What changed in this filing

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Item 2. Management’s Discussion and Analysis

2021-11-15 compared with 2021-08-13 · 148 added, 163 removed, 309 unchanged (50% of the section changed)

32 unchanged sentences

The Company engages in trust and wealth management services through Wye Financial Partners, a division of Shore United Bank.

As discussed in Note 15 to the consolidated financial statements, the Company recently completed its acquisition of Annapolis-based Severn Bancorp, Inc.

The acquisition of Severn will expand the Company’s footprint in the Annapolis and Anne Arundel County market areas, among others, and provide additional banking resources to our customers, including but not limited to, a robust secondary market mortgage banking line of business.

The shares of common stock of Shore Bancshares, Inc.

15 unchanged sentences

Loans under the PPP do not require any collateral or personal guarantees, as such, these loans are included in the Company’s commercial loans segment.

The first round of PPP lending resulted in 1,495 loans for $129.0 million, of which 1,037 loans have been forgiven or paid down in the amount of $102.3 million as of June 30, 2021.

The first round of PPP lending resulted in 1,495 loans for $129.0 million, of which 1,447 loans have been forgiven or paid down in the amount of $125.9 million as of September 30, 2021.

The second round of PPP lending which began in 2021, resulted in 959 loans for $67.3 million, of which 597 loans have been forgiven or paid down in the amount of $28.9 million.

As of June 30, 2021, the Company had 1,195 PPP loans totaling $86.8 million that were outstanding, inclusive of loans issued during both the first and second rounds of the PPP.

As of September 30, 2021, the Company had 410 PPP loans totaling $41.5 million that were outstanding, inclusive of loans issued during both the first and second rounds of the PPP.

This has allowed us to further strengthen and deepen our client relationships, while positively impacting thousands of individuals.

4 unchanged sentences

In accordance with interagency guidance issued in April 2020 and December 2020, short-term modifications made to borrowers affected by the COVID-19 pandemic and governmental shutdown orders, such as payment deferrals, fee waivers and extensions of repayment terms, do not need to be identified as TDRs if the loans were current at the time a modification plan was implemented.

Since the beginning of the pandemic and through June 30, 2021, the Company had executed principal and/or interest deferrals on outstanding loan balances of $221.1 million, of which only $9.5 million, or 0.65% of the total portfolio, remained on deferral as of June 30, 2021.

Loans Modified

Balance as of

Modified as of

Only Payments

(Dollars in thousands)

June 30, 2021

(6 months or less)

Hospitality Industry

Non-owner occupied Retail Stores

Non-owner occupied Restaurants

Owner-occupied Retail Stores

Owner-occupied Restaurants

Oil & Gas Industry

Other Commercial Loans

Total Commercial Loans

Residential 1-4 family Personal

Residential 1-4 family Rentals

Home Equity Loans

Total Residential Real Estate Loans

Consumer Loans

Mortgage Warehouse Loans

Credit Card, Overdrafts and Other

Since the beginning of the pandemic and through September 30, 2021, the Company had executed principal and/or interest deferrals on outstanding loan balances of $221.1 million.

As of September 30, 2021, the Company had no COVID related loan deferrals remaining.

We are vigilantly monitoring our liquidity position on an ongoing basis.

3 unchanged sentences

Share Repurchases

At the present time all share repurchases have been suspended due to the current status of our merger with Severn.

Once the merger is consummated, the Company intends to resume its current share buyback program in which $546 thousand remains available.

The Board of directors and management will re-evaluate the need for an additional stock repurchase program once the current plan is exhausted or expires.

The Company currently has a share repurchase program, in which $542 thousand remains available until expirations on December 31, 2021.

The Board of directors and management will re-evaluate the need for an additional stock repurchase program based on the market price of the Company’s stock, capital position, and necessary regulatory approvals.

Dividends and Capital

We currently expect to maintain our quarterly cash dividend based on our strong capital position.

At June 30, 2021, the Bank exceeded all the capital requirements to which it was subject, and based on the most recent notification from its primary federal regulator is considered to be well-capitalized.

At September 30, 2021, the Bank exceeded all the capital requirements to which it was subject, and based on the most recent notification from its primary federal regulator is considered to be well-capitalized.

There are no conditions or events since that notification that management believes would change the Bank’s classification.

We are closely monitoring our capital position and

are taking appropriate steps to ensure our level of capital remains strong.

We are closely monitoring our capital position and are taking appropriate steps to ensure our level of capital remains strong.

Our capital, while significant, may deteriorate in future periods due to the impact of the pandemic and limit our ability to pay dividends.

7 unchanged sentences

These policies, along with the disclosures presented in the notes to the financial statements and in this discussion, provide information on how significant assets and liabilities are valued in the financial statements and how those values are determined.

Based on the valuation techniques used and the sensitivity of financial statement amounts to the methods, assumptions, and estimates underlying those amounts, management has determined that the accounting policies with respect to the allowance for credit losses and goodwill and other intangible assets are critical accounting policies.

Based on the valuation techniques used and the sensitivity of financial statement amounts to the methods,

assumptions, and estimates underlying those amounts, management has determined that the accounting policies with respect to the allowance for credit losses and goodwill are critical accounting policies.

These policies are considered critical because they relate to accounting areas that require the most subjective or complex judgments, and, as such, could be most subject to revision as new information becomes available.

9 unchanged sentences

If the fair value of a reporting unit is less than book value, an expense may be required to write down the related goodwill to record an impairment loss.

As of June 30, 2021, the Company had only one banking reporting unit.

The Company reported net income of $4.0 million for the second quarter of 2021, or diluted income per common share of $0.34, compared to net income of $5.3 million, or diluted income per common share of $0.43, for the second quarter of 2020.

For the first quarter of 2021, the Company reported net income of $4.0 million, or diluted income per common share of $0.34.

When comparing net income for the second quarter of 2021 to the second quarter of 2020, the decrease was due to salary and wages being deferred in the second quarter of 2020 due to the originations of the first round of PPP loans.

Despite these salary and wage deferrals, net interest income increased when compared to the second quarter of 2020 by $1.1 million, while a reduced provision for credit losses of $350 thousand and higher noninterest income of $134 thousand had a positive impact on net income.

When comparing the second quarter of 2021 to the first quarter of 2021, the net income was essentially unchanged, from period to period with offsetting variances related to higher net interest income of $303 thousand and noninterest income of $346 thousand, partially offset by an increase in the provision for credit losses of $225 thousand and noninterest expense of $377 thousand.

Merger-related expenses of $377 thousand were recorded in

the second quarter of 2021, which had an impact on the profitability of the quarter when compared to the linked and previous quarters.

For the first six months of 2021, the Company reported net income of $8.0 million, or diluted income per common share of $0.68, compared to net income of $8.5 million, or diluted income per common share of $0.68, for the first six months of 2020.

When comparing net income for the first six months of 2021 to the first six months of 2020, the decrease in net income was primarily due to the deferral of salaries and wages as previously mentioned above, as well as an increase in almost all noninterest expense line items for a total of $3.4 million, partially offset by improvements in net interest income of $2.4 million, noninterest income of $339 thousand and a reduced provision for credit losses of $275 thousand.

The reason for the similar diluted income per share for both periods despite the lower net income in 2021, was due to buybacks of the Company’s common stock, resulting in fewer outstanding shares period over period.

As of September 30, 2021, the Company had only one banking reporting unit.

As previously noted, the Company acquired Severn Bancorp, Inc.

during the 4 th quarter of 2021.

The Company’s 2021 Annual Report on Form 10-K will also include the critical accounting policies related to its acquisition of Severn.

The Company reported net income of $4.6 million for the third quarter of 2021, or diluted income per common share of $0.39, compared to net income of $3.4 million, or diluted income per common share of $0.27, for the third quarter of 2020.

For the second quarter of 2021, the Company reported net income of $4.0 million, or diluted income per common share of $0.34.

When comparing net income for the third quarter of 2021 to the third quarter of 2020, net income increased $1.2 million, primarily due to increases in net interest income of $2.3 million and noninterest income of $328 thousand, combined with a lower provision for credit losses of $1.2 million.

These improvements to net income were partially offset by an increase in almost all expense line items, adding $2.1 million to noninterest expense.

When comparing the third quarter of 2021 to the second quarter of 2021, the net income increased $586 thousand, due to an increase in net interest income of $1.5 million and lower provision for credit losses of $360 thousand, which was partially offset by an increase in noninterest expense of $1.1 million.

In addition, merger-related expenses were recorded for the second and third quarters of 2021 of $377 thousand and $538 thousand, respectively.

For the first nine months of 2021, the Company reported net income of $12.6 million, or diluted income per common share of $1.08, compared to net income of $11.8 million, or diluted income per common share of $0.95, for the first nine months of 2020.

When comparing net income for the first nine months of 2021 to the first nine months of 2020, net income increased $801 thousand, primarily due to increases in net interest income of $4.7 million and noninterest income of $667 thousand, combined with a lower provision for credit losses of $1.5 million.

These improvements to net income were partially offset by an increase in almost all expense line items, adding $5.5 million to noninterest expense.

In addition, total merger-related expenses for the first nine months were $915 thousand.

RESULTS OF OPERATIONS

1 unchanged sentence

Tax-equivalent net interest income is net interest income adjusted for the tax-favored status of income from certain loans and investments.

As shown in the table below, tax-equivalent net interest income was $14.1 million for the second quarter of 2021 and $13.1 million for the second quarter of 2020.

Tax-equivalent net interest income was $13.8 million for the first quarter of 2021.

The increase in net interest income when comparing the second quarter of 2021 to the second quarter of 2020, was the result of higher interest and fees on loans and income from taxable investment securities, coupled with a decrease in interest expense.

Net interest income increased for the second quarter of 2021 when compared to the first quarter of 2021 due to an increase in income from taxable investment securities and a decrease in interest expense.

As shown in the table below, tax-equivalent net interest income was $15.6 million for the third quarter

of 2021 and $13.3 million for the third quarter of 2020.

Tax-equivalent net interest income was $14.1 million for the second quarter of 2021.

The increase in net interest income when comparing the third quarter of 2021 to the third quarter of 2020 and the second quarter of 2021, was the result of higher interest and fees on loans and income from taxable investment securities, coupled with a decrease in interest expense.

Net interest margin is tax-equivalent net interest income (annualized) divided by average earning assets.

The net interest margin for the second quarter of 2021 was 2.91%, which was a decrease of 50bps when compared to 3.41% for the second quarter of 2020 and a decrease of 9bps when compared to 3.00% for the first quarter of 2021.

The decline in net interest margin in the second quarter of 2021 when compared to the first quarter of 2021 and the second quarter of 2020, was significantly impacted by excess liquidity and the decrease in yields of taxable investment securities.

Without excess liquidity of $100 million, the margin for the second quarter of 2021 would have been 3.07%.

The net interest margin for the third quarter of 2021 was 2.99%, which was a decrease of 18bps when compared to 3.17% for the third quarter of 2020 and an increase of 8bps when compared to 2.91% for the second quarter of 2021.

The decline in net interest margin in the third quarter of 2021 when compared to the third quarter of 2020, was significantly impacted by excess liquidity and the decrease in yields of taxable investment securities.

The increase in net interest margin when compared to the second quarter of 2021, was primarily due to improvement in the yields on earning assets, specifically loans of 14bps, and the continued decrease in rates paid on interest-bearing deposits.

Without excess liquidity of $200 million, the margin for the third quarter of 2021 would have been 3.31%.

Interest Income

On a tax-equivalent basis, interest income increased $938 thousand, or 6.4%, for the second quarter of 2021 when compared to the second quarter of 2020.

On a tax-equivalent basis, interest income increased $2.0 million, or 13.4%, for the third quarter of 2021 when compared to the third quarter of 2020.

The increase was the result of higher interest and fees on loans and income from investment securities.

The primary driver for the increase in interest income on loans was the higher average volume of loans of $70.4 million, which included PPP lending.

The primary driver for the increase in interest income on loans was the higher average volume of loans of $80.6 million and a higher average yield of 13bps, partially impacted by PPP forgiveness in the third quarter of 2021.

The average balance of investment securities increased $198.2 million, providing $588 thousand of additional income, despite a decrease in the average yield of 56bps.

On a tax-equivalent basis, interest income increased $189 thousand, or 1.2%, for the second quarter of 2021 when compared to the first quarter of 2021.

The increase was primarily a result of taxable investment securities which were purchased during the second quarter of 2021, resulting in a higher average balance in these securities of $58.3 million.

On a tax-equivalent basis, interest income increased $1.4 million, or 8.8%, for the third quarter of 2021 when compared to the second quarter of 2021.

The increase was primarily a result of growth in the average balance in loans of $42.6 million and a higher average yield of 14bps, partially impacted by PPP forgiveness in the third quarter of 2021.

In addition, taxable investment securities were purchased during the third quarter of 2021, resulting in a higher average balance in these securities of $48.1 million and improvement in the average yield of 5bps, which provided $224 thousand of additional income.

Interest Expense

Interest expense decreased $135 thousand, or 8.6%, when comparing the second quarter of 2021 to the second quarter of 2020.

The decrease in interest expense from the second quarter of 2020 was a result of the decrease in the average rate paid on interest-bearing deposits of 29bps.

This decrease in interest expense was partially offset by the issuance of subordinated debt in the third quarter of 2020 which added $370 thousand of additional expense for the second quarter of 2021.

Interest expense decreased $116 thousand, or 7.5%, when comparing the second quarter of 2021 to the first quarter of 2021.

The decrease in interest expense on deposits was due to a 6bps decline in the average rate paid on interest-bearing deposits, specifically time deposits that matured and renewed during the second quarter of 2021.

The following tables present the distribution of the average consolidated balance sheets, interest income/expense, and annualized yields earned and rates paid for the three months ended June 30, 2021 and 2020.

Interest expense decreased $309 thousand, or 19.0%, when comparing the third quarter of 2021 to the third quarter of 2020.

The decrease in interest expense from the third quarter of 2020 was a result of the decrease in the average rate paid on interest-bearing deposits of 27bps.

This decrease in interest expense was partially offset by the issuance of subordinated debt late in the third quarter of 2020 which added $211 thousand of additional expense for the third quarter of 2021 when compared to the third quarter of 2020.

Interest expense decreased $116 thousand, or 8.1%, when comparing the third quarter of 2021 to the second quarter of 2021.

The decrease in interest expense on deposits was due to a 6bps decline in the average rate paid on interest-bearing deposits, specifically time deposits.

For Three Months Ended

June 30, 2021

June 30, 2020

September 30, 2021

September 30, 2020

(Dollars in thousands)

13 unchanged sentences

Securities sold under retail repurchase agreements and short-term FHLB advances

Advances from FHLB - short-term

Advances from FHLB - long-term

12 unchanged sentences

Net Interest Income

Tax-equivalent net interest income increased $2.4 million, or 9.2%, during the six months ended June 30, 2021 compared to the six months ended June 30, 2020.

The higher net interest income was due to an increase in interest income of $1.6 million, or 5.4% and a decrease in interest expenses on interest-bearing deposits of $1.4 million, or 38.0%.

Despite the improved results, compression in the margin was due to lower yields on earning assets, specifically taxable investment securities of 71bps and interest-bearing deposits with the Fed of 54bps.

This resulted in a net interest margin of 2.96% for the six months ended June 30, 2021 compared to 3.45% for the six months ended June 30, 2020.

Tax-equivalent net interest income increased $4.7 million, or 12.0%, during the nine months ended September 30, 2021 compared to the nine months ended September 30, 2020.

The higher net interest income was due to an increase in interest income of $3.6 million, or 8.1% and a decrease in interest expense on interest-bearing deposits of $1.9 million, or 20.0%.

Despite the improved results, compression in the margin was due to lower yields on total earning assets.

This resulted in a net interest margin of 2.97% for the nine months ended September 30, 2021 compared to 3.35% for the nine months ended September 30, 2020.

Interest Income

On a tax-equivalent basis, interest income increased $1.6 million, or 5.4%, for the six months ended June 30, 2021 when compared to the six months ended June 30, 2020.

The increase was primarily due to higher interest and fees on loans of $1.0 million, or 3.6% and taxable investment securities of $668 thousand, or 49.2%.

The increase in interest and fees on

loans was due to a higher average balance of loans of $128.9 million, or 9.8%, which included PPP loans which have a lower yield than more traditional loans, resulting in a lower overall yield of 23bps.

On a tax-equivalent basis, interest income increased $3.6 million, or 8.1%, for the nine months ended September 30, 2021 when compared to the nine months ended September 30, 2020.

The increase was primarily due to higher interest and fees

on loans of $2.4 million, or 5.6% and taxable investment securities of $1.3 million, or 60.2%.

The increase in interest and fees on loans was due to a higher average balance of loans of $112.7 million, or 8.4%, which included forgiveness on PPP loans in 2021.

The increase in interest on taxable investment securities was due to a higher average balance in these securities of $158.6 million, or 127.4%, despite the decline in the average yield of such securities of 66bps.

Interest Expense

Interest expense decreased $760 thousand, or 20.4%, when comparing the six months ended June 30, 2021 to the six months ended June 30, 2020.

Interest expense decreased $1.1 million, or 20.0%, when comparing the nine months ended September 30, 2021 to the nine months ended September 30, 2020.

The decrease in interest expense was due to a decline in the rates paid on interest-bearing deposits of 33bps and the elimination of long-term advances from FHLB.

These improvements were partially offset by the addition of subordinated debt, issued in the third quarter of 2020, which added $729 thousand in interest expense for the first six months of 2021.

The following tables present the distribution of the average consolidated balance sheets, interest income/expense, and annualized yields earned and rates paid for the six months ended June 30, 2021 and 2020.

For Six Months Ended

June 30, 2021

June 30, 2020

These improvements were partially offset by the addition of subordinated debt, issued in the third quarter of 2020, which added $940 thousand in interest expense when compared to the first nine months of 2020.

The following tables present the distribution of the average consolidated balance sheets, interest income/expense, and annualized yields earned and rates paid for the nine months ended September 30, 2021 and 2020.

For Nine Months Ended

September 30, 2021

September 30, 2020

(Dollars in thousands)

9 unchanged sentences

Money market and savings deposits

Brokered Deposits

Certificates of deposit $100,000 or more

2 unchanged sentences

Securities sold under retail repurchase agreements and federal funds purchased

Advances from FHLB - short-term

Advances from FHLB - long-term

12 unchanged sentences

Noninterest Income

Total noninterest income for the second quarter of 2021 increased $134 thousand, or 4.8%, when compared to the second quarter of 2020.

The increase from the second quarter of 2020 was due to higher deposit related fees, other bank service charges and trust and investment fee income, partially offset by the absence of gains on sale of investment securities.

Noninterest income increased $346 thousand, or 13.5%, when compared to the first quarter of 2021 primarily due to higher deposit related fees and service charges.

Total noninterest income for the six months ended June 30, 2021 increased $339 thousand, or 6.6%, when compared to the same period in 2020.

The increase in noninterest income primarily consisted of increases in deposit related fees, other bank service charges and trust and investment fee income, partially offset by the absence of gains on sale of investment securities.

The increases in deposit related fees and other bank service charges were mostly due to the local government-imposed shutdowns in 2020 and a return to a more normalized local economy and consumer demand for products and services in 2021.

Total noninterest income for the third quarter of 2021 increased $328 thousand, or 12.7%, when compared to the third quarter of 2020.

The increase from the third quarter of 2020 included all lines of business, but predominately service charges on deposit accounts, trust and investment fee income and other debit card interchange fees.

Noninterest income increased $6 thousand, or less than 1%, when compared to the second quarter of 2021 primarily due to higher service charges on deposit accounts, almost entirely offset by the absence of a debit card incentive received in the second quarter of 2021.

Total noninterest income for the nine months ended September 30, 2021, increased $667 thousand, or 8.7%, when compared to the same period in 2020.

The increase in noninterest income primarily consisted of higher trust and investment fee income, deposit related fees and service charges on other bank services, partially off-set by lower gains on securities year over year.

The increase in deposit related fees and other bank service charges has been impacted by the growth in

new accounts and balances of deposits, as well as a return to a more normalized local economy and consumer demand for products and services in 2021.

Noninterest Expense

Total noninterest expense for the second quarter of 2021 increased $3.2 million, or 41.9%, when compared to the second quarter of 2020 and increased $377 thousand, or 3.6%, when compared to the first quarter of 2021.

The increase in noninterest expenses when compared to the second quarter of 2020 was primarily driven by salary and wages being deferred in the second quarter of 2020, the result of originating first round PPP loans.

Absent the increased deferrals of salaries and wages related to the first round of PPP, increases in furniture and fixtures, data processing, FDIC insurance and merger-related expenses resulted in the overall increase in noninterest expenses.

The significant growth in new and existing customer accounts accounted for the increase in data processing costs and FDIC insurance premiums.

The increase in noninterest expense when compared to the first quarter of 2021 was primarily due to merger-related expenses, salaries and wages, furniture and fixtures and legal and professional fees, partially offset by lower employee benefit costs due to lower payroll taxes and medical claims.

The increase in salaries and wages was mainly attributed to the deferral of costs associated with originating the second round of PPP loans in the first quarter of 2021.

The increase in furniture and fixtures when compared to both the second quarter of 2020 and the first quarter of 2021 was due to an on-going branch renovation.

Total noninterest expense for the six months ended June 30, 2021 increased $3.4 million, or 18.7%, when compared to the same period in 2020.

The increase was mainly the result of the absence of the deferral in salaries and wages due to PPP loan originations in 2020, higher data processing costs, FDIC insurance premiums and occupancy costs.

Total noninterest expense for the third quarter of 2021 increased $2.1 million, or 21.4%, when compared to the third quarter of 2020 and increased $1.1 million, or 9.7%, when compared to the second quarter of 2021.

The increase in noninterest expense when compared to both the third quarter of 2020 and second quarter of 2021 was primarily driven by salary and wages being deferred in the third quarter of 2020 and the second quarter of 2021, the result of originating first and second round PPP loans, combined with additional accruals related to incentive payouts and bonuses for employees.

In addition, increases in employee benefits, furniture and fixtures, and FDIC insurance contributed to the higher expense base in the third quarter of 2021.

Employee benefits increased due to higher supplemental executive retirement plan costs in the third quarter of 2021, while furniture and fixtures increased due to renovations of an existing bank branch.

FDIC insurance premiums have increased due to the growth in deposit accounts in 2021.

Merger-related expenses due to the acquisition of Severn remained a significant variance when comparing the comparative third quarters of 2021 and 2020.

Total noninterest expense for the nine months ended September 30, 2021, increased $5.5 million, or 19.6%, when compared to the same period in 2020.

The increase was mainly the result of the absence of the deferral in salaries and wages due to PPP loan originations in 2020, accruals related to incentive payouts and bonuses, higher data processing costs, FDIC insurance premiums and occupancy costs.

The higher occupancy costs are associated with a new branch lease in Ocean City, Maryland which will open in 2022.

In addition, the Company recorded merger-related expenses of $377 thousand for the first six months of 2021 due to the pending acquisition of Severn.

In addition, the Company recorded merger-related expenses of $915 thousand for the first nine months of 2021 due to the acquisition of Severn.

Provision for Credit Losses

The provision for credit losses was $650 thousand for the second quarter of 2021, $1.0 million for the second quarter of 2020 and $425 thousand for the first quarter of 2021.

The ratio of the allowance for credit losses to period-end loans was 1.02% at June 30, 2021, 0.95% at December 31, 2020 and 0.98% at March 31, 2021.

Excluding PPP loans, the ratio of the allowance for credit losses to period-end loans was 1.09% at June 30, 2021, higher than both the 1.04% at December 31, 2020 and the 1.07% at March 31, 2021.

The primary drivers of the increased percentage of the allowance to total loans, excluding PPP loans, as compared to December 31, 2020 and March 31, 2021, were significant loan originations in the second quarter of 2021, specifically within the construction and consumer loan portfolios, which require a higher level of allowance than the PPP loans which were forgiven during the second quarter of 2021, coupled with pandemic related qualitative factors which have remained elevated due to uncertainty and associated risks with the COVID-19 virus/variants and lagging vaccination rates.

The Company reported net recoveries in the second quarter of 2021 of $125 thousand, compared to net recoveries of $61 thousand for the fourth quarter of 2020 and no net charge offs or recoveries for the first quarter of 2021.

The provision for credit losses for the six months ended June 30, 2021 and 2020 was $1.1 million and $1.4 million, respectively, while net recoveries were $125 thousand and net charge-offs were $767 thousand, respectively.

The decrease in provision for credit losses was the result of lower charge-offs in 2021 and overall improved credit quality.

The ratio of allowance to total loans increased from 0.95% at December 31, 2020, to 1.02% at June 30, 2021.

Excluding PPP loans, the ratio of the allowance for credit losses to period-end loans was 1.09% at June 30, 2021, higher than the 1.04% at December 31, 2020.

The primary drivers for the increase in the percentage of allowance for credit losses to total loans were significant originations within the construction and consumer loan portfolios, which require a higher level of allowance than the PPP loans that were forgiven during the second quarter of 2021, as well as continued elevated pandemic related qualitative factors.

The ratio of annualized net recoveries to average loans was 0.03% for the first half of 2021, compared to annualized net charge-offs of 0.12% for the first half of 2020.

The provision for credit losses was $290 thousand for the third quarter of 2021, $1.5 million for the third quarter of 2020 and $650 thousand for the second quarter of 2021.

The ratio of the allowance for credit losses to period-end loans was 1.04% at September 30, 2021, 0.95% at December 31, 2020 and 1.02% at June 30, 2021.

Excluding PPP loans, the ratio of the allowance for credit losses to period-end loans was 1.07% at September 30, 2021, higher than the 1.04% at December 31, 2020 and slightly lower than the 1.09% at June 30, 2021.

The primary driver of the increased percentage of the allowance to total loans, excluding PPP loans, as compared to December 31, 2020, was significant loan originations within segments of the portfolio which carry higher reserves.

The decrease in the percentage of the allowance to total loans, excluding PPP loans, as compared to June 30, 2021, was due slightly reduced pandemic qualitative factors within the allowance model.

The Company reported net recoveries in the third quarter of 2021 of $147 thousand, compared to net recoveries of $187 thousand for the third quarter of 2020 and net recoveries of $125 thousand for the second quarter of 2021.

The provision for credit losses for the nine months ended September 30, 2021, and 2020 was $1.4 million and $2.9 million, respectively, while net recoveries were $272 thousand and net charge-offs were $580 thousand, respectively.

The decrease in the provision for credit losses was the result of lower charge-offs in 2021, overall improved credit quality and a slight reduction in pandemic related qualitative factors.

The ratio of allowance to total loans increased from 0.95% at December 31, 2020, to 1.04% at September 30, 2021.

Excluding PPP loans, the ratio of the allowance for credit losses to period-end loans was 1.07% at September 30, 2021, higher than the 1.04% at December 31, 2020.

The ratio of annualized net recoveries to average loans was 0.07% for the first nine months of 2021, compared to annualized net charge-offs of 0.06% for the first nine months of 2020.

Management will continue to evaluate the adequacy of the allowance for credit losses as more economic data becomes available and as changes within the Company’s portfolio are known.

The Company reported income tax expense of $1.4 million for the second quarter of 2021, $1.8 million for the second quarter of 2020 and $1.4 million for the first quarter of 2021.

Income tax expense decreased when compared to the second quarter of 2020 due to lower pre-tax earnings and stayed flat when compared to the first quarter of 2021.

The effective tax rate for the first and second quarter of 2021 was 26.4% and was 25.2% for the second quarter of 2020.

Income tax expense for the six months ended June 30, 2021 and the six months ended June 30, 2020 remained flat at $2.9 million.

The Company reported income tax expense of $1.7 million for the third quarter of 2021, $1.1 million for the third quarter of 2020 and $1.4 million for the second quarter of 2021.

Income tax expense increased when compared to both the third

quarter of 2020 and second quarter of 2021 due to higher pre-tax earnings.

The effective tax rate for the second and third quarters of 2021 was 26.4% and was 25.2% for the third quarter of 2020.

Income tax expense for the nine months ended September 30, 2021, compared to the nine months ended September 30, 2020, increased $544 thousand due to higher pre-tax earnings.

The effective tax rate at September 30, 2021 and September 30, 2020 were 26.4% and 25.2%, respectively.

ANALYSIS OF FINANCIAL CONDITION

Loans totaled $1.472 billion at June 30, 2021 and $1.454 billion at December 31, 2020, an increase of $18.2 million, or 1.2%.

Excluding PPP loans, the increase in total loans was $68.6 million, or 4.7%, due to significant loan growth late in the second quarter of 2021.

The increase in loans, excluding PPP loans, was comprised of increases in consumer loans of $32.9 million, or 104.6%, commercial loans of $10.9 million, or 5.2%, construction loans of $10.0 million, or 9.4%, and residential real estate loans of $6.3 million, or 1.4%.

These increases were partially offset by a decrease in commercial real estate loans of $6.0 million, or less than 1%.

Construction loans included deferred fees, net of deferred costs, of $549 thousand and discounts on acquired loans of $625 thousand at June 30, 2021, compared to deferred costs, net of deferred fees, of $622 thousand and discounts on acquired loans of $754 thousand at December 31, 2020.

Outstanding PPP loans totaled $86.8 million at June 30, 2021 and $122.8 million at December 31, 2020, a decrease of $36.0 million or 29.3%.

The decrease was primarily due to forgiveness on first round PPP loans originated in 2020, partially offset by the origination of second round PPP loans in 2021.

Loans totaled $1.495 billion at September 30, 2021 and $1.454 billion at December 31, 2020, an increase of $40.6 million, or 2.8%.

Excluding PPP loans, the increase in total loans was $121.9 million, or 9.2%, due to significant loan growth late in the second and third quarters of 2021.

The increase in loans, excluding PPP loans, was comprised of increases in consumer loans of $62.8 million, or 199.7%, construction loans of $23.8 million, or 22.3%, residential real estate loans of $17.3 million, or 3.9%, commercial loans of $15.2 million, or 7.2%, and commercial real estate loans of $2.7 million, or less than 1%.

Construction loans included deferred fees, net of deferred costs, of $376 thousand and discounts on acquired loans of $577 thousand at September 30, 2021, compared to deferred costs, net of deferred fees, of $622 thousand and discounts on acquired loans of $754 thousand at December 31, 2020.

Outstanding PPP loans totaled $41.5 million at September 30, 2021 and $122.8 million at December 31, 2020, a decrease of $81.3 million or 66.2%.

The decrease was primarily due to forgiveness on first and second round PPP loans originated in 2020 and 2021.

We do not engage in foreign or subprime lending activities.

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Our loan portfolio has a commercial real estate loan concentration, which is generally defined as a combination of certain construction and commercial real estate loans.

Construction loans were $116.8 million, or 7.9% of total loans, at June 30, 2021 and $106.8 million, or 7.3% of total loans, at December 31, 2020.

Commercial real estate loans were $655.3 million, or 44.5% of total loans, at June 30, 2021, compared to $661.2 million, or 45.5% of total loans, at December 31, 2020.

Construction loans were $130.6 million, or 8.7% of total loans, at September 30, 2021 and $106.8 million, or 7.3% of total loans, at December 31, 2020.

Commercial real estate loans were $663.9 million, or 44.4% of total loans, at September 30, 2021, compared to $661.2 million, or 45.5% of total loans, at December 31, 2020.

The federal banking regulators have issued guidance for those institutions which are deemed to have concentrations in commercial real estate lending.

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Institutions which are deemed to have concentrations in commercial real estate lending are expected to employ heightened levels of risk management with respect to their commercial real estate portfolios, and may be required to hold higher levels of capital.

The Company, like many community banks, has a concentration in commercial real estate loans,

and the Company has experienced significant growth in its commercial real estate portfolio in recent years.

At June 30, 2021, non-owner-occupied commercial real estate loans (including construction, land and land development loans) represented 302.3% of total risk-based capital.

The Company, like many community banks, has a concentration in commercial real estate loans, and the Company has experienced significant growth in its commercial real estate portfolio in recent years.

At September 30, 2021, non-owner-occupied commercial real estate loans (including construction, land and land development loans) represented 301.6% of total risk-based capital.

At such time, construction, land and land development loans represented 61.8% of total risk-based capital.

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Please refer to the discussion above under the caption “Critical Accounting Policies” for an overview of the underlying methodology management employs to maintain the allowance.

The allowance for credit losses was $15.1 million at June 30, 2021, $13.9 million at December 31, 2020 and $14.3 million at March 31, 2021.

There were net recoveries of $125 thousand for the second quarter of 2021, compared to net recoveries of $61 thousand for the fourth quarter of 2020 and no net charge offs or recoveries for the first quarter of 2021.

The ratio of annualized net recoveries to average loans was 0.03% for the second quarter of 2021, compared to annualized net recoveries of 0.02% for the fourth quarter of 2020 and 0% for the first quarter of 2021.

The allowance for credit losses was $15.5 million at September 30, 2021, $13.9 million at December 31, 2020 and $15.1 million at June 30, 2021.

There were net recoveries of $147 thousand for the third quarter of 2021, compared to net recoveries of $61 thousand for the fourth quarter of 2020 and net recoveries of $125 thousand for the second quarter of 2021.

The ratio of annualized net recoveries to average loans was 0.04% for the third quarter of 2021, compared to annualized net recoveries of 0.02% for the fourth quarter of 2020 and 0.03% for the second quarter of 2021.

Management remains focused on its efforts to dispose of problem loans and to prudently charge-off nonperforming loans to enable the Company to continue to improve its overall credit quality.

The allowance for credit losses as a percentage of period-end loans was 1.02% at June 30, 2021 and 0.95% at December 31, 2020.

Excluding PPP loans, the ratio of the allowance for credit losses to period-end loans as 1.09% at June 30, 2021, higher than the 1.04% at December 31, 2020.

The increase in the percentage of the allowance to total loans at June 30, 2021, compared to December 31, 2020, was primarily due to significant loan growth in the second quarter of 2021 as previously discussed.

Management currently believes that the provision for credit losses and the resulting allowance were adequate to provide for probable losses inherent in our loan portfolio at June 30, 2021.

The following tables present a summary of the activity in the allowance for credit losses at or for the three and six months ended June 30, 2021 and 2020.

For the Three Months Ended June 30,

The allowance for credit losses as a percentage of period-end loans was 1.04% at September 30, 2021 and 0.95% at December 31, 2020.

Excluding PPP loans, the ratio of the allowance for credit losses to period-end loans as 1.07% at September 30, 2021, higher than the 1.04% at December 31, 2020.

The increase in the percentage of the allowance to total loans at September 30, 2021, compared to December 31, 2020, was primarily due to significant loan growth in the second and third quarters of 2021 as previously discussed.

Management currently believes that the provision for credit losses and the resulting allowance were adequate to provide for probable losses inherent in our loan portfolio at September 30, 2021.

The following tables present a summary of the activity in the allowance for credit losses at or for the three and nine months ended September 30, 2021 and 2020.

For the Three Months Ended September 30,

Percentage of net

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Allowance for credit losses at period end as a percentage of period end nonaccrual loans

(1) At June 30, 2021, the loan balances used to calculate the ratio include PPP loans of $86.8 million.

(1) At September 30, 2021, the loan balances used to calculate the ratio include PPP loans of $41.5 million.

Excluding PPP loans, the ratio is 1.07%.

At June 30, 2020, the loan balances used to calculate the ratio included PPP loans of $122.9 million.

At September 30, 2020, the loan balances used to calculate the ratio included PPP loans of $126.7 million.

Excluding PPP loans, the ratio is 0.98%.

(2) At June 30, 2021, the quarter-to-date average loan balances used to calculate the ratio include PPP loans of $116.9 million.

(2) At September 30, 2021, the quarter-to-date average loan balances used to calculate the ratio include PPP loans of $63.9 million.

Excluding PPP loans, the ratio is 1.09%.

At June 30, 2020, the quarter-to-date average loan balances used to calculate the ratio included PPP loans of $90.2 million.

At September 30, 2020, the quarter-to-date average loan balances used to calculate the ratio included PPP loans of $125.7 million.

Excluding PPP loans, the ratio is 1.00%.

For the Six Months Ended June 30,

For the Nine Months Ended September 30,

Percentage of net

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Allowance for credit losses at period end as a percentage of period end nonaccrual loans

(1) At June 30, 2021, the loan balances used to calculate the ratio include PPP loans of $86.8 million.

(1) At September 30, 2021, the loan balances used to calculate the ratio include PPP loans of $41.5 million.

Excluding PPP loans, the ratio is 1.07%.

At June 30, 2020, the loan balances used to calculate the ratio included PPP loans of $122.9 million.

At September 30, 2020, the loan balances used to calculate the ratio included PPP loans of $126.7 million.

Excluding PPP loans, the ratio is 0.98%.

(2) At June 30, 2021, the year-to-date average loan balances used to calculate the ratio include PPP loans of $124.3 million.

(2) At September 30, 2021, the year-to-date average loan balances used to calculate the ratio include PPP loans of $103.9 million.

Excluding PPP loans, the ratio is 1.14%.

At June 30, 2020, the year-to-date average loan balances used to calculate the ratio included PPP loans of $45.1 million.

At September 30, 2020, the year-to-date average loan balances used to calculate the ratio included PPP loans of $72.2 million.

Excluding PPP loans, the ratio is 1.00%.

Nonperforming Assets and Accruing TDRs

As shown in the following table, nonperforming assets were $4.9 million and $6.3 million at June 30, 2021 and December 31, 2020, respectively.

As shown in the following table, nonperforming assets were $4.4 million and $6.3 million at September 30, 2021 and December 31, 2020, respectively.

The balance of nonperforming assets decreased primarily due to a decline in nonaccrual loans of $2.0 million, or 36.6%.

Accruing troubled debt restructurings (“TDRs”) decreased $659 thousand, or 9.4%, over the same time period.

Accruing troubled debt restructurings (“TDRs”) decreased $1.2 million, or 17.8%, over the same time period.

Other real estate owned properties increased to $203 thousand from $0 at December 31, 2020.

The ratio of nonaccrual loans and accruing TDRs to total loans decreased to 0.70% at June 30, 2021 from 0.86% at December 31, 2020.

The ratio of nonaccrual loans and accruing TDRs to total loans decreased to 0.62% at September 30, 2021 from 0.86% at December 31, 2020.

The Company continues to focus on the resolution of its nonperforming and problem assets.

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The reduction of nonperforming and problem assets is and will continue to be a high priority for the Company.

The following table summarizes our nonperforming assets and accruing TDRs at June 30, 2021 and December 31, 2020.

The following table summarizes our nonperforming assets and accruing TDRs at September 30, 2021 and December 31, 2020.

(Dollars in thousands)

June 30, 2021

September 30, 2021

December 31, 2020

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They represent securities which may be sold as part of the asset/liability management strategy or in response to changing interest rates.

Net unrealized holding gains and losses on these securities are reported net of related income taxes as accumulated other comprehensive income (loss), a separate component of stockholders’ equity.

Net unrealized holding gains and losses on these securities are reported net of related income taxes as accumulated other comprehensive income, a separate component of stockholders’ equity.

Investment securities in the held to maturity category are stated at cost adjusted for amortization of premiums and accretion of discounts.

We have the intent and current ability to hold such securities until maturity.

At June 30, 2021, 36.5% of the portfolio of debt securities was classified as available for sale and 63.5% was classified as held to maturity, compared to 68.0% and 32.0% respectively, at December 31, 2020.

At September 30, 2021, 29.8% of the portfolio of debt securities was classified as available for sale and 70.2% was classified as held to maturity, compared to 68.0% and 32.0% respectively, at December 31, 2020.

See Note 3 – “Investment Securities”, in the Notes to Consolidated Financial Statements for additional details on the composition of our investment portfolio.

Investment securities including restricted stock totaled $317.4 million at June 30, 2021, a $107.1 million, or 50.9%, increase since December 31, 2020.

The increase was primarily due to the purchases of held to maturity securities of $136.4 million, partially offset by proceeds from maturities and sales of available for sale securities of $23.9 million, during 2021.

Investment securities including restricted stock totaled $360.2 million at September 30, 2021, a $149.9 million, or 71.3%, increase since December 31, 2020.

The increase was primarily due to the purchases of held to maturity securities of $214.2 million, partially offset by proceeds from maturities and sales of available for sale securities and held to maturity securities of $32.0 million and $29.0 million, respectively, during 2021.

Due to the excess liquidity experienced in 2020 and 2021, the Company strategically purchased short duration held to maturity securities and subordinated debt of other banks which earn significantly higher average yields than interest-bearing deposits with other banks.

As loan demand begins to strengthen, the Company will redeploy proceeds from maturities and paydowns, as well as excess liquidity to fund loan growth.

At June 30, 2021, 84.2% of the securities available for sale were mortgage-backed and 15.8% were U.S.

At September 30, 2021, 82.9% of the securities available for sale were mortgage-backed and 17.1% were U.S.

Government agencies, compared to 83.1% and 16.9%, respectively, at year-end 2020.

At June 30, 2021, 58.4% of the securities held to maturity were mortgage-backed, 31.7% were U.S.

At September 30, 2021, 67.6% of the securities held to maturity were mortgage-backed, 27.1% were U.S.

Government agencies and 5.3% were other debt securities, compared to 41.5%, 28.7% and 29.2%, respectively, at year-end 2020.

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Government agencies or government-sponsored agencies.

Total deposits at June 30, 2021 amounted to $1.88 billion, an increase of $179.9 million, or 10.6%, when compared to the level at December 31, 2020.

Total deposits at September 30, 2021 amounted to $2.02 billion, an increase of $317.4 million, or 18.7%, when compared to the level at December 31, 2020.

The increase in total deposits consisted of increases in the following categories:

Savings and money market accounts of $150.6 million, noninterest-bearing deposits of $28.9 million and other time deposits of $2.7 million, partially offset by a decrease in checking accounts of $2.3 million.

Savings and money market accounts of $193.1 million, checking accounts of $69.6 million, noninterest-bearing deposits of $45.8 million and other time deposits of $8.9 million.

The significant movement within deposit accounts continues to be impacted by direct government stimulus payments to our customers and new account openings.

Short-Term Borrowings

Short-term borrowings consisted of securities sold under agreements to repurchase, which increased by $1.9 million, or 176.9%, to $2.9 million at June 30, 2021 when compared to December 31, 2020.

Short-term borrowings consisted of securities sold under agreements to repurchase, which increased by $2.5 million, or 233.4%, to $3.5 million at September 30, 2021 when compared to December 31, 2020.

Securities sold under agreements to repurchase are issued in conjunction with cash management services for commercial depositors.

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Short-term advances are defined as those with original maturities of one year or less.

At June 30, 2021 and December 31, 2020, the Company had no outstanding short-term or long-term advances with FHLB.

At September 30, 2021 and December 31, 2020, the Company had no outstanding short-term or long-term advances with FHLB.

Long-Term Debt

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We derive liquidity through increased customer deposits, non-reinvestment of the cash flow from the investment portfolio, loan repayments, borrowings and income from earning assets.

As seen in the Consolidated Statements of Cash Flows in the Financial Statements, the net increase in cash and cash equivalents was $50.3 million for the first six months of 2021 compared to an increase of $31.3 million for the first six months of 2020.

As seen in the Consolidated Statements of Cash Flows in the Financial Statements, the net increase in cash and cash equivalents was $123.9 million for the first nine months of 2021 compared to an increase of $61.5 million for the first nine months of 2020.

The increase in cash and cash equivalents in 2021 was mainly due to the significant increase in deposits, the direct result of new account openings, government stimulus and significant increases in municipal accounts.

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The Bank is also a member of the FHLB, which provides another source of liquidity.

Through the FHLB, the Bank had collateral pledged of approximately $298.9 million and $316.7 million at June 30, 2021 and December 31, 2020, respectively.

Through the FHLB, the Bank had collateral pledged of approximately $299.2 million and $316.7 million at September 30, 2021 and December 31, 2020, respectively.

The Bank has pledged, under a blanket lien, all qualifying residential and commercial real estate loans under borrowing agreements with the FHLB.

Total stockholders’ equity increased $3.7 million to $198.7 million at June 30, 2021 when compared to December 31, 2020 primarily due to the current year’s retained earnings, partially offset by dividends paid during the first six months of 2021 and the change in fair value of available-for-sale securities recorded in accumulated other comprehensive income.

Total stockholders’ equity increased $6.6 million to $201.6 million, or 3.4%, at September 30, 2021 when compared to December 31, 2020 primarily due to the current year’s retained earnings, partially offset by dividends paid during the first nine months of 2021 and the change in fair value of available-for-sale securities recorded in accumulated other comprehensive income.

On September 17, 2019, the FDIC finalized a rule that introduces an optional simplified measure of capital adequacy for qualifying community banking organizations (i.e., the community bank leverage ratio (“CBLR”) framework), as required by the Economic Growth, Regulatory Relief and Consumer Protection Act.

The CBLR framework is designed to reduce burden by removing the requirements for calculating and reporting risk-based capital ratios for qualifying community banking organizations that opt into the framework.

The CBLR framework is designed

to reduce burden by removing the requirements for calculating and reporting risk-based capital ratios for qualifying community banking organizations that opt into the framework.

On April 6, 2020, in a joint statement, the FDIC, Federal Reserve and the Office of Comptroller of the Currency (“OCC”), issued two interim final rules regarding temporary changes to the CBLR framework to implement provisions of the CARES Act.

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The phase-in period for the final rules became effective for the Bank on January 1, 2015, with full compliance with all of the final rules’ requirements phased in over a multi-year schedule, which was fully phased in on January 1, 2019.

As of June 30, 2021, the Bank’s capital levels remained characterized as “well-capitalized” under the rules.

The following tables present the applicable capital ratios as of June 30, 2021 and December 31, 2020.

As of September 30, 2021, the Bank’s capital levels remained characterized as “well-capitalized” under the rules.

The following tables present the applicable capital ratios as of September 30, 2021 and December 31, 2020.

Common Equity

June 30, 2021

September 30, 2021

capital ratio

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Compared sentence by sentence after normalising whitespace, quotation marks, case and digits, so re-formatting and restated figures do not read as changed language. Wording changes appear as one removal and one addition. The current filing and the prior one are authoritative.

What changed 10-Q

Item 2. Management’s Discussion and Analysis