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UNITED STATES

SECURITIES AND EXCHANGE COMMISSION

WASHINGTON, D.C. 20549

FORM 10-Q


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

For the quarterly period ended June 30, ~~2019~~2020


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

For the transition period from to

Commission file number: 001-34292

ORRSTOWN FINANCIAL SERVICES, INC.

(Exact Name of Registrant as Specified in its Charter)

Pennsylvania

23-2530374

(State or Other Jurisdiction of Incorporation or Organization)

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

77 East King Street

P. O. Box 250

Shippensburg

Pennsylvania

17257

(Address of Principal Executive Offices)

(Zip Code)

Registrant’s Telephone Number, Including Area Code:

(717)

532-6114

Securities registered pursuant to Section 12(b) of the Act:

Title of each class

Trading symbol(s)

Name of each exchange on which registered

Common Stock, no par value

ORRF

Nasdaq Stock Market

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

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

Indicate by check mark whether the registrant is a large accelerated filer, an accelerated filer, a non-accelerated filer, a smaller reporting company, or an emerging growth company. See the definitions of “large accelerated filer,” “accelerated filer,” “smaller reporting company,” and "emerging growth company" in Rule 12b-2 of the Exchange Act.

Large accelerated filer

Accelerated filer

☒

Non-accelerated filer

Smaller reporting company

☒

Emerging growth company

☐

If an emerging growth company, indicate by check mark if the registrant has elected not to use the extended transition period for complying with any new or revised financial accounting standards provided pursuant to Section 13(a) of the Exchange Act.

Indicate by check mark whether the registrant is a shell company (as defined in Rule 12b-2 of the Act.). Yes ☐ No x

~~Securities registered pursuant to Section 12(b) of the Act:~~

~~Title of each class~~

~~Trading symbol(s)~~

~~Name of each exchange on which registered~~

~~Common Stock, no par value~~

~~ORRF~~

~~Nasdaq Capital Market~~

Number of shares outstanding of the registrant’s Common Stock as of July 30, ~~2019: 11,221,354.~~2020: 11,209,146.

Table of Contents

ORRSTOWN FINANCIAL SERVICES, INC.

INDEX


		Page
Part I – FINANCIAL INFORMATION

	Glossary	3

Item 1.	Financial Statements	4

	Consolidated Balance Sheets (Unaudited)	4

	Consolidated Statements of Income (Unaudited)	5

	Consolidated Statements of Comprehensive Income (Unaudited)	6

	Consolidated Statements of Changes in Shareholders’ Equity (Unaudited)	7

	Consolidated Statements of Cash Flows (Unaudited)	9

	Notes to Consolidated Financial Statements (Unaudited)	11

Item 2	Management’s Discussion and Analysis of Financial Condition and Results of Operations	4651

Item 3.	Quantitative and Qualitative Disclosures About Market Risk	6475

Item 4.	Controls and Procedures	6576

PART II – OTHER INFORMATION

Item 1.	Legal Proceedings	6677

Item 1A.	Risk Factors	6677

Item 2.	Unregistered Sales of Equity Securities and Use of Proceeds	6677

Item 3.	Defaults upon Senior Securities	6677

Item 4.	Mine Safety Disclosures	6677

Item 5.	Other Information	6677

Item 6.	Exhibits	6778

SIGNATURES			6879

Table of Contents

Glossary of Defined Terms

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


Term			Definition

ALL			Allowance for loan losses
AFS			Available for sale
AOCI			Accumulated other comprehensive income (loss)
ASC			Accounting Standards Codification
ASU			Accounting Standards Update
Bank			Orrstown Bank, the commercial banking subsidiary of Orrstown Financial Services, Inc.
CDI			Core deposit intangible
CET1			Common Equity Tier 1
CMO			Collateralized mortgage obligation
Company			Orrstown Financial Services, Inc. and subsidiaries (interchangeable with "Orrstown” below)

EPS			Earnings per common share
ERM			Enterprise risk management
Exchange Act			Securities Exchange Act of 1934, as amended
FASB			Financial Accounting Standards Board
FDIC			Federal Deposit Insurance Corporation
FHLB			Federal Home Loan Bank
FRB			Board of Governors of the Federal Reserve System
GAAP			Accounting principles generally accepted in the United States of America
GSE			U.S. government-sponsored enterprise
Hamilton			Hamilton Bancorp, Inc., and its wholly-owned banking subsidiary, Hamilton Bank
IRC			Internal Revenue Code of 1986, as amended
LHFS			Loans held for sale
MBS			Mortgage-backed securities
~~Mercersburg~~			~~Mercersburg Financial Corporation and its wholly-owned banking subsidiary, First Community Bank of Mercersburg (acquired October 1, 2018)~~
MPF Program			Mortgage Partnership Finance Program
MSR			Mortgage servicing right
NIM			Net interest margin
OCI			Other comprehensive income ~~(loss)~~

OREO			Other real estate owned ~~(foreclosed real estate)~~
Orrstown			Orrstown Financial Services, Inc. and subsidiaries
OTTI			Other-than-temporary impairment
~~Parent Company~~			~~Orrstown Financial Services, Inc., the parent company of Orrstown Bank and Wheatland Advisors, Inc.~~
2011 Plan			2011 Orrstown Financial Services, Inc. Incentive Stock Plan
PCI loans			Purchased credit impaired loans

Repurchase Agreements			Securities sold under agreements to repurchase
ROU			Right of use (leases)
SBA			U.S. Small Business Administration
SEC			Securities and Exchange Commission
Securities Act			Securities Act of 1933, as amended
TDR			Troubled debt restructuring
Wheatland			Wheatland Advisors, Inc., the Registered Investment Advisor subsidiary of Orrstown Financial Services, Inc.
Unless the context otherwise requires, the terms “Orrstown,” “we,” “us,” “our,” and “Company” refer to Orrstown Financial Services, Inc. and its subsidiaries.

Table of Contents

PART I – FINANCIAL INFORMATION

Item 1. Financial Statements

Condensed Consolidated Balance Sheets (Unaudited)

ORRSTOWN FINANCIAL SERVICES, INC.


(Dollars in thousands, except per share information)		June 30, 2019		December 31, 2018
(Dollars in thousands, except per share amounts)						(Dollars in thousands, except per share amounts)	June 30, 2020		December 31, 2019
Assets	Assets					Assets
Cash and due from banks	Cash and due from banks	$	35,468	$	26,156	Cash and due from banks	$	26,652	$	25,969
Interest-bearing deposits with banks	Interest-bearing deposits with banks	72,670		45,664		Interest-bearing deposits with banks	25,638		29,994
Federal funds sold		8,741		16,995

Cash and cash equivalents	Cash and cash equivalents	116,879		88,815		Cash and cash equivalents	52,290		55,963
Restricted investments in bank stocks	Restricted investments in bank stocks	10,105		10,842		Restricted investments in bank stocks	16,256		16,184
Securities available for sale		496,930		465,844
Loans held for sale		7,152		3,340
Securities available for sale (amortized cost of $488,433 and $491,492 at June 30, 2020 and December 31, 2019, respectively)						Securities available for sale (amortized cost of $488,433 and $491,492 at June 30, 2020 and December 31, 2019, respectively)	483,936		490,885
Loans held for sale, at fair value						Loans held for sale, at fair value	13,594		9,364

Loans	Loans	1,601,670		1,247,657		Loans	2,041,317		1,644,330
Less: Allowance for loan losses	Less: Allowance for loan losses	(14,460)		(14,014)		Less: Allowance for loan losses	(17,517)		(14,655)
Net loans	Net loans	1,587,210		1,233,643		Net loans	2,023,800		1,629,675
Premises and equipment, net	Premises and equipment, net	41,508		38,201		Premises and equipment, net	36,976		37,524
Cash surrender value of life insurance	Cash surrender value of life insurance	59,551		41,327		Cash surrender value of life insurance	64,411		63,613
Goodwill	Goodwill	19,621		12,592		Goodwill	18,724		19,925
Other intangible assets, net	Other intangible assets, net	8,140		3,910		Other intangible assets, net	6,160		7,180
Accrued interest receivable	Accrued interest receivable	6,558		5,927		Accrued interest receivable	8,182		6,040
Other assets	Other assets	45,854		29,947		Other assets	48,467		46,921
Total assets	Total assets	$	2,399,508	$	1,934,388	Total assets	$	2,772,796	$	2,383,274
Liabilities	Liabilities					Liabilities
Deposits:	Deposits:					Deposits:
Noninterest-bearing	Noninterest-bearing	$	247,205	$	204,843	Noninterest-bearing	$	436,290	$	249,450
Interest-bearing	Interest-bearing	1,768,336		1,353,913		Interest-bearing	1,815,441		1,626,072
Total deposits	Total deposits	2,015,541		1,558,756		Total deposits	2,251,731		1,875,522
Short-term borrowings		9,373		64,069
Long-term debt		83,261		83,450
Securities sold under agreements to repurchase						Securities sold under agreements to repurchase	23,716		8,269
FHLB advances and other						FHLB advances and other	202,804		209,667
Subordinated notes	Subordinated notes	31,821		31,859		Subordinated notes	31,875		31,847
Accrued interest and other liabilities		39,644		22,821
Other liabilities						Other liabilities	37,032		34,720
Total liabilities	Total liabilities	2,179,640		1,760,955		Total liabilities	2,547,158		2,160,025

Commitments and contingencies						Commitments and contingencies

Shareholders’ Equity	Shareholders’ Equity					Shareholders’ Equity
Preferred stock, $1.25 par value per share; 500,000 shares authorized; no shares issued or outstanding		0		0
Common stock, no par value—$0.05205 stated value per share 50,000,000 shares authorized; 11,223,993 and 9,439,255 shares issued; 11,223,993 and 9,430,224 shares outstanding		584		491
Preferred stock, $1.25 par value per share; 500,000 shares authorized; 0 shares issued or outstanding						Preferred stock, $1.25 par value per share; 500,000 shares authorized; 0 shares issued or outstanding	—		—
Common stock, no par value—$0.05205 stated value per share 50,000,000 shares authorized; 11,268,429 shares issued and 11,209,146 outstanding at June 30, 2020; 11,220,604 shares issued and 11,199,874 outstanding at December 31, 2019						Common stock, no par value—$0.05205 stated value per share 50,000,000 shares authorized; 11,268,429 shares issued and 11,209,146 outstanding at June 30, 2020; 11,220,604 shares issued and 11,199,874 outstanding at December 31, 2019	586		584
Additional paid - in capital	Additional paid - in capital	188,414		151,678		Additional paid - in capital	188,226		188,365
Retained earnings	Retained earnings	27,462		24,472		Retained earnings	42,862		35,246
Accumulated other comprehensive income (loss)		3,408		(2,972)
Treasury stock—common, 0 and 9,031 shares, at cost		0		(236)
Accumulated other comprehensive loss						Accumulated other comprehensive loss	(5,114)		(480)
Treasury stock— 59,283 and 20,730 shares, at cost at June 30, 2020 and December 31, 2019, respectively						Treasury stock— 59,283 and 20,730 shares, at cost at June 30, 2020 and December 31, 2019, respectively	(922)		(466)
Total shareholders’ equity	Total shareholders’ equity	219,868		173,433		Total shareholders’ equity	225,638		223,249
Total liabilities and shareholders’ equity	Total liabilities and shareholders’ equity	$	2,399,508	$	1,934,388	Total liabilities and shareholders’ equity	$	2,772,796	$	2,383,274

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

Table of Contents

Condensed Consolidated Statements of Income (Unaudited)

ORRSTOWN FINANCIAL SERVICES, INC.


		Three Months Ended						Six Months Ended							Three Months Ended				Six Months Ended
(Dollars in thousands, except per share information)		June 30, 2019		June 30, 2018		June 30, 2019		June 30, 2018
(Dollars in thousands, except per share amounts)										(Dollars in thousands, except per share amounts)	June 30, 2020		June 30, 2019		June 30, 2020		June 30, 2019
Interest income	Interest income									Interest income
Loans	Loans	$	19,553	$	11,731	$	34,612	$	22,787	Loans	$	21,794	$	19,658	$	41,960	$	34,809
Investment securities - taxable	Investment securities - taxable	3,679		2,539		7,171		4,832		Investment securities - taxable	2,795		3,681		6,233		7,173
Investment securities - tax-exempt	Investment securities - tax-exempt	632		1,008		1,474		1,879		Investment securities - tax-exempt	420		632		704		1,474
Short-term investments	Short-term investments	503		46		676		101		Short-term investments	13		501		92		674
Total interest income	Total interest income	24,367		15,324		43,933		29,599		Total interest income	25,022		24,472		48,989		44,130
Interest expense	Interest expense									Interest expense
Deposits	Deposits	4,870		2,161		8,564		3,985		Deposits	3,310		4,892		7,664		8,607
Short-term borrowings		34		402		277		765
Long-term debt		532		408		975		812
Securities sold under agreements to repurchase										Securities sold under agreements to repurchase	152		28		184		55
FHLB advances and other										FHLB advances and other	260		538		1,078		1,197
Subordinated notes	Subordinated notes	499		0		996		0		Subordinated notes	502		499		1,003		996
Total interest expense	Total interest expense	5,935		2,971		10,812		5,562		Total interest expense	4,224		5,957		9,929		10,855
Net interest income	Net interest income	18,432		12,353		33,121		24,037		Net interest income	20,798		18,515		39,060		33,275
Provision for loan losses	Provision for loan losses	200		200		600		400		Provision for loan losses	1,900		200		2,825		600
Net interest income after provision for loan losses	Net interest income after provision for loan losses	18,232		12,153		32,521		23,637		Net interest income after provision for loan losses	18,898		18,315		36,235		32,675
Noninterest income	Noninterest income									Noninterest income
Service charges on deposit accounts	Service charges on deposit accounts	1,680		1,463		3,169		2,881		Service charges on deposit accounts	554		837		1,401		1,590
Interchange income										Interchange income	819		843		1,607		1,579
Other service charges, commissions and fees	Other service charges, commissions and fees	346		689		587		938		Other service charges, commissions and fees	165		241		305		390
Swap fees										Swap fees	232		—		432		—
Trust and investment management income	Trust and investment management income	1,749		1,701		3,507		3,369		Trust and investment management income	1,696		1,749		3,336		3,507
Brokerage income	Brokerage income	672		501		1,150		1,059		Brokerage income	599		672		1,318		1,150
Mortgage banking activities	Mortgage banking activities	652		679		1,120		1,314		Mortgage banking activities	1,609		652		1,941		1,120
Gain on sale of portfolio loans										Gain on sale of portfolio loans	925		—		2,803		—
Income from life insurance	Income from life insurance	684		291		1,026		568		Income from life insurance	532		684		1,072		1,026
Investment securities gains (losses)										Investment securities gains (losses)	9		2,064		(31)		2,403
Other income	Other income	32		135		144		216		Other income	53		32		83		144
Investment securities gains		2,064		46		2,403		862
Total noninterest income	Total noninterest income	7,879		5,505		13,106		11,207		Total noninterest income	7,193		7,774		14,267		12,909
Noninterest expenses	Noninterest expenses									Noninterest expenses
Salaries and employee benefits	Salaries and employee benefits	8,922		7,855		17,599		15,877		Salaries and employee benefits	10,063		8,922		21,657		17,599
Occupancy	Occupancy	1,066		679		2,067		1,477		Occupancy	1,122		1,066		2,249		2,067
Furniture and equipment	Furniture and equipment	1,140		1,068		2,163		1,987		Furniture and equipment	1,204		1,140		2,366		2,163
Data processing	Data processing	1,058		595		1,828		1,214		Data processing	791		1,058		1,662		1,828
Telephone and communication		202		165		414		361

Automated teller and interchange fees	Automated teller and interchange fees	238		190		474		361		Automated teller and interchange fees	249		238		500		474
Advertising and bank promotions	Advertising and bank promotions	548		237		1,069		619		Advertising and bank promotions	167		548		956		1,069
FDIC insurance	FDIC insurance	221		172		406		338		FDIC insurance	214		221		261		406
Legal fees		120		83		173		149

Other professional services	Other professional services	587		476		1,091		779		Other professional services	1,021		707		1,737		1,264
Directors' compensation	Directors' compensation	261		205		497		456		Directors' compensation	264		261		465		497

Real estate owned		12		53		14		78

Taxes other than income	Taxes other than income	314		251		620		502		Taxes other than income	449		314		451		620
Intangible asset amortization	Intangible asset amortization	402		24		610		48		Intangible asset amortization	404		402		867		610

Merger related		6,860		154		7,505		154
Insurance claim receivable write off		0		0		615		0
Merger related and branch consolidation expenses										Merger related and branch consolidation expenses	—		6,860		—		7,505
Insurance claim receivable (recovery) write-off										Insurance claim receivable (recovery) write-off	—		—		(486)		615
Other operating expenses	Other operating expenses	1,363		1,065		2,351		1,941		Other operating expenses	2,483		1,555		4,050		2,736
Total noninterest expenses	Total noninterest expenses	23,314		13,272		39,496		26,341		Total noninterest expenses	18,431		23,292		36,735		39,453
Income before income tax expense	Income before income tax expense	2,797		4,386		6,131		8,503		Income before income tax expense	7,660		2,797		13,767		6,131
Income tax expense	Income tax expense	110		374		342		866		Income tax expense	1,301		110		2,340		342
Net income	Net income	$	2,687	$	4,012	$	5,789	$	7,637	Net income	$	6,359	$	2,687	$	11,427	$	5,789
Per share information:	Per share information:									Per share information:
Basic earnings per share	Basic earnings per share	$	0.26	$	0.50	$	0.59	$	0.94	Basic earnings per share	$	0.58	$	0.26	$	1.04	$	0.59
Diluted earnings per share	Diluted earnings per share	0.26		0.48		0.58		0.92		Diluted earnings per share	0.58		0.26		1.04		0.58

Dividends paid per share										Dividends paid per share	0.17		0.15		0.34		0.30

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

Table of Contents

Condensed Consolidated Statements of Comprehensive Income (Unaudited)

ORRSTOWN FINANCIAL SERVICES, INC.


		Three Months Ended						Six Months Ended							Three Months Ended				Six Months Ended
(Dollars in thousands)	(Dollars in thousands)	June 30, 2019		June 30, 2018		June 30, 2019		June 30, 2018		(Dollars in thousands)	June 30, 2020		June 30, 2019		June 30, 2020		June 30, 2019
Net income	Net income	$	2,687	$	4,012	$	5,789	$	7,637	Net income	$	6,359	$	2,687	$	11,427	$	5,789
Other comprehensive income (loss), net of tax:
Unrealized gains (losses) on securities available for sale arising during the period		5,353		(530)		10,480		(6,149)
Reclassification adjustment for gains realized in net income		(2,064)		(46)		(2,403)		(862)
Net unrealized gains (losses)		3,289		(576)		8,077		(7,011)
Other comprehensive income, net of tax:										Other comprehensive income, net of tax:
Unrealized (losses) gains on securities available for sale arising during the period										Unrealized (losses) gains on securities available for sale arising during the period	13,367		5,353		(3,921)		10,480
Reclassification adjustment for (gains) losses realized in net income										Reclassification adjustment for (gains) losses realized in net income	(9)		(2,064)		31		(2,403)
Net unrealized gains (losses) on securities available for sale										Net unrealized gains (losses) on securities available for sale	13,358		3,289		(3,890)		8,077
Tax effect	Tax effect	(691)		121		(1,697)		1,473		Tax effect	(2,805)		(691)		817		(1,697)
Total other comprehensive income (loss), net of tax and reclassification adjustments on securities available for sale										Total other comprehensive income (loss), net of tax and reclassification adjustments on securities available for sale	10,553		2,598		(3,073)		6,380
Unrealized loss on interest rate swaps used in cash flow hedges										Unrealized loss on interest rate swaps used in cash flow hedges	(842)		—		(2,101)		—
Reclassification adjustment for losses realized in net income										Reclassification adjustment for losses realized in net income	121		—		125		—
Net unrealized loss on interest rate swaps used in cash flow hedges										Net unrealized loss on interest rate swaps used in cash flow hedges	(721)		—		(1,976)		—
Tax effect										Tax effect	151		—		415		—
Total other comprehensive loss, net of tax and reclassification adjustments on interest rate swaps										Total other comprehensive loss, net of tax and reclassification adjustments on interest rate swaps	(570)		—		(1,561)		—
Total other comprehensive income (loss), net of tax and reclassification adjustments	Total other comprehensive income (loss), net of tax and reclassification adjustments	2,598		(455)		6,380		(5,538)		Total other comprehensive income (loss), net of tax and reclassification adjustments	9,983		2,598		(4,634)		6,380
Total comprehensive income	Total comprehensive income	$	5,285	$	3,557	$	12,169	$	2,099	Total comprehensive income	$	16,342	$	5,285	$	6,793	$	12,169

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

Table of Contents

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

ORRSTOWN FINANCIAL SERVICES, INC.


	Three Months Ended June 30, 2020
(Dollars in thousands, except per share amounts)	Common Stock		Additional Paid-In Capital		Retained Earnings		Accumulated Other Comprehensive Income (Loss)		Treasury Stock		Total Shareholders’ Equity









Balance, March 31, 2020	$	586	$	187,843	$	38,408	$	(15,097)	$	(1,170)	$	210,570
Net income	—		—		6,359		—		—		6,359

Total other comprehensive income, net of taxes	—		—		—		9,983		—		9,983
Cash dividends ($0.17 per share)	—		—		(1,905)		—		—		(1,905)

Share-based compensation plans:
250 net common shares forfeited and 12,672 net treasury shares issued, including compensation expense totaling $651	—		383		—		—		248		631

Balance, June 30, 2020	$	586	$	188,226	$	42,862	$	(5,114)	$	(922)	$	225,638




















	Six Months Ended June 30, 2020
(Dollars in thousands, except per share amounts)	Common Stock		Additional Paid-In Capital		Retained Earnings		Accumulated Other Comprehensive Loss		Treasury Stock		Total Shareholders’ Equity
Balance, January 1, 2020	$	584	$	188,365	$	35,246	$	(480)	$	(466)	$	223,249
Net income	—		—		11,427		—		—		11,427

Total other comprehensive loss, net of taxes	—		—		—		(4,634)		—		(4,634)
Cash dividends ($0.34 per share)	—		—		(3,811)		—		—		(3,811)

Share-based compensation plans:
47,825 net common shares issued and 38,553 net treasury shares acquired, including compensation expense totaling $1,176	2		(139)		—		—		(456)		(593)

Balance, June 30, 2020	$	586	$	188,226	$	42,862	$	(5,114)	$	(922)	$	225,638

Three Months Ended June 30, 2018
(Dollars in thousands, except per share information) Common
Stock Additional
Paid-In
Capital Retained
Earnings Accumulated
Other
Comprehensive
Income (Loss) Treasury
Stock Total
Shareholders’
Equity
Balance, March 31, 2018 438 125,988 18,667 (2,238) (299) 142,556
Net income 0 0 4,012 0 0 4,012
Total other comprehensive loss, net of taxes 0 0 0 (455) 0 (455)
Cash dividends ($0.13 per share) 0 0 (1,095) 0 0 (1,095)
Share-based compensation plans:
300 net common shares forfeited and 11,317 net treasury shares acquired, including compensation expense of $444 0 414 0 0 (295) 119
Balance, June 30, 2018 438 126,402 21,584 (2,693) (594) 145,137
Six Months Ended June 30, 2018
(Dollars in thousands, except per share information) Common
Stock Additional
Paid-In
Capital Retained
Earnings Accumulated
Other
Comprehensive
Income (Loss) Treasury
Stock Total
Shareholders’
Equity
Balance, January 1, 2018 $ 435 $ 125,458 $ 16,042 $ 2,845 $ (15) $ 144,765
Net income 0 0 7,637 0 0 7,637
Total other comprehensive loss, net of taxes 0 0 0 (5,538) 0 (5,538)
Cash dividends ($0.25 per share) 0 0 (2,095) 0 0 (2,095)
Share-based compensation plans:
75,623 net common shares issued and 21,965 net treasury shares acquired, including compensation expense of $924 3 944 0 0 (579) 368
Balance, June 30, 2018 $ 438 $ 126,402 $ 21,584 $ (2,693) $ (594) $ 145,137

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															Three Months Ended June 30, 2019
(Dollars in thousands, except per share amounts)														(Dollars in thousands, except per share amounts)	Common Stock		Additional Paid-In Capital		Retained Earnings		Accumulated Other Comprehensive Income		Treasury Stock		Total Shareholders’ Equity

		Three Months Ended June 30, 2019
(Dollars in thousands, except per share information)		Common Stock		Additional Paid-In Capital		Retained Earnings		Accumulated Other Comprehensive Income (Loss)		Treasury Stock		Total Shareholders’ Equity

Balance, March 31, 2019	Balance, March 31, 2019	494		151,702		26,161		810		0		179,167		Balance, March 31, 2019	$	494	$	151,702	$	26,161	$	810	$	—	$	179,167
Net income	Net income	0		0		2,687		0		0		2,687		Net income	—		—		2,687		—		—		2,687

Total other comprehensive loss, net of taxes	Total other comprehensive loss, net of taxes	0		0		0		2,598		0		2,598		Total other comprehensive loss, net of taxes	—		—		—		2,598		—		2,598
Cash dividends ($0.15 per share)	Cash dividends ($0.15 per share)	0		0		(1,386)		0		0		(1,386)		Cash dividends ($0.15 per share)	—		—		(1,386)		—		—		(1,386)
Issuance of stock (1,765,704 common shares) to acquire Hamilton Bancorp, Inc.	Issuance of stock (1,765,704 common shares) to acquire Hamilton Bancorp, Inc.	92		36,530		0		0		0		36,622		Issuance of stock (1,765,704 common shares) to acquire Hamilton Bancorp, Inc.	92		36,530		—		—		—		36,622
Share-based compensation plans:	Share-based compensation plans:													Share-based compensation plans:
26,480 net common shares forfeited, including compensation expense of $180	26,480 net common shares forfeited, including compensation expense of $180	(2)		182		0		0		0		180		26,480 net common shares forfeited, including compensation expense of $180	(2)		182		—		—		—		180

Balance, June 30, 2019	Balance, June 30, 2019	584		188,414		27,462		3,408		0		219,868		Balance, June 30, 2019	$	584	$	188,414	$	27,462	$	3,408	$	—	$	219,868

		Six Months Ended June 30, 2019																							Six Months Ended June 30, 2019
(Dollars in thousands, except per share information)		Common Stock		Additional Paid-In Capital		Retained Earnings		Accumulated Other Comprehensive Income (Loss)		Treasury Stock		Total Shareholders’ Equity
(Dollars in thousands, except per share amounts)														(Dollars in thousands, except per share amounts)	Common Stock		Additional Paid-In Capital		Retained Earnings		Accumulated Other Comprehensive Income		Treasury Stock		Total Shareholders’ Equity
Balance, January 1, 2019	Balance, January 1, 2019	$	491	$	151,678	$	24,472	$	(2,972)	$	(236)	$	173,433	Balance, January 1, 2019	$	491	$	151,678	$	24,472	$	(2,972)	$	(236)	$	173,433
Net income	Net income	0		0		5,789		0		0		5,789		Net income	—		—		5,789		—		—		5,789

Total other comprehensive loss, net of taxes		0		0		0		6,380		0		6,380
Total other comprehensive income, net of taxes														Total other comprehensive income, net of taxes	—		—		—		6,380		—		6,380
Cash dividends ($0.30 per share)	Cash dividends ($0.30 per share)	0		0		(2,799)		0		0		(2,799)		Cash dividends ($0.30 per share)	—		—		(2,799)		—		—		(2,799)
Issuance of stock (1,765,704 common shares) to acquire Hamilton Bancorp, Inc.	Issuance of stock (1,765,704 common shares) to acquire Hamilton Bancorp, Inc.	92		36,530		0		0		0		36,622		Issuance of stock (1,765,704 common shares) to acquire Hamilton Bancorp, Inc.	92		36,530		—		—		—		36,622
Share-based compensation plans:	Share-based compensation plans:													Share-based compensation plans:
19,034 net common shares issued and 9,031 net treasury shares issued, including compensation expense of $679		1		206		0		0		236		443
19,034 net common shares issued and 9,031 net treasury shares acquired, including compensation expense totaling $679														19,034 net common shares issued and 9,031 net treasury shares acquired, including compensation expense totaling $679	1		206		—		—		236		443

Balance, June 30, 2019	Balance, June 30, 2019	$	584	$	188,414	$	27,462	$	3,408	$	0	$	219,868	Balance, June 30, 2019	$	584	$	188,414	$	27,462	$	3,408	$	—	$	219,868

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

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~~Consolidated Statements of Cash Flows (Unaudited)~~

~~ORRSTOWN FINANCIAL SERVICES, INC.~~

Six Months Ended
(Dollars in thousands) June 30,
2019 June 30,
2018
Cash flows from operating activities
Net income $ 5,789 $ 7,637
Adjustments to reconcile net income to net cash provided by operating activities:
Net premium amortization 2,203 947
Depreciation and amortization (including amortization of ROU assets) 2,366 1,721
Provision for loan losses 600 400
Share-based compensation 679 924
Gain on sales of loans originated for sale (909) (1,066)
Mortgage loans originated for sale (43,471) (45,050)
Proceeds from sales of loans originated for sale 40,392 46,485
Net gain on disposal of OREO (8) (106)
Writedown of OREO 0 13
Net (gain) loss on disposal of premises and equipment 607 (6)
Deferred income taxes 263 518
Investment securities gains (2,403) (862)
Income from life insurance (1,026) (568)
(Increase) decrease in accrued interest receivable 730 (520)
Increase in accrued interest payable and other liabilities (1,147) 5,218
Other, net 1,100 (1,739)
Net cash provided by operating activities 5,765 13,946
Cash flows from investing activities
Proceeds from sales of AFS securities 174,335 88,110
Maturities, repayments and calls of AFS securities 15,297 7,059
Purchases of AFS securities (150,386) (132,373)
Net cash and cash equivalents received from acquisitions 29,442 0
Net (purchases) redemptions of restricted investments in bank stocks 3,395 (2,700)
Net increase in loans (8,395) (54,132)
Purchases of bank premises and equipment (1,489) (1,053)
Proceeds from disposal of OREO 374 1,028
Proceeds from disposal of bank premises and equipment 0 7
Purchases of bank owned life insurance 0 (900)
Proceeds from settlement of life insurance contracts 571 0
Net cash used in investing activities 63,144 (94,954)
Cash flows from financing activities
Net increase in deposits 68,525 106,351
Net increase (decrease) in borrowings with original maturities less than 90 days (29,696) 10,263
Payments on other short-term borrowings (25,000) (40,000)
Proceeds from long-term debt 20,000 0
Payments on long-term debt (71,582) (180)
Subordinated note issuance costs (57) 0
Dividends paid (2,799) (2,095)
Treasury shares repurchased for employee taxes associated with restricted stock vesting (294) (651)
Proceeds from issuance of stock for option exercises and employee stock purchase plan 58 95
Net cash provided by financing activities (40,845) 73,783
Net increase (decrease) in cash and cash equivalents 28,064 (7,225)
Cash and cash equivalents at beginning of period 88,815 29,807
Cash and cash equivalents at end of period $ 116,879 $ 22,582

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Supplemental disclosures of cash flow information:
Cash paid during the period for:
Interest $ 10,326 $ 5,562
Income taxes 0 60
Supplemental schedule of noncash investing activities:
OREO acquired in settlement of loans 161 408
ROU assets obtained in exchange for lease obligations 8,115 0
Security purchases not yet settled 0 4,002

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

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Condensed Consolidated Statements of Cash Flows (Unaudited)

ORRSTOWN FINANCIAL SERVICES, INC.


	Six Months Ended
(Dollars in thousands)	June 30, 2020		June 30, 2019
Cash flows from operating activities
Net income	$	11,427	$	5,789
Adjustments to reconcile net income to net cash provided by operating activities:
Net (discount accretion) premium amortization	(2,020)		2,203
Depreciation and amortization expense	2,707		2,366
Impairment of intangibles	153		—
Provision for loan losses	2,825		600
Share-based compensation	1,176		679
Gain on sales of loans originated for sale	(1,903)		(909)
Mortgage loans originated for sale	(76,417)		(43,471)
Proceeds from sales of loans originated for sale	73,323		40,392
Gain on sale of portfolio loans	(2,803)		—
Net gain on disposal of OREO	(21)		(8)

Net loss on disposal of premises and equipment	1		607
Deferred income taxes	63		263
Investment securities losses (gains)	31		(2,403)
Income from life insurance	(1,072)		(1,026)
(Increase) decrease in accrued interest receivable	(2,142)		730
Increase (decrease) in accrued interest payable and other liabilities	85		(1,147)
Other, net	1,445		1,100
Net cash provided by operating activities	6,858		5,765
Cash flows from investing activities
Proceeds from sales of AFS securities	—		173,836
Maturities, repayments and calls of AFS securities	29,317		15,297
Purchases of AFS securities	(26,691)		(150,386)
Net cash and cash equivalents received from acquisitions	—		29,442
Net (purchases) redemptions of restricted investments in bank stocks	(72)		3,395
Net decrease (increase) in loans	43,961		(8,395)
Proceeds from sales of portfolio loans	22,665		—

Purchases of bank premises and equipment	(464)		(1,489)

Proceeds from disposal of OREO	198		374


Death benefit proceeds from life insurance contracts	—		571

Net cash provided by investing activities	68,914		62,645
Cash flows from financing activities
Net (decrease) increase in deposits	(82,449)		68,525
Net decrease in borrowings with original maturities less than 90 days	(111,152)		(29,696)
Proceeds from FHLB advances and other borrowings	160,284		20,000
Payments on FHLB advances and other borrowings	(40,548)		(96,582)



Subordinated note issuance costs	—		(57)

Dividends paid	(3,811)		(2,799)

Acquisition of treasury stock	(1,170)		—
Treasury shares repurchased for employee taxes associated with restricted stock vesting	(660)		(294)
Proceeds from issuance of employee stock purchase plan shares	61		58

Net cash used in financing activities	(79,445)		(40,845)
Net (decrease) increase in cash and cash equivalents	(3,673)		27,565
Cash and cash equivalents at beginning of period	55,963		88,815
Cash and cash equivalents at end of period	$	52,290	$	116,380

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Supplemental disclosures of cash flow information:
Cash paid during the period for:
Interest	$	10,367	$	10,326

Supplemental schedule of noncash investing activities:
OREO acquired in settlement of loans	—		161

Lease liabilities arising from obtaining ROU assets	—		8,115

SBA PPP loans originated	458,606		—

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

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Notes to Condensed Consolidated Financial Statements (Unaudited)

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

NOTE 1. SUMMARY OF SIGNIFICANT ACCOUNTING POLICIES

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

Nature of Operations – Orrstown Financial Services, Inc. ~~and subsidiaries~~ is a financial holding company that operates Orrstown Bank, a commercial bank with banking and financial advisory offices in Berks, Cumberland, Dauphin, Franklin, Lancaster, Perry and York Counties, Pennsylvania, and in Anne Arundel, Baltimore, Howard and Washington Counties, Maryland, as well as Baltimore City, Maryland and Wheatland Advisors, Inc., a registered investment advisor non-bank subsidiary, headquartered in Lancaster County, Pennsylvania. The Wheatland operations were discontinued effective July 31, 2020. The Company operates in the community banking segment and engages in lending activities, including commercial, residential, commercial mortgages, construction, municipal, and various forms of consumer lending, and deposit services, including checking, savings, time, and money market deposits. The Company also provides fiduciary services, investment advisory, insurance and brokerage services. The Company and the Bank are subject to regulation by certain federal and state agencies and undergo periodic examinations by such regulatory authorities.

Basis of Presentation – The accompanying unaudited condensed consolidated financial statements include the accounts of Orrstown Financial Services, Inc. and its wholly owned subsidiaries, the Bank and Wheatland. The Company has prepared these unaudited condensed consolidated financial statements in accordance with GAAP for interim financial information, SEC rules that permit reduced disclosure for interim periods, and Article 10 of Regulation S-X. In the opinion of management, all adjustments (all of which are of a normal recurring nature) that are necessary for a fair statement are reflected in the unaudited condensed consolidated financial statements. The December 31, ~~2018~~2019 consolidated balance sheet information contained in this Quarterly Report on Form 10-Q was derived from the ~~2018~~Company's 2019 audited consolidated financial statements. ~~Interim results are not necessarily indicative of results for a full year.~~ The unaudited condensed consolidated financial statements should be read in conjunction with the audited consolidated financial statements, including the notes thereto, included in the Company’s Annual Report on Form 10-K for the year ended December 31, ~~2018.~~2019. Operating results for the three and six months ended June 30, ~~2019~~2020 are not necessarily indicative of the results that may be expected for the year ending December 31, ~~2019.~~2020. All significant intercompany transactions and accounts have been eliminated. Certain reclassifications may have been made to prior year amounts to conform with current year classifications.

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

The preparation of financial statements in conformity with 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 financial statements and the reported amounts of revenues and expenses during the reporting periods. Actual results could differ from those estimates. The effects of the COVID-19 pandemic may negatively impact material estimates. Material estimates that are particularly susceptible to significant change include the determination of the ALL and those used in valuation methodologies in areas with no observable market, such as loans, deposits, borrowings, goodwill, core deposit and other intangible assets, mortgage servicing rights, other assets and liabilities obtained or assumed in business combinations.

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

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

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value of the hedged asset or liability that are attributable to the hedged risk in a fair value hedge or the earnings effect of the hedged forecasted transactions in a cash flow hedge.

The Company may enter into derivative contracts that are intended to economically hedge certain of its risk, even though hedge accounting does not apply or the Company elects not to apply hedge accounting. The Company's objectives in using interest rate derivatives are to add stability to interest income and to manage its exposure to interest rate movements. To accomplish this objective, the Company primarily uses interest rate swaps as part of its interest rate risk management strategy. Interest rate swaps designated as cash flow hedges involve the receipt of fixed amounts from a counterparty in exchange for the Company making variable-rate payments over the life of the agreements without exchange of the underlying notional amount. The Company may enter into derivative contracts that are intended to economically hedge certain of its risk, even though hedge accounting does not apply or the Company elects not to apply hedge accounting.

Changes to the fair value of derivatives designated and that qualify as cash flow hedges are recorded in accumulated other comprehensive income and are subsequently reclassified into earnings in the period that the hedged transaction affects earnings. During the six months ended June 30, 2020, such derivatives were used to hedge the variable cash flows associated with overnight borrowings.

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

Leases - ~~We evaluate our~~The Company evaluates its contracts at inception to determine if an arrangement either is a lease or contains ~~a lease.~~one. Operating ~~leases~~lease ROU assets are included in ~~operating lease ROU assets in Other~~other assets and operating lease liabilities in ~~Accrued~~accrued interest payable and other liabilities in ~~our~~the unaudited condensed consolidated balance sheets. The Company ~~has~~had no finance ~~leases.~~

leases at June 30, 2020.

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

~~We adopted~~In accordance with ASU 2016-02, “Leases (Topic 842),” ~~on January 1, 2019,~~(“ASU 2016-02”), the effective date of the guidance, using the practical expedient transition method whereby we did not revise comparative period information or disclosure. The new standard requires lessees to record assets and liabilities on the balance sheet for all leases with terms longer than 12 months. We elected the package of practical expedients permitted under the transition guidance within the new standard, which among other things, allows us to carryforward the historical lease classification. We also elected certain optional practical expedients,

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including the hindsight practical expedient under which we considered the actual outcomes of lease renewals and terminations when measuring the lease term at adoption, and we made an accounting policy election to keepCompany keeps leases with an initial term of 12 months or less off of the balance sheet. ~~We recognize~~The Company recognizes these lease payments in the unaudited condensed consolidated statements of income on a straight-line basis over the lease term. ~~We have~~The Company has lease agreements with lease and non-lease components and ~~we have~~has elected the practical expedient to account for ~~these~~them as a single lease component.

~~Our~~The Company's operating leases relate primarily to bank branches and office space. ~~In conjunction with~~Upon the adoption of ASU 2016-02 on January 1, 2019, ~~we recognized~~ operating lease liabilities of ~~$7,971,000~~$10.5 million and related lease assets of ~~$7,494,000~~$7.5 million were recognized on ~~our~~the unaudited condensed consolidated balance ~~sheet.~~sheets. The difference between the lease assets and lease liabilities primarily consists of deferred rent liabilities reclassified upon adoption to reduce the measurement of the lease assets. ~~The standard did not materially impact our consolidated net income and had no impact on cash flows.~~

Recent Accounting Pronouncements - ASU No. 2016-13, Financial Instruments - Credit Losses (Topic 326): Measurement of Credit Losses on Financial ~~Instruments.~~Instruments ("ASU 2016-13"). The amendments in this update require ~~a financial asset (or a group of financial assets) measured at amortized cost basis~~an organization to ~~be presented at the net amount~~measure all expected to be collected. The allowance for credit losses is a valuation account that is deducted from the amortized cost basis of the financial assets to present the net carrying value at the amount expected to be collected on the financial assets. Under the updates, the income statement will reflect the measurement of credit losses for ~~newly recognized~~ financial assets ~~as well as~~held at the ~~expected increases or decreases of expected credit losses that have taken place during the period. The measurement of expected credit losses is~~reporting date based on ~~relevant information about past events, including~~ historical experience, current conditions, and reasonable and supportable ~~forecasts that affect the collectibility~~forecasts. Financial institutions and other organizations will use forward-looking information to better inform their credit loss estimates. Many of the ~~reported~~loss estimation techniques applied today will still be permitted, although the inputs to those techniques will change to reflect the full amount of ~~financial assets. An entity must~~expected credit losses. Organizations will continue to use judgment ~~in determining the relevant information and~~to determine which loss estimation ~~methods that are~~method is appropriate ~~in its~~for their circumstances. The allowance for credit losses for purchased financial assets with a more-than-insignificant amount of credit deterioration since origination that are measured at amortized cost basis is determined in a similar manner to other financial assets measured at amortized cost basis; however, the initial allowance for credit losses is added to the purchase price rather than being reported as a credit loss expense. Only subsequent changes in the allowance for credit losses are recorded as a credit loss expense for these assets. Off-balance-sheet arrangements such as commitments to extend credit, guarantees, and standby letters of credit that are not considered derivatives under ASC 815 and are not unconditionally cancellable are also within the scope of this update. Credit losses relating to available for sale debt securities should be recorded through an allowance for credit losses. An entity will applyAdditionally, the amendments in this update amend the accounting for credit losses on a modified retrospective basis through a cumulative-effect adjustment to retained earnings as of the beginning of the first reporting period in which the guidance is effective. In that regard, the Company has formed a cross-functional working group, under the direction of the Chief Financial Officeravailable-for-sale debt securities and ~~the Chief Risk Officer. The working group is comprised of individuals from various functional areas including~~purchased financial assets with credit risk management, finance and information technology. Our implementation plan includes, but is not not limited to, an assessment of processes, portfolio segmentation, model development, system requirements and the identification of data and resource needs. We are currently evaluating various loss estimation models. We are also working with a third party vendor solution to assist with the application of ASU 2016-13 and anticipate running parallel models in 2019. While we currently cannot reasonably estimate the impact of adopting this standard, we expect the impact will be influenced by the composition, characteristics and quality of our loan and securities portfolios, as well as the general economic conditions and forecasts at the adoption date.deterioration. For certain public companies, ~~the~~this update iswas effective for interim and annual periods beginning after December 15, ~~2019, including interim periods within those fiscal years. On July 17, 2019,~~2019. The Company delayed the ~~FASB voted to propose to delay~~adoption of ASU 2016-13 as noted below.

ASU No. 2019-10, Financial Instruments—Credit Losses (Topic 326), Derivatives and Hedging (Topic 815), and Leases (Topic 842): Effective Dates ("ASU 2019-10"), extended the ~~effective date~~implementation deadline of ~~this~~ ASU 2016-13 for smaller reporting and other companies until the fiscal ~~years~~year and interim periods beginning after December 15, ~~2022, with earlier adoption permitted, although the full proposal has not yet been released.~~2022. The Company ~~currently~~ meets the

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requirements to be considered a smaller reporting company under SEC Regulation S-K and SEC Rule 405, and did not adopt ASU 2016-13 on January 1, 2020. The Company is evaluating the impact of the ~~roposed~~ delay for adoption of ASU 2016-13. The Company is working with a third party vendor solution to assist with the ~~update.~~

application of ASU ~~2017-04, Intangibles - Goodwill~~2016-13 and ~~Other (Topic 350): Simplifying~~finalizing the ~~Test for Goodwill Impairment.~~ The update simplifies how all entities assess goodwill for impairment by eliminating Step 2 from the goodwill impairment test. As amended, the goodwill impairment test will consist of one step comparing the fair value of a reporting unit with its carrying amount. An entity should recognize a goodwill impairment charge for the amount byloss estimation models to be used. Once management determines which ~~the carrying amount exceeds the reporting unit’s fair value. ASU 2017-04~~methods will be ~~effective for~~utilized, a third party will be contracted to perform a model validation prior to adoption. While the Company anticipates the allowance for loan losses will increase under its current assumptions, it expects the impact of adopting ASU 2016-13 will be influenced by the composition, characteristics and quality of its loan and securities portfolios, as well as general economic conditions and forecasts at the adoption date. The other provisions of ASU 2019-10 were not applicable to the Company.

In March 2020, the FASB issued ASU No. 2020-04, Reference Rate Reform (Topic 848): Facilitation of the Effects of Reference Rate Reform on ~~January 1, 2020, with earlier~~Financial Reporting ("ASU 2020-04). ASU 2020-04 contains optional expedients and exceptions for applying generally accepted accounting principles to contract modifications and hedging relationships, subject to meeting certain criteria, that reference LIBOR or another reference rate expected to be discontinued. The optional expedients apply consistently to all contracts or transactions within the scope of this topic, while the optional expedients for hedging relationships can be elected on an individual basis. The Company has formed a cross-functional working group to lead the transition from LIBOR to a planned adoption ~~permitted,~~of an alternate index. The Company has not yet determined what index will replace LIBOR in its loan agreements. The Company is in the process of implementing fallback language for loans that will mature after 2021. The Company expects to adopt the LIBOR transition relief allowed under this standard, and is ~~not expected to have a material~~currently evaluating the potential impact of this guidance on ~~the Company's consolidated~~its financial statements.

~~ASU 2017-08, Receivables - Nonrefundable Fees and Other Costs (Subtopic 310-20).~~ The update shortens the amortization period of certain callable debt securities held at a premium to the earliest call date unless applicable guidance related to certain pools of securities is applied to consider estimated prepayments. Under prior guidance, entities were generally required to amortize premiums on individual, non-pooled callable debt securities as a yield adjustment over the contractual life of the security. ASU 2017-08 does not change the accounting for callable debt securities held at a discount. On January 1, 2019, we adopted ASU 2016-18 with no material impact on our consolidated financial condition or results of operations.

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~~In August 2018, the SEC adopted the final rule under SEC Release No. 33-10532,~~ ~~Disclosure Update and Simplification,~~ amending certain disclosure requirements. In addition, the amendments expanded the disclosure requirements on the analysis of stockholders' equity for interim financial statements. Under the amendments, an analysis of changes in each caption of stockholders' equity presented in the balance sheet must be provided in a note or separate statement and should present a reconciliation of the beginning balance to the ending balance for each period for which a statement of comprehensive income is presented. The Company implemented the additional disclosure requirements effective with the filing of its March 31, 2019 Form 10-Q.

NOTE 2. MERGERS AND ACQUISITIONS

~~Mercersburg Financial Corporation~~

On October 1, 2018, we acquired 100% of the outstanding common shares of Mercersburg Financial Corporation and its wholly-owned subsidiary, First Community Bank of Mercersburg, headquartered in Mercersburg, Pennsylvania. We issued 1,052,635 shares of our common stock and paid $4,866,000 in cash for all outstanding shares of Mercersburg stock. Based on our $23.80 closing stock price on Friday, September 28, 2018, the consideration paid to acquire Mercersburg totaled $29,919,000.

The fair value of assets acquired, excluding goodwill, totaled $181,430,000, including loans totaling $141,103,000 and investment securities available for sale totaling $7,352,000. The fair value of liabilities assumed totaled $163,384,000, including deposits totaling $160,433,000. The Company recognized $11,873,000 in initial goodwill, representing consideration transferred in excess of the fair value of the net assets acquired in the Mercersburg acquisition. The goodwill resulting from the acquisition represents the value expected from the expansion of our market in south central Pennsylvania and the enhancement of our operations through customer synergies and efficiencies, thereby providing enhanced customer service.

The Mercersburg acquisition was accounted for using the acquisition method of accounting and, accordingly, purchased assets, including identifiable intangible assets, and assumed liabilities were recorded at their respective acquisition date fair values. The fair value measurements of assets acquired and liabilities assumed are subject to refinement for up to one year after the closing date of the acquisition as additional information relative to closing date fair values become available. The Company continues to finalize the fair values of loans and, as a result, the fair value adjustment is preliminary and may change as information becomes available. No material measurement period adjustments were made in the six months ended June 30, 2019. The results of operations for the Company include Mercersburg's results from and after October 1, 2018.

Hamilton Bancorp, Inc.

On May 1, 2019, wethe Company acquired 100% of the outstanding common shares of Hamilton Bancorp, Inc., and its wholly-owned subsidiary, Hamilton Bank, based in Towson, Maryland. WeThe Company acquired Hamilton to introduce our banking and financial services into the Greater Baltimore area of Maryland.

Pursuant to the merger agreement, wethe Company issued 1,765,704 shares of ~~our~~its common stock and paid ~~$14,197,000~~$14.2 million in cash for all outstanding shares of Hamilton stock and options vesting upon acquisition. Based on ~~our~~the Company's closing stock price of $20.74 on ~~Tuesday,~~ April 30, 2019, the consideration paid to acquire Hamilton totaled approximately ~~$50,819,000.~~$50.8 million.

The fair value of assets acquired, excluding goodwill, totaled ~~$493,194,000,~~$494.0 million, including loans totaling ~~$347,667,000.~~$347.1 million. The fair value of liabilities assumed totaled ~~$449,405,000,~~$449.4 million, including deposits totaling ~~$388,246,000.~~$388.2 million. Goodwill represents consideration transferred in excess of the fair value of the net assets acquired. At May 1, 2019, the Company recognized ~~$7,030,000~~$6.1 million in ~~initial~~ goodwill associated with the Hamilton acquisition. The goodwill resulting from the acquisition represents the value expected from the expansion of our market in the Greater Baltimore area and the enhancement of our operations through customer synergies and efficiencies, thereby providing enhanced customer service. Goodwill acquired in the Hamilton acquisition is not deductible for tax purposes.

The Hamilton acquisition was accounted for using the acquisition method of accounting and, accordingly, purchased assets, including identifiable intangible assets, and assumed liabilities were recorded at their respective acquisition date fair values. The fair value measurements of assets acquired and liabilities assumed are subject to refinement for up to one year after the closing date of the acquisition as additional information relative to closing date fair values ~~become~~becomes available. The Company ~~continues to finalize~~finalized the fair values of loans, intangible assets, other assets, income taxes and ~~liabilities. As a result, the fair value adjustments are preliminary and may change~~liabilities associated with Hamilton as ~~information becomes available. Fair value adjustments will be finalized no later than May 2020. The results~~ of ~~operations for the Company include Hamilton's results from and after~~ May 1, ~~2019.~~

2020. Measurement period adjustments made from the date of acquisition through May 1, 2020 are summarized in Note 6 - Goodwill and Other Intangible Assets.

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The following table summarizes the consideration paid for Hamilton and the estimated fair values of the assets acquired and liabilities assumed recognized at the acquisition date:


~~(Dollars in thousands)~~
Fair value of consideration transferred:
Cash	$	14,197
Common stock issued	36,622
Total consideration transferred	$	50,819

Estimated fair values of assets acquired and ~~(liabilities)~~liabilities assumed:
Cash and cash equivalents	$	43,140
Securities available for sale	60,882
Restricted investments in bank stocks	2,658
Loans	~~347,667~~347,143
Premises and equipment	3,749
Core deposit intangible	4,550
Goodwill	~~7,030~~6,132
Cash surrender value of life insurance	17,948
Deferred tax asset, net	~~5,838~~7,257
ROU lease asset	~~2,746~~2,793
Other assets	~~4,016~~3,925
Total assets acquired	~~500,224~~500,177

Deposits	(388,246)
Borrowings	(51,393)
Other liabilities	~~(9,766)~~(9,719)
Total liabilities assumed	~~(449,405)~~$	(449,358)
	$		~~50,819~~

The determination of estimated fair values of the acquired loans required the Company to make certain estimates about discount rates, future expected cash flows, market conditions and other future events that are highly subjective in nature. Based on such factors as past due status, nonaccrual status, bankruptcy status, and credit risk ratings, the acquired loans were divided into loans with evidence of credit quality deterioration, which are accounted for under ASC 310-30 (purchased credit impaired), and loans that do not meet this criteria, which are accounted for under ASC 310-20 (purchased non-impaired). Expected cash flows, both principal and interest, were estimated based on key assumptions covering such factors as prepayments, default rates and severity of loss given default. These assumptions were developed using both Hamilton's historical experience and the portfolio characteristics as of the acquisition date, as well as available market research. The fair value estimates for acquired loans were based on the amount and timing of expected principal, interest and other cash flows, including expected prepayments, discounted at prevailing market interest rates applicable to the types of acquired loans, which wethe Company considered to be level 3 fair value measurements. Deposit liabilities assumed in the Hamilton acquisition were segregated into two categories: time-deposits (i.e., deposit accounts with a stated maturity) and demand deposits, both using level 2 fair value measurements. In determining fair value of time deposits, the Company discounted the contractual cash flows of the deposit accounts using prevailing market interest rates for time deposit accounts of similar type and duration. For demand deposits, the acquisition date outstanding balance of the assumed demand deposit accounts approximates fair value. Acquisition date fair values for securities available for sale were determined using Level 1 or Level 2 inputs consistent with the methods discussed further in ~~“Note 12~~Note 13 - Fair ~~Value.”~~Value. The remaining acquisition date fair values represent either Level 2 fair value measurements or Level 3 fair value measurements (premises and equipment and core deposit intangible).

Upon completion of the acquisition, the Company sold the acquired investment portfolio and paid off acquired borrowings at the indicated fair value amounts in conjunction with its asset/liability management strategies.

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WeThe Company recognized a core deposit intangible of ~~$4,550,000,~~$4.6 million, which ~~will be~~is being amortized using an accelerated method over a 10-year amortization period, consistent with expected future cash flows.

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Loans acquired with Hamilton were measured at fair value at the acquisition date with no carryover of any ALL. Loans were segregated into those loans considered to be performing and those considered PCI. The following table presents performing and PCI loans acquired, by loan class, at May 1, ~~2019.~~2019:


(in thousands)		Performing		PCI		Total
									Performing		PCI		Total
Commercial real estate:	Commercial real estate:							Commercial real estate:
Owner-occupied	Owner-occupied	$	42,148	$	6,324	$	48,472	Owner-occupied	$	42,148	$	5,894	$	48,042
Non-owner occupied	Non-owner occupied	45,401		770		46,171		Non-owner occupied	45,401		770		46,171
Multi-family	Multi-family	10,773		0		10,773		Multi-family	10,773		—		10,773

Acquisition and development:	Acquisition and development:							Acquisition and development:
1-4 family residential construction	1-4 family residential construction	7,450		0		7,450		1-4 family residential construction	7,450		—		7,450
Commercial and land development	Commercial and land development	4,528		0		4,528		Commercial and land development	4,528		—		4,528
Commercial and industrial	Commercial and industrial	32,316		1,702		34,018		Commercial and industrial	32,316		1,914		34,230

Residential mortgage:	Residential mortgage:							Residential mortgage:
First lien	First lien	152,657		10,800		163,457		First lien	152,657		10,494		163,151
Home-equity - term	Home-equity - term	4,478		1		4,479		Home-equity - term	4,478		1		4,479
Home equity - lines of credit	Home equity - lines of credit	13,657		0		13,657		Home equity - lines of credit	13,657		—		13,657
Installment and other loans	Installment and other loans	14,467		195		14,662		Installment and other loans	14,467		195		14,662
Total loans acquired	Total loans acquired	$	327,875	$	19,792	$	347,667	Total loans acquired	$	327,875	$	19,268	$	347,143

The following table presents the fair value adjustments made to the amortized cost basis of loans acquired at May 1, ~~2019.~~2019:


~~(in thousands)~~
Gross amortized cost basis at acquisition	$	362,125
Market rate adjustment	(5,309)
Credit fair value adjustment on non-credit impaired loans	(3,947)
Credit fair value adjustment on ~~impaired~~PCI loans	~~(5,202)~~(5,726)
Estimated fair value of acquired loans	$	~~347,667~~347,143

The market rate adjustment represents the movement in market interest rates, irrespective of credit adjustments, compared to the contractual rates of the acquired loans. The credit fair value adjustment made on ~~non-PCI~~non-credit impaired loans represents the changes in credit quality of the underlying borrowers from loan inception to the acquisition date. The credit fair value adjustment on PCI loans is derived in accordance with ASC 310-30, Loans and Debt Securities Acquired with Deteriorated Credit Quality,and represents the portion of the loan balance that has been deemed uncollectible based on our expectations of future cash flows for each respective loan.

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The following table provides information about acquired PCI loans at May 1, ~~2019.~~2019:


~~(in thousands)~~
Contractually required principal and interest at acquisition	$	31,599
Nonaccretable difference	~~(8,310)~~(8,834)
Expected cash flows at acquisition	~~23,289~~22,765
Accretable yield	(3,497)
Estimated fair value of acquired PCI loans	$	~~19,792~~19,268

Unaudited pro forma net income for the three and six months ended June 30, 2018, would have totaled $3,557,000 and $2,516,000, and revenues would have totaled $34,878,000 and $58,695,000 for the same period had the Mercersburg and Hamilton acquisitions occurred January 1, 2018. Unaudited pro forma net incomeCompany for the three and six months ended June 30, 2019, would have totaled ~~$6,152,000~~$6.2 million and ~~$9,710,000, and revenues~~$9.7 million, respectively. Revenues would have totaled ~~$27,607,000~~$27.6 million and ~~$50,923,000~~$50.9 million, respectively, for the ~~same period~~three and six months ended June 30, 2019, had the Hamilton acquisition occurred on January 1, 2019.

In connection with the Mercersburg and Hamilton acquisitions, wethe Company incurred merger related expenses totaling ~~$6,860,000~~$6.9 million and ~~$7,505,000~~$7.5 million for the three and six months ending June 30, 2019, which are included in noninterest expenses.

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The Company did 0t incur any merger related expenses ~~consisted primarily of $1,649,000~~in connection with the Hamilton acquisition for the three and $1,967,000 of investment banking, legal and consulting fees; $3,492,000 and $3,619,000 of information systems expense, including canceling of contracts; and $1,719,000 and $1,919,000 of other expenses, including payout of employee termination contracts.six months ended June 30, 2020.

NOTE 3. INVESTMENT SECURITIES ~~AVAILABLE FOR SALE~~

At June 30, ~~2019~~2020 and December 31, ~~2018,~~2019, all investment securities were classified as AFS. The following table summarizes amortized cost and fair value of ~~AFS~~investment securities, and the corresponding amounts of gross unrealized gains and losses recognized in AOCI, at June 30, ~~2019~~2020 and December 31, ~~2018.~~2019:


(Dollars in thousands)		Amortized Cost		Gross Unrealized Gains		Gross Unrealized Losses		Fair Value
June 30, 2019
											Amortized Cost		Gross Unrealized Gains		Gross Unrealized Losses		Fair Value
June 30, 2020										June 30, 2020

States and political subdivisions										States and political subdivisions	$	105,122	$	8,156	$	183	$	113,095
GSE residential MBSs										GSE residential MBSs	4,519		86		—		4,605
GSE residential CMOs										GSE residential CMOs	63,655		3,116		704		66,067
Non-agency CMOs										Non-agency CMOs	17,213		97		—		17,310

Private label commercial CMOs										Private label commercial CMOs	73,388		25		3,677		69,736
Asset-backed										Asset-backed	224,181		97		11,510		212,768
Other										Other	355		—		—		355
Totals										Totals	$	488,433	$	11,577	$	16,074	$	483,936
December 31, 2019										December 31, 2019

States and political subdivisions	States and political subdivisions	$	96,080	$	6,030	$	0	$	102,110	States and political subdivisions	$	83,607	$	4,288	$	32	$	87,863

GSE residential CMOs	GSE residential CMOs	72,269		1,055		903		72,421		GSE residential CMOs	67,928		1,000		774		68,154
Non-agency CMOs										Non-agency CMOs	17,210		—		123		17,087

Private label commercial CMOs	Private label commercial CMOs	94,354		299		225		94,428		Private label commercial CMOs	86,704		156		231		86,629
Asset-backed and other		229,913		141		2,083		227,971
Asset-backed										Asset-backed	235,406		138		5,029		230,515
Other										Other	637		—		—		637
Totals	Totals	$	492,616	$	7,525	$	3,211	$	496,930	Totals	$	491,492	$	5,582	$	6,189	$	490,885
December 31, 2018

States and political subdivisions		$	144,596	$	1,919	$	1,511	$	145,004

GSE residential CMOs		110,421		332		2,689		108,064

Private label residential CMOs		144		0		1		143
Private label commercial CMOs		75,911		55		921		75,045
Asset-backed and other		138,535		126		1,073		137,588
Totals		$	469,607	$	2,432	$	6,195	$	465,844

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The following table summarizes ~~AFS~~investment securities with unrealized losses at June 30, ~~2019~~2020 and December 31, ~~2018,~~2019, aggregated by major security type and the length of time in a continuous unrealized loss position.


		Less Than 12 Months								12 Months or More										Total								Less Than 12 Months					12 Months or More	Total
(Dollars in thousands)		# of Securities	Fair Value		Unrealized Losses		# of Securities	Fair Value		Unrealized Losses		# of Securities	Fair Value		Unrealized Losses
June 30, 2019
																		# of Securities	Fair Value		Unrealized Losses		# of Securities	Fair Value		Unrealized Losses		# of Securities	Fair Value		Unrealized Losses
June 30, 2020																	June 30, 2020

States and political subdivisions																	States and political subdivisions	1	$	10,032	$	183	—	$	—	$	—	1	$	10,032	$	183

GSE residential CMOs	GSE residential CMOs	0	0		0		4	43,662		903		4	43,662		903		GSE residential CMOs	3	26,496		704		—	—		—		3	26,496		704

Private label commercial CMOs	Private label commercial CMOs	11	49,100		175		3	21,846		50		14	70,946		225		Private label commercial CMOs	5	29,410		1,618		8	33,814		2,059		13	63,224		3,677
Asset-backed and other		14	173,546		1,691		2	19,066		392		16	192,612		2,083
Asset-backed																	Asset-backed	9	73,071		2,724		11	133,451		8,786		20	206,522		11,510
Totals	Totals	25	$	222,646	$	1,866	9	$	84,574	$	1,345	34	$	307,220	$	3,211	Totals	18	$	139,009	$	5,229	19	$	167,265	$	10,845	37	$	306,274	$	16,074
December 31, 2018
December 31, 2019																	December 31, 2019

States and political subdivisions	States and political subdivisions	27	$	46,585	$	662	6	$	23,036	$	849	33	$	69,621	$	1,511	States and political subdivisions	1	$	6,173	$	32	—	$	—	$	—	1	$	6,173	$	32

GSE residential CMOs	GSE residential CMOs	1	18,037		122		7	46,168		2,567		8	64,205		2,689		GSE residential CMOs	5	37,158		309		1	11,602		465		6	48,760		774
Non-agency CMOs																	Non-agency CMOs	1	17,087		123		—	—		—		1	17,087		123

Private label residential CMOs		1	143		1		0	0		0		1	143		1

Private label commercial CMOs	Private label commercial CMOs	11	56,499		712		2	6,349		209		13	62,848		921		Private label commercial CMOs	6	26,079		67		8	39,726		164		14	65,805		231
Asset-backed and other		6	78,900		859		3	10,808		214		9	89,708		1,073
Asset-backed																	Asset-backed	9	92,189		1,145		9	121,399		3,884		18	213,588		5,029
Totals	Totals	46	$	200,164	$	2,356	18	$	86,361	$	3,839	64	$	286,525	$	6,195	Totals	22	$	178,686	$	1,676	18	$	172,727	$	4,513	40	$	351,413	$	6,189

The Company determines whether unrealized losses are temporary in nature in accordance with FASB ASC 320-10, Investments - Overall, (“FASB ASC 320-10”) and FASB ASC 325-40, Investments – Beneficial Interests in Securitized Financial Assets, when applicable. The evaluation is based upon factors such as the creditworthiness of the underlying borrowers, performance of the underlying collateral, if applicable, and the level of credit support in the security structure. Management also evaluates other factors and circumstances that may be indicative of an OTTI condition. This includes, but is not limited to, an evaluation of the type of security, length of time and extent to which the fair value has been less than cost and near-term prospects of the issuer.

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

As of June 30, 2020, the Company had no cumulative OTTI. There were no OTTI charges recognized in earnings as a result of credit losses on investments in the three and six months ended June 30, 2020 and 2019. During the six months ended June 30, 2020, unrealized losses were substantially higher due to market uncertainty brought about by the COVID-19 pandemic. The sudden and desperate need for liquidity from many institutional pools of capital combined with the global economic implications of the COVID-19 pandemic caused significant widening of spreads.

States and Political Subdivisions. The unrealized losses presented in the table above have been caused by a widening of spreads ~~and/or a rise in interest rates~~ from the time these securities were purchased. Management considers the investment rating, the state of the issuer of the security and other credit support in determining whether the security is OTTI. Because the Company does not intend to sell these securities and it is not more likely than not that the Company will be required to sell them before recovery of their amortized cost basis, which may be maturity, the Company does not consider these securities to be OTTI at June 30, 2020 or December 31, ~~2018.~~2019.

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GSE Residential CMOs. The unrealized losses presented in the table above have been caused by a widening of spreads ~~and/or a rise in interest rates~~ from the time these securities were purchased. The contractual terms of these securities do not permit the issuer to settle the securities at a price less than its par value basis. Because the Company does not intend to sell these securities and it is not more likely than not that the Company will be required to sell them before recovery of their amortized cost basis, which may be maturity, the Company does not consider these securities to be OTTI at June 30, ~~2019~~2020 or at December 31, ~~2018.~~2019.

~~Private Label Residential~~Non-agency CMOs. The unrealized losses presented in the table above have been caused by a widening of spreads from the time the securities were purchased. Management considers the investment rating and other credit support in determining whether a security is other-than-temporarily impaired. As of June 30, 2020, management concluded that an OTTI did not exist on any of the aforementioned securities based upon its assessment. Management also concluded that it does not intend to sell nor will it be required to sell the securities, before their recovery, which may be maturity, and management expects to recover the entire amortized cost basis of these securities.

Private Label Commercial CMOs and ~~Asset-backed and Other.~~Asset-backed. The unrealized losses presented in the table above have been caused by a widening of spreads ~~and/or a rise in interest rates~~ from the time the securities were purchased. Management considers the investment rating and other credit support in determining whether a security is other-than-temporarily impaired. Because the Company does not intend to sell these securities and it is not more likely than not that the Company will be required to sell them before recovery of their amortized cost basis, which may be maturity, the Company does not consider these securities to be OTTI at June 30, ~~2019~~2020 or at December 31, ~~2018.~~2019.

The following table summarizes the credit ratings and collateral associated with the Company's investment portfolio, excluding equity securities, at June 30, 2020:


Sector	Portfolio Mix		Amortized Book		Fair Value		Credit Enhancement		AAA		AA		A		BBB		NR		Collateral Type
Unsecured ABS	2	%	$	10,003	$	9,694	41	%	6	%	—	%	—	%	—	%	94	%	Unsecured Consumer Debt
Student Loan ABS	3	%	12,624		11,777		26	%	—	%	—	%	—	%	—	%	100	%	Seasoned Student Loans
Federal Family Education Loan ABS	37	%	182,759		172,613		6	%	4	%	74	%	22	%	—	%	—	%	Federal Family Education Loan ⁽¹⁾
PACE Loan ABS	1	%	6,149		6,246		6	%	100	%	—	%	—	%	—	%	—	%	PACE Loans
Non-Agency CMBS	15	%	73,388		69,735		55	%	80	%	7	%	3	%	10	%	—	%	Commercial Real Estate
Non-Agency RMBS	4	%	17,213		17,310		33	%	100	%	—	%	—	%	—	%	—	%	Reverse Mortgages ⁽²⁾
Municipal - General Obligation	11	%	53,984		58,963				3	%	84	%	12	%	—	%	—	%
Municipal - Revenue	10	%	51,138		54,132				—	%	61	%	19	%	—	%	20	%
SBA ReRemic	3	%	12,647		12,439				—	%	100	%	—	%	—	%	—	%	SBA Guarantee ⁽³⁾
Agency MBS	14	%	68,174		70,673				—	%	100	%	—	%	—	%	—	%	Residential Mortgages ⁽³⁾
Bank CDs	—	%	249		249				—	%	—	%	—	%	—	%	100	%	FDIC Insured CD
	100	%	$	488,328	$	483,831			19	%	61	%	12	%	1	%	7	%

⁽¹⁾97% guaranteed by U.S. government
⁽²⁾ Currently 6% credit enhancement; expected credit enhancement is provided above
⁽³⁾ 100% guaranteed by U.S. government agencies

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

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The following table summarizes amortized cost and fair value of ~~AFS~~investment securities by contractual maturity at June 30, ~~2019.~~2020. Expected maturities may differ from contractual maturities if borrowers have the right to call or prepay obligations with or without call or prepayment penalties. Securities not due at a single maturity date are shown separately.


		Available for Sale							Amortized Cost		Fair Value
(Dollars in thousands)		Amortized Cost		Fair Value
Due in one year or less	Due in one year or less	$	525	$	525	Due in one year or less	$	—	$	—
Due after one year through five years	Due after one year through five years	0		0		Due after one year through five years	249		249
Due after five years through ten years	Due after five years through ten years	23,446		24,326		Due after five years through ten years	27,182		29,157
Due after ten years	Due after ten years	72,109		77,259		Due after ten years	78,046		84,044
CMOs	CMOs	166,623		166,849		CMOs	158,775		157,718
Asset-backed and other		229,913		227,971
Asset-backed						Asset-backed	224,181		212,768
		$	492,616	$	496,930		$	488,433	$	483,936

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The following table summarizes proceeds from sales of ~~AFS~~investment securities and gross gains and gross losses for the three and six months ended June 30, ~~2019~~2020 and ~~2018.~~2019:


		Three months ended June 30,						Six months ended June 30,							Three months ended June 30,				Six months ended June 30,
(Dollars in thousands)		2019		2018		2019		2018
Proceeds from sale of AFS securities		$	114,871	$	25,533	$	174,335	$	88,110
											2020		2019		2020		2019
Proceeds from sale of investment securities										Proceeds from sale of investment securities	$	—	$	114,372	$	—	$	173,836
Gross gains	Gross gains	2,109		211		2,628		1,052		Gross gains	9		2,109		—		2,628
Gross losses	Gross losses	45		165		225		190		Gross losses	—		45		31		225

~~In July 2019,~~During the ~~Company sold an additional $18,000,000 of principally States~~three and ~~Political subdivisions securities at~~six months ended June 30, 2020, a ~~net~~ gain of ~~approximately $2,300,000.~~

~~AFS~~$9 thousand and a loss of $31 thousand, respectively, was recorded to adjust an equity security to market value, compared to net investment security gains of $2.1 million and $2.4 million, respectively, for the three and six months ended June 30, 2019 from security sales. There were no sales of investment securities during the three and six months ended June 30, 2020. Investment securities with a fair value of ~~$176,270,000~~$428.1 million and ~~$164,233,000~~$158.7 million at June 30, ~~2019~~2020 and December 31, ~~2018~~2019, respectively, were pledged to secure public funds and for other purposes as required or permitted by law.

NOTE 4. LOANS AND ALLOWANCE FOR LOAN LOSSES

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

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

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

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

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Acquisition and development loans consist of 1-4 family residential construction and commercial and land development loans. The risk of loss on these loans is largely dependent on the Company’s ability to assess the property’s value at the completion of the project, which should exceed the property’s construction costs. During the construction phase, a number of factors could potentially negatively impact the collateral value, including cost overruns, delays in completing the project, competition, and real estate market conditions which may change based on the supply of similar properties in the area. In the event the collateral value at the completion of the project is not sufficient to cover the outstanding loan balance, the Company must rely upon other repayment sources, including, if any, the guarantors of the project or other collateral securing the loan.

Commercial and industrial loans include advances to local and regional businesses for general commercial purposes and include permanent and short-term working capital, machinery and equipment financing, and may be either in the form of lines of credit or term loans. Although commercial and industrial loans may be unsecured to our highest-rated borrowers, the majority of these loans are secured by the borrower’s accounts receivable, inventory and machinery and equipment. In a significant number of these loans, the collateral also includes the business real estate or the business owner’s personal real estate or assets. Commercial and industrial loans present credit exposure to the Company, as they are more susceptible to risk of loss during a downturn in the economy as borrowers may have greater difficulty in meeting their debt service requirements and the value of the collateral may decline. The Company attempts to mitigate this risk through its underwriting standards, including evaluating the creditworthiness of the borrower and, to the extent available, credit ratings on the business. Additionally, monitoring of the loans through annual renewals and meetings with the borrowers are typical. However, these procedures cannot eliminate the risk of loss associated with commercial and industrial lending.

~~Table~~ At June 30, 2020 and December 31, 2019, commercial and industrial loans include $447.2 million and $0, respectively, of ~~Contents~~

loans, net of deferred fees, originated through the U.S. Small Business Administration Paycheck Protection Program ("SBA PPP").

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

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

Home equity loans, including term loans and lines of credit, present a slightly higher risk to the Company than 1-4 family first liens, as these loans can be first or second liens on 1-4 family owner occupied residential property, but can have loan-to-value ratios of no greater than 90% of the value of the real estate taken as collateral. The creditworthiness of the borrower is considered including credit scores and debt-to-income ratios.

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

On March 27, 2020, the Coronavirus Aid, Relief and Economic Security (“CARES”) Act was enacted. The CARES Act established the SBA PPP. The SBA PPP is intended to provide economic relief to small businesses nationwide adversely impacted under the COVID-19 Emergency Declaration issued on March 13, 2020. The SBA PPP, which began on April 3, 2020, provides small businesses with funds to cover up to 24 weeks of payroll costs and other expenses, including benefits. It also provides for forgiveness of up to the full principal amount of qualifying loans. The Bank closed and funded almost 2,800 PPP loans for a total loan amount of $459.6 million in the three months ended June 30, 2020. As these loans are 100% guaranteed by the SBA, there is no associated allowance for loan losses at June 30, 2020. These loans resulted in net fee income of $13.2 million to be recognized through net interest income over the life of the loans, which is between two and five years. During the three and six months ended June 30, 2020, the Company recognized $1.9 million of net deferred fees, included in interest income on loans on the condensed consolidated statements of income. In addition, in an effort to assist clients which were negatively impacted by the COVID-19 pandemic, the Bank offered various mitigation options, including a loan payment deferral program. Under this program, most commercial deferrals were for a 90-day period, while most consumer deferrals were for a 180-day period. As of June 30, 2020, the Company processed loan deferrals under this program for commercial and consumer clients with a total loan balance of $218.1 million and $21.2 million, respectively. In accordance with the revised Interagency Statement on Loan Modifications by Financial Institutions Working with Customers Affected by the Coronavirus issued on April 7, 2020, these deferrals are exempt from TDR status as they meet the specified requirements.

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The following table presents the loan portfolio by segment and class, excluding residential mortgage LHFS, at June 30, ~~2019~~2020 and December 31, ~~2018.~~2019:


(Dollars in thousands)		June 30, 2019		December 31, 2018
							June 30, 2020		December 31, 2019
Commercial real estate:	Commercial real estate:					Commercial real estate:
Owner occupied	Owner occupied	$	170,272	$	129,650	Owner occupied	$	164,442	$	170,884
Non-owner occupied	Non-owner occupied	298,989		252,794		Non-owner occupied	390,980		361,050
Multi-family	Multi-family	93,342		78,933		Multi-family	111,016		106,893
Non-owner occupied residential	Non-owner occupied residential	121,364		100,367		Non-owner occupied residential	116,531		120,038
Acquisition and development:	Acquisition and development:					Acquisition and development:
1-4 family residential construction	1-4 family residential construction	12,801		7,385		1-4 family residential construction	7,966		15,865
Commercial and land development	Commercial and land development	57,027		42,051		Commercial and land development	50,220		41,538
Commercial and industrial(1)	Commercial and industrial(1)	219,551		160,964		Commercial and industrial(1)	665,312		214,554
Municipal	Municipal	48,358		50,982		Municipal	34,276		47,057
Residential mortgage:	Residential mortgage:					Residential mortgage:
First lien	First lien	363,946		235,296		First lien	295,736		336,372
Home equity - term	Home equity - term	15,989		12,208		Home equity - term	11,944		14,030
Home equity - lines of credit	Home equity - lines of credit	157,645		143,616		Home equity - lines of credit	160,842		165,314
Installment and other loans	Installment and other loans	42,386		33,411		Installment and other loans	32,052		50,735
Total Loans ⁽¹⁾		$	1,601,670	$	1,247,657
Total loans						Total loans	$	2,041,317	$	1,644,330

⁽¹⁾~~Includes $453,280,000~~ This balance includes $447.2 million and ~~$135,009,000~~$0 of ~~acquired~~SBA PPP loans, net of deferred fees and costs, at June 30, ~~2019~~2020 and December 31, ~~2018.~~

2019, respectively.

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

~~Table of Contents~~

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

Internal loan reviews are completed annually on all commercial relationships with a committed loan balance in excess of ~~$500,000,~~$500 thousand, which includes confirmation of risk rating by an independent credit officer. ~~Credit Administration also reviews loans in excess of $1,000,000.~~ In addition, all commercial relationships greater than ~~$250,000~~$500 thousand rated Substandard, Doubtful or Loss are reviewed quarterly and corresponding risk ratings are reaffirmed by the Company's Problem Loan Committee, with subsequent reporting to the Management ERM ~~Committee.~~

Committee and the Board of Directors.

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The following table summarizes the Company’s loan portfolio ratings based on its internal risk rating system at June 30, ~~2019~~2020 and December 31, ~~2018.~~2019:


(Dollars in thousands)		Pass		Special Mention		Non-Impaired Substandard		Impaired - Substandard		Doubtful		PCI Loans		Total
June 30, 2019
																	Pass		Special Mention		Non-Impaired Substandard		Impaired - Substandard		Doubtful		PCI Loans		Total
June 30, 2020																June 30, 2020
Commercial real estate:	Commercial real estate:															Commercial real estate:
Owner occupied	Owner occupied	$	158,247	$	1,366	$	878	$	1,737	$	0	$	8,044	$	170,272	Owner occupied	$	144,332	$	7,223	$	4,666	$	3,371	$	—	$	4,850	$	164,442
Non-owner occupied	Non-owner occupied	286,669		10,935		0		0		0		1,385		298,989		Non-owner occupied	345,176		45,468		—		—		—		336		390,980
Multi-family	Multi-family	86,765		5,065		700		114		0		698		93,342		Multi-family	95,478		14,796		662		80		—		—		111,016
Non-owner occupied residential	Non-owner occupied residential	114,607		2,264		1,156		270		0		3,067		121,364		Non-owner occupied residential	108,985		4,404		1,357		283		—		1,502		116,531
Acquisition and development:	Acquisition and development:															Acquisition and development:
1-4 family residential construction	1-4 family residential construction	12,151		650		0		0		0		0		12,801		1-4 family residential construction	7,844		122		—		—		—		—		7,966
Commercial and land development	Commercial and land development	56,268		188		571		0		0		0		57,027		Commercial and land development	38,947		9,895		541		837		—		—		50,220
Commercial and industrial	Commercial and industrial	198,699		9,523		6,946		253		0		4,130		219,551		Commercial and industrial	636,604		15,372		9,222		708		—		3,406		665,312
Municipal	Municipal	48,358		0		0		0		0		0		48,358		Municipal	30,025		4,251		—		—		—		—		34,276
Residential mortgage:	Residential mortgage:															Residential mortgage:
First lien	First lien	351,523		0		0		2,392		0		10,031		363,946		First lien	287,633		—		—		2,461		—		5,642		295,736
Home equity - term	Home equity - term	15,877		79		0		12		0		21		15,989		Home equity - term	11,841		—		72		11		—		20		11,944
Home equity - lines of credit	Home equity - lines of credit	156,731		187		22		705		0		0		157,645		Home equity - lines of credit	160,036		175		35		596		—		—		160,842
Installment and other loans	Installment and other loans	42,089		0		0		8		0		289		42,386		Installment and other loans	31,950		—		—		17		—		85		32,052
		$	1,527,984	$	30,257	$	10,273	$	5,491	$	0	$	27,665	$	1,601,670		$	1,898,851	$	101,706	$	16,555	$	8,364	$	—	$	15,841	$	2,041,317

December 31, 2018
December 31, 2019																December 31, 2019
Commercial real estate:	Commercial real estate:															Commercial real estate:
Owner occupied	Owner occupied	$	121,903	$	3,024	$	987	$	1,880	$	0	$	1,856	$	129,650	Owner occupied	$	151,161	$	4,513	$	3,163	$	5,872	$	—	$	6,175	$	170,884
Non-owner occupied	Non-owner occupied	242,136		10,008		0		0		0		650		252,794		Non-owner occupied	342,753		17,152		—		—		—		1,145		361,050
Multi-family	Multi-family	71,482		5,886		717		131		0		717		78,933		Multi-family	100,361		4,822		682		345		—		683		106,893
Non-owner occupied residential	Non-owner occupied residential	97,590		736		1,197		309		0		535		100,367		Non-owner occupied residential	111,697		4,534		1,115		235		—		2,457		120,038
Acquisition and development:	Acquisition and development:															Acquisition and development:
1-4 family residential construction	1-4 family residential construction	7,385		0		0		0		0		0		7,385		1-4 family residential construction	15,865		—		—		—		—		—		15,865
Commercial and land development	Commercial and land development	41,251		25		583		0		0		192		42,051		Commercial and land development	39,939		206		1,393		—		—		—		41,538
Commercial and industrial	Commercial and industrial	150,286		2,278		2,940		286		0		5,174		160,964		Commercial and industrial	198,951		1,133		8,899		1,763		—		3,808		214,554
Municipal	Municipal	50,982		0		0		0		0		0		50,982		Municipal	42,649		4,408		—		—		—		—		47,057
Residential mortgage:	Residential mortgage:															Residential mortgage:
First lien	First lien	229,971		0		0		2,877		0		2,448		235,296		First lien	323,040		978		—		2,590		—		9,764		336,372
Home equity - term	Home equity - term	12,170		0		0		16		0		22		12,208		Home equity - term	13,774		74		149		13		—		20		14,030
Home equity - lines of credit	Home equity - lines of credit	142,638		165		15		798		0		0		143,616		Home equity - lines of credit	164,469		74		38		733		—		—		165,314
Installment and other loans	Installment and other loans	33,229		15		1		0		0		166		33,411		Installment and other loans	50,497		—		—		85		—		153		50,735
		$	1,201,023	$	22,137	$	6,440	$	6,297	$	0	$	11,760	$	1,247,657		$	1,555,156	$	37,894	$	15,439	$	11,636	$	—	$	24,205	$	1,644,330

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

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

Loan charge-offs, which may include partial charge-offs, are taken on an impaired loan that is collateral dependent if the loan’s carrying balance exceeds its collateral’s appraised value, the loan has been identified as uncollectible, and it is deemed to be a confirmed loss. Typically, impaired loans with a charge-off or partial charge-off will continue to be considered impaired, unless the note is split into ~~two,~~2, and management expects the performing note to continue to perform and is adequately secured. The second, or non-performing note, would be charged-off. Generally, an impaired loan with a partial charge-off may continue to have an impairment reserve on it after the partial charge-off, if factors warrant.

At June 30, ~~2019~~2020 and December 31, ~~2018,~~2019, nearly all of the Company’s ~~impaired loans’ extent of impairment~~loan impairments were measured based on the estimated fair value of the collateral securing the loan, except for TDRs. By definition, TDRs are considered impaired. All ~~restructured loans’~~TDR impairment ~~was determined~~analyses are initially based on discounted cash flows for those ~~loans classified as TDRs and still accruing interest.~~loans. For real estate loans, collateral generally consists of commercial real estate, but in the case of commercial and industrial loans, it could also consist of accounts receivable, inventory, equipment or other business assets. Commercial and industrial loans may also have real estate collateral.

Updated appraisals are generally required every 18 months for classified commercial loans in excess of ~~$250,000.~~$250 thousand. The “as is" value provided in the appraisal is often used as the fair value of the collateral in determining impairment, unless circumstances, such as subsequent improvements, approvals, or other circumstances, dictate that another value than that provided by the appraiser is more appropriate.

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

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

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

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

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

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~~development and commercial and industrial loans rated Substandard to be collectively, as opposed to individually, evaluated for impairment. Although the Company believes~~ these loans meet the definition of ~~Substandard,~~substandard, they are generally performing and management has concluded that it is likely wethe Company will be able to collect the scheduled payments of principal and interest when due according to the contractual terms of the loan agreement.

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

The following table, which excludes PCI loans, summarizes impaired loans by segment and class, segregated by those for which a specific allowance was required and those for which a specific allowance was not required at June 30, ~~2019~~2020 and December 31, ~~2018.~~2019. The recorded investment in loans excludes accrued interest receivable due to insignificance. Related allowances established generally pertain to those loans in which loan forbearance agreements were in the process of being negotiated or updated appraisals were pending, and any partial charge-off will be recorded when final information is received.

Impaired Loans with a Specific Allowance Impaired Loans with No Specific Allowance
(Dollars in thousands) Recorded
Investment
(Book Balance) Unpaid Principal
Balance
(Legal Balance) Related
Allowance Recorded
Investment
(Book Balance) Unpaid Principal
Balance
(Legal Balance)
June 30, 2019
Commercial real estate:
Owner occupied $ 0 $ 0 $ 0 $ 1,737 $ 2,509
Multi-family 0 0 0 114 329
Non-owner occupied residential 0 0 0 270 612
Commercial and industrial 0 0 0 253 439
Residential mortgage:
First lien 554 554 37 1,838 2,940
Home equity - term 0 0 0 12 20
Home equity - lines of credit 0 0 0 705 999
Installment and other loans 0 0 0 8 17
$ 554 $ 554 $ 37 $ 4,937 $ 7,865
December 31, 2018
Commercial real estate:
Owner occupied $ 0 $ 0 $ 0 $ 1,880 $ 2,576
Multi-family 0 0 0 131 336
Non-owner occupied residential 0 0 0 309 632
Commercial and industrial 0 0 0 286 457
Residential mortgage:
First lien 743 743 38 2,134 2,727
Home equity - term 0 0 0 16 23
Home equity - lines of credit 0 0 0 798 1,081
$ 743 $ 743 $ 38 $ 5,554 $ 7,832


	Impaired Loans with a Specific Allowance										Impaired Loans with No Specific Allowance
	Recorded Investment (Book Balance)		Unpaid Principal Balance (Legal Balance)		Related Allowance		Recorded Investment (Book Balance)		Unpaid Principal Balance (Legal Balance)
June 30, 2020
Commercial real estate:
Owner-occupied	$	—	$	—	$	—	$	3,371	$	4,124
Non-owner occupied	—		—		—		—		313
Multi-family	—		—		—		80		—
Non-owner occupied residential	—		—		—		283		399
Acquisition and development:

Commercial and land development	—		—		—		837		875
Commercial and industrial	—		—		—		708		1,858
Residential mortgage:
First lien	688		688		35		1,773		3,083
Home equity—term	—		—		—		11		14
Home equity—lines of credit	—		—		—		596		830
Installment and other loans	—		—		—		17		28
	$	688	$	688	$	35	$	7,676	$	11,524
December 31, 2019
Commercial real estate:
Owner-occupied	$	—	$	—	$	—	$	5,872	$	8,086

Multi-family	—		—		—		345		569
Non-owner occupied residential	—		—		—		235		422



Commercial and industrial	—		—		—		1,763		3,361
Residential mortgage:
First lien	425		425		36		2,165		3,164
Home equity—term	—		—		—		13		15
Home equity—lines of credit	—		—		—		733		1,077
Installment and other loans	—		—		—		85		97
	$	425	$	425	$	36	$	11,211	$	16,791

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The following table, which excludes accruing PCI loans, summarizes the average recorded investment in impaired loans and related recognized interest income for the three and six months ended June 30, ~~2019~~2020 and ~~2018.~~2019:


		2019						2018							2020				2019
(Dollars in thousands)		Average Impaired Balance		Interest Income Recognized		Average Impaired Balance		Interest Income Recognized
											Average Impaired Balance		Interest Income Recognized		Average Impaired Balance		Interest Income Recognized
Three Months Ended June 30,	Three Months Ended June 30,									Three Months Ended June 30,
Commercial real estate:	Commercial real estate:									Commercial real estate:
Owner-occupied	Owner-occupied	$	1,770	$	1	$	1,233	$	0	Owner-occupied	$	4,639	$	—	$	1,770	$	1
Non-owner occupied	Non-owner occupied	0		0		2,960		0		Non-owner occupied	169		—		—		—
Multi-family	Multi-family	118		0		153		0		Multi-family	270		—		118		—
Non-owner occupied residential	Non-owner occupied residential	282		0		356		0		Non-owner occupied residential	521		—		282		—
Acquisition and development:	Acquisition and development:									Acquisition and development:
1-4 family residential construction		0		0		201		0

Commercial and land development										Commercial and land development	837		—		—		—
Commercial and industrial	Commercial and industrial	260		0		330		0		Commercial and industrial	1,320		—		260		—
Residential mortgage:	Residential mortgage:									Residential mortgage:
First lien	First lien	2,512		14		3,310		14		First lien	3,177		12		2,512		14
Home equity – term	Home equity – term	13		0		20		0		Home equity – term	12		—		13		—
Home equity - lines of credit	Home equity - lines of credit	709		1		667		1		Home equity - lines of credit	704		1		709		1
Installment and other loans	Installment and other loans	9		0		5		0		Installment and other loans	18		—		9		—
		$	5,673	$	16	$	9,235	$	15		$	11,667	$	13	$	5,673	$	16
Six Months Ended June 30,	Six Months Ended June 30,									Six Months Ended June 30,
Commercial real estate:	Commercial real estate:									Commercial real estate:
Owner occupied	Owner occupied	$	1,819	$	1	$	1,233	$	1	Owner occupied	$	5,143	$	1	$	1,819	$	1
Non-owner occupied	Non-owner occupied	0		0		3,421		0��		Non-owner occupied	96		—		—		—
Multi-family	Multi-family	122		0		157		0		Multi-family	301		—		122		—
Non-owner occupied residential	Non-owner occupied residential	291		0		364		0		Non-owner occupied residential	396		—		291		—
Acquisition and development:	Acquisition and development:									Acquisition and development:
1-4 family residential construction		0		0		250		0

Commercial and land development										Commercial and land development	478		—		—		—
Commercial and industrial	Commercial and industrial	269		0		336		0		Commercial and industrial	1,384		—		269		—
Residential mortgage:	Residential mortgage:									Residential mortgage:
First lien	First lien	2,652		29		3,538		29		First lien	2,874		24		2,652		29
Home equity - term	Home equity - term	14		0		20		0		Home equity - term	12		—		14		—
Home equity - lines of credit	Home equity - lines of credit	736		1		589		1		Home equity - lines of credit	715		1		736		1
Installment and other loans	Installment and other loans	8		0		8		0		Installment and other loans	34		—		8		—
		$	5,911	$	31	$	9,916	$	31		$	11,433	$	26	$	5,911	$	31

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The following table presents impaired loans that are TDRs, with the recorded investment at June 30, ~~2019~~2020 and December 31, ~~2018.~~2019:


		June 30, 2019				December 31, 2018						June 30, 2020			December 31, 2019
(Dollars in thousands)		Number of Contracts	Recorded Investment		Number of Contracts	Recorded Investment
									Number of Contracts	Recorded Investment		Number of Contracts	Recorded Investment
Accruing:	Accruing:							Accruing:
Commercial real estate:	Commercial real estate:							Commercial real estate:
Owner occupied	Owner occupied	1	$	31	1	$	39	Owner occupied	1	$	28	1	$	30

Residential mortgage:	Residential mortgage:							Residential mortgage:
First lien	First lien	11	1,052		11	1,069		First lien	9	916		9	931
Home equity - lines of credit	Home equity - lines of credit	1	21		1	24		Home equity - lines of credit	1	16		1	18
		13	1,104		13	1,132			11	960		11	979
Nonaccruing:	Nonaccruing:							Nonaccruing:
Commercial real estate:	Commercial real estate:							Commercial real estate:
Owner occupied	Owner occupied	1	34		1	37		Owner occupied	1	215		4	1,909

Residential mortgage:	Residential mortgage:							Residential mortgage:
First lien	First lien	7	438		8	658		First lien	5	337		5	359

		8	472		9	695			6	552		9	2,268
		21	$	1,576	22	$	1,827		17	$	1,512	20	$	3,247

There were ~~no modified restructured loans~~0 new TDR's for the three and six months ended June 30, ~~2019~~2020 or ~~2018. No additional commitments have been made to borrowers whose loans are considered TDRs.~~2019.

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Management further monitors the performance and credit quality of the loan portfolio by analyzing the length of time a portfolio is past due, by aggregating loans based on its delinquencies. The following table presents the classes of loan portfolio summarized by aging categories of performing loans and nonaccrual loans at June 30, ~~2019~~2020 and December 31, ~~2018.~~2019:


				Days Past Due																			Days Past Due
(Dollars in thousands)		Current		30-59		60-89		90+ (still accruing)		Total Past Due		Non- Accrual		Total Loans
June 30, 2019
																	Current		30-59		60-89		90+ (still accruing)		Total Past Due		Non- Accrual		Total Loans
June 30, 2020																June 30, 2020
Commercial real estate:	Commercial real estate:															Commercial real estate:
Owner occupied	Owner occupied	$	160,522	$	0	$	0	$	0	$	0	$	1,706	$	162,228	Owner occupied	$	155,868	$	113	$	268	$	—	$	381	$	3,343	$	159,592
Non-owner occupied	Non-owner occupied	297,509		95		0		0		95		0		297,604		Non-owner occupied	390,644		—		—		—		—		—		390,644
Multi-family	Multi-family	92,280		250		0		0		250		114		92,644		Multi-family	110,936		—		—		—		—		80		111,016
Non-owner occupied residential	Non-owner occupied residential	117,729		298		0		0		298		270		118,297		Non-owner occupied residential	114,303		106		286		51		443		283		115,029
Acquisition and development:	Acquisition and development:															Acquisition and development:
1-4 family residential construction	1-4 family residential construction	12,801		0		0		0		0		0		12,801		1-4 family residential construction	7,966		—		—		—		—		—		7,966
Commercial and land development	Commercial and land development	57,002		0		25		0		25		0		57,027		Commercial and land development	49,356		27		—		—		27		837		50,220
Commercial and industrial	Commercial and industrial	214,816		254		98		0		352		253		215,421		Commercial and industrial	661,099		99		—		—		99		708		661,906
Municipal	Municipal	48,358		0		0		0		0		0		48,358		Municipal	34,276		—		—		—		—		—		34,276
Residential mortgage:	Residential mortgage:															Residential mortgage:
First lien	First lien	350,054		1,826		695		0		2,521		1,340		353,915		First lien	284,370		2,038		1,877		264		4,179		1,545		290,094
Home equity - term	Home equity - term	15,951		5		0		0		5		12		15,968		Home equity - term	11,826		87		—		—		87		11		11,924
Home equity - lines of credit	Home equity - lines of credit	156,226		498		237		0		735		684		157,645		Home equity - lines of credit	159,724		273		265		—		538		580		160,842
Installment and other loans	Installment and other loans	41,880		162		47		0		209		8		42,097		Installment and other loans	31,889		42		13		6		61		17		31,967
Subtotal	Subtotal	1,565,128		3,388		1,102		0		4,490		4,387		1,574,005		Subtotal	2,012,257		2,785		2,709		321		5,815		7,404		2,025,476
Loans acquired with credit deterioration:	Loans acquired with credit deterioration:																	Loans acquired with credit deterioration:
Commercial real estate:	Commercial real estate:															Commercial real estate:
Owner occupied	Owner occupied	8,005		0		0		39		39		0		8,044		Owner occupied	4,850		—		—		—		—		—		4,850
Non-owner occupied	Non-owner occupied	605		0		0		780		780		0		1,385		Non-owner occupied	336		—		—		—		—		—		336
Multi-family		698		0		0		0		0		0		698

Non-owner occupied residential	Non-owner occupied residential	2,997		0		0		70		70		0		3,067		Non-owner occupied residential	1,270		—		66		166		232		—		1,502

Commercial and industrial	Commercial and industrial	3,781		121		173		55		349		0		4,130		Commercial and industrial	3,382		—		—		24		24		—		3,406

Residential mortgage:	Residential mortgage:															Residential mortgage:
First lien	First lien	8,745		365		204		717		1,286		0		10,031		First lien	3,922		1,304		18		398		1,720		—		5,642
Home equity - term	Home equity - term	16		0		5		0		5		0		21		Home equity - term	20		—		—		—		—		—		20

Installment and other loans	Installment and other loans	219		68		2		0		70		0		289		Installment and other loans	66		1		18		—		19		—		85
Subtotal	Subtotal	25,066		554		384		1,661		2,599		0		27,665		Subtotal	13,846		1,305		102		588		1,995		—		15,841
		$	1,590,194	$	3,942	$	1,486	$	1,661	$	7,089	$	4,387	$	1,601,670		$	2,026,103	$	4,090	$	2,811	$	909	$	7,810	$	7,404	$	2,041,317

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				Days Past Due																			Days Past Due
(Dollars in thousands)		Current		30-59		60-89		90+ (still accruing)		Total Past Due		Non- Accrual		Total Loans
December 31, 2018
																	Current		30-59		60-89		90+ (still accruing)		Total Past Due		Non- Accrual		Total Loans
December 31, 2019																December 31, 2019
Commercial real estate:	Commercial real estate:															Commercial real estate:
Owner occupied	Owner occupied	$	125,887	$	66	$	0	$	0	$	66	$	1,841	$	127,794	Owner occupied	$	158,723	$	144	$	—	$	—	$	144	$	5,842	$	164,709
Non-owner occupied	Non-owner occupied	252,144		0		0		0		0		0		252,144		Non-owner occupied	359,425		480		—		—		480		—		359,905
Multi-family	Multi-family	78,085		0		0		0		0		131		78,216		Multi-family	105,865		—		—		—		—		345		106,210
Non-owner occupied residential	Non-owner occupied residential	99,268		226		29		0		255		309		99,832		Non-owner occupied residential	116,370		841		66		69		976		235		117,581
Acquisition and development:	Acquisition and development:															Acquisition and development:
1-4 family residential construction	1-4 family residential construction	7,385		0		0		0		0		0		7,385		1-4 family residential construction	15,587		278		—		—		278		—		15,865
Commercial and land development	Commercial and land development	41,822		37		0		0		37		0		41,859		Commercial and land development	40,403		1,135		—		—		1,135		—		41,538
Commercial and industrial	Commercial and industrial	154,988		411		105		0		516		286		155,790		Commercial and industrial	208,668		315		—		—		315		1,763		210,746
Municipal	Municipal	50,982		0		0		0		0		0		50,982		Municipal	47,057		—		—		—		—		—		47,057
Residential mortgage:	Residential mortgage:															Residential mortgage:
First lien	First lien	228,714		1,592		734		0		2,326		1,808		232,848		First lien	314,473		9,092		1,234		150		10,476		1,659		326,608
Home equity - term	Home equity - term	11,487		678		5		0		683		16		12,186		Home equity - term	13,993		—		4		—		4		13		14,010
Home equity - lines of credit	Home equity - lines of credit	142,394		420		28		0		448		774		143,616		Home equity - lines of credit	163,907		417		275		—		692		715		165,314
Installment and other loans	Installment and other loans	33,135		66		44		0		110		0		33,245		Installment and other loans	50,224		236		37		—		273		85		50,582
Subtotal	Subtotal	1,226,291		3,496		945		0		4,441		5,165		1,235,897		Subtotal	1,594,695		12,938		1,616		219		14,773		10,657		1,620,125
Loans acquired with credit deterioration:	Loans acquired with credit deterioration:																	Loans acquired with credit deterioration:
Commercial real estate:	Commercial real estate:															Commercial real estate:
Owner occupied	Owner occupied	1,784		0		72		0		72		0		1,856		Owner occupied	6,015		—		129		31		160		—		6,175
Non-owner occupied	Non-owner occupied	650		0		0		0		0		0		650		Non-owner occupied	564		—		—		581		581		—		1,145
Multi-family	Multi-family	717		0		0		0		0		0		717		Multi-family	683		—		—		—		—		—		683
Non-owner occupied residential	Non-owner occupied residential	535		0		0		0		0		0		535		Non-owner occupied residential	1,710		105		111		531		747		—		2,457
Acquisition and development:

Commercial and land development		192		0		0		0		0		0		192

Commercial and industrial	Commercial and industrial	4,943		231		0		0		231		0		5,174		Commercial and industrial	3,792		—		—		16		16		—		3,808

Residential mortgage:	Residential mortgage:															Residential mortgage:
First lien	First lien	1,971		382		42		53		477		0		2,448		First lien	6,308		1,857		745		854		3,456		—		9,764
Home equity - term	Home equity - term	17		5		0		0		5		0		22		Home equity - term	16		4		—		—		4		—		20

Installment and other loans	Installment and other loans	149		13		0		4		17		0		166		Installment and other loans	131		22		—		—		22		—		153
Subtotal	Subtotal	10,958		631		114		57		802		0		11,760		Subtotal	19,219		1,988		985		2,013		4,986		—		24,205
		$	1,237,249	$	4,127	$	1,059	$	57	$	5,243	$	5,165	$	1,247,657		$	1,613,914	$	14,926	$	2,601	$	2,232	$	19,759	$	10,657	$	1,644,330

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

~~Table of Contents~~

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

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

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

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

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

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

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

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

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

Quality of Loan Review – including the years of experience of the loan review staff; in-house versus outsourced provider of review; turnover of staff and the perceived quality of their work in relation to other external information.

National and Local Economic Conditions – including trends in the consumer price index, unemployment rates, the housing price index, housing statistics compared to the prior year, bankruptcy rates, regulatory and legal environment risks and competition. During the three and six months ended June 30, 2020, this factor was increased for the commercial and consumer portfolios to account for the negative economic impact of the COVID-19 pandemic.

COVID-19 – during the three months ended June 30, 2020, a qualitative allocation was implemented associated with the potential impact of the COVID-19 pandemic on the Company's commercial loan portfolio. The factor assumes downgrades of loans with identified hardships resulting from the shutdown driven by the pandemic.

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The following table presents the activity in the ALL for the three and six months ended June 30, ~~2019~~2020 and ~~2018.~~2019:


		Commercial																		Consumer															Commercial								Consumer
(Dollars in thousands)		Commercial Real Estate		Acquisition and Development		Commercial and Industrial		Municipal		Total		Residential Mortgage		Installment and Other		Total		Unallocated		Total
																							Commercial Real Estate		Acquisition and Development		Commercial and Industrial		Municipal		Total		Residential Mortgage		Installment and Other		Total		Unallocated		Total
Three Months Ended	Three Months Ended																					Three Months Ended
June 30, 2020																						June 30, 2020
Balance, beginning of period																						Balance, beginning of period	$	8,420	$	1,033	$	2,647	$	99	$	12,199	$	3,139	$	294	$	3,433	$	171	$	15,803
Provision for loan losses																						Provision for loan losses	877		31		590		(24)		1,474		323		102		425		1		1,900

Charge-offs																						Charge-offs	—		—		(421)		—		(421)		(18)		(14)		(32)		—		(453)
Recoveries																						Recoveries	50		5		100		—		155		108		4		112		—		267
Balance, end of period																						Balance, end of period	$	9,347	$	1,069	$	2,916	$	75	$	13,407	$	3,552	$	386	$	3,938	$	172	$	17,517
June 30, 2019	June 30, 2019																					June 30, 2019
Balance, beginning of period	Balance, beginning of period	$	7,025	$	969	$	1,814	$	98	$	9,906	$	3,765	$	217	$	3,982	$	395	$	14,283	Balance, beginning of period	$	7,025	$	969	$	1,814	$	98	$	9,906	$	3,765	$	217	$	3,982	$	395	$	14,283
Provision for loan losses	Provision for loan losses	(221)		39		325		(4)		139		(32)		40		8		53		200		Provision for loan losses	(221)		39		325		(4)		139		(32)		40		8		53		200
Charge-offs	Charge-offs	0		0		(47)		0		(47)		(25)		(51)		(76)		0		(123)		Charge-offs	—		—		(47)		—		(47)		(25)		(51)		(76)		—		(123)
Recoveries	Recoveries	43		0		28		0		71		26		3		29		0		100		Recoveries	43		—		28		—		71		26		3		29		—		100
Balance, end of period	Balance, end of period	$	6,847	$	1,008	$	2,120	$	94	$	10,069	$	3,734	$	209	$	3,943	$	448	$	14,460	Balance, end of period	$	6,847	$	1,008	$	2,120	$	94	$	10,069	$	3,734	$	209	$	3,943	$	448	$	14,460
June 30, 2018
Six Months Ended																						Six Months Ended
June 30, 2020																						June 30, 2020
Balance, beginning of period	Balance, beginning of period	$	6,770	$	510	$	1,590	$	83	$	8,953	$	3,382	$	204	$	3,586	$	461	$	13,000	Balance, beginning of period	$	7,634	$	959	$	2,356	$	100	$	11,049	$	3,147	$	319	$	3,466	$	140	$	14,655
Provision for loan losses	Provision for loan losses	(418)		208		8		(3)		(205)		237		44		281		124		200		Provision for loan losses	1,260		102		912		(25)		2,249		400		144		544		32		2,825

Charge-offs	Charge-offs	0		0		0		0		0		(86)		(47)		(133)		0		(133)		Charge-offs	—		—		(496)		—		(496)		(109)		(86)		(195)		—		(691)
Recoveries	Recoveries	328		2		0		0		330		11		29		40		0		370		Recoveries	453		8		144		—		605		114		9		123		—		728
Balance, end of period	Balance, end of period	$	6,680	$	720	$	1,598	$	80	$	9,078	$	3,544	$	230	$	3,774	$	585	$	13,437	Balance, end of period	$	9,347	$	1,069	$	2,916	$	75	$	13,407	$	3,552	$	386	$	3,938	$	172	$	17,517
Six Months Ended
June 30, 2019	June 30, 2019																					June 30, 2019
Balance, beginning of period	Balance, beginning of period	$	6,876	$	817	$	1,656	$	98	$	9,447	$	3,753	$	244	$	3,997	$	570	$	14,014	Balance, beginning of period	$	6,876	$	817	$	1,656	$	98	$	9,447	$	3,753	$	244	$	3,997	$	570	$	14,014
Provision for loan losses	Provision for loan losses	(118)		189		484		(4)		551		157		14		171		(122)		600		Provision for loan losses	(118)		189		484		(4)		551		157		14		171		(122)		600
Charge-offs	Charge-offs	(25)		0		(90)		0		(115)		(271)		(71)		(342)		0		(457)		Charge-offs	(25)		—		(90)		—		(115)		(271)		(71)		(342)		—		(457)
Recoveries	Recoveries	114		2		70		0		186		95		22		117		0		303		Recoveries	114		2		70		—		186		95		22		117		—		303
Balance, end of period	Balance, end of period	$	6,847	$	1,008	$	2,120	$	94	$	10,069	$	3,734	$	209	$	3,943	$	448	$	14,460	Balance, end of period	$	6,847	$	1,008	$	2,120	$	94	$	10,069	$	3,734	$	209	$	3,943	$	448	$	14,460
June 30, 2018
Balance, beginning of period		$	6,763	$	417	$	1,446	$	84	$	8,710	$	3,400	$	211	$	3,611	$	475	$	12,796
Provision for loan losses		(411)		300		152		(4)		37		202		51		253		110		400
Charge-offs		0		0		0		0		0		(86)		(118)		(204)		0		(204)
Recoveries		328		3		0		0		331		28		86		114		0		445
Balance, end of period		$	6,680	$	720	$	1,598	$	80	$	9,078	$	3,544	$	230	$	3,774	$	585	$	13,437

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The following table summarizes the ending loan balance individually evaluated for impairment based upon loan segment, as well as the related ALL loss allocation for each at June 30, ~~2019~~2020 and December 31, ~~2018, excluding~~2019. PCI ~~loans.~~loans are excluded from loans individually evaluated for impairment.


		Commercial																		Consumer															Commercial								Consumer
(Dollars in thousands)		Commercial Real Estate		Acquisition and Development		Commercial and Industrial		Municipal		Total		Residential Mortgage		Installment and Other		Total		Unallocated		Total
June 30, 2019
																							Commercial Real Estate		Acquisition and Development		Commercial and Industrial		Municipal		Total		Residential Mortgage		Installment and Other		Total		Unallocated		Total
June 30, 2020																						June 30, 2020
Loans allocated by:																						Loans allocated by:
Individually evaluated for impairment																						Individually evaluated for impairment	$	3,734	$	837	$	708	$	—	$	5,279	$	3,068	$	17	$	3,085	$	—	$	8,364
Collectively evaluated for impairment																						Collectively evaluated for impairment	779,235		57,349		664,604		34,276		1,535,464		465,454		32,035		497,489		—		2,032,953

																							$	782,969	$	58,186	$	665,312	$	34,276	$	1,540,743	$	468,522	$	32,052	$	500,574	$	—	$	2,041,317
ALL allocated by:																						ALL allocated by:
Individually evaluated for impairment																						Individually evaluated for impairment	$	—	$	—	$	—	$	—	$	—	$	35	$	—	$	35	$	—	$	35
Collectively evaluated for impairment																						Collectively evaluated for impairment	9,347		1,069		2,916		75		13,407		3,517		386		3,903		172		17,482

																							$	9,347	$	1,069	$	2,916	$	75	$	13,407	$	3,552	$	386	$	3,938	$	172	$	17,517
December 31, 2019																						December 31, 2019
Loans allocated by:	Loans allocated by:																					Loans allocated by:
Individually evaluated for impairment	Individually evaluated for impairment	$	2,121	$	0	$	253	$	0	$	2,374	$	3,109	$	8	$	3,117	$	0	$	5,491	Individually evaluated for impairment	$	6,452	$	—	$	1,763	$	—	$	8,215	$	3,336	$	85	$	3,421	$	—	$	11,636
Collectively evaluated for impairment	Collectively evaluated for impairment	681,846		69,828		219,298		48,358		1,019,330		534,471		42,378		576,849		0		1,596,179		Collectively evaluated for impairment	752,413		57,403		212,791		47,057		1,069,664		512,380		50,650		563,030		—		1,632,694
		$	683,967	$	69,828	$	219,551	$	48,358	$	1,021,704	$	537,580	$	42,386	$	579,966	$	0	$	1,601,670		$	758,865	$	57,403	$	214,554	$	47,057	$	1,077,879	$	515,716	$	50,735	$	566,451	$	—	$	1,644,330
ALL allocated by:	ALL allocated by:																					ALL allocated by:
Individually evaluated for impairment	Individually evaluated for impairment	$	0	$	0	$	0	$	0	$	0	$	37	$	0	$	37	$	0	$	37	Individually evaluated for impairment	$	—	$	—	$	—	$	—	$	—	$	36	$	—	$	36	$	—	$	36
Collectively evaluated for impairment	Collectively evaluated for impairment	6,847		1,008		2,120		94		10,069		3,697		209		3,906		448		14,423		Collectively evaluated for impairment	7,634		959		2,356		100		11,049		3,111		319		3,430		140		14,619
		$	6,847	$	1008	$	2,120	$	94	$	10,069	$	3,734	$	209	$	3,943	$	448	$	14,460		$	7,634	$	959	$	2,356	$	100	$	11,049	$	3,147	$	319	$	3,466	$	140	$	14,655
December 31, 2018
Loans allocated by:
Individually evaluated for impairment		$	2,320	$	0	$	286	$	0	$	2,606	$	3,691	$	0	$	3,691	$	0	$	6,297
Collectively evaluated for impairment		559,424		49,436		160,678		50,982		820,520		387,429		33,411		420,840		0		1,241,360
		$	561,744	$	49,436	$	160,964	$	50,982	$	823,126	$	391,120	$	33,411	$	424,531	$	0	$	1,247,657
ALL allocated by:
Individually evaluated for impairment		$	0	$	0	$	0	$	0	$	0	$	38	$	0	$	38	$	0	$	38
Collectively evaluated for impairment		6,876		817		1,656		98		9,447		3,715		244		3,959		570		13,976
		$	6,876	$	817	$	1,656	$	98	$	9,447	$	3,753	$	244	$	3,997	$	570	$	14,014

The following table provides activity for the accretable yield of ~~purchased credit impaired~~PCI loans for the three and six months ended June 30, ~~2019.~~2020 and 2019:


		Three Months Ended				Six Months Ended				Three Months Ended							Six Months Ended
(Dollars in thousands)		June 30, 2019		June 30, 2019
								June 30, 2020			June 30, 2019		June 30, 2020		June 30, 2019
Accretable yield, beginning of period	Accretable yield, beginning of period	$	1,894	$	2,065		Accretable yield, beginning of period	$	4,414		$	1,894	$	6,950	$	2,065
New loans purchased		3,497		3,497
Additions ⁽¹⁾							Additions ⁽¹⁾	—			3,497		570		3,497
Accretion of income	Accretion of income	(1,221)		(1,392)			Accretion of income	(1,315)			(1,221)		(1,913)		(1,392)
Reclassifications from nonaccretable difference due to improvement in expected cash flows	Reclassifications from nonaccretable difference due to improvement in expected cash flows	617		617			Reclassifications from nonaccretable difference due to improvement in expected cash flows	1,104			617		1,121		617
Other changes, net(2)	Other changes, net(2)	201		201			Other changes, net(2)	(21)			201		(2,546)		201
Accretable yield, end of period	Accretable yield, end of period	$	4,988	$	4,988		Accretable yield, end of period	$	4,182		$	4,988	$	4,182	$	4,988

⁽¹⁾ This amount reflects a measurement period adjustment during the six months ended June 30, 2020 for Hamilton loans that should have been in the PCI pool at the acquisition date.

⁽²⁾ This balance represents the impact of purchased credit impaired loans sold during the six months ended June 30, 2020.

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NOTE 5. LEASES

A lease provides the lessee the right to control the use of an identified asset for a period of time in exchange for consideration. The Company has primarily entered into operating leases for branches and office space. Most of the Company's leases contain renewal options, which the Company is reasonably certain to exercise. Including renewal options, the Company's leases range from three years to 50 years. Operating lease right-of-use assets and lease liabilities are included in other assets and accrued interest and other liabilities on the Company's unaudited condensed consolidated balance sheets.

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

The following table presents information related to the Company's operating leases at June 30, 2020 and December 31, 2019:


	June 30, 2020			December 31, 2019
Operating lease ROU assets	$	8,746		$	9,222
Operating lease ROU liabilities	9,265			9,688
Weighted-average remaining lease term (in years)	17.9			17.6
Weighted-average discount rate	4.6		%	4.5		%

The following table presents information related to the Company's operating leases for the three and six months ended June 30, 2020 and 2019:


	Three Months Ended						Six Months Ended
	June 30, 2020		June 30, 2019		June 30, 2020		June 30, 2019
Cash paid for operating lease liabilities	$	319	$	281	$	637	$	461
Operating lease expense	370		256		750		509

The following table presents expected future maturities of the Company's lease liabilities as of June 30, 2020:


Remainder of 2020	$	642
2021	1,147
2022	727
2023	748
2024	738
Thereafter	10,549
	14,551
Less: imputed interest	5,286
Total lease liabilities	$	9,265

NOTE 5.6. GOODWILL AND OTHER INTANGIBLE ASSETS

The following table presents changes in goodwill at June 30, ~~2019~~2020 and December 31, ~~2018.~~2019:


(Dollars in thousands)		June 30, 2019		December 31, 2018
							June 30, 2020		December 31, 2019
Balance, beginning of year	Balance, beginning of year	$	12,592	$	719	Balance, beginning of year	$	19,925	$	12,592
Acquired goodwill	Acquired goodwill	7,029		11,873		Acquired goodwill	—		7,029
Adjustments to acquired goodwill ⁽¹⁾						Adjustments to acquired goodwill ⁽¹⁾	(1,201)		304

Balance, end of period	Balance, end of period	$	19,621	$	12,592	Balance, end of period	$	18,724	$	19,925

⁽¹⁾ The Company finalized its purchase accounting adjustments associated with Hamilton as of May 1, 2020.

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Goodwill is not amortized but is reviewed for potential impairment on at least an annual basis, with testing between annual tests if an event occurs or circumstances change that could potentially reduce the fair value of a reporting unit. Due to the severe economic impact of COVID-19, the Company reviewed its goodwill for impairment. It was concluded that 0 impairment existed at June 30, 2020. Management will continue to evaluate current economic conditions to determine if a triggering event would impact the current valuations for these assets.

The following table presents changes in other intangible assets for the three and six months ended June 30, ~~2019~~2020 and ~~2018.~~2019:


		QTD						YTD/YE							Three Months Ended June 30,				Six Months Ended June 30,
(Dollars in thousands)		June 30, 2019		June 30, 2018		June 30, 2019		June 30, 2018
											2020		2019		2020		2019
Beginning of period	Beginning of period	$	3,702	$	332	$	3,910	$	356	Beginning of period	$	6,717	$	3,702	$	7,180	$	3,910
Acquired CDI	Acquired CDI	4,550		0		4,550		0		Acquired CDI	—		4,550		—		4,550

Non-compete agreement	Non-compete agreement	290		0		290		0		Non-compete agreement	—		290		—		290
Amortization Expense	Amortization Expense	(402)		(24)		(610)		(48)		Amortization Expense	(404)		(402)		(867)		(610)
Impairment										Impairment	(153)		—		(153)		—
Balance, end of period	Balance, end of period	$	8,140	$	308	$	8,140	$	308	Balance, end of period	$	6,160	$	8,140	$	6,160	$	8,140

During the three and six months ended June 30, 2020, the Company recorded an impairment charge of $153 thousand for the full remaining balance attributable to a customer list intangible asset due to the pending dissolution of Wheatland. NaN impairment charges were recorded in the three and six months ended June 30, 2019.

The following table presents the components of other identifiable intangible assets at June 30, ~~2019~~2020 and December 31, ~~2018.~~2019:


		June 30, 2019						December 31, 2018							June 30, 2020				December 31, 2019
(Dollars in thousands)		Gross Amount		Accumulated Amortization		Gross Amount		Accumulated Amortization
											Gross Amount		Accumulated Amortization		Gross Amount		Accumulated Amortization
Amortized intangible assets:	Amortized intangible assets:									Amortized intangible assets:
Core deposit intangibles	Core deposit intangibles	$	8,390	$	708	$	3,840	$	190	Core deposit intangibles	$	8,390	$	2,235	$	8,390	$	1,493
Other customer relationship intangibles	Other customer relationship intangibles	931		715		931		671		Other customer relationship intangibles	174		169		524		338
Non-compete agreement	Non-compete agreement	290		48		0		0		Non-compete agreement	—		—		290		193
Total	Total	$	9,611	$	1,471	$	4,771	$	861	Total	$	8,564	$	2,404	$	9,204	$	2,024

The following table presents future estimated aggregate amortization expense for intangible assets remaining at June 30, ~~2019.~~2020:



Remainder of 2020	$	702
2021	1,275
2022	1,105
2023	935
2024	766
Thereafter	1,377
	$	6,160

(Dollars in thousands)
2019 $ 960
2020 1,591
2021 1,313
2022 1,137
2023 960
Thereafter 2,179
$ 8,140

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~~NOTE 6. LEASES~~

A lease provides the lessee the right to control the use of an identified asset for a period of time in exchange for consideration. The Company has primarily entered into operating leases for branches and office space. Most of our leases contain renewal options, which we are reasonably certain to exercise. Including renewal options, our leases range from 3 years to 50 years Operating lease right-of-use assets and lease liabilities are included in Other assets and Accrued interest and other liabilities on the Company's Consolidated Balance Sheet.

~~The following table summarizes the Company's ROU assets and related lease liabilities for the three and six months at June 30, 2019.~~

Three Months Ended Six Months Ended
(Dollars in thousands) June 30, 2019 June 30, 2019
Cash paid for operating lease liabilities 281 $ 461
Right-of-use assets obtained in exchange for operating lease obligations ⁽¹⁾
2,746 $ 10,861
Weighted-average remaining lease term (in years) 17.5 17.5
Weighted-average discount rate 4.5 % 4.5 %

⁽¹⁾ Includes $7,971,000 for operating leases existing on January 1, 2019, and $144,000 for operating leases that commenced in the first quarter of 2019, and $2,746,000 for operating leases that were acquired in the second quarter of 2019.

~~The following table presents maturities of the Company's lease liabilities.~~

(Dollars in thousands)
Remainder of 2019 $ 662
2020 1,336
2021 1,207
2022 788
2023 810
2024 801
Thereafter 11,025
16,629
Less imputed interest 5,929
Total lease liabilities $ 10,700

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NOTE 7. INCOME TAXES

The Company files income tax returns in the U.S. federal jurisdiction, the Commonwealth of Pennsylvania and the State of Maryland. The Company is no longer subject to tax examination by tax authorities for years before ~~2015.~~2016.

The following table summarizes income tax expense for the three and six months ended June 30, ~~2019~~2020 and ~~2018.~~

Three months ended June 30, Six months ended June 30,
(Dollars in thousands) 2019 2018 2019 2018
Current expense $ 69 $ 125 $ 90 $ 348
Deferred expense 41 249 252 518
Income tax expense $ 110 $ 374 $ 342 $ 866
2019:

Income tax expense includes $433,000 and $10,000 related to net securities gains for the three months ended June 30, 2019 and 2018, and $505,000 and $181,000 related to net security gains for the six months ended June 30, 2019 and 2018.


	Three months ended June 30,						Six months ended June 30,
	2020		2019		2020		2019
Current expense	$	427	$	69	$	455	$	90


Deferred expense	874		41		1,885		252




Income tax expense	$	1,301	$	110	$	2,340	$	342

The following table summarizes deferred tax assets and liabilities at June 30, ~~2019~~2020 and December 31, ~~2018.~~2019:

(Dollars in thousands) June 30,
2019 December 31,
2018
Deferred tax assets:
Allowance for loan losses $ 3,392 $ 3,143
Deferred compensation 755 723
Retirement and salary continuation plans 1,956 1,416
Share-based compensation 832 742
Off-balance sheet reserves 265 219
Nonaccrual loan interest 839 537
Net unrealized losses on AFS securities 0 791
Purchase accounting adjustments 4,571 1,795
Bonus accrual 216 470
Low-income housing credit carryforward 496 641
Net operating loss carryovers 1,859 0
Other 1,288 321
Total deferred tax assets 16,469 10,798
Deferred tax liabilities:
Depreciation 433 458
Net unrealized gains on AFS securities 906 0
Mortgage servicing rights 674 590
Purchase accounting adjustments 1,765 1,021
Other 231 150
Total deferred tax liabilities 4,009 2,219
Net deferred tax asset, included in Other Assets $ 12,460 $ 8,579

The provision for income taxes differs from that computed by applying statutory rates to income before income taxes, primarily due to the effects of tax-exempt income, non-deductible expenses and tax credits. In the first quarter of 2019, the Company recorded a tax benefit of $185,000, related to a favorable tax law clarification concerning the treatment of life insurance assets of an acquired entity. In the second quarter of 2019, the Company recorded a tax benefit of $334,000, related to an increase in its deferred state income tax asset for the effect of the state tax rate change resulting from the Hamilton acquisition.


(Dollars in thousands)	June 30, 2020		December 31, 2019
Deferred tax assets:
Allowance for loan losses	$	4,056	$	3,418
Deferred compensation	505		415
Retirement and salary continuation plans	2,429		2,357
Share-based compensation	620		631
Off-balance sheet reserves	270		234
Nonaccrual loan interest	740		697
Net unrealized losses on AFS securities	944		127
Purchase accounting adjustments	2,496		4,081
Bonus accrual	257		493
Interest Rate Swaps	441		—
Low-income housing credit carryforward	230		—



Net operating loss carryovers	1,645		1,872

Other	719		672
Total deferred tax assets	15,352		14,997
Deferred tax liabilities:
Depreciation	433		452

Mortgage servicing rights	557		694

Purchase accounting adjustments	1,356		1,599
Other	275		275
Total deferred tax liabilities	2,621		3,020
Net deferred tax asset, included in other assets	$	12,731	$	11,977

At June 30, ~~2019,~~2020, the Company had ~~low-income housing credit carryforwards that expire through 2038 and~~ acquired federal and state net operating loss carryforwards ~~that are~~of $11.1 million and $6.7 million, respectively, subject to annual loss limitation limits, that expire ~~in years~~ through 2037. A deferred tax asset is recognized for these carryforwards because the benefit is more likely than not to be realized.

FASB ASC 740, Income Taxes, (“ASC 740”) clarifies the accounting for income taxes by prescribing a minimum probability threshold that a tax position must meet before a financial statement benefit is recognized. The minimum threshold is defined in ASC 740 as a tax position that is more likely than not to be sustained upon examination by the applicable taxing authority, including resolution of any related appeals or litigation processes, based on the technical merits of the position. The tax benefit to be recognized is measured as the largest amount of benefit that has a greater than 50% likelihood of being realized upon ultimate settlement. ASC 740 was applied to all existing tax positions upon initial adoption. There was no liability for uncertain tax positions and no known unrecognized tax benefits at June 30, 2020 or December 31, 2019.

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NOTE 8. SHARE-BASED COMPENSATION PLANS

The Company maintains share-based compensation plans under the shareholder-approved 2011 Plan. The purpose of the share-based compensation plans is to provide officers, employees, and non-employee members of the Board of Directors of the Company with additional incentive to further the success of the Company. At June 30, ~~2019,~~2020, 881,920 shares of the common stock of the Company were reserved to be issued and ~~493,239~~347,721 shares were available to be issued.

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

The table below presents a summary of nonvested restricted shares activity for the six months ended June 30, ~~2019.~~2020:


		Shares	Weighted Average Grant Date Fair Value			Shares	Weighted Average Grant Date Fair Value
Nonvested shares, beginning of year	Nonvested shares, beginning of year	275,412	$	20.33	Nonvested shares, beginning of year	228,758	$	21.90
Granted	Granted	75,293	19.49		Granted	111,307	20.24
Forfeited	Forfeited	(34,680)	19.18		Forfeited	(4,000)	19.65
Vested	Vested	(23,405)	17.69		Vested	(61,731)	20.52
Nonvested shares, at period end	Nonvested shares, at period end	292,620	$	20.44	Nonvested shares, at period end	274,334	$	21.57

The following table presents restricted shares compensation expense, with tax benefit information, and fair value of shares vested, for the three and six months ended June 30, ~~2019~~2020 and ~~2018.~~2019:


		Three months ended June 30,						Six months ended June 30,							Three months ended June 30,				Six months ended June 30,
(Dollars in thousands)		2019		2018		2019		2018
											2020		2019		2020		2019
Restricted share award expense	Restricted share award expense	$	181	$	444	$	676	$	920	Restricted share award expense	$	654	$	181	$	1,173	$	676
Restricted share award tax benefit	Restricted share award tax benefit	38		93		148		193		Restricted share award tax benefit	137		38		246		148
Fair value of shares vested	Fair value of shares vested	0		659		444		1056		Fair value of shares vested	347		—		1,089		444

The unrecognized compensation expense related to the share awards totaled ~~$2,245,000~~$3.1 million at June 30, ~~2019~~2020 and ~~$2,115,000~~$2.2 million at December 31, ~~2018.~~2019. The unrecognized compensation expense at June 30, ~~2019~~2020 is expected to be recognized over a weighted-average period of ~~1.8~~2.0 years.

The following table presents a summary of outstanding stock options activity for the six months ended June 30, ~~2019.~~2020:


		Shares	Weighted Average Exercise Price			Shares	Weighted Average Exercise Price
Outstanding, beginning of year	Outstanding, beginning of year	40,984	$	24.34	Outstanding, beginning of year	30,559	$	21.56

Forfeited					Forfeited	(1,000)	21.14
Expired	Expired	(5,335)	28.21		Expired	(2,792)	25.76

Options outstanding and exercisable	Options outstanding and exercisable	35,649	$	23.76	Options outstanding and exercisable	26,767	$	21.14

The exercise price of each option equals the market price of the Company’s stock on the grant date. An option’s maximum term is ten years. All options are fully vested upon issuance. The following table presents information pertaining to options outstanding and exercisable at June 30, ~~2019.~~2020:

Range of Exercise Prices Number Outstanding Weighted Average Remaining Contractual Life (Years) Weighted Average Exercise Price
$21.14 - $24.99 27,767 1.06 $ 21.14
$25.00 - $34.99 2,792 0.76 25.76
$35.00 - $37.59 5,090 0.08 36.95
$21.14 - $37.59 35,649 0.90 $ 23.76


Exercise Price	Number Outstanding	Remaining Contractual Life (Years)	Exercise Price





$21.14	26,767	0.06	$	21.14

Outstanding and exercisable options had an intrinsic value of ~~$24,000~~0 at June 30, ~~2019~~2020 and $0$41 thousand at December 31, ~~2018.~~2019.

The Company maintains an employee stock purchase plan to provide its employees ~~of the Company~~with an opportunity to purchase Company common stock. Eligible employees may purchase shares in an amount that does not exceed 10% of their annual

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salary, at the lower of 95% of the fair market value of the shares on the semi-annual offering date or related purchase

~~Table~~ date. The purchases occur in March and September of ~~Contents~~

~~date.~~each year. The Company reserved 350,000 shares of its common stock to be issued under the employee stock purchase plan. At June 30, ~~2019, 170,461~~2020, 164,453 shares were available to be issued.

The following table presents information for the employee stock purchase plan for the three and six months ended June 30, ~~2019~~2020 and ~~2018.~~2019:


		Three months ended June 30,						Six months ended June 30,							Three months ended June 30,				Six months ended June 30,
(Dollars in thousands except share information)		2019		2018		2019		2018
											2020		2019		2020		2019
Shares purchased	Shares purchased	0		0		3,004		2,956		Shares purchased	—		—		3,613		3,004
Weighted average price of shares purchased	Weighted average price of shares purchased	$	0.00	$	0.00	$	18.96	$	23.47	Weighted average price of shares purchased	$	—	$	—	$	16.91	$	18.96
Compensation expense recognized	Compensation expense recognized	0		0		3		4		Compensation expense recognized	—		—		3		3
Tax benefits	Tax benefits	0		0		1		1		Tax benefits	—		—		1		1

The Company issues either new shares or treasury shares, depending on market conditions, infor award through its share-based compensation plans.

NOTE 9. DERIVATIVE FINANCIAL INSTRUMENTS

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

The Company’s objectives in using interest rate derivatives are to add stability to interest expense and to manage its exposure to interest rate movements. To accomplish this objective, the Company primarily uses interest rate swaps as part of its interest rate risk management strategy. Interest rate swaps designated as cash flow hedges involve the receipt of variable amounts from a counterparty in exchange for the Company making fixed-rate payments over the life of the agreements without exchange of the underlying notional amount. At June 30, 2020, the Company had 2 interest rate derivatives designated as hedging instruments with an aggregate notional amount of $100.0 million. The Company had 0 derivative instruments at December 31, 2019. Such derivatives were used to hedge the variable cash flows associated with the Company's borrowings. At June 30, 2020, the Company had cash collateral of $2.3 million held with the counterparty for these derivatives.

The Company enters into interest rate swaps that allow its commercial loan customers to effectively convert a variable-rate commercial loan agreement to a fixed-rate commercial loan agreement. Under these agreements, the Company enters into a variable-rate loan agreement with a customer in addition to an interest rate swap agreement, which serves to effectively swap the customer’s variable-rate loan into a fixed-rate loan. The Company then enters into a corresponding swap agreement with a third party in order to economically hedge its exposure through the customer agreement. The interest rate swaps with both the customers and third parties are not designated as hedges and are marked through earnings. At June 30, 2020, the Company had 2 interest rate derivative not designated as a hedging instrument with an aggregate notional amount of $14.2 million. The Company had 0 such derivative instruments at December 31, 2019.

As a part of its normal residential mortgage operations, the Company will enter into an interest rate lock commitment with a potential borrower. The Company enters into a corresponding commitment to an investor to sell that loan at a specific price

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shortly after origination. In accordance with FASB ASC 820, adjustments are recorded through earnings to account for the net change in fair value of these transactions for the held for sale pipeline.

The following table summarizes the fair value of the Company's derivative instruments at June 30, 2020 and December 31, 2019:


	6/30/2020								12/31/2019
	Notional Amount		Balance Sheet Location	Fair Value		Notional Amount		Balance Sheet Location	Fair Value
Derivatives designated as hedging instruments:

Interest rate swaps - balance sheet hedge	$	100,000	Other liabilities	$	(1,978)	$	—		$	—
Total derivatives designated as hedging instruments				$	(1,978)				$	—

Derivatives not designated as hedging instruments:
Interest rate swap - commercial borrower	$	7,100	Other assets	$	234	$	—		$	—
Interest rate swap - counterparty	7,100		Other liabilities	(251)		—			—
Interest rate lock commitments with customers	34,839		Other assets	986		4,408		Other assets	103
Forward sale commitments	13,187		Other liabilities	(54)		8,969		Other assets	1
Total derivatives not designated as hedging instruments				$	915				$	104

The following tables summarize the effect of the Company's derivative financial instruments on OCI and net income for the three and six months ended June 30, 2020 and 2019:


	Amount of Loss Recognized in OCI on Derivative						Amount of Loss Recognized in OCI on Derivative
	Three Months Ended June 30,						Six Months Ended June 30,
	2020		2019		2020		2019
Derivatives in cash flow hedging relationships:
Interest rate products	$	(842)	$	—	$	(2,101)	$	—
Total	$	(842)	$	—	$	(2,101)	$	—


	Amount of Loss Reclassified from Accumulated OCI into Income						Amount of Loss Reclassified from AOCI into Income			Location of Loss Recognized from AOCI into Income
	Three Months Ended June 30,						Six Months Ended June 30,
	2020		2019		2020		2019
Derivatives in cash flow hedging relationships:
Interest rate products	$	(121)	$	—	$	(125)	$	—	Interest expense
Total	$	(121)	$	—	$	(125)	$	—


	Amount of Gain (Loss) Recognized in Income						Amount of Gain (Loss) Recognized in Income			Location of Gain (Loss) Recognized in Income
	Three Months Ended June 30,						Six Months Ended June 30,
	2020		2019		2020		2019
Derivatives not designated as hedging instruments:
Interest rate products	$	(17)	$	—	$	(17)	$	—	Other operating expenses
Interest rate lock commitments with customers	551		—		883		—		Mortgage banking activities
Forward sale commitment	141		—		(197)		—		Mortgage banking activities
Total	$	675	$	—	$	669	$	—

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The following table is a summary of interest rate swap components at June 30, 2020 and December 31, 2019:


	June 30, 2020		December 31, 2019
Weighted average pay rate	0.54	%	—	%
Weighted average receive rate	0.08	%	—	%
Weighted average maturity in years	5.7		—

NOTE 9.10. SHAREHOLDERS’ EQUITY AND REGULATORY CAPITAL

Banks and bank holding companies are subject to regulatory capital requirements administered by federal banking agencies. Capital adequacy guidelines and, additionally for banks, prompt corrective action regulations, involve quantitative measures of assets, liabilities and certain off-balance sheet items calculated under regulatory accounting practices. Capital amounts and classifications are also subject to qualitative judgments by regulators. Failure to meet capital requirements can initiate regulatory action. Under the Basel Committee on Banking Supervision's capital guidelines for U.S. Banks ("Basel III rules"), an entity must hold a capital conservation buffer above the adequately capitalized risk-based capital ratios. The ~~required capital conservation buffer was 1.875%~~Company and the Bank have elected not to include net unrealized gain or loss on available for ~~2018 and is 2.50% for 2019 under phase-in rules which were completed~~sale securities in ~~2019.~~computing regulatory capital.

The consolidated asset limit on small bank holding companies is ~~$3,000,000,000~~$3.0 billion and a company with assets under that limit is not subject to the FRB consolidated capital rules, but may file reports that include capital amounts and ratios. The Company has elected to file those reports.

Management believes that the Company and the Bank met all capital adequacy requirements to which they are subject at June 30, ~~2019~~2020 and December 31, ~~2018.~~2019.

At June 30, 2019, the most recent regulatory notifications categorized the Bank as well capitalized under the regulatory framework for prompt corrective action. There are no conditions or events since that notification that management believes have changed the Bank's classification. Prompt corrective action regulations provide five classifications: well capitalized, adequately capitalized, undercapitalized, significantly undercapitalized and critically undercapitalized, although these terms are not used to represent overall financial condition. If adequately capitalized, regulatory approval is required to accept brokered deposits. If undercapitalized, capital distributions are limited, as is asset growth and expansion, and capital restoration plans are required.

At June 30, 2020, the most recent regulatory notifications categorized the Bank as well capitalized under the regulatory framework for prompt corrective action. There are no conditions or events since that notification that management believes have changed the Bank's classification.

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The following table presents capital amounts and ratios at June 30, ~~2019~~2020 and December 31, ~~2018.~~2019:

Actual For Capital Adequacy Purposes
(includes applicable capital conservation buffer) To Be Well
Capitalized Under
Prompt Corrective Action Provisions
(Dollars in thousands) Amount Ratio Amount Ratio Amount Ratio
June 30, 2019
Total Capital to risk weighted assets
Consolidated $ 235,676 14.1 % $ 175,939 10.5 % n/a n/a
Bank 218,046 13.0 % 175,859 10.5 % $ 167,485 10.0 %
Tier 1 Capital to risk weighted assets
Consolidated 188,207 11.2 % 142,427 8.5 % n/a n/a
Bank 202,398 12.1 % 142,362 8.5 % 133,988 8.0 %
Common Tier 1 (CET1) to risk weighted assets
Consolidated 188,207 11.2 % 117,293 7.0 % n/a n/a
Bank 202,398 12.1 % 117,239 7.0 % 108,865 6.5 %
Tier 1 Capital to average assets
Consolidated 188,207 8.5 % 88,973 4.0 % n/a n/a
Bank 202,398 8.6 % 94,303 4.0 % 117,879 5.0 %
December 31, 2018
Total Capital to risk weighted assets
Consolidated $ 206,988 15.6 % $ 131,393 9.875 % n/a n/a
Bank 177,892 13.4 % 131,286 9.875 % $ 132,948 10.0 %
Tier 1 Capital to risk weighted assets
Consolidated 160,117 12.0 % 104,782 7.875 % n/a n/a
Bank 162,880 12.3 % 104,696 7.875 % 106,358 8.0 %
Common Tier 1 (CET1) to risk weighted assets
Consolidated 160,117 12.0 % 84,823 6.375 % n/a n/a
Bank 162,880 12.3 % 84,754 6.375 % 86,416 6.5 %
Tier 1 Capital to average assets
Consolidated 160,117 8.4 % 76,089 4.0 % n/a n/a
Bank 162,880 8.6 % 76,113 4.0 % 95,142 5.0 %


	Actual						For Capital Adequacy Purposes (includes applicable capital conservation buffer)						To Be Well Capitalized Under Prompt Corrective Action Provisions
	Amount		Ratio		Amount		Ratio		Amount		Ratio
June 30, 2020
Total risk-based capital:
Orrstown Financial Services, Inc.	$	256,183	14.5	%	$	185,262	10.5	%	n/a		n/a
Orrstown Bank	244,669		13.9	%	185,169		10.5	%	$	176,352	10.0	%
Tier 1 risk-based capital:
Orrstown Financial Services, Inc.	205,582		11.7	%	149,974		8.5	%	n/a		n/a
Orrstown Bank	225,943		12.8	%	149,899		8.5	%	141,081		8.0	%
Tier 1 common equity risk-based capital:
Orrstown Financial Services, Inc.	205,582		11.7	%	123,508		7.0	%	n/a		n/a
Orrstown Bank	225,943		12.8	%	123,446		7.0	%	114,629		6.5	%
Tier 1 leverage capital:
Orrstown Financial Services, Inc.	205,582		7.6	%	107,855		4.0	%	n/a		n/a
Orrstown Bank	225,943		8.4	%	107,901		4.0	%	134,876		5.0	%
December 31, 2019
Total risk-based capital:
Orrstown Financial Services, Inc.	$	244,003	14.1	%	$	182,028	10.5	%	n/a		n/a
Orrstown Bank	231,805		13.4	%	181,948		10.5	%	$	173,284	10.0	%
Tier 1 risk-based capital:
Orrstown Financial Services, Inc.	196,451		11.3	%	147,356		8.5	%	n/a		n/a
Orrstown Bank	216,100		12.5	%	147,291		8.5	%	138,627		8.0	%
Tier 1 common equity risk-based capital:
Orrstown Financial Services, Inc.	196,451		11.3	%	121,352		7.0	%	n/a		n/a
Orrstown Bank	216,100		12.5	%	121,299		7.0	%	112,635		6.5	%
Tier 1 leverage capital:
Orrstown Financial Services, Inc.	196,451		8.6	%	91,782		4.0	%	n/a		n/a
Orrstown Bank	216,100		9.4	%	91,798		4.0	%	114,747		5.0	%

In September 2015, the Board of Directors of the Company authorized a share repurchase program under which the Company may repurchase up to 5% of the Company's outstanding shares of common stock, or approximately 416,000 shares, in accordance with all applicable securities laws and regulations, including Rule 10b-18 of the Exchange Act of 1934, as amended. When and if appropriate, repurchases may be made in open market or privately negotiated transactions, depending on market conditions, regulatory requirements and other corporate considerations, as determined by management. Share repurchases may not occur and may be discontinued at any time. At June 30, ~~2019, 82,725~~2020, 154,680 shares had been repurchased under the program at a total cost of ~~$1,438,000,~~$2.6 million, or ~~$17.38~~$16.88 per share.

On July ~~24, 2019,~~21, 2020, the Board declared a cash dividend of ~~$0.15~~$0.17 per common share, which will be paid on August ~~12, 2019~~10, 2020 to shareholders of record at August ~~5, 2019.~~

3, 2020.

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NOTE ~~10.~~11. EARNINGS PER SHARE

The following table presents earnings per share for the three and six months ended June 30, ~~2019~~2020 and ~~2018.~~2019:


		Three Months Ended June 30,						Six Months Ended June 30,							Three Months Ended June 30,				Six Months Ended June 30,
(In thousands, except per share information)		2019		2018		2019		2018
											2020		2019		2020		2019
Net income	Net income	$	2,687	$	4,012	$	5,789	$	7,637	Net income	$	6,359	$	2,687	$	11,427	$	5,789
Weighted average shares outstanding - basic	Weighted average shares outstanding - basic	10,348		8,094		9,757		8,088		Weighted average shares outstanding - basic	10,916		10,348		10,937		9,757
Dilutive effect of share-based compensation	Dilutive effect of share-based compensation	166		189		166		187		Dilutive effect of share-based compensation	77		166		90		166
Weighted average shares outstanding - diluted	Weighted average shares outstanding - diluted	10,514		8,283		9,923		8,275		Weighted average shares outstanding - diluted	10,993		10,514		11,027		9,923
Per share information:	Per share information:									Per share information:
Basic earnings per share	Basic earnings per share	$	0.26	$	0.50	$	0.59	$	0.94	Basic earnings per share	$	0.58	$	0.26	$	1.04	$	0.59
Diluted earnings per share	Diluted earnings per share	0.26		0.48		0.58		0.92		Diluted earnings per share	0.58		0.26		1.04		0.58

Average outstanding stock options ~~of 37,000~~ and ~~22,000~~restricted shares totaling 27,667 and 37,232 for the three months ended June 30, 2020 and 2019, ~~and 2018,~~respectively, and of ~~39,000~~29,113 and ~~24,000~~39,108 for the six months ended June 30, 2020 and 2019, ~~and 2018,~~respectively, were not included in the computation of earnings per share because the effect was antidilutive, due to the exercise price exceeding the average market price. The dilutive effect of share-based compensation in each period above relates principally to restricted stock awards.

NOTE ~~11.~~12. FINANCIAL INSTRUMENTS WITH OFF-BALANCE SHEET RISK

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

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


		Contract or Notional Amount							Contractual or Notional Amount
(Dollars in thousands)		June 30, 2019		December 31, 2018
							June 30, 2020		December 31, 2019
Commitments to fund:	Commitments to fund:					Commitments to fund:
Home equity lines of credit	Home equity lines of credit	$	197,374	$	160,971	Home equity lines of credit	$	215,471	$	205,502
1-4 family residential construction loans	1-4 family residential construction loans	29,312		13,002		1-4 family residential construction loans	18,836		19,812
Commercial real estate, construction and land development loans	Commercial real estate, construction and land development loans	30,839		31,133		Commercial real estate, construction and land development loans	28,505		19,018
Commercial, industrial and other loans	Commercial, industrial and other loans	181,780		147,518		Commercial, industrial and other loans	244,489		222,288
Standby letters of credit	Standby letters of credit	16,546		13,909		Standby letters of credit	10,684		10,588

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

Standby letters of credit and financial guarantees written are conditional commitments issued by the Company to guarantee the performance of a customer to a third party. Those guarantees are primarily issued to support public and private borrowing arrangements. The credit risk involved in issuing letters of credit is essentially the same as that involved in extending loans to customers. The Company holds collateral supporting those commitments when deemed necessary by management. The liability, at June 30, ~~2019~~2020 and December 31, ~~2018,~~2019, for guarantees under standby letters of credit issued was not material.

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The Company maintains a reserve, based on historical loss experience of the related loan class, for off-balance sheet credit exposures that currently are not funded, in other liabilities on the unaudited condensed consolidated balance sheets. This reserve totaled $1.2 million at June 30, 2020 and $1.0 million at December 31, 2019.

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NOTE ~~12.~~13. FAIR VALUE

Fair value is the exchange price that would be received for an asset or paid to transfer a liability (exit price) in the principal or most advantageous market for the asset or liability in an orderly transaction between market participants on the measurement date. Certain financial instruments and all non-financial instruments are excluded from disclosure requirements. Accordingly, the aggregate fair value amounts presented do not represent the underlying value of the Company.

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

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

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

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

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

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

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

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The Company had no0 fair value liabilities measured on a recurring basis at June 30, ~~2019~~2020 and December 31, ~~2018.~~2019.

The following table summarizes assets measured at fair value on a recurring basis at June 30, ~~2019~~2020 and December 31, ~~2018.~~2019:


(Dollars in Thousands)		Level 1		Level 2		Level 3		Total Fair Value Measurements
June 30, 2019
AFS Securities:
											Level 1		Level 2		Level 3		Total Fair Value Measurements
June 30, 2020										June 30, 2020
Investment securities:										Investment securities:

States and political subdivisions										States and political subdivisions	$	—	$	113,095	$	—	$	113,095
GSE residential MBSs										GSE residential MBSs	—		4,605		—		4,605
GSE residential CMOs										GSE residential CMOs	—		66,067		—		66,067
Nonagency CMOs										Nonagency CMOs	—		—		17,309		17,310

Private label commercial CMOs										Private label commercial CMOs	—		63,211		6,525		69,736
Asset-backed										Asset-backed	—		212,768		—		212,768
Other										Other	355		—		—		355
Loans held for sale										Loans held for sale	—		13,594		—		13,594
Interest rate swaps										Interest rate swaps	—		234		—		234
Interest rate lock commitments on residential mortgages										Interest rate lock commitments on residential mortgages	—		—		986		986
Totals										Totals	$	355	$	473,574	$	24,820	$	498,750

December 31, 2019										December 31, 2019
Investment securities:										Investment securities:

States and political subdivisions	States and political subdivisions	$	0	$	102,110	$	0	$	102,110	States and political subdivisions	$	—	$	87,863	$	—	$	87,863

GSE residential CMOs	GSE residential CMOs	0		72,421		0		72,421		GSE residential CMOs	—		68,154		—		68,154
Nonagency CMOs										Nonagency CMOs	—		—		17,087		17,087

Private label commercial CMOs	Private label commercial CMOs	0		87,098		7,330		94,428		Private label commercial CMOs	—		79,437		7,192		86,629
Asset-backed and other		0		227,971		0		227,971
Asset-backed										Asset-backed	—		230,515		—		230,515
Other										Other	637		—		—		637
Loans held for sale										Loans held for sale	—		9,364		—		9,364

Interest rate lock commitments on residential mortgages										Interest rate lock commitments on residential mortgages	—		—		103		103
Totals	Totals	$	0	$	489,600	$	7,330	$	496,930	Totals	$	637	$	475,333	$	24,382	$	500,352

December 31, 2018
AFS Securities:

States and political subdivisions		$	0	$	145,004	$	0	$	145,004

GSE residential CMOs		0		108,064		0		108,064

Private label residential CMOs		0		143		0		143
Private label commercial CMOs		0		67,836		7,209		75,045
Asset-backed and other		0		137,588		0		137,588
Totals		$	0	$	458,635	$	7,209	$	465,844

~~One private label commercial CMO was~~The Company has CMOs measured at fair value on a recurring basis using significant unobservable inputs (Level 3) at June 30, ~~2019~~2020 and December 31, 2018. Fair value for this investment totaled $7,330,000 at June 30, 2019 and $7,209,000 at December 31, 2018. The investment was purchased at $7,213,000. Premium amortization expense totaling $19,000 and $41,000 was included in earnings for the three and six months ended June 30, 2019, and an unrealized gain of $88,000 and $199,000 was recognized in other comprehensive income for the three and six months ended June 30, 2019. The Level 3 valuation is based on a non-executable broker quote, which is considered a significant unobservable input. Such quotes are updated as available and may remain constant for a period of time for certain broker-quoted securities that do not move with the market or that are not interest rate sensitive as a result of their structure or overall attributes.

Effective October 1, 2019, the Company’s residential mortgage loans held for sale were recorded at fair value utilizing Level 2 measurements. This fair value measurement is determined based upon third party quotes obtained on similar loans. For loans held for sale for which the fair value option has been elected, the aggregate fair value exceeded the aggregate principal balance by $407 thousand as of June 30, 2020.

The determination of the fair value of interest rate lock commitments on residential mortgages is based on agreed upon pricing with the respective investor on each loan and includes a pull through percentage. The pull through percentage represents an estimate of loans in the pipeline to be delivered to an investor versus the total loans committed for delivery. Significant changes in this input could result in a significantly higher or lower fair value measurement. As the pull through percentage is a significant unobservable input, this is deemed a Level 3 valuation input. The average pull through percentage, which is based upon historical experience, was 93% as of June 30, 2020. An increase or decrease of 5% in the pull through assumption would result in a positive or negative change of $57 thousand in the fair value of interest rate lock commitments at June 30, 2020.

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The following provides details of the Level 3 fair value measurement activity for the periods ended June 30, 2020 and 2019:

CMOs:


	Three Months Ended June 30,						Six Months Ended June 30,
	2020		2019		2020		2019
Balance, beginning of period	$	23,250	$	—	$	24,279	$	—


Unrealized gain (loss) included in OCI	532		—		(429)		—


Principal payments and other	52		—		(16)		—


Balance, end of period	$	23,834	$	—	$	23,834	$	—

Interest rate lock commitments on residential mortgages:


	Three Months Ended June 30,						Six Months Ended June 30,
	2020		2019		2020		2019
Balance, beginning of period	$	435	$	—	$	103	$	—
Total gains, realized/unrealized:
Included in earnings	551		—		883		—


Balance, end of period	$	986	$	—	$	986	$	—

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

Impaired Loans

Loans are designated as impaired when, in the judgment of management and based on current information and events, it is probable that all amounts due, according to the contractual terms of the loan agreement, will not be collected. The measurement of loss associated with impaired loans for all loan classes can be based on either the observable market price of the loan, the fair value of the collateral, or discounted cash flows ~~based on~~using a market rate of interest for performing TDRs. For collateral-dependent loans, fair value is measured based on the value of the collateral securing the loan, less estimated costs to sell. Collateral may be in the form of real estate or business assets including equipment, inventory, and accounts receivable. The value of the real estate collateral is determined utilizing an income or market valuation approach based on an appraisal conducted by an independent, licensed appraiser outside of the Company using observable market data (Level 2). However, if the collateral is a house or building in the process of construction, or if management adjusts the appraisal value, then the fair value is considered Level 3. The value of business equipment is based upon an outside appraisal, if deemed significant, or the net book value on the applicable business’ financial statements if not considered significant using observable market data. Likewise, values for inventory and accounts receivable collateral are based on financial statement balances or aging reports (Level 3). Impaired loans with an allocation to the ALL are measured at fair value on a nonrecurring basis. Any fair value adjustments are recorded in the period incurred as provision for loan losses on the unaudited condensed consolidated statements of income. ~~Specific allocations to the ALL or partial charge-offs totaled $910,000 and $928,000 at June 30, 2019 and December 31, 2018.~~

~~Table of Contents~~

~~The following table presents~~Any changes in the fair value ~~for~~of impaired loans still held ~~at June 30, considered in the determination of the provision for loan losses,~~were not material for the three and six months ended June 30, ~~2019~~2020 and ~~2018.~~2019:

Three months ended June 30, Six months ended June 30,
(Dollars in thousands) 2019 2018 2019 2018
Changes in fair value of impaired loans still held $ 24 $ 79 $ 28 $ 84

Foreclosed Real Estate

OREO property acquired through foreclosure is initially recorded at the fair value of the property at the transfer date less estimated selling cost. Subsequently, OREO is carried at the lower of its carrying value or the fair value less estimated selling cost. Fair value is usually determined based upon an independent third-party appraisal of the property or occasionally upon a recent sales offer. ~~Specific~~There were 0 charges recorded to the value of OREO at the lower of cost or fair value on properties held atduring the three and six months ended June 30, ~~2019~~2020 and ~~December 31, 2018 both totaled $0.~~2019. There were no0 changes in the fair value of OREO for properties, still held at June 30, that were charged to real estate expenses for the three and six months ended June 30, 2020 and 2019.

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Mortgage Servicing Rights

The MSR fair value is estimated to be equal to its carrying value, unless the quarterly valuation model calculates the present value of ~~OREO properties changed $13,000 for~~the estimated net servicing income is less than its carrying value, in which case an impairment charge is taken. At June 30, 2020 and December 31, 2019, an impairment reserve of $890 thousand and $70 thousand, respectively, existed on the mortgage servicing right portfolio. For the three months ended June 30, 2020 and 2019, impairment charges of $317 thousand and $0 were included, respectively, in mortgage banking activities on the unaudited condensed consolidated statements of income. For the six months ended June 30, ~~2018.~~2020 and 2019, impairment charges of $820 thousand and $0 were included, respectively, in mortgage banking activities on the unaudited condensed consolidated statements of income. The impairment charges resulted from rapidly declining market rates caused by the COVID-19 pandemic.

The following table summarizes assets measured at fair value on a nonrecurring basis at June 30, ~~2019~~2020 and December 31, ~~2018.~~2019:


(Dollars in thousands)		Level 1		Level 2		Level 3		Total Fair Value Measurements
June 30, 2019
											Level 1		Level 2		Level 3		Total Fair Value Measurements
June 30, 2020										June 30, 2020
Impaired Loans	Impaired Loans									Impaired Loans
Commercial real estate:	Commercial real estate:									Commercial real estate:
Owner occupied	Owner occupied	$	0	$	0	$	1,004	$	1,004	Owner occupied	$	—	$	—	$	892	$	892

Multi-family	Multi-family	0		0		114		114		Multi-family	—		—		80		80
Non-owner occupied residential	Non-owner occupied residential	0		0		243		243		Non-owner occupied residential	—		—		42		42

Commercial and industrial	Commercial and industrial	0		0		11		11		Commercial and industrial	—		—		211		211
Residential mortgage:	Residential mortgage:									Residential mortgage:
First lien	First lien	0		0		787		787		First lien	—		—		885		885

Home equity - lines of credit	Home equity - lines of credit	0		0		335		335		Home equity - lines of credit	—		—		179		179
Installment and other loans	Installment and other loans	0		0		8		8		Installment and other loans	—		—		7		7
Total impaired loans	Total impaired loans	$	0	$	0	$	2,502	$	2,502	Total impaired loans	$	—	$	—	$	2,296	$	2,296

Mortgage servicing rights										Mortgage servicing rights	$	—	$	—	$	2,501	$	2,501

December 31, 2018
December 31, 2019										December 31, 2019
Impaired Loans	Impaired Loans									Impaired Loans
Commercial real estate:	Commercial real estate:									Commercial real estate:
Owner occupied	Owner occupied	$	0	$	0	$	1,087	$	1,087	Owner occupied	$	—	$	—	$	938	$	938

Multi-family	Multi-family	0		0		131		131		Multi-family	—		—		96		96
Non-owner occupied residential	Non-owner occupied residential	0		0		278		278		Non-owner occupied residential	—		—		103		103

Commercial and industrial	Commercial and industrial	0		0		25		25		Commercial and industrial	—		—		11		11
Residential mortgage:	Residential mortgage:									Residential mortgage:
First lien	First lien	0		0		1,121		1,121		First lien	—		—		641		641

Home equity - lines of credit	Home equity - lines of credit	0		0		409		409		Home equity - lines of credit	—		—		400		400

Installment and other loans										Installment and other loans	—		—		7		7
Total impaired loans	Total impaired loans	$	0	$	0	$	3,051	$	3,051	Total impaired loans	$	—	$	—	$	2,196	$	2,196

Mortgage servicing rights										Mortgage servicing rights	$	—	$	—	$	3,119	$	3,119

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

~~(Dollars in thousands)~~

Fair Value
Estimate

Valuation
Techniques

~~Unobservable Input~~

~~Range~~

~~June 30, 2019~~

~~Impaired loans~~

~~2,502~~

Appraisal of
collateral

~~Management adjustments on appraisals for property type and recent activity~~

~~5% - 25% discount~~

~~- Management adjustments for liquidation expenses~~

~~6% - 33% discount~~

~~December 31, 2018~~

~~Impaired loans~~

~~3,051~~

Appraisal of
collateral

~~Management adjustments on appraisals for property type and recent activity~~

~~5% - 75% discount~~

~~- Management adjustments for liquidation expenses~~

~~6% - 20% discount~~

Fair Value
Estimate

Valuation
Techniques

Unobservable Input

Range

June 30, 2020

Impaired loans

2,296

Appraisal of collateral

Management adjustments on appraisals for property type and recent activity

0% - 20% discount

- Management adjustments for liquidation expenses

6%- 33% discount

Mortgage servicing rights

2,501

Discounted cash flows

Weighted average CPR

15.16%

- Weighted average discount rate

9.59%

December 31, 2019

Impaired loans

2,196

Appraisal of collateral

Management adjustments on appraisals for property type and recent activity

0% - 20% discount

- Management adjustments for liquidation expenses

6% - 33% discount

Mortgage servicing rights

3,119

Discounted cash flows

Weighted average CPR

11.63%

- Weighted average discount rate

9.54%

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Fair values of financial instruments

The following table presents carrying amounts and estimated fair values of the Company’s financial instruments at June 30, ~~2019~~2020 and December 31, ~~2018:~~2019:


(Dollars in thousands)		Carrying Amount		Fair Value		Level 1		Level 2		Level 3
June 30, 2019
													Carrying Amount		Fair Value		Level 1		Level 2		Level 3
June 30, 2020												June 30, 2020
Financial Assets	Financial Assets											Financial Assets
Cash and due from banks	Cash and due from banks	$	35,468	$	35,468	$	35,468	$	0	$	0	Cash and due from banks	$	26,652	$	26,652	$	26,652	$	—	$	—
Interest-bearing deposits with banks	Interest-bearing deposits with banks	72,670		72,670		72,670		0		0		Interest-bearing deposits with banks	25,638		25,638		25,638		—		—
Federal Funds Sold		8,741		8,741		8,741		0		0

Restricted investments in bank stocks	Restricted investments in bank stocks	10,105		n/a		n/a		n/a		n/a		Restricted investments in bank stocks	16,256		n/a		n/a		n/a		n/a
AFS securities		496,930		496,930		0		489,600		7,330
Investment securities												Investment securities	483,936		483,936		—		460,102		23,834
Loans held for sale	Loans held for sale	7,152		7,344		0		7,344		0		Loans held for sale	13,594		13,594		—		13,594		—
Loans, net of allowance for loan losses	Loans, net of allowance for loan losses	1,587,210		1,617,064		0		0		1,617,064		Loans, net of allowance for loan losses	2,023,800		2,007,374		—		—		2,007,374
Interest rate lock commitments on residential mortgages												Interest rate lock commitments on residential mortgages	986		986		—		—		986
Interest rate swaps												Interest rate swaps	234		234		—		234		—
Accrued interest receivable	Accrued interest receivable	6,558		6,558		0		1,943		4,615		Accrued interest receivable	8,182		8,182		—		1,750		6,432

Financial Liabilities	Financial Liabilities											Financial Liabilities
Deposits	Deposits	2,015,541		2,013,623		0		2,013,623		0		Deposits	2,251,731		2,255,147		—		2,255,147		—
Short-term borrowings		9,373		9,373		0		9,373		0
Long-term debt		83,261		83,550		0		83,550		0
Securities sold under agreements to repurchase												Securities sold under agreements to repurchase	23,716		23,716		—		23,716		—
FHLB Advances												FHLB Advances	202,804		203,100		—		203,100		—
Subordinated notes	Subordinated notes	31,821		33,276		0		33,276		0		Subordinated notes	31,875		32,436		—		32,436		—
Interest rate swaps												Interest rate swaps	2,227		2,227		—		2,227		—
Accrued interest payable	Accrued interest payable	1,979		1,979		0		1,979		0		Accrued interest payable	441		441		—		441		—
Off-balance sheet instruments		0		0		0		0		0

December 31, 2018

December 31, 2019												December 31, 2019
Financial Assets	Financial Assets											Financial Assets
Cash and due from banks	Cash and due from banks	$	26,156	$	26,156	$	26,156	$	0	$	0	Cash and due from banks	$	25,969	$	25,969	$	25,969	$	—	$	—
Interest-bearing deposits with banks	Interest-bearing deposits with banks	45,664		45,664		45,664		0		0		Interest-bearing deposits with banks	30,493		30,493		30,493		—		—
Federal Funds Sold		16,995		16,995		16,995		0		0

Restricted investments in bank stocks	Restricted investments in bank stocks	10,842		n/a		n/a		n/a		n/a		Restricted investments in bank stocks	16,184		n/a		n/a		n/a		n/a
AFS securities		465,844		465,844		0		458,635		7,209
Investment securities												Investment securities	490,386		490,386		—		466,107		24,279
Loans held for sale	Loans held for sale	3,340		3,413		0		3,413		0		Loans held for sale	9,364		9,364		—		9,364		—
Loans, net of allowance for loan losses	Loans, net of allowance for loan losses	1,233,643		1,229,645		0		0		1,229,645		Loans, net of allowance for loan losses	1,629,675		1,652,788		—		—		1,652,788
Interest rate lock commitments on residential mortgages												Interest rate lock commitments on residential mortgages	103		103		—		—		103
Accrued interest receivable	Accrued interest receivable	5,927		5,927		0		2,853		3,074		Accrued interest receivable	6,040		6,040		—		1,863		4,177

Financial Liabilities	Financial Liabilities											Financial Liabilities
Deposits	Deposits	1,558,756		1,555,912		0		1,555,912		0		Deposits	1,875,522		1,876,555		—		1,876,555		—
Short-term borrowings		64,069		64,069		0		64,069		0
Long-term debt		83,450		82,951		0		82,951		0
Securities sold under agreements to repurchase												Securities sold under agreements to repurchase	8,269		8,269		—		8,269		—
FHLB Advances												FHLB Advances	209,667		210,005		—		210,005		—
Subordinated notes	Subordinated notes	31,859		31,256		0		31,256		0		Subordinated notes	31,847		33,953		—		33,953		—
Accrued interest payable	Accrued interest payable	1,301		1,301		0		1,301		0		Accrued interest payable	879		879		—		879		—
Off-balance sheet instruments		0		0		0		0		0

~~Table~~The methods used to estimate the fair value of ~~Contents~~financial instruments at June 30, 2020 did not necessarily represent an exit price. In accordance with the Company's adoption of ASU 2016-01,

~~The~~Financial Instruments – Overall (Subtopic 825-10): Recognition and Measurement of Financial Assets and Financial Liabilities, the methods utilized to measure the fair value of financial instruments at June 30, ~~2019 and December 31, 2018 represent~~2020 represents an approximation of exit price; however, an actual exit price may differ.

~~NOTE 13. REVENUE FROM CONTRACTS WITH CUSTOMERS~~

All of the Company's revenue from contracts with customers within the scope of ASC 606 is recognized within noninterest income on the consolidated statements of income. Consistent with ASC 606, noninterest income covered by this guidance is recognized as services are transferred to our customers in an amount that reflects the consideration we expect to be entitled to in exchange for those services.

~~Service Charges on Deposit Accounts~~ - The Company earns fees from its deposit customers for transaction-based, account maintenance, and overdraft services. Transaction-based fees, which include services such as ATM use fees, stop payment charges, statement rendering, and ACH fees, are recognized at the time the transaction is executed, as that is the point in time the Company fulfills the customer's request. Account maintenance fees, which relate primarily to monthly maintenance, are earned over the course of a month, representing the period over which the Company satisfies the performance obligation. Overdraft fees are recognized at the point in time that the overdraft occurs. Service charges on deposits are withdrawn from the customer's account balance.

~~Interchange Income~~
- The Company earns interchange fees from debit/credit cardholder transactions conducted through the MasterCard payment network. Interchange fees from cardholder transactions represent a percentage of the underlying transaction value and are recognized daily, concurrently with the transaction processing services provided to the cardholder. Interchange income is presented net of cardholder rewards.

~~Wealth Management and Investment Advisory Income (Gross)~~ - The Company earns wealth management and investment brokerage fees from its contracts with trust and wealth management customers to manage assets for investment, and/or to transact on their accounts. Asset management fees are primarily earned over time as the Company provides the contracted services and are generally assessed based on a tiered scale of the market value of assets under management. Fees that are transaction based, including trade execution services, are recognized at the point in time that the transaction is executed, i.e., the trade date. Other related services provided included financial planning services, and the fees the Company earns for such services, which are based on a fixed fee schedule, are recognized when the services are rendered. Services are generally billed in arrears and a receivable is recorded until fees are paid.

~~Investment Brokerage Income (Net)~~ - The Company earns fees from investment management and brokerage services provided to its customers through a third-party service provider. The Company receives commissions from the third-party service provider and recognizes income on a weekly basis based upon customer activity. Because the Company acts as an agent in arranging the relationship between the customer and the third-party service provider and does not control the services rendered to the customers, investment brokerage income is presented net of related costs.

~~Gains/Losses on Sales of OREO~~ - The Company records a gain or loss on the sale of OREO when control of the property transfers to the buyer, which generally occurs at the time of an executed deed. If the Company finances the sale of OREO to the buyer, the Company assesses whether the buyer is committed to perform their obligations under the contract and whether collectability of the transaction price is probable. Once these criteria are met, the OREO asset is derecognized and the gain or loss on sale is recorded upon the transfer of control of the property to the buyer. In determining the gain or loss on the sale, the Company adjusts the transaction price and related gain (loss) on sale if a significant financing component is present.

~~At June 30, 2019 and December 31, 2018, the Company had receivables from customers totaling $728,000 and $640,000.~~

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~~The following table presents our noninterest income disaggregated by revenue source for the three and six months ended June 30, 2019 and 2018.~~

Three Months Ended Six Months Ended
(Dollars in thousands) June 30, 2019 June 30, 2018 June 30, 2019 June 30, 2018
Noninterest income
Service charges on deposits $ 935 $ 835 $ 1,777 $ 1,673
Trust and investment management income 1,749 1,701 3,507 3,369
Brokerage income 672 501 1,150 1,059
Merchant and bankcard fees (interchange income) 843 711 1,579 1,366
Revenue from contracts with customers 4,199 3,748 8,013 7,467
Other service charges 248 606 400 780
Mortgage banking activities 652 679 1,120 1,314
Income from life insurance 684 291 1,026 568
Other income 32 135 144 216
Investment securities gains 2,064 46 2,403 862
Total noninterest income $ 7,879 $ 5,505 $ 13,106 $ 11,207

NOTE 14. CONTINGENCIES

The nature of the Company’s business generates a certain amount of litigation involving matters arising out of the ordinary course of business. Except as described below, in the opinion of management, there are no0 legal proceedings that might have a material effect on the results of operations, liquidity, or the financial position of the Company at this time.

On March 5, 2019, Paul Parshall, a purported individual stockholder of Hamilton, filed, on behalf of himself and all of Hamilton’s stockholders other than the named defendants and their affiliates (the “Purported Class”), a derivative and putative class action complaint in the Circuit Court for Baltimore City, Maryland, captioned Paul Parshall v. Carol Coughlin et. al., naming each Hamilton director, Orrstown, and Hamilton as defendants (the “Action”). The Action alleged, among other things, that Hamilton’s directors breached their fiduciary duties to the Purported Class in connection with the merger, and that the Proxy Statement/Prospectus omitted certain material information regarding the merger. Orrstown was alleged to have aided and abetted the Hamilton directors’ alleged breaches of their fiduciary duties. The Action sought, among other remedies, to enjoin the merger or, in the event the merger was completed, rescission of the merger or rescissory damages; unspecified damages; and costs of the lawsuit, including attorneys’ and experts’ fees. A settlement was reached on the Action in March 2020 which resulted in a payment by the Company of $135 thousand in mootness fees to the defendants in April 2020.

On May 25, 2012, SEPTA filed a putative class action complaint in the U.S. District Court for the Middle District of Pennsylvania against the Company, the Bank and certain current and former directors and executive officers (collectively, the ~~“Defendants”~~“Orrstown Defendants”). The complaint alleges, among other things, that (i) in connection with the Company’s Registration Statement on Form S-3 dated February 23, 2010 and its Prospectus Supplement dated March 23, 2010, and (ii) during the purported class period of March 24, 2010 through October 27, 2011, the Company issued materially false and misleading statements regarding the Company’s lending practices and financial results, including misleading statements concerning the stringent nature of the Bank’s credit practices and underwriting standards, the quality of its loan portfolio, and the intended use of the proceeds from the Company’s March 2010 public offering of common stock. The complaint asserts claims under Sections 11, 12(a) and 15 of the Securities Act of 1933, Sections 10(b) and 20(a) of the Securities Exchange Act of 1934 and Rule 10b-5 promulgated thereunder, and seeks class certification, unspecified money damages, interest, costs, fees and equitable or injunctive relief. Under the Private Securities Litigation Reform Act of 1995 (“PSLRA”), motions for appointment of Lead Plaintiff in this case were due by July 24, 2012. SEPTA was the sole movant and the Court appointed SEPTA Lead Plaintiff on August 20, 2012.

Pursuant to the PSLRA and the Court’s September 27, 2012 Order, SEPTA was given until October 26, 2012 to file an amended complaint and the Orrstown Defendants until December 7, 2012 to file a motion to dismiss the amended complaint. SEPTA’s opposition to the ~~Defendant’s~~Orrstown Defendants’ motion to dismiss was originally due January 11, 2013. Under the PSLRA, discovery and all other proceedings in the case were stayed pending the Court’s ruling on the motion to dismiss. The September 27, 2012 Order specified that if the motion to dismiss were denied, the Court would schedule a conference to address discovery and the filing of a motion for class certification. On October 26, 2012, SEPTA filed an unopposed motion for enlargement of time to file its amended complaint in order to permit the parties and new defendants to be named in the amended complaint time to discuss plaintiff’s claims and defendants’ defenses. On October 26, 2012, the Court granted SEPTA’s motion, mooting its September 27, 2012 scheduling Order, and requiring SEPTA to file its amended complaint on or before January 16, 2013 or otherwise advise the Court of circumstances that require a further enlargement of time. On January 14, 2013, the Court granted SEPTA’s second unopposed motion for enlargement of time to file an amended complaint on or before March 22, 2013.

On March 4, 2013, SEPTA filed an amended complaint. The amended complaint ~~expands~~expanded the list of defendants in the action to include the Company’s former independent registered public accounting firm, Smith Elliott Kearns & Company, LLC (“SEK”), and the underwriters of the Company’s March 2010 public offering of common stock. In addition, among other things, the amended complaint extends the purported 1934 Exchange Act class period from March 15, 2010 through April 5, 2012. Pursuant to the Court’s March 28, 2013 Second Scheduling Order, on May 28, 2013, all defendants filed their motions to dismiss the amended complaint, and on July 22, 2013, SEPTA filed its “omnibus” opposition to all of the defendants’ motions to dismiss. On August 23, 2013, all defendants filed

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reply briefs in further support of their motions to dismiss. On December 5, 2013, the Court ordered oral argument on the Orrstown Defendants’ motion to dismiss the amended complaint to be heard on February 7, 2014. Oral argument on the pending motions to dismiss SEPTA’s amended complaint was held on April 29, 2014.

The Second Scheduling Order stayed all discovery in the case pending the outcome of the motions to dismiss, and informed the parties that, if required, a telephonic conference to address discovery and the filing of SEPTA’s motion for class certification would be scheduled after the Court’s ruling on the motions to dismiss.

On April 10, 2015, pursuant to Court order, all parties filed supplemental briefs addressing the impact of the U.S. Supreme Court’s March 24, 2015 decision in Omnicare, Inc. v. Laborers District Council Construction Industry Pension Fund on defendants’ motions to dismiss the amended complaint.

On June 22, 2015, in a 96-page Memorandum, the Court dismissed without prejudice SEPTA’s amended complaint against all defendants, finding that SEPTA failed to state a claim under either the Securities Act of 1933, as amended, or the

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Securities Exchange Act of 1934, as amended. The Court ordered that, within 30 days, SEPTA either seek leave to amend its amended complaint, accompanied by the proposed amendment, or file a notice of its intention to stand on the amended complaint.

On July 22, 2015, SEPTA filed a motion for leave to amend under Local Rule 15.1, and attached a copy of its proposed second amended complaint to its motion. Many of the allegations of the proposed second amended complaint are essentially the same or similar to the allegations of the dismissed amended complaint. The proposed second amended complaint also alleges that the Orrstown Defendants did not publicly disclose certain alleged failures of internal controls over loan underwriting, risk management, and financial reporting during the period 2009 to 2012, in violation of the federal securities laws. On February 8, 2016, the Court granted SEPTA’s motion for leave to amend and SEPTA filed its second amended complaint that same day.

On February 25, 2016, the Court issued a scheduling Order directing: all defendants to file any motions to dismiss by March 18, 2016; SEPTA to file an omnibus opposition to defendants’ motions to dismiss by April 8, 2016; and all defendants to file reply briefs in support of their motions to dismiss by April 22, 2016. Defendants timely filed their motions to dismiss the second amended complaint and the parties filed their briefs in accordance with the Court-ordered schedule, above. The February 25, 2016 Order stays all discovery and other deadlines in the case (including the filing of SEPTA’s motion for class certification) pending the outcome of the motions to dismiss.

The allegations of SEPTA’s second amended complaint disclosed the existence of a confidential, non-public, fact-finding inquiry regarding the Company being conducted by the SEC. As disclosed in the Company’s Form 8-K filed on September 27, 2016, on that date the Company entered into a settlement agreement with the SEC resolving the investigation of accounting and related matters at the Company for the periods ended June 30, 2010 to December 31, 2011. As part of the settlement of the SEC’s administrative proceedings and pursuant to the cease-and-desist order, without admitting or denying the SEC’s findings, the Company, its Chief Executive Officer, its former Chief Financial Officer, its former Executive Vice President and Chief Credit Officer, and its Chief Accounting Officer, agreed to pay civil money penalties to the SEC. The Company agreed to pay a civil money penalty of ~~$1,000,000.~~$1.0 million. The Company had previously established a reserve for that amount which was expensed in the second fiscal quarter of 2016. In the settlement agreement with the SEC, the Company also agreed to cease and desist from committing or causing any violations and any future violations of Securities Act Sections 17(a)(2) and 17(a)(3) and Exchange Act Sections 13(a), 13(b)(2)(A) and 13(b)(2)(B), and Rules 12b-20, 13a-1 and 13a-13 promulgated thereunder.

On September 27, 2016, the Orrstown Defendants filed with the Court a Notice of Subsequent Event in Further Support of their Motion to Dismiss the Second Amended Complaint, regarding the settlement with the SEC. The Notice attached a copy of the SEC’s cease-and-desist order and briefly described what the Company believed were the most salient terms of the neither-admit-nor-deny settlement. On September 29, 2016, SEPTA filed a Response to the Notice, in which SEPTA argued that the settlement with the SEC did not support dismissal of the second amended complaint.

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

On January 31, 2017, the Court entered a Case Management Order establishing the schedule for the litigation and, on August 15, 2017, it entered a revised Order that, among other things, set the following deadlines: all fact discovery ~~closes~~closed on March 1, 2018, and SEPTA’s motion for class certification iswas due the same day; expert merits discovery ~~closes~~closed May 30, 2018; summary judgment motions ~~are~~were due by June 26, 2018; the mandatory pretrial and settlement conference iswas set for December 11, 2018; and trial iswas scheduled to begin on January 7, 2019.

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On December 15, 2017, the Orrstown Defendants and SEPTA exchanged expert reports in opposition to and in support of class certification, respectively. On January 15, 2018, the parties exchanged expert rebuttal reports. SEPTA’s motion for class certification was due March 1, 2018, with the Orrstown Defendants’ opposition due April 2, 2018, and SEPTA’s reply due April 23, 2018.

On February 9, 2018, SEPTA filed a Status Report and Request for a Telephonic Status Conference asking the Court to convene a conference to discuss the status of discovery in the case and possible revisions to the case schedule. On February 12, 2018, the Orrstown Defendants filed their status report to provide the Court with a summary of document discovery in the case to date. On February 27, 2018, SEPTA filed an unopposed motion for a continuance of the existing case deadlines pending a status conference with the Court or the issuance of a revised case schedule. On February 28, 2018, the Court issued an Order continuing all case management deadlines until further order of the Court.

On March 27, 2018, the Court held a telephonic status conference with the parties to discuss outstanding discovery issues and case deadlines. On May 2, 2018, the parties filed a joint status report. On May 10, 2018, the Court held a follow-up

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telephonic status conference at which the parties reported on the progress of discovery to date. Party and non-party document discovery in the case has continued. To date, SEPTA has taken a few non-party depositions.

On August 9, 2018, SEPTA filed a motion to compel the production of Confidential Supervisory Information (CSI) of non-parties the Board of Governors of the Federal Reserve System (FRB) and the Pennsylvania Department of Banking and Securities, in the possession of Orrstown and third parties. On August 23, 2018, the Orrstown Defendants filed a response to the motion to compel. On August 30, 2018, the FRB filed an unopposed motion to intervene in the Action for the purpose of opposing SEPTA’s motion to compel, and on September 27, 2018, the FRB filed its brief in opposition to SEPTA’s motion. On October 11, 2018, SEPTA filed its reply brief in support of its motion to compel. On February 12, 2019, the Court denied SEPTA’s motion to compel the production of CSI on the ground that SEPTA had failed to exhaust its administrative remedies.

On April 11, 2019, SEPTA filed a motion for leave to file a third amended complaint. The proposed third amended complaint seeks to reassert the Securities Act claims that the Court dismissed as to all defendants on December 7, 2016, when the Court granted in part and denied in part defendants’ motions to dismiss SEPTA’s second amended complaint. The proposed third amended complaint also seeks to reassert the Exchange Act claims against those defendants that the Court dismissed from the case on December 7, 2016. Defendants’ briefs in opposition to SEPTA’s motion for leave to file a third amended complaint were filed on April 25, 2019. SEPTA filed a reply brief in further support of its motion for leave to file a third amended complaint on May 9, 2019. ~~That motion is pending.~~

On June 13, 2019, Orrstown filed a motion for protective order to stay discovery pending resolution of SEPTA’s motion for leave to file a third amended complaint. On June 19, 2019, former defendants ~~Smith Elliott Kearns & Company, LLC~~SEK and the underwriters of the Company’s March 2010 public offering joined in Orrstown’s motion for protective order. On June 25, 2019, SEPTA filed its opposition to Orrstown’s motion. On July 9, 2019, Orrstown filed a reply brief in further support of its motion. On July 17, 2019, the Court entered an Order partially granting Orrstown’s motion for protective order, ruling that all deposition discovery in the case is stayed pending a decision on SEPTA’s motion for leave to file a third amended complaint.

On February 14, 2020, the Court issued an Order and Memorandum granting SEPTA’s motion for leave to file a third amended complaint. The third amended complaint is now the operative complaint. It reinstates the Orrstown Defendants, as well as SEK and the underwriter defendants, previously dismissed from the case on December 7, 2016. The third amended complaint also revives the previously-dismissed 1933 Securities Act claim against the Orrstown Defendants, SEK, and the underwriter defendants. Under the Court-ordered briefing schedule, defendants filed their motions to dismiss the third amended complaint on April 24, 2020. SEPTA’s opposition was filed on July 8, 2020, and defendants’ reply briefs are due on August 12, 2020.

On February 24, 2020, the Orrstown Defendants, and the underwriter defendants and SEK, separately filed motions under 28 U.S.C. § 1292(b) asking the District Court to certify its February 14, 2020 Order for interlocutory appeal to the Third Circuit Court of Appeals. The District Court granted those motions on July 17, 2020, and defendants filed their Petition for Permission to Appeal with the Third Circuit on July 27, 2020. SEPTA’s opposition to the Petition is due by August 6, 2020.

The Company believes that the allegations of SEPTA’s ~~second amended complaint, and the allegations of the proposed~~ third amended complaint are without merit and intends to defend itself vigorously against those claims. It is not possible at this time to estimate reasonably possible losses, or even a range of reasonably possible losses, in connection with the litigation.

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~~See the Glossary of Defined Terms at the beginning of this Report for terms used throughout this Form 10-Q.~~

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

The following discussion and analysis is intended to assist readers in understanding the consolidated financial condition and results of operations of Orrstown and should be read in conjunction with the preceding unaudited condensed consolidated financial statements and notes thereto included in this Quarterly Report on Form 10-Q, as well as with the audited consolidated financial statements and notes thereto for the year ended December 31, 2019, included in our Annual Report on Form 10-K. Throughout this discussion, the yield on earning assets is stated on a fully taxable-equivalent basis and balances represent average daily balances unless otherwise stated. Certain prior period amounts presented in this discussion and analysis have been reclassified to conform to current period classifications.

Overview

The Company, headquartered in Shippensburg, Pennsylvania, is a one-bank holding company that has elected status as a financial holding company. The consolidated financial information presented herein reflects the Company and its wholly-owned subsidiaries, the Bank and Wheatland. At June 30, ~~2019,~~2020, the Company had total assets of ~~$2,399,508,000,~~$2.8 billion, total liabilities of ~~$2,179,640,000~~$2.5 billion and total shareholders’ equity of ~~$219,868,000.~~$225.6 million.

Caution About Forward-Looking Statements

Certain statements appearing herein, which are not historical in nature, are forward-looking statements within the meaning of the Private Securities Litigation Reform Act of 1995. In addition, we may make other written and oral communications, from time to time, that contain such statements. Such forward-looking statements refer to a future period or periods, reflecting our current beliefs as to likely future developments, and use words like “may,” “will,” “expect,” “estimate,” “anticipate” or similar terms. Forward-looking statements are statements that include projections, predictions, expectations, or beliefs about events or results or otherwise are not statements of historical facts, including, but not limited to, statements related to new business development, new loan opportunities, growth in the balance sheet and fee based revenue lines of business, merger and acquisition activity, reducing risk assets, and mitigating losses in the future. Actual results and trends could differ materially from those set forth in such statements and there can be no assurances that we will achieve the desired level of new business development and new loans, growth in the balance sheet and fee based revenue lines of business, successful merger and acquisition activity, continue to reduce risk assets or mitigate losses in the future. ~~Factors~~In addition to risks and uncertainties related to the COVID-19 pandemic and resulting governmental and societal responses, factors that could cause actual results to differ from those expressed or implied by the forward-looking statements include, but are not limited to, the following: ineffectiveness of the Company’s business strategy due to changes in current or future market conditions; the effects of competition, including industry consolidation and development of competing financial products and services; difficulty integrating the Company's strategic acquisitions; the inability to fully achieve expected savings, efficiencies or synergies from mergers and acquisitions, or taking longer than estimated for such savings, efficiencies and synergies to be realized; changes in laws and regulations; interest rate movements; changes in credit quality; inability to raise capital, if necessary, under favorable conditions; ~~volatilities~~volatility in the securities markets; deteriorating economic conditions; expenses associated with pending litigation and legal proceedings; the failure of the SBA to honor its guarantee of loans issued under the SBA PPP; and other risks and uncertainties, including those detailed in our Annual Report on Form 10-K for the year ended December 31, ~~2018,~~2019, and our Quarterly Reports on Form 10-Q under the sections titled “Risk Factors” and “Management’s Discussion and Analysis of Financial Condition and Results of Operations” and in other filings made with the SEC. The statements are valid only as of the date hereof and we disclaim any obligation to update this information.

Economic Climate and Market Conditions

The ~~following~~pace of U.S. economic growth weakened substantially late in the first quarter of 2020 and into the second quarter of 2020 as over 30 million people in the U.S filed for unemployment since mid-March 2020. Early in 2020, a novel coronavirus (“COVID-19”) emerged and spread, first in China and then around the globe. The fast spread of the virus and the fear that resulted combined to create a high level of uncertainty about the near and intermediate future economic outlook. Because of this uncertainty, markets were pricing in a wide range of potential outcomes by buying sovereign government bonds, especially U.S. Treasuries, and selling stocks and bonds not issued by sovereign governments. The COVID-19 pandemic has adversely affected, and is likely to continue to adversely affect, economic activity globally, nationally and locally. Actions taken around the world to help mitigate the spread of COVID-19 include restrictions on travel, quarantines in certain areas, and forced closures for certain types of public places and businesses, as well as shelter-in-place orders by many states.

Preliminary real GDP for the second quarter of 2020 resulted in a record decline of 32.9%. This is a ~~discussion~~substantial decrease from negative 5.0% for the first quarter of ~~our consolidated~~2020. The decline in second quarter GDP reflected the response to COVID-19, as shelter-in-place orders issued in March and April were partially lifted in some areas of the country in May and June, and government pandemic assistance payments were distributed to households and businesses. This led to shifts in economic activity, as businesses remained closed or operated remotely and consumers and businesses significantly reduced or redirected their spending. Actions taken to mitigate the spread of COVID-19 have had and are expected to continue to have an adverse

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impact on the economies and financial ~~condition~~markets of many countries, including the geographical area in which the Company operates.

Due to the COVID-19 pandemic, market interest rates have declined significantly, with the 10-year Treasury bond falling below 1.00% on March 3, 2020 for the first time and it was at 0.66% on June 30, ~~2019~~2020. On March 3, 2020, in reaction to the increase in uncertainty, the Federal Reserve cut the Fed Funds rates by 50 basis points between regularly scheduled meetings to a target range of 1.00% to 1.25%. On March 11, 2020, the World Health Organization declared COVID-19 a global pandemic. On March 13, 2020, a national emergency was declared by President Trump under the National Emergencies Act. On March 15, 2020, the Federal Reserve responded by again reducing the Fed Funds rate, this time by 100 basis points, to 0% to 0.25%. These reductions in interest rates and other effects of the COVID-19 pandemic may adversely affect the Company's financial condition and results of operations ~~for~~in future periods. It is unknown how long the ~~six months ended June 30, 2019~~adverse conditions associated with the COVID-19 pandemic will last and ~~2018. Throughout this discussion,~~what the ~~yield on earning assets~~complete financial effect will be to the Company. It is ~~stated on a fully taxable-equivalent basis and balances represent average daily balances unless otherwise stated. The discussion and analysis should be read~~reasonably foreseeable that estimates made in ~~conjunction with our unaudited consolidated~~the financial statements could be materially and ~~accompanying notes presented elsewhere~~adversely impacted in ~~this report. Certain prior period amounts, presented in this discussion~~the near term as a result of these conditions, including expected credit losses on loans and ~~analysis, may have been reclassified to conform to current period classifications.~~the fair value of financial instruments that are carried at fair value.

Critical Accounting Estimates

The Company’s accounting and reporting policies are in accordance with GAAP and follow accounting and reporting guidelines prescribed by bank regulatory authorities and general practices within the financial services industry in which it operates. Our financial position and results of operations are affected by management's application of accounting policies, including estimates, and assumptions and judgments that affect the amounts reported in the consolidated financial statements and accompanying notes. These estimates, assumptions, and judgments are based on information available as of the balance sheet date and through the date the financial statements are filed with the SEC. Different assumptions in the application of these policies could result in material changes in the consolidated financial position and/or consolidated results of operations and related disclosures. The more critical accounting estimates include accounting for credit losses and valuation methodologies. Accordingly, these critical accounting estimates are discussed in detail in "Management's Discussion and Analysis of Financial Condition and Results of Operations" in our Annual Report on Form 10-K for the year ended December 31, ~~2018.~~2019. Significant accounting policies and any changes in accounting principles and effects of new accounting pronouncements are discussed in Note 1, Summary of Significant Accounting Policies, to the Consolidated Financial Statements under Part II, Item 8, "Financial Statements and Supplementary Data," in our Annual Report on Form 10-K for the year ended December 31, ~~2018.~~2019. Additional disclosures regarding the effects of new accounting pronouncements are included in this report in Note 1, Summary of Significant Accounting Policies, to the ~~Consolidated Financial Statements~~unaudited condensed consolidated financial statements under Part I, Item 1, "Financial Information."

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RESULTS OF OPERATIONS

~~Quarter~~Three months ended June 30, ~~2019~~2020 compared with ~~quarter~~three months ended June 30, ~~2018~~2019

Summary

Net income totaled ~~$2,687,000~~$6.4 million for the three months ended June 30, ~~2019~~2020 compared with net income of ~~$4,012,000~~$2.7 million for the same period in ~~2018.~~2019. Diluted EPS for the three months ended June 30, ~~2019~~2020 totaled ~~$0.26,~~$0.58, compared with ~~$0.48~~$0.26 for the three months ended June 30, ~~2018.~~2019. Net interest income positively influenced results of operations, and totaled ~~$18,432,000~~$20.8 million for the three months ended June 30, ~~2019,~~2020, a ~~49.21%~~$2.3 million increase compared with ~~2018.~~2019. Noninterest income, excluding investment securities gains, totaled ~~$5,815,000~~$7.2 million for the three months ended June 30, ~~2019 and $5,459,000 for 2018.~~2020 compared with $5.7 million in 2019. Investment securities gains totaled ~~$2,064,000~~$9 thousand in the three months ended June 30, ~~2019,~~2020, compared with ~~$46,000~~net gains of $2.1 million for the same period in ~~2018.~~2019. Noninterest expenses totaled ~~$23,314,000~~$18.4 million and ~~$13,272,000~~$23.3 million for the three months ended June 30, 2020 and 2019, ~~and 2018. Noninterest expenses in 2019 included merger related expenses totaling $6,860,000 associated with the Company's ongoing growth strategy.~~respectively.

The comparability of operating results for 2020 with 2019 ~~with 2018 have~~has generally been impacted by ~~the Mercersburg acquisition, completed on October 1, 2018, and~~ the Hamilton acquisition completed on May 1, ~~2019.~~2019 and the SBA PPP loans originated in the three months ended June 30, 2020.

Net Interest Income

Net interest income increased ~~$6,079,000,~~by $2.3 million, from ~~$12,353,000~~$18.5 million to ~~$18,432,000,~~$20.8 million, for the three months ended June 30, ~~2019~~2020 compared with the ~~same period in 2018.~~three months ended June 30, 2019. Interest ~~and fees~~ income on loans increased ~~$7,822,000,~~by $2.1 million, from ~~$11,731,000~~$19.7 million to ~~$19,553,000,~~$21.8 million, securities interest income ~~increased $764,000,~~decreased $1.1 million, from ~~$3,547,000~~$4.3 million to ~~$4,311,000,~~$3.2 million, and total interest expense ~~increased $2,964,000~~decreased $1.7 million from ~~$2,971,000~~$6.0 million to ~~$5,935,000,~~$4.2 million, in comparing the three months ended June 30, ~~2019~~2020 with ~~2018.~~

the three months ended June 30, 2019.

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The following table presents net interest income, net interest spread and net interest margin for the three months ended June 30, ~~2019~~2020 and ~~2018~~2019 on a taxable-equivalent ~~basis.~~

Three Months Ended June 30, 2019 Three Months Ended June 30, 2018
(Dollars in thousands) Average Balance Taxable- Equivalent Interest Taxable- Equivalent Rate Average Balance Taxable- Equivalent Interest Taxable- Equivalent Rate
Assets
Federal funds sold & interest-bearing bank balances $ 84,843 $ 503 2.38 % $ 9,189 $ 46 2.01 %
Securities 496,803 4,479 3.62 470,993 3,815 3.25
Loans 1,497,445 19,677 5.27 1,055,562 11,825 4.49
Total interest-earning assets 2,079,091 24,659 4.76 1,535,744 15,686 4.10
Other assets 175,566 108,087
Total $ 2,254,657 $ 1,643,831
Liabilities and Shareholders’ Equity
Interest-bearing demand deposits $ 922,612 2,040 0.89 $ 741,161 $ 1,006 0.54
Savings deposits 146,063 81 0.22 99,407 39 0.16
Time deposits 575,660 2,749 1.92 300,576 1,116 1.49
Short-term borrowings 9,594 34 1.41 87,463 402 1.84
Long-term debt 97,161 532 2.19 83,686 408 1.96
Subordinated notes 31,819 499 6.28 0 0 0.00
Total interest-bearing liabilities 1,782,909 5,935 1.34 1,312,293 2,971 0.91
Noninterest-bearing demand deposits 235,046 172,813
Other 31,692 16,408
Total Liabilities 2,049,647 1,501,514
Shareholders’ Equity 205,010 142,317
Total $ 2,254,657 $ 1,643,831
Taxable-equivalent net interest income /net interest spread 18,724 3.42 % 12,715 3.19 %
Taxable-equivalent net interest margin 3.61 % 3.32 %
Taxable-equivalent adjustment (292) (362)
Net interest income $ 18,432 $ 12,353

~~Table notes: (1) Yields and interest income on tax-exempt assets have been computed on a taxable-equivalent basis assuming a 21% tax rate.~~

~~(2) For yield calculation purposes, nonaccruing loans are included in the average loan balance.~~basis:


	Three Months Ended June 30, 2020										Three Months Ended June 30, 2019
	Average Balance		Taxable- Equivalent Interest		Taxable- Equivalent Rate		Average Balance		Taxable- Equivalent Interest		Taxable- Equivalent Rate
Assets
Federal funds sold & interest-bearing bank balances	$	27,949	$	13	0.18	%	$	84,344	$	501	2.38	%


Securities ⁽¹⁾	493,847		3,327		2.71		497,302		4,481		3.61


Loans ^(1)(2)(3)	1,988,114		21,912		4.43		1,497,445		19,782		5.30
Total interest-earning assets	2,509,910		25,252		4.05		2,079,091		24,764		4.78


Other assets	200,684						175,566

Total	$	2,710,594					$	2,254,657
Liabilities and Shareholders’ Equity
Interest-bearing demand deposits	$	1,154,434	1,259		0.44		$	922,612	2,062		0.90
Savings deposits	160,738		63		0.16		153,235		89		0.23
Time deposits	462,664		1,988		1.73		568,488		2,741		1.93
Securities sold under agreements to repurchase	21,582		24		0.45		8,847		29		1.31
FHLB Advances and other	175,336		388		0.89		97,908		537		2.20
Subordinated notes	31,867		502		6.33		31,819		499		6.28
Total interest-bearing liabilities	2,006,621		4,224		0.85		1,782,909		5,957		1.34
Noninterest-bearing demand deposits	452,253						235,046
Other	36,511						31,692
Total Liabilities	2,495,385						2,049,647
Shareholders’ Equity	215,209						205,010
Total	$	2,710,594					$	2,254,657
Taxable-equivalent net interest income /net interest spread			21,028		3.20	%			18,807		3.44	%
Taxable-equivalent net interest margin					3.37	%					3.63	%
Taxable-equivalent adjustment			(230)						(292)
Net interest income			$	20,798					$	18,515


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

For the three months ended June 30, ~~2019,~~2020, taxable-equivalent basis net interest income increased ~~$6,009,000 from 2018.~~by $2.2 million compared with the three months ended June 30, 2019. The increase reflected ~~increased~~an increase of $430.8 million in average interest-earning assets ~~balances at increased market interest rates,~~ partially offset by ~~a higher~~an increase of $223.7 million in average ~~balance of~~ interest-bearing liabilities ~~at higher interest rates.~~from the three months ended June 30, 2019 to the three months ended June 30, 2020. These balances increased due to the SBA PPP loans originated in the three months ended June 30, 2020.

Taxable-equivalent interest income earned on ~~loans~~loans increased ~~$7,852,000~~by $2.1 million year-over-year. The ~~$441,883,000~~$490.7 million increase in average loan balance year-over-year primarily reflects average loans originated through the SBA PPP of $354.3 million during the three months ended June 30, 2020. The three months ended June 30, 2020 also reflects an extra month of loans from the Hamilton acquisition as compared to the same prior year period. For the three months ended June 30, 2020, interest income on loans includes ~~approximately $350,150,000~~$1.9 million of deferred fees recognized associated with the SBA PPP loans. A total of $13.2 million in net

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deferred fees were recorded for these loans ~~acquired~~to be recognized over the life of the loans, which is between two and five years. The yield on loans was 4.43% for the three months ended June 30, 2020 as compared to 5.30% for the three months ended June 30, 2019. This decline reflects a reduction in market interest rates on variable rate loans in the ~~Mercersburg and Hamilton transactions,~~portfolio as well as ~~continued growth in legacy and newer markets through sales efforts with additional loan officers. Increases in prime lending rates between June 30, 2018 and December 31, 2019,~~a lower yield on the SBA PPP loans, which contributed to ~~the 78~~13 basis ~~point increase in yield, but a flattened yield curve partially offset the benefit~~points of the ~~rate increases.~~decline. Accretion of purchase accounting adjustments ~~in connection with~~were $1.3 million for the ~~Mercersburg~~three months ended June 30, 2020 as compared to $1.2 million for the three months ended June 30, 2019. The three months ended June 30, 2020 and ~~Hamilton acquisitions increased second quarter~~ 2019 ~~interest income by $1,385,000. Interest income~~ included ~~$715,000~~$278 thousand and $530 thousand, respectively, of accelerated accretion related to the payoff of purchased credit impaired loans.

Taxable-equivalent securities interest income ~~increased $664,000~~decreased by $1.2 million year-over-year, with ~~the average balance of securities increasing $25,810,000 from June 30, 2018 to June 30, 2019, and~~ the taxable equivalent yield ~~increasing~~decreasing from ~~3.25%~~3.61% for the three months ended June 30, 2019 to ~~3.62%.~~2.71% for the three months ended June 30, 2020. The 3790 basis point ~~increase in the yield on securities year-over-year~~decrease in taxable-equivalent ~~interest income~~yield on securities reflected the ~~increased~~decreased interest rate environment between years and certain repositioning ~~within~~within the portfolio under the Company's asset/liability management strategies. The impact of the interest rate decline was partially offset by a decrease of $3.5 million in the average balance of securities from the three months ended June 30, 2019 to the three months ended June 30, 2020. As the Bank continues to execute its plan to grow relationship loans, it will work to reduce its investment portfolio to fund some of this loan growth through investment repayments.

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Interest expense on ~~deposits and borrowings increased $2,964,000~~interest-bearing liabilities decreased by $1.7 million year-over-year ~~with~~due to a decline of 49 basis points in the cost of interest-bearing liabilities. The impact of a significant decline in market interest rates was partially offset by the average balance of interest-bearing deposits increasing ~~$503,191,000~~by $133.5 million and the average balance of total borrowings ~~decreasing $32,575,000. In addition~~increasing by $90.2 million. The increase in these balances was due primarily to the ~~impact of~~SBA PPP loans originated during the ~~noted increased interest rate environment on interest expense,~~three months ended June 30, 2020. During the three months ended June 30, 2020, the Company ~~issued $32,500,000~~obtained funding through the Federal Reserve’s Paycheck Protection Program Liquidity Facility ("PPPLF") with an average balance of ~~6.0% subordinated notes in December 2018. Also,~~$3.2 million during ~~2019,~~ the ~~Company has experienced a gradual repricing~~three months ended June 30, 2020. The balance of ~~term~~deposits and ~~non-maturity deposits.~~borrowings associated with the SBA PPP loans are expected to decline significantly into the first quarter of 2021 as the funds are drawn by the borrowers and the loans are forgiven by the SBA.

Provision for Loan Losses

Asset quality trends continue to be solid with a low level of charge-offs and nonperforming loans. The provision for loan losses totaled ~~$200,000~~$1.9 million for the three months ended June 30, 2020 compared with $200 thousand for the same period in 2019. The provision recorded in the ~~second quarter~~three months ended June 30, 2020 was driven by an increase in qualitative factor assumptions as a result of ~~both 2019 and 2018. The Company's organic loan portfolio growth, taking into account historical charge-off statistics and generally stable economic and market conditions for~~ the ~~last several years, were key factors included~~COVID-19 pandemic. Due to continuing uncertainty in the ~~quantitative and~~external environment, management increased the qualitative ~~considerations used by management~~factors for certain commercial loan segments in the ~~determination of the provision expense required to maintain an adequate~~Bank’s allowance for loan ~~losses~~loss analysis in the three months ended June 30, 2020. Net charge-offs in the three months ended June 30, 2020 totaled $186 thousand, as compared to $23 thousand in the comparable prior year period. Nonperforming loans were 0.36% of gross loans at June 30, 2020, compared with 0.65% of gross loans at December 31, 2019. Nonperforming loans decreased by $3.3 million from December 31, 2019 to June 30, 2020 due primarily to a measurement period adjustment for the transfer of a $2.6 million loan from the Hamilton acquisition into the PCI pool during the three months ended March 31, 2020.

Additional information is included in the "Credit Risk Management" section herein.

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Noninterest Income

The following table compares noninterest income for the three months ended June 30, ~~2019~~2020 and ~~2018.~~2019:


		Three Months Ended June 30,						$ Change				% Change	Three Months Ended June 30,						$ Change	% Change
(Dollars in thousands)		2019		2018		2019-2018		2019-2018
											2020		2019		2020-2019		2020-2019
Service charges on deposit accounts	Service charges on deposit accounts	$	1,680	$	1,463	$	217	14.8	%	Service charges on deposit accounts	$	554	$	837	$	(283)	(34)	%
Interchange income										Interchange income	819		843		(24)		(3)	%
Other service charges, commissions and fees	Other service charges, commissions and fees	346		689		(343)		(49.8)	%	Other service charges, commissions and fees	165		241		(76)		(32)	%
Swap fees										Swap fees	232		—		232		—	%
Trust and investment management income	Trust and investment management income	1,749		1,701		48		2.8	%	Trust and investment management income	1,696		1,749		(53)		(3)	%
Brokerage income	Brokerage income	672		501		171		34.1	%	Brokerage income	599		672		(73)		(11)	%
Mortgage banking activities	Mortgage banking activities	652		679		(27)		(4.0)	%	Mortgage banking activities	1,609		652		957		147	%
Gain on sale of portfolio loans										Gain on sale of portfolio loans	925		—		925		—	%
Income from life insurance	Income from life insurance	684		291		393		135.1	%	Income from life insurance	532		684		(152)		(22)	%
Other income	Other income	32		135		(103)		(76.3)	%	Other income	53		32		21		66	%
Subtotal before securities gains		5,815		5,459		356		6.5	%
Investment securities gains		2,064		46		2,018		nm*
Subtotal before securities gains (losses)										Subtotal before securities gains (losses)	7,184		5,710		1,474		26	%
Investment securities gains (losses)										Investment securities gains (losses)	9		2,064		(2,055)		(100)	%
Total noninterest income	Total noninterest income	$	7,879	$	5,505	$	2,374	43.1	%	Total noninterest income	$	7,193	$	7,774	$	(581)	(7)	%
nm*: not meaningful

The following factors contributed to the more significant changes in noninterest income between the three months ended June 30, ~~2019~~2020 and ~~2018.~~2019:

•~~Other service~~Service charges ~~commissions and fees included increased loan transaction~~on deposit accounts decreased by $283 thousand due primarily to waivers of ATM fees in ~~2018.~~response to the COVID-19 pandemic and reductions in overdraft charges from lower deposit account usage during the three months ended June 30, 2020 due to the pandemic.

•~~Income~~In the three months ended June 30, 2020, the Company recognized income of $232 thousand in swap fees for ~~trust and investment management income and brokerage income included the effect of increased revenue from additional advisors and increased estate fees in 2019.~~an interest rate swap arrangement directly entered into with one commercial borrower.

•Mortgage banking income ~~decreased~~increased by $957 thousand. Refinance activity was strong in the ~~year-over-year comparison. Loans~~three months ended June 30, 2020 due to the decrease in interest rates, and the gain on sale margin increased. Mortgage loans sold in the ~~second quarter of 2019~~three months ended June 30, 2020 totaled ~~$24,400,000~~$49.5 million compared with ~~$25,100,000~~$24.6 million in ~~second quarter~~ the three months ended June 30, 2019. In addition, there was an increase of ~~2018.~~$551 thousand in the fair value of interest rate lock commitments in the three months ended June 30, 2020 as compared to $0 for the three months ended June 30, 2019. The Company began recognizing this income in the fourth quarter of 2019. During the three months ended June 30, 2020, the Company recorded an MSR impairment charge of $319 thousand driven by significant market interest rate reductions caused by the COVID-19 pandemic, partially offsetting the mortgage gains.

•~~Income from life insurance included death benefit proceeds totaling $255,000~~During the three months ended June 30, 2020, the Bank recorded $925 thousand in ~~2019, with~~gains due to the ~~remainder~~sale of ~~the increase in 2019 attributable to additional life insurance policies acquired in the Mercersburg and Hamilton acquisitions.~~$1.7 million of classified loans.

•~~Other line items within noninterest income showed fluctuations between 2019 and 2018 attributable~~During the three months ended June 30, 2020, the Company recorded a net investment securities gain of $9 thousand due to ~~normal business operations and~~ the ~~effect~~change in the value of ~~the acquisitions.~~

an equity security. There were no investment sales during this period. The Company recognized net investment securities gains of $2.1 million in 2019 ~~and 2018~~ as opportunities became available to reposition part of the investment portfolio under asset/liability management strategies or to improve responsiveness of the portfolio to interest rate conditions, while also considering funding requirements of anticipated lending activity.

4956

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Noninterest Expenses

The following table compares noninterest expenses for the three months ended June 30, ~~2019~~2020 and ~~2018.~~2019:


		Three Months Ended June 30,						$ Change				% Change	Three Months Ended June 30,						$ Change	% Change
(Dollars in thousands)		2019		2018		2019-2018		2019-2018
											2020		2019		2020-2019		2020-2019
Salaries and employee benefits	Salaries and employee benefits	$	8,922	$	7,855	$	1,067	13.6	%	Salaries and employee benefits	$	10,063	$	8,922	$	1,141	12.8	%
Occupancy	Occupancy	1,066		679		387		57.0	%	Occupancy	1,122		1,066		56		5.3	%
Furniture and equipment	Furniture and equipment	1,140		1,068		72		6.7	%	Furniture and equipment	1,204		1,140		64		5.6	%
Data processing	Data processing	1,058		595		463		77.8	%	Data processing	791		1,058		(267)		(25.2)	%
Telephone and communication		202		165		37		22.4	%

Automated teller machine and interchange fees	Automated teller machine and interchange fees	238		190		48		25.3	%	Automated teller machine and interchange fees	249		238		11		4.6	%
Advertising and bank promotions	Advertising and bank promotions	548		237		311		131.2	%	Advertising and bank promotions	167		548		(381)		(69.5)	%
FDIC insurance	FDIC insurance	221		172		49		28.5	%	FDIC insurance	214		221		(7)		(3.2)	%
Legal		120		83		37		44.6	%

Other professional services	Other professional services	587		476		111		23.3	%	Other professional services	1,021		707		314		44.4	%
Directors' compensation	Directors' compensation	261		205		56		27.3	%	Directors' compensation	264		261		3		1.1	%

Real estate owned		12		53		(41)		(77.4)	%

Taxes other than income	Taxes other than income	314		251		63		25.1	%	Taxes other than income	449		314		135		43.0	%
Intangible asset amortization	Intangible asset amortization	402		24		378		nm*		Intangible asset amortization	404		402		2		0.5	%

Merger related		6,860		154		6,706		nm*
Merger related and branch consolidation expenses										Merger related and branch consolidation expenses	0		6,860		(6,860)		(100.0)	%

Other operating expenses	Other operating expenses	1,363		1,065		298		28.0	%	Other operating expenses	2,483		1,555		928		59.7	%
Total noninterest expenses	Total noninterest expenses	$	23,314	$	13,272	$	10,042	75.7	%	Total noninterest expenses	$	18,431	$	23,292	$	(4,861)	(20.9)	%
nm*: not meaningful

The following factors contributed to the more significant changes in noninterest expenses between the three months ended June 30, ~~2019~~2020 and ~~2018.~~2019:

•~~Expanded operations with the addition of employees and branches from the Mercersburg acquisition~~The increase in October 2018 and the Hamilton acquisition in May 2019; two branches opened in the fourth quarter of 2018 and two opened in the first quarter of 2019 in Lancaster County, Pennsylvania; and additional support personnel for the Company's ongoing expansion efforts all contributed to increases in salaries ~~and employee benefits, occupancy costs, furniture and equipment, and data processing costs year-over-year, as well as the timing of advertising and bank promotions expenses incurred.~~

•~~Salaries~~ and employee benefits principally reflected employees added in the ~~acquisitions~~Hamilton acquisition and ~~for additional employees for~~prior year additions to the ~~Company's new branches.~~Bank’s commercial lending team. In addition, the increase included the impact of our overall expansion efforts ~~annual merit increases,~~ and incremental expense for additional share-based compensation awards granted in ~~2019,~~2020, net of the benefit of forfeitures. ~~In 2019, overall costs associated with the Company's self-insured group health plan were higher than in 2018 due to an increased number of employees and fluctuations in claims experience.~~

•~~Occupancy, furniture~~There was a decline in data processing expense of $267 thousand as the completion of the Hamilton integration in the second half of 2019 resulted in reduced costs in 2020.

•Advertising and ~~equipment~~bank promotions decreased by $381 thousand due primarily to targeted campaigns in the prior year which did not recur in 2020 as well as reduced marketing efforts in 2020 due to the COVID-19 pandemic.

•Other professional services increased by $314 thousand due to legal costs ~~reflected Mercersburg and Hamilton branches acquired, and~~incurred in the ~~Company's expanded presence~~three months ended June 30, 2020 in ~~Lancaster County, Pennsylvania.~~connection with the SEPTA litigation.

•The Company incurred merger related expenses of $6.9 million in the ~~second quarter of~~three months ended June 30, 2019, principally due to data processing contract termination costs, employee contract termination costs and legal and consulting fees for the Hamilton acquisition.

•Other operating expenses increased by $928 thousand due primarily to a reduction of $544 thousand in the fair value of a property held for sale, an increase of $172 thousand in the reserve for unfunded commitments due to increased qualitative factors and an impairment charge of $152 thousand on a customer list intangible asset due to the discontinuance of Wheatland, effective July 31, 2020, during the three months ended June 30, 2020.

•Other line items within noninterest expenses showed fluctuations between ~~2019~~2020 and ~~2018~~2019 attributable to normal business operations and the impact of ~~the~~ acquisitions.

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Income Tax Expense

Income tax expense totaled ~~$110,000,~~$1.3 million, an effective tax rate of 17.0%, for the three months ended June 30, 2020, compared with $110 thousand, an effective tax rate of 3.9%, for the three months ended June 30, ~~2019, compared with $374,000, an effective tax rate of 8.5%, for the three months ended June 30, 2018.~~2019. The Company’s effective tax rate is significantly less than the 21% federal statutory rate, principally due to tax-free income, which includes interest income on tax-free loans and securities and income from life insurance policies, federal income tax credits, and the impact of non-tax deductible expenses, including certain merger related expenses. In the second quarter of 2019, we recorded a tax benefit of approximately $334,000, related to an increase in its deferred state income tax asset for the effect of the state tax rate change resulting from the Hamilton acquisition. This tax benefit had the effect of lowering the effective tax rate for the second quarter of 2019 from approximately 15.9% to 3.9%.

~~Six months ended June 30, 2019 compared with six months ended June 30, 2018~~

~~Summary~~

Net income totaled $5,789,000 for the six months ended June 30, 2019 compared with net income of $7,637,000 for the same period in 2018. Diluted EPS for the six months ended June 30, 2019 totaled $0.58, compared with $0.92 for the six months ended June 30, 2018. Net interest income positively influenced results of operations, and totaled $33,121,000 for the six months ended June 30, 2019, a $9,084,000 increase compared with 2018. Noninterest income, excluding investment securities gains, totaled $10,703,000 for the six months ended June 30, 2019 compared with $10,345,000 in 2018. Investment securities gains totaled $2,403,000 in the six months ended June 30, 2019, compared with $862,000 for the same period in 2018. Noninterest expenses totaled $39,496,000 and $26,341,000 for the six months ended June 30, 2019 and 2018. Noninterest expenses in 2019 included merger related expenses totaling $7,505,000 associated with the Company's ongoing growth strategy, increased salaries and occupancy expenses, and the write-off of an insurance claim receivable totaling $615,000 resulting from an insurer's denial of a claim from a cyber security incident reported in 2018.

The comparability of operating results for 2019 with 2018 have generally been impacted by the Mercersburg acquisition, completed on October 1, 2018, and the Hamilton acquisition, completed on May 1, 2019.

~~Table of Contents~~

~~Net Interest Income~~

Net interest income increased $9,084,000, from $24,037,000 to $33,121,000, for the six months ended June 30, 2019 compared with the same period in 2018. Interest and fees income on loans increased $11,825,000, from $22,787,000 to $34,612,000, securities interest income increased $1,934,000, from $6,711,000 to $8,645,000, and total interest expense increased $5,250,000 from $5,562,000 to $10,812,000, in comparing the six months ended June 30, 2019 with 2018.

~~The following table presents net interest income, net interest spread and net interest margin for the six months ended June 30, 2019 and 2018 on a taxable-equivalent basis.~~

Six Months Ended June 30, 2019 Six Months Ended June 30, 2018
(Dollars in thousands) Average
Balance Taxable-
Equivalent
Interest Taxable-
Equivalent
Rate Average
Balance Taxable-
Equivalent
Interest Taxable-
Equivalent
Rate
Assets
Federal funds sold & interest-bearing bank balances $ 57,130 $ 676 2.39 % $ 11,717 $ 101 1.74 %
Securities 498,271 9,037 3.66 459,892 7,210 3.16
Loans 1,378,213 34,857 5.10 1,043,258 22,967 4.44
Total interest-earning assets 1,933,614 44,570 4.65 1,514,867 30,278 4.03
Other assets 156,786 105,964
Total $ 2,090,400 $ 1,620,831
Liabilities and Shareholders’ Equity
Interest-bearing demand deposits $ 884,065 3,868 0.88 $ 729,362 1,814 0.50
Savings deposits 130,276 125 0.19 98,400 77 0.16
Time deposits 489,855 4,571 1.88 291,257 2,094 1.45
Short-term borrowings 25,769 277 2.17 93,584 765 1.65
Long-term debt 92,644 975 2.12 83,731 812 1.96
Subordinated notes 31,852 996 6.30 0 0 0.00
Total interest-bearing liabilities 1,654,461 10,812 1.32 1,296,334 5,562 0.87
Noninterest-bearing demand deposits 218,796 166,440
Other 27,523 16,053
Total Liabilities 1,900,780 1,478,827
Shareholders’ Equity 189,620 142,004
Total $ 2,090,400 $ 1,620,831
Taxable-equivalent net interest income /net interest spread 33,758 3.33 % 24,716 3.16 %
Taxable-equivalent net interest margin 3.52 % 3.29 %
Taxable-equivalent adjustment (637) (679)
Net interest income $ 33,121 $ 24,037

~~Table notes: (1) Yields and interest income on tax-exempt assets have been computed on a taxable-equivalent basis assuming a 21% tax rate.~~

~~(2) For yield calculation purposes, nonaccruing loans are included in the average loan balance.~~

For the six months ended June 30, 2019, taxable-equivalent basis net interest income increased $9,042,000 compared with 2018. The increase reflected increased interest-earning assets balances at increased market interest rates, partially offset by a higher average balance of interest-bearing liabilities at higher interest rates.

Taxable-equivalent interest income earned on loans increased $11,890,000 year-over-year. The $334,955,000 increase in average loan balance year-over-year includes approximately $240,250,000 in loans acquired in the Mercersburg and Hamilton transactions, as well as continued growth in legacy and newer markets through sales efforts with additional loan officers. Increases in prime lending rates between June 30, 2018 and December 31, 2018 contributed to the 66 basis point increase in yield, but a flattened yield curve partially offset the benefit of the rate increases. Accretion of purchase accounting adjustments in connection with the Mercersburg and Hamilton acquisitions increased first half 2019 interest income by $1,385,000. Interest income included $715,000 related to the payoff of purchased credit impaired loans.

~~Table of Contents~~

Taxable-equivalent securities interest income increased $1,827,000 year-over-year, with the average balance of securities increasing $38,379,000 from June 30, 2018 to June 30, 2019, and the taxable equivalent yield increasing from 3.16% to 3.66%. The 50 basis point increase in the yield on securities year-over-year in taxable-equivalent interest income on securities reflected the increased interest rate environment and certain repositioning within the portfolio under the Company's asset/liability management strategies.

Interest expense on deposits and borrowings increased $5,250,000 year-over-year, with the average balance of interest-bearing deposits increasing $385,177,000 and the average balance of total borrowings decreasing $27,050,000. In addition to the impact of the noted increased interest rate environment on interest expense, the Company issued $32,500,000 of 6.0% subordinated notes in December 2018. Additionally, the Company has experienced a gradual repricing of term and non-maturity deposits during the first six months of 2019.

~~Provision for Loan Losses~~

The provision for loan losses totaled $600,000 for the six months ended June 30, 2019 compared with $400,000 for the same period in 2018. Net loan charge-offs experienced in the first quarter of 2019 and the Company's organic loan portfolio growth, taking into account historical charge-off statistics and generally stable economic and market conditions for the last several years, were key factors included in the quantitative and qualitative considerations used by management in the determination of the provision expense required to maintain an adequate allowance for loan losses at June 30, 2019.

~~Additional information is included in the "Credit Risk Management" section herein.~~

~~Noninterest Income~~

~~The following table compares noninterest income for the six months ended June 30, 2019 and 2018.~~

Six Months Ended June 30, $ Change % Change
(Dollars in thousands) 2019 2018 2019-2018 2019-2018
Service charges on deposit accounts $ 3,169 $ 2,881 $ 288 10.0 %
Other service charges, commissions and fees 587 938 (351) (37.4) %
Trust and investment management income 3,507 3,369 138 4.1 %
Brokerage income 1,150 1,059 91 8.6 %
Mortgage banking activities 1,120 1,314 (194) (14.8) %
Income from life insurance 1,026 568 458 80.6 %
Other income 144 216 (72) (33.3) %
Subtotal before securities gains 10,703 10,345 358 3.5 %
Investment securities gains 2,403 862 1,541 178.8 %
Total noninterest income $ 13,106 $ 11,207 $ 1,899 16.9 %
nm*: not meaningful

~~Table of Contents~~

~~The following factors contributed to the more significant changes in noninterest income between the six months ended June 30, 2019 and 2018.~~

•~~Other service charges, commissions and fees included increased loan transaction fees in 2018.~~

•Income for trust and investment management income and brokerage income reflected fluctuations in customer volumes and market conditions, as well as the effect of increased revenue from additional advisors and increased estate fees in 2019.

•~~Mortgage banking income decreased in the year-over-year comparison. Loans sold in the first half of 2019 totaled $39,600,000 compared with $45,600,000 in 2018.~~

•Income from life insurance included death benefit proceeds in the second quarter of 2019 totaling $255,000, with the remainder of the increase in 2019 attributable to additional life insurance policies acquired in the Mercersburg and Hamilton transactions.

•~~Other line items within noninterest income showed fluctuations between 2019 and 2018 attributable to normal business operations and the effect of the acquisitions.~~

The Company recognized net investment securities gains in 2019 and 2018 as opportunities became available to reposition part of the investment portfolio under asset/liability management strategies or to improve responsiveness of the portfolio to interest rate conditions, while also considering funding requirements of anticipated lending activity.

~~Noninterest Expenses~~

~~The following table compares noninterest expenses for the six months ended June 30, 2019 and 2018.~~

Six Months Ended June 30, $ Change % Change
(Dollars in thousands) 2019 2018 2019-2018 2019-2018
Salaries and employee benefits $ 17,599 $ 15,877 $ 1,722 10.8 %
Occupancy 2,067 1,477 590 39.9 %
Furniture and equipment 2,163 1,987 176 8.9 %
Data processing 1,828 1,214 614 50.6 %
Telephone and communication 414 361 53 14.7 %
Automated teller machine and interchange fees 474 361 113 31.3 %
Advertising and bank promotions 1,069 619 450 72.7 %
FDIC insurance 406 338 68 20.1 %
Legal 173 149 24 16.1 %
Other professional services 1,091 779 312 40.1 %
Directors' compensation 497 456 41 9.0 %
Real estate owned 14 78 (64) (82.1) %
Taxes other than income 620 502 118 23.5 %
Intangible asset amortization 610 48 562 nm*
Merger related 7,505 154 7,351 nm*
Insurance claim receivable write off 615 0 615 nm*
Other operating expenses 2,351 1,941 410 21.1 %
Total noninterest expenses $ 39,496 $ 26,341 $ 13,155 49.9 %
nm*: not meaningful

~~The following factors contributed to the more significant changes in noninterest expenses between the six months ended June 30, 2019 and 2018.~~

•Expanded operations with the addition of employees and branches from the Mercersburg acquisition in October, 2018, and the Hamilton merger in May, 2019; two branches opened in the fourth quarter of 2018 and two opened in the first quarter of 2019 in Lancaster County, Pennsylvania; and additional support personnel for the Company's ongoing expansion efforts all contributed to increases in salaries and employee benefits, occupancy costs, furniture and equipment, and data processing costs year-over-year, as well as the timing of advertising and bank promotions expenses incurred.

~~Table of Contents~~

•Salaries and employee benefits principally reflected employees added in the acquisitions and for additional employees for the Company's new branches. In addition, the increase included the impact of our overall expansion efforts, annual merit increases, and incremental expense for additional share-based compensation awards granted in 2019, net of the benefit of forfeitures. In 2019, overall costs associated with the Company's self-insured group health plan were higher than in 2018 due to an increased number of employees and fluctuations in claims experience.

•~~Occupancy, furniture and equipment costs reflected Mercersburg and Hamilton branches acquired, and the Company's expanded presence in Lancaster County, Pennsylvania.~~

•The Company incurred merger related expenses principally in the second quarter of 2019, for data processing contract termination costs, employee contract termination costs and legal and consulting fees for the Hamilton acquisition. We also incurred system conversion expenses for the Mercersburg acquisition in the first quarter of 2019.

•~~As previously reported, in the first quarter of 2019 we incurred a $615,000 expense to write off an insurance claim receivable from a 2018 cyber security incident.~~

•~~Other line items within noninterest expenses showed fluctuations between 2019 and 2018 attributable to normal business operations and the impact of acquisitions.~~

~~Income Tax Expense~~

Income tax expense totaled $342,000, an effective tax rate of 5.6%, for the six months ended June 30, 2019, compared with $866,000, an effective tax rate of 10.2%, for the six months ended June 30, 2018. The Company’s effective tax rate is significantly less than the 21% federal statutory rate, principally due to tax-free income, which includes interest income on tax-free loans and securities and income from life insurance policies, federal income tax credits, and the impact of non-tax deductible expenses, including merger related expenses. The Company recorded a tax benefit of ~~$185,000~~$334 thousand in the second quarter of 2019, related to an increase in its deferred state income tax asset for the effect of the state tax rate change resulting from the Hamilton acquisition. This tax benefit had the effect of lowering the effective tax rate for the second quarter of 2019 by approximately 12%. The remaining difference in the effective tax rate from the three months ended June 30, 2019 to the three months ended June 30, 2020 was due to an increase in estimated earnings before income taxes.

Six months ended June 30, 2020 compared with six months ended June 30, 2019

Summary

Net income totaled $11.4 million for the six months ended June 30, 2020 compared with net income of $5.8 million for the same period in 2019. Diluted earnings per share for the six months ended June 30, 2020 totaled $1.04, compared with $0.58 for the six months ended June 30, 2019. Net interest income positively influenced results of operations, and totaled $39.1 million for the six months ended June 30, 2020, a $5.8 million increase compared with 2019. Noninterest income, excluding investment securities gains, totaled $14.3 million for the six months ended June 30, 2020 compared with $10.5 million in 2019. Investment securities losses totaled $31 thousand in the six months ended June 30, 2020, compared with net gains of $2.4 million for the same period in 2019. Noninterest expenses totaled $36.7 million and $39.5 million for the six months ended June 30, 2020 and 2019, respectively.

The comparability of operating results for 2020 with 2019 have generally been impacted by the Hamilton acquisition completed on May 1, 2019 and the SBA PPP loans originated in the six months ended June 30, 2020.

Net Interest Income

Net interest income increased by $5.8 million, from $33.3 million to $39.1 million, for the six months ended June 30, 2020 compared with the six months ended June 30, 2019. Interest income on loans increased by $7.2 million, from $34.8 million to $42.0 million, securities interest income decreased $1.7 million, from $8.6 million to $6.9 million, and total interest expense decreased $926 thousand from $10.9 million to $9.9 million, in comparing the six months ended June 30, 2020 with the six months ended June 30, 2019.

Table of Contents

The following table presents net interest income, net interest spread and net interest margin for the six months ended June 30, 2020 and 2019 on a taxable-equivalent basis:


	Six Months Ended June 30, 2020										Six Months Ended June 30, 2019
	Average Balance		Taxable- Equivalent Interest		Taxable- Equivalent Rate		Average Balance		Taxable- Equivalent Interest		Taxable- Equivalent Rate
Assets
Federal funds sold & interest-bearing bank balances	$	25,409	$	92	0.73	%	$	56,879	$	674	2.39	%


Securities ⁽¹⁾	497,418		7,124		2.88		498,522		9,039		3.66


Loans ^(1)(2)(3)	1,820,830		42,199		4.66		1,378,213		35,054		5.13
Total interest-earning assets	2,343,657		49,415		4.24		1,933,614		44,767		4.67


Other assets	194,543						156,786

Total	$	2,538,200					$	2,090,400
Liabilities and Shareholders’ Equity
Interest-bearing demand deposits	$	1,063,460	3,161		0.60		$	884,065	3,911		0.89
Savings deposits	155,966		127		0.16		137,606		142		0.21
Time deposits	483,014		4,376		1.82		482,525		4,554		1.90
Securities sold under agreements to repurchase	15,499		52		0.67		8,755		57		1.31
FHLB Advances and other	181,372		1,210		1.34		109,658		1,195		2.20
Subordinated notes	31,860		1,003		6.29		31,852		996		6.30
Total interest-bearing liabilities	1,931,171		9,929		1.03		1,654,461		10,855		1.32
Noninterest-bearing demand deposits	351,208						218,796
Other	35,139						27,523
Total Liabilities	2,317,518						1,900,780
Shareholders’ Equity	220,682						189,620
Total	$	2,538,200					$	2,090,400
Taxable-equivalent net interest income /net interest spread			39,486		3.21	%			33,912		3.35	%
Taxable-equivalent net interest margin					3.39	%					3.54	%
Taxable-equivalent adjustment			(426)						(637)
Net interest income			$	39,060					$	33,275


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

For the six months ended June 30, 2020, taxable-equivalent basis net interest income increased by $5.6 million compared with the six months ended June 30, 2019. The increase reflected an increase of $410.0 million in average interest-earning assets partially offset by an increase of $276.7 million in average interest-bearing liabilities from the six months ended June 30, 2019 to the six months ended June 30, 2020. These balances increased primarily due to the SBA PPP loans originated in the six months ended June 30, 2020 as well as loans acquired from Hamilton on May 1, 2019.

Taxable-equivalent interest income earned on loans increased by $7.1 million year-over-year. The $442.6 million increase in average loan balance year-over-year reflects four extra months of Hamilton loans in the six months ended June 30, 2020 as compared to the same prior year period. In addition, SBA PPP loans averaged $177.3 million during the six months ended June 30, 2020. There was an offsetting decrease in residential mortgage loans during the period due to significant refinance activity resulting from the low interest rate environment. For the six months ended June 30, 2020, interest income on loans includes $1.9 million of deferred fees recognized associated with the SBA PPP loans. A total of $13.2 million in net deferred fees were

Table of Contents

recorded for these loans to be recognized over the life of the loans, which is between two and five years. The yield on loans was 4.66% for the six months ended June 30, 2020 as compared to 5.13% for the six months ended June 30, 2019. This decline reflects a reduction in market interest rates on variable rate loans in the portfolio, as well as a lower yield on the SBA PPP loans, which contributed to 13 basis points of the decline. Accretion of purchase accounting adjustments was $1.9 million for the six months ended June 30, 2020 as compared to $1.4 million for the six months ended June 30, 2019. The six months ended June 30, 2020 and 2019 included $743 thousand and $639 thousand, respectively, of accelerated accretion related to the payoff purchased credit impaired loans.

Taxable-equivalent securities interest income decreased by $1.9 million year-over-year, with the taxable equivalent yield decreasing from 3.66% for the six months ended June 30, 2019 to 2.88% for the six months ended June 30, 2020. The 78 basis point decrease in taxable-equivalent yield on securities reflected the decreased interest rate environment between years and certain repositioning within the portfolio under the Company's asset/liability management strategies. The impact of the interest rate decline was partially offset by a decrease of $1.1 million in the average balance of securities from the six months ended June 30, 2019 to the six months ended June 30, 2020. As the Bank continues to execute its plan to grow relationship loans, it will work to reduce its investment portfolio to fund some of this loan growth through investment repayments.

Interest expense on deposits and borrowings decreased by $926 thousand year-over-year, with the average balance of interest-bearing deposits increasing by $198.2 million and the average balance of total borrowings increasing by $78.5 million. The increase in these balances was due primarily to the SBA PPP loans originated during the six months ended June 30, 2020. During the six months ended June 30, 2020, the Company obtained funding through the PPPLF with an average balance of $1.6 million during the six months ended June 30, 2020. The balance of deposits and borrowings associated with the SBA PPP loans are expected to decline significantly into the first quarter of 2021 as the funds are drawn by the borrowers and the loans are forgiven by the SBA.

Provision for Loan Losses

Asset quality trends continue to be solid with a low level of charge-offs and nonperforming loans. The provision for loan losses totaled $2.8 million for the six months ended June 30, 2020 compared with $600 thousand for the same period in 2019. The provision recorded in the six months ended June 30, 2020 was driven by an increase in qualitative factor assumptions as a result of the COVID-19 pandemic. Net recoveries in the six months ended June 30, 2020 totaled $37 thousand, as compared to net charge-offs of $154 thousand in the comparable prior year period. Nonperforming loans were 0.36% of gross loans at June 30, 2020, compared with 0.65% of gross loans at December 31, 2019. Nonperforming loans decreased by $3.3 million from December 31, 2019 to June 30, 2020 due primarily to a measurement period adjustment for the transfer of a $2.6 million loan from the Hamilton acquisition into the PCI pool during the six months ended June 30, 2020.

Additional information is included in the "Credit Risk Management" section herein.

Noninterest Income

The following table compares noninterest income for the six months ended June 30, 2020 and 2019:


	Six Months Ended June 30,						$ Change		% Change
	2020		2019		2020-2019		2020-2019
Service charges on deposit accounts	$	1,401	$	1,590	$	(189)	(12)	%
Interchange income	1,607		1,579		28		2	%
Other service charges, commissions and fees	305		390		(85)		(22)	%
Swap fees	432		—		432		—	%
Trust and investment management income	3,336		3,507		(171)		(5)	%
Brokerage income	1,318		1,150		168		15	%
Mortgage banking activities	1,941		1,120		821		73	%
Gain on sale of portfolio loans	2,803		—		2,803		—	%
Income from life insurance	1,072		1,026		46		4	%
Other income	83		144		(61)		(42)	%
Subtotal before securities (losses) gains	14,298		10,506		3,792		36	%
Investment securities (losses) gains	(31)		2,403		(2,434)		(101)	%
Total noninterest income	$	14,267	$	12,909	$	1,358	11	%

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The following factors contributed to the more significant changes in noninterest income between the six months ended June 30, 2020 and 2019:

•Service charges on deposit accounts decreased due primarily to waivers of ATM fees in response to the COVID-19 pandemic and reductions in overdraft charges from lower deposit account usage during the six months ended June 30, 2020 due to the pandemic.

•In the six months ended June 30, 2020, the Company recognized income of $432 thousand for swap fees. This includes referral fees under a program in which it refers qualified commercial borrowers to a third party, which enters into an interest rate swap agreement with the borrower. The program began in the third quarter of 2019. The rate swap provides the borrower with the economic equivalent of a fixed-rate loan while allowing the Company to receive a variable rate of interest. During the three months ended June 30, 2020, the Company also earned fees on an interest rate swap arrangement entered into directly with one commercial borrower.

•Mortgage banking income increased by $821 thousand. Refinance activity was strong in the three months ended June 30, 2020 due to the decrease in interest rates, and the gain on sale margin increased. Loans sold in the six months ended June 30, 2020 totaled $71.8 million compared with $39.8 million in the six months ended June 30, 2019. In addition, there was an increase of $863 thousand in the fair value of interest rate lock commitments in the six months ended June 30, 2020 as compared to $0 for the six months ended June 30, 2019. The Company began recognizing this income in the fourth quarter of 2019. During the six months ended June 30, 2020, the Company recorded MSR impairment charges totaling $820 thousand driven by significant market interest rate reductions caused by the COVID-19 pandemic, partially offsetting the mortgage gains.

•During the six months ended June 30, 2020, the Bank recorded $2.8 million in gains due to the sale of $10.9 million of classified loans for net gains of $2.5 million, and the sale of an $11.0 million portfolio of recreational vehicle loans for a gain of $314 thousand.

During the six months ended June 30, 2020, the Company recorded a net investment securities loss of $31 thousand due to the decrease in the value of an equity security. The Company recognized net investment securities gains of $2.4 million in 2019 as opportunities became available to reposition part of the investment portfolio under asset/liability management strategies or to improve responsiveness of the portfolio to interest rate conditions, while also considering funding requirements of anticipated lending activity.

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Noninterest Expenses

The following table compares noninterest expenses for the six months ended June 30, 2020 and 2019:


	Six Months Ended June 30,						$ Change		% Change
	2020		2019		2020-2019		2020-2019
Salaries and employee benefits	$	21,657	$	17,599	$	4,058	23.1	%
Occupancy	2,249		2,067		182		8.8	%
Furniture and equipment	2,366		2,163		203		9.4	%
Data processing	1,662		1,828		(166)		(9.1)	%

Automated teller machine and interchange fees	500		474		26		5.5	%
Advertising and bank promotions	956		1,069		(113)		(10.6)	%
FDIC insurance	261		406		(145)		(35.7)	%

Other professional services	1,737		1,264		473		37.4	%
Directors' compensation	465		497		(32)		(6.4)	%


Taxes other than income	451		620		(169)		(27.3)	%
Intangible asset amortization	867		610		257		42.1	%

Merger related and branch consolidation expenses	—		7,505		(7,505)		(100.0)	%
Insurance claim receivable (recovery) write off	(486)		615		(1,101)		(179.0)	%
Other operating expenses	4,050		2,736		1,314		48.0	%
Total noninterest expenses	$	36,735	$	39,453	$	(2,718)	(6.9)	%

The following factors contributed to the more significant changes in noninterest expenses between the six months ended June 30, 2020 and 2019:

•Expanded operations with the addition of employees and branches from the Hamilton acquisition in May 2019.

•The increase in salaries and employee benefits principally reflected employees added in the Hamilton acquisition and prior year additions to the Bank’s commercial lending team. In addition, the increase included the impact of our overall expansion efforts, annual merit increases, and incremental expense for additional share-based compensation awards granted in 2020, net of the benefit of forfeitures.

•Occupancy, furniture and equipment costs reflected the Hamilton branches acquired, partially offset by the impact of the consolidation of five branches in the first quarter of 2020.

•Advertising and bank promotions decreased by $113 thousand due primarily to due primarily to targeted campaigns in the prior year which did not recur in 2020 as well as reduced marketing efforts in 2020 due to the COVID-19 pandemic.

•The decrease in FDIC insurance expense reflects credits received in the first quarter of 2020 that offset the Bank's fourth quarter 2019 FDIC assessment. The FDIC's assessment regulations provide that, for banks with consolidated total assets under $10 billion, after the reserve ratio reaches 1.38% (and provided that it remains at least 1.38%), the FDIC will automatically apply credits to reduce regular deposit insurance assessments up to the full amount of their assessments or the full amount of their credits, whichever is less. The reserve ratio reached 1.40% on June 30, 2019. Therefore, credits were first applied during the third quarter of 2019. The final credit was applied as of the March 31, 2020 payment as the reserve ratio was sufficiently maintained.

•Other professional services increased by $473 thousand due to legal costs incurred in the six months ended June 30, 2020 in connection with the SEPTA litigation.

•Taxes other than income decreased by $169 thousand as increased contributions to the Pennsylvania Educational Improvement Tax Credit program resulted in a reduction in the Bank’s Pennsylvania bank shares tax expense during the six months ended June 30, 2020.

•Intangible asset amortization increased principally due to amortization of core deposit intangibles recorded in the Hamilton acquisition.

•The Company incurred merger related expenses in the six months ended June 30, 2019 for data processing contract termination costs, employee contract termination costs and legal and consulting fees for the Hamilton acquisition. The Company also incurred system conversion expenses for the Mercersburg acquisition in the first quarter of 2019.

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•In the six months ended June 30, 2019, the Company incurred a $615 thousand expense to write off an insurance claim receivable from a 2018 cyber security incident. During the six months ended June 30, 2020, $486 thousand of this expense was recovered through refunds received from the insurance company.

•Other operating expenses increased by $1.3 million due primarily to a reduction of $544 thousand in the fair value of a property held for sale, an increase of $172 thousand in the reserve for unfunded commitments due to increased qualitative factors and an impairment charge of $152 thousand on a customer list intangible asset due to the discontinuance of Wheatland, effective July 31, 2020, during the six months ended June 30, 2020.

•Other line items within noninterest expenses showed fluctuations between 2020 and 2019 attributable to normal business operations and the impact of acquisitions.

Income Tax Expense

Income tax expense totaled $2.3 million, an effective tax rate of 17.0%, for the six months ended June 30, 2020, compared with $342 thousand, an effective tax rate of 5.6%, for the six months ended June 30, 2019. The Company’s effective tax rate is less than the 21% federal statutory rate, principally due to tax-free income, which includes interest income on tax-free loans and securities and income from life insurance policies, federal income tax credits, and the impact of non-tax deductible expenses, including merger related expenses. The Company recorded a tax benefit of $185 thousand during the six months ended June 30, 2019, related to a favorable tax law clarification concerning the treatment of life insurance assets of an acquired entity. In the ~~second quarter of 2019, we~~prior year period, the Company also recorded a tax benefit of ~~$334,000,~~$334 thousand related to an increase in ~~our~~its deferred state income tax asset for the effect of the state tax rate change resulting from the Hamilton acquisition. These tax ~~benefit items~~benefits had the effect of lowering the effective tax rate for the six months ended June 30, 2019 by approximately 8.4%. The remaining difference in the effective tax rate from ~~approximately 14.0%~~the six months ended June 30, 2019 to ~~5.6%.~~the six months ended June 30, 2020 was due to an increase in estimated earnings before income taxes.

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FINANCIAL CONDITION

Management devotes substantial time to overseeing the investment of funds in loans and securities and the formulation of policies directed toward the profitability and management of the risks associated with these investments.

~~AFS~~Investment Securities

The Company utilizes investment securities ~~available for sale~~ to manage interest rate risk, to enhance income through interest and dividend income, to provide liquidity and to provide collateral for certain deposits and borrowings. At June 30, ~~2019, AFS~~2020, investment securities totaled ~~$496,930,000, an increase~~$483.9 million, a decrease of ~~$31,086,000,~~$6.9 million, from the ~~$465,844,000~~$490.9 million balance at December 31, ~~2018.~~2019. The balance of investment securities included net unrealized losses of $4.5 million at June 30, 2020 as compared to net unrealized losses of $607 thousand at December 31, 2019. This decline was driven by the significant reduction in market rates in the six months ended June 30, 2020, resulting from market uncertainty related to the COVID-19 pandemic.

In the six months ended June 30, ~~2019,~~2020, the Company realized net losses totaling $31 thousand due to a market value adjustment to an equity security, compared to net investment security gains ~~totaling $2,403,000 from sales~~ of investments, as it repositioned parts of its portfolio in response to market and interest rate opportunities under its asset/liability management strategies. Sales of investments in states and political subdivisions were$2.4 million for the ~~principal driver of the realized net gains. Sale proceeds totaling $174,335,000 were principally redeployed in investments in asset-backed securities.~~

~~In July 2019, the Company sold an additional $18,000,000 of principally states and political subdivisions securities at a net gain of approximately $2,300,000.~~six months ended June 30, 2019.

Loan Portfolio

The Company offers a variety of products to meet the credit needs of its borrowers, principally commercial real estate loans, commercial and industrial loans, and retail loans consisting of loans secured by residential properties, and to a lesser extent, installment loans. No loans are extended to non-domestic borrowers or governments.

The risks associated with lending activities differ among loan classes and are subject to the impact of changes in interest rates, market conditions of collateral securing the loans and general economic conditions. Any of these factors may adversely impact a borrower’s ability to repay loans, and also impact the associated collateral. See Note 4, Loans ~~Receivable~~ and Allowance for Loan Losses, to the ~~Consolidated Financial Statements~~unaudited condensed consolidated financial statements under Part I, Item 1, "Financial Information," for a description of the Company’s loan classes and differing levels of associated credit risk.

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The following table presents the loan portfolio, excluding residential LHFS, by segment and class at June 30, ~~2019~~2020 and December 31, ~~2018.~~2019:


(Dollars in thousands)		June 30, 2019		December 31, 2018
							June 30, 2020		December 31, 2019
Commercial real estate:	Commercial real estate:					Commercial real estate:
Owner occupied	Owner occupied	$	170,272	$	129,650	Owner occupied	$	164,442	$	170,884
Non-owner occupied	Non-owner occupied	298,989		252,794		Non-owner occupied	390,980		361,050
Multi-family	Multi-family	93,342		78,933		Multi-family	111,016		106,893
Non-owner occupied residential	Non-owner occupied residential	121,364		100,367		Non-owner occupied residential	116,531		120,038
Acquisition and development:	Acquisition and development:					Acquisition and development:
1-4 family residential construction	1-4 family residential construction	12,801		7,385		1-4 family residential construction	7,966		15,865
Commercial and land development	Commercial and land development	57,027		42,051		Commercial and land development	50,220		41,538
Commercial and industrial(1)	Commercial and industrial(1)	219,551		160,964		Commercial and industrial(1)	665,312		214,554
Municipal	Municipal	48,358		50,982		Municipal	34,276		47,057
Residential mortgage:	Residential mortgage:					Residential mortgage:
First lien	First lien	363,946		235,296		First lien	295,736		336,372
Home equity - term	Home equity - term	15,989		12,208		Home equity - term	11,944		14,030
Home equity - lines of credit	Home equity - lines of credit	157,645		143,616		Home equity - lines of credit	160,842		165,314
Installment and other loans	Installment and other loans	42,386		33,411		Installment and other loans	32,052		50,735
		$	1,601,670	$	1,247,657		$	2,041,317	$	1,644,330

~~The above totals include $453,280,000~~⁽¹⁾ This balance includes $447.2 million and ~~$135,009,000~~$0 of ~~acquired~~SBA PPP loans at June 30, ~~2019~~2020 and December 31, ~~2018.~~2019, respectively.

Total loans grew ~~$354,013,000~~by $397.0 million from December 31, ~~2018~~2019 to June 30, ~~2019. Balances~~2020. This increase is due primarily to the origination of SBA PPP loans during the six months ended June 30, 2020. These loans, net of deferred fees, totaled $447.2 million at June 30, ~~2019, include approximately $335,000,000 acquired from Hamilton. The Hamilton acquisition increased the Company's loan portfolio principally~~2020. This increase was partially offset by a reduction in ~~the~~ residential mortgage ~~- first lien, commercial real estate - owner occupied~~loans due to significant refinancing activity. In addition, the Company sold $10.9 million in classified loans and ~~non-owner occupied, and commercial and industrial classes.~~$11.0 million of acquired recreational vehicle loans during the six months ended June 30, 2020.

~~Competition for new business opportunities remains strong, which has contributed to a reduced rate~~

Table of ~~organic loan growth in 2019 compared with prior years and may temper loan growth in future quarters.~~Contents

Asset Quality

Risk Elements

The Company’s loan portfolio is subject to varying degrees of credit risk. Credit risk is managed through our underwriting standards, on-going credit reviews, and monitoring of asset quality measures. Additionally, loan portfolio diversification, which limits exposure to a single industry or borrower, and collateral requirements also mitigate our risk of credit loss.

The loan portfolio consists principally of loans to borrowers in south central Pennsylvania and the greater Baltimore, Maryland region. As the majority of loans are concentrated in these geographic regions, a substantial portion of the borrowers' ability to honor their obligations may be affected by the level of economic activity in the market areas.

Nonperforming assets include nonaccrual loans and foreclosed real estate. In addition, restructured loans still accruing and loans past due 90 days or more and still accruing are also deemed to be risk assets. For all loan classes, generally the accrual of interest income ceases when principal or interest is past due 90 days or more and collateral is inadequate to cover principal and interest or immediately if, in the opinion of management, full collection is unlikely. Interest will continue to accrue on loans past due 90 days or more if the collateral is adequate to cover principal and interest, and the loan is in the process of collection. Interest accrued, but not collected, as of the date of placement on nonaccrual status, is generally reversed and charged against interest income, unless fully collateralized. Subsequent payments received are either applied to the outstanding principal balance or recorded as interest income, depending on management’s assessment of the ultimate collectability of principal. Loans are returned to accrual status, for all loan classes, when all the principal and interest amounts contractually due are brought current, the loans have performed in accordance with the contractual terms of the note for a reasonable period of time, generally six months, and the ultimate collectability of the total contractual principal and interest is reasonably assured. Past due status is based on contract terms of the loan.

Loans, the terms of which are modified, are classified as TDRs if a concession was granted for legal or economic reasons related to a borrower’s financial difficulties. Concessions granted under a TDR typically involve a temporary deferral of scheduled loan payments, an extension of a loan’s stated maturity date, temporary reduction in interest rates, or below market

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rates. If a modification occurs while the loan is on accruing status, it will continue to accrue interest under the modified terms. Nonaccrual TDRs are restored to accrual status if scheduled principal and interest payments, under the modified terms, are current for six months after modification, and the borrower continues to demonstrate its ability to meet the modified terms. TDRs are evaluated individually for impairment if they have been restructured during the most recent calendar year, or if they are not performing according to their modified terms.

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The following table presents the Company’s risk elements, including the aggregate balances of nonaccrual loans, restructured loans still accruing, loans past due 90 days or more, and OREO as of June 30, ~~2019,~~2020 and December 31, ~~2018 and June 30, 2018.~~2019. Relevant asset quality ratios are also presented.


(Dollars in thousands)		June 30, 2019			December 31, 2018			June 30, 2018
Nonaccrual loans (cash basis)		$	4,387		$	5,165		$	4,998
												June 30, 2020			December 31, 2019
Nonaccrual loans											Nonaccrual loans	$	7,404		$	10,657
OREO	OREO	735			130			395			OREO	17			197
Total nonperforming assets	Total nonperforming assets	5,122			5,295			5,393			Total nonperforming assets	7,421			10,854
Restructured loans still accruing	Restructured loans still accruing	1,104			1,132			1,156			Restructured loans still accruing	960			979
Loans past due 90 days or more and still accruing	Loans past due 90 days or more and still accruing	1,661			57			0			Loans past due 90 days or more and still accruing	909			2,232
Total nonperforming and other risk assets	Total nonperforming and other risk assets	$	7,887		$	6,484		$	6,549		Total nonperforming and other risk assets	$	9,290		$	14,065
Loans 30-89 days past due	Loans 30-89 days past due	$	5,428		$	5,186		$	1,857		Loans 30-89 days past due	$	6,901		$	17,527
Asset quality ratios:	Asset quality ratios:										Asset quality ratios:
Total nonperforming loans to total loans	Total nonperforming loans to total loans	0.27		%	0.41		%	0.47		%	Total nonperforming loans to total loans	0.36		%	0.65		%
Total nonperforming assets to total assets	Total nonperforming assets to total assets	0.21		%	0.27		%	0.33		%	Total nonperforming assets to total assets	0.27		%	0.46		%
Total nonperforming assets to total loans and OREO	Total nonperforming assets to total loans and OREO	0.32		%	0.42		%	0.51		%	Total nonperforming assets to total loans and OREO	0.36		%	0.66		%
Total risk assets to total loans and OREO	Total risk assets to total loans and OREO	0.49		%	0.52		%	0.62		%	Total risk assets to total loans and OREO	0.46		%	0.86		%
Total risk assets to total assets	Total risk assets to total assets	0.33		%	0.34		%	0.40		%	Total risk assets to total assets	0.34		%	0.59		%
ALL to total loans	ALL to total loans	0.90		%	1.12		%	1.26		%	ALL to total loans	0.86		%	0.89		%
ALL to nonperforming loans	ALL to nonperforming loans	329.61		%	271.33		%	268.85		%	ALL to nonperforming loans	236.59		%	137.52		%
ALL to nonperforming loans and restructured loans still accruing	ALL to nonperforming loans and restructured loans still accruing	263.34		%	222.55		%	218.35		%	ALL to nonperforming loans and restructured loans still accruing	209.43		%	125.95		%

Total nonperforming and other risk assets ~~increased $1,403,000,~~decreased by $4.8 million, or ~~21.6%~~33.9%, from December 31, ~~2018~~2019 to June 30, ~~2019 and increased $1,338,000, or 20.4%, from June 30, 2018.~~2020. The principal driver for this decrease is a measurement period adjustment for the ~~increase in nonperforming and risk assets is~~transfer of a $2.6 million loan from the ~~increase in loans past due 90 days or more and still accruing, all of which were acquired in~~Hamilton acquisition into the ~~mergers with Mercersburg and Hamilton.~~PCI pool during the six months ended June 30, 2020.

The following table presents detail of impaired loans at June 30, ~~2019~~2020 and December 31, ~~2018~~. 2019:


		June 30, 2019										December 31, 2018											June 30, 2020				December 31, 2019
(Dollars in thousands)		Nonaccrual Loans		Restructured Loans Still Accruing		Total		Nonaccrual Loans		Restructured Loans Still Accruing		Total
															Nonaccrual Loans		Restructured Loans Still Accruing		Total		Nonaccrual Loans		Restructured Loans Still Accruing		Total
Commercial real estate:	Commercial real estate:													Commercial real estate:
Owner occupied	Owner occupied	$	1,706	$	31	$	1,737	$	1,841	$	39	$	1,880	Owner occupied	$	3,343	$	28	$	3,371	$	5,842	$	30	$	5,872

Multi-family	Multi-family	114		0		114		131		0		131		Multi-family	80		—		80		345		—		345
Non-owner occupied residential	Non-owner occupied residential	270		0		270		309		0		309		Non-owner occupied residential	283		—		283		235		—		235
Acquisition and development:														Acquisition and development:

Commercial and land development														Commercial and land development	837		—		837		—		—		—
Commercial and industrial	Commercial and industrial	253		0		253		286		0		286		Commercial and industrial	708		—		708		1,763		—		1,763
Residential mortgage:	Residential mortgage:													Residential mortgage:
First lien	First lien	1,340		1,052		2,392		1,808		1,069		2,877		First lien	1,545		916		2,461		1,659		931		2,590
Home equity - term	Home equity - term	12		0		12		16		0		16		Home equity - term	11		—		11		13		—		13
Home equity - lines of credit	Home equity - lines of credit	684		21		705		774		24		798		Home equity - lines of credit	580		16		596		715		18		733
Installment and other loans	Installment and other loans	8		0		8		0		0		0		Installment and other loans	17		—		17		85		—		85
		$	4,387	$	1,104	$	5,491	$	5,165	$	1,132	$	6,297		$	7,404	$	960	$	8,364	$	10,657	$	979	$	11,636

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The following table presents our exposure to borrowers with impaired loans, partial charge-offs taken to date and specific reserves established on the borrowing relationships at June 30, ~~2019~~2020 and December 31, ~~2018.~~2019. Of the relationships deemed to be impaired at June 30, ~~2019, none~~2020, one had a recorded balance in excess of ~~$1,000,000~~$1.0 million, and ~~63,~~66, or ~~74.0%~~42.8%, of total impaired loans, had recorded balances of less than ~~$250,000.~~$250 thousand.


(Dollars in thousands)		# of Relationships	Recorded Investment		Partial Charge-offs to Date		Specific Reserves
June 30, 2019
										# of Relationships	Recorded Investment		Partial Charge-offs to Date		Specific Reserves
June 30, 2020									June 30, 2020
Relationships greater than $1,000,000									Relationships greater than $1,000,000	1	$	2,765	$	—	$	—
Relationships greater than $500,000 but less than $1,000,000	Relationships greater than $500,000 but less than $1,000,000	1	775		17		0		Relationships greater than $500,000 but less than $1,000,000	1	706		17		—
Relationships greater than $250,000 but less than $500,000	Relationships greater than $250,000 but less than $500,000	2	650		0		0		Relationships greater than $250,000 but less than $500,000	4	1,314		242		—
Relationships less than $250,000	Relationships less than $250,000	63	4,066		856		37		Relationships less than $250,000	66	3,579		496		35
		66	$	5,491	$	873	$	37		72	$	8,364	$	755	$	35
December 31, 2018

December 31, 2019									December 31, 2019
Relationships greater than $1,000,000									Relationships greater than $1,000,000	2	$	5,218	$	—	$	—
Relationships greater than $500,000 but less than $1,000,000	Relationships greater than $500,000 but less than $1,000,000	1	810		17		0		Relationships greater than $500,000 but less than $1,000,000	2	1,516		17		—
Relationships greater than $250,000 but less than $500,000	Relationships greater than $250,000 but less than $500,000	2	673		0		0		Relationships greater than $250,000 but less than $500,000	3	980		—		—
Relationships less than $250,000	Relationships less than $250,000	64	4,814		873		38		Relationships less than $250,000	68	3,922		781		36
		67	$	6,297	$	890	$	38		75	$	11,636	$	798	$	36

The Company takes partial charge-offs on collateral-dependent loans when carrying value exceeds estimated fair value, as determined by the most recent appraisal adjusted for current (within the quarter) conditions, less costs to dispose. Impairment reserves remain in place if updated appraisals are pending, and represent management’s estimate of potential loss.

Internal loan reviews are completed annually on all commercial relationships with a committed loan balance in excess of ~~$500,000,~~$500 thousand, which includes confirmation of risk rating by an independent credit officer. Credit Administration also reviews loans in excess of ~~$1,000,000.~~$1.0 million. In addition, all relationships greater than ~~$250,000~~$250 thousand rated Substandard, Doubtful or Loss are reviewed and corresponding risk ratings are reaffirmed by the Bank's Problem Loan Committee, with subsequent reporting to the Management ERM Committee.

In its individual loan impairment analysis, the Company determines the extent of any full or partial charge-offs that may be required, or any reserves that may be needed. The determination of the Company’s charge-offs or impairment reserve include an evaluation of the outstanding loan balance and the related collateral securing the credit. Through a combination of collateral securing the loans and partial charge-offs taken to date, the Company believes that it has adequately provided for the potential losses that it may incur on these relationships at June 30, ~~2019.~~2020. However, over time, additional information may result in increased reserve allocations or, alternatively, it may be deemed that the reserve allocations exceed those that are needed.

In an effort to assist clients which were negatively impacted by the COVID-19 pandemic, the Bank offered various mitigation options, including a loan payment deferral program. Under this program, most commercial deferrals were for a 90-day period, while most consumer deferrals were for a 180-day period. As of June 30, 2020, the Company processed loan deferrals under this program for commercial and consumer clients with a total loan balance of $218.1 million and $21.2 million, respectively. Deferred interest associated with these loans totaled $1.5 million for the three months ended June 30, 2020. In accordance with the revised Interagency Statement on Loan Modifications by Financial Institutions Working with Customers Affected by the Coronavirus issued on April 7, 2020, these deferrals are exempt from TDR status as they meet the specified requirements. Below is a summary of select loan concentrations and the deferrals within those categories at June 30, 2020.

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			As a Percentage of
Category	Outstanding Balance		Total Loans		Risk-based Capital		COVID-19 Deferrals as a Percentage of Category
Office	$	163,408	8.0	%	66.8	%	12.0	%
Multifamily residential	111,279		5.5		45.5		32.7
Strip Center / Retail	51,328		2.5		21.0		23.1
Commercial Construction	50,220		2.5		20.5		4.2
Hotel / Motels	53,881		2.6		22.0		68.3
Warehouses	46,774		2.3		19.1		3.6
Restaurants & Bars	48,293		2.4		19.7		37.8
Storage Units	25,151		1.2		10.3		40.6
Residential Construction	7,966		0.4		3.3		13.0

The Company’s OREO ~~totaled $735,000~~balance of $17 thousand at June 30, 2020 consisted of one residential property and the balance at December 31, 2019 ~~and~~ consisted of two commercial and one residential properties. ~~The increase in~~All OREO ~~from $130,000 at December 31, 2018 was the result of the addition of one commercial and one residential property. All~~ properties are carried at the lower of cost or fair value, less costs to dispose.

~~At June 30, 2019, the Company believes the value of OREO represents the properties' fair values, but if the real estate market changes, additional expense may be recorded.~~

Credit Risk Management

Allowance for Loan Losses

The Company maintains the ALL at a level deemed adequate by management for probable incurred credit losses. The ALL is established and maintained through a provision for loan losses charged to earnings. Quarterly, management assesses the adequacy of the ALL using a defined methodology which considers specific credit evaluation of impaired loans, past loan loss historical experience and qualitative factors. Management addresses the requirements for loans individually identified as impaired, loans collectively evaluated for impairment, and other bank regulatory guidance in its assessment.

The ALL is evaluated based on review of the collectability of loans in light of historical experience; the nature and volume of the loan portfolio; adverse situations that may affect a borrower’s ability to repay; estimated value of any underlying collateral; and prevailing economic conditions. This evaluation is inherently subjective as it requires estimates that are susceptible to significant revision as more information becomes available. A description of the methodology for establishing the allowance and provision for loan losses and related procedures in establishing the appropriate level of reserve is included in Note 4, Loans and Allowance for Loan Losses, to the ~~Consolidated Financial Statements~~unaudited condensed consolidated financial statements under Part I, Item 1, "Financial Information."

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The following table summarizes the Company’s internal risk ratings at June 30, ~~2019~~2020 and December 31, ~~2018:~~2019:


(Dollars in thousands)		Pass		Special Mention		Non-Impaired Substandard		Impaired - Substandard		Doubtful		PCI Loans		Total
June 30, 2019
																	Pass		Special Mention		Non-Impaired Substandard		Impaired - Substandard		Doubtful		PCI Loans		Total
June 30, 2020																June 30, 2020
Commercial real estate:	Commercial real estate:															Commercial real estate:
Owner occupied	Owner occupied	$	158,247	$	1,366	$	878	$	1,737	$	0	$	8,044	$	170,272	Owner occupied	$	144,332	$	7,223	$	4,666	$	3,371	$	—	$	4,850	$	164,442
Non-owner occupied	Non-owner occupied	286,669		10,935		0		0		0		1,385		298,989		Non-owner occupied	345,176		45,468		—		—		—		336		390,980
Multi-family	Multi-family	86,765		5,065		700		114		0		698		93,342		Multi-family	95,478		14,796		662		80		—		—		111,016
Non-owner occupied residential	Non-owner occupied residential	114,607		2264		1,156		270		0		3,067		121,364		Non-owner occupied residential	108,985		4,404		1,357		283		—		1,502		116,531
Acquisition and development:	Acquisition and development:															Acquisition and development:
1-4 family residential construction	1-4 family residential construction	12,151		650		0		0		0		0		12,801		1-4 family residential construction	7,844		122		—		—		—		—		7,966
Commercial and land development	Commercial and land development	56,268		188		571		0		0		0		57,027		Commercial and land development	38,947		9,895		541		837		—		—		50,220
Commercial and industrial	Commercial and industrial	198,699		9,523		6,946		253		0		4,130		219,551		Commercial and industrial	636,604		15,372		9,222		708		—		3,406		665,312
Municipal	Municipal	48,358		0		0		0		0		0		48,358		Municipal	30,025		4,251		—		—		—		—		34,276
Residential mortgage:	Residential mortgage:															Residential mortgage:
First lien	First lien	351,523		0		0		2,392		0		10,031		363,946		First lien	287,633		—		—		2,461		—		5,642		295,736
Home equity - term	Home equity - term	15,877		79		0		12		0		21		15,989		Home equity - term	11,841		—		72		11		—		20		11,944
Home equity - lines of credit	Home equity - lines of credit	156,731		187		22		705		0		0		157,645		Home equity - lines of credit	160,036		175		35		596		—		—		160,842
Installment and other loans	Installment and other loans	42,089		0		0		8		0		289		42,386		Installment and other loans	31,950		—		—		17		—		85		32,052
		$	1,527,984	$	30,257	$	10,273	$	5,491	$	0	$	27,665	$	1,601,670		$	1,898,851	$	101,706	$	16,555	$	8,364	$	—	$	15,841	$	2,041,317
December 31, 2018
December 31, 2019																December 31, 2019
Commercial real estate:	Commercial real estate:															Commercial real estate:
Owner occupied	Owner occupied	$	121,903	$	3,024	$	987	$	1,880	$	0	$	1,856	$	129,650	Owner occupied	$	151,161	$	4,513	$	3,163	$	5,872	$	—	$	6,175	$	170,884
Non-owner occupied	Non-owner occupied	242,136		10,008		0		0		0		650		252,794		Non-owner occupied	342,753		17,152		—		—		—		1,145		361,050
Multi-family	Multi-family	71,482		5,886		717		131		0		717		78,933		Multi-family	100,361		4,822		682		345		—		683		106,893
Non-owner occupied residential	Non-owner occupied residential	97,590		736		1,197		309		0		535		100,367		Non-owner occupied residential	111,697		4,534		1,115		235		—		2,457		120,038
Acquisition and development:	Acquisition and development:															Acquisition and development:
1-4 family residential construction	1-4 family residential construction	7,385		0		0		0		0		0		7,385		1-4 family residential construction	15,865		—		—		—		—		—		15,865
Commercial and land development	Commercial and land development	41,251		25		583		0		0		192		42,051		Commercial and land development	39,939		206		1,393		—		—		—		41,538
Commercial and industrial	Commercial and industrial	150,286		2,278		2,940		286		0		5,174		160,964		Commercial and industrial	198,951		1,133		8,899		1,763		—		3,808		214,554
Municipal	Municipal	50,982		0		0		0		0		0		50,982		Municipal	42,649		4,408		—		—		—		—		47,057
Residential mortgage:	Residential mortgage:															Residential mortgage:
First lien	First lien	229,971		0		0		2,877		0		2,448		235,296		First lien	323,040		978		—		2,590		—		9,764		336,372
Home equity - term	Home equity - term	12,170		0		0		16		0		22		12,208		Home equity - term	13,774		74		149		13		—		20		14,030
Home equity - lines of credit	Home equity - lines of credit	142,638		165		15		798		0		0		143,616		Home equity - lines of credit	164,469		74		38		733		—		—		165,314
Installment and other loans	Installment and other loans	33,229		15		1		0		0		166		33,411		Installment and other loans	50,497		—		—		85		—		153		50,735
		$	1,201,023	$	22,137	$	6,440	$	6,297	$	0	$	11,760	$	1,247,657		$	1,555,156	$	37,894	$	15,439	$	11,636	$	—	$	24,205	$	1,644,330

Potential problem loans are defined as performing loans which have characteristics that cause management concern over the ability of the borrower to perform under present loan repayment terms and which may result in the reporting of these loans as nonperforming loans in the future. Generally, management feels that Substandard loans that are currently performing and not considered impaired result in some doubt as to the borrower’s ability to continue to perform under the terms of the loan, and

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represent potential problem loans. Additionally, the Special Mention classification is intended to be a temporary classification reflective of loans that have potential weaknesses that may, if not monitored or corrected, weaken the asset or inadequately protect the Company’s position at some future date. Special Mention loans represent an elevated risk, but their weakness does not yet justify a more severe, or classified, rating. These loans require inquiry by lenders on the cause of the potential weakness and, once analyzed, the loan classification may be downgraded to Substandard or, alternatively, could be upgraded to Pass. Special Mention loans increased by $63.8 million from December 31, 2019 to June 30, 2020 due to commercial loan downgrades, primarily in the hospitality industry, as a result of the significant economic impact of the COVID-19 pandemic.

The following table summarizes activity in the ALL for the ~~three and~~ six months ended June 30, ~~2019~~2020 and ~~2018.~~2019:


		Commercial																		Consumer															Commercial								Consumer
(Dollars in thousands)		Commercial Real Estate		Acquisition and Development		Commercial and Industrial		Municipal		Total		Residential Mortgage		Installment and Other		Total		Unallocated		Total
																							Commercial Real Estate		Acquisition and Development		Commercial and Industrial		Municipal		Total		Residential Mortgage		Installment and Other		Total		Unallocated		Total
Three Months Ended	Three Months Ended																					Three Months Ended
June 30, 2020																						June 30, 2020
Balance, beginning of period																						Balance, beginning of period	$	8,420	$	1,033	$	2,647	$	99	$	12,199	$	3,139	$	294	$	3,433	$	171	$	15,803
Provision for loan losses																						Provision for loan losses	877		31		590		(24)		1,474		323		102		425		1		1,900

Charge-offs																						Charge-offs	—		—		(421)		—		(421)		(18)		(14)		(32)		—		(453)
Recoveries																						Recoveries	50		5		100		—		155		108		4		112		—		267
Balance, end of period																						Balance, end of period	$	9,347	$	1,069	$	2,916	$	75	$	13,407	$	3,552	$	386	$	3,938	$	172	$	17,517
June 30, 2019	June 30, 2019																					June 30, 2019
Balance, beginning of period	Balance, beginning of period	$	7,025	$	969	$	1,814	$	98	$	9,906	$	3,765	$	217	$	3,982	$	395	$	14,283	Balance, beginning of period	$	7,025	$	969	$	1,814	$	98	$	9,906	$	3,765	$	217	$	3,982	$	395	$	14,283
Provision for loan losses	Provision for loan losses	(221)		39		325		(4)		139		(32)		40		8		53		200		Provision for loan losses	(221)		39		325		(4)		139		(32)		40		8		53		200
Charge-offs	Charge-offs	0		0		(47)		0		(47)		(25)		(51)		(76)		0		(123)		Charge-offs	—		—		(47)		—		(47)		(25)		(51)		(76)		—		(123)
Recoveries	Recoveries	43		0		28		0		71		26		3		29		0		100		Recoveries	43		—		28		—		71		26		3		29		—		100
Balance, end of period	Balance, end of period	$	6,847	$	1,008	$	2,120	$	94	$	10,069	$	3,734	$	209	$	3,943	$	448	$	14,460	Balance, end of period	$	6,847	$	1,008	$	2,120	$	94	$	10,069	$	3,734	$	209	$	3,943	$	448	$	14,460
June 30, 2018
Six Months Ended																						Six Months Ended
June 30, 2020																						June 30, 2020
Balance, beginning of period	Balance, beginning of period	$	6,770	$	510	$	1,590	$	83	$	8,953	$	3,382	$	204	$	3,586	$	461	$	13,000	Balance, beginning of period	$	7,634	$	959	$	2,356	$	100	$	11,049	$	3,147	$	319	$	3,466	$	140	$	14,655
Provision for loan losses	Provision for loan losses	(418)		208		8		(3)		(205)		237		44		281		124		200		Provision for loan losses	1,260		102		912		(25)		2,249		400		144		544		32		2,825

Charge-offs	Charge-offs	0		0		0		0		0		(86)		(47)		(133)		0		(133)		Charge-offs	—		—		(496)		—		(496)		(109)		(86)		(195)		—		(691)
Recoveries	Recoveries	328		2		0		0		330		11		29		40		0		370		Recoveries	453		8		144		—		605		114		9		123		—		728
Balance, end of period	Balance, end of period	$	6,680	$	720	$	1,598	$	80	$	9,078	$	3,544	$	230	$	3,774	$	585	$	13,437	Balance, end of period	$	9,347	$	1,069	$	2,916	$	75	$	13,407	$	3,552	$	386	$	3,938	$	172	$	17,517
Six Months Ended
June 30, 2019	June 30, 2019																					June 30, 2019
Balance, beginning of period	Balance, beginning of period	$	6,876	$	817	$	1,656	$	98	$	9,447	$	3,753	$	244	$	3,997	$	570	$	14,014	Balance, beginning of period	$	6,876	$	817	$	1,656	$	98	$	9,447	$	3,753	$	244	$	3,997	$	570	$	14,014
Provision for loan losses	Provision for loan losses	(118)		189		484		(4)		551		157		14		171		(122)		600		Provision for loan losses	(118)		189		484		(4)		551		157		14		171		(122)		600
Charge-offs	Charge-offs	(25)		0		(90)		0		(115)		(271)		(71)		(342)		0		(457)		Charge-offs	(25)		—		(90)		—		(115)		(271)		(71)		(342)		—		(457)
Recoveries	Recoveries	114		2		70		0		186		95		22		117		0		303		Recoveries	114		2		70		—		186		95		22		117		—		303
Balance, end of period	Balance, end of period	$	6,847	$	1,008	$	2,120	$	94	$	10,069	$	3,734	$	209	$	3,943	$	448	$	14,460	Balance, end of period	$	6,847	$	1,008	$	2,120	$	94	$	10,069	$	3,734	$	209	$	3,943	$	448	$	14,460
June 30, 2018
Balance, beginning of period		$	6,763	$	417	$	1,446	$	84	$	8,710	$	3,400	$	211	$	3,611	$	475	$	12,796
Provision for loan losses		(411)		300		152		(4)		37		202		51		253		110		400
Charge-offs		0		0		0		0		0		(86)		(118)		(204)		0		(204)
Recoveries		328		3		0		0		331		28		86		114		0		445
Balance, end of period		$	6,680	$	720	$	1,598	$	80	$	9,078	$	3,544	$	230	$	3,774	$	585	$	13,437

The ALL at June 30, ~~2019,~~2020, increased ~~$446,000~~by $2.9 million from December 31, ~~2018,~~2019, reflecting the ~~$600,000~~$2.8 million provision for loan losses ~~and net charge-offs~~ during the ~~quarter.~~six months ended June 30, 2020. The provision for loan losses increased in the six months ended June 30, 2020 as a result of qualitative factor adjustments for the impact of the COVID-19 pandemic on the Bank’s loan portfolio and commercial loan downgrades. Net charge-offs totaled ~~$(23,000)~~$186 thousand and ~~$(154,000)~~$37 thousand for the three and six ~~months~~months ended June 30, ~~2019~~2020, respectively, compared with net ~~recoveries~~charge-offs of ~~$237,000~~$23 thousand and ~~$241,000~~$154 thousand, respectively, for the same periods in 2018. The ratio of annualized net charge-offs (recoveries) to average loans outstanding was 0.01% and 0.02% for the three and six months ended June 30, 2019 compared with (0.09)% and (0.05)% for 2018.2019. Classified loans totaled ~~$15,764,000~~$24.9 million at June 30, ~~2019,~~2020, or ~~1.0%~~1.2% of total loans outstanding, and ~~increased~~decreased from ~~$12,737,000~~$27.1 million at December 31, ~~2018,~~2019, or ~~1.0%~~1.6% of loans outstanding. The asset quality ratios previously noted are indicative of the continued benefit the Company has received from favorable historical charge-off statistics and generally stable economic and market conditions for the last few years, even while the loan portfolio has been growing. Recent loan growth trends, as well as concerns regarding the COVID-19 pandemic, contributed to management's determination that aan increased provision for loan losses was required to maintain an adequate ALL, with an ALL to total loans ratio of ~~0.90%~~0.86% at June 30, 2020 as compared to 0.89% at December 31, 2019. ~~A principal factor impacting a comparison with~~Excluding SBA loans, which are 100% guaranteed, the ALL to total loans ~~ratio of 1.26%~~was 1.1% at June 30, ~~2018,~~2020. The ALL plus purchase accounting marks to unguaranteed loans was ~~loans acquired in the Mercersburg~~1.8% at June 30, 2020 and ~~Hamilton transactions that were recorded~~ 2.0% at ~~fair value, which incorporated a credit factor, and did not require an increase in the Company's ALL.~~December 31, 2019.

Table of Contents

Despite generally favorable historical charge-off data, ~~and stable~~the impact of the COVID-19 pandemic on economic ~~and market~~ conditions ~~the growth the Company has experienced in its loan portfolio~~ may result in the need for additional provisions for loan losses in future quarters.

~~Table of Contents~~

The following table summarizes the ending loan balances individually or collectively evaluated for impairment based on loan type, as well as the ALL allocation for each, at June 30, ~~2019~~2020 and December 31, ~~2018, excluding~~2019, including PCI ~~loans.~~loans:


		Commercial																		Consumer															Commercial								Consumer
(Dollars in thousands)		Commercial Real Estate		Acquisition and Development		Commercial and Industrial		Municipal		Total		Residential Mortgage		Installment and Other		Total		Unallocated		Total
June 30, 2019
																							Commercial Real Estate		Acquisition and Development		Commercial and Industrial		Municipal		Total		Residential Mortgage		Installment and Other		Total		Unallocated		Total
June 30, 2020																						June 30, 2020
Loans allocated by:																						Loans allocated by:
Individually evaluated for impairment																						Individually evaluated for impairment	$	3,734	$	837	$	708	$	—	$	5,279	$	3,068	$	17	$	3,085	$	—	$	8,364
Collectively evaluated for impairment																						Collectively evaluated for impairment	779,235		57,349		664,604		34,276		1,535,464		465,454		32,035		497,489		—		2,032,953

																							$	782,969	$	58,186	$	665,312	$	34,276	$	1,540,743	$	468,522	$	32,052	$	500,574	$	—	$	2,041,317
ALL allocated by:																						ALL allocated by:
Individually evaluated for impairment																						Individually evaluated for impairment	$	—	$	—	$	—	$	—	$	—	$	35	$	—	$	35	$	—	$	35
Collectively evaluated for impairment																						Collectively evaluated for impairment	9,347		1,069		2,916		75		13,407		3,517		386		3,903		172		17,482

																							$	9,347	$	1,069	$	2,916	$	75	$	13,407	$	3,552	$	386	$	3,938	$	172	$	17,517
December 31, 2019																						December 31, 2019
Loans allocated by:	Loans allocated by:																					Loans allocated by:
Individually evaluated for impairment	Individually evaluated for impairment	$	2,121	$	0	$	253	$	0	$	2,374	$	3,109	$	8	$	3,117	$	0	$	5,491	Individually evaluated for impairment	$	6,452	$	—	$	1,763	$	—	$	8,215	$	3,336	$	85	$	3,421	$	—	$	11,636
Collectively evaluated for impairment	Collectively evaluated for impairment	681,846		69,828		219,298		48,358		1,019,330		534,471		42,378		576,849		0		1,596,179		Collectively evaluated for impairment	752,413		57,403		212,791		47,057		1,069,664		512,380		50,650		563,030		—		1,632,694
		$	683,967	$	69,828	$	219,551	$	48,358	$	1,021,704	$	537,580	$	42,386	$	579,966	$	0	$	1,601,670		$	758,865	$	57,403	$	214,554	$	47,057	$	1,077,879	$	515,716	$	50,735	$	566,451	$	—	$	1,644,330
ALL allocated by:	ALL allocated by:																					ALL allocated by:
Individually evaluated for impairment	Individually evaluated for impairment	$	0	$	0	$	0	$	0	$	0	$	37	$	0	$	37	$	0	$	37	Individually evaluated for impairment	$	—	$	—	$	—	$	—	$	—	$	36	$	—	$	36	$	—	$	36
Collectively evaluated for impairment	Collectively evaluated for impairment	6,847		1,008		2,120		94		10,069		3,697		209		3,906		448		14,423		Collectively evaluated for impairment	7,634		959		2,356		100		11,049		3,111		319		3,430		140		14,619
		$	6,847	$	1,008	$	2,120	$	94	$	10,069	$	3,734	$	209	$	3,943	$	448	$	14,460		$	7,634	$	959	$	2,356	$	100	$	11,049	$	3,147	$	319	$	3,466	$	140	$	14,655
December 31, 2018
Loans allocated by:
Individually evaluated for impairment		$	2,320	$	0	$	286	$	0	$	2,606	$	3,691	$	0	$	3,691	$	0	$	6,297
Collectively evaluated for impairment		559,424		49,436		160,678		50,982		820,520		387,429		33,411		420,840		0		1,241,360
		$	561,744	$	49,436	$	160,964	$	50,982	$	823,126	$	391,120	$	33,411	$	424,531	$	0	$	1,247,657
ALL allocated by:
Individually evaluated for impairment		$	0	$	0	$	0	$	0	$	0	$	38	$	0	$	38	$	0	$	38
Collectively evaluated for impairment		6,876		817		1,656		98		9,447		3,715		244		3,959		570		13,976
		$	6,876	$	817	$	1,656	$	98	$	9,447	$	3,753	$	244	$	3,997	$	570	$	14,014

In addition to the specific reserve allocations on impaired loans noted previously, 1715 loans, with aggregate outstanding principal balances of ~~$3,683,000,~~$1.7 million, have had cumulative partial charge-offs to the ALL totaling ~~$873,000~~$755 thousand at June 30, ~~2019.~~2020. As updated appraisals ~~were~~are received on collateral-dependent loans, partial charge-offs ~~were~~are taken to the extent the loans’ principal balance ~~exceeded~~exceeds their fair value.

Management believes the allocation of the ALL between the various loan classes adequately reflects the probable incurred credit losses in each portfolio and is based on the methodology outlined in Note 4, Loans and Allowance for Loan Losses, to the Consolidated Financial Statements under Part I, Item 1, "Financial Information." Management re-evaluates and makes enhancements to its reserve methodology to better reflect the risks inherent in the different segments of the portfolio, particularly in light of increased charge-offs, with noticeable differences between the different loan classes. Management believes these enhancements to the ALL methodology improve the accuracy of quantifying probable incurred credit losses inherent in the portfolio. Management charges actual loan losses to the reserve and bases the provision for loan losses on its overall analysis.

The unallocated portion of the ALL reflects estimated inherent losses within the portfolio that have not been detected, as well as the risk of error in the specific and general reserve allocation, other potential exposure in the loan portfolio, variances in management’s assessment of national and local economic conditions and other factors management believes appropriate at the time. The unallocated portion of the ALL totaled ~~$448,000,~~$172 thousand, or ~~3.1%~~1.0% of the ALL balance, at June 30, ~~2019~~2020 compared with ~~$570,000,~~$140 thousand, or ~~4.1%~~1.0% of the ALL balance at December 31, ~~2018.~~2019. The Company monitors the unallocated portion of the ALL

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and, by policy, has determined it should not exceed 6% of the total reserve. Future negative provisions for loan losses may result if the unallocated portion was to increase, and management determined the reserves were not required for the anticipated risk in the portfolio.

~~Table of Contents~~

Management believes the Company’s ALL is adequate based on currently available information. Future adjustments to the ALL and enhancements to the methodology may be necessary due to changes in economic conditions, regulatory guidance, or management’s assumptions as to future delinquencies or loss rates.

Deposits

Deposits totaled ~~$2,015,541,000~~$2.3 billion at June 30, ~~2019,~~2020, an increase of ~~$456,785,000,~~$376.2 million, or ~~29.3%~~20.1%, from ~~$1,558,756,000~~$1.9 billion at December 31, ~~2018.~~2019.

Noninterest-bearing deposits increased ~~$42,362,000,~~by $186.8 million, or ~~20.7%~~74.9%, from December 31, ~~2018~~2019 to June 30, ~~2019.~~2020. Interest-bearing deposits totaled ~~$1,768,336,000~~$1.8 billion at June 30, ~~2019,~~2020, an increase of ~~$414,423,000,~~$189.4 million, or ~~30.6%~~11.6% from the ~~$1,353,913,000~~$1.6 billion balance at December 31, ~~2018. The Hamilton acquisition contributed approximately 80% of the increase in noninterest-bearing deposits and approximately 85% of the increase in interest-bearing deposits.~~2019.

The Company continues to increase both noninterest-bearing and interest-bearing deposit relationships from its enhanced ~~cash~~treasury management offerings as it increases its commercial relationships. Deposit growth in the first six months of ~~2019~~2020 was principally ~~used~~due to ~~reduce total~~clients seeking a safe haven for their deposits during the COVID-19 pandemic and the high usage of checking accounts for SBA PPP loan funds. As the SBA PPP clients utilize their borrowings ~~and~~ to fund ~~growth in~~operations, the ~~loan and investment portfolios.~~associated deposits are expected to decline.

Shareholders' Equity, Capital Adequacy and Regulatory Matters

Capital management in a regulated financial services industry must properly balance return on equity to its shareholders while maintaining sufficient levels of capital and related risk-based regulatory capital ratios to satisfy statutory regulatory requirements. The Company’s capital management strategies have been developed to provide attractive rates of returns to its shareholders, while maintaining a “well capitalized” position of regulatory strength.

Shareholders’ equity totaled ~~$219,868,000~~$225.6 million at June 30, ~~2019, and increased $46,435,000~~2020, an increase of $2.4 million, or ~~26.8%~~1.1%, from ~~$173,433,000~~$223.2 million at December 31, ~~2018.~~2019. The increase was primarily attributable to ~~growth in retained earnings~~net income totaling ~~$5,789,000~~$11.4 million for the six months ended June 30, ~~2019,~~2020. This increase was partially offset by an increase in accumulated other comprehensive loss from changes in net unrealized gains and losses in securities available for sale, net of tax, which fell by $3.1 million from December 31, 2019 to June 30, 2020 due to declining interest rates and market uncertainty resulting from the COVID-19 pandemic. Accumulated other comprehensive loss also included $1.6 million in losses on cash flow hedges, net of tax, during the six months ended June 30, 2020. In addition, there were dividends paid on common stock totaling ~~$2,799,000, and improvement in net unrealized gains/losses in AOCI, net of taxes, totaling $6,380,000, and~~$3.8 million during the ~~issuance of the Company's common stock in connection with the acquisition of Hamilton totaling $36,622,000.~~six months ended June 30, 2020.

The Company routinely evaluates its capital levels in light of its risk profile to assess its capital needs. The Company and the Bank are subject to various regulatory capital requirements administered by federal and state banking agencies. The consolidated asset limit on small bank holding companies is ~~$3,000,000,000~~ $3.0 billion and a company with assets under that limit is not subject to the FRB consolidated capital rules, but may file reports that include capital amounts and ratios. The Company has elected to file those reports.

At June 30, ~~2019~~2020 and December 31, ~~2018,~~2019, the Bank was considered well capitalized under applicable banking regulations. Under capital adequacy guidelines and the regulatory framework for prompt corrective action, the Bank must meet specific guidelines that involve quantitative measures of assets, liabilities and certain off-balance sheet items as calculated under regulatory accounting practices. Prompt corrective action provisions are not applicable to bank holding companies, including financial holding companies.

Note 9,10, Shareholders' Equity and Regulatory Capital, to the Notes to Unaudited Condensed Consolidated Financial Statements under Part I, Item 1, "Financial Information," includes a table presenting capital amounts and ratios for the Company and the Bank at June 30, ~~2019~~2020 and December 31, ~~2018.~~2019.

In addition to the minimum capital ratio requirement and minimum capital ratio to be well capitalized presented in the referenced table in Note 9,10, the Bank must maintain a capital conservation buffer as more fully described in the Company's Annual Report on Form 10-K for the year ended December 31, ~~2018,~~2019, Item 1 - Business, under the topic Basel III Capital Rules. At June 30, ~~2019,~~2020, the Bank's capital conservation buffer, based on the most restrictive Total Capital to risk weighted assets capital ratio, was ~~5.0%~~5.9%, which is greater than the ~~2.50% requirement for 2019.~~2.5% requirement.

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Liquidity

The primary function of asset/liability management is to ensure adequate liquidity and manage the Company’s sensitivity to changing interest rates. Liquidity management involves the ability to meet the cash flow requirements of customers who may be either depositors wanting to withdraw funds or borrowers needing assurance that sufficient funds will be available to meet their credit needs. Our primary sources of funds consist of deposit inflows, loan repayments, maturities and sales of investment securities, the sale of mortgage loans and borrowings from the FHLB of Pittsburgh. While maturities and scheduled amortization of loans and securities are predictable sources of funds, deposit flows and mortgage prepayments are greatly influenced by general interest rates, economic conditions and competition. The maximum borrowing capacity from the FHLB is $843.0 million at June 30, 2020.

We regularly adjust our investments in liquid assets based upon our assessment of expected loan demand, expected deposit flows, yields available on interest-earning deposits and securities and the objectives of our asset/liability management policy. Unencumbered investment securities totaled $55.7 million at June 30, 2020. At June 30, 2020, the Company has $211.4 million of investment securities pledged at the FRB Discount Window, with no associated borrowings outstanding.

The Company applied for and received access to the PPPLF, a liquidity facility created by the Federal Reserve for the pledging of PPP loans, to further expand its already robust access to off balance sheet liquidity. Borrowings through the PPPLF facility totaled $33.7 million at June 30, 2020, with SBA PPP loans of the same amount pledged as collateral. The remaining availability to the Company under this facility is $424.9 million at June 30, 2020.

Mergers and Acquisitions

See Note 2, Mergers and Acquisitions, to the Consolidated Financial Statements under Part I, Item 1, "Financial Statements" in this Form 10-Q.

Supplemental Reporting of Non-GAAP Measures

As a result of acquisitions, the Company ~~has~~had intangible assets consisting of goodwill and core deposit and other intangible assets totaling ~~$27,761,000~~$24.9 million and ~~$16,502,000~~$27.1 million at June 30, ~~2019~~2020 and December 31, ~~2018.~~2019, respectively.

Management believes providing certain “non-GAAP” financial information will assist investors in their understanding of the effect of acquisition activity on reported results, particularly to overcome comparability issues related to the influence of intangibles (principally goodwill) created in acquisitions.

Tangible book value per share and net interest margin excluding the impact of purchase accounting, as used by the Company in this supplemental reporting presentation, are determined by methods other than in accordance with ~~U.S. Generally Accepted Accounting Principles ("GAAP").~~GAAP. While we believe this information is a useful supplement to GAAP based measures presented in this Form 10-Q, readers are cautioned that this non-GAAP disclosure has limitations as an analytical tool, should not be viewed as a substitute for financial measures determined in accordance with GAAP, and should not be considered in isolation or as a substitute for analysis of our results and financial condition as reported under GAAP, nor are such measures necessarily comparable to non-GAAP performance measures that may be presented by other companies. This supplemental presentation should not be construed as an inference that our future results will be unaffected by similar adjustments to be determined in accordance with GAAP.

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


											June 30, 2020				December 31, 2019

(in thousands, except per share information)		June 30, 2019				December 31, 2018
Tangible Book Value per Common Share	Tangible Book Value per Common Share							Tangible Book Value per Common Share
Shareholders' equity	Shareholders' equity	$	219,868			$	173,433	Shareholders' equity			$	225,638			$	223,249
Goodwill and other intangible assets, net of related tax effect				26,052				15,698
Less: Goodwill								Less: Goodwill			18,724				19,925
Other intangible assets								Other intangible assets			6,160				7,180
Related tax effect								Related tax effect			(1,294)				(1,508)
Tangible common equity (non-GAAP)	Tangible common equity (non-GAAP)	$	193,816			$	157,735	Tangible common equity (non-GAAP)			$	202,048			$	197,652

Common shares outstanding	Common shares outstanding	11,224				9,430		Common shares outstanding			11,209				11,200

Book value per share (most directly comparable GAAP based measure)	Book value per share (most directly comparable GAAP based measure)			$	19.59			$	18.39	Book value per share (most directly comparable GAAP based measure)			$	20.13			$	19.93
Intangible assets per share	Intangible assets per share	2.32				1.66		Intangible assets per share			2.10				2.28
Tangible book value per share (non-GAAP)	Tangible book value per share (non-GAAP)	$	17.27			$	16.73	Tangible book value per share (non-GAAP)			$	18.03			$	17.65

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At or For The Three Months Ended At or For The Six Months Ended
June 30, 2019 June 30, 2018 June 30, 2019 June 30, 2018
Net Interest Margin (excluding the impact of purchase accounting)
Net interest margin as reported 3.61 % 3.32 % 3.52 % 3.29 %
Adjustment for purchase accounting:
Total interest-earning assets (loans) (0.30) % 0.00 % (0.19) % 0.00 %
Net Interest Margin (excluding the impact of purchase accounting) (non-GAAP) 3.31 % 3.32 % 3.33 % 3.29 %


	Three Months Ended June 30,
		2020						2019
Taxable-Equivalent Net Interest Margin (excluding the effect of purchase accounting)
Taxable-equivalent net interest income/margin, as reported		$	21,028	3.37	%	$	18,807	3.63	%
Effect of purchase accounting:
Loans	Income	(1,603)		(0.27)	%	(1,385)		(0.29)	%
Time deposits	Expenses	24		0.00	%	24		(0.01)	%

Purchase accounting effect on taxable-equivalent income/ margin		(1,627)		(0.27)	%	(1,409)		(0.30)	%
Taxable-equivalent net interest income/margin (excluding the effect of purchase accounting) (non-GAAP)		$	19,401	3.10	%	$	17,398	3.33	%

	Six Months Ended June 30,
		2020						2019
Taxable-Equivalent Net Interest Margin (excluding the effect of purchase accounting)
Taxable-equivalent net interest income/margin, as reported		$	39,486	3.39	%	$	33,912	3.54	%
Effect of purchase accounting:
Loans	Income	(2,502)		(0.23)	%	(1,638)		(0.22)	%
Time deposits	Expenses	52		0.00	%	14		0.00	%

Purchase accounting effect on taxable-equivalent income/ margin		(2,554)		(0.23)	%	(1,652)		(0.22)	%
Taxable-equivalent net interest income/margin (excluding the effect of purchase accounting) (non-GAAP)		$	36,932	3.16	%	$	32,260	3.32	%


	June 30, 2020
Allowance to unguaranteed loans
Allowance for loan losses	$	17,517
Gross loans	$	2,041,317
less: SBA guaranteed loans	(460,365)
Unguaranteed loans	$	1,580,952

Allowance to unguaranteed loans	1.11		%


	June 30, 2020			December 31, 2019
Allowance plus purchase accounting marks to unguaranteed loans:
Allowance for loan losses	$	17,517		$	14,655
Purchase accounting marks	11,025			18,160
Allowance plus purchase accounting marks	28,542			32,815

Gross loans	2,041,317			1,644,330
less: SBA guaranteed loans	(460,365)			(1,559)
Unguaranteed loans	$	1,580,952		$	1,642,771

Allowance plus purchase accounting marks to unguaranteed loans:	1.8		%	2.0		%

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Item 3. Quantitative and Qualitative Disclosures about Market Risk

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

Interest Rate Risk

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

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

Management endeavors to control the exposure to changes in interest rates by understanding, reviewing and making decisions based on its risk position. The Company primarily uses its securities portfolio, FHLB advances, interest rate swaps and brokered deposits to manage its interest rate risk position. Additionally, pricing, promotion and product development activities are directed in an effort to emphasize the loan and deposit term or repricing characteristics that best meet current interest rate risk objectives. ~~At present, we do not use hedging instruments for risk management, but we do evaluate them and may use them in the future.~~

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

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

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~~Earnings at Risk~~Net Interest Income Sensitivity

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

The simulation analysis results are presented in the ~~Earnings at Risk~~Net Interest Income table below. At June 30, ~~2019, similar to at~~2020 and December 31, ~~2018, these~~2019, results ~~indicate~~indicated the Company would be better positioned over the subsequent 12 months in a moderately ~~rising~~declining rate environment than it would be if interest rates ~~increased~~increased. This is due to a shift in the mix of assets to more ~~substantially or decreased.~~floating rate loans, a shift in the mix of liabilities to fewer certificates of deposit, and the steep decline in interest rates.

Economic Value ~~at Risk~~

Net present value analysis provides information on the risk inherent in the balance sheet that might not be taken into account in the simulation analysis due to the short time horizon used in that analysis. The net present value of the balance sheet incorporates the discounted present value of expected asset cash flows minus the discounted present value of expected liability cash flows. The analysis involves changing the interest rates used in determining the expected cash flows and in discounting the cash ~~flows, assuming a point in time balance sheet with no management actions to actively manage the balance sheet for improved results.~~flows. The resulting percentage change in net present value in various rate scenarios is an indication of the longer term repricing risk and options embedded in the balance sheet.

At June 30, ~~2019,~~2020, similar to at December 31, ~~2018,~~2019, these results ~~indicate~~indicated the Company would be better positioned in a rising interest rate environment than it would be if interest rates decreased. As a result of the low interest rates at June 30, 2020, the impact of increased rates on the economic value of the balance sheet would be substantial. To improve the comparability across periods, the Company follows best practices and maintains the size and mix of the period end balance sheet; thus, the results do not reflect actions management may take to improve results.


Earnings at Risk									Value at Risk
Net Interest Income											Net Interest Income								Economic Value
		% Change in Net Interest Income							% Change in Market Value							% Change in Net Interest Income					% Change in Market Value
Change in Market Interest Rates (basis points)	Change in Market Interest Rates (basis points)	June 30, 2019		December 31, 2018		Change in Market Interest Rates (basis points)	June 30, 2019		December 31, 2018		Change in Market Interest Rates (basis points)	June 30, 2020		December 31, 2019		Change in Market Interest Rates (basis points)	June 30, 2020		December 31, 2019
(100)	(100)	(2.1)	%	(2.1)	%	(100)	(25.0)	%	(14.1)	%	(100)	0.1	%	(0.5)	%	(100)	(128.5)	%	(21.7)	%
100	100	1.1	%	(0.6)	%	100	13.0	%	6.1	%	100	(0.4)	%	(1.3)	%	100	119.0	%	10.9	%
200	200	0.7	%	(2.2)	%	200	19.0	%	7.1	%	200	(1.3)	%	(3.8)	%	200	191.3	%	15.1	%
300											300	(4.3)	%	(8.1)	%	300	233.0	%	15.0	%

Item 4. Controls and Procedures

Based on the evaluation required by Securities Exchange Act Rules 13a-15(b) and 15d-15(b), the ~~Company’s~~Company's management, including the ~~Principal~~Chief Executive Officer and ~~Interim~~ Chief ~~Accounting~~Financial Officer, conducted an evaluation of the effectiveness of our disclosure controls and procedures, as defined in Securities Exchange Act Rules 13a-15(e) and 15d-15(e), at June 30, ~~2019.~~2020. Based on that evaluation, ~~the Principal~~our Chief Executive Officer and ~~Interim~~ Chief ~~Accounting~~Financial Officer concluded that ~~the~~our disclosure controls and procedures were effective at June 30, ~~2019.~~2020. There have been no changes in internal control over financial reporting that have materially affected, or are reasonably likely to materially affect, our internal control over financial reporting during the ~~second quarter of 2019.~~

six months ended June 30, 2020.

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PART II – OTHER INFORMATION

Item 1 – Legal Proceedings

Information regarding legal proceedings is included in Note ~~13,~~14, Contingencies, to the Consolidated Financial Statements under Part I, Item 1, "Financial Statements" and incorporated herein by reference.

Item 1A – Risk Factors

Except as ~~described~~noted below, there have been no material changes from the risk factors as disclosed in our Annual Report on Form 10-K for the year ended December 31, ~~2018.~~

~~Certain risk factors related to mergers~~2019 and ~~acquisitions in~~ our ~~Annual~~Quarterly Report on Form ~~10-K~~10-Q for the ~~year~~quarterly period ended ~~December~~March 31, 2018 referenced risks associated with the completion of the Company's merger with Hamilton. As noted elsewhere in this Form 10-Q, the merger with Hamilton was completed on May 1, 2019 and our market area now includes Anne Arundel, Baltimore, and Howard Counties, Maryland, as well as Baltimore City, Maryland.2020.

~~The risk factor related to changes~~Interest rate volatility stemming from COVID-19 could negatively affect our net interest income, lending activities, deposits and profitability.

Our net interest income, lending activities, deposits and profitability could be negatively affected by volatility in ~~our accounting policies or in accounting standards appearing in our Annual Report on Form 10-K~~interest rates caused by uncertainties stemming from COVID-19. In March 2020, the Federal Reserve lowered the target range for the ~~year ended December 31, 2018 referenced an adoption date in 2020 for ASU 2016-13, for changes in measurement of credit losses. As noted elsewhere in this Form 10-Q, the FASB has proposed~~federal funds rate to a ~~delay in the effective date of this ASU for smaller reporting companies until fiscal years beginning after December 15, 2022, with earlier adoption permitted. The Company is evaluating~~range from 0 to 0.25 percent, citing concerns about the impact of COVID-19 on markets and stress in the ~~proposed delay for adoption~~energy sector. A prolonged period of extremely volatile and unstable market conditions would likely increase our funding costs and negatively affect market risk mitigation strategies. Higher income volatility from changes in interest rates and spreads to benchmark indices could cause a loss of future net interest income and a decrease in current fair market values of our assets. Fluctuations in interest rates will impact both the ~~update.~~level of income and expense recorded on most of our assets and liabilities and the market value of all interest-earning assets and interest-bearing liabilities, which in turn could have a material adverse effect on our net income, operating results, or financial condition.

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

~~No shares of the Company were repurchased from April 1, 2019 to June 30, 2019.~~

In September 2015, the Board of Directors of the Company authorized a share repurchase program under which the Company may repurchase up to 5% of the Company's outstanding shares of common stock, or approximately 416,000 shares, in accordance with all applicable securities laws and regulations, including Rule 10b-18 of the Exchange Act. When and if appropriate, repurchases may be made in open market or privately negotiated transactions, depending on market conditions, regulatory requirements and other corporate considerations, as determined by management. Share repurchases may not occur and may be discontinued at any time. At June 30, ~~2019, 82,725~~2020, 154,680 shares had been repurchased under the program at a total cost of ~~$1,438,000,~~$2.6 million, or ~~17.38~~$16.88 per share. The maximum number of shares that may yet be purchased under the plan is ~~333,275~~261,320 at June 30, ~~2019.~~2020.

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


2.1(a)		Agreement and Plan of Merger, dated May 31, 2018, by and between Orrstown Financial Services, Inc. and Mercersburg Financial Corporation, incorporated by reference to Exhibit 2.1 of the Registrant's Form 8-K filed June 1, 2018.

2.1(b)		Agreement and Plan of Merger, dated October 23, 2018, by and between Orrstown Financial Services, Inc. and Hamilton Bancorp, Inc., incorporated by reference to Exhibit 2.1 of the Registrant's Form 8-K filed October 24, 2018.

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

3.2		By-laws as amended, incorporated by reference to Exhibit 3.2 to the Registrant’s Report on Form 8-K filed January 30, 2018.

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

~~10.1~~31.1	~~Employment Agreement between Orrstown Financial Services, Inc. and Thomas R. Brugger, incorporated by reference to Exhibit 10.1 to the Registrant's Report on Form 8-K filed June 25, 2019.~~

~~10.2~~		Change in Control Agreement between Orrstown Financial Services, Inc., Orrstown Bank and Thomas R. Brugger, incorporated by reference to Exhibit 10.2 to the Registrant's Report on Form 8-K filed June 25, 2019.

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

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

32.1		Section 1350 Certifications (Principal Executive Officer)

32.2		Section 1350 Certifications ~~(Interim Chief Accounting~~(Principal Financial Officer)

101.LAB		XBRL Taxonomy Extension Label Linkbase

101.PRE		XBRL Taxonomy Extension Presentation Linkbase

101.INS		XBRL Instance Document

101.SCH		XBRL Taxonomy Extension Schema

101.CAL		XBRL Taxonomy Extension Calculation Linkbase

101.DEF		XBRL Taxonomy Extension Definition Linkbase

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

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SIGNATURES

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


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

			/s/ ~~Gary A. Manley~~Thomas R. Brugger
			~~Gary A. Manley~~Thomas R. Brugger
			~~Interim~~Executive Vice President and Chief ~~Accounting~~Financial Officer
			(~~Chief Accounting~~Principal Financial Officer)

			Date: August ~~8, 2019~~7, 2020

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	Three Months Ended June 30, 2018
(Dollars in thousands, except per share information)	Common Stock		Additional Paid-In Capital		Retained Earnings		Accumulated Other Comprehensive Income (Loss)		Treasury Stock		Total Shareholders’ Equity






















Balance, March 31, 2018	438		125,988		18,667		(2,238)		(299)		142,556
Net income	0		0		4,012		0		0		4,012

Total other comprehensive loss, net of taxes	0		0		0		(455)		0		(455)
Cash dividends ($0.13 per share)	0		0		(1,095)		0		0		(1,095)

Share-based compensation plans:
300 net common shares forfeited and 11,317 net treasury shares acquired, including compensation expense of $444	0		414		0		0		(295)		119

Balance, June 30, 2018	438		126,402		21,584		(2,693)		(594)		145,137




















	Six Months Ended June 30, 2018
(Dollars in thousands, except per share information)	Common Stock		Additional Paid-In Capital		Retained Earnings		Accumulated Other Comprehensive Income (Loss)		Treasury Stock		Total Shareholders’ Equity
Balance, January 1, 2018	$	435	$	125,458	$	16,042	$	2,845	$	(15)	$	144,765
Net income	0		0		7,637		0		0		7,637

Total other comprehensive loss, net of taxes	0		0		0		(5,538)		0		(5,538)
Cash dividends ($0.25 per share)	0		0		(2,095)		0		0		(2,095)

Share-based compensation plans:
75,623 net common shares issued and 21,965 net treasury shares acquired, including compensation expense of $924	3		944		0		0		(579)		368

Balance, June 30, 2018	$	438	$	126,402	$	21,584	$	(2,693)	$	(594)	$	145,137


(Dollars in thousands)
Remainder of 2019	$	662
2020	1,336
2021	1,207
2022	788
2023	810
2024	801
Thereafter	11,025
	16,629
Less imputed interest	5,929
Total lease liabilities	$	10,700


Range of Exercise Prices	Number Outstanding	Weighted Average Remaining Contractual Life (Years)	Weighted Average Exercise Price
$21.14 - $24.99	27,767	1.06	$	21.14
$25.00 - $34.99	2,792	0.76	25.76

$35.00 - $37.59	5,090	0.08	36.95

$21.14 - $37.59	35,649	0.90	$	23.76


	At or For The Three Months Ended						At or For The Six Months Ended
	June 30, 2019		June 30, 2018		June 30, 2019		June 30, 2018























Net Interest Margin (excluding the impact of purchase accounting)
Net interest margin as reported	3.61	%	3.32	%	3.52	%	3.29	%
Adjustment for purchase accounting:
Total interest-earning assets (loans)	(0.30)	%	0.00	%	(0.19)	%	0.00	%
Net Interest Margin (excluding the impact of purchase accounting) (non-GAAP)	3.31	%	3.32	%	3.33	%	3.29	%