UNITED STATES

SECURITIES AND EXCHANGE COMMISSION

Washington, D.C. 20549

FORM

10-Q

(Mark One)

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

For the Quarterly Period Ended June 30, 2022

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

THE COMMUNITY FINANCIAL CORPORATION

(Exact Name of Registrant as Specified in Its Charter)

Maryland						52-1652138
(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 class

Trading Symbol(s)

Name of each exchange on which registered

Common Stock, par value $0.01 per share

TCFC

The NASDAQ Stock Market LLC

Indicate by check mark whether the registrant (1) has filed all reports required to be filed by Section 13 or 15(d) of the Securities Exchange Act of 1934 during the preceding 12 months (or for such shorter period that the registrant was required to file such reports), and (2) has been subject to such filing requirements for the past 90 days. Yes  ☒  No ☐

Indicate by check mark whether the registrant has submitted electronically every Interactive Data File required to be submitted pursuant to Rule 405 of Regulation S-T (§ 232.405 of this chapter) during the preceding 12 months (or for such shorter period that the registrant was required to submit such files). Yes  ☒  No ☐

Indicate by check mark whether the registrant is a large accelerated filer, an accelerated filer, a non-accelerated filer, a smaller reporting company, or an emerging growth company. See 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 July 29, 2022, the registrant had 5,651,269 shares of common stock outstanding. 

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TABLE OF CONTENTS

Table of Contents						Page
Forward-Looking Statements
PART I – FINANCIAL INFORMATION
Item 1 – Financial Statements (Unaudited)						1
Consolidated Balance Sheets						1
Consolidated Statements of Income						2
Consolidated Statements of Comprehensive Income/Loss						3
Consolidated Statements of Changes in Stockholders’ Equity						4
Consolidated Statements of Cash Flows						6
Notes to Consolidated Financial Statements						8
Item 2 – Management’s Discussion and Analysis (MD&A) of Financial Condition and Results of Operations						41
Item 3 – Quantitative and Qualitative Disclosures about Market Risk						74
Item 4 – Controls and Procedures						75
PART II – OTHER INFORMATION
Item 1 – Legal Proceedings						76
Item 1A – Risk Factors						76
Item 2 – Unregistered Sales of Equity Securities and Use of Proceeds						76
Item 3 – Defaults Upon Senior Securities						76
Item 4 – Mine Safety Disclosures						76
Item 5 – Other Information						76
Item 6 – Exhibits						77
SIGNATURES						78

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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 or phrases such as “is optimistic”, “project,” “believe,” “expect,” “anticipate,” “estimate,” “assume” 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: (i) 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 future financial or business performance strategies or expectations; (ii) 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 undertaken or that we undertake in the future; (iii) plans and cost savings regarding branch closings or consolidation; (iv) projections related to certain financial metrics, including with respect to the quarterly expense run rate; (v) expected benefits of programs we introduce, including residential mortgage programs and retail and commercial credit card programs; and (vi) 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: (i) 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; (ii) 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); (iii) the impacts related to or resulting from Russia’s military action in Ukraine, including the broader impacts to financial markets and the global macroeconomic and geopolitical environments; (iv) assumptions that interest-earning assets will reprice faster than interest-bearing liabilities and the Bank’s ability to maintain its current favorable funding mix; (v) 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; (vi) the impact of our adoption of the CECL standard; (vii) limitations on our ability to declare and pay dividends or engage in share repurchases; (viii) changes in the Company’s or the Bank’s strategy, costs or difficulties related to integration matters might be greater than expected; (ix) availability of and costs associated with obtaining adequate and timely sources of liquidity; (x) the ability to maintain credit quality; (xi) general economic trends and conditions, including inflation and its impacts; (xii) changes in interest rates; (xiii) loss of deposits and loan demand to other financial institutions; (xiv) substantial changes in financial markets; (xv) changes in real estate value and the real estate market; (xxi) regulatory changes; (xvii) the impact of government shutdowns or sequestration; (xviii) the possibility of unforeseen events affecting the industry generally; (xix) the uncertainties associated with newly developed or acquired operations; (xx) the outcome of pending or threatened litigation, or of matters before regulatory agencies, whether currently existing or commencing in the future; (xxi) market disruptions and other effects of terrorist activities; and (xxii) the matters described in “Item 1A Risk Factors” in the Company’s Annual Report on Form 10-K for the Year Ended December 31, 2021, 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)						June 30, 2022						December 31, 2021
Assets
Cash and due from banks						$	16,164					$	108,990
Federal funds sold						37,320						—
Interest-bearing deposits with banks						34,659						30,664
Securities available for sale ("AFS"), at fair value						485,456						497,839
Equity securities carried at fair value through income						4,423						4,772
Non-marketable equity securities held in other financial institutions						207						207
Federal Home Loan Bank ("FHLB") stock - at cost						1,234						1,472
Net U.S. Small Business Administration ("SBA") Paycheck Protection Program ("PPP") Loans						5,022						26,398
Portfolio loans receivable net of allowance for credit losses of $21,404 and $18,417						1,631,055						1,560,393
Net loans						1,636,077						1,586,791
Goodwill						10,835						10,835
Premises and equipment, net						21,802						21,427
Accrued interest receivable						6,099						5,588
Investment in bank owned life insurance						39,363						38,932
Core deposit intangible						821						1,032
Net deferred tax assets						20,223						9,033
Right of use assets - operating leases						6,123						6,124
Other assets						2,708						3,600
Total Assets						$	2,323,514					$	2,327,306
Liabilities and Stockholders’ Equity
Deposits
Non-interest-bearing deposits						$	635,649					$	445,778
Interest-bearing deposits						1,449,727						1,610,386
Total deposits						2,085,376						2,056,164
Long-term debt						—						12,231
Guaranteed preferred beneficial interest in junior subordinated debentures ("TRUPs")						12,000						12,000
Subordinated notes net of debt issuance costs - 4.75%						19,538						19,510
Lease liabilities - operating leases						6,372						6,343
Accrued expenses and other liabilities						15,357						12,925
Total Liabilities						2,138,643						2,119,173
Stockholders’ Equity
Common stock - par value $0.01; authorized - 15,000,000 shares; issued 5,649,729 and 5,718,528 shares, respectively						56						57
Additional paid in capital						97,455						96,896
Retained earnings						119,523						113,448
Accumulated other comprehensive losses						(31,847)						(1,952)
Unearned ESOP shares						(316)						(316)
Total Stockholders’ Equity						184,871						208,133
Total Liabilities and Stockholders’ Equity						$	2,323,514					$	2,327,306

See notes to Consolidated Financial Statements

1

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CONSOLIDATED STATEMENTS OF INCOME

(Unaudited)

						Three Months Ended June 30,												Six Months Ended June 30,
(dollars in thousands, except per share amounts)						2022						2021						2022						2021
Interest and Dividend Income
Loans, including fees						$	16,772					$	16,320					$	32,382					$	32,912
Interest and dividends on investment securities						1,924						1,101						3,590						2,165
Interest on deposits with banks						78						23						138						45
Total Interest and Dividend Income						18,774						17,444						36,110						35,122
Interest Expense
Deposits						819						640						1,332						1,442
Short-term borrowings						16						—						16						—
Long-term debt						371						369						725						736
Total Interest Expense						1,206						1,009						2,073						2,178
Net Interest Income						17,568						16,435						34,037						32,944
Provision for credit losses						425						291						875						586
Provision (recovery) for unfunded commitments						26						—						(5)						—
Net Interest Income After Provision For Credit Losses						17,117						16,144						33,167						32,358
Noninterest Income
Loan appraisal, credit, and miscellaneous charges						44						44						220						242
Gain on sale of assets						—						68						—						68
Net gains on sale of investment securities						—						—						—						586
Unrealized (losses) gains on equity securities						(155)						13						(377)						(72)
Income from bank owned life insurance						217						218						431						432
Service charges						1,108						892						2,034						2,079
Referral fee income						—						621						361						1,072
Net gains (losses) on sale of loans originated for sale						1						—						(3)						—
Gains (losses) on sale of loans						209						—						209						(191)
Total Noninterest Income						1,424						1,856						2,875						4,216
Noninterest Expense
Compensation and benefits						5,051						5,332						10,106						10,120
Occupancy expense						820						688						1,552						1,449
Advertising						159						148						223						227
Data processing expense						1,008						990						2,015						1,926
Professional fees						845						604						1,576						1,244
Depreciation of premises and equipment						150						135						299						282
FDIC Insurance						177						140						356						392
OREO valuation allowance and expenses						—						488						6						669
Core deposit intangible amortization						102						126						211						259
Fraud losses (recoveries)						30						(217)						70						1,112
Other expenses						996						944						2,004						1,846
Total Noninterest Expense						9,338						9,378						18,418						19,526
Income before income taxes						9,203						8,622						17,624						17,048
Income tax expense						2,369						2,190						4,502						4,317
Net Income						$	6,834					$	6,432					$	13,122					$	12,731
Earnings Per Common Share
Basic						$	1.21					$	1.10					$	2.32					$	2.17
Diluted						$	1.21					$	1.10					$	2.31					$	2.17
Cash dividends paid per common share						$	0.175					$	0.150					$	0.35					$	0.28

See notes to Consolidated Financial Statements

2

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CONSOLIDATED STATEMENTS OF COMPREHENSIVE INCOME/LOSS

(Unaudited)

						Three Months Ended June 30,												Six Months Ended June 30,
(dollars in thousands)						2022						2021						2022						2021
Net Income						$	6,834					$	6,432					$	13,122					$	12,731
Net unrealized holding (losses) gains arising during period, net of tax (benefits) expenses of $(4,539) and $486, and $(10,537) and $(661), respectively.						(12,878)						1,379						(29,895)						(1,874)
Reclassification adjustment for gains included in net income, net of tax expense of $0 and $0, and $0 and $153, respectively.						—						—						—						433
Comprehensive (Loss) Income						$	(6,044)					$	7,811					$	(16,773)					$	11,290

See notes to Consolidated Financial Statements

3

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CONSOLIDATED STATEMENTS OF CHANGES IN STOCKHOLDERS’ EQUITY

(Unaudited)

For the Three Months Ended June 30, 2022 and 2021

(dollars in thousands)						Common Stock						Additional Paid-in Capital						Retained Earnings						Accumulated Other Comprehensive Loss						Unearned ESOP Shares						Total
Balance at March 31, 2022						$	57					$	97,189					$	115,179					$	(18,969)					$	(316)					$	193,140
Net Income						—						—						6,834						—						—						6,834
Unrealized holding loss on investment securities, net of tax $(4,539)						—						—						—						(12,878)						—						(12,878)
Cash dividend at $0.175 per common share						—						—						(939)						—						—						(939)
Dividend reinvestment						—						53						(53)						—						—						—
Net change in fair market value below cost of leveraged ESOP shares released						—						3						—						—						—						3
Repurchase of common stock						(1)						—						(1,498)						—						—						(1,499)
Stock based compensation						—						210						—						—						—						210
Balance at June 30, 2022						$	56					$	97,455					$	119,523					$	(31,847)					$	(316)					$	184,871

(dollars in thousands)						Common Stock						Additional Paid-in Capital						Retained Earnings						Accumulated Other Comprehensive Income						Unearned ESOP Shares						Total
Balance at March 31, 2021						$	59					$	96,181					$	103,294					$	1,684					$	(459)					$	200,759
Net Income						—						—						6,432						—						—						6,432
Unrealized holding gain on investment securities, net of tax $486						—						—						—						1,379						—						1,379
Cash dividend at $0.150 per common share						—						—						(841)						—						—						(841)
Dividend reinvestment						—						45						(45)						—						—						—
Net change in fair market value below cost of leveraged ESOP shares released						—						1						—						—						—						1
Repurchase of common stock						(1)						—						(3,951)						—						—						(3,952)
Stock based compensation						—						184						—						—						—						184
Balance at June 30, 2021						$	58					$	96,411					$	104,889					$	3,063					$	(459)					$	203,962

See notes to Consolidated Financial Statements

4

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CONSOLIDATED STATEMENTS OF CHANGES IN STOCKHOLDERS’ EQUITY

(Unaudited)

For the Six Months Ended June 30, 2022 and 2021

(dollars in thousands)						Common Stock						Additional Paid-in Capital						Retained Earnings						Accumulated Other Comprehensive Loss						Unearned ESOP Shares						Total
Balance at January 1, 2022						$	57					$	96,896					$	113,448					$	(1,952)					$	(316)					$	208,133
Cumulative effect adjustment due to the adoption of ASC 326, net of tax						—						—						(2,006)						—						—						(2,006)
Net Income						—						—						13,122						—						—						13,122
Unrealized holding gain on investment securities net of tax $(10,537)						—						—						—						(29,895)						—						(29,895)
Cash dividend at $0.350 per common share						—						—						(1,888)						—						—						(1,888)
Dividend reinvestment						—						105						(105)						—						—						—
Net change in fair market value below cost of leveraged ESOP shares released						—						9						—						—						—						9
Net change in unearned ESOP shares						—						—						—						—						—						—
Repurchase of common stock						(1)						—						(3,048)						—						—						(3,049)
Stock based compensation						—						445						—						—						—						445
Balance at June 30, 2022						$	56					$	97,455					$	119,523					$	(31,847)					$	(316)					$	184,871

(dollars in thousands)						Common Stock						Additional Paid-in Capital						Retained Earnings						Accumulated Other Comprehensive Income						Unearned ESOP Shares						Total
Balance at January 1, 2021						$	59					$	95,965					$	97,944					$	4,504					$	(459)					$	198,013
Net Income						—						—						12,731						—						—						12,731
Unrealized holding gain on investment securities net of tax $(508)						—						—						—						(1,441)						—						(1,441)
Cash dividend at $0.275 per common share						—						—						(1,543)						—						—						(1,543)
Dividend reinvestment						—						80						(80)						—						—						—
Net change in fair market value over cost of leveraged ESOP shares released						—						(4)						—						—						—						(4)
Net change in unearned ESOP shares						—						—						—						—						—						—
Repurchase of common stock						(1)						—						(4,163)						—						—						(4,164)
Stock based compensation												370						—																		370
Balance at June 30, 2021						$	58					$	96,411					$	104,889					$	3,063					$	(459)					$	203,962

See notes to Consolidated Financial Statements

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CONSOLIDATED STATEMENTS OF CASH FLOWS

(Unaudited)

						Six Months Ended June 30,
(dollars in thousands)						2022						2021
Cash Flows from Operating Activities
Net income						$	13,122					$	12,731
Adjustments to reconcile net income to net cash provided by operating activities
Provision for credit losses						875						586
Recovery for unfunded commitments						(5)						—
Depreciation and amortization						746						771
Loans originated for resale						(1,600)						—
Proceeds from sale of loans originated for sale						1,635						—
Net losses on sale of loans held for sale						3						—
(Gains) losses on sale of loans						(209)						191
Net gains on the sale of OREO						—						(16)
Gains on sales of investment securities						—						(586)
Unrealized losses on equity securities						377						72
Gains on sale of assets						—						(68)
Net amortization of premium/discount on investment securities						1,371						292
Net accretion of merger accounting adjustments						(105)						(165)
Net amortization of debt issuance costs						28						(44)
Amortization of core deposit intangible						211						259
Amortization of right of use asset						187						214
Net change in right of use assets and lease liabilities						(157)						(208)
Increase in OREO valuation allowance						—						641
Increase in cash surrender value of bank owned life insurance						(431)						(432)
Increase in deferred income tax benefit						45						278
(Increase) decrease in accrued interest receivable						(511)						2,127
Stock based compensation						445						370
Net change in fair market value above (below) cost of leveraged ESOP shares released						9						(4)
Decrease in net deferred loan costs						301						1,461
Increase in accrued expenses and other liabilities						2,219						1,790
Decrease (increase) in other assets						893						(1,146)
Net Cash Provided by Operating Activities						19,449						19,114
Cash Flows from Investing Activities
Purchase of AFS investment securities						(57,727)						(142,181)
Proceeds from redemption or principal payments of AFS investment securities						28,279						26,381
Proceeds from sale of AFS investment securities						—						12,540
Net decrease of FHLB stock						238						741
Net change in loans						(56,261)						(19,230)
Purchase of premises and equipment						(1,121)						(2,130)
Proceeds from sale of OREO						—						947
Proceeds from sale of loans						3,588						8,858
Proceeds from disposal of asset						—						12
Net Cash Used in Investing Activities						(83,004)						(114,062)

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CONSOLIDATED STATEMENTS OF CASH FLOWS (Unaudited)

(Continued)

						Six Months Ended June 30,
(dollars in thousands)						2022						2021
Cash Flows from Financing Activities
Net increase in deposits						$	29,212					$	162,536
Payments of long-term debt						(12,231)						(35)
Dividends paid						(1,888)						(1,543)
Repurchase of common stock						(3,049)						(4,164)
Net Cash Provided by Financing Activities						12,044						156,794
(Decrease) increase in Cash and Cash Equivalents						(51,511)						61,846
Cash and Cash Equivalents - January 1						139,654						77,065
Cash and Cash Equivalents - June 30						$	88,143					$	138,911
Supplemental Disclosures of Cash Flow Information
Cash paid during the period for
Interest						$	2,095					$	2,378
Income taxes						$	3,491					$	4,460
Supplemental Schedule of Non-Cash Operating Activities
Issuance of common stock for payment of compensation						$	154					$	—
Supplemental Schedule of Non-Cash Investing and Financing Activities
Cumulative effect adjustment for adoption of ASU 2016-13						$	2,006					$	—

See notes to Consolidated Financial Statements

7

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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 include the accounts of The Community Financial Corporation and its wholly-owned subsidiary, Community Bank of the Chesapeake (the “Bank”), (collectively, the “Company”), included herein are unaudited.

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, 2021 have been derived from audited Consolidated Financial Statements. The Company’s accounting policies are disclosed in the 2021 Annual Report included in Note 1, as well as the adoption of the new Current Expected Credit Loss ("CECL") accounting standard that is described below. The results of operations for the six months June 30, 2022 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 2021 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 credit losses ("ACL"), 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.

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New Accounting Policy

Allowance for Credit Losses

On January 1, 2022, the Company adopted ASU 2016-13 Financial Instruments - Credit Losses (Topic 326) - Measurement of Credit Losses on Financial Instruments, which replaced the incurred loss methodology for determining the provision for credit losses and ACL with the CECL methodology. The measurement of expected credit losses under the CECL methodology applies to financial assets subject to credit losses and measured at amortized cost, and certain off-balance sheet credit exposures. This includes, but is not limited to, loans, leases, held-to-maturity securities, loan commitments, and financial guarantees. In addition, ASU 2016-13 made changes to the accounting for available-for-sale ("AFS") debt securities. Credit-related impairments of AFS debt securities are now recognized through an allowance for credit loss rather than a write-down of the securities' amortized cost basis when management does not intend to sell or believes that it is not likely that they will be required to sell the securities prior to recovery of the securities amortized cost basis.

We adopted ASU 2016-13 using the modified retrospective method. Results for reporting periods beginning after January 1, 2022 are presented under ASU 2016-13 while prior period amounts continue to be reported in accordance with previously applicable GAAP. At adoption, the Company did not hold Held to Maturity ("HTM") investment debt securities.

The following table shows the impact of the Company's adoption of ASC 326:

						January 1, 2022
(dollars in thousands)						As Reported Under ASC 326						Pre-ASC 326 Adoption						Impact of ASC 326 Adoption
Portfolio Loans:
Commercial real estate						$	1,113,793					$	1,115,485					(1,692)
Residential first mortgages						92,710						91,120						1,590
Residential rentals						194,911						195,035						(124)
Construction and land development						35,502						35,590						(88)
Home equity and second mortgages						25,661						25,638						23
Commercial loans						50,512						50,574						(62)
Consumer loans						3,015						3,002						13
Commercial equipment						62,706						62,499						207
Gross Portfolio Loans						1,578,810						1,578,943						(133)
Adjustments:
Net deferred costs						—						(133)						133
Allowance for credit losses						(20,913)						(18,417)						(2,496)
Net Portfolio Loans						1,557,897						1,560,393						(2,496)
U.S. Small Business Administration ("SBA") Paycheck Protection Program ("PPP") loans						26,398						27,276						(878)
Net deferred fees						—						(878)						878
Net U.S. SBA PPP Loans						26,398						26,398						—
Total Net Loans						$	1,584,295					$	1,586,791					$	(2,496)
Liabilities: Reserve for Unfunded Commitments						$	268					$	51					$	217

Loans that the Company has the intent and ability to hold for the foreseeable future, or until maturity or payoff, are reported at their outstanding unpaid principal balances, adjusted for the allowance for credit losses and any deferred fees or premiums. Interest income is accrued on the unpaid principal balance. Loan origination fees and premiums, net of certain direct origination costs, are deferred and recognized as an adjustment of the related loan yield using the interest method.

Loans purchased with evidence of credit deterioration since origination and for which it is probable that all contractually required payments will not be collected are considered credit deteriorated. Evidence of credit quality deterioration as of the purchase date may include statistics such as internal risk grade, past due and nonaccrual status, recent borrower credit scores and recent loan-to-value (“LTV”) percentages. At December 31, 2021, the Bank had purchased credit-deteriorated (“PCD”) loans from the County First acquisition with unpaid principal balances of $1.4 million and carrying values of $1.1 million. At the adoption of ASC 326, management evaluated the remaining unamortized discount on the PCD loans and determined that approximately $8,000 of the discount was credit related and

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reclassified into the ACL. The non-credit component of the discount will be recognized in interest income over the remaining life of the loans.

The Company considers a loan to be past due or delinquent when the terms of the contractual obligation are not met by the borrower. Loans are reviewed on a regular basis and are placed on non-accrual status when, in the opinion of management, the collection of additional interest is doubtful. The accrual of interest on mortgage and commercial loans is discontinued at the time the loan is 90 days delinquent unless the credit is well secured and in the process of collection. Non-accrual loans include certain loans that are current with all loan payments and are placed on non-accrual status due to customer operating results and cash flows. Non-accrual loans are evaluated for impairment on a loan-by-loan basis in accordance with the Company’s impairment methodology.

Consumer loans, excluding credit card loans, are typically charged-off no later than 90 days past due. Credit card loans are typically charged-off no later than 180 days past due. Mortgage and commercial loans are fully or partially charged-off when in management’s judgment all reasonable efforts to return a loan to performing status have occurred. In all cases, loans are placed on non-accrual or charged-off at an earlier date if collection of principal or interest is considered doubtful.

All interest accrued but not collected from loans that are placed on non-accrual or charged-off is reversed against interest income. The interest on these loans is accounted for on the cash-basis or cost-recovery method, until qualifying for return to accrual status. Loans are returned to accrual status when all principal and interest amounts contractually due are brought current and future payments are reasonably assured.

TDRs are loans that have been modified to provide for a reduction or a delay in the payment of either interest or principal because of deterioration in the financial condition of the borrower. A loan extended or renewed at a stated interest rate equal to the current interest rate for new debt with similar risk is not considered a TDR. Once an obligation has been classified as a TDR it continues to be considered a TDR until paid in full or until the debt is refinanced and considered unimpaired. All TDRs are assessed on a loan-by-loan basis. The Company does not participate in any specific government or Company-sponsored loan modification programs. All restructured loan agreements are individual contracts negotiated with a borrower.

Allowance for Credit Losses - Loans

The ACL is an estimate of the expected credit losses for loans held for investment and off-balance sheet exposures. ASU 2016-13 replaced the incurred loss model that recognized a loss when it became probable that a credit loss had occurred, with a model that immediately recognizes the credit loss expected to occur over the lifetime of a financial asset whether originated or purchased. Charge-offs are recorded to the ACL when management believes the loan is uncollectible. Subsequent recoveries, if any, are credited to the ACL. Management believes the ACL is in accordance with U.S. GAAP and in compliance with appropriate regulatory guidelines.

The ACL includes quantitative estimates of losses for collectively and individually evaluated loans. As more fully described below, the model-based quantitative estimate for collectively evaluated loans is determined using the probability of default (PD) and loss given default (LGD) at the segment level and applied at the loan level against the expected exposure at default (EAD). Qualitative adjustments to the quantitative estimate may be made using information not considered in the quantitative model.

The Bank uses a range of data to estimate expected credit losses under CECL, including information about past events, current conditions, and reasonable and supportable forecasts relevant to assessing the collectability of the cash flows of the loans. Historical loss experience serves as the foundation for our estimated credit losses. Adjustments to our historical loss experience are made for differences in current loan portfolio segment credit risk characteristics such as the impact of changing unemployment rates, changes in U.S. Treasury yields, portfolio concentrations, the volume of classified loans, and other prevailing economic conditions and factors that may affect the borrower’s ability to repay, or reduce the estimated value of underlying collateral. This evaluation is inherently subjective, as it requires estimates that are susceptible to significant revision as more information becomes available.

The ACL is measured on a collective basis when similar risk characteristics exist. Generally, collectively assessed loans are grouped by loan type code or product type codes and assigned to a corresponding portfolio segment. Portfolio segments may be further subdivided into similar risk profile groupings based on interest rate structure, types of collateral or other terms and characteristics.

The probability of default (“PD”) calculation analyzes the historical loan portfolio over the given look back period to identify, by segment, loans that have defaulted. A default is defined as a loan that has moved to past due 90 days and greater, nonaccrual status, or experienced a charge-off during the period. The model observes loans over a 12-month window, detecting any events previously defined. This information is then used by the model to calculate annual iterative count-based PD rates for each segment. This process is then repeated for all dates within the historical data range. These averaged PD’s are used for a 12-month straight-line reversion to the historical mean. The historical data used was from mid-2006 through the most recent quarter end.

The Company utilizes reasonable and supportable forecasts of future economic conditions when estimating the ACL on loans. The model’s calculation also includes a 12-month forecasted PD based on a regression model that compares the Company’s historical loan data to

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various national economic metrics during the same periods. The results show the Company’s past losses having a high rate of correlation to national unemployment rates for fixed rate loans and the 10-Year U.S. Treasury for adjustable-rate loans. The model uses this information, along with the most recently published Wall Street Journal survey of sixty economists’ forecasts predicting unemployment rates out over the next four quarters to estimate the PD for the forward-looking 12-month period. These data are also used to predict credit losses at different levels of stress, including a baseline, low, high and adverse economic conditions. After the forecast period, PD rates revert to the historical mean straight line over a 12-month period for the entire data set.

The loss given default (“LGD”) calculation is based on actual losses (charge-offs, net of recoveries) at a loan level over the entire look-back period aggregated for each loan segment. The aggregate loss is divided by the exposure at default to determine an LGD rate. Defaults occurring during the look-back period are included in the denominator, whether or not a loss occurred and exposure at default is determined by the loan balance immediately preceding the default event. When the Company's data are insufficient. an industry index is used.

The exposure at default (“EAD”) calculation projects future expected balances from monthly cash flow schedules to apply PD and LGD assumptions. These are derived based on current contractual terms (balance, interest rate, payment structure), adjusted for expected voluntary prepayments. The contractual terms exclude expected extensions, renewals and modifications unless either of the following applies: management has the reasonable expectation that a loan will be restructured, or the extension or renewal option are included in the borrower contract.

On a quarterly basis, the Company uses internal portfolio credit data, such as levels of non-accrual loans, classified assets and concentrations of credit along with other external information not used in the quantitative calculation to determine qualitative adjustments.

Loans that do not share the same common risk characteristics with other loans are individually assessed. Such loans include non-accrual loans, TDRs, loans classified as substandard or worse, loans that are greater than 89 days delinquent and any other loan identified by management for individual assessment. Reserves on individually assessed loans are measured on a loan-by-loan basis. Generally, consumer loans, including credit cards, are not individually assessed as the Bank's policy is to charge-off credit card loans when they become 180 days delinquent and other consumer loans when they are more than 90 days delinquent.

The methodology used to estimate the ACL is designed to be responsive to changes in portfolio credit quality and forecasted economic conditions. Changes due to new information are reflected in the pool-based allowance and in reserves assigned on an individual basis. Executive management closely monitors loss ratios, reviews the appropriateness of the ACL and presents conclusions to the Credit Risk Committee and the Audit Committee. The committees report to the Board as part of Board's quarterly review of our regulatory reporting and consolidated financial statements.

The calculation of the ACL excludes accrued interest receivable balances because these balances are reversed in a timely manner against previously recognized interest income when a loan is placed on non-accrual status.

Allowance for Credit Losses - AFS Debt securities

As described above, the Company does not presently hold any HTM debt securities and therefore is not presently required to apply a CECL methodology for an HTM investment portfolio.

The impairment model for AFS debt securities measures fair value. Although ASU No. 2016-13 replaced the legacy other-than-temporary impairment (“OTTI”) model with a credit loss model, it retained the fundamental nature of the legacy OTTI model for AFS securities. One notable change from the legacy OTTI model is when evaluating whether credit loss exists, an entity may no longer consider the length of time fair value has been less than amortized cost. For AFS debt securities in an unrealized loss position, the Company first assesses whether it intends to sell, or it is more likely than not that it will be required to sell the security before recovery of its amortized cost basis. If either criterion is met, the security’s amortized cost basis is written down to fair value through income. For AFS debt securities that do not meet the aforementioned criteria, the Company evaluates whether the decline in fair value has resulted from credit losses or other factors.

In making this assessment, management considers the extent to which fair value is less than amortized cost, any changes to the rating of the security by a rating agency, and adverse conditions specifically related to the security, among other factors. If this assessment indicates that a credit loss exists, the present value of cash flows expected to be collected are compared to the amortized cost basis of the security. If the present value of cash flows expected to be collected is less than the amortized cost basis, a credit loss exists and a corresponding allowance for credit losses is recorded. Any impairment that has not been recorded through an allowance for credit losses is recognized in other comprehensive income. Changes in the allowance for credit losses are recorded as a provision for (or reversal of) credit losses. Losses are charged against the allowance when management believes the uncollectibility of an AFS security is confirmed or when either of the criteria regarding intent or requirement to sell is met. Any impairment not recorded through an allowance for credit loss is recognized in other comprehensive income as a noncredit-related impairment. As of June 30, 2022, the Company determined that the unrealized loss positions

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in AFS securities were not the result of credit losses, and therefore, an allowance for credit losses was not recorded. See Note 2 Investment Securities for more information.

The Bank elected as allowed under ASU No. 2016-13 to exclude accrued interest from the amortized cost basis of AFS debt securities and report accrued interest separately in accrued interest and other assets in the consolidated balance sheets. AFS debt securities are placed on non- accrual status when management no longer expects to receive all contractual amounts due, which is generally at 90 days past due. Accrued interest receivable is reversed against interest income when a security is placed on non-accrual status. Accordingly, the Company does not recognize an allowance for credit loss against accrued interest receivable. The majority of AFS debt securities as of June 30, 2022 and December 31, 2021 were issued by Government Sponsored Enterprises (“GSEs”) and U.S. agencies. As such, an allowance for credit losses is not considered necessary.

Collateral Dependent Financial Assets

Loans that do not share risk characteristics are evaluated on an individual basis. For collateral dependent financial assets where the Company has determined that foreclosure of the collateral is probable, or where the borrower is experiencing financial difficulty and the Company expects repayment of the financial asset to be provided substantially through the operation or sale of the collateral, the ACL is measured based on the difference between the fair value of the collateral and the amortized cost basis of the asset as of the measurement date. When repayment is expected to be from the operation of the collateral, expected credit losses are calculated as the amount by which the amortized cost basis of the financial asset exceeds the Net Present Value ("NPV") from the operation of the collateral. When repayment is expected to be from the sale of the collateral, expected credit losses are calculated as the amount by which the amortized costs basis of the financial asset exceeds the fair value of the underlying collateral less estimated cost to sell. The ACL may be zero if the fair value of the collateral at the measurement date exceeds the amortized cost basis of the financial asset. Subsequent changes to the fair value of collateral, for which an ACL was previously recognized, will be reported as a provision (recovery) for credit losses.

The Bank generally uses the practical expedient of the fair value of the collateral, net of estimated selling costs, to determine the expected credit loss for individually assessed collateral dependent loans.

Loan Commitments and Allowance for Credit Losses on Off-Balance Sheet Credit Exposure

Financial instruments include off-balance sheet credit instruments such as commitments to make loans and commercial letters of credit issued to meet customer financing needs. The Company's exposure to credit loss in the event of nonperformance by the other party to the financial instrument for off-balance sheet loan commitments is represented by the contractual amount of those instruments. Such financial instruments are recorded when they are funded.

The Company records a reserve for unfunded commitments (“RUC”) on off-balance sheet credit exposures through a charge to provision for credit loss expense in the Company’s consolidated statements of operations. The RUC on off-balance sheet credit exposures is estimated by loan segment at each balance sheet date under the CECL model using the same methodologies as portfolio loans, taking into consideration the likelihood that funding will occur, and is included in Other Liabilities on the Company’s consolidated balance sheets.

See Note 1 – Summary of Significant Accounting Policies included in the Company’s 2021 Annual Report on Form 10-K for a list of policies in effect as of December 31, 2021.

Financial Accounting Standards Board (“FASB”) Accounting Standards Update (“ASU”)

Adopted New Accounting Standard

ASU 2016-13 – Financial Instruments – Credit Losses (Topic 326) - Measurement of Credit Losses on Financial Instruments. ASU 2016-13 significantly 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 replaced the existing “incurred loss” approach with an “expected loss” model. The new model, referred to as the current expected credit loss (“CECL”) model, applies to (1) financial assets subject to credit losses and measured at amortized cost, and (2) certain off-balance sheet credit exposures. This includes, but is not limited to, loans, leases, HTM securities, loan commitments, and financial guarantees. Credit losses relating to AFS debt securities will be recorded through an allowance for credit losses. 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 loan and lease losses. 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).

In December 2019, the FASB issued ASU No 2019-10, Financial Instruments - Credit Losses (Topic 326). This update amends the effective date of ASU 2016-13 for certain entities, including smaller reporting companies until fiscal years beginning after December 15, 2022, including interim periods within those fiscal periods. Early adoption was permitted. The FASB has issued other ASUs that clarify items related to ASU 2016-13. The Company adopted this guidance effective January 1, 2022.

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The Company's estimates are derived using one-year reasonable and supportable economic forecasts with subsequent one-year reversion to the historical mean loss rates. For loans that share similar risk characteristics and are collectively assessed, the Company uses a probability of default/loss given default cash flow method to determine the expected losses at the loan level. Loans that do not share similar risk characteristics are evaluated on an individual basis. Based on forecasted economic conditions and portfolio balances as of January 1, 2022, we recognized an increase to the opening allowance for credit losses of $2.5 million. The increase is primarily related to the change in methodology from estimating losses incurred as of the balance sheet date to estimating lifetime credit losses required by the CECL standard.

The impact of adoption was not significant to the Bank's regulatory capital. The Bank did not elect to phase-in, over a three-year period, the standard's initial impact on regulatory capital as permitted by the regulatory transition rules.

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 HTM debt securities. Entities are required to make this election on an instrument-by-instrument basis. The Company adopted ASU 2019-05 concurrently upon adoption of ASU 2016-13. The adoption of CECL did not have a material effect on available-for-sale securities, which are predominantly composed of mortgage-backed securities issued by government sponsored entities and U.S. agencies and U.S. government obligations.

Pending adoption

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.

ASU Update 2022-02 – Financial Instruments-Credit Losses (Topic 326): Troubled Debt Restructurings and Vintage Disclosures. ASU Update 2022-02 eliminates the TDR recognition and measurement guidance and, instead required that an entity evaluate whether the modification represents a new loan or a continuation of an existing loan. The amendments enhance existing disclosure requirements and introduce new requirements related to certain modifications of receivables made to borrowers experiencing financial difficulty. In addition, ASU Update 2022-02 requires that an entity disclosure current-period gross write-offs by year of origination for financing receivables and net investment in leases. Entities have the option to apply a modified retrospective transition method for TDRs. The disclosure amendments in the Update 2022-02 will be applied prospectively. The amendments are effective for fiscal years beginning after December 15, 2022, including interim periods within those fiscal years. The Company does not expect these amendments to have a material effect on its Consolidated Financial Statements.

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NOTE 2 – INVESTMENT SECURITIES

Amortized cost and fair values of investment securities at June 30, 2022 and December 31, 2021 are summarized as follows:

						June 30, 2022
(dollars in thousands)						Amortized Cost						Gross Unrealized Gains						Gross Unrealized Losses						Estimated Fair Value
AFS Securities
Asset-backed securities issued by GSEs and U.S. Agencies
Residential Mortgage Backed Securities ("MBS")						$	130,329					$	19					$	10,152					$	120,196
Residential Collateralized Mortgage Obligations ("CMOs")						192,524						47						11,601						180,970
U.S. Agency						14,544						—						1,668						12,876
Asset-backed securities ("ABSs") issued by Others:
Residential CMOs						180						—						16						164
Student Loan Trust ABSs						52,333						23						2,083						50,273
Municipal bonds						98,811						—						15,359						83,452
Corporate bonds						3,000						—						143						2,857
U.S. government obligations						36,806						—						2,138						34,668
Total AFS Securities						$	528,527					$	89					$	43,160					$	485,456
Equity securities carried at fair value through income
CRA investment fund						$	4,423					$	—					$	—					$	4,423
Non-marketable equity securities
Other equity securities						$	207					$	—					$	—					$	207
Total Investment Securities						$	533,157					$	89					$	43,160					$	490,086

						December 31, 2021
(dollars in thousands)						Amortized Cost						Gross Unrealized Gains						Gross Unrealized Losses						Estimated Fair Value
AFS Securities
Asset-backed securities issued by GSEs and U.S. Agencies
Residential MBS						$	121,125					$	1,057					$	2,266					$	119,916
Residential CMOs						198,780						710						2,367						197,123
U.S. Agency						14,433						11						140						14,304
Asset-backed securities issued by Others:
Residential CMOs						220						5						4						221
Student Loan Trust ABSs						56,422						438						286						56,574
Municipal bonds						92,556						1,169						884						92,841
U.S. government obligations						16,942						—						82						16,860
Total AFS Securities						$	500,478					$	3,390					$	6,029					$	497,839
Equity securities carried at fair value through income
CRA investment fund						$	4,772					$	—					$	—					$	4,772
Non-marketable equity securities
Other equity securities						$	207					$	—					$	—					$	207
Total Investment Securities						$	505,457					$	3,390					$	6,029					$	502,818

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The Company elected to exclude accrued interest receivable (“AIR”) from the amortized cost basis of debt securities disclosed throughout this footnote. AFS debt securities, AIR totaled $1.4 million and $1.1 million as of June 30, 2022, and December 31, 2021, respectively. AIR is included in the “accrued interest receivable” line item on the Company’s consolidated balance sheets.

At June 30, 2022 and December 31, 2021, securities with an amortized cost of $56.9 million and $50.9 million were pledged to secure certain customer deposits.

During the quarter ended June 30, 2022, the Company did not sell any securities. During the year ended December 31, 2021, the Company recognized net gains of $0.6 million on the sale of AFS securities with aggregate carrying values of $11.9 million.

Management does not believe that the AFS debt securities in an unrealized loss position as of June 30, 2022 have credit loss impairment. As of June 30, 2022, and December 31, 2021, the gross unrealized loss positions were primarily related to mortgage-backed securities issued by U.S. government agencies or U.S. government sponsored enterprises. These securities carry the explicit and/or implicit guarantee of the U.S. government, are widely recognized as “risk free,” and have a long history of zero credit loss. The Company also performed credit reviews on municipal bonds issued by States and Political Subdivisions and asset backed securities issued by Student Loan Trust. Total gross unrealized losses were primarily attributable to changes in interest rates, relative to when the investment securities were purchased, and not due to the credit quality of the investment securities. The Company does not intend to sell the investment securities that were in an unrealized loss position, and it is not more likely than not that the Company will be required to sell the investment securities before recovery of their amortized cost basis, which may be at maturity. 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 June 30, 2022, and December 31, 2021 were as follows:

June 30, 2022						Less Than 12 Months												More Than 12 Months												Total
(dollars in thousands)						Fair Value						Unrealized Loss						Fair Value						Unrealized Loss						Fair Value						Unrealized Losses
Asset-backed securities issued by GSEs and U.S. Agencies						$	147,515					$	12,749					$	157,883					$	10,672					$	305,398					$	23,421
Asset-backed securities issued by Others						—						—						164						16						164						16
Student Loan Trust ABSs						11,633						1,026						37,072						1,057						48,705						2,083
Municipal bonds						52,238						9,881						31,214						5,478						83,452						15,359
Corporate bonds						2,857						143						—						—						2,857						143
U.S. government obligations						19,138						736						15,530						1,402						34,668						2,138
						$	233,381					$	24,535					$	241,863					$	18,625					$	475,244					$	43,160

December 31, 2021						Less Than 12 Months												More Than 12 Months												Total
(dollars in thousands)						Fair Value						Unrealized Loss						Fair Value						Unrealized Loss						Fair Value						Unrealized Losses
Asset-backed securities issued by GSEs and U.S. Agencies						$	205,891					$	3,997					$	41,327					$	776					$	247,218					$	4,773
Asset-backed securities issued by Others						—						—						57						4						57						4
Student Loan Trust ABSs						21,640						281						2,226						5						23,866						286
Municipal bonds						47,314						776						6,696						108						54,010						884
U.S. government obligations						14,860						82						1,999						—						16,859						82
						$	289,705					$	5,136					$	52,305					$	893					$	342,010					$	6,029

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Maturities

The amortized cost and estimated fair value of debt securities at June 30, 2022, and December 31, 2021 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.

						June 30, 2022												December 31, 2021
(dollars in thousands)						Amortized Cost						Estimated Fair Value						Amortized Cost						Estimated Fair Value
Within one year						$	36,130					$	33,185					$	36,859					$	36,665
Over one year through five years						141,354						129,835						121,308						120,668
Over five years through ten years						202,767						186,244						191,166						190,158
After ten years						148,276						136,192						151,145						150,348
Total AFS securities						$	528,527					$	485,456					$	500,478					$	497,839

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NOTE 3 – LOANS

Portfolio loans, net of deferred costs and fees, are summarized by type as follows at June 30, 2022:

						June 30, 2022
(dollars in thousands)						Total						% of Total Loans
Portfolio Loans:
Commercial real estate						$	1,178,758					71.33		%
Residential first mortgages						84,782						5.13		%
Residential rentals						210,116						12.72		%
Construction and land development						31,068						1.88		%
Home equity and second mortgages						25,200						1.53		%
Commercial loans						43,472						2.63		%
Consumer loans						4,511						0.27		%
Commercial equipment						74,552						4.51		%
Total portfolio loans (1)						1,652,459						100.00		%
Less: Allowance for Credit Losses						(21,404)						(1.30)		%
Total net portfolio loans						1,631,055
U.S. SBA PPP loans (1)						5,022
Total net loans						$	1,636,077
Portfolio loans are summarized by type as follows at December 31, 2021:
Portfolio Loans:						December 31, 2021
Commercial real estate						$	1,115,485					70.66		%
Residential first mortgages						91,120						5.77		%
Residential rentals						195,035						12.35		%
Construction and land development						35,590						2.25		%
Home equity and second mortgages						25,638						1.62		%
Commercial loans						50,574						3.20		%
Consumer loans						3,002						0.19		%
Commercial equipment						62,499						3.96		%
Gross portfolio loans (1)						1,578,943						100.00		%
Adjustments:
Net deferred costs						(133)						(0.01)		%
Allowance for loan losses						(18,417)						(1.17)		%
						(18,550)
Net portfolio loans						1,560,393
Gross U.S. SBA PPP loans (1)						27,276
Net deferred fees						(878)
Net U.S. SBA PPP Loans						26,398
Total net loans						$	1,586,791
Total gross loans						$	1,606,219

(1)Excludes accrued interest receivable of $4.7 million and $4.2 million, at June 30, 2022 and December 31, 2021, respectively.

The Company has segregated its loans into portfolio loans and U.S. SBA PPP loans at December 31, 2021.

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Deferred Costs/Fees

Portfolio net deferred fees of $0.5 million at June 30, 2022 included deferred fees paid by customers of $4.6 million offset by deferred costs of $4.1 million. Deferred loan costs include premiums paid for the purchase of residential first mortgages and deferred loan origination costs in accordance with ASC 310-20. Net deferred loan fees of $0.1 million at December 31, 2021 included deferred fees paid by customers of $4.1 million offset by deferred costs of $4.0 million.

U.S. SBA PPP loan net deferred fees of $0.2 million at June 30, 2022 included deferred fees paid by the U.S. SBA of $0.2 million partially offset by deferred costs of $18,000. U.S. SBA PPP net deferred loan fees of $0.5 million at December 31, 2021 included deferred fees paid by the SBA of $0.5 million offset by deferred costs of $41,000. The net deferred fees are being amortized as a component of interest income through the contractual maturity date of each U.S. SBA PPP loan. Net deferred fees include fees received by participant banks for each U.S. SBA PPP loan underwritten and funded net of costs incurred to underwrite the loans. Net deferred fees will be recognized in income when the U.S. SBA PPP loan is forgiven or paid.

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 commercial loan portfolio has business loans secured by real estate and real estate development loans. At June 30, 2022 and December 31, 2021, 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 (classes), which are levels at which the Company develops and documents its allowance for loan loss methodology. These segments are:

Commercial Real Estate (“CRE”)

Commercial and other real estate projects include office, medical and professional buildings, retail locations, churches, other special purpose buildings and commercial construction. Commercial construction balances were 6.7% and 6.5% of the CRE portfolio at June 30, 2022 and December 31, 2021, respectively. The Bank offers both fixed-rate and adjustable-rate loans under these product lines. 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. There are also credit risks resulting from potential increased costs to the borrower as a result of repricing of adjustable-rate mortgage loans. During periods of rising interest rates, the risk of default on adjustable-rate mortgage loans may increase due to the upward adjustment of interest cost to the borrower. The Bank’s adjustable rate residential first mortgage portfolio was $13.8 million or 0.8% of total portfolio loans of $1.7 billion at June 30, 2022 compared to $18.9 million or 1.2% of total gross portfolio loans of $1.6 billion at December 31, 2021.

The Bank generally retains the right to service loans sold for a payment based upon a percentage (generally 0.25% of the outstanding loan balance). As of June 30, 2022 and December 31, 2021, the Bank serviced $20.6 million and $20.9 million, respectively, in residential mortgage loans for others.

Residential Rentals

Residential rental mortgage loans are amortizing long-term loans. 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. During periods of rising interest rates, the risk of default on adjustable-rate mortgage loans may increase due to the upward adjustment of interest cost to the borrower.

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 adverse conditions in the rental real estate market or the economy than similar owner-occupied properties.

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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 the borrower’s ability to successfully manage construction and development activities. The repayment of these loans is also subject to economic risks such as changing prices and interest rates.

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 and credit card loans. The repayment of these loans is dependent on the continued financial 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 as determined by the Bank. Commercial loans are dependent on the success of the underlying business or the strength of the guarantor.

U.S. SBA PPP Loans

U.S. SBA PPP loans are fully guaranteed by the Small Business Administration and the Bank's ACL 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.

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Loans

Non-accrual loans as of June 30, 2022 and December 31, 2021 were as follows:

						June 30, 2022
(dollars in thousands)						Nonaccrual with No Allowance for Credit Losses						Nonaccrual with Allowance for Credit Losses						Total Nonaccrual Loans
Commercial real estate						$	4,615					$	87					$	4,702
Residential rentals						981						—						981
Home equity and second mortgages						267						—						267
Commercial loans						—						25						25
Commercial equipment						10						250						260
Total						$	5,873					$	362					$	6,235
Interest Income on Nonaccrual Loans						$	95					$	—					$	95

						June 30, 2022
(dollars in thousands)						Non-accrual Delinquent Loans						Non-accrual Current Loans						Total Non-accrual Loans
Commercial real estate						$	—					$	4,702					$	4,702
Residential rentals						—						981						981
Home equity and second mortgages						98						169						267
Commercial loans						—						25						25
Commercial equipment						29						231						260
						$	127					$	6,108					$	6,235

						December 31, 2021
(dollars in thousands)						Non-accrual Delinquent Loans						Non-accrual Current Loans						Total Non-accrual Loans
Commercial real estate						$	—					$	4,890					$	4,890
Residential first mortgages						450						—						450
Residential rentals						252						690						942
Home equity and second mortgages						202						399						601
Commercial equipment						—						691						691
U.S. SBA PPP loans						57						—						57
						$	961					$	6,670					$	7,631

Non-accrual loans decreased $1.4 million from $7.6 million or 0.46% of total loans at December 31, 2021 to $6.2 million or 0.38% of total loans at June 30, 2022. Loans can be current but classified as non-accrual due to customer operating results or payment history. All interest accrued but not collected from loans that are placed on non-accrual or charged-off is reversed against interest income. In accordance with the Company’s policy, such interest income is recognized on a cash basis or cost-recovery method, until qualifying for return to accrual status.

At December 31, 2021, there were $6.7 million (87%) of non-accrual loans were current with all payments of principal and interest with no impairment and $1.0 million (13%) of non-accrual loans were delinquent with specific valuation reserves of $0.3 million.

Non-accrual loans at June 30, 2022 and December 31, 2021 included no delinquent TDRs. Non-accrual loans on which the recognition of interest has been discontinued, which did not have a specific allowance for impairment, amounted to $5.9 million and $7.4 million at June 30, 2022 and December 31, 2021, respectively. Interest due but not recognized on these balances at June 30, 2022 and December 31, 2021 was $21,000 and $0.1 million, respectively. Non-accrual loans with a specific allowance for impairment amounted to $0.4 million and $0.3 million at June 30, 2022 and December 31, 2021, respectively. Interest due but not recognized on these balances at June 30, 2022 and December 31, 2021 was $3,000 and $1,000, respectively.

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The Company considers a loan to be past due or delinquent when the terms of the contractual obligation are not met by the borrower. 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 days past due ("DPD") loans as of June 30, 2022 follows:

						June 30, 2022
(dollars in thousands)						31-60 DPD						61-89 DPD						90 DPD and Still Accruing						90 DPD and Not Accruing						Total Past Due						Current Non-Accrual Loans						Current Accrual Loans						Total Loans
Commercial real estate						$	625					$	—					$	—					$	—					$	625					$	4,702					$	1,173,431					$	1,178,758
Residential first mortgages						—						—						—						—						—						—						84,782						84,782
Residential rentals						—						185						—						—						185						981						208,950						210,116
Construction and land development						—						—						—						—						—						—						31,068						31,068
Home equity and second mortgages						40						—						—						98						138						169						24,893						25,200
Commercial loans						—						—						—						—						—						25						43,447						43,472
Consumer loans						14						7						49						—						70						—						4,441						4,511
Commercial equipment						29						—						—						—						29						231						74,292						74,552
U.S. SBA PPP						—						—						—						—						—						—						5,022						5,022
Total Loans						$	708					$	192					$	49					$	98					$	1,047					$	6,108					$	1,650,326					$	1,657,481

Loan delinquency (total past due) decreased $0.4 million from $1.4 million, or 0.09% of loans, at December 31, 2021 to $1.0 million, or 0.06% of loans, at June 30, 2022.

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. An analysis of days past due loans as of December 31, 2021 follows:

						December 31, 2021
(dollars in thousands)						31-60 Days						61-89 Days						90 or Greater Days						Total Past Due						PCI Loans						Current						Total Loan Receivables
Commercial real estate						$	—					$	—					$	—					$	—					$	1,116					$	1,114,369					$	1,115,485
Residential first mortgages						—						277						450						727						—						90,393						91,120
Residential rentals						—						42						252						294						—						194,741						195,035
Construction and land development						—						—						—						—						—						35,590						35,590
Home equity and second mortgages						200						—						202						402						—						25,236						25,638
Commercial loans						—						—						—						—						—						50,574						50,574
Consumer loans						—						—						—						—						—						3,002						3,002
Commercial equipment						—						—						—						—						—						62,499						62,499
Total portfolio loans						$	200					$	319					$	904					$	1,423					$	1,116					$	1,576,404					$	1,578,943
U.S. SBA PPP loans						$	9					$	40					$	57					$	106					$	—					$	27,170					$	27,276

There were no loans that were past due 90 days or greater accruing interest at December 31, 2021.

Allowance for Credit Losses ("ACL")

The following tables detail activity in the ACL at and for the three and six months ended June 30, 2022 and 2021. 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.

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Three Months Ended						June 30, 2022
(dollars in thousands)						Beginning Balance												Charge-offs						Recoveries						Provisions						Ending Balance
Commercial real estate						$	17,313											$	(280)					$	—					$	(200)					$	16,833
Residential first mortgages						284												(111)						—						82						255
Residential rentals						1,546												—						—						114						1,660
Construction and land development						137												—						—						29						166
Home equity and second mortgages						178												—						1						(36)						143
Commercial loans						319												(50)						1						(32)						238
Consumer loans						73												(6)						—						65						132
Commercial equipment						1,532												—						42						403						1,977
						$	21,382											$	(447)					$	44					$	425					$	21,404

Three Months Ended						June 30, 2021
(dollars in thousands)						Beginning Balance						Charge-offs						Recoveries						Provisions						Ending Balance
Commercial real estate						$	13,285					$	(1)					$	1					$	633					$	13,918
Residential first mortgages						1,024						—						—						(177)						847
Residential rentals						1,361						—						—						(175)						1,186
Construction and land development						365						—						—						(33)						332
Home equity and second mortgages						263						—						2						(23)						242
Commercial loans						1,012						(26)						5						122						1,113
Consumer loans						29						—						—						(1)						28
Commercial equipment						917						(34)						22						(107)						798
						$	18,256					$	(61)					$	30					$	239					$	18,464
Purchase Credit Impaired**						$	—					$	—					$	—					$	52					$	52

Six Months Ended						June 30, 2022
(dollars in thousands)						Beginning Balance						Impact of ASC 326 Adoption						Charge-offs						Recoveries						Provisions						Ending Balance
Commercial real estate						$	13,095					$	3,734					$	(280)					$	—					$	284					$	16,833
Residential first mortgages						1,002						(679)						(111)						—						43						255
Residential rentals						2,175						(586)						—						—						71						1,660
Construction and land development						260						(82)						—						—						(12)						166
Home equity and second mortgages						274						(86)						—						1						(46)						143
Commercial loans						582						(290)						(50)						1						(5)						238
Consumer loans						58						2						(6)						—						78						132
Commercial equipment						971						483						—						61						462						1,977
						$	18,417					$	2,496					$	(447)					$	63					$	875					$	21,404

_______________________________________

**There is no allowance for credit loss on the SBA PPP portfolios. A more detailed roll forward schedule will be presented if an allowance is required.

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Six Months Ended						June 30, 2021
(dollars in thousands)						Beginning Balance						Charge-offs						Recoveries						Provisions						Ending Balance
Commercial real estate						$	13,744					$	(1,248)					$	2					$	1,420					$	13,918
Residential first mortgages						1,305						(142)						—						(316)						847
Residential rentals						1,413						(46)						—						(181)						1,186
Construction and land development						401						—						—						(69)						332
Home equity and second mortgages						261						—						3						(22)						242
Commercial loans						1,222						(76)						10						(43)						1,113
Consumer loans						20						—						—						8						28
Commercial equipment						1,058						(34)						37						(263)						798
						$	19,424					$	(1,546)					$	52					$	534					$	18,464
Purchase Credit Impaired**						$	—					$	—					$	—					$	52					$	52

_______________________________________

**There is no allowance for loan loss on the PCI or the SBA PPP portfolios. A more detailed roll forward schedule will be presented if an allowance is required.

The following table presents the amortized cost basis of collateral-dependent loans by class of loans.

						June 30, 2022
(dollars in thousands)						Business/Other Assets						Real Estate
Commercial real estate						$	—					$	4,702
Residential first mortgages						—						410
Residential rentals						—						981
Home equity and second mortgages						—						266
Commercial loans						25						—
Commercial equipment						699						—
Total						$	724					$	6,359

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Credit Quality Indicators

Credit quality indicators as of June 30, 2022 were as follows:

Credit Risk Profile by Internally Assigned Grade

The risk category of loans by class of loans is as follows:

						Term Loans by Origination Year
(dollars in thousands)						Prior						2018						2019						2020						2021						2022						Revolving Loans						Total
Commercial Real Estate
Pass						$	352,690					$	75,430					$	107,948					$	189,510					$	282,681					$	149,006					$	—					$	1,157,265
Watch						—						4,239						—						5,566						—						6,986						—						16,791
Special Mention						—						—						—						—						—						—						—						—
Substandard						825						—						3,018						—						859						—						—						4,702
Total						$	353,515					$	79,669					$	110,966					$	195,076					$	283,540					$	155,992					$	—					$	1,178,758
Residential Rentals
Pass						$	46,786					$	4,555					$	23,050					$	43,010					$	66,964					$	24,770					$	—					$	209,135
Watch						—						—						—						—						—						—						—						—
Special Mention						—						—						—						—						—						—						—						—
Substandard						981						—						—						—						—						—						—						981
Total						$	47,767					$	4,555					$	23,050					$	43,010					$	66,964					$	24,770					$	—					$	210,116
Construction and Land Development
Pass						$	7,069					$	12,082					$	7,294					$	1,515					$	2,762					$	346					$	—					$	31,068
Watch						—						—						—						—						—						—						—						—
Special Mention						—						—						—						—						—						—						—						—
Substandard						—						—						—						—						—						—						—						—
Total						$	7,069					$	12,082					$	7,294					$	1,515					$	2,762					$	346					$	—					$	31,068
Commercial Loans
Pass						$	25,598					$	2,942					$	3,278					$	1,746					$	7,623					$	2,260					$	—					$	43,447
Watch						—						—						—						—						—						—						—						—
Special Mention						—						—						—						—						—						—						—						—
Substandard						—						—						—						25						—						—						—						25
Total						$	25,598					$	2,942					$	3,278					$	1,771					$	7,623					$	2,260					$	—					$	43,472
Commercial Equipment
Pass						$	9,375					$	5,930					$	16,662					$	8,526					$	14,016					$	19,443					$	—					$	73,952
Watch						—						180						—						—						—						—						—						180
Special Mention						—						—						160						—						—						—						—						160
Substandard						29						—						231						—						—						—						—						260
Total						$	9,404					$	6,110					$	17,053					$	8,526					$	14,016					$	19,443					$	—					$	74,552
Total loans by risk category						$	443,353					$	105,358					$	161,641					$	249,898					$	374,905					$	202,811					$	—					$	1,537,966

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Loans evaluated by performance category are as follows:

						Term Loans by Origination Year
(dollars in thousands)						Prior						2018						2019						2020						2021						2022						Revolving Loans						Total
Residential First Mortgages
Performing						$	41,010					$	3,932					$	19,673					$	8,904					$	5,332					$	5,931					$	—					$	84,782
Non-performing						—						—						—						—						—						—						—						—
Total						$	41,010					$	3,932					$	19,673					$	8,904					$	5,332					$	5,931					$	—					$	84,782
Home Equity and Second Mortgages
Performing						$	16,607					$	1,324					$	920					$	1,337					$	3,569					$	1,349					$	—					$	25,106
Non-performing						94						—						—						—						—						—						—						94
Total						$	16,701					$	1,324					$	920					$	1,337					$	3,569					$	1,349					$	—					$	25,200
Consumer Loans
Performing						$	53					$	3					$	126					$	161					$	733					$	464					$	2,971					$	4,511
Non-performing						—												—																								—						—
Total						$	53					$	3					$	126					$	161					$	733					$	464					$	2,971					$	4,511
U.S. SBA PPP Loans
Performing						$	—					$	—					$	—					$	—					$	5,022					$	—					$	—					$	5,022
Non-performing						—						—						—						—						—						—						—						—
Total						$	—					$	—					$	—					$	—					$	5,022					$	—					$	—					$	5,022
Total loans evaluated by performing status						$	57,764					$	5,259					$	20,719					$	10,402					$	14,656					$	7,744					$	2,971					$	119,515
Total Recorded Investment						$	501,117					$	110,617					$	182,360					$	260,300					$	389,561					$	210,555					$	2,971					$	1,657,481

Credit quality indicators as of December 31, 2021 were as follows:

						Commercial Real Estate						Construction and Land Development						Residential Rentals
(dollars in thousands)						12/31/2021						12/31/2021						12/31/2021
Unrated						$	—					$	—					$	—
Pass						1,111,857						35,590						194,093
Special mention						—						—						—
Substandard						3,628						—						942
Doubtful						—						—						—
Loss						—						—						—
Total						$	1,115,485					$	35,590					$	195,035

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						Commercial Loans						Commercial Equipment						Total Commercial Portfolios
(dollars in thousands)						12/31/2021						12/31/2021						12/31/2021
Unrated						$	—					$	—					$	—
Pass						50,574						62,326						1,454,440
Special mention						—						—						—
Substandard						—						173						4,743
Doubtful						—						—						—
Loss						—						—						—
Total						$	50,574					$	62,499					$	1,459,183

						Non-Commercial Portfolios **						U.S. SBA PPP Loans						Total Loans Portfolios
(dollars in thousands)						12/31/2021						12/31/2021						12/31/2021
Unrated						$	100,403					$	27,276					$	127,679
Pass						18,889						—						1,473,329
Special mention						—						—						—
Substandard						468						—						5,211
Doubtful						—						—						—
Loss						—						—						—
Total						$	119,760					$	27,276					$	1,606,219

_______________________________________

**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 Mortgages						Home Equity and Second Mortgages						Consumer Loans
(dollars in thousands)						12/31/2021						12/31/2021						12/31/2021
Performing						$	90,670					$	25,436					$	3,002
Nonperforming						450						202						—
Total						$	91,120					$	25,638					$	3,002

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. Loans are graded at inception, annually thereafter when financial statements are received and at other times when there is an indication that a credit may have weakened or improved. 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 March 31, 2021, the Bank's policy was amended to risk rate all commercial loan relationships.

Home equity and second mortgages and consumer loans are evaluated for creditworthiness in underwriting and are monitored based on borrower payment history. Residential first mortgages are evaluated for creditworthiness during credit due diligence before being purchased. 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 TDRs or nonperforming loans with an Other Assets Especially Mentioned ("OAEM") or higher risk rating due to a delinquency payment history.

The overall quality of the Bank’s loan portfolio is assessed using the Bank’s risk-grading scale, the level and trends of net charge-offs, nonperforming loans and delinquencies, the performance of TDRs and the general economic conditions in the Company’s geographical market. This review process is assisted by frequent internal reporting of loan production, loan quality, concentrations of credit, loan delinquencies and nonperforming and potential problem loans. Credit quality indicators and allowance factors are adjusted based on management’s judgment during the monthly and quarterly review process. Loans subject to risk ratings are graded on a scale of one to ten. The Company considers loans rated substandard, doubtful and loss as classified assets for regulatory and financial reporting.

Ratings 1 thru 6 - Pass

Ratings 1 thru 6 have asset risks ranging from excellent-low to adequate. The specific rating assigned considers customer history of earnings, cash flows, liquidity, leverage, capitalization, consistency of debt service coverage, the nature and extent of customer relationship and other relevant specific business factors such as the stability of the industry or market area, changes to management, litigation or unexpected events that could have an impact on risks.

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Rating 7 - OAEM (Other Assets Especially Mentioned) – Special Mention

These credits, while protected by the financial strength of the borrowers, guarantors or collateral, have reduced quality due to economic conditions, less than adequate earnings performance or other factors which require the lending officer to direct more than normal attention to the credit. Financing alternatives may be limited and/or command higher risk interest rates. OAEM loans relationships are reviewed at least quarterly.

Rating 8 - Substandard

Substandard assets are assets that are inadequately protected by the sound worth or paying capacity of the borrower or of the collateral pledged. Substandard loans are the first adversely classified loans on the Bank's watchlist. These assets have a well-defined weakness or weaknesses that jeopardize the liquidation of the debt. They are characterized by the possibility that the Bank will sustain some loss if the deficiencies are not corrected. Loss potential, while existing in the aggregate amount of substandard assets, does not have to exist in individual assets classified substandard. The loans may have a delinquent history or combination of weak collateral, weak guarantor strength or operating losses. When a loan is assigned to this category the Bank may estimate a specific reserve in the loan loss allowance analysis. These assets listed may include assets with histories of repossessions or some that are non-performing bankruptcies. These relationships will be reviewed at least quarterly.

Rating 9 - Doubtful

Doubtful assets have many of the same characteristics of Substandard with the exception that the Bank has determined that loss is not only possible but is probable and the risk is close to certain that loss will occur. When a loan is assigned to this category the Bank will identify the probable loss and the loan will receive a specific reserve in the loan loss allowance analysis. These relationships will be reviewed at least quarterly.

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.

TDRs included in the impaired loan schedules above, as of June 30, 2022 and December 31, 2021 were as follows:

						June 30, 2022												December 31, 2021
(dollars in thousands)						Number of Loans						Recorded Investments						Number of Loans						Recorded Investments
Commercial equipment						1						$	438					1						$	447
Total TDRs						1						$	438					1						$	447
Less: TDRs included in non-accrual loans						—						—						—						—
Total accrual TDR loans						1						$	438					1						$	447

The Company had no specific reserves on TDRs at June 30, 2022 and at December 31, 2021. During the year ended December 31, 2021, TDR disposals, which included payoffs and refinancing, included three loans totaling $0.1 million. TDR loan principal curtailment was $5,000 for the quarter ended June 30, 2022 and $19,000 for the year ended December 31, 2021. There were no TDRs added during the three months ended June 30, 2022 or the year ended December 31, 2021.

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Prior to adoption of CECL

Impaired Loans and Troubled Debt Restructures (“TDRs”)

Impaired loans, including TDRs at December 31, 2021 and June 30, 2021, were as follows:

						December 31, 2021
(dollars in thousands)						Unpaid Contractual Principal Balance						Recorded Investment With No Allowance						Recorded Investment With Allowance						Total Recorded Investment						Related Allowance						YTD Average Recorded Investment						YTD Interest Income Recognized
Commercial real estate						$	4,994					$	4,797					$	93					$	4,890					$	93					$	4,866					$	254
Residential first mortgages						879						866						—						866						—						874						32
Residential rentals						982						942						—						942						—						959						48
Home equity and second mortgages						626						601						—						601						—						604						14
Commercial equipment						1,200						1,022						173						1,195						173						2,184						99
Total						$	8,681					$	8,228					$	266					$	8,494					$	266					$	9,487					$	447

						June 30, 2021
(dollars in thousands)						Unpaid Contractual Principal Balance						Recorded Investment With No Allowance						Recorded Investment With Allowance						Total Recorded Investment						Related Allowance						Quarter Average Recorded Investment						Quarter Interest Income Recognized						YTD Average Recorded Investment						YTD Interest Income Recognized
Commercial real estate						$	12,007					$	6,478					$	5,294					$	11,772					$	743					$	11,782					$	114					$	11,802					$	224
Residential first mortgages						888						879						—						879						—						880						6						883						18
Residential rentals						999						984						—						984						—						990						12						994						25
Home equity and second mortgages						602						584						—						584						—						615						3						617						6
Commercial equipment						527						475						35						510						35						531						1						549						13
Total						$	15,023					$	9,400					$	5,329					$	14,729					$	778					$	14,798					$	136					$	14,845					$	286

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The following tables detail loan receivable and allowance balances disaggregated on the basis of the Company’s impairment methodology at June 30, 2021 and December 31, 2021.

						December 31, 2021																								June 30, 2021
(dollars in thousands)						Ending balance: individually evaluated for impairment						Ending balance: collectively evaluated for impairment						Purchased Credit Impaired						Total						Ending balance: individually evaluated for impairment						Ending balance: collectively evaluated for impairment						Purchased Credit Impaired						Total
Loan Receivables:
Commercial real estate						$	4,890					$	1,109,479					$	1,116					$	1,115,485					$	11,772					$	1,098,578					$	1,263					$	1,111,613
Residential first mortgages						866						90,254						—						91,120						879						104,603						—						105,482
Residential rentals						942						194,093						—						195,035						984						141,226						—						142,210
Construction and land development						—						35,590						—						35,590						—						36,918						—						36,918
Home equity and second mortgages						601						25,037						—						25,638						584						27,743						399						28,726
Commercial loans						—						50,574						—						50,574						—						47,567						—						47,567
Consumer loans						—						3,002						—						3,002						—						1,442						—						1,442
Commercial equipment						1,195						61,304						—						62,499						510						59,408						—						59,918
						$	8,494					$	1,569,333					$	1,116					$	1,578,943					$	14,729					$	1,517,485					$	1,662					$	1,533,876
Allowance for credit losses:
Commercial real estate						$	93					$	13,002					$	—					$	13,095					$	743					$	13,175					$	52					$	13,970
Residential first mortgages						—						1,002						—						1,002						—						847						—						847
Residential rentals						—						2,175						—						2,175						—						1,186						—						1,186
Construction and land development						—						260						—						260						—						332						—						332
Home equity and second mortgages						—						274						—						274						—						242						—						242
Commercial loans						—						582						—						582						—						1,113						—						1,113
Consumer loans						—						58						—						58						—						28						—						28
Commercial equipment						173						798						—						971						35						763						—						798
						$	266					$	18,151					$	—					$	18,417					$	778					$	17,686					$	52					$	18,516

Purchased Credit-Impaired Loans and Acquired Loans ("PCI")

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 considering prepayment assumptions and to discount those cash flows at appropriate rates of interest. 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. In accordance with GAAP upon the adoption of CECL, there was no carryover of a previously established allowance for credit losses from acquisition. A summary of changes in the accretable yield for PCI loans for the three and six months ended June 30, 2021 and the year ended December 31, 2021 follows:

						Three Months Ended June 30,						Six Months Ended June 30,						Year Ended
(dollars in thousands)						2021						2021						December 31, 2021
Accretable yield, beginning of period						$	311					$	342					$	342
Additions						—						—						—
Accretion						(29)						(60)						(117)
Reclassification from nonaccretable difference						15						15						43
Other changes, net						29						29						55
Accretable yield, end of period						$	326					$	326					$	323

At December 31, 2021 acquired performing loans, which totaled $41.1 million, included a $0.8 million net acquisition accounting fair market value adjustment, representing a 1.25% discount; and PCI loans which totaled $1.1 million, included a $0.3 million adjustment, representing a 14.95% discount.

During the three months ended June 30, 2021 there was $0.1 million of accretion interest.

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Accounting standards require a periodic recast of the expected cash flows on the PCI loan portfolio. The recast was performed during the fourth quarter of 2021 which resulted in a reclassification of $0.5 million, 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 December 31, 2021:

BY ACQUIRED AND NON-ACQUIRED						December 31, 2021						%
Acquired loans - performing						$	41,066					2.56		%
Acquired loans - purchase credit impaired ("PCI")						1,116						0.07		%
Total acquired loans						42,182						2.63		%
U.S. SBA PPP loans						27,276						1.70		%
Non-acquired loans**						1,536,761						95.68		%
Gross loans						1,606,219
Net deferred fees						(1,011)						(0.06)		%
Total loans, net of deferred fees						$	1,605,208

______________________________

**Non-acquired loans include loans transferred from acquired pools following release of acquisition accounting FMV adjustments.

NOTE 4 – GOODWILL AND OTHER INTANGIBLE ASSETS

Goodwill and other intangible assets are presented in the tables below.

(dollars in thousands)						As of June 30, 2022						As of December 31, 2021
Goodwill						$	10,835					$	10,835

						As of June 30, 2022																		As of December 31, 2021
(dollars in thousands)						Gross Carrying Amount						Accumulated Amortization						Net Intangible Assets						Gross Carrying Amount						Accumulated Amortization						Net Intangible Assets
Core deposit intangible ("CDI")						$	3,590					$	(2,769)					$	821					$	3,590					$	(2,558)					$	1,032

The estimated aggregate future amortization expense for intangible assets remaining as of June 30, 2022 is as follows:

(dollars in thousands)
Remainder of 2022						$	187
2023						302
2024						205
2025						109
2026						18
						$	821

At June 30, 2022 the Company had goodwill of $10.8 million or 5.86% of equity and CDI of $0.8 million or 0.44% of equity.

Management performed its annual analysis of goodwill and CDI during the fourth quarter of 2021 and concluded that there was no impairment at December 31, 2021. At June 30, 2022, management's analysis concluded that there were no changes in the Company's financial statements or operations subsequent to the fourth quarter 2021 annual analyses 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 incorporating current appraised values, local real estate market conditions and related costs. An analysis of activity follows.

						Six Months Ended June 30,												Years Ended December 31,
(dollars in thousands)						2022						2021						2021
Balance at beginning of year						$	—					$	3,109					$	3,109
Additions of underlying property						—						—						—
Disposals of underlying property						—						(932)						(1,722)
Valuation allowance						—						(641)						(1,387)
Balance at end of period						$	—					$	1,536					$	—

Expenses applicable to OREO assets included the following.

						Six Months Ended June 30,
(dollars in thousands)						2022						2021
Valuation allowance						$	—					$	641
Losses (gains) on dispositions						—						(16)
Operating expenses						6						44
						$	6					$	669

The Company had $0.1 million impaired loans secured by residential real estate for which formal foreclosure proceedings were in process as of June 30, 2022. There were no loans secured by residential real estate for which formal foreclosure proceedings were in the process as of December 31, 2021.

NOTE 6 – DEPOSITS

Deposits consist of the following:

						June 30, 2022												December 31, 2021
(dollars in thousands)						Balance						%						Balance						%
Noninterest-bearing demand						$	635,649					30.48		%				$	445,778					21.68		%
Interest-bearing:
Demand						635,344						30.47		%				790,481						38.45		%
Money market deposits						380,712						18.26		%				372,717						18.13		%
Savings						119,363						5.72		%				119,767						5.82		%
Certificates of deposit						314,308						15.07		%				327,421						15.92		%
Total interest-bearing						1,449,727						69.52		%				1,610,386						78.32		%
Total Deposits						$	2,085,376					100.00		%				$	2,056,164					100.00		%

The aggregate amount of certificates of deposit that exceed the FDIC insurance limit of $250,000 at June 30, 2022 and December 31, 2021 was $56.7 million and $57.6 million, respectively.

The Company monitors all customer deposit concentrations at or above 2% of total deposits. At June 30, 2022, the Bank had two customer deposit relationships that exceeded 2% of total deposits, totaling $310.7 million which represented 14.9% of total deposits. At December 31, 2021, the Bank had two customer deposit relationships that exceeded 2% of total deposits, totaling $335.6 million which represented 16.3% of total deposits. These concentrations were with local municipal agencies.

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NOTE 7 – LEASE COMMITMENTS & CONTINGENCIES

Operating Leases

The Company's, operating lease agreements are primarily for leases of branches and office space. Topic 842 requires operating lease agreements to be recognized on the consolidated balance sheet as a right-of-use-asset with a corresponding lease liability.

The table below details the Right of Use asset (net of accumulated amortization), lease liability and other information related to the Company's operating leases:

(dollars in thousands)						June 30, 2022						December 31, 2021
Operating Leases
Operating lease right of use asset, net						$	6,123					$	6,124
Operating lease liability						$	6,372					$	6,343
Weighted average remaining lease term						16.06 years						17.21 years
Weighted average discount rate						3.50		%				3.51		%
Remaining lease term - min						5.0 years						6.3 years
Remaining lease term - max						22.0 years						23.0 years

The table below details the Company's lease cost, which is included in occupancy expense in the Unaudited Consolidated Statements of Income.

						Three Months Ended June 30,												Six Months Ended June 30,
(dollars in thousands)						2022						2021						2022						2021
Operating lease cost						$	150					$	146					$	297					$	343
Cash paid for lease liability						$	135					$	159					$	266					$	176

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 June 30, 2022
Lease payments due:
Within one year						$	564
After one but within two years						582
After two but within three years						600
After three but within four years						635
After four but within five years						638
After five years						5,526
Total undiscounted cash flows						$	8,545
Discount on cash flows						2,173
Total lease liability						$	6,372

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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. The Company recognized amortization expense of $28,000 and $28,000 for the six months ended June 30, 2022 and 2021, respectively.

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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 regular 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 the numerator in banking institutions’ regulatory capital ratios. The Basel III Capital Rules also address risk weights and other issues affecting the denominator in 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 June 30, 2022 and December 31, 2021, the Company and Bank were well-capitalized under the regulatory framework for prompt corrective action ("PCA") under the new Basel III Capital Rules. Management believes, as of June 30, 2022 and December 31, 2021, that the Company and the Bank met all capital adequacy requirements to which they were subject. The Company’s and the Bank’s actual regulatory capital amounts and ratios are presented in the following table.

Regulatory Capital and Ratios						Regulatory Minimum Ratio + CCB(1)						The Company												The Bank
(dollars in thousands)												June 30, 2022						December 31, 2021						June 30, 2022						December 31, 2021
Common equity												$	184,871					$	208,133					$	212,697					$	236,561
Goodwill												(10,835)						(10,835)						(10,835)						(10,835)
Core deposit intangible (net of deferred tax liability)												(609)						(766)						(609)						(766)
AOCI losses												31,847						1,952						31,847						1,952
Common Equity Tier 1 Capital												205,274						198,484						233,100						226,912
TRUPs												12,000						12,000						—						—
Tier 1 Capital												217,274						210,484						233,100						226,912
Allowable reserve for credit losses and other Tier 2 adjustments												21,666						18,468						21,666						18,468
Subordinated notes												19,538						19,510						—						—
Tier 2 Capital												$	258,478					$	248,462					$	254,766					$	245,380
Risk-Weighted Assets ("RWA")												$	1,760,591					$	1,665,296					$	1,758,662					$	1,663,831
Average Assets ("AA")												$	2,306,077					$	2,281,210					$	2,304,266					$	2,279,835
Common Tier 1 Capital to RWA						7.00%						11.66		%				11.92		%				13.25		%				13.64		%
Tier 1 Capital to RWA						8.50%						12.34						12.64						13.25						13.64
Tier 2 Capital to RWA						10.50%						14.68						14.92						14.49						14.75
Tier 1 Capital to AA (Leverage) (2)						n/a						9.42						9.23						10.12						9.95

____________________________________

(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 certain restrictions on capital distributions, including dividend payments and share repurchases. These restrictions generally require advanced 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 quarter ended June 30, 2022 or the year ended December 31, 2021.

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 government sponsored entities (“GSEs”), municipal bonds and corporate debt securities. Securities classified as Level 3 include asset-backed securities in less liquid markets.

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 government sponsored entities (“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.

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Loans held for sale

The Company has elected to carry loans held for sale at fair value. This election reduces certain timing differences in the Consolidated Statement of Income and better aligns with the management of the portfolio from a business perspective. Fair value is derived from secondary market quotations for similar instruments. Gains and losses on sales of residential mortgage loans are recorded as a component of noninterest income in the Consolidated Statements of Income. As such, loans subjected to fair value adjustments are classified as Level 2 valuation

Loans Receivable

The Company does not record loans at fair value on a recurring basis; however, from time to time, a loan is individually evaluated and an ACL 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 segregated individually. Management estimates the fair value of individually evaluated loans using one of several methods, including the collateral value, market value of similar debt, or discounted cash flows. Individually evaluated loans not requiring an allowance are those for which the fair value of expected repayments or collateral exceed the recorded investment in such loans. At June 30, 2022 and December 31, 2021, substantially all of the individually evaluated loans were based upon 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")

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.

Mortgage Banking Derivatives

The mortgage banking derivative comprises interest rate lock commitments for residential loans to be sold on a best-efforts basis. The significant unobservable input used in the fair value measurement of the Bank's interest rate lock commitments is the pull-through rate, which represents the percentage of loans currently in a lock position which management estimates will ultimately close. The pull-through rate is estimated based on mortgage banking activity in 2021. All interest rate lock commitments are considered to be Level 3.

Assets and Liabilities Recorded at Fair Value on a Recurring Basis

The tables below present the recorded amount of assets as of June 30, 2022 and December 31, 2021 measured at fair value on a recurring basis.

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(dollars in thousands)						June 30, 2022
Description of Asset						Fair Value						Level 1						Level 2						Level 3
AFS securities
Asset-backed securities issued by GSEs and U.S. Agencies
MBS						$	120,196					$	—					$	120,196					$	—
CMOs						180,970						—						180,970						—
U.S. Agency						12,876						—						12,876						—
Asset-backed securities issued by Others:
Residential CMOs						164						—						164						—
Student Loan Trust ABSs						50,273						—						50,273						—
Municipal bonds						83,452						—						83,452						—
Corporate bonds						2,857						—						2,857						—
U.S. government obligations						34,668						—						34,668						—
Total AFS securities						$	485,456					$	—					$	485,456					$	—
Equity securities carried at fair value through income
CRA investment fund						$	4,423					$	—					$	4,423					$	—
Non-marketable equity securities
Other equity securities						$	207					$	—					$	207					$	—
Loans held for sale						$	—					$	—					$	—					$	—
Mortgage banking derivative
Interest rate lock commitments						$	—					$	—					$	—					$	—

(dollars in thousands)						December 31, 2021
Description of Asset						Fair Value						Level 1						Level 2						Level 3
AFS securities
Asset-backed securities issued by GSEs and U.S. Agencies
MBS						$	119,916					$	—					$	119,916					$	—
CMOs						197,123						—						197,123						—
U.S. Agency						14,304						—						14,304						—
Asset-backed securities issued by others:
Residential CMOs						221						—						221						—
Student Loan Trust ABSs						56,574						—						56,574						—
Municipal bonds						92,841						—						92,841						—
U.S. government obligations						16,860						—						16,860						—
Total AFS securities						$	497,839					$	—					$	497,839					$	—
Equity securities carried at fair value through income
CRA investment fund						$	4,772					$	—					$	4,772					$	—
Non-marketable equity securities
Other equity securities						$	207					$	—					$	207					$	—
Mortgage banking derivative
Interest rate lock commitments						$	28					$	—					$	—					$	28

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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 June 30, 2022 and December 31, 2021 were included in the tables below.

(dollars in thousands)						June 30, 2022
Description of Asset						Fair Value						Level 1						Level 2						Level 3
Individually assessed loans
Commercial real estate						$	—					$	—					$	—					$	—
Commercial loans						—						—						—						—
Commercial equipment						64						—						—						64
Total individually assessed loans with an ACL						$	64					$	—					$	—					$	64
Premises and equipment held for sale						$	—					$	—					$	—					$	—
Other real estate owned						$	—					$	—					$	—					$	—

(dollars in thousands)

December 31, 2021

Description of Asset

Fair Value

Level 1

Level 2

Level 3

Loans with impairment

Commercial real estate

$

—

$

—

$

—

$

—

Commercial loans

—

—

—

—

Commercial equipment

—

—

—

—

Total loans with impairment

$

—

$

—

$

—

$

—

Premises and equipment held for sale

$

—

$

—

$

—

$

—

Other real estate owned

$

—

$

—

$

—

$

—

Loans with an allowance had unpaid principal balances of $0.4 million and $0.3 million at June 30, 2022 and December 31, 2021, respectively.

The following tables provide information describing the unobservable inputs used in Level 3 fair value measurements at June 30, 2022 and December 31, 2021.

June 30, 2022

Fair Value

Valuation Technique

Unobservable Inputs

Range (Weighted Average)

(dollars in thousands)

Description of Asset

Loans with individually assessed loans

$

64

Third party appraisals and in-house equipment evaluations of fair value

Management discount for equipment type and current market conditions

0% - 50% - 100%

December 31, 2021

Fair Value

Valuation Technique

Unobservable Inputs

Range (Weighted Average)

(dollars in thousands)

Description of Asset

Interest rate lock commitments

$

28

Freddie Mac pricing of loans with comparable terms

Pull-through rate

0% - 100% - 75%

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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.

June 30, 2022						Carrying Amount						Fair Value						Fair Value Measurements
Description of Asset (dollars in thousands)																		Level 1						Level 2						Level 3
Assets
Investment securities - AFS						$	485,456					$	485,456					$	—					$	485,456					$	—
Equity securities carried at fair value through income						4,423						4,423						—						4,423						—
Non-marketable equity securities in other financial institutions						207						207						—						207						—
FHLB Stock						1,234						1,234						—						1,234						—
Net loans receivable						1,636,077						1,573,581						—						—						1,573,581
Accrued interest receivable						6,099						6,099						—						6,099						—
Investment in BOLI						39,363						39,363						—						39,363						—
Liabilities
Savings, NOW and money market accounts						$	1,771,068					$	1,771,068					$	—					$	1,771,068					$	—
Time deposits						314,308						314,330						—						314,330						—
TRUPs						12,000						11,048						—						11,048						—
Subordinated notes						19,538						19,463						—						19,463						—

See the Company’s methodologies disclosed in Note 21 of the Company’s 2021 Form 10-K for the fair value methodologies used as of December 31, 2021:

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December 31, 2021						Carrying Amount						Fair Value						Fair Value Measurements
Description of Asset (dollars in thousands)																		Level 1						Level 2						Level 3
Assets
Investment securities - AFS						$	497,839					$	497,839					$	—					$	497,839					$	—
Equity securities carried at fair value through income						4,772						4,772						—						4,772						—
Non-marketable equity securities in other financial institutions						207						207						—						207						—
FHLB Stock						1,472						1,472						—						1,472						—
Net loans receivable						1,586,791						1,578,032						—						—						1,578,032
Accrued interest receivable						5,588						5,588						—						5,588						—
Investment in BOLI						38,932						38,932						—						38,932						—
Mortgage ranking derivatives						28						28						—						—						28
Liabilities
Savings, NOW and money market accounts						$	1,728,743					$	1,728,743					$	—					$	1,728,743					$	—
Time deposits						327,421						328,083						—						328,083						—
Long-term debt						12,231						12,391						—						12,391						—
TRUPs						12,000						11,589						—						11,589						—
Subordinated notes						19,510						20,979						—						20,979						—

At June 30, 2022 and December 31, 2021, the Company had outstanding loan commitments and standby letters of credit with customers of $90.1 million and $64.4 million, respectively, and $19.9 million and $22.0 million, respectively. Additionally, at June 30, 2022 and December 31, 2021, customers had $240.2 million and $241.7 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 value of these instruments differs significantly from their carrying values.

The fair value estimates presented herein are based on pertinent information available to management as of June 30, 2022 and December 31, 2021. 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/LOSS ("AOCI"/"AOCL")

The following table presents the changes in each component of accumulated other comprehensive gain, net of tax, for the three and six months ended June 30, 2022 and 2021.

						Three Months Ended June 30, 2022						Three Months Ended June 30, 2021						Six Months Ended June 30, 2022						Six Months Ended June 30, 2021
(dollars in thousands)						Net Unrealized Gains And Losses						Net Unrealized Gains And Losses						Net Unrealized Gains And Losses						Net Unrealized Gains And Losses
Beginning of period						$	(18,969)					$	1,684					$	(1,952)					$	4,504
Other comprehensive (losses) gains, net of tax before reclassifications						(12,878)						1,379						(29,895)						(1,874)
Amounts reclassified from accumulated other comprehensive gain						—						—						—						433
Net other comprehensive (losses) gains						(12,878)						1,379						(29,895)						(1,441)
End of period						$	(31,847)					$	3,063					$	(31,847)					$	3,063

As of the six months ended June 30, 2021, reclassification adjustment was due to the gain on sale of AFS investment securities of $0.6 million.

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

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outstanding if dilutive potential common shares had been issued. Potential common shares that may have been issued by the Company related to outstanding unvested restricted stock unit and performance stock unit awards were determined using the treasury stock method and included in the calculation of dilutive common stock equivalents. The Company has not granted any stock options since 2007 and all outstanding options expired on July 17, 2017.

As of three and six months ended June 30, 2022, there were 564 and 426, respectively of no unvested restricted stock and performance stock unit awards which were excluded from the calculation as their effect would be anti-dilutive. There we no antidilutive awards that were excluded from the calculation for the three and six months ended June 30, 2021. 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 June 30,												Six Months Ended June 30,
						2022						2021						2022						2021
Net Income						$	6,834					$	6,432					$	13,122					$	12,731
Average number of common shares outstanding						5,647,821						5,845,009						5,667,909						5,866,510
Dilutive effect of common stock equivalents						9,912						11,945						10,256						11,188
Average number of shares used to calculate diluted EPS						5,657,733						5,856,954						5,678,165						5,877,698
Anti-dilutive shares						564						—						426						—
Earnings Per Common Share
Basic						$	1.21					$	1.10					$	2.32					$	2.17
Diluted						$	1.21					$	1.10					$	2.31					$	2.17

NOTE 15 – INCOME TAXES

The Company files a consolidated federal income tax return with its subsidiaries. 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 June 30,												Six Months Ended June 30,
						2022						2021						2022						2021
Current income tax expense						$	2,620					$	2,144					$	4,547					$	4,039
Deferred income tax expense						(251)						46						(45)						278
Income tax expense as reported						$	2,369					$	2,190					$	4,502					$	4,317
Effective tax rate						25.7		%				25.4		%				25.5		%				25.3		%

Net deferred tax assets totaled $20.2 million at June 30, 2022 and $9.0 million at December 31, 2021. $0.0 million valuation allowance for deferred tax assets was recorded at June 30, 2022 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 effective tax rate differed from the statutory federal and state income rates during 2022 and 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 2022.

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ITEM 2 – MANAGEMENT'S DISCUSSION AND ANALYSIS (“MD&A”) OF FINANCIAL CONDITION AND RESULTS OF OPERATIONS

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 credit losses ("ACL"), goodwill impairment, 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, 2021, as filed with the SEC.

For additional information regarding the ACL, Goodwill, and the valuation of deferred taxes, refer to Notes 1, 3, 4, and 14 in the Consolidated Financial Statements as presented in the Company’s Form 10-K for the year ended December 31, 2021.

On January 1, 2022, the Company adopted FASB ASU 2016-13, which changes the accounting for the allowance for credit losses. For a discussion of this new accounting policy, refer to Note 1 "Basis of Presentation" to the Consolidated Financial Statements.

OVERVIEW

Community Bank of the Chesapeake (the “Bank”) is headquartered in Southern Maryland with 12 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. The Bank believes that its 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 Bank’s marketing is directed towards increasing its balances of transactional deposit accounts. The Bank believes that increases in these account types will lessen the Bank’s dependence on higher-cost funding, such as certificates of deposit and borrowings.

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 loans and investments, and the expense on 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 will continue to focus on growth and operating efficiency to deliver strong results during 2022. During the first six months of 2022, we had robust portfolio loan growth, strong non-interest bearing and transaction deposit growth, and continued to optimize our branch and virtual banking operations.

•The Company reported record net income for the three months ended June 30, 2022 of $6.8 million, or $1.21 per diluted common share compared to net income of $6.4 million or $1.10 per diluted common share for the quarter ended June 30, 2021. The Company reported record net income for the six months ended June 30, 2022 of $13.1 million or diluted earnings per share of $2.31 compared to net income for the comparable 2021 period of $12.7 million or diluted earnings per share of $2.17.

•Portfolio loan end of period contractual rates increased by 21 basis points to 4.05% at June 30, 2022 compared to December 31, 2021. The loan portfolio is positioned for rising rates with $482.1 million or 29% of loans, excluding the allowance for credit losses, scheduled to reprice monthly or in the next three months and an additional $53.1 million or 3% repricing the following nine months. The Bank's effective duration on the loan portfolio was 2.1 years at June 30, 2022. In addition, increased non-interest bearing accounts as a percentage of deposits also better positions the Company for a rising rate environment.

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•Total portfolio loans increased $73.6 million or 9.3% annualized to $1,652.5 million from December 31, 2021, as the Company maintained its market dominance in Southern Maryland and continued to gain market share in Virginia. The loan pipeline at June 2022 was $166.0 million, which is expected to provide solid loan growth in the third quarter.

•Non-interest-bearing accounts increased $189.9 million to $635.6 million or 30.48% of deposits at June 30, 2022, from 21.68% of deposits at December 31, 2021. Transaction deposits increased $42.3 million, or 4.90% annualized, to $1,771.1 million in the first six months of 2022. The Company's change in funding mix has well positioned the balance sheet for a rising rate environment.

•As of June 30, 2022, the FOMC had increased the federal funds target rate range to between 1.50%-1.75%. As a result of the Company's balance sheet being asset sensitive, net interest margin increased 13 basis points to 3.25% for the three months ended June 30, 2022 compared to the first quarter of 2022.

•Total stockholders’ equity decreased $23.3 million during the six months ended June 30, 2022. The decrease in equity was primarily due to an increase of $29.9 million in accumulated other comprehensive loss ("AOCL") in the Bank's AFS securities portfolio due to changes in market interest rates, partially offset by net income of $13.1 million. Management intends and has the ability to hold its AFS securities until maturity. See discussion in Liquidity and Capital Resources section of this MD&A.

•The Company's common equity to assets ratio decreased to 7.96% at June 30, 2022 from 8.94% at December 31, 2021. The Company’s ratio of tangible common equity ("TCE") to tangible assets decreased to 7.49% at June 30, 2022 from 8.48% at December 31, 2021 (see Non-GAAP reconciliation schedules) due primarily to increases in AOCL. Regulatory capital was not impacted by the increase in AOCL and Tier 1 capital to average asset ratios at the Bank and the Company remained strong.

•Asset quality continues to improve as non-accrual loans, OREO and TDRs were $6.7 million or 0.29% of total assets at June 2022 compared to $8.1 million or 0.35% of total assets at December 31, 2021.

•The Bank opened its second Virginia branch in May 2022 in Fredericksburg. Additionally, with our Virginia lending team managing approximately 50% of the Bank's loans, the Bank intends to open a loan production office in Charlottesville in the fourth quarter of 2022 to support our existing efforts there. Management believes the greater Fredericksburg area provides significant opportunities for continued organic growth supported by our efficient operating model and ability to leverage technology.

Subsequent events

The Company has evaluated subsequent events for potential recognition and/or disclosure through the date the unaudited Consolidated Financial Statements included in this Quarterly Report on Form 10-Q were issued.

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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)						June 30, 2022						December 31, 2021						June 30, 2021
Total assets						$	2,323,514					$	2,327,306					$	2,195,059
Less: intangible assets
Goodwill						10,835						10,835						10,835
Core deposit intangible						821						1,032						1,267
Total intangible assets						11,656						11,867						12,102
Tangible assets						$	2,311,858					$	2,315,439					$	2,182,957
Total common equity						$	184,871					$	208,133					$	203,962
Less: intangible assets						11,656						11,867						12,102
Tangible common equity						$	173,215					$	196,266					$	191,860
Common shares outstanding at end of period						5,649,729						5,718,528						5,786,928
GAAP common equity to assets						7.96		%				8.94		%				9.29		%
Non-GAAP tangible common equity to tangible assets						7.49		%				8.48		%				8.79		%
GAAP common book value per share						$	32.72					$	36.40					$	35.25
Non-GAAP tangible common book value per share						$	30.66					$	34.32					$	33.15

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RECONCILIATION OF NON-GAAP MEASURES (UNAUDITED)

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 June 30,												Six Months Ended June 30,
(dollars in thousands)						2022						2021						2022						2021
Net income (as reported)						$	6,834					$	6,432					$	13,122					$	12,731
ROACE						14.39		%				12.62		%				13.31		%				12.57		%
Average equity						$	189,992					$	203,893					$	197,233					$	202,516

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 June 30,												Six Months Ended June 30,
(dollars in thousands)						2022						2021						2022						2021
Net income (as reported)						$	6,834					$	6,432					$	13,122					$	12,731
Core deposit intangible amortization (net of tax)						76						94						157						193
Net earnings applicable to common shareholders						$	6,910					$	6,526					$	13,279					$	12,924
ROATCE						15.50		%				13.62		%				14.32		%				13.59		%
Average tangible common equity						$	178,269					$	191,708					$	185,457					$	190,266

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SUMMARY OF OPERATING RESULTS

A comparison of the results of operations for the three and six months ended June 30, 2022 and June 30, 2021 is presented below.

						(Unaudited)												(Unaudited)
						Three Months Ended June 30,												Six Months Ended June 30,
(dollars in thousands, except per share amounts)						2022						2021						2022						2021
OPERATING DATA
Interest and dividend income						$	18,774					$	17,444					$	36,110					$	35,122
Interest expenses						1,206						1,009						2,073						2,178
Net interest income ("NII")						17,568						16,435						34,037						32,944
Provision for credit losses						425						291						875						586
Provision (recovery) for unfunded commitments						26						—						(5)						—
NII after provision for credit losses and unfunded commitments						17,117						16,144						33,167						32,358
Noninterest income						1,424						1,856						2,875						4,216
Noninterest expenses						9,338						9,378						18,418						19,526
Income before income taxes						9,203						8,622						17,624						17,048
Income taxes						2,369						2,190						4,502						4,317
Net income						6,834						6,432						13,122						12,731
Income available to common shares						$	6,834					$	6,432					$	13,122					$	12,731

						(Unaudited)												(Unaudited)
						Three Months Ended June 30,												Six Months Ended June 30,
						2022						2021						2022						2021
KEY OPERATING RATIOS
Return on average assets ("ROAA")						1.19		%				1.22		%				1.14		%				1.22		%
Return on average common equity ("ROACE")						14.39						12.62						13.31						12.57
Return on Average Tangible Common Equity ("ROATCE")						15.50						13.62						14.32						13.59
Average total equity to average total assets						8.28						9.63						8.54						9.67
Interest rate spread						3.14						3.30						3.10						3.36
Net interest margin						3.25						3.37						3.19						3.43
Efficiency ratio(1)						49.17						51.27						49.90						52.55
Non-interest income to average assets						0.25						0.35						0.25						0.40
Non-interest expense to average assets						1.63						1.77						1.59						1.87
Net operating expense to average assets(2)						1.38						1.42						1.35						1.46
COMMON SHARE DATA
Basic net income per common share						$	1.21					$	1.10					$	2.32					$	2.17
Diluted net income per common share						$	1.21					$	1.10					$	2.31					$	2.17
Cash dividends paid per common share						$	0.175					$	0.150					$	0.350					$	0.275
Common dividend payout ratio						14.46		%				13.63		%				15.12		%				12.67		%

_______________________________________

(1) Efficiency ratio is noninterest expense divided by the sum of net interest income and noninterest income.

(2) Net operating expense is the sum of non-interest expense offset by non-interest income.

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COMPARISON OF RESULTS OF OPERATIONS FOR THE THREE MONTHS ENDED JUNE 30, 2022 AND 2021

Summary of Financial Results

The Company reported net income for the three months ended June 30, 2022 of $6.8 million or diluted earnings per share of $1.21 compared to net income of $6.4 million or $1.10 per diluted earnings per share for the three months ended June 30, 2021. The Company’s ROAA and ROACE were 1.19% and 14.39% for the three months ended June 30, 2022 compared to 1.22% and 12.62% in June 30, 2021.

Net income in the second quarter of 2022 increased 6.3% compared to the same quarter in 2021, primarily due to increased net interest income partially offset by lower noninterest income.

						Three Months Ended June 30,
(dollars in thousands)						2022						2021						$ Change						% Change
Interest and dividend income						$	18,774					$	17,444					$	1,330					7.6		%
Interest expense						1,206						1,009						197						19.5		%
Net interest income						17,568						16,435						1,133						6.9		%
Provision for credit losses						425						291						134						46.0		%
Provision (recovery) for unfunded commitments						26						—						26						—		%
Noninterest income						1,424						1,856						(432)						(23.3)		%
Noninterest expense						9,338						9,378						(40)						(0.4)		%
Income before income taxes						9,203						8,622						581						6.7		%
Income tax (income) expense						2,369						2,190						179						8.2		%
Net income						$	6,834					$	6,432					$	402					6.3		%

Net Interest Income

Net interest income is the difference between income earned on assets and interest paid on the deposits and borrowings used to fund them. Net interest income is affected by the difference between the yields earned on the Company’s interest-earning assets and the rates paid on interest-bearing liabilities, as well as the relative amounts of such assets and liabilities. Net interest income, divided by average interest-earning assets, represents the Company’s net interest margin. The following table shows the components of net interest income and the dollar and percentage changes for the periods presented.

						Three Months Ended June 30,
(dollars in thousands)						2022						2021						$ Change						% Change
Interest and Dividend Income
Loans, including fees						$	16,772					$	16,320					$	452					2.8		%
Taxable interest and dividends on investment securities						1,924						1,101						823						74.8		%
Interest on deposits with banks						78						23						55						239.1		%
Total Interest and Dividend Income						18,774						17,444						1,330						7.6		%
Interest Expenses
Deposits						819						640						179						28.0		%
Short-term borrowings						16						—						16						—		%
Long-term debt						371						369						2						0.5		%
Total Interest Expenses						1,206						1,009						197						19.5		%
Net Interest Income (NII)						$	17,568					$	16,435					$	1,133					6.9		%

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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 June 30,
						2022																		2021
(dollars in thousands)						Average Balance						Interest						Average Yield/Cost						Average Balance						Interest						Average Yield/Cost
Assets
Commercial real estate						$	1,181,885					$	11,842					4.01		%				$	1,089,781					$	10,953					4.02		%
Residential first mortgages						85,030						730						3.43		%				109,296						838						3.07		%
Residential rentals						194,972						1,999						4.10		%				139,080						1,410						4.06		%
Construction and land development						30,302						361						4.77		%				38,315						425						4.44		%
Home equity and second mortgages						26,101						274						4.20		%				29,061						251						3.45		%
Commercial loans						42,744						517						4.84		%				43,100						516						4.79		%
Commercial equipment loans						68,349						699						4.09		%				61,017						592						3.88		%
U.S. SBA PPP loans						11,847						315						10.64		%				104,426						1,318						5.05		%
Consumer loans						4,040						35						3.47		%				1,425						17						4.77		%
Allowance for credit losses						(21,375)						—						—						(18,265)						—						0.00		%
Loan portfolio (1)						1,623,895						16,772						4.13		%				1,597,236						16,320						4.09		%
Taxable investment securities						484,079						1,808						1.49		%				276,019						1,020						1.48		%
Nontaxable investment securities						21,304						117						2.20		%				15,559						81						2.08		%
Interest-bearing deposits in other banks						23,958						63						1.05		%				28,844						13						0.18		%
Federal funds sold						6,178						14						0.91		%				34,778						10						0.12		%
Interest-Earning Assets ("IEAs")						2,159,414						18,774						3.48		%				1,952,436						17,444						3.57		%
Cash and cash equivalents						28,645																		65,897
Goodwill						10,835																		10,835
Core deposit intangible						888																		1,350
Other assets						93,754																		86,421
Total Assets						$	2,293,536																	$	2,116,939
Liabilities and Stockholders’ Equity
Noninterest-bearing demand deposits						$	650,249					$	—					—		%				$	406,166					$	—					—		%
Interest-bearing demand deposits
Savings						120,645						15						0.05		%				105,814						13						0.05		%
Demand deposits						571,475						431						0.30		%				622,544						86						0.06		%
Money market deposits						385,594						103						0.11		%				354,657						99						0.11		%
Certificates of deposit						317,930						270						0.34		%				344,533						442						0.51		%
Total interest-bearing deposits						1,395,644						819						0.23		%				1,427,548						640						0.18		%
Total Deposits						2,045,893						819						0.16		%				1,833,714						640						0.14		%
Long-term debt						3,350						22						2.63		%				27,273						43						0.63		%
Short-term borrowings						5,791						16						1.11		%				—						—						—		%
Subordinated Notes						19,529						252						5.16		%				19,473						251						5.16		%
Guaranteed preferred beneficial interest in junior subordinated debentures ("TRUPs")						12,000						97						3.23		%				12,000						75						2.50		%
Total Debt						40,670						387						3.81		%				58,746						369						2.51		%

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						Three Months Ended June 30,
						2022																		2021
(dollars in thousands)						Average Balance						Interest						Average Yield/Cost						Average Balance						Interest						Average Yield/Cost
Interest-Bearing Liabilities ("IBLs")						1,436,314						1,206						0.34		%				1,486,294						1,009						0.27		%
Total Funds						2,086,563						1,206						0.23		%				1,892,460						1,009						0.21		%
Other liabilities						16,981																		20,586
Stockholders’ equity						189,992																		203,893
Total Liabilities and Stockholders’ Equity						$	2,293,536																	$	2,116,939
Net interest income												$	17,568																	$	16,435
Interest rate spread																		3.14		%																3.30		%
Net yield on interest-earning assets																		3.25		%																3.37		%
Average loans to average deposits																		79.37		%																87.10		%
Average transaction deposits to total average deposits **																		84.46		%																81.21		%
Ratio of average IEAs to average IBLs																		150.34		%																131.36		%

__________________________

(1)Average balance includes non-accrual loans. There are no tax equivalent adjustments. There was $55,000 and $75,000 of accretion interest during the three months ended June 30, 2022 and 2021, respectively.

**Transaction deposits exclude time deposits

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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 June 30, 2022 Compared to the Three Months Ended June 30, 2021
(dollars in thousands)						Volume						Due to Rate						Total
Interest income:
Loan portfolio (1)
Commercial real estate						$	923					$	(34)					$	889
Residential first mortgages						(208)						100						(108)
Residential rentals						573						16						589
Construction and land development						(95)						31						(64)
Home equity and second mortgages						(31)						54						23
Commercial loans						(4)						5						1
Commercial equipment loans						75						32						107
SBA PPP loans						(2,462)						1,459						(1,003)
Consumer loans						23						(5)						18
Taxable investment securities						777						11						788
Nontaxable investment securities						32						4						36
Interest-bearing deposits in other banks						(13)						63						50
Federal funds sold						(65)						69						4
Total interest-earning assets						$	(475)					$	1,805					$	1,330
Interest-bearing liabilities:
Savings						$	2					$	—					$	2
Demand deposits						(39)						384						345
Money market deposits						8						(4)						4
Certificates of deposit						(23)						(149)						(172)
Long-term debt						(157)						136						(21)
Guaranteed preferred beneficial interest in junior subordinated debentures ("TRUPs")						—						22						22
Total interest-bearing liabilities						$	(191)					$	388					$	197
Net change in net interest income						$	(284)					$	1,417					$	1,133

___________________________________

(1)Average balance includes non-accrual loans. There are no tax equivalent adjustments. There was $55,000 and $0.1 million of accretion interest during the three months ended June 30, 2022 and 2021, respectively.

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. In response to the inflation effects on the economy, the Federal Reserve Open Market Committee ("FOMC") has increased the federal funds interest rate by 150 basis points from a target range of 0.00% to 0.25% in January 2022 to a target range of 1.50% to 1.75% at June 30, 2022. On July 27, 2022, the FOMC further increased the target range to 2.25% to 2.50% with Federal Reserve Bank commentary indicating that it was probable that the next scheduled meeting would result in additional rate hikes of at least 50 basis points.

Net interest income for the comparable quarters increased primarily from larger average balances in interest-earning assets and higher loan yields partially offset by increased interest expense from slightly higher funding rates and volume. Interest income increased as portfolio loan interest income more than replaced U.S. SBA PPP income and as overall loan yields, excluding U.S. SBA PPP loans, increased for the comparable quarters. Loan interest income increased $0.5 million for the comparable periods. If U.S. SBA PPP loan interest was excluded, loan interest income increased $1.5 million from $15.0 million for the three months ended June 30, 2021 to $16.5 million for the three months ended June 30, 2022. Average investment and interest-earning cash balances increased $180.3 million for the comparable periods and contributed $0.9 million in additional interest income. Net interest income decreased $0.2 million from increased interest expense from slightly higher cost of funds and average funding balances.

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Net interest margin of 3.25% for the three months ended June 30, 2022 decreased 12 basis points from 3.37% for the three months ended June 30, 2021. The decrease in net interest margin from the second quarter of 2021 resulted primarily from the Company’s increased average investment and interest-earning cash balances. Average yields on loans increased to 4.13% in the second quarter of 2022 compared to 4.09% for the three months ended June 30, 2021, while overall interest earning asset yields decreased to 3.48% for the three months ended June 30, 2022 from 3.57% for the three months ended June 30, 2021. Interest income from the Company's participation in the U.S. SBA PPP program was $0.3 million and $1.3 million for the three months ended June 30, 2022 and June 30, 2021, respectively. U.S. SBA PPP loan interest positively impacted margins by four basis points for the three months ended June 30, 2022 and 10 basis points for the three months ended June 30, 2021.

The Company’s cost of funds was 0.23% during the second quarter of 2022 increased from 0.21% for the three months ended June 30, 2021. The Bank's interest rate asset sensitivity improved as average non-interest bearing deposit accounts increased to 31.8% of total average deposits for the second quarter of 2022 compared to 22.1% for the comparable period in 2021. Management is optimistic that improvements in the Bank's funding composition will benefit margins and profitability in an increasing interest-rate environment.

Net interest margins began to increase in the second quarter of 2022 as FOMC rate increases began to impact the Bank's asset sensitive balance sheet. Average yields on loans and investments increased to 4.13% and 1.52% for the three months ended June 30, 2022 from 3.99% and 1.33% for the three months ended March 31, 2022. Net interest margin increased 13 basis points from 3.12% for the three months ended March 31, 2022 to 3.25% for the three months ended June 30, 2022.

Management is optimistic that a stable to increasing net interest margin is possible during the balance of 2022 assuming interest-earning assets continue to reprice faster than interest-bearing liabilities and the Bank maintains its current favorable funding mix.

Provision for Credit Losses

The following table shows the dollar and percentage changes for the provision for credit losses for the periods presented.

						Three Months Ended June 30,
(dollars in thousands)						2022						2021						$ Change						% Change
Provision for credit losses						$	425					$	291					$	134					46.05		%

The provision for credit losses is a function of the calculation of the allowance for credit losses 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 June 30,
(dollars in thousands)						2022						2021						$ Change						% Change
Noninterest Income
Loan appraisal, credit, and miscellaneous charges						$	44					$	44					$	—					—		%
Gain on sale of assets						—						68						(68)						(100.0)		%
Unrealized (losses) gain on equity securities						(155)						13						(168)						(1,292)		%
Income from bank owned life insurance						217						218						(1)						(0.5)		%
Service charges						1,108						892						216						24.2		%
Referral fee income						—						621						(621)						(100.0)		%
Net gains (losses) on sale of loans originated for sale						1						—						1						—		%
Gains on sale of loans						209						—						209						—		%
Total Noninterest Income						$	1,424					$	1,856					$	(432)					(23.3)		%

Noninterest income for the three months ended June 30, 2022 decreased from the three months ended June 30, 2021. The $0.4 million decrease in noninterest income in the current quarter was principally due to no interest rate protection referral fee income for the three months ended June 30, 2022. In addition, changes in interest rates resulted in unrealized losses on securities invested in a Community Reinvestment Act mutual fund. These reductions in noninterest income for the comparable quarters were partially offset by increases in service charges due to increased interchange fees and gains of $0.2 million from the sale of two impaired loans. Noninterest income as a percentage of average assets was 0.25% and 0.35%, respectively, for the three months ended June 30, 2022 and 2021.

Noninterest Expense

The following tables show the components of noninterest expense and the dollar and percentage changes for the periods presented.

						Three Months Ended June 30,
(dollars in thousands)						2022						2021						$ Change						% Change
Noninterest Expense
Compensation and benefits						$	5,051					$	5,332					$	(281)					(5.3)		%
OREO valuation allowance and expenses						—						488						(488)						(100.0)		%
Sub-total						5,051						5,820						(769)						(13.2)		%
Operating Expenses
Occupancy expense						820						688						132						19.2		%
Advertising						159						148						11						7.4		%
Data processing expense						1,008						990						18						1.8		%
Professional fees						845						604						241						39.9		%
Depreciation of premises and equipment						150						135						15						11.1		%
FDIC Insurance						177						140						37						26.4		%
Core deposit intangible amortization						102						126						(24)						(19.0)		%
Fraud losses (recoveries)						30						(217)						247						(113.8)		%
Other expenses						996						944						52						5.5		%
Total Operating Expenses						$	4,287					$	3,558					$	729					20.5		%
Total Noninterest Expense						$	9,338					$	9,378					$	(40)					(0.4)		%

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The flat overall expense run rate for the comparable periods were primarily due to decreases in compensation and benefits and no credit related expenses for OREO, partially offset by increases in occupancy expenses and professional fees as well as a fraud recovery in the second quarter of 2021. OREO expenses reflect management's actions in 2020 and 2021 to reduce non-performing assets. Increases in occupancy and professional fees were driven by increasing utilities and vendor wage appreciation as well as the opening of our newest branch in Fredericksburg, Virginia.

Lower than anticipated health care costs and a lower average full-time equivalent headcount contributed to a lower compensation and benefits run rate in the second quarter of 2022. In addition, compensation and benefits expense has benefited from the Company's increased use of technology. In the second quarter, the Bank increased base compensation by 4% and its minimum starting wage to $20.00 per hour for non-executive employees to address local wage pressures caused by inflation and to attract and retain our employees. Management's projected quarterly expense run rate for the third quarter of 2022 is estimated between $9.6 million and $9.7 million and includes consideration of the base compensation increases and an average FTE count of 195-197 employees.

The Company’s efficiency ratio was 49.17% for the three months ended June 30, 2022 compared to 51.27% for the three months ended June 30, 2021. The Company’s net operating expense ratio was 1.38% for the three months ended June 30, 2022 compared to 1.42% for the three months ended June 30, 2021. The efficiency and net operating expense ratios have improved (decreased) as the Company has been able to improve asset quality and generate more operating revenues while controlling expense growth.

Income Tax Expense

The effective tax rate for the three months ended June 30, 2022 was 25.74% compared to an effective tax rate of 25.40% for the three months ended June 30, 2021.

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COMPARISON OF RESULTS OF OPERATIONS FOR THE SIX MONTHS ENDED JUNE 30, 2022 AND 2021

Summary of Financial Results

The Company reported net income for the six months ended June 30, 2022 of $13.1 million or diluted earnings per share of $2.31 compared to net income of $12.7 million or $2.17 per diluted share for the six months ended June 30, 2021. The Company’s ROAA and ROACE were 1.14% and 13.31% for the six months ended June 30, 2022 compared to 1.22% and 12.57% for the six months ended June 30, 2021.

The increase to net income in the first six months of 2022 compared to the same period in 2021 was due to increased net interest income and decreased noninterest expense partially offset by an increase in provision for credit losses and a decrease in non-interest income.

						Six Months Ended June 30,
(dollars in thousands)						2022						2021						$ Change						% Change
Interest and dividend income						$	36,110					$	35,122					$	988					2.8		%
Interest expense						2,073						2,178						(105)						(4.8)		%
Net interest income						34,037						32,944						1,093						3.3		%
Provision for credit losses						875						586						289						49.3		%
Recovery for unfunded commitments						(5)						—						(5)						—		%
Noninterest income						2,875						4,216						(1,341)						(31.8)		%
Noninterest expense						18,418						19,526						(1,108)						(5.7)		%
Income before income taxes						17,624						17,048						576						3.4		%
Income tax expense						4,502						4,317						185						4.3		%
Net income						$	13,122					$	12,731					$	391					3.1		%

Net Interest Income

The following table shows the components of net interest income and the dollar and percentage changes for the periods presented.

						Six Months Ended June 30,
(dollars in thousands)						2022						2021						$ Change						% Change
Interest and Dividend Income
Loans, including fees						$	32,382					$	32,912					$	(530)					(1.6)		%
Taxable interest and dividends on investment securities						3,590						2,165						1,425						65.8		%
Interest on deposits with banks						138						45						93						206.7		%
Total Interest and Dividend Income						36,110						35,122						988						2.8		%
Interest Expenses
Deposits						1,332						1,442						(110)						(7.6)		%
Short-term borrowings						16						—						16						—		%
Long-term debt						725						736						(11)						(1.5)		%
Total Interest Expenses						2,073						2,178						(105)						(4.8)		%
Net Interest Income (NII)						$	34,037					$	32,944					$	1,093					3.3		%

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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 six months ended June 30, 2022 and 2021, respectively.

						Six Months Ended June 30,
						2022																		2021
(dollars in thousands)						Average Balance						Interest						Average Yield/Cost						Average Balance						Interest						Average Yield/Cost
Assets
Commercial real estate						$	1,147,188					$	22,579					3.94		%				$	1,074,874					$	21,648					4.03		%
Residential first mortgages						85,912						1,442						3.36		%				117,097						1,752						2.99		%
Residential rentals						196,136						3,830						3.91		%				139,150						2,855						4.10		%
Construction and land development						31,977						768						4.80		%				37,209						828						4.45		%
Home equity and second mortgages						26,024						519						3.99		%				29,166						499						3.42		%
Commercial loans						44,696						1,068						4.78		%				43,915						1,067						4.86		%
Commercial equipment loans						65,050						1,341						4.12		%				60,782						1,111						3.66		%
U.S. SBA PPP loans						16,122						767						9.51		%				110,183						3,120						5.66		%
Consumer loans						3,629						68						3.75		%				1,373						32						4.66		%
Allowance for credit losses						(21,210)						—						—						(18,936)						—						0.00		%
Loan portfolio (1)						1,595,524						32,382						4.06		%				1,594,813						32,912						4.13		%
Taxable investment securities						484,118						3,379						1.40		%				253,043						1,970						1.56		%
Non-taxable investment securities						19,419						211						2.17		%				18,185						195						2.14		%
Interest bearing deposits in other banks						33,231						124						0.75		%				26,964						28						0.21		%
Federal funds sold						3,106						14						0.90		%				26,794						17						0.13		%
Interest-Earning Assets ("IEAs")						2,135,398						36,110						3.38		%				1,919,799						35,122						3.66		%
Cash and cash equivalents						72,359																		74,237
Goodwill						10,835																		10,835
Core deposit intangible						941																		1,415
Other assets						90,069																		87,600
Total Assets						$	2,309,602																	$	2,093,886
Liabilities and Stockholders’ Equity
Noninterest-bearing demand deposits						$	630,137					$	—					—		%				$	393,682					$	—					—		%
Interest-bearing liabilities:
Savings						120,939						30						0.05		%				103,809						26						0.05		%
Demand deposits						598,210						535						0.18		%				612,745						183						0.06		%
Money market deposits						382,206						203						0.11		%				352,201						197						0.11		%
Certificates of deposit						320,126						564						0.35		%				347,930						1,036						0.60		%
Total Interest-bearing deposits						1,421,481						1,332						0.19		%				1,416,685						1,442						0.20		%
Total Deposits						2,051,618						1,332						0.13		%				1,810,367						1,442						0.16		%
Long-term debt						7,760						47						1.21		%				27,282						83						0.61		%
Short-term borrowings						2,912						16						1.10		%				—						—						—		%
Subordinated Notes						19,522						503						5.15		%				19,482						503						5.16		%
Guaranteed preferred beneficial interest in junior subordinated debentures ("TRUPs")						12,000						175						2.92		%				12,000						150						2.50		%
Total debt						42,194						741						3.51		%				58,764						736						2.50		%

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						Six Months Ended June 30,
						2022																		2021
(dollars in thousands)						Average Balance						Interest						Average Yield/Cost						Average Balance						Interest						Average Yield/Cost
Total Interest-Bearing Liabilities ("IBLs")						1,463,675						2,073						0.28		%				1,475,449						2,178						0.30		%
Total funds						2,093,812						2,073						0.20		%				1,869,131						2,178						0.23		%
Other liabilities						18,557																		22,239
Stockholders’ equity						197,233																		202,516
Total Liabilities and Stockholders’ Equity						$	2,309,602																	$	2,093,886
Net interest income												$	34,037																	$	32,944
Interest rate spread																		3.10		%																3.36		%
Net yield on interest-earning assets																		3.19		%																3.43		%
Average loans to avg. deposits																		77.77		%																88.09		%
Average transaction deposits to total average deposits **																		84.40		%																80.78		%
Ratio of average IEAs to average IBLs																		145.89		%																130.12		%
Cost of funds																		0.20		%																0.23		%
Cost of deposits																		0.13		%																0.16		%
Cost of debt																		3.51		%																2.50		%

__________________________

(1)Average balance includes non-accrual loans. There are no tax equivalent adjustments. There was $105,000 and $165,000 of accretion interest during the six months ended June 30, 2022 and 2021, respectively.

**Transaction deposits excluded time deposits

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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 Six Months Ended June 30, 2022 compared to the Six Months Ended June 30, 2021
(dollars in thousands)						Volume						Due to Rate						Total
Interest income:
Loan portfolio (1)
Commercial real estate						$	1,423					$	(492)					$	931
Residential first mortgages						(523)						213						(310)
Residential rentals						1,113						(138)						975
Construction and land development						(126)						66						(60)
Home equity and second mortgages						(63)						83						20
Commercial loans						19						(18)						1
Commercial equipment loans						88						142						230
SBA PPP loans						(4,475)						2,122						(2,353)
Consumer loans						42						(6)						36
Taxable investment securities						1,613						(204)						1,409
Nontaxable investment securities						13						3						16
Interest-bearing deposits in other banks						23						73						96
Federal funds sold						(107)						104						(3)
Total interest-earning assets						$	(960)					$	1,948					$	988
Interest-bearing liabilities:
Savings						$	4					$	—					$	4
Demand deposits						(13)						365						352
Money market deposits						16						(10)						6
Certificates of deposit						(49)						(423)						(472)
Long-term debt						(118)						82						(36)
Short-term borrowings						16						—						16
Subordinated notes						1						(1)						—
Guaranteed preferred beneficial interest in junior subordinated debentures						—						25						25
Total interest-bearing liabilities						$	(143)					$	38					$	(105)
Net change in net interest income						$	(817)					$	1,910					$	1,093

___________________________________

(1)Average balance includes non-accrual loans. There are no tax equivalent adjustments. There was $105,000 and $165,000 of accretion interest during the six months ended June 30, 2022 and 2021, respectively.

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Net interest income increased $1.1 million or 3.3% for the six months ended June 30, 2022, compared to the six months ended June 30, 2021 with interest income increasing $1.0 million and interest expense decreasing of $0.1 million. Increased interest income was primarily due to growth in investments income of $1.5 million. Interest income from the growth of the Company's portfolio loans nearly replaced the decrease in U.S. SBA PPP loan interest income. Overall loan interest income decreased $0.5 million to $32.4 million for the six months ended June 30, 2022 from $32.9 million for the six months ended June 30, 2021. Excluding U.S. SBA PPP loans, interest income for the same comparable periods increased $1.8 million to $31.6 million from $29.8 million. Interest expense decreased $0.1 million due to changes in the Bank's funding mix away from higher cost debt and time deposits into non-interest bearing and transaction deposit accounts.

Net interest margin of 3.19% for the six months ended June 30, 2022 was 24 basis points lower than the 3.43% for the six months ended June 30, 2021. Loan yields decreased from 4.13% for the six months ended June 30, 2021 to 4.06% for the six months ended June 30, 2022. Loan yields, excluding U.S. SBA PPP loan interest income, were 4.00% and 4.01% for the six months ended June 30, 2022 and June 30, 2021. U.S. SBA PPP loan interest positively impacted margins by five basis points for the six months ended June 30, 2022 and 13 basis points for the six months ended June 30, 2021.

As a result of organic growth, average total earning assets increased $215.6 million, or 11.2%, for the six months ended June 30, 2022 to $2,135.4 million compared to $1,919.8 million for the six months ended June 30, 2021. The increase in average total earning assets for the six months ended June 30, 2022 from the comparable period in 2021 resulted primarily from a $0.7 million, or 0.04%, increase in average loans, with average U.S. SBA PPP loans decreasing $94.0 million and average portfolio loans increasing $94.7 million, and an increase of $214.9 million, or 66.1%, increase in average investments, federal funds sold, and interest-bearing deposits.

The Company’s cost of funds was 0.20% during the first six months of 2022 compared to 0.23% for the six months ended June 30, 2021. Average total interest-bearing liabilities decreased $11.8 million, or 0.8%, for the six months ended June 30, 2022 to $1,463.7 million compared to $1,475.4 million for the six months ended June 30, 2021. During the same time, the Company increased balance sheet asset sensitivity with average noninterest-bearing demand deposits increasing $236.5 million, or 60.1%, to $630.1 million, or 30.7% of average deposits compared to $393.7 million, or 21.8% of average deposits.

Provision for Credit Losses

The following table shows the dollar and percentage changes for the provision for credit losses for the periods presented.

						Six Months Ended June 30,
(dollars in thousands)						2022						2021						$ Change						% Change
Provision for credit losses						$	875					$	586					$	289					49.32		%

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.

						Six Months Ended June 30,
(dollars in thousands)						2022						2021						$ Change						% Change
Noninterest Income
Loan appraisal, credit, and miscellaneous charges						$	220					$	242					$	(22)					(9.1)		%
Gain on sale of assets						—						68						(68)						(100.0)		%
Net gains on sale of investment securities						—						586						(586)						(100.0)		%
Unrealized losses on equity securities						(377)						(72)						(305)						423.6		%
Income from bank owned life insurance						431						432						(1)						(0.2)		%
Service charges						2,034						2,079						(45)						(2.2)		%
Referral fee income						361						1,072						(711)						(66.3)		%
Net losses on sale of loans originated for sale						(3)						—						(3)						—		%
Gains (losses) on sale of loans						209						(191)						400						(209.4)		%
Total Noninterest Income						$	2,875					$	4,216					$	(1,341)					(31.8)		%

Noninterest income for the six months ended June 30, 2022 decreased compared to the six months ended June 30, 2021. The decreases were primarily due to decreased referral fee income, gain on sales of investments in the first six months of 2021, and unrealized losses on securities invested in a Community Reinvestment Act mutual fund that was impacted by increases in interest rates. These reductions for the comparable periods were partially offset by $0.4 million related to the sale of impaired loans. In the first quarter of 2021, the Bank sold non-accrual and classified commercial real estate and residential mortgage loans and recognized a loss on the sale of $0.2 million and in the second quarter of 2022, impaired loan sales resulted in a gain of $0.2 million. Noninterest income as a percentage of assets was 0.25% and 0.40%, respectively, for the six months ended June 30, 2022 and 2021.

Noninterest Expense

The following tables show the components of noninterest expense and the dollar and percentage changes for the periods presented.

						Six Months Ended June 30,
(dollars in thousands)						2022						2021						$ Change						% Change
Noninterest Expense
Compensation and benefits						$	10,106					$	10,120					$	(14)					(0.1)		%
OREO valuation allowance and expenses						6						669						(663)						(99.1)		%
Sub-total						10,112						10,789						(677)						(6.3)		%
Operating Expense
Occupancy expense						1,552						1,449						103						7.1		%
Advertising						223						227						(4)						(1.8)		%
Data processing expense						2,015						1,926						89						4.6		%
Professional fees						1,576						1,244						332						26.7		%
Depreciation of premises and equipment						299						282						17						6.0		%
FDIC Insurance						356						392						(36)						(9.2)		%
Core deposit intangible amortization						211						259						(48)						(18.5)		%
Fraud losses						70						1,112						(1,042)						(93.7)		%
Other expenses						2,004						1,846						158						8.6		%
Total Operating Expense						8,306						8,737						(431)						(4.9)		%
Total Noninterest Expense						$	18,418					$	19,526					$	(1,108)					(5.7)		%

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The decrease in noninterest expense for the comparable periods was primarily due to decreased OREO expenses and fraud losses. Noninterest expense decreased for the comparable periods as decreases in OREO expenses, compensation, fraud losses, amortization of core deposit intangible and FDIC insurance were offset by increases in occupancy, data processing, professional fees, depreciation and other expenses. OREO expenses have moderated as the Bank has been successful at disposing assets and reducing OREO balances to zero. Noninterest expenses in the first six month of 2021 included a $1.3 million initial expense and subsequent recovery of $0.2 million related to an isolated wire transfer fraud incident. Professional fees increased for the comparable prior year period due to costs related to the implementation of CECL, the new retail and commercial credit card program, and vendor wage appreciation. Increases in occupancy were driven by increasing utilities as well as the opening of our newest branch in Fredericksburg, Virginia.

During the first six months of 2022, lower than anticipated health care costs and a lower average full-time equivalent headcount contributed to lower compensation and benefits. In the second quarter, the Bank increased base compensation by 4% and its minimum starting wage to $20.00 per hour for non-executive employees to address local wage pressures caused by inflation and to attract and retain employees. Management's projected quarterly expense run rate for the third quarter of 2022 is estimated between $9.6 million and $9.7 million and includes consideration of the base compensation increases and an average FTE count of 195-197 employees.

The Company’s efficiency ratio was 49.90% for the six months ended June 30, 2022 compared to 52.55% for the six months ended June 30, 2021. The Company’s net operating expense ratio was 1.35% at June 30, 2022 compared to 1.46% at June 30, 2021. 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.

Expenses applicable to OREO assets included the following.

						Six Months Ended June 30,
(dollars in thousands)						2022						2021
Valuation allowance						$	—					$	641
Losses (gains) on dispositions						—						(16)
Operating expenses						6						44
						$	6					$	669

To adjust properties to current appraised values, additions to the valuation allowance were taken for the six months ended June 30, 2021. 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. At June 30, 2022 and December 31, 2021, the carrying value of OREO assets was zero.

Income Tax Expense

The Company’s consolidated effective tax rate for the six months ended June 30, 2022 and June 30, 2021 was 25.5% and 25.3%, respectively.

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COMPARISON OF FINANCIAL CONDITION AT JUNE 30, 2022 AND DECEMBER 31, 2021

The following table shows selected historical consolidated financial data for the Company, which has been derived from our audited consolidated financial statements. You should read this table together with our consolidated financial statements and related notes included in this Quarterly Report for Form 10-Q and in the Annual Report on Form 10-K for the year ended December 31, 2021.

						(Unaudited)
(dollars in thousands, except per share amounts)						June 30, 2022						December 31, 2021
FINANCIAL CONDITION DATA
Total assets						$	2,323,514					$	2,327,306
Loans receivable, net						1,636,077						1,586,791
Investment securities						490,086						502,818
Goodwill						10,835						10,835
Core deposit intangible						821						1,032
Deposits						2,085,376						2,056,164
Borrowings						—						12,231
Junior subordinated debentures						12,000						12,000
Subordinated notes - 4.75% **						19,538						19,510
Stockholders’ equity - common						184,871						208,133

____________________________________

**Company issued $20.0 million of 4.75% subordinated notes due 2030 on October 14, 2020.

						(Unaudited)
(dollars in thousands, except per share amounts)						June 30, 2022						December 31, 2021
COMMON SHARE DATA
Book value per common share						$	32.72					$	36.40
Tangible book value per common share**						$	30.66					$	34.32
Common shares outstanding at end of period						5,649,729						5,718,528
OTHER DATA
Full-time equivalent employees						190						186
Branches						12						11
Loan Production Offices						4						4
CAPITAL RATIOS
Tier 1 capital to average assets (Leverage)						9.42		%				9.23		%
Tier 1 common capital to risk-weighted assets						11.66						11.92
Tier 1 capital to risk-weighted assets						12.34						12.64
Total risk-based capital to risk-weighted assets						14.68						14.92
Common equity to total assets						7.96						8.94
Tangible common equity to tangible assets**						7.49						8.48

____________________________________

**Non-GAAP financial measure. See reconciliation of GAAP and NON-GAAP measures.

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Assets

Total assets at June 30, 2022 were comparable to December 31, 2021 as cash balances decreased to fund loan growth. In addition, net deferred tax assets increased primarily due to increases in unrealized losses of the Bank's AFS investment portfolio related to changes in interest rates as well as increases in the ACL for the adoption of the current expected credit losses ("CECL") accounting standard on January 1, 2022. The differences in allocations between the cash and investment categories reflect operational needs.

The following table shows the Company’s assets and the dollar and percentage changes for the periods presented.

(dollars in thousands)						June 30, 2022						December 31, 2021						$ Change						% Change
Cash and due from banks						$	16,164					$	108,990					$	(92,826)					(85.2)		%
Federal funds sold						37,320						—						37,320						—		%
Interest-bearing deposits with banks						34,659						30,664						3,995						13.0		%
Securities available for sale ("AFS"), at fair value						485,456						497,839						(12,383)						(2.5)		%
Equity securities carried at fair value through income						4,423						4,772						(349)						(7.3)		%
Non-marketable equity securities held in other financial institutions						207						207						—						—		%
FHLB stock - at cost						1,234						1,472						(238)						(16.2)		%
Net Loans						1,636,077						1,586,791						49,286						3.1		%
Goodwill						10,835						10,835						—						—		%
Premises and equipment, net						21,802						21,427						375						1.8		%
Accrued interest receivable						6,099						5,588						511						9.1		%
Investment in bank owned life insurance						39,363						38,932						431						1.1		%
Core deposit intangible						821						1,032						(211)						(20.4)		%
Net deferred tax assets						20,223						9,033						11,190						123.9		%
Right of use assets, net operating leases						6,123						6,124						(1)						—		%
Other assets						2,708						3,600						(892)						(24.8)		%
Total Assets						$	2,323,514					$	2,327,306					$	(3,792)					(0.2)		%

Cash and Cash Equivalents

Cash and cash equivalents totaled $88.1 million at June 30, 2022, compared to $139.7 million at December 31, 2021. Total cash and cash equivalents fluctuate on a daily basis 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.

Investment Securities and Credit Quality of Investment Securities

Investment securities and FHLB stock at June 30, 2022 and December 31, 2021, estimated fair values were $491.3 million, and $504.3 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 June 30, 2022 and December 31, 2021. AFS securities are evaluated quarterly to determine whether a decline in their value is the result of a deterioration in credit quality. A reserve for credit losses was not recorded for the periods reported.

At June 30, 2022, approximately 92%, or $447.6 million of the carrying value of AFS securities were rated AAA by Standard & Poor’s or the equivalent credit rating from another major rating agency compared to approximately 92%, or $456.2 million, at December 31, 2021.

Gross unrealized losses at June 30, 2022 and December 31, 2021 for AFS securities were $43.2 million and $6.0 million, respectively, of amortized cost of $528.5 million and $500.5 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.

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The Bank holds 70.8% or $374.2 million of its AFS investment securities at amortized cost, as asset-backed securities issued by GSEs or U.S. Agencies, GSE agency bonds or U.S. government obligations. In addition, the Company's amortized cost investment of $52.3 million in student loan trusts, which represent 9.9% of the AFS investment portfolio, are 97% U.S. government guaranteed. At June 30, 2022, the Company also had $98.8 million or 18.7% of AFS investments in municipal bonds.

The average effective duration of the Company's AFS investment portfolio at June 30, 2022 and December 31, 2021, were 4.10 years and 3.90 years, respectively.

At June 30, 2022 and December 31, 2021, AFS asset-backed securities issued and guaranteed by GSEs and U.S. Agencies had an average life of 6.51 years and 6.91 years and an average duration of 5.70 years and 6.41 years, respectively. At June 30, 2022 and December 31, 2021, AFS asset-backed securities issued by student loan trusts and others had an average life of 6.16 years and 6.24 years and an average duration of 5.44 years and 6.03 years, respectively. At June 30, 2022 and December 31, 2021, AFS municipal bonds issued by states, political subdivisions or agencies had average life of 11.07 years and 8.75 years and an average duration of 9.24 years and 7.83 years, respectively.

The amortized cost of AFS investment securities by contractual maturity at June 30, 2022 are shown below. Expected maturities will differ from contractual maturities because the issuers of the securities may have the right to prepay obligations without prepayment penalties. The maturities and weighted average yields at June 30, 2022 are shown below.

						One year or Less												After One Through Five Years												After Five Through Ten Years												After Ten Years												Total Investment Securities
(dollars in thousands)						Amortized Cost						Average Yield						Amortized Cost						Average Yield						Amortized Cost						Average Yield						Amortized Cost						Average Yield						Amortized Cost						Fair Value
AFS Investment securities:
Asset-backed securities issued by GSEs and U.S. Agencies						$	23,064					2.35		%				$	90,237					2.35		%				$	129,441					2.28		%				$	94,655					2.58		%				$	337,397					$	314,042
Asset-backed securities issued by Others						3,590						1.85		%				14,044						1.85		%				20,147						1.83		%				14,732						1.79		%				52,513						50,437
Municipal securities						6,755						2.47		%				26,427						2.47		%				37,908						2.47		%				27,721						2.69		%				98,811						83,452
Corporate bonds						205						3.88		%				802						3.88		%				1,151						3.88		%				842						—		%				3,000						2,857
U.S. Treasury bonds						2,516						1.17		%				9,844						1.24		%				14,120						1.23		%				10,326						—		%				36,806						34,668
Total AFS investment securities						$	36,130					2.25		%				$	141,354					2.25		%				$	202,767					2.26		%				$	148,276					2.53		%				$	528,527					$	485,456

The tables below present the Standard & Poor’s (“S&P”) or equivalent credit rating from other major rating agencies for AFS securities at June 30, 2022 and December 31, 2021 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.

June 30, 2022												December 31, 2021
Credit Rating						Amount						Credit Rating						Amount
(dollars in thousands)												(dollars in thousands)
AAA						$	447,599					AAA						$	456,162
AA						34,836						AA						41,455
A						164						A						222
BBB						2,857						BBB						—
Total						$	485,456					Total						$	497,839

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Loan Portfolio and U.S. SBA PPP Loans

The Bank's primary market areas consist of Southern Maryland, the city of Fredericksburg, Virginia and Spotsylvania and Stafford counties in Virginia. Management is committed to continue as the leading commercial financial institution in Southern Maryland. In 2021, the Bank increased lending in Virginia in the cities and surrounding areas of Culpeper, Orange and Charlottesville. The Bank plans to open a loan production office in Charlottesville, Virginia in 2022. At June 30, 2022, loans managed by our Maryland and Virginia lending teams are almost evenly distributed. Management is optimistic that the Virginia market will continue to provide opportunities for organic loan growth.

At June 30, 2022, total net loans, which include portfolio loans and U.S. SBA PPP loans, increased 6.2% annualized or $49.3 million from December 31, 2021. Total net portfolio loans increased $70.7 million and U.S. SBA PPP loans decreased $21.4 million for the comparable period ends. The commercial real estate portfolio increased in total during the first six months of 2022, while increasing slightly as a percentage of total portfolio loans. The Company’s loan pipeline was $166.0 million at June 30, 2022 compared to $160.0 million at December 31, 2021.

During 2020 and 2021, the Company originated 1,532 U.S. SBA PPP loans with original balances of $201.3 million. As of June 30, 2022, there were 48 U.S. SBA PPP loans with outstanding balances of $5.2 million.

The following is a breakdown of the Company’s loan portfolio, net of deferred costs and fees at June 30, 2022 and December 31, 2021:

(dollars in thousands)						June 30, 2022						%						December 31, 2021**						%						$ Change						Annualized % Change
BY LOAN TYPE
Portfolio Loans:
Commercial real estate						$	1,178,758					71.33		%				$	1,113,793					70.54		%				$	64,965					11.67		%
Residential first mortgages						84,782						5.13		%				92,710						5.87		%				(7,928)						(17.10)		%
Residential rentals						210,116						12.72		%				194,911						12.35		%				15,205						15.60		%
Construction and land development						31,068						1.88		%				35,502						2.25		%				(4,434)						(24.98)		%
Home equity and second mortgages						25,200						1.53		%				25,661						1.63		%				(461)						(3.59)		%
Commercial loans						43,472						2.63		%				50,512						3.20		%				(7,040)						(27.87)		%
Consumer loans						4,511						0.27		%				3,015						0.19		%				1,496						99.24		%
Commercial equipment						74,552						4.51		%				62,706						3.97		%				11,846						37.78		%
Total portfolio loans						1,652,459						100.00		%				1,578,810						100.00		%				73,649						9.33		%
Less: Allowance for Credit Losses						(21,404)						(1.30)		%				(18,417)						(1.17)		%				(2,987)						32.44		%
Total net portfolio loans						1,631,055												1,560,393												70,662						9.06		%
U.S. SBA PPP loans						5,022												26,398												(21,376)						(161.95)		%
Total net loans						$	1,636,077											$	1,586,791											$	49,286					6.21		%

____________________________________

**December 31, 2021 reported balance are shown net of deferred costs and fees to conform with the current period's presentation.

Loan Concentrations

At June 30, 2022 and December 31, 2021, commercial loans, including residential rentals, represented 91.2% and 90.1%, respectively, of total 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 June 30, 2022 and December 31, 2021 were $893.9 million or 351.2% and $813.0 million or 331.4%, respectively. Construction loans as a percentage of risk-based capital at June 30, 2022 and December 31, 2021 were $133.1 million or 52.3% and $140.4 million or 57.2%, respectively.

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Asset Quality

The following tables show asset quality ratios at June 30, 2022 and December 31, 2021.

						(Unaudited)
(dollars in thousands, except per share amounts)						June 30, 2022						December 31, 2021
ASSET QUALITY
Total portfolio loans						$	1,652,459					$	1,578,810
Classified Assets						6,062						5,211
Allowance for credit losses						21,404						18,417
Past due loans - 31 to 89 days						900						568
Past due loans >=90 days (1)						147						961
Total past due (delinquency) loans						1,047						1,529
Non-accrual loans (2)						6,235						7,631
Accruing troubled debt restructures (TDRs) (3)						439						447
Other real estate owned (OREO)						—						—
Non-accrual loans, OREO and TDRs						$	6,674					$	8,078
ASSET QUALITY RATIOS (4)
Classified assets to total assets						0.26		%				0.22		%
Classified assets to risk-based capital						2.35						2.10
Allowance for credit losses to total portfolio loans						1.30						1.17
Allowance for credit losses to non-accrual loans						343.29						241.34
Past due loans - 31 to 89 days to total portfolio loans						0.05						0.04
Past due loans >=90 days to total portfolio loans						0.01						0.06
Total past due (delinquency) to total portfolio loans						0.06						0.10
Non-accrual loans to total portfolio loans						0.38						0.48
Non-accrual loans and TDRs to total portfolio loans						0.40						0.51
Non-accrual loans and OREO to total assets						0.27						0.33
Non-accrual loans and OREO to total portfolio loans and OREO						0.38						0.48
Non-accrual loans, OREO and TDRs to total assets						0.29						0.35

___________________________________________

(1) Nonperforming loans include all loans that are 90 days or more delinquent.

(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.

(3) TDR loans include both non-accrual and accruing performing loans. All TDR loans are included in the calculation of asset quality financial ratios. Non-accrual TDR loans are included in the non-accrual balance and accruing TDR loans are included in the accruing TDR balance.

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Allowance for Credit Losses ("ACL"), Provision for Credit Losses ("PCL"), Allowance for Loan Losses ("ALLL) and Provision for Loan Losses ("PLL")

The following is a breakdown of the Company’s general and specific allowances as a percentage of total portfolio loans at June 30, 2022 and 2021 and at December 31, 2021:

Breakdown of general and specific allowance as a percentage of total portfolio loans (1)

						June 30, 2022						June 30, 2021						December 31, 2021
General allowance						$	21,108					$	17,738					$	18,151
Specific allowance						296						778						266
						$	21,404					$	18,516					$	18,417
General allowance						1.28		%				1.15		%				1.15		%
Specific allowance						0.02		%				0.05		%				0.02		%
Allowance to total portfolio loans(1)						1.30		%				1.20		%				1.17		%
Allowance to non-acquired loans(2)						n/a						1.25		%				1.20		%
Total acquired loans(2)						n/a						$	54,697					$	42,182
Non-acquired loans**(2)						n/a						$	1,479,179					$	1,536,761
Total portfolio loans						$	1,652,459					$	1,533,876					$	1,578,943

____________________________________

**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.

(1)Portfolio loans include all loan portfolios except the U.S. SBA PPP loan portfolio.

(2)Allowance to non-acquired loans is no longer relevant as the ACL considers all portfolio loans.

On January 1, 2022, the Company adopted ASU 2016-13 and implemented the current expected credit loss model ("CECL"). The ACL is a valuation account that is deducted from loans' amortized cost basis to present the net amount expected to be collected on the loans. Loans are charged-off against the allowance when management believes the uncollectibility of a loan balance is confirmed. Expected recoveries do not exceed the aggregate of amounts previously charged-off and expected to be charged-off.

The Bank uses a range of data to estimate expected credit losses under CECL, including information about past events, current conditions, and reasonable and supportable forecasts relevant to assessing the collectability of the cash flows of the loans. Historical loss experience serves as the foundation for our estimated credit losses. Adjustments to our historical loss experience are made for differences in current loan portfolio segment credit risk characteristics such as the impact of changing unemployment rates, changes in U.S. Treasury yields, portfolio concentrations, the volume of classified loans, and other prevailing economic conditions and factors that may affect the borrower’s ability to repay, or reduce the estimated value of any underlying collateral. This evaluation is inherently subjective, as it requires estimates that are susceptible to significant revision as more information becomes available.

We adopted ASU 2016-13 using the modified retrospective method. Results for reporting periods beginning after January 1, 2022 are presented under ASU 2016-13 while prior period amounts continue to be reported in accordance with previously applicable GAAP.

Upon the adoption of ASC 326, the Company recorded a $2.5 million increase to the ACL. At June 30, 2022, the ACL was $21.4 million increased $3.0 million or 16.2% when compared to $18.4 million at December 31, 2021. The increase is related to the impact of adoption and the current year-to-date provision.

ACL balances increased to 1.30% of portfolio loans at June 30, 2022 compared to 1.17% at December 31, 2021. At and for the six months ended June 30, 2022, the Company's ACL increased $3.0 million or 16.2% to $21.4 million at June 30, 2022 from $18.4 million at December 31, 2021. The increase in the general allowance was primarily related to the impact of adoption of ASC-326 and portfolio loan growth.

The Company recorded a $0.4 million and $0.9 million PCL for the three and six months ended June 30, 2022 compared to a $0.3 million and $0.6 million PLL for the three and six months ended June 30, 2021. There were $0.4 million in net charge-offs during the six months ended June 30, 2022 compared to $1.5 million in net charge-offs for the six months ended June 30, 2021. During the six months ended June 30, 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. During the six months ended June 30, 2022,

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the Bank sold non-accrual and classified commercial real estate and residential mortgage loans with an amortized cost of $3.4 million, net of charge-offs of $0.4 million, and recognized a gain on the sale of $209,000.

Management believes that the allowance is adequate at June 30, 2022. The ACL as a percent of total loans may increase or decrease in future periods based on economic conditions. Management’s determination of the adequacy of the allowance is based on a periodic evaluation of the portfolio. For additional information regarding the allowance for credit losses, refer to Notes 1 and 3 of the Consolidated Financial Statements and the Critical Accounting Policy section of the MD&A.

The following table allocates the ACL and ALLL by portfolio loan category at the dates indicated. The allocation of the allowance to each category is not necessarily indicative of future losses and does not restrict the use of the allowance to absorb losses in any category.

						June 30, 2022												December 31, 2021
(dollars in thousands)						Amount						%**						Amount						%**
Commercial real estate						$	16,833					71.33		%				$	13,095					72.28		%
Residential first mortgages						255						5.13		%				1,002						5.30		%
Residential rentals						1,660						12.72		%				2,175						11.73		%
Construction and land development						166						1.88		%				260						1.88		%
Home equity and second mortgages						143						1.53		%				274						1.62		%
Commercial loans						238						2.63		%				582						3.00		%
Consumer loans						132						0.27		%				58						0.22		%
Commercial equipment						1,977						4.51		%				971						3.97		%
Total allowance for credit losses						$	21,404					100.00		%				$	18,417					100.00		%

____________________________________

**Percent of loans in each category to total portfolio loans. December 31, 2021 reported percentages are shown net of deferred costs and fees to conform with the current period's presentation.

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The following table indicates net charge-offs by average portfolio loan category for the three and six months ended June 30, 2022 and June 30, 2021, and for the year ended December 31, 2021:

						Three Months Ended
						June 30, 2022																		June 30, 2021
(dollars in thousands)						Net (Charge-off) Recovery						Average Balance						%						Net (Charge-off) Recovery						Average Balance						%
Commercial real estate						$	(280)					$	1,181,885					(0.09)		%				$	—					$	1,089,781					—		%
Residential first mortgages						(111)						85,030						(0.52)						—						109,296						—
Residential rentals						—						194,972						—						—						139,080						—
Construction and land development						—						30,302						—						—						38,315						—
Home equity and second mortgages						1						26,101						0.02						2						29,061						0.03
Commercial loans						(49)						42,744						(0.46)						(21)						43,100						(0.19)
Consumer loans						(6)						4,040						(0.59)						—						1,425						—
Commercial equipment loans						42						68,349						0.25						(12)						61,017						(0.08)
						(403)						1,633,423						(0.10)						(31)						1,511,075						(0.01)
Allowance for credit losses						—						(21,375)						—						—						(18,265)						—
Total net charge-off and average portfolio loans						$	(403)					$	1,612,048					(0.10)		%				$	(31)					$	1,492,810					(0.01)		%

						Six Months Ended																																				Year Ended
						June 30, 2022																		June 30, 2021																		December 31, 2021
(dollars in thousands)						Net (Charge-off) Recovery						Average Balance						%						Net (Charge-off) Recovery						Average Balance						%						Net (Charge-off) Recovery						Average Balance						%
Commercial real estate						$	(280)					$	1,147,188					(0.05)		%				$	(1,246)					$	1,074,874					(0.23)		%				$	(1,914)					$	1,085,823					(0.18)		%
Residential first mortgages						(111)						85,912						(0.26)						(142)						117,097						(0.24)						(142)						107,011						(0.13)
Residential rentals						—						196,136						—						(46)						139,150						(0.07)						(46)						151,606						(0.03)
Construction and land development						—						31,977						—						—						37,209						—						—						36,891						—
Home equity and second mortgages						1						26,024						0.01						3						29,166						0.02						5						28,051						0.02
Commercial loans						(49)						44,696						(0.22)						(66)						43,915						(0.30)						467						46,390						1.01
Consumer loans						(6)						3,629						(0.33)						—						1,373						—						—						1,783						—
Commercial equipment loans						61						65,050						0.19						3						60,782						0.01						37						60,845						0.06
						(384)						1,600,612						(0.05)						(1,494)						1,503,566						(0.20)						(1,593)						1,518,400						(0.10)
Allowance for credit losses						—						(21,210)						—						—						(18,936)						—						—						(18,788)						—
Total net charge-off and average portfolio loans						$	(384)					$	1,579,402					(0.05)		%				$	(1,494)					$	1,484,630					(0.20)		%				$	(1,593)					$	1,499,612					(0.11)		%

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Off Balance Sheet Credit Exposure Reserve

The Company's reserve for off balance sheet credit exposures was $0.2 million and increased due to impact of the ASC 326 adoption. 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 increased $0.9 million from $5.2 million at December 31, 2021 to $6.1 million at June 30, 2022. Management considers classified assets to be an important measure of asset quality. The Company's risk rating process for classified loans are an important input into the Company's ACL qualitative framework. The following is a breakdown of the Company’s classified and special mention assets at June 30, 2022, and March 31, 2022, December 31, 2021, 2020, 2019, and 2018, respectively:

									As of
(dollars in thousands)												6/30/2022						3/31/2022						12/31/2021						12/31/2020						12/31/2019						12/31/2018
Classified loans
Substandard												$	6,062					$	4,745					$	5,211					$	19,249					$	26,863					$	32,226
Doubtful												—						—						—						—						—						—
Total classified loans												6,062						4,745						5,211						19,249						26,863						32,226
Special mention loans												160						—						—						7,672						—						—
Total classified and special mention loans												$	6,222					$	4,745					$	5,211					$	26,921					$	26,863					$	32,226
Classified loans												6,062						$	4,745					$	5,211					$	19,249					$	26,863					$	32,226
Classified securities												—						—						—						—						—						482
Other real estate owned												—						—						—						3,109						7,773						8,111
Total classified assets												$	6,062					$	4,745					$	5,211					$	22,358					$	34,636					$	40,819
Total classified assets as a percentage of total assets												0.26		%				0.20		%				0.22		%				1.10		%				1.93		%				2.42		%
Total classified assets as a percentage of Risk Based Capital												2.35		%				1.87		%				2.10		%				9.61		%				16.21		%				21.54		%

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Non-Performing Assets

(dollars in thousands)						June 30, 2022						December 31, 2021
Non-accrual loans:
Commercial real estate						$	4,702					$	4,890
Residential first mortgages						—						450
Residential rentals						981						942
Construction and land development						—						—
Home equity and second mortgages						267						601
Commercial loans						25						—
Consumer loans						—						—
Commercial equipment						260						691
U.S. SBA PPP loans						—						57
Total non-accrual loans (1)						6,235						7,631
OREO						—						—
TDRs: (1) (2)
Commercial real estate						—						—
Residential first mortgages						—						—
Residential rentals						—						—
Construction and land development						—						—
Home equity and second mortgages						—						—
Commercial loans						—						—
Consumer loans						—						—
Commercial equipment						438						447
U.S. SBA PPP loans						—						—
Total TDRs						438						447
Total Accrual TDRs						438						447
Total non-accrual loans, OREO and Accrual TDRs						$	6,673					$	8,078
Interest income due at stated rates, but not recognized on non-accruals						$	23					$	102

___________________________________________

(1) 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.

(2) TDR loans include both non-accrual and accruing performing loans. All TDR loans are included in the calculation of asset quality financial ratios. Non-accrual TDR loans are included in the non-accrual balance and accruing TDR loans are included in the accruing TDR balance.

Non-performing assets, which consist of OREO, non-accrual loans and TDRs, decreased $1.4 million from $8.1 million at December 31, 2021 to $6.7 million at June 30, 2022.

Non-accrual loans and OREO to total portfolio loans and OREO decreased 10 basis points from 0.48% at December 31, 2021 to 0.38% at June 30, 2022. Non-accrual loans, OREO and TDRs to total assets decreased six basis points from 0.35% at December 31, 2021 to 0.29% at June 30, 2022. 

All interest accrued but not collected from loans that are placed on non-accrual or charged-off is reversed against interest income. Interest income is recognized on a cash-basis or cost-recovery method, until qualifying for return to accrual status. Loans are reviewed on a regular basis and are placed on non-accrual status when, in the opinion of management, the collection of additional interest is doubtful. The accrual of interest on loans is discontinued at the time the loan is 90 days delinquent unless the credit is well secured and in the process of collection. Non-accrual loans include certain loans that are current with all loan payments and are placed on non-accrual status due to customer operating results and cash flows. Non-accrual loans are considered impaired and evaluated for impairment on a loan-by-loan basis.

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At June 30, 2022, there were $6.1 million (98.0%) of non-accrual loans current with all payments of principal and interest with specific reserves of $0.3 million. Delinquent non-accrual loans were $0.1 million (2.0%) of with no specific reserves at June 30, 2022. At December 31, 2021, there were $6.3 million (83.7%) of non-accrual loans current with all payments of principal and interest with no impairment and $1.2 million (16.3%) of delinquent non-accrual loans with a total of zero specifically reserved. There were no non-accrual TDRs at June 30, 2022. Non-accrual loans at December 31, 2021 included zero TDRs. These loans were classified solely as non-accrual for the calculation of financial ratios.

Other Real Estate Owned

There were no OREO balances at June 30, 2022 and at December 31, 2021. For additional information on OREO, refer to Note 5 of the Consolidated Financial Statements.

LIABILITIES

The following table shows the Company’s liabilities and the dollar and percentage changes for the periods presented.

(dollars in thousands)						June 30, 2022						December 31, 2021						$ Change						% Change
Deposits
Non-interest-bearing deposits						$	635,649					$	445,778					$	189,871					42.6		%
Interest-bearing deposits						1,449,727						1,610,386						(160,659)						(10.0)		%
Total deposits						2,085,376						2,056,164						29,212						1.4		%
Long-term debt						—						12,231						(12,231)						(100.0)		%
Guaranteed preferred beneficial interest in junior subordinated debentures ("TRUPs")						12,000						12,000						—						—		%
Subordinated notes net of debt issuance costs - 4.75%						19,538						19,510						28						—		%
Lease liabilities - operating leases						6,372						6,343						29						0.5		%
Accrued expenses and other liabilities						15,357						12,925						2,432						18.8		%
Total Liabilities						$	2,138,643					$	2,119,173					$	19,470					0.9		%

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 $2,060.4 million or 98.8% of funding at June 30, 2022 compared to $2,048.2 million or 99.0% of funding at December 31, 2021. Wholesale funding, which consists of FHLB advances and brokered deposits, was $25.0 million or 1.2% of funding at June 30, 2022 compared to $20.2 million or 1.0% of funding at December 31, 2021.

In addition to funding for operations, 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 June 30, 2022 and December 31, 2021.

The following is a breakdown of the Company’s deposit portfolio at June 30, 2022 and December 31, 2021:

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						June 30, 2022												December 31, 2021
(dollars in thousands)						Balance						%						Balance						%
Noninterest-bearing demand						$	635,649					30.48		%				$	445,778					21.68		%
Interest-bearing:
Demand						635,344						30.47		%				790,481						38.45		%
Money market deposits						380,712						18.26		%				372,717						18.13		%
Savings						119,363						5.72		%				119,767						5.82		%
Certificates of deposit						314,308						15.07		%				327,421						15.92		%
Total interest-bearing						1,449,727						69.52		%				1,610,386						78.32		%
Total Deposits						$	2,085,376					100.00		%				$	2,056,164					100.00		%
Transaction accounts						$	1,771,068					84.93		%				$	1,728,743					84.08		%

Total deposits increased $29.2 million or 1.42% (2.8% annualized) at June 30, 2022 compared to December 31, 2021. The increase reflects a $42.3 million increase to transaction deposits offsetting a $13.1 million decrease to time deposits. During the first six months of 2022, non-interest-bearing demand deposits increased $189.9 million to $635.6 million at June 30, 2022, representing 30.5% of deposits, compared to 21.7% of deposits at December 31, 2021. The Company's business development efforts continue to focus on increasing non-interest bearing and lower cost transaction accounts. The Bank's increased customer deposit balances provided additional on-balance sheet liquidity compared to the prior year.

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 June 30, 2022 were $71.7 million compared to $65.7 million at December 31, 2021. 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)						June 30, 2022						December 31, 2021						$ Change						% Change
Common Stock at par of $0.01						$	56					$	57					$	(1)					(1.75)		%
Additional paid in capital						97,455						96,896						559						0.58		%
Retained earnings						119,523						113,448						6,075						5.35		%
Accumulated other comprehensive loss						(31,847)						(1,952)						(29,895)						1,531.51		%
Unearned ESOP shares						(316)						(316)						—						—		%
Total Stockholders’ Equity						$	184,871					$	208,133					$	(23,262)					(11.18)		%

Total stockholders’ equity decreased $23.3 million during the six months ended June 30, 2022. Equity increased due to net income of $13.1 million and net stock related activities in connection with stock-based compensation and ESOP activity of $0.5 million. The decrease in equity was primarily due to an increase of $29.9 million in accumulated other comprehensive loss ("AOCL") in the Bank's AFS securities portfolio due to changes in market interest rates. In addition, equity decreased for common dividends paid of $1.9 million, stock repurchases of $3.0 million and $2.0 million for the adoption of the CECL accounting standard on January 1, 2022. On May 25, 2022, the Company announced a quarterly cash dividend of $0.175 per share of common stock. The dividend was paid on or about July 26, 2022 to stockholders of record as of the close of business on July 12, 2022.

The Company had a book value per common share of $32.72 and $36.40, at June 30, 2022 and December 31, 2021, respectively. Tangible book value at June 30, 2022 and December 31, 2021 was $30.66 and $34.32. The Company's common equity to assets ratio decreased to 7.96% at June 30, 2022 from 8.94% at December 31, 2021. The Company’s ratio of TCE to tangible assets decreased to 7.49% at June 30, 2022 from 8.48% at December 31, 2021 (see Non-GAAP reconciliation schedules). The decrease in the TCE ratio was due primarily to increased unrealized losses in the Bank's AFS investment portfolio.

In April 2020, banking regulators issued an interim final rule that excluded U.S. SBA PPP loans from the calculation of risk-based capital ratios by assigning a zero percent risk weight. The Company remains well capitalized at June 30, 2022 with a Tier 1 capital to average assets ("leverage ratio") of 9.42% at June 30, 2022 compared to 9.23% at December 31, 2021.

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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 June 30, 2022 and December 31, 2021, 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 June 30, 2022 and December 31, 2021, 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 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 June 30, 2022 and December 31, 2021, the Bank had $90.1 million and $64.4 million, respectively, in loan commitments outstanding. In addition, at June 30, 2022 and December 31, 2021, the Bank had $19.9 million and $22.0 million, respectively, in letters of credit and approximately $240.2 million and $241.7 million, respectively, available under lines of credit. Certificates of deposit due within one year of June 30, 2022 and December 31, 2021 totaled $254.1 million, or 80.85% and $256.9 million, or 78.45%, 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 has increased oversight and review of customer line of credit usage due to current inflationary pressures and the possibility of a recession. 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, our level of borrowed funds could increase.

At June 30, 2022, the Company had on-balance sheet liquidity of $88.1 million in cash and cash equivalents. At June 30, 2022, the Company had loans and securities pledged or in safekeeping at FHLB which provided for funding availability of $586.4 million at June 30, 2022.

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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. FHLB long-term debt may consist of adjustable-rate advances with rates based upon LIBOR, fixed-rate advances, and convertible advances. As of June 30, 2022, the Bank has no FHLB long-term debt outstanding. The Bank has also established unsecured and secured lines of credit with the Federal Reserve Bank and commercial banks.

The decrease in equity of $23.3 million during the six months ended June 30, 2022 was primarily due to an increase of $29.9 million in AOCL in the Bank's AFS securities portfolio due to changes in market interest rates. The Company intends and has the ability to hold AFS securities with unrealized losses until maturity or interest rates decrease. Management believe there is adequate available liquidity with available lines of credit and cash to fund operational needs.

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, 2021.

The Company’s net loan to deposit ratio increased from 77.2% at December 31, 2021 and to 78.5% at June 30, 2022. The Company intends to use available on-balance sheet liquidity to fund loans 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.

The Bank is subject to various regulatory restrictions on the payment of dividends.

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.

During the six months ended June 30, 2022, all financing activities provided $12.0 million in cash compared to $156.8 million in cash for the same period in 2021. Cash from financing activities decreased $144.8 million for the six months ended June 30, 2022 compared to the six months ended June 30, 2021 primarily due to decreased deposit growth of $133.3 million and increase in dividends paid and repurchases of common stock.

During the six months ended June 30, 2022 all investing activities used $83.0 million in cash compared to $114.1 million in cash used for the same period in 2021. The decrease in cash used was primarily the result of purchases of investment securities which decreased $84.5 million from $142.2 million for the six months ended June 30, 2021 to $57.7 million for the six months ended June 30, 2022. Cash used increased $42.3 million as cash used for loan activities for the six months ended June 30, 2022 increased over the prior year comparable period. In addition, cash used decreased $10.6 million as total proceeds from the sales and principal payments of available for sale securities for the six months ended June 30, 2022 decreased over the prior year comparable period.

Operating activities provided cash of $19.4 million, or $0.3 million more cash, for the six months ended June 30, 2022, compared to $19.1 million of cash provided for the same period of 2021.

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, 2021.

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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. Depending on the composition of the balance sheet, increasing or decreasing interest rates can negatively affect the Company’s results of operations and financial condition.

The Company measures interest rate risk over the short and long term. The Company measures interest rate risk as the change in net interest income (“NII”) caused by a change in interest rates over twelve and twenty-four months. The Company’s NII simulations provide information about short-term interest rate risk exposure. The Company also measures interest rate risk by measuring changes in the values of assets and liabilities due to changes in interest rates. The economic value of equity (“EVE”) is defined as the present value of future cash flows from existing assets, minus the present value of future cash flows from existing liabilities. EVE simulations reflect the interest rate sensitivity of assets and liabilities over a longer time period, considering the maturities, average life and duration of all balance sheet accounts.

The Board of Directors has approved the Company's interest rate risk policy and assigned oversight to the Board Risk Oversight Committee (“BROC”). The policy establishes limits on risk, which are quantitative measures of the percentage change in NII and EVE resulting from changes in interest rates. Both NII and EVE simulations assist in identifying, measuring, monitoring and controlling interest rate risk and along with mitigating strategies are used by management to maintain interest rate risk exposure within Board policy guidelines.

The Company’s interest rate risk (“IRR”) model uses assumptions which include factors such as call features, prepayment options and interest rate caps and floors included in investment and loan portfolio contracts. The IRR model estimates the lives and interest rate sensitivity of the Company’s non-maturity deposits. These assumptions have a significant effect on model results. The assumptions are developed primarily based upon historical behavior of Bank customers. The Company also considers industry and regional data in developing IRR model assumptions. There are inherent limitations in the Company’s IRR model and underlying assumptions. When interest rates change, actual movements of interest-earning assets and interest-bearing liabilities, loan prepayments, and withdrawals of time and other deposits, may deviate significantly from assumptions used in the model.

The Company prepares a current base case and several alternative simulations at least quarterly. Current interest rates are shocked by +/- 100, 200, 300, and 400 basis points (“bp”). In addition, the Company simulates additional rate curve scenarios (e.g., bear flattener). The Company may elect not to use particular scenarios that it determines are impractical in a current rate environment.

The Company’s internal limits for parallel shock scenarios are as follows:

Shock in Basis Points						Net Interest Income						Economic Value of Equity
+ - 400						25%						40%
+ - 300						20%						30%
+ - 200						15%						20%
+ - 100						10%						10%

It is management’s goal to manage the Bank’s portfolios so that net interest income at risk over twelve and twenty-four-month periods and the economic value of equity at risk do not exceed policy guidelines at the various interest rate shock levels. At June 30, 2022 and December 31, 2021, the Company did not exceed any Board approved sensitivity limits for percentage change in net interest income. In the second quarter of 2022 the percentage change in economic value of equity exceeded policy guidelines due to already low level of rates on non-maturing deposit instruments. Management has determined that due to the level of market rates at June 30, 2022, interest rate shocks of -100, -200, -300 and -400 basis points leave the Bank with near zero down to negative rate instruments and are not considered practical or informative. Measures of net interest income at risk produced by simulation analysis are indicators of an institution’s short-term performance in alternative rate environments. The below schedule estimates the changes in net interest income over a twelve-month period for parallel rate shocks for up 200, 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)		%
June 30, 2022						1.60		%				1.55		%				(6.23)		%
March 31, 2022						(1.83)		%				(0.84)		%				(5.95)		%
December 31, 2021						(1.54)		%				(0.74)		%				(1.13)		%

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Measures of equity value at risk indicate the ongoing economic value of the Company by considering the effects of changes in interest rates on all of the Company’s cash flows, and by discounting the cash flows to estimate the present value of assets and liabilities. The below schedule estimates the 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)		%
June 30, 2022						10.34		%				6.82		%				(11.88)		%
March 31, 2022						13.66		%				9.28		%				(16.40)		%
December 31, 2021						24.45		%				15.16		%				(25.07)		%

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.

Changes in Internal Control over Financial Reporting

Effective January 1, 2022, the Company adopted FASB ASU 2016-13. The Company designed new controls and modified existing controls as part of the adoption. Management revised previous internal controls used under legacy GAAP and incorporated new internal controls related to the methodology of the new allowance for credit losses. There were no other changes in the Company's internal control over financial reporting that occurred during the period covered by this report that have materially affected, or are reasonably 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, 2021 that the Company filed with the SEC on March 3, 2022. 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 3, 2022.

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. On July 15, 2021, the Company announced that it had completed the repurchase of the $7.0 million of shares of the Company’s common stock that it was originally authorized to repurchase under the 2020 repurchase plan. On December 9, 2021, the Company announced that its Board of Directors authorized the Company to continue repurchasing shares of the Company’s common stock under the October 2020 repurchase plan using up to $4.0 million in the aggregate and up to $1.5 million in the aggregate on a quarterly basis. As of June 30, 2022, 13,647 shares were available to be repurchased under the 2020 repurchase plan. The following schedule shows the repurchases during the three months ended June 30, 2022.

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
April 1-30, 2022						38,017						$	39.43					38,017						13,647
May 1-31, 2022						—						$	—					—						13,647
June 1-30, 2022						—						$	—					—						13,647
Total						38,017						$	39.43					38,017						13,647

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

Number						Description
16.1						Letter of FORVIS, LLP dated June 6, 2022 to the SEC (Incorporated by reference to Exhibit 16.1 to the Form 8-K filed on June 6, 2022).
31						Rule 13a‑14(a) Certifications
32						Section 1350 Certifications
101						The following materials from the Company’s Quarterly Report on Form 10-Q for the quarter ended June 30, 2022, 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/Loss, (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.
104						Cover Page Interactive Data File (formatted as Inline XBRL and contained in Exhibit 101)

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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: August 3, 2022			By:			/s/ William J. Pasenelli
						William J. Pasenelli
						Chief Executive Officer

Date: August 3, 2022			By:			/s/ Todd L. Capitani
						Todd L. Capitani
						Chief Financial Officer

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