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COMMUNITY FINANCIAL CORP /MD/ - Quarter Report: 2021 September (Form 10-Q)

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UNITED STATES
SECURITIES AND EXCHANGE COMMISSION
Washington, D.C. 20549
FORM10-Q
(Mark One)
QUARTERLY REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES EXCHANGE ACT OF 1934
For the Quarterly Period Ended September 30, 2021
OR
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: 001-36094
tcfc-20210930_g1.jpg
THE COMMUNITY FINANCIAL CORPORATION
(Exact Name of Registrant as Specified in Its Charter)
Maryland52-1652138
(State of Other Jurisdiction of Incorporation or Organization)(I.R.S. Employer Identification No.)
3035 Leonardtown Road, Waldorf, MD, 20601
(Address of Principal Executive Offices) (Zip Code)
(301) 645-5601
(Registrant’s Telephone Number, Including Area Code)
Not applicable
(Former name, former address and former fiscal year, if changed since last report)
Securities registered pursuant to Section 12(b) of Act:
Title of each classTrading Symbol(s)Name of each exchange on which registered
Common Stock, par value $0.01 per shareTCFCThe NASDAQ Stock Market LLC
Indicate by check mark whether the registrant (1) has filed all reports required to be filed by Section 13 or 15(d) of the Securities Exchange Act of 1934 during the preceding 12 months (or for such shorter period that the registrant was required to file such reports), and (2) has been subject to such filing requirements for the past 90 days. Yes  No
Indicate by check mark whether the registrant has submitted electronically every Interactive Data File required to be submitted pursuant to Rule 405 of Regulation S-T (§ 232.405 of this chapter) during the preceding 12 months (or for such shorter period that the registrant was required to submit such files). Yes  No
Indicate by check mark whether the registrant is a large accelerated filer, an accelerated filer, a non-accelerated filer, a smaller reporting company, or an emerging growth company. See definitions of “large accelerated filer”, “accelerated filer”, “smaller reporting company” and “emerging growth company” in Rule 12b-2 of the Exchange Act.
Large Accelerated Filer Accelerated Filer 
Non-accelerated Filer Smaller Reporting Company
Emerging growth company
If an emerging growth company, indicate by check mark if the registrant has elected not to use the extended transition period for complying with any new or revised financial accounting standards provided pursuant to Section 13(a) of the Exchange Act. 
Indicate by check mark whether the registrant is a shell company (as defined in Rule 12b-2 of the Exchange Act). Yes No
As of November 3, 2021, the registrant had 5,725,186 shares of common stock outstanding. 


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FORWARD-LOOKING STATEMENTS
Certain statements contained in this Report may not be based on historical facts and are “forward-looking statements” within the meaning of Section 27A of the Securities Act of 1933, as amended, and Section 21E of the Securities Exchange Act of 1934, as amended. Forward-looking statements can generally be identified by the fact that they do not relate strictly to historical or current facts. They often include words like “believe,” “expect,” “anticipate,” “estimate” and “intend” or future or conditional verbs such as “will,” “would,” “should,” “could” or “may.” Statements in this report that are not strictly historical are forward-looking and are based upon current expectations that may differ materially from actual results. These forward-looking statements include, without limitation, those relating to the Company’s and Community Bank of the Chesapeake’s future growth and management’s outlook or expectations for revenue, assets, asset quality, profitability, business prospects, net interest margin, non-interest revenue, allowance for loan losses, the level of credit losses from lending, liquidity levels, capital levels, or other future financial or business performance strategies or expectations, and any statements of the plans and objectives of management for future operations products or services, including the expected benefits from, and/or the execution of integration plans relating to any acquisition we have undertaking or that we undertake in the future; plans and cost savings regarding branch closings or consolidation; projections related to certain financial metrics; expected benefits of programs we introduce, including residential mortgage programs and retail and commercial credit card programs; and any statement of expectation or belief, and any assumptions underlying the foregoing. These forward-looking statements express management’s current expectations or forecasts of future events, results and conditions, and by their nature are subject to and involve risks and uncertainties that could cause actual results to differ materially from those anticipated by the statements made herein. Factors that might cause actual results to differ materially from those made in such statements include, but are not limited to: risks, uncertainties and other factors relating to the COVID-19 pandemic (including the length of time that the pandemic continues, the ability of states and local governments to successfully implement the lifting of restrictions on movement and the potential imposition of further restrictions on movement and travel in the future, the effect of the pandemic on the general economy and on the businesses of our borrowers and their ability to make payments on their obligations; the remedial actions and stimulus measures adopted by federal, state and local governments, and the inability of employees to work due to illness, quarantine, or government mandates); the synergies and other expected financial benefits from any acquisition that we have undertaken or may undertake in the future; may or may not be realized within the expected time frames; the impact of our adoption of the CECL standard; limitations on our ability to declare and pay dividends or engage in share repurchases; changes in the Company's or Community Bank of the Chesapeake’s strategy, costs or difficulties related to integration matters might be greater than expected; availability of and costs associated with obtaining adequate and timely sources of liquidity; the ability to maintain credit quality; general economic trends; changes in interest rates; loss of deposits and loan demand to other financial institutions; substantial changes in financial markets; changes in real estate value and the real estate market; regulatory changes; the impact of government shutdowns or sequestration; the possibility of unforeseen events affecting the industry generally; the uncertainties associated with newly developed or acquired operations; the outcome of pending or threatened litigation, or of matters before regulatory agencies, whether currently existing or commencing in the future; market disruptions and other effects of terrorist activities; and the matters described in “Item 1A Risk Factors” in the Company’s Annual Report on Form 10-K for the Year Ended December 31, 2020, and in its other Reports filed with the Securities and Exchange Commission (the “SEC”).
The Company’s forward-looking statements may also be subject to other risks and uncertainties, including those that it may discuss elsewhere in this Report or in its filings with the SEC, accessible on the SEC’s Web site at www.sec.gov. The Company undertakes no obligation to update these forward-looking statements to reflect events or circumstances after the date hereof or to reflect the occurrence of unforeseen events, except as required under the rules and regulations of the SEC.
You are cautioned not to place undue reliance on the forward-looking statements contained in this document in that actual results could differ materially from those indicated in such forward-looking statements, due to a variety of factors. Any forward-looking statement speaks only as of the date of this Report, and the Company undertakes no obligation to update these forward-looking statements to reflect events or circumstances that occur after the date of this Report.


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PART 1 – FINANCIAL INFORMATION
ITEM 1 – FINANCIAL STATEMENTS
CONSOLIDATED BALANCE SHEETS
(Unaudited)
(dollars in thousands, except per share amounts)September 30, 2021December 31, 2020
Assets
Cash and due from banks$112,314 $56,887 
Interest-bearing deposits with banks34,929 20,178 
Securities available for sale ("AFS"), at fair value456,664 246,105 
Equity securities carried at fair value through income4,805 4,855 
Non-marketable equity securities held in other financial institutions207 207 
Federal Home Loan Bank ("FHLB") stock - at cost1,472 2,777 
Net U.S. Small Business Administration ("SBA") Paycheck Protection Program ("PPP") Loans54,807 107,960 
Portfolio Loans Receivable net of allowance for loan losses of $18,579 and $19,424
1,514,837 1,486,115 
Net loans1,569,644 1,594,075 
Goodwill10,835 10,835 
Premises and equipment, net21,795 20,271 
Other real estate owned ("OREO")1,536 3,109 
Accrued interest receivable6,045 8,717 
Investment in bank owned life insurance38,713 38,061 
Core deposit intangible1,147 1,527 
Net deferred tax assets8,790 7,909 
Right of use assets - operating leases6,215 7,831 
Other assets3,581 3,095 
Total Assets$2,278,692 $2,026,439 
Liabilities and Stockholders’ Equity
Deposits
Non-interest-bearing deposits$432,606 $362,079 
Interest-bearing deposits1,572,001 1,383,523 
Total deposits2,004,607 1,745,602 
Long-term debt12,249 27,302 
Guaranteed preferred beneficial interest in junior subordinated debentures ("TRUPs")12,000 12,000 
Subordinated notes net of debt issuance costs - 4.75%
19,496 19,526 
Lease liabilities - operating leases6,418 8,088 
Accrued expenses and other liabilities19,794 15,908 
Total Liabilities2,074,564 1,828,426 
Stockholders’ Equity
Common stock - par value $0.01; authorized - 15,000,000 shares; issued 5,724,011 and 5,903,613 shares, respectively
57 59 
Additional paid in capital96,649 95,965 
Retained earnings107,890 97,944 
Accumulated other comprehensive (loss) income(9)4,504 
Unearned ESOP shares(459)(459)
Total Stockholders’ Equity204,128 198,013 
Total Liabilities and Stockholders’ Equity$2,278,692 $2,026,439 
See notes to Consolidated Financial Statements
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CONSOLIDATED STATEMENTS OF INCOME
(Unaudited)
Three Months Ended September 30,Nine Months Ended September 30,
(dollars in thousands, except per share amounts)2021202020212020
Interest and Dividend Income
Loans, including fees$16,342 $16,176 $49,254 $48,955 
Interest and dividends on investment securities1,296 1,269 3,461 4,079 
Interest on deposits with banks21 38 66 126 
Total Interest and Dividend Income17,659 17,483 52,781 53,160 
Interest Expense
Deposits594 1,534 2,036 6,515 
Short-term borrowings— 14 — 111 
Long-term debt456 567 1,192 1,589 
Total Interest Expense1,050 2,115 3,228 8,215 
Net Interest Income16,609 15,368 49,553 44,945 
Provision for loan losses— 2,500 586 10,100 
Net Interest Income After Provision For Loan Losses16,609 12,868 48,967 34,845 
Noninterest Income
Loan appraisal, credit, and miscellaneous charges29 49 271 98 
Gain on sale or disposition of assets— 68 
Net gains on sale of investment securities— 229 586 670 
Unrealized (loss) gain on equity securities(22)— (94)115 
Provision for loss on premises and equipment held for sale(20)— (20)— 
Income from bank owned life insurance220 222 652 661 
Service charges987 839 3,066 2,530 
Referral fee income176 321 1,248 1,966 
Net gain on sale of loans held for sale30 — 30 — 
Loss on sale of loans— — (191)— 
Total Noninterest Income1,400 1,666 5,616 6,046 
Noninterest Expense
Compensation and benefits 5,650 5,099 15,770 15,001 
Occupancy expense731 734 2,180 2,204 
Advertising145 129 372 380 
Data processing expense840 990 2,766 2,842 
Professional fees676 652 1,920 1,755 
Depreciation of equipment137 142 419 451 
FDIC Insurance120 249 512 679 
OREO valuation allowance and expenses20 421 689 2,303 
Core deposit intangible amortization121 144 380 452 
Other expenses1,007 891 3,965 2,464 
Total Noninterest Expense9,447 9,451 28,973 28,531 
Income before income taxes8,562 5,083 25,610 12,360 
Income tax expense2,158 1,284 6,475 2,363 
Net Income$6,404 $3,799 $19,135 $9,997 
Earnings Per Common Share
Basic$1.12 $0.64 $3.29 $1.70 
Diluted$1.12 $0.64 $3.29 $1.70 
See notes to Consolidated Financial Statements
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CONSOLIDATED STATEMENTS OF COMPREHENSIVE INCOME
(Unaudited)
Three Months Ended September 30,Nine Months Ended September 30,
(dollars in thousands)2021202020212020
Net Income$6,404 $3,799 $19,135 $9,997 
Net unrealized holding (loss) gain arising during period, net of tax (benefit) expenses of $(1,083) and $34, and $(1,744) and $940, respectively.
(3,072)94 (4,946)2,781 
Reclassification adjustment for gains included in net income, net of tax expense of $0 and $59, and $153 and $175, respectively.
— 169 433 495 
Comprehensive Income$3,332 $4,062 $14,622 $13,273 
See notes to Consolidated Financial Statements
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CONSOLIDATED STATEMENTS OF CHANGES IN STOCKHOLDERS’ EQUITY
(Unaudited)
For the Three Months Ended September 30, 2021 and 2020
(dollars in thousands)Common StockAdditional Paid-in CapitalRetained EarningsAccumulated Other Comprehensive IncomeUnearned ESOP SharesTotal
Balance at June 30, 2021$58 $96,411 $104,889 $3,063 $(459)$203,962 
Net Income— — 6,404 — — 6,404 
Unrealized holding loss on investment securities net of tax $(1,083)
— — — (3,072)— (3,072)
Cash dividend at $0.150 per common share
— — (812)— — (812)
Dividend reinvestment— 45 (45)— — — 
Net change in fair market value below cost of leveraged ESOP shares released— — — — 
Repurchase of common stock(1)— (2,546)— — (2,547)
Stock based compensation— 191 — — — 191 
Balance at September 30, 2021$57 $96,649 $107,890 $(9)$(459)$204,128 
(dollars in thousands)Common StockAdditional Paid-in CapitalRetained EarningsAccumulated Other Comprehensive IncomeUnearned ESOP SharesTotal
Balance at June 30, 2020$59 $95,687 $89,781 $4,517 $(602)$189,442 
Net Income— — 3,799 — — 3,799 
Unrealized holding gain on investment securities net of tax $93
— — — 263 — 263 
Cash dividend at $0.125 per common share
— — (705)— — (705)
Dividend reinvestment— 34 (34)— — — 
Net change in fair market value below cost of leveraged ESOP shares released— (21)— — — (21)
Stock based compensation— 99 — — — 99 
Balance at September 30, 2020$59 $95,799 $92,814 $4,780 $(602)$192,850 

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CONSOLIDATED STATEMENTS OF CHANGES IN STOCKHOLDERS’ EQUITY
(Unaudited)
For the Nine Months Ended September 30, 2021 and 2020
(dollars in thousands)Common StockAdditional Paid-in Capital
Retained Earnings 
Accumulated Other Comprehensive IncomeUnearned ESOP SharesTotal
Balance at January 1, 2021$59 $95,965 $97,944 $4,504 $(459)$198,013 
Net Income— — 19,135 — — 19,135 
Unrealized holding loss on investment securities net of tax $(1,591)
— — — (4,513)— (4,513)
Cash dividend at $0.425 per common share
— — (2,355)— — (2,355)
Dividend reinvestment— 125 (125)— — — 
Net change in fair market value below cost of leveraged ESOP shares released— (2)— — — (2)
Repurchase of common stock(2)— (6,709)— — (6,711)
Stock based compensation— 561 — — — 561 
Balance at September 30, 2021$57 $96,649 $107,890 $(9)$(459)$204,128 
(dollars in thousands)Common StockAdditional Paid-in CapitalRetained EarningsAccumulated Other Comprehensive Income (Loss)Unearned ESOP SharesTotal
Balance at January 1, 2020$59 $95,474 $85,059 $1,504 $(602)$181,494 
Net Income— — 9,997 — — 9,997 
Unrealized holding gain on investment securities net of tax $1,115
— — — 3,276 — 3,276 
Cash dividend at $0.375 per common share
— — (2,115)— — (2,115)
Dividend reinvestment— 100 (100)— — — 
Net change in fair market value over cost of leveraged ESOP shares released— (37)— — — (37)
Stock based compensation— 262 — — — 262 
Balance at September 30, 2020$59 $95,799 $92,814 $4,780 $(602)$192,850 
See notes to Consolidated Financial Statements
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CONSOLIDATED STATEMENTS OF CASH FLOWS
(Unaudited)
Nine Months Ended September 30,
(dollars in thousands)20212020
Cash Flows from Operating Activities
Net income$19,135 $9,997 
Adjustments to reconcile net income to net cash provided by operating activities
Provision for loan losses586 10,100 
Depreciation and amortization1,150 1,185 
Provision for loss on premises held for sale20 — 
Loans originated for resale(1,479)— 
Proceeds from sale of loans originated for sale1,514 — 
Net gains on sale of loans held for sale(30)— 
Loss on sale of loans 191 — 
Net (gain) loss on the sale of OREO(16)
Gains on sales of investment securities(586)(670)
Unrealized loss (gain) on equity securities94 (115)
Gain on sale or disposition of assets(68)(6)
Net amortization of premium/discount on investment securities636 70 
Net accretion of merger accounting adjustments(256)(509)
Net amortization of debt issuance costs(30)— 
Amortization of core deposit intangible380 452 
Amortization of right of use asset304 377 
Net change in right of use assets and lease liabilities(302)(302)
Increase in OREO valuation allowance641 2,177 
Increase in cash surrender value of bank owned life insurance(652)(661)
Decrease (increase) in deferred income tax benefit710 (2,253)
Decrease (increase) in accrued interest receivable2,672 (3,956)
Stock based compensation561 262 
Net change due to deficit of fair market value over cost of leveraged ESOP shares released(2)(37)
Decrease (increase) in net deferred loan costs2,324 3,542 
Increase (decrease) in accrued expenses and other liabilities3,886 1,236 
(Increase) decrease in other assets(917)(917)
Net Cash Provided by Operating Activities30,466 19,979 
Cash Flows from Investing Activities
Purchase of AFS investment securities(265,704)(107,351)
Proceeds from redemption or principal payments of AFS investment securities36,408 26,731 
Proceeds from sale of AFS investment securities12,540 64,109 
Net decrease (increase) of FHLB stock1,305 32 
Net change in loans9,617 (176,388)
Purchase of premises and equipment(2,264)(209)
Proceeds from sale of OREO947 2,831 
Proceeds from sale of loans11,965 — 
Proceeds from disposal of asset12 21 
Net Cash Used in Investing Activities(195,174)(190,224)

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CONSOLIDATED STATEMENTS OF CASH FLOWS (Continued)
(Unaudited)
Nine Months Ended September 30,
(dollars in thousands)20212020
Cash Flows from Financing Activities
Net increase in deposits$259,005 $267,769 
Proceeds from long-term debt— 164,036 
Payments of long-term debt(15,053)(76,194)
Net increase in short term borrowings— (5,000)
Payments of subordinated notes - 6.25%— (23,000)
Dividends paid(2,355)(2,115)
Repurchase of common stock(6,711)(27)
Net Cash Provided by Financing Activities234,886 325,469 
Increase in Cash and Cash Equivalents70,178 155,224 
Cash and Cash Equivalents - January 177,065 32,469 
Cash and Cash Equivalents - September 30$147,243 $187,693 
Supplemental Disclosures of Cash Flow Information
Cash paid during the period for
Interest$3,205 $9,072 
Income taxes$6,278 $7,133 
Supplemental Schedule of Non-Cash Operating Activities
Issuance of common stock for payment of compensation$164 $303 
Transfer from loans to OREO$— $1,240 
See notes to Consolidated Financial Statements
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NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
(UNAUDITED)
NOTE 1 – BASIS OF PRESENTATION AND NATURE OF OPERATIONS
Basis of Presentation
The Consolidated Financial Statements of The Community Financial Corporation (the “Company”) and its wholly-owned active subsidiary, Community Bank of the Chesapeake (the “Bank”).
The consolidated financial statements reflect all adjustments consisting only of normal recurring accruals that, in the opinion of management, are necessary to present fairly the Company’s financial condition, results of operations, and cash flows for the periods presented. Certain information and note disclosures normally included in consolidated financial statements prepared in accordance with accounting principles generally accepted in the United States of America ("U.S. GAAP") have been condensed or omitted pursuant to the rules and regulations of the SEC. Management believes that the included disclosures are adequate to make the information presented not misleading. The balances as of December 31, 2020 have been derived from audited consolidated financial statements. Additions to the Company’s accounting policies are disclosed in the 2020 Annual Report as well as the adoption of new accounting standards included in Note 1. The results of operations for the nine months September 30, 2021 are not necessarily indicative of the results of operations to be expected for the remainder of the year or any other period.
These consolidated financial statements should be read in conjunction with the consolidated financial statements and notes included in the Company’s 2020 Annual Report on Form 10-K.
Reclassification
Certain items in prior consolidated financial statements have been reclassified to conform to the current presentation.
Nature of Operations
The Company provides financial services to individuals and businesses through its offices in Southern Maryland, and Fredericksburg, Virginia. Its primary deposit products are demand, savings and time deposits, and its primary lending products are commercial and residential mortgage loans, commercial loans, construction and land development loans, home equity and second mortgages and commercial equipment loans.

Use of Estimates
The preparation of consolidated financial statements in conformity with U.S. GAAP requires management to make estimates and assumptions that affect the reported amounts of assets and liabilities and disclosure of contingent assets and liabilities as of the date of the consolidated financial statements and the reported amount of income and expenses during the reporting periods. Actual results could differ from those estimates. Material estimates that are particularly susceptible to significant change in the near term relate to the determination of the allowance for loan losses ("ALLL"), real estate acquired in the settlement of loans ("OREO"), fair value of financial instruments, fair value of assets acquired, and liabilities assumed in a business combination, evaluating other-than-temporary-impairment ("OTTI") of investment securities and valuation of deferred tax assets.
COVID-19
The COVID-19 pandemic impacted the Company's customers abilities to fulfill their financial obligations. In response to the likely effects on the economy of the pandemic, the Federal Open Market Committee reduced the federal funds rate from a target range of 1.50% to 1.75% to a target range of 0% to 0.25%.
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New Accounting Policy
See Note 1 – Summary of Significant Accounting Policies included in the Company’s 2020 Annual Report on Form 10-K for a list of policies in effect as of December 31, 2020.
COVID-19 Deferrals
On March 22, 2020, federal banking regulatory agencies, including the Board of Governors of the Federal Reserve System and the Federal Deposit Insurance Corporation, ("the agencies") issued an interagency statement on loan modifications and reporting for financial institutions working with customers affected by the Coronavirus. The interagency statement impacted accounting for loan modifications. Under Accounting Standards Codification 310-40, "Receivables - Troubled Debt Restructurings by Creditors," ("ASC 310-40"), a restructuring of debt constitutes a troubled debt restructure ("TDR") if the creditor, for economic or legal reasons related to the debtor's financial difficulties, grants a concession to the debtor that it would not otherwise consider. The agencies confirmed with the staff of the FASB that short-term modifications made on a good faith basis in response to COVID-19 to borrowers, who were current prior to any relief, are not to be considered TDRs. Under current law modifications were required to be executed between March 1, 2020, and the earlier of (A) January 1, 2022 or (B) 60 days after the date on which the national COVID-19 emergency terminates. The impacts of the interagency guidance are further described in the consolidated financial statements, notes to consolidated financial statements and Management's Discussion and Analysis of this Form 10Q and the Company’s 2020 Annual Report on Form 10-K.
The Company offered payment deferral programs for its customers who were adversely affected by the pandemic. Depending on the need of the client, the Company deferred full or partial loan payments up to 180 days. Interest and fees accrued to income, until the loan is placed in nonaccrual status, at which time interest income and fees accrued would be reversed. As of September 30, 2021 and December 31, 2020, the Company had $3.4 million and $35.4 million of loan deferrals, respectively.
Under the Coronavirus Aid, Relief and Economic Security ("CARES") Act, borrowers who were not considered past due prior to becoming affected by COVID-19 and then receive payment accommodations as a result of the effects of COVID-19 would not be reported as past due or nonaccrual for regulatory and financial reporting during the deferral period. If new information during the deferral period indicates that there is evidence of default, the Bank will change the classification rating and accrual status.
Financial Accounting Standards Board (“FASB”) Accounting Standards Update (“ASU”)
ASU 2016-13 - Financial Instruments - Credit Losses (Topic 326) - Measurement of Credit Losses on Financial Instruments. ASU No. 2016-13 changes how entities will measure credit losses for most financial assets and certain other instruments that are not measured at fair value through net income. The standard will replace the current “incurred loss” approach with an “expected loss” model. The new model, referred to as the current expected credit loss (“CECL”) model, will apply to: (1) financial assets subject to credit losses and measured at amortized cost, and (2) certain off-balance sheet credit exposures. This includes loans, leases, held-to-maturity securities, loan commitments, and financial guarantees. The ASU also simplifies the accounting model for purchase credit impaired (“PCI”) debt securities and loans. ASU 2016-13 also expands the disclosure requirements regarding an entity’s assumptions, models, and methods for estimating the Allowance for Credit Losses ("ACL"). In addition, entities will need to disclose the amortized cost balance for each class of financial asset by credit quality indicator, disaggregated by the year of origination. Entities will apply the standard’s provisions as a cumulative-effect adjustment to retained earnings as of the beginning of the first reporting period in which the guidance is effective (i.e., modified retrospective approach).
The Company is planning for CECL adoption. Our CECL model has been substantially developed and our third party model validation is substantially complete. We are conducting parallel runs of the loss estimation models throughout 2021. We are refining the qualitative components and forecasting components of our model. ASU 2016-13 will also require the establishment of an allowance for expected credit losses for certain debt securities and other financial assets.
The Company is required to adopt ASU No. 2016-13 for fiscal years beginning after December 15, 2022. Early adoption is permitted, and the Company expects to adopt ASU No. 2016-13 in the first quarter of 2022. Management expects to recognize a one-time cumulative effect adjustment to the allowance for credit losses as of the January 1, 2022. At this time, we expect our implementation of CECL to increase our reserve for credit losses, but cannot reasonably estimate a range of the impact of the adoption. Our fourth quarter refinement of our CECL qualitative framework may impact the cumulative effect adjustment.
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ASU 2019-05 - Financial Instruments-Credit Losses (Topic 326). In May 2019, the FASB issued ASU No. 2019-05. This ASU allows entities to irrevocably elect, upon adoption of ASU 2016-13, the fair value option for financial instruments that (1) were previously recorded at amortized cost and (2) are within the scope of ASC 326-20 if the instruments are eligible for the fair value option under ASC 825-10. The fair value option election does not apply to held-to-maturity debt securities. Entities are required to make this election on an instrument-by-instrument basis. The Company plans to adopt ASU 2019-05 upon adoption of ASU 2016-13 unless an earlier adoption is permitted in an accounting update. The Company is evaluating the impact of electing the fair value option of ASU 2019-05 on the Company's consolidated financial statements.
ASU 2020-04 - Reference Rate Reform (Topic 848). In March 2020, the FASB issued guidance to provide temporary optional guidance to ease the potential burden in accounting for reference rate reform. The amendments are effective as of March 12, 2020 through December 31, 2022. The Company does not expect these amendments to have a material effect on its consolidated financial statements.
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NOTE 2 – SECURITIES
Amortized cost and fair values of investment securities at September 30, 2021 and December 31, 2020 are as follows:
September 30, 2021
(dollars in thousands)Amortized CostGross Unrealized GainsGross Unrealized LossesEstimated Fair Value
Available-for-Sale ("AFS") Securities
Asset-backed securities issued by GSEs and U.S. Agencies
Residential Mortgage-Backed Securities ("MBS")$103,173 $1,302 $1,791 $102,684 
Residential Collateralized Mortgage Obligations ("CMOs")205,234 1,122 1,468 204,888 
U.S. Agency11,773 35 11,800 
Asset-backed securities ("ABSs") issued by Others:
Residential CMOs241 243 
Student Loan Trust ABSs57,244 623 155 57,712 
Municipal bonds62,571 1,020 718 62,873 
U.S. government obligations16,440 29 16,464 
Total AFS Securities
$456,676 $4,138 $4,150 $456,664 
Equity securities carried at fair value through income
CRA investment fund$4,805 $— $— $4,805 
Non-marketable equity securities
Other equity securities$207 $— $— $207 
Total Investment Securities
$461,688 $4,138 $4,150 $461,676 

December 31, 2020
(dollars in thousands)Amortized CostGross Unrealized GainsGross Unrealized LossesEstimated Fair Value
Available-for-Sale ("AFS") Securities
Asset-backed securities issued by GSEs and U.S. Agencies
Residential MBS$33,248 $1,735 $30 $34,953 
Residential CMOs125,564 2,180 297 127,447 
ABSs issued by Others:
Residential CMOs292 288 
Student Loan Trust ABSs37,141 386 88 37,439 
Municipal bonds42,268 2,210 — 44,478 
U.S. government obligations1,500 — — 1,500 
Total AFS Securities
$240,013 $6,516 $424 $246,105 
Equity securities carried at fair value through income
CRA investment fund$4,855 $— $— $4,855 
Non-marketable equity securities
Other equity securities$207 $— $— $207 
Total Investment Securities
$245,075 $6,516 $424 $251,167 
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At September 30, 2021 and December 31, 2020 securities with an amortized cost of $49.5 million and $48.2 million were pledged to secure certain customer deposits.
The Company recognized net gains of $0.6 million on the sale of AFS securities with aggregate carrying values of $11.9 million for the nine months ended September 30, 2021. During the year ended December 31, 2020, the Company recognized net gains of $1.4 million on the sale of AFS securities with carrying values of $62.5 million.
The Company’s investment portfolio includes securities that are in an unrealized loss position as of September 30, 2021. The Company has no intent to sell these securities, and maintains the ability to hold them until all principal of the securities has been recovered. Declines in the fair values of these securities are due to interest rate movements. As of September 30, 2021, the Company considers all securities with unrealized loss positions to be temporarily impaired, and consequently, does not believe it will sustain any material realized losses as a result of the current temporary decline in fair value. No charges related to OTTI were made during the three and nine months ended September 30, 2021, and the year ended December 31, 2020. Management believes that the securities will either recover in market value or be paid off as agreed.
AFS Securities
Gross unrealized losses and estimated fair value by length of time that individual AFS securities have been in a continuous unrealized loss position at September 30, 2021, and December 31, 2020 were as follows:
September 30, 2021Less Than 12 MonthsMore Than 12 MonthsTotal
(dollars in thousands)Fair ValueUnrealized LossFair ValueUnrealized LossFair ValueUnrealized Losses
Asset-backed securities issued by GSEs and U.S. Agencies$188,243 $2,803 $12,640 $464 $200,883 $3,267 
Residential CMOs
— — 68 68 
Student Loan Trust ABSs13,339 86 7,109 69 20,448 155 
Municipal bonds28,783 707 1,011 11 29,794 718 
U.S. government obligations3,997 1,500 — 5,497 
$234,362 $3,601 $22,328 $549 $256,690 $4,150 

December 31, 2020Less Than 12 MonthsMore Than 12 MonthsTotal
(dollars in thousands)Fair ValueUnrealized LossFair ValueUnrealized LossFair ValueUnrealized Losses
Asset-backed securities issued by GSEs and U.S. Agencies$32,281 $320 $670 $$32,951 $327 
Residential CMOs— — 87 87 
Student Loan Trust ABSs12,511 88 — — 12,511 88 
$44,792 $408 $757 $16 $45,549 $424 
Maturities
The amortized cost and estimated fair value of debt securities at September 30, 2021, and December 31, 2020 by contractual maturity, are shown below. Actual maturities will differ from contractual maturities because borrowers may have the right to call or prepay obligations with or without call premiums or prepayment penalties.
September 30, 2021December 31, 2020
(dollars in thousands)Amortized CostEstimated Fair ValueAmortized CostEstimated Fair Value
Within one year$32,679 $32,678 $36,165 $37,084 
Over one year through five years109,422 109,419 60,669 62,209 
Over five years through ten years167,788 167,784 67,158 68,862 
After ten years146,787 146,783 76,021 77,950 
Total AFS securities$456,676 $456,664 $240,013 $246,105 
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NOTE 3 – LOANS
Loans consist of the following:
 September 30, 2021December 31, 2020
(dollars in thousands)Total% of Gross LoansTotal% of Gross Loans
Portfolio Loans:
Commercial real estate$1,088,636 71.02 %$1,049,147 69.75 %
Residential first mortgages96,835 6.32 %133,779 8.89 %
Residential rentals172,082 11.22 %139,059 9.24 %
Construction and land development37,139 2.42 %37,520 2.49 %
Home equity and second mortgages26,518 1.73 %29,129 1.94 %
Commercial loans48,327 3.15 %52,921 3.52 %
Consumer loans2,168 0.14 %1,027 0.07 %
Commercial equipment61,346 4.00 %61,693 4.10 %
Gross portfolio loans1,533,051 100.00 %1,504,275 100.00 %
Adjustments:
Net deferred costs365 0.01 %1,264 0.08 %
Allowance for loan losses(18,579)(1.21)%(19,424)(1.29)%
(18,214)(18,160)
Net portfolio loans1,514,837 1,486,115 
Gross U.S. Small Business Administration ("SBA") Paycheck Protection Program ("PPP") loans56,424 110,320 
Net deferred fees(1,617)(2,360)
Net U.S. SBA PPP Loans54,807 107,960 
Total net loans$1,569,644 $1,594,075 
Gross Loans$1,589,475 $1,614,595 
The Company has segregated its loans into two categories: portfolio loans and U.S. SBA PPP loans.
Deferred Costs/Fees
Net deferred costs consist of fees paid by customers offset by the estimated costs to produce the loans. U.S. SBA PPP deferred fees consist of fees paid by the SBA offset by estimated costs. Deferred fees and costs are amortized into interest income as loans are repaid or forgiven.
Risk Characteristics of Portfolio Segments
Concentrations of Credit - Loans are primarily made within the Company’s operating footprint of Southern Maryland and the greater Fredericksburg area of Virginia. Real estate loans can be affected by the condition of the local real estate market. Commercial and industrial loans can be affected by the local economic conditions. The Bank's commercial loan portfolios include business loans secured by real estate, real estate development loans, commercial lines of credit and equipment loans. At September 30, 2021 and December 31, 2020, the Company had no loans outstanding with foreign entities.
The Company manages its credit products and exposure to credit losses (credit risk) by the following specific portfolio segments, which are levels at which the Company develops and documents its allowance for loan loss methodology. These segments are:
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Commercial Real Estate (“CRE”)
Commercial real estate loan balances include commercial construction and financing for a variety of commercial properties. Construction balances were 4.8% and 6.9% of the CRE portfolio at September 30, 2021 and December 31, 2020, respectively. The primary security on a commercial real estate loan is the real property and the leases that produce income for the real property. Loans secured by commercial real estate are generally limited to 80% of the lower of the appraised value or sales price at origination and have an initial contractual loan payment period ranging from three to 20 years.
Because payments on loans secured by such properties are often dependent on the successful operation or management of the properties, repayment of such loans may be subject to adverse conditions in the real estate market or the economy.
Residential First Mortgages
Residential first mortgage loans are generally long-term (10 to 30 years) amortizing loans. The Bank’s residential portfolio has both fixed-rate and adjustable-rate residential first mortgages.
The annual and lifetime limitations on interest rate adjustments may constrain interest rate increases on these loans.
As of September 30, 2021 and December 31, 2020, the Bank serviced $18.7 million and $23.9 million, respectively, in residential mortgage loans for others.
Residential Rentals
Residential rental mortgage loans are amortizing long-term loans. The loans are secured by income-producing 1-4 family units and apartments. Loans secured by residential rental properties are generally limited to 80% of the lower of the appraised value or sales price at origination and have an initial contractual loan payment period ranging from three to 20 years.
Loans secured by residential rental properties involve greater risks than 1-4 family residential mortgage loans. Although, there are similar risk characteristics shared with commercial real estate loans, the balances for the loans secured by residential rental properties are generally smaller. Payments on loans secured by residential rental properties are dependent on the successful operation of the properties; and repayment of these loans may be subject to more volatile conditions in the rental real estate market or the economy than similar owner-occupied properties.
Construction and Land Development
The Bank offers loans for the construction of residential dwellings. These loans are secured by the real estate under construction as well as by guarantees of the principals involved. In addition, the Bank offers loans to acquire and develop land. Construction and Land Development loans are dependent on the successful completion of the underlying project or the borrowers guarantee to repay the loan. As such, they are subject to the risks of the project including changing prices and interest rates. The repayment of these loans is also dependent on the borrower’s ability to successfully manage the construction and development activities.
Home Equity and Second Mortgage Loans
The Bank maintains a portfolio of home equity and second mortgage loans. These products contain a higher risk of default than residential first mortgages as in the event of foreclosure, the first mortgage would need to be paid off prior to collection of the second mortgage.
Commercial Loans
Commercial loans including lines of credit are short-term loans (5 years or less) that are secured by the equipment financed, the guarantees of the borrower, and other collateral. These loans are dependent on the success of the underlying business or the strength of the guarantor.
Consumer Loans
Consumer loans consist of loans secured by automobiles, boats, recreational vehicles and trucks. The Bank also makes home improvement loans and offers both secured and unsecured personal lines of credit. The repayment of these loans is dependent on the continued stability of the customer.
Commercial Equipment Loans
These loans consist primarily of fixed-rate, short-term loans collateralized by a commercial customer’s equipment or secured by real property, accounts receivable, or other security. These loans are dependent on the success of the underlying business or the strength of the guarantor.
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U.S. SBA PPP Loans
U.S. SBA PPP loans are fully guaranteed by the Small Business Administration and the Bank's ALLL does not include an allowance for U.S. SBA PPP loans. Management believes all U.S. SBA PPP loans were underwritten in accordance with the program's guidelines.
Non-accrual and Aging Analysis of Current and Past Due Loans
Non-accrual loans as of September 30, 2021 and December 31, 2020 were as follows:
 September 30, 2021
(dollars in thousands)Non-accrual Delinquent LoansNon-accrual Current LoansTotal Non-accrual Loans
Commercial real estate$758 $2,378 $3,136 
Residential first mortgages182 269 451 
Residential rentals257 704 961 
Home equity and second mortgages202 378 580 
Commercial equipment— 32 32 
 $1,399 $3,761 $5,160 
 December 31, 2020
(dollars in thousands)Non-accrual Delinquent LoansNon-accrual Current LoansTotal Non-accrual Loans
Commercial real estate$11,428 $5,184 $16,612 
Residential first mortgages335 459 794 
Residential rentals— 275 275 
Home equity and second mortgages202 293 495 
Commercial equipment— 46 46 
$11,965 $6,257 $18,222 
Non-accrual loans at December 31, 2020 included three TDRs totaling $1.52 million. There were no non-accrual TDR loans at September 30, 2021.
Non-accrual loans which did not have a specific allowance for impairment, amounted to $4.4 million and $12.4 million at September 30, 2021 and December 31, 2020, respectively. Interest due but not recognized on these balances at September 30, 2021 and December 31, 2020 were $0.1 million and $0.4 million, respectively. Non-accrual loans with a specific allowance for impairment amounted to $0.8 million and $5.8 million at September 30, 2021 and December 31, 2020, respectively. Interest due but not recognized on these balances at September 30, 2021 and December 31, 2020 were $0.1 million and $0.4 million, respectively.
The Company considers a loan to be past due or delinquent when the terms of the contractual obligation are not met by the borrower. Purchase Credit Impaired ("PCI") loans are included as a single category in the table below as management believes there is a lower likelihood of aggregate loss related to these loan pools. Additionally, PCI loans are discounted to allow for the accretion of income on a level yield basis over the life of the loan based on expected cash flows. Regardless of payment status, as long as cash flows can be reasonably estimated, the associated discount on these loan pools results in income recognition. An analysis of past due loans as of September 30, 2021 and December 31, 2020 were as follows:

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Age Analysis of Past Due Loan Receivables and PCI Loans
 September 30, 2021
(dollars in thousands)31-60 Days61-89 Days90 or Greater DaysTotal Past DuePCI LoansCurrentTotal Loan Receivables
Commercial real estate$— $— $759 $759 $1,144 $1,086,733 $1,088,636 
Residential first mortgages— — 182 182 — 96,653 96,835 
Residential rentals— 189 257 446 — 171,636 172,082 
Construction and land dev.— — — — — 37,139 37,139 
Home equity and second mtg.— — 202 202 — 26,316 26,518 
Commercial loans— — — — — 48,327 48,327 
Consumer loans— — — — — 2,168 2,168 
Commercial equipment— — — — — 61,346 61,346 
Total portfolio loans$— $189 $1,400 $1,589 $1,144 $1,530,318 $1,533,051 
U.S. SBA PPP loans$— $— $— $— $— $56,424 $56,424 

 December 31, 2020
(dollars in thousands)31-60 Days61-89 Days90 or Greater DaysTotal Past DuePCI LoansCurrentTotal Loan Receivables
Commercial real estate$— $— $11,428 $11,428 $1,572 $1,036,147 $1,049,147 
Residential first mortgages— — 335 335 — 133,444 133,779 
Residential rentals— — — — — 139,059 139,059 
Construction and land dev.— — — — — 37,520 37,520 
Home equity and second mtg.167 — 202 369 406 28,354 29,129 
Commercial loans— — — — — 52,921 52,921 
Consumer loans— — — 1,019 1,027 
Commercial equipment— — — 61,689 61,693 
Total portfolio loans$175 $$11,965 $12,144 $1,978 $1,490,153 $1,504,275 
U.S. SBA PPP loans$— $— $— $— $— $110,320 $110,320 

There were no loans that were past due 90 days or greater accruing interest at September 30, 2021 and December 31, 2020.
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Impaired Loans and Troubled Debt Restructures (“TDRs”)
Impaired loans, including TDRs, at September 30, 2021 and 2020 and at December 31, 2020 were as follows:
 September 30, 2021
(dollars in thousands)Unpaid Contractual Principal BalanceRecorded Investment With No AllowanceRecorded Investment With AllowanceTotal Recorded InvestmentRelated AllowanceQuarter Average Recorded InvestmentQuarter Interest Income RecognizedYTD Average Recorded InvestmentYTD Interest Income Recognized
Commercial real estate$3,205 $2,377 $759 $3,136 $291 $3,146 $25 $3,177 $80 
Residential first mortgages884 872 — 872 — 873 878 25 
Residential rentals990 961 — 961 — 961 13 956 38 
Home equity and second mtg.602 580 — 580 — 581 583 10 
Commercial equipment490 455 32 487 32 489 493 16 
Total$6,171 $5,245 $791 $6,036 $323 $6,050 $53 $6,087 $169 
 September 30, 2020
(dollars in thousands)Unpaid Contractual Principal BalanceRecorded Investment With No AllowanceRecorded Investment With AllowanceTotal Recorded InvestmentRelated AllowanceQuarter Average Recorded InvestmentQuarter Interest Income RecognizedYTD Average Recorded InvestmentYTD Interest Income Recognized
Commercial real estate$18,355 $16,000 $2,148 $18,148 $468 $18,181 $74 $18,243 $299 
Residential first mortgages1,741 1,739 — 1,739 — 1,747 11 1,770 39 
Residential rentals636 636 — 636 — 638 648 24 
Home equity and second mtg.552 540 — 540 — 542 607 12 
Commercial loans1,807 1,807 — 1,807 — 1,807 — 1,807 — 
Consumer loans— — — — — — — — — 
Commercial equipment532 476 42 518 42 527 536 29 
Total$23,623 $21,198 $2,190 $23,388 $510 $23,442 $102 $23,611 $403 

 December 31, 2020
(dollars in thousands)Unpaid Contractual Principal BalanceRecorded Investment With No AllowanceRecorded Investment With AllowanceTotal Recorded InvestmentRelated AllowanceYTD Average Recorded InvestmentYTD Interest Income Recognized
Commercial real estate$17,952 $11,915 $5,799 $17,714 $1,316 $17,729 $361 
Residential first mortgages2,001 1,989 — 1,989 — 2,043 70 
Residential rentals626 625 — 625 — 643 32 
Home equity and second mtg.568 555 — 555 — 559 15 
Commercial equipment527 472 40 512 40 531 30 
Total$21,674 $15,556 $5,839 $21,395 $1,356 $21,505 $508 
TDRs included in the impaired loan schedules above, as of September 30, 2021 and December 31, 2020 were as follows:
 September 30, 2021December 31, 2020
(dollars in thousands)Dollars Number of LoansDollarsNumber of Loans
Commercial real estate$— — $1,376 
Residential first mortgages— — 247 
Commercial equipment455 471 
Total TDRs455 2,094 
Less: TDRs included in non-accrual loans— — (1,522)(3)
Total accrual TDR loans$455 $572 
The Company had specific reserves of $0.4 million on six TDRs totaling $2.1 million at December 31, 2020 and no reserves on TDRs at September 30, 2021.
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Allowance for Loan Losses ("ALLL")
The following tables detail activity in the ALLL at and for the three and nine months ended September 30, 2021 and 2020. An allocation of the allowance to one category of loans does not prevent the Company from using that allowance to absorb losses in a different category.
Three Months EndedSeptember 30, 2021
(dollars in thousands)Beginning BalanceCharge-offsRecoveriesProvisionsEnding Balance
Commercial real estate$13,918 $(491)$$(12)$13,419 
Residential first mortgages847 — — 65 912 
Residential rentals1,186 — — 614 1,800 
Construction and land development332 — — 36 368 
Home equity and second mortgages242 — 249 
Commercial loans1,113 — 529 (733)909 
Consumer loans28 — — 14 42 
Commercial equipment798 — 20 10 828 
 18,464 (491)554 — 18,527 
Purchase Credit Impaired52 — — — 52 
Total$18,516 $(491)$554 $— $18,579 
Nine Months Ended
September 30, 2021
(dollars in thousands)Beginning BalanceCharge-offsRecoveriesProvisionsEnding Balance
Commercial real estate$13,744 $(1,739)$$1,408 $13,419 
Residential first mortgages1,305 (142)— (251)912 
Residential rentals1,413 (46)— 433 1,800 
Construction and land development401 — — (33)368 
Home equity and second mortgages261 — (16)249 
Commercial loans1,222 (76)539 (776)909 
Consumer loans20 — — 22 42 
Commercial equipment1,058 (34)57 (253)828 
19,424 (2,037)606 534 18,527 
Purchase Credit Impaired— — — 52 52 
Total$19,424 $(2,037)$606 $586 $18,579 
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Three Months EndedSeptember 30, 2020
(dollars in thousands)Beginning BalanceCharge-offsRecoveriesProvisionsEnding Balance
Commercial real estate$11,268 $(15)$15 $1,852 $13,120 
Residential first mortgages885 — — 225 1,110 
Residential rentals1,059 — — 420 1,479 
Construction and land development428 — — 26 454 
Home equity and second mortgages259 — 46 312 
Commercial loans1,161 — (87)1,079 
Consumer loans15 (6)— 11 20 
Commercial equipment1,243 (44)49 1,255 
16,318 (65)76 2,500 18,829 
Purchase Credit Impaired— — — — — 
Total$16,318 $(65)$76 $2,500 $18,829 
Nine Months Ended
September 30, 2020
(dollars in thousands)Beginning BalanceCharge-offsRecoveriesProvisionsEnding Balance
Commercial real estate$7,398 $(944)$15 $6,651 $13,120 
Residential first mortgages464 — — 646 1,110 
Residential rentals397 — — 1,082 1,479 
Construction and land development273 — — 181 454 
Home equity and second mortgages149 (25)180 312 
Commercial loans1,086 (1,027)15 1,005 1,079 
Consumer loans10 (6)— 16 20 
Commercial equipment1,165 (326)77 339 1,255 
10,942 (2,328)115 10,100 18,829 
Purchase Credit Impaired— — — — — 
Total$10,942 $(2,328)$115 $10,100 $18,829 

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The following tables detail loan receivable and allowance balances at September 30, 2021 and 2020 and December 31, 2020.
 September 30, 2021December 31, 2020September 30, 2020
(dollars in thousands)Ending balance: individually evaluated for impairmentEnding balance: collectively evaluated for impairmentPurchase Credit ImpairedTotalEnding balance: individually evaluated for impairmentEnding balance: collectively evaluated for impairmentPurchase Credit ImpairedTotalEnding balance: individually evaluated for impairmentEnding balance: collectively evaluated for impairmentPurchase Credit ImpairedTotal
Loan Receivables:
Commercial real estate$3,136 $1,084,356 $1,144 $1,088,636 $17,714 $1,029,861 $1,572 $1,049,147 $18,148 $1,002,258 $1,581 $1,021,987 
Residential first mortgages872 95,963 — 96,835 1,989 131,790 — 133,779 1,739 146,017 — 147,756 
Residential rentals961 171,121 — 172,082 625 138,434 — 139,059 636 137,314 — 137,950 
Construction and land development— 37,139 — 37,139 — 37,520 — 37,520 — 36,061 — 36,061 
Home equity and second mortgages580 25,938 — 26,518 555 28,168 406 29,129 540 30,483 404 31,427 
Commercial loans— 48,327 — 48,327 — 52,921 — 52,921 1,807 57,087 — 58,894 
Consumer loans— 2,168 — 2,168 — 1,027 — 1,027 — 1,081 — 1,081 
Commercial equipment487 60,859 — 61,346 512 61,181 — 61,693 518 60,858 — 61,376 
$6,036 $1,525,871 $1,144 $1,533,051 $21,395 $1,480,902 $1,978 $1,504,275 $23,388 $1,471,159 $1,985 $1,496,532 
Allowance for loan losses:
Commercial real estate$291 $13,128 $52 $13,471 $1,316 $12,428 $— $13,744 $468 $12,652 $— $13,120 
Residential first mortgages— 912 — 912 — 1,305 — 1,305 — 1,110 — 1,110 
Residential rentals— 1,800 — 1,800 — 1,413 — 1,413 — 1,479 — 1,479 
Construction and land development— 368 — 368 — 401 — 401 — 454 — 454 
Home equity and second mortgages— 249 — 249 — 261 — 261 — 312 — 312 
Commercial loans— 909 — 909 — 1,222 — 1,222 — 1,079 — 1,079 
Consumer loans— 42 — 42 — 20 — 20 — 20 — 20 
Commercial equipment32 796 — 828 40 1,018 — 1,058 42 1,213 — 1,255 
$323 $18,204 $52 $18,579 $1,356 $18,068 $— $19,424 $510 $18,319 $— $18,829 

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Credit Quality Indicators
Credit quality indicators as of September 30, 2021 and December 31, 2020 were as follows:
Credit Risk Profile by Internally Assigned Grade
 Commercial Real EstateConstruction and Land Dev.Residential Rentals
(dollars in thousands)9/30/202112/31/20209/30/202112/31/20209/30/202112/31/2020
Unrated$— $162,434 $— $1,036 $— $47,605 
Pass1,084,372 866,648 37,139 36,484 171,121 90,633 
Special mention600 2,417 — — — 821 
Substandard3,664 17,648 — — 961 — 
Doubtful— — — — — — 
Loss— — — — — — 
Total$1,088,636 $1,049,147 $37,139 $37,520 $172,082 $139,059 
 Commercial LoansCommercial EquipmentTotal Commercial Portfolios
(dollars in thousands)9/30/202112/31/20209/30/202112/31/20209/30/202112/31/2020
Unrated$— $12,962 $— $26,585 $— $250,622 
Pass48,327 39,959 61,134 31,091 1,402,093 1,064,815 
Special mention— — 180 3,977 780 7,215 
Substandard— — 32 40 4,657 17,688 
Doubtful— — — — — — 
Loss— — — — — — 
Total$48,327 $52,921 $61,346 $61,693 $1,407,530 $1,340,340 

Non-Commercial Portfolios**U.S. SBA PPP LoansTotal Loans Portfolios
(dollars in thousands)9/30/202112/31/20206/30/202012/31/20199/30/202112/31/2020
Unrated$103,696 $136,792 $56,424 $110,320 $160,120 $497,734 
Pass21,355 25,125 — — 1,423,448 1,089,940 
Special mention— 457 — — 780 7,672 
Substandard470 1,561 — — 5,127 19,249 
Doubtful— — — — — — 
Loss— — — — — — 
Total$125,521 $163,935 $56,424 $110,320 $1,589,475 $1,614,595 
_______________________________________
**Non-commercial portfolios are generally evaluated based on payment activity but may be risk graded if part of a larger commercial relationship or are credit impaired (e.g. non-accrual loans, TDRs).
Credit Risk Profile Based on Payment Activity
 Residential First MortgagesHome Equity and Second Mtg.Consumer Loans
(dollars in thousands)9/30/202112/31/20209/30/202112/31/20209/30/202112/31/2020
Performing$96,653 $133,444 $26,316 $28,927 $2,168 $1,027 
Nonperforming182 335 202 202 — — 
Total$96,835 $133,779 $26,518 $29,129 $2,168 $1,027 
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A risk-grading scale is used to assign grades to commercial relationships, which include commercial real estate, residential rentals, construction and land development, commercial loans and commercial equipment loans. Commercial loan relationships are graded at inception and at a minimum annually. At December 31, 2020 and prior, only commercial loan relationships with an aggregate exposure to the Bank of $1,000,000 or greater were subject to being risk rated. During the quarter ended June 30, 2021, the Bank's policy was amended to risk rate all commercial loan relationships.
Home equity, second mortgages, consumer loans, and residential first mortgages are evaluated for creditworthiness in underwriting and are monitored based on borrower payment history. Residential first mortgages, home equity and second mortgages and consumer loans are classified as unrated unless they are part of a larger commercial relationship that requires grading or are loans with an Other Assets Especially Mentioned ("OAEM") or higher risk rating.
Management regularly reviews credit quality indicators. Loans subject to risk ratings are graded on a scale of one to ten.
Ratings 1 thru 6 - Pass Loans rated pass display none of the characteristics of classified loans.
Rating 7 - OAEM (Other Assets Especially Mentioned) – Special Mention loans have potential weaknesses that deserve management’s close attention. If uncorrected these weaknesses may result in deterioration of the repayment prospects or collateral position at some future date. Special mention assets are not adversely classified.
Rating 8 - Substandard – A substandard loan is inadequately protected by the current net worth and payment capacity of the borrower or of the collateral pledged. Loans classified as substandard have a well-defined weakness, or weaknesses that jeopardize the liquidation of the debt. These loans are characterized by the distinct possibility of loss if the deficiencies are not corrected.
Rating 9 - Doubtful – A loan classified as doubtful has all the weaknesses inherent in a loan classified as substandard with the added characteristics that the weaknesses make collection or liquidation in full improbable on the basis of currently existing facts, conditions, and values.
Rating 10 – Loss – Once an asset is identified as a definite loss to the Bank, it will receive the classification of “loss.” There may be some future potential recovery; however, it is more practical to write off the loan at the time of classification. Losses will be taken in the period in which they are determined to be non-collectable.
PCI Loans and Acquired Loans
PCI loans had an unpaid principal balance of $1.4 million and a carrying value of $1.1 million at September 30, 2021. Determining the fair value of the PCI loans at the time of acquisition required the Company to estimate cash flows expected to result from those loans and to discount those cash flows at appropriate rates of interest considering prepayment assumptions. For such loans, the excess of cash flows expected at acquisition over the estimated fair value is recognized as interest income over the remaining lives of the loans and is called accretable yield. The difference between contractually required payments at acquisition and the cash flows expected to be collected at acquisition reflects the impact of estimated credit losses and is called the nonaccretable difference.
A summary of changes in the accretable yield for PCI loans for the three and nine months ended September 30, 2021 and 2020 and the year ended December 31, 2020 follows:
 Three Months Ended September 30,Nine Months Ended September 30,
(dollars in thousands)2021202020212020
Accretable yield, beginning of period$324 $415 $342 $677 
Additions— — — — 
Accretion(31)(46)(92)(184)
Reclassification from nonaccretable difference15 — 29 24 
Other changes, net(15)— 14 (148)
Accretable yield, end of period$293 $369 $293 $369 
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At September 30, 2021 performing acquired loans, which totaled $49.3 million, included a $0.5 million net acquisition accounting fair market value adjustment, representing a 1.09% discount; and PCI loans which totaled $1.1 million, included a $0.3 million adjustment, representing a 20.59% discount. At December 31, 2020 acquired performing loans, which totaled $59.0 million, included an $0.8 million net acquisition accounting fair market value adjustment, representing a 1.25% discount; and PCI loans which totaled $2.0 million, included a $0.3 million adjustment, representing a 14.95% discount.
During the three months ended September 30, 2021 and 2020 there was $91,000 and $0.1 million, respectively, of accretion interest.
Accounting standards require a periodic recast of the expected cash flows on the PCI loan portfolio. The recast was performed during the second quarter of 2021 and 2020 which resulted in a reclassification of $37,000, net of PCI impairment, and $24,000, respectively, from the credit (nonaccretable) portion of the discount to the liquidity (accretable) portion of the discount.
The following is a summary of acquired and non-acquired loans as of September 30, 2021 and December 31, 2020:
BY ACQUIRED AND NON-ACQUIREDSeptember 30, 2021%December 31, 2020%
Acquired loans - performing$49,342 3.10 %$58,999 3.66 %
Acquired loans - PCI1,144 0.07 %1,978 0.12 %
Total acquired loans50,486 3.17 %60,977 3.78 %
U.S. SBA PPP loans56,424 3.55 %110,320 6.83 %
Non-acquired loans**1,482,565 93.28 %1,443,298 89.39 %
Gross loans1,589,475 1,614,595 
Net deferred fees(1,252)(0.08)%(1,096)(0.07)%
Total loans, net of deferred fees$1,588,223 $1,613,499 
______________________________
**Non-acquired loans include loans transferred from acquired pools following release of acquisition accounting FMV adjustments.
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NOTE 4 – GOODWILL AND OTHER INTANGIBLE ASSETS
Goodwill and other intangible assets are presented in the tables below.
(dollars in thousands)As of September 30, 2021As of December 31, 2020
Goodwill$10,835 $10,835 
As of September 30, 2021As of December 31, 2020
(dollars in thousands)Gross Carrying AmountAccumulated AmortizationNet Intangible AssetsGross Carrying AmountAccumulated AmortizationNet Intangible Assets
Core deposit intangible$3,590 $(2,443)$1,147 $3,590 $(2,063)$1,527 
The estimated future amortization expense for intangible assets remaining as of September 30, 2021 is as follows:
(dollars in thousands)
Remainder of 2021$115 
2022398 
2023302 
2024205 
2025109 
Thereafter18 
$1,147 
As of September 30, 2021, the Company did not have impairment to goodwill or core deposit intangibles ("CDI").
In the third quarter of 2020, management determined that the COVID-19 pandemic and its impact on the banking industry, was deemed a triggering event that required an interim impairment test for goodwill. Management engaged an independent consultant to perform a quantitative goodwill and CDI impairment analysis for the Company's single reporting unit, the Bank, as of September 15, 2020 ("the measurement date"). The impairment analysis used both market and income valuation approaches. The market approach analyzed transaction and control premium information for the Company and a selected peer group. The income approach analyzed discounted cash flows. The results of the methods were weighted to determine an overall value. Significant estimates and assumptions included, but were not limited to, projected profitability ratios, discount rates, cash flows projections selection and evaluation and selection of control premiums in appropriate market transactions and selection of peers.
Management performed its annual analysis of goodwill and CDI during the fourth quarter of 2020 and concluded that there was no impairment at December 31, 2020. At September 30, 2021, management's analysis concluded that there were no changes in the Company's financial statements or operations subsequent to the measurement date and the fourth quarter 2020 annual analysis that would indicate that it was more likely than not that goodwill or CDI was impaired.
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NOTE 5 – OTHER REAL ESTATE OWNED (“OREO”)
OREO assets are presented net of the valuation allowance. The Company considers OREO as classified assets for regulatory and financial reporting. OREO carrying amounts reflect management’s estimate of the realizable value of these properties. An analysis of OREO activity follows.
Nine Months Ended September 30,Years Ended December 31,
(dollars in thousands)202120202020
Balance at beginning of year$3,109 $7,773 $7,773 
Additions of underlying property— 1,240 1,240 
Disposals of underlying property(932)(2,838)(2,882)
Valuation allowance(641)(2,177)(3,022)
Balance at end of period$1,536 $3,998 $3,109 
Expenses applicable to OREO assets included the following.
Nine Months Ended September 30,
(dollars in thousands)20212020
Valuation allowance$641 $2,177 
Losses (gains) on dispositions(16)
Operating expenses64 119 
$689 $2,303 
There were no impaired loans secured by residential real estate for which formal foreclosure proceedings were in the process as of September 30, 2021 and December 31, 2020.
NOTE 6 – DEPOSITS
Deposits consist of the following:
(dollars in thousands)September 30, 2021December 31, 2020
Balance%Balance%
Noninterest-bearing demand$432,606 21.58 %$362,079 20.74 %
Interest-bearing:
Demand764,482 38.14 %590,159 33.81 %
Money market deposits355,582 17.74 %340,725 19.52 %
Savings112,282 5.60 %98,783 5.66 %
Certificates of deposit339,655 16.94 %353,856 20.27 %
Total interest-bearing1,572,001 78.42 %1,383,523 79.26 %
Total Deposits$2,004,607 100.00 %$1,745,602 100.00 %
The aggregate amount of certificates of deposit that exceed the FDIC insurance limit of $250,000 at September 30, 2021 and December 31, 2020 was $63.2 million and $64.3 million, respectively.
The Company monitors all customer deposit concentrations at or above 2% of total deposits. At September 30, 2021, the Bank had three customer deposit relationships that exceeded 2% of total deposits, totaling $383.4 million. At December 31, 2020, the Bank had two customer deposit relationships that exceeded 2% of total deposits, totaling $238.8 million. These concentrations were with local municipal agencies.
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NOTE 7 – COMMITMENTS & CONTINGENCIES
Operating Leases
The Company's operating lease agreements are for branches and office space.
The table below details the Company's operating leases:
(dollars in thousands)September 30, 2021December 31, 2020
Operating Leases
Operating lease right of use asset, net$6,215 $7,831 
Operating lease liability$6,418 $8,088 
Weighted average remaining lease term17.18 years18.21 years
Weighted average discount rate3.51 %3.52 %
Remaining lease term - min6.0 years0.7 years
Remaining lease term - max23.0 years24.0 years
The table below details the Company's lease cost, which is included in occupancy expense.
Three Months Ended September 30,Nine Months Ended September 30,
(dollars in thousands)2021202020212020
Operating lease cost$146 $198 $489 $594 
Cash paid for lease liability$150 $175 $485 $521 
A maturity analysis of operating lease liabilities and reconciliation of the undiscounted cash flows to the total operating lease liability is as follows:
(dollars in thousands)As of September 30, 2021
Lease payments due:
Within one year$527 
After one but within two years536 
After two but within three years542 
After three but within four years568 
After four but within five years593 
After five years5,974 
Total undiscounted cash flows8,740 
Discount on cash flows2,322 
Total lease liability$6,418 
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NOTE 8 – GUARANTEED PREFERRED BENEFICIAL INTEREST IN JUNIOR SUBORDINATED DEBENTURES (“TRUPs”)
On June 15, 2005, Tri-County Capital Trust II (“Capital Trust II”), a Delaware business trust formed, funded and wholly-owned by the Company, issued $5.0 million of variable-rate capital securities in a private pooled transaction. The variable rate is based on the 90-day LIBOR rate plus 1.70%. The Trust used the proceeds from this issuance, along with the $0.2 million for Capital Trust II’s common securities, to purchase $5.2 million of the Company’s junior subordinated debentures. The interest rate on the debentures and the trust preferred securities is variable and adjusts quarterly. These capital securities qualify as Tier I capital and are presented in the Consolidated Balance Sheets as “Guaranteed Preferred Beneficial Interests in Junior Subordinated Debentures.” Both the capital securities of Capital Trust II and the junior subordinated debentures are scheduled to mature on June 15, 2035, unless called by the Company.
On July 22, 2004, Tri-County Capital Trust I (“Capital Trust I”), a Delaware business trust formed, funded and wholly owned by the Company, issued $7.0 million of variable-rate capital securities in a private pooled transaction. The variable rate is based on the 90-day LIBOR rate plus 2.60%. The Trust used the proceeds from this issuance, along with the Company’s $0.2 million capital contribution for Capital Trust I’s common securities, to purchase $7.2 million of the Company’s junior subordinated debentures. The interest rate on the debentures and the trust preferred securities is variable and adjusts quarterly. These debentures qualify as Tier I capital and are presented in the Consolidated Balance Sheets as “Guaranteed Preferred Beneficial Interests in Junior Subordinated Debentures.” Both the capital securities of Capital Trust I and the junior subordinated debentures are scheduled to mature on July 22, 2034, unless called by the Company.
NOTE 9 – SUBORDINATED NOTES
On October 14, 2020, the Company issued and sold $20.0 million in aggregate principal amount of its 4.75% Fixed to Floating Rate Subordinated Notes due 2030 (the "Notes"). The Notes were sold by the Company in a private offering. The Notes mature on October 15, 2030 and bear interest at a fixed rate of 4.75% to October 14, 2025. From October 15, 2025 to the maturity date or early redemption date, the interest rate will reset quarterly to the three month Secured Overnight Financing Rate ("SOFR") plus 458 basis points. The Company may redeem the Notes at any time after October 14, 2025, and at any time in whole, but not in part, upon the occurrence of certain events. Any redemption of the Notes will be subject to prior regulatory approval. The Company incurred debt issuance costs for placement fees, legal and other out-of-pocket expenses of approximately $0.6 million, which are being amortized over the life of the Notes.
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NOTE 10 – REGULATORY CAPITAL
The Bank’s primary regulator is the Federal Deposit Insurance Corporation (“FDIC”). The Bank is subject to regulation, supervision and examination by the Maryland Commissioner of Financial Regulation (the “Commissioner”) and the FDIC. The Company is subject to regulation, examination, and supervision by the Federal Reserve Board under the Bank Holding Company Act of 1956, as amended (the “BHCA”).
The Company and Bank are subject to the Basel III Capital Rules which establish a comprehensive capital framework for U.S. banking organizations. The rules implement the Basel Committee’s “Basel III” framework for strengthening international capital standards as well as certain provisions of the Dodd-Frank Act. The Basel III Capital Rules define the components of capital and address other issues affecting banking institutions’ regulatory capital ratios.

The rules include a common equity Tier 1 capital to risk-weighted assets minimum ratio of 4.50%, a minimum ratio of Tier 1 capital to risk-weighted assets of 6.0%, require a minimum ratio (“Min. Ratio”) of Total Capital to risk-weighted assets of 8.0%, and require a minimum Tier 1 leverage ratio of 4.0%. A capital conservation buffer (“CCB”) is also established above the regulatory minimum capital requirements. The rules revised the definition and calculation of Tier 1 capital, Total Capital, and risk-weighted assets.
As of September 30, 2021 and December 31, 2020, the Company and Bank were well-capitalized under the regulatory framework for prompt corrective action ("PCA") under the new Basel III Capital Rule and Management believes the Company and the Bank met all capital adequacy requirements. The Company’s and the Bank’s actual regulatory capital amounts and ratios are presented in the following table.
Regulatory Capital and RatiosThe CompanyThe Bank
(dollars in thousands)September 30, 2021December 31, 2020September 30, 2021December 31, 2020
Common equity$204,128 $198,013 $231,839 $217,142 
Goodwill(10,835)(10,835)(10,835)(10,835)
Core deposit intangible (net of deferred tax liability)(851)(1,129)(851)(1,129)
AOCI (gains) losses(4,504)(4,504)
Common Equity Tier 1 Capital192,451 181,545 220,162 200,674 
TRUPs12,000 12,000 — — 
Tier 1 Capital204,451 193,545 220,162 200,674 
Allowable reserve for credit losses and other Tier 2 adjustments18,630 19,475 18,630 19,475 
Subordinated notes19,496 19,526 — — 
Tier 2 Capital$242,577 $232,546 $238,792 $220,149 
Risk-Weighted Assets ("RWA")$1,618,114 $1,582,581 $1,616,802 $1,580,786 
Average Assets ("AA")$2,172,192 $2,025,061 $2,170,563 $2,023,325 
Regulatory Min. Ratio + CCB (1)
Common Tier 1 Capital to RWA7.00 %11.89 %11.47 %13.62 %12.69 %
Tier 1 Capital to RWA8.50 12.64 12.23 13.62 12.69 
Tier 2 Capital to RWA10.50 14.99 14.69 14.77 13.93 
Tier 1 Capital to AA (Leverage) (2)
n/a9.41 9.56 10.14 9.92 
____________________________________
(1)The regulatory minimum capital ratio ("Min. Ratio") + the capital conservation buffer ("CCB").
(2)Tier 1 Capital to AA (Leverage) has no capital conservation buffer defined. The PCA well capitalized is defined as 5.00%.
Dividends paid by the Company are substantially funded from dividends received from the Bank. Federal and holding company regulations, as well as Maryland law, impose restrictions on capital distributions, including dividend payments and share repurchases. Some of the restrictions generally require advance approval from the Bank's regulator for payment of dividends in excess of the sum of net income for the current calendar year and the retained net income of the prior two calendar years.
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NOTE 11 – FAIR VALUE MEASUREMENTS
The Company adopted FASB ASC Topic 820, “Fair Value Measurements” and FASB ASC Topic 825, “The Fair Value Option for Financial Assets and Financial Liabilities”, which provides a framework for measuring and disclosing fair value under U.S. GAAP. FASB ASC Topic 820 requires disclosures about the fair value of assets and liabilities recognized in the balance sheet in periods subsequent to initial recognition, whether the measurements are made on a recurring basis (for example, AFS investment securities) or on a nonrecurring basis (for example, impaired loans).
FASB ASC Topic 820 defines fair value as the exchange price that would be received for an asset or paid to transfer a liability (an 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. FASB ASC Topic 820 also establishes a fair value hierarchy, which requires an entity to maximize the use of observable inputs and minimize the use of unobservable inputs when measuring fair value.
The Company utilizes fair value measurements to record fair value adjustments to certain assets and to determine fair value disclosures. AFS securities are recorded at fair value on a recurring basis. Additionally, from time to time, the Company may be required to record at fair value other assets on a nonrecurring basis such as loans held for investment and certain other assets. These nonrecurring fair value adjustments typically involve application of lower of cost or market accounting or write-downs of individual assets.
Under FASB ASC Topic 820, the Company groups assets and liabilities at fair value in three levels, based on the markets in which the assets and liabilities are traded, and the reliability of the assumptions used to determine the fair value. These hierarchy levels are:
Level 1 inputs - Unadjusted quoted prices in active markets for identical assets or liabilities that the entity has the ability to access at the measurement date.
Level 2 inputs - Inputs other than quoted prices included in Level 1 that are observable for the asset or liability, either directly or indirectly. These might include quoted prices for similar assets and liabilities in active markets, and inputs other than quoted prices that are observable for the asset or liability, such as interest rates and yield curves that are observable at commonly quoted intervals.
Level 3 inputs - Unobservable inputs for determining the fair values of assets or liabilities that reflect an entity’s own assumptions about the assumptions that market participants would use in pricing the assets or liabilities.
Transfers between levels of the fair value hierarchy are recognized on the actual date of the event or circumstances that caused the transfer, which generally coincides with the Company’s quarterly valuation process. Intra-quarter transfers in and out of level 3 assets and liabilities recorded at fair value on a recurring basis are disclosed. There were no such transfers during the three and six months ended September 30, 2021 or the year ended December 31, 2020.
Following is a description of valuation methodologies used for assets and liabilities recorded at fair value:
Securities Available for Sale
AFS investment securities are recorded at fair value on a recurring basis. Standard inputs include quoted prices, if available. If quoted prices are not available, fair values are measured using independent pricing models or other model-based valuation techniques such as the present value of future cash flows, adjusted for the security’s credit rating, prepayment assumptions and other factors such as credit loss assumptions. Level 1 securities include those traded on an active exchange, such as the New York Stock Exchange, Treasury securities that are traded by dealers or brokers in active over-the-counter markets and money market funds. Level 2 securities include mortgage-backed securities issued by GSEs, municipal bonds and corporate debt securities. Securities classified as Level 3 include asset-backed securities in less liquid markets.
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Equity Securities Carried at Fair Value Through Income
Equity securities carried at fair value through income are recorded at fair value on a recurring basis. Standard inputs include quoted prices, if available. If quoted prices are not available, fair values are measured using independent pricing models or other model-based valuation techniques such as the present value of future cash flows, adjusted for the security’s credit rating, prepayment assumptions and other factors such as credit loss assumptions. Level 1 equity securities include those traded on an active exchange, such as the New York Stock Exchange. Level 2 equity securities include mutual funds with asset-backed securities issued by GSEs as the underlying investment supporting the fund. Equity securities classified as Level 3 include mutual funds with asset-backed securities in less liquid markets.
Loans Receivable
The Company does not record loans at fair value on a recurring basis; however, from time to time, a loan is considered impaired and an allowance for loan loss is established. Loans for which it is probable that payment of interest and principal will not be made in accordance with the contractual terms of the loan are considered impaired. Management estimates the fair value of impaired loans using one of several methods, including the collateral value, market value of similar debt, or discounted cash flows. Impaired loans not requiring a specific allowance are those for which the fair value of expected repayments or collateral exceed the recorded investment in such loans. At September 30, 2021 and December 31, 2020, substantially all of the impaired loans were evaluated based on the fair value of the collateral.
In accordance with FASB ASC 820, impaired loans where an allowance is established based on the fair value of collateral (loans with impairment) require classification in the fair value hierarchy. When the fair value of the collateral is based on an observable market price (e.g., contracted sales price), the Company records the loan as nonrecurring Level 2. When the fair value of the impaired loan is derived from an appraisal, the Company records the loan as nonrecurring Level 3. Fair value is re-assessed at least quarterly or more frequently when circumstances occur that indicate a change in the fair value. The fair values of impaired loans that are not measured based on collateral values are measured using discounted cash flows and considered to be Level 3 inputs.
Other Real Estate Owned
OREO is adjusted for fair value upon transfer of the loans to foreclosed assets. Subsequently, OREO is reported at the lower of carrying value or fair value. Fair value is based on independent market prices, appraised value of the collateral or management’s estimation of the value of the collateral. When the fair value of the collateral is based on an observable market price (e.g., contracted sales price), the Company records the foreclosed asset as nonrecurring Level 2. When the fair value is derived from an appraisal, the Company records the foreclosed asset at nonrecurring Level 3.
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Assets and Liabilities Recorded at Fair Value on a Recurring Basis
The tables below present the recorded amount of assets as of September 30, 2021 and December 31, 2020 measured at fair value on a recurring basis.
(dollars in thousands)September 30, 2021
Description of AssetFair ValueLevel 1Level 2Level 3
AFS securities
Asset-backed securities issued by GSEs and U.S. Agencies
MBS$102,684 $— $102,684 $— 
CMOs204,888 — 204,888 — 
U.S. Agency11,800 — 11,800 — 
Asset-backed securities issued by Others:
Residential CMOs243 — 243 — 
Student Loan Trust ABSs57,712 — 57,712 — 
Municipal bonds62,873 — 62,873 — 
U.S. government obligations16,464 — 16,464 — 
Total AFS securities$456,664 $— $456,664 $— 
Equity securities carried at fair value through income
CRA investment fund$4,805 $— $4,805 $— 
Non-marketable equity securities
Other equity securities$207 $— $207 $— 
(dollars in thousands)December 31, 2020
Description of AssetFair ValueLevel 1Level 2Level 3
AFS securities
Asset-backed securities issued by GSEs and U.S. Agencies
MBS$34,953 $— $34,953 $— 
CMOs127,447 — 127,447 — 
Asset-backed securities issued by others:
Residential CMOs288 — 288 — 
Student Loan Trust ABSs37,439 — 37,439 — 
Municipal bonds44,478 — 44,478 — 
U.S. government obligations1,500 — 1,500 — 
Total AFS securities$246,105 $— $246,105 $— 
Equity securities carried at fair value through income
CRA investment fund$4,855 $— $4,855 $— 
Non-marketable equity securities
Other equity securities$207 $— $207 $— 
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Assets and Liabilities Measured at Fair Value on a Nonrecurring Basis
The Company may be required to measure certain assets at fair value on a nonrecurring basis in accordance with U.S. GAAP. These include assets that are measured at the lower of cost or market that were recognized at fair value below cost at the end of the period. Assets measured at fair value on a nonrecurring basis as of September 30, 2021 and December 31, 2020 were included in the tables below.
(dollars in thousands)September 30, 2021
Description of AssetFair ValueLevel 1Level 2Level 3
Loans with impairment
Commercial real estate$468 $— $— $468 
Total loans with impairment468 — — 468 
Other real estate owned$1,536 $— $— $1,536 
(dollars in thousands)December 31, 2020
Description of AssetFair ValueLevel 1Level 2Level 3
Loans with impairment
Commercial real estate
$4,483 $— $— $4,483 
Total loans with impairment
4,483 — — 4,483 
Other real estate owned$3,109 $— $— $3,109 
Loans with impairment had unpaid principal balances of $0.8 million and $5.8 million at September 30, 2021 and December 31, 2020, respectively.
The following tables provide information describing the unobservable inputs used in Level 3 fair value measurements at September 30, 2021 and December 31, 2020.
September 30, 2021Fair ValueValuation TechniqueUnobservable InputsRange (Weighted Average)
(dollars in thousands)
Description of Asset
Loans with impairment$468 Third party appraisals and in-house real estate evaluations of fair valueManagement discount for property type, selling costs and current market conditions
0% - 50% (41%)
Other real estate owned$1,536 Third party appraisals and in-house real estate evaluations of fair valueManagement discount for property type and current market conditions
0% - 50% (54%)
December 31, 2020Fair ValueValuation TechniqueUnobservable InputsRange (Weighted Average)
(dollars in thousands)
Description of Asset
Loans with impairment$4,483 Third party appraisals and in-house real estate evaluations of fair valueManagement discount for property type, selling costs and current market conditions
0% - 50% (23%)
Other real estate owned$3,109 Third party appraisals and in-house real estate evaluations of fair valueManagement discount for property type and current market conditions
0% - 50% (47%)
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NOTE 12 – FAIR VALUE OF FINANCIAL INSTRUMENTS
Financial instruments require disclosure of fair value information, whether or not recognized in the consolidated balance sheets when it is practical to estimate the fair value. A financial instrument is defined as cash, evidence of an ownership interest in an entity or a contractual obligation which requires the exchange of cash. Certain items are specifically excluded from the financial instrument fair value disclosure requirements, including the Company’s common stock, OREO, premises and equipment and other assets and liabilities.
The estimated fair value amounts have been determined by the Company using available market information and appropriate valuation methodologies. However, considerable judgment is required to interpret market data to develop the estimates of fair value. Accordingly, the estimates presented herein are not necessarily indicative of the amounts the Company could realize in a current market exchange. The use of different market assumptions and/or estimation methodologies may have a material effect on the estimated fair value amounts. Therefore, any aggregate unrealized gains or losses should not be interpreted as a forecast of future earnings or cash flows. Furthermore, the fair values disclosed should not be interpreted as the aggregate current value of the Company.
The Company’s estimated fair values of financial instruments are presented in the following tables.
September 30, 2021Carrying AmountFair ValueFair Value Measurements
Description of Asset (dollars in thousands)
Level 1Level 2Level 3
Assets
Investment securities - AFS$456,664 $456,664 $— $456,664 $— 
Equity securities carried at fair value through income4,805 4,805 — 4,805 — 
Non-marketable equity securities in other financial institutions207 207 — 207 — 
FHLB Stock1,472 1,472 — 1,472 — 
Net loans receivable1,569,644 1,560,392 — — 1,560,392 
Accrued Interest Receivable6,045 6,045 — 6,045 — 
Investment in BOLI38,713 38,713 — 38,713 — 
Liabilities
Savings, NOW and money market accounts$1,664,952 $1,664,952 $— $1,664,952 $— 
Time deposits339,655 340,463 — 340,463 — 
Long-term debt12,249 12,461 — 12,461 — 
TRUPs12,000 11,355 — 11,355 — 
Subordinated notes19,496 21,102 — 21,102 — 
See the Company’s methodologies disclosed in Note 21 of the Company’s 2020 Form 10-K for the fair value methodologies used as of December 31, 2020:
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December 31, 2020Carrying AmountFair ValueFair Value Measurements
Description of Asset (dollars in thousands)
Level 1Level 2Level 3
Assets
Investment securities - AFS$246,105 $246,105 $— $246,105 $— 
Equity securities carried at fair value through income4,855 4,855 — 4,855 — 
Non-marketable equity securities in other financial institutions207 207 — 207 — 
FHLB Stock2,777 2,777 — 2,777 — 
Net loans receivable1,594,075 1,581,922 — — 1,581,922 
Accrued Interest Receivable8,717 8,717 — 8,717 — 
Investment in BOLI38,061 38,061 — 38,061 — 
Liabilities
Savings, NOW and money market accounts$1,391,746 $1,391,746 $— $1,391,746 $— 
Time deposits353,856 355,478 — 355,478 — 
Long-term debt27,302 27,805 — 27,805 — 
TRUPs12,000 9,444 — 9,444 — 
Subordinated notes19,526 20,106 — 20,106 — 
At September 30, 2021 and December 31, 2020, the Company had outstanding loan commitments and standby letters of credit with customers of $80.2 million and $66.5 million, respectively, and $22.3 million and $20.0 million, respectively. Additionally, at September 30, 2021 and December 31, 2020, customers had $237.1 million and $225.5 million, respectively, available and unused on lines of credit, which include lines of credit for commercial customers, home equity loans as well as builder and construction lines. Based on the short-term lives of these instruments, the Company does not believe that the fair values of these instruments differ significantly from their carrying values.
The fair value estimates presented herein are based on pertinent information available to management as of September 30, 2021 and December 31, 2020. Although management is not aware of any factors that would significantly affect the estimated fair value amounts, such amounts have not been comprehensively revalued for purposes of these consolidated financial statements since that date and, therefore, current estimates of fair value may differ significantly from the amounts presented herein.
NOTE 13 – ACCUMULATED OTHER COMPREHENSIVE INCOME ("AOCI")
The following table presents the changes in each component of other comprehensive income (loss), net of tax, for the three and nine months ended September 30, 2021 and 2020.
Three Months Ended September 30, 2021Three Months Ended September 30, 2020Nine Months Ended September 30, 2021Nine Months Ended September 30, 2020
(dollars in thousands)Net Unrealized Gains And LossesNet Unrealized Gains And LossesNet Unrealized Gains And LossesNet Unrealized Gains And Losses
Beginning of period$3,063 $4,517 $4,504 $1,504 
Other comprehensive (loss) gain, net of tax before reclassifications(3,072)94 (4,946)2,781 
Amounts reclassified from accumulated other comprehensive gain— 169 433 495 
Net other comprehensive (loss) income(3,072)263 (4,513)3,276 
End of period$(9)$4,780 $(9)$4,780 
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NOTE 14 – EARNINGS PER SHARE (“EPS”)
Basic earnings per common share represent income available to common shareholders, divided by the weighted average number of common shares outstanding during the period. Diluted earnings per share reflect additional common shares that would have been outstanding if dilutive potential common shares had been issued. Common shares that may be issued by the Company related to outstanding unvested restricted stock units and performance stock unit awards were determined using the treasury stock method and are included in the calculation of dilutive common stock equivalents.
Basic and diluted earnings per share have been computed based on weighted-average common and common equivalent shares outstanding as follows:
(dollars in thousands, except per share amounts)Three Months Ended September 30,Nine Months Ended September 30,
2021202020212020
Net Income$6,404 $3,799 $19,135 $9,997 
Average number of common shares outstanding5,709,814 5,895,074 5,813,704 5,892,107 
Dilutive effect of common stock equivalents10,187 — 9,514 — 
Average number of shares used to calculate diluted EPS5,720,001 5,895,074 5,823,218 5,892,107 
Anti-dilutive shares40 — 3,355 — 
Earnings Per Common Share
Basic$1.12 $0.64 $3.29 $1.70 
Diluted$1.12 $0.64 $3.29 $1.70 
NOTE 15 – INCOME TAXES
The Company files a consolidated federal income tax return. Deferred tax assets and liabilities are determined using the liability (or balance sheet) method which requires that deferred tax assets and liabilities be recognized using enacted tax rates for the effect of temporary differences between the book and tax bases of recorded assets and liabilities. If it is more likely than not that some portion or the entire deferred tax asset will not be realized, deferred tax assets will be reduced by a valuation allowance. It is the Company’s policy to recognize accrued interest and penalties related to unrecognized tax benefits as a component of tax expense.
(dollars in thousands)Three Months Ended September 30,Nine Months Ended September 30,
2021202020212020
Current income tax expense$1,448 $2,119 $6,048 $4,616 
Deferred income tax expense (benefit)710 (835)427 (2,253)
Income tax expense as reported$2,158 $1,284 $6,475 $2,363 
Effective tax rate25.2 %25.3 %25.3 %19.1 %
Net deferred tax assets totaled $8.8 million at September 30, 2021 and $7.9 million at December 31, 2020. No valuation allowance for deferred tax assets was recorded at September 30, 2021 as management believes it is more likely than not that deferred tax assets will be realized against deferred tax liabilities and projected future taxable income.
The increase in income tax expense for the three and nine months ended September 30, 2021 was primarily due to a higher pretax income and a change in the Company's state tax apportionment approach which was implemented during the first quarter of 2020 and included the impact of amended income tax filings of the Company and Bank. Management determined the change in tax position qualified as a change in estimate under FASB ASC Section 250.
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The effective tax rate differed from the statutory federal and state income rates during 2021 primarily due to the effect of tax-exempt loans, life insurance policies, the income tax effects associated with stock-based compensation and certain non-deductible expenses for state income taxes. The Company’s consolidated effective tax rate is expected to be between 25.00% and 26.06% in 2021.
The effective income tax rates differed from the statutory federal and state income tax rates during 2020 primarily due to an adjustment of $0.7 million related to state apportionment of interest income on loans. In addition, the effective income tax rates differed from the statutory federal and state income tax rates due to the effect of tax-exempt loans, life insurance policies, the income tax effects associated with stock-based compensation and certain non-deductible expenses for state income taxes.
NOTE 16 – OTHER EXPENSES
The Company had the following other noninterest expenses for the three and nine months ended September 30, 2021 and 2020:
Three Months Ended September 30,Nine Months Ended September 30,
(dollars in thousands)2021202020212020
Deposit account expenses$130 $108 $372 $320 
Insurance111 46 319 143 
ATM expenses93 79 236 247 
Fraud losses132 32 1,243 64 
Other expenses541 626 1,795 1,690 
$1,007 $891 $3,965 $2,464 
For the nine months ended September 30, 2021, fraud losses include a $1.3 million charge related to an isolated wire transfer fraud incident. No additional expense is expected to be incurred relating to this incident and the Company submitted an insurance claim that could result in a recovery of a portion of the expense. As of the nine months ended September 30, 2021, the Company recovered approximately $0.2 million from other financial institutions related to the wire transfer incident.
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ITEM 2 – MANAGEMENT'S DISCUSSION AND ANALYSIS (“MD&A”) OF FINANCIAL CONDITION AND RESULTS OF OPERATIONS
SELECTED FINANCIAL INFORMATION AND RATIOS
The following table shows selected historical consolidated financial data for the Company for the three and nine months ended September 30, 2021 and 2020 and as of September 30, 2021 and December 31, 2020. This table should be read together with the Company's consolidated financial statements and related notes and Item 6, Selected Financial Data as presented in the Company’s Form 10-K for the year ended December 31, 2020.
(Unaudited)(Unaudited)
Three Months Ended September 30,Nine Months Ended September 30,
2021202020212020
KEY OPERATING RATIOS  
Return on average assets ("ROAA")1.17 %0.73 %1.20 %0.68 %
Return on average common equity ("ROACE")12.45 7.86 12.53 7.06 
Return on Average Tangible Common Equity ("ROATCE")**13.41 8.65 13.53 7.85 
Average total equity to average total assets9.40 9.33 9.58 9.66 
Interest rate spread3.22 3.15 3.31 3.19 
Net interest margin3.28 3.27 3.38 3.34 
Cost of funds0.21 0.46 0.23 0.63 
Cost of deposits0.12 0.37 0.15 0.55 
Cost of debt3.19 1.16 2.73 1.42 
Efficiency ratio(1)
52.46 55.48 52.52 55.95 
Non-interest expense to average assets1.73 1.82 1.82 1.95 
Net operating expense to average assets(2)
1.47 1.50 1.47 1.53 
Average interest-earning assets to average interest-bearing liabilities132.54 125.40 130.95 125.14 
Net charge-offs to average portfolio loans(0.02)— 0.13 0.20 
COMMON SHARE DATA
Basic net income per common share$1.12 $0.64 $3.29 $1.70 
Diluted net income per common share1.12 0.64 3.29 1.70 
Cash dividends paid per common share0.150 0.125 0.425 0.375 
Weighted average common shares outstanding:
Basic5,709,814 5,895,074 5,813,704 5,892,107 
Diluted5,720,001 5,895,074 5,823,218 5,892,107 
_______________________________________
**Non-GAAP financial measure. See reconciliation of GAAP and non-GAAP measures.
(1)Efficiency ratio is defined as noninterest expense divided by the sum of net interest income plus noninterest income.
(2)The net operating expense ratio is defined as noninterest expense less noninterest income divided by average assets.
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 (Unaudited) 
(dollars in thousands, except per share amounts)September 30, 2021December 31, 2020
COMMON SHARE DATA
Book value per common share$35.66 $33.54 
Tangible book value per common share**33.57 31.45 
Common shares outstanding at end of period5,724,011 5,903,613 
OTHER DATA
Full-time equivalent employees196 189 
Branches11 12 
Loan Production Offices
CAPITAL RATIOS
Tier 1 capital to average assets9.41 %9.56 %
Tier 1 common capital to risk-weighted assets11.89 11.47 
Tier 1 capital to risk-weighted assets12.64 12.23 
Total risk-based capital to risk-weighted assets14.99 14.69 
Common equity to assets8.96 9.77 
Tangible common equity to tangible assets **8.48 9.22 
_______________________________________
**Non-GAAP financial measure. See reconciliation of GAAP and non-GAAP measures.
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USE OF NON-GAAP FINANCIAL MEASURES
Statements included in management’s discussion and analysis include non-GAAP financial measures and should be read along with the accompanying tables, which provide a reconciliation of non-GAAP financial measures to GAAP financial measures. The Company’s management uses these non-GAAP financial measures and believes that non-GAAP financial measures provide additional useful information that allows readers to evaluate the ongoing performance of the Company. Non-GAAP financial measures should not be considered as an alternative to any measure of performance or financial condition as promulgated under GAAP, and investors should consider the Company’s performance and financial condition as reported under GAAP and all other relevant information when assessing the performance or financial condition of the Company. Non-GAAP financial measures have limitations as analytical tools, and investors should not consider them in isolation or as a substitute for analysis of the results or financial condition as reported under GAAP. See Non-GAAP reconciliation schedules that immediately follow:
RECONCILIATION OF NON-GAAP MEASURES (UNAUDITED)
Reconciliation of U.S. GAAP total assets, common equity, common equity to assets and book value to Non-GAAP tangible assets, tangible common equity, tangible common equity to tangible assets and tangible book value.
This Form 10-Q, including the accompanying financial statement tables, contains financial information determined by methods other than in accordance with GAAP. This financial information includes certain performance measures, which exclude intangible assets. These non-GAAP measures are included because the Company believes they may provide useful supplemental information for evaluating the underlying performance trends of the Company.
(dollars in thousands, except per share amounts)September 30, 2021December 31, 2020September 30, 2020
Total assets$2,278,692 $2,026,439 $2,137,437 
Less: intangible assets
Goodwill10,835 10,835 10,835 
Core deposit intangible1,147 1,527 1,666 
Total intangible assets11,982 12,362 12,501 
Tangible assets$2,266,710 $2,014,077 $2,124,936 
Total common equity$204,128 $198,013 $192,850 
Less: intangible assets11,982 12,362 12,501 
Tangible common equity$192,146 $185,651 $180,349 
Common shares outstanding at end of period5,724,011 5,903,613 5,911,940 
Common equity to assets8.96 %9.77 %9.02 %
Tangible common equity to tangible assets8.48 %9.22 %8.49 %
Common book value per share$35.66 $33.54 $32.62 
Tangible common book value per share$33.57 $31.45 $30.51 

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RECONCILIATION OF NON-GAAP MEASURES (UNAUDITED) - THREE AND NINE MONTHS ENDED SEPTEMBER 30, 2021 AND 2020
Return on Average Common Equity ("ROACE")
The ROACE is a financial ratio that measures the profitability of a company in relation to the average shareholders' equity. This financial metric is expressed in the form of a percentage which is equal to net income after tax divided by the average shareholders' equity for a specific period of time.
Three Months Ended September 30,Nine Months Ended September 30,
(dollars in thousands)2021202020212020
Net income (as reported)$6,404 $3,799 $19,135 $9,997 
ROACE12.45 %7.86 %12.53 %7.06 %
Average common equity$205,723 $193,351 $203,597 $188,853 
Return on Average Tangible Common Equity ("ROATCE")
ROATCE is computed by dividing net earnings applicable to common shareholders by average tangible common shareholders' equity. Management believes that ROATCE is meaningful because it measures the performance of a business consistently, whether acquired or internally developed. ROATCE is a non-GAAP measure and may not be comparable to similar non-GAAP measures used by other companies.
Three Months Ended September 30,Nine Months Ended September 30,
(dollars in thousands)2021202020212020
Net income (as reported)$6,404 $3,799 $19,135 $9,997 
Core deposit intangible amortization (net of tax)91 108 284 366 
Net earnings applicable to common shareholders$6,495 $3,907 $19,419 $10,363 
ROATCE13.41 %8.65 %13.53 %7.85 %
Average tangible common equity$193,662 $180,755 $191,411 $176,108 
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CRITICAL ACCOUNTING POLICIES
Critical accounting policies are defined as those that involve significant judgments and uncertainties and could result in materially different results under different assumptions and conditions. The Company considers its determination of the allowance for loan losses ("ALLL"), goodwill impairment, the valuation of foreclosed real estate (OREO) and the valuation of deferred tax assets to be critical accounting policies. The Company believes that the most critical accounting policies upon which its financial condition and results of operation depend, and which involve the most complex subjective decisions or assessments, are included in the discussion entitled "Critical Accounting Policies" in Item 7, "Management's Discussion and Analysis of Financial Condition and Results of Operations," in the Company's Annual Report on Form 10-K for the fiscal year ended December 31, 2020, as filed with the SEC.
For additional information regarding the ALLL, Goodwill, OREO and the valuation of deferred taxes, refer to Notes 1, 3, 4, 6 and 14 in the consolidated financial statements as presented in the Company’s Form 10-K for the year ended December 31, 2020.
OVERVIEW
Community Bank of the Chesapeake (the “Bank”) is headquartered in Southern Maryland with 11 branches located in Maryland and Virginia. The Bank is a wholly-owned subsidiary of The Community Financial Corporation (the “Company”). The Company provides financial services to individuals and businesses through its offices in Southern Maryland and Fredericksburg, Virginia. Its primary deposit products are demand, savings and time deposits, and its primary lending products are commercial and residential mortgage loans, commercial loans, construction and land development loans, home equity and second mortgages and commercial equipment loans.
Our customer focus is to serve small and medium sized commercial businesses as well as local municipal agencies and not-for-profits. Relationship teams provide customers with specific banker contacts and a support team to address product and service demands. We believe our ability to offer fast, flexible, local decision-making will continue to attract significant new business relationships. Our structure provides a consistent and superior level of professional service and excelling at customer service is a critical part of our culture.

The Company’s income is primarily earned from interest received on its loans and investments. The Company's primary source of funds for making these loans and investments is its deposits. One of the key measures of the Company's success is its net interest income, or the difference between the income on its interest-earning assets, such as loans and investments, and the expense on its interest-bearing liabilities, such as deposits and borrowings. Another key measure is the spread between the yield the Company earns on these interest-earning assets and the rate the Company pays on interest-bearing liabilities, which is called net interest spread. In addition to earning interest on loans and investments, the Company earns income through fees and other charges for services to clients.
Management continues to drive profitability, operating efficiency and shareholder value. During the first nine months of 2021, we repurchased common shares, significantly reduced nonperforming assets, introduced two new product lines and continued to optimize our branch and virtual banking operations.
During the nine months ended September 30, 2021, the Company repurchased 190,587 shares of common stock at an average price of $35.21 per share. Third quarter 2021 diluted earnings per share of $1.12 was positively impacted $0.03 per share from second quarter and third quarter 2021 repurchases.
The Company increased its dividends paid to shareholders by 20% from $0.125 in the first quarter of 2021 to $0.150 in the second quarter of 2021.
During the nine months ended September 30, 2021, we improved asset quality with the sale of impaired non-accrual and classified commercial real estate and residential mortgage loans with an aggregate amortized cost of $16.3 million. The Company's sale of these impaired loans decreased the specific ALLL reserve, improved asset quality and improved several ALLL qualitative factors. Non-accrual loans, OREO and TDRs to total assets decreased 77 basis points to 0.31% at September 30, 2021 from 1.08% at December 31, 2020. Classified assets decreased $15.7 million to $6.7 million at September 30, 2021 from $22.4 million at December 31, 2020.
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In September 2021, the Company was named one of the top-performing publicly traded small-cap banks and thrifts in the country in the Piper Sandler Bank & Thrift SM-ALL Stars Class of 2021. The Company is one of two named institutions from Maryland of the 35 total institutions named to the Class of 2021. Piper Sandler is an investment banking firm and broker-dealer focused on the financial services sector.
The Bank has increased non-interest bearing deposits in 2021, which has moderated net interest margin compression. Noninterest-bearing accounts increased by $70.5 million to $432.6 million or 21.58% of deposits at September 30, 2021 from 20.74% of deposits at December 31, 2020.
In March 2021, the Bank introduced a new residential mortgage program and a retail and commercial credit card program. These new product lines merge the technology and expertise of two proven FinTech firms with our business development team's demonstrated capabilities. The Company expects these programs to improve non-interest income and interest income beginning in 2022. The Bank's credit card program balances increased from approximately $50,000 at June 30, 2021 to just under $800,000 at September 30, 2021.
On April 21, 2021, the Bank purchased its second branch location in Virginia at 5831 Plank Road, Spotsylvania. The full-service branch is expected to open in late 2021 or early 2022 and will provide banking, lending and wealth management services with a focus on digital banking. At September 30, 2021, loans in the greater Fredericksburg, Virginia area accounted for approximately 45% of the Bank's outstanding portfolio loans, and Fredericksburg branch deposits were $89.0 million with an average cost of deposits of six basis points. The greater Fredericksburg area provides significant opportunities for continued organic growth supported by our efficient operating model and ability to leverage technology.
On March 31, 2021, the Bank consolidated its St. Patrick's Drive branch in Waldorf, Maryland into the Bank's nearby main office branch.
The net financial impact of the new Spotsylvania branch and the closing of the St. Patrick's Drive branch is expected to be neutral to the Company's expense run rate.
The COVID-19 pandemic has presented economic and operational challenges as well as opportunities in 2021 and 2020. The Company has addressed COVID-19 credit concerns by maintaining an adequate allowance for loan losses, resolving multiple OREO assets, and strengthening regulatory capital in October 2020 through the issuance of subordinated debt. In 2021 and 2020, we have continued to help our community and customers navigate economic uncertainty by originating U.S. SBA PPP loans and offering loan payment deferral programs.
Despite the challenges of navigating our business during a pandemic, the Company's balance sheet and operating results have remained strong. We believe current market disruptions in the banking industry caused by both the COVID-19 pandemic as well as industry consolidation has provided opportunities for continued organic growth in 2021. The addition of new customers during the past 18 months continued our success in increasing lower-cost transaction deposits in each of the last five years. Our core profitability has increased from a stable net interest margin primarily due to improved funding composition, increased non-interest income from additional products and services and expense control.
Throughout the COVID-19 pandemic, the Company has remained focused on the financial and personal well-being of our customers and employees.
The Company offered payment deferral programs for its business and individual customers. Depending on the need of the client, the Company deferred either the full or partial loan payment between 90 and 180 days. As of September 30, 2021, the Bank's loan deferrals had decreased to $3.4 million, which represented 0.2% of gross portfolio loans from $35.4 million or 2.4% of gross portfolio loans as of December 31, 2020.
The Company actively assisted customers and community businesses with applications for resources through the U.S. SBA PPP program. As of September 30, 2021, the Company had 345 U.S. SBA PPP loans with balances of $56.4 million.
The Bank continues to work with customers using its mobile banking and other online channels as well as in-branch services to ensure our customers are able to transact business through the various stages of the pandemic.
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For additional information regarding the Company's COVID-19 programs, including risk factors and accounting treatment, refer to Item 1A, "Risk Factors" and Item 7, "Management's Discussion and Analysis of Financial Condition and Results of Operations," in the Company's Annual Report on Form 10-K for the fiscal year ended December 31, 2020, as filed with the SEC. In addition, refer to Notes 1, 3, and 11 in the consolidated financial statements as presented in the Company’s Form 10-K for the year ended December 31, 2020.
Subsequent events
The Company has evaluated subsequent events for potential recognition and/or disclosure through the date the unaudited consolidated financial statements were issued.
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COMPARISON OF RESULTS OF OPERATIONS FOR THE THREE MONTHS ENDED SEPTEMBER 30, 2021 AND 2020
Summary of Financial Results
The Company reported net income for the three months ended September 30, 2021 of $6.4 million or diluted earnings per share of $1.12 compared to net income of $3.8 million or $0.64 per diluted earnings per share for the three months ended September 30, 2020. The Company’s ROAA and ROACE were 1.17% and 12.45% for the three months ended September 30, 2021 compared to 0.73% and 7.86% in September 30, 2020.
The increase to net income in the third quarter of 2021 compared to the same quarter in 2020 was primarily due to a lower provision for loan losses and lower interest expense, partially offset by lower in noninterest income.
Three Months Ended September 30,
(dollars in thousands)20212020$ Change% Change
Interest and dividend income$17,659 $17,483 $176 1.0 %
Interest expense1,050 2,115 (1,065)(50.4)%
Net interest income16,609 15,368 1,241 8.1 %
Provision for loan losses— 2,500 (2,500)(100.0)%
Noninterest income1,400 1,666 (266)(16.0)%
Noninterest expense9,447 9,451 (4)— %
Income before income taxes8,562 5,083 3,479 68.4 %
Income tax expense2,158 1,284 874 68.1 %
Net income$6,404 $3,799 $2,605 68.6 %
Net Interest Income
The following table shows the components of net interest income and the dollar and percentage changes for the periods presented.
Three Months Ended September 30,
(dollars in thousands)20212020$ Change% Change
Interest and Dividend Income
Loans, including fees$16,342 $16,176 $166 1.0 %
Taxable interest and dividends on investment securities1,296 1,269 27 2.1 %
Interest on deposits with banks21 38 (17)(44.7)%
Total Interest and Dividend Income17,659 17,483 176 1.0 %
Interest Expenses
Deposits594 1,534 (940)(61.3)%
Short-term borrowings— 14 (14)(100.0)%
Long-term debt456 567 (111)(19.6)%
Total Interest Expenses1,050 2,115 (1,065)(50.4)%
Net Interest Income$16,609 $15,368 $1,241 8.1 %

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Average Balances and Yields
The following table sets forth average balances, average yields and costs, and certain other information for the periods indicated. No tax-equivalent yield adjustments were made, as the effect thereof was not material. All average balances are daily average balances. Non-accrual loans were included in the computation of average balances. The yields set forth below include the effect of deferred fees, discounts and premiums that are amortized or accreted to interest income or expense.
Three Months Ended September 30,
20212020
(dollars in thousands)Average BalanceInterestAvg. Yield/CostAverage BalanceInterestAvg. Yield/Cost
Assets
Commercial real estate$1,094,089 $10,977 4.01 %$1,006,436 $10,627 4.22 %
Residential first mortgages100,195 742 2.96 %157,039 1,188 3.03 %
Residential rentals154,481 1,565 4.05 %132,572 1,499 4.52 %
Construction and land development34,810 399 4.58 %38,861 448 4.61 %
Home equity and second mortgages27,751 246 3.55 %32,670 295 3.61 %
Commercial and equipment loans104,845 1,161 4.43 %116,472 1,205 4.14 %
U.S. SBA PPP loans71,751 1,236 6.89 %127,092 902 2.84 %
Consumer loans1,742 16 3.67 %1,102 12 4.36 %
Allowance for loan losses(18,852)— — (16,738)— — %
Loan portfolio (1)
1,570,812 16,342 4.16 %1,595,506 16,176 4.06 %
Taxable investment securities370,498 1,212 1.31 %218,305 1,143 2.09 %
Nontaxable investment securities16,204 84 2.07 %23,633 126 2.13 %
Interest-bearing deposits in other banks36,516 16 0.18 %24,713 25 0.40 %
Federal funds sold30,266 0.07 %20,561 13 0.25 %
Interest-Earning Assets ("IEAs")2,024,296 17,659 3.49 %1,882,718 17,483 3.71 %
Cash and cash equivalents66,292 87,895 
Goodwill10,835 10,835 
Core deposit intangible1,226 1,761 
Other assets85,340 88,278 
Total Assets$2,187,989 $2,071,487 
Liabilities and Stockholders’ Equity
Noninterest-bearing demand deposits$434,316 $— — %$351,951 $— — %
Interest-bearing demand deposits
Savings110,873 14 0.05 %89,036 20 0.09 %
Interest-bearing demand and money market accounts1,017,642 175 0.07 %848,981 313 0.15 %
Certificates of deposit341,672 405 0.47 %363,296 1,201 1.32 %
Total interest-bearing deposits1,470,187 594 0.16 %1,301,313 1,534 0.47 %
Total Deposits1,904,503 594 0.12 %1,653,264 1,534 0.37 %
Long-term debt25,625 131 2.04 %63,847 380 2.38 %
Short-term borrowings— — — %3,159 14 1.77 %
Paycheck Protection Program Liquidity Facility ("PPPLF") Advance— — — %121,070 107 0.35 %
Subordinated Notes19,487 251 5.15 %— — — %
Guaranteed preferred beneficial interest in junior subordinated debentures ("TRUPs")12,000 74 2.47 %12,000 80 2.67 %
Total Debt57,112 456 3.19 %200,076 581 1.16 %
Interest-Bearing Liabilities ("IBLs")1,527,299 1,050 0.27 %1,501,389 2,115 0.56 %
Total Funds1,961,615 1,050 0.21 %1,853,340 2,115 0.46 %
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Three Months Ended September 30,
20212020
(dollars in thousands)Average BalanceInterestAvg. Yield/CostAverage BalanceInterestAvg. Yield/Cost
Other liabilities20,648 24,796 
Stockholders’ equity205,723 193,351 
Total Liabilities and Stockholders’ Equity$2,187,986 $2,071,487 
Net interest income$16,609 $15,368 
Interest rate spread3.22 %3.15 %
Net yield on interest-earning assets3.28 %3.27 %
Average loans to average deposits82.48 %96.51 %
Average transaction deposits to total average deposits**82.06 %78.03 %
Ratio of average IEAs to average IBLs132.54 %125.40 %
__________________________
(1)Average balance includes non-accrual loans. There are no tax equivalent adjustments. There was $91,000 and $0.1 million of accretion interest during the three months ended September 30, 2021 and 2020, respectively.
**Transaction deposits exclude time deposits
The following table presents changes in interest income and interest expense of the Company for the periods indicated. For each category of interest-earning asset and interest-bearing liability, information is provided on changes attributable to (1) changes in volume (changes in volume multiplied by old rate); and (2) changes in rate (changes in rate multiplied by old volume). Changes in rate-volume (changes in rate multiplied by the change in volume) have been allocated to changes due to volume.
For the Three Months Ended September 30, 2021 compared to the Three Months Ended September 30, 2020
(dollars in thousands)VolumeDue to RateTotal
Interest income:
Loan portfolio$(257)$423 $166 
Investment securities, federal funds sold and interest-bearing deposits482 (472)10 
Total interest-earning assets225 (49)176 
Interest-bearing liabilities:
Savings(9)(6)
Interest-bearing demand and money market accounts29 (167)(138)
Certificates of deposit(26)(770)(796)
Long-term debt(195)(54)(249)
Short-term borrowings— (14)(14)
Paycheck Protection Program Liquidity Facility ("PPPLF") Advance— (107)(107)
Subordinated Notes251 — 251 
Guaranteed preferred beneficial interest in junior subordinated debentures ("TRUPs")— (6)(6)
Total interest-bearing liabilities62 (1,127)(1,065)
Net change in net interest income$164 $1,078 $1,241 

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Fluctuations in net interest income can result from the combination of changes in the average balances of asset and liability categories and changes in interest rates. Interest rates earned and paid are affected by general economic conditions, particularly changes in market interest rates, and by competitive factors, government policies and actions of regulatory authorities.
Net interest income increased for the three months ended September 30, 2021 compared to the three months ended September 30, 2020. The increase in net interest income resulted primarily from significant decreases in interest expense from lower funding costs as well as volume increases in interest-earning assets. Interest income increased from larger average balances and accelerated loan fee recognition following the forgiveness of U.S. SBA PPP loans, partially offset by lower asset yields from virtually all interest-earnings assets. Interest income from the Company's participation in the U.S. SBA PPP program was $1.2 million for the three months ended September 30, 2021 as compared to $0.9 million for the comparable quarter in 2020.
Net interest margin of 3.28% for the three months ended September 30, 2021 increased one basis points from 3.27% for the comparable period. The sharp decline in interest rates in 2020 and 2021 not only reduced interest income on floating-rate commercial loans and liquid interest-earning assets and investments, but it also reduced competitive pressures and depositor expectations concerning deposit interest rates. The flat net interest margin for the comparable periods was due to similar rate declines for asset yields and funding costs.
Cost of funds decreased from 0.46% for the three months ended September 30, 2020 to 0.21% for the three months ended September 30, 2021. The Bank's cost of funds in 2021 decreased due to the prepayments of $30.0 million of FHLB advances with a 2.2% average rate in the last six months of 2020, the repricing of time deposits, the increase in non-interest bearing accounts as a percentage of total deposits and lower costs for transaction deposit accounts. These decreases in the cost of funds were partially offset by interest related to the prepayment of $15.0 million of FHLB advances in late September 2021 and the issuance of $20.0 million in subordinated notes in October 2020.
For the three months ended September 30, 2021, net interest margin increased 13 basis points as a result of net U.S. SBA PPP loan interest income and accelerated loan fee recognition. Loan yields increased from 4.06% for the three months ended September 30, 2020 to 4.16% for the three months ended September 30, 2021. Loan yields, excluding U.S. SBA PPP loan interest income, were 4.02% and 4.16% for the three months ended September 30, 2021 and September 30, 2020, respectively.
Excluding the acceleration of deferred fees into interest income with U.S. SBA PPP loan forgiveness, compression of our net interest margin is likely in the fourth quarter of 2021 as interest-earning assets reprice lower and the Bank continues to invest excess liquidity into securities. Average investments and interest-bearing cash accounts have increased $196.8 million from $256.7 million for the three months ended December 31, 2020 to $453.5 million for the three months ended September 30, 2021. We expect U.S. SBA PPP loan forgiveness to positively impact margins and net interest income in the fourth quarter of 2021 with the recognition of remaining net deferred fees.
Provision for Loan Losses
The provision for loan losses is a function of the calculation of the allowance for loan loss on the Company's end of period loan portfolios. See further discussion of the provision and the allowance under the caption “Asset Quality” in the Comparison of Financial Condition section of this MD&A.
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Noninterest Income
The following table shows the components of noninterest income and the dollar and percentage changes for the periods presented.
Three Months Ended September 30,
(dollars in thousands)20212020$ Change % Change
Noninterest Income
Loan appraisal, credit, and miscellaneous charges$29 $49 $(20)(40.8)%
Gain on sale or disposition of assets— (6)(100.0)%
Net gains on sale of investment securities— 229 (229)(100.0)%
Unrealized gain (losses) on equity securities(22)— (22)— %
Provision for loss on premises and equipment held for sale(20)— (20)— %
Income from bank owned life insurance220 222 (2)(0.9)%
Service charges987 839 148 17.6 %
Referral fee income176 321 (145)(45.2)%
Net gain on sale of loans held for sale30 — 30 — %
Total Noninterest Income$1,400 $1,666 $(266)(16.0)%
Noninterest income for the three months ended September 30, 2021 decreased from the three months ended September 30, 2020. The decrease for the comparable periods was primarily due to decreased referral fee income and decreased gains on the sale of investment securities partially offset by increased service charge income. Noninterest income as a percentage of average assets was 0.26% and 0.32%, respectively, for the three months ended September 30, 2021 and 2020.

Noninterest Expense
The following tables show the components of noninterest expense and the dollar and percentage changes for the periods presented.
Three Months Ended September 30,
(dollars in thousands)20212020$ Change% Change
Noninterest Expense        
Compensation and benefits$5,650 $5,099 $551 10.8 %
OREO valuation allowance and expenses20 421 (401)(95.2)%
Sub-total5,670 5,520 150 2.7 %
Operating Expenses
Occupancy expense731 734 (3)(0.4)%
Advertising145 129 16 12.4 %
Data processing expense840 990 (150)(15.2)%
Professional fees676 652 24 3.7 %
Depreciation of premises and equipment137 142 (5)(3.5)%
FDIC Insurance120 249 (129)(51.8)%
Core deposit intangible amortization121 144 (23)(16.0)%
Other expenses1,007 891 116 13.0 %
Total Operating Expenses3,777 3,931 (154)(3.9)%
Total Noninterest Expense$9,447 $9,451 $(4)— %




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Noninterest expense was flat for the comparable periods as increased compensation and benefits and other expenses were offset by decreased OREO expenses, FDIC insurance and data processing. Compensation and benefits increased for the comparable periods primarily due to increased health insurance claims as well as larger incentive compensation accruals resulting from improvements in profitability and asset quality. In addition, no costs were deferred for the origination of U.S. SBA PPP loans in third quarter of 2021 compared with the deferral of $0.1 million in the third quarter of 2020. The FDIC insurance decreased due to improved balance sheet credit trends. Decreased OREO expenses reflect management's actions in 2021 and 2020 to reduce non-performing assets. Data processing costs decreased for the comparable periods due to the timing of scheduled projects as well as a reduction related to PPP loan processing costs incurred during 2020 that were not incurred in 2021.
The Company’s efficiency ratio was 52.46% for the three months ended September 30, 2021 compared to 55.48% for the three months ended September 30, 2020. The Company’s net operating expense ratio was 1.47% for the three months ended September 30, 2021 compared to 1.50% for the three months ended September 30, 2020. The efficiency and net operating expense ratios have improved (decreased) as the Company has been able to generate more noninterest income while controlling expense growth.
Income Tax Expense
Income tax expense increased $0.9 million for the three months ended September 30, 2021 compared to the same quarter in the prior year. For the three months ended September 30, 2021 the effective tax rate was 25.2%. The Company’s consolidated effective tax rate was a 25.3% in the third quarter of 2020.
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COMPARISON OF RESULTS OF OPERATIONS FOR THE NINE MONTHS ENDED SEPTEMBER 30, 2021 AND 2020
Earnings Summary
The Company reported net income for the nine months ended September 30, 2021 of $19.1 million or diluted earnings per share of $3.29 compared to net income of $10.0 million or $1.70 per diluted share for the nine months ended September 30, 2020. The Company’s ROAA and ROACE were 1.20% and 12.53% for the nine months ended September 30, 2021 compared to 0.68% and 7.06% for the nine months ended September 30, 2020.
The increase to net income in the first nine months of 2021 compared to the same period in 2020 was due to a lower provision for loan losses and increased net interest income partially offset by a decrease in non-interest income and increases in non-interest expense and income tax expense. The increase in income tax expense was due to higher pre-tax income and a change in the Company's state tax apportionment approach implemented in the first quarter of 2020. The Company's higher effective tax rate is explained in the income tax expense section included in the discussion of results for the nine months ended September 30, 2021 in this MD&A.
Nine Months Ended September 30,
(dollars in thousands)20212020$ Change% Change
Interest and dividend income$52,781 $53,160 $(379)(0.7)%
Interest expense3,228 8,215 (4,987)(60.7)%
Net interest income49,553 44,945 4,608 10.3 %
Provision for loan losses586 10,100 (9,514)(94.2)%
Noninterest income5,616 6,046 (430)(7.1)%
Noninterest expense28,973 28,531 442 1.5 %
Income before income taxes25,610 12,360 13,250 107.2 %
Income tax expense6,475 2,363 4,112 174.0 %
Net income$19,135 $9,997 $9,138 91.4 %
Net Interest Income
The following table shows the components of net interest income and the dollar and percentage changes for the periods presented.
Nine Months Ended September 30,
(dollars in thousands)20212020$ Change% Change
Interest and Dividend Income
Loans, including fees$49,254 $48,955 $299 0.6 %
Taxable interest and dividends on investment securities3,461 4,079 (618)(15.2)%
Interest on deposits with banks66 126 (60)(47.6)%
Total Interest and Dividend Income52,781 53,160 (379)(0.7)%
Interest Expenses
Deposits2,036 6,515 (4,479)(68.7)%
Short-term borrowings— 111 (111)(100.0)%
Long-term debt1,192 1,589 (397)(25.0)%
Total Interest Expenses3,228 8,215 (4,987)(60.7)%
Net Interest Income$49,553 $44,945 $4,608 10.3 %

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Average Balances and Yields
The following table sets forth average balances, average yields and costs, and certain other information for the periods indicated. No tax-equivalent yield adjustments were made, as the effect thereof was not material. All average balances are daily average balances. Non-accrual loans were included in the computation of average balances. The yields set forth below include the effect of deferred fees, discounts and premiums that are amortized or accreted to interest income or expense. The following table presents information on the average balances of the Company’s interest-earning assets and interest-bearing liabilities and interest earned or paid for the nine months ended September 30, 2021 and 2020, respectively.
Nine Months Ended September 30,
20212020
(dollars in thousands)Average BalanceInterestAvg. Yield/CostAverage BalanceInterestAvg. Yield/Cost
Assets
Commercial real estate$1,081,350 $32,625 4.02 %$981,944 $32,406 4.40 %
Residential first mortgages111,401 2,494 2.99 %165,632 4,098 3.30 %
Residential rentals144,316 4,421 4.08 %131,839 4,373 4.42 %
Construction and land development36,401 1,226 4.49 %38,608 1,360 4.70 %
Home equity and second mortgages28,689 745 3.46 %34,604 1,066 4.11 %
Commercial and equipment loans104,747 3,339 4.25 %119,927 4,219 4.69 %
U.S. SBA PPP loans97,231 4,356 5.97 %76,418 1,395 2.43 %
Consumer loans1,497 48 4.28 %1,113 38 4.55 %
Allowance for loan losses(18,908)— — (14,521)— — %
Loan portfolio (1)
1,586,724 49,254 4.14 %1,535,564 48,955 4.25 %
Taxable investment securities292,625 3,182 1.45 %215,223 3,854 2.39 %
Non-taxable investment securities17,517 279 2.12 %12,144 225 2.47 %
Interest bearing deposits in other banks30,183 44 0.19 %16,246 87 0.71 %
Federal funds sold27,964 22 0.10 %13,520 39 0.38 %
Interest-Earning Assets ("IEAs")1,955,013 52,781 3.60 %1,792,697 53,160 3.95 %
Cash and cash equivalents71,559 61,832 
Goodwill10,835 10,835 
Core deposit intangible1,351 1,910 
Other assets86,838 87,973 
Total Assets$2,125,596 $1,955,247 
Liabilities and Stockholders’ Equity
Noninterest-bearing demand deposits$407,375 $— — %$310,451 $— — %
Interest-bearing liabilities:
Savings106,190 40 0.05 %80,412 68 0.11 %
Interest-bearing demand and money market accounts982,704 555 0.08 %816,975 2,118 0.35 %
Certificates of deposit345,821 1,441 0.56 %375,606 4,329 1.54 %
Total Interest-bearing deposits1,434,715 2,036 0.19 %1,272,993 6,515 0.68 %
Total Deposits1,842,090 2,036 0.15 %1,583,444 6,515 0.55 %
Long-term debt26,723 213 1.06 %62,101 916 1.97 %
Short-term borrowings— — — %10,895 111 1.36 %
Paycheck Protection Program Liquidity Facility ("PPPLF") Advance— — — %69,656 182 0.35 %
Subordinated Notes19,483 754 5.16 %4,953 184 4.95 %
Guaranteed preferred beneficial interest in junior subordinated debentures ("TRUPs")12,000 225 2.50 %12,000 307 3.41 %
Total debt58,206 1,192 2.73 %159,605 1,700 1.42 %
Total Interest-Bearing Liabilities ("IBLs")1,492,921 3,228 0.29 %1,432,598 8,215 0.76 %
Total funds1,900,296 3,228 0.23 %1,743,049 8,215 0.63 %
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Nine Months Ended September 30,
20212020
(dollars in thousands)Average BalanceInterestAvg. Yield/CostAverage BalanceInterestAvg. Yield/Cost
Other liabilities21,703 23,345 
Stockholders’ equity203,597 188,853 
Total Liabilities and Stockholders’ Equity$2,125,596 $1,955,247 
Net interest income$49,553 $44,945 
Interest rate spread3.31 %3.19 %
Net yield on interest-earning assets3.38 %3.34 %
Average loans to average deposits86.14 %96.98 %
Average transaction deposits to total average deposits**81.23 %76.28 %
Ratio of average IEAs to average IBLs130.95 %125.14 %
Cost of funds0.23 %0.63 %
Cost of deposits0.15 %0.55 %
Cost of debt2.73 %1.42 %
__________________________
(1)Average balance includes non-accrual loans. There are no tax equivalent adjustments. There was $0.3 million and $0.5 million of accretion interest during the nine months ended September 30, 2021 and 2020, respectively.
**Transaction deposits excluded time deposits
The following table presents changes in interest income and interest expense of the Company for the periods indicated. For each category of interest-earning asset and interest-bearing liability, information is provided on changes attributable to (1) changes in volume (changes in volume multiplied by old rate); and (2) changes in rate (changes in rate multiplied by old volume). Changes in rate-volume (changes in rate multiplied by the change in volume) have been allocated to changes due to volume.
For the Nine Months Ended September 30, 2021 compared to the Nine Months Ended September 30, 2020
(dollars in thousands)VolumeDue to RateTotal
Interest income:
Loan portfolio$1,588 $(1,289)$299 
Investment securities, federal funds sold and interest-bearing deposits1,067 (1,745)(678)
Total interest-earning assets2,655 (3,034)(379)
Interest-bearing liabilities:
Savings10 (38)(28)
Interest-bearing demand and money market accounts94 (1,657)(1,563)
Certificates of deposit(124)(2,764)(2,888)
Long-term debt(282)(421)(703)
Short-term borrowings— (111)(111)
PPPLF Advance— (182)(182)
Subordinated notes562 570 
Guaranteed preferred beneficial interest in junior subordinated debentures— (82)(82)
Total interest-bearing liabilities260 (5,247)(4,987)
Net change in net interest income$2,396 $2,213 $4,608 

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Net interest income increased $4.6 million or 10.3% for the comparable periods with $3.1 million of the increase attributable to U.S. SBA PPP program increased net interest income.

Interest income decreased $0.4 million for the nine months ended September 30, 2021 compared to the same period of 2020. The decrease in interest income resulted from significantly lower asset yields partially offset by larger average balances of interest-earning assets and the accelerated loan fee recognition following the forgiveness of U.S. SBA PPP loans. Interest income from the Company's participation in the U.S. SBA PPP program was $4.4 million for the nine months ended September 30, 2021 compared to $1.4 million for the nine months ended September 30, 2020.

As a result of organic growth, average total earning assets increased $162.3 million or 9.1%, for the nine months ended September 30, 2021 to $1,955.0 million compared to $1,792.7 million for the nine months ended September 30, 2020. The increase in average total earning assets for the nine months ended September 30, 2021 from the comparable period in 2020 resulted from a $51.2 million increase in average loans and an increase of $111.2 million increase in average investments, federal funds sold, and interest-bearing deposits.
Interest expense decreased $5.0 million for the nine months ended September 30, 2021 compared to the same period of 2020. Lower interest rates accounted for $5.2 million of the decrease in interest expense partially offset by $0.3 million in increased interest expense from larger average balances and changes in the funding mix of interest-bearing liabilities. Interest expense decreased during 2021 as the Bank's cost of funds decreased. The prepayment of FHLB advances in the last six months of 2020, reductions in PPPLF debt, an increase in non-interest bearing accounts as a percentage of total deposits and the repricing of time and transaction deposits at lower rates all contributed to the decrease in interest expense.
Average total interest-bearing liabilities increased $60.3 million, or 4.2%, for the nine months ended September 30, 2021 to $1,492.9 million compared to $1,432.6 million for the nine months ended September 30, 2020. During the same time, average noninterest-bearing demand deposits increased $96.9 million, or 31.2%, to $407.4 million compared to $310.5 million. Noninterest-bearing deposits increased for the comparable periods due to customer acquisition efforts and the Bank's participation in the U.S. SBA PPP program. For the nine-month comparative periods, average total debt decreased $101.4 million, which reflects the second half of 2020 payoff of Federal Reserve's PPPLF advances and the prepayment of FHLB advances, partially offset by an increase in average Subordinated Notes of $14.5 million. During the nine months ended September 30, 2021, average transaction accounts increased $288.4 million or 23.9% to $1,496.3 million from $1,207.8 million for the nine months ended September 30, 2020. During the same time, average time deposits decreased $29.8 million or 7.9% to $345.8 million for the nine months ended September 30, 2021.
Net interest margin of 3.38% for the nine months ended September 30, 2021 was four basis points higher than the 3.34% for the nine months ended September 30, 2020. The increase in net interest margin from the first nine months of 2020 resulted primarily from the Company’s interest earning asset yields decreasing at a slower rate than overall funding costs. Interest earning asset yields decreased 35 basis points from 3.95% for the nine months ended September 30, 2020 to 3.60% for the nine months ended September 30, 2021. The Company’s cost of funds decreased 40 basis points from 0.63% for the nine months ended September 30, 2020 to 0.23% for the nine months ended September 30, 2021. Net interest income was impacted by accretion interest of $0.3 million and $0.5 million for the nine months ended September 30, 2021 and 2020, respectively.
As a result of net U.S. SBA PPP loan interest income and accelerated loan fee recognition net interest margin increased 14 basis point for the nine months ended September 30, 2021. Net interest margin decreased six basis points for the nine months ended September 30, 2020 due to lower yields from U.S. SBA PPP loans compared to other loan portfolios. Loan yields decreased from 4.25% for the nine months ended September 30, 2020 to 4.14% for the nine months ended September 30, 2021. Loan yields, excluding U.S. SBA PPP loan interest income, were 4.35% for the nine months ended September 30, 2020 compared to 4.02% for the nine months ended September 30, 2021.
Provision for Loan Losses
See further discussion of the provision and the allowance under the caption “Asset Quality” in the Comparison of Financial Condition section of this MD&A.
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Noninterest Income
The following table shows the components of noninterest income and the dollar and percentage changes for the periods presented.
Nine Months Ended September 30,
(dollars in thousands)20212020$ Change% Change
Noninterest Income
Loan appraisal, credit, and miscellaneous charges$271 $98 $173 176.5 %
Gain on sale or disposition of assets68 62 1,033.3 %
Net gains on sale of investment securities586 670 (84)(12.5)%
Unrealized (loss) gain on equity securities(94)115 (209)(182)%
Provision for loss on premises and equipment held for sale(20)— (20)— %
Income from bank owned life insurance652 661 (9)(1.4)%
Service charges3,066 2,530 536 21.2 %
Referral fee income1,248 1,966 (718)(36.5)%
Net gain on sale of loans held for sale30 — 30 — %
Loss on sale of loans(191)— (191)— %
Total Noninterest Income$5,616 $6,046 $(430)(7.1)%
Noninterest income for the nine months ended September 30, 2021 decreased compared to the nine months ended September 30, 2020. The decreases were primarily due to decreased referral fee income, a loss on sale of impaired loans, and unrealized loss on equity securities, partially offset by increased service charge and miscellaneous income. During the quarter ended March 31, 2021, the Bank sold classified and non-accrual commercial real estate and residential loans with an aggregate amortized cost, net of charge-offs, of $9.1 million and recognized a $0.2 million loss on the sale. Increased service charges reflect increased fees from customer acquisition, new products as well as recognition of sign-on bonus fees associated with our Mastercard program. Noninterest income as a percentage of average assets was 0.35% and 0.41%, respectively, for the nine months ended September 30, 2021 and 2020. In 2020, the COVID-19 crisis had impacted spending habits of customers and reduced growth in service fee income, which has rebounded in 2021. In addition, the COVID-19 crisis curtailed expected commercial loan volume in the first nine months of 2021, which impacted interest rate protection agreement referral fee opportunities.
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Noninterest Expense
The following tables show the components of noninterest expense and the dollar and percentage changes for the periods presented.
Nine Months Ended September 30,
(dollars in thousands)20212020$ Change% Change
Noninterest Expense
Compensation and benefits$15,770 $15,001 $769 5.1 %
OREO valuation allowance and expenses689 2,303 (1,614)(70.1)%
Sub-total16,459 17,304 (845)(4.9)%
Operating Expense
Occupancy expense2,180 2,204 (24)(1.1)%
Advertising372 380 (8)(2.1)%
Data processing expense2,766 2,842 (76)(2.7)%
Professional fees1,920 1,755 165 9.4 %
Depreciation of premises and equipment419 451 (32)(7.1)%
FDIC Insurance512 679 (167)(24.6)%
Core deposit intangible amortization380 452 (72)(15.9)%
Other3,965 2,464 1,501 60.9 %
Total Operating Expense12,514 11,227 1,287 11.5 %
Total Noninterest Expense$28,973 $28,531 $442 1.5 %
The 1.5% increase in noninterest expense for the comparable periods was due to increased other expenses, compensation expenses and professional fees, partially offset by a decrease in OREO expenses and FDIC insurance. Other expenses include a $1.2 million charge, net of a partial recovery, related to an isolated wire transfer fraud incident that occurred in the first quarter of 2021. Compensation expense increased due to fewer deferred costs allocated for PPP loans as well as increased employee health insurance claims and larger incentive compensation accruals resulting from improvement in profitability and asset quality. Compensation and benefits for the nine months ended September 30, 2021 and 2020 were reduced $0.28 million and $0.48 million, respectively, for the allocation of deferred origination costs for U.S. SBA PPP loans. Decreased OREO expenses reflect management's actions in 2020 to reduce non-performing assets. OREO expenses have moderated as the Bank has reduced foreclosed assets over the last 12 months from $4.0 million at September 30, 2020 to $1.5 million at September 30, 2021. The FDIC insurance decreased due to improved balance sheet credit trends.
Our investigation of the first quarter 2021 wire fraud found no evidence that information systems of the Bank were compromised or that employee fraud was involved. In the second quarter of 2021, the Company submitted an insurance claim which could result in a recovery of a portion of the expense. Any recovery of insurance proceeds would be recognized in the quarter received.
Including the wire transfer fraud expense, the Company's quarterly expense run rate for the nine months ended September 30, 2021 averaged $9.7 million. The Company's quarterly expense run rate, excluding the wire transfer fraud expense, for the nine months ended September 30, 2021 averaged $9.3 million. Management's projected quarterly expense run rate for the fourth quarter of 2021 is estimated between $9.4 and $9.6 million with the increase over the average attributable to year end incentive compensation and employee benefit costs.
The Company’s efficiency ratio was 52.52% for the nine months ended September 30, 2021 compared to 55.95% for the nine months ended September 30, 2020. The Company’s net operating expense ratio was 1.47% at September 30, 2021 compared to 1.53% at September 30, 2020. The efficiency and net operating expense ratios have improved (decreased) as the Company has been able to generate more noninterest income while controlling expense growth.
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Income Tax Expense
The Company's effective tax rate for the nine months ended September 30, 2021 was 25.3%. The Company’s consolidated effective tax rate was 19.1% for the nine months ended September 30, 2020. The Company's new state apportionment approach was implemented during the first quarter of 2020 and included the impact of amended income tax filings of the Company and the Bank. The following table shows a breakdown of income tax expense for the nine months ended September 30, 2020 split between the apportionment adjustment and a normalized 2020 income tax provision:
Nine Months Ended September 30, 2020
(dollars in thousands)Tax ProvisionEffective Tax Rate
Income tax apportionment adjustment$(743)(6.0)%
Income taxes before apportionment adjustment3,106 25.1 %
Income tax expense as reported$2,363 19.1 %
Income before income taxes$12,360 
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COMPARISON OF FINANCIAL CONDITION AT SEPTEMBER 30, 2021 AND DECEMBER 31, 2020
ASSETS
Total assets increased primarily due to growth in cash, interest-bearing deposits with banks and investment securities, which have increased in 2021 as U.S. PPP loans have been forgiven and customer deposits have increased. These increases were partially offset by a decrease in net loans and small net decreases in all other asset accounts. The differences in allocations between the cash and investment categories reflect operational needs. Total assets and on-balance sheet liquidity increased in the first nine months of 2021 from deposit growth.
The following table shows the Company’s assets and the dollar and percentage changes for the periods presented.
(dollars in thousands)September 30, 2021December 31, 2020$ Change% Change
Cash and due from banks$112,314 $56,887 $55,427 97.4 %
Interest-bearing deposits with banks34,929 20,178 14,751 73.1 %
Securities available for sale ("AFS"), at fair value456,664 246,105 210,559 85.6 %
Equity securities carried at fair value through income4,805 4,855 (50)(1.0)%
Non-marketable equity securities held in other financial institutions207 207 — — %
FHLB stock - at cost1,472 2,777 (1,305)(47.0)%
Net Loans1,569,644 1,594,075 (24,431)(1.5)%
Goodwill10,835 10,835 — — %
Premises and equipment, net21,795 20,271 1,524 7.5 %
Other real estate owned ("OREO")1,536 3,109 (1,573)(50.6)%
Accrued interest receivable6,045 8,717 (2,672)(30.7)%
Investment in bank owned life insurance38,713 38,061 652 1.7 %
Core deposit intangible1,147 1,527 (380)(24.9)%
Net deferred tax assets8,790 7,909 881 11.1 %
Right of use assets, net operating leases6,215 7,831 (1,616)(20.6)%
Other assets3,581 3,095 486 15.7 %
Total Assets$2,278,692 $2,026,439 $252,253 12.4 %
Cash and Cash Equivalents
Cash and cash equivalents totaled $147.2 million at September 30, 2021, compared to $77.1 million at December 31, 2020. Total cash and cash equivalents fluctuate daily due to transactions in process and other liquidity demands. Management believes liquidity needs are satisfied by the current balance of cash and cash equivalents, access to traditional and wholesale funding sources, and the portions of the investment and loan portfolios that mature within one year.
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Investment Securities and Credit Quality of Investment Securities
Investment securities and FHLB stock at September 30, 2021 and December 31, 2020, estimated fair values were $463.1 million and $253.9 million, respectively.
Management monitors and manages investment portfolio performance and liquidity through monthly reporting including analyses of expected cash inflows and outflows from investment securities. Management believes the risk characteristics inherent in the investment portfolio are acceptable. The Company did not hold any noninvestment grade securities at September 30, 2021 and December 31, 2020. AFS securities are evaluated quarterly to determine whether a decline in their value is other than temporarily impaired ("OTTI"). No OTTI charge was recorded for the periods reported.
Gross unrealized losses at September 30, 2021 and December 31, 2020 for AFS securities were $4.2 million and $0.4 million of amortized cost of $456.7 million and $240.0 million, respectively (see Note 2 in consolidated financial statements). The change in unrealized losses was the result of changes in interest rates and other non-credit related factors, while credit risks remained stable. The Company intends to, and has the ability to, hold investment securities with unrealized losses until they mature, at which time the Company will receive full value for the securities. Management believes that the investment securities with unrealized losses will either recover in market value or be paid off as agreed.
The Bank holds 73.7% or $336.6 million (amortized cost) of its AFS investment securities, as asset-backed securities issued by GSEs or U.S. Agencies, GSE agency bonds or U.S. government obligations. In addition, the Company's investment of $57.2 million (amortized cost) in student loan trusts, which represent 12.5% of the AFS investment portfolio, are 97% U.S. government guaranteed. At September 30, 2021, the Company also had $62.6 million or 13.7% of AFS investments in municipal bonds.
At September 30, 2021 and December 31, 2020, AFS asset-backed securities issued and guaranteed by GSEs and U.S. Agencies had an average life of 7.04 years and 5.09 years and an average duration of 6.54 years and 4.81 years, respectively. At September 30, 2021 and December 31, 2020, AFS asset-backed securities issued by student loan trust and others had an average life of 6.57 years and 6.47 years and an average duration of 6.24 years and 6.14 years, respectively. At September 30, 2021 and December 31, 2020, AFS municipal bonds issued by states, political subdivisions or agencies had average life of 9.37 years and 9.81 years and an average duration of 8.29 years and 8.53 years, respectively.
The tables below present the Standard & Poor’s (“S&P”) or equivalent credit rating from other major rating agencies for AFS securities at September 30, 2021 and December 31, 2020 by carrying value. The Company considers noninvestment grade securities rated BB+ or lower as classified assets for regulatory and financial reporting. GSE asset-backed securities and GSE agency bonds with S&P AA+ ratings were treated as AAA based on regulatory guidance.
September 30, 2021December 31, 2020
Credit RatingAmountCredit RatingAmount
(dollars in thousands)(dollars in thousands)
AAA$422,682 AAA$220,757 
AA33,739 AA25,059 
A243 A289 
Total$456,664 Total$246,105 

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Loan Portfolio and U.S. SBA PPP Loans
At September 30, 2021, net loans, which include portfolio loans and U.S. SBA PPP loans, decreased 2.0% annualized or $24.4 million from December 31, 2020. Net portfolio loans increased $28.7 million and net U.S. SBA PPP loans decreased $53.2 million for the comparable period ends. The commercial real estate and residential rental portfolios increased in total during the first nine months of 2021, while increasing slightly as a percentage of gross portfolio loans. The Company’s loan pipeline was $192.0 million at September 30, 2021 compared to $134.0 million at December 31, 2020.
The following is a breakdown of the Company’s loan portfolio at September 30, 2021 and December 31, 2020:
(dollars in thousands)September 30, 2021%  December 31, 2020%  $ ChangeAnnualized % Change
BY LOAN TYPE
Portfolio Loans:
Commercial real estate$1,088,636 71.02 %$1,049,147 69.75 %$39,489 5.0 %
Residential first mortgages96,835 6.32 %133,779 8.89 %(36,944)(36.8)%
Residential rentals172,082 11.22 %139,059 9.24 %33,023 31.7 %
Construction and land development37,139 2.42 %37,520 2.49 %(381)(1.4)%
Home equity and second mortgages26,518 1.73 %29,129 1.94 %(2,611)(12.0)%
Commercial loans48,327 3.15 %52,921 3.52 %(4,594)(11.6)%
Consumer loans2,168 0.14 %1,027 0.07 %1,141 148.1 %
Commercial equipment61,346 4.00 %61,693 4.10 %(347)(0.8)%
Gross portfolio loans1,533,051 100.00 %1,504,275 100.00 %28,776 2.6 %
Net deferred costs365 0.01 %1,264 0.08 %(899)(94.8)%
Allowance for loan losses(18,579)(1.21)%(19,424)(1.29)%845 (5.8)%
(18,214)(18,160)(54)0.4 %
Net portfolio loans1,514,837 1,486,115 28,722 2.6 %
Gross U.S. Small Business Administration ("SBA") Paycheck Protection Program ("PPP") loans56,424 $110,320 (53,896)(65.1)%
Net deferred fees(1,617)(2,360)743 (42.0)%
Net U.S. SBA PPP Loans54,807 107,960 (53,153)(65.7)%
Total net loans$1,569,644 $1,594,075 $(24,431)(2.0)%
Gross Loans$1,589,475 $1,614,595 $(25,120)(2.1)%
Loan Concentrations
At September 30, 2021 and December 31, 2020, commercial loans, including residential rentals, represented 89.4% and 86.6%, respectively, of gross portfolio loans. The Bank's commercial loans are concentrated in its market area; however, these loans are distributed among many different borrowers and industries.
Non-owner occupied commercial real estate as a percentage of risk-based capital at September 30, 2021 and December 31, 2020 were $776.0 million or 325.1% and $695.8 million or 316.1%, respectively. Construction loans as a percentage of risk-based capital at September 30, 2021 and December 31, 2020 were $123.6 million or 51.8% and $139.2 million or 63.2%, respectively.
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Asset Quality
The following tables show asset quality ratios at September 30, 2021 and December 31, 2020.
 (Unaudited)
(dollars in thousands, except per share amounts)September 30, 2021December 31, 2020$ Change% Change
ASSET QUALITY
Total assets$2,278,692 $2,026,439 $252,253 12.4 %
Gross portfolio loans(1)
1,533,051 1,504,275 28,776 1.9 
Classified Assets6,663 22,358 (15,695)(70.2)
Allowance for loan losses18,579 19,424 (845)(4.4)
Past due loans - 31 to 89 days189 179 10 5.6 
Past due loans >=90 days1,400 11,965 (10,565)(88.3)
Total past due (delinquency) loans1,589 12,144 (10,555)(86.9)
Non-accrual loans(2)
5,160 18,222 (13,062)(71.7)
Accruing troubled debt restructures (TDRs)(3)
455 572 (117)(20.5)
Other real estate owned (OREO)1,536 3,109 (1,573)(50.6)
Non-accrual loans, OREO and TDRs$7,151 $21,903 $(14,752)(67.4)%
ASSET QUALITY RATIOS(4)
Classified assets to total assets0.29 %1.10 %
Classified assets to risk-based capital2.75 9.61 
Allowance for loan losses to total loans1.21 1.29 
Allowance for loan losses to non-accrual loans360.06 106.60 
Past due loans - 31 to 89 days to total loans0.01 0.01 
Past due loans >=90 days to total loans0.09 0.80 
Total past due (delinquency) to total loans0.10 0.81 
Non-accrual loans to total loans0.34 1.21 
Non-accrual loans and TDRs to total loans0.37 1.25 
Non-accrual loans and OREO to total assets0.29 1.05 
Non-accrual loans and OREO to total loans and OREO0.44 1.42 
Non-accrual loans, OREO and TDRs to total assets0.31 1.08 
____________________________________
(1)Portfolio loans include all loan portfolios except the U.S. SBA PPP loan portfolio. Asset quality ratios for loans exclude U.S. SBA PPP loans.
(2)Non-accrual loans include all loans that are 90 days or more delinquent and loans that are non-accrual due to the operating results or cash flows of a customer. Non-accrual loans can include loans that are current with all loan payments. At September 30, 2021 and December 31, 2020, the Company had current non-accrual loans of $3.8 million and $6.3 million, respectively.
(3)At September 30, 2021 and December 31, 2020, the Bank had total TDRs of $0.5 million and $2.1 million, respectively, with $0 and $1.5 million, respectively, in non-accrual status. These loans are classified as non-accrual loans for the calculation of financial ratios.
(4)Asset quality ratios are calculated using total portfolio loans. Portfolio loans include all loan portfolios except the U.S. SBA PPP loan portfolio.
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Allowance for Loan Losses ("ALLL") and Provision for Loan Losses ("PLL")
Management’s determination of the adequacy of the allowance is based on a periodic evaluation of the portfolio with consideration given to overall loss experience; current economic conditions; size, growth and composition of the loan portfolio; financial condition of the borrowers; current appraised values of underlying collateral and other factors that, in management’s judgment, warrant recognition in determining an adequate allowance. Improvements to baseline charge-off factors for the periods used to evaluate the adequacy of the allowance as well as improvements in some qualitative factors, such as improvements in classified assets were offset by deterioration in other qualitative factors. Although year to date 2021 charge-offs were comparable to the prior year, charge-off activity for the periods used to evaluate the allowance remained low. The specific allowance is based on management’s estimate of realizable value for particular loans. Management believes that the specific and general components of the allowance are adequate. The following is a summary roll-forward of the allowance and a breakdown of the Company’s general and specific allowances as a percentage of gross loans at and for the three and nine months ended September 30, 2021 and 2020 and year ended December 31, 2020:
 Three Months Ended September 30,Nine Months Ended September 30,Year Ended
(dollars in thousands)2021202020212020December 31, 2020
Beginning of period$18,516 $16,318 $19,424 $10,942 $10,942 
Charge-offs(491)(65)(2,037)(2,328)(2,358)
Recoveries554 76 606 115 140 
Net charge-offs63 11 (1,431)(2,213)(2,218)
Provision for loan losses— 2,500 534 10,100 10,700 
End of period$18,579 $18,829 $18,527 $18,829 $19,424 
Net charge-offs to average loans (annualized)0.02 %— %(0.38)%(0.61)%(0.61)%
Breakdown of general and specific allowance as a percentage of gross loans
 September 30, 2021December 31, 2020
General allowance$18,204 $18,068 
Specific allowance323 1,356 
Total allowance to non-acquired loans18,527 19,424 
PCI loans52 — 
Total allowance to gross portfolio loans with PCI loans$18,579 $19,424 
General allowance1.19 %1.20 %
Specific allowance0.02 %0.09 %
Total allowance to gross portfolio loans(1)
1.21 %1.29 %
Total allowance to gross portfolio loans with PCI loans(2)
1.21 %— %
Allowance to non-acquired gross loans1.25 %1.35 %
Total acquired loans$50,486 $60,977 
Non-acquired loans(3)
$1,482,565 $1,443,298 
Gross portfolio loans$1,533,051 $1,504,275 
____________________________________
(1)Portfolio loans include all loan portfolios except the U.S. SBA PPP loan portfolio.
(2)There were no allowances for loan loss on the PCI portfolios prior to the three months ended June 30, 2021.
(3)Non-acquired loans include loans transferred from acquired pools following release of acquisition accounting FMV adjustments. Non-acquired loans exclude U.S. SBA PPP loans.
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The Company's allowance reflects the continued economic uncertainty from the COVID-19 pandemic. The Company's allowance methodology considers quantitative historical loss factors and qualitative factors to determine the estimated level of incurred losses in the Company's loan portfolios. ALLL levels decreased to 1.21% of portfolio loans at September 30, 2021 compared to 1.29% at December 31, 2020. At September 30, 2021, the Company's ALLL decreased $0.9 million or 4.6% to $18.5 million at September 30, 2021 from $19.4 million at December 31, 2020.
The Company recorded $0.6 million of PLL for the nine months ended September 30, 2021 compared to $10.1 million for the nine months ended months ended September 30, 2020. Net charge-offs also decreased for the comparable periods from $2.2 million in the first nine months of 2020 to $1.4 million for the nine months ended September 30, 2021. During the three months ended September 30, 2021, net recoveries of $0.1 million included recoveries of $0.6 million partially offset by charge-offs of $0.5 million on two non-accrual relationships totaling $7.8 million that were resolved in the third quarter through a loan sale and a payoff.
The Company's general allowance increased from $18.1 million at December 31, 2020 to $18.2 million at September 30, 2021. The stability in the general allowance was primarily due to improvements in some qualitative factors partially offset by 2021 growth in the higher risk commercial real estate portfolio. During the first quarter of 2021, the Bank sold non-accrual and classified commercial real estate and residential mortgage loans with an amortized cost of $9.1 million, net of charge-offs of $1.4 million, and recognized a loss on the sale of $191,000. In the third quarter of 2021, the Bank resolved $7.8 million of non-accrual loans through $0.5 million in charge-offs that resulted in a loan sale and a payoff. The Company's resolution of these impaired loans decreased the specific reserve, improved asset quality and improved several ALLL qualitative factors.
Gross U.S. SBA PPP loans at September 30, 2021 totaled $56.4 million and 345 loans, a decrease of $53.9 million compared to December 31, 2020. No credit issues are anticipated with U.S. SBA PPP loans as they are guaranteed by the SBA and the Bank's allowance for loan loss does not include an allowance for U.S. SBA PPP loans.
Management believes that loans included in the COVID-19 deferral program in 2020 and 2021 are more likely to default in the future and that the identification and resolution of problem credits could be delayed. In our evaluation of current and previously deferred loans, we considered the length of the deferral period, the type and amount of collateral and customer industries. Consistent with regulatory guidance, if new information during the deferral period indicates that there is evidence of default, the Bank may change the classification rating (e.g., change from passing credit to substandard) and accrual status (e.g., change from accrual to non-accrual status) as deemed appropriate. As of September 30, 2021, $3.4 million or 0.2% of gross portfolio loans had deferral agreements, a decrease of $32.0 million from the $35.4 million or 2.4% of gross portfolio loans at December 31, 2020. As of September 30, 2021 and December 31, 2020, there were $1.0 million and $3.4 million of COVID-19 deferred loans deemed to be non-accrual and substandard based on reviews.
Below are schedules that provide information on COVID-19 deferred loans as of September 30, 2021:
COVID-19 Deferred Loans
(Unaudited)
September 30, 2021
Accrual LoansNon-Accrual Loans
(dollars in thousands)Loan Balances% of Deferred Loans% of Gross Portfolio LoansLoan BalancesNumber of LoansLoan BalancesNumber of Loans
Commercial real estate$3,422 100.00 %0.22 %$2,469 2$954 1
Total$3,422 100.00 %0.22 %$2,469 2$954 1
COVID-19 Deferred Loans - Next Payment Due by Month(Unaudited)
(dollars in thousands)Loan Balances%Number of Loans
December-21$3,422 100.00 %3
Total$3,422 100.00 %3
COVID-19 Deferred Loans by NAICS Industry(Unaudited)
(dollars in thousands)September 30, 2021Number of Loans
Arts, Entertainment, and Recreation$3,422 3
Total$3,422 3
Management believes that the allowance is adequate at September 30, 2021.
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Off Balance Sheet Credit Exposure Reserve
The Company's reserve for off balance sheet credit exposures was $51,000 and did not increase in the first nine months of 2021. The Company is monitoring line of credit usage and has not seen substantive increases in usage or expected usage. Management believes that many of the Bank's customers presently have sufficient liquidity due to COVID-19 government stimulus programs. The Company will continue to monitor activity for potential increases in the off-balance sheet reserve in future quarters as customers use available liquidity.
Classified Assets and Special Mention Assets
Classified assets decreased $15.7 million from $22.4 million at December 31, 2020 to $6.7 million at September 30, 2021. Management considers classified assets to be an important measure of asset quality. The Company's risk rating process for classified loans is an important input into the Company's allowance methodology. Risk ratings are expected to be an important indicator in assessing ongoing credit risks of loans that are presently or were for a period of time COVID-19 deferred loans. The following is a breakdown of the Company’s classified and special mention assets at September 30, 2021, June 30, 2021, March 31, 2021, and December 31, 2020, 2019, 2018, and 2017, respectively:
As of
(dollars in thousands)9/30/20216/30/20213/31/202112/31/202012/31/201912/31/201812/31/2017
Classified loans
Substandard$5,127 $13,382 $13,816 $19,249 $26,863 $32,226 $40,306 
Doubtful— — — — — — — 
Total classified loans5,127 13,382 13,816 19,249 26,863 32,226 40,306 
Special mention loans780 4,524 7,769 7,672 — — 96 
Total classified and special mention loans5,907 17,906 21,585 26,921 26,863 32,226 40,402 
Classified loans5,127 13,382 13,816 19,249 26,863 32,226 40,306 
Classified securities— — — — — 482 651 
Other real estate owned1,536 1,536 2,329 3,109 7,773 8,111 9,341 
Total classified assets$6,663 $14,918 $16,145 $22,358 $34,636 $40,819 $50,298 
Total classified assets as a percentage of total assets0.29 %0.68 %0.75 %1.10 %1.93 %2.42 %3.58 %
Total classified assets as a percentage of Risk Based Capital2.75 %6.24 %6.81 %9.61 %16.21 %21.54 %32.10 %
Asset quality has continued to improve in 2021 with the resolution of $16.9 million in non-accrual and impaired loans through loan sales and negotiated payoffs. Management remains committed to expeditiously resolve non-performing or substandard credits that are not likely to become performing or passing credits in a reasonable timeframe. During the first nine months of 2021 classified loans decreased $14.1 million from $19.2 million at December 31, 2020 to $5.1 million at September 30, 2021.
Non-Performing Assets
Non-performing assets, which consist of OREO, non-accrual loans and TDRs, decreased $14.8 million from $21.9 million at December 31, 2020 to $7.2 million at September 30, 2021.
OREO decreased from December 31, 2020 to September 30, 2021. There were no additions to OREO during the nine months ended September 30, 2021. See Note 5 in the financial statements for an analysis of OREO activity for the nine-month periods ended September 30, 2021 and 2020 and the year ended December 31, 2020. OREO carrying amounts reflect management’s estimate of the realizable value of these properties incorporating current appraised values, local real estate market conditions and related costs.
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Non-accrual loans decreased $13.1 million from $18.2 million at December 31, 2020 to $5.2 million at September 30, 2021. The decrease in non-accrual loans during the first nine months of 2021 was largely the result of the March 2021 and August 2021 sales and negotiated payoffs of several substandard classified relationships. Non-accrual loans of $3.8 million (73%) were current with all payments of principal and interest with specific reserves of $32,000 at September 30, 2021. Delinquent non-accrual loans were $1.4 million (27%) with specific reserves of $0.3 million at September 30, 2021. 
Non-accrual loans and OREO to total gross portfolio loans and OREO decreased 98 basis points from 1.42% at December 31, 2020 to 0.44% at September 30, 2021. Non-accrual loans, OREO and TDRs to total assets decreased 77 basis points from 1.08% at December 31, 2020 to 0.31% at September 30, 2021. 
Loan delinquency (90 days or greater delinquent and 31-89 days delinquent) decreased $10.6 million from $12.1 million or 0.81% of portfolio loans, at December 31, 2020 to $1.6 million, or 0.10% of portfolio loans, at September 30, 2021. Early-stage delinquency (31-89 days delinquent) remained flat at $0.2 million at December 31, 2020 and at September 30, 2021.
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LIABILITIES
The following table shows the Company’s liabilities and the dollar and percentage changes for the periods presented.
(dollars in thousands)September 30, 2021December 31, 2020$ Change% Change
Deposits        
Non-interest-bearing deposits$432,606 $362,079 $70,527 19.5 %
Interest-bearing deposits1,572,001 1,383,523 188,478 13.6 %
Total deposits2,004,607 1,745,602 259,005 14.8 %
Long-term debt12,249 27,302 (15,053)(55.1)%
Guaranteed preferred beneficial interest in junior subordinated debentures ("TRUPs")12,000 12,000 — — %
Subordinated notes net of debt issuance costs - 4.75%19,496 19,526 (30)— %
Lease liabilities - operating leases6,418 8,088 (1,670)(20.6)%
Accrued expenses and other liabilities19,794 15,908 3,886 24.4 %
Total Liabilities$2,074,564 $1,828,426 $246,138 13.5 %
Funding
The Bank uses retail deposits and wholesale funding. Wholesale funding includes short-term borrowings, long-term debt and brokered deposits. Retail deposits continue to be the most significant source of funds totaling $1,996.6 million or 99.0% of funding at September 30, 2021 compared to $1,737.6 million or 98.0% of funding at December 31, 2020. Wholesale funding, which consists of FHLB advances and brokered deposits, was $20.3 million or 1.0% of funding at September 30, 2021 compared to $35.3 million or 2.0% of funding at December 31, 2020.
The Company had junior subordinated debentures of $12.0 million and subordinated notes of $20.0 million of 4.75% fixed-to-floating rate subordinated notes at September 30, 2021 and December 31, 2020.
The following is a breakdown of the Company’s deposit portfolio at September 30, 2021 and December 31, 2020:
September 30, 2021December 31, 2020
(dollars in thousands)Balance%Balance%
Noninterest-bearing demand$432,606 21.58 %$362,079 20.74 %
Interest-bearing:
Demand764,482 38.14 %590,159 33.81 %
Money market deposits355,582 17.74 %340,725 19.52 %
Savings112,282 5.60 %98,783 5.66 %
Certificates of deposit339,655 16.94 %353,856 20.27 %
Total interest-bearing1,572,001 78.42 %1,383,523 79.26 %
Total Deposits$2,004,607 100.00 %$1,745,602 100.00 %
Transaction accounts$1,664,952 83.06 %$1,391,746 79.73 %
Total deposits increased $259.0 million or 14.84% (19.8% annualized) at September 30, 2021 compared to December 31, 2020. The increase consisted of a $273.2 million increase to transaction deposits partially offset by a $14.2 million decrease to time deposits. In the first nine months of 2021, transaction deposits increased due to new customer acquisitions as well as lower levels of consumer and business spending related to the COVID-19 pandemic. The Bank's increased customer deposit balances provided additional on-balance sheet liquidity compared to the prior year.
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For FDIC call reporting purposes reciprocal deposits are classified as brokered deposits when they exceed 20% of a bank’s liabilities or $5.0 billion. Reciprocal deposits considered brokered deposits for call reporting purposes at September 30, 2021 were $62.2 million compared to zero at December 31, 2020. Reciprocal deposits are included in retail deposits and are used to maximize FDIC insurance available to the Bank's customers.
STOCKHOLDERS' EQUITY AND REGULATORY CAPITAL
The following table shows the Company’s equity and the dollar and percentage changes for the periods presented.
(dollars in thousands)September 30, 2021December 31, 2020$ Change% Change
Common Stock at par of $0.01$57 $59 $(2)(3.39)%
Additional paid in capital96,649 95,965 684 0.71 %
Retained earnings107,890 97,944 9,946 10.15 %
Accumulated other comprehensive (loss) income(9)4,504 (4,513)(100.20)%
Unearned ESOP shares(459)(459)— — %
Total Stockholders’ Equity$204,128 $198,013 $6,115 3.09 %
Total stockholders’ equity increased primarily due to net income of $19.1 million, partially offset by an increase in accumulated other comprehensive loss of $4.5 million due to a reduction in unrealized gains in the investment portfolio, repurchases of common stock of $6.7 million and common dividends paid of $2.4 million.
The Company had a book value per common share of $35.66 and $33.54 at September 30, 2021 and December 31, 2020, respectively. Tangible book value at September 30, 2021 and December 31, 2020 were $33.57 and $31.45. The Company's common equity to assets ratio decreased to 8.96% at September 30, 2021 from 9.77% at December 31, 2020. The Company’s ratio of tangible common equity ("TCE") to tangible assets decreased to 8.48% at September 30, 2021 from 9.22% at December 31, 2020 (see Non-GAAP reconciliation schedules). The decrease in the TCE ratio was due to repurchases of 190,587 shares of Company's common stock during the first nine months of 2021 and significant increases in cash and investments.
U.S. SBA PPP loans are excluded from the calculation of risk-based capital ratios by assigning a zero percent risk weight. The Company remains well capitalized at September 30, 2021 with a Tier 1 capital to average assets ("leverage ratio") of 9.41% at September 30, 2021 compared to 9.56% at December 31, 2020.
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LIQUIDITY AND CAPITAL RESOURCES
Capital Resources
The Company has no business other than holding the stock of the Bank and does not have significant operating cash needs, except for the payment of dividends declared on common stock, and the payment of interest on subordinated debentures and subordinated notes, and noninterest expense.
The Company evaluates capital resources by its ability to maintain adequate regulatory capital ratios. The Company and the Bank annually update a three-year strategic capital plan. In developing its plan, the Company considers the impact to capital of asset growth, income accretion, dividends, holding company liquidity, investment in markets and people and stress testing.
Federal banking regulations require the Company and the Bank to maintain specified levels of capital. As of September 30, 2021, and December 31, 2020, the Company and Bank were well-capitalized under the regulatory framework for prompt corrective action under the Basel III Capital Rules. Management believes, as of September 30, 2021 and December 31, 2020, that the Company and the Bank met all capital adequacy requirements to which they were subject. See Note 10 of the consolidated financial statements.
Liquidity
Liquidity is our ability to meet cash demands as they arise. Cash needs may come from operations, loan demand, deposit withdrawals or acquisition opportunities. Potential obligations resulting from the issuance of standby letters of credit and commitments to fund future borrowings to our loan customers are other factors affecting our liquidity needs. Many of these obligations and commitments are expected to expire without being drawn upon; therefore, the total commitment amounts do not necessarily represent future cash requirements affecting our liquidity position.
Based on management’s going concern evaluation, we believe that there are no conditions or events, considered in the aggregate, that raise substantial doubt about the Company’s or the Bank’s ability to continue as a going concern, within one year of the date of the issuance of the financial statements.
The Company’s principal sources of liquidity are cash on hand and dividends received from the Bank. The Bank’s most liquid assets are cash, cash equivalents and federal funds sold. The levels of such assets are dependent on the Bank’s operating, financing and investment activities at any given time. The variations in levels of cash and cash equivalents are influenced by deposit flows and anticipated future deposit flows. Customer deposits are considered the primary source of funds supporting the Bank’s lending and investment activities.
Liquidity is provided by access to funding sources, which include core depositors and brokered deposits. Other sources of funds include our ability to borrow, such as purchasing federal funds from correspondent banks, sales of securities under agreements to repurchase and advances from the FHLB of Atlanta. The Bank uses wholesale funding (brokered deposits and other sources of funds) to supplement funding when loan growth exceeds core deposit growth and for asset-liability management purposes.
At September 30, 2021 and December 31, 2020, the Bank had $80.2 million and $66.5 million, respectively, in loan commitments outstanding. In addition, at September 30, 2021 and December 31, 2020, the Bank had $22.3 million and $20.0 million, respectively, in letters of credit and approximately $237.1 million and $225.5 million, respectively, available under lines of credit. Certificates of deposit due within one year of September 30, 2021 and December 31, 2020 totaled $272.8 million, or 80.3% and $266.1 million, or 75.2%, respectively, of total certificates of deposit outstanding. If maturing deposits do not remain, the Bank will be required to seek other sources of funds, including other certificates of deposit and borrowings. Depending on market conditions, the Bank may be required to pay higher rates on such deposits or other borrowings than the Bank currently pays on the certificates of deposits. Management believes, however, based on past experience that a significant portion of the Bank's certificates of deposit will remain with the Bank. Management has the ability to attract and retain deposits by adjusting the interest rates offered.
Management monitors customer line of credit usage. If we were to experience increases in draws on customer lines of credit or decreased deposit levels in future periods as a result of the distressed economic conditions in our market areas relating to the COVID-19 pandemic, our level of borrowed funds could increase.
At September 30, 2021, the Company had on-balance sheet liquidity of $147.2 million in cash and cash equivalents. At September 30, 2021, the Company had loans and securities pledged or in safekeeping at FHLB which provided for funding availability of $515.2 million at September 30, 2021.
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Advances from the FHLB are secured by the Bank’s stock in the FHLB, a portion of the Bank’s loan portfolio and certain investments. Generally, the Bank’s ability to borrow from the FHLB of Atlanta is limited by its available collateral and also by an overall limitation of 30% of assets. In addition, the Bank has established unsecured and secured lines of credit with the Federal Reserve Bank and commercial banks.
For additional information on these agreements, including collateral, see Note 8 of the consolidated financial statements as presented in the Company’s Form 10-K for the year ended December 31, 2020.
The Company’s net loan to deposit ratio decreased from 91.3% at December 31, 2020 and to 78.3% at September 30, 2021. The Company intends to use available on-balance sheet liquidity to fund loans, increase investments and limit the use of wholesale funding.
The Bank’s principal sources of funds for investment and operations are net income, deposits, sales of loans, borrowings, principal and interest payments on loans, principal and interest received on investment securities and proceeds from the maturity and sale of investment securities. The Bank’s principal funding commitments are for the origination or purchase of loans, the purchase of securities and the payment of maturing deposits.
During the nine months ended September 30, 2021, all financing activities provided $234.9 million in cash compared to $325.5 million in cash for the same period in 2020. Cash from financing activities decreased $90.6 million for the nine months ended September 30, 2021 compared to the nine months ended September 30, 2020 primarily due to a decrease in long term borrowings of $102.9 million, decreased deposit growth of $8.8 million and the repurchase of common stock of $6.7 million, partially offset by a decrease in subordinated debt activities of $23.0 million.
During the nine months ended September 30, 2021 all investing activities used $195.2 million in cash compared to $190.2 million in cash used for the same period in 2020. The increase in cash used was primarily the result of cash used for purchases of investment securities partially offset by a decrease in cash used for loan activities. Cash used for loan activities decreased $186.0 million from $176.4 million, for the nine months ended September 30, 2020 to $9.6 million of cash provided for the nine months ended September 30, 2021 primarily due to decreased PPP originations in 2021 compared to the prior year comparable period. Cash used for the purchase of investment securities increased $158.4 million from $107.4 million for the nine months ended September 30, 2020 to $265.7 million for the nine months ended September 30, 2021. Cash used decreased $41.9 million as total proceeds from the sales and principal payments of securities for the nine months ended September 30, 2021 decreased over the prior year comparable period.
Operating activities provided cash of $30.5 million, or $10.5 million more cash, for the nine months ended September 30, 2021, compared to $20.0 million of cash provided for the same period of 2020.
For information on risks relating to liquidity, see Item 1A. "Risk Factors - Liquidity Risk", as presented in the Company's Form 10-K for the year ended December 31, 2020.
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ITEM 3 – QUANTITATIVE AND QUALITATIVE DISCLOSURE ABOUT MARKET RISK
Interest rate risk is defined as the exposure to changes in net interest income and capital that arises from movements in interest rates. Increasing or decreasing interest rates can negatively affect the Company’s results of operations and financial condition.
The Company measures interest rate risk by modeling changes to Net Interest Income ("NII") and changes to the Economic Value of Equity ("EVE") caused by a change in interest rates. The economic value of equity (“NII”) is defined as the present value of future cash flows from existing assets, minus the present value of future cash flows from existing liabilities. NII changes are modeled over twelve and twenty-four months.
The Company’s interest rate risk (“IRR”) model bases its results on the characteristics of the Company's assets and liabilities including contractual features as well as estimates of consumer behavior. There are inherent limitations in the Company’s IRR model and underlying assumptions. When interest rates change, actual changes in EVE and NII may deviate significantly from the model. The Company prepares a current base case and several alternative simulations quarterly. Current interest rates are shocked by +/- 100, 200, 300, and 400 basis points (“bp”). In addition, the Company simulates additional scenarios that model non-parallel changes in rates. The Company may elect not to use scenarios that it determines are impractical in a current rate environment. The Company's interest rate risk policy establishes limits on the percentage change in NII and EVE resulting from changes in interest rates. The limits established for parallel shock scenarios are as follows:
Shock in Basis PointsNet Interest IncomeEconomic Value of Equity
+ - 40025%40%
+ - 30020%30%
+ - 20015%20%
+ - 10010%10%
At September 30, 2021 and December 31, 2020, the Company did not exceed any sensitivity limits for change in NII. In the third quarter of 2021 the change in EVE exceeded policy guidelines due to the historically low interest rate environment. The Company has determined that due to the level of market rates at September 30, 2021, interest rate shocks of -100, -200, -300 and -400 basis points are not informative.
Estimated changes for NII over a twelve-month period for parallel rate shocks for up 200, up 100 and down 100 scenarios:
Estimated Changes in Net Interest Income
Change in Interest Rates:+ 200 bp+ 100 bp-100 bp
Policy Limit(15.00)%(10.00)%(10.00)%
September 30, 2021(1.28)%(0.60)%(1.17)%
June 30, 20211.69 %0.82 %(1.09)%
March 31, 2021(0.89)%(0.53)%(1.02)%
December 31, 2020(1.28)%(0.23)%(1.17)%
The below schedule details the estimated changes in the EVE at parallel shocks for up 200, up 100 and down 100 scenarios:
Estimated Changes in Economic Value of Equity
Change in Interest Rates:+ 200 bp+ 100 bp-100 bp
Policy Limit(20.00)%(10.00)%(10.00)%
September 30, 202127.10 %16.77 %(29.34)%
June 30, 202132.17 %19.50 %(32.54)%
March 31, 202128.56 %17.31 %(28.84)%
December 31, 202052.00 %32.00 %(47.00)%

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ITEM 4 – CONTROLS AND PROCEDURES
As of the end of the period covered by this report, management of the Company carried out an evaluation, under the supervision and with the participation of the Company’s principal executive officer and principal financial officer, of the effectiveness of the Company’s disclosure controls and procedures. Based on this evaluation, the Company’s principal executive officer and principal financial officer concluded that the Company’s disclosure controls and procedures are effective in ensuring that information required to be disclosed by the Company in reports that it files or submits under the Securities Exchange Act of 1934, as amended, (1) is recorded, processed, summarized and reported within the time periods specified in the SEC’s rules and forms and (2) is accumulated and communicated to the Company’s management, including its principal executive and financial officers as appropriate to allow timely decisions regarding required disclosure. It should be noted that the design of the Company’s disclosure controls and procedures is based in part upon certain reasonable assumptions about the likelihood of future events, and there can be no reasonable assurance that any design of disclosure controls and procedures will succeed in achieving its stated goals under all potential future conditions, regardless of how remote, but the Company’s principal executive and financial officers have concluded that the Company’s disclosure controls and procedures are, in fact, effective at a reasonable assurance level. There were no changes in the Company’s internal control over financial reporting during the quarter ended September 30, 2021 that have materially affected, or are reasonable likely to materially affect, the Company’s internal control over financial reporting.
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PART II – OTHER INFORMATION
Item 1 – Legal Proceedings
In the normal course of business, the Company becomes involved in litigation arising from the banking, financial and other activities it conducts. Management, after consultation with legal counsel, does not anticipate that the ultimate liability, if any, arising from these matters will have a material effect on the Company’s financial condition, operating results or liquidity.
Item 1A – Risk Factors 
In addition to the other information set forth in this report, you should carefully consider the risk factors disclosed in Part I, “Item 1A- Risk Factors” in the Form 10-K for the year ended December 31, 2020 that the Company filed with the SEC on March 4, 2021. These risk factors could materially affect our business, financial condition or future results. The risks described are not the only risks that the Company face. Additional risks and uncertainties not currently known or that the Company currently deem to be immaterial also may materially adversely affect its business, financial condition and/or operating results. There have been no material changes to the risk factors discussed in the Company's Form 10-K filed on March 4, 2021.
Item 2 – Unregistered Sales of Equity Securities and Use of Proceeds
(a)Not applicable
(b)Not applicable
(c)On October 20, 2020, 184,863 shares were available to be repurchased under the 2015 repurchase plan, and, on that date, the Board of Directors approved an expansion to the 2015 repurchase plan (the "2020 repurchase plan") that allows the Company to repurchase up to 300,000 of the Company’s outstanding shares of common stock using up to $7.0 million of the proceeds the Company raised in its $20.0 million subordinated debt offering completed in October 2020. As of September 30, 2021, 200,550 shares were purchased at a total cost of approximately $7.0 million or an average of $34.81 per share under the 2020 repurchase plan, which completed the usage of the proceeds the Company allocated from its October 2020 $20.0 million subordinated debt offering toward share repurchases under the 2020 repurchase plan. The Company will continue to evaluate the use of additional capital management strategies to enhance overall shareholder value, including repurchasing some or all of the 99,450 shares remaining under the 2020 repurchase plan. Any further plans to resume repurchases under the 2020 repurchase plan will be publicly announced. The following schedule shows the repurchases during the three months ended September 30, 2021.
Period( a )
Total Number of Shares Purchased
( b )
Average Price Paid per Share
( c )
Total Number of Shares Purchased as Part of Publicly Announced Plans or Programs
( d )
Maximum Number of Shares that May Yet Be Purchased Under the Plans or Programs
July 1-31, 202171,196 $35.63 71,196 99,725 
August 1-31, 2021275 $37.78 275 99,450 
September 1-30, 2021— $— — 99,450 
Total71,471 $35.64 71,471 99,450 
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
NumberDescription
31
32
101
The following materials from the Company’s Quarterly Report on Form 10-Q for the quarter ended September 30, 2021, formatted in iXBRL (Inline Extensible Business Reporting Language):
(i) the Consolidated Balance Sheets, (ii) the Consolidated Statements of Income, (iii) the Consolidated Statements of Comprehensive Income, (iv) the Consolidated Statements of Changes in Stockholders' Equity, (v) the Consolidated Statements of Cash Flows; and (vi) the Notes to the Consolidated Financial Statements.
104Cover Page Interactive Data File (formatted as Inline XBRL and contained in Exhibit 101)
__________________________________
*Management contract or compensation arrangement.
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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.
THE COMMUNITY FINANCIAL CORPORATION
Date: November 8, 2021By:/s/ William J. Pasenelli
William J. Pasenelli
Chief Executive Officer
Date: November 8, 2021By:/s/ Todd L. Capitani
Todd L. Capitani
Chief Financial Officer

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