Stock Yards Bancorp, Inc. 10-Q

sybt20200630_10q.htm     Table of Contents   UNITED STATES   SECURITIES AND EXCHANGE COMMISSION   Washington, D.C. 20549     FORM  10-Q    ☒ Quarterly report pursuant to Section 13 or 15(d) of the Securities Exchange Act of 1934    For the quarterly period ended June 30 , 2020    or      ☐ Transition report pursuant to Section 13 or 15(d) of the Securities Exchange Act of 1934    Commission File Number: 1 - 13661       STOCK YARDS BANCORP, INC.   (Exact name of registrant as specified in its charter)    Kentucky   61-1137529 (State or other jurisdiction of incorporation or organization)   (I.R.S. Employer Identification No.)     1040 East Main Street , Louisville , Kentucky   40206 (Address of principal executive offices)   (Zip Code)    Registrant’s telephone number, including area code: ( 502 ) 582-2571    Securities registered pursuant to Section 12(b) of the Act:  Title of each class Trading symbol(s) Name of each exchange on which registered Common stock, no par value SYBT The NASDAQ Stock Market, LLC   Indicate by check mark whether the registrant (1) has filed all reports required to be filed by Section 13 or 15(d) of the Securities Exchange Act of 1934 during the preceding 12 months (or for such shorter period that the registrant was required to file such reports), and (2) has been subject to such filing requirements for the past 90 days.  ☒  Yes    ☐ No    Indicate by check mark whether the registrant has submitted electronically every Interactive Data File required to be submitted pursuant to Rule 405 of Regulation S-T (§232.405 of this chapter) during the preceding 12 months (or for such shorter period that the registrant was required to submit such files).  ☒  Yes   ☐ No    Indicate by check mark whether the registrant is a large accelerated filer, an accelerated filer, a non-accelerated filer, a smaller reporting company, or an emerging growth company. See the definitions of “large accelerated filer,” “accelerated filer,” “smaller reporting company,” and “emerging growth company” in Rule 12b-2 of the Exchange Act.               Large accelerated filer  ☒    Accelerated filer ☐   Non-accelerated filer ☐   Smaller reporting company  ☐   Emerging growth company  ☐                If an emerging growth company, indicate by check mark if the registrant has elected not to use the extended transition period for complying with any new or revised financial accounting standards provided pursuant to Section 13(a) of the Exchange Act. ☐    Indicate by check mark whether the registrant is a shell company (as defined in Rule 12b-2 of the Exchange Act).  ☐  Yes  ☒ No   The number of shares outstanding of the registrant’s Common Stock, no par value, as of July 31, 2020, was 22,681,848 .     1 Table of Contents     TABLE OF CONTENTS   Part I – Financial Information         Item 1. Financial Statements. 4         Consolidated Balance Sheets 4         Consolidated Statements of Income 5         Consolidated Statements of Comprehensive Income 6         Consolidated Statements of Changes in Stockholders’ Equity 7         Consolidated Statements of Cash Flows 9         Footnotes to Consolidated Financial Statements 11       Item 2. Management’s Discussion and Analysis of Financial Condition and Results of Operations. 58     Item 3. Quantitative and Qualitative Disclosures about Market Risk. 94     Item 4. Controls and Procedures. 94         Part II – Other Information 94     Item 1. Legal Proceedings. 94     Item1A. Risk Factors. 94     Item 2. Unregistered Sales of Equity Securities and Use of Proceeds. 96     Item 6. Exhibits. 96         S ignatures 97   2 Table of Contents     GLOSSARY OF ABBREVIATIONS AND ACRONYMS   The acronyms and abbreviations identified in alphabetical order below are used throughout this Report on Form 10-Q:   Acronym or Term     Definition     Acronym or Term     Definition     Acronym or Term     Definition ACH   Automatic Clearing House   ETR   Effective Tax Rate   NIM   Net Interest Margin (FTE) AFS   Available for Sale   EVP    Executive Vice President   NPV   Net Present Value APIC   Additional paid-in capital   FASB   Financial Accounting Standards Board   Net Interest Spread   Net Interest Spread (FTE) ACL   Allowance for Credit Losses   FDIC   Federal Deposit Insurance Corporation   NM   Not Meaningful AOCI   Accumulated Other Comprehensive Income   FFP   Federal Funds Purchased   OAEM   Other Assets Especially Mentioned ASC   Accounting Standards Codification   FFS   Federal Funds Sold   OCI   Other Comprehensive Income ASU   Accounting Standards Update   FFTR   Federal Funds Target Rate   OREO   Other Real Estate Owned ATM   Automated Teller Machine   FHA   Federal Housing Authority   PPP   Paycheck Protection Program AUM   Assets Under Management   FHC   Financial Holding Company   PV   Present Value Bancorp / the Company   Stock Yards Bancorp, Inc.    FHLB   Federal Home Loan Bank of Cincinnati   PCD   Purchased with Credit Deteriorated Bank / SYB   Stock Yards Bank & Trust Company    FHLMC   Federal Home Loan Mortgage Corporation    PCI   Purchased Credit Impaired BOLI   Bank Owned Life Insurance   FICA   Federal Insurance Contributions Act   Prime   The  Wall Street Journal Prime Interest Rate BP   Basis Point - 1/100th of one percent   FNMA   Federal National Mortgage Association   Provision   Provision for Credit Losses C&D   Construction and Development   FRB   Federal Reserve Bank   PSU   Performance Stock Unit CARES Act   Coronavirus Aid, Relief and Economic Security Act   FTE   Fully Tax Equivalent   ROA   Return on Average Assets C&I   Commercial and Industrial   GAAP   United States Generally Accepted Accounting Principles   ROE   Return on Average Equity CD   Certificate of Deposit   GLB Act   Gramm-Leach-Bliley Act   RSA   Restricted Stock Award CDI   Core Deposit Intangible   GNMA   Government National Mortgage Association   RSU   Restricted Stock Unit CECL   Current Expected Credit Loss (ASC-326)   HB   House Bill   SAB   Staff Accounting Bulletin CEO   Chief Executive Officer   HELOC   Home Equity Line of Credit   SAR   Stock Appreciation Right CFO   Chief Financial Officer   ITM   Interactive Teller Machine   SEC   Securities and Exchange Commission COVID-19   Coronavirus Disease - 2019   KBST   King Bancorp Statutory Trust I   SSUAR   Securities Sold Under Agreements to Repurchase CRA   Community Reinvestment Act   KSB   King Bancorp, Inc. and King Southern Bank   SBA   Small Business Administration CRE   Commercial Real Estate   LIBOR   London Interbank Offered Rate   TCE   Tangible Common Equity Dodd-Frank Act   The Dodd-Frank Wall Street Reform and Consumer Protection Act   Loans   Loans and Leases   TDR   Troubled Debt Restructuring DTA   Deferred Tax Asset   MBS   Mortgage Backed Securities   TPS   Trust Preferred Securities DTL   Deferred Tax Liability   MSA   Metropolitan Statistical Area   VA   U.S. Department of Veterans Affairs DCF   Discounted Cash Flow   MSRs   Mortgage Servicing Rights   WM&T   Wealth Management and Trust EPS   Earnings Per Share   NASDAQ   The NASDAQ Stock Market, LLC           3 Table of Contents     PART I – FINANCIAL INFORMATION   Item 1. Financial Statements   CONSOLIDATED BALANCE SHEETS   June 30, 2020 (unaudited) and December 31, 2019 (in thousands, except per share data)       June 30,     December 31,       2020     2019   Assets                 Cash and due from banks   $ 46,362     $ 46,863   Federal funds sold and interest bearing due from banks     178,032       202,861   Total cash and cash equivalents     224,394       249,724                     Mortgage loans held for sale     17,364       8,748   Available for sale debt securities (amortized cost of $ 472,797 in 2020 and $ 469,313 in 2019, respectively     485,249       470,738   Federal Home Loan Bank stock, at cost     11,284       11,284   Loans     3,464,077       2,845,016   Allowance for credit losses     47,708       26,791   Net loans     3,416,369       2,818,225                     Premises and equipment, net     56,832       58,618   Bank owned life insurance     32,912       32,557   Accrued interest receivable     13,535       8,534   Goodwill     12,513       12,513   Core deposit intangible     2,122       2,285   Other assets     61,959       50,971   Total assets   $ 4,334,533     $ 3,724,197                     Liabilities                 Deposits:                 Non-interest bearing   $ 1,205,253     $ 810,475   Interest bearing     2,521,903       2,323,463   Total deposits     3,727,156       3,133,938                     Securities sold under agreements to repurchase     42,722       31,895   Federal funds purchased     8,401       10,887   Federal Home Loan Bank advances     61,432       79,953   Accrued interest payable     471       640   Other liabilities     74,120       60,587   Total liabilities     3,914,302       3,317,900                     Commitments and contingent liabilities (Footnote 10)     —       —                     Stockholders’ equity                 Preferred stock, no par value. Authorized 1,000,000 shares; no shares issued or outstanding     —       —   Common stock, no par value. Authorized 40,000,000 shares; issued and outstanding 22,667,000 and 22,604,000 shares in 2020 and 2019, respectively     36,415       36,207   Additional paid-in capital     39,425       35,714   Retained earnings     335,575       333,699   Accumulated other comprehensive income     8,816       677   Total stockholders’ equity     420,231       406,297   Total liabilities and stockholders’ equity   $ 4,334,533     $ 3,724,197     See accompanying notes to unaudited consolidated financial statements.   4 Table of Contents     CONSOLIDATED STATEMENTS OF INCOME (unaudited) For the three and six months ended June 30 , 2020 and 2019 (in thousands, except per share data)       Three months ended     Six months ended       June 30,     June 30,       2020     2019     2020     2019   Interest income:                                 Loans, including fees   $ 34,099     $ 33,447     $ 67,848     $ 65,018   Federal funds sold and interest bearing due from banks     88       830       619       1,563   Mortgage loans held for sale     125       43       186       80   Securities available for sale:                                 Taxable     2,136       2,546       4,602       5,114   Tax-exempt     58       130       133       277   Total interest income     36,506       36,996       73,388       72,052   Interest expense:                                 Deposits     2,607       5,652       6,569       10,718   Securities sold under agreements to repurchase     8       28       24       53   Federal funds purchased and other short-term borrowing     2       64       31       124   Federal Home Loan Bank advances     361       424       790       645   Subordinated debentures     —       26       —       26   Total interest expense     2,978       6,194       7,414       11,566   Net interest income     33,528       30,802       65,974       60,486   Provision for credit losses     5,550       —       11,100       600   Net interest income after provision     27,978       30,802       54,874       59,886   Non-interest income:                                 Wealth management and trust services     5,726       5,662       11,944       11,101   Deposit service charges     800       1,260       2,083       2,438   Debit and credit card income     2,063       2,168       4,043       3,912   Treasury management fees     1,249       1,202       2,533       2,359   Mortgage banking income     1,622       760       2,468       1,210   Net investment product sales commissions and fees     391       364       857       720   Bank owned life insurance     176       184       355       362   Other     595       624       875       1,130   Total non-interest income     12,622       12,224       25,158       23,232   Non-interest expenses:                                 Compensation     11,763       12,715       23,996       24,516   Employee benefits     2,871       2,807       6,038       5,362   Net occupancy and equipment     2,089       1,967       3,970       3,816   Technology and communication     1,947       1,848       3,960       3,621   Debit and credit card processing     603       631       1,259       1,218   Marketing and business development     465       903       1,025       1,528   Postage, printing and supplies     442       410       883       816   Legal and professional     628       1,523       1,251       2,057   FDIC insurance     330       248       459       486   Amortization of investments in tax credit partnerships     53       52       89       104   Capital and deposit based taxes     1,225       967       2,255       1,871   Credit loss expense for off-balance sheet exposures     1,475       -       1,850       -   Other     993       1,382       1,799       2,670   Total non-interest expenses     24,884       25,453       48,834       48,065   Income before income tax expense     15,716       17,573       31,198       35,053   Income tax expense     2,348       1,030       4,598       2,869   Net income   $ 13,368     $ 16,543     $ 26,600     $ 32,184   Net income per share, basic   $ 0.59     $ 0.73     $ 1.18     $ 1.42   Net income per share, diluted   $ 0.59     $ 0.72     $ 1.17     $ 1.40   Weighted average outstanding shares:                                 Basic     22,560       22,689       22,538       22,675   Diluted     22,739       22,949       22,737       22,948     See accompanying notes to unaudited consolidated financial statements.   5 Table of Contents     CONSOLIDATED STATEMENTS OF COMPREHENSIVE INCOME (unaudited) For the three and six months ended June 30 , 2020 and 2019 (in thousands)       Three months ended     Six months ended       June 30,     June 30,       2020     2019     2020     2019   Net income   $ 13,368     $ 16,543     $ 26,600     $ 32,184   Other comprehensive income:                                 Change in unrealized gain on AFS debt securities     3,086       5,021       11,027       8,446   Change in fair value of derivatives used in cash flow hedge     28       ( 321 )     ( 318 )     ( 530 ) Total other comprehensive income, before income tax expense     3,114       4,700       10,709       7,916   Tax effect     750       1,121       2,570       1,708   Total other comprehensive income, net of tax     2,364       3,579       8,139       6,208   Comprehensive income   $ 15,732     $ 20,122     $ 34,739     $ 38,392     See accompanying notes to unaudited consolidated financial statements.   6 Table of Contents     CONSOLIDATED STATEMENTS OF CHANGES IN STOCKHOLDERS’ EQUITY (unaudited) For the three and six mo nths ended June 30 , 2020 a nd 2019 (in thousands, except per share data)                                       Accumulated               Common stock     Additional             other     Total       Shares             paid-in     Retained     comprehensive     stockholders'       outstanding     Amount     capital     earnings     income (loss)     equity                                                     Balance, January 1, 2019     22,749     $ 36,689     $ 36,797     $ 298,156     $ ( 5,142 )   $ 366,500                                                     Activity for three months ended March 31, 2019:                                                 Net income     —       —       —       15,641       —       15,641   Other comprehensive income     —       —       —       —       2,629       2,629   Stock compensation expense     —       —       863       —       —       863   Stock issued for share-based awards, net of withholdings to satisfy employee tax obligations     74       245       2,254       ( 4,452 )     —       ( 1,953 ) Cash dividends declared, $ 0.25 per share     —       —       —       ( 5,686 )     —       ( 5,686 )                                                   Balance, March 31, 2019     22,823     $ 36,934     $ 39,914     $ 303,659     $ ( 2,513 )   $ 377,994                                                                                                       Activity for three months ended June 30, 2019:                                                                                                   Net income     —       —       —       16,543       —       16,543   Other comprehensive income     —       —       —       —       3,579       3,579   Stock compensation expense     —       —       993       —       —       993   Common stock repurchased     ( 107 )     ( 357 )     ( 3,308 )     —       —       ( 3,665 ) Stock issued for share-based awards, net of withholdings to satisfy employee tax obligations     5       19       182       ( 363 )     —       ( 162 ) Cash dividends declared, $ 0.26 per share     —       —       —       ( 5,917 )     —       ( 5,917 ) Shares cancelled     —       —       ( 5 )     5       —       —                                                     Balance, June 30, 2019     22,721     $ 36,596     $ 37,776     $ 313,927     $ 1,066     $ 389,365     See accompanying notes to unaudited consolidated financial statements.   7 Table of Contents   CONSOLIDATED STATEMENTS OF CHANGES IN STOCKHOLDERS’ EQUITY (unaudited) For the three and six mo nths ended June 30 , 2020 a nd 2019 (in thousands, except per share data)                                       Accumulated               Common stock     Additional             other     Total       Shares             paid-in     Retained     comprehensive     stockholders'       outstanding     Amount     capital     earnings     income     Total                                                     Balance, January 1, 2020     22,604     $ 36,207     $ 35,714     $ 333,699     $ 677     $ 406,297                                                     Activity for three months ended March 31, 2020:                                                 Impact of adoption of ASC 326     —       —       —       ( 8,823 )     —       ( 8,823 ) Net income     —       —       —       13,232       —       13,232   Other comprehensive income     —       —       —       —       5,775       5,775   Stock compensation expense     —       —       817       —       —       817   Stock issued for share-based awards, net of withholdings to satisfy employee tax obligations     62       203       1,858       ( 3,546 )     —       ( 1,485 ) Cash dividends declared, $ 0.27 per share     —       —       —       ( 6,111 )     —       ( 6,111 ) Shares cancelled     ( 1 )     ( 2 )     ( 22 )     24       —       —                                                     Balance, March 31, 2020     22,665     $ 36,408     $ 38,367     $ 328,475     $ 6,452     $ 409,702                                                     Activity for three months ended June 30, 2020:                                                 Net income     —       —       —       13,368       —       13,368   Other comprehensive income     —       —       —       —       2,364       2,364   Stock compensation expense     —       —       976       —       —       976   Stock issued for share-based awards, net of withholdings to satisfy employee tax obligations     2       8       96       ( 163 )     —       ( 59 ) Cash dividends declared, $ 0.27 per share     —       —       —       ( 6,120 )     —       ( 6,120 ) Shares cancelled     —       ( 1 )     ( 14 )     15       —       —   Balance, June 30, 2020     22,667     $ 36,415     $ 39,425     $ 335,575     $ 8,816     $ 420,231     See accompanying notes to unaudited consolidated financial statements.   8 Table of Contents     CONSOLIDATED STATEMENTS OF CASH FLOWS (unaudited) For the six months ended June 30 , 2020 and 2019 (in thousands)       2020     2019   Operating activities:                 Net income   $ 26,600     $ 32,184   Adjustments to reconcile net income to net cash provided by operating activities:                 Provision for credit losses     11,100       600   Depreciation, amortization and accretion, net     2,815       1,679   Deferred income tax benefit     ( 1,947 )     ( 3,959 ) Gain on sales of mortgage loans held for sale     ( 2,593 )     ( 719 ) Origination of mortgage loans held for sale     ( 103,509 )     ( 38,081 ) Proceeds from sale of mortgage loans held for sale     97,486       36,553   Bank owned life insurance income     ( 355 )     ( 362 ) (Gain)/loss on the disposal of premises and equipment     ( 209 )     6   Gain on the sale of other real estate owned     —       ( 63 ) Stock compensation expense     1,793       1,856   Excess tax (benefit) expense from share-based compensation arrangements     3       ( 392 ) Net change in accrued interest receivable and other assets     ( 14,245 )     ( 3,429 ) Net change in accrued interest payable and other liabilities     11,741       ( 3,974 ) Net cash provided by operating activities     28,680       21,899   Investing activities:                 Purchases of available for sale debt securities     ( 192,713 )     ( 373,761 ) Proceeds from sales of acquired available for sale debt securities     —       12,427   Proceeds from maturities and paydowns of available for sale debt securities     189,047       396,367   Proceeds from redemption of Federal Home Loan Bank stock     —       591   Proceeds from redemption of Federal Reserve Bank stock     —       490   Proceeds from redemption of interest bearing due from banks     —       1,761   Net change in traditional loans     12,616       ( 49,280 ) Net change in PPP loans     ( 630,082 )     —   Purchases of premises and equipment     ( 2,526 )     ( 3,321 ) Proceeds from disposal of premises and equipment     1,222       45   Proceeds from surrender of acquired bank owned life insurance     —       3,431   Proceeds from bank owned life insurance mortality benefit     —       909   Other investment activities     ( 646 )     ( 1,532 ) Proceeds from sales of other real estate owned     —       868   Cash for acquisition, net of cash acquired     —       ( 24,684 ) Net cash used in investing activities     ( 623,082 )     ( 35,689 ) Financing activities:                 Net change in deposits     593,179       ( 36,464 ) Net change in securities sold under agreements to repurchase and federal funds purchased     8,341       ( 2,086 ) Proceeds from Federal Home Loan Bank advances     60,000       60,000   Repayments of Federal Home Loan Bank advances     ( 78,629 )     ( 67,250 ) Repayment of acquired bank holding company line of credit     —       ( 2,300 ) Redemption of acquired bank subordinated debentures     —       ( 3,609 ) Repurchase of common stock     —       ( 3,665 ) Share repurchases related to compensation plans     ( 1,544 )     ( 2,115 ) Cash dividends paid     ( 12,275 )     ( 11,621 ) Net cash provided by (used in) financing activities     569,072       ( 69,110 ) Net change in cash and cash equivalents     ( 25,330 )     ( 82,900 ) Cash and cash equivalents at beginning of period     249,724       198,939   Cash and cash equivalents at end of period   $ 224,394     $ 116,039     (continued)   9 Table of Contents   CONSOLIDATED STATEMENTS OF CASH FLOWS (unaudited) (continued) For the six months ended June 30 , 2020 and 2019 (in thousands)       2020     2019   Supplemental cash flow information:                 Interest paid   $ 7,583     $ 5,382   Income taxes paid, net of refunds     418       11,320   Cash paid for operating lease liabilities     790       694   Supplemental non-cash activity:                 Unfunded commitments in tax credit investments   $ 5,503     $ 3,477   Initial recognition of right-of-use lease assets     —       16,747   Initial recognition operating lease liabilities     —       18,067   Loans transferred to OREO     —       —                     Liabilities assumed in conjunction with acquisition                 Fair value of assets acquired   $ —     $ 204,613   Cash paid in acquisition     —       28,000   Liabilities assumed   $ —     $ 176,613     See accompanying notes to unaudited consolidated financial statements.   10 Table of Contents   N OTES TO CONSOLIDATED FINANCIAL STATEMENTS (Unaudited)     ( 1 ) Basis of Presentation and Summary of Significant Accounting Policies   Nature of Operations – Stock Yards Bancorp, Inc. (“Bancorp” or “the Company”) is a FHC headquartered in Louisville, Kentucky. The accompanying consolidated financial statements include the accounts of its wholly owned subsidiary, SYB (“the Bank). Established in 1904, SYB is a state-chartered non-member financial institution that provides services in the Louisville, Kentucky, Indianapolis, Indiana and Cincinnati, Ohio MSAs through 42 full service banking center locations.   As a result of its acquisition on May 1, 2019, Bancorp became the 100 % successor owner of KBST, an unconsolidated finance subsidiary. As permitted under the terms of the governing documents, Bancorp redeemed the TPS at the par amount of approximately $ 4 million in June 2019.   Bancorp is divided into two reportable segments: Commercial Banking and WM&T:   Commercial Banking provides a full range of loan and deposit products to individual consumers and businesses in all its markets through retail lending, mortgage banking, deposit services, online banking, mobile banking, private banking, commercial lending, treasury management services, merchant services, international banking, correspondent banking and other banking services. The Bank also offers securities brokerage services via its banking center network through an arrangement with a third party broker-dealer in the Commercial Banking segment.    WM&T provides custom-tailored financial planning, investment management, company retirement plan management, retirement planning, trust and estate services in all markets in which Bancorp operates. The magnitude of WM&T revenue distinguishes Bancorp from other community banks of similar asset size.   Principles of Consolidation and Basis of Presentation – The accompanying unaudited condensed consolidated financial statements have been prepared in accordance with GAAP for interim financial information and with the instructions to Form 10 -Q and Rule 10 - 01 of Regulation S- X. Accordingly, the financial statements do not include all the information and footnotes required by GAAP for complete financial statements.   In the opinion of management, all adjustments (consisting of normal recurring accruals) considered necessary for fair presentation have been included. Intercompany transactions have been eliminated. These condensed consolidated financial statements should be read in conjunction with Bancorp’s Annual Report on Form 10 -K for the year ended December 31, 2019. Operating results for the three and six month periods ended June 30, 2020 are not necessarily indicative of the results that may be expected for the year ending December  31, 2020.   Critical Accounting Policies and Estimates – Certain accounting estimates are important to the portrayal of Bancorp’s financial condition, since they require management to make difficult, complex or subjective judgments, some of which may relate to matters that are inherently uncertain. Estimates are susceptible to material changes as a result of changes in facts and circumstances. Facts and circumstances which could affect these judgments include, but are not limited to, changes in interest rates, changes in the performance of the economy, including pandemic-related changes, and changes in the financial condition of borrowers.   Bancorp’s accounting policies are fundamental to understanding management’s discussion and analysis of our results of operations and financial condition. At December 31, 2019, the significant accounting policy considered the most critical in preparing Bancorp’s consolidated financial statements is the determination of the ACL on loans. See the section titled “ Critical Accounting Policies and Estimates ” in Bancorp’s 2019 Annual Report on Form  10 -K for additional detail.   On January 1, 2020, Bancorp adopted ASC 326 “ Financial Instruments – Credit Losses , ” which created material changes to Bancorp’s existing critical accounting policy that existed at December 31, 2019. Effective January 1, 2020 through June 30, 2020, the significant accounting policy considered the most critical in preparing Bancorp’s consolidated financial statements is the determination of the ACL on loans.   The ACL on loans is established through credit loss expense charged to current earnings. The amount maintained in the ACL reflects management’s estimate of the net amount not expected to be collected on the loan portfolio at the balance sheet date. The ACL is comprised of specific reserves assigned to certain loans that do not share general risk characteristics and general reserves on pools of loans that do share general risk characteristics. Factors contributing to the determination of specific reserves include the creditworthiness of the borrower and more specifically, changes in the expected future receipt of principal and interest payments and/or in the value of pledged collateral. A reserve is recorded when the carrying amount of the loan exceeds the discounted estimated cash flows using the loan’s initial effective interest rate or the fair value of the collateral for certain collateral-dependent loans. For purposes of establishing the general reserve, Bancorp stratifies the loan portfolio into homogeneous groups of loans that possess similar loss potential characteristics and calculates the net amount expected to be collected over the life of the loans to estimate the credit losses in the loan portfolio. Bancorp’s methodologies for estimating the ACL on loans consider available relevant information about the collectability of cash flows, including information about past events, current conditions, and reasonable and supportable forecasts.   11 Table of Contents   Significant Accounting Policies – In preparing the unaudited consolidated financial statements, management is required to make estimates and assumptions that affect the reported amounts of certain assets and liabilities and disclosure of contingent assets and liabilities at the date of the financial statements and the reported amounts of related revenues and expenses during the reporting period. Actual results could differ from those estimates. A description of significant accounting policies is presented in Bancorp’s Annual Report on Form 10 -K for the year ended December 31, 2019.   Debt Securities – Bancorp determines the classification of debt securities at the time of purchase. Debt securities that management has the positive intent and ability to hold to maturity are classified as held to maturity and recorded at amortized cost. Debt securities not classified as held to maturity are classified as AFS and recorded at fair value, with unrealized gains and losses excluded from earnings and reported in AOCI, net of tax. All debt securities were classified as AFS at June 30, 2020 and December 31, 2019.   Gains and losses on the sale of securities are recorded on the trade date and are determined using the specific-identification method. Amortization of premiums and discounts are recognized in interest income over the period to maturity using the interest method, except for premiums on callable debt securities, which are amortized to their earliest call date.   Bancorp has made a policy election to exclude accrued interest from the amortized cost basis of debt securities and reports accrued interest separately in the consolidated balance sheets. A debt security is placed on non-accrual status at the time any principal or interest payments become more than 90 days delinquent or if full collection of interest or principal becomes uncertain. Accrued interest for a security placed on non-accrual is reversed against interest income. There was no accrued interest related to AFS debt securities reversed against interest income for the three and six -month periods ended June 30, 2020 and 2019.   ACL – AFS Debt Securities – For AFS debt securities in an unrealized loss position, Bancorp evaluates the securities to determine whether the decline in the fair value below the amortized cost basis (impairment) is due to credit-related factors or non-credit related factors. Any impairment that is not credit-related is recognized in AOCI, net of tax. Credit-related impairment is recognized as an a ACL on AFS debt securities on the balance sheet, limited to the amount by which the amortized cost basis exceeds the fair value, with a corresponding adjustment to earnings. Accrued interest receivable is excluded from the estimate of credit losses. Both the ACL and the adjustment to net income may be reversed if conditions change. However, if Bancorp intends to sell an impaired AFS debt security or more likely than not will be required to sell such a security before recovering its amortized cost basis, the entire impairment amount would be recognized in earnings with a corresponding adjustment to the security’s amortized cost basis. Because the security’s amortized cost basis is adjusted to fair value, there is no ACL in this situation.   In evaluating AFS debt securities in unrealized loss positions for impairment and the criteria regarding its intent or requirement to sell such securities, Bancorp considers the extent to which fair value is less than amortized cost, whether the securities are issued by the federal government or its agencies, whether downgrades by bond rating agencies have occurred, and the results of reviews of the issuers’ financial condition, among other factors. There were no credit related factors underlying unrealized losses on AFS debt securities at June 30, 2020 and December 31, 2019.   Changes in the ACL on AFS debt securities are recorded as expense. Losses are charged against the ACL when management believes the uncollectability of an AFS debt security is confirmed or when either of the criteria regarding intent or requirement to sell is met.   Loans – Loans that management has the intent and ability to hold for the foreseeable future or until maturity or payoff are reported at amortized cost basis, which is the unpaid principal balance outstanding, net of unearned income, deferred loan fees and costs, premiums and discounts associated with acquisition date fair value adjustments on acquired loans and any direct partial charge-offs. Bancorp has made a policy election to exclude accrued interest from the amortized cost basis of loans and report accrued interest separately from the related loan balance in the consolidated balance sheets.   Interest income is accrued on the unpaid principal balance. Loan origination fees, net of certain direct origination costs, are deferred and recognized in interest income over the remaining life of the loan without anticipating prepayments.   12 Table of Contents   Loans are considered past due or delinquent when the contractual principal and/or interest due in accordance with the terms of the loan agreement or any portion thereof remains unpaid after the due date of the scheduled payment. Loans are classified as non-accrual when, in the opinion of management, collection of principal or interest is doubtful. The accrual of interest income on loans is typically discontinued at the time the loan is 90 days delinquent unless the loan is well-secured and in process of collection, or if full collection of interest or principal becomes uncertain. Consumer loans are typically charged off no later than 120 days past due. All interest accrued but not received for a loan placed on non-accrual is reversed against interest income. Interest received on such loans is accounted for on the cash-basis or cost-recovery method, until qualifying for return to accrual. Under the cost-recovery method, interest income is not recognized until the loan balance is reduced to zero. Under the cash-basis method, interest income is recorded when the payment is received in cash. Loans are returned to accrual status when all the principal and interest amounts contractually due are brought current and future payments are reasonably assured.   Acquired loans are recorded at fair value at the date of acquisition based on a DCF methodology that considers various factors including the type of loan and related collateral, classification status, fixed or variable interest rate, term of loan and whether or not the loan was amortizing, and a discount rate reflecting Bancorp’s assessment of risk inherent in the cash flow estimates. Certain larger purchased loans are individually evaluated while certain purchased loans are grouped together according to similar risk characteristics and are treated in aggregate when applying various valuation techniques. These cash flow evaluations are inherently subjective, as they require material estimates, all of which may be susceptible to significant change.   Prior to January 1, 2020, loans acquired in a business combination that had evidence of deterioration of credit quality since origination and for which it was probable, at acquisition, that Bancorp would be unable to collect all contractually required payments receivable were considered PCI. PCI loans were individually evaluated and recorded at fair value at the date of acquisition with no initial ACL based on a DCF methodology that considered various factors including the type of loan and related collateral, classification status, fixed or variable interest rate, term of loan and whether or not the loan was amortizing, and a discount rate reflecting Bancorp’s assessment of risk inherent in the cash flow estimates. The difference between the DCFs expected at acquisition and the investment in the loan, or the “accretable yield,” was recognized as interest income on a level-yield method over the life of the loan. Contractually required payments for interest and principal that exceed the DCFs expected at acquisition, or the “non-accretable difference,” were not recognized on the balance sheet and did not result in any yield adjustments, loss accruals or valuation allowances. Increases in expected cash flows, including prepayments, subsequent to the initial investment were recognized prospectively through adjustment of the yield on the loan over its remaining life. Decreases in expected cash flows were recognized as impairment. ACLs on PCI loans reflected only losses incurred post-acquisition (meaning the PV of all cash flows expected at acquisition that ultimately were not to be received).   Subsequent to January 1, 2020, loans acquired in a business combination that have experienced more-than-insignificant deterioration in credit quality since origination are considered PCD loans. At the acquisition date, an estimate of expected credit losses is made for groups of PCD loans with similar risk characteristics and individual PCD loans without similar risk characteristics. This initial ACL is allocated to individual PCD loans and added to the purchase price or acquisition date fair values to establish the initial amortized cost basis of the PCD loans. As the initial ACL is added to the purchase price, there is no credit loss expense recognized upon acquisition of a PCD loan. Any difference between the unpaid principal balance of PCD loans and the amortized cost basis is considered to relate to non-credit factors and results in a discount or premium. Discounts and premiums are recognized through interest income on a level-yield method over the life of the loans. Approximately $ 1.6 million in PCI loans were converted to PCD on January 1, 2020.   For acquired loans not deemed PCD at acquisition, the differences between the initial fair value and the unpaid principal balance are recognized as interest income on a level-yield basis over the lives of the related loans. At the acquisition date, an initial ACL on loans is estimated and recorded as credit loss expense.   The subsequent measurement of expected credit losses for all acquired loans is the same as the subsequent measurement of expected credit losses for originated loans.   ACL – Loans – Under the current CECL model, the ACL on loans represents a valuation allowance estimated at each balance sheet date in accordance with GAAP that is deducted from the loans’ amortized cost basis to present the net amount expected to be collected on the loan portfolio.   Bancorp estimates the ACL on loans based on the underlying assets’ amortized cost basis, which is the amount at which the receivable is originated or acquired, adjusted for applicable accretion or amortization of premium, discount, and net deferred fees or costs, collection of payment, and charge-offs. In the event that collection of principal becomes uncertain, Bancorp has policies in place to reverse accrued interest in a timely manner. Therefore, Bancorp has made a policy election to exclude accrued interest from the measurement of ACL.   13 Table of Contents   Expected credit losses are reflected in the ACL through a charge to provision. When Bancorp deems all or a portion of a financial asset to be uncollectible, the appropriate amount is written-off and the ACL is reduced by the same amount. Bancorp applies judgment to determine when a financial asset is deemed uncollectible; however, generally speaking, an asset will be considered uncollectible no later than when all efforts at collection have been exhausted and the collateral, if any, has been liquidated. Subsequent recoveries, if any, are credited to the ACL when received.   Bancorp’s methodologies for estimating the ACL consider available relevant information about the collectability of cash flows, including information about past events, current conditions and reasonable and supportable forecasts. The methodologies apply historical loss information, adjusted for asset-specific characteristics, economic conditions at the measurement date, and forecasts about future economic conditions expected to exist through the contractual lives of the financial assets that are reasonable and supportable, to the identified pools of financial assets with similar risk characteristics for which the historical loss experience was observed. Bancorp’s methodologies may revert to historical loss information on a straight-line basis over a number quarters when it can no longer develop reasonable and supportable forecasts.   Loans are predominantly segmented by FDIC Call Report Codes into loan pools that have similar risk characteristics, similar collateral type and are assumed to pose consistent risk of loss to Bancorp. Bancorp has identified the following pools of financial assets with similar risk characteristics for measuring expected credit losses:   Commercial real e stat e – owner occupied – Includes non-farm non-residential real estate loans for a variety of commercial property types and purposes, and is typically secured by commercial office or industrial buildings, warehouses or retail buildings where the owner of the building occupies the property. The primary source of repayment is the cash flow from the ongoing operations and activities conducted by the party (or affiliate) who owns the property. Repayment terms vary considerably; interest rates are fixed or variable and are structured for full, partial, or no amortization of principal.   Commercial real e stat e – non-owner occupied – Includes investment real estate loans secured by similar collateral as above. The primary source of income for this loan type is typically rental income associated with the property. These loans generally involve a greater degree of credit risk, as these borrowers are more sensitive to adverse economic conditions. This category also includes apartment or multifamily residential buildings (secured by five or more dwelling units).   Construction and land development — Consists of loans to finance the ground up construction, improvement and/or carrying for sale after the completion of construction of owner occupied and non-owner occupied residential and commercial properties and loans secured by raw or improved land. The repayment of C&D loans is generally dependent upon the successful completion of the improvements by the builder for the end user, the leasing of the property, or sale of the property to a third party. Repayment of land secured loans are dependent upon the successful development and sale of the property, the sale of the land as is, or the outside cash flow of the owners to support the retirement of the debt. Bancorp’s construction loans may convert to real estate-secured once construction is completed or principal amortization payments begin, assuming the borrower retains financing with the Bank.   Commercial and Industrial — Represents loans for C&I purposes to sole proprietorships, partnerships, corporations and other business enterprises, where secured (other than those that meet the definition of a “loan secured by real estate”) or unsecured, single payment or installment. This category includes loans originated for financing capital expenditures, non-real estate loans guaranteed by the SBA and non-real estate related construction loans in addition to loans secured by accounts receivable, inventory and other business assets such as equipment. Bancorp originates these loans for a variety of purposes across a various industries. This category also includes loans to commercial banks in the U.S. This portfolio has been segregated between term loans and revolving lines of credits based on the varied characteristics of these individual loan structures.   Residential real estate — Includes non-revolving (closed-end) first and junior liens secured by residential real estate primarily in Bancorp’s market areas. This portfolio has been segregated between owner occupied and non-owner occupied status, as the investment nature of the latter poses additional credit risks to Bancorp.   14 Table of Contents   Home equity lines of credit – Similar to the above, however these are revolving (open-ended) lines of credit that predominantly represent junior liens.   Consumer — Represents loans to individuals for household, family and other personal expenditures that may be secured or unsecured. This includes pre-arranged overdraft plans, secured automobile loans and other consumer-purposed loans.   Leases — Represents a variety of leasing options to businesses to acquire equipment.   Commercial Credit Cards — Represents revolving loans to businesses to manage operating cash flows.   Bancorp measures expected credit losses for its loan portfolio segments as follows:   Loan Portfolio Segment   ACL Methodology       Commercial real estate - non-owner occupied   Discounted cash flow Commercial real estate - owner occupied   Discounted cash flow Commercial and industrial - term   Static pool Commercial and industrial - line of credit   Static pool Residential real estate - owner occupied   Discounted cash flow Residential real estate - non-owner occupied   Discounted cash flow Construction and land development   Static pool Home equity lines of credit   Static pool Consumer   Static pool Leases   Static pool Credit cards - commercial   Static pool   Discounted Cash flow Method – The DCF methodology is used to develop cash flow projections at the instrument level wherein payment expectations are adjusted for estimated prepayment speeds, curtailments, time to recovery, probability of default and loss given default. The modeling of expected prepayment speeds, curtailment rates and time to recovery are based on historical internal data.   Bancorp uses regression analysis of historical internal and peer data to determine suitable loss drivers to utilize when modeling lifetime probability of default and loss given default. This analysis also determines how expected probability of default and loss given default will react to forecasted levels of the loss drivers. For all loan pools utilizing the DCF method, management utilizes the forecasted Seasonally Adjusted National Civilian Unemployment Rate as its primary loss driver, as this was determined to best correlate to historical losses.   With regard to the DCF model and the adoption of CECL on January 1, 2020, management determined that four quarters represented a reasonable and supportable forecast period with reversion back to a historical loss rate over eight quarters on a straight-line basis.   The combination of adjustments for credit expectations (default and loss) and timing expectations (prepayment, curtailment, and time to recovery) produces an expected cash flow stream at the instrument level. Instrument effective yield is calculated, net of the impacts of prepayment assumptions and the instrument expected cash flows are then discounted at that effective yield to produce an instrument-level NPV of expected cash flows. An ACL is established for the difference between the instrument’s NPV and amortized cost basis.   Static Pool Method – The static pool methodology is utilized for the loan portfolio segments that typically have shorter durations. For each of these loan segments, Bancorp applies an expected loss ratio based on historical losses adjusted as appropriate for qualitative factors. Qualitative loss factors are based on management's judgment of company, market, industry or business specific data, changes in underlying loan composition of specific portfolios, trends relating to credit quality, delinquency, non-performing and adversely rated loans and reasonable and supportable forecasts of economic conditions.   Coll ateral Dependent Loans – Loans that do not share risk characteristics are evaluated on an individual basis. For collateral dependent loans where Bancorp has determined that foreclosure of the collateral is probable, or where the borrower is experiencing financial difficulty and Bancorp expects repayment of the financial asset to be provided substantially through the operation of the business or sale of the collateral, the ACL is measured based on the difference between the fair value of the collateral and the amortized cost basis of the asset as of the measurement date. When repayment is expected to be from the operation of the collateral, expected credit losses are calculated as the amount by which the amortized cost basis of the financial asset exceeds the NPV of expected cash flows from the operation of the collateral. When repayment is expected to be from the sale of the collateral, expected credit losses are calculated as the amount by which the amortized costs basis of the financial asset exceeds the fair value of the underlying collateral less estimated cost to sell. The ACL may be zero if the fair value of the collateral at the measurement date exceeds the amortized cost basis of loan. Bancorp’s estimate of the ACL reflects losses expected over the remaining contractual life of the loan and the contractual term does not consider extensions, renewals or modifications.   15 Table of Contents   A loan that has been modified or renewed is considered a TDR when two conditions are met: 1 ) the borrower is experiencing financial difficulty and 2 ) concessions are made for the borrower's benefit that would not otherwise be considered for a borrower or transaction with similar credit risk characteristics. TDRs are evaluated individually to determine the required ACL. TDRs performing in accordance with their modified contractual terms for a reasonable period may be included in Bancorp’s existing pools based on the underlying risk characteristics of the loan to measure the ACL.   Off-Balance Sheet Credit Exposures – Financial instruments include off-balance sheet credit instruments, such as commitments to originate loans and commercial letters of credit issued to meet customer-financing needs. Bancorp’s exposure to credit loss in the event of non-performance by the other party to the financial instrument for off-balance sheet loan commitments is represented by the contractual amount of those instruments. Such financial instruments are recorded when they are funded.   Bancorp records an ACL on off-balance sheet credit exposures, unless the commitments to extend credit are unconditionally cancelable, through a charge to credit loss expense for off-balance sheet credit exposures included in other non-interest expense in Bancorp’s consolidated statements of income. The ACL on off-balance sheet credit exposures is estimated by loan portfolio segment at each balance sheet date under the current CECL model using the same methodologies as portfolio loans, taking into consideration the likelihood that funding will occur and is included in other liabilities on Bancorp’s consolidated balance sheets.   16 Table of Contents   Recently Adopted Accounting Standards – Bancorp adopted ASC 326, “ Financial Instruments – Credit Losses ,” on January 1, 2020 using the modified retrospective approach. Results for the periods subsequent to January 1, 2020 are presented under ASC 326, while prior period amounts continue to be reported in accordance with previously applicable GAAP. Bancorp recorded a net reduction of retained earnings of $ 8.8 million upon adoption. The transition adjustment included an increase in the ACL on loans of $ 8.2 million and an increase in the ACL on off-balance sheet credit exposures of $ 3.5 million, net of the total corresponding DTA increase of $ 2.9 million.   Bancorp adopted ASC 326 using the prospective transition approach for loans purchased with PCD that were previously classified as PCI and accounted for under ASC 310 - 30. In accordance with the standard, management did not reassess whether PCI loans met the criteria of PCD loans as of the adoption date. On January 1, 2020, non-accretable yield marks of $1.6 million related to formerly classified PCI loans were reclassified between the amortized cost basis of loans and corresponding ACL.   The following table summarizes the impact of the adoption of ASC 326:       January 1, 2020   (in thousands)   As reported under ASC 326     Pre-ASC 326 Adoption     Impact of Adoption (1)                             Allowance for credit losses on loans:                                                   Commercial real estate - non-owner occupied   $ 8,333     $ 5,235     $ 3,098   Commercial real estate - owner occupied     6,219       3,327       2,892   Total commercial real estate     14,552       8,562       5,990                             Commercial and industrial - term     7,147       6,782       365   Commercial and industrial - line of credit     4,129       5,657       ( 1,528 ) Total commercial and industrial     11,276       12,439       ( 1,163 )                           Residential real estate - owner occupied     2,713       1,527       1,186   Residential real estate - non-owner occupied     1,376       947       429   Total residential real estate     4,089       2,474       1,615                             Construction and land development     5,161       2,105       3,056   Home equity lines of credit     842       728       114   Consumer     398       100       298   Leases     233       237       ( 4 ) Credit cards - commercial     96       146       ( 50 ) Total allowance for credit losses on loans   $ 36,647     $ 26,791     $ 9,856                             Total allowance for credit losses on off-balance sheet exposures   $ 3,850     $ 350     $ 3,500     ( 1 ) – The impact of the ASC 326 adoption on the ACL on loans reflects $8.2 million related to the transition from the incurred loss ACL model to the CECL ACL model and $1.6 million related to the transition from PCI to PCD methodology as defined in the standard.   In August 2018, the FASB issued ASU No. 2018 - 13, Fair Value Measurement (Topic 820 ): “ Disclosure Framework - Changes to the Disclosure Requirements for Fair Value Measurement .” The amendments in this update modify the disclosure requirements for fair value measurements by removing, modifying, or adding certain disclosures. The update is effective for interim and annual periods in fiscal years beginning after December 15, 2019, with early adoption permitted for the removed disclosures and delayed adoption until the fiscal year 2020 permitted for the new disclosures. The removed and modified disclosures will be adopted on a retrospective basis, and the new disclosures will be adopted on a prospective basis. The adoption did not have a material effect on Bancorp’s consolidated financial statements.   In January 2017, the FASB issued ASU 2017 - 04,  “ Intangibles - Goodwill and Other (Topic 350 ) - Simplifying the Test for Goodwill Impairment .” This ASU simplifies the accounting for goodwill impairment by requiring impairment charges to be based on the first step in the previous two -step impairment test. Under the new guidance, if a reporting unit’s carrying amount exceeds its fair value, an entity will record an impairment charge based on that difference. The impairment charge will be limited to the amount of goodwill allocated to that reporting unit. The standard eliminates the prior requirement to calculate a goodwill impairment charge using Step 2, which requires an entity to calculate any impairment charge by comparing the implied fair value of goodwill with its carrying amount. ASU 2017 - 04 was effective for Bancorp on January 1, 2020 and it did not have a material impact on Bancorp’s financial statements.   17 Table of Contents   In August 2018, the FASB issued ASU 2018 - 15,  “ Intangibles - Goodwill and Other - Internal-Use Software (Subtopic 350 - 40 ) - Customer’s Accounting for Implementation Costs Incurred in a Cloud Computing Arrangement That Is a Service Contract.” This ASU aligns the requirements for capitalizing implementation costs incurred in a hosting arrangement that is a service contract with the requirements for capitalizing implementation costs incurred to develop or obtain internal-use software (and hosting arrangements that include an internal use software license). The accounting for the service element of a hosting arrangement that is a service contract is not affected by these amendments. ASU 2018 - 15 was effective for Bancorp on January 1, 2020 and did not have a material impact on Bancorp’s financial statements.   In March 2020, interagency guidance was issued regarding loan modifications and reporting for financial institutions working with customers affected by COVID- 19. The interagency statement was effective immediately and affected accounting for loan modifications. Under ASC 310 - 40, “ Receivables – Troubled Debt Restructurin gs by Creditors ,” a restructuring of debt constitutes a TDR if the creditor, for economic or legal reasons related to the debtor’s financial difficulties, grants a concession to the debtor that it would not otherwise consider. The agencies confirmed with the staff of the FASB that short-term modifications made on a good faith basis in response to COVID- 19 to borrowers who were current prior to such relief, are not to be considered TDRs. This includes short-term (e.g., six months) modifications such as full payment and principal only deferrals. Borrowers considered current are those that are less than 30 days past due on their contractual payments at the time a modification program was implemented. This interagency guidance in addition to deferral guidance included in the CARES Act could have a material impact on Bancorp’s financial statements; however, this impact cannot be quantified at this time.   In March 2020, the FASB issued ASU No. 2020 - 04, Reference Rate Reform (Topic 848 ): “ Facilitation of the Effects of Reference Rate Reform on Financial Reporting .” The amendments in this update provide optional guidance for a limited period to ease the potential burden in accounting for (or recognizing the effects of) reference rate reform on financial reporting. It provides optional expedients and exceptions for applying GAAP to contracts, hedging relationships, and other transactions affected by reference rate reform if certain criteria are met. The amendments in this update are effective for all entities as of March 12, 2020 through December 31, 2022. Bancorp is currently evaluating the impact of this ASU on Bancorp’s consolidated financial statements.   Accounting Standards Updates – Generally, if an issued but not yet effective ASU with an expected immaterial impact to Bancorp has been disclosed in prior SEC filings, it will not be re-disclosed.   In April 2019, the FASB issued ASU No. 2019 - 04, “ Codification Improvements to Financial Instruments - Credit Losses (ASC 326 ), Derivatives and Hedging (ASC 815 ), and Financial Instruments (ASC 825 ) .” The amendments in the ASU improve the Codification by eliminating inconsistencies and providing clarifications. The amended guidance in this ASU related to the credit losses will be effective for Bancorp’s for fiscal years and interim periods beginning after December 15, 2022. Bancorp is currently evaluating the impact of the ASU on the Company’s consolidated financial statements.   18 Table of Contents     ( 2 ) Acquisition   On May 1, 2019, Bancorp completed its acquisition of KSB, for $ 28 million in cash. The acquisition expanded Bancorp’s market area into nearby Nelson County, Kentucky, while growing its customer base in Louisville, Kentucky.   Effective March 31, 2020, management finalized the fair values of the acquired assets and assumed liabilities in advance of 12 months post acquisition date, as allowed by GAAP.   The following table provides a summary of the assets acquired and liabilities assumed as recorded by the acquiree, the previously reported preliminary fair value adjustments necessary to adjust those acquired assets and assumed liabilities to fair value, final recast adjustments to those previously reported preliminary fair values, and the final fair values of those assets and liabilities as recorded by Bancorp.       May 1, 2019       As Recorded     Fair Value       Recast       As Recorded   (in thousands)   by KSB     Adjustments (1)       Adjustments       by Bancorp   Assets acquired:                                                                           Cash and due from banks   $ 3,316     $ —       $ —       $ 3,316   Interest bearing due from banks     1,761       —         —         1,761   Available for sale debt securities     12,404       23   a     —         12,427   Federal Home Loan Bank stock, at cost     1,517       —         —         1,517   Federal Reserve Bank stock, at cost     490       —         —         490   Loans     165,744       ( 1,597 ) b     ( 118 ) b     164,029   Allowance for credit losses     ( 1,812 )     1,812   b     —         —   Net loans     163,932       215         ( 118 )       164,029   Premises and equipment, net     4,358       ( 1,328 ) c     431   c     3,461   Bank owned life insurance     3,431       —         —         3,431   Core deposit intangible     —       1,519   d     —         1,519   Other real estate owned     325       ( 325 ) e     —         —   Other assets and accrued interest receivable     867       ( 36 ) f     —         831   Total assets acquired   $ 192,401     $ 68       $ 313       $ 192,782                                         Liabilities assumed:                                                                           Deposits:                                     Non-interest bearing   $ 24,939     $ —       $ —       $ 24,939   Interest bearing     100,839       ( 252 ) g     —         100,587   Total deposits     125,778       ( 252 )       —         125,526                                         Federal funds purchased     1,566       —         —         1,566   Federal Home Loan Bank advances     43,718       ( 419 ) h     —         43,299   Subordinated note     3,609       —         —         3,609   Holding Company line of credit     2,300       —         —         2,300   Other liabilities and accrued interest payable     313       —         —         313                                         Total liabilities assumed     177,284       ( 671 )       —         176,613                                         Net assets acquired   $ 15,117     $ 739       $ 313       $ 16,169                                         Cash consideration paid                                 ( 28,000 )                                       Goodwill                               $ 11,831     ( 1 )  – See the following page for explanations of individual fair value adjustments.   19 Table of Contents   Explanation of the above pre-ASC 326 fair value adjustments :     a. Reflects the fair value adjustment based on Bancorp’s evaluation of the acquired investment portfolio.     b. Reflects the fair value adjustment based on Bancorp’s evaluation of the acquired loan portfolio and to eliminate the acquiree’s recorded ACL .     c. Reflects the fair value adjustment based on Bancorp’s evaluation of the premises and equipment acquired.     d. Reflects the fair value adjustment for the CDI asset recorded as a result of the acquisition.     e. Reflects the fair value adjustment based upon Bancorp’s evaluation of the foreclosed real estate acquired.     f. Reflects the write-off of a miscellaneous other asset.     g. Reflects the fair value adjustment based on Bancorp ’s evaluation of the assumed time deposits.     h. Reflects the fair value adjustment based upon Bancorp’s evaluation of the assumed FHLB advances.     Goodwill of approximately $ 12 million, which is the excess of the acquisition consideration over the fair value of net assets acquired, was recorded and is the result of expected operational synergies and other factors. This goodwill was entirely attributable to Bancorp’s Commercial Banking segment and deductible for tax purposes.   Based upon the proximity to existing branch locations, Bancorp closed and ultimately sold three acquired full service branch locations in 2019, while retaining the associated customer relationships. Goodwill was recast in 2019 based on these sales.   Pro forma financial information as of the acquisition was not considered material.   20 Table of Contents     ( 3 ) Available for Sale Debt Securities   All of Bancorp’s debt securities are classified as AFS. Amortized cost, unrealized gains and losses and fair value of securities follow:   (in thousands)         Unrealized     Allowance         June 30, 2020   Amortized cost     Gains     Losses     for Credit Losses     Fair value                                             Obligations of states and political subdivisions   $ —     $ —     $ —     $ —     $ —   Government sponsored enterprise obligations     199,838       4,788       ( 215 )     —       204,411   Mortgage backed securities - government agencies     262,565       7,702       ( 13 )     —       270,254   Obligations of states and political subdivisions     10,394       190       —       —       10,584                                             Total available for sale debt securities   $ 472,797     $ 12,680     $ ( 228 )   $ —     $ 485,249                                             December 31, 2019                                                                                   Obligations of states and political subdivisions   $ 49,887     $ 10     $ —     $ —     $ 49,897   Government sponsored enterprise obligations     208,933       1,189       ( 178 )     —       209,944   Mortgage backed securities - government agencies     193,574       1,243       ( 956 )     —       193,861   Obligations of states and political subdivisions     16,919       117       —       —       17,036                                             Total available for sale debt securities   $ 469,313     $ 2,559     $ ( 1,134 )   $ —     $ 470,738     At June 30, 2020 and December 31, 2019, there were no holdings of debt securities of any one issuer, other than the U.S. government and its agencies, in an amount greater than 10% of stockholders’ equity.   There were no gains or losses on sales or calls of securities for the three -month and six -month periods ending June 30, 2020 and 2019. Securities acquired in the May 1, 2019 acquisition totaling $ 12 million, were sold immediately following the acquisition with no gain or loss realized in the income statement.   Accrued interest on AFS debt securities totaled $ 1.5 million and $ 1.6 million at June 30, 2020 and December 31, 2019, respectively, and was included in the consolidated balance sheets.   A summary of AFS debt securities by contractual maturity as of June 30, 2020 follows:   (in thousands)   Amortized cost     Fair value                     Due within 1 year   $ 75,092     $ 75,164   Due after 1 year but within 5 years     31,457       32,114   Due after 5 years but within 10 years     3,972       4,145   Due after 10 years     99,711       103,572   Mortgage backed securities - government agencies     262,565       270,254   Total securities available for sale   $ 472,797     $ 485,249       Actual maturities may differ from contractual maturities because some issuers have the right to call or prepay obligations with or without prepayment penalties. The investment portfolio includes MBS’s, which are guaranteed by agencies such as FHLMC, FNMA and GNMA. These securities differ from traditional debt securities primarily in that they may have uncertain principal payment dates and are priced based on estimated prepayment rates on the underlying collateral.   Securities with a carrying value of $ 395 million and $ 403 million were pledged at June 30, 2020 and December 31, 2019, respectively, to secure accounts of commercial depositors in cash management accounts, public funds and uninsured cash balances for WM&T accounts.   21 Table of Contents   AFS debt securities with unrealized loss position for which an ACL has not been recorded, aggregated by investment category and length of time that individual securities have been in a continuous loss position follow:       Less than 12 months     12 months or more     Total                       (in thousands)   Fair     Unrealized     Fair     Unrealized     Fair     Unrealized   June 30, 2020   value     losses     value     losses     value     losses                                                     Government sponsored enterprise obligations   $ 19,614     $ ( 149 )   $ 5,548     $ ( 66 )   $ 25,162     $ ( 215 ) Mortgage-backed securities - government agencies     16,358       ( 13 )     —       —       16,358       ( 13 )                                                   Total   $ 35,972     $ ( 162 )   $ 5,548     $ ( 66 )   $ 41,520     $ ( 228 )                                                   December 31, 2019                                                 Government sponsored enterprise obligations   $ 16,503     $ ( 107 )   $ 11,492     $ ( 71 )   $ 27,995     $ ( 178 ) Mortgage-backed securities - government agencies     81,664       ( 496 )     32,453       ( 460 )     114,117       ( 956 )                                                   Total   $ 98,167     $ ( 603 )   $ 43,945     $ ( 531 )   $ 142,112     $ ( 1,134 )     Applicable dates for determining when securities are in an unrealized loss position are June 30, 2020 and December 31, 2019. As such, it is possible that a security had a market value lower than its amortized cost on other days during the past 12 months, but is not in the “Less than 12 months” category above.   For AFS debt securities in an unrealized loss position, Bancorp evaluates the securities to determine whether the decline in the fair value below the amortized cost basis (impairment) is due to credit-related factors or non-credit related factors. Any impairment that is not credit-related is recognized in AOCI, net of tax. Credit-related impairment is recognized as an a ACL on AFS debt securities on the balance sheet, limited to the amount by which the amortized cost basis exceeds the fair value, with a corresponding adjustment to earnings. Accrued interest receivable is excluded from the estimate of credit losses. Both the ACL and the adjustment to net income may be reversed if conditions change. However, if Bancorp intends to sell an impaired AFS debt security or more likely than not will be required to sell such a security before recovering its amortized cost basis, the entire impairment amount would be recognized in earnings with a corresponding adjustment to the security’s amortized cost basis. Because the security’s amortized cost basis is adjusted to fair value, there is no ACL in this situation.   In evaluating AFS debt securities in unrealized loss positions for impairment and the criteria regarding its intent or requirement to sell such securities, Bancorp considers the extent to which fair value is less than amortized cost, whether the securities are issued by the federal government or its agencies, whether downgrades by bond rating agencies have occurred, and the results of reviews of the issuers’ financial condition, among other factors. Unrealized losses on Bancorp’s investment securities portfolio have not been recognized as an expense because the securities are of high credit quality, and the decline in fair values is attributable to changes in the prevailing interest rate environment since the purchase date. Fair value is expected to recover as securities reach maturity and/or the interest rate environment returns to conditions similar to when these securities were purchased. These investments consisted of 9 and 54 separate investment positions as of June 30, 2020 and December 31, 2019, respectively. There were no credit related factors underlying unrealized losses on AFS debt securities at June 30, 2020 and December 31, 2019.   FHLB stock represents an investment held by Bancorp that is not readily marketable and is carried at cost adjusted for identified impairment, if any. Impairment is evaluated on an annual basis in the fourth quarter and more often if market conditions warrant. Bancorp has never recorded FHLB stock impairment. Holdings of FHLB stock are required for access to FHLB advances.   22 Table of Contents     ( 4 ) Loans and Allowance for Credit Losses on Loans   Composition of loans by class as reported under ASC 326 follows:   (in thousands)   June 30, 2020     December 31, 2019                     Commercial real estate - non-owner occupied   $ 815,464     $ 746,283   Commercial real estate - owner occupied     472,457       474,329   Total commercial real estate     1,287,921       1,220,612                     Commercial and industrial - term     510,384       457,298   Commercial and industrial - term - PPP     630,082       —   Commercial and industrial - lines of credit     254,096       381,502   Total commercial and industrial     1,394,562       838,800                     Residential real estate - owner occupied     215,891       217,606   Residential real estate - non-owner occupied     139,121       134,995   Total residential real estate     355,012       352,601                     Construction and land development     255,447       255,816   Home equity lines of credit     103,672       103,854   Consumer     43,758       47,467   Leases     14,843       16,003   Credits cards - commercial     8,862       9,863   Total loans (1)   $ 3,464,077     $ 2,845,016     ( 1 ) Total loans are presented inclusive of premiums, discounts, and net of loan origination fees and costs.   For historical comparative purposes, the composition of loans by class pre-ASC 326 adoption follows:   (in thousands)   December 31, 2019             Commercial and industrial   $ 870,511   Construction and development, excluding undeveloped land     213,822   Undeveloped land     46,360             Real estate mortgage:         Commercial investment     736,618   Owner occupied commercial     473,783   1-4 family residential     334,358   Home equity - first lien     48,620   Home equity - junior lien     73,477   Subtotal: Real estate mortgage     1,666,856   Consumer     47,467   Total loans (1)   $ 2,845,016     ( 1 ) Total loans are presented inclusive of premiums, discounts, and net of loan origination fees and costs.   Accrued interest on loans, which is excluded from the amortized cost of loans, totaled $ 12 million and $ 7 million at June 30, 2020 and December  31, 2019, respectively, and was included in the consolidated balance sheets.   Loans with carrying amounts of $ 1.9 billion and $ 1.6 billion at June 30, 2020 and December 31, 2019, respectively, were pledged to secure FHLB borrowing capacity.   Loans to directors and their related interests, including loans to companies for which directors are principal owners and executive officers, totaled $ 46 million and $ 43 million as of June 30, 2020 and December 31, 2019, respectively.   23 Table of Contents   The following table summarizes loans acquired in Bancorp’s May 1, 2019 acquisition, as recasted:       May 1, 2019       Contractual     Non-accretable     Accretable     Acquisition-day   (in thousands)   Receivable     Yield     Yield     Fair Value                                     Commercial and industrial   $ 8,249     $ —     $ ( 23 )   $ 8,226   Construction and land development     18,738       —       86       18,824   Real estate mortgage:                                 Commercial real estate     84,219       —       ( 456 )     83,763   Residential real estate     50,556       —       322       50,878   Home equity lines of credit     875       —       8       883   Subtotal: Real estate mortgage     135,650       —       ( 126 )     135,524                                     Consumer     1,528       —       ( 73 )     1,455                                     Total loans acquired under ASC 310-20     164,165       —       ( 136 )     164,029                                     Commercial and industrial     —       —       —       —   Construction and land development     —       —       —       —   Real estate mortgage:                                 Commercial real estate     1,351       ( 1,351 )     —       —   Residential real estate     228       ( 228 )     —       —   Home equity lines of credit     —       —       —       —   Subtotal: Real estate mortgage     1,579       ( 1,579 )     —       —                                     Consumer     —       —       —       —                                     Total purchased credit impaired loans acquired under ASC 310-30     1,579       ( 1,579 )     —       —                                     Total loans   $ 165,744     $ ( 1,579 )   $ ( 136 )   $ 164,029       The Bank acquired PCI loans related to its 2019 and 2013 acquisitions. At acquisition date, these loans were accounted for under ASC 310 - 30. On January 1, 2020, Bancorp adopted ASC 326 using the prospective transition approach for loans purchased with credit deterioration that were previously classified as PCI and accounted for under ASC 310 - 30. In accordance with the standard, management did not reassess whether PCI loans met the criteria of PCD loans as of the adoption date. On January 1, 2020, non-accretable yield marks of $ 1.6 million related to formerly classified PCI loans were reclassed between the amortized cost basis of loans and corresponding ACL.   24 Table of Contents   Bancorp’s estimate of the ACL on loans reflects losses expected over the remaining contractual life of the assets. The contractual term does not consider extensions, renewals or modifications. The activity in the ACL related to loans follows ( 2020 is presented in accordance with ASC 326 and 2019 in accordance with ASC 310 ):   (in thousands) Three Months Ended June 30, 2020   Beginning Balance     Impact of Adopting ASC 326     Initial ACL on Loans Purchased with Credit Deterioration     Provision for Credit Losses     Charge-offs     Recoveries     Ending Balance                                                             Commercial real estate - non-owner occupied   $ 13,435     $ -     $ -     $ 5,403     $ -     $ 1     $ 18,839   Commercial real estate - owner occupied     6,509       -       -       197       -       -       6,706   Total commercial real estate     19,944       -       -       5,600       -       1       25,545                                                             Commercial and industrial - term     7,990       -       -       ( 651 )     -       -       7,339   Commercial and industrial - lines of credit     3,866       -       -       ( 624 )     -       -       3,242   Total commercial and industrial     11,856       -       -       ( 1,275 )     -       -       10,581                                                             Residential real estate - owner occupied     2,702       -       -       162       ( 18 )     2       2,848   Residential real estate - non-owner occupied     1,419       -       -       175       -       -       1,594   Total residential real estate     4,121       -       -       337       ( 18 )     2       4,442                                                             Construction and land development     5,185       -       -       423       -       -       5,608   Home equity lines of credit     623       -       -       209       -       -       832   Consumer     198       -       -       134       ( 80 )     110       362   Leases     159       -       -       64       -       -       223   Credit cards - commercial     57       -       -       58       -       -       115   Total net loan (charge-offs) recoveries   $ 42,143     $ -     $ -     $ 5,550     $ ( 98 )   $ 113     $ 47,708     (in thousands) Six Months Ended June 30, 2020   Beginning Balance     Impact of Adopting ASC 326     Initial ACL on Loans Purchased with Credit Deterioration     Provision for Credit Losses     Charge-offs     Recoveries     Ending Balance                                                             Commercial real estate - non-owner occupied   $ 5,235     $ 2,946     $ 152     $ 10,503     $ -     $ 3     $ 18,839   Commercial real estate - owner occupied     3,327       1,542       1,350       487       -       -       6,706   Total commercial real estate     8,562       4,488       1,502       10,990       -       3       25,545                                                             Commercial and industrial - term     6,782       365       -       185       -       7       7,339   Commercial and industrial - lines of credit     5,657       ( 1,528 )     -       ( 887 )     -       -       3,242   Total commercial and industrial     12,439       ( 1,163 )     -       ( 702 )     -       7       10,581                                                             Residential real estate - owner occupied     1,527       1,087       99       151       ( 18 )     2       2,848   Residential real estate - non-owner occupied     947       429       -       218       -       -       1,594   Total residential real estate     2,474       1,516       99       369       ( 18 )     2       4,442                                                             Construction and land development     2,105       3,056       -       447       -       -       5,608   Home equity lines of credit     728       114       -       ( 10 )     -       -       832   Consumer     100       264       34       ( 3 )     ( 254 )     221       362   Leases     237       ( 4 )     -       ( 10 )     -       -       223   Credit cards - commercial     146       ( 50 )     -       19       -       -       115   Total net loan (charge-offs) recoveries   $ 26,791     $ 8,221     $ 1,635     $ 11,100     $ ( 272 )   $ 233     $ 47,708     25 Table of Contents   (in thousands) Three Months Ended June 30, 2019   Beginning Balance     Provision for Credit Losses     Charge-offs     Recoveries     Ending Balance                                             Real estate mortgage   $ 12,001     $ 10     $ ( 13 )   $ 32     $ 12,030   Commercial and industrial     11,762       92       -       4       11,858   Construction and development     1,884       ( 74 )     -       -       1,810   Undeveloped land     662       ( 61 )     -       -       601   Consumer     155       33       ( 148 )     77       117       $ 26,464     $ -     $ ( 161 )   $ 113     $ 26,416     (in thousands) Six Months Ended Six June 30, 2019   Beginning Balance     Provision for Credit Losses     Charge-offs     Recoveries     Ending Balance                                             Real estate mortgage   $ 10,681     $ 1,310     $ ( 13 )   $ 52     $ 12,030   Commercial and industrial     11,965       ( 210 )     ( 3 )     106       11,858   Construction and development     1,760       ( 153 )     -       203       1,810   Undeveloped land     752       ( 151 )     -       -       601   Consumer     376       ( 196 )     ( 244 )     181       117       $ 25,534     $ 600     $ ( 260 )   $ 542     $ 26,416       Upon adoption of ASC 326 on January 1, 2020, Bancorp recorded an increase of $ 8.2 million to the ACL on loans and a corresponding decrease to retained earnings, net of the DTA impact. In addition, non-accretable yield marks of $1.6 million related to formerly classified PCI loans were re-classed between the amortized cost basis of loans and corresponding ACL. The adjustment upon adoption of ASC 326 raised the ACL on loans balance to $ 37 million on January 1, 2020. In addition to CECL adoption, the ACL on the first and second quarters of 2020 was significantly impacted by Bancorp’s national unemployment forecast adjustments within the CECL model, changes in the loan mix and the addition of a large specific reserve during the second quarter of 2020.   Bancorp measures expected credit losses of financial assets on a collective (pool) basis, when the financial assets share similar risk characteristics. Depending on the nature of the pool of financial assets with similar risk characteristics, Bancorp has measured its portfolio classes as follows:   Loan Portfolio Segment   ACL Methodology       Commercial real estate - non-owner occupied   Discounted cash flow Commercial real estate - owner occupied   Discounted cash flow Commercial and industrial - term   Static pool Commercial and industrial - line of credit   Static pool Residential real estate - owner occupied   Discounted cash flow Residential real estate - non-owner occupied   Discounted cash flow Construction and land development   Static pool Home equity lines of credit   Static pool Consumer   Static pool Leases   Static pool Credit cards - commercial   Static pool   The static pool methodology is utilized for the loan portfolio segments that typically have shorter durations. For each of these loan segments, Bancorp applies an expected loss ratio based on historical losses adjusted as appropriate for qualitative factors. Qualitative loss factors are based on management's judgment of company, market, industry or business specific data, changes in underlying loan composition of specific portfolios, trends relating to credit quality, delinquency, non-performing and adversely rated loans, and reasonable and supportable forecasts of economic conditions.   When developing the ACL CECL model for loan pools utilizing the DCF method, Bancorp utilized regression analysis of historical internal and peer data to identify a suitable loss driver to utilize when modeling lifetime probability of default and loss given default. Such regression analysis was used to measure how the expected probability of default and loss given default would react to changes in forecasted levels of the loss driver. Based on this regression analysis, management determined that the forecasted Seasonally Adjusted National Civilian Unemployment Rate best correlated to Bancorp’s historical losses and elected to use this rate as the primary loss driver to be consistently applied across all applicable loan segments over a reasonable and supportable forecast period.   26 Table of Contents   Upon adoption of ASC 326 on January 1, 2020, management determined that four quarters represented a reasonable and supportable national unemployment forecast period with reversion back to Bancorp’s historical loss rate over eight quarters on a straight-line basis. This resulted in an $ 8.2 million initial increase in the ACL on loans with the offset to retained earnings.   Subsequent to January 1, 2020, based on the economic crisis caused by COVID- 19 and measures taken to protect public health such as stay-at-home orders and mandatory closures of businesses, economic activity halted significantly and job losses surged. As such, national unemployment has fluctuated widely over the last several months as follows:       Jun 20     May 20     Apr 20     Mar 20     Feb 20     Jan 20     Dec 19                                                             National Unemployment Rate     11.10 %     13.30 %     14.70 %     4.40 %     3.50 %     3.60 %     3.50 %   As of March 31, 2020, based on the evolving pandemic, Bancorp elected to forecast for only one quarter of national unemployment (versus the four quarters used as of January 1, 2020) and modified its forecast to reflect a significant increase in unemployment (utilizing the highest unemployment rate in Bancorp’s observed history) reverting back to the long-term average in the third quarter of 2020, with the loss driver remaining significantly worse compared to recent trends. The impact of the increased national unemployment forecast was muted by an adjustment in qualitative factors attributed to the massive federal stimulus programs enacted at the end of the first quarter in response to the pandemic. The forecasted increase in national unemployment coupled with the qualitative factor adjustments resulted in approximately $ 4.2 million of the total provision expense recorded for the three months ended March 31, 2020.   For all loan pools utilizing the DCF method, management utilizes the forecasted Seasonally Adjusted National Civilian Unemployment Rate as its primary loss driver, as this was determined to best correlate to historical losses. During the second quarter, for the first time during 2020, the FRB released a forecasted Seasonally Adjusted National Civilian Unemployment Rate for the 12 months ended December 31, 2020, 2021 and 2022 as follows:       2020     2021     2022                             Upper end of range     14.0 %     12.0 %     8.0 % Median     9.3 %     6.5 %     5.5 % Lower end of range     7.0 %     4.5 %     4.0 %   As of June 30, 2020, based on the above and the continuation of the economic crisis, Bancorp elected to forecast for one quarter of national unemployment utilizing actual unemployment in June then stepping down to a blended rate based on the above FRB median forecast over the next four quarters before reverting back to the long-term average. Similar to the first quarter of 2020, the impact of the increased unemployment forecast was muted by an adjustment in qualitative factors attributed to the massive federal stimulus programs that have been enacted. The forecasted increase in unemployment coupled with the qualitative factor adjustments resulted in approximately $ 4.6 million of the total provision expense recorded for the three months ended June 30, 2020 and $ 8.8 million for the six months ended June 30, 2020.   Outstanding loans (excluding PPP loans) increased $ 92 million during the first three months of 2020 and contracted $ 103 million during the second quarter of 2020, as outstanding C&I lines of credit were reduced by $ 114 million. The overall net change in the loan mix contributed to $ 1.3 million of additional provision expense for the three months ended March 31, 2020. During the second quarter of 2020, the loan contraction (mainly C&I lines of credit) led to a $ 1.0 million reduction in the required ACL on loans.   The pandemic has had a material impact on Bancorp’s ACL on loans calculations for both March 31, 2020 and June 30, 2020. While Bancorp has not yet experienced any credit quality issues such as charge-offs related to the pandemic, the ACL calculation for loans and resulting provision were significantly impacted by changes in forecasted economic conditions. Should the forecast for economic conditions worsen, Bancorp could experience further increases in its required ACL and record additional provision expense. While the execution of Bancorp’s payment deferral program has assisted the ratio of past due loans to total loans at March 31, 2020 and June 30, 2020, it is possible that asset quality could worsen at future measurement periods if the effects of the pandemic are prolonged.   In connection with the adoption of ASC 326, Bancorp analyzed its unused lines of credit and recorded credit loss expense for off-balance sheet exposures (non-interest expense) totaling $ 375,000 and $ 1.5 million during the first and second quarters of 2020. The second quarter increase directly correlates to the increased availability due to C&I line of credit pay downs. At June 30, 2020, approximately $ 6 million was accrued within other liabilities related to off balance sheet exposures.   27 Table of Contents   During the three months ended June 30, 2020, a large CRE relationship was placed on non-accrual status and received a $ 2 million specific reserve allocation within the ACL on loans. The borrower did not receive PPP funds, the loan was current at the time of non-accrual classification, and no payments related to the loan have been deferred.   The following table presents the amortized cost basis and ACL allocated for collateral dependent loans in accordance with ASC 326, which are individually evaluated to determine expected credit losses:   (in thousands) June 30, 2020   Real Estate     Accounts Receivable / Equipment     Other     Total     ACL Allocation                                             Commercial real estate - non-owner occupied   $ 10,569     $ -     $ -     $ 10,569     $ 2,255   Commercial real estate - owner occupied     3,014       -       -       3,014       1,351   Total commercial real estate     13,583       -       -       13,583       3,606                                             Commercial and industrial - term     -       9       18       27       18   Commercial and industrial - lines of credit     -       -       -       -       -   Total commercial and industrial     -       9       18       27       18                                             Residential real estate - owner occupied     445       -       -       445       99   Residential real estate - non-owner occupied     225       -       -       225       -   Total residential real estate     670       -       -       670       99                                             Construction and land development     -       -       -       -       -   Home equity lines of credit     -       -       -       -       -   Consumer     -       -       26       26       26   Leases     -       -       -       -       -   Credit cards - commercial     -       -       -       -       -   Total collateral dependent loans   $ 14,253     $ 9     $ 44     $ 14,306     $ 3,749       There have been no significant changes to the types of collateral securing Bancorp’s collateral dependent loans.   The following table presents loans individually and collectively evaluated for impairment and the respective ACL allocation as of December 31, 2019, as determined in accordance with ASC 310 prior to the adoption of ASC 326:       Loans     ACL   (in thousands) December 31, 2019   Loans individually evaluated for impairment     Loans collectively evaluated for impairment     Loans acquired with deteriorated credit quality     Total loans     Loans individually evaluated for impairment     Loans collectively evaluated for impairment     Loans acquired with deteriorated credit quality     Total ACL                                                                     Commercial and industrial   $ 8,223     $ 862,288     $ —     $ 870,511     $ 1,150     $ 11,672     $ —     $ 12,822   Construction and development, excluding undeveloped land     —       213,822       —       213,822       —       1,319       —       1,319   Undeveloped land     —       46,360       —       46,360       —       786       —       786   Real estate mortgage     3,307       1,663,549       —       1,666,856       13       11,751       —       11,764   Consumer     —       47,467       —       47,467       —       100       —       100                                                                     Total   $ 11,530     $ 2,833,486     $ —     $ 2,845,016     $ 1,163     $ 25,628     $ —     $ 26,791     28 Table of Contents   The following table presents information pertaining to impaired loans as of December 31, 2019 and the three and six months periods ended June 30, 2019, as determined in accordance with ASC 310:       As of     Three months ended     Six months ended       December 31, 2019     June 30, 2019     June 30, 2019                                                                         Unpaid             Average     Interest     Average     Interest       Recorded     principal     Related     recorded     income     recorded     income   (in thousands)   investment     balance     ACL     investment     recognized     investment     recognized                                                             Impaired loans with no related ACL                                                         Commercial and industrial   $ 174     $ 174     $ —     $ 144     $ —     $ 160     $ —   Construction and development, excluding undeveloped land     —       —       —       —       —       106       —   Undeveloped land     —       —       —       —       —       158       —                                                             Real estate mortgage                                                         Commercial investment     741       741       —       311       —       254       —   Owner occupied commercial     2,278       2,736       —       1,455       —       1,165       —   1-4 family residential     124       124       —       779       —       773       —   Home equity - junior lien     151       151       —       462       —       356       —   Subtotal: Real estate mortgage     3,294       3,752       —       3,007       —       2,548       —                                                             Subtotal   $ 3,468     $ 3,926     $ —     $ 3,151     $ —     $ 2,972     $ —                                                             Impaired loans with an ACL                                                         Commercial and industrial   $ 8,049     $ 8,049     $ 1,150     $ 24     $ —     $ 26     $ 1   Real estate mortgage 1-4 family residential     13       13       13       14       —       14       —   Subtotal: Real estate mortgage     13       13       13       14       —       14       —                                                             Subtotal   $ 8,062     $ 8,062     $ 1,163     $ 38     $ —     $ 40     $ 1                                                             Total impaired loans:                                                         Commercial and industrial   $ 8,223     $ 8,223     $ 1,150     $ 168     $ —     $ 186     $ 1   Construction and development, excluding undeveloped land     —       —       —       —       —       106       —   Undeveloped land     —       —       —       —       —       158       —                                                             Real estate mortgage                                                         Commercial investment     741       741       —       311       —       254       —   Owner occupied commercial     2,278       2,736       —       1,455       —       1,165       —   1-4 family residential     137       137       13       793       —       787       —   Home equity - junior lien     151       151       —       462       —       356       —   Subtotal: Real estate mortgage     3,307       3,765       13       3,021       —       2,562       —                                                             Total   $ 11,530     $ 11,988     $ 1,163     $ 3,189     $ —     $ 3,012     $ 1       Differences between recorded investment amounts and unpaid principal balance amounts less related ACL are due to partial charge-offs which have occurred over the lives of certain loans.   29 Table of Contents   The following tables present the aging of contractually past due loans by portfolio class ( 2020 is presented in accordance with ASC 326 and 2019 in accordance with ASC 310 ):   (in thousands)           30-59 days     60-89 days     90 or more     Total     Total   June 30, 2020   Current     Past Due     Past Due     Days Past Due     Past Due     Loans                                                     Commercial real estate - non-owner occupied   $ 814,610     $ 121     $ 35     $ 698     $ 854     $ 815,464   Commercial real estate - owner occupied     469,529       256       —       2,672       2,928       472,457   Total commercial real estate     1,284,139       377       35       3,370       3,782       1,287,921                                                     Commercial and industrial - term     1,140,384       59       14       9       82       1,140,466   Commercial and industrial - line of credit     253,645       41       310       100       451       254,096   Total commercial and industrial     1,394,029       100       324       109       533       1,394,562                                                     Residential real estate - owner occupied     214,681       603       290       317       1,210       215,891   Residential real estate - non-owner occupied     138,823       —       24       274       298       139,121   Total residential real estate     353,504       603       314       591       1,508       355,012                                                     Construction and land development     255,399       —       —       48       48       255,447   Home equity lines of credit     103,672       —       —       —       —       103,672   Consumer     43,727       30       1       —       31       43,758   Leases     14,843       —       —       —       —       14,843   Credit cards - commercial     8,862       —       —       —       —       8,862   Total   $ 3,458,175     $ 1,110     $ 674     $ 4,118     $ 5,902     $ 3,464,077                                 90 or more                                               Days Past Due                   (in thousands)           30-59 days     60-89 days     (includes all     Total     Total   December 31, 2019   Current     Past Due     Past Due     non-accrual)     Past Due     Loans                                                     Commercial and industrial   $ 861,860     $ 253     $ 194     $ 8,204     $ 8,651     $ 870,511   Construction and development, excluding undeveloped land     213,766       6       50       —       56       213,822   Undeveloped land     46,360       —       —       —       —       46,360                                                     Real estate mortgage:                                                 Commercial investment     735,387       94       —       1,137       1,231       736,618   Owner occupied commercial     470,951       467       86       2,279       2,832       473,783   1-4 family residential     332,718       1,368       33       239       1,640       334,358   Home equity - first lien     48,441       179       —       —       179       48,620   Home equity - junior lien     72,995       196       100       186       482       73,477   Subtotal: Real estate mortgage     1,660,492       2,304       219       3,841       6,364       1,666,856                                                     Consumer     47,379       84       4       —       88       47,467                                                     Total   $ 2,829,857     $ 2,647     $ 467     $ 12,045     $ 15,159     $ 2,845,016     30 Table of Contents   The following table presents the amortized cost basis of non-performing loans and the amortized cost basis of loans on non-accrual status for which there was no related ACL losses of June 30, 2020:                       Past Due 90-Days-   (In thousands)   Non-accrual     Total     or-More and Still   June 30, 2020   with no ACL     Non-accrual     Accruing Interest                             Commercial real estate - non-owner occupied   $ 213     $ 10,569     $ -   Commercial real estate - owner occupied     1,663       3,014       -   Total commercial real estate     1,876       13,583       -                             Commercial and industrial - term     9       9       -   Commercial and industrial - lines of credit     -       -       -   Total commercial and industrial     9       9       -                             Residential real estate - owner occupied     306       445       -   Residential real estate - non-owner occupied     225       225       -   Total residential real estate     531       670       -                             Construction and land development     -       -       48   Home equity lines of credit     -       -       -   Consumer     -       -       -   Leases     -       -       -   Credit cards - commercial     -       -       -   Total   $ 2,416     $ 14,262     $ 48       For the three and six month periods ended June 30, 2020 and 2019, the amount of accrued interest income previously recorded as revenue and subsequently reversed due to the change in accrual status was immaterial.   For the three and six month periods ended June 30, 2020 and 2019, no interest income was recognized on loans on non-accrual status.   The following table presents the recorded investment in non-performing loans by portfolio class as of December 31, 2019:   December 31, 2019 (in thousands)   Non-accrual     Past Due 90-Days-or- More and Still Accruing Interest                     Commercial and industrial   $ 8,202     $ —   Construction and development, excluding undeveloped land     —       —   Undeveloped land     —       —                     Real estate mortgage:                 Commercial investment     740       396   Owner occupied commercial     2,278       —   1-4 family residential     123       104   Home equity - first lien     —       —   Home equity - junior lien     151       35   Subtotal: Real estate mortgage     3,292       535   Consumer     —       —                     Total   $ 11,494     $ 535     31 Table of Contents   Loan Risk Ratings   Consistent with regulatory guidance, Bancorp categorizes loans into credit risk rating categories 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. Pass-rated loans include all risk-rated loans other than those classified as OAEM, substandard, and doubtful, which are defined below:   OAEM – Loans classified as OAEM have potential weaknesses requiring management's heightened attention. These potential weaknesses may result in deterioration of repayment prospects for the loan or of Bancorp's credit position at some future date.   Substandard – Loans classified as substandard are inadequately protected by the paying capacity of the obligor or of collateral pledged, if any. Loans so classified have well-defined weaknesses that jeopardize ultimate repayment of the debt. Default is a distinct possibility if the deficiencies are not corrected.   Substandard non-performing – Loans classified as substandard non-performing have all the characteristics of substandard loans and have been placed on non-accrual status or have been accounted for as TDRs. Loans are placed on non-accrual status when prospects for recovering both principal and accrued interest are considered doubtful or when a default of principal or interest has existed for 90 days or more.   Doubtful – Loans classified as doubtful have all the weaknesses inherent in those classified as substandard, with the added characteristic that the weaknesses make collection or repayment in full, on the basis of currently existing facts, conditions and values, highly questionable and improbable.   32 Table of Contents   Management considers the guidance in ASC 310 - 20 when determining whether a modification, extension, or renewal of loan constitutes a current period origination. Current period renewals of credit are re-underwritten at the point of renewal and considered current period originations for purposes of the table below. As of June 30, 2020, the risk rating of loans based on year of origination is as follows:         Term Loans Amortized Cost Basis by Origination Year                                                                               Revolving     Revolving                                                               loans     loans           (in thousands)                                                   amortized     converted           June 30, 2020   2020     2019     2018     2017     2016     Prior     cost basis     to term     Total                                                                             Commercial real estate - non-owner occupied:                                                                         Risk rating                                                                         Pass   $ 174,017     $ 171,037     $ 106,905     $ 126,594     $ 95,310     $ 96,646     $ 13,982     $ 11,989     $ 796,480   OAEM     61       -       -       -       1,578       52       472       -       2,163   Substandard     4,200       2,051       -       -       -       1       -       -       6,252   Substandard non-performing     9,727       -       -       614       -       228       -       -       10,569   Doubtful     -       -       -       -       -       -       -       -       -   Total Commercial real estate non-owner occupied   $ 188,005     $ 173,088     $ 106,905     $ 127,208     $ 96,888     $ 96,927     $ 14,454     $ 11,989     $ 815,464                                                                             Commercial real estate - owner occupied:                                                                         Risk rating                                                                         Pass   $ 102,192     $ 109,160     $ 91,659     $ 53,309     $ 44,522     $ 49,472     $ 7,144     $ 851     $ 458,309   OAEM     -       62       967       825       252       76       -       -       2,182   Substandard     -       6,997       1,363       105       127       360       -       -       8,952   Substandard non-performing     -       -       20       500       -       2,151       -       343       3,014   Doubtful     -       -       -       -       -       -       -       -       -   Total Commercial real estate owner occupied   $ 102,192     $ 116,219     $ 94,009     $ 54,739     $ 44,901     $ 52,059     $ 7,144     $ 1,194     $ 472,457                                                                             Commercial and industrial - term:                                                                         Risk rating                                                                         Pass   $ 768,510     $ 110,924     $ 111,287     $ 51,862     $ 43,348     $ 26,536     $ -     $ 7,755     $ 1,120,222   OAEM     -       928       11,679       160       83       17       -       -       12,867   Substandard     5,249       1,853       -       -       189       77       -       -       7,368   Substandard non-performing     -       -       -       -       9       -       -       -       9   Doubtful     -       -       -       -       -       -       -       -       -   Total Commercial and industrial - term   $ 773,759     $ 113,705     $ 122,966     $ 52,022     $ 43,629     $ 26,630     $ -     $ 7,755     $ 1,140,466                                                                             Commercial and industrial - lines of credit                                                                         Risk rating                                                                         Pass   $ 13,460     $ 29,646     $ 4,191     $ 2,956     $ 364     $ -     $ 193,105     $ -     $ 243,722   OAEM     -       -       -       -       -       -       783       -       783   Substandard     -       -       -       -       -       -       9,591       -       9,591   Substandard non-performing     -       -       -       -       -       -       -       -       -   Doubtful     -       -       -       -       -       -       -       -       -   Total Commercial and industrial - lines of credit   $ 13,460     $ 29,646     $ 4,191     $ 2,956     $ 364     $ -     $ 203,479     $ -     $ 254,096       (continued)   33 Table of Contents   (continued)   Term Loans Amortized Cost Basis by Origination Year                                                                               Revolving     Revolving                                                               loans     loans           (in thousands)                                                   amortized     converted           June 30, 2020   2020     2019     2018     2017     2016     Prior     cost basis     to term     Total                                                                             Residential real estate - owner occupied                                                                         Risk rating                                                                         Pass   $ 35,591     $ 43,994     $ 29,055     $ 26,881     $ 32,877     $ 46,720     $ -     $ 195     $ 215,313   OAEM     -       -       -       -       -       -       -       -       -   Substandard     16       -       -       118       -       -       -       -       134   Substandard non-performing     -       -       -       101       38       205       -       100       444   Doubtful     -       -       -       -       -       -       -       -       -   Total Residential real estate - owner occupied   $ 35,607     $ 43,994     $ 29,055     $ 27,100     $ 32,915     $ 46,925     $ -     $ 295     $ 215,891                                                                             Residential real estate - non-owner occupied                                                                         Risk rating                                                                         Pass   $ 43,459     $ 27,037     $ 29,437     $ 12,618     $ 11,728     $ 12,740     $ -     $ 158     $ 137,177   OAEM     -       1,600       -       -       -       88       -       -       1,688   Substandard     -       -       31       -       -       -       -       -       31   Substandard non-performing     -       -       -       -       -       225       -       -       225   Doubtful     -       -       -       -       -       -       -       -       -   Total Residential real estate - non-owner occupied   $ 43,459     $ 28,637     $ 29,468     $ 12,618     $ 11,728     $ 13,053     $ -     $ 158     $ 139,121                                                                             Construction and land development                                                                         Risk rating                                                                         Pass   $ 55,195     $ 97,608     $ 66,746     $ 23,159     $ 1,249     $ 2,764     $ 6,842     $ 1,883     $ 255,446   OAEM     -       -       -       -       -       -       -       -       -   Substandard     -       -       -       -       1       -       -       -       1   Substandard non-performing     -       -       -       -       -       -       -       -       -   Doubtful     -       -       -       -       -       -       -       -       -   Total Construction and land development   $ 55,195     $ 97,608     $ 66,746     $ 23,159     $ 1,250     $ 2,764     $ 6,842     $ 1,883     $ 255,447                                                                             Home equity lines of credit                                                                         Risk rating                                                                         Pass   $ -     $ -     $ -     $ -     $ -     $ -     $ 103,672     $ -     $ 103,672   OAEM     -       -       -       -       -       -       -       -       -   Substandard     -       -       -       -       -       -       -       -       -   Substandard non-performing     -       -       -       -       -       -       -       -       -   Doubtful     -       -       -       -       -       -       -       -       -   Total Home equity lines of credit   $ -     $ -     $ -     $ -     $ -     $ -     $ 103,672     $ -     $ 103,672                                                                             Consumer                                                                         Risk rating                                                                         Pass *   $ 3,680     $ 5,697     $ 4,042     $ 498     $ 525     $ 1,506     $ 27,638     $ 145     $ 43,731   OAEM     -       -       -       -       -       -       -       -       -   Substandard     -       26       -       -       -       -       -       -       26   Substandard non-performing     -       -       -       -       -       1       -       -       1   Doubtful     -       -       -       -       -       -       -       -       -   Total Consumer   $ 3,680     $ 5,723     $ 4,042     $ 498     $ 525     $ 1,507     $ 27,638     $ 145     $ 43,758       * - Revolving loans include $ 506,000 in overdrawn demand deposit balances.     (continued)   34 Table of Contents   (continued)   Term Loans Amortized Cost Basis by Origination Year                                                                               Revolving     Revolving                                                               loans     loans           (in thousands)                                                   amortized     converted           June 30, 2020   2020     2019     2018     2017     2016     Prior     cost basis     to term     Total                                                                             Leases                                                                         Risk rating                                                                         Pass   $ 1,692     $ 2,238     $ 2,495     $ 1,774     $ 3,272     $ 2,502     $ -     $ -     $ 13,973   OAEM     -       -       34       -       -       4       -       -       38   Substandard     -       -       -       -       832       -       -       -       832   Substandard non-performing     -       -       -       -       -       -       -       -       -   Doubtful     -       -       -       -       -       -       -       -       -   Total Consumer   $ 1,692     $ 2,238     $ 2,529     $ 1,774     $ 4,104     $ 2,506     $ -     $ -     $ 14,843                                                                             Credit cards - commercial                                                                         Risk rating                                                                         Pass   $ -     $ -     $ -     $ -     $ -     $ -     $ 8,862     $ -     $ 8,862   OAEM     -       -       -       -       -       -       -       -       -   Substandard     -       -       -       -       -       -       -       -       -   Substandard non-performing     -       -       -       -       -       -       -       -       -   Doubtful     -       -       -       -       -       -       -       -       -   Total Consumer   $ -     $ -     $ -     $ -     $ -     $ -     $ 8,862     $ -     $ 8,862                                                                             Total loans                                                                         Risk rating                                                                         Pass   $ 1,197,796     $ 597,341     $ 445,817     $ 299,651     $ 233,195     $ 238,886     $ 361,245     $ 22,976     $ 3,396,907   OAEM     61       2,590       12,680       985       1,913       237       1,255       -       19,721   Substandard     9,465       10,927       1,394       223       1,149       438       9,591       -       33,187   Substandard non-performing     9,727       -       20       1,215       47       2,810       -       443       14,262   Doubtful     -       -       -       -       -       -       -       -       -   Total Loans   $ 1,217,049     $ 610,858     $ 459,911     $ 302,074     $ 236,304     $ 242,371     $ 372,091     $ 23,419     $ 3,464,077       Bancorp considers the performance of the loan portfolio and its impact on the ACL. For certain loan classes, such as credit cards, credit quality is evaluated based on the aging status of the loan, which was previously presented, and by payment activity. The following table presents the recorded investment in commercial credit cards based on payment activity:       June, 30   (in thousands)   2020             Credit cards - commercial         Performing   $ 8,862   Non-performing     —   Total credit cards - commercial   $ 8,862     35 Table of Contents   Internally assigned risk ratings of loans by loan portfolio class classification category as of December 31, 2019 follows:   (in thousands)                           Substandard             Total   December 31, 2019   Pass     OAEM     Substandard     Non-performing     Doubtful     Loans                                                     Commercial and industrial   $ 840,105     $ 704     $ 21,500     $ 8,202     $ —     $ 870,511   Construction and development, excluding undeveloped land     213,822       —       —       —       —       213,822   Undeveloped land     46,360       —       —       —       —       46,360                                                     Real estate mortgage:                                                 Commercial investment     722,747       6,459       6,275       1,137       —       736,618   Owner occupied commercial     460,981       1,375       9,050       2,377       —       473,783   1-4 family residential     332,294       1,701       122       241       —       334,358   Home equity - first lien     48,620       —       —       —       —       48,620   Home equity - junior lien     73,273       —       17       187       —       73,477   Subtotal: Real estate mortgage     1,637,915       9,535       15,464       3,942       —       1,666,856                                                     Consumer     47,429       —       38       —       —       47,467                                                     Total   $ 2,785,631     $ 10,239     $ 37,002     $ 12,144     $ —     $ 2,845,016     Troubled Debt Restructurings   Detail of outstanding TDRs included in total non-performing loans follows:       June 30, 2020     December 31, 2019               Specific     Additional             Specific     Additional               reserve     commitment             reserve     commitment   (in thousands)   Balance     allocation     to lend     Balance     allocation     to lend                                                     Commercial and industrial - term   $ 19     $ 19     $ —     $ 21     $ 21     $ —   Residential real estate     —       —       —       13       13       —   Consumer     26       26       —       —       —       —                                                     Total TDRs   $ 45     $ 45     $ —     $ 34     $ 34     $ —       In March 2020, the FASB issued ASU No. 2020 - 04, Reference Rate Reform (Topic 848 ): “ Facilitation of the Effects of Reference Rate Reform on Financial Reporting .” The amendments in this update provide optional guidance for a limited period to ease the potential burden in accounting for (or recognizing the effects of) reference rate reform on financial reporting. It provides optional expedients and exceptions for applying GAAP to contracts, hedging relationships, and other transactions affected by reference rate reform if certain criteria are met. The amendments in this update are effective for all entities as of March 12, 2020 through December 31, 2022. Bancorp is currently evaluating the impact of this ASU on the Company’s consolidated financial statements.   In accordance with Section 4013 of the CARES Act and in response to requests from borrowers who experienced business or personal cash flow interruptions related to the pandemic, Bancorp executed a payment deferral program. Depending on the demonstrated need of the customer, Bancorp deferred either the full loan payment or the interest only portion of respective loan payments for 90 or 180 days.  As of June 30, 2020, Bancorp executed 1,100 of full payment deferrals (predominantly three months) on outstanding loan balances of $ 502 million - representing 18 % of the loan portfolio (excluding PPP loans). Approximately 85 % of the total deferrals processed (in terms of dollars) occurred in the month of April, with the subsequent pace slowing significantly. Pursuant to the CARES Act, these loan deferrals were not classified as TDRs and not included in non-performing loan statistics. Subsequent to the end of the second quarter and through July, a significant portion of the deferred loan portfolio returned to full paying status. As of July 31, 2020, Bancorp estimates that 10 % of the total loan portfolio (excluding PPP loans) remained in full payment deferment status. Bancorp is monitoring loan modification expirations daily and anticipates the potential for more customers to return to full payment status over the next two months as their initial deferral period ends.   36 Table of Contents   During the three and six month periods ended June 30, 2020 and 2019, there were no loans modified as TDRs and there were no payment defaults of existing TDRs within 12 months following the modification. Default is determined at 90 or more days past due, charge-off, or foreclosure.   At June 30, 2020 and December 31, 2019, Bancorp had $ 177,000 and $ 239,000 , respectively, in residential real estate loans for which formal foreclosure proceedings were in process.   Purchased Credit Impaired Loans (Prior to the Adoption o f ASC 326 )   Management utilized the following criteria in determining which loans were classified as PCI loans for its 2019 acquisition: ●     Loans classified by management as substandard, doubtful or loss ●     Loans classified as non-accrual when acquired ●     Loans past due 90 days or more when acquired ●     Loans for which management assigned a non-accretable mark   The Bank acquired $ 1.6 million in PCI loans in connection with its 2019 acquisition. Under ASC 310 - 30, the non-accretable amount attributed to these loans equaled the contractually required principal at acquisition date and as of June 30, 2020.   The following table presents a roll forward of the accretable amount of PCI loans acquired in its 2013 acquisition:       Three months ended     Six months ended   (in thousands)   June 30, 2019     June 30, 2019                     Balance, beginning of period   $ ( 62 )   $ ( 68 ) Transfers between non-accretable and accretable     —       —   Net accretion into interest income on loans, including loan fees     5       11   Balance, end of period   $ ( 57 )   $ ( 57 )   37 Table of Contents     ( 5 ) Goodwill and Intangible Assets   Goodwill and intangible assets consist of the following:   (in thousands)   June 30, 2020     December 31, 2019                     Goodwill   $ 12,513     $ 12,513   Core deposit intangibles     2,122       2,285   Mortgage servicing rights     1,888       1,372       Goodwill represents $ 11.8 million related to the May 1, 2019 acquisition and $ 682,000 related to the 1996 purchase of a bank in southern Indiana. See the footnote titled “ Acquisition ” for further details. Related to the May 2019 acquisition, effective March 31, 2020, management finalized the fair values of the acquired assets and assumed liabilities ahead of the 12 months as allowed by GAAP.   GAAP requires that goodwill and intangible assets with indefinite useful lives not be amortized, but instead be tested for impairment at least annually. Impairment exists when a reporting unit’s carrying value of goodwill exceeds its fair value. Bancorp’s annual goodwill impairment test is conducted as of September 30 of each year or more often as situations dictate. At September 30, 2019, Bancorp’s Commercial Banking reporting unit had positive equity and Bancorp 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 not more-likely-than- not that the carrying value of the reporting unit exceeded its fair value. Therefore, Bancorp did not complete the two -step impairment test as of September 30, 2019. As of March 31, 2020 and June 30, 2020, consistent with market volatility and uncertain economic conditions resulting from the COVID- 19 pandemic, interim impairment testing was conducted and indicated that it was not more-likely-than- not that the carrying value of the reporting unit exceeded its fair value.   Changes in the carrying value of goodwill follows:       Three months ended     Six months ended       June 30,     June 30,   (in thousands)   2020     2019     2020     2019   Balance at beginning of period   $ 12,513     $ 682     $ 12,513     $ 682   Goodwill acquired     —       12,144       —       12,144   Recast adjustments     —       —       —       —   Impairment     —       —       —       —   Balance at end of period   $ 12,513     $ 12,826     $ 12,513     $ 12,826       Bancorp recorded CDI assets of $ 1.5 million and $ 2.5 million in association with its May 1, 2019 and 2013 acquisitions. See the footnote titled “ Acquisition ” for further details.   Changes in the net carrying amount of CDIs follows:       Three months ended     Six months ended       June 30,     June 30,   (in thousands)   2020     2019     2020     2019   Balance at beginning of period   $ 2,203     $ 1,015     $ 2,285     $ 1,056   Core deposit intangible acquired     —       1,519       —       1,519   Amortization     ( 81 )     ( 73 )     ( 163 )     ( 114 ) Balance at end of period   $ 2,122     $ 2,461     $ 2,122     $ 2,461     38 Table of Contents   MSRs, a component of other assets, are initially recognized at fair value when mortgage loans are sold with servicing retained. The MSRs are amortized in proportion to and over the period of estimated net servicing income, considering appropriate prepayment assumptions. MSRs are evaluated quarterly for impairment by comparing carrying value to fair value. Fair value is based on a valuation model that calculates the PV of estimated net servicing income. The model incorporates assumptions that market participants would use in estimating future net servicing income.   The estimated fair value of MSRs at both June 30, 2020 and December 31, 2019 were $3 million. There was no valuation allowance for MSRs as of June 30, 2020 and December 31, 2019, as fair value exceeded carrying value.   Changes in the net carrying amount of MSRs follows:       Three months ended     Six months ended       June 30,     June 30,   (in thousands)   2020     2019     2020     2019   Balance at beginning of period   $ 1,446     $ 1,070     $ 1,372     $ 1,022   Additions for mortgage loans sold     511       134       641       214   Amortization     ( 69 )     ( 36 )     ( 125 )     ( 68 ) Impairment     —       —       —       —   Balance at end of period   $ 1,888     $ 1,168     $ 1,888     $ 1,168       Total outstanding principal balances of loans serviced for others were $ 349 million and $ 327 million at June 30, 2020 and December 31, 2019, respectively.   39 Table of Contents     ( 6 ) Income Taxes   Components of income tax expense (benefit) from operations follow:       Three months ended     Six months ended       June 30,     June 30,   (in thousands)   2020     2019     2020     2019   Current income tax expense:                                 Federal   $ 4,363     $ 3,772     $ 6,205     $ 6,498   State     209       189       340       330   Total current income tax expense     4,572       3,961       6,545       6,828                                     Deferred income tax expense (benefit):                                 Federal     ( 1,798 )     224       ( 1,146 )     789   State     ( 427 )     ( 3,155 )     ( 803 )     ( 4,768 ) Total deferred income tax expense (benefit)     ( 2,225 )     ( 2,931 )     ( 1,949 )     ( 3,979 ) Change in valuation allowance     1       —       2       20   Total income tax expense   $ 2,348     $ 1,030     $ 4,598     $ 2,869       An analysis of the difference between the statutory and ETR from operations follows:       Three months ended     Six months ended       June 30,     June 30,       2020     2019     2020     2019   U.S. federal statutory income tax rate     21.0 %     21.0 %     21.0 %     21.0 % Tax credits     ( 5.9 )     ( 0.7 )     ( 5.9 )     ( 0.7 ) Kentucky state income tax enactments     ( 1.7 )     ( 14.1 )     ( 1.9 )     ( 10.7 ) Change in cash surrender value of life insurance     ( 2.0 )     ( 0.6 )     ( 0.4 )     ( 0.9 ) State income taxes, net of federal benefit     0.6       0.8       0.8       0.8   Excess tax benefit from stock-based compensation arrangements     ( 0.4 )     ( 0.4 )     -       ( 1.1 ) Tax exempt interest income     ( 0.2 )     ( 0.3 )     ( 0.3 )     ( 0.3 ) Other, net     3.5       0.2       1.4       0.1   Effective tax rate     14.9 %     5.9 %     14.7 %     8.2 %     Current state income tax expense represents tax owed to the state of Indiana. Kentucky and Ohio state bank taxes are currently based on capital levels and are recorded as other non-interest expense.   The ETR at June 30, 2020 includes one -half of the anticipated full year impact of a large historic tax credit project scheduled to be placed in service later in 2020.   In March 2019, the Kentucky Legislature passed HB354 requiring financial institutions to transition from a capital based franchise tax to the Kentucky corporate income tax beginning in 2021. Historically, the franchise tax, a component of non-interest expenses, was assessed at 1.1 % of net capital and averaged $ 2.5 million annually over the prior two year-end periods. The Kentucky corporate income tax will be assessed at 5 % of Kentucky taxable income and will be included as a component of current and deferred state income tax expense. Associated with this change, predominantly during the first quarter of 2019, Bancorp established a Kentucky state DTA related to existing temporary differences estimated to reverse after the effective date of the law change. Bancorp recorded a corresponding state tax benefit, net of federal tax impact of $ 1.3 million, or approximately $ 0.06 per diluted share for 2019. While this is positive in the short-term, Bancorp anticipates an unfavorable impact of approximately $ 200,000 per year beginning in 2021.   In April 2019, the Kentucky Legislature passed HB458 allowing entities filing a combined Kentucky income return to share certain tax attributes, including net operating loss carryforwards. The combined filing beginning in 2021 will allow Bancorp’s net operating loss carryforwards to offset against net revenue generated by the Bank up to 50 % of the Bank’s Kentucky taxable income and reduce Bancorp’s tax liability. Bancorp recorded a state tax benefit, net of federal tax impact of $ 2.4 million, predominantly in the second quarter of 2019, or approximately $ 0.11 per diluted share for 2019.  The losses are expected to be utilized when Bancorp begins filing a combined Kentucky income tax return. A valuation allowance is maintained for the loss that will expire in 2020.   GAAP provides guidance on financial statement recognition and measurement of tax positions taken, or expected to be taken, in tax returns. If recognized, tax benefits would reduce tax expense and accordingly, increase net income. The amount of unrecognized tax benefits may increase or decrease in the future for various reasons, including adding amounts for current year tax positions, expiration of open income tax returns due to statutes of limitation, changes in management’s judgment about the level of uncertainty, the status of examinations, litigation and legislative activity and the addition or elimination of uncertain tax positions. As of June 30, 2020 and December 31, 2019, the gross amount of unrecognized tax benefits was immaterial to the consolidated financial statements of Bancorp. Federal and state income tax returns are subject to examination for the years after 2015.   40 Table of Contents     ( 7 ) Deposits   The composition of the Bank’s deposits follows:   (in thousands)   June 30, 2020     December 31, 2019                     Non-interest bearing demand deposits   $ 1,205,253     $ 810,475                     Interest bearing deposits:                 Interest bearing demand     1,147,357       979,595   Savings     196,655       169,622   Money market     761,256       742,029                     Time deposits of $250 thousand or more     76,954       81,412   Other time deposits(1)     339,681       350,805   Total time deposits     416,635       432,217                     Total interest bearing deposits     2,521,903       2,323,463                     Total deposits   $ 3,727,156     $ 3,133,938     ( 1 )     Includes $ 30 million in broke red deposits as of both June 30 , 2020 and December 31, 2019 .   Deposits totaling $ 126 million were acquired on May 1, 2019, associated with an acquisition.       ( 8 ) Securities Sold Under Agreements to Repurchase   SSUAR represent a funding source of Bancorp and are primarily used by commercial customers in conjunction with collateralized corporate cash management accounts. Such repurchase agreements are considered financing agreements and mature within one business day from the transaction date. At June 30, 2020, all of these financing arrangements had overnight maturities and were secured by government sponsored enterprise obligations and government agency mortgage-backed securities that were owned and controlled by Bancorp.   Information concerning SSUAR follows:   (dollars in thousands)   June 30, 2020     December 31, 2019   Outstanding balance at end of period   $ 42,722     $ 31,895   Weighted average interest rate at end of period     0.08 %     0.22 %         Three months ended     Six months ended       June 30,     June 30,   (dollars in thousands)   2020     2019     2020     2019                                     Average outstanding balance during the period   $ 41,517     $ 39,969     $ 37,465     $ 38,755   Average interest rate during the period     0.08 %     0.28 %     0.13 %     0.28 % Maximum outstanding at any month end during the period   $ 42,722     $ 43,160     $ 42,722     $ 43,160     41 Table of Contents     ( 9 ) FHLB Advances   Bancorp had 49 separate advances totaling $ 61 million outstanding as of June 30, 2020 as compared with 57 separate advances totaling $ 80 million as of December 31, 2019. As a result of the 2019 acquisition, Bancorp assumed 46 advances totaling $ 43 million, with maturities extending to 2028. These advances were discounted to fair value as of the acquisition date. See the footnote titled “ Acquisition ” for further details. As of June 30, 2020, for 10 advances totaling $ 38 million, all of which are non-callable, interest payments are due monthly, with principal due at maturity. For the remaining advances, principal and interest payments are due monthly based on an amortization schedule.   The following is a summary of the contractual maturities and average effective rates of outstanding advances:   (dollars in thousands)   June 30, 2020     December 31, 2019   Maturity           Weighted average             Weighted average   Year   Advance     Fixed Rate     Advance     Fixed Rate   2020   $ 37,533       0.67 %   $ 50,004       1.99 % 2021     2,281       2.57       2,400       2.52   2022     —       —       —       —   2023     360       1.01       456       1.00   2024     1,479       2.36       2,023       2.36   2025     3,055       2.43       3,774       2.41   2026     5,625       1.95       8,156       1.96   2027     6,323       1.75       7,445       1.73   2028     4,776       2.33       5,695       2.32                                     Total   $ 61,432       1.22 %   $ 79,953       2.02 %     FHLB advances are collateralized by certain CRE and residential real estate mortgage loans under blanket mortgage collateral pledge agreements, as well as Bancorp’s PPP loan portfolio and FHLB stock. Bancorp views these advances as an effective lower-costing alternative to brokered deposits to fund loan growth. At June 30, 2020 and December 31, 2019, the amount of available credit from the FHLB totaled $ 806 million and $ 599 million, respectively. Bancorp also had $ 80 million and $ 105 million in FFP lines available from correspondent banks at June 30, 2020 and December 31, 2019, respectively, with the decrease resulting from the closing of an inactive correspondent relationship during the second quarter.   42 Table of Contents     ( 10 ) Commitments and Contingent Liabilities   As of June 30, 2020 and December 31, 2019, Bancorp had various commitments outstanding that arose in the normal course of business which are properly not reflected in the consolidated financial statements. Total off balance sheet commitments to extend credit follows:   (in thousands)   June 30, 2020     December 31, 2019   Commercial and industrial   $ 501,632     $ 416,195   Construction and development     229,676       240,503   Home equity     167,409       155,920   Credit cards     30,789       26,439   Overdrafts     34,149       32,715   Letters of credit     22,352       24,193   Other     44,782       40,083   Future loan commitments     207,847       236,885                     Total off balance sheet commitments to extend credit   $ 1,238,636     $ 1,172,933     Commitments to extend credit are an agreement to lend to a customer either unsecured or secured, as long as collateral is available as agreed upon and there is no violation of any condition established in the contract. Commitments generally have fixed expiration dates or other termination clauses. Since some of the commitments are expected to expire without being drawn upon, the total commitment amounts do not represent future cash requirements. Bancorp uses the same credit and collateral policies in making commitments and conditional guarantees as for on-balance sheet instruments. Bancorp evaluates each customer’s creditworthiness on a case-by-case basis. The amount of collateral obtained is based on management’s credit evaluation of the customer. Collateral held varies but may include accounts receivable, inventory, securities, equipment and real estate. However, should the commitments be drawn upon and should our customers default on their resulting obligation to us, our maximum exposure to credit loss, without consideration of collateral, is represented by the contractual amount of those instruments.   At June 30, 2020 and December 31, 2019, Bancorp had accrued $ 6 million and $ 350,000 , respectively, in other liabilities for its estimate of inherent risks related to unfunded credit commitments. In accordance with the adoption of ASC 326 on January 1, 2020, Bancorp’s ACL on off-balance sheet exposures was increased from $ 350,000 at December 31, 2019 to $ 3.9 million ($ 2.6 million net of the DTA) with the offset recorded to retained earnings on a tax-effected basis, with no impact on earnings.   Standby letters of credit are conditional commitments issued by Bancorp to guarantee the performance of a customer to a first party beneficiary. Those guarantees are primarily issued to support commercial transactions. Standby letters of credit generally have maturities of one to two years.   Certain commercial customers require confirmation of Bancorp’s letters of credit by other banks since Bancorp does not have a rating by a national rating agency. Terms of the agreements range from one month to a year with certain agreements requiring between one and six months’ notice to cancel. If an event of default on all contracts had occurred at June 30, 2020, Bancorp would have been required to make payments of approximately $ 2.2 million, or the maximum amount payable under those contracts. No payments have ever been required because of default on these contracts. These agreements are normally secured by collateral acceptable to Bancorp, which limits credit risk associated with the agreements.   As of June 30, 2020, in the normal course of business, there were pending legal actions and proceedings in which claims for damages are asserted. Management, after discussion with legal counsel, believes the ultimate result of these legal actions and proceedings will not have a material adverse effect on the consolidated financial position or results of operations of Bancorp.   43 Table of Contents     ( 11 ) Assets and Liabilities Measured and Reported at Fair Value   Fair value represents the exchange price that would be received for an asset or paid to transfer a liability (exit price) in the principal or most advantageous market for the asset or liability in an orderly transaction between market participants on the measurement date. There are three levels of inputs that may be used to measure fair values:   Level 1 – Quoted prices (unadjusted) for identical assets or liabilities in active markets that the entity has the ability to access as of the measurement date.   Level 2 – Significant other 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.   Level 3 – Significant unobservable inputs that reflect a company’s own assumptions about the assumptions that market participants would use in pricing an asset or liability.   The methods of determining the fair value of assets and liabilities presented in this note are consistent with the methodologies disclosed in Bancorp’s 2019 Annual Report on Form 10 -K.   Assets and liabilities measured at fair value on a recurring basis are summarized as follows:       Fair Value Measurements Using     Total   June 30, 2020 (in thousands)   Level 1     Level 2     Level 3     Fair Value   Assets:                                 Available for sale debt securities:                                 Government sponsored enterprise obligations   $ —     $ 204,411     $ —     $ 204,411   Mortgage backed securities - government agencies     —       270,254       —       270,254   Obligations of states and political subdivisions     —       10,584       —       10,584                                     Total available for sale debt securities     —       485,249       —       485,249                                     Interest rate swaps     —       9,895       —       9,895                                     Total assets   $ —     $ 495,144     $ —     $ 495,144                                     Liabilities:                                 Interest rate swaps   $ —     $ 10,283     $ —     $ 10,283         Fair Value Measurements Using     Total   December 31, 2019 (in thousands)   Level 1     Level 2     Level 3     Fair Value   Assets:                                 Available for sale debt securities:                                 U.S. Treasury and other U.S. government obligations   $ 49,897     $ —     $ —     $ 49,897   Government sponsored enterprise obligations     —       209,944       —       209,944   Mortgage backed securities - government agencies     —       193,861       —       193,861   Obligations of states and political subdivisions     —       17,036       —       17,036                                     Total available for sale debt securities     49,897       420,841       —       470,738                                     Interest rate swaps     —       2,696       —       2,696                                     Total assets   $ 49,897     $ 423,537     $ —     $ 473,434                                     Liabilities:                                 Interest rate swaps   $ —     $ 2,767     $ —     $ 2,767       There were no transfers into or out of Level 3 of the fair value hierarchy during 2020 or 2019.     44 Table of Contents   Assets measured at fair value on a non-recurring basis are summarized as follows:                                       Losses recorded                                               Three months     Six months       Fair Value Measurements Using     Total     ended     ended   June 30, 2020 (in thousands)   Level 1     Level 2     Level 3     Fair Value     June 30, 2020     June 30, 2020                                                     Collateral dependent loans   $ —     $ —     $ 8,434     $ 8,434     $ —     $ —   Other real estate owned     —       —       493       493       —       —                                         Losses recorded                                               Three months     Six months       Fair Value Measurements Using     Total     ended     ended   December 31, 2019 (in thousands)   Level 1     Level 2     Level 3     Fair Value     June 30, 2019     June 30, 2019                                                     Impaired loans   $ —     $ —     $ 7,253     $ 7,253     $ —     $ —   Other real estate owned     —       —       493       493       —       —     There were no liabilities measured at fair value on a non-recurring basis at June 30, 2020 and December  31, 2019.   For Level 3 assets measured at fair value on a non-recurring basis, the significant unobservable inputs used in the fair value measurements are presented below.       June 30, 2020   (dollars in thousands)   Fair Value   Valuation Technique   Unobservable Inputs   Weighted Average                           Collateral dependent loans   $ 8,434   Appraisal   Appraisal discounts     7.2 % Other real estate owned     493   Appraisal   Appraisal discounts     17.1         December 31, 2019   (dollars in thousands)   Fair Value   Valuation Technique   Unobservable Inputs   Weighted Average                           Impaired loans - collateral dependent   $ 7,253   Appraisal   Appraisal discounts     60.3 % Other real estate owned     493   Appraisal   Appraisal discounts     17.1       Collateral Dependent Loans with an ACL (Impaired Loans with Specific Reserves prior to the adoption of ASC 326 ) : For collateral-dependent loans where Bancorp has determined that foreclosure of the collateral is probable, or where the borrower is experiencing financial difficulty and the Company expects repayment of the loan to be provided substantially through the operation or sale of the collateral, the ACL is measured based on the difference between the fair value of the collateral and the amortized cost basis of the loan as of the measurement date. For real estate loans, fair value of the loan’s collateral is determined by third party appraisals, which are then adjusted for the estimated selling and closing costs related to liquidation of the collateral. For this asset class, the actual valuation methods (income, comparable sales, or cost) vary based on the status of the project or property. For example, land is generally based on the comparable sales method while construction and improved real estate is based on the income and/or comparable sales methods. The unobservable inputs may vary depending on the individual assets with no one of the three methods being the predominant approach. Bancorp reviews the third party appraisal for appropriateness and adjusts the value downward to consider selling and closing costs, which typically range from 8 % to 10 % of the appraised value. For non-real estate loans, fair value of the loan’s collateral may be determined using an appraisal, net book value per the borrower’s financial statements, or aging reports, adjusted or discounted based on management’s historical knowledge, changes in market conditions from the time of the valuation and management’s expertise and knowledge of the client and client’s business.   45 Table of Contents   Other Real Estate Owned : OREO is primarily comprised of real estate acquired in partial or full satisfaction of loans. OREO is recorded at its estimated fair value less estimated selling and closing costs at the date of transfer, with any excess of the related loan balance over the fair value less expected selling costs charged to the ACL. Subsequent changes in fair value are reported as adjustments to the carrying amount and are recorded against earnings. Bancorp outsources the valuation of OREO with material balances to third party appraisers. For this asset class, the actual valuation methods (income, sales comparable, or cost) vary based on the status of the project or property. For example, land is generally based on the sales comparable method while construction and improved real estate is based on the income and/or sales comparable methods. The unobservable inputs may vary depending on the individual assets with no one of the three methods being the predominant approach. Bancorp reviews the third party appraisal for appropriateness and adjusts the value downward to consider selling and closing costs, which typically range from 8 % to 10 % of the appraised value.   The estimated fair values of Bancorp’s financial instruments not measured at fair value on a recurring or non-recurring basis follows:     (in thousands)   Carrying             Fair Value Measurements Using   June 30, 2020   amount     Fair value     Level 1     Level 2     Level 3                                             Assets                                         Cash and cash equivalents   $ 224,394     $ 224,394     $ 224,394     $ —     $ —   Mortgage loans held for sale     17,364       18,008       —       18,008       —   Federal Home Loan Bank stock     11,284       11,284       —       11,284       —   Loans, net     3,416,369       3,454,659       —       —       3,454,659   Accrued interest receivable     13,535       13,535       13,535       —       —                                             Liabilities                                         Non-interest bearing deposits   $ 1,205,253     $ 1,205,253     $ —     $ 1,205,253     $ —   Transaction deposits     2,105,268       2,105,268       —       2,105,268       —   Time deposits     416,635       422,131       —       422,131       —   Securities sold under agreement to repurchase     42,722       42,722       —       42,722       —   Federal funds purchased     8,401       8,401       —       8,401       —   Federal Home Loan Bank advances     61,432       63,436       —       63,436       —   Accrued interest payable     471       471       471       —       —       (in thousands)   Carrying             Fair Value Measurements Using   December 31, 2019   amount     Fair value     Level 1     Level 2     Level 3                                             Assets                                         Cash and cash equivalents   $ 249,724     $ 249,724     $ 249,724     $ —     $ —   Mortgage loans held for sale     8,748       8,923       —       8,923       —   Federal Home Loan Bank stock     11,284       11,284       —       11,284       —   Loans, net     2,818,225       2,841,767       —       —       2,841,767   Accrued interest receivable     8,534       8,534       8,534       —       —                                             Liabilities                                         Non-interest bearing deposits   $ 810,475     $ 810,475     $ —     $ 810,475     $ —   Transaction deposits     1,891,246       1,891,246       —       1,891,246       —   Time deposits     432,217       434,927       —       434,927       —   Securities sold under agreement to repurchase     31,895       31,895       —       31,895       —   Federal funds purchased     10,887       10,887       —       10,887       —   Federal Home Loan Bank advances     79,953       80,906       —       80,906       —   Accrued interest payable     640       640       640       —       —     Fair value estimates are made at a specific point in time based on relevant market information and information about financial instruments. Because no market exists for a significant portion of Bancorp’s financial instruments, fair value estimates are based on judgments regarding future expected loss experience, current economic conditions, risk characteristics of various financial instruments and other factors. These estimates are subjective in nature and involve uncertainties and matters of significant judgment and therefore cannot be determined with precision. Therefore, calculated fair value estimates in many instances cannot be substantiated by comparison to independent markets and, in many cases, may not be realizable in a current sale of the instrument. Changes in assumptions could significantly impact estimates.   46 Table of Contents     ( 12 ) Other Comprehensive Income (Loss)   The following table illustrates activity within the balances of AOCI by component:   (in thousands)   Net unrealized gains (losses) on available for sale debt securities     Net unrealized gains (losses) on cash flow hedges     Minimum pension liability adjustment     Total   Three months ended June 30, 2020                                 Balance, March 31, 2020   $ 7,123     $ ( 302 )   $ ( 369 )   $ 6,452   Net current period other comprehensive income (loss)     2,343       21       —       2,364   Balance, June 30, 2020   $ 9,466     $ ( 281 )   $ ( 369 )   $ 8,816                                     Three months ended June 30, 2019                                 Balance, March 31, 2019   $ ( 2,536 )   $ 234     $ ( 211 )   $ ( 2,513 ) Net current period other comprehensive income (loss)     3,827       ( 248 )     —       3,579   Balance, June 30, 2019   $ 1,291     $ ( 14 )   $ ( 211 )   $ 1,066       (in thousands)   Net unrealized gains (losses) on available for sale debt securities     Net unrealized gains (losses) on cash flow hedges     Minimum pension liability adjustment     Total   Six months ended June 30, 2020                                 Balance, January 1, 2020   $ 1,085     $ ( 39 )   $ ( 369 )   $ 677   Net current period other comprehensive income (loss)     8,381       ( 242 )     —       8,139   Balance, June 30, 2020   $ 9,466     $ ( 281 )   $ ( 369 )   $ 8,816                                     Six months ended June 30, 2019                                 Balance, January 1, 2019   $ ( 5,330 )   $ 408     $ ( 220 )   $ ( 5,142 ) Net current period other comprehensive income (loss)     6,621       ( 422 )     9       6,208   Balance, June 30, 2019   $ 1,291     $ ( 14 )   $ ( 211 )   $ 1,066     47 Table of Contents     ( 13 ) Preferred Stock   Bancorp has one class of preferred stock ( no par value; 1,000,000 shares authorized), the relative rights, preferences and other terms of the class or any series within the class will be determined by the Board of Directors prior to any issuance. None of this stock has been issued to date.         ( 14 ) Net Income Per Share   The following table reflects net income (numerator) and average shares outstanding (denominator) for basic and diluted net income per share computations:       Three months ended     Six months ended       June 30,     June 30,   (in thousands, except per share data)   2020     2019     2020     2019   Net income   $ 13,368     $ 16,543     $ 26,600     $ 32,184                                     Weighted average shares outstanding - basic     22,560       22,689       22,538       22,675   Dilutive securities     179       260       199       273   Weighted average shares outstanding- diluted     22,739       22,949       22,737       22,948                                     Net income per share - basic   $ 0.59     $ 0.73     $ 1.18     $ 1.42   Net income per share - diluted     0.59       0.72       1.17       1.40       Certain SARs that were excluded from the EPS calculation because their impact was antidilutive were as follows:       Three months ended     Six months ended   (in thousands)   June 30,     June 30,       2020     2019     2020     2019   Antidilutive SARs     248       200       248       200     48 Table of Contents     ( 15 ) Stock-Based Compensation   The fair value of all stock-based awards granted, net of estimated forfeitures, is recognized as compensation expense over the respective service period.   At Bancorp's 2015 Annual Meeting of Shareholders, shareholders approved the 2015 Omnibus Equity Compensation Plan and authorized the shares available from the expiring 2005 plan for future awards under the 2015 plan. In 2018, shareholders approved an additional 500,000 shares for issuance under the plan. As of June 30, 2020, there were 397,000 shares available for future awards. The 2005 Stock Incentive Plan expired in April 2015 and SARs granted under this plan expire as late as 2025. The 2015 Stock Incentive Plan has no defined expiration date.   SAR Grants – SARs granted have a vesting schedule of 20 % per year and expire ten years after the grant date unless forfeited due to employment termination.   Fair values of SARs are estimated at the date of grant using the Black-Scholes option-pricing model, a leading formula for calculating such value. This model requires the input of assumptions, changes to which can materially impact the fair value estimate. The following assumptions were used in SAR valuations at the grant date in each year:   Assumptions   2020     2019                     Dividend yield     2.51 %     2.52 % Expected volatility     20.87 %     20.40 % Risk free interest rate     1.25 %     2.55 % Expected life (in years)     7.1       7.2       Dividend yield and expected volatility are based on historical information for Bancorp corresponding to the expected life of SARs granted. Expected volatility is the volatility of underlying shares for the expected term calculated on a monthly basis. The risk free interest rate is the implied yield currently available on U.S. Treasury issues with a remaining term equal to the expected life of the awards. The expected life of SARs is based on actual experience of past like-term SARs. Bancorp evaluates historical exercise and post-vesting termination behavior when determining the expected life.   RSA Grants – RSAs granted to officers vest over five years. For all grants prior to 2015, grantees are entitled to dividend payments during the vesting period. For grants in 2015 and forward, forfeitable dividends are deferred until shares are vested. Fair value of RSAs is equal to the market value of the shares on the date of grant.   PSU Grants – PSUs vest based upon service and a three -year performance period, which begins January 1 of the first year of the performance period. Because grantees are not entitled to dividend payments during the performance period, the fair value of these PSUs is estimated based upon the market value of the underlying shares on the date of grant, adjusted for non-payment of dividends. Grants require a one -year post-vesting holding period and the fair value of such grants incorporates a liquidity discount related to the holding period of 4.4 % and 4.1 % for 2020 and 2019.   RSU Grants – RSUs are only granted to non-employee directors, are time-based and vest 12 months after grant date. Because grantees are entitled to deferred dividend payments at the end of the vesting period, fair value of the RSUs equals market value of underlying shares on the date of grant.   In the first quarters of 2020 and 2019, Bancorp awarded 6,570 and 9,834 RSUs to non-employee directors of Bancorp with a grant date fair value of $ 270,000 and $ 247,000 , respectively.   Bancorp utilized cash of $ 224,000 and $ 272,000 during the first six months of 2020 and 2019, respectively, for the purchase of shares upon the vesting of RSUs.   49 Table of Contents   Bancorp has recognized stock-based compensation expense for SARs, RSAs and PSUs within compensation expense and RSUs for directors within other non-interest expense, as follows:       Three months ended June 30, 2020   (in thousands)   Stock Appreciation Rights     Restricte Stock Awards     Restricted Stock Units     Performance Stock Units     Total                                             Expense   $ 87     $ 317     $ 67     $ 505     $ 976   Deferred tax benefit     ( 18 )     ( 67 )     ( 14 )     ( 106 )     ( 205 ) Total net expense   $ 69     $ 250     $ 53     $ 399     $ 771           Three months ended June 30, 2019   (in thousands)   Stock Appreciation Rights     Restricte Stock Awards     Restricted Stock Units     Performance Stock Units     Total                                             Expense   $ 86     $ 306     $ 83     $ 518     $ 993   Deferred tax benefit     ( 18 )     ( 65 )     ( 17 )     ( 109 )     ( 209 ) Total net expense   $ 68     $ 241     $ 66     $ 409     $ 784             Six months ended June 30, 2020   (in thousands)   Stock Appreciation Rights     Restricted Stock Awards     Restricted Stock Units     Performance Stock Units     Total                                             Expense   $ 177     $ 643     $ 135     $ 838     $ 1,793   Deferred tax benefit     ( 37 )     ( 135 )     ( 28 )     ( 177 )     ( 377 ) Total net expense   $ 140     $ 508     $ 107     $ 661     $ 1,416           Six months ended June 30, 2019   (in thousands)   Stock Appreciation Rights     Restricted Stock Awards     Restricted Stock Units     Performance Stock Units     Total                                             Expense   $ 170     $ 599     $ 164     $ 923     $ 1,856   Deferred tax benefit     ( 36 )     ( 126 )     ( 34 )     ( 194 )     ( 390 ) Total net expense   $ 134     $ 473     $ 130     $ 729     $ 1,466     Detail of unrecognized stock-based compensation expense follows:   (in thousands) Year ended   Stock Appreciation Rights     Restricted Stock Awards     Restricted Stock Units     Performance Stock Units     Total                                             Remainder of 2020   $ 176     $ 636     $ 135     $ 1,182     $ 2,129   2021     304       1,090       1       952       2,347   2022     249       823       —       490       1,562   2023     174       580       —       —       754   2024     68       305       —       —       373   2025     9       29       —       —       38   Total estimated expense   $ 980     $ 3,463     $ 136     $ 2,624     $ 7,203     50 Table of Contents   The following table summarizes SARs activity and related information:                                               Weighted                       Weighted             Weighted     average                       average     Aggregate     average     remaining             Exercise     exercise     intrinsic     fair     contractual   (in thousands, except per share data)   SARs   price     price     value (1)     value     life (in years)                                                     Outstanding, January 1, 2019     731   $ 14.02 - $ 40.00     $ 22.42     $ 8,422     $ 3.83       5.2   Granted     53   36.65 - 38.18       37.01       213       6.24           Exercised     ( 143 ) 14.02 - 22.96       15.99       3,025       3.47           Forfeited     —     —         —       —       —           Outstanding, December 31, 2019     641   $ 14.02 - $ 40.00     $ 25.06     $ 10,250     $ 4.10       5.3                                                     Outstanding, January 1, 2020     641   $ 14.02 - $ 40.00     $ 25.06     $ 10,250     $ 4.10       5.3   Granted     48   37.30 - 37.30       37.30       140       5.80           Exercised     ( 12 ) 14.02 - 15.84       15.19       279       3.09           Forfeited     —     —         —       —       —           Outstanding, June 30, 2020     677   $ 15.24 - $ 40.00     $ 26.10     $ 9,550     $ 4.24       5.2                                                     Vested and exercisable     485   $ 15.24 - $ 40.00     $ 21.87     $ 8,887     $ 3.62       3.9   Unvested     192   24.56 - 40.00       36.76       663       5.81       8.3   Outstanding, June 30, 2020     677   $ 15.24 - $ 40.00     $ 26.10     $ 9,550     $ 4.24       5.2                                                     Vested at June 30, 2020     57   $ 22.96 - $ 40.00     $ 30.80     $ 537     $ 5.02             ( 1 ) - In trinsic value for SARs is defined as the amount by which the current market price of the underlying stock exceeds the exercise or grant price.     The following table summarizes activity for RSAs granted to officers:               Grant date               weighted   (in thousands, except per share data)   RSAs     average cost                     Unvested at January 1, 2019     110     $ 32.09   Shares awarded     40       34.88   Restrictions lapsed and shares released     ( 40 )     28.74   Shares forfeited     ( 2 )     35.36   Unvested at December 31, 2019     108     $ 34.31                     Unvested at January 1, 2020     108     $ 34.31   Shares awarded     36       39.30   Restrictions lapsed and shares released     ( 38 )     32.13   Shares forfeited     ( 1 )     36.70   Unvested at June 30, 2020     105     $ 36.81       Shares expected to be awarded for PSUs granted to executive officers of Bancorp, the three -year performance period for which began January 1 of the award year, are as follows:       Vesting             Expected   Grant   period     Fair     shares to   year   in years     value     be awarded   2018   3     $ 31.54       71,932   2019   3       32.03       43,603   2020   3       32.27       45,577     51 Table of Contents     ( 16 ) Derivative Financial Instruments   Periodically, Bancorp enters into interest rate swap transactions with borrowers who desire to hedge exposure to rising interest rates, while at the same time entering into an offsetting interest rate swap, with substantially matching terms, with another approved independent counterparty. These are undesignated derivative instruments and are recognized on the balance sheet at fair value. Because of matching terms of offsetting contracts and collateral provisions mitigating any non-performance risk, changes in fair value subsequent to initial recognition have an insignificant effect on earnings. Exchanges of cash flows related to undesignated interest rate swap agreements were offsetting and therefore had no effect on Bancorp’s earnings or cash flows.   Interest rate swap agreements derive their value from underlying interest rates. These transactions involve both credit and market risk. Notional amounts are amounts on which calculations, payments and the value of the derivative are based. Notional amounts do not represent direct credit exposures. Direct credit exposure is limited to the net difference between the calculated amounts to be received and paid, if any. Bancorp is exposed to credit-related losses in the event of non-performance by counterparties to these agreements. Bancorp mitigates the credit risk of its financial contracts through credit approvals, limits, collateral and monitoring procedures, and does not expect any counterparties to fail their obligations.   Bancorp had outstanding undesignated interest rate swap contracts as follows:       Receiving     Paying       June 30,     December 31,     June 30,     December 31,   (dollars in thousands)   2020     2019     2020     2019                                     Notional amount   $ 103,526     $ 99,000     $ 103,526     $ 99,000   Weighted average maturity (years)     7.9       8.2       7.9       8.2   Fair value   $ 9,895     $ 2,696     $ 9,914     $ 2,767       In 2015, Bancorp entered into an interest rate swap to hedge cash flows of a $ 20 million rolling fixed-rate three -month FHLB borrowing. The swap began December 9, 2015 and matures December 6, 2020. In 2016, Bancorp entered into an interest rate swap to hedge cash flows of a $ 10 million rolling fixed-rate three -month FHLB borrowing. The swap began December 6, 2016 and matures December 6, 2021. For purposes of hedging, rolling fixed rate advances are considered to be floating rate liabilities. Interest rate swaps involve exchange of Bancorp’s floating rate interest payments for fixed rate swap payments on underlying principal amounts. These swaps were designated and qualified, for cash-flow hedge accounting. For derivative instruments that are designated and qualify as cash flow hedging instruments, the effective portion of gains or losses is reported as a component of OCI, and is subsequently reclassified into earnings as an adjustment to interest expense in periods for which the hedged forecasted transaction impacts earnings.     The following table details the notional and fair value amounts of Bancorp’s derivative positions designated as cash flow hedges:   (dollars in thousands)                                               Fair value   Notional   Maturity   Receive (variable)   Pay fixed     assets (liabilities)   amount   date   index   swap rate     June 30, 2020     December 31, 2019   $ 10,000   12/6/2021   US 3 Month LIBOR     1.89 %   $ ( 239 )   $ ( 45 )   20,000   12/6/2020   US 3 Month LIBOR     1.79 %     ( 130 )     ( 6 ) $ 30,000             1.82 %   $ ( 369 )   $ ( 51 )   52 Table of Contents     ( 17 ) Regulatory Matters   Bancorp and the Bank are subject to capital regulations in accordance with Basel III, as administered by banking regulators. Regulatory agencies measure capital adequacy within a framework that makes capital requirements, in part, dependent on the individual risk profiles of financial institutions. Failure to meet minimum capital requirements can initiate certain mandatory and possibly additional discretionary actions by regulators that, if undertaken, could have a direct material effect on Bancorp’s financial statements. Under capital adequacy guidelines and the regulatory framework for prompt corrective action, Bancorp and the Bank must meet specific capital guidelines that involve quantitative measures of Bancorp’s assets, liabilities and certain off-balance sheet items, as calculated under regulatory accounting practices. The capital amounts and classification are also subject to qualitative judgments by the regulators regarding components, risk weightings and other factors.   Banking regulators have categorized the Bank as well-capitalized. The regulations in accordance with Basel III define “well capitalized” as a 6.5 % Common Equity Tier 1 Risk-Based Capital ratio, an 8.0 % Tier 1 Risk-Based Capital ratio, a 10.0 % Total Risk-Based Capital ratio and a 5.0 % Tier 1 Leverage ratio. Additionally, in order to avoid limitations on capital distributions, including dividend payments and certain discretionary bonus payments to executive officers, Bancorp and Bank must hold a capital conservation buffer composed of Common Equity Tier 1 Risk-Based Capital above their minimum risk-based capital requirements. The capital conservation buffer set forth by the Basel III regulatory capital framework was 2.5 % of risk-weighted assets above the minimum risk based capital ratio requirements at June 30, 2020 and December 31, 2019. The capital conservation buffer is designed to absorb losses during periods of economic stress and requires increased capital levels for the purpose of capital distributions and other payments. Failure to meet the full amount of the buffer will result in restrictions on Bancorp’s ability to make capital distributions, including dividend payments and stock repurchases, and to pay discretionary bonuses to executive officers. At June 30, 2020 and December 31, 2019, Bancorp’s and the Bank’s risk-based capital exceeded the required capital conservation buffer.   Bancorp continues to exceed the regulatory requirements to be considered “well-capitalized” for Total Risk Based Capital, Common Equity Tier I Risk Based Capital, Tier I Risk Based Capital and Tier I Leverage. Bancorp and the Bank intend to maintain a capital position that meets or exceeds the well-capitalized requirements as defined by the FRB and the FDIC, in addition to the Capital Conservation Buffer. There are no conditions or events since June 30, 2020 that management believes have changed Bancorp’s well-capitalized status.   As permitted by the interim final rule issued on March 27, 2020 by the federal banking regulatory agencies, Bancorp elected the option to delay the estimated impact on regulatory capital related to the adoption of ASC 326 “ Financial Instruments – Credit Losses ,” or CECL , which was effective January 1, 2020. The initial impact of adoption of ASC 326, as well as 25% of the quarterly increases in the ACL subsequent to adoption of ASC 326 (collectively the “transition adjustments”) were declared to be delayed for two years. After two years, the cumulative amount of the transition adjustments will become fixed and will be phased out of the regulatory capital calculations evenly over a three -year period, with 75% recognized in year three, 50% recognized in year four and 25% recognized in year five. After five years, the temporary regulatory capital benefits will be fully reversed. Had Bancorp elected not to defer the regulatory capital impact of CECL, the post ASC 326 adoption capital ratios of Bancorp and the Bank would have exceeded the well-capitalized level.   Dividends paid by Bancorp are limited to, without prior regulatory approval, current year earnings and earnings less dividends paid during the preceding two years.   53 Table of Contents   The following table sets forth consolidated Bancorp’s and the Bank’s risk based capital amounts and ratios:   (dollars in thousands)   Actual     Minimum for adequately capitalized     Minimum for well capitalized   June 30, 2020   Amount     Ratio     Amount     Ratio     Amount     Ratio                                                     Total risk-based capital (1)                                                 Consolidated   $ 446,117       13.50 %   $ 264,297       8.00 %   NA     NA   Bank     430,654       13.07       263,610       8.00     $ 329,512       10.00 %                                                   Common equity tier 1 risk-based capital                                                 Consolidated     409,251       12.39       148,667       4.50     NA     NA   Bank     393,788       11.95       148,280       4.50       214,183       6.50                                                     Tier 1 risk-based capital (1)                                                 Consolidated     409,251       12.39       198,223       6.00     NA     NA   Bank     393,788       11.95       197,707       6.00       263,610       8.00                                                     Leverage (2)                                                 Consolidated     409,251       9.50       172,277       4.00     NA     NA   Bank     393,788       9.15       172,124       4.00       215,155       5.00       (dollars in thousands)   Actual     Minimum for adequately capitalized     Minimum for well capitalized   December 31, 2019   Amount     Ratio     Amount     Ratio     Amount     Ratio                                                     Total risk-based capital (1)                                                 Consolidated   $ 418,460       12.85 %   $ 260,448       8.00 %   NA     NA   Bank     396,299       12.20       259,823       8.00     $ 324,778       10.00 %                                                   Common equity tier 1 risk-based capital                                                 Consolidated     391,319       12.02       146,502       4.50     NA     NA   Bank     369,158       11.37       146,150       4.50       211,106       6.50                                                     Tier 1 risk-based capital (1)                                                 Consolidated     391,319       12.02       195,336       6.00     NA     NA   Bank     369,158       11.37       194,867       6.00       259,823       8.00                                                     Leverage (2)                                                 Consolidated     391,319       10.60       147,733       4.00     NA     NA   Bank     369,158       10.67       138,392       4.00       172,990       5.00     ( 1 )     Ratio is computed in relation to risk-weighted assets. ( 2 )     Ratio is computed in relation to average assets.      NA – Not Applicable   54 Table of Contents     ( 18 ) Segments   Bancorp’s principal activities include commercial banking and WM&T. Commercial banking provides a full range of loan and deposit products to individual consumers and businesses. Commercial banking also includes Bancorp’s mortgage banking and investment products sales activity. WM&T provides custom-tailored financial planning, investment management, company retirement plan management, retirement planning, trust and estate services in all markets in which Bancorp operates. The magnitude of WM&T revenue distinguishes Bancorp from other community banks of similar asset size.   Financial information for each business segment reflects that which is specifically identifiable or allocated based on an internal allocation method. Income taxes are allocated based on the effective federal income tax rate adjusted for any tax-exempt activity. All tax-exempt activity and provision have been allocated fully to the commercial banking segment. Measurement of performance of business segments is based on the management structure of Bancorp and is not necessarily comparable with similar information for any other financial institution. Information presented is also not necessarily indicative of the segments’ operations if they were independent entities.   Principally, all of the net assets of Bancorp are involved in the commercial banking segment. Goodwill of $ 12.5 million, of which $ 682,000 relates to a bank acquisition in 1996 and $ 11.8 million relates to the May 2019 acquisition, has been assigned to the commercial banking segment. Assets assigned to WM&T primarily consist of net premises and equipment and a receivable related to fees earned that have not been collected.   Selected financial information by business segment follows:       Three months ended June 30, 2020     Three months ended June 30, 2019                                                     (dollars in thousands)   Commercial Banking     WM&T     Total     Commercial Banking     WM&T     Total                                                     Net interest income   $ 33,443     $ 85     $ 33,528     $ 30,718     $ 84     $ 30,802   Provision for credit losses     5,550       —       5,550       —       —       —   Wealth management and trust services     —       5,726       5,726       —       5,662       5,662   All other non-interest income     6,896       —       6,896       6,562       —       6,562   Non-interest expenses     21,763       3,121       24,884       22,286       3,167       25,453   Income before income tax expense     13,026       2,690       15,716       14,994       2,579       17,573   Income tax expense     1,764       584       2,348       471       559       1,030   Net income   $ 11,262     $ 2,106     $ 13,368     $ 14,523     $ 2,020     $ 16,543                                                     Segment assets     4,330,893     $ 3,640     $ 4,334,533       3,460,040     $ 3,783     $ 3,463,823         Six months ended June 30, 2020     Six months ended June 30, 2019                                                     (dollars in thousands)   Commercial Banking     WM&T     Total     Commercial Banking     WM&T     Total                                                     Net interest income   $ 65,804     $ 170     $ 65,974     $ 60,326     $ 160     $ 60,486   Provision for credit losses     11,100       —       11,100       600       —       600   Wealth management and trust services     —       11,944       11,944       —       11,101       11,101   All other non-interest income     13,214       —       13,214       12,131       —       12,131   Non-interest expenses     42,401       6,433       48,834       41,865       6,200       48,065   Income before income tax expense     25,517       5,681       31,198       29,992       5,061       35,053   Income tax expense     3,365       1,233       4,598       1,771       1,098       2,869   Net income   $ 22,152     $ 4,448     $ 26,600     $ 28,221     $ 3,963     $ 32,184                                                     Segment assets     4,330,893     $ 3,640     $ 4,334,533       3,460,040     $ 3,783     $ 3,463,823     55 Table of Contents     ( 19 ) Revenue from Contracts with Customers   All of Bancorp’s revenue from contracts with customers in the scope of ASC 606 is recognized within non-interest income. The table below presents Bancorp’s sources of non-interest income with items outside the scope of ASC 606 noted as such:       Three months ended June 30, 2020     Three months ended June 30, 2019                                                     (dollars in thousands)   Commercial Banking     WM&T     Total     Commercial     WM&T     Total   Wealth management and trust services   $ —     $ 5,726     $ 5,726     $ —     $ 5,662     $ 5,662   Deposit service charges     800       —       800       1,260       —       1,260   Debit and credit card income     2,063       —       2,063       2,168       —       2,168   Treasury management fees     1,249       —       1,249       1,202       —       1,202   Mortgage banking income(1)     1,622       —       1,622       760       —       760   Net investment product sales commissions and fees     391       —       391       364       —       364   Bank owned life insurance(1)     176       —       176       184       —       184   Other(2)     595       —       595       624       —       624   Total non-interest income   $ 6,896     $ 5,726     $ 12,622     $ 6,562     $ 5,662     $ 12,224           Six months ended June 30, 2020     Six months ended June 30, 2019                                                     (Dollars in thousands)   Commercial Banking     WM&T     Total     Commercial     WM&T     Total   Wealth management and trust services   $ —     $ 11,944     $ 11,944     $ —     $ 11,101     $ 11,101   Deposit service charges     2,083       —       2,083       2,438       —       2,438   Debit and credit card income     4,043       —       4,043       3,912       —       3,912   Treasury management fees     2,533       —       2,533       2,359       —       2,359   Mortgage banking income(1)     2,468       —       2,468       1,210       —       1,210   Net investment product sales commissions and fees     857       —       857       720       —       720   Bank owned life insurance(1)     355       —       355       362       —       362   Other(2)     875       —       875       1,130       —       1,130   Total non-interest income   $ 13,214     $ 11,944     $ 25,158     $ 12,131     $ 11,101     $ 23,232     ( 1 ) Outside of the scope of ASC 606. ( 2 ) Outside of the scope of ASC 606, with the exception of safe deposit fees which were nominal for all periods.     Bancorp’s revenue on the consolidated statement of income is categorized by product type, which effectively depicts how the nature, timing and extent of cash flows are affected by economic factors. Revenue sources within the scope of ASC 606 are discussed below:   Bancorp earns fees from its deposit customers for transaction-based, account management and overdraft services. Transaction-based fees, which include services such as ATM use fees, stop payments fees and ACH fees, are recognized at the time the transaction is executed, as that is when the company fulfills the performance obligation. Account management fees are earned over the course of a month and charged in the month in which the services are provided.   Treasury management transaction fees are recognized at the time the transaction is executed, as that is when the company fulfills the performance obligation. Account management fees are earned over the course of a month and charged in the month in which the services are provided. Treasury management fees are withdrawn from customers’ account balances.   WM&T provides customers fiduciary and investment management services as agreed upon in asset management contracts. The contracts require WM&T to provide a series of distinct services for which fees are earned over time. The contracts are cancellable upon demand with fees typically based upon the asset value of investments. Revenue is accrued and recognized monthly based upon month-end asset values and collected from the customer predominately in the following month except for a small percentage of fees collected quarterly. Incentive compensation related to WM&T activities is considered a cost of obtaining the contract. Contracts between WM&T and clients do not permit performance-based fees and accordingly, none of the fee income earned by WM&T is performance-based. Trust fees receivable were $ 2.1 million as of both June 30, 2020 and December 31, 2019.   Investment products sales commissions and fees represent the Bank’s share of transaction fees and wrap fees resulting from investment services and programs provided through an agent relationship with a third party broker-dealer. Transaction fees are assessed at the time of the transaction. Those fees are collected and recognized on a monthly basis. Trailing fees are based upon market values and are assessed, collected and recognized on a quarterly basis. Because the Bank acts as an agent in arranging the relationship between the customer and third party provider, and does not control the services rendered, investment product sales commissions and fees are reported net of related costs, including nominal incentive compensation, and trading activity charges of $ 283,000 and $ 258,000 for the six month periods ended June 30, 2020 and 2019.   Debit and credit card revenue primarily consists of debit and credit card interchange income. Interchange income represents fees assessed within the payment card system for acceptance of card-based transactions. Interchange fees are assessed as the performance obligation is satisfied, which is at the point in time the card transaction is authorized. Revenue is collected and recognized daily through the payment network settlement process.   Bancorp did not establish any contract assets or liabilities as a result of adopting ASC 606, nor were any recognized during the six -month period ending June 30, 2020.   56 Table of Contents     ( 20 ) Leases   Bancorp has operating leases for various branch locations with terms ranging from one month to 13 years, some of which include options to extend the leases in five -year increments. Options reasonably expected to be exercised are included in determination of the right-of-use asset. Bancorp elected the practical expedient to expense short-term lease obligations associated with leases with original terms of 12 months or less. Bancorp elected not to separate non-lease components from lease components for its operating leases. The right-of-use lease asset and operating lease liability are recorded in premises and equipment and other liabilities on the consolidated balance sheet.   Balance sheet, income statement and cash flow detail regarding operating leases follows:   (in thousands)                 Balance Sheet   June 30, 2020     December 31, 2019                     Operating lease right-of-use assets   $ 11,547     $ 12,737   Operating lease liabilities     12,992       14,369                     Weighted average remaining lease term     9.0       9.4   Weighted average discount rate     3.50 %     2.46 %                   Maturities of lease liabilities:                 One year or less   $ 986     $ 1,964   Year 2     1,916       1,915   Year 3     1,930       1,930   Year 4     1,972       1,972   Year 5     1,781       1,781   Greater than 5 years     6,619       6,619   Total lease payments   $ 15,204     $ 16,181   Less imputed interest     2,212       1,812   Total lease liabilities   $ 12,992     $ 14,369       (in thousands)   Three months ended     Three months ended   Income Statement   June 30, 2020     June 30, 2019   Components of lease expense:                 Operating lease cost   $ 473     $ 489   Variable lease cost     45       24   Less sublease income     25       13   Total lease cost   $ 493     $ 500     (in thousands)   Six months ended     Six months ended   Income Statement   June 30, 2020     June 30, 2019   Components of lease expense:                 Operating lease cost   $ 943     $ 997   Variable lease cost     87       63   Less sublease income     38       27   Total lease cost   $ 992     $ 1,033     (in thousands)   Six months ended     Six months ended   Cash flow Statement   June 30, 2020     June 30, 2019   Supplemental cash flow information:                 Operating cash flows from operating leases   $ 790     $ 694       As of June 30, 2020, Bancorp had not entered into any lease agreements that had yet to commence.   57 Table of Contents     Item 2.      Management’s Discussion and Analysis of Financial Condition and Results of Operations The consolidated financial statements include the accounts of Stock Yards Bancorp, Inc. and its wholly owned subsidiary, SYB, collectively referred to as “Bancorp” or the “Company.” All significant inter-company transactions and accounts have been eliminated in consolidation.   Stock Yards Bancorp, Inc. is a FHC headquartered in Louisville, Kentucky. Established in 1904, SYB is a state-chartered non-member financial institution that provides services in the Louisville, Kentucky, Indianapolis, Indiana and Cincinnati, Ohio MSAs through 42 full service banking center locations.   This section presents management’s perspective on our financial condition and results of operations. Management’s Discussion and Analysis of Financial Condition and Results of Operations should be read in conjunction with the consolidated financial statements and accompanying footnotes presented in Part 1 Item 1 “ Financial Statements ” and other information appearing in Bancorp’s Annual Report on Form 10-K for the year ended December 31, 2019. To the extent that this discussion describes prior performance, the descriptions relate only to the periods listed, which may not be indicative of Bancorp’s future financial outcomes. In addition to historical information, this discussion contains forward-looking statements that involve risks, uncertainties and assumptions that could cause results to differ materially from management’s expectations.   Cautionary Statement Regarding Forward-Looking Statements      This document contains statements relating to future results of Bancorp that are considered “forward-looking” as defined by Section 27A of the Securities Act of 1933, as amended, and Section 21E of the Securities Exchange Act of 1934, as amended. The forward-looking statements are principally, but not exclusively, contained in Part I Item 2 “ Management’s Discussion and Analysis of Financial Condition and Results of Operations ” and Part II Item 1A “ Risk Factors.”    Forward-looking statements involve known and unknown risks, uncertainties, and other factors that may cause actual results, performance, or achievements to be materially different from future results, performance, or achievements expressed or implied by the statement. These statements are often, but not always, made through the use of words or phrases such as “anticipate,” “believe,” “can,” “conclude,” “continue,” “could,” “estimate,” “expect,” “foresee,” “goal,” “intend,” “may,” “might,” “outlook,” “possible,” “plan,” “predict,” “project,” “potential,” “seek,” “should,” “target,” “will,” “will likely,” “would,” or other similar expressions. These forward-looking statements are not historical facts and are based on current expectations, estimates and projections about our industry, management’s beliefs and certain assumptions made by management, many of which, by their nature, are inherently uncertain and beyond our control, particularly with regard to developments related to COVID-19. Forward-looking statements detail management’s expectations regarding the future and are based on information known to management only as of the date the statements are made and management undertakes no obligation to update forward-looking statements, except as required by applicable law.   There is no assurance that any list of risks and uncertainties or risk factors is complete. Factors that could cause actual results to differ materially from those expressed or implied in forward-looking statements include, among other things:     ● impact of COVID-19 on Bancorp’s business, including the impact of the actions taken by governmental authorities to try and contain the virus or address the impact of the virus on the U.S. economy (including, without limitation, the CARES Act), and the resulting effect of all of such items on our operations, liquidity and capital position, and on the financial condition of Bancorp’s borrowers and other customers;   ● changes in or forecasts of future political and economic conditions;   ● accuracy of assumptions and estimates used in establishing the ACL on loans and other estimates;   ● impairment of investment securities, goodwill, other intangible assets or DTAs;   ● ability to effectively navigate an economic slowdown or other economic or market disruption;   ● changes in laws and regulations or the interpretation thereof;   ● changes in fiscal, monetary, and/or regulatory policies;   ● changes in tax polices including but not limited to changes in federal and state statutory rates;   ● behavior of securities and capital markets, including changes in market volatility and liquidity;   ● ability to effectively manage capital and liquidity;   ● long-term and short-term interest rate fluctuations, as well as the shape of the U.S. Treasury yield curve;   ● the magnitude and frequency of changes to the FFTR implemented by the Federal Open Market Committee of the FRB;   ● competitive product and pricing pressures;   ● projections of revenue, expenses, capital expenditures, losses, EPS, dividends, capital structure, etc.;   58 Table of Contents     ● descriptions of plans or objectives for future operations, products, or services;   ● changes in the credit quality of Bancorp’s customers and counterparties, deteriorating asset quality and charge-off levels;   ● changes in technology instituted by Bancorp, its counterparties or competitors;   ● changes to or the effectiveness of Bancorp’s overall internal control environment;   ● adequacy of Bancorp’s risk management framework, disclosure controls and procedures and internal control over financial reporting;   ● changes in applicable accounting standards, including the introduction of new accounting standards;   ● changes in investor sentiment or consumer spending or savings behavior;   ● ability to appropriately address social, environmental and sustainability concerns that may arise from business activities;   ● integration of acquired businesses or future acquisitions;   ● occurrence of natural or man-made disasters or calamities, including health emergencies, the spread of infectious diseases, pandemics or outbreaks of hostilities, and Bancorp’s ability to deal effectively with disruptions caused by the foregoing;   ● ability to maintain the security of its financial, accounting, technology, data processing and other operational systems and facilities;   ● ability to withstand disruptions that may be caused by any failure of its operational systems or those of third parties;   ● ability to effectively defend itself against cyberattacks or other attempts by unauthorized parties to access information of Bancorp or its customers or to disrupt systems; and   ● other risks and uncertainties reported from time to time in Bancorp’s filings with the SEC, including Part II Item 1A “ Risk Factors.”     Acquisition of King Bancorp, Inc. and its wholly owned subsidiary King Southern Bank   On May 1, 2019, Bancorp completed its acquisition of KSB for $28 million in cash. The acquisition expanded Bancorp’s market area into nearby Nelson County, Kentucky, while expanding the customer base in Louisville, Kentucky. At May 1, 2019, the acquiree reported approximately $192 million in total assets, approximately $164 million in loans and approximately $126 million in deposits. As a result of the acquisition, goodwill totaling $11.8 million was recorded during the second quarter of 2019, with nominal recast adjustments posted during the third and fourth quarters of 2019.   As a result of the completion of the acquisition, Bancorp incurred pre-tax transaction charges totaling $1.3 million predominantly during the second quarter of 2019. Net income from the acquisition was accretive to Bancorp’s overall operating results beginning with the third quarter of 2019. Effective March 31, 2020, management finalized the fair values of the acquired assets and assumed liabilities in advance of the 12-month post acquisition date, as allowed by GAAP.   In connection with the acquisition, Bancorp became the 100% successor owner of KBST, an unconsolidated finance subsidiary. As permitted under the terms of KBST’s governing documents, Bancorp redeemed the TPS at the par amount of approximately $4 million on June 17, 2019.     Issued but Not Yet Effective Accoun ting Standards Updates   For disclosure regarding the impact to Bancorp’s financial statements of issued-but-not-yet-effective ASUs, see the footnote titled “ Basis of Presentation and Summary of Significant Accounting Policies ” of Part I Item 1 “ Financial Statements .”   59 Table of Contents   Business Segment Overview   Bancorp is divided into two reportable segments: Commercial Banking and WM&T:   Commercial Banking provides a full range of loan and deposit products to individual consumers and businesses in all its markets through retail lending, mortgage banking, deposit services, online banking, mobile banking, private banking, commercial lending, treasury management services, merchant services, international banking, correspondent banking and other banking services. The Bank also offers securities brokerage services via its banking center network through an arrangement with a third party broker-dealer in the Commercial Banking segment.    WM&T provides custom-tailored financial planning, investment management, company retirement plan management, retirement planning, trust and estate services in all markets in which Bancorp operates. The magnitude of WM&T revenue distinguishes Bancorp from other community banks of similar asset size.     Overview – Impact of the COVID-19 Pandemic on Financial Condition and Results of Operations   The COVID-19 pandemic in the U.S. and efforts to contain it have had a complex and significant adverse impact on the economy, the banking industry and Bancorp. The impact on future fiscal periods is subject to a high degree of uncertainty.   On March 11, 2020, the World Health Organization declared COVID-19 to be a global pandemic, indicating that almost all public commerce and related business activities must be, to varying degrees, curtailed with the goal of decreasing the rate of new infections. The spread of the outbreak has caused significant disruptions in the U.S. economy and has disrupted banking and other financial activity in the markets in which Bancorp operates. While some industries have been impacted more severely than others, all businesses have been impacted to some degree. This disruption resulted in the initial shuttering of non-essential businesses across most of the country, significant job loss, and aggressive measures by the federal government. While there has been some phased-in re-opening of commerce that began in the second quarter, unemployment levels have remained elevated.   In response to the above, Congress, the President and regulatory agencies took action designed to lessen the economic fallout. Most notably, the CARES Act was signed into law at the end of March. The goal of the CARES Act was to prevent a severe economic downturn through various measures, including direct financial aid to American families and economic stimulus to significantly impacted industry sectors.   The CARES Act, established the SBA PPP to provide loans for eligible businesses/not-for-profits with the focus on job retention and certain operating expenses. Portions of these loans qualify for forgiveness for payroll costs, mortgage interest, rent and utilities during the 24-week period beginning with the date of the loan. Loans funded through the PPP are fully guaranteed by the U.S. government.   The CARES Act permits financial institutions to suspend requirements under GAAP for loan modifications to borrowers affected by COVID-19 and is intended to provide interpretive guidance as to conditions that would constitute a short-term modification that would not meet the definition of a TDR. This includes the following (i) the loan modification is made between March 1, 2020 and the earlier of December 31, 2020 or 60 days after the end of the coronavirus emergency declaration, and (ii) the applicable loan was not more than 30 days past due as of December 31, 2019. Bancorp is applying this guidance to qualifying loan modifications and has implemented modifications meeting these conditions Federal bank regulatory authorities also issued guidance to encourage banks to make loan modifications for borrowers affected by COVID-19 and to assure banks that they will not be criticized by examiners for doing so.   The PPP directly impact ed Bancorp’s financial condition and results of operations for the three and six months ended June 30, 2020 as follows:     ● During the second quarter of 2020, 3,250 loans totaling $647 million were originated, with the PPP portfolio representing 18% of total loans outstanding at June 30, 2020.     ● While the PPP was primarily offered to Bancorp’s customer base to limit fraud risk, Bancorp added approximately 350 new relationship prospects that have begun the process of migrating over their full commercial banking relationship.     ● With origination fees ranging between 1% and 5% based on the size of the loan, Bancorp received $20 million in origination fees from the SBA that will be recognized over the term of the loans (predominantly 24 months).   60 Table of Contents     ● Approximately $3.4 million in interest and fee income was recognized during the three months ended June 30, 2020. While this had a positive impact to interest income and net interest income, the 1% stated yield on the PPP portfolio negatively impacted the overall loan portfolio yield and NIM.     ● Based on the 100% SBA guarantee of PPP loans, Bancorp did not reserve for potential losses within the ACL on these loans.     ● Bancorp experienced a significant increase in deposit balances (both average and ending) directly related to customers who originated PPP loans.     ● A portion of Bancorp’s customer base paid down existing operating C&I lines of credit in part with excess liquidity resulting from PPP loans, a sign of the strength of certain borrowers.     ● Bancorp relied on deposit growth in addition to excess cash on hand to fund the PPP loans with no reliance placed on external funding sources. Maintaining excess liquidity related to the PPP loan portfolio contributed to overall NIM compression.     ● With regard to Bancorp’s compensation expense, the origination of the PPP loans led to elevated levels of deferred salary costs with the offset to deferred loan fees and amortized over the term of the related loans.     ● Consistent with the historic decline in credit utilization coupled with the adoption of ASC-326, Bancorp incurred a significant increase in reserves for off-balance sheet credit exposures recorded as a component of non-interest expenses.     ● Bancorp’s leverage ratio, which consists of tier-1 capital divided by adjusted quarterly average assets, was negatively impacted by the outsized balance sheet growth attributed to PPP participation. This will normalize over time, as PPP loans pay-off early or ultimately mature. Bancorp and the Bank remained “well capitalized” in all other capital ratios at June 30, 2020.   Other pandemic-related impacts to Bancorp’s financial condition and results of operations for the three and six months ended June 30, 2020 as follows:     ● As previously disclosed, on March 16, 2020, the FRB responded to the pandemic by lowering the FFTR to a range of 0% - 0.25% resulting in Prime dropping to 3.25%.     ● Loan loss provisioning for the second quarter of 2020 was significantly impacted by the economic crisis and corresponding impact on national unemployment forecast adjustments within the CECL model, changes in the loan mix and the addition of a large specific reserve during the second quarter.     ● Bancorp deferred either the full loan payment or the principal only portion of respective loan payments for 90 or 180 days for some borrowers directly impacted by the pandemic.  As of June 30, 2020, Bancorp executed 1,100 of full payment deferrals (predominantly 3 months) on outstanding loan balances of $502 million - representing 18% of the loan portfolio (excluding PPP loans). Approximately 85% of the total deferrals processed (in terms of dollars) occurred in the month of April, with the subsequent pace slowing significantly. Pursuant to the CARES Act, these loan deferrals were not classified as TDRs and not included in non-performing loan statistics. Subsequent to the end of the second quarter and through the end of July, a significant portion of the deferred loan portfolio returned to full paying status. As of July 31, 2020, Bancorp estimates that 10% of the total loan portfolio (excluding PPP loans) remained in full payment deferment status. Bancorp is monitoring loan modification expirations daily and anticipates the potential for more customers to return to full payment status over the next two months as their initial deferral period ends. While the modifications themselves did not trigger a loan risk rating downgrade, if the impact of COVID-19 continues, borrower operations do not improve or if other negative events occur, such modified loans could transition to potential problem loans or into problem loans.     ● Deposit balance for both commercial customers who received PPP funding and those that did not were elevated at June 30, 2020 based on the deferment of tax payments.     ● Consistent with the industry, deposit service charges and debit/credit card income were impacted by pandemic driven changes in customer behavior. This led to among other things, lower transaction volumes and types of spending during April and May with June showing notable improvement for the quarter.     ● Bancorp did not incur material non-interest expenses related to the execution of its pandemic plan first placed in service in March.     o During the second quarter of 2020, debit/credit card processing expense declined directionally consistent with the decline in revenue noted above.     o Marketing and business development expenses include all costs associated with promoting Bancorp, community support, retaining customers and acquiring new business. Marketing and business development expenses decreased sharply during the second quarter corresponding directly with less physical customer interaction as a result of the pandemic.   In tandem with the declaration of the global pandemic, Bancorp invoked its Board approved pandemic plan, which included timely communication to employees, implementing remote work arrangements to the full extent possible, separating individual departments, operating select branch lobbies by appointment only, fully staffing all branch drive-thru lanes, communicating with and encouraging our customers to use Bancorp’s free self-service tools such as ITMs/ATMs, online banking, mobile banking and bill pay and actively promoting social distancing in all aspects of business.   61 Table of Contents   Bancorp has focused first on the well-being of its employees, customers and communities during this time. Preventative health measures were put in place and many employees worked remotely for the majority of the second quarter. Bancorp also established social distancing precautions for all employees in the office and customers visiting branches, preventative cleaning at offices and branches, and eliminated business related travel. Towards the end of the second quarter, Bancorp began returning employees to the office pursuant to new health and safety procedures and in accordance with guidance from the CDC and local authorities, including regular symptom checks, requiring cloth face coverings, increasing physical space between employees, and requiring employees with symptoms associated with COVID-19 or potential exposure to quarantine away from the office. Bancorp implemented business continuity measures as necessary throughout the pandemic including monitoring potential business interruptions. Bancorp has not incurred material expense related to executing the pandemic plan and no material operational or internal control challenges or risks have been identified to date.   Bancorp has taken measures both to support customers affected by the pandemic and to maintain strong asset quality, including:     ● Assisting business customers through PPP and other government sponsored loan products   ● Tightening underwriting standards   ● Monitoring portfolio risk and related mitigation strategies by segments   ● Limiting originations to higher risk industries and customers including, but not limited to, transportation, travel, hospitality, entertainment, and retail   ● Proactively contacting customers in order to assess credit situations and needs and develop long-term contingency financial plans   ● Offering flexible repayment options to current customers and a streamlined loan modification process, when appropriate     Management continues to meet regularly to anticipate and respond to any future pandemic interruptions or developments. Bancorp has not incurred any significant challenges to its ability to maintain its systems and controls in light of the measures taken to prevent the spread of COVID-19 and has not incurred significant resource constraints through the implementation of its business continuity plans and does not anticipate incurring such in the future. Bancorp has not made, and at this time does not expect to make, any material staffing or compensation changes as a result of the pandemic.   62 Table of Contents   Overview – Operating Results (FTE)     The following table presents an overview of Bancorp’s financial performance for the three months ended June 30, 2020 and 2019:   Three months ended June 30 , (dollars in thousands, except per share data)   2020     2019     $ Change   % Change                                   Net income   $ 13,368     $ 16,543     $ (3,175 )   -19 % Diluted earnings per share   $ 0.59     $ 0.72     $ (0.13 )   -18 % Annualized return on average assets     1.25 %     1.93 %   (68 ) bps   -35 % Annualized return on average equity     12.90 %     17.40 %   (450 ) bps   -26 %   Additional discussion follows under the section titled “ Results of Operations.”   Ge neral highlights for the three months ended June 30 , 2020 compared to June 30, 2019:   ● Net income totaled $13.4 million, resulting in diluted EPS of $0.59, an 18% decline over $0.72 for the same period of 2019, the latter of which included a $2.4 million favorable non-recurring tax adjustment related to a Kentucky tax law change that equated to $0.11 per diluted share in addition to significant acquisition deal costs that equated to $0.05 per diluted share. ● NIM decreased 54 bps to 3.27% for the three months ended June 30, 2020 compared to 3.81% for the same period in 2019 consistent with the large decline in interest rates led by the FRB, the significant addition of the low yielding PPP loan portfolio and excess balance sheet liquidity; offset by strong average quarter over prior quarter loan growth (excluding PPP loans) and the strategic lowering of stated deposit interest rates and CD offering rates in tandem with the FRB interest rate actions. ● Despite the decline in NIM, net interest income increased $2.7 million, or 9%, for the three months ended June 30, 2020 compared to the same period in 2019 based on the fee income recognized associated with the PPP portfolio and significant benefit from the strategic lowering of stated deposit rates. ● Total loans (excluding PPP loans) contracted $103 million during the second quarter of 2020. C&I loan balances led the decline, falling $119 million. Average loans (excluding PPP loans) increased 8% for the three months ended June 30, 2020 compared to the same period in 2019, driven by strong organic loan growth within Bancorp’s three markets over the previous 12 months in addition to the May 2019 acquisition. ● Both ending and quarterly average deposit balances ended at record levels at June 30, 2020, primarily as a result of PPP funding in addition to higher levels of liquidity held by customers attributable to current economic uncertainty. ● The quarter ended June 30, 2020 was the second in which Bancorp accounted for credit losses under ASC 326, or CECL. Despite continued minimal net charge-offs and overall strong credit metrics, significant provisioning occurred based on the economic crisis and corresponding impact on national unemployment forecast adjustments within the CECL model, changes in the loan mix and the addition of a large specific reserve during the second quarter totaling $2 million related to one CRE customer. Consistent with the significant decline in line utilization (mainly C&I) experienced in the second quarter of 2020, Bancorp also recorded $1.5 million in additional non-interest expense related to credit exposure for unfunded off-balance sheet commitments. At June 30, 2020, approximately $6 million was accrued within other liabilities related to off balance sheet exposures. ● Bancorp’s ACL to total loans was 1.38% at June 30, 2020, compared to 1.43% at March 31, 2020 and 0.94% at December 31, 2019. Bancorp’s ACL to total loans (excluding PPP loans) rose to 1.68% at June 30, 2020. ● Non-interest income increased 3% for the three months ended June 30, 2020 compared to the same period in 2019:   o Despite economic uncertainty and market volatility, WM&T income increased for the quarterly comparison.   o As noted above, deposit service charges and debit/credit card income were negatively impacted by the pandemic during the quarter.   o The Treasury Management department was able to overcome the significant decline in pandemic related transaction volume with new product sales and expansion within its customer base. The demand for treasury products has increased during the pandemic, as these products allow customers to operate more efficiently in a decentralized environment.   o The sustained low interest rate environment led to elevated mortgage refinancing activity and record mortgage banking results. ● Bancorp’s efficiency ratio (FTE) for the three months ended June 30, 2020, was 53.87% compared with 59.08% for the same period in 2019, the latter of which included $1.3 million in one-time deal costs associated with an acquisition. ● Non-interest expenses remained well-controlled and declined 2% for the three months ended June 30, 2020 compared to the same period in 2019 despite the addition of branches, personnel and increased provisioning for off-balance sheet credit exposures. ● The ETR increased to 14.9% for the three months ended June 30, 2020 from 5.9% for the same period in 2019. The second quarter of 2019 reflected a $2.4 million non-recurring state tax adjustment related to Kentucky tax law changes.   63 Table of Contents   The following table presents an overview of Bancorp’s financial performance for the six months ended June 30, 2020 and 2019:   Six months ended June 30, (dollars in thousands, except per share data)   2020     2019     $ Change   % Change                                   Net income   $ 26,600     $ 32,184     $ (5,584 )   -17 % Diluted earnings per share   $ 1.17     $ 1.40     $ (0.23 )   -16 % Annualized return on average assets     1.33 %     1.93 %   (60 ) bps   -31 % Annualized return on average equity     13.04 %     17.25 %   (421 ) bps   -24 %   Additional discussion follows under the section titled “ Results of Operations.”   General highlights for the six months ended June 30, 2020 compared to June 30, 2019:   ● The momentum associated with a record 2019 was halted late in the first quarter by the COVID-19 pandemic. Uncertain economic conditions, a substantially lower interest rate environment and government stimulus action have had a significant impact on Bancorp’s results, mainly during the second quarter of 2020 as detailed in the previous section of the document. ● Effective January 1, 2020, Bancorp began accounting for credit losses under ASC 326, or CECL. The adoption of this standard increased the opening balance of the ACL on loans by $8.2 million and reserve for off-balance sheet exposures by $3.5 million as of January 1. The adoption entries reduced Bancorp’s retained earnings on a tax-effected basis of $8.8 million, with no impact on earnings. In addition, on January 1, 2020, the amortized cost basis of the PCD loans were adjusted upwards to reflect the addition of $1.6 million of the ACL on loans. ● Net income totaled $26.6 million for the six months ended June 30, 2020, resulting in diluted EPS of $1.17, a 16% decline from the same period in 2019, the latter of which included $3.8 million in non-recurring tax adjustments related to two Kentucky tax law changes that equated to $0.17 per diluted share in addition to significant acquisition deal costs, which equated to $0.05 per diluted share. ● The FRB has lowered the FFTR five times since June 30, 2019, resulting in a combined 225 bps decrease in the FFTR over the last 12 months. The most recent of these cuts occurred in mid-March 2020, when the FRB lowered the FFTR to a range of 0% - 0.25% in response to the pandemic - the lowest level seen since late 2015. Bancorp has lowered the stated rate of interest-bearing deposit account types and CD offering rates in tandem with these cuts and further decreases in the interest rate environment. ● NIM decreased 38 bps to 3.47% for the six months ended June 30, 2020 compared to 3.85% for the same period in 2019 consistent with the lowering of the FFTR, the PPP portfolio and excess balance sheet liquidity; offset by strong average year over prior year loan growth (excluding PPP loans) and the strategic lowering of stated deposit interest rates and CD offering rates in tandem with FRB interest rate actions. ● Despite the decline in NIM, net interest income increased $5.5 million, or 9%, for the six months ended June 30, 2020 compared to the same period in 2019 based on the fee income recognized associated with the PPP portfolio and significant benefit from the strategic lowering of stated deposit rates. ● Total loans (excluding PPP loans) contracted $11 million during the first six months of 2020, with the second quarter decline completely reversing the first quarter growth of $92 million fueled by robust and record first quarter production. During 2020, a $67 million increase in the CRE portfolio was offset by a $74 million decline in the C&I portfolio – primarily operating lines of credit. ● Despite flat line of credit usage for the first quarter of 2020, usage declined significantly to 39% at June 30, 2020 compared to 48% at June 30, 2019. ● Both ending and year to date average deposit balances ended at record levels at June 30, 2020, primarily as a result of PPP funding in addition to higher levels of liquidity held attributable to current economic uncertainty. ● Despite continued minimal net charge-offs and overall strong credit metrics, significant provisioning occurred based on the economic crisis and corresponding impact on national unemployment forecast adjustments within the CECL model, changes in the loan mix and the addition of a large specific reserve during the second quarter totaling $2 million related to one CRE relationship. Consistent with the significant decline in line utilization (mainly C&I), Bancorp also recorded $1.9 million in additional non-interest expense related to credit exposure for unfunded off-balance sheet commitments, with $1.5 million of the expense recorded in the second quarter of 2020. At June 30, 2020, approximately $6 million was accrued within other liabilities related to off balance sheet exposures. ● Bancorp’s ACL to total loans was 1.38% at June 30, 2020, compared to 0.94% at December 31, 2019. Bancorp’s ACL to total loans (excluding PPP loans) was 1.68% at June 30, 2020. ● Non-interest income increased 8%, for the six months ended June 30, 2020 compared to the same period in 2019 led by mortgage banking and WM&T income. The sustained low interest rate environment has continued to incentivize record mortgage refinancing activity and WM&T income was boosted by a large non-recurring estate fee collected in the first quarter of 2020. Card income and treasury management fees also continued to stand out as diversifying revenue streams, representing a combined 26% of total non-interest income. ● Bancorp’s efficiency ratio (FTE) for the six months ended June 30, 2020 was 53.53% compared with 57.34% for the same period in 2019, the latter of which included $1.3 million in one-time deal costs associated with an acquisition closed in the prior year. ● Non-interest expenses, which have remained well-controlled, increased 2%, for the six months ended June 30, 2020 compared to the same period in 2019 despite the addition of branches, personnel and other expenses related to the May 2019 acquisition and increased provisioning for off-balance sheet credit exposures. ● The ETR increased to 14.7% for the six months ended June 30, 2020 from 8.2% for the same period in 2019, the latter of which reflected $4.0 million in non-recurring tax adjustments related to two Kentucky tax law changes. ● TCE is a measure of a company’s capital, which is useful in evaluating the quality and adequacy of capital. Bancorp’s ratio of TCE to total tangible assets was 9.39% as of June 30, 2020, compared with 10.55% at December 31, 2019 and 10.85% at June 30, 2019. The fluctuation from December 31, 2019 to June 30, 2020 was driven by asset growth (mainly PPP loans), the change in AOCI and CECL related adjustments. See the section titled “Non-GAAP Financial Measures” for reconcilement of non-GAAP to GAAP measures.   64 Table of Contents     Results of Operations   Net Interest Income - Overview   As is the case with most banks, Bancorp’s primary revenue sources are net interest income and fee income from various financial services provided to customers. Net interest income is the difference between interest income earned on loans, investment securities and other interest earning assets less interest expense on deposit accounts and other interest bearing liabilities. Loan volume and interest rates earned on those loans are critical to overall profitability. Similarly, deposit volume is crucial to funding loans and rates paid on deposits directly impact profitability. New business volume is influenced by economic factors including market interest rates, business spending, consumer confidence and competitive conditions within the marketplace.   Comparative information regarding net interest income follows:   As of and for the three months ended June 30,                   Variance   (dollars in thousands)   2020     2019     2020 / 2019                             Net interest income   $ 33,528     $ 30,802       8.9 % Net interest spread     3.10 %     3.47 %     (37 ) bps Net interest margin     3.27 %     3.81 %     (54 ) bps Average interest earning assets   $ 4,124,046     $ 3,244,941       27.1 %     As of and for the six months ended June 30,                   Variance   (dollars in thousands)   2020     2019     2020 / 2019                             Net interest income   $ 65,974     $ 60,486       9.1 % Net interest spread     3.27 %     3.52 %     (25 ) bps Net interest margin     3.47 %     3.85 %     (38 ) bps Average interest earning assets   $ 3,823,598     $ 3,173,069       20.5 %     The discussion that follows is based on FTE data.   NIM and net interest spread calculations above exclude the sold portion of certain participation loans. These sold loans are on Bancorp’s balance sheet as required by GAAP because Bancorp retains some form of effective control; however, Bancorp receives no interest income on the sold portion. These participation loans sold are excluded from analysis, as Bancorp believes it provides a more accurate depiction of the performance of its loan portfolio.   Bancorp’s loan portfolio is currently composed of approximately 71% fixed and 29% variable rate loans, with the fixed rate portfolio pricing based on a spread to the five-year treasury curve at the time of origination and the variable portion pricing based on an on-going spread to Prime (approximately 60%) or one month LIBOR (approximately 40%). Bancorp’s loan portfolio (excluding PPP loans) at June 30, 2020 was composed of approximately 65% fixed and 35% variable rate loans with the fluctuation in the C&I portfolio driving down variable rate concentration for the quarter.   The FRB has lowered the FFTR five times since June 30, 2019, resulting in a combined 225 bps decrease in the FFTR over the last 12 months. The most recent of these cuts came in mid-March 2020 when the FRB lowered the FFTR to a range of 0% - 0.25% in response to the COVID-19 pandemic, the lowest level seen since late 2015. The following table details the volatility experienced within the interest rate environment over the past several months by comparing period end and quarterly average rates:       June 30,     March 31,     December 31,     June 30,     March 31,       2020     2020     2019     2019     2019                                             Five-year Treasury note - period end     0.29 %     0.37 %     1.69 %     1.76 %     2.23 % Five-year Treasury note - quarterly average     0.36 %     1.14 %     1.61 %     2.12 %     2.46 % Prime rate - period end     3.25 %     3.25 %     4.75 %     5.50 %     5.50 % Prime rate - quarterly average     3.25 %     4.40 %     4.83 %     5.50 %     5.50 % One-month LIBOR - period end     0.16 %     0.99 %     1.79 %     2.40 %     2.49 % One-month LIBOR - quarterly average     0.35 %     1.40 %     2.22 %     2.44 %     2.50 %   65 Table of Contents   Bancorp has lowered the stated rate of interest-bearing deposit account types and CD offering rates in tandem with the above-mentioned FRB interest rate actions and managed to fully offset the decline in loan yields associated with the first two FFTR rate reductions, which occurred in August and September of 2019. The subsequent rate cuts in October 2019, and to a greater extent in March of 2020, have resulted in significant NIM compression, as further deposit rate reductions have not been able to fully off-set the decline in loan yields. As of June 30, 2020, current deposit rates are at or below rates offered during the Great Recession.   The short end of the treasury yield curve at both March 31, 2020 and June 30, 2020 mirrored what was experienced during the Great Recession with the long end, particularly the five-year treasury, dramatically lower. While the curve normalized during the first quarter of 2020, the steep decline/inversion of the treasury curve that began in the second quarter of 2019 has led to intense pricing pressure and stiff competition over this period. With 60% of the variable rate loan portfolio tied to Prime and the majority with floor rates of 4.00%, short-term rates would have to increase over 75 bps for these loans to move above their floor rates given Prime is at 3.25% as of June 30, 2020. Beyond potential ongoing pricing pressure/competition and the absolute low level of rates, the current economic outlook and prospects of a sustained zero-rate environment continues to pose challenges regarding potential ongoing NIM compression.     Net Interest Income – Three months ended June 30, 2020 compared to June 30, 2019   Net interest spread and NIM were 3.10% and 3.27%, for the three months ended June 30, 2020 compared to 3.47% and 3.81% for the same period in 2019. NIM during the three months ended June 30, 2020 was significantly impacted by:     ● The lowering of the FFTR between August 2019 and mid-March 2020, ending at a range of 0% - 0.25% resulting in Prime dropping to 3.25%.   ● PPP loan originations during the second quarter of 2020, with significant concentration during the month of April.   ● The strategic lowering of stated deposit interest rates and CD offering rates over the past 12 months in tandem with FRB interest rate actions.   ● Strong average loan growth (excluding PPP loans) related to both a prior year acquisition and organic growth.   ● Excess balance sheet liquidity.   During the second quarter of 2020, 3,250 PPP loans totaling $647 million were originated, with the portfolio representing 18% of total loans outstanding at June 30, 2020. Origination fees ranged between 1% and 5% based on the size of the loan with the average fee equating to 3.12%. During the three months ended June 30, 2020, Bancorp received $20 million in origination fees from the SBA and recognized $2.1 million in fee income. While this had a positive impact to interest and fee income and net interest income, the 1% stated yield on the PPP portfolio negatively impacted the overall loan portfolio (excluding PPP loans) yield and NIM by 27 bps and 11 bps, respectively. With a heavy concentration of these loans originating in April, the average balance of the portfolio ended at $529 million for the quarter ended June 30, 2020 with a yield of 2.58% - significantly below the 4.31% yield on the loan portfolio (excluding PPP loans) for the three months ended June 30, 2020.   With regard to the PPP, borrowers are eligible for forgiveness from the SBA for the portion of funding received utilized for job retention and certain other expenses, such as payroll costs, mortgage interest, rent and utilities during the 24-week period beginning with the date of the loan. With a significant portion of these loans potentially eligible for full forgiveness there is high likelihood of early pay off prior to maturity (24 months and 60 months for loans that originated post June 5, 2020). Early payoff of such would accelerate recognition of the fee (and to a lesser extent the deferred salary cost) and could have a material positive impact to future operating results.   Average FFS and interest bearing due from bank balances increased significantly for the three months ended June 30, 2020 compared with the same period in 2019. This excess liquidity contributed to approximately 19 bps of NIM compression for the three months ended June 30, 2020.   Net interest income increased $2.7 million, or 9%, for the three months ended June 30, 2020 compared to the same period of 2019, led primarily by increased fee income associated with the PPP loan portfolio and decreased funding costs on deposits.   66 Table of Contents   Total average interest earning assets increased $879 million, or 27%, to $4.1 billion for the three months ended June 30, 2020, with the average rate earned on total interest earning assets contracting 102 bps to 3.56%.     ● Average loans increased $739 million, or 28%, for the three months ended June 30, 2020 compared to the same period in 2019 with $529 million of this growth attributed to the PPP portfolio. Strong quarter over prior year quarter organic growth across all three markets in addition to the May 2019 acquisition has boosted the loan portfolio (excluding PPP loans) average loans by $210 million over the past 12 months.     ● Average FFS/interest bearing due from bank balances increased $148 million for the three months ended June 30, 2020 as compared with the same period in 2019, consistent with the increase in deposits.   Total interest income decreased $500,000, or 1%, to $36.6 million for the three months ended June 30, 2020, as compared to the same period of 2019.     ● Interest and fee income on loans increased $660,000, or 2%, to $34.1 million, attributed mainly to fee income associated with the PPP portfolio. Despite significant average loan balance (excluding PPP loans) growth, interest income declined $2.7 million, or 8%, consistent with significant interest rate contraction within the loan portfolio over the past 12 months.     ● With the exception of mortgage loans held for sale, interest income on the remaining interest earning asset portfolio was significantly impacted by the lower interest rate environment over the past 12 months coupled with significant average balance growth.   Total average interest bearing liabilities increased $375 million, or 17%, to $2.6 billion for the three-month period ended June 30, 2020 compared with the same period in 2019, with the total average cost declining 65 bps to 0.46%.     ● Average interest bearing deposits increased $388 million, or 18%, for the three months ended June 30, 2020 compared to the same period in 2019, with interest-bearing demand deposits representing $284 million of the increase. Customers who received PPP loans, the proceeds for which were deposited into accounts held at the Bank, have generally been slow in deploying the funds. Further, the economic slow-down and uncertainty surrounding the pandemic has resulted in the customer base maintaining higher levels of liquidity in general, similar to behavior seen during the Great Recession.     ● Average FHLB advances decreased $9 million, or 12%, for the three months ended June 30, 2020 compared to the same period of 2019, as a portion of the advances assumed in a prior year acquisition have been paid off.   Total interest expense decreased $3.2 million, or 52%, for the three months ended June 30, 2020, compared to the same period of 2019, as a direct result of strategic deposit rate reductions implemented in response to the changing interest rate environment.     ● Total interest bearing deposit expense decreased $3.0 million, or 54%, representing a 65 bps decrease in the cost of average interest bearing liabilities.   67 Table of Contents   Net Interest Income – Six months ended June 30, 2020 compared to June 30, 2019   Net interest spread and NIM were 3.27% and 3.47%, for the six months ended June 30, 2020 compared to 3.53% and 3.85% for the same period in 2019. NIM during the six months ended June 30, 2020 was significantly impacted by:     ● The FFTR was lowered 225 bps between August 2019 and mid-March 2020, resulting in Prime dropping to 3.25%. Average Prime has declined significantly to 3.81% for the six months ended June 30, 2020 compared to 5.50% for the same period in 2019.   ● PPP loan originations   ● The strategic lowering of stated deposit interest rates and CD offering rates over the past 12 months in tandem with FRB interest rate actions.   ● Strong average loan (excluding PPP loans) growth related to both a prior year acquisition and organic growth.   ● Excess balance sheet liquidity that has carried over from the first quarter of 2020 and expanded.   During the first six months of 2020, Bancorp received $20 million in origination fees from the SBA and recognized $2.1 million in fee income. While this had a positive impact to interest and fee income and net interest income, the 1% stated yield on the PPP portfolio negatively impacted the overall loan portfolio yield and NIM by 17 bps and 7 bps, respectively. With a heavy concentration of these loans originating in April, the average balance of the portfolio ended at $265 million for the six months ended June 30, 2020 with a yield of 2.58% - significantly below the 4.51% yield on the loan portfolio (excluding PPP loans) for the six months ended June 30, 2020.   Average FFS and interest bearing due from bank balances increased significantly for the six months ended June 30, 2020 compared with the same period in 2019. This excess liquidity contributed to approximately 17 bps of NIM compression for the six months ended June 30, 2020.   Net interest income increased $5.5 million, or 9%, for the first six months of 2020 compared to the same period of 2019, led primarily by increased fee income associated with the PPP loan portfolio and decreased funding costs on deposits.   Total average interest earning assets increased $651 million, or 21%, to $3.8 billion for the six months ended June 30, 2020, with the average rate earned on total interest earning assets contracting 73 bps to 3.86%.     ● Average loans increased $551 million, or 21%, for the six months ended June 30, 2020 compared to the same period in 2019 with $265 million of the growth attributed to the PPP portfolio. In addition to the May 2019 acquisition, Bancorp has experienced strong organic growth across all three markets leading to a $286 million increase in the loan portfolio (excluding PPP loans). Significant average loan balance growth during the first quarter of 2020 was partially reversed with a $24 million decline during the second quarter of 2020.     ● Average FFS and interest bearing due from bank balances increased $97 million for the six months ended June 30, 2020 as compared with the same period in 2019, consistent with the increase in deposits.   Total interest income increased $1.3 million, or 2%, to $73.5 million for the six months ended June 30, 2020, as compared with the first six months of 2019.     ● Interest income on loans increased approximately $2.8 million, or 4%, to $67.9 million, attributed mainly to fee income associated with the PPP portfolio. Despite significant average loan (excluding PPP loans) balance growth, interest income declined $551,000, or 1%, consistent with significant interest rate contraction within the loan portfolio over the past 12 months. In addition, NIM and loan yields were positively impacted by a large non-accrual commercial relationship that paid off in the first quarter of 2020, triggering previously unrecognized non-accrual interest of $350,000 to be recognized.     ● With the exception of mortgage loans held for sale, interest income on the remaining interest earning asset portfolio was significantly impacted by the lower interest rate environment over the past 12 months coupled with significant average balance growth.   Total average interest bearing liabilities increased $332 million, or 15%, to $2.5 billion for the six-month period ended June 30, 2020 as compared with the same period in 2019, with the average cost decreasing 47 bps to 0.59%.     ● Average interest bearing deposits increased $328 million, or 16%, for the six months ended June 30, 2020 compared to the same period in 2019, with interest-bearing demand deposits representing $205 million of the increase. Customers who received PPP loans, the proceeds for which were deposited into accounts held at the Bank, have generally been slow in deploying the funds. Further, the economic slow-down and uncertainty surrounding the pandemic has resulted in the customer base maintaining higher levels of liquidity in general, similar to behavior seen during the Great Recession.     ● Average FHLB advances increased $8 million, or 14%, for the six months ended June 30, 2020 compared to the same period of 2019, as a result of advances assumed in the May 2019 acquisition. These advances were retained by Bancorp based upon the favorable rates and terms at the time of acquisition in relation to the execution of Bancorp’s asset liability management strategy. A portion of these advances have either matured or been paid off without penalty during the first six months of 2020.   Total interest expense decreased $4.2 million, or 36%, for the six months ended June 30, 2020, compared to the same period of 2019, as a direct result of strategic deposit rate reductions implemented in response to the changing interest rate environment.     ● Total interest bearing deposit expense decreased $4.1 million, or 39%, and representing a 49 bps decline in the cost of average interest bearing liabilities.   68 Table of Contents   Total Company Average Balance Sheets and Interest Rates  - Three-Month Comparison       Three months ended June 30,       2020     2019       Average             Average     Average             Average   (dollars in thousands)   Balance     Interest     Rate     Balance     Interest     Rate                                                     Interest earning assets:                                                 Federal funds sold and interest bearing due from banks   $ 285,617     $ 88       0.12 %   $ 137,130     $ 830       2.43 % Mortgage loans held for sale     18,010       125       2.79       3,794       43       4.55   Securities available for sale:                                                 Taxable     401,750       2,066       2.07       410,201       2,395       2.34   Tax-exempt     10,618       72       2.73       25,190       162       2.58   Total securities     412,368       2,138       2.09       435,391       2,557       2.36                                                     Federal Home Loan Bank stock     11,284       70       2.50       10,590       151       5.72                                                     SBA Paycheck Protection Program (PPP) loans     529,361       3,392       2.58       —       —       —   Non-PPP loans     2,867,406       30,738       4.31       2,658,036       33,470       5.05   Total loans     3,396,767       34,130       4.04       2,658,036       33,470       5.05                                                     Total interest earning assets     4,124,046       36,551       3.56       3,244,941       37,051       4.58                                                     Less allowance for credit losses     42,952                       27,190                                                                     Non-interest earning assets:                                                 Cash and due from banks     43,346                       43,955                   Premises and equipment, net     57,206                       64,238                   Bank Owned Life Insurance     32,814                       33,038                   Accrued interest receivable and other     102,970                       77,193                   Total assets   $ 4,317,430                     $ 3,436,175                                                                     Interest bearing liabilities:                                                 Deposits:                                                 Interest bearing demand deposits   $ 1,128,075     $ 351       0.13 %   $ 843,768     $ 1,408       0.67 % Savings deposits     188,931       5       0.01       169,883       109       0.26   Money market deposits     760,210       211       0.11       689,954       2,079       1.21   Time deposits     423,099       2,040       1.94       409,163       2,056       2.02   Total interest bearing deposits     2,500,315       2,607       0.42       2,112,768       5,652       1.07                                                     Securities sold under agreements to repurchase     41,517       8       0.08       39,969       28       0.28   Federal funds purchased     8,423       2       0.10       11,774       64       2.18   Federal Home Loan Bank advances     63,896       361       2.27       72,923       424       2.33   Subordinated note     —       —       —       1,497       26       6.97                                                                                                       Total interest bearing liabilities     2,614,151       2,978       0.46       2,238,931       6,194       1.11                                                     Non-interest bearing liabilities:                                                 Non-interest bearing demand deposits     1,213,136                       754,592                   Accrued interest payable and other     73,223                       61,382                   Total liabilities     3,900,510                       3,054,905                                                                     Stockholders’ equity     416,920                       381,270                   Total liabilities and stockholder's equity   $ 4,317,430                     $ 3,436,175                   Net interest income           $ 33,573                     $ 30,857           Net interest spread                     3.10 %                     3.47 % Net interest margin                     3.27 %                     3.81 %   69 Table of Contents   Total Company Average Balance Sheets and Interest Rates  - Six-Month Comparison       Six months ended June 30,       2020     2019       Average             Average     Average             Average   (dollars in thousands)   Balance     Interest     Rate     Balance     Interest     Rate                                                     Interest earning assets:                                                 Federal funds sold and interest bearing due from banks   $ 227,090     $ 619       0.55 %   $ 129,701     $ 1,563       2.43 % Mortgage loans held for sale     11,481       186       3.26       2,766       80       5.83   Securities available for sale:                                                 Taxable     417,006       4,461       2.15       410,018       4,806       2.36   Tax-exempt     12,519       163       2.62       26,480       337       2.57   Total securities     429,525       4,624       2.16       436,498       5,143       2.38                                                     Federal Home Loan Bank stock     11,284       141       2.51       10,392       308       5.98                                                     SBA Paycheck Protection Program (PPP) loans     264,680       3,392       2.58       —       —       —   Non-PPP loans     2,879,538       64,518       4.51       2,593,712       65,069       5.06   Total loans     3,144,218       67,910       4.34       2,593,712       65,069       5.06                                                     Total interest earning assets     3,823,598       73,480       3.86       3,173,069       72,163       4.59                                                     Less allowance for credit losses     40,146                       26,662                                                                     Non-interest earning assets:                                                 Cash and due from banks     43,767                       42,810                   Premises and equipment, net     57,624                       63,083                   Bank Owned Life Insurance     32,725                       32,687                   Accrued interest receivable and other     96,207                       69,185                   Total assets   $ 4,013,775                     $ 3,354,172                                                                     Interest bearing liabilities:                                                 Deposits:                                                 Interest bearing demand deposits   $ 1,057,079     $ 1,162       0.22 %   $ 852,347     $ 2,811       0.67 % Savings deposits     179,503       23       0.03       163,504       205       0.25   Money market deposits     747,228       1,203       0.32       683,767       4,054       1.20   Time deposits     424,735       4,181       1.98       381,358       3,648       1.93   Total interest bearing deposits     2,408,545       6,569       0.55       2,080,976       10,718       1.04                                                     Securities sold under agreements to repurchase     37,465       24       0.13       38,755       53       0.28   Federal funds purchased     9,375       31       0.66       11,602       124       2.16   Federal Home Loan Bank advances     68,918       790       2.31       60,512       645       2.15   Subordinated note     —       —       —       752       26       6.97                                                                                                       Total interest bearing liabilities     2,524,303       7,414       0.59       2,192,597       11,566       1.06   Non-interest bearing liabilities:                                                 Non-interest bearing demand deposits     1,008,302                       724,896                   Accrued interest payable and other     70,859                       60,481                   Total liabilities     3,603,464                       2,977,974                                                                     Stockholders’ equity     410,311                       376,198                   Total liabilities and stockholder's equity   $ 4,013,775                     $ 3,354,172                   Net interest income           $ 66,066                     $ 60,597           Net interest spread                     3.27 %                     3.53 % Net interest margin                     3.47 %                     3.85 %   70 Table of Contents   Total Company Average Balance Sheets and Interest Rates  - Supplemental Information     ● Average loan balances include the principal balance of non-ac crual loans, as well as unearned income such as loan premiums, discounts, fees and costs, and exclude participation loans accou nted for as secured borrowings. P a rticipation loans averaged $9 million and $1 0 million for the three-month periods ended June 30 , 2020 and 2019, and $8 million and $10 million for the six-month periods ended June 30, 2020 and 2019.     ● Interest income on a FTE basis includes additional amounts of interest income that would have been earned if investments in certain tax- exempt interest earning assets had been made in assets subject to federal taxes yield ing the same after-tax income. Interest income on municipal securities and tax-exempt loans has been calc ulated on a FTE basis using a federal income tax rate of 21% for 2020 and 2019 . Approximate tax equivalent adjust me nts to interest income were $4 5 ,000 and $ 55 ,000 for the three month periods ended June 30, 2020 and 2019, and $92 ,000 and $111 ,000 for the six month periods ended June 30, 2020 and 2019.     ● Interest income includes loan fees of $2.4 million ($2.1 million associated with the PPP) and $360 ,000 for the three months ended June 30 , 2020 and 2019 , and $2.8 million and $883 ,000 for the six months ended June 30, 2020 and 2019 . Interest income on loans may be impacted by the level of prepayment fees collected and accretion related to loan purchased.     ● Net interest income, the mos t significant component of Bancorp 's earnings , represents total interest income less total interest expense. The level of net interest income is determined by mix and volume of interest earning assets, interest bearing deposits and borrowed funds, and changes in interest rates.     ● NIM represents net interest income on a FTE basis as a percentage of average interest earn ing assets.     ● Net interest spread is the difference between taxable equivalent rates ea rn ed on interest earning assets less the cost of interest bearing liabilities.     ● The fair market value adjustment on investment securities resulting from ASC 320, Investments – Debt and Equity Securities is included as a component of other assets.   ______________________________   71 Table of Contents   Asset/Liability Management and Interest Rate Risk   Managing interest rate risk is fundamental for the financial services industry. The primary objective of interest rate risk management is to neutralize effects of interest rate changes on net income. By considering both on and off-balance sheet financial instruments, management evaluates interest rate sensitivity with the goal of optimizing net interest income within the constraints of prudent capital adequacy, liquidity needs, market opportunities and customer requirements.   Interest Rate Simulation Sensitivity Analysis   Bancorp uses an earnings simulation model to estimate and evaluate the impact of an immediate change in interest rates on earnings in a one-year forecast. The simulation model is designed to reflect dynamics of interest earning assets and interest bearing liabilities. By estimating effects of interest rate fluctuations, the model can approximate interest rate risk exposure. This simulation model is used by management to gauge approximate results given a specific change in interest rates at a given point in time. The model is therefore a tool to indicate earnings trends in given interest rate scenarios and may not indicate actual or expected results.   The June 30, 2020 simulation reflects the mid-March 2020 FRB action to lower the FFTR to near zero. Bancorp’s interest rate simulation sensitivity analysis details that increases in interest rates of 100 bps would have a slightly negative effect on interest income, while an increase in rates of 200 bps would have a positive effect on net interest income. These results are attributed to over half of the variable rate loan portfolio being currently at or near floor rates, as these yields will not increase until short-term rates exceed these floor rates. For example, a significant portion of the variable rate loan portfolio is tied to Prime, with floor rates of 4.00%. Given Prime is at 3.25% as of June 30, 2020, short-term rates would have to increase over 75 bps for these loans to move above their floor rates.   The overall increase in net interest income in the rising rate scenarios is primarily due to variable rate loans and short-term investments repricing more quickly than deposits and short-term borrowings. Asset balances subject to immediate repricing cause an estimated decline in net interest income in the down 100 bps scenario, as rates on non-maturity deposits cannot be lowered sufficiently to offset declining interest income. These estimates are summarized below.       Change in Rates       -200     -100     +100     +200       Basis Points     Basis Points     Basis Points     Basis Points   % Change from base net interest income at June 30, 2020   N/A       -3.31 %     -0.19 %     2.54 %     Bancorp’s loan portfolio is currently composed of approximately 71% fixed and 29% variable rate loans, with the fixed rate portfolio pricing based on a spread to the five-year treasury curve at the time of origination and the variable portion pricing based on an on-going spread to Prime (approximately 60%) or one month LIBOR (approximately 40%). Bancorp’s loan portfolio (excluding PPPP loans) at June 30, 2020 was composed of approximately 65% fixed and 35% variable rate loans with the fluctuation in the C&I portfolio driving down variable rate percentage for the quarter.   Periodically, Bancorp enters into interest rate swap transactions with borrowers who desire to hedge exposure to rising interest rates, while at the same time entering into an offsetting interest rate swap, with substantially matching terms, with another approved independent counterparty. These are undesignated derivative instruments and are recognized on the balance sheet at fair value, with changes in fair value recorded in other non-interest income as interest rates fluctuate. Because of matching terms of offsetting contracts, in addition to collateral provisions which mitigate the impact of non-performance risk, changes in fair value subsequent to initial recognition have a minimal effect on earnings, and are therefore not included in the simulation analysis results above. For additional information, see the footnote titled “Assets and Liabilities Measured and Reported at Fair Value. ”   In addition, Bancorp uses derivative financial instruments as part of its interest rate risk management, including interest rate swaps. These interest rate swaps are designated as cash flow hedges as described in the footnote titled “ Derivative Financial Instruments.” For these derivatives, the effective portion of gains or losses is reported as a component of OCI, and is subsequently reclassified into earnings as an adjustment to interest expense in periods in which the hedged forecasted transaction impacts earnings.   72 Table of Contents   Provision for Credit Losses   An analysis of the changes in the ACL on loans, including provision, and selected ratios follow:       Three months ended     Six months ended       June 30,     June 30,   (dollars in thousands)   2020     2019     2020     2019                                     Beginning balance, prior to the adoption of ASC 326   $ 42,143     $ 26,464     $ 26,791     $ 25,534   Impact of adopting ASC 326     —       —       8,221       —   Initial ACL on loans purchased with credit deterioration     —       —       1,635       —   Provision for credit losses     5,550       —       11,100       600                                     Total charge-offs     (98 )     (161 )     (272 )     (260 ) Total recoveries     113       113       233       542   Net loan (charge-offs) recoveries     15       (48 )     (39 )     282   ACL at the end of the period   $ 47,708     $ 26,416     $ 47,708     $ 26,416   Average loans   $ 3,396,767     $ 2,658,036     $ 3,144,218     $ 2,593,712   Provision to average loans (1)     0.16 %     0.00 %     0.35 %     0.02 % Net loan (charge-offs) recoveries to average loans (1)     0.00 %     0.00 %     0.00 %     0.01 % ACL to average loans     1.40 %     0.99 %     1.52 %     1.02 % ACL to total loans     1.38 %     0.96 %     1.38 %     0.96 % (1) Ratios are not annualized   Provision represents the amount of expense that, based on Management’s judgment, is required to maintain the ACL on loans at an appropriate level under the CECL model. The determination of the amount of the ACL on loans is complex and involves a high degree of judgment and subjectivity. See the footnote titled “ Basis of Presentation and Summary of Significant Accounting Policies ” for detailed discussion regarding Bancorp’s ACL methodology by loan segment.   Upon adoption of ASC 326 on January 1, 2020, Bancorp recorded an incr