The following discussion and analysis is intended to assist readers in understanding the consolidated financial condition and results of operations ofOrrstown and should be read in conjunction with the preceding unaudited condensed consolidated financial statements and notes thereto included in this Quarterly Report on Form 10-Q, as well as with the audited consolidated financial statements and notes thereto for the year endedDecember 31, 2021 , included in our Annual Report on Form 10-K. Throughout this discussion, the yield on earning assets is stated on a fully taxable-equivalent basis and balances represent average daily balances unless otherwise stated. Certain prior period amounts presented in this discussion and analysis have been reclassified to conform to current period classifications.
Overview
The Company, headquartered inShippensburg, Pennsylvania , is a one-bank holding company that has elected status as a financial holding company. The consolidated financial information presented herein reflects the Company and its wholly-owned subsidiary, the Bank. AtJune 30, 2022 , the Company had total assets of$2.8 billion , total liabilities of$2.6 billion and total shareholders' equity of$237.5 million .
Cautionary Note About Forward-Looking Statements
Certain statements appearing herein, which are not historical in nature, are forward-looking statements within the meaning of Section 27A of the Securities Act and Section 21E of the Exchange Act, and are intended to be covered by the safe harbor provisions of the Private Securities Litigation Reform Act of 1995. In addition, we may make other written and oral communications, from time to time, that contain such statements. Such forward-looking statements reflect the current views of the Company's management with respect to, among other things, future events and the Company's financial performance. These statements are often, but not always, made through the use of words or phrases such as "may," "will," "expect," "estimate," "anticipate" or similar terms, or the negative variations of those words or other comparable words of a future or forward-looking nature. Forward-looking statements are statements that include projections, predictions, expectations, estimates or beliefs about events or results or otherwise are not statements of historical facts, many of which, by their nature, are inherently uncertain and beyond the Company's control, and include, but are not limited to, statements related to new business development, new loan opportunities, growth in the balance sheet and fee-based revenue lines of business, merger and acquisition activity, reducing risk assets, and mitigating losses in the future. Accordingly, the Company cautions you that any such forward-looking statements are not guarantees of future performance and are subject to risks, assumptions and uncertainties that are difficult to predict. Although the Company believes that the expectations reflected in these forward-looking statements are reasonable as of the date made, actual results may prove to be materially different from the results expressed or implied by the forward-looking statements and there can be no assurances that the Company will achieve the desired level of new business development and new loans, growth in the balance sheet and fee-based revenue lines of business, successful merger and acquisition activity, continue to reduce risk assets or mitigate losses in the future. In addition to risks and uncertainties related to the COVID-19 pandemic (including those related to variants) and resulting governmental and societal responses, factors that could cause actual results to differ from those expressed or implied by the forward-looking statements include, but are not limited to, the following: ineffectiveness of the Company's strategic growth plan due to changes in current or future market conditions; the effects of competition and how it may impact our community banking model, including industry consolidation and development of competing financial products and services; the integration of the Company's strategic acquisitions; the inability to fully achieve expected savings, efficiencies or synergies from mergers and acquisitions, or taking longer than estimated for such savings, efficiencies and synergies to be realized; changes in laws and regulations; interest rate movements; changes in credit quality; inability to raise capital, if necessary, under favorable conditions; volatility in the securities markets; the demand for our products and services; deteriorating economic conditions; geopolitical tensions; operational risks including, but not limited to, cybersecurity incidents, fraud, natural disasters and future pandemics; expenses associated with pending litigation and legal proceedings; the failure of the SBA to honor its guarantee of loans issued under the SBA PPP; the timing of the repayment of SBA PPP loans and the impact it has on fee recognition; our ability to convert new relationships gained through the SBA PPP efforts to full banking relationships; and other risks and uncertainties, including those detailed in our Annual Report on Form 10-K for the year endedDecember 31, 2021 , and our Quarterly Reports on Form 10-Q under the sections titled "Risk Factors" and "Management's Discussion and Analysis of Financial Condition and Results of Operations" and in other filings made with theSEC . The statements are valid only as of the date hereof and we disclaim any obligation to update this information.
Economic Climate, Inflation and Interest Rates
Preliminary real GDP for the second quarter of 2022 reflected an annualized decrease of 0.9%, which is a modest improvement from the 1.6% decline during the first quarter of 2022. The annualized growth for the second quarter of 2021 was 6.7%. The decrease in the second quarter of 2022 continued to be caused by decreases in private inventory investment, which 43
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includes retail trade on motor vehicles and general merchandise stores, and government spending, partially offset by increases in personal consumption, primarily within healthcare, travel, food services and accommodations. The personal consumption expenditures ("PCE") price index increased to 7.1% in the second quarter of 2022, compared to an increase of 7.0% in the first quarter of 2022. The national unemployment rate remained at 3.6% inJune 2022 fromMarch 2022 , down from 6.0% inJune 2021 . Within the Company's geographic footprint, the unemployment rate has decreased inPennsylvania by 2.6% from 6.6% atMay 2021 to 4.0% atMay 2022 , and decreased inMaryland by 2.3% from 6.0% atMay 2021 to 3.7% inMay 2022 . These decreases in unemployment rates are consistent to the counties in which the Company operates branches and other corporate offices. There continued to be notable job gains in healthcare, leisure and hospitality and professional and business services during the second quarter of 2022. Although there was strong economic recovery in 2021 from the pandemic, the decrease in GDP during the first half of 2022 is indicative of inflation, supply chain challenges, and labor shortages compared to levels pre-pandemic inFebruary 2020 . AtJune 30, 2022 , the 10-yearTreasury bond reached 2.98%, an increase of 0.64% from 2.34% atMarch 31, 2022 , as it continued to rise due to stock market volatility and inflationary pressures. InMarch 2022 , the Federal Reserve Open Markets Committee ("FOMC") approved an increase to the Fed Funds rate of 25 basis points due to inflation, elevating geopolitical tensions and the state of the labor market recovery. During the second quarter of 2022, theFOMC approved additional increases to the Fed Funds rate of 50 basis points onMay 5, 2022 and 75 basis points onJune 16, 2022 . OnJuly 27, 2022 , theFOMC further increased theFed Fund rate by another 75 basis points as the FRB continues to attempt to combat the impact of inflation and evaluate the economic state based on unemployment, a rising consumer price index and geopolitical tensions that could cause supply chain disruptions. The majority of the assets and liabilities of a financial institution are monetary in nature and, therefore, differ greatly from most commercial and industrial companies that have significant investments in fixed assets or inventories. However, inflation does have an impact on the Company, particularly with respect to the growth of total assets and noninterest expenses, which tend to rise during periods of general inflation. Risks also exist due to supply and demand imbalances, employment shortages, the interest rate environment, and geopolitical tensions. It is reasonably foreseeable that estimates made in the financial statements could be materially and adversely impacted in the near term as a result of these conditions, including expected credit losses on loans and the fair value of financial instruments that are carried at fair value.
Critical Accounting Estimates
The Company's accounting and reporting policies are in accordance with GAAP and follow accounting and reporting guidelines prescribed by bank regulatory authorities and general practices within the financial services industry in which it operates. Our financial position and results of operations are affected by management's application of accounting policies, including estimates, and assumptions and judgments that affect the amounts reported in the consolidated financial statements and accompanying notes. These estimates, assumptions, and judgments are based on information available as of the balance sheet date and through the date the financial statements are filed with theSEC . Different assumptions in the application of these policies could result in material changes in the consolidated financial position and/or consolidated results of operations and related disclosures. The more critical accounting estimates include accounting for credit losses and valuation methodologies. Accordingly, these critical accounting estimates are discussed in detail in "Management's Discussion and Analysis of Financial Condition and Results of Operations" in our Annual Report on Form 10-K for the year endedDecember 31, 2021 . Significant accounting policies and any changes in accounting principles and effects of new accounting pronouncements are discussed in Note 1, Summary of Significant Accounting Policies, to the Consolidated Financial Statements under Part II, Item 8, "Financial Statements and Supplementary Data," in our Annual Report on Form 10-K for the year endedDecember 31, 2021 . Additional disclosures regarding the effects of new accounting pronouncements are included in this report in Note 1, Summary of Significant Accounting Policies, to the unaudited condensed consolidated financial statements under Part I, Item 1, "Financial Information." 44
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RESULTS OF OPERATIONS
Three months ended
Summary
Net income totaled$8.9 million for the three months endedJune 30, 2022 compared with net income of$8.8 million for the same period in 2021. Diluted earnings per share for the three months endedJune 30, 2022 totaled$0.83 compared to$0.79 for the three months endedJune 30, 2021 . Net interest income positively influenced results of operations, and totaled$24.1 million for the three months endedJune 30, 2022 compared to$21.9 million for the three months endedJune 30, 2021 . Noninterest income totaled approximately$7.2 million and$6.7 million for the three months endedJune 30, 2022 and 2021, respectively. Noninterest expenses totaled$18.8 million for the three months endedJune 30, 2022 compared to$17.0 million for the three months endedJune 30, 2021 . The comparison of operating results for 2022 with 2021 reflects the impact of the investment of cash in higher yielding commercial loans and investment securities, rising interest rates and reductions in the cost of funds, partially offset by increases in the provision for loan losses and salaries and employee benefits expense. 45
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Net Interest Income
Net interest income increased by$2.2 million from$21.9 million to$24.1 million from the three months endedJune 30, 2021 to the three months endedJune 30, 2022 . Total interest expense decreased from$1.8 million for the three months endedJune 30, 2021 to$1.2 million for the three months endedJune 30, 2022 . Interest income on loans increased by$704 thousand , from$21.3 million to$22.0 million , and interest income on investment securities increased by$836 thousand , from$2.3 million to$3.1 million , for the three months endedJune 30, 2022 compared to the same period in the prior year. The following table presents net interest income, net interest spread and net interest margin for the three months endedJune 30, 2022 and 2021 on a taxable-equivalent basis: Three Months Ended June 30, 2022 Three Months Ended June 30, 2021 Taxable- Taxable- Taxable- Taxable- Average Equivalent Equivalent Average Equivalent Equivalent Balance Interest Rate Balance Interest Rate Assets Federal funds sold & interest-bearing bank balances$ 131,449 $ 235 0.72 %$ 290,039 $ 81 0.11 % Investment securities (1) 523,940 3,388 2.59 438,110 2,421 2.22 Loans (1)(2)(3) 2,008,283 22,090 4.41 2,014,600 21,375 4.26 Total interest-earning assets 2,663,672 25,713 3.87 2,742,749 23,877 3.49 Other assets 192,561 188,810 Total$ 2,856,233 $ 2,931,559 Liabilities and Shareholders' Equity Interest-bearing demand deposits$ 1,420,051 301 0.09$ 1,394,384 292 0.08 Savings deposits 236,916 63 0.11 200,439 50 0.10 Time deposits 275,408 337 0.49 382,467 739 0.78 Total interest-bearing deposits 1,932,375 701 0.15 1,977,290 1,081
0.22
Securities sold under agreements to repurchase 24,045 7 0.11 22,417 8
0.14
FHLB advances and other borrowings 1,741 21 4.74 57,896 164 1.14 Subordinated notes 31,985 503 6.29 31,924 502 6.29 Total interest-bearing liabilities 1,990,146 1,232 0.25 2,089,527 1,755
0.34
Noninterest-bearing demand deposits 572,171 545,617 Other 47,190 37,561 Total liabilities 2,609,507 2,672,705 Shareholders' equity 246,726 258,854 Total$ 2,856,233 $ 2,931,559 Taxable-equivalent net interest income /net interest spread 24,481 3.62 % 22,122 3.15 % Taxable-equivalent net interest margin 3.68 % 3.24 % Taxable-equivalent adjustment (363) (221) Net interest income$ 24,118 $ 21,901
NOTES TO ANALYSIS OF NET INTEREST INCOME:
Yields and interest income on tax-exempt assets
have been computed on a taxable-equivalent
(1) basis assuming a 21% tax rate. (2) Average balances include nonaccrual loans. (3) Interest income on loans includes prepayment and
late fees, where applicable.
Net interest income on a taxable-equivalent basis increased by$2.4 million to$24.5 million for the three months endedJune 30, 2022 from$22.1 million for the three months endedJune 30, 2021 . The Company's net interest spread increased by 47 basis points to 3.62% for the three months endedJune 30, 2022 compared to 3.15% for the three months endedJune 30, 2021 . 46
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Taxable-equivalent net interest margin increased 44 basis points to 3.68% for the three months endedJune 30, 2022 from 3.24% for the three months endedJune 30, 2021 . The taxable-equivalent yield on interest-earning assets increased 38 basis points from the three months endedJune 30, 2021 to the three months endedJune 30, 2022 reflecting the deployment of cash into higher yielding commercial loans and investment securities and home equity loans. The decrease in the cost of interest-bearing liabilities from the three months endedJune 30, 2021 to the three months endedJune 30, 2022 also benefited the tax-equivalent net interest margin, reflecting the decrease in time deposit balances and repayment of overnight borrowings. Average loans remained approximately$2.0 billion , during both the three months endedJune 30, 2022 and 2021, as the commercial and home equity loan growth in three months endedJune 30, 2022 was partially offset by the impact of SBA PPP loan forgiveness. Average investment securities increased by$85.8 million from$438.1 million for the three months endedJune 30, 2021 to$523.9 million for the same period in 2022 due to investment purchases. Average interest-bearing liabilities declined by$99.4 million to$2.0 billion for the 2022 period from$2.1 billion for the 2021 period due primarily to decreased average balances in time deposits and overnight borrowings. The yield on loans increased by 15 basis points to 4.41% for the three months endedJune 30, 2022 compared to 4.26% for the three months endedJune 30, 2021 . Taxable-equivalent interest income earned on loans increased by$715 thousand year-over-year primarily due to an increase in the average balances of commercial loans excluding SBA PPP loans, and the impact of the rising interest rate environment. The increase in interest income on loans due to loan growth, excluding SBA PPP loans, was partially offset by a decrease in interest income from SBA PPP loans. This decrease in SBA PPP interest income is due to a lower average balance of SBA PPP loans forgiven during the three months endedJune 30, 2022 compared to the three months endedJune 30, 2021 . SBA PPP loans, net of deferred fees and costs, averaged$72.5 million during the three months endedJune 30, 2022 compared to$471.2 million during the three months endedJune 30, 2021 . This decrease was due to the forgiveness of SBA PPP loans. The average balance of commercial loans, excluding SBA PPP loans, increased by$400.9 million from$1.1 billion during the three months endedJune 30, 2021 to$1.5 billion during the three months endedJune 30, 2022 . Average home equity loans increased by$17.4 million from$154.0 million for the three months endedJune 30, 2021 to$171.4 million for the three months endedJune 30, 2022 . Average installment and other consumer loans decreased by$14.3 million from$41.3 million for the three months endedJune 30, 2021 to$27.0 million for the three months endedJune 30, 2022 . Average residential mortgage loans decreased by$11.6 million from$215.4 million during the three months endedJune 30, 2021 to$203.8 million during the three months endedJune 30, 2022 due to lower housing inventory and runoff. For the three months endedJune 30, 2022 , interest income on loans included$1.9 million of interest and net deferred fee income recognized associated with the SBA PPP loans compared to$5.2 million of such interest and fee income for the three months endedJune 30, 2021 . Prepayment fee income on commercial loans increased by$266 thousand from$132 thousand for the three months endedJune 30, 2021 to$398 thousand for the same period in 2022. Accretion of purchase accounting adjustments included in interest income was$429 thousand and$508 thousand for the three months endedJune 30, 2022 and 2021, respectively. The three months endedJune 30, 2022 and 2021 included$323 thousand and$349 thousand , respectively, of accelerated accretion related to the payoff of acquired loans. Interest income on investment securities on a tax-equivalent basis increased by$967 thousand to$3.4 million for the three months endedJune 30, 2022 from$2.4 million for the three months endedJune 30, 2021 , with the taxable equivalent yield increasing from 2.22% for the three months endedJune 30, 2021 to 2.59% for the three months endedJune 30, 2022 . This 37 basis point increase reflected the higher interest rate environment in 2022 and certain repositioning within the portfolio under the Company's asset/liability management strategies. Although the average balance of federal funds sold and interest-bearing bank balances decreased by$158.6 million from$290.0 million for the three months endedJune 30, 2021 to$131.4 million for the same period in 2022 due primarily to the deployment of cash into loans and investment securities, the related interest income on a tax-equivalent basis increased by$154 thousand to$235 thousand for the three months endedJune 30, 2022 from$81 thousand for the three months endedJune 30, 2021 . This increase was caused by the increase in the interest rate at the FRB as a result of multiple Fed Funds rate increases by theFOMC during 2022. Interest expense on deposits and borrowings decreased by$523 thousand year-over-year, reflecting a decrease in the average balance of interest-bearing deposits of$44.9 million due primarily to continued runoff of certificates of deposit. The cost of interest-bearing liabilities declined by nine basis points from 0.34% for the three months endedJune 30, 2021 to 0.25% for the three months endedJune 30, 2022 due to the timing of deposit rate reductions in 2021 combined with the continued maturity of higher yielding certificates of deposits and the repayment of overnight borrowings in the third quarter of 2021. 47
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Provision for Loan Losses
The Company recorded a provision for loan losses of$1.8 million for the three months endedJune 30, 2022 compared to$625 thousand for the same period in 2021. In calculating the provision for loan losses, both quantitative and qualitative factors, including the Company's historical charge-off data and economic and market conditions, were considered. For the three months endedJune 30, 2022 and 2021, the provision for loan losses was driven primarily by an increase in commercial loans; however, the increase for the three months endedJune 30, 2021 was partially offset by the release of a portion of the Company's COVID-19 related reserve of$790 thousand . Net charge-offs in the three months endedJune 30, 2022 totaled$4 thousand , compared to net charge-offs of$211 thousand in the comparable prior year period. Nonaccrual loans were 0.27% of gross loans atJune 30, 2022 , compared with 0.51% of gross loans atJune 30, 2021 . Nonaccrual loans decreased by$4.5 million fromJune 30, 2021 toJune 30, 2022 and classified loans decreased by$9.0 million from$28.7 million to$19.7 million fromJune 30, 2021 toJune 30, 2022 , respectively. The decrease in non-accrual loans includes the payoff of one loan of$2.6 million , loans returning to accrual status of$652 thousand , and charge-offs of$189 thousand , with the remaining decrease due to paydowns. The decrease in classified loans reflects upgrades to commercial loan ratings, including loans that were previously downgraded due to the impact of the COVID-19 pandemic.
Additional information is included in the "Credit Risk Management" section herein.
Noninterest Income
The following table compares noninterest income for the three months endedJune 30, 2022 and 2021: Three Months Ended June 30, $ Change % Change 2022 2021 2022-2021 2022-2021
Service charges on deposit accounts $ 964
$ 266 38.1 % Interchange income 1,064 1,064 - - % Other service charges and fees 230 182 48 26.4 % Swap fee income 785 15 770 5133.3 % Trust and investment management income 1,905 2,020 (115) (5.7) % Brokerage income 989 910 79 8.7 % Mortgage banking activities 498 1,162 (664) (57.1) % Income from life insurance 593 564 29 5.1 % Other income 169 38 131 344.7 % Investment securities (losses) gains (3) 11 (14) (127.3) % Total noninterest income$ 7,194 $ 6,664 $ 530 8.0 %
The following factors contributed to the more significant changes in noninterest
income between the three months ended
•Service charges on deposit accounts increased by$266 thousand due to higher customer transaction activity as the economy continued to recover from the COVID-19 pandemic and changes to the deposit fee structure that took effect inApril 2022 .
•Swap fee income increased by
•Trust and investment management income decreased by$115 thousand due to the negative impact of the stock and bond market conditions on clients' investment portfolios. •Mortgage banking income decreased by$664 thousand due to current market conditions, including low housing inventory and a rising interest rate environment, which caused declines in residential mortgage loan production, the residential mortgage loan pipeline and secondary market sales during the second quarter of 2022, compared to the same period in 2021. These changes resulted in a decrease in the gains on sales of residential mortgage loans of$600 thousand for the three months endedJune 30, 2022 compared to the second quarter of 2021. Mortgage loans sold totaled$22.6 million in the second quarter of 2022 compared with$51.8 million in the second quarter of 2021.
•Other line items within noninterest income showed fluctuations between 2022 and 2021 attributable to normal business operations.
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Noninterest Expenses
The following table compares noninterest expenses for the three months endedJune 30, 2022 and 2021: Three Months Ended June 30, $ Change % Change 2022 2021 2022-2021 2022-2021
Salaries and employee benefits
$ 1,100 10.8 % Occupancy 1,132 1,098 34 3.1 % Furniture and equipment 1,291 1,302 (11) (0.8) % Data processing 1,165 1,032 133 12.9 % Automated teller machine and interchange fees 318 319 (1) (0.3) % Advertising and bank promotions 881 274 607 221.5 % FDIC insurance 190 158 32 20.3 % Professional services 722 579 143 24.7 % Directors' compensation 230 235 (5) (2.1) % Taxes other than income 108 462 (354) (76.6) % Intangible asset amortization 281 324 (43) (13.3) % Other operating expenses 1,164 1,038 126 12.1 % Total noninterest expenses$ 18,794 $ 17,033 $ 1,761 10.3 %
The following factors contributed to the more significant changes in noninterest
expenses between the three months ended
•Salaries and employee benefits expense increased by$1.1 million due primarily to increases in wages and additions to staff that filled vacancies and drive and support a strong growth trajectory, which also resulted in an increase in employee benefit costs.
•Data processing increased by
•Advertising and bank promotions increased by$607 thousand due to an increase in contributions, which included$500 thousand in thePennsylvania ("PA") EITC, with the remaining increase primarily due to promotional expenses and bank events.
•Professional services increased by
•Taxes other than income decreased by$354 thousand due to$450 thousand of eligible tax credits associated with the contributions made to the PA EITC. This decrease was partially offset by an increase in PABank Shares Tax expense as the Bank's total equity balance grew from the prior period. •Other operating expenses increased by$126 thousand . The reserve for unfunded commitments was reduced by$434 thousand during the three months endedJune 30, 2021 compared to no change in the reserve during the same period in 2022. This increase was partially offset by a decrease in loan-related costs of$256 thousand and a decrease in expense of$77 thousand related to income from derivative fair value adjustments compared to the same period in 2021.
•Other line items within noninterest expenses showed fluctuations between 2022 and 2021 attributable to normal business operations.
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Income Tax Expense
Income tax expense totaled$1.9 million , an effective tax rate of 17.4%, for the three months endedJune 30, 2022 compared with$2.1 million , an effective tax rate of 19.5%, for the three months endedJune 30, 2021 . The Company's effective tax rate is less than the 21% federal statutory rate, principally due to tax-free income, which includes interest income on tax-free loans and investment securities and income from life insurance policies, federal income tax credits, and the impact of non-tax deductible expenses. The decrease in the effective tax rate from the three months endedJune 30, 2021 to the three months endedJune 30, 2022 was due primarily to an increase in projected income from tax-free investment securities and loans for the 2022 fiscal year compared to the prior year.
Six months ended
Summary
Net income totaled$17.2 million for the six months endedJune 30, 2022 compared with net income of$19.0 million for the same period in 2021. Diluted earnings per share for the six months endedJune 30, 2022 totaled$1.59 , compared with$1.71 for the six months endedJune 30, 2021 . Net interest income positively influenced results of operations, and totaled$46.7 million for the six months endedJune 30, 2022 , compared to$43.8 million for the six months endedJune 30, 2021 . Noninterest income totaled$14.7 million and$14.2 million for the six months endedJune 30, 2022 and 2021, respectively. Noninterest expenses totaled$38.2 million for the six months endedJune 30, 2022 compared to$34.8 million for the six months endedJune 30, 2021 . The comparison of operating results for 2022 with 2021 reflects increases in the provision for loan losses and salaries and employee benefits expense, partially offset by the increase in net interest income from the investment of cash into higher yielding commercial loans and investment securities and reduction in the cost of funds. 50
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Net Interest Income
Net interest income increased by$2.9 million from$43.8 million for the six months endedJune 30, 2021 to$46.7 million for the six months endedJune 30, 2022 . Total interest expense decreased from$3.8 million for the six months endedJune 30, 2021 to$2.4 million for the six months endedJune 30, 2022 . Interest income on loans increased by$562 thousand , from$42.8 million to$43.4 million , and investment securities interest income increased by$777 thousand , from$4.6 million to$5.4 million , compared to the same period in the prior year. Interest expense on deposits decreased by$1.1 million , from$2.5 million for the six months endedJune 30, 2021 to$1.4 million for the six months endedJune 30, 2022 . The following table presents net interest income, net interest spread and net interest margin for the six months endedJune 30, 2022 and 2021 on a taxable-equivalent basis: Six Months Ended June 30, 2022 Six Months Ended June 30, 2021 Taxable- Taxable- Taxable- Taxable- Average Equivalent Equivalent Average Equivalent Equivalent Balance Interest Rate Balance Interest Rate Assets Federal funds sold & interest-bearing bank balances $ 165,430$ 336 0.41 % $ 218,216$ 120 0.11 % Investment securities (1) 498,210
5,900 2.37 453,108 4,933 2.20 Loans (1)(2)(3) 1,991,636 43,519 4.40 2,023,858 42,949 4.28 Total interest-earning assets 2,655,276 49,755 3.77 2,695,182 48,002 3.59 Other assets 188,454 185,791 Total$ 2,843,730 $ 2,880,973 Liabilities and Shareholders' Equity Interest-bearing demand deposits$ 1,409,177 557 0.08$ 1,364,483 728 0.11 Savings deposits 232,322 120 0.10 192,039 96 0.10 Time deposits 286,949 709 0.50 389,828 1,649 0.85 Total interest-bearing deposits 1,928,448 1,386 0.14 1,946,350 2,473 0.26 Securities sold under agreements to repurchase 23,789 14 0.12 21,937 17 0.16 FHLB Advances and other borrowings 1,795 43 4.74 57,948 335 1.17 Subordinated notes 31,977 1,006 6.29 31,916 1,004 6.29 Total interest-bearing liabilities 1,986,009 2,448 0.25 2,058,151 3,829 0.38 Noninterest-bearing demand deposits 556,243 531,313 Other 44,072 36,906 Total liabilities 2,586,324 2,626,370 Shareholders' equity 257,406 254,603 Total$ 2,843,730 $ 2,880,973 Taxable-equivalent net interest income /net interest spread 47,307 3.52 % 44,173 3.22 % Taxable-equivalent net interest margin 3.59 % 3.31 % Taxable-equivalent adjustment (615) (417) Net interest income$ 46,692 $ 43,756
NOTES TO ANALYSIS OF NET INTEREST INCOME:
Yields and interest income on tax-exempt assets
have been computed on a taxable-equivalent
(1) basis assuming a 21% tax rate. (2) Average balances include nonaccrual loans. (3) Interest income on loans includes prepayment and late fees, where applicable. 51
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Net interest income on a taxable-equivalent basis increased by$3.1 million to$47.3 million for the six months endedJune 30, 2022 from$44.2 million for the six months endedJune 30, 2021 . The Company's net interest spread increased by 30 basis points to 3.52% for the six months endedJune 30, 2022 compared to 3.22% for the six months endedJune 30, 2021 . Taxable-equivalent net interest margin increased by 28 basis points to 3.59% for the six months endedJune 30, 2022 from 3.31% for the six months endedJune 30, 2021 . The taxable-equivalent yield on interest-earning assets increased by 18 basis points from the six months endedJune 30, 2021 to the six months endedJune 30, 2022 reflecting the deployment of cash into higher yielding commercial loans and investment securities. The decrease in the cost of interest-bearing liabilities from the six months endedJune 30, 2021 to the six months endedJune 30, 2022 also benefited the tax-equivalent net interest margin, which reflected the decrease in time deposit balances and repayment of overnight borrowings. Average loans remained approximately$2.0 billion , during both the six months endedJune 30, 2022 and 2021, as commercial and home equity loan growth for the six months endedJune 30, 2022 was offset primarily by the impact of SBA PPP loan forgiveness. Average investment securities increased by$45.1 million from$453.1 million for the six months endedJune 30, 2021 to$498.2 million for the same period in 2022 due to investment purchases. Average interest-bearing liabilities declined$72.1 million to$2.0 billion for the 2022 period from$2.1 billion for the 2021 period due to decreased average balances in time deposits and overnight borrowings. The yield on loans increased by 12 basis points to 4.40% for the six months endedJune 30, 2022 compared to 4.28% for the six months endedJune 30, 2021 . Taxable-equivalent interest income earned on loans increased by$570 thousand year-over-year due to an increase in the average balance of commercial loans, excluding SBA PPP loans, and from the impact of the rising interest rate environment. The increase in interest income was partially offset by the decrease in interest income from SBA PPP loans. This decrease is due to a lower average balance of SBA PPP loans resulting from loans forgiven during the six months endedJune 30, 2022 compared to the six months endedJune 30, 2021 . SBA PPP loans, net of deferred fees and costs, averaged$113.6 million during the six months endedJune 30, 2022 compared to$467.5 million during the six months endedJune 30, 2021 . This decrease was due to the forgiveness of SBA PPP loans. The average balance of commercial loans, excluding SBA PPP loans, increased by$348.7 million from$1.1 billion in the six months endedJune 30, 2021 to$1.5 billion during the six months endedJune 30, 2022 . Average home equity loans increased by$12.9 million from$155.0 million for the six months endedJune 30, 2021 to$167.9 million for the six months endedJune 30, 2022 . Average installment and other consumer loans decreased by$15.7 million from$43.8 million for the six months endedJune 30, 2021 to$28.1 million for the six months endedJune 30, 2022 . Average residential mortgage loans decreased by$24.1 million from$223.9 million during the six months endedJune 30, 2021 to$199.8 million during the six months endedJune 30, 2022 due to lower housing inventory and runoff. For the six months endedJune 30, 2022 , interest income on loans includes$5.4 million of interest and net deferred fee income recognized associated with the SBA PPP loans compared to$9.7 million of such interest and fee income for the six months endedJune 30, 2021 . Accretion of purchase accounting adjustments included in interest income was$810 thousand and$1.1 million for the six months endedJune 30, 2022 and 2021, respectively. The six months endedJune 30, 2022 and 2021 included$583 thousand and$764 thousand , respectively, of accelerated accretion related to the payoff of acquired loans. Interest income on investment securities on a tax-equivalent basis increased by$967 thousand to$5.9 million for the six months endedJune 30, 2022 from$4.9 million for the six months endedJune 30, 2021 , with the taxable equivalent yield increasing from 2.20% for the six months endedJune 30, 2021 to 2.37% for the six months endedJune 30, 2022 . The 17 basis point increase reflected the higher interest rate environment in 2022 and certain repositioning within the portfolio under the Company's asset/liability management strategies. Although the average balance of federal funds sold and interest-bearing bank balances decreased by$52.8 million from$218.2 million for the six months endedJune 30, 2021 , to$165.4 million for the same period in 2022 due primarily to the deployment of cash into loans and investment securities, the related interest income on a tax-equivalent basis increased by$216 thousand to$336 thousand for the six months endedJune 30, 2022 , from$120 thousand for the six months endedJune 30, 2021 . This increase was caused by the increase in the interest rate at the FRB as a result of multiple Fed Funds rate increases by theFOMC during 2022. Interest expense on deposits and borrowings decreased by$1.4 million year-over-year, reflecting a decrease in the average balance of interest-bearing deposits of$17.9 million due primarily to continued runoff of certificates of deposit. The cost of interest-bearing liabilities declined 13 basis points from 0.38% for the six months endedJune 30, 2021 to 0.25% for the six months endedJune 30, 2022 due to the timing of deposit rate reductions in 2021 combined with the continued maturity of higher yielding certificates of deposits and the repayment and maturities of overnight borrowings in the third quarter of 2021. 52
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Provision for Loan Losses
The Company recorded a provision for loan losses of$2.1 million for the six months endedJune 30, 2022 compared to negative provision for loan losses of$375 thousand for the same period in 2021. In calculating the provision for loan losses, both quantitative and qualitative factors, including the Company's historical charge-off data and economic and market conditions, were considered. The provision for loan losses for the six months endedJune 30, 2022 was driven primarily by an increase in commercial loans, partially offset by the impact of a reduction in qualitative factors to unwind a$726 thousand increase applied to the commercial real estate loan portfolio in 2020 associated with the economic impact of the COVID-19 pandemic. The negative provision for loan losses recorded in the six months endedJune 30, 2021 was due to the release of a portion of the Company's remaining COVID-19 related reserve of$1.7 million . Net recoveries in the six months endedJune 30, 2022 totaled$24 thousand , compared to net charge-offs of$395 thousand in the comparable prior year period. Nonaccrual loans were 0.27% of gross loans atJune 30, 2022 , compared with 0.51% of gross loans atJune 30, 2021 . Nonaccrual loans decreased by$4.5 million fromJune 30, 2021 toJune 30, 2022 and classified loans decreased by$9.0 million to$19.7 million fromJune 30, 2021 toJune 30, 2022 . The decrease in non-accrual loans includes the payoff of one loan of$2.6 million , loans returning to accrual status of$652 thousand and charge-offs of$189 thousand , with the remaining decrease due to paydowns. The decrease in classified loans reflects upgrades to commercial loan ratings, including loans that were previously downgraded due to the impact of the COVID-19 pandemic.
Additional information is included in the "Credit Risk Management" section herein.
Noninterest Income
The following table compares noninterest income for the six months endedJune 30, 2022 and 2021: Six Months Ended June 30, $ Change % Change 2022 2021 2022-2021 2022-2021
Service charges on deposit accounts
$ 449 31 % Interchange income 2,045 2,019 26 1 % Other service charges and fees 383 330 53 16 % Swap fee income 1,738 68 1,670 2,456 % Trust and investment management income 3,846 3,932 (86) (2) % Brokerage income 1,917 1,721 196 11 % Mortgage banking activities 1,219 3,351 (2,132) (64) % Income from life insurance 1,159 1,121 38 3 % Other income 626 75 551 735 % Investment securities (losses) gains (149) 156 (305) (196) % Total noninterest income$ 14,668 $ 14,208 $ 460 3 %
The following factors contributed to the more significant changes in noninterest
income between the six months ended
•Service charges on deposit accounts increased by$449 thousand due to increased customer transaction activity as the economy continued to recover from the COVID-19 pandemic and changes to the deposit fee structure that took effect inApril 2022 .
•Swap fee income increased by
•Brokerage income increased by
•Mortgage banking income decreased by$2.1 million due to current market conditions, including low housing inventory and a rising interest rate environment, which caused declines in residential mortgage loan production, the residential mortgage loan pipeline and secondary market sales during the first half of 2022, compared to strong refinancing activity in the same period in 2021. These changes resulted in a decrease in the gain on sale of residential mortgage loans of$1.4 million for the six months endedJune 30, 2022 compared to the first quarter of 2021. In addition, the Company recorded an MSR valuation reserve reversal of$79 thousand in the six months endedJune 30, 2022 compared to an MSR valuation reserve reversal of$651 thousand in the six months endedJune 30, 2021 , which was driven by significant market interest rate reductions caused by the COVID-19 pandemic 53
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earlier in 2021. Mortgage loans sold totaled
•Other income increased by
•During the six months endedJune 30, 2022 , the Company recorded net investment securities losses of$149 thousand due to a loss of$171 thousand on one non-agency CMO security that was called by the issuer in the second quarter of 2022. The loss was partially offset by a gain of$22 thousand from the partial sale of$3.1 million of one municipal security. During the six months endedJune 30, 2021 , the Company sold 14 securities with a principal balance of$75.6 million for a gain of$128 thousand .
•Other line items within noninterest income showed fluctuations between 2022 and 2021 attributable to normal business operations.
Noninterest Expenses
The following table compares noninterest expenses for the six months endedJune 30, 2022 and 2021: Six Months Ended June 30, $ Change % Change 2022 2021 2022-2021 2022-2021
Salaries and employee benefits
$ 2,240 11.0 % Occupancy 2,420 2,338 82 3.5 % Furniture and equipment 2,570 2,580 (10) (0.4) % Data processing 2,218 2,051 167 8.1 % Automated teller machine and interchange fees 623 568 55 9.7 % Advertising and bank promotions 1,236 699 537 76.8 % FDIC insurance 473 352 121 34.4 % Professional services 1,530 1,300 230 17.7 % Directors' compensation 461 469 (8) (1.7) % Taxes other than income 672 913 (241) (26.4) % Intangible asset amortization 573 658 (85) (12.9) % Other operating expenses 2,733 2,479 254 10.2 % Total noninterest expenses$ 38,158 $ 34,816 $ 3,342 9.6 %
The following factors contributed to the more significant changes in noninterest
expenses between the six months ended
•Salaries and employee benefits expense increased by$2.2 million due primarily to increases in wages and additions to staff that filled vacancies and to drive and support a strong growth trajectory, which also resulted in an increase in employee benefit costs. •Advertising and bank promotions increased by$537 thousand due primarily to an increase in contributions of$500 thousand to the PA EITC, with the remaining increase due to promotions expenses and bank events. •FDIC insurance expense increased by$121 thousand due to an increase in the assessment rate driven by commercial loan growth and a lower deduction in theFDIC assessment rate calculation from SBA PPP loans due to forgiveness.
•Professional services increased by
•Taxes other than income decreased by$241 thousand due to$450 thousand of eligible tax credits associated with the contributions made to the PA EITC during the six months endedJune 30, 2022 , partially offset by an increase year-over year in the PennsylvaniaBank Shares Tax expense, as the Bank's total equity balance grew. •Other operating expenses increased by$254 thousand as the reserve for unfunded commitments increased by$196 thousand during the six months endedJune 30, 2022 , compared to the same period in the prior year. In addition, employee related costs, which includes travel, meals and seminars, increased by$177 thousand during the same comparative periods as employees have returned from the work-from-home environment caused by the COVID-19 pandemic, and travel increased as the economy and businesses recovered. These increases were partially offset by an increase of$124 thousand in income from fair value adjustments to derivatives between the six months endedJune 30, 2022 and 2021. 54
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•Other line items within noninterest expenses showed fluctuations between 2022 and 2021 attributable to normal business operations.
Income Tax Expense
Income tax expense totaled$3.9 million , an effective tax rate of 18.4%, for the six months endedJune 30, 2022 compared with$4.5 million , an effective tax rate of 19.3%, for the six months endedJune 30, 2021 . The Company's effective tax rate is less than the 21% federal statutory rate, principally due to tax-free income, which includes interest income on tax-free loans and investment securities and income from life insurance policies, federal income tax credits, and the impact of non-tax deductible expenses. The decrease in the effective tax rate from the six months endedJune 30, 2021 to the six months endedJune 30, 2022 was primarily due to an increase in projected income from tax-free investment securities and loans for the 2022 fiscal year compared to the prior year. FINANCIAL CONDITION Management devotes substantial time to overseeing the investment of funds in loans and investment securities and the formulation of policies directed toward the profitability and management of the risks associated with these investments.
The Company utilizes investment securities to manage interest rate risk, to enhance income through interest and dividend income, provide liquidity and provide collateral for certain deposits and borrowings. AtJune 30, 2022 , AFS securities totaled$512.7 million , an increase of$40.3 million , from$472.4 million atDecember 31, 2021 . During the six months endedJune 30, 2022 , the Company purchased$73.7 million of municipal securities,$41.2 million of agency MBS and CMO, and$6.6 million of non-agency CMO, partially offset by the sale of$3.1 million of a municipal security for a gain of$22 thousand . During the first quarter of 2022, the Company recorded a loss of$171 thousand on one$14.7 million par value non-agency CMO, which was called by the issuer in the second quarter of 2022. There was no OTTI recorded during the second quarter of 2022. The balance of investment securities included net unrealized losses of$37.2 million atJune 30, 2022 compared to net unrealized gains of$5.6 million atDecember 31, 2021 . This change was due to market interest rate increases. 55
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The following table summarizes the credit ratings and collateral associated with the Company's investment portfolio, excluding equity securities, atJune 30, 2022 : Amortized Book Sector Portfolio Mix Value Fair Value Credit Enhancement AAA AA A BBB NR Collateral Type Unsecured ABS 1 %$ 5,684 $ 5,664 32 % - % - % - % - % 100 % Unsecured Consumer Debt Student Loan ABS 2 7,717 7,558 26 - - - - 100 Seasoned Student Loans Federal Family Federal Family Education Loan ABS 17 94,462 90,719 7 86 14 - - - Education Loan (1) PACE Loan ABS 1 3,153 3,025 6 100 - - - - PACE Loans Non-Agency RMBS 3 17,520 16,221 11 61 - - - 39 Reverse Mortgages (2) Municipal - General Obligation 22 122,863 114,009 5 90 5 - - Municipal - Revenue 24 132,281 119,518 - 83 12 - 5 SBA ReRemic 1 6,469 6,367 - 100 - - - SBA Guarantee (3) Residential Mortgages Agency MBS 25 139,251 131,249 - 100 - - - (3) U.S. Treasury securities 4 20,077 17,969 - 100 - - - Bank CDs - 249 249 - - - - 100 FDIC Insured CD 100 %$ 549,726 $ 512,548 18 % 73 % 4 % - % 5 % (1) Minimum of 17% guaranteed byU.S. government (2) Reverse mortgages fund over time, credit enhancement is estimated based on prior experience (3) 77% guaranteed byU.S. government agencies
Note : Ratings in table are the lowest of the six rating agencies (
Loan Portfolio The Company offers a variety of products to meet the credit needs of its borrowers, principally commercial real estate loans, commercial and industrial loans, retail loans secured by residential properties, and to a lesser extent, installment loans. No loans are extended to non-domestic borrowers or governments. The risks associated with lending activities differ among loan classes and are subject to the impact of changes in interest rates, market conditions of collateral securing the loans and general economic conditions. Any of these factors may adversely impact a borrower's ability to repay loans, and also impact the associated collateral. See Note 3, Loans and Allowance for Loan Losses, to the unaudited condensed consolidated financial statements under Part I, Item 1, "Financial Information," for a description of the Company's loan classes and differing levels of associated credit risk. 56
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The following table presents the loan portfolio, excluding residential LHFS, by
segment and class at
June 30, December 31, 2022 2021 Commercial real estate: Owner occupied$ 287,825 $ 238,668 Non-owner occupied 559,309 551,783 Multi-family 116,110 93,255 Non-owner occupied residential 109,141 106,112 Acquisition and development: 1-4 family residential construction 22,650 12,279 Commercial and land development 134,947 93,925 Commercial and industrial (1) 379,729 485,728 Municipal 12,957 14,989 Residential mortgage: First lien 202,787 198,831 Home equity - term 5,996 6,081 Home equity - lines of credit 171,269 160,705 Installment and other loans 14,909 17,630$ 2,017,629 $ 1,979,986
(1) This balance includes
Total loans increased by$37.6 million fromDecember 31, 2021 toJune 30, 2022 . This increase is due to growth in commercial loans, excluding SBA PPP loans, of$185.6 million , home equity lines of credit of$10.6 million and first lien residential mortgages of$4.0 million , partially offset by a decrease of$159.7 million in SBA PPP loans due to loan forgiveness during the six months endedJune 30, 2022 . Overall loan growth, excluding SBA PPP loans, was 11.0% for the six months endedJune 30, 2022 .
Asset Quality
Risk Elements
The Company's loan portfolio is subject to varying degrees of credit risk. Credit risk is managed through the Company's underwriting standards, on-going credit reviews, and monitoring of asset quality measures. Additionally, loan portfolio diversification, which limits exposure to a single industry or borrower, and collateral requirements also mitigate the Company's risk of credit loss. The loan portfolio consists principally of loans to borrowers in south centralPennsylvania and the greaterBaltimore, Maryland region. As the majority of loans are concentrated in these geographic regions, a substantial portion of the borrowers' ability to honor their obligations may be affected by the level of economic activity in the market areas. Nonperforming assets include nonaccrual loans and foreclosed real estate. In addition, restructured loans still accruing and loans past due 90 days or more and still accruing are also deemed to be risk assets. For all loan classes, the accrual of interest income generally ceases when principal or interest is past due 90 days or more and collateral is inadequate to cover principal and interest or immediately if, in the opinion of management, full collection is unlikely. Interest will continue to accrue on loans past due 90 days or more if the collateral is adequate to cover principal and interest, and the loan is in the process of collection. Interest accrued, but not collected, as of the date of placement on nonaccrual status, is generally reversed and charged against interest income, unless fully collateralized. Subsequent payments received are either applied to the outstanding principal balance or recorded as interest income, depending on management's assessment of the ultimate collectability of principal. Loans are returned to accrual status, for all loan classes, when all the principal and interest amounts contractually due are brought current, the loans have performed in accordance with the contractual terms of the note for a reasonable period of time, generally six months, and the ultimate collectability of the total contractual principal and interest is reasonably assured. Past due status is based on contract terms of the loan. Loans, the terms of which are modified, are classified as TDRs if a concession was granted for legal or economic reasons related to a borrower's financial difficulties. Concessions granted under a TDR typically involve a temporary deferral of scheduled loan payments, an extension of a loan's stated maturity date, temporary reduction in interest rates, or below market 57
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rates. If a modification occurs while the loan is on accruing status, it will continue to accrue interest under the modified terms. Nonaccrual TDRs are restored to accrual status if scheduled principal and interest payments, under the modified terms, are current for six months after modification, and the borrower continues to demonstrate its ability to meet the modified terms. TDRs are evaluated individually for impairment if they have been restructured during the most recent calendar year, or if they are not performing according to their modified terms. The following table presents the Company's total nonperforming and other risk assets, including the aggregate balances of nonaccrual loans, restructured loans still accruing, loans past due 90 days or more, and OREO as ofJune 30, 2022 andDecember 31, 2021 . Loans 30-89 days past due and relevant asset quality ratios as ofJune 30, 2022 andDecember 31, 2021 are also presented. June 30, December 31, 2022 2021 Nonaccrual loans$ 5,387 $ 6,449 OREO - - Total nonperforming assets 5,387 6,449 Restructured loans still accruing 568 804 Loans past due 90 days or more and still accruing 322 1,201
Total nonperforming and other risk assets (total risk assets)
$ 2,925 $ 5,925 Asset quality ratios: Total nonperforming loans to total loans 0.27 % 0.33 % Total nonperforming assets to total assets 0.19 % 0.23 % Total nonperforming assets to total loans and OREO 0.27 % 0.33 % Total risk assets to total loans and OREO 0.31 % 0.43 % Total risk assets to total assets 0.22 % 0.30 % ALL to total loans 1.15 % 1.07 % ALL to nonperforming loans 432.13 % 328.42 %
ALL to nonperforming loans and restructured loans still accruing 390.92 %
292.02 % Total nonperforming and other risk assets decreased by$2.2 million , or 26%, fromDecember 31, 2021 toJune 30, 2022 . Non-accrual loans decreased by$1.1 million fromDecember 31, 2021 toJune 30, 2022 due primarily to$596 thousand of loans returning to accrual status and payment activity of$712 thousand , partially offset by additions in loans classified as non-accrual loans of$267 thousand . Loans past due 90 days and still accruing decreased by$879 thousand fromDecember 31, 2021 toJune 30, 2022 due to the collection on a loan guaranteed by the SBA during the first quarter of 2022. The following table presents detail of impaired loans atJune 30, 2022 andDecember 31, 2021 : June 30, 2022 December 31, 2021 Restructured Restructured Nonaccrual Loans Still Nonaccrual Loans Still Loans Accruing Total Loans Accruing Total Commercial real estate: Owner occupied$ 2,910 $ -$ 2,910 $ 3,763 $ -$ 3,763 Non-owner occupied residential 98 - 98 122 - 122 Commercial and industrial 62 - 62 250 - 250 Residential mortgage: First lien 1,880 568 2,448 1,831 804 2,635 Home equity - term 6 - 6 7 - 7 Home equity - lines of credit 389 - 389 436 - 436 Installment and other loans 42 - 42 40 - 40$ 5,387 $ 568$ 5,955 $ 6,449 $ 804$ 7,253 58
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The following table presents our exposure to relationships with an impaired balance, which excludes accruing PCI loans, and the partial charge-offs taken to date and specific reserves established on those relationships atJune 30, 2022 andDecember 31, 2021 . Of the relationships deemed to be impaired atJune 30, 2022 , one had a recorded balance in excess of$1.0 million , and 58 relationships, which represents 49% of total impaired loans, had recorded balances of less than$250 thousand . Partial # of Recorded Charge-offs Specific Relationships Investment to Date ReservesJune 30, 2022 Relationships greater than$1,000,000 1
- - - - Relationships greater than$250,000 but less than$500,000 2 587 - - Relationships less than$250,000 58 2,919 280 28 61
1
1 602 17 - Relationships greater than$250,000 but less than$500,000 2 601 - - Relationships less than$250,000 63 3,515 303 28 67$ 7,253 $ 320 $ 28 The Company takes partial charge-offs on collateral-dependent loans when carrying value exceeds estimated fair value, as determined by the most recent appraisal adjusted for current (within the quarter) conditions, less costs to dispose. Impairment reserves remain in place if updated appraisals are pending, and represent management's estimate of potential loss. Internal loan reviews are completed annually on all commercial relationships with a committed loan balance in excess of$1.0 million , which includes confirmation of risk rating by an independent credit officer. In addition, all commercial relationships greater than$500 thousand rated Substandard, Doubtful or Loss are reviewed and corresponding risk ratings are reaffirmed by the Bank's Problem Loan Committee, with subsequent reporting to the Management ERM Committee. In its individual loan impairment analysis, the Company determines the extent of any full or partial charge-offs that may be required, or any reserves that may be needed. The determination of the Company's charge-offs or impairment reserve include an evaluation of the outstanding loan balance and the related collateral securing the credit. Through a combination of collateral securing the loans and partial charge-offs taken to date, the Company believes that it has adequately provided for the potential losses that it may incur on these relationships atJune 30, 2022 . However, over time, additional information may result in increased reserve allocations or, alternatively, it may be deemed that the reserve allocations exceed those that are needed.
Credit Risk Management
Allowance for Loan Losses
The Company maintains the ALL at a level deemed adequate by management for probable incurred credit losses. The ALL is established and maintained through a provision for loan losses, which is charged to earnings. On a quarterly basis, management assesses the adequacy of the ALL using a defined methodology which considers specific credit evaluation of impaired loans, historical loss experience and qualitative factors. Management addresses the requirements for loans individually identified as impaired, loans collectively evaluated for impairment, and other bank regulatory guidance in its assessment. The ALL is evaluated based on review of the collectability of loans in light of historical experience; the nature and volume of the loan portfolio; adverse situations that may affect a borrower's ability to repay; estimated value of any underlying collateral; and prevailing economic conditions. This evaluation is inherently subjective as it requires estimates that are susceptible to significant revision as more information becomes available. A description of the methodology for establishing the allowance and provision for loan losses and related procedures in establishing the appropriate level of reserve is included in Note 3, Loans and Allowance for Loan Losses, to the unaudited condensed consolidated financial statements under Part I, Item 1, "Financial Information." 59
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The following table summarizes the Company's internal risk ratings at
Special Non-Impaired Impaired - Pass Mention Substandard Substandard Doubtful PCI Loans TotalJune 30, 2022 Commercial real estate: Owner occupied$ 274,188 $ 6,086 $ 2,375 $ 2,910 $ -$ 2,266 $ 287,825 Non-owner occupied 547,382 9,221 2,409 - - 297 559,309 Multi-family 107,779 8,082 249 - - - 116,110 Non-owner occupied residential 105,680 2,261 503 98 - 599 109,141 Acquisition and development: 1-4 family residential construction 22,650 - - - - - 22,650 Commercial and land development 133,264 1,683 - - - - 134,947 Commercial and industrial 365,407 5,877 6,266 62 - 2,117 379,729 Municipal 12,957 - - - - - 12,957 Residential mortgage: First lien 195,674 - 221 2,448 - 4,444 202,787 Home equity - term 5,974 - - 6 - 16 5,996 Home equity - lines of credit 170,834 - 46 389 - - 171,269 Installment and other loans 14,861 - - 42 - 6 14,909$ 1,956,650 $ 33,210 $ 12,069 $ 5,955 $ -$ 9,745 $ 2,017,629 December 31, 2021 Commercial real estate: Owner occupied$ 219,250 $ 7,239 $ 6,087 $ 3,763 $ -$ 2,329 $ 238,668 Non-owner occupied 528,010 23,297 166 - - 310 551,783 Multi-family 84,414 8,238 603 - - - 93,255 Non-owner occupied residential 102,588 1,065 1,153 122 - 1,184 106,112 Acquisition and development: 1-4 family residential construction 12,279 - - - - - 12,279 Commercial and land development 92,049 1,385 491 - - - 93,925 Commercial and industrial 470,579 7,917 4,720 250 - 2,262 485,728 Municipal 14,989 - - - - - 14,989 Residential mortgage: First lien 191,386 - 225 2,635 - 4,585 198,831 Home equity - term 6,058 - - 7 - 16 6,081 Home equity - lines of credit 160,203 20 46 436 - - 160,705 Installment and other loans 17,584 - - 40 - 6 17,630$ 1,899,389 $ 49,161 $ 13,491 $ 7,253 $ -$ 10,692 $ 1,979,986
Potential problem loans are defined as performing loans which have characteristics that cause management concern over the ability of the borrower to perform under present loan repayment terms and which may result in the reporting of these loans as nonperforming loans in the future. Generally, management feels that Substandard loans that are currently performing and not
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considered impaired result in some doubt as to the borrower's ability to
continue to perform under the terms of the loan, and represent potential problem
loans. Non-impaired Substandard loans totaled
Additionally, the Special Mention classification is intended to be a temporary classification reflective of loans that have potential weaknesses that may, if not monitored or corrected, weaken the asset or inadequately protect the Company's position at some future date. Special Mention loans represent an elevated risk, but their weakness does not yet justify a more severe, or classified, rating. These loans require inquiry by lenders on the cause of the potential weakness and, once analyzed, the loan classification may be downgraded to Substandard or, alternatively, could be upgraded to Pass. Special Mention loans decreased by$16.0 million fromDecember 31, 2021 toJune 30, 2022 due to continued improvements in economic conditions resulting in upgrades to commercial loans, including those that were previously downgraded due to the impact of the COVID-19 pandemic.
The following table summarizes activity in the ALL for the three and six months
ended
Commercial Consumer Acquisition Commercial Commercial and and Residential Installment Real Estate Development Industrial Municipal Total Mortgage and Other Total Unallocated Total Three Months Ended June 30, 2022 Balance, beginning of period$ 11,546 $ 2,321 $
4,301
748 695 184 (3) 1,624 127 24 151 - 1,775 Charge-offs - - (54) - (54) - (5) (5) - (59) Recoveries - 8 40 - 48 4 3 7 - 55
Balance, end of period
4,471$ 26 $ 19,815 $ 3,004 $ 223 $ 3,227 $ 237 $ 23,279 June 30, 2021 Balance, beginning of period$ 10,671 $ 1,046 $
3,714
806 197 (223) (9) 771 (142) 19 (123) (23) 625 Charge-offs (181) - (112) - (293) (71) (9) (80) - (373) Recoveries 19 - 116 - 135 18 9 27 - 162
Balance, end of period
3,495$ 29 $ 16,082 $ 2,863 $ 227 $ 3,090 $ 209 $ 19,381 Six Months Ended June 30, 2022 Balance, beginning of period$ 12,037 $ 2,062 $
3,814
225 953 684 (4) 1,858 199 18 217 - 2,075 Charge-offs - - (115) - (115) (10) (18) (28) - (143) Recoveries 32 9 88 - 129 30 8 38 - 167
Balance, end of period
4,471$ 26 $ 19,815 $ 3,004 $ 223 $ 3,227 $ 237 $ 23,279 June 30, 2021 Balance, beginning of period$ 11,151 $ 1,114 $
3,942
312 128 (277) (11) 152 (431) (87) (518) (9) (375) Charge-offs (181) - (566) - (747) (92) (29) (121) - (868) Recoveries 33 1 396 - 430 24 19 43 - 473
Balance, end of period
3,495$ 29 $ 16,082 $ 2,863 $ 227 $ 3,090 $ 209 $ 19,381 The ALL totaled$23.3 million atJune 30, 2022 , an increase of$2.1 million fromDecember 31, 2021 , resulting from a provision for loan losses of$2.1 million , which was inclusive of net recoveries of$24 thousand during the six months endedJune 30, 2022 . AtJune 30, 2022 , the ALL is higher as a percentage of the total loan portfolio at 1.15% compared to 1.07% atJune 30, 2021 . The ALL increased in the six months endedJune 30, 2022 primarily as a result of commercial loan growth; however, this was partially offset by the reduction in qualitative factors to unwind an increase from 2020 applied to the commercial real estate portfolio associated with the COVID-19 pandemic. Excluding SBA loans, which are 100% guaranteed, the ALL to total loans remained at 1.2% at bothJune 30, 2022 andDecember 31, 2021 . Despite generally favorable historical charge-off data, the impact of current economic conditions may result in the need for additional provisions for loan losses in future quarters. Classified loans totaled$19.7 million atJune 30, 2022 , or 1.0% of total loans outstanding, reflecting a decrease from$23.1 million , or 1.2% of loans outstanding, atDecember 31, 2021 . The asset quality ratios previously noted are indicative of 61
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the continued benefit the Company has received from favorable historical charge-off statistics and generally stable economic and market conditions for the last few years, even while the commercial loan portfolio has been growing.
The following table summarizes the ending loan balances individually or collectively evaluated for impairment based on loan type, as well as the ALL allocation for each, atJune 30, 2022 andDecember 31, 2021 , including PCI loans: Commercial Consumer Acquisition Commercial Commercial and and Residential Installment Real Estate Development Industrial Municipal Total Mortgage and Other Total Unallocated TotalJune 30, 2022 Loans allocated by: Individually evaluated for impairment$ 3,008 $ -$ 62 $ -$ 3,070 $ 2,843 $ 42$ 2,885 $ -$ 5,955 Collectively evaluated for impairment 1,069,377 157,597 379,667 12,957 1,619,598 377,209 14,867 392,076 - 2,011,674$ 1,072,385 $ 157,597 $ 379,729 $ 12,957 $ 1,622,668 $ 380,052 $ 14,909 $ 394,961 $ -$ 2,017,629 ALL allocated by: Individually evaluated for impairment $ - $ - $ - $ - $ - $ 28 $ -$ 28 $ -$ 28 Collectively evaluated for impairment 12,294 3,024 4,471 26 19,815 2,976 223 3,199 237 23,251$ 12,294 $ 3,024 $ 4,471 $ 26 $ 19,815 $ 3,004 $ 223 $ 3,227 $ 237 $ 23,279 December 31, 2021 Loans allocated by: Individually evaluated for impairment$ 3,885 $ -$ 250 $ -$ 4,135 $ 3,078 $ 40$ 3,118 $ -$ 7,253 Collectively evaluated for impairment 985,933 106,204 485,478 14,989 1,592,604 362,539 17,590 380,129 - 1,972,733$ 989,818 $ 106,204 $ 485,728 $ 14,989 $ 1,596,739 $ 365,617 $ 17,630 $ 383,247 $ -$ 1,979,986 ALL allocated by: Individually evaluated for impairment $ - $ - $ - $ - $ - $ 28 $ -$ 28 $ -$ 28 Collectively evaluated for impairment 12,037 2,062 3,814 30 17,943 2,757 215 2,972 237 21,152$ 12,037 $ 2,062 $ 3,814 $ 30 $ 17,943 $ 2,785 $ 215 $ 3,000 $ 237 $ 21,180
In addition to the specific reserve allocations on impaired loans noted
previously, eight loans, with aggregate outstanding principal balances of
Management believes the allocation of the ALL among the various loan classes adequately reflects the probable incurred credit losses in each portfolio and is based on the methodology outlined in Note 3, Loans and Allowance for Loan Losses, to the Consolidated Financial Statements under Part I, Item 1, "Financial Information." Management re-evaluates and makes enhancements to its reserve methodology to better reflect the risks inherent in the different segments of the portfolio, particularly in light of increased charge-offs, with noticeable differences between the different loan classes. Management believes these enhancements to the ALL methodology improve the accuracy of quantifying probable incurred credit losses inherent in the portfolio. Management charges actual loan losses to the reserve and bases the provision for loan losses on its overall analysis. The unallocated portion of the ALL reflects estimated inherent losses within the portfolio that have not been detected, as well as the risk of error in the specific and general reserve allocation, other potential exposure in the loan portfolio, variances in management's assessment of national and local economic conditions and other factors management believes appropriate at the time. The unallocated portion of the ALL was 1.0% and 1.1% of the ALL balance atJune 30, 2022 andDecember 31, 2021 , respectively. The Company monitors the unallocated portion of the ALL and, by policy, has determined it should not exceed 62
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3% of the total reserve. Future negative provisions for loan losses may result if the unallocated portion was to increase, and management determined the reserves were not required for the anticipated risk in the portfolio.
Management believes the Company's ALL is adequate based on currently available information. Future adjustments to the ALL and enhancements to the methodology may be necessary due to changes in economic conditions, regulatory guidance, or management's assumptions as to future delinquencies or loss rates.
Deposits
Deposits grew by
Noninterest-bearing deposits increased by$16.0 million , or 3%, to$569.2 million , fromDecember 31, 2021 toJune 30, 2022 . Interest-bearing deposits totaled$1.9 billion atJune 30, 2022 , an decrease of$2.3 million , or less than 1%, from the$1.9 billion balance atDecember 31, 2021 , despite a decrease in time deposits, due to maturities, of$36.0 million , or 12%. Deposit growth in the first six months of 2022 was principally due to continued high levels of excess liquidity in the system as well as seasonality from public fund clients.
Shareholders' Equity, Capital Adequacy and Regulatory Matters
Capital management in a regulated financial services industry must properly balance return on equity to its shareholders while maintaining sufficient levels of capital and related risk-based regulatory capital ratios to satisfy statutory regulatory requirements. The Company's capital management strategies have been developed to provide attractive rates of returns to its shareholders, while maintaining a "well capitalized" position of regulatory strength. Shareholders' equity totaled$237.5 million atJune 30, 2022 , a decrease of$34.1 million , or 13%, from$271.7 million atDecember 31, 2021 . The decrease was primarily attributable to other comprehensive losses of$33.8 million due to an increase in unrealized losses on AFS securities caused by a substantial increase in market interest rates, as well as dividends paid of$4.2 million and shared-based compensation costs of$13.3 million , partially offset by net income of$17.2 million . The Company routinely evaluates its capital levels in light of its risk profile to assess its capital needs. The Company and the Bank are subject to various regulatory capital requirements administered by federal and state banking agencies. The consolidated asset limit on small bank holding companies is$3.0 billion and a company with assets under that limit is not subject to the FRB consolidated capital rules, but may file reports that include capital amounts and ratios. The Company has elected to file those reports. AtJune 30, 2022 andDecember 31, 2021 , the Bank was considered well capitalized under applicable banking regulations. The decrease of 1.5% from 15.0% atDecember 31, 2021 to 13.5% atJune 30, 2022 was due primarily to an increase in risk-weighted assets from the deployment of cash into commercial loans, a decrease in capital from share repurchases and an increase in deferred tax assets resulting from the increase in unrealized losses on AFS securities. Under capital adequacy guidelines and the regulatory framework for prompt corrective action, the Bank must meet specific guidelines that involve quantitative measures of assets, liabilities and certain off-balance sheet items as calculated under regulatory accounting practices. Prompt corrective action provisions are not applicable to bank holding companies, including financial holding companies. Note 8,Shareholders' Equity and Regulatory Capital , to the Notes to Unaudited Condensed Consolidated Financial Statements under Part I, Item 1, "Financial Information," includes a table presenting capital amounts and ratios for the Company and the Bank atJune 30, 2022 andDecember 31, 2021 . In addition to the minimum capital ratio requirement and minimum capital ratio to be well capitalized presented in the referenced table in Note 8, the Bank must maintain a capital conservation buffer as more fully described in the Company's Annual Report on Form 10-K for the year endedDecember 31, 2021 , Item 1 - Business, under the topic Basel III Capital Rules. AtJune 30, 2022 , the Bank's capital conservation buffer, based on the most restrictive Total Capital to risk weighted assets capital ratio, was 5.3%, which is greater than the 2.5% requirement. 63
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Liquidity
The primary function of asset/liability management is to ensure adequate liquidity and manage the Company's sensitivity to changing interest rates. Liquidity management involves the ability to meet the cash flow requirements of clients who may be either depositors wanting to withdraw funds or borrowers needing assurance that sufficient funds will be available to meet their credit needs. The Company's primary sources of funds consist of deposit inflows, loan repayments, maturities and sales of investment securities, the sale of mortgage loans and borrowings from the FHLB ofPittsburgh . While maturities and scheduled amortization of loans and investment securities are predictable sources of funds, deposit flows and mortgage prepayments are greatly influenced by general interest rates, economic conditions and competition. The Company's maximum borrowing capacity from the FHLB is$933.1 million atJune 30, 2022 . The Company regularly adjusts its investments in liquid assets based upon our assessment of expected loan demand, expected deposit flows, yields available on interest-earning deposits and investment securities and the objectives of our asset/liability management policy. Unencumbered investment securities totaled$170.7 million atJune 30, 2022 . AtJune 30, 2022 , the Company had$26.6 million of investment securities pledged at the FRB Discount Window, with no associated borrowings outstanding.
Supplemental Reporting of Non-GAAP Measures
As a result of acquisitions, the Company had intangible assets consisting of goodwill and core deposit and other intangible assets totaling$22.3 million and$22.9 million atJune 30, 2022 andDecember 31, 2021 , respectively. Management believes providing certain "non-GAAP" financial information will assist investors in their understanding of the effect of acquisition activity on reported results, particularly to overcome comparability issues related to the influence of intangibles (principally goodwill) created in acquisitions. Management also believes providing certain other "non-GAAP" financial information will provide investors with clarity on its ALL to total loans ratios. The Company believes that excluding SBA-guaranteed loans, due to their credit enhancement, from loans held for investment is useful due to the size and effect on the total and ratio. Tangible book value per share and the ALL to non-SBA guarantee loans, as used by the Company in this supplemental reporting presentation, are determined by methods other than in accordance with GAAP. While we believe this information is a useful supplement to GAAP-based measures presented in this Form 10-Q, readers are cautioned that this non-GAAP disclosure has limitations as an analytical tool, should not be viewed as a substitute for financial measures determined in accordance with GAAP, and should not be considered in isolation or as a substitute for analysis of our results and financial condition as reported under GAAP, nor are such measures necessarily comparable to non-GAAP performance measures that may be presented by other companies. This supplemental presentation should not be construed as an inference that our future results will be unaffected by similar adjustments to be determined in accordance with GAAP. The decrease in tangible book value per share (non-GAAP) fromDecember 31, 2021 toJune 30, 2022 is primarily due to an increase in other comprehensive losses, net of taxes, of$33.8 million due to higher unrealized losses on available-for-sale securities and share repurchases.
The following table presents the computation of each non-GAAP based measure shown together with its most directly comparable GAAP based measure.
June 30, 2022 December 31, 2021 Tangible Book Value per Common Share Shareholders' equity$ 237,527 $ 271,656 Less: Goodwill 18,724 18,724 Other intangible assets 3,610 4,183 Related tax effect (758) (878) Tangible common equity (non-GAAP)$ 215,951 $ 249,627 Common shares outstanding 10,676 11,183
Book value per share (most directly comparable GAAP based measure)
$ 22.25 $ 24.29 Intangible assets per share 2.02 1.97 Tangible book value per share (non-GAAP) $ 20.23 $ 22.32 64
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June 30, 2022 December 31, 2021 Allowance for Loan Losses to Non-SBA Guaranteed Loans: Allowance for loan losses$ 23,279 $ 21,180 Gross loans$ 2,017,629 $ 1,979,986 less: SBA guaranteed loans (32,599) (195,585) Non-SBA guaranteed loans$ 1,985,030 $ 1,784,401 Allowance for loan losses to non-SBA guaranteed loans 1.2 % 1.2 %
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