Critical Accounting Policies and Estimates

The accounting policies of the Company conform with U.S. generally accepted accounting principles and require management to make estimates and develop assumptions that affect the amounts reported in the financial statements and related footnotes. These estimates and assumptions are based on information available to management as of the date of the financial statements. Actual results could differ significantly from management's estimates. As this information changes, management's estimates and assumptions used to prepare the Company's financial statements and related disclosures may also change. The most significant accounting policies followed by the Company are presented in Note One to the audited financial statements included in the Company's 2021 Annual Report to Shareholders. The information included in this Quarterly Report on Form 10-Q, including the Consolidated Financial Statements, Notes to Consolidated Financial Statements, and Management's Discussion and Analysis of Financial Condition and Results of Operations, should be read in conjunction with the financial statements and notes thereto included in the 2021 Annual Report of the Company. Based on the sensitivity of financial statement amounts to the methods, assumptions, and estimates underlying those amounts, management has identified the determination of the allowance for credit losses and income taxes to be the accounting areas that require the most subjective or complex judgments and, as such, could be most subject to revision as new information becomes available.

Allowance for Credit Losses

The allowance for credit losses is a valuation account that is deducted from the loans' amortized cost basis to present the net amount expected to be collected on the loans. Loans are charged off against the allowance when management believes the uncollectibility of a loan balance is confirmed. Expected recoveries do not exceed the aggregate of amounts previously charged-off and expected to be charged-off in the future. Management estimates the allowance balance using relevant available information, from internal and external sources, relating to past events, current conditions, and reasonable and supportable forecasts. Historical credit loss experience provides the basis for the estimation of expected credit losses. Adjustments to historical loss information are made for differences in current loan-specific risk characteristics, such as differences in underwriting standards, portfolio mix, delinquency level, or term, as well as for changes in environmental conditions, such as changes in unemployment rates, property values, or other relevant factors. These evaluations are conducted at least quarterly and more frequently if deemed necessary. Additionally, all commercial loans within the portfolio are subject to internal risk grading. Risk grades are generally assigned by the primary lending officer and are periodically evaluated by the Company's internal loan review process.

In evaluating the appropriateness of its allowance for credit losses, the Company stratifies the loan portfolio into six major groupings. The Company has identified the following portfolio segments and measures the allowance for credit losses using the following methods:


          Portfolio Segment             Measurement Method
Commercial and industrial                   Migration
Commercial real estate:
  1-4 family                                Migration
  Hotels                                    Migration
  Multi-family                              Migration
  Non Residential Non-Owner Occupied        Migration
  Non Residential Owner Occupied            Migration
Residential real estate                      Vintage
Home equity                                  Vintage
Consumer                                     Vintage


Migration is an analysis that tracks a closed pool of loans for a configurable period of time and calculates a loss ratio on only those loans in the pool at the start date based on outstanding balance. Vintage is a predictive loss model that includes a reasonable approximation of probable and estimable future losses by tracking each loan's net losses over the life of the loan as compared to its original balance. For demand deposit overdrafts, the allowance for credit losses is measured using the historical loss rate. Loans that do not share risk characteristics are evaluated on an individual basis. Loans evaluated individually are not included in the collective evaluation. When management determines that foreclosure is probable, the expected credit losses are based on the fair value of the collateral at the reporting date, adjusted for selling costs as appropriate.


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Expected credit losses are estimated over the contractual term of the loan, adjusted for expected prepayments when appropriate. The contractual term excludes expected extensions, renewals, and modifications unless either of the following applies: management has a reasonable expectation at the reporting date that a troubled-debt restructuring will be executed with an individual borrower or the extension or renewal options are included in the original or modified contract at the reporting date and are not unconditionally cancellable by the Company.

The Company uses a number of economic variables in its scenarios to estimate the allowance for credit losses, with the most significant drivers being an unemployment rate forecast and qualitative adjustments. In the June 30, 2022 estimate, the Company assumed a 2-year unemployment forecast range of 3.7% to 5.0%, compared to 3.5% to 5.2% in both the March 31, 2022 and December 31, 2021 estimates. Historical loss rates from periods where the average unemployment rate matches the forecast range are considered when calculating the forecast period loss rate. Based on sensitivity of the portfolio, leaving the unemployment forecast range unchanged would have increased the reserve $0.4 million.

Based on sensitivity analysis of all portfolios, a 0.0050% change (slight improvement or decline on bank's scale) in all 11 qualitative risk factors (where assigned) would have a $1.9 million impact on the reserve allocation. Changing each factor by 0.01% (moderate improvement or decline) would have a $3.7 million impact. Management recognizes that these are extreme scenarios and it is very unlikely that all risk factors would change by 0.005% or 0.01% simultaneously. For the June 30, 2022 estimate, management assigned a "moderate decline," or 0.005% increase, to the Interest Rate Risk factor for all pools due to the rising rate environment. In total, the change increased the ACL (Allowance for Credit Losses) by approximately $0.4 million.

Income Taxes

The Company is subject to federal and state income taxes in the jurisdictions in which it conducts business. In computing the provision for income taxes, management must make judgments regarding interpretation of laws in those jurisdictions. Because the application of tax laws and regulations for many types of transactions is susceptible to varying interpretations, amounts reported in the financial statements could be changed at a later date upon final determinations by taxing authorities. On a quarterly basis, the Company estimates its annual effective tax rate for the year and uses that rate to provide for income taxes on a year-to-date basis. The amount of unrecognized tax benefits could change over the next twelve months as a result of various factors. However, management cannot currently estimate the range of possible change. The Company is currently open to audit under the statute of limitations by the Internal Revenue Service and various state taxing authorities for the years ended December 31, 2018 and forward.

The effective tax rate is calculated by taking the statutory rate and adjusting for permanent and discrete items. The discrete items can vary between periods but historically have remained consistent.

Financial Summary

Six months ended June 30, 2022 vs. 2021

The Company's financial performance is summarized in the following table:


                                                                     Six months ended June 30,
                                                                        2022            2021

Net income available to common shareholders (in thousands) $ 44,025 $ 41,962 Earnings per common share, basic

$       2.92     $       2.66
Earnings per common share, diluted                                $       2.92     $       2.66
Dividend payout ratio                                                     41.1   %         43.6  %
ROA*                                                                      1.47   %         1.44  %
ROE*                                                                      13.6   %         11.9  %
ROATCE*                                                                   16.6   %         14.3  %
Average equity to average assets ratio                                    10.8   %         12.1  %


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Table of Contents *ROA (Return on Average Assets) is a measure of the effectiveness of asset utilization. ROE (Return on Average Equity) is a measure of the return on shareholders' investment. ROATCE (Return on Average Tangible Common Equity) is a measure of the return on shareholders' equity, less intangible assets.

The Company's net interest income for the six months ended June 30, 2022 increased $3.8 million compared to the six months ended June 30, 2021 (see Net Interest Income). The Company recorded a recovery of credit losses of $0.8 million for the six months ended June 30, 2022 compared to a recovery of credit losses of $2.4 million for the six months ended June 30, 2021 (see Allowance for Credit Losses). As further discussed under the caption Non-Interest Income and Non-Interest Expense, non-interest income increased $1.2 million and non-interest expense increased $0.8 million for the six months ended June 30, 2022 from the six months ended June 30, 2021.

Financial Summary

Three months ended June 30, 2022 vs. 2021

The Company's financial performance is summarized in the following table:


                                                                    Three months ended June 30,
                                                                       2022              2021

Net income available to common shareholders (in thousands) $ 22,683 $ 22,148 Earnings per common share, basic

$        1.51     $        1.41
Earnings per common share, diluted                               $        1.51     $        1.41
Dividend payout ratio                                                     39.8   %          41.2  %
ROA*                                                                      1.51   %          1.49  %
ROE*                                                                      14.7   %          12.6  %
ROATCE*                                                                   18.1   %          15.2  %
Average equity to average assets ratio                                    10.3   %          11.8  %


*ROA (Return on Average Assets) is a measure of the effectiveness of asset utilization. ROE (Return on Average Equity) is a measure of the return on shareholders' investment. ROATCE (Return on Average Tangible Common Equity) is a measure of the return on shareholders' equity, less intangible assets.

The Company's net interest income for the three months ended June 30, 2022 increased $3.4 million compared to the three months ended June 30, 2021 (see Net Interest Income). The Company recorded no provision for credit losses for the three months ended June 30, 2022 compared to a $2.0 million recovery of credit losses for the three months ended June 30, 2021 (see Allowance for Credit Losses). As further discussed under the caption Non-Interest Income and Non-Interest Expense, non-interest income increased $0.4 million and non-interest expense increased $1.1 million for the three months ended June 30, 2022 from the three months ended June 30, 2021.

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