpaid interest accrued to date is reversed from income. Subsequent payments are applied to the outstanding principal balance with the interest portion of the payment recorded on the balance sheet as a contra-loan. Interest received on impaired loans may be realized once all contractual principal amounts are received or when a borrower establishes a history of six consecutive timely principal and interest payments. It is at the discretion of management to determine when a loan is placed back on accrual status upon receipt of six consecutive timely payments. Large groups of smaller balance homogenous loans are collectively evaluated for impairment. Accordingly, individual consumer and residential loans are not separately identified for impairment measurements, unless such loans are the subject of a restructuring agreement due to financial difficulties of the borrower. Premises and Equipment Depreciable assets are stated at cost less accumulated depreciation. Depreciation is charged to expense using the straight-line method for buildings and equipment over the estimated useful lives of the assets. Leasehold improvements are capitalized and depreciated using the straight-line method over the terms of the respective leases. Long-lived Asset Impairment The Company evaluates the recoverability of the carrying value of long-lived assets whenever events or circumstances indicate the carrying amount may not be recoverable. If a long-lived asset is tested for recoverability and the undiscounted estimated future cash flows expected to result from the use and eventual disposition of the asset is less than the carrying amount of the asset, the asset’s cost is adjusted to fair value and an impairment loss is recognized as the amount by which the carrying amount of a long-lived asset exceeds its fair value. Federal Reserve Bank and Federal Home Loan Bank Stock FRB and FHLB stock are required investments for institutions that are members of the FRB and FHLB systems. The required investment in the common stock is based on a predetermined formula, carried at cost and evaluated for impairment. Foreclosed Assets Held for Sale Assets acquired through, or in lieu of, loan foreclosure are held for sale and are initially recorded at fair value less costs to sell at the date of foreclosure, establishing a new cost basis. Subsequent to foreclosure, valuations are periodically performed by management and the assets are carried at the lower of the carrying amount or the fair value less cost to sell. Revenue and expenses from operations related to foreclosed assets and changes in the valuation allowance are included in net income or expense from foreclosed assets. Goodwill Goodwill is tested for impairment annually. If the implied fair value of goodwill is lower than its carrying amount, goodwill impairment is indicated and goodwill is written down to its implied fair value. Core Deposits and Other Intangibles Intangible assets are being amortized on a straight-line basis over weighted-average periods ranging from one to fifteen years. Such assets are periodically evaluated as to the recoverability of their carrying value. Purchased software is being amortized using the straight-line method over periods ranging from one to three years. Derivatives The Company utilizes derivative financial instruments to help manage exposure to interest rate risk and the effects that changes in interest rates may have on net income and the fair value of assets and liabilities. The Company enters into interest rate swap agreements as part of its asset liability management strategy to help manage its interest rate risk position. Additionally, the Company enters into forward contracts for the future delivery of mortgage loans to third-party investors and enters into interest rate lock commitments (“IRLCs”) with potential borrowers to fund specific mortgage loans that will be sold into the secondary market. The forward contracts are entered into in order to economically hedge the effect of changes in interest rates resulting from the Company’s commitment to fund the loans. F- 8 The IRLCs and forward contracts are not designated as accounting hedges and are recorded at fair value with the changes in fair value reflected in noninterest income on the consolidated statements of income. The fair value of derivative instruments with a positive fair value are reported in accrued income and other assets in the consolidated balance sheets, while the derivative instruments with a negative fair value are reported in accrued expenses and other liabilities in the consolidated balance sheets. For exchange-traded contracts, fair value is based on quoted market prices. For non-exchange traded contracts, fair value is based on dealer quotes, pricing models, discounted cash flow methodologies or similar techniques for which the determination of fair value may require significant management judgment or estimation. Mortgage Servicing Rights Mortgage servicing assets are recognized separately when rights are acquired through purchase or through sale of financial assets. Under the servicing assets and liabilities accounting guidance, (Accounting Standards Codification “ASC” 806-50), servicing rights from the sale or securitization of loans originated by the Company are initially measured at fair value at the date of transfer. The Company subsequently measures each class of servicing asset using the amortization method. Under the amortization method, servicing rights are amortized in proportion to and over the period of estimated net servicing income. The amortized assets are assessed for impairment based on fair value at each reporting date. Fair value is based on market prices for comparable mortgage servicing contracts, when available, or alternatively, is based on a valuation model that calculates the present value of estimated future net servicing income. The valuation model incorporates assumptions that market participants would use in estimating future net servicing income, such as the cost of service, the discount rate, the custodial earning rate, an inflation rate, ancillary income, prepayment speeds and default rates and losses. These variables change from quarter to quarter as market conditions and projected interest rates change, and may have an adverse impact on the value of the mortgage servicing right and may result in a reduction to noninterest income. Each class of separately recognized servicing assets subsequently measured using the amortization method is evaluated and measured for impairment. Impairment is determined by stratifying rights into tranches based on predominant characteristics, such as interest rate, loan type and investor type. Impairment is recognized through a valuation allowance for an individual tranche, to the extent that fair value is less than the carrying amount of the servicing assets for that tranche. The valuation allowance is adjusted to reflect changes in the measurement of impairment after the initial measurement of impairment. Changes in valuation allowances are reported with “Mortgage loan servicing fees, net” in the income statement. Fair value in excess of the carrying amount of servicing assets for that stratum is not recognized. Servicing fee income is recorded for fees earned for servicing loans. The fees are based on a contractual percentage of the outstanding principal or a fixed amount per loan and are recorded as income when earned. The amortization of mortgage servicing rights is netted against loan servicing fee income. Share-Based Employee Compensation Plan At December 31, 2020 and 2019, the Company had a share-based employee compensation plan (see Note 19 to the Consolidated Financial Statements). Transfers of Financial Assets Transfers of financial assets are accounted for as sales, when control over the assets has been surrendered. Control over transferred assets is deemed to be surrendered when (1) the assets have been isolated from the Company – put presumptively beyond the reach of the transferor and its creditors, even in bankruptcy or other receivership, (2) the transferee obtains the right (free of conditions that constrain it from taking advantage of that right) to pledge or exchange the transferred assets and (3) the Company does not maintain effective control over the transferred assets through an agreement to repurchase them before the maturity or the ability to unilaterally cause the holder to return specific assets. F- 9 Income Taxes The Company accounts for income taxes in accordance with income tax accounting guidance (ASC 740). The income tax accounting guidance results in two components of income tax expense: current and deferred. Current income tax expense reflects taxes to be paid or refunded for the current period by applying the provisions of the enacted tax law to the taxable income or excess of deductions over revenues. The Company determines deferred income taxes using the liability (or balance sheet) method. Under this method, the net deferred tax asset or liability is based on the tax effects of the differences between the book and tax bases of assets and liabilities, and enacted changes in tax rates and laws are recognized in the period in which they occur. Deferred income tax expense results from changes in deferred tax assets and liabilities between periods. Deferred tax assets are reduced by a valuation allowance if, based on the weight of evidence available, it is more likely than not that some portion or all of a deferred tax asset will not be realized. Uncertain tax positions are recognized if it is more likely than not, based on the technical merits, that the tax position will be realized or sustained upon examination. The term more likely than not means a likelihood of more than 50 percent; the term “upon examination” also includes resolution of the related appeals or litigation processes, if any. A tax position that meets the more-likely-than-not recognition threshold is initially and subsequently measured as the largest amount of tax benefit that has a greater than 50 percent likelihood of being realized upon settlement with a taxing authority that has full knowledge of all relevant information. The determination of whether or not a tax position has met the more-likely-than-not recognition threshold considers the facts, circumstances and information available at the reporting date and is subject to management’s judgment. The Company recognizes interest and penalties on income taxes as a component of income tax expense. The Company files consolidated income tax returns with its subsidiaries. With a few exceptions, the Company is no longer subject to U.S. Federal, State and Local examinations by tax authorities for the years before 2017. As of December 31, 2020, the Company had no uncertain income tax positions. Treasury Shares Treasury stock is stated at cost. Cost is determined by the weighted-average cost method. Earnings Per Share Earnings per common share is computed using the two-class method. Basic earnings per share represent income available to common shareholders divided by the weighted-average number of common shares outstanding during each period. Diluted earnings per share reflect additional potential common shares and convertible preferred shares that would have been outstanding if dilutive potential common shares had been issued, as well as any adjustment to income that would result from the assumed issuance. Potential common shares that may be issued by the Company relate solely to outstanding stock options which are determined using the treasury stock method and convertible preferred shares which are determined using the converted method. Treasury stock shares are not deemed outstanding for earnings per share calculations. Comprehensive Income Comprehensive income consists of net income and other comprehensive income, net of applicable income taxes. Other comprehensive income includes unrealized appreciation (depreciation) on available-for-sale securities. AOCI consists solely of the cumulative unrealized gains and losses on available-for-sale securities net of income tax. F- 10 Revenue Recognition The Company recognizes revenues as they are earned based on contractual terms, as transactions occur, or services are provided and collectability is reasonably assured. The Company’s principal source of revenue is interest income from loans and leases and investment securities. The Company also earns noninterest income from various banking and financial services offered through State Bank. Interest income is the largest source of revenue for the Company which is primarily recognized on an accrual basis. Noninterest income is earned through a variety of financial and transaction services provided to corporate and consumer clients such as trust and wealth advisory, deposit account, debit card, mortgage banking and insurance. New and applicable accounting pronouncements: ASU No. 2017-04: Intangibles – Goodwill and Other (Topic 350) This ASU simplifies the test for goodwill impairment. Specifically, these amendments eliminate Step 2 from the goodwill impairment test, and also eliminate the requirements for any reporting unit with a zero or negative carrying amount to perform a qualitative assessment and, if it fails that qualitative test, to perform Step 2 of the goodwill impairment test. The Company has adopted this ASU, and management did not believe the changes will have a material effect on the Company’s accounting and disclosures. ASU No. 2018-13: Fair Value Measurement - Disclosure Framework – Changes to the Disclosure Requirements for Fair Value Measurement (Topic 820) The updated guidance improves the disclosure requirements for fair value measurements. The ASU removes certain disclosures required by Topic 820 related to transfers between Level 1 and Level 2 of the fair value hierarchy; the policy for timing of transfers between levels; and the valuation processes for Level 3 fair value measurements. The ASU modifies certain disclosures required by Topic 820 related to disclosure of transfers into and out of Level 3 of the fair value hierarchy; the requirement to disclose the timing of liquidation of an investee’s assets and the date when restrictions from redemption might lapse only if the investee has communicated the timing to the entity or announced the timing publicly for investments in certain entities that calculate net asset value; and clarification that the measurement uncertainty disclosure is to communicate information about the uncertainty in measurement as of the reporting date. The ASU adds certain disclosure requirements related to changes in unrealized gains and losses for the period included in other comprehensive income for recurring Level 3 fair value measurements held at the end of the reporting period and the range and weighted-average of significant unobservable inputs used to develop Level 3 fair value measurements. For certain unobservable inputs, an entity may disclose other quantitative information in lieu of the weighted- average if the entity determines that other quantitative information would be a more reasonable and rational method to reflect the distribution of unobservable inputs used to develop Level 3 fair value measurements. The amendments in this update are effective for fiscal years, and interim periods within those fiscal years beginning after December 15, 2019. The impact of this new guidance did not have a material impact on the Company’s consolidated financial statements. Accounting standards not yet adopted: ASU No. 2020-04: Reference Rate Reform – Facilitation of the Effects of Reference Rate Reform on Financial Reporting (Topic 848) This guidance provides temporary options to ease the potential burden in accounting for reference rate reform. It is intended to help stakeholders during the global market-wide reference rate transition period. The guidance is effective as of March 12, 2020 through December 31, 2022. The Company anticipates being fully prepared to implement a replacement for the reference rate and has determined that any change will not have a material impact to the consolidated financial statements. F- 11 ASU No. 2020-01: Investments – Equity Securities (Topic 321), Investments – Equity Method and Joint Ventures (Topic 323), and Derivatives and Hedging (Topic 815) – Clarifying the Interactions between Topic 321, Topic 323 and Topic 815 This guidance was issued in January 2020 to clarify that a company should consider observable transactions that require a company to either apply or discontinue the equity method of accounting under Topic 323, Investments-Equity Method and Joint Ventures, for the purposes of applying the measurement alternative in accordance with Topic 321 immediately before applying or upon discontinuing the equity method. The amendments also clarify that when determining the accounting for certain forward contracts and purchased options a company should not consider, whether upon settlement or exercise, if the underlying securities would be accounted for under the equity method or fair value option. The guidance is effective beginning after December 15, 2020. The Company is currently assessing the impact on its accounting and disclosures. ASU No. 2016-13: Financial Instruments – Credit Losses (Topic 326) This ASU, which is commonly known as “CECL,” replaces the current GAAP incurred impairment methodology regarding credit losses with a methodology that reflects expected credit losses and requires consideration of a broader range of reasonable and supportable information to inform credit loss estimates. The amendments in this update affect an entity to varying degrees depending on the credit quality of the assets held by the entity, their duration, and how the entity applies current GAAP. The adoption of ASU 2016-13 is likely to result in an increase in the allowance for loan losses as a result of changing from an “incurred loss” model, which encompasses allowances for current known and inherent losses within the portfolio, to an “expected loss” model, which encompasses allowances for losses expected to be incurred over the life of the portfolio. Furthermore, ASU 2016-13 will necessitate that we establish an allowance for expected credit losses on debt securities. In December 2018, the OCC, the Federal Reserve Board, and the FDIC approved a final rule to address changes to credit loss accounting under GAAP, including banking organizations’ implementation of CECL. The final rule provides banking organizations the option to phase in over a three-year period the day-one adverse effects on regulatory capital that may result from the adoption of the new accounting standard. On November 15, 2019, the FASB delayed the effective date for certain small public companies and other private companies. As the Company is currently a smaller reporting company, the amendment will delay the effective date of ASU No. 2016-13 to the fiscal year beginning January 1, 2023. While we are currently unable to reasonably estimate the impact of adopting ASU 2016-13, we expect that the impact of adoption will be significantly influenced by the composition, characteristics and quality of our loan and securities portfolios as well as the prevailing economic conditions and forecasts as of the adoption date. The Company implemented a process to track required data by utilizing accounting software in preparation for compliance. We anticipate being fully prepared for implementation by January 1, 2023. Reclassifications: Certain reclassifications have been made to prior period financial statements to conform to the current financial statement presentation. These reclassifications had no effect on net income. F- 12 Note 2: Earnings Per Share Earnings per common share (“EPS”) is computed using the two-class method. Basic earnings per common share is computed by dividing net income available to common shareholders by the weighted-average number of common shares outstanding during the applicable period, excluding participating securities. Participating securities include non-vested restricted stock awards. Non-vested restricted stock awards are considered participating securities to the extent the holders of these securities receive non-forfeitable dividends at the same rate as holders of common shares. Diluted earnings per common share is computed using the weighted-average number of shares determined for the basic earnings per common share plus the convertible impact of preferred shares and the dilutive effect of stock compensation using the treasury stock method. EPS for the years ended December 31, 2020 and 2019 is computed as follows: Twelve Months Ended Dec. 31, ($ and outstanding shares in thousands - except per share data) 2020 2019 Distributed earnings allocated to common shares $ 3,070 $ 2,331 Undistributed (in excess of) earnings allocated to common shares 11,858 8,675 Net earnings allocated to common shares 14,928 11,006 Net earnings allocated to participating securities 16 17 Dividends on convertible preferred shares - 950 Net Income allocated to common shares and participating securities $ 14,944 $ 11,973 Weighted average shares outstanding for basic earnings per share 7,613 6,456 Dilutive effect of stock compensation 22 46 Dilutive effect of convertible shares - 1,433 Weighted average shares outstanding for diluted earnings per share 7,635 7,935 Basic earnings per common share $ 1.96 $ 1.71 Diluted earnings per common share $ 1.96 $ 1.51 There were no anti-dilutive shares in 2020 or 2019. Note 3: Business Combination Effective June 5, 2020, the Company acquired Edon Bancorp and its subsidiary, The Edon State Bank Company of Edon, Ohio. Edon Bancorp was headquartered in Edon, Ohio and had one retail banking office. The Edon State Bank was merged with and into State Bank, with State Bank surviving. Under the terms of the merger agreement, shareholders of Edon received fixed consideration of $103.50 in cash for each share of Edon common stock for total consideration of $15.5 million. The Company accounted for the transaction under the acquisition method of accounting, which means that the acquired assets and liabilities were recorded at fair value at the date of acquisition. In accordance with ASC 805, the Company expensed approximately $1.2 million of direct acquisition costs during the twelve months ended December 31, 2020. The $1.2 million in merger expense was split between data processing and professional fees expense. As a result of the acquisition, the Company recorded $4.3 million of goodwill and $0.7 million of intangible assets in the second quarter of 2020. The Company was able to increase both its deposit and loan base and acquire new households in a new market. It is expected that this transaction will result in business synergies and economies of scale. The acquisition was consistent with the Company’s strategy to expand its presence in Northwest Ohio and to increase profitability by introducing existing products and services to the acquired customer base. The intangible assets are related to core deposits, which are being amortized over 10 years on a straight-line basis. For tax purposes, goodwill is non-deductible but will be evaluated annually for impairment. F- 13 The following table summarizes the fair value of the total consideration transferred as part of the acquisition as well as the fair value of identifiable assets and liabilities assumed as of the effective date of the transaction based on assumptions that are subject to change as management continues to evaluate relevant information as it becomes available. If, prior to the end of the one-year measurement period for finalizing the purchase price allocation, relevant information becomes available which would indicate adjustments are required to the purchase price allocation, such adjustments will be recorded in the reporting period in which the adjustment amounts are determined. Potential adjustments, if any, will be related to assets that may have changes to valuation amounts that were not readily determinable at the acquisition date. The contractual principal of loans at the acquisition date was $16.8 million and the estimate of the contractual cash flows not expected to be collected is $0.4 million. ($ in thousands) June 5, 2020 Fair value of assets acquired Cash and cash equivalents $ 31,756 Interest bearing time deposits 11,542 Investment securities 1,362 Federal Home Loan Bank stock 117 Loans held for investment 16,395 Premises and equipment 446 Goodwill 4,299 Core deposit intangible 660 Other assets 192 Total assets acquired $ 66,769 Fair value of liabilities assumed Deposits $ 51,053 Other liabilities 223 Total liabilities assumed 51,276 Total purchase price (cash) $ 15,493 F- 14 Pro Forma Financial Information The results of operations of Edon Bancorp have been included in the Company’s consolidated financial statements since the acquisition date of June 5, 2020. The following schedule includes the pro forma results for the three and twelve months ended December 31, 2020 and 2019, as if the Edon acquisition had occurred as of the beginning of the reporting periods presented. The acquisition’s impact was immaterial to the Company’s operating performance for the twelve months ended December 31, 2020. Twelve Months Ended December 31 Summary of Operations ($ in thousands) 2020 2019 Net interest income $ 36,429 $ 36,307 Provision for loan losses 4,500 806 Net interest income after provision $ 31,929 $ 35,501 Non interest income 30,140 18,132 Non interest expense 44,158 38,484 Income before income taxes $ 17,911 $ 15,149 Income tax expense* 3,384 2,768 Net income $ 14,527 $ 12,381 Preferred share dividends - 487 Net income to common shareholders $ 14,527 $ 11,894 Basic earnings per share $ 1.90 $ 1.84 Diluted earnngs per share $ 1.90 $ 1.56 * Income tax expense for Edon calculated using a 21% statuatory rate Certain nonrecurring costs were included in the pro-forma, specifically $0.7 million was incurred by Edon prior to the acquisition in the 2020 fiscal year and the Company incurred $1.2 million in nonrecurring costs for the acquisition in the 2020 fiscal year. The Company and Edon incurred no acquisition related costs for the 2019 fiscal year. Note 4: Available-for-Sale Securities The amortized cost and appropriate fair values, together with gross unrealized gains and losses, of available-for-sale securities are as follows: Gross Gross Amortized Unrealized Unrealized ($ in thousands) Cost Gains Losses Fair Value December 31, 2020: U.S. Treasury and Government agencies $ 6,541 $ 323 $ - $ 6,864 Mortgage-backed securities 125,973 1,845 (57 ) 127,761 State and political subdivisions 11,595 680 - 12,275 Other corporate securities 2,500 6 - 2,506 Totals $ 146,609 $ 2,854 $ (57 ) $ 149,406 Gross Gross Amortized Unrealized Unrealized Cost Gains Losses Fair Value December 31, 2019: U.S. Treasury and Government agencies $ 12,023 $ 181 $ (2 ) $ 12,202 Mortgage-backed securities 77,892 492 (202 ) 78,182 State and political subdivisions 10,199 366 (1 ) 10,564 Totals $ 100,114 $ 1,039 $ (205 ) $ 100,948 F- 15 The amortized cost and fair value of securities available-for-sale at December 31, 2020, by contractual maturity, are shown below. Expected maturities differ from contractual maturities because issuers may have the right to call or prepay obligations with or without call or prepayment penalties. Amortized Fair ($ in thousands) Cost Value Within one year $ 3,560 $ 3,630 Due after one year through five years 3,681 3,760 Due after five years through ten years 8,011 8,413 Due after ten years 5,384 5,842 20,636 21,645 Mortgage-backed securities 125,973 127,761 Totals $ 146,609 $ 149,406 The fair value of securities pledged as collateral, to secure public deposits and for other purposes, was $53.7 million at December 31, 2020, and $34.8 million at December 31, 2019. Securities delivered for repurchase agreements (not included above) were $28.2 million at December 31, 2020 and $19.5 million at December 31, 2019. There were no realized gains or losses on available-for-sale securities in 2020. Gross gains of $0.2 million was a reclassification from accumulated other comprehensive income and is included in the net gain on sales of securities for 2019. The related tax expense for net security gains for 2019 was $0.04 million and was a reclassification from accumulated other comprehensive income and is included in the income tax expense line in the income statement. Certain investments in debt securities are reported in the financial statements at an amount less than their historical cost. Total fair value of these investments at December 31, 2020 and 2019, was $27.3 million and $38.8 million, respectively, which was approximately 18 percent and 38 percent, respectively, of the Company’s available-for-sale investment portfolio. Based on evaluation of available evidence, including recent changes in market interest rates, credit rating information and information obtained from regulatory filings, management believes the declines in fair value for these securities are temporary. Should the impairment of any of these securities become other than temporary, the cost basis of the investment will be reduced and the resulting loss recognized in net income in the period the other-than-temporary impairment is identified. F- 16 The following tables present securities with unrealized losses at December 31, 2020 and 2019: Less than 12 Months 12 Months or Longer Total ($ in thousands) December 31, 2020 Fair Value Unrealized Losses Fair Value Unrealized Losses Fair Value Unrealized Losses U.S. Treasury and Government agencies $ - $ - $ - $ - $ - $ - Mortgage-backed securities 26,582 (54 ) 717 (3 ) 27,299 (57 ) State and political subdivisions - - - - - - Other corporate securities - - - - - - Totals $ 26,582 $ (54 ) $ 717 $ (3 ) $ 27,299 $ (57 ) Less than 12 Months 12 Months or Longer Total December 31, 2019 Fair Value Unrealized Losses Fair Value Unrealized Losses Fair Value Unrealized Losses U.S. Treasury and Government agencies $ 872 $ (1 ) $ 2,598 $ (1 ) $ 3,470 $ (2 ) Mortgage-backed securities 30,692 (157 ) 4,264 (45 ) 34,956 (202 ) State and political subdivisions 339 (1 ) - - 339 (1 ) Totals $ 31,903 $ (159 ) $ 6,862 $ (46 ) $ 38,765 $ (205 ) The unrealized loss on the securities portfolio decreased by $0.15 million as of December 31, 2020, from the prior year. Management reviews these securities on a quarterly basis and has determined that no impairment exists. Management evaluates securities for other-than-temporary impairment at least on a quarterly basis, and more frequently when economic or market concern warrants such evaluation. When the Company does not intend to sell a debt security, and it is more likely than not the Company will not have to sell the security before recovery of its cost basis, it recognizes the credit component of an other-than-temporary impairment of a debt security in earnings and the remaining portion in other comprehensive income. Note 5: Loans and Allowance for Loan Losses The following tables present the categories of loans at December 31, 2020 and 2019: Total Loans Nonaccrual Loans ($ in thousands) December 2020 December 2019 December 2020 December 2019 Commercial & industrial $ 204,767 $ 151,047 $ 902 $ 1,772 Commercial real estate - owner occupied 113,169 98,488 1,450 1,362 Commercial real estate - nonowner occupied 257,651 268,294 962 464 Agricultural 55,235 50,994 - - Residential real estate 182,165 193,159 2,704 1,635 Home equity line of credit (HELOC) 46,310 48,070 390 249 Consumer 14,847 14,738 18 18 Total loans $ 874,144 $ 824,790 $ 6,426 $ 5,500 Net deferred costs (fees) $ (1,421 ) $ 720 Total loans, net deferred costs (fees) $ 872,723 $ 825,510 Allowance for loan losses $ (12,574 ) $ (8,755 ) F- 17 The Company makes commercial, agri-business, consumer and residential loans to customers throughout its defined market area. 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. Since a portion of the commitments may expire without being drawn upon, the total commitment amounts do not necessarily represent future cash requirements. Each customer’s creditworthiness is evaluated on a case-by-case basis. The amount of collateral obtained, if deemed necessary, is based on management’s credit evaluation of the customer. Collateral held varies, but may include accounts receivable, inventory, property, plant and equipment, commercial real estate and residential real estate. Standby letters of credit are conditional commitments issued by the Company to guarantee the performance of a customer to a third party. Those guarantees are primarily issued to support public and private borrowing arrangements, including commercial paper, bond financing and similar transactions. The credit risk involved in issuing letters of credit is essentially the same as that involved in extending loans to customers. Forward sale commitments are commitments to sell groups of residential mortgage loans that the Company originates or purchases as part of its mortgage banking activities. The Company commits to sell the loans at specified prices in a future period, typically within forty-five days. These commitments are acquired to reduce market risk on mortgage loans in the process of origination and mortgage loans held-for-sales since the Company is exposed to interest rate risk during the period between issuing a loan commitment and the sales of the loan into the secondary market. Listed below is a summary of loan commitments, unused lines of credit and standby letters of credit as of December 31, 2020 and 2019. ($ in thousands) 2020 2019 Loan commitments and unused lines of credit $ 215,616 $ 187,855 Standby letters of credit 3,161 2,657 Totals $ 218,777 $ 190,512 There are various contingent liabilities that are not reflected in the consolidated financial statements, including claims and legal actions arising in the ordinary course of business. In the opinion of management, after consultation with legal counsel, the ultimate disposition of these matters is not expected to have a material effect on the Company’s consolidated financial condition or results of operations. The risk characteristics of each loan portfolio segment are as follows: Commercial & Industrial and Agricultural Commercial & industrial and agricultural loans are primarily based on the identified cash flows of the borrower and secondarily on the underlying collateral provided by the borrower. The cash flows of borrowers, however, may not be as expected and the collateral securing these loans may fluctuate in value. Most commercial loans are secured by the assets being financed or other business assets, such as accounts receivable or inventory, and may include a personal guarantee. Short-term loans may be made on an unsecured basis. In the case of loans secured by accounts receivable, the availability of funds for the repayment of these loans may be substantially dependent on the ability of the borrower to collect amounts due from its customers. F- 18 Commercial Real Estate (Owner and Nonowner Occupied) Commercial real estate loans are viewed primarily as cash flow loans and secondarily as loans secured by real estate. Commercial real estate lending typically involves higher loan principal amounts and the repayment of these loans is generally dependent on the successful operation of the property securing the loan or the business conducted on the property securing the loan. Commercial real estate loans may be more adversely affected by conditions in the real estate markets or in the general economy. The characteristics of properties securing the Company’s commercial real estate portfolio are diverse, but with geographic location almost entirely in the Company’s market area. Management monitors and evaluates commercial real estate loans based on collateral, geography and risk grade criteria. In general, the Company avoids financing single purpose projects unless other underwriting factors are present to help mitigate risk. In addition, management tracks the level of owner-occupied commercial real estate versus non-owner-occupied loans. Construction loans are underwritten utilizing feasibility studies, independent appraisal reviews and financial analysis of the developers and property owners. Construction loans are generally based on estimates of costs and value associated with the completed project. These estimates may be inaccurate. Construction loans often involve the disbursement of substantial funds with repayment substantially dependent on the success of the ultimate project. Sources of repayment for these types of loans may be pre-committed permanent loans from approved long-term lenders, sales of developed property or an interim loan commitment from the Company until permanent financing is obtained. These loans are closely monitored by on-site inspections and are considered to have higher risks than other real estate loans due to their ultimate repayment being sensitive to interest rate changes, governmental regulation of real property, general economic conditions and the availability of long-term financing. Residential Real Estate, Home Equity Line of Credit (“HELOC”) and Consumer Residential and consumer loans consist of two segments – residential mortgage loans and personal loans. Residential mortgage loans are secured by 1-4 family residences and are generally owner-occupied, and the Company generally establishes a maximum loan-to-value ratio and requires private mortgage insurance if that ratio is exceeded. HELOCs are typically secured by a subordinate interest in 1-4 family residences, and consumer personal loans are secured by consumer personal assets, such as automobiles or recreational vehicles. Some consumer personal loans are unsecured, such as small installment loans and certain lines of credit. Repayment of these loans is primarily dependent on the personal income of the borrowers, which can be impacted by economic conditions in their market areas, such as unemployment levels. Repayment can also be impacted by changes in property values on residential properties. Risk is mitigated by the fact that these loans are of smaller individual amounts and spread over a large number of borrowers. F- 19 The following tables present the balance of the allowance for loan and lease losses (“ALLL”) and the recorded investment in loans based on portfolio segment and impairment method as of December 31, 2020 and 2019: ($ in thousands) For the Twelve Months Ended December 31, 2020 Commercial & industrial Commercial real estate Agricultural Residential real estate Consumer Total Beginning balance $ 1,883 $ 3,602 $ 434 $ 2,203 $ 633 $ 8,755 Charge offs (582 ) - - (82 ) (79 ) (743 ) Recoveries 16 - - 40 6 62 Provision 1,757 1,849 62 373 459 4,500 Ending balance $ 3,074 $ 5,451 $ 496 $ 2,534 $ 1,019 $ 12,574 December 31, 2020 Commercial & industrial Commercial real estate Agricultural Residential real estate Consumer Total Allowance: Ending balance: individually evaluated for impairment $ - $ 174 $ - $ 160 $ 3 $ 337 Ending balance: collectively evaluated for impairment $ 3,074 $ 5,277 $ 496 $ 2,374 $ 1,016 $ 12,237 Totals $ 3,074 $ 5,451 $ 496 $ 2,534 $ 1,019 $ 12,574 Loans: Ending balance: individually evaluated for impairment $ 849 $ 2,202 $ - $ 2,746 $ 162 $ 5,959 Ending balance: collectively evaluated for impairment $ 203,918 $ 368,618 $ 55,235 $ 179,419 $ 60,995 $ 868,185 Totals $ 204,767 $ 370,820 $ 55,235 $ 182,165 $ 61,157 $ 874,144 ($ in thousands) For the Twelve Months Ended December 31, 2019 Commercial & industrial Commercial real estate Agricultural Residential real estate Consumer Total Beginning balance $ 1,435 $ 2,923 $ 482 $ 2,567 $ 760 $ 8,167 Charge offs (143 ) - - (53 ) (63 ) (259 ) Recoveries 9 1 - 14 23 47 Provision (credit) 582 678 (48 ) (325 ) (87 ) 800 Ending balance $ 1,883 $ 3,602 $ 434 $ 2,203 $ 633 $ 8,755 December 31, 2019 Commercial & industrial Commercial real estate Agricultural Residential real estate Consumer Total Allowance: Ending balance: individually evaluated for impairment $ 511 $ 147 $ - $ 68 $ - $ 726 Ending balance: collectively evaluated for impairment $ 1,372 $ 3,455 $ 434 $ 2,135 $ 633 $ 8,029 Totals $ 1,883 $ 3,602 $ 434 $ 2,203 $ 633 $ 8,755 Loans: Ending balance: individually evaluated for impairment $ 1,722 $ 1,558 $ - $ 2,274 $ 31 $ 5,585 Ending balance: collectively evaluated for impairment $ 149,325 $ 365,224 $ 50,994 $ 190,885 $ 62,777 $ 819,205 Totals $ 151,047 $ 366,782 $ 50,994 $ 193,159 $ 62,808 $ 824,790 F- 20 Credit Risk Profile The Company categorizes loans into risk categories (loan grades) based on relevant information about the ability of borrowers to service their debt such as current financial information, historical payment experience, credit documentation, public information and current economic trends, among other factors. The Company analyzes loans individually by classifying the loans as to credit risk. This analysis includes loans with an outstanding balance greater than $100,000 and non-homogeneous loans, such as commercial and commercial real estate loans. This analysis is performed on a quarterly basis. The Company uses the following definitions for risk ratings: Pass (grades 1 – 4): Loans which management has determined to be performing as expected and in agreement with the terms established at the time of loan origination. Special Mention (grade 5): Assets have potential weaknesses that deserve management’s close attention. If left uncorrected, these potential weaknesses may result in deterioration of the repayment prospects for the asset or in the Company’s credit position at some future date. Special mention assets are not adversely classified and do not expose the Company to sufficient risk to warrant adverse classification. Ordinarily, special mention credits have characteristics which corrective management action would remedy. Substandard (grade 6): Loans are inadequately protected by the current sound worth and paying capacity of the obligor or of the collateral pledged, if any. Loans so classified must have a well-defined weakness or weaknesses that jeopardized the liquidation of the debt. They are characterized by the distinct possibility that the Company will sustain some loss if the deficiencies are not corrected. Doubtful (grade 7): Loans classified as doubtful have all the weaknesses inherent in those classified Substandard with the added characteristic that the weaknesses make collection or liquidation in full, on the basis of current known facts, conditions and values, highly questionable and improbable. Loss (grade 8): Loans are considered uncollectable and of such little value that continuing to carry them as assets on the Company’s financial statement is not feasible. Loans will be classified as loss when it is neither practical nor desirable to defer writing off or reserving all or a portion of a basically worthless asset, even though partial recovery may be possible at some time in the future. The following tables present the credit risk profile of the Company’s loan portfolio based on rating category as of December 31, 2020 and 2019: ($ in thousands) December 31, 2020 Commercial & industrial Commercial real estate - owner occupied Commercial real estate - nonowner occupied Agricultural Residential real estate HELOC Consumer Total Pass (1 - 4) $ 202,543 $ 108,726 $ 250,405 $ 55,227 $ 178,575 $ 45,866 $ 14,807 $ 856,149 Special Mention (5) 1,485 2,993 3,338 - - - 14 7,830 Substandard (6) 151 - 3,026 8 3,560 444 26 7,215 Doubtful (7) 588 1,450 882 - 30 - - 2,950 Loss (8) - - - - - - - - Total Loans $ 204,767 $ 113,169 $ 257,651 $ 55,235 $ 182,165 $ 46,310 $ 14,847 $ 874,144 December 31, 2019 Commercial & industrial Commercial real estate - owner occupied Commercial real estate - nonowner occupied Agricultural Residential real estate HELOC Consumer Total Pass (1 - 4) $ 147,667 $ 96,836 $ 265,839 $ 50,994 $ 190,438 $ 47,787 $ 14,706 $ 814,267 Special Mention (5) 597 - 543 - - - - 1,140 Substandard (6) 1,444 290 1,663 - 2,689 283 32 6,401 Doubtful (7) 1,339 1,362 249 - 32 - - 2,982 Loss (8) - - - - - - - - Total Loans $ 151,047 $ 98,488 $ 268,294 $ 50,994 $ 193,159 $ 48,070 $ 14,738 $ 824,790 F- 21 The Company evaluates the loan risk grading system definitions and allowance for loan loss methodology on an ongoing basis. The Company uses a five-year average of historical losses for the general component of the allowance for loan loss calculation. No significant changes were made to the loan risk grading system definitions and allowance for loan loss methodology during the periods presented. The following tables present the Company’s loan portfolio aging analysis as of December 31, 2020 and 2019: ($ in thousands) 30-59 Days 60-89 Days Greater Than 90 Days Total Past Total Loans December 31, 2020 Past Due Past Due Past Due Due Current Receivable Commercial & industrial $ 380 $ - $ 618 $ 998 $ 203,769 $ 204,767 Commercial real estate - owner occupied - - 1,450 1,450 111,719 113,169 Commercial real estate - nonowner occupied - 141 699 840 256,811 257,651 Agricultural 8 - - 8 55,227 55,235 Residential real estate 12 1,393 1,212 2,617 179,548 182,165 HELOC 190 74 198 462 45,848 46,310 Consumer 123 42 20 185 14,662 14,847 Total Loans $ 713 $ 1,650 $ 4,197 $ 6,560 $ 867,584 $ 874,144 30-59 Days 60-89 Days Greater Than 90 Days Total Past Total Loans December 31, 2019 Past Due Past Due Past Due Due Current Receivable Commercial & industrial $ 64 $ - $ 312 $ 376 $ 150,671 $ 151,047 Commercial real estate - owner occupied - - - - 98,488 98,488 Commercial real estate - nonowner occupied - - 215 215 268,079 268,294 Agricultural 13 - - 13 50,981 50,994 Residential real estate 309 415 644 1,368 191,791 193,159 HELOC 166 91 56 313 47,757 48,070 Consumer 65 93 14 172 14,566 14,738 Total Loans $ 617 $ 599 $ 1,241 $ 2,457 $ 822,333 $ 824,790 All loans past due 90 days are systematically placed on nonaccrual status. A loan is considered impaired, in accordance with the impairment accounting guidance (ASC 310-10-35-16), when based on current information and events, it is probable that the Company will be unable to collect all amounts due from the borrower in accordance with the contractual terms of the loan. Impaired loans include nonperforming commercial loans but also include loans modified in TDRs where concessions have been granted to borrowers experiencing financial difficulties. These concessions could include a reduction in the interest rate on the loan, payment extensions, forgiveness of principal, forbearance or other actions intended to maximize collection. F- 22 The following tables present impaired loan activity for the twelve months ended December 31, 2020 and 2019: ($ in thousands) Twelve Months Ended Recorded Unpaid Principal Related Average Recorded Interest Income December 31, 2020 Investment Balance Allowance Investment Recognized With no related allowance recorded: Commercial & industrial $ 849 $ 1,645 $ - $ 1,878 $ 50 Commercial real estate - owner occupied 1,441 1,441 - 1,573 11 Commercial real estate - nonowner occupied 182 182 - 258 14 Agricultural - - - - - Residential real estate 1,017 1,084 - 1,243 64 HELOC 89 89 98 4 Consumer 7 7 - 12 1 With a specific allowance recorded: Commercial & industrial - - - - - Commercial real estate - owner occupied - - - - - Commercial real estate - nonowner occupied 579 579 174 579 3 Agricultural - - - - - Residential real estate 1,729 1,774 160 1,785 14 HELOC 66 66 3 83 6 Consumer - - - - - Totals: Commercial & industrial $ 849 $ 1,645 $ - $ 1,878 $ 50 Commercial real estate - owner occupied $ 1,441 $ 1,441 $ - $ 1,573 $ 11 Commercial real estate - nonowner occupied $ 761 $ 761 $ 174 $ 837 $ 17 Agricultural $ - $ - $ - $ - $ - Residential real estate $ 2,746 $ 2,858 $ 160 $ 3,028 $ 78 HELOC $ 155 $ 155 $ 3 $ 181 $ 10 Consumer $ 7 $ 7 $ - $ 12 $ 1 ($ in thousands) Twelve Months Ended Recorded Unpaid Principal Related Average Recorded Interest Income December 31, 2019 Investment Balance Allowance Investment Recognized With no related allowance recorded: Commercial & industrial $ 722 $ 1,092 $ - $ 1,377 $ 114 Commercial real estate - owner occupied - - - - - Commercial real estate - nonowner occupied 196 197 - 259 21 Agricultural - - - - - Residential real estate 1,621 1,687 - 2,001 106 HELOC 16 16 18 1 Consumer 15 15 - 19 1 With a specific allowance recorded: Commercial & industrial 1,000 1,000 511 823 49 Commercial real estate - owner occupied 1,362 1,362 147 1,362 38 Commercial real estate - nonowner occupied - - - - - Agricultural - - - - - Residential real estate 653 653 68 666 31 HELOC - - - - - Consumer - - - - - Totals: Commercial & industrial $ 1,722 $ 2,092 $ 511 $ 2,200 $ 163 Commercial real estate - owner occupied $ 1,362 $ 1,362 $ 147 $ 1,362 $ 38 Commercial real estate - nonowner occupied $ 196 $ 197 $ - $ 259 $ 21 Agricultural $ - $ - $ - $ - $ - Residential real estate $ 2,274 $ 2,340 $ 68 $ 2,667 $ 137 HELOC $ 16 $ 16 $ - $ 18 $ 1 Consumer $ 15 $ 15 $ - $ 19 $ 1 Impaired loans less than $100,000 are included in groups of homogenous loans. These loans are evaluated based on delinquency status. Interest income recognized on a cash basis does not materially differ from interest income recognized on an accrual basis. F- 23 Troubled Debt Restructured (TDR) Loans TDRs are modified loans where a concession was provided to a borrower experiencing financial difficulties. Loan modifications are considered TDRs when the concessions provided are not available to the borrower through either normal channels or other sources. However, not all loan modifications are TDRs. TDR Concession Types The Company’s standards relating to loan modifications consider, among other factors, minimum verified income requirements, cash flow analysis, and collateral valuations. Each potential loan modification is reviewed individually and the terms of the loan are modified to meet a borrower’s specific circumstances at a point in time. All loan modifications, including those classified as TDRs, are reviewed and approved. The types of concessions provided to borrowers include: ● Interest rate reduction: A reduction of the stated interest rate to a nonmarket rate for the remaining original life of the debt. The Company also may grant interest rate concessions for a limited timeframe on a case by case basis. ● Amortization or maturity date change beyond what the collateral supports, including a change that does any of the following: (1) Lengthens the amortization period of the amortized principal beyond market terms. This concession reduces the minimum monthly payment and increases the amount of the balloon payment at the end of the term of the loan. Principal is generally not forgiven. (2) Reduces the amount of loan principal to be amortized. This concession also reduces the minimum monthly payment and increases the amount of the balloon payment at the end of the term of the loan. Principal is generally not forgiven. (3) Extends the maturity date or dates of the debt beyond what the collateral supports. This concession generally applies to loans without a balloon payment at the end of the term of the loan. In addition, there may be instances where renewing loans potentially require non-market terms and would then be reclassified as TDRs. ● Other: A concession that is not categorized as one of the concessions described above. These concessions include, but are not limited to: principal forgiveness, collateral concessions, covenant concessions, and reduction of accrued interest. Principal forgiveness may result from any TDR modification of any concession type. There were no new TDRs during the period ended December 31, 2020. The following table represents new TDR activity for the twelve months ended December 31, 2019: ($ in thousands) Number of Loans Pre-Modification Recorded Balance Post Modification Recorded Balance Commercial & industrial 3 $ 763 $ 763 Total modifications 3 $ 763 $ 763 Interest Total Only Term Combination Modification Commercial & industrial $ 150 $ 613 $ - $ 763 Total modifications $ 150 $ 613 $ - $ 763 F- 24 There were no TDRs modified during the past twelve months that have subsequently defaulted. On March 22, 2020, a statement was issued by the Company’s bank regulators and titled the “Interagency Statement on Loan Modifications and Reporting for Financial Institutions Working with Customers Affected by the Coronavirus” (the “Interagency Statement”) that encourages financial institutions to work prudently with borrowers who are unable to meet the contractual payment obligations due to the effects of COVID-19. Additionally, Section 4013 of the CARES Act further provides that a qualified loan modification is exempt by law from classification as a troubled debt restructure as defined by GAAP, from the period beginning March 1, 2020 until the earlier of December 31, 2021 or the date that is 60 days after the date on which the national emergency concerning the COVID-19 outbreak under the National Emergencies Act (50 U.S.C. 1601 et seq.) terminates. As of December 31, 2020, the Company had nine loans with a total balance of $23.2 million still on payment deferral. The Company was an active participant in the Paycheck Protection Program (“PPP”) initiative as detailed in the discussion of financial results for 2020. The Company originated approximately 700 loans with a total balance of $83.6 million. As of December 31, 2020, $70.6 million in balances remained outstanding. Fees for the originations were $3.2 million of which $1.4 million was taken into income during 2020. Note 6: Accounting for Certain Loans Acquired in a Transfer The Company acquired loans in the acquisition of The Edon State Bank Company of Edon, Ohio, effective June 5, 2020. None of the acquired loans had evidence of deterioration of credit quality since origination, and it was probable, at acquisition, that all contractually required payments would be collected. The following table presents the carrying amount of the acquired loans included in the balance sheet as of December 31, 2020: ($ in thousands) December 31, 2020 Commercial & industrial $ 1,499 Commercial real estate - owner occupied - Commercial real estate - nonowner occupied 505 Agricultural 9,180 Residential real estate 3,176 Home equity line of credit (HELOC) - Consumer 93 Total loans $ 14,453 Accretable yield, or income expected to be collected as of December 31, 2020 is $0.3 million. Note 7: Premises and Equipment Major classifications of premises and equipment stated at cost were as follows at December 31: ($ in thousands) 2020 2019 Land $ 3,996 $ 3,945 Buildings and improvements 26,743 26,953 Equipment 11,506 10,786 Construction in process 997 128 43,242 41,812 Less accumulated depreciation (19,685 ) (18,427 ) Net premises and equipment $ 23,557 $ 23,385 F- 25 Note 8: Goodwill and Intangibles On June 5, 2020, the Company acquired Edon Bancorp (“Edon”) and its subsidiary, The Edon State Bank Company of Edon, Ohio. The acquisition resulted in approximately $4.3 million in goodwill. On March 15, 2019, the Company formed SBFG Title, LLC (“Title”) and purchased all of the assets and real estate of an Ohio based title agency. The purchase resulted in approximately $1.4 million in goodwill. The balance of goodwill as of December 31, 2020 and December 31, 2019 was $22.1 million and $17.8 million, respectively. Twelve Months Ended December 31, 2020 Twelve Months Ended December 31, 2019 ($ in thousands) Carrying Amount Carrying Amount Beginning balance $ 17,792 $ 16,353 Acquired goodwill 4,325 1,439 Measurement period adjustments (26 ) - Ending balance $ 22,091 $ 17,792 Impairment exists when a reporting unit’s carrying value of goodwill exceeds its fair value. Goodwill is tested on the last day of the last quarter of each calendar year. At December 31, 2020, the Company elected to perform a qualitative assessment to determine if it was more likely than not that the fair value of the reporting unit exceeded its carrying value, including goodwill. The qualitative assessment indicated that it was more likely than not that the fair value of the reporting unit exceeded its carrying value, resulting in no impairment. Carrying basis and accumulated amortization of intangible assets were as follows at December 31: 2020 2019 Gross Carrying Accumulated Gross Carrying Accumulated ($ in thousands) Amount Amortization Amount Amortization Core deposits intangible $ 5,359 $ (4,735 ) $ 4,698 $ (4,692 ) Customer relationship intangible 200 (170 ) 200 (166 ) Banking intangibles $ 5,559 $ (4,905 ) $ 4,898 $ (4,858 ) Amortization expense for intangibles for the years ended December 31, 2020 and 2019 was $0.05 million and $0.01 million, respectively. Estimated amortization expense for each of the following five years is immaterial. Note 9: Mortgage Banking and Servicing Rights Mortgage loans serviced for others are not included in the accompanying balance sheets. The unpaid principal balance of mortgage loans serviced for others approximated $1.3 billion and $1.2 billion at December 31, 2020 and 2019, respectively. Contractually specified servicing fees of approximately $3.2 million and $2.6 million were included in mortgage loan servicing fees in the income statement for the years ended December 31, 2020 and 2019, respectively. F- 26 The following table summarizes mortgage servicing rights capitalized and related amortization, along with activity in the related valuation allowance: ($ in thousands) 2020 2019 Carrying amount, beginning of year $ 11,017 $ 11,365 Mortgage servicing rights capitalized during the year 5,090 2,872 Mortgage servicing rights amortization during the year (4,762 ) (2,126 ) Net change in valuation allowance (3,586 ) (1,094 ) Carrying amount, end of year $ 7,759 $ 11,017 Valuation allowance: Beginning of year $ 1,306 $ 212 Increase (reduction) 3,586 1,094 End of year $ 4,892 $ 1,306 Fair value, beginning of period $ 11,864 $ 12,672 Fair value, end of period $ 7,759 $ 11,864 Note 10: Derivative Financial Instruments The Company is exposed to certain risks arising from both its business operations and economic conditions. The Company manages its exposures to a wide variety of business and operational risks primarily through management of its core business activities. The Company manages economic risks, including interest rate, liquidity and credit risk, primarily by managing the amount, sources and duration of its assets and liabilities and through the use of derivative financial instruments. Specifically, the Company enters into derivative financial instruments to manage exposures that arise from business activities that result in the receipt or payment of future known and uncertain cash amounts, the value of which are determined by interest rates. The Company’s derivative financial instruments are used to manage differences in the amount, timing and duration of the Company’s known or expected cash payments principally related to certain variable-rate assets. The Company does not use derivatives for trading or speculative purposes. Derivatives not designated as hedges are not speculative and result from a service the Company provides to certain customers. The Company executes interest rate swaps with commercial banking customers to facilitate their respective risk management strategies. Those interest rate swaps are simultaneously hedged by offsetting interest rate swaps that the Company executes with a third party, such that the Company minimizes its net risk exposure resulting from such transactions. As the interest rate swaps associated with this program do not meet the strict hedge accounting requirements, changes in the fair value of both the customer swaps and the offsetting swaps are recognized directly in earnings. Additionally, the Company enters into forward contracts for the future delivery of mortgage loans to third-party investors and enters into IRLCs with potential borrowers to fund specific mortgage loans that will be sold into the secondary market. The forward contracts that are entered into, economically hedge the effect of changes in interest rates resulting from the Company’s commitment to fund the loans. The IRLCs and forward contracts are not designated as accounting hedges and are recorded at fair value with changes in fair value reflected in noninterest income on the consolidated statements of income. The fair value of derivative instruments with a positive fair value are reported in accrued income and other assets in the consolidated balance sheets, while derivative instruments with a negative fair value are reported in accrued expenses and other liabilities in the consolidated balance sheets. F- 27 The table below presents the notional amount and fair value of the Company’s interest rate swaps, IRLCs and forward contracts utilized as of December 31, 2020 and 2019. December 31, 2020 December 31, 2019 Notional Fair Notional Fair ($ in thousands) Amount Value Amount Value Asset Derivatives Derivatives not designated as hedging instruments Interest rate swaps associated with loans $ 87,687 $ 7,962 $ 82,826 $ 2,846 IRLCs 46,130 278 16,347 55 Total contracts $ 133,817 $ 8,240 $ 99,173 $ 2,901 Liability Derivatives Derivatives not designated as hedging instruments Interest rate swaps associated with loans $ 87,687 $ (7,962 ) $ 82,826 $ (2,846 ) Forward contracts 50,000 (265 ) 22,000 (32 ) Total contracts $ 137,687 $ (8,227 ) $ 104,826 $ (2,878 ) The fair value of interest rate swaps were estimated using a discounted cash flow method that incorporates current market interest rates as of the balance sheet date. Fair values of IRLCs and forward contracts were estimated using changes in mortgage interest rates from the date the Company entered into the IRLC and the balance sheet date. The following table presents the amounts included in the consolidated statements of income for non-hedging derivative financial instruments for the twelve months ended December 31, 2020 and 2019. Amount of gain (loss) ($ in thousands) Statement of income classification 2020 2019 Interest rate swap contracts Other income $ 355 $ 513 Interest rate swap contracts Other expense - (41 ) IRLCs Gain on sale of mortgage loans & OMSR 223 (28 ) Forward contracts Gain on sale of mortgage loans & OMSR (233 ) 81 The following table shows the offsetting of financial assets and derivative assets at December 31, 2020 and 2019. Gross Gross amounts offset in the Net amounts of assets presented in Gross amounts not offset in the consolidated balance sheet ($ in thousands) amounts of recognized assets consolidated balance sheet the consolidated balance sheet Financial instruments Cash collateral received Net amount December 31, 2020 Interest rate swaps $ 7,962 $ - $ 7,962 $ - $ - $ 7,962 December 31, 2019 Interest rate swaps $ 2,901 $ 55 $ 2,846 $ - $ - $ 2,846 F- 28 The following table shows the offsetting of financial liabilities and derivative liabilities at December 31, 2020 and 2019. Gross Gross amounts offset in the Net amounts of liabilities presented in Gross amounts not offset in the consolidated balance sheet ($ in thousands) amounts of recognized liabilities consolidated balance sheet the consolidated balance sheet Financial instruments Cash collateral pledged Net amount December 31, 2020 Interest rate swaps $ 7,962 $ - $ 7,962 $ - $ 8,896 $ (934 ) December 31, 2019 Interest rate swaps $ 2,901 $ 55 $ 2,846 $ - $ 3,242 $ (396 ) Note 11: Interest-Bearing Deposits Interest-bearing time deposits in denominations of $250,000 or more totaled $27.8 million on December 31, 2020 and $36.2 million on December 31, 2019. Certificates of deposit obtained from brokers totaled approximately $5.0 million and $5.2 million at December 31, 2020 and 2019, respectively, and mature in 2021. At December 31, 2020, the scheduled maturities of time deposits were as follows: ($ in thousands) 2021 $ 156,761 2022 47,518 2023 18,399 2024 4,338 2025 2,351 Thereafter 182 Total $ 229,549 Included in time deposits at December 31, 2020 and 2019 were $73.1 million and $88.3 million, respectively, of deposits which were obtained through the Certificate of Deposit Account Registry Service (“CDARS”). This service allows deposit customers to maintain fully insured balances in excess of the $250,000 FDIC limit without the inconvenience of having multi-banking relationships. Under the reciprocal program that the Company is currently participating in, customers agree to allow their deposits to be placed with other participating banks in the CDARS program in insurable amounts under $250,000. In exchange, other banks in the program agree to place their deposits with the Company also in insurable amounts under $250,000. Note 12: Short-Term Borrowings ($ in thousands) 2020 2019 Securities Sold Under Repurchase Agreements $ 20,189 $ 12,945 The Company has retail repurchase agreements to facilitate cash management transactions with commercial customers. Securing these obligations are agency securities of $10.7 million and $4.5 million for 2020 and 2019, respectively, and mortgage-backed securities of $17.5 million and $15.0 million for 2020 and 2019, respectively, which are held at FHLB. This collateral has maturities from 2022 through 2061. At December 31, 2020, these repurchase agreements totaled $20.2 million. The maximum amount of outstanding agreements at any month end during 2020 and 2019 totaled $25.6 million and $22.7 million, respectively, and the monthly average of such agreements totaled $20.8 million and $15.3 million, respectively. The repurchase agreements mature within one month. F- 29 The Company has borrowing capabilities at the Federal Reserve Discount Window by pledging either securities or loans as collateral. As of December 31, 2020, there was no collateral pledged or borrowings drawn at the Discount Window. The Company participated in the PPP initiative and also has the ability to borrow from the Federal Reserve’s special purpose Paycheck Protection Program Liquidity Facility (“PPPLF”) for additional funding. At December 31, 2020, the Company had no borrowings from the PPPLF. At December 31, 2020 and December 31, 2019, the Company had $41.0 million in federal funds lines, of which none were drawn. Note 13: Federal Home Loan Bank Advances The FHLB advances were secured by $147.1 million in mortgage loans at December 31, 2020. Advances, at interest rates from 2.77 to 2.93 percent, are subject to restrictions or penalties in the event of prepayment. Aggregate annual maturities of FHLB advances at December 31, 2020, were: ($ in thousands) Debt 2021 $ 2,500 2022 3,000 2023 2,500 Total $ 8,000 Note 14: Trust Preferred Securities On September 15, 2005, RST II, a wholly-owned subsidiary of the Company, closed a pooled private offering of 10,000 Capital Securities with a liquidation amount of $1,000 per security. The proceeds of the offering were loaned to the Company in exchange for junior subordinated debentures with terms similar to the Capital Securities. Distributions on the Capital Securities are payable quarterly at a variable rate that is based upon the 3-month LIBOR plus 1.80 percent and are included in interest expense in the consolidated financial statements. These securities may be included in Tier 1 capital and may be prepaid at anytime without penalty (with certain limitations applicable) under current regulatory guidelines and interpretations. The balance of the Capital Securities as of December 31, 2020 and 2019 was $10.3 million, with a maturity date of September 15, 2035. Note 15: Income Taxes The provision for income taxes includes these components: For The Year Ended December 31, ($ in thousands) 2020 2019 Taxes currently payable $ 5,939 $ 2,938 Deferred provision (2,444 ) (279 ) Income tax expense $ 3,495 $ 2,659 F- 30 A reconciliation of income tax expense at the statutory rate to the Company’s actual income tax expense is shown below: For The Year Ended December 31, ($ in thousands) 2020 2019 Computed at the statutory rate (21%) $ 3,872 $ 3,073 Increase (decrease) resulting from Tax exempt interest (91 ) (113 ) BOLI income (65 ) (71 ) Stock compensation (39 ) (45 ) Other (182 ) (185 ) Actual tax expense $ 3,495 $ 2,659 The tax effects of temporary differences related to deferred taxes shown on the balance sheets are: For The Year Ended December 31, ($ in thousands) 2020 2019 Deferred tax assets Allowance for loan losses $ 2,641 $ 1,838 Net deferred loan fees 298 53 Section 475 MTM 645 209 Accrued bonus 375 192 Other 714 258 4,673 2,550 Deferred tax liabilities Depreciation (1,168 ) (1,009 ) Mortgage servicing rights (1,668 ) (2,378 ) Unrealized gains on available-for-sale securities (587 ) (175 ) Purchase accounting adjustments (1,628 ) (1,227 ) Prepaids (465 ) (447 ) FHLB stock dividends (288 ) (288 ) (5,804 ) (5,524 ) Net deferred tax liability $ (1,131 ) $ (2,974 ) Note 16: Accumulated Other Comprehensive Income The following table presents reclassifications out of accumulated other comprehensive income related to unrealized gains and losses on available-for-sale securities for the two years ending December 31: ($ in thousands) 2020 2019 Affected Line Item in Income Statement Realized gains included in net income $ - $ 206 Gains on investment securities - 206 Income before income taxes Tax effect - (43 ) Provision for income taxes Net of Tax $ - $ 163 Net income F- 31 Note 17: Regulatory Matters As of December 31, 2020, based on its call report computations, State Bank was classified as well capitalized under the regulatory framework for prompt corrective action. To be categorized as well capitalized, State Bank must maintain capital ratios as set forth in the table below. There are no conditions or events since December 31, 2020 that management believes have changed State Bank’s capital classification. State Bank’s actual capital amounts and ratios are presented in the following table. Capital levels are presented for the State Bank only as the Company is exempt from quarterly reporting at the holding company level: Actual For Capital Adequacy Purposes To Be Well Capitalized Under Prompt Corrective Action Procedures ($ in thousands) Amount Ratio Amount Ratio Amount Ratio As of December 31, 2020 Tier I Capital to average assets $ 119,480 9.94 % $ 48,099 4.0 % $ 60,123 5.0 % Tier I Common equity capital to risk-weighted assets 119,480 12.91 % 41,651 4.5 % 60,162 6.5 % Tier I Capital to risk-weighted assets 119,480 12.91 % 55,534 6.0 % 74,046 8.0 % Total Risk-based capital to risk-weighted assets 131,062 14.16 % 74,046 8.0 % 92,557 10.0 % As of December 31, 2019 Tier I Capital to average assets $ 116,884 11.36 % $ 41,165 4.0 % $ 51,456 5.0 % Tier I Common equity capital to risk-weighted assets 116,884 12.46 % 42,204 4.5 % 60,962 6.5 % Tier I Capital to risk-weighted assets 116,884 12.46 % 56,273 6.0 % 75,030 8.0 % Total Risk-based capital to risk-weighted assets 125,639 13.40 % 75,030 8.0 % 93,788 10.0 % The above minimum capital requirements exclude the capital conservation buffer required to avoid limitations on capital distributions, including dividend payments and certain discretionary bonus payments to executive officers. The capital conservation buffer was 2.50 percent at December 31, 2020. The net unrealized gain or loss on available-for-sale securities is not included in computing regulatory capital. Management believes as of December 31, 2020, State Bank met all capital adequacy requirements to which they are subject. Note 18: Employee Benefits The Company has instituted a long-term incentive program, with the objective of rewarding senior management with restricted shares of the Company, in addition to the existing stock option program (see Note 19 to the Consolidated Financial Statements). The Company has a retirement savings 401(k) plan covering substantially all employees. The Company contributes a safe harbor matching contribution equal to 100% of an employees’ salary deferral amounts up to 4% of the employees’ eligible compensation. Employees are immediately vested in their voluntary contributions and in any Company safe harbor matching contributions. Any discretionary contribution made by the Company is fully vested after three years of credited service. Employer contributions charged to expense for 2020 and 2019 were $0.7 million and $0.6 million, respectively. Also, the Company has Supplemental Executive Retirement Plan (“SERP”) Agreements with certain active and retired officers. The agreements provide monthly payments for up to 15 years that equal 15 percent to 25 percent of average compensation prior to retirement or death. The charges to expense for the current agreements were $0.3 million and $0.3 million for 2020 and 2019, respectively. F- 32 Additional life insurance is provided to certain officers through a bank-owned life insurance policy (“BOLI”). By way of a separate split-dollar agreement, the policy interests are divided between the Company and the insured’s beneficiary. The Company owns the policy cash value and a portion of the policy net death benefit, over and above the cash value assigned to the insured’s beneficiary. The cash surrender value of all life insurance policies totaled $17.5 million and $17.2 million at December 31, 2020 and 2019, respectively. The Company has a noncontributory employee stock ownership plan (“ESOP”) covering substantially all employees of the Company and its subsidiaries. Voluntary contributions are made by the Company to the plan. Each eligible employee is vested based upon years of service, including prior years of service. The Company’s contributions to the account of each employee become fully vested after three years of service. Benefit expense for the value of the stock purchased is recorded equal to the fair market value of the stock when contributions, which are determined annually by the Board of Directors of the Company, are made to the ESOP. Allocated shares in the ESOP at December 31, 2020 and 2019, were 412,402 and 415,286, respectively. Dividends on allocated shares are recorded as dividends and charged to retained earnings. Compensation expense is recorded equal to the fair market value of the stock when contributions, which are determined annually by the Board of Directors of the Company, are made to the ESOP. ESOP expense for the years ended December 31, 2020 and 2019 was $0.2 million and $0.0 million, respectively. Note 19: Share Based Compensation Plan In April 2017, the shareholders approved a new share-based incentive compensation plan, the SB Financial Group, Inc. 2017 Stock Incentive Plan (the “2017 Plan”), which replaced the Company’s 2008 Stock Incentive Plan. This plan permits the grant or award of incentive stock options, nonqualified stock options, stock appreciation rights (“SAR’s”), restricted stock, and restricted stock units (“RSU’s”) for up to 500,000 Common Shares of the Company. The Company’s 2008 Stock Incentive Plan (the “2008 Plan”), which was approved by the shareholders in April 2008, permitted the grant or award of incentive stock options, nonqualified stock options, stock appreciation rights, and restricted stock for up to 250,000 Common Shares of the Company. The 2008 and 2017 Plans are intended to advance the interests of the Company and its shareholders by offering employees, directors and advisory board members of the Company and its subsidiaries an opportunity to acquire or increase their ownership interest in the Company through grants of equity-based awards. The 2008 and 2017 Plans permit equity-based awards to be used to attract, motivate, reward and retain highly competent individuals upon whose judgment, initiative, leadership and efforts are key to the success of the Company by encouraging those individuals to become shareholders of the Company. Option awards are granted with an exercise price equal to the market price of the Company’s stock at the date of grant and those option awards vest based on 5 years of continuous service and have 10-year contractual terms. The fair value of each option award is estimated on the date of grant using the Black-Scholes valuation model. No options were granted in 2020 or 2019. There was no compensation expense charged against income with respect to option awards under the Plans for 2020 or 2019. F- 33 A summary of incentive stock option activity under the 2008 and 2017 Plans as of December 31, 2020 and changes during the year ended is presented below: Shares Weighted-Average Exercise Price Weighted-Average Remaining Term Aggregate Intrinsic Value Outstanding, beginning of year 28,250 $ 6.98 Granted - - Exercised (26,950 ) 6.98 Forfeited - - Expired (1,300 ) 6.98 Outstanding, end of year - $ - - $ - Exercisable, end of year - $ - - $ - During 2020, the 26,950 option shares exercised had a total intrinsic value of $0.3 million and the cash received from these exercised options was $0.2 million. The tax benefit from these transactions was immaterial. As of December 31, 2020, there was no unrecognized compensation cost related to incentive option share-based compensation arrangements granted under the 2008 Plan. The Long Term Incentive (“LTI”) Plan awards restricted stock in the Company to certain key executives under the 2008 and 2017 Plans. These restricted stock awards vest over a four-year period and are intended to assist the Company in retention of key executives. During 2020 and 2019, the Company met certain performance targets and restricted stock awards were approved by the Board. The compensation cost charged against income for the LTI Plan was $0.4 million and $0.4 million for 2020 and 2019, respectively. The total income tax benefit recognized in the income statement for share-based compensation arrangements was $0.1 million and $0.1 million for 2020 and 2019, respectively. A summary of restricted stock activity under the Company’s LTI Plan as of December 31, 2020 (issued under both the 2008 and 2017 plan) and changes during the year ended is presented below: Shares Weighted-Average Value per Share Nonvested, beginning of year 43,741 $ 17.41 Granted 16,442 19.57 Vested (22,451 ) 17.18 Forfeited (2,954 ) 18.01 Nonvested, end of year 34,778 $ 18.52 As of December 31, 2020, there was $0.4 million of total unrecognized compensation cost related to non-vested share-based compensation arrangements related to the restricted stock awards under the 2008 and 2017 Plans which were granted in accordance with the LTI Plan. That cost is expected to be recognized over a weighted-average period of 1.66 years. Note 20: Preferred Stock On December 23, 2014, the Company completed its public offering of 1,500,000 depositary shares, each representing a 1/100th ownership interest in a 6.50 percent Noncumulative Convertible Perpetual Preferred Share, Series A (“Series A Preferred Shares”), of the Company with a liquidation preference of $1,000 per share (equivalent to $10.00 per depositary shares). The Company sold the maximum of 1,500,000 depositary shares in the offering, resulting in gross proceeds to the Company of $15.0 million. Net proceeds to the Company after all expenses related to the offering were $14.0 million. F- 34 On December 26, 2019, the Company exercised its right to convert all of its Series A Preferred Shares and all of its depositary shares, representing interests in the Series A Preferred Shares, into common shares, no par value, of the Company (“Common Shares”) in accordance with the terms of the Series A Preferred Shares and depositary shares. Each outstanding Series A Preferred Share converted into the right to receive 990 Common Shares, and each outstanding depositary share converted into the right to receive 0.9908093 Common Shares based on the December 26 th conversion price of $10.09276. There were 1,412,425 depositary shares and 1,412 underlying Series A Preferred Shares issued and outstanding. A total of 1,399,443 Common Shares were issued as a result of the conversion. No fractional Common Shares were issued upon conversion of the depositary shares and Series A Preferred Shares; instead, cash was paid in lieu of any fractional Common Share in an amount equal to the fraction multiplied by $18.49, which was the average closing price of the Common Shares during the previous 30 consecutive trading days. The Company paid its last dividend on the depositary shares (and underlying Series A Preferred Shares) on December 15, 2019. No further dividends were accrued, declared or paid on the depositary shares or underlying Series A Preferred Shares following the December 26, 2019 Conversion Date. Note 21: Disclosures About Fair Value of Assets and Liabilities Pursuant to ASC 820, fair value is defined as the price that would be received to sell an asset or paid to transfer a liability in an orderly transaction between market participants at the measurement date. A three level hierarchy exists in ASC 820 for fair value measurements based upon the inputs to the valuation of an asset or liability: Level 1: Quoted prices in active markets for identical assets or liabilities Level 2: Observable inputs other than Level 1 prices, such as quoted prices for similar assets or liabilities; quoted prices in markets that are not active; or other inputs that are observable or can be corroborated by observable market data for substantially the full term of the assets or liabilities. Level 3: Unobservable inputs that are supported by little or no market activity and that are significant to the fair value of the assets or liabilities Following is a description of the valuation methodologies, inputs used for assets measured at fair value on a recurring basis, recognized in the accompanying balance sheets, as well as the general classification of such assets pursuant to the valuation hierarchy. Available-for-sale securities The fair value of available-for-sale securities are determined by various valuation methodologies. Level 2 securities include U.S. government agencies, mortgage-backed securities, obligations of political and state subdivisions, and corporate securities. Level 2 inputs do not include quoted prices for individual securities in active markets; however, they do include inputs that are either directly or indirectly observable for the individual security being valued. Such observable inputs include interest rates and yield curves at commonly quoted intervals, volatilities, prepayment speeds, credit risks and default rates. Also included are inputs derived principally from or corroborated by observable market data by correlation or other means. Interest rate contracts The fair values of interest rate contracts are based upon the estimated amount the Company would receive or pay to terminate the contracts or agreements, taking into account underlying interest rates, creditworthiness of underlying customers for credit derivatives and, when appropriate, the creditworthiness of the counterparties. F- 35 Forward contracts The fair values of forward contracts on to-be-announced securities are determined using quoted prices in active markets, or benchmarked thereto (Level 1). Interest Rate Lock Commitments The fair value of IRLCs are determined using the projected sale price of individual loans based on changes in the market interest rates, projected pull-through rates (the probability that an IRLC will ultimately result in an originated loan), the reduction in the value of the applicant’s option due to the passage of time, and the remaining origination costs to be incurred based on management’s estimate of market costs (Level 3). The following table presents the fair value measurements of securities measured at fair value on a recurring basis and the level within the fair value hierarchy in which the fair value measurements fell at December 31, 2020 and 2019: ($ in thousands) Fair Values at 12/31/2020 (Level 1) (Level 2) (Level 3) U.S. Treasury and Government Agencies $ 6,864 $ - $ 6,864 $ - Mortgage-backed securities 127,761 - 127,761 - State and political subdivisions 12,275 - 12,275 - Other corporate securities 2,506 - 2,506 - Interest rate contracts - assets 7,962 - 7,962 - Interest rate contracts - liabilities (7,962 ) - (7,962 ) - Forward contracts (265 ) (265 ) - - IRLCs 278 - - 278 ($ in thousands) Fair Values at 12/31/2019 (Level 1) (Level 2) (Level 3) U.S. Treasury and Government Agencies $ 12,202 $ - $ 12,202 $ - Mortgage-backed securities 78,182 - 78,182 - State and political subdivisions 10,564 - 10,564 - Interest rate contracts - assets 2,846 - 2,846 - Interest rate contracts - liabilities (2,846 ) - (2,846 ) - Forward contracts (32 ) (32 ) - - IRLCs 55 - - 55 Level 1 - quoted prices in active markets for identical assets Level 2 - significant other observable inputs Level 3 - significant unobservable inputs F- 36 The following is a description of the valuation methodologies and inputs used for assets measured at fair value on a nonrecurring basis and recognized in the accompanying balance sheets, as well as the general classification of such assets pursuant to the valuation hierarchy. Collateral-dependent Impaired Loans, Net of ALLL Loans for which it is probable the Company will not collect all principal and interest due according to contractual terms are measured for impairment. The estimated fair value of collateral-dependent impaired loans is based on the appraised value of the collateral, less estimated cost to sell. Collateral-dependent impaired loans are classified within Level 3 of the fair value hierarchy. This method requires obtaining independent appraisals of the collateral from a list of preapproved appraisers, which are reviewed for accuracy and consistency by the Company. The appraised values are reduced by applying a discount factor to the value based on the Company’s loan review policy. All impaired loans held by the Company were collateral dependent at December 31, 2020 and 2019. Mortgage Servicing Rights Mortgage servicing rights do not trade in an active, open market with readily observable prices. Accordingly, fair value is estimated using discounted cash flow models associated with the servicing rights and discounting the cash flows using discount market rates, prepayment speeds and default rates. The servicing portfolio has been valued using all relevant positive and negative cash flows including servicing fees, miscellaneous income and float; marginal costs of servicing; the cost of carry of advances; and foreclosure losses; and applying certain prevailing assumptions used in the marketplace. Due to the nature of the valuation inputs, mortgage servicing rights are classified within Level 3 of the hierarchy. These mortgage servicing rights are tested for impairment on a quarterly basis. The following table presents the fair value measurements of assets measured at fair value on a non-recurring basis and the level within the fair value hierarchy in which the fair value measurements fell at December 31, 2020 and 2019: ($ in thousands) Fair values at 12/31/2020 (Level 1) (Level 2) (Level 3) Impaired loans $ 3,544 $ - $ - $ 3,544 Mortgage servicing rights 7,759 - - 7,759 ($ in thousands) Fair values at 12/31/2019 (Level 1) (Level 2) (Level 3) Impaired loans $ 2,527 $ - $ - $ 2,527 Mortgage servicing rights 5,084 - - 5,084 Level 1 - quoted prices in active markets for identical assets Level 2 - significant other observable inputs Level 3 - significant unobservable inputs F- 37 Unobservable (Level 3) Inputs The following tables present quantitative information about unobservable inputs used in recurring and nonrecurring Level 3 fair value measurements at December 31, 2020 and 2019: Fair value at Valuation Range (weighted- ($ in thousands) 31-12-2020 technique Unobservable inputs average) Collateral-dependent impaired loans $ 3,544 Market comparable properties Comparability adjustments (%) 0 - 43% (22 )% Mortgage servicing rights 7,759 Discounted cash flow Discount Rate 8.28 % Constant prepayment rate 20.87 % P&I earnings credit 0.14 % T&I earnings credit 0.24 % Inflation for cost of servicing 1.50 % IRLCs 278 Discounted cash flow Loan closing rates 49% - 100 % Fair Value at Valuation Range (weighted- ($ in thousands) 31-12-2019 technique Unobservable inputs average) Collateral-dependent impaired loans $ 2,527 Market comparable properties Comparability adjustments (%) 2 - 62% (28 )% Mortgage servicing rights 5,084 Discounted cash flow Discount Rate 9.36 % Constant prepayment rate 10.19 % P&I earnings credit 1.78 % T&I earnings credit 1.93 % Inflation for cost of servicing 1.50 % IRLCs 55 Discounted cash flow Loan closing rates 66% - 100 % The mortgage servicing rights portfolio is measured for fair value by an independent third party. The valuation of the portfolio hinges on a number of quantitative factors. These factors include, but are not limited to, a discount rate applied to the cash flows, and an assumption of future principal prepayments. The prepayment assumptions are based upon the historical performance of the Company’s portfolio as well as market metrics. With interest rates decreasing during 2020, the mortgage servicing rights have decreased in value. The servicing rights have had an increase in prepayments and the 10.68 percent increase in the constant prepayment rate reflects the change in market rates. In addition, the earnings credit rates decreased as did the discount rate. The following methods were used to estimate the fair value of all other financial instruments recognized in the accompanying balance sheets at amounts other than fair value. Cash and Due From Banks, Interest Bearing Time Deposits, Federal Reserve and Federal Home Loan Bank Stock and Interest Receivable and Payable Fair value is determined to be the carrying amount for these items (which include cash on hand, due from banks, and federal funds sold) because they represent cash or mature in 90 days or less, and do not represent unanticipated credit concerns. Loans Held for Sale The fair value of loans held for sale is based upon quoted market prices, where available, or is determined by discounting estimated cash flows using interest rates approximating the Company’s current origination rates for similar loans and adjusted to reflect the inherent credit risk. Loans The estimated fair value of loans follows the guidance in ASU 2016-01, which prescribes an “exit price” approach in estimating and disclosing fair value of financial instruments. The fair value calculation at that date discounted estimated future cash flows using rates that incorporated discounts for credit, liquidity, and marketability factors. F- 38 Deposits, Repurchase Agreements & FHLB Advances Deposits include demand deposits, savings accounts and certain money market deposits. The carrying amount approximates the fair value. The estimated fair value for fixed-maturity time deposits, as well as borrowings, is based on estimates of the rate the Company could pay on similar instruments with similar terms and maturities at December 31, 2020 and 2019. Loan Commitments The fair value of commitments is estimated using the fees currently charged to enter into similar agreements, taking into account the remaining terms of the agreements and the present creditworthiness of the counterparties. The estimated fair values for other financial instruments and off-balance-sheet loan commitments approximate cost at December 31, 2020 and 2019 and are not considered significant to this presentation. Trust Preferred Securities The fair value for Trust Preferred Securities is estimated by discounting the cash flows using an appropriate discount rate. The following table presents estimated fair values of the Company’s financial instruments. The fair values of certain instruments were calculated by discounting expected cash flows, which involves significant judgments by management and uncertainties. Fair value is the estimated amount at which financial assets or liabilities could be exchanged in a current transaction between willing parties, other than in a forced or liquidation sale. Because no market exists for these financial instruments, and because management does not intend to sell these financial instruments, the Company does not know whether the fair values shown below represent values at which the respective financial instruments could be sold individually or in the aggregate. ($ in thousands) Carrying Fair Fair value measurements using December 31, 2020 amount value (Level 1) (Level 2) (Level 3) Financial assets Cash and due from banks $ 140,690 $ 140,690 $ 140,690 $ - $ - Interest bearing time deposits 5,823 5,823 - 5,823 - Loans held for sale 7,234 7,508 - 7,508 - Loans, net of allowance for loan losses 860,149 853,294 - - 853,294 Federal Reserve and FHLB Bank stock, at cost 5,303 5,303 - 5,303 - Interest receivable 3,799 3,799 - 3,799 - Financial liabilities Deposits $ 1,049,011 $ 1,050,558 $ 819,462 $ 231,096 $ - Short term borrowings 20,189 20,189 - 20,189 - FHLB advances 8,000 8,257 - 8,257 - Trust preferred securities 10,310 8,394 - 8,394 - Interest payable 616 616 - 616 - ($ in thousands) Carrying Fair Fair value measurements using December 31, 2019 amount value (Level 1) (Level 2) (Level 3) Financial assets Cash and due from banks $ 27,064 $ 27,064 $ 27,064 $ - $ - Loans held for sale 7,258 7,419 - 7,419 - Loans, net of allowance for loan losses 816,755 804,808 - - 804,808 Federal Reserve and FHLB Bank stock, at cost 4,648 4,648 - 4,648 - Interest receivable 3,106 3,106 - 3,106 - Financial liabilities Deposits $ 840,219 $ 840,272 $ 582,466 $ 257,806 $ - Repurchase agreements 12,945 12,945 - 12,945 - FHLB advances 16,000 16,149 - 16,149 - Trust preferred securities 10,310 9,201 - 9,201 - Interest payable 1,191 1,191 - 1,191 - F- 39 Note 22: Parent Company Financial Information Presented below is condensed financial information of the parent company only: Condensed Balance Sheets ($ in thousands) 2020 2019 Assets Cash & cash equivalents $ 2,178 $ 7,457 Investment in banking subsidiaries 143,244 134,244 Investment in nonbanking subsidiaries 5,617 4,883 Other assets 3,229 192 Total assets $ 154,268 $ 146,776 Liabilities Trust preferred securities $ 10,000 $ 10,000 Borrowings from nonbanking subsidiaries 310 310 Other liabilities & accrued interest payable 1,035 372 Total liabilities 11,345 10,682 Stockholders’ equity 142,923 136,094 Total liabilities and stockholders’ equity $ 154,268 $ 146,776 Condensed Statements of Income ($ in thousands) 2020 2019 Dividends from subsidiaries: Banking subsidiaries $ 24,025 $ 6,000 Nonbanking subsidiaries - 575 Total income 24,025 6,575 Expenses Interest expense 256 414 Other expense 2,950 1,773 Total expenses 3,206 2,187 Income before income tax 20,819 4,388 Income tax benefit (712 ) (508 ) Income before equity in undistributed income of subsidiaries 21,531 4,896 Equity in undistributed income of subsidiaries Banking subsidiaries (8,071 ) 6,526 Nonbanking subsidiaries 1,484 551 Total (6,587 ) 7,077 Net income 14,944 11,973 Preferred stock dividends - 950 Net income available to common shareholders $ 14,944 $ 11,023 F- 40 Condensed Statements of Comprehensive Income ($ in thousands) 2020 2019 Net income $ 14,944 $ 11,973 Other comprehensive income: Available-for-sale investment securities: Gross unrealized holding gain (loss) arising in the period 1,963 1,327 Related tax (expense) benefit (412 ) (279 ) Less: reclassification adjustment for gain realized in income - 206 Related tax expense - (43 ) Net effect on other comprehensive income 1,551 1,211 Total comprehensive income $ 16,495 $ 13,184 Condensed Statements of Cash Flows ($ in thousands) 2020 2019 Operating activities Net income $ 14,944 $ 11,973 Items not requiring (providing) cash Equity in undistributed net income of subsidiaries 6,587 (7,077 ) Stock compensation expense 382 417 Other assets (2,287 ) 32 Other liabilities 663 (884 ) Net cash provided by operating activities 20,289 4,461 Investing activities Capital contributed to banking subsidiary (15,520 ) - Capital contributed to nonbanking subsidiary - (3,100 ) Net cash used in investing activities (15,520 ) (3,100 ) Financing activities Dividends on common shares (3,070 ) (2,331 ) Dividends on preferred shares - (950 ) Proceeds from issuance of common shares - 139 Conversion of preferred shares - (1 ) Proceeds from share-based compensation plans 188 251 Repurchase of common shares (7,166 ) (5,050 ) Net cash used in financing activities (10,048 ) (7,942 ) Net change in cash and cash equivalents (5,279 ) (6,581 ) Cash and cash equivalents at beginning of year 7,457 14,038 Cash and cash equivalents at end of year $ 2,178 $ 7,457 F- 41 Note 23: Quarterly Financial Information Quarterly Financial Information (unaudited) Years ended December 31, ($ in thousands, except per share data) 2020 December September June March Interest income $ 10,589 $ 10,807 $ 10,595 $ 10,644 Interest expense 1,338 1,548 1,723 2,096 Net interest income 9,251 9,259 8,872 8,548 Provision for loan losses 800 1,800 1,300 600 Noninterest income 8,902 10,418 8,615 2,161 Noninterest expense 10,684 11,335 11,662 9,406 Income tax expense 1,311 1,292 870 22 Net income 5,358 5,250 3,655 681 Preferred share dividend - - - - Net income available to common $ 5,358 $ 5,250 $ 3,655 $ 681 Basic earnings per common share $ 0.71 $ 0.69 $ 0.47 $ 0.09 Diluted earnings per common share $ 0.71 $ 0.69 $ 0.47 $ 0.09 Dividends per share $ 0.105 $ 0.100 $ 0.100 $ 0.095 2019 December September June March Interest income $ 11,205 $ 11,546 $ 11,151 $ 10,498 Interest expense 2,609 2,488 2,319 2,158 Net interest income 8,596 9,058 8,832 8,340 Provision for loan losses 300 300 200 - Noninterest income 5,959 5,366 3,691 3,000 Noninterest expense 10,176 9,500 9,108 8,626 Income tax expense 721 862 588 488 Net income 3,358 3,762 2,627 2,226 Preferred share dividend 230 233 243 244 Net income available to common $ 3,128 $ 3,529 $ 2,384 $ 1,982 Basic earnings per common share $ 0.48 $ 0.55 $ 0.37 $ 0.31 Diluted earnings per common share $ 0.42 $ 0.48 $ 0.33 $ 0.28 Dividends per share $ 0.095 $ 0.090 $ 0.090 $ 0.085 F- 42 Report of Independent Registered Public Accounting Firm To the Stockholders, Board of Directors and Audit Committee SB Financial Group, Inc. Defiance, Ohio Opinion on the Financial Statements We have audited the accompanying consolidated balance sheets of SB Financial Group, Inc. (the “Company”) as of December 31, 2020 and 2019, the related consolidated statements of income, comprehensive income, stockholders’ equity and cash flows for each of the years ended December 31, 2020 and 2019, and the related notes (collectively referred to as the “financial statements”). In our opinion, the consolidated financial statements referred to above present fairly, in all material respects, the financial position of the Company as of December 31, 2020 and 2019, and the results of its operations and its cash flows for each of the years then ended, in conformity with accounting principles generally accepted in the United States of America. Basis for Opinion These financial statements are the responsibility of the Company’s management. Our responsibility is to express an opinion on the Company’s financial statements based on our audits. We are a public accounting firm registered with the PCAOB and are required to be independent with respect to the Company in accordance with the U.S. federal securities laws and the applicable rules and regulations of the Securities and Exchange Commission and the PCAOB. We conducted our audits in accordance with the standards of the PCAOB. Those standards require that we plan and perform the audits to obtain reasonable assurance about whether the financial statements are free of material misstatement, whether due to error or fraud. Our audits included performing procedures to assess the risks of material misstatement of the financial statements, whether due to error or fraud, and performing procedures that respond to those risks. Such procedures include examining, on a test basis, evidence regarding the amounts and disclosures in the financial statements. Our audits also included evaluating the accounting principles used and significant estimates made by management, as well as evaluating the overall presentation of the financial statements. We believe that our audits provide a reasonable basis for our opinion. Critical Audit Matters The critical audit matters communicated below are matters arising from the current-period audit of the financial statements that was communicated or required to be communicated to the audit committee and that: (1) relate to accounts or disclosures that are material to the financial statements and (2) involved our especially challenging, subjective or complex judgments. The communication of critical audit matters does not alter in any way our opinion on the financial statements, taken as a whole, and we are not, by communicating the critical audit matters below, providing separate opinions on the critical audit matters or on the accounts or disclosures to which they relate. Allowances for Loan Losses Description of the Matter As described in Note 5 to the consolidated financial statements, the Company’s consolidated allowance for loan and lease losses (ALLL) was $12.6 million at December 31, 2020. The Company also describes in Note 1 of the consolidated financial statements the accounting policy around this estimate. The ALLL is an estimate of losses inherent in the loan and lease portfolio. The determination of the reserve requires significant judgment reflecting the Company’s best estimate of probable loan and lease losses. The estimate consists of several key elements, which include: specific reserves for impaired loans, general reserves for each business lending division portfolio including percentage allocations for special attention loans and leases not deemed impaired, and reserves for pooled homogenous loans and leases, among others. The Company’s evaluation is based upon a continuing review of these portfolios, estimates of customer performance, collateral values and dispositions, and assessments of economic and geopolitical events, all of which are subject to judgment and will change. F- 43 We identified the valuation of the ALLL as a critical audit matter. Auditing the ALLL involves a high degree of subjectivity in evaluating management’s estimates, such as evaluating management’s assessment of economic conditions and other environmental factors used to adjust historical loss rates, evaluating the adequacy of specific reserves associated with impaired loans and assessing the appropriateness of loan grades. How We Addressed the Matter in Our Audit Our audit procedures related to the estimated allowance for loan losses included: ● Testing the design of internal controls, including those related to technology, over the ALLL including data completeness and accuracy, classifications of loans by loan segment, historical loss data, the calculation of a loss rate, the establishment of qualitative adjustments, grading and risk classification of loans and establishment of specific reserves on impaired loans and management’s review controls over the ALLL balance ● Testing clerical/computational accuracy of the formulas within the ALLL model. ● Testing of completeness and accuracy of the information and reports utilized in the ALLL, including reports used in management review controls over the ALLL. ● Computing an independent calculation of an acceptable range and comparing it to the Company’s estimate. ● Evaluating the qualitative adjustment to the historical loss rates, including assessing the basis for the adjustments and the reasonableness of the significant assumptions. ● Testing of the loan review function and the accuracy of loan grades determined. Specifically, utilizing internal loan grading professionals to assist us in evaluating the appropriateness of loan grades and to assess the reasonableness of specific impairments on loans. ● Evaluating the overall reasonableness of qualitative factors and the appropriateness of their direction and magnitude and the Company’s support for the direction and magnitude compared to previous years. Acquisition Description of the Matter As described in Note 3 to the consolidated financial statements, the Company completed the acquisition of a bank holding company and its wholly owned subsidiary during the year ended December 31, 2020 with total consideration of $15.5 million, including the recognition of $4.3 million of goodwill. As part of the acquisition, management determined that the acquisition qualified as a business and accordingly all identifiable assets and liabilities acquired were valued at fair value as part of the purchase price allocation as of the acquisition date. The identification and valuation of such acquired assets and assumed liabilities required management to exercise significant judgment and the use of third-party specialists to estimate the fair value allocations. We identified the acquisition and the valuation of acquired assets and assumed liabilities a critical audit matter. Auditing the acquisition transaction involved a high degree of subjectivity in evaluating management’s operational assumptions, fair value estimates, purchase price allocations and assessing the appropriateness of valuation models. How We Addressed the Matter in Our Audit The primary procedures we performed to address this critical audit matter included: ● Obtaining and reviewing executed Plan and Agreement of Merger documents to gain an understanding of the underlying terms of the consummated acquisition; ● Obtaining and reviewing management’s reconciliation procedures of significant accounts and testing of completion procedures performed and asset/liability identification considerations made; F- 44 ● Testing management’s computation of purchase price and determination of goodwill recognized focusing on the completeness and accuracy of the balance sheet acquired and related fair value purchase price allocations made to identified assets acquired and liabilities assumed; ● Obtaining and reviewing valuation estimates prepared by specialists engaged by the Company, and challenging management’s review of the appropriateness of the valuations assessed and allocation to assets acquired and liabilities assumed. The procedures included but were not limited to, testing critical inputs, including key assumptions applied and the valuation models utilized by the Company’s specialists; ● Utilization of our internal specialists to assist with testing and challenging the related fair value purchase price allocations made to identified assets acquired and liabilities assumed; ● Reviewing and evaluating the adequacy of the disclosures made in the footnotes related to the acquisition. Goodwill Impairment Analysis The Company’s goodwill totaled $22.1 million at December 31, 2020. As discussed in Notes 1 and 8 to the consolidated financial statements, goodwill is tested for impairment on an annual basis, or more often if events or circumstances indicate that there may be impairment. During the third quarter of 2020, the Company’s market value fell below book value, which caused the Company to engage a third-party valuation specialist to perform a quantitative assessment of the reporting unit’s value as of September 30, 2020. The Company performed an additional qualitative assessment as of March 31, 2020, June 30, 2020 and December 31, 2020. Based on each of these assessments, the Company’s reporting segment’s fair value exceeded the carrying value and no goodwill impairment was recorded. We identified the valuation of goodwill as a critical audit matter due to the subjective nature of the assumptions used to estimate the reporting unit’s fair value. The Company’s estimate of future cash flows is based on multiple assumptions, such as revenue growth projections and the ability to adhere to anticipated expense levels, as well as the selected discount rate and terminal value, which are sensitive to changes in expectations about future market or economic conditions, including uncertainty resulting from the COVID-19 pandemic. To test the estimated fair value of the Company’s reporting unit, with the support from our internal valuation specialists, we performed audit procedures that included, among others: ● Assessing methodologies selected by management and testing the significant assumptions discussed above. ● Testing the accuracy of the underlying data used by the Company in its analysis. ● Comparing the significant assumptions used by management to current industry and economic trends. ● Performing sensitivity analyses of significant assumptions to evaluate changes in the fair value estimate of the reporting unit resulting from changes in the assumptions. ● Testing management’s reconciliation of the fair value of the reporting unit to the market capitalization of the Company. /s/ BKD, LLP We have served as the Company’s auditor since 2002. Indianapolis, IN March 8, 2021 F- 45 Item 9. Changes in and Disagreements With Accountants on Accounting and Financial Disclosure . Not Applicable.