ORRF 10-Q Quarterly Report Sept. 30, 2022

ORRSTOWN FINANCIAL SERVICES INC

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orrf-20220930

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 September 30, 2022


☐			TRANSITION REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES EXCHANGE ACT OF 1934

For the transition period from to

Commission file number: 001-34292

ORRSTOWN FINANCIAL SERVICES, INC.

(Exact Name of Registrant as Specified in its Charter)

Pennsylvania

23-2530374

(State or Other Jurisdiction of Incorporation or Organization)

(I.R.S. Employer Identification No.)

77 East King Street

P. O. Box 250

Shippensburg

Pennsylvania

17257

(Address of Principal Executive Offices)

(Zip Code)

Registrant’s Telephone Number, Including Area Code:

(717)

532-6114

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

ORRF

Nasdaq Stock Market

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 x 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 x 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 Act.). Yes ☐ No x

Number of shares outstanding of the registrant’s Common Stock as of November 7, 2022: 10,677,554 .

Table of Contents

ORRSTOWN FINANCIAL SERVICES, INC.

INDEX


		Page
Part I – FINANCIAL INFORMATION

	Glossary	3

Item 1.	Financial Statements	4

	Consolidated Balance Sheets (Unaudited)	4

	Consolidated Statements of (Loss) Income (Unaudited)	5

	Consolidated Statements of Comprehensive (Loss) Income (Unaudited)	7

	Consolidated Statements of Changes in Shareholders’ Equity (Unaudited)	8

	Consolidated Statements of Cash Flows (Unaudited)	10

	Notes to Consolidated Financial Statements (Unaudited)	12

Item 2	Management’s Discussion and Analysis of Financial Condition and Results of Operations	45

Item 3.	Quantitative and Qualitative Disclosures About Market Risk	68

Item 4.	Controls and Procedures	70

PART II – OTHER INFORMATION

Item 1.	Legal Proceedings	71

Item 1A.	Risk Factors	71

Item 2.	Unregistered Sales of Equity Securities and Use of Proceeds	71

Item 3.	Defaults upon Senior Securities	71

Item 4.	Mine Safety Disclosures	71

Item 5.	Other Information	71

Item 6.	Exhibits	72

SIGNATURES		73

Table of Contents

Glossary of Defined Terms

The following terms may be used throughout this Report, including the unaudited condensed consolidated financial statements and related notes.


Term			Definition

ALL			Allowance for loan losses
AFS			Available for sale
AOCI			Accumulated other comprehensive income
ASC			Accounting Standards Codification
ASU			Accounting Standards Update
Bank			Orrstown Bank, the commercial banking subsidiary of Orrstown Financial Services, Inc.
CDI			Core deposit intangible

CMO			Collateralized mortgage obligation


EITC			Educational Improvement Tax Credit Program

ERM			Enterprise risk management
Exchange Act			Securities Exchange Act of 1934, as amended
FASB			Financial Accounting Standards Board
FDIC			Federal Deposit Insurance Corporation
FHLB			Federal Home Loan Bank
FRB			Board of Governors of the Federal Reserve System
GAAP			Accounting principles generally accepted in the United States of America
GDP			Gross Domestic Deposit
GSE			U.S. government-sponsored enterprise

IRC			Internal Revenue Code of 1986, as amended
LHFS			Loans held for sale
LIBOR			London Interbank Offered Rate
MBS			Mortgage-backed securities

MSR			Mortgage servicing right

OCI			Other comprehensive income

OREO			Other real estate owned

OTTI			Other-than-temporary impairment

2011 Plan			2011 Orrstown Financial Services, Inc. Incentive Stock Plan
PCI loans			Purchased credit impaired loans
PACE			Property Assessed Clean Energy loans
PPP			Paycheck Protection Program


ReRemic			Re-securitization of Real Estate Mortgage Investment Conduits
ROU			Right of use (leases)
SBA			U.S. Small Business Administration
SEC			Securities and Exchange Commission
Securities Act			Securities Act of 1933, as amended
SOFR			Secured Overnight Financing Rate
TDR			Troubled debt restructuring
Unless the context otherwise requires, the terms “Orrstown,” “we,” “us,” “our,” and “Company” refer to Orrstown Financial Services, Inc. and its subsidiaries.

Table of Contents

PART I – FINANCIAL INFORMATION

Item 1. Financial Statements

Condensed Consolidated Balance Sheets (Unaudited)

ORRSTOWN FINANCIAL SERVICES, INC.


(Dollars in thousands, except per share amounts)	September 30, 2022		December 31, 2021
Assets
Cash and due from banks	$	34,481	$	21,217
Interest-bearing deposits with banks	32,446		187,493

Cash and cash equivalents	66,927		208,710
Restricted investments in bank stocks	6,469		7,252
Securities available for sale (amortized cost of $ 558,057 and $ 466,806 at September 30, 2022 and December 31, 2021, respectively)	503,596		472,438
Loans held for sale, at fair value	10,175		8,868
Loans	2,087,927		1,979,986
Less: Allowance for loan losses	( 24,709 )		( 21,180 )
Net loans	2,063,218		1,958,806
Premises and equipment, net	31,457		34,045
Cash surrender value of life insurance	71,332		70,217
Goodwill	18,724		18,724
Other intangible assets, net	3,338		4,183
Accrued interest receivable	9,212		8,234
Deferred tax assets, net	26,875		11,648
Other assets	40,769		31,440
Total assets	$	2,852,092	$	2,834,565
Liabilities
Deposits:
Noninterest-bearing	$	562,024	$	553,238
Interest-bearing	1,943,829		1,911,691
Total deposits	2,505,853		2,464,929
Securities sold under agreements to repurchase	21,065		23,301
FHLB advances and other borrowings	1,567		1,896
Subordinated notes	32,010		31,963
Other liabilities	74,219		40,820
Total liabilities	2,634,714		2,562,909

Commitments and contingencies

Shareholders’ Equity
Preferred stock, $ 1.25 par value per share; 500,000 shares authorized; no shares issued or outstanding	—		—
Common stock, no par value—$ 0.05205 stated value per share 50,000,000 shares authorized; 11,236,558 shares issued and 10,686,064 outstanding at September 30, 2022; 11,258,167 shares issued and 11,183,050 outstanding at December 31, 2021	585		586
Additional paid - in capital	188,730		189,689
Retained earnings	84,867		78,700
Accumulated other comprehensive (loss) income	( 43,468 )		4,449
Treasury stock— 550,494 and 75,117 shares, at cost at September 30, 2022 and December 31, 2021, respectively	( 13,336 )		( 1,768 )
Total shareholders’ equity	217,378		271,656
Total liabilities and shareholders’ equity	$	2,852,092	$	2,834,565

The Notes to Unaudited Condensed Consolidated Financial Statements are an integral part of these statements.

Table of Contents

Condensed Consolidated Statements of (Loss) Income (Unaudited)

ORRSTOWN FINANCIAL SERVICES, INC.


	Three Months Ended				Nine Months Ended
(Dollars in thousands, except per share amounts)	September 30, 2022		September 30, 2021		September 30, 2022		September 30, 2021
Interest income
Loans	$	23,152	$	19,890	$	66,548	$	62,724
Investment securities - taxable	2,907		1,514		6,462		5,007
Investment securities - tax-exempt	1,160		652		3,013		1,790
Short-term investments	200		135		536		255
Total interest income	27,419		22,191		76,559		69,776
Interest expense
Deposits	1,372		937		2,758		3,410
Securities sold under agreements to repurchase	10		8		24		25
FHLB advances and other borrowings	78		123		121		458
Subordinated notes	504		503		1,510		1,507
Total interest expense	1,964		1,571		4,413		5,400
Net interest income	25,455		20,620		72,146		64,376
Provision for loan losses	1,500		365		3,575		( 10 )
Net interest income after provision for loan losses	23,955		20,255		68,571		64,386
Noninterest income
Service charges on deposit accounts	977		796		2,861		2,231
Interchange income	1,014		1,030		3,059		3,049
Other service charges and fees	239		197		622		527
Swap fee income	197		67		1,935		135
Trust and investment management income	2,006		1,930		5,852		5,862
Brokerage income	947		987		2,864		2,708
Mortgage banking activities	( 1,014 )		1,333		205		4,684

Income from life insurance	583		569		1,742		1,690
Investment securities (losses) gains	( 14 )		479		( 163 )		635
Other income	1,123		263		1,749		338
Total noninterest income	6,058		7,651		20,726		21,859
Noninterest expenses
Salaries and employee benefits	12,705		11,498		35,354		31,907
Occupancy	1,166		1,154		3,586		3,492
Furniture and equipment	1,214		1,220		3,784		3,800
Data processing	1,192		990		3,410		3,041

Automated teller and interchange fees	329		294		952		862
Advertising and bank promotions	278		735		1,514		1,434
FDIC insurance	294		218		767		570

Professional services	887		562		2,417		1,862
Directors' compensation	213		155		674		624


Taxes other than income	488		16		1,160		929
Intangible asset amortization	272		314		845		972

Provision for legal settlement	13,000		—		13,000		—
Restructuring expenses	3,155		—		3,155		—

Other operating expenses	1,219		1,879		3,952		4,358
Total noninterest expenses	36,412		19,035		74,570		53,851
(Loss) income before income tax (benefit) expense	( 6,399 )		8,871		14,727		32,394
Income tax (benefit) expense	( 1,571 )		1,679		2,316		6,219
Net (loss) income	$	( 4,828 )	$	7,192	$	12,411	$	26,175

Table of Contents



	Three Months Ended				Nine Months Ended
	September 30, 2022		September 30, 2021		September 30, 2022		September 30, 2021
Per share information:
Basic (loss) earnings per share	$	( 0.47 )	$	0.66	$	1.17	$	2.38
Diluted (loss) earnings per share	( 0.47 )		0.65		1.16		2.36
Dividends paid per share	0.19		0.19		0.57		0.55

The Notes to Unaudited Condensed Consolidated Financial Statements are an integral part of these statements.

Table of Contents

Condensed Consolidated Statements of Comprehensive (Loss) Income (Unaudited)

ORRSTOWN FINANCIAL SERVICES, INC.


	Three Months Ended				Nine Months Ended
(Dollars in thousands)	September 30, 2022		September 30, 2021		September 30, 2022		September 30, 2021
Net (loss) income	$	( 4,828 )	$	7,192	$	12,411	$	26,175
Other comprehensive (loss) income, net of tax:
Unrealized (losses) gains on securities available for sale arising during the period	( 17,297 )		( 2,346 )		( 60,256 )		2,335
Reclassification adjustment for losses (gains) realized in net income	14		( 479 )		163		( 635 )
Net unrealized (losses) gains on securities available for sale	( 17,283 )		( 2,825 )		( 60,093 )		1,700
Tax effect	3,629		593		12,620		( 357 )
Total other comprehensive (loss) gain, net of tax and reclassification adjustments on securities available for sale	( 13,654 )		( 2,232 )		( 47,473 )		1,343
Unrealized (losses) gains on interest rate swaps used in cash flow hedges	( 562 )		( 183 )		( 562 )		473
Reclassification adjustment for losses realized in net income	—		581		—		757
Net unrealized (losses) gains on interest rate swaps used in cash flow hedges	( 562 )		398		( 562 )		1,230
Tax effect	118		( 83 )		118		( 258 )
Total other comprehensive (losses) gains, net of tax and reclassification adjustments on interest rate swaps used in cash flow hedges	( 444 )		315		( 444 )		972
Total other comprehensive (loss) gain, net of tax and reclassification adjustments	( 14,098 )		( 1,917 )		( 47,917 )		2,315
Total comprehensive (loss) income	$	( 18,926 )	$	5,275	$	( 35,506 )	$	28,490

The Notes to Unaudited Condensed Consolidated Financial Statements are an integral part of these statements.

Table of Contents

Condensed Consolidated Statements of Changes in Shareholders’ Equity (Unaudited)

ORRSTOWN FINANCIAL SERVICES, INC.


	Three Months Ended September 30, 2022
(Dollars in thousands, except per share amounts)	Common Stock		Additional Paid-In Capital		Retained Earnings		Accumulated Other Comprehensive Loss		Treasury Stock		Total Shareholders’ Equity


















Balance, June 30, 2022	$	585	$	188,178	$	91,723	$	( 29,370 )	$	( 13,589 )	$	237,527
Net loss	—		—		( 4,828 )		—		—		( 4,828 )

Total other comprehensive loss, net of taxes	—		—		—		( 14,098 )		—		( 14,098 )
Cash dividends ($ 0.19 per share)	—		—		( 2,028 )		—		—		( 2,028 )

Share-based compensation plans:
0 net common shares issued and 10,385 net treasury shares issued, including compensation expense totaling $ 741	—		552		—		—		253		805

Balance, September 30, 2022	$	585	$	188,730	$	84,867	$	( 43,468 )	$	( 13,336 )	$	217,378











	Nine Months Ended September 30, 2022
(Dollars in thousands, except per share amounts)	Common Stock		Additional Paid-In Capital		Retained Earnings		Accumulated Other Comprehensive Income (Loss)		Treasury Stock		Total Shareholders’ Equity
Balance, January 1, 2022	$	586	$	189,689	$	78,700	$	4,449	$	( 1,768 )	$	271,656
Net income	—		—		12,411		—		—		12,411

Total other comprehensive loss, net of taxes	—		—		—		( 47,917 )		—		( 47,917 )
Cash dividends ($ 0.57 per share)	—		—		( 6,244 )		—		—		( 6,244 )

Share-based compensation plans:
21,609 net common shares acquired and 475,377 net treasury shares acquired, including compensation expense totaling $ 1,608	( 1 )		( 959 )		—		—		( 11,568 )		( 12,528 )

Balance, September 30, 2022	$	585	$	188,730	$	84,867	$	( 43,468 )	$	( 13,336 )	$	217,378

The Notes to Unaudited Condensed Consolidated Financial Statements are an integral part of these statements.

Table of Contents


	Three Months Ended September 30, 2021
(Dollars in thousands, except per share amounts)	Common Stock		Additional Paid-In Capital		Retained Earnings		Accumulated Other Comprehensive Income (Loss)		Treasury Stock		Total Shareholders’ Equity































Balance, July 1, 2021	$	586	$	188,772	$	69,052	$	7,578	$	( 50 )	$	265,938
Net income	—		—		7,192		—		—		7,192

Total other comprehensive loss, net of taxes	—		—		—		( 1,917 )		—		( 1,917 )
Cash dividends ($ 0.19 per share)	—		—		( 2,122 )		—		—		( 2,122 )

Share-based compensation plans:
16,593 net common shares acquired and 41,106 net treasury shares acquired, including compensation expense totaling $ 483	—		396		—		—		( 918 )		( 522 )

Balance, September 30, 2021	$	586	$	189,168	$	74,122	$	5,661	$	( 968 )	$	268,569











	Nine Months Ended September 30, 2021
(Dollars in thousands, except per share amounts)	Common Stock		Additional Paid-In Capital		Retained Earnings		Accumulated Other Comprehensive Income		Treasury Stock		Total Shareholders’ Equity
Balance, January 1, 2021	$	586	$	189,066	$	54,099	$	3,346	$	( 848 )	$	246,249
Net income	—		—		26,175		—		—		26,175

Total other comprehensive income, net of taxes	—		—		—		2,315		—		2,315
Cash dividends ($ 0.55 per share)	—		—		( 6,152 )		—		—		( 6,152 )

Share-based compensation plans:
8,129 net common shares acquired and 11,864 net treasury shares issued, including compensation expense totaling $ 1,428	—		102		—		—		( 120 )		( 18 )

Balance, September 30, 2021	$	586	$	189,168	$	74,122	$	5,661	$	( 968 )	$	268,569

The Notes to Unaudited Condensed Consolidated Financial Statements are an integral part of these statements.

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Condensed Consolidated Statements of Cash Flows (Unaudited)

ORRSTOWN FINANCIAL SERVICES, INC.


	Nine Months Ended
(Dollars in thousands)	September 30, 2022		September 30, 2021
Cash flows from operating activities
Net income	$	12,411	$	26,175
Adjustments to reconcile net income to net cash provided by operating activities:
Net premium amortization (discount accretion)	1,319		( 690 )
Depreciation and amortization expense	3,536		4,014

Provision for loan losses	3,575		( 10 )
Share-based compensation	1,608		1,428
Gains on sales of loans originated for sale	( 1,305 )		( 4,253 )
Fair value adjustments on loans held for sale	1,405		273
Mortgage loans originated for sale	( 72,247 )		( 150,652 )
Proceeds from sales of loans originated for sale	67,554		159,425
Gains on sale of portfolio loans	( 306 )		—

Writedown of OREO and premises held for sale	1,297		—
Net loss on disposal of premises and equipment	483		—
Deferred income tax benefit	( 2,489 )		( 267 )
Investment securities losses (gains)	163		( 635 )
Provision for legal settlement	13,000		—
Return on investments in limited partnerships	( 964 )		—
Loss on derivative terminations	—		514
Income from life insurance	( 1,742 )		( 1,690 )
(Increase) decrease in accrued interest receivable	( 978 )		912
Increase (decrease) in other liabilities	20,271		( 221 )
Other, net	( 8,833 )		( 4,108 )
Net cash provided by operating activities	37,758		30,215
Cash flows from investing activities
Proceeds from sales of AFS securities	3,075		149,038
Maturities, repayments and calls of AFS securities	42,442		30,525
Purchases of AFS securities	( 139,580 )		( 156,912 )

Net redemptions of restricted investments in bank stocks	783		3,512
Net distributions from investments in limited partnerships	1,410		—
Net (increase) decrease in loans	( 109,424 )		41,504
Proceeds from sales of portfolio loans	4,443		—

Purchases of bank premises and equipment	( 805 )		( 891 )





Death benefit proceeds from life insurance contracts	142		—

Net cash (used in) provided by investing activities	( 197,514 )		66,776
Cash flows from financing activities
Net increase in deposits	40,917		145,203
Net increase in borrowings with original maturities less than 90 days	( 2,236 )		8,129

Payments on FHLB advances and other borrowings	( 329 )		( 56,042 )
Settlement of terminated derivatives	—		( 525 )





Dividends paid	( 6,244 )		( 6,152 )

Acquisition of treasury stock	( 14,056 )		( 1,069 )
Shares repurchased as treasury stock for employee taxes associated with restricted stock vesting	( 262 )		( 514 )
Proceeds from issuance of employee stock purchase plan shares	183		136

Net cash provided by financing activities	17,973		89,166
Net (decrease) increase in cash and cash equivalents	( 141,783 )		186,157
Cash and cash equivalents at beginning of period	208,710		125,258
Cash and cash equivalents at end of period	$	66,927	$	311,415

Table of Contents


	Nine Months Ended
	September 30, 2022		September 30, 2021
Supplemental disclosures of cash flow information:
Cash paid during the period for:
Interest	$	3,917	$	5,007
Income taxes	3,400		4,100
Supplemental schedule of noncash activities:
Loans transferred from LHFS to portfolio loans	1,510		—

Premise and equipment transferred to held for sale	2,844		—
Lease liabilities arising from obtaining ROU assets	94		1,392

The Notes to Unaudited Condensed Consolidated Financial Statements are an integral part of these statements.

Table of Contents

Notes to Condensed Consolidated Financial Statements (Unaudited)

(All dollar amounts presented in the tables, except per share amounts, are in thousands)

NOTE 1. SUMMARY OF SIGNIFICANT ACCOUNTING POLICIES

See the Glossary of Defined Terms at the beginning of this Report for terms used throughout the unaudited condensed consolidated financial statements and related notes of this Form 10-Q.

Nature of Operations – Orrstown Financial Services, Inc. is a financial holding company that operates Orrstown Bank, a commercial bank providing banking and financial advisory services in Berks, Cumberland, Dauphin, Franklin, Lancaster, Perry and York Counties, Pennsylvania, and in Anne Arundel, Baltimore, Howard and Washington Counties, Maryland. The Company operates in the community banking segment and engages in lending activities, including commercial, residential, commercial mortgages, construction, municipal, and various forms of consumer lending, and deposit services, including checking, savings, time, and money market deposits. The Company also provides fiduciary, investment advisory, insurance and brokerage services. The Company and the Bank are subject to regulation by certain federal and state agencies and undergo periodic examinations by such regulatory authorities.

Basis of Presentation – The accompanying unaudited condensed consolidated financial statements include the accounts of Orrstown Financial Services, Inc. and its wholly owned subsidiary, the Bank. The Company has prepared these unaudited condensed consolidated financial statements in accordance with GAAP for interim financial information, SEC rules that permit reduced disclosure for interim periods, and Article 10 of Regulation S-X. In the opinion of management, all adjustments (all of which are of a normal recurring nature) that are necessary for a fair statement are reflected in the unaudited condensed consolidated financial statements. The December 31, 2021 consolidated balance sheet information contained in this Quarterly Report on Form 10-Q was derived from the Company's 2021 audited consolidated financial statements. The unaudited condensed consolidated financial statements should be read in conjunction with the audited consolidated financial statements, including the notes thereto, included in the Company’s Annual Report on Form 10-K for the year ended December 31, 2021. Operating results for the nine months ended September 30, 2022 are not necessarily indicative of the results that may be expected for the year ending December 31, 2022. All significant intercompany transactions and accounts have been eliminated. Certain reclassifications have been made to the prior period amounts to conform with current period classifications. These reclassifications did not have a material impact on the Company's consolidated financial condition, results of operations or statement of consolidated cash flows.

The Company's management has evaluated all activity of the Company and concluded that subsequent events are properly reflected in the Company's unaudited condensed consolidated financial statements and notes as required by GAAP.

To prepare financial statements in conformity with GAAP, management makes estimates and assumptions based on available information. These estimates and assumptions affect the amounts reported in the financial statements and the disclosures provided, and actual results could differ.

Derivatives - FASB ASC 815, Derivatives and Hedging (“ASC 815”), provides the disclosure requirements for derivatives and hedging activities with the intent to provide users of financial statements with an enhanced understanding of: (a) how and why an entity uses derivative instruments, (b) how the entity accounts for derivative instruments and related hedged items, and (c) how derivative instruments and related hedged items affect an entity’s financial position, financial performance, and cash flows. Further, qualitative disclosures are required that explain the Company’s objectives and strategies for using derivatives, as well as quantitative disclosures about the fair value of and gains and losses on derivative instruments, and disclosures about credit-risk-related contingent features in derivative instruments.

As required by ASC 815, the Company records all derivatives on the balance sheet at fair value. The accounting for changes in the fair value of derivatives depends on the intended use of the derivative, whether the Company has elected to designate a derivative in a hedging relationship and apply hedge accounting and whether the hedging relationship has satisfied the criteria necessary to apply hedge accounting. Derivatives designated and qualifying as a hedge of the exposure to changes in the fair value of an asset, liability, or firm commitment attributable to a particular risk, such as interest rate risk, are considered fair value hedges. Derivatives designated and qualifying as a hedge of the exposure to variability in expected future cash flows, or other types of forecasted transactions, are considered cash flow hedges. Hedge accounting generally provides for the matching of the timing of gain or loss recognition on the hedging instrument with the recognition of the changes in the fair value of the hedged asset or liability that are attributable to the hedged risk in a fair value hedge or the earnings effect of the hedged forecasted transactions in a cash flow hedge.

The Company may enter into derivative contracts that are intended to economically hedge certain of its risk, even though hedge accounting does not apply or the Company elects not to apply hedge accounting. The Company's objectives in using interest rate derivatives are to add stability to interest income and to manage its exposure to interest rate movements. To

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accomplish this objective, the Company uses interest rate swaps as part of its interest rate risk management strategy. Interest rate swaps designated as cash flow hedges involve the receipt of fixed amounts from a counterparty in exchange for the Company making variable-rate payments over the life of the agreements without exchange of the underlying notional amount.

Changes to the fair value of derivatives designated and that qualify as cash flow hedges are recorded in AOCI and are subsequently reclassified into earnings in the period that the hedged transaction affects earnings. The Company discontinues cash flow hedge accounting if it is probable the forecasted hedged transactions will not occur in the initially identified time period due to circumstances, such as the impact of the COVID-19 pandemic. Upon discontinuance, the associated gains and losses deferred in AOCI are reclassified immediately into earnings and subsequent changes in the fair value of the cash flow hedge are recognized in earnings. At September 30, 2022, the Company had two interest rate derivatives designated as hedging instruments with a total notional value of $ 100.0 million compared to no interest rate derivatives designated as a hedging instrument at December 31, 2021.

Derivatives not designated as hedges are not speculative and result from a service the Company provides to certain customers. The Company executes interest rate swaps with commercial banking customers to facilitate their respective risk management strategies. Those interest rate swaps are simultaneously hedged by offsetting derivatives that the Company executes with a third party, such that the Company minimizes its net risk exposure resulting from such transactions. As the interest rate derivatives associated with this program do not meet the strict hedge accounting requirements, changes in the fair value of both the customer derivatives and the offsetting derivatives are recognized directly in earnings. At September 30, 2022 and December 31, 2021, the Company had interest rate swaps not designated as hedges with a total notional value of $ 206.4 million and $ 75.8 million, respectively.

The Company also may enter into risk participation agreements with a financial institution counterparty for an interest rate derivative contract related to a loan in which the Company may be a participant or the agent bank. The risk participation agreement provides credit protection to the agent bank should the borrower fail to perform on its interest rate derivative contracts with the agent bank. The Company manages its credit risk on risk participation agreements by monitoring the creditworthiness of the borrower, which follows the same credit review process as derivative instruments entered into directly with the borrower. The notional amount of a risk participation agreement reflects the Company's pro-rata share of the derivative instrument, consistent with its share of the related participated loan. Changes in the fair value of the risk participation agreement are recognized directly into earnings. At September 30, 2022 and December 31, 2021, the Company had a risk participation with sold protection with a notional value of $ 15.9 million for both periods, and a risk participation with purchased protection with a notional value of $ 5.0 million and zero at September 30, 2022 and December 31, 2021, respectively.

As a part of its normal residential mortgage operations, the Company will enter into an interest rate lock commitment with a potential borrower. The Company may enter into a corresponding commitment with an investor to sell that loan at a specific price shortly after origination. In accordance with FASB ASC 820, adjustments are recorded through earnings to account for the net change in fair value of these held for sale loans. The fair value of held for sale loans can vary based on the interest rate locked with the customer and the current market interest rate at the balance sheet date.

Leases - The Company evaluates its contracts at inception to determine if an arrangement either is a lease or contains one. Operating lease ROU assets are included in other assets and operating lease liabilities in accrued interest payable and other liabilities in the unaudited condensed consolidated balance sheets. The Company had no finance leases at September 30, 2022 and December 31, 2021.

ROU assets represent the right to use an underlying asset for the lease term, and lease liabilities represent an obligation to make lease payments arising from the lease. Operating lease ROU assets and liabilities are recognized at commencement date based on the present value of lease payments over the lease term. The Company's leases do not provide an implicit rate, so the Company's incremental borrowing rate is used, which approximates its fully collateralized borrowing rate, based on the information available at commencement date in determining the present value of lease payments. The incremental borrowing rate is reevaluated upon lease modification. The operating lease ROU asset also includes any initial direct costs and prepaid lease payments made less any lease incentives. In calculating the present value of lease payments, the Company may include options to extend the lease when it is reasonably certain that it will exercise that option.

In accordance with ASU 2016-02, “Leases (Topic 842)” (“ASU 2016-02”), the Company keeps leases with an initial term of 12 months or less off of the balance sheet. The Company recognizes these lease payments in the unaudited condensed consolidated statements of income on a straight-line basis over the lease term. The Company has lease agreements with lease and non-lease components and has elected the practical expedient to account for them as a single lease component.

The Company's operating leases relate primarily to bank branches and office space. The difference between the lease asset and lease liabilities primarily consists of deferred rent liabilities reclassified upon adoption to reduce the measurement of the lease assets. The standard does not materially impact the Company's unaudited condensed consolidated statements of income.

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Recent Accounting Pronouncements - ASU No. 2016-13, Financial Instruments - Credit Losses (Topic 326): Measurement of Credit Losses on Financial Instruments ( "ASU 2016-13" ). The amendments in this update require an organization to measure all expected credit losses for financial assets held at the reporting date based on historical experience, current conditions, and reasonable and supportable forecasts. Financial institutions and other organizations will use forward-looking information to better inform their credit loss estimates. Many of the loss estimation techniques applied today will still be permitted, although the inputs to those techniques will change to reflect the full amount of expected credit losses. Organizations will continue to use judgment to determine which loss estimation method is appropriate for their circumstances. Additionally, the amendments in this update amend the accounting for credit losses on AFS debt securities and purchased financial assets with credit deterioration. For certain public companies, this update was effective for interim and annual periods beginning after December 15, 2019. The implementation deadline of ASU 2016-13 was extended for smaller reporting and other companies until the fiscal year and interim periods beginning after December 15, 2022. The Company will implement ASU 2016-13 effective January 1, 2023.

ASU No. 2019-10, Financial Instruments—Credit Losses (Topic 326), Derivatives and Hedging (Topic 815), and Leases (Topic 842): Effective Dates ("ASU 2019-10"), extended the implementation deadline of ASU 2016-13 for smaller reporting and other companies until the fiscal year and interim periods beginning after December 15, 2022. The Company meets the requirements to be considered a smaller reporting company under SEC Regulation S-K and SEC Rule 405, and will adopt ASU 2016-13 effective January 1, 2023. The Company is evaluating the impact of the adoption of ASU 2016-13, and is working with a third-party vendor solution to assist with the application of ASU 2016-13 and finalizing the loss estimation models to be used. Once management finalizes which methods will be utilized, another third party vendor will perform a model validation prior to adoption. The Company expects to recognize a one-time cumulative-effect adjustment to the allowance for credit losses as of the date of adoption of the new standard. While the Company anticipates the allowance for loan losses will increase under its current assumptions, it expects the impact of adopting ASU 2016-13 will be influenced by the composition, characteristics and quality of its loan and investment securities portfolios, as well as general economic conditions and forecasts at the adoption date. The other provisions of ASU 2019-10 were not applicable to the Company.

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 ("ASU 2020-04"). ASU 2020-04 contains optional expedients and exceptions for applying generally accepted accounting principles to contract modifications and hedging relationships, subject to meeting certain criteria, that reference LIBOR or another reference rate expected to be discontinued. The optional expedients apply consistently to all contracts or transactions within the scope of this topic, while the optional expedients for hedging relationships can be elected on an individual basis. The Company has formed a cross-functional working group to lead the transition from LIBOR to a planned adoption of an alternate index. The Company currently plans to replace LIBOR with the 30-Day Average SOFR or Term SOFR in its loan agreements. The Company implemented fallback language for loans with maturities after 2021. The Company expects to adopt the LIBOR transition relief allowed under this standard, and is currently evaluating the potential impact of this guidance on its financial statements.

In March 2022, the FASB issued ASU No. 2022-02, Financial Instruments – Credit Losses (Topic 326): Troubled Debt Restructurings and Vintage Disclosures (“ASU 2022-02”). ASU 2022-02 eliminates the troubled debt restructuring accounting model. This change will require all loan modifications to be accounted for under the general loan modification guidance in Subtopic 310-20, Receivables – Nonrefundable Fees and Other Costs, and subject entities to new disclosure requirements on loan modifications to borrowers experiencing financial difficulty. For entities that have adopted Topic 326, ASU 2022-02 is effective for periods beginning after December 15, 2022. For entities adopting Topic 326 in periods after December 15, 2022, ASU 2022-02 is effective when the company adopts Topic 326. The Company will implement ASU 2022-02 effective January 1, 2023, and is evaluating the impact.

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NOTE 2. INVESTMENT SECURITIES

At September 30, 2022 and December 31, 2021, all investment securities were classified as AFS. The following table summarizes amortized cost and fair value of investment securities, and the corresponding amounts of gross unrealized gains and losses recognized in AOCI, at September 30, 2022 and December 31, 2021:


	Amortized Cost		Gross Unrealized Gains		Gross Unrealized Losses		Fair Value
September 30, 2022
U.S. Treasury securities	$	20,074	$	—	$	2,959	$	17,115


States and political subdivisions	254,603		125		34,692		220,036
GSE residential MBSs	64,258		—		5,055		59,203
GSE residential CMOs	70,964		—		6,814		64,150
Non-agency CMOs	31,346		—		2,374		28,972



Asset-backed	116,427		—		2,692		113,735
Other	385		—		—		385
Totals	$	558,057	$	125	$	54,586	$	503,596
December 31, 2021
U.S. Treasury securities	$	20,084	$	—	$	382	$	19,702


States and political subdivisions	185,437		8,606		673		193,370
GSE residential MBSs	41,260		44		578		40,726
GSE residential CMOs	66,430		436		944		65,922
Non-agency CMOs	30,676		—		978		29,698



Asset-backed	122,520		401		300		122,621
Other	399		—		—		399
Totals	$	466,806	$	9,487	$	3,855	$	472,438

The following table summarizes investment securities with unrealized losses at September 30, 2022 and December 31, 2021, aggregated by major investment security type and the length of time in a continuous unrealized loss position.


	Less Than 12 Months					12 Months or More					Total
	# of Securities	Fair Value		Unrealized Losses		# of Securities	Fair Value		Unrealized Losses		# of Securities	Fair Value		Unrealized Losses
September 30, 2022
U.S. Treasury securities	—	$	—	$	—	3	$	17,115	$	2,959	3	$	17,115	$	2,959

States and political subdivisions	54	180,836		27,459		8	23,384		7,233		62	204,220		34,692
GSE residential MBSs	8	37,055		1,919		7	22,148		3,136		15	59,203		5,055
GSE residential CMOs	9	31,506		2,633		7	32,644		4,181		16	64,150		6,814
Non-agency CMOs	3	20,101		871		2	8,871		1,503		5	28,972		2,374



Asset-backed	14	85,529		2,081		3	28,206		611		17	113,735		2,692
Totals	88	$	355,027	$	34,963	30	$	132,368	$	19,623	118	$	487,395	$	54,586
December 31, 2021
U.S. Treasury securities	3	$	19,702	$	382	—	$	—	$	—	3	$	19,702	$	382


States and political subdivisions	12	45,522		673		—	—		—		12	45,522		673
GSE residential MBSs	9	37,899		578		—	—		—		9	37,899		578
GSE residential CMOs	7	41,163		944		—	—		—		7	41,163		944
Non-agency CMOs	3	24,661		978		—	—		—		3	24,661		978



Asset-backed	3	21,245		138		3	34,180		162		6	55,425		300
Totals	37	$	190,192	$	3,693	3	$	34,180	$	162	40	$	224,372	$	3,855

The Company determines whether unrealized losses are temporary in nature in accordance with FASB ASC 320-10, Investments - Overall , (“FASB ASC 320-10”) and FASB ASC 325-40, Investments – Beneficial Interests in Securitized Financial Assets , when applicable. The evaluation is based upon factors such as the creditworthiness of the underlying borrowers, performance of the underlying collateral, if applicable, and the level of credit support in the security structure.

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Management also evaluates other factors and circumstances that may be indicative of an OTTI condition. This includes, but is not limited to, an evaluation of the type of security, length of time and extent to which the fair value has been less than cost and near-term prospects of the issuer.

FASB ASC 320-10 requires the Company to assess if an OTTI exists by considering whether the Company has the intent to sell the security or it is more likely than not that it will be required to sell the security before recovery. If either of these situations applies, the guidance requires the Company to record an OTTI charge to earnings on debt securities for the difference between the amortized cost basis of the security and the fair value of the security. If neither of these situations applies, the Company is required to assess whether it is expected to recover the entire amortized cost basis of the security. If the Company is not expected to recover the entire amortized cost basis of the security, the guidance requires the Company to bifurcate the identified OTTI into a credit loss component and a component representing loss related to other factors. A discount rate is applied which equals the effective yield of the security. The difference between the present value of the expected flows and the amortized book value is considered a credit loss, which would be recorded through earnings as an OTTI charge. When a market price is not readily available, the market value of the security is determined using the same expected cash flows; the discount rate is a rate the Company determines from the open market and other sources as appropriate for the security. The difference between the market value and the present value of cash flows expected to be collected is recognized in AOCI on the unaudited condensed consolidated statements of financial condition.

U.S. Treasury Securities. The unrealized losses presented in the table above have been caused by an increase in rates from the time these securities were purchased. Management considers the full faith and credit of the U.S. government in determining whether a security is OTTI. Because the Company does not intend to sell these securities and it is not more likely than not that the Company will be required to sell them before recovery of their amortized cost basis, which may be maturity, the Company does not consider these securities to be OTTI at September 30, 2022 or December 31, 2021.

States and Political Subdivisions. The unrealized losses presented in the table above have been caused by a rise in interest rates from the time these securities were purchased. Management considers the investment rating, the state of the issuer of the security and other credit support in determining whether the security is OTTI. Because the Company does not intend to sell these securities and it is not more likely than not that the Company will be required to sell them before recovery of their amortized cost basis, which may be maturity, the Company does not consider these securities to be OTTI at September 30, 2022 or December 31, 2021.

GSE Residential CMOs and GSE Residential MBS. The unrealized losses presented in the table above have been caused by a widening of spreads and a rise in interest rates from the time these securities were purchased. The contractual terms of these securities do not permit the issuer to settle the securities at a price less than its par value basis. Because the Company does not intend to sell these securities and it is not more likely than not that the Company will be required to sell them before recovery of their amortized cost basis, which may be maturity, the Company does not consider these securities to be OTTI at September 30, 2022 or December 31, 2021.

Non-Agency CMOs. The unrealized losses presented in the table above were caused by a widening of spreads and a rise in interest rates from the time the securities were purchased. Management considers the investment rating and other credit support in determining whether a security is OTTI. Because the Company does not intend to sell these securities and it is not more likely than not that the Company will be required to sell them before recovery of their amortized cost basis, which may be maturity, the Company does not consider these securities to be OTTI at September 30, 2022 or December 31, 2021.

Asset-backed. The unrealized losses presented in the table above were caused by a widening of spreads and a rise in the interest rates from the time the securities were purchased. Management considers the investment rating and other credit support in determining whether a security is OTTI. Because the Company does not intend to sell these securities and it is not more likely than not that the Company will be required to sell them before recovery of their amortized cost basis, which may be maturity, the Company does not consider these securities to be OTTI at September 30, 2022 or December 31, 2021.

The following table summarizes amortized cost and fair value of investment securities by contractual maturity at September 30, 2022. Expected maturities may differ from contractual maturities if borrowers have the right to call or prepay

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obligations with or without call or prepayment penalties. Securities not due at a single maturity date are shown separately.


	Amortized Cost		Fair Value
Due in one year or less	$	249	$	249
Due after one year through five years	8,440		8,065
Due after five years through ten years	85,918		75,831
Due after ten years	180,455		153,391
CMOs and MBSs	166,568		152,325
Asset-backed	116,427		113,735
Totals	$	558,057	$	503,596

The following table summarizes proceeds from sales of investment securities and gross gains and gross losses for the three and nine months ended September 30, 2022 and 2021:


	Three months ended September 30,				Nine months ended September 30,
	2022		2021		2022		2021
Proceeds from sale of investment securities	$	—	$	73,319	$	3,075	$	149,038
Gross gains	—		482		25		1,844
Gross losses	14		3		17		1,209

During the three and nine months ended September 30, 2022, the Company recorded net investment security losses of $ 14 thousand and net investment security gains of $ 8 thousand, respectively, compared to net gains of $ 479 thousand and $ 635 thousand for the three and nine months ended September 30, 2021, respectively. A non-agency CMO was called, which resulted in a loss of $ 171 thousand for the nine months ended September 30, 2022. During the nine months ended September 30, 2022, the principal balance of $ 3.1 million of one security was sold for proceeds of $ 3.1 million compared to 18 securities with a principal balance of $ 148.4 million that were sold for proceeds of $ 149.0 million during the nine months ended September 30, 2021. There were four investment securities with a principal balance of $ 72.8 million sold for proceeds of $ 73.3 million during the three months ended September 30, 2021, compared to none during the three months ended September 30, 2022. Investment securities with a fair value of $ 404.1 million and $ 295.6 million at September 30, 2022 and December 31, 2021, respectively, were pledged to secure public funds and for other purposes as required or permitted by law.

NOTE 3. LOANS AND ALLOWANCE FOR LOAN LOSSES

Consistent with ASU 2010-20, Disclosures about the Credit Quality of Financing Receivables and the Allowance for Loan Losses, the Company’s loan portfolio is grouped into segments which are further broken down into classes to allow management to monitor the performance by the borrower and to monitor the yield on the portfolio.

The risks associated with lending activities differ among the various loan classes and are subject to the impact of changes in interest rates, market conditions of collateral securing the loans, and general economic conditions. All of these factors may adversely impact both the borrower’s ability to repay its loans and associated collateral.

The Company has various types of commercial real estate loans, which have differing levels of credit risk. Owner occupied commercial real estate loans are generally dependent upon the successful operation of the borrower’s business, with the cash flows generated from the business being the primary source of repayment of the loan. If the business suffers a downturn in sales or profitability, the borrower’s ability to repay the loan could be in jeopardy.

Non-owner occupied and multi-family commercial real estate loans and non-owner occupied residential loans present a different credit risk to the Company than owner occupied commercial real estate loans, as the repayment of the loan is dependent upon the borrower’s ability to generate a sufficient level of occupancy to produce rental income that exceeds debt service requirements and operating expenses. Lower occupancy or lease rates may result in a reduction in cash flows, which hinders the ability of the borrower to meet debt service requirements, and may result in lower collateral values. The Company generally recognizes that greater risk is inherent in these credit relationships compared to owner occupied loans mentioned above.

Acquisition and development loans consist of 1-4 family residential construction and commercial and land development loans. The risk of loss on these loans is largely dependent on the Company’s ability to assess the property’s value at the completion of the project, which should exceed the property’s construction costs. During the construction phase, a number of factors could potentially negatively impact the collateral value, including cost overruns, delays in completing the project,

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competition, and real estate market conditions, which may change based on the supply of similar properties in the area. In the event the collateral value at the completion of the project is not sufficient to cover the outstanding loan balance, the Company must rely upon other repayment sources, if any, including the guarantors of the project or other collateral securing the loan.

On March 27, 2020, the Coronavirus Aid, Relief and Economic Security (“CARES”) Act was enacted. The CARES Act established the SBA PPP. The SBA PPP is intended to provide economic relief to small businesses nationwide adversely impacted under the COVID-19 Emergency Declaration issued on March 13, 2020. The SBA PPP, which began on April 3, 2020, provided small businesses with funds to cover up to 24 weeks of payroll costs and other expenses, including benefits. It also provides for forgiveness of up to the full principal amount of qualifying loans. In total, the Bank closed and funded almost 6,500 loans for a total gross loan amount of $ 699.4 million through December 31, 2021.

Commercial and industrial loans include advances to local and regional businesses for general commercial purposes and include permanent and short-term working capital, machinery and equipment financing, and may be either in the form of lines of credit or term loans. Although commercial and industrial loans may be unsecured to our highest-rated borrowers, the majority of these loans are secured by the borrower’s accounts receivable, inventory and machinery and equipment. In a significant number of these loans, the collateral also includes the business real estate or the business owner’s personal real estate or assets. Commercial and industrial loans present credit exposure to the Company, as they are more susceptible to risk of loss during a downturn in the economy as borrowers may have greater difficulty in meeting their debt service requirements and the value of the collateral may decline. The Company attempts to mitigate this risk through its underwriting standards, including evaluating the creditworthiness of the borrower and, to the extent available, credit ratings on the business. Additionally, monitoring of the loans through annual renewals and meetings with the borrowers are typical. However, these procedures cannot eliminate the risk of loss associated with commercial and industrial lending. At September 30, 2022 and December 31, 2021, commercial and industrial loans include $ 17.0 million and $ 189.9 million, respectively, of loans, net of deferred fees and costs, originated through the SBA PPP. At September 30, 2022, the Bank has $ 347 thousand of net deferred SBA PPP fees remaining to be recognized through net interest income over the remaining life of the loans. The timing of the recognition of these fees is dependent upon the loan forgiveness process established by the SBA. As these loans are 100 % guaranteed by the SBA, there is no associated ALL at September 30, 2022.

Municipal loans consist of extensions of credit to municipalities and school districts within the Company’s market area. These loans generally present a lower risk than commercial and industrial loans, as they are generally secured by the municipality’s full taxing authority, by revenue obligations, or by its ability to raise assessments on its clients for a specific utility.

The Company originates loans to its retail clients, including fixed-rate and adjustable first lien mortgage loans, with the underlying 1-4 family owner occupied residential property securing the loan. The Company’s risk exposure is minimized in these types of loans through the evaluation of the creditworthiness of the borrower, including credit scores and debt-to-income ratios, and underwriting standards, which limit the loan-to-value ratio to generally no more than 80 % upon loan origination, unless the borrower obtains private mortgage insurance.

Home equity loans, including term loans and lines of credit, present a slightly higher risk to the Company than 1-4 family first liens, as these loans can be first or second liens on 1-4 family owner occupied residential property, but can have loan-to-value ratios of no greater than 85 % of the value of the real estate taken as collateral. The creditworthiness of the borrower is also considered, including credit scores and debt-to-income ratios.

Installment and other loans’ credit risk is mitigated through prudent underwriting standards, including evaluation of the creditworthiness of the borrower through credit scores and debt-to-income ratios and, if secured, the collateral value of the assets. These loans can be unsecured or secured by assets the value of which may depreciate quickly or may fluctuate, and may present a greater risk to the Company than 1-4 family residential loans.

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The following table presents the loan portfolio by segment and class, excluding residential mortgage LHFS, at September 30, 2022 and December 31, 2021:


	September 30, 2022		December 31, 2021
Commercial real estate:
Owner occupied	$	313,125	$	238,668
Non-owner occupied	573,605		551,783
Multi-family	114,561		93,255
Non-owner occupied residential	105,267		106,112
Acquisition and development:
1-4 family residential construction	20,810		12,279
Commercial and land development	148,512		93,925
Commercial and industrial (1)	378,574		485,728
Municipal	12,683		14,989
Residential mortgage:
First lien	220,970		198,831
Home equity - term	5,869		6,081
Home equity - lines of credit	180,267		160,705
Installment and other loans	13,684		17,630
Total loans	$	2,087,927	$	1,979,986

(1) This balance includes $ 17.0 million and $ 189.9 million of SBA PPP loans, net of deferred fees and costs, at September 30, 2022 and December 31, 2021, respectively.

In order to monitor ongoing risk associated with its loan portfolio and specific loans within the segments, management uses an internal grading system. The first several rating categories, representing the lowest risk to the Bank, are combined and given a “Pass” rating. Management generally follows regulatory definitions in assigning criticized ratings to loans, including "Special Mention," "Substandard," "Doubtful" or "Loss." The Special Mention category includes loans that have potential weaknesses that may, if not monitored or corrected, weaken the asset or inadequately protect the Bank's position at some future date. These assets pose elevated risk, but their weakness does not yet justify a more severe, or classified rating. Substandard loans are classified as they have a well-defined weakness, or weaknesses that jeopardize liquidation of the debt. These loans are characterized by the distinct possibility that the Bank will sustain some loss if the deficiencies are not corrected. Substandard loans include loans that management has determined not to be impaired, as well as loans considered to be impaired. A Doubtful loan has a high probability of total or substantial loss, but because of specific pending events that may strengthen the asset, its classification as Loss is deferred. Loss loans are considered uncollectible, as the borrowers are often in bankruptcy, have suspended debt repayments, or have ceased business operations. Once a loan is classified as Loss, there is little prospect of collecting the loan’s principal or interest and it is charged-off.

The Company has a loan review policy and program, which is designed to identify and monitor risk in the lending function. The Management ERM Committee, comprised of executive officers, senior officers and loan department personnel, is charged with the oversight of overall credit quality and risk exposure of the Company's loan portfolio. This includes the monitoring of the lending activities of all Company personnel with respect to underwriting and processing new loans and the timely follow-up and corrective action for loans showing signs of deterioration in quality. A loan review program provides the Company with an independent review of the commercial loan portfolio on an ongoing basis. Generally, consumer and residential mortgage loans are included in the Pass categories unless a specific action, such as extended delinquencies, bankruptcy, repossession or death of the borrower occurs, which heightens awareness as to a possible credit event.

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 quarterly and corresponding risk ratings are reaffirmed by the Company's Problem Loan Committee, with subsequent reporting to the Management ERM Committee and the Board of Directors.

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The following table summarizes the Company’s loan portfolio ratings based on its internal risk rating system at September 30, 2022 and December 31, 2021:


	Pass		Special Mention		Non-Impaired Substandard		Impaired - Substandard		Doubtful		PCI Loans		Total
September 30, 2022
Commercial real estate:
Owner occupied	$	302,001	$	3,392	$	2,649	$	2,849	$	—	$	2,234	$	313,125
Non-owner occupied	566,996		3,931		2,388		—		—		290		573,605
Multi-family	106,306		8,010		245		—		—		—		114,561
Non-owner occupied residential	102,136		1,979		493		90		—		569		105,267
Acquisition and development:
1-4 family residential construction	20,810		—		—		—		—		—		20,810
Commercial and land development	132,621		15,891		—		—		—		—		148,512
Commercial and industrial	349,319		20,891		6,236		45		—		2,083		378,574
Municipal	12,683		—		—		—		—		—		12,683
Residential mortgage:
First lien	213,812		—		223		2,593		—		4,342		220,970
Home equity - term	5,849		—		—		5		—		15		5,869
Home equity - lines of credit	179,850		—		45		372		—		—		180,267
Installment and other loans	13,639		—		—		38		—		7		13,684
	$	2,006,022	$	54,094	$	12,279	$	5,992	$	—	$	9,540	$	2,087,927

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

For commercial real estate, acquisition and development and commercial and industrial loans, a loan is considered impaired when, based on current information and events, it is probable that the Company will be unable to collect the scheduled payments of principal or interest when due according to the contractual terms of the loan agreement. Factors considered by

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management in determining impairment include payment status, collateral value, and the probability of collecting scheduled principal and interest payments when due. Loans that experience insignificant payment delays and payment shortfalls generally are not classified as impaired. Generally, loans that are more than 90 days past due are deemed impaired. Management determines the significance of payment delays and payment shortfalls on a case-by-case basis, taking into consideration all of the circumstances surrounding the loan and the borrower, including the length of the delay, the reasons for the delay, the borrower’s prior payment record, and the amount of the shortfall in relation to the principal and interest owed to determine if the loan should be placed on nonaccrual status. Nonaccrual loans in the commercial and commercial real estate portfolios and any TDRs are, by definition, deemed to be impaired. Impairment is measured on a loan-by-loan basis for commercial, construction and restructured loans by either the present value of the expected future cash flows discounted at the loan’s effective interest rate, the loan’s obtainable market price, or the fair value of the collateral if the loan is collateral dependent. A loan is collateral dependent if the repayment of the loan is expected to be provided solely by the underlying collateral. For loans that are deemed to be impaired for extended periods of time, periodic updates on fair values are obtained, which may include updated appraisals. Updated fair values are incorporated into the impairment analysis in the next reporting period.

Loan charge-offs, which may include partial charge-offs, are taken on an impaired loan that is collateral dependent if the loan’s carrying balance exceeds its collateral’s appraised value, the loan has been identified as uncollectible, and it is deemed to be a confirmed loss. Typically, impaired loans with a charge-off or partial charge-off will continue to be considered impaired, unless the note is split into two , and management expects the performing note to continue to perform and is adequately secured. The second, or non-performing note, would be charged-off. Generally, an impaired loan with a partial charge-off may continue to have an impairment reserve on it after the partial charge-off, if factors warrant.

At September 30, 2022 and December 31, 2021, except for TDRs, all of the Company’s loan impairments were measured based on the estimated fair value of the collateral securing the loan. By definition, TDRs are considered impaired. All TDR impairment analyses are initially based on discounted cash flows for those loans. For real estate loans, collateral generally consists of commercial real estate, but in the case of commercial and industrial loans, it could also consist of accounts receivable, inventory, equipment or other business assets. Commercial and industrial loans may also have real estate collateral.

Updated appraisals are generally required every 18 months for classified commercial loans in excess of $ 250 thousand. The “as is" value provided in the appraisal is often used as the fair value of the collateral in determining impairment, unless circumstances, such as subsequent improvements, approvals, or other circumstances, dictate that another value than that provided by the appraiser is more appropriate.

Generally, impaired commercial loans secured by real estate, other than performing TDRs, are measured at fair value using certified real estate appraisals that had been completed within the last 18 months. Appraised values are discounted for estimated costs to sell the property and other selling considerations to arrive at the property’s fair value. In those situations in which it is determined an updated appraisal is not required for loans individually evaluated for impairment, fair values are based on either an existing appraisal or a discounted cash flow analysis as determined by management. The approaches are discussed below:

• Existing appraisal – if the existing appraisal provides a strong loan-to-value ratio (generally 70 % or lower) and, after consideration of market conditions and knowledge of the property and area, it is determined by the Credit Administration staff that there has not been a significant deterioration in the collateral value, the existing certified appraised value may be used. Discounts to the appraised value, as deemed appropriate for selling costs, are factored into the fair value.

• Discounted cash flows – in limited cases, discounted cash flows may be used on projects in which the collateral is liquidated to reduce the borrowings outstanding, and is used to validate collateral values derived from other approaches.

Collateral on certain impaired loans is not limited to real estate, and may consist of accounts receivable, inventory, equipment or other business assets. Estimated fair values are determined based on borrowers’ financial statements, inventory ledgers, accounts receivable aging or appraisals from individuals with knowledge in the business. Stated balances are generally discounted for the age of the financial information or the quality of the assets. In determining fair value, liquidation discounts are applied to this collateral based on existing loan evaluation policies.

The Company distinguishes substandard loans on both an impaired and non-impaired basis, as it places less emphasis on a loan’s classification, and increased reliance on whether the loan was performing in accordance with the contractual terms. A substandard classification does not automatically meet the definition of impaired. Loss potential, while existing in the aggregate amount of substandard loans, does not have to exist in individual extensions of credit classified as substandard. As a result, the Company’s methodology includes an evaluation of certain accruing commercial real estate, acquisition and development, and commercial and industrial loans rated substandard to be collectively evaluated for impairment. Although the Company believes

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these loans meet the definition of substandard, they are generally performing and management has concluded that it is likely the Company will be able to collect the scheduled payments of principal and interest when due according to the contractual terms of the loan agreement.

Larger groups of smaller balance homogeneous loans are collectively evaluated for impairment. Generally, the Company does not separately identify individual consumer and residential loans for impairment disclosures, unless such loans are the subject of a restructuring agreement due to financial difficulties of the borrower.

The following table, which excludes accruing PCI loans, summarizes impaired loans by segment and class, segregated by those for which a specific allowance was required and those for which a specific allowance was not required at September 30, 2022 and December 31, 2021. The recorded investment in loans excludes accrued interest receivable due to insignificance. Related allowances established generally pertain to those loans in which loan forbearance agreements were in the process of being negotiated or updated appraisals were pending, and any partial charge-off will be recorded when final information is received.


	Impaired Loans with a Specific Allowance						Impaired Loans with No Specific Allowance
	Recorded Investment (Book Balance)		Unpaid Principal Balance (Legal Balance)		Related Allowance		Recorded Investment (Book Balance)		Unpaid Principal Balance (Legal Balance)
September 30, 2022
Commercial real estate:
Owner-occupied	$	—	$	—	$	—	$	2,849	$	3,840


Non-owner occupied residential	—		—		—		90		211



Commercial and industrial	—		—		—		45		306
Residential mortgage:
First lien	233		233		28		2,360		3,181
Home equity—term	—		—		—		5		8
Home equity—lines of credit	—		—		—		372		609
Installment and other loans	—		—		—		38		38
	$	233	$	233	$	28	$	5,759	$	8,193
December 31, 2021
Commercial real estate:
Owner-occupied	$	—	$	—	$	—	$	3,763	$	4,902


Non-owner occupied residential	—		—		—		122		259



Commercial and industrial	—		—		—		250		547
Residential mortgage:
First lien	341		341		28		2,294		3,337
Home equity—term	—		—		—		7		10
Home equity—lines of credit	—		—		—		436		653
Installment and other loans	—		—		—		40		40
	$	341	$	341	$	28	$	6,912	$	9,748

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The following table, which excludes accruing PCI loans, summarizes the average recorded investment in impaired loans and related recognized interest income for the three and nine months ended September 30, 2022 and 2021:


	2022				2021
	Average Impaired Balance		Interest Income Recognized		Average Impaired Balance		Interest Income Recognized
Three Months Ended September 30,
Commercial real estate:
Owner-occupied	$	2,881	$	—	$	4,179	$	—


Non-owner occupied residential	93		—		232		—



Commercial and industrial	51		—		3,073		—
Residential mortgage:
First lien	2,390		10		2,541		11
Home equity – term	5		—		10		—
Home equity - lines of credit	382		—		463		—
Installment and other loans	43		—		24		—
	$	5,845	$	10	$	10,522	$	11
Nine Months Ended September 30,
Commercial real estate:
Owner occupied	$	3,126	$	—	$	3,848	$	1

Multi-family	—		—		7		—
Non-owner occupied residential	100		—		252		—
Acquisition and development:

Commercial and land development	—		—		246		—
Commercial and industrial	132		—		3,046		—
Residential mortgage:
First lien	2,370		25		2,575		32
Home equity - term	6		—		12		—
Home equity - lines of credit	407		—		547		—
Installment and other loans	45		—		17		—
	$	6,186	$	25	$	10,550	$	33

The following table presents impaired loans that are TDRs, with the recorded investment at September 30, 2022 and December 31, 2021:


	September 30, 2022			December 31, 2021
	Number of Contracts	Recorded Investment		Number of Contracts	Recorded Investment
Accruing:





Residential mortgage:
First lien	8	$	689	8	$	804


Nonaccruing:





Residential mortgage:
First lien	4	219		5	285
Installment and other loans	1	3		—	—
	5	222		5	285
	13	$	911	13	$	1,089

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There were no new TDRs in the three months ended September 30, 2022. For the nine months ended September 30, 2022, there were two new TDRs, both on non-accrual status, totaling $ 3 thousand. There were no new TDRs in 2021. One of the two new TDRs during 2022 was paid off in full during the three months ended September 30, 2022.

Management further monitors the performance and credit quality of the loan portfolio by analyzing the length of time a portfolio is past due, by aggregating loans based on its delinquencies. The following table presents the classes of loan portfolio summarized by aging categories of performing loans and nonaccrual loans at September 30, 2022 and December 31, 2021:


			Days Past Due
	Current		30-59		60-89		90+ (still accruing)		Total Past Due		Non- Accrual		Total Loans
September 30, 2022
Commercial real estate:
Owner occupied	$	307,819	$	223	$	—	$	—	$	223	$	2,849	$	310,891
Non-owner occupied	573,233		82		—		—		82		—		573,315
Multi-family	114,561		—		—		—		—		—		114,561
Non-owner occupied residential	104,502		106		—		—		106		90		104,698
Acquisition and development:
1-4 family residential construction	20,810		—		—		—		—		—		20,810
Commercial and land development	148,512		—		—		—		—		—		148,512
Commercial and industrial	376,166		11		269		—		280		45		376,491
Municipal	12,683		—		—		—		—		—		12,683
Residential mortgage:
First lien	213,733		746		219		26		991		1,904		216,628
Home equity - term	5,849		—		—		—		—		5		5,854
Home equity - lines of credit	179,365		107		423		—		530		372		180,267
Installment and other loans	13,521		105		13		—		118		38		13,677
Subtotal	2,070,754		1,380		924		26		2,330		5,303		2,078,387
Loans acquired with credit deterioration:
Commercial real estate:
Owner occupied	2,234		—		—		—		—		—		2,234
Non-owner occupied	290		—		—		—		—		—		290

Non-owner occupied residential	458		—		—		111		111		—		569



Commercial and industrial	2,083		—		—		—		—		—		2,083

Residential mortgage:
First lien	4,130		8		109		95		212		—		4,342
Home equity - term	15		—		—		—		—		—		15

Installment and other loans	7		—		—		—		—		—		7
Subtotal	9,217		8		109		206		323		—		9,540
	$	2,079,971	$	1,388	$	1,033	$	232	$	2,653	$	5,303	$	2,087,927

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			Days Past Due
	Current		30-59		60-89		90+ (still accruing)		Total Past Due		Non- Accrual		Total Loans
December 31, 2021
Commercial real estate:
Owner occupied	$	231,371	$	314	$	—	$	891	$	1,205	$	3,763	$	236,339
Non-owner occupied	551,473		—		—		—		—		—		551,473
Multi-family	93,255		—		—		—		—		—		93,255
Non-owner occupied residential	104,645		161		—		—		161		122		104,928
Acquisition and development:
1-4 family residential construction	12,279		—		—		—		—		—		12,279
Commercial and land development	93,793		132		—		—		132		—		93,925
Commercial and industrial	483,088		128		—		—		128		250		483,466
Municipal	14,989		—		—		—		—		—		14,989
Residential mortgage:
First lien	189,043		2,995		281		96		3,372		1,831		194,246
Home equity - term	6,042		16		—		—		16		7		6,065
Home equity - lines of credit	159,628		641		—		—		641		436		160,705
Installment and other loans	17,467		109		8		—		117		40		17,624
Subtotal	1,957,073		4,496		289		987		5,772		6,449		1,969,294
Loans acquired with credit deterioration:
Commercial real estate:
Owner occupied	2,329		—		—		—		—		—		2,329
Non-owner occupied	310		—		—		—		—		—		310

Non-owner occupied residential	479		—		587		118		705		—		1,184



Commercial and industrial	2,262		—		—		—		—		—		2,262

Residential mortgage:
First lien	3,937		387		166		95		648		—		4,585
Home equity - term	15		—		—		1		1		—		16

Installment and other loans	6		—		—		—		—		—		6
Subtotal	9,338		387		753		214		1,354		—		10,692
	$	1,966,411	$	4,883	$	1,042	$	1,201	$	7,126	$	6,449	$	1,979,986

The Company maintains its ALL at a level management believes adequate for probable incurred credit losses. The ALL is established and maintained through a provision for loan losses charged to earnings. On a quarterly basis, management assesses the adequacy of the ALL utilizing a defined methodology, which considers specific credit evaluation of impaired loans as discussed above, historical loan loss experience, and qualitative factors. Management believes its approach properly addresses relevant accounting guidance for loans individually identified as impaired and for loans collectively evaluated for impairment, and other bank regulatory guidance.

In connection with its quarterly evaluation of the adequacy of the ALL, management reviews its methodology to determine if it properly addresses the current risk in the loan portfolio. For each loan class, general allowances based on quantitative factors, principally historical loss trends, are provided for loans that are collectively evaluated for impairment. An

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adjustment to historical loss factors may be incorporated for delinquency and other potential risk not elsewhere defined within the ALL methodology.

In addition to this quantitative analysis, adjustments to the ALL requirements are allocated on loans collectively evaluated for impairment based on additional qualitative factors, including:

Nature and Volume of Loans – including loan growth in the current and subsequent quarters based on the Company’s targeted growth and strategic plan, coupled with the types of loans booked based on risk management and credit culture; the number of exceptions to loan policy; and supervisory loan to value exceptions.

Concentrations of Credit and Changes within Credit Concentrations – including the composition of the Company’s overall portfolio makeup and management's evaluation related to concentration risk management and the inherent risk associated with the concentrations identified.

Underwriting Standards and Recovery Practices – including changes to underwriting standards and perceived impact on anticipated losses; trends in the number of exceptions to loan policy; supervisory loan to value exceptions; and administration of loan recovery practices.

Delinquency Trends – including delinquency percentages noted in the portfolio relative to economic conditions; severity of the delinquencies; and whether the ratios are trending upwards or downwards.

Classified Loans Trends – including internal loan ratings of the portfolio; severity of the ratings; whether the loan segment’s ratings show a more favorable or less favorable trend; and underlying market conditions and impact on the collateral values securing the loans.

Experience, Ability and Depth of Management/Lending staff – including the level of experience of senior and middle management and the lending staff; turnover of the staff; and instances of repeat criticisms.

Quality of Loan Review – including the level of experience of the loan review staff; in-house versus outsourced provider of review; turnover of the staff; and instances of repeat criticisms.

National and Local Economic Conditions – including trends in the consumer price index, unemployment rates, the housing price index, housing statistics compared to the prior year, bankruptcy rates, regulatory and legal environment risks and competition.

All factors noted above were deemed appropriate at September 30, 2022. For the nine months ended September 30, 2022, these factors were unchanged, except for a reduction in the National and Local Economic Conditions factor during the first quarter of 2022. This factor had been increased previously for economic concerns in the commercial real estate portfolio associated with the COVID-19 pandemic. The additional allocation was removed at March 31, 2022 as these concerns had subsided.

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The following table presents the activity in the ALL for the three and nine months ended September 30, 2022 and 2021:


	Commercial										Consumer
	Commercial Real Estate		Acquisition and Development		Commercial and Industrial		Municipal		Total		Residential Mortgage		Installment and Other		Total		Unallocated		Total
Three Months Ended
September 30, 2022
Balance, beginning of period	$	12,294	$	3,024	$	4,471	$	26	$	19,815	$	3,004	$	223	$	3,227	$	237	$	23,279
Provision for loan losses	551		342		296		( 1 )		1,188		309		( 5 )		304		8		1,500

Charge-offs	—		—		( 87 )		—		( 87 )		—		( 24 )		( 24 )		—		( 111 )
Recoveries	—		1		32		—		33		2		6		8		—		41
Balance, end of period	$	12,845	$	3,367	$	4,712	$	25	$	20,949	$	3,315	$	200	$	3,515	$	245	$	24,709
September 30, 2021
Balance, beginning of period	$	11,315	$	1,243	$	3,495	$	29	$	16,082	$	2,863	$	227	$	3,090	$	209	$	19,381
Provision for loan losses	( 179 )		290		386		( 2 )		495		( 147 )		18		( 129 )		( 1 )		365
Charge-offs	( 89 )		—		( 55 )		—		( 144 )		—		( 20 )		( 20 )		—		( 164 )
Recoveries	305		8		60		—		373		5		5		10		—		383
Balance, end of period	$	11,352	$	1,541	$	3,886	$	27	$	16,806	$	2,721	$	230	$	2,951	$	208	$	19,965
Nine Months Ended
September 30, 2022
Balance, beginning of period	$	12,037	$	2,062	$	3,814	$	30	$	17,943	$	2,785	$	215	$	3,000	$	237	$	21,180
Provision for loan losses	776		1,295		980		( 5 )		3,046		508		13		521		8		3,575

Charge-offs	—		—		( 202 )		—		( 202 )		( 10 )		( 42 )		( 52 )		—		( 254 )
Recoveries	32		10		120		—		162		32		14		46		—		208
Balance, end of period	$	12,845	$	3,367	$	4,712	$	25	$	20,949	$	3,315	$	200	$	3,515	$	245	$	24,709
September 30, 2021
Balance, beginning of period	$	11,151	$	1,114	$	3,942	$	40	$	16,247	$	3,362	$	324	$	3,686	$	218	$	20,151
Provision for loan losses	133		418		109		( 13 )		647		( 578 )		( 69 )		( 647 )		( 10 )		( 10 )
Charge-offs	( 270 )		—		( 621 )		—		( 891 )		( 92 )		( 49 )		( 141 )		—		( 1,032 )
Recoveries	338		9		456		—		803		29		24		53		—		856
Balance, end of period	$	11,352	$	1,541	$	3,886	$	27	$	16,806	$	2,721	$	230	$	2,951	$	208	$	19,965

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The following table summarizes the ending loan balance individually evaluated for impairment based upon loan segment, as well as the related ALL loss allocation for each at September 30, 2022 and December 31, 2021. Accruing PCI loans are excluded from loans individually evaluated for impairment.


	Commercial										Consumer
	Commercial Real Estate		Acquisition and Development		Commercial and Industrial		Municipal		Total		Residential Mortgage		Installment and Other		Total		Unallocated		Total
September 30, 2022
Loans allocated by:
Individually evaluated for impairment	$	2,939	$	—	$	45	$	—	$	2,984	$	2,970	$	38	$	3,008	$	—	$	5,992
Collectively evaluated for impairment	1,103,619		169,322		378,529		12,683		1,664,153		404,136		13,646		417,782		—		2,081,935

	$	1,106,558	$	169,322	$	378,574	$	12,683	$	1,667,137	$	407,106	$	13,684	$	420,790	$	—	$	2,087,927
ALL allocated by:
Individually evaluated for impairment	$	—	$	—	$	—	$	—	$	—	$	28	$	—	$	28	$	—	$	28
Collectively evaluated for impairment	12,845		3,367		4,712		25		20,949		3,287		200		3,487		245		24,681

	$	12,845	$	3,367	$	4,712	$	25	$	20,949	$	3,315	$	200	$	3,515	$	245	$	24,709
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

The following table provides activity for the accretable yield on purchased impaired loans for the three and nine months ended September 30, 2022 and 2021, respectively:


	Three Months Ended				Nine Months Ended
	September 30, 2022		September 30, 2021		September 30, 2022		September 30, 2021
Accretable yield, beginning of period	$	2,420	$	3,016	$	2,661	$	3,438

Accretion of income	( 171 )		( 203 )		( 761 )		( 878 )
Reclassifications from nonaccretable difference due to improvement in expected cash flows	23		11		368		128
Other changes, net	248		( 12 )		252		124
Accretable yield, end of period	$	2,520	$	2,812	$	2,520	$	2,812

NOTE 4. LEASES

A lease provides the lessee the right to control the use of an identified asset for a period of time in exchange for consideration. The Company has primarily entered into operating leases for branches and office space. Most of the Company's leases contain renewal options, which the Company is reasonably certain to exercise. Including renewal options, the Company's

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leases range from five to 31 years. Operating lease right-of-use assets and lease liabilities are included in other assets and accrued interest and other liabilities on the Company's unaudited condensed consolidated balance sheets.

The Company uses its incremental borrowing rate to determine the present value of the lease payments, as the rate implicit in the Company's leases is not readily determinable. Lease agreements that contain non-lease components are generally accounted for as a single lease component, while variable costs, such as common area maintenance expenses and property taxes, are expensed as incurred.

The following table summarizes the Company's operating leases at September 30, 2022 and December 31, 2021:


	September 30, 2022			December 31, 2021
Operating lease ROU assets	$	9,474		$	10,515
Operating lease ROU liabilities	10,134			11,119
Weighted-average remaining lease term (in years)	14.4			14.6
Weighted-average discount rate	4.1		%	4.1		%

The following table presents information related to the Company's operating leases for the three and nine months ended September 30, 2022 and 2021:


	Three Months Ended				Nine Months Ended
	September 30, 2022		September 30, 2021		September 30, 2022		September 30, 2021
Cash paid for operating lease liabilities	$	300	$	331	$	889	$	947
Operating lease expense	347		388		1,090		1,179

The following table presents expected future maturities of the Company's lease liabilities as of September 30, 2022:


Remainder of 2022	$	260
2023	1,153
2024	1,179
2025	1,201
2026	1,233
Thereafter	9,455
	14,481
Less: imputed interest	4,347
Total lease liabilities	$	10,134

NOTE 5. GOODWILL AND OTHER INTANGIBLE ASSETS

At September 30, 2022 and 2021, goodwill was $ 18.7 million. No impairment charges were recorded in the three and nine months ended September 30, 2022 and September 30, 2021.

Goodwill is not amortized but is reviewed for potential impairment on at least an annual basis, with testing between annual tests if an event occurs or circumstances change that could potentially reduce the fair value of a reporting unit.

The Company conducted its last annual goodwill impairment test as of November 30, 2021 using generally accepted valuation methods. As a result of that impairment test, no goodwill impairment was identified. No changes occurred that would impact the results of that analysis through September 30, 2022.

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The following table presents changes in and components of other intangible assets for the three and nine months ended September 30, 2022 and 2021:


	Three Months Ended September 30,				Nine Months Ended September 30,
	2022		2021		2022		2021
Beginning of period	$	3,610	$	4,800	$	4,183	$	5,458



Amortization expense	( 272 )		( 314 )		( 845 )		( 972 )

Balance, end of period	$	3,338	$	4,486	$	3,338	$	4,486

No impairment charges were recorded in the three and nine months ended September 30, 2022 and September 30, 2021.

The following table presents the components of other identifiable intangible assets at September 30, 2022 and December 31, 2021:


	September 30, 2022				December 31, 2021
	Gross Amount		Accumulated Amortization		Gross Amount		Accumulated Amortization
Amortized intangible assets:
Core deposit intangibles	$	8,390	$	5,052	$	8,390	$	4,208
Other customer relationship intangibles	25		25		25		24

Total	$	8,415	$	5,077	$	8,415	$	4,232

The following table presents future estimated aggregate amortization expense for intangible assets remaining at September 30, 2022:



Remainder of 2022	$	260
2023	935
2024	766
2025	596
2026	427
Thereafter	354
	$	3,338

NOTE 6. SHARE-BASED COMPENSATION PLANS

The Company maintains share-based compensation plans under the shareholder-approved 2011 Plan. The purpose of the share-based compensation plans is to provide officers, employees, and non-employee members of the Board of Directors of the Company with additional incentive to further the success of the Company. At the Company's 2022 Annual Meeting of Shareholders held on April 26, 2022, the Company's shareholders approved an amendment to the 2011 Plan increasing the number of shares available for issuance under the 2011 Plan by 400,000 . At September 30, 2022, 1,281,920 shares of the common stock of the Company were reserved, of which 530,211 shares are available to be issued.

The 2011 Plan incentive awards may consist of grants of incentive stock options, nonqualified stock options, stock appreciation rights, restricted stock, deferred stock units and performance shares. All employees and members of the Board of Directors of the Company and its subsidiaries are eligible to participate in the 2011 Plan. The 2011 Plan allows for the Compensation Committee of the Board of Directors to determine the type of incentive to be awarded, its term, manner of exercise, vesting and restrictions on shares. Generally, awards are nonqualified under the IRC, unless the awards are deemed to be incentive awards to employees at the Compensation Committee’s discretion.

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The following table presents a summary of nonvested restricted shares activity for the nine months ended September 30, 2022:


	Shares	Weighted Average Grant Date Fair Value
Nonvested shares, beginning of year	274,697	$	20.05
Granted	144,849	24.95
Forfeited	( 26,290 )	21.40
Vested	( 79,681 )	19.74
Nonvested shares, at period end	313,575	$	22.28

The following table presents restricted share compensation expense, with tax benefit information, and fair value of shares vested, for the three and nine months ended September 30, 2022 and 2021:


	Three months ended September 30,				Nine months ended September 30,
	2022		2021		2022		2021
Restricted share award expense	$	602	$	468	$	1,461	$	1,380
Restricted share award tax benefit	126		98		307		316
Fair value of shares vested	71		—		1,935		1,539

The unrecognized compensation expense related to the share awards totaled $ 3.7 million at September 30, 2022 and $ 2.3 million at December 31, 2021. The unrecognized compensation expense at September 30, 2022 is expected to be recognized over a weighted-average period of 1.9 years.

The Company maintains an employee stock purchase plan to provide its employees with an opportunity to purchase Company common stock. Eligible employees may purchase shares in an amount that does not exceed 10 % of their annual salary, at the lower of 95 % of the fair market value of the shares on the semi-annual offering date or related purchase date. The purchases occur in March and September of each year. The Company reserved 350,000 shares of its common stock to be issued under the employee stock purchase plan, of which 143,373 shares were available to be issued at September 30, 2022.

The following table presents information for the employee stock purchase plan for the three and nine months ended September 30, 2022 and 2021:


	Three months ended September 30,				Nine months ended September 30,
	2022		2021		2022		2021
Shares purchased	4,154		3,271		8,107		8,755
Weighted average price of shares purchased	$	22.60	$	19.16	$	22.53	$	15.58
Compensation expense recognized	13		15		21		48

The Company issues new shares or treasury shares, depending on market conditions, in its share-based compensation plans.

NOTE 7. DERIVATIVE FINANCIAL INSTRUMENTS

The Company is exposed to certain risks arising from both its business operations and economic conditions. The Company principally manages its exposures to a wide variety of business and operational risks through management of its core business activities. The Company manages economic risks, including interest rate, liquidity, and credit risk primarily by managing the amount, sources, and duration of its assets and liabilities and the use of derivative financial instruments. Specifically, the Company may enter into derivative financial instruments to manage exposures that arise from business activities that result in the receipt or payment of future known and uncertain cash amounts, the value of which are determined by interest rates. Derivative financial instruments may be used as risk management tools by the Company to manage differences in the amount, timing, and duration of the Company’s known or expected cash receipts and its known or expected cash payments principally related to the Company’s borrowings and are not used for trading or speculative purposes.

The Company’s objectives in using interest rate derivatives are to add stability to interest expense and to manage its exposure to interest rate movements. To accomplish this objective, the Company uses interest rate swaps as part of its interest rate risk management strategy. Interest rate swaps designated as cash flow hedges involve the receipt of fixed amounts from a counterparty in exchange for the Company making variable-rate payments over the life of the agreements without exchange of the underlying notional amount. The Company, however, discontinues cash flow hedge accounting if it is probable the forecasted hedged transactions will not occur in the initially identified time period due to circumstances, such as the impact of

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the COVID-19 pandemic. Upon discontinuance, the associated gains and losses deferred in AOCI are reclassified immediately into earnings and subsequent changes in the fair value of the cash flow hedge are recognized in earnings. During the three and nine months ended September 30, 2022, the Company entered into two interest rate swaps designated as hedging instruments with a total notional value of $ 100.0 million for the purpose of hedging the variable cash flows of selected AFS securities or loans. The Company had no interest rate swaps designated as a hedging instrument at December 31, 2021.

The Company enters into interest rate swaps agreements that allow its commercial loan customers to effectively convert a variable-rate commercial loan agreement to a fixed-rate commercial loan agreement. Under these agreements, the Company enters into a variable-rate loan agreement with a customer in addition to an interest rate swap agreement, which serves to effectively swap the customer’s variable-rate loan into a fixed-rate loan. The Company then enters into a corresponding swap agreement with a third party in order to economically hedge its exposure through the customer agreement. The interest rate swaps with both the customers and third parties are not designated as hedges and are marked through earnings. At September 30, 2022, the Company had 21 customer and 21 corresponding third-party broker interest rate derivatives not designated as a hedging instrument with an aggregate notional amount of $ 206.4 million. The Company had $ 75.8 million in notional amount of such derivative instruments at December 31, 2021. The Company entered into four new interest rate swaps with its commercial loan customers and recognized swap fee income of $ 197 thousand during the three months ended September 30, 2022 compared to one new interest rate swap that resulted in swap fee income of $ 67 thousand during the three months ended September 30, 2021. During the nine months ended September 30, 2022 and 2021, the Company recognized swap fee income of $ 1.9 million from nine new interest rate swaps and $ 135 thousand from two new interest rate swaps, respectively, which are included in noninterest income in the unaudited condensed consolidated statements of income. At September 30, 2022 and December 31, 2021, the Company had cash collateral of $ 5.8 million and $ 260 thousand with the third parties for certain of these derivatives, respectively. At September 30, 2022 and December 31, 2021, the Company was holding cash collateral of $ 9.8 million and $ 490 thousand from the third parties for certain of these derivatives, respectively.

The Company also may enter into risk participation agreements with a financial institution counterparty for an interest rate derivative contract related to a loan in which the Company may be a participant or the agent bank. The risk participation agreement provides credit protection to the agent bank should the borrower fail to perform on its interest rate derivative contracts with the agent bank. The Company manages its credit risk on the risk participation agreement by monitoring the creditworthiness of the borrower, which follows the same credit review process as the derivative instruments entered into directly with the borrower. The notional amount of such risk participation agreement reflects the Company’s pro-rata share of the derivative instrument, consistent with its share of the related participated loan. At September 30, 2022 and December 31, 2021, the Company had a risk participation with sold protection with a notional value of $ 15.9 million for both periods, and a risk participation with purchased protection with a notional value of $ 5.0 million and zero at September 30, 2022 and December 31, 2021, respectively. For the three and nine months ended September 30, 2021, the Company received an upfront fee of zero and $ 53 thousand, respectively, upon entry into the risk participation agreement with sold protection, which is included in noninterest income in the unaudited condensed consolidated statements of income. There was no upfront fee on the new risk participation during the three and nine months ended September 30, 2022.

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The following table summarizes the fair value of the Company's derivative instruments at September 30, 2022 and December 31, 2021:


	September 30, 2022					December 31, 2021
	Notional Amount		Balance Sheet Location	Fair Value		Notional Amount		Balance Sheet Location	Fair Value
Derivatives designated as hedging instruments:

Interest rate swaps - balance sheet hedge	$	100,000	Other liabilities	$	( 562 )	$	—		$	—
Total derivatives designated as hedging instruments				$	( 562 )				$	—

Derivatives not designated as hedging instruments:
Interest rate swaps	$	103,206	Other assets	$	10,987	$	37,915	Other assets	$	764
Interest rate swaps	103,206		Other liabilities	( 10,672 )		37,915		Other liabilities	( 758 )
Risk participation - sold credit protection	15,855		Other liabilities	—		15,855		Other liabilities	( 2 )
Risk participation - purchased credit protection	4,966		Other assets	17		—		Not applicable	—
Interest rate lock commitments with customers	3,516		Other assets	88		16,604		Other assets	353
Forward sale commitments	1,997		Other assets	73		8,665		Other assets	52
Total derivatives not designated as hedging instruments				$	493				$	409

The following tables summarize the effect of the Company's derivative financial instruments on OCI and net income for the three and nine months ended September 30, 2022 and 2021:


	Amount of Loss Recognized in OCI on Derivative				Amount of (Loss) Gain Recognized in OCI on Derivative
	Three Months Ended September 30,				Nine Months Ended September 30,
	2022		2021		2022		2021
Derivatives in cash flow hedging relationships:
Interest rate products	$	( 562 )	$	( 183 )	$	( 562 )	$	473
Total	$	( 562 )	$	( 183 )	$	( 562 )	$	473


	Amount of Loss Reclassified from AOCI into Income				Amount of Loss Reclassified from AOCI into Income				Location of Loss Recognized from AOCI into Income
	Three Months Ended September 30,				Nine Months Ended September 30,
	2022		2021		2022		2021
Derivatives in cash flow hedging relationships:
Interest rate products	$	—	$	( 581 )	$	—	$	( 757 )	Interest Income (1) / Interest Expense (2)
Total	$	—	$	( 581 )	$	—	$	( 757 )

(1) For interest rate swaps designated as cash flow hedges entered into during the three and nine months ended September 30, 2022, the a mount of loss reclassified from AOCI will be recorded to other income in the unaudited condensed consolidated statements of income .

(2) During the three and nine months ended September 30, 2021, the Company terminated its interest rate swap designated as a hedging instrument with a notional value of $ 50.0 million. The Company recorded a $ 514 thousand loss in other operating expenses in the unaudited condensed consolidated statements of income.

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	Amount of (Loss) Gain Recognized in Income				Amount of Gain (Loss) Recognized in Income				Location of Gain (Loss) Recognized in Income
	Three Months Ended September 30,				Nine Months Ended September 30,
	2022		2021		2022		2021
Derivatives not designated as hedging instruments:
Interest rate products	$	179	$	8	$	309	$	44	Other operating expenses
Risk participation agreements	( 11 )		1		19		( 3 )		Other operating expenses
Interest rate lock commitments with customers	( 99 )		89		( 265 )		( 128 )		Mortgage banking activities
Forward sale commitments	( 610 )		1		21		84		Mortgage banking activities
Total	$	( 540 )	$	99	$	84	$	( 3 )

The following table is a summary of components for interest rate swaps designated as cash flow hedges at September 30, 2022. At September 30, 2022, the Company had two interest rate derivatives designated as cash flow hedges with a total notional value of $ 100.0 million.


	September 30, 2022
Weighted average pay rate	2.86	%
Weighted average receive rate	3.81	%
Weighted average maturity in years	1.5

NOTE 8. SHAREHOLDERS’ EQUITY AND REGULATORY CAPITAL

Banks and bank holding companies are subject to regulatory capital requirements administered by federal banking agencies. Capital adequacy guidelines and, additionally for banks, prompt corrective action regulations, involve quantitative measures of assets, liabilities and certain off-balance sheet items calculated under regulatory accounting practices. Capital amounts and classifications are also subject to qualitative judgments by regulators. Failure to meet capital requirements can initiate regulatory action. Under the Basel Committee on Banking Supervision's capital guidelines for U.S. Banks ("Basel III rules"), an entity must hold a capital conservation buffer above the adequately capitalized risk-based capital ratios. The Company and the Bank have elected not to include net unrealized gains or losses included in AOCI in computing regulatory capital.

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.

Management believes that the Company and the Bank met all capital adequacy requirements to which they are subject at September 30, 2022 and December 31, 2021.

Prompt corrective action regulations provide five classifications: well capitalized, adequately capitalized, undercapitalized, significantly undercapitalized and critically undercapitalized, although these terms are not used to represent overall financial condition. If adequately capitalized, regulatory approval is required to accept brokered deposits. If undercapitalized, capital distributions are limited, as is asset growth and expansion, and capital restoration plans are required. At September 30, 2022, the most recent regulatory notifications categorized the Bank as well capitalized under the regulatory framework for prompt corrective action. There are no conditions or events since that notification that management believes have changed the Bank's classification.

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The following table presents capital amounts and ratios at September 30, 2022 and December 31, 2021:


	Actual				For Capital Adequacy Purposes (includes applicable capital conservation buffer)				To Be Well Capitalized Under Prompt Corrective Action Provisions
	Amount		Ratio		Amount		Ratio		Amount		Ratio
September 30, 2022
Total risk-based capital:
Orrstown Financial Services, Inc.	$	295,961	12.7	%	$	243,886	10.5	%	n/a		n/a
Orrstown Bank	298,755		12.9	%	243,078		10.5	%	$	231,503	10.0	%
Tier 1 risk-based capital:
Orrstown Financial Services, Inc.	237,609		10.2	%	197,431		8.5	%	n/a		n/a
Orrstown Bank	272,413		11.8	%	196,777		8.5	%	185,202		8.0	%
Tier 1 common equity risk-based capital:
Orrstown Financial Services, Inc.	237,609		10.2	%	162,591		7.0	%	n/a		n/a
Orrstown Bank	272,413		11.8	%	162,052		7.0	%	150,477		6.5	%
Tier 1 leverage capital:
Orrstown Financial Services, Inc.	237,609		8.4	%	113,077		4.0	%	n/a		n/a
Orrstown Bank	272,413		9.6	%	113,105		4.0	%	141,381		5.0	%
December 31, 2021
Total risk-based capital:
Orrstown Financial Services, Inc.	$	297,823	15.0	%	$	208,617	10.5	%	n/a		n/a
Orrstown Bank	278,780		14.0	%	208,550		10.5	%	$	198,619	10.0	%
Tier 1 risk-based capital:
Orrstown Financial Services, Inc.	243,075		12.2	%	168,880		8.5	%	n/a		n/a
Orrstown Bank	255,995		12.9	%	168,826		8.5	%	158,895		8.0	%
Tier 1 common equity risk-based capital:
Orrstown Financial Services, Inc.	243,075		12.2	%	139,078		7.0	%	n/a		n/a
Orrstown Bank	255,995		12.9	%	139,033		7.0	%	129,102		6.5	%
Tier 1 leverage capital:
Orrstown Financial Services, Inc.	243,075		8.5	%	114,384		4.0	%	n/a		n/a
Orrstown Bank	255,995		8.9	%	114,470		4.0	%	143,087		5.0	%

In September 2015, the Board of Directors of the Company authorized a share repurchase program under which the Company may repurchase up to 5 % of the Company's outstanding shares of common stock, or approximately 416,000 shares, in accordance with all applicable securities laws and regulations, including Rule 10b-18 of the Exchange Act. On April 19, 2021, the Board of Directors authorized the additional future repurchase of up to 562,000 shares of its outstanding common stock. When and if appropriate, repurchases may be made in the open market or privately negotiated transactions, depending on market conditions, regulatory requirements and other corporate considerations, as determined by management. Share repurchases may not occur and may be discontinued at any time. At September 30, 2022, 824,798 shares had been repurchased at a total cost of $ 18.8 million, or $ 22.79 per share. Common stock available for future repurchase totals 153,202 shares, or 1 %, of the Company's outstanding common stock at September 30, 2022.

On October 17, 2022, the Board of Directors declared a cash dividend of $ 0.19 per common share, which will be paid on November 7, 2022 to shareholders of record at October 31, 2022.

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NOTE 9. (LOSS) EARNINGS PER SHARE

The following table presents (loss) earnings per share for the three and nine months ended September 30, 2022 and 2021:


	Three Months Ended September 30,				Nine Months Ended September 30,
(shares presented in the table are in thousands)	2022		2021		2022		2021
Net (loss) income	$	( 4,828 )	$	7,192	$	12,411	$	26,175
Weighted average shares outstanding - basic	10,369		10,979		10,611		10,976
Dilutive effect of share-based compensation	—		143		147		127
Weighted average shares outstanding - diluted	10,369		11,122		10,758		11,103
Per share information:
Basic (loss) earnings per share	$	( 0.47 )	$	0.66	$	1.17	$	2.38
Diluted (loss) earnings per share	( 0.47 )		0.65		1.16		2.36

Average outstanding restricted award shares totaling 1,000 and zero for the three months ended September 30, 2022 and 2021, respectively, and 39,219 and zero for the nine months ended September 30, 2022 and 2021, respectively, were excluded from the computation of earnings per share because the effect was antidilutive. The dilutive effect of share-based compensation in each period above relates principally to restricted stock awards.

NOTE 10. FINANCIAL INSTRUMENTS WITH OFF-BALANCE SHEET RISK

The Company is a party to financial instruments with off-balance sheet risk in the normal course of business to meet the financing needs of its clients. These financial instruments include commitments to extend credit and standby letters of credit. Those instruments involve, to varying degrees, elements of credit and interest rate risk in excess of the amount recognized in the unaudited condensed consolidated balance sheets. The contract amounts of those instruments reflect the extent of involvement the Company has in particular classes of financial instruments.

The Company’s exposure to credit loss in the event of nonperformance by the other party to the financial instrument for commitments to extend credit and standby letters of credit and financial guarantees written is represented by the contractual amount of those instruments. The Company uses the same credit policies in making commitments and conditional obligations as it does for on-balance sheet instruments. The following table presents these contractual, or notional, amounts:


	Contractual or Notional Amount
	September 30, 2022		December 31, 2021
Commitments to fund:
Home equity lines of credit	$	292,369	$	261,580
1-4 family residential construction loans	66,101		40,348
Commercial real estate, construction and land development loans	162,947		124,488
Commercial, industrial and other loans	301,154		378,996
Standby letters of credit	24,407		19,724

Commitments to extend credit are agreements to lend to a client as long as there is no violation of any condition established in the contract. Commitments generally have fixed expiration dates or other termination clauses and may require the payment of a fee. Since many of the commitments are expected to expire without being drawn upon, the total commitment amounts do not necessarily represent future cash requirements. The Company evaluates each client’s credit-worthiness on a case-by-case basis. The amount of collateral obtained, if deemed necessary by the Company upon extension of credit, is based on management’s credit evaluation of the client. Collateral varies but may include accounts receivable, inventory, equipment, residential real estate, and income-producing commercial properties.

Standby letters of credit and financial guarantees written are conditional commitments issued by the Company to guarantee the performance of a client to a third party. Those guarantees are primarily issued to support public and private borrowing arrangements. The credit risk involved in issuing letters of credit is essentially the same as that involved in extending loans to clients. The Company holds collateral supporting those commitments when deemed necessary by management. The liability at September 30, 2022 and December 31, 2021 for guarantees under standby letters of credit issued was not considered to be material.

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The Company maintains a reserve, based on historical loss experience of the related loan class and utilization assumptions, for off-balance sheet credit exposures that currently are not funded, in other liabilities on the unaudited condensed consolidated balance sheets. This reserve totaled approximately $ 1.6 million at both September 30, 2022 and December 31, 2021.

NOTE 11. FAIR VALUE

Fair value is 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. Certain financial instruments and all non-financial instruments are excluded from disclosure requirements. Accordingly, the aggregate fair value amounts presented do not represent the underlying value of the Company.

The fair value hierarchy distinguishes between (1) market participant assumptions developed based on market data obtained from independent sources (observable inputs) and (2) an entity's own assumptions about market participant assumptions based on the best information available in the circumstances (unobservable inputs). The fair value hierarchy consists of three broad levels, which gives the highest priority to unadjusted quoted prices in active markets for identical assets or liabilities (Level 1) and the lowest priority to unobservable inputs (Level 3). The three levels of the fair value hierarchy are:

Level 1 – quoted prices (unadjusted) for identical assets or liabilities in active markets that the entity has the ability to access at the measurement date.

Level 2 – significant other observable inputs other than Level 1 prices such as prices for similar assets and liabilities in active markets; quoted prices for identical or similar instruments in markets that are not active; or other inputs that are observable or can be corroborated by observable market data.

Level 3 – at least one significant unobservable input that reflects a company's own assumptions about the assumptions that market participants would use in pricing an asset or liability.

In instances in which multiple levels of inputs are used to measure fair value, hierarchy classification is based on the lowest level input that is significant to the fair value measurement in its entirety. The Company's assessment of the significance of a particular input to the fair value measurement in its entirety requires judgment, and considers factors specific to the asset or liability.

The Company used the following methods and significant assumptions to estimate fair value for instruments measured on a recurring basis:

Where quoted prices are available in an active market, investment securities are classified within Level 1 of the valuation hierarchy. Level 1 investment securities include highly liquid government bonds, mortgage products and exchange traded equities. If quoted market prices are not available, investment securities are classified within Level 2 and fair values are estimated by using pricing models, quoted prices of securities with similar characteristics or discounted cash flow. Level 2 investment securities include U.S. agency securities, MBS, obligations of states and political subdivisions and certain corporate, asset backed and other securities. In certain cases where there is limited activity or less transparency around inputs to the valuation, investment securities are classified within Level 3 of the valuation hierarchy. The Company’s investment securities are classified as available for sale.

The fair values of interest rate swaps and risk participation derivatives are determined using models that incorporate readily observable market data into a market standard methodology. This methodology nets the discounted future cash receipts and the discounted expected cash payments. The discounted variable cash receipts and payments are based on expectations of future interest rates derived from observable market interest rate curves. In addition, fair value is adjusted for the effect of nonperformance risk by incorporating credit valuation adjustments for the Company and its counterparties. These assets and liabilities are classified as Level 2 fair values, based upon the lowest level of input that is significant to the fair value measurements.

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The following table summarizes assets and liabilities measured at fair value on a recurring basis at September 30, 2022 and December 31, 2021:


	Level 1		Level 2		Level 3		Total Fair Value Measurements
September 30, 2022
Financial Assets
Investment securities:
U.S. Treasury securities	$	17,115	$	—	$	—	$	17,115


States and political subdivisions	—		214,207		5,829		220,036
GSE residential MBSs	—		59,203		—		59,203
GSE residential CMOs	—		64,150		—		64,150
Non-agency CMOs	—		28,972		—		28,972



Asset-backed	—		113,735		—		113,735
Other	385		—		—		385
Loans held for sale	—		10,175		—		10,175
Derivatives	—		11,004		88		11,092


Totals	$	17,500	$	501,446	$	5,917	$	524,863
Financial Liabilities
Derivatives	$	—	$	11,234	$	—	$	11,234


December 31, 2021
Financial Assets
Investment securities:
U.S. Treasury securities	$	19,702	$	—	$	—	$	19,702


States and political subdivisions	—		183,171		10,199		193,370
GSE residential MBSs	—		40,726		—		40,726
GSE residential CMOs	—		65,922		—		65,922
Non-agency CMOs	—		16,750		12,948		29,698



Asset-backed	—		122,621		—		122,621
Other	399		—		—		399
Loans held for sale	—		8,868		—		8,868
Derivatives	—		764		353		1,117


Totals	$	20,101	$	438,822	$	23,500	$	482,423
Financial Liabilities
Derivatives	$	—	$	760	$	—	$	760

The Company had one municipal bond measured at fair value on a recurring basis using significant unobservable inputs (Level 3) at September 30, 2022 and one municipal bond and one non-agency CMO measured at fair value on a recurring basis using significant unobservable inputs (Level 3) at December 31, 2021. During the nine months ended September 30, 2022, the non-agency CMO security was called by the issuer. The Level 3 valuation is based on a non-executable broker quote, which is considered a significant unobservable input. Such quotes are updated as available and may remain constant for a period of time for certain broker-quoted securities that do not move with the market or that are not interest rate sensitive as a result of their structure or overall attributes.

The Company’s residential mortgage LHFS are recorded at fair value utilizing Level 2 measurements. This fair value measurement is determined based upon third party quotes obtained on similar loans. For LHFS, for which the fair value option has been elected, the aggregate fair value declined below the aggregate principal balance by $ 1.2 million as of September 30, 2022, and exceeded the aggregate principal balance by $ 150 thousand as of December 31, 2021.

The determination of the fair value of interest rate lock commitments on residential mortgages is based on agreed upon pricing with the respective investor on each loan and includes a pull through percentage. The pull through percentage represents an estimate of loans in the pipeline to be delivered to an investor versus the total loans committed for delivery. Significant

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changes in this input could result in a significantly higher or lower fair value measurement. As the pull through percentage is a significant unobservable input, this is deemed a Level 3 valuation input. The average pull through percentage, which is based upon historical experience, was 91 % as of September 30, 2022. An increase or decrease of 5 % in the pull through assumption would result in a positive or negative change of $ 1 thousand in the fair value of interest rate lock commitments at September 30, 2022.

The following provides details of the Level 3 fair value measurement activity for the periods ended September 30, 2022 and 2021:

Investment securities:


	Three Months Ended September 30,				Nine Months Ended September 30,
	2022		2021		2022		2021
Balance, beginning of period	$	6,255	$	24,925	$	23,147	$	31,503


Unrealized (losses) gains included in OCI	( 422 )		( 964 )		( 2,002 )		467

Net (premium amortization) discount accretion	( 4 )		—		62		—
Principal payments and other	—		( 487 )		—		( 4,951 )
Sales	—		—		( 3,053 )		( 3,545 )
Calls	—		—		( 12,154 )		—

OTTI	—		—		( 171 )		—
Balance, end of period	$	5,829	$	23,474	$	5,829	$	23,474

Interest rate lock commitments on residential mortgages:


	Three Months Ended September 30,				Nine Months Ended September 30,
	2022		2021		2022		2021
Balance, beginning of period	$	186	$	456	$	353	$	673

Total (losses) gains included in earnings	( 98 )		90		( 265 )		( 127 )


Balance, end of period	$	88	$	546	$	88	$	546

Certain financial assets are measured at fair value on a nonrecurring basis. Adjustments to the fair value of these assets usually results from the application of lower of cost or market accounting or write-downs of individual assets. The Company used the following methods and significant assumptions to estimate fair value for these financial assets.

Impaired Loans

Loans are designated as impaired when, in the judgment of management and based on current information and events, it is probable that all amounts due, according to the contractual terms of the loan agreement, will not be collected. The measurement of loss associated with impaired loans for all loan classes can be based on either the observable market price of the loan, the fair value of the collateral, or discounted cash flows using the rate of return implicit in the original loan for TDRs. For collateral-dependent loans, fair value is measured based on the value of the collateral securing the loan, less estimated costs to sell. Collateral may be in the form of real estate or business assets including equipment, inventory, and accounts receivable. The value of the real estate collateral is determined utilizing an income or market valuation approach based on an appraisal conducted by an independent, licensed appraiser outside of the Company using observable market data (Level 2). However, if the collateral is a house or building in the process of construction, or if management adjusts the appraisal value, then the fair value is considered Level 3. The value of business equipment is based upon an outside appraisal, if deemed significant, or the net book value on the applicable business’ financial statements if not considered significant using observable market data. Likewise, values for inventory and accounts receivable collateral are based on financial statement balances or aging reports (Level 3). Impaired loans with an allocation to the ALL are measured at fair value on a nonrecurring basis. Any fair value adjustments are recorded in the period incurred as provision for loan losses on the unaudited condensed consolidated statements of income.

Any changes in the fair value of impaired loans still held were not material for the three and nine months ended September 30, 2022 and 2021.

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Foreclosed Real Estate

OREO property acquired through foreclosure is initially recorded at the fair value of the property at the transfer date less estimated selling cost. Subsequently, OREO is carried at the lower of its carrying value or the fair value less estimated selling cost. Fair value is usually determined based upon an independent third-party appraisal of the property or occasionally upon a recent sales offer. The Company had no OREO balances at both September 30, 2022 and December 31, 2021.

Mortgage Servicing Rights

The MSR fair value is estimated to be equal to its carrying value, unless the quarterly valuation model calculates the present value of the estimated net servicing income is less than its carrying value, in which case an impairment charge is taken. Fair value adjustments on the MSR only occur if there is impairment. At September 30, 2022 and December 31, 2021, an impairment reserve of zero and $ 79 thousand, respectively, existed on the MSR portfolio. For the three months ended September 30, 2022 and 2021, impairment valuation allowance reversals of zero and $ 43 thousand were included, respectively, in mortgage banking activities on the unaudited condensed consolidated statements of income. For the nine months ended September 30, 2022 and 2021, impairment valuation allowance reversals of $ 79 thousand and $ 695 thousand, respectively, were included in mortgage banking activities on the unaudited condensed consolidated statements of income. The reversals in the three and nine months ended September 30, 2022 and 2021 were due to increases in market rates, which increased the MSR fair value.

The following table summarizes assets measured at fair value on a nonrecurring basis at September 30, 2022 and December 31, 2021:


	Level 1		Level 2		Level 3		Total Fair Value Measurements
September 30, 2022
Impaired Loans
Commercial real estate:
Owner occupied	$	—	$	—	$	126	$	126


Non-owner occupied residential	—		—		15		15




Residential mortgage:
First lien	—		—		372		372

Home equity - lines of credit	—		—		59		59

Total impaired loans	$	—	$	—	$	572	$	572






Mortgage servicing rights	$	—	$	—	$	—	$	—

December 31, 2021
Impaired Loans
Commercial real estate:
Owner occupied	$	—	$	—	$	751	$	751


Non-owner occupied residential	—		—		24		24




Residential mortgage:
First lien	—		—		545		545

Home equity - lines of credit	—		—		72		72

Total impaired loans	$	—	$	—	$	1,392	$	1,392






Mortgage servicing rights	$	—	$	—	$	322	$	322

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The following table presents additional qualitative information about assets measured on a nonrecurring basis and for which the Company has utilized Level 3 inputs to determine fair value:

Fair Value
Estimate

Valuation
Techniques

Unobservable Input

Range

September 30, 2022

Impaired loans

572

Appraisal of collateral

Management adjustments on appraisals for property type and recent activity

10 % - 25 % discount

- Management adjustments for liquidation expenses

6.08 % - 17.93 % discount

December 31, 2021

Impaired loans

1,392

Appraisal of collateral

Management adjustments on appraisals for property type and recent activity

10 % - 25 % discount

- Management adjustments for liquidation expenses

6.08 % - 17.93 % discount

Mortgage servicing rights

322

Discounted cash flows

Weighted average CPR

12.60 %

- Weighted average discount rate

9.03 %

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Fair values of financial instruments

GAAP requires disclosure of the fair value of financial assets and liabilities, including those that are not measured and reported at fair value on a recurring or nonrecurring basis. The following table presents carrying amounts and estimated fair values of the financial assets and liabilities at September 30, 2022 and December 31, 2021:


	Carrying Amount		Fair Value		Level 1		Level 2		Level 3
September 30, 2022
Financial Assets
Cash and due from banks	$	34,481	$	34,481	$	34,481	$	—	$	—
Interest-bearing deposits with banks	32,446		32,446		32,446		—		—

Restricted investments in bank stock	6,469		n/a		n/a		n/a		n/a
Investment securities	503,596		503,596		17,500		480,267		5,829
Loans held for sale	10,175		10,175		—		10,175		—
Loans, net of allowance for loan losses	2,063,218		1,912,225		—		—		1,912,225

Derivatives	11,092		11,092		—		11,004		88
Accrued interest receivable	9,212		9,212		—		3,781		5,431

Financial Liabilities
Deposits	2,505,853		2,502,308		—		2,502,308		—
Securities sold under agreements to repurchase	21,065		21,065		—		21,065		—
FHLB advances and other borrowings	1,567		1,576		—		1,576		—
Subordinated notes	32,010		31,969		—		31,969		—
Derivatives	11,234		11,234		—		11,234		—
Accrued interest payable	650		650		—		650		—
Off-balance sheet instruments	—		—		—		—		—

December 31, 2021
Financial Assets
Cash and due from banks	$	21,217	$	21,217	$	21,217	$	—	$	—
Interest-bearing deposits with banks	187,493		187,493		187,493		—		—

Restricted investments in bank stock	7,252		n/a		n/a		n/a		n/a
Investment securities	472,438		472,438		20,101		429,190		23,147
Loans held for sale	8,868		8,868		—		8,868		—
Loans, net of allowance for loan losses	1,958,806		1,946,365		—		—		1,946,365

Derivatives	1,117		1,117		—		764		353
Accrued interest receivable	8,234		8,235		—		2,203		6,032

Financial Liabilities
Deposits	2,464,929		2,466,191		—		2,466,191		—
Securities sold under agreements to repurchase	23,301		23,301		—		23,301		—
FHLB advances and other borrowings	1,896		2,035		—		2,035		—
Subordinated notes	31,963		31,815		—		31,815		—
Derivatives	760		760		—		760		—
Accrued interest payable	154		154		—		154		—
Off-balance sheet instruments	—		—		—		—		—

In accordance with the Company's adoption of ASU 2016-01, Financial Instruments – Overall (Subtopic 825-10): Recognition and Measurement of Financial Assets and Financial Liabilities, the methods utilized to measure the fair value of financial instruments at September 30, 2022 and December 31, 2021 represent an approximation of exit price; however, an actual exit price may differ.

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NOTE 12. CONTINGENCIES

The nature of the Company’s business generates a certain amount of litigation involving matters arising out of the ordinary course of business. Except as described below, in the opinion of management, there are no legal proceedings that might have a material effect on the results of operations, liquidity, or the financial position of the Company at this time.

On May 25, 2012, SEPTA filed a putative class action complaint in the U.S. District Court for the Middle District of Pennsylvania against the Company, the Bank and nine independent current and former directors and three current and former officers (collectively, the “Orrstown Defendants”). The complaint alleged, among other things, that (i) in connection with the Company’s Registration Statement on Form S-3 dated February 23, 2010 and its Prospectus Supplement dated March 23, 2010, and (ii) during the purported class period of March 24, 2010 through October 27, 2011, the Company issued materially false and misleading statements regarding the Company’s lending practices and financial results, including misleading statements concerning the stringent nature of the Bank’s credit practices and underwriting standards, the quality of its loan portfolio, and the intended use of the proceeds from the Company’s March 2010 public offering of common stock. The complaint asserted claims under Sections 11, 12(a) and 15 of the Securities Act, Sections 10(b) and 20(a) of the Exchange Act and Rule 10b-5 promulgated thereunder, and sought class certification, unspecified money damages, interest, costs, fees and equitable or injunctive relief. Under the Private Securities Litigation Reform Act of 1995, the Court appointed SEPTA Lead Plaintiff on August 20, 2012.

On March 4, 2013, SEPTA filed an amended complaint. The amended complaint expanded the list of defendants in the action to include the Company’s former independent registered public accounting firm, Smith Elliott Kearns & Company, LLC (“SEK”), and the underwriters of the Company’s March 2010 public offering of common stock. In addition, among other things, the amended complaint extended the purported Exchange Act class period from March 15, 2010 through April 5, 2012.

On June 22, 2015, the Court dismissed without prejudice SEPTA’s amended complaint against all defendants, finding that SEPTA failed to state a claim under either the Securities Act, or the Exchange Act. On February 8, 2016, the Court granted SEPTA’s motion for leave to amend again and SEPTA filed its second amended complaint that same day.

On December 7, 2016, the Court issued an Order and Memorandum granting in part and denying in part defendants’ motions to dismiss SEPTA’s second amended complaint. The Court granted the motions to dismiss the Securities Act claims against all defendants, and granted the motions to dismiss the Exchange Act Section 10(b) and Rule 10b-5 claims against all defendants except Orrstown Financial Services, Inc., Orrstown Bank, Thomas R. Quinn, Jr., Bradley S. Everly, and Jeffrey W. Embly. The Court also denied the motions to dismiss the Exchange Act Section 20(a) claims against Quinn, Everly, and Embly.

On August 9, 2018, SEPTA filed a motion to compel the production of Confidential Supervisory Information ("CSI") of non-parties the FRB and the Pennsylvania Department of Banking and Securities, in the possession of Orrstown Bank and third parties. On August 30, 2018, the FRB filed an unopposed motion to intervene in the Action for the purpose of opposing SEPTA’s motion to compel. On February 12, 2019, the Court denied SEPTA’s motion to compel the production of CSI on the ground that SEPTA had failed to exhaust its administrative remedies.

On April 11, 2019, SEPTA filed a motion for leave to file a third amended complaint. The third amended complaint sought to reassert the Securities Act claims that the Court dismissed as to all defendants on December 7, 2016, when the Court granted in part and denied in part defendants’ motions to dismiss SEPTA’s second amended complaint. The third amended complaint also sought to reassert the Exchange Act claims against those defendants that the Court dismissed from the case on December 7, 2016.

On June 13, 2019, the Orrstown Defendants filed a motion for protective order to stay discovery pending resolution of SEPTA’s motion for leave to file a third amended complaint. On July 17, 2019, the Court entered an Order partially granting the Orrstown Defendants' motion for protective order, ruling that all deposition discovery in the case was stayed pending a decision on SEPTA’s motion for leave to file a third amended complaint. Party and non-party document discovery in the case has largely been completed.

On February 14, 2020, the Court issued an Order and Memorandum granting SEPTA’s motion for leave to file a third amended complaint. The third amended complaint is now the operative complaint. It reinstates the Orrstown Defendants, as well as SEK and the underwriter defendants, previously dismissed from the case on December 7, 2016. The third amended complaint also revives the previously dismissed Securities Act claim against the Orrstown Defendants, SEK, and the underwriter defendants. Defendants filed their motions to dismiss the third amended complaint on April 24, 2020. SEPTA’s opposition was filed on July 8, 2020, and Orrstown’s reply brief was filed on August 12, 2020.

On August 18, 2022, the Court issued an Order and Memorandum granting in part and denying in part the defendants’ motions to dismiss SEPTA’s third amended complaint. The Court granted in part and denied in part the motion to dismiss the

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Securities Act claims against the Orrstown Defendants; granted in part and denied in part the motion to dismiss the Securities Act claims against the underwriter defendants; granted the motion to dismiss the Exchange Act Section 10(b) and Rule 10b-5 claims against defendants Zullinger, Shoemaker, Snoke and Coy; granted in part and denied in part the motion to dismiss the Exchange Act Section 10(b) and Rule 10b-5 claims against Orrstown Financial Services, Inc., Orrstown Bank, Quinn, Everly and Embly; and denied the motion to dismiss the Securities Act and Exchange Act Section 10(b) and Rule 10b-5 claims against SEK. Also on August 18, 2022, the Court issued an Order and Memorandum granting SEPTA’s renewed motion to compel the production of CSI. The CSI was produced by the Orrstown Defendants on September 8, 2022.

On November 7, 2022, the Company entered into a Memorandum of Understanding (the “MOU”) to settle and resolve the lawsuit. The MOU memorializes the parties’ agreement to execute and submit a formal, binding settlement agreement for the Court’s approval, setting forth all of the material terms of the settlement reached by the plaintiffs and defendants. The settlement provides for a payment to the plaintiffs of $ 15.0 million, to which the Company has agreed to contribute $ 13.0 million. The settlement agreement will include a mutual release of all claims against all parties, and the lawsuit will be dismissed with prejudice. The MOU does not include any admission of wrongdoing by any party.

On March 25, 2022, a customer of the Bank filed a putative class action complaint against the Bank in the Court of Common Pleas of Cumberland County, Pennsylvania, in a case captioned Alleman, on behalf of himself and all others similarly situated, v. Orrstown Bank . The complaint alleges, among other things, that the Bank breached its account agreements by charging certain overdraft fees. The complaint seeks a refund of all allegedly improper fees, damages in an amount to be proven at trial, attorneys’ fees and costs, and an injunction against the Bank’s allegedly improper overdraft practices. This lawsuit is similar to lawsuits recently filed against other financial institutions pertaining to overdraft fee disclosures. The Company filed a preliminary objection to the complaint on May 16, 2022. The plaintiff filed a brief in opposition to the Company's preliminary objection on June 16, 2022, and the Company filed its reply brief on June 30, 2022. The Bank believes that the allegations and claims against the Bank are without merit.

NOTE 13. SUBSEQUENT EVENTS

The Company evaluated subsequent events in accordance with ASC Topic 855 and determined that the following qualifies as a recognized Type 1 subsequent event.

On November 7, 2022, the Company entered into the MOU to settle and resolve the previously disclosed shareholder class action lawsuit. The MOU memorializes the parties’ agreement to execute and submit a formal, binding settlement agreement for the Court’s approval, setting forth all of the material terms of the settlement reached by the plaintiffs and defendants. The settlement provides for a payment to the plaintiffs of $ 15.0 million, to which the Company has agreed to contribute $ 13.0 million. The settlement agreement will include a mutual release of all claims against all parties, and the lawsuit will be dismissed with prejudice. The MOU does not include any admission of wrongdoing by any party. As a result of the agreed upon settlement, the Company recorded a $ 13.0 million provision for legal settlement, a corresponding liability, and related tax effects in its unaudited condensed consolidated financial statements as of September 30, 2022. See Note 12, Contingencies, for additional information.

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Item 2. Management’s Discussion and Analysis of Financial Condition and Results of Operations

The following discussion and analysis is intended to assist readers in understanding the consolidated financial condition and results of operations of Orrstown 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 ended December 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.

Overview

The Company, headquartered in Shippensburg, 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. At September 30, 2022, the Company had total assets of $2.9 billion, total liabilities of $2.6 billion and total shareholders’ equity of $217.4 million.

For the three and nine months ended September 30, 2022, the Company had a net loss of $4.8 million and net income of $12.4 million, respectively. As discussed in the notes to the unaudited condensed consolidated financial statements above, during the fourth quarter of 2022, the Company agreed to settle a litigation matter, which resulted in a provision for legal settlement ("legal settlement") of $13.0 million, before the tax effect, recorded in the third quarter of 2022. In addition, during the third quarter of 2022, the Company announced strategic initiatives designed to drive long-term growth and improve operating efficiencies through planned branch closures and staffing model adjustments, which resulted in pre-tax non-interest expenses ("restructuring charge") of $3.2 million. Excluding the legal settlement and the restructuring charge, net income for the three and nine months ended September 30, 2022 totaled $7.9 million and $25.2 million, respectively. For the three months ended September 30, 2022, diluted loss per share totaled $0.47. For the nine months ended September 30, 2022, diluted earnings per share totaled $1.16. Excluding the legal settlement and restructuring charge, diluted earnings per share totaled $0.75 and $2.34 for the three and nine months ended September 30, 2022, respectively.

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, cost savings initiatives, 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 and cost savings initiatives, 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: the failure to reach an agreement acceptable to all parties to settle and resolve the shareholder class action; the failure to obtain court approval of the proposed settlement; the number of plaintiffs who opt-out of the proposed settlement; whether the proposed settlement is appealed; 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

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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 ended December 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 the SEC. 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 third quarter of 2022 reflected an annualized increase of 2.6%, which is an improvement from the declines of 1.6% and 0.6% during the first and second quarters of 2022, respectively. The annualized growth for the third quarter of 2021 was 2.3%. The increase in the third quarter of 2022 was the result of increases in exports, due primarily to petroleum, nondurable goods, and travel, government spending, due to defense spending, and consumer spending; however, real GDP continues to be hampered by decreases in residential fixed investments and private inventory caused by lower new single-family construction and retail trade. The personal consumption expenditures ("PCE") price index increased to 4.2% in the third quarter of 2022, compared to an increase of 7.3% for the final estimate in the second quarter of 2022. Excluding food and energy prices, the PCE price index increased 4.5% in the third quarter of 2022 compared to 4.7% in the second quarter of 2022. The national unemployment rate slightly decreased by 0.1% to 3.5% in September 2022 compared to 3.6% in June 2022, down from 4.8% in September 2021. Within the Company's geographic footprint, the unemployment rate has decreased in Pennsylvania by 1.9% from 6.7% at August 2021 to 4.8% at August 2022, and decreased in Maryland by 1.4% from 5.8% at August 2021 to 4.4% in August 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 during the third quarter of 2022. Although there was a strong economic recovery in 2021 from the pandemic, the fluctuations in real GDP during 2022 are indicative of inflation, supply chain challenges, geopolitical tensions and labor shortages.

At September 30, 2022, the 10-year Treasury bond reached 3.83%, an increase of 0.85% from 2.98% at June 30, 2022, as it continued to rise due to inflationary pressures. In an attempt to combat the impact of inflation, the rising consumer price index, supply chain disruptions, the state of the labor market and geopolitical tensions, the Federal Reserve Open Markets Committee ("FOMC") approved increases to the Fed Funds rate of:

• 25 basis points on March 17, 2022;

• 50 basis points on May 5, 2022;

• 75 basis points on June 16, 2022;

• 75 basis points on July 27, 2022;

• 75 basis points on September 21, 2022; and

• 75 basis points on November 2, 2022.

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 the SEC. 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.

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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 ended December 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 ended December 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."

RESULTS OF OPERATIONS

Three months ended September 30, 2022 compared with three months ended September 30, 2021

Summary

Net loss totaled $4.8 million for the three months ended September 30, 2022 compared with net income of $7.2 million for the same period in 2021. Diluted loss per share for the three months ended September 30, 2022 totaled $0.47 compared to diluted earnings per share of $0.65 for the three months ended September 30, 2021. Net interest income positively influenced results of operations, and totaled $25.5 million for the three months ended September 30, 2022 compared to $20.6 million for the three months ended September 30, 2021. Noninterest income totaled approximately $6.1 million and $7.7 million for the three months ended September 30, 2022 and 2021, respectively. Noninterest expenses totaled $36.4 million for the three months ended September 30, 2022 compared to $19.0 million for the three months ended September 30, 2021. Excluding the legal settlement and the restructuring charge, for the three months ended September 30, 2022, net income totaled $7.9 million and diluted earnings per share totaled $0.75. See “Supplemental Reporting of Non-GAAP Measures.”

The comparison of operating results for 2022 with 2021 reflects the impact of the legal settlement and restructuring charge, increases in the provision for loan losses, salaries and employee benefits expense and costs of funds and a decrease in mortgage banking income, partially offset by the net interest income benefit from the deployment of cash into higher yielding commercial loans and investment securities, as well as rising interest rates.

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Net Interest Income

Net interest income increased by $4.9 million from $20.6 million to $25.5 million from the three months ended September 30, 2021 to the three months ended September 30, 2022. Interest income on loans increased by $3.3 million, from $19.9 million to $23.2 million, and interest income on investment securities increased by $1.9 million, from $2.2 million to $4.1 million, for the three months ended September 30, 2022 compared to the same period in the prior year. Total interest expense increased from $1.6 million for the three months ended September 30, 2021 to $2.0 million for the three months ended September 30, 2022.

The following table presents net interest income, net interest spread and net interest margin for the three months ended September 30, 2022 and 2021 on a taxable-equivalent basis:


	Three Months Ended September 30, 2022						Three Months Ended September 30, 2021
	Average Balance		Taxable- Equivalent Interest		Taxable- Equivalent Rate		Average Balance		Taxable- Equivalent Interest		Taxable- Equivalent Rate
Assets
Federal funds sold & interest-bearing bank balances	$	38,068	$	200	2.08	%	$	347,242	$	135	0.15	%


Investment securities (1)	528,988		4,377		3.31		464,417		2,339		2.00


Loans (1)(2)(3)	2,051,707		23,219		4.49		1,919,926		19,945		4.12
Total interest-earning assets	2,618,763		27,796		4.22		2,731,585		22,419		3.26


Other assets	196,277						195,089

Total	$	2,815,040					$	2,926,674
Liabilities and Shareholders’ Equity
Interest-bearing demand deposits	$	1,379,082	912		0.26		$	1,411,243	286		0.08
Savings deposits	237,462		90		0.15		209,112		53		0.10
Time deposits	265,015		370		0.55		349,215		598		0.68
Total interest-bearing deposits	1,881,559		1,372		0.29		1,969,570		937		0.19
Securities sold under agreements to repurchase	23,480		10		0.18		23,578		8		0.13
FHLB advances and other borrowings	10,394		78		3.02		45,071		123		1.09
Subordinated notes	32,000		504		6.29		31,938		503		6.29
Total interest-bearing liabilities	1,947,433		1,964		0.40		2,070,157		1,571		0.30
Noninterest-bearing demand deposits	575,777						548,923
Other	49,964						38,409
Total liabilities	2,573,174						2,657,489
Shareholders’ equity	241,866						269,185
Total	$	2,815,040					$	2,926,674
Taxable-equivalent net interest income /net interest spread			25,832		3.82	%			20,848		2.96	%
Taxable-equivalent net interest margin					3.92	%					3.03	%
Taxable-equivalent adjustment			(377)						(228)
Net interest income			$	25,455					$	20,620


NOTES TO ANALYSIS OF NET INTEREST INCOME:
(1)			Yields and interest income on tax-exempt assets have been computed on a taxable-equivalent basis assuming a 21% tax rate.
(2)			Average balances include nonaccrual loans.
(3)			Interest income on loans includes prepayment and late fees, where applicable.

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Net interest income on a taxable-equivalent basis increased by $5.0 million to $25.8 million for the three months ended September 30, 2022 from $20.8 million for the three months ended September 30, 2021. The Company's net interest spread increased by 86 basis points to 3.82% for the three months ended September 30, 2022 compared to 2.96% for the three months ended September 30, 2021.

Taxable-equivalent net interest margin increased 89 basis points to 3.92% for the three months ended September 30, 2022 from 3.03% for the three months ended September 30, 2021. The taxable-equivalent yield on interest-earning assets increased 96 basis points from the three months ended September 30, 2021 to the three months ended September 30, 2022 reflecting the deployment of cash into higher yielding loans and investment securities, as well as the impact of rising interest rates on the loan and investment securities portfolios, which was partially offset by the increase of 10 basis points in the cost of interest-bearing liabilities from the three months ended September 30, 2021 to the three months ended September 30, 2022. The cost of interest-bearing liabilities increased 10 basis points from the three months ended September 30, 2021 to the three months ended September 30, 2022 reflecting an increase to deposit rates due to the rising rate environment, partially offset by the runoff in higher cost time deposit balances and the repayment of overnight borrowings during the third quarter of 2021. Average loans increased by $131.8 million to $2.1 billion during the three months ended September 30, 2022 from $1.9 billion for the three months ended September 30, 2021, as commercial and home equity loan growth in three months ended September 30, 2022 was partially offset by the impact of SBA PPP loan forgiveness. Average investment securities increased by $64.6 million from $464.4 million for the three months ended September 30, 2021 to $529.0 million for the same period in 2022 due to investment purchases. Average interest-bearing liabilities declined by $122.7 million to $1.9 billion for the 2022 period from $2.1 billion for the 2021 period due primarily to a decrease in average balances in time deposits and overnight borrowings.

The yield on loans increased by 37 basis points to 4.49% for the three months ended September 30, 2022 compared to 4.12% for the three months ended September 30, 2021. Taxable-equivalent interest income earned on loans increased by $3.3 million 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 from loan growth, excluding SBA PPP loans, was partially offset by a decrease in interest income from SBA PPP loans due to reduced fee income as a lower amount of SBA PPP loans were forgiven during the three months ended September 30, 2022 compared to the three months ended September 30, 2021.

SBA PPP loans, net of deferred fees and costs, averaged $25.0 million during the three months ended September 30, 2022 compared to $303.2 million during the three months ended September 30, 2021. This decrease was due to the forgiveness of SBA PPP loans since September 30, 2021. The average balance of commercial loans, excluding SBA PPP loans, increased by $385.9 million from $1.2 billion during the three months ended September 30, 2021 to $1.6 billion during the three months ended September 30, 2022. Average home equity loans increased by $24.7 million from $155.0 million for the three months ended September 30, 2021 to $179.7 million for the three months ended September 30, 2022. Average installment and other consumer loans decreased by $11.2 million from $36.6 million for the three months ended September 30, 2021 to $25.4 million for the three months ended September 30, 2022. Average residential mortgage loans increased by $10.6 million from $203.0 million during the three months ended September 30, 2021 to $213.6 million during the three months ended September 30, 2022 due to jumbo and adjustable-rate mortgage production.

For the three months ended September 30, 2022, interest income on loans included $523 thousand of interest and net deferred fee income associated with the SBA PPP loans compared to $3.4 million of such interest and fee income for the three months ended September 30, 2021. Accretion of purchase accounting adjustments included in interest income was $157 thousand and $296 thousand for the three months ended September 30, 2022 and 2021, respectively. The three months ended September 30, 2022 and 2021 included $64 thousand and $154 thousand, respectively, of accelerated accretion related to the payoff of acquired loans.

Interest income on investment securities on a tax-equivalent basis increased by $2.1 million to $4.4 million for the three months ended September 30, 2022 from $2.3 million for the three months ended September 30, 2021, with the taxable equivalent yield increasing from 2.00% for the three months ended September 30, 2021 to 3.31% for the three months ended September 30, 2022. This 131 basis point increase reflects the higher interest rate environment in 2022 and investment purchases at higher yields.

Average balance of federal funds sold and interest-bearing bank balances decreased by $309.1 million from $347.2 million for the three months ended September 30, 2021 to $38.1 million for the same period in 2022, due primarily to the deployment of cash into loans and investment securities. The related interest income increased by $65 thousand to $200 thousand for the three months ended September 30, 2022 from $135 thousand for the three months ended September 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 the FOMC during 2022.

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Interest expense on interest-bearing liabilities increased by $393 thousand year-over-year due to the increase in the cost of interest-bearing liabilities by 10 basis points from 0.30% for the three months ended September 30, 2021 to 0.40% for the three months ended September 30, 2022. This increase is due to deposit rate increases made in 2022, partially offset by the impact of a decrease in the average balance of interest-bearing deposits of $88.0 million that resulted from continued runoff of certificates of deposit and the repayment of overnight borrowings in the third quarter of 2021.

Provision for Loan Losses

The Company recorded a provision for loan losses of $1.5 million for the three months ended September 30, 2022 compared to $365 thousand for the same period in 2021. In calculating the provision for loan losses, both quantitative and qualitative factors, including the Company's historical net charge-off data and economic and market conditions, were considered. For the three months ended September 30, 2022 and 2021, the provision for loan losses was driven primarily by loan growth; however, the increase in the provision for loan losses for the three months ended September 30, 2021 attributable to loan growth was partially offset by the release of a portion of the Company's COVID-19 related reserve of $991 thousand. Net charge-offs in the three months ended September 30, 2022 totaled $70 thousand, compared to net recoveries of $219 thousand in the comparable prior year period. Nonaccrual loans were 0.25% of gross loans at September 30, 2022, compared with 0.47% of gross loans at September 30, 2021. Nonaccrual loans decreased by $3.8 million from $9.1 million at September 30, 2021 to $5.3 million at September 30, 2022 and classified loans decreased by $9.2 million from $26.9 million at September 30, 2021 to $19.6 million at September 30, 2022. In addition, special mention loans decreased by $16.7 million from $70.8 million at September 30, 2021 to $54.1 million at September 30, 2022, primarily due to risk rating upgrades. The decrease in non-accrual loans includes the payoff of one loan of $2.6 million, loans returning to accrual status of $721 thousand, and charge-offs of $101 thousand, partially offset by loans transferred to non-accrual status of $881 thousand. The remaining decrease in non-accrual loans is due to paydowns. The decrease in criticized and 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 ended September 30, 2022 and 2021:


	Three Months Ended September 30,				$ Change		% Change
	2022		2021		2022-2021		2022-2021
Service charges on deposit accounts	$	977	$	796	$	181	22.7	%
Interchange income	1,014		1,030		(16)		(1.6)	%
Other service charges and fees	239		197		42		21.3	%
Swap fee income	197		67		130		194.0	%
Trust and investment management income	2,006		1,930		76		3.9	%
Brokerage income	947		987		(40)		(4.1)	%
Mortgage banking activities	(1,014)		1,333		(2,347)		(176.1)	%

Income from life insurance	583		569		14		2.5	%
Other income	1,123		263		860		327.0	%

Investment securities (losses) gains	(14)		479		(493)		(102.9)	%
Total noninterest income	$	6,058	$	7,651	$	(1,593)	(20.8)	%

The following factors contributed to the more significant changes in noninterest income between the three months ended September 30, 2022 and 2021:

• Service charges on deposit accounts increased by $181 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 in April 2022.

• Swap fee income increased by $130 thousand. The timing and volume of these fees are dependent on client needs and loan size.

• Mortgage banking income decreased by $2.3 million due to a significant decline in the fair value of the held-for-sale mortgages caused by current market conditions, including the rapidly rising interest rates and lower housing inventory. The difficult mortgage market has also slowed residential mortgage loan production, thereby causing

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corresponding reductions in the residential mortgage loan pipeline and secondary market sales during the three months ended September 30, 2022. Mortgage loans sold totaled $12.7 million in the third quarter of 2022 compared with $48.0 million in the third quarter of 2021.

• Other income increased by $860 thousand due primarily to distributions of $964 thousand from investments in non-housing limited partnerships partially offset by the decrease of $128 thousand in the tax credits recognized from the Bank's investment in solar renewable energy partnerships in the third quarter of 2022 compared to the third quarter of 2021.

• Investment securities gains decreased by $493 thousand due primarily to $482 thousand in gains recorded from the sales of $72.8 million of asset-backed securities during the third quarter of 2021.

• 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 three months ended September 30, 2022 and 2021:


	Three Months Ended September 30,				$ Change		% Change
	2022		2021		2022-2021		2022-2021
Salaries and employee benefits	$	12,705	$	11,498	$	1,207	10.5	%
Occupancy	1,166		1,154		12		1.0	%
Furniture and equipment	1,214		1,220		(6)		(0.5)	%
Data processing	1,192		990		202		20.4	%

Automated teller machine and interchange fees	329		294		35		11.9	%
Advertising and bank promotions	278		735		(457)		(62.2)	%
FDIC insurance	294		218		76		34.9	%

Professional services	887		562		325		57.8	%
Directors' compensation	213		155		58		37.4	%


Taxes other than income	488		16		472		2950.0	%
Intangible asset amortization	272		314		(42)		(13.4)	%

Provision for legal settlement	13,000		—		13,000		100.0	%
Restructuring expenses	3,155		—		3,155		100.0	%

Other operating expenses	1,219		1,879		(660)		(35.1)	%
Total noninterest expenses	$	36,412	$	19,035	$	17,377	91.3	%

The following factors contributed to the more significant changes in noninterest expenses between the three months ended September 30, 2022 and 2021:

• Salaries and employee benefits expense increased by $1.2 million due primarily to additions to staff that filled vacancies, merit-based and incentive compensation increases and higher employee benefit costs.

• Data processing increased by $202 thousand due primarily to an increase in core system costs and investments in technology.

• Advertising and bank promotions expense decreased by $457 thousand due primarily to the timing difference of $500 thousand in contributions to Pennsylvania ("PA") EITC during 2022 and 2021.

• FDIC expense increased by $76 thousand due to an increase in the assessment rate driven by commercial loan growth and a lower deduction in the FDIC assessment rate calculation from SBA PPP loans due to forgiveness.

• Professional services expense increased by $325 thousand due to an increase in compliance and technology consulting services resulting from the need to supplement these services due to vacancies in staff and higher legal expenses partially associated with outstanding litigation.

• Directors' compensation expense increased by $58 thousand due primarily to the addition of a new director and an increase in the stock price on issued restricted stock awards.

• Taxes other than income increased by $472 thousand due to the timing difference of $450 thousand of eligible tax credits associated with the contributions made to the PA EITC during 2022 and 2021.

• During the fourth quarter of 2022, the Company agreed to settle a litigation matter, which resulted in a provision for legal settlement of $13.0 million recorded in the third quarter of 2022.

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• During the third quarter of 2022, the Company announced that five branch locations would be closing and staffing model adjustments would be made to drive long-term growth and improve operating efficiencies in 2023 and forward. As a result of these initiatives, the Company recorded a pre-tax restructuring charge of $3.2 million, which consisted of building and fixed asset write-offs of $1.9 million and early retirement/severance costs of $1.3 million.

• Other operating expenses decreased by $660 thousand due to a loss of $514 thousand from the termination of an interest rate swap designated as a cash flow hedge recorded in the three months ended September 30, 2021. Also, the fair value of derivatives increased by $160 thousand from the three months ended September 30, 2021 to the three months ended September 30, 2022.

• Other line items within noninterest expenses showed fluctuations between 2022 and 2021 attributable to normal business operations.

Income Tax (Benefit) Expense

Income tax benefit totaled $1.6 million, an effective tax rate of 24.6%, for the three months ended September 30, 2022 compared with income tax expense of $1.7 million, an effective tax rate of 18.9%, for the three months ended September 30, 2021. Excluding the impact of the legal settlement, the effective tax rate was 17.6% for the three months ended September 30, 2022. The Company’s effective tax rate is less than the 21% federal statutory rate, principally due to tax-exempt income, which includes interest income on tax-exempt 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 ended September 30, 2021 to the three months ended September 30, 2022 was due primarily to an increase in projected income from tax-exempt investment securities and loans for the 2022 fiscal year compared to the prior year.

Nine months ended September 30, 2022 compared with nine months ended September 30, 2021

Summary

Net income totaled $12.4 million for the nine months ended September 30, 2022 compared with net income of $26.2 million for the same period in 2021. Diluted earnings per share for the nine months ended September 30, 2022 totaled $1.16, compared with $2.36 for the nine months ended September 30, 2021. Net interest income positively influenced results of operations, and totaled $72.1 million for the nine months ended September 30, 2022, compared to $64.4 million for the nine months ended September 30, 2021. Noninterest income totaled $20.7 million and $21.9 million for the nine months ended September 30, 2022 and 2021, respectively. Noninterest expenses totaled $74.6 million for the nine months ended September 30, 2022 compared to $53.9 million for the nine months ended September 30, 2021.

The comparison of operating results for 2022 with 2021 reflects the impact in 2022 of the litigation matter and the restructuring charge, increases in the provision for loan losses, and salaries and employee benefits expense and a decrease in mortgage banking income, partially offset by the net interest income benefit from the deployment of cash in higher yielding commercial loans and investment securities, as well as rising interest rates, and increases in other non-interest fees. Excluding the impact from the legal settlement and the restructuring charge, for the nine months ended September 30, 2022, net income totaled $25.2 million and diluted earnings per share totaled $2.34. See “Supplemental Reporting of Non-GAAP Measures.”

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Net Interest Income

Net interest income increased by $7.7 million from $64.4 million for the nine months ended September 30, 2021 to $72.1 million for the nine months ended September 30, 2022. Total interest expense decreased from $5.4 million for the nine months ended September 30, 2021 to $4.4 million for the nine months ended September 30, 2022. Interest income on loans increased by $3.8 million, from $62.7 million to $66.5 million, and interest income on investment securities increased by $2.7 million, from $6.8 million to $9.5 million, compared to the same period in the prior year. Interest expense on deposits decreased by $652 thousand from $3.4 million for the nine months ended September 30, 2021 to $2.8 million for the nine months ended September 30, 2022.

The following table presents net interest income, net interest spread and net interest margin for the nine months ended September 30, 2022 and 2021 on a taxable-equivalent basis:


	Nine Months Ended September 30, 2022						Nine Months Ended September 30, 2021
	Average Balance		Taxable- Equivalent Interest		Taxable- Equivalent Rate		Average Balance		Taxable- Equivalent Interest		Taxable- Equivalent Rate
Assets
Federal funds sold & interest-bearing bank balances	$	122,509	$	536	0.59	%	$	261,697	$	255	0.13	%


Investment securities (1)	508,582		10,276		2.70		456,919		7,272		2.13


Loans (1)(2)(3)	2,011,881		66,738		4.43		1,988,834		62,895		4.23
Total interest-earning assets	2,642,972		77,550		3.92		2,707,450		70,422		3.48


Other assets	191,090						188,924

Total	$	2,834,062					$	2,896,374
Liabilities and Shareholders’ Equity
Interest-bearing demand deposits	$	1,399,035	1,470		0.14		$	1,380,241	1,014		0.10
Savings deposits	234,054		209		0.12		197,792		149		0.10
Time deposits	279,557		1,079		0.52		376,142		2,247		0.80
Total interest-bearing deposits	1,912,646		2,758		0.19		1,954,175		3,410		0.23
Securities sold under agreements to repurchase	23,685		24		0.14		22,490		25		0.15
FHLB Advances and other borrowings	4,693		121		3.44		53,608		458		1.14
Subordinated notes	31,985		1,510		6.29		31,924		1,507		6.29
Total interest-bearing liabilities	1,973,009		4,413		0.30		2,062,197		5,400		0.35
Noninterest-bearing demand deposits	562,826						537,247
Other	46,058						37,413
Total liabilities	2,581,893						2,636,857
Shareholders’ equity	252,169						259,517
Total	$	2,834,062					$	2,896,374
Taxable-equivalent net interest income /net interest spread			73,137		3.62	%			65,022		3.13	%
Taxable-equivalent net interest margin					3.70	%					3.21	%
Taxable-equivalent adjustment			(991)						(646)
Net interest income			$	72,146					$	64,376


NOTES TO ANALYSIS OF NET INTEREST INCOME:
(1)			Yields and interest income on tax-exempt assets have been computed on a taxable-equivalent basis assuming a 21% tax rate.
(2)			Average balances include nonaccrual loans.
(3)			Interest income on loans includes prepayment and late fees, where applicable.

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Net interest income on a taxable-equivalent basis increased by $8.1 million to $73.1 million for the nine months ended September 30, 2022 from $65.0 million for the nine months ended September 30, 2021. The Company's net interest spread increased by 49 basis points to 3.62% for the nine months ended September 30, 2022 compared to 3.13% for the nine months ended September 30, 2021.

Taxable-equivalent net interest margin increased by 49 basis points to 3.70% for the nine months ended September 30, 2022 from 3.21% for the nine months ended September 30, 2021. The taxable-equivalent yield on interest-earning assets increased by 44 basis points from the nine months ended September 30, 2021 to the nine months ended September 30, 2022 reflecting the deployment of cash into higher yielding loans and investment securities, as well as the impact of rising interest rates on the loan and investment securities portfolios. The decrease in the cost of interest-bearing liabilities of five basis points from the nine months ended September 30, 2021 to the nine months ended September 30, 2022 also contributed to the increase in the tax-equivalent net interest margin, which reflected the runoff of higher cost time deposit balances and the repayment of overnight borrowings in the third quarter of 2021. Average loans remained approximately $2.0 billion, during both the nine months ended September 30, 2022 and 2021, as commercial and home equity loan growth for the nine months ended September 30, 2022 was offset primarily by the impact of SBA PPP loan forgiveness. Average investment securities increased by $51.7 million from $456.9 million for the nine months ended September 30, 2021 to $508.6 million for the same period in 2022 due to investment purchases. Average interest-bearing liabilities declined by $89.2 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 20 basis points to 4.43% for the nine months ended September 30, 2022 compared to 4.23% for the nine months ended September 30, 2021. Taxable-equivalent interest income earned on loans increased by $3.8 million 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 from loan growth was partially offset by the decrease in interest income from SBA PPP loans. This decrease is due to reduced fee income as a lower amount of SBA PPP loans were forgiven during the nine months ended September 30, 2022 compared to the nine months ended September 30, 2021.

SBA PPP loans, net of deferred fees and costs, averaged $83.8 million during the nine months ended September 30, 2022 compared to $412.2 million during the nine months ended September 30, 2021. This decrease was due to the forgiveness of SBA PPP loans since September 30, 2021. The average balance of commercial loans, excluding SBA PPP loans, increased by $361.2 million from $1.2 billion in the nine months ended September 30, 2021 to $1.5 billion during the nine months ended September 30, 2022. Average home equity loans increased by $16.9 million from $155.0 million for the nine months ended September 30, 2021 to $171.9 million for the nine months ended September 30, 2022. Average installment and other consumer loans decreased by $14.2 million from $41.4 million for the nine months ended September 30, 2021 to $27.2 million for the nine months ended September 30, 2022. Average residential mortgage loans decreased by $12.5 million from $216.9 million during the nine months ended September 30, 2021 to $204.4 million during the nine months ended September 30, 2022 due to significant refinancing activity in late 2021.

For the nine months ended September 30, 2022, interest income on loans includes $5.9 million of interest and net deferred fee income associated with SBA PPP loans compared to $13.0 million of such interest and fee income for the nine months ended September 30, 2021. Accretion of purchase accounting adjustments included in interest income was $966 thousand and $1.4 million for the nine months ended September 30, 2022 and 2021, respectively. The nine months ended September 30, 2022 and 2021 included $647 thousand and $919 thousand, respectively, of accelerated accretion related to the payoff of acquired loans.

Interest income on investment securities on a tax-equivalent basis increased by $3.0 million to $10.3 million for the nine months ended September 30, 2022 from $7.3 million for the nine months ended September 30, 2021, with the taxable equivalent yield increasing from 2.13% for the nine months ended September 30, 2021 to 2.70% for the nine months ended September 30, 2022. The 57 basis point increase reflected the higher interest rate environment in 2022 and investment security purchases at higher yields.

The average balance of federal funds sold and interest-bearing bank balances decreased by $139.2 million from $261.7 million for the nine months ended September 30, 2021, to $122.5 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 $281 thousand to $536 thousand for the nine months ended September 30, 2022, from $255 thousand for the nine months ended September 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 the FOMC during 2022.

Interest expense on interest-bearing liabilities decreased by $1.0 million year-over-year, reflecting a decrease in the average balance of interest-bearing deposits of $41.5 million due primarily to continued runoff of higher yielding certificates of

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deposit. The cost of interest-bearing liabilities declined by five basis points from 0.35% for the nine months ended September 30, 2021 to 0.30% for the nine months ended September 30, 2022 due to the timing of deposit rate decreases in 2021 and increases in 2022 combined with the continued runoff of higher yielding certificates of deposits and the repayment and maturities of overnight borrowings in the third quarter of 2021.

Provision for Loan Losses

The Company recorded a provision for loan losses of $3.6 million for the nine months ended September 30, 2022 compared to a negative provision for loan losses of $10 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 nine months ended September 30, 2022, the provision for loan losses was driven primarily by an increase in commercial loans. The negative provision for loan losses recorded in the nine months ended September 30, 2021 was due to the release of a portion of the Company's remaining COVID-19 related reserve of $2.7 million. Net charge-offs in the nine months ended September 30, 2022 totaled $46 thousand, compared to net charge-offs of $176 thousand in the comparable prior year period. Nonaccrual loans were 0.25% of gross loans at September 30, 2022, compared with 0.47% of gross loans at September 30, 2021. Nonaccrual loans decreased by $3.8 million from September 30, 2021 to September 30, 2022 and classified loans decreased by $9.2 million to $19.6 million from September 30, 2021 to September 30, 2022. In addition, loans with a special mention risk rating decreased by $16.7 million from $70.8 million at September 30, 2021 to $54.1 million at September 30, 2022 due to risk rating upgrades. The decrease in non-accrual loans includes the payoff of one loan of $2.6 million, loans returning to accrual status of $721 thousand, and charge-offs of $101 thousand, partially offset by loans transferred to non-accrual status of $881 thousand. The remaining decrease in non-accrual loans is due to paydowns. The decrease in criticized and 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 nine months ended September 30, 2022 and 2021:


	Nine Months Ended September 30,				$ Change		% Change
	2022		2021		2022-2021		2022-2021
Service charges on deposit accounts	$	2,861	$	2,231	$	630	28	%
Interchange income	3,059		3,049		10		—	%
Other service charges and fees	622		527		95		18	%
Swap fee income	1,935		135		1,800		1,333	%
Trust and investment management income	5,852		5,862		(10)		—	%
Brokerage income	2,864		2,708		156		6	%
Mortgage banking activities	205		4,684		(4,479)		(96)	%

Income from life insurance	1,742		1,690		52		3	%
Other income	1,749		338		1,411		417	%

Investment securities (losses) gains	(163)		635		(798)		(126)	%
Total noninterest income	$	20,726	$	21,859	$	(1,133)	(5)	%

The following factors contributed to the more significant changes in noninterest income between the nine months ended September 30, 2022 and 2021:

• Service charges on deposit accounts increased by $630 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 in April 2022.

• Swap fee income increased by $1.8 million due to increased client interest in locking in interest rates on commercial loans in the rising interest rate environment.

• Mortgage banking income decreased by $4.5 million due primarily to a significant decline in the fair value of held-for-sale mortgages caused by current market conditions, including rapidly rising interest rates and lower housing inventory. The difficult mortgage market also slowed residential mortgage loan production, thereby causing corresponding reductions in the residential mortgage loan pipeline and secondary market sales during the nine months ended September 30, 2022 compared to the same period in 2021. Mortgage loans sold totaled $67.6 million

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in the first nine months of 2022 compared with $157.1 million in the first nine months of 2021. In addition, the Company recorded an MSR valuation reserve reversal of $79 thousand in the nine months ended September 30, 2022 compared to an MSR valuation reserve reversal of $695 thousand in the nine months ended September 30, 2021. Significant market interest rate reductions in 2021, which were caused by the COVID-19 pandemic resulted in decreases in the MSR fair values. Rate increases in 2022 offset this impact.

• Other income increased by $1.4 million due primarily to distributions of $964 thousand from investments in non-housing limited partnerships and gains on the sales of two SBA loans totaling $306 thousand.

• During the nine months ended September 30, 2022, the Company recorded net investment securities losses of $163 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 $8 thousand from the sale of $3.1 million in principal balance of one security. During the nine months ended September 30, 2021, the Company sold 18 securities with a principal balance of $148.4 million for a gain of $609 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 nine months ended September 30, 2022 and 2021:


	Nine Months Ended September 30,				$ Change		% Change
	2022		2021		2022-2021		2022-2021
Salaries and employee benefits	$	35,354	$	31,907	$	3,447	10.8	%
Occupancy	3,586		3,492		94		2.7	%
Furniture and equipment	3,784		3,800		(16)		(0.4)	%
Data processing	3,410		3,041		369		12.1	%

Automated teller machine and interchange fees	952		862		90		10.4	%
Advertising and bank promotions	1,514		1,434		80		5.6	%
FDIC insurance	767		570		197		34.6	%

Professional services	2,417		1,862		555		29.8	%
Directors' compensation	674		624		50		8.0	%


Taxes other than income	1,160		929		231		24.9	%
Intangible asset amortization	845		972		(127)		(13.1)	%

Provision for legal settlement	13,000		—		13,000		100.0	%
Restructuring expenses	3,155		—		3,155		100.0	%

Other operating expenses	3,952		4,358		(406)		(9.3)	%
Total noninterest expenses	$	74,570	$	53,851	$	20,719	38.5	%

The following factors contributed to the more significant changes in noninterest expenses between the nine months ended September 30, 2022 and 2021:

• Salaries and employee benefits expense increased by $3.4 million due primarily to the additions to staff that filled vacancies, merit-based and incentive compensation increases and higher employee benefit costs, including healthcare expenses.

• Data processing increased by $369 thousand due primarily to an increase in core system costs and investments in technology.

• FDIC insurance expense increased by $197 thousand due to an increase in the assessment rate driven by commercial loan growth and a lower deduction in the FDIC assessment rate calculation from SBA PPP loans due to forgiveness.

• Professional services increased by $555 thousand due to an increase in compliance and technology consulting services resulting from the need to supplement these services due to vacancies in staff and higher legal expenses partially due to outstanding litigation.

• Taxes other than income increased by $231 thousand due to an increase year-over year in the Pennsylvania Bank Shares Tax expense, as the Bank's total equity balance grew between the annual assessments measured at January 1st.

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• During the fourth quarter of 2022, the Company agreed to settle a litigation matter, which resulted in a provision for legal settlement of $13.0 million recorded in the third quarter of 2022.

• Other operating expenses decreased by $406 thousand due to a loss of $514 thousand from the termination of an interest rate derivative designated as a cash flow hedge recorded in the nine months ended September 30, 2021 and the fair value of derivatives increased by $287 thousand between the nine months ended September 30, 2022 and 2021. These decreases were offset by an increase in the reserve for unfunded commitments of $196 thousand due to reversals in 2021 following a review of historical loss and line utilization experience. In addition, there was an increase of $151 thousand in employee related costs, which includes travel, meals and seminars as employees returned to a normal operating environment post COVID-19.

• Other line items within noninterest expenses showed fluctuations between 2022 and 2021 attributable to normal business operations.

Income Tax Expense

Income tax expense totaled $2.3 million, an effective tax rate of 15.7%, for the nine months ended September 30, 2022 compared with $6.2 million, an effective tax rate of 19.2%, for the nine months ended September 30, 2021. Excluding the impact of the provision for legal settlement, the effective tax rate was 18.2% for the nine months ended September 30, 2022. The Company’s effective tax rate is less than the 21% federal statutory rate, principally due to lower pre-tax income and the impact of tax-exempt income, which includes interest income on tax-exempt 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 nine months ended September 30, 2021 to the nine months ended September 30, 2022 was primarily due to an increase in projected income from tax-exempt 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.

Investment Securities

The Company utilizes investment securities to manage interest rate risk, enhance income through interest and dividend income, provide liquidity and provide collateral for certain deposits and borrowings. At September 30, 2022, AFS securities totaled $503.6 million, an increase of $31.2 million, from $472.4 million at December 31, 2021. During the nine months ended September 30, 2022, the Company purchased $73.7 million of municipal securities, $41.2 million of agency MBS and CMO, and $16.7 million of non-agency CMO, and sold $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 third quarter of 2022. The balance of investment securities included net unrealized losses of $54.5 million at September 30, 2022 compared to net unrealized gains of $5.6 million at December 31, 2021. This change was due to significant market interest rate increases in 2022.

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The following table summarizes the credit ratings and collateral associated with the Company's investment portfolio, excluding equity securities, at September 30, 2022:


Sector	Portfolio Mix		Amortized Book Value		Fair Value		Credit Enhancement		AAA		AA		A		BBB		NR		Collateral Type
Unsecured ABS	1	%	$	5,230	$	4,731	28	%	—	%	—	%	—	%	—	%	100	%	Unsecured Consumer Debt
Student Loan ABS	1		7,284		7,079		26		—		—		—		—		100		Seasoned Student Loans
Federal Family Education Loan ABS	18		99,582		97,456		8		87		13		—		—		—		Federal Family Education Loan (1)
PACE Loan ABS	—		2,777		2,542		6		100		—		—		—		—		PACE Loans
Non-Agency CMBS	2		10,047		10,045		18		—		—		—		—		100		Bridge to HUD Non-Agency CMBS
Non-Agency RMBS	3		17,012		15,116		13		100		—		—		—		—		Reverse Mortgages (2)
Municipal - General Obligation	22		122,576		107,870				5		90		5		—		—
Municipal - Revenue	24		132,026		112,166				—		83		12		—		5
SBA ReRemic	1		5,840		5,737				—		100		—		—		—		SBA Guarantee (3)
Agency MBS	24		135,223		123,353				—		100		—		—		—		Residential Mortgages (3)
U.S. Treasury securities	4		20,074		17,115				—		100		—		—		—
Bank CDs	—		249		249				—		—		—		—		100		FDIC Insured CD
	100	%	$	557,920	$	503,459			20	%	71	%	4	%	—	%	5	%

(1) Minimum of 18% guaranteed by U.S. government
(2) Reverse mortgages fund over time; credit enhancement is estimated based on prior experience
(3) 75% guaranteed by U.S. government agencies



Note : Ratings in table are the lowest of the six rating agencies (Standard & Poor's, Moody's, Fitch, Morningstar, DBRS and Kroll Bond Rating Agency). Standard & Poor's rates U.S. government obligations at AA+

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.

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The following table presents the loan portfolio, excluding residential LHFS, by segment and class at September 30, 2022 and December 31, 2021:


	September 30, 2022		December 31, 2021
Commercial real estate:
Owner occupied	$	313,125	$	238,668
Non-owner occupied	573,605		551,783
Multi-family	114,561		93,255
Non-owner occupied residential	105,267		106,112
Acquisition and development:
1-4 family residential construction	20,810		12,279
Commercial and land development	148,512		93,925
Commercial and industrial (1)	378,574		485,728
Municipal	12,683		14,989
Residential mortgage:
First lien	220,970		198,831
Home equity - term	5,869		6,081
Home equity - lines of credit	180,267		160,705
Installment and other loans	13,684		17,630
	$	2,087,927	$	1,979,986

(1) This balance includes $17.0 million and $189.9 million of SBA PPP loans, net of deferred fees and costs, at September 30, 2022 and December 31, 2021, respectively.

Total loans increased by $107.9 million from December 31, 2021 to September 30, 2022. This increase is due to growth in commercial loans, excluding SBA PPP loans, of $243.3 million, home equity lines of credit of $19.6 million and first lien residential mortgages of $22.1 million, partially offset by a decrease of $172.9 million in SBA PPP loans due to loan forgiveness during the nine months ended September 30, 2022. Overall loan growth, excluding SBA PPP loans, was 16% for the nine months ended September 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 central Pennsylvania and the greater Baltimore, 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

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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 of September 30, 2022 and December 31, 2021. Loans 30-89 days past due and relevant asset quality ratios as of September 30, 2022 and December 31, 2021 are also presented.


	September 30, 2022			December 31, 2021
Nonaccrual loans	$	5,303		$	6,449
OREO	—			—
Total nonperforming assets	5,303			6,449
Restructured loans still accruing	689			804
Loans past due 90 days or more and still accruing	232			1,201
Total nonperforming and other risk assets (total risk assets)	$	6,224		$	8,454
Loans 30-89 days past due and still accruing	$	2,421		$	5,925
Asset quality ratios:
Total nonperforming loans to total loans	0.25		%	0.33		%
Total nonperforming assets to total assets	0.19		%	0.23		%
Total nonperforming assets to total loans and OREO	0.25		%	0.33		%
Total risk assets to total loans and OREO	0.30		%	0.43		%
Total risk assets to total assets	0.22		%	0.30		%
ALL to total loans	1.18		%	1.07		%
ALL to nonperforming loans	465.94		%	328.42		%
ALL to nonperforming loans and restructured loans still accruing	412.37		%	292.02		%

Total nonperforming and other risk assets decreased by $2.2 million , or 26%, from December 31, 2021 to September 30, 2022. Non-accrual loans decreased by $1.1 million from December 31, 2021 to September 30, 2022 due primarily to $721 thousand of loans returning to accrual status and payment activity of $972 thousand, partially offset by additions in loans classified as non-accrual loans of $583 thousand. Loans past due 90 days and still accruing decreased by $969 thousand from December 31, 2021 to September 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, excluding accruing PCI loans, at September 30, 2022 and December 31, 2021:


	September 30, 2022						December 31, 2021
	Nonaccrual Loans		Restructured Loans Still Accruing		Total		Nonaccrual Loans		Restructured Loans Still Accruing		Total
Commercial real estate:
Owner occupied	$	2,849	$	—	$	2,849	$	3,763	$	—	$	3,763


Non-owner occupied residential	90		—		90		122		—		122



Commercial and industrial	45		—		45		250		—		250
Residential mortgage:
First lien	1,904		689		2,593		1,831		804		2,635
Home equity - term	5		—		5		7		—		7
Home equity - lines of credit	372		—		372		436		—		436
Installment and other loans	38		—		38		40		—		40
	$	5,303	$	689	$	5,992	$	6,449	$	804	$	7,253

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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 at September 30, 2022 and December 31, 2021. Of the relationships deemed to be impaired at September 30, 2022, one had a recorded balance in excess of $1.0 million, and 56 relationships, which represents 50% of total impaired loans, had recorded balances of less than $250 thousand.


	# of Relationships	Recorded Investment		Partial Charge-offs to Date		Specific Reserves
September 30, 2022
Relationships greater than $1,000,000	1	$	2,406	$	—	$	—
Relationships greater than $500,000 but less than $1,000,000	—	—		—		—
Relationships greater than $250,000 but less than $500,000	2	577		—		—
Relationships less than $250,000	56	3,009		280		28
	59	$	5,992	$	280	$	28
December 31, 2021
Relationships greater than $1,000,000	1	$	2,535	$	—	$	—
Relationships greater than $500,000 but less than $1,000,000	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 at September 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.

In an effort to assist clients which were negatively impacted by the COVID-19 pandemic, the Bank offered various mitigation options, including a loan payment deferral program. Under this program, most commercial deferrals were for a 90-day period, while most consumer deferrals were for a 180-day period. As of September 30, 2022, the Company had a loan deferral under this program for a consumer client with a total loan balance of $214 thousand as of September 30, 2022. As of December 31, 2021, the Company had a consumer loan under this deferral program of $56 thousand for which the deferral period subsequently expired in 2022. In accordance with the revised Interagency Statement on Loan Modifications by Financial Institutions Working with Customers Affected by the Coronavirus issued on April 7, 2020, these deferrals are exempt from TDR status as they meet the specified requirements.

The following table summarizes COVID-19 related modifications, including deferrals and forbearances:


Loan Type	Amount of Loans				Percent of Non-PPP Loans
	September 30, 2022		December 31, 2021		September 30, 2022		December 31, 2021

Consumer loans	$	214	$	56	—	%	—	%
Total loans	$	214	$	56	—	%	—	%

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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."

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The following table summarizes the Company’s internal risk ratings at September 30, 2022 and December 31, 2021:


	Pass		Special Mention		Non-Impaired Substandard		Impaired - Substandard		Doubtful		PCI Loans		Total
September 30, 2022
Commercial real estate:
Owner occupied	$	302,001	$	3,392	$	2,649	$	2,849	$	—	$	2,234	$	313,125
Non-owner occupied	566,996		3,931		2,388		—		—		290		573,605
Multi-family	106,306		8,010		245		—		—		—		114,561
Non-owner occupied residential	102,136		1,979		493		90		—		569		105,267
Acquisition and development:
1-4 family residential construction	20,810		—		—		—		—		—		20,810
Commercial and land development	132,621		15,891		—		—		—		—		148,512
Commercial and industrial	349,319		20,891		6,236		45		—		2,083		378,574
Municipal	12,683		—		—		—		—		—		12,683
Residential mortgage:
First lien	213,812		—		223		2,593		—		4,342		220,970
Home equity - term	5,849		—		—		5		—		15		5,869
Home equity - lines of credit	179,850		—		45		372		—		—		180,267
Installment and other loans	13,639		—		—		38		—		7		13,684
	$	2,006,022	$	54,094	$	12,279	$	5,992	$	—	$	9,540	$	2,087,927
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 $12.3 million at September 30, 2022.

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 increased by $4.9 million f rom December 31, 2021 to September 30, 2022 primarily due to downgrades for one borrower within Acquisition and Development and the other borrower within the Commercial and Industrial loan categories. These risk rating downgrades were partially offset by continued improvements in economic conditions resulting in upgrades to other 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 nine months ended September 30, 2022 and 2021:


	Commercial										Consumer
	Commercial Real Estate		Acquisition and Development		Commercial and Industrial		Municipal		Total		Residential Mortgage		Installment and Other		Total		Unallocated		Total
Three Months Ended
September 30, 2022
Balance, beginning of period	$	12,294	$	3,024	$	4,471	$	26	$	19,815	$	3,004	$	223	$	3,227	$	237	$	23,279
Provision for loan losses	551		342		296		(1)		1,188		309		(5)		304		8		1,500

Charge-offs	—		—		(87)		—		(87)		—		(24)		(24)		—		(111)
Recoveries	—		1		32		—		33		2		6		8		—		41
Balance, end of period	$	12,845	$	3,367	$	4,712	$	25	$	20,949	$	3,315	$	200	$	3,515	$	245	$	24,709
September 30, 2021
Balance, beginning of period	$	11,315	$	1,243	$	3,495	$	29	$	16,082	$	2,863	$	227	$	3,090	$	209	$	19,381
Provision for loan losses	(179)		290		386		(2)		495		(147)		18		(129)		(1)		365
Charge-offs	(89)		—		(55)		—		(144)		—		(20)		(20)		—		(164)
Recoveries	305		8		60		—		373		5		5		10		—		383
Balance, end of period	$	11,352	$	1,541	$	3,886	$	27	$	16,806	$	2,721	$	230	$	2,951	$	208	$	19,965
Nine Months Ended
September 30, 2022
Balance, beginning of period	$	12,037	$	2,062	$	3,814	$	30	$	17,943	$	2,785	$	215	$	3,000	$	237	$	21,180
Provision for loan losses	776		1,295		980		(5)		3,046		508		13		521		8		3,575

Charge-offs	—		—		(202)		—		(202)		(10)		(42)		(52)		—		(254)
Recoveries	32		10		120		—		162		32		14		46		—		208
Balance, end of period	$	12,845	$	3,367	$	4,712	$	25	$	20,949	$	3,315	$	200	$	3,515	$	245	$	24,709
September 30, 2021
Balance, beginning of period	$	11,151	$	1,114	$	3,942	$	40	$	16,247	$	3,362	$	324	$	3,686	$	218	$	20,151
Provision for loan losses	133		418		109		(13)		647		(578)		(69)		(647)		(10)		(10)
Charge-offs	(270)		—		(621)		—		(891)		(92)		(49)		(141)		—		(1,032)
Recoveries	338		9		456		—		803		29		24		53		—		856
Balance, end of period	$	11,352	$	1,541	$	3,886	$	27	$	16,806	$	2,721	$	230	$	2,951	$	208	$	19,965

The ALL totaled $24.7 million at September 30, 2022, an increase of $3.5 million from December 31, 2021, resulting from a provision for loan losses of $3.6 million, which was inclusive of net charge-offs of $46 thousand during the nine months ended September 30, 2022. At September 30, 2022, the ALL as a percentage of the total loan portfolio was 1.18% compared to 1.03% at September 30, 2021. The ALL increased in the nine months ended September 30, 2022 primarily as a result of commercial loan growth. Despite generally favorable delinquency and nonperforming loan data, the impact of current economic conditions may result in the need for additional provisions for loan losses in future quarters.

Classified loans totaled $19.6 million at September 30, 2022, or 0.9% of total loans outstanding, reflecting a decrease from $23.1 million, or 1.2% of loans outstanding, at December 31, 2021. The asset quality ratios, including the nonperforming loans and risk assets metrics, previously noted are indicative of the continued benefit the Company has received from favorable

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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, at September 30, 2022 and December 31, 2021, including PCI loans:


	Commercial										Consumer
	Commercial Real Estate		Acquisition and Development		Commercial and Industrial		Municipal		Total		Residential Mortgage		Installment and Other		Total		Unallocated		Total
September 30, 2022
Loans allocated by:
Individually evaluated for impairment	$	2,939	$	—	$	45	$	—	$	2,984	$	2,970	$	38	$	3,008	$	—	$	5,992
Collectively evaluated for impairment	1,103,619		169,322		378,529		12,683		1,664,153		404,136		13,646		417,782		—		2,081,935

	$	1,106,558	$	169,322	$	378,574	$	12,683	$	1,667,137	$	407,106	$	13,684	$	420,790	$	—	$	2,087,927
ALL allocated by:
Individually evaluated for impairment	$	—	$	—	$	—	$	—	$	—	$	28	$	—	$	28	$	—	$	28
Collectively evaluated for impairment	12,845		3,367		4,712		25		20,949		3,287		200		3,487		245		24,681

	$	12,845	$	3,367	$	4,712	$	25	$	20,949	$	3,315	$	200	$	3,515	$	245	$	24,709
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 $367 thousand, have had cumulative partial charge-offs to the ALL totaling $280 thousand at September 30, 2022. As updated appraisals are received on collateral-dependent loans, partial charge-offs are taken to the extent the loans’ principal balance exceeds their fair value.

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 at September 30, 2022 and December 31, 2021, respectively. The Company monitors the unallocated portion of the ALL and, by policy, has determined it should not

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exceed 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 $40.9 million, or 2%, remaining at approximately $2.5 billion at both September 30, 2022 and December 31, 2021.

Noninterest-bearing deposits increased by $8.8 million, or 2%, to $562.0 million, from December 31, 2021 to September 30, 2022. Interest-bearing deposits totaled $1.9 billion at September 30, 2022, an increase of $32.1 million, or less than 1%, from the $1.9 billion balance at December 31, 2021, despite a decrease in time deposits, due to maturities, of $48.1 million, or 16%.

Deposit growth in the first nine months of 2022 was principally due to seasonality from public fund clients and retail deposit generation.

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 $217.4 million at September 30, 2022, a decrease of $54.3 million, or 20%, from $271.7 million at December 31, 2021. The decrease was primarily attributable to other comprehensive losses of $47.9 million due to an increase in unrealized losses on AFS securities and interest rate swaps designated as cash flow hedges, caused by a substantial increase in market interest rates, as well as dividends paid of $6.2 million and shared-based compensation costs of $12.5 million, partially offset by net income of $12.4 million.

For the nine months ended September 30, 2022, total comprehensive losses totaled $35.5 million, a decrease of $64.0 million, from total comprehensive income of $28.5 million for the same period in 2021. This decrease was primarily due to an increase in unrealized losses on AFS securities, net of taxes, of $48.8 million and a decrease in net income of $13.8 million, due partially to the provision for legal settlement of $13.0 million and a restructuring charge of $3.2 million, compared to the same period in 2021. The unrealized losses included in the unaudited consolidated statements of comprehensive (loss) income are the result of the significant increase in market interest rates.

At September 30, 2022, book value per common share was $20.34 per share compared to $24.29 per share at December 31, 2021. Tangible book value per share also decreased from $22.32 per share at December 31, 2021 to $18.34 per share at September 30, 2022. These decreases are primarily a result of the decrease in shareholders' equity. See “Supplemental Reporting of Non-GAAP Measures.”

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.

At September 30, 2022 and December 31, 2021, the Bank was considered well-capitalized under applicable banking regulations. The decrease of 1.1% in Total Risk-Based Capital from 14.0% at December 31, 2021 to 12.9% at September 30, 2022 was due primarily to an increase in risk-weighted assets from the deployment of cash into commercial loans and an increase in deferred tax assets resulting from the increase in unrealized losses on AFS securities and interest rate swaps designated as cash flow hedges. 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.

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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 at September 30, 2022 and December 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 ended December 31, 2021, Item 1 - Business, under the topic Basel III Capital Rules. At September 30, 2022, the Bank's capital conservation buffer, based on the most restrictive Total Capital to risk weighted assets capital ratio, was 4.9%, which is greater than the 2.5% requirement.

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 of Pittsburgh. 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 $987.9 million at September 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 $99.5 million at September 30, 2022. At September 30, 2022, the Company had $19.1 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 $22.1 million and $22.9 million at September 30, 2022 and December 31, 2021, respectively. Additionally, the Company incurred, before taxes, $3.2 million and $13.0 million in restructuring charges and provision for legal settlement, respectively, during the three and nine months ended September 30, 2022.

Management believes providing certain “non-GAAP” financial information will assist investors in their understanding of the effect on recent financial results from non-recurring charges.

Tangible book value per share and the impact of the legal settlement and restructuring charge on net income and diluted earnings per share, 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) from December 31, 2021 to September 30, 2022 is primarily due to an increase in other comprehensive losses, net of taxes, of $47.9 million due to higher unrealized losses on AFS securities and interest rate swaps designated as cash flow hedges and share repurchases.

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The following table presents the computation of each non-GAAP based measure shown together with its most directly comparable GAAP based measure.


(dollars and shares in thousands)	September 30, 2022		December 31, 2021
Tangible Book Value per Common Share
Shareholders' equity	$	217,378	$	271,656
Less: Goodwill	18,724		18,724
Other intangible assets	3,338		4,183
Related tax effect	(701)		(878)
Tangible common equity (non-GAAP)	$	196,017	$	249,627

Common shares outstanding	10,686		11,183

Book value per share (most directly comparable GAAP based measure)	$	20.34	$	24.29
Intangible assets per share	2.00		1.97
Tangible book value per share (non-GAAP)	$	18.34	$	22.32


Adjusted Net Income and Adjusted Diluted Earnings Per Share	September 30, 2022
(dollars and shares in thousands)	Three Months Ended		Nine Months Ended
Net (loss) income (most directly comparable GAAP based measure)	$	(4,828)	$	12,411
Plus: Restructuring charges	3,155		3,155
Plus: Provision for legal settlement	13,000		13,000
Less: Related tax effect	(3,393)		(3,393)
Adjusted net income (non-GAAP)	$	7,934	$	25,173

Weighted average shares - diluted (most directly comparable GAAP-based measure)	10,369		10,758
Diluted (losses) earnings per share (most directly comparable GAAP-based measure)	(0.47)		1.16
Weighted average shares - diluted (non-GAAP)	10,529		10,758
Diluted earnings per share, adjusted (non-GAAP)	0.75		2.34

Item 3. Quantitative and Qualitative Disclosures about Market Risk

Market risk comprises exposure to interest rate risk, foreign currency exchange rate risk, commodity price risk, and other relevant market rate or price risks. In the banking industry, a major risk exposure is changing interest rates. The primary objective of monitoring our interest rate sensitivity, or risk, is to provide management the tools necessary to manage the balance sheet to minimize adverse changes in net interest income as a result of changes in the direction and level of interest rates. FRB monetary control efforts, economic uncertainty and legislative changes have been significant factors affecting the task of managing interest rate sensitivity positions in recent years.

Interest Rate Risk

Interest rate risk is the exposure to fluctuations in the Company’s future earnings (earnings at risk) and value (value at risk) resulting from changes in interest rates. This exposure results from differences between the amounts of interest-earning assets and interest-bearing liabilities that reprice within a specified time period as a result of scheduled maturities, scheduled and unscheduled repayments, the propensity of borrowers and depositors to react to changes in their economic interests, and loan contractual interest rate changes.

We attempt to manage the level of repricing and maturity mismatch through our asset/liability management process so that fluctuations in net interest income are maintained within policy limits across a range of market conditions, while satisfying liquidity and capital requirements. Management recognizes that a certain amount of interest rate risk is inherent, appropriate and necessary to ensure the Company’s profitability. Thus, the goal of interest rate risk management is to evaluate the amount of

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reward for taking risk and adjusting both the size and composition of the balance sheet relative to the level of reward available for taking risk.

Management endeavors to control the exposure to changes in interest rates by understanding, reviewing and making decisions based on its risk position. The Company primarily uses its securities portfolio, FHLB advances, interest rate swaps and brokered deposits to manage its interest rate risk position. Additionally, pricing, promotion and product development activities are directed in an effort to emphasize the loan and deposit term or repricing characteristics that best meet current interest rate risk objectives.

We use simulation analysis to assess earnings at risk and net present value analysis to assess value at risk. These methods allow management to regularly monitor both the direction and magnitude of our interest rate risk exposure. These analyses require numerous assumptions including, but not limited to, changes in balance sheet mix, prepayment rates on loans and securities, cash flows and repricing of all financial instruments, changes in volumes and pricing, future shapes of the yield curve, relationship of market interest rates to each other (basis risk), credit spread and deposit sensitivity. Assumptions are based on management’s best estimates but may not accurately reflect actual results under certain changes in interest rate due to the timing, magnitude and frequency of rate changes and changes in market conditions and management strategies, among other factors. However, the analyses are useful in quantifying risk and providing a relative gauge of our interest rate risk position over time.

Our asset/liability committee operates under management policies, approved by the Board of Directors, which define guidelines and limits on the level of risk. The committee meets regularly and reviews our interest rate risk position and monitors various liquidity ratios to ensure a satisfactory liquidity position. By utilizing our analyses, we can determine changes that may need to be made to the asset and liability mixes to mitigate the change in net interest income under various interest rate scenarios. Management continually evaluates the condition of the economy, the pattern of market interest rates and other economic data to inform the committee on the selection of investment securities. Regulatory authorities also monitor our interest rate risk position along with other liquidity ratios.

Net Interest Income Sensitivity

Simulation analysis evaluates the effect of upward and downward changes in market interest rates on future net interest income. The analysis involves changing the interest rates used in determining net interest income over the next twelve months. The resulting percentage change in net interest income in various rate scenarios is an indication of the Company's short-term interest rate risk. The analysis assumes recent pricing trends in new loan and deposit volumes will continue while balances remain constant. Additional assumptions are applied to modify pricing under the various rate scenarios.

The simulation analysis results are presented in the Net Interest Income table below. At September 30, 2022 and December 31, 2021, the results indicated the Company could experience interest income pressure as interest rates continue to rise. This is due to the assumption that interest-bearing liabilities will begin repricing faster than interest-earning assets. The faster liability repricing combined with the composition of the balance sheet between fixed- and floating-rate assets has led to the Company becoming more liability sensitive as interest rates continue to rise. As such, if certain model assumptions occur, further increases in interest rates in a flat balance sheet scenario could negatively impact the Company's net interest income.

Economic Value

Net present value analysis provides information on the risk inherent in the balance sheet that might not be considered in the simulation analysis due to the short time horizon used in that analysis. The net present value of the balance sheet incorporates the discounted present value of expected asset cash flows minus the discounted present value of expected liability cash flows. The analysis involves changing the interest rates used in determining the expected cash flows and in discounting the cash flows. The resulting percentage change in net present value in various rate scenarios is an indication of the longer term repricing risk and options embedded in the balance sheet.

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The results at September 30, 2022 reflect the impact of the FOMC's interest rate increases to date. As the federal funds rate increases further, the increase in asset yields is countered by the model's acceleration in the cost of liabilities as compared to a slower realized pace so far in this rate cycle. To improve the comparability across periods, the Company strives to follow best practices related to the assumption setting and maintains the size and mix of the period end balance sheet; thus, the results do not reflect actions management may take through the normal course of business that would impact results.


Net Interest Income					Economic Value
	% Change in Net Interest Income					% Change in Market Value
Change in Market Interest Rates (basis points)	September 30, 2022		December 31, 2021		Change in Market Interest Rates (basis points)	September 30, 2022		December 31, 2021
(100)	(3.4)	%	(1.4)	%	(100)	(11.5)	%	(43.8)	%
100	(1.4)	%	3.7	%	100	3.7	%	25.8	%
200	(3.9)	%	6.7	%	200	4.6	%	41.2	%

Item 4. Controls and Procedures

Based on the evaluation required by Exchange Act Rules 13a-15(b) and 15d-15(b), the Company's management, including the Chief Executive Officer and Chief Financial Officer, conducted an evaluation of the effectiveness of its disclosure controls and procedures, as defined in Exchange Act Rules 13a-15(e) and 15d-15(e), at September 30, 2022. Based on that evaluation, our Chief Executive Officer and Chief Financial Officer concluded that the Company's disclosure controls and procedures were effective at September 30, 2022. There have been no changes in internal control over financial reporting that have materially affected, or are reasonably likely to materially affect, the Company's internal control over financial reporting during the nine months ended September 30, 2022.

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PART II – OTHER INFORMATION

Item 1 – Legal Proceedings

Information regarding legal proceedings is included in Note 12, Contingencies, to the Consolidated Financial Statements under Part I, Item 1, "Financial Statements" and incorporated herein by reference.

Item 1A – Risk Factors

There have been no material changes from the risk factors as disclosed in our Annual Report on Form 10-K for the year ended December 31, 2021, and our Quarterly Report on Form 10-Q for the periods ended March 31, 2022 and June 30, 2022.

Item 2 – Unregistered Sales of Equity Securities and Use of Proceeds


	(a)	(b)		(c)	(d)
Period	Total number of shares (or units) purchased	Average price paid per share (or unit)		Total number of shares (or units) purchased as part of publicly announced plans or programs	Maximum number (or approximate dollar value) of shares (or units) that may yet be purchased under the plans or programs
July 1, 2022 to July 31, 2022	—	$	—	—	154,371
August 1, 2022 to August 31, 2022	1,169	26.14		1,169	153,202
September 1, 2022 to September 30, 2022	—	—		—	153,202
Total	1,169	$	26.14	1,169

In September 2015, the Board of Directors of the Company authorized a share repurchase program under which the Company may repurchase up to 5% of the Company's outstanding shares of common stock, or approximately 416,000 shares, in accordance with all applicable securities laws and regulations, including Rule 10b-18 of the Exchange Act. On April 19, 2021, the Board of Directors authorized the additional future repurchase of up to 562,000 shares of its outstanding common stock. When and if appropriate, repurchases may be made in open market or privately negotiated transactions, depending on market conditions, regulatory requirements and other corporate considerations, as determined by management. Share repurchases may not occur and may be discontinued at any time. For the three months ended September 30, 2022, the Company repurchased 1,169 shares of its common stock at an average price of $26.14 per share. At September 30, 2022, 824,798 shares had been repurchased under the program at a total cost of $18.8 million, or $22.79 per share. Common stock available for future repurchase totals approximately 153,202 shares, or 1% of the Company's outstanding common stock at September 30, 2022.

Item 3 – Defaults Upon Senior Securities

Not applicable.

Item 4 – Mine Safety Disclosures

Not applicable.

Item 5 – Other Information

None.

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Item 6 – Exhibits


3.1						Articles of Incorporation as amended, incorporated by reference to Exhibit 3.1 of the Registrant’s Report on Form 8-K filed on January 29, 2010.

3.2						By-laws as amended, incorporated by reference to Exhibit 3.2 to the Registrant’s Report on Form 8-K filed June 2, 2021 .

4.1						Specimen Common Stock Certificate, incorporated by reference to the Registrant’s Registration Statement on Form S-3 filed February 8, 2010 (File No. 333-164780).

31.1						Rule 13a – 14(a)/15d-14(a) Certification (Principal Executive Officer)

31.2						Rule 13a – 14(a)/15d-14(a) Certifications (Principal Financial Officer)

32.1						Section 1350 Certifications (Principal Executive Officer)

32.2						Section 1350 Certifications (Principal Financial Officer)

101.LAB						XBRL Taxonomy Extension Label Linkbase

101.PRE						XBRL Taxonomy Extension Presentation Linkbase

101.INS						XBRL Instance Document

101.SCH						XBRL Taxonomy Extension Schema

101.CAL						XBRL Taxonomy Extension Calculation Linkbase

101.DEF						XBRL Taxonomy Extension Definition Linkbase

104						Cover Page Interactive Data File (formatted as inline XBRL and contained in Exhibit 101)

All other exhibits for which provision is made in the applicable accounting regulations of the Securities and Exchange Commission are not required under the related instructions or are inapplicable and therefore have been omitted.

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SIGNATURES

Pursuant to the requirements of the Securities Exchange Act of 1934, the registrant has duly caused this report to be signed on its behalf by the undersigned thereunto duly authorized.


			/s/ Thomas R. Quinn, Jr.
			Thomas R. Quinn, Jr.
			President and Chief Executive Officer
			(Principal Executive Officer)

			/s/ Neelesh Kalani
			Neelesh Kalani
			Executive Vice President and Chief Financial Officer
			(Principal Financial Officer)

			Date: November 9, 2022

TABLE OF CONTENTS

Part I Financial Information Item 1. Financial Statements Note 1. Summary Of Significant Accounting Policies Note 2. Investment Securities Note 3. Loans and Allowance For Loan Losses Note 4. Leases Note 5. Goodwill and Other Intangible Assets Note 6. Share-based Compensation Plans Note 7. Derivative Financial Instruments Note 8. Shareholders Equity and Regulatory Capital Note 9. (loss) Earnings Per Share Note 10. Financial Instruments with Off-balance Sheet Risk Note 11. Fair Value Note 12. Contingencies Note 13. Subsequent Events Item 2. Management S Discussion and Analysis Of Financial Condition and Results Of Operations Item 3. Quantitative and Qualitative Disclosures About Market Risk Item 4. Controls and Procedures Part II Other Information Item 1 Legal Proceedings Item 1A Risk Factors Item 2 Unregistered Sales Of Equity Securities and Use Of Proceeds Item 3 Defaults Upon Senior Securities Item 4 Mine Safety Disclosures Item 5 Other Information Item 6 Exhibits

Exhibits

3.1 Articles of Incorporation as amended, incorporated by reference to Exhibit 3.1 of the Registrants Report on Form8-K filed on January29, 2010. 3.2 By-laws as amended, incorporated by reference to Exhibit 3.2 to the Registrants Report on Form8-K filedJune 2, 2021. 4.1 Specimen Common Stock Certificate, incorporated by reference to the Registrants Registration Statement on FormS-3 filed February8, 2010 (File No.333-164780). 31.1 Rule 13a 14(a)/15d-14(a) Certification (Principal Executive Officer) 31.2 Rule 13a 14(a)/15d-14(a) Certifications (Principal Financial Officer) 32.1 Section 1350 Certifications (Principal Executive Officer) 32.2 Section 1350 Certifications (Principal Financial Officer)

ORRF 10-Q Quarter ended Sept. 30, 2022

Exhibits