UNITED STATES

SECURITIES AND EXCHANGE COMMISSION

Washington, D.C. 20549

FORM 10-Q

(Mark One)

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

For the quarterly period ended September 30, 2020

or

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

For the transition from                       to                     

Commission file number: 001-38827

Cortland Bancorp Inc

(Exact name of registrant as specified in its charter)

Ohio	34-1451118
(State or other jurisdiction of Incorporation or organization)	(I.R.S. Employer Identification No.)
194 West Main Street, Cortland, Ohio	44410
(Address of principal executive offices)	(Zip code)

330- 637-8040

(Registrant’s telephone number, including area code)

N/A

(Former name, former address and former fiscal year, if changed since last report)

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	CLDB	NASDAQ Capital 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  ☒    No  ☐

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

Indicate by check mark whether the registrant is a large accelerated filer, an accelerated filer, a non-accelerated filer, 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 Exchange Act).    Yes  ☐    No  ☒

APPLICABLE ONLY TO ISSUERS INVOLVED IN BANKRUPTCY PROCEEDINGS DURING THE PRECEDING FIVE YEARS:

Indicate by check mark whether the registrant has filed all documents and reports required to be filed by Section 12, 13 or 15(d) of the Securities Exchange Act of 1934 subsequent to the distribution of securities under a plan confirmed by a court.      Yes ☐    No ☐ 

APPLICABLE ONLY TO CORPORATE ISSUERS:

Indicate the number of shares outstanding of each of the issuer’s classes of common stock, as of the latest practicable date.

TITLE OF CLASS	SHARES OUTSTANDING
Common Stock, No Par Value	4,223,153 Shares October 29, 2020

PART I – FINANCIAL INFORMATION
Item 1.	Financial Statements
	Cortland Bancorp and Subsidiaries:
	Consolidated Balance Sheets (unaudited) – September 30, 2020 and December 31, 2019	2
	Consolidated Statements of Income (unaudited) – Three and nine months ended September 30, 2020 and 2019	3
	Consolidated Statements of Comprehensive Income (unaudited) – Three and nine months ended September 30, 2020 and 2019	4
	Consolidated Statements of Changes in Shareholders’ Equity (unaudited) – Three and nine months ended September 30, 2020 and 2019	5
	Consolidated Statements of Cash Flows (unaudited) – Nine months ended September 30, 2020 and 2019	6
	Notes to Consolidated Financial Statements (unaudited)	7
Item 2.	Management’s Discussion and Analysis of Financial Condition and Results of Operations	28
	Consolidated Average Balance Sheets, Yields and Rates – Year-to-Date September 30, 2020 and September 30, 2019	28
	Consolidated Average Balance Sheets, Yields and Rates – Quarter-to-Date September 30, 2020, June 30, 2020 and September 30, 2019	29
	Selected Financial Data	30
	Financial Review	31
Item 3.	Quantitative and Qualitative Disclosures About Market Risk	46
Item 4.	Controls and Procedures	46
PART II – OTHER INFORMATION		47
Item 1.	Legal Proceedings	47
Item 1A.	Risk Factors	47
Item 2.	Unregistered Sales of Equity Securities and Use of Proceeds	48
Item 3.	Defaults Upon Senior Securities	48
Item 4.	Mine Safety Disclosures	48
Item 5.	Other Information	48
Item 6.	Exhibits	49
SIGNATURES		52

1

CORTLAND BANCORP AND SUBSIDIARIES

CONSOLIDATED BALANCE SHEETS (UNAUDITED)

(Amounts in thousands, except share data)

	September 30,			December 31,
	2020			2019
ASSETS
Cash and due from banks	$	7,808		$	8,448
Interest-earning deposits		40,825			19,367
Total cash and cash equivalents		48,633			27,815
Investment securities available-for-sale (Note 3)		167,577			136,131
Regulatory stock (Note 3)		3,031			2,835
Loans held for sale		6,564			4,890
Total loans (Note 4)		534,146			518,716
Less allowance for loan losses (Note 4)		(6,045	)		(4,465	)
Net loans		528,101			514,251
Premises and equipment		11,885			12,018
Bank-owned life insurance		21,046			17,768
Other assets		24,788			21,454
Total assets	$	811,625		$	737,162
LIABILITIES
Noninterest-bearing deposits	$	194,174		$	133,340
Interest-bearing deposits		486,466			485,041
Total deposits		680,640			618,381
Securities sold under agreements to repurchase (Note 13)		1,088			1,922
Federal Home Loan Bank advances - short term		7,000			—
Federal Home Loan Bank advances - long term		24,000			24,000
Subordinated debt (Note 7)		5,155			5,155
Other liabilities		15,594			13,366
Total liabilities		733,477			662,824
SHAREHOLDERS’ EQUITY
Common stock - $5.00 stated value - authorized 20,000,000 shares; issued 4,728,267 shares in 2020 and 2019; outstanding shares, 4,223,153 in 2020 and 4,323,822 in 2019		23,641			23,641
Additional paid-in capital		21,153			21,266
Retained earnings		39,657			36,187
Accumulated other comprehensive income (Note 10)		4,301			1,168
Treasury stock, at cost, 505,114 shares in 2020 and 404,445 in 2019		(10,604	)		(7,924	)
Total shareholders’ equity		78,148			74,338
Total liabilities and shareholders’ equity	$	811,625		$	737,162

See accompanying notes to the unaudited consolidated financial statements of Cortland Bancorp and Subsidiaries

2

CORTLAND BANCORP AND SUBSIDIARIES

CONSOLIDATED STATEMENTS OF INCOME (UNAUDITED)

(Amounts in thousands, except per share data)

	THREE MONTHS ENDED					NINE MONTHS ENDED
	SEPTEMBER 30,					SEPTEMBER 30,
	2020		2019			2020		2019
INTEREST AND DIVIDEND INCOME
Interest and fees on loans	$	5,772	$	6,257		$	17,593	$	19,250
Interest and dividends on investment securities:
Taxable interest		303		382			946		1,440
Nontaxable interest		569		466			1,543		1,187
Dividends		13		29			53		103
Other interest income		14		90			84		235
Total interest and dividend income		6,671		7,224			20,219		22,215
INTEREST EXPENSE
Deposits		752		1,238			2,731		3,607
Securities sold under agreements to repurchase		1		1			4		4
Federal Home Loan Bank advances - short term		5		17			9		128
Federal Home Loan Bank advances - long term		87		96			262		271
Subordinated debt		23		50			91		157
Total interest expense		868		1,402			3,097		4,167
Net interest income		5,803		5,822			17,122		18,048
PROVISION FOR LOAN LOSSES		525		180			1,575		535
NET INTEREST INCOME AFTER PROVISION FOR LOAN LOSSES		5,278		5,642			15,547		17,513
NON-INTEREST INCOME
Fees for customer services		528		617			1,563		1,701
Investment securities available-for-sale gains (losses), net		—		—			18		(44	)
Mortgage banking gains, net		1,281		492			2,777		1,173
Earnings on bank-owned life insurance		90		86			278		296
Other non-interest income		66		232			496		557
Total non-interest income		1,965		1,427			5,132		3,683
NON-INTEREST EXPENSES
Salaries and employee benefits		2,598		2,622			7,827		8,436
Occupancy and equipment		608		610			1,913		1,765
State and local taxes		150		130			448		389
FDIC insurance		46		(8	)		99		107
Professional fees		287		348			871		816
Advertising and marketing		64		78			156		276
Data processing fees		63		72			204		215
Other operating expenses		905		909			2,761		2,848
Total non-interest expenses		4,721		4,761			14,279		14,852
INCOME BEFORE FEDERAL INCOME TAX EXPENSE		2,522		2,308			6,400		6,344
Federal income tax expense		360		363			935		966
NET INCOME	$	2,162	$	1,945		$	5,465	$	5,378
EARNINGS PER SHARE BASIC AND DILUTED	$	0.51	$	0.45		$	1.30	$	1.24
CASH DIVIDENDS DECLARED PER SHARE	$	0.14	$	0.11		$	0.47	$	0.38

See accompanying notes to the unaudited consolidated financial statements of Cortland Bancorp and Subsidiaries

3

CORTLAND BANCORP AND SUBSIDIARIES

CONSOLIDATED STATEMENTS OF COMPREHENSIVE INCOME (UNAUDITED)

(Amounts in thousands)

	THREE MONTHS ENDED						NINE MONTHS ENDED
	SEPTEMBER 30,						SEPTEMBER 30,
	2020			2019			2020			2019
Net income	$	2,162		$	1,945		$	5,465		$	5,378
Other comprehensive income:
Securities available for sale:
Unrealized holding gains on available-for-sale securities		933			1,764			4,020			6,154
Tax effect		(195	)		(371	)		(844	)		(1,293	)
Reclassification adjustment for net (gains) losses in net income		—			—			(18	)		44
Tax effect		—			—			4			(9	)
Total securities available-for-sale		738			1,393			3,162			4,896
Change in post-retirement obligations		(18	)		7			(29	)		21
Total other comprehensive income		720			1,400			3,133			4,917
Total comprehensive income	$	2,882		$	3,345		$	8,598		$	10,295

See accompanying notes to the unaudited consolidated financial statements of Cortland Bancorp and Subsidiaries

4

CORTLAND BANCORP AND SUBSIDIARIES

CONSOLIDATED STATEMENTS OF CHANGES IN SHAREHOLDERS’ EQUITY (UNAUDITED)

(Amounts in thousands, except per share data)

	THREE MONTHS ENDED						NINE MONTHS ENDED
	SEPTEMBER 30,						SEPTEMBER 30,
	2020			2019			2020			2019
COMMON STOCK
Balance	$	23,641		$	23,641		$	23,641		$	23,641
ADDITIONAL PAID IN CAPITAL
Beginning balance		21,069			21,027			21,266			20,984
Treasury shares reissued (2,770 shares)		—			—			—			11
Equity compensation		84			126			(113	)		158
Ending Balance		21,153			21,153			21,153			21,153
RETAINED EARNINGS
Beginning balance		38,085			33,345			36,187			31,089
Net income		2,162			1,945			5,465			5,378
Cash dividend declared, $0.14 and $0.47 and $0.11 and $0.38 per share for three and nine months ended September 30, 2020 and 2019, respectively		(590	)		(482	)		(1,995	)		(1,659	)
Ending balance		39,657			34,808			39,657			34,808
ACCUMULATED OTHER COMPREHENSIVE INCOME (LOSS)
Beginning balance		3,581			(139	)		1,168			(3,656	)
Other comprehensive income		720			1,400			3,133			4,917
Ending balance		4,301			1,261			4,301			1,261
TREASURY STOCK
Beginning balance		(10,604	)		(6,710	)		(7,924	)		(7,140	)
Treasury shares reissued (2,770 shares)		—			—			—			49
Treasury shares purchased (no shares purchased in third quarter 2020 or 2019, and 150,920 shares for the nine months ended 2020 and 5,352 shares for the nine months ended 2019)		—			—			(3,154	)		(122	)
Equity compensation		—			—			474			503
Ending balance		(10,604	)		(6,710	)		(10,604	)		(6,710	)
TOTAL SHAREHOLDERS' EQUITY	$	78,148		$	74,153		$	78,148		$	74,153

See accompanying notes to the unaudited consolidated financial statements of Cortland Bancorp and Subsidiaries

5

CORTLAND BANCORP AND SUBSIDIARIES

CONSOLIDATED STATEMENTS OF CASH FLOWS (UNAUDITED)

(Amounts in thousands)

	FOR THE NINE MONTHS
	ENDED SEPTEMBER 30,
	2020			2019
Net cash flow from operating activities	$	6,488		$	4,193
Cash (deficit) flow from investing activities
Purchases of available-for-sale securities		(47,579	)		(16,478	)
Proceeds from sale of available-for-sale securities		2,610			13,622
Proceeds from call, maturity and principal payments on available-for-sale securities		16,308			8,467
Purchases of regulatory stock		(196	)		(254	)
Net (increase) decrease in loans made to customers		(15,425	)		25,865
Purchases of bank-owned life insurance		(3,000	)		(2,068	)
Proceeds from bank-owned life insurance		—			403
Contributions to partnership funds		(1,049	)		(1,827	)
Purchases of premises and equipment		(615	)		(2,196	)
Net cash (deficit) flow from investing activities		(48,946	)		25,534
Cash flow (deficit) from financing activities
Net increase (decrease) in deposit accounts		62,259			(17,291	)
Net change in securities sold under agreements to repurchase		(834	)		(899	)
Net change in Federal Home Loan Bank advances - short term		7,000			(12,000	)
Repayments of Federal Home Loan Bank advances - long term		(6,000	)		(6,000	)
Proceeds from Federal Home Loan Bank advances - long term		6,000			9,000
Dividends paid		(1,995	)		(1,659	)
Treasury shares purchased		(3,154	)		(122	)
Treasury shares reissued		—			60
Net cash flow (deficit) from financing activities		63,276			(28,911	)
Net change in cash and cash equivalents		20,818			816
Cash and cash equivalents
Beginning of period		27,815			19,692
End of period	$	48,633		$	20,508
Supplemental disclosures:
Cash paid during the period for:
Income taxes	$	800		$	—
Interest	$	3,196		$	3,914
Adoption of lease standard:
Increase in ROU asset	$	—		$	2,061
Increase in lease liability	$	—		$	2,061

See accompanying notes to the unaudited consolidated financial statements of Cortland Bancorp and Subsidiaries

6

NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (UNAUDITED)

1.) Basis of Presentation and Reclassifications:

The accompanying unaudited consolidated financial statements of Cortland Bancorp (the Company) and the Cortland Savings and Banking Company (the Bank) have been prepared in accordance with accounting principles generally accepted in the United States (U.S. GAAP) for interim financial information and with the instructions to Form 10-Q and Article 10 of Regulation S-X. Accordingly, they do not include all of the information and footnotes required by U.S. GAAP for complete financial statements. In the opinion of management, all adjustments (consisting of normal recurring items) considered necessary for a fair presentation have been included. Operating results for the three and nine months ended September 30, 2020 are not necessarily indicative of the results that may be expected for the year ending December 31, 2020. These interim unaudited consolidated financial statements should be read in conjunction with our annual audited financial statements as of December 31, 2019, included in our Form 10-K for the year ended December 31, 2019, filed with the United States Securities and Exchange Commission. The accompanying Consolidated Balance Sheet at December 31, 2019 has been derived from the audited Consolidated Balance Sheet but do not include all of the information and footnotes required by U.S. GAAP for complete financial statements.

Certain items contained in the 2019 financial statements have been reclassified to conform to the presentation for 2020. Such reclassifications had no effect on the net results of operations or shareholders’ equity.

2.) Authoritative Accounting Guidance:

In June 2016, the FASB issued ASU 2016-13, Financial Instruments - Credit Losses: Measurement of Credit Losses on Financial Instruments (“ASU 2016-13”), which changes the impairment model for most financial assets. This Update is intended to improve financial reporting by requiring timelier recording of credit losses on loans and other financial instruments held by financial institutions and other organizations. The underlying premise of the Update is that financial assets measured at amortized cost should be presented at the net amount expected to be collected, through an allowance for credit losses that is deducted from the amortized cost basis. The allowance for credit losses should reflect management’s current estimate of credit losses that are expected to occur over the remaining life of a financial asset. The income statement will be effected for the measurement of credit losses for newly recognized financial assets, as well as the expected increases or decreases of expected credit losses that have taken place during the period. ASU 2016-13 is effective for annual and interim periods beginning after December 15, 2019, and early adoption is permitted for annual and interim periods beginning after December 15, 2018. With certain exceptions, transition to the new requirements will be through a cumulative effect adjustment to opening retained earnings as of the beginning of the first reporting period in which the guidance is adopted. In November 2019, the FASB issued ASU 2019-10, Financial Instruments ‒ Credit Losses (Topic 326), Derivatives and Hedging (Topic 815), and Leases (Topic 842). This Update defers the effective date of ASU 2016-13 for SEC filers that are eligible to be smaller reporting companies, non-SEC filers, and all other companies to fiscal years beginning after December 15, 2022, including interim periods within those fiscal years. We expect to recognize a one-time cumulative effect adjustment to the allowance for loan losses as of the beginning of the first reporting period in which the new standard is effective, but cannot yet determine the magnitude of any such one-time adjustment or the overall impact of the new guidance on the consolidated financial statements.

In August 2018, the FASB issued ASU 2018-13, Fair Value Measurement (Topic 820): Disclosure Framework – Changes the Disclosure Requirements for Fair Value Measurements. The Update removes the requirement to disclose the amount of and reasons for transfers between Level I and Level II of the fair value hierarchy; the policy for timing of transfers between levels; and the valuation processes for Level III fair value measurements. The Update requires disclosure of changes in unrealized gains and losses for the period included in other comprehensive income (loss) for recurring Level III fair value measurements held at the end of the reporting period and the range and weighted average of significant unobservable inputs used to develop Level III fair value measurements. This Update is effective for all entities for fiscal years, and interim periods within those fiscal years, beginning after December 15, 2019. This Update did not have a significant impact on the Company’s financial statements.

In August 2018, the FASB issued ASU 2018-15, Intangibles – Goodwill and Other – Internal-Use Software (Subtopic 350-40). This Update addresses customers’ accounting for implementation costs incurred in a cloud computing arrangement that is a service contract and also adds certain disclosure requirements related to implementation costs incurred for internal-use software and cloud computing arrangements. The amendment aligns the requirements for capitalizing implementation costs incurred in a hosting arrangement that is a service contract with the requirements for capitalizing implementation costs incurred to develop or obtain internal-use software (and hosting arrangements that include an internal-use software license). This Update is effective for public business entities for fiscal years beginning after December 15, 2019, and interim periods within those fiscal years, with early adoption permitted. For all other entities, the amendments are effective for fiscal years beginning after December 15, 2020, and interim periods within fiscal years beginning after December 15, 2021. The amendments in this Update can be applied either retrospectively or prospectively to all implementation costs incurred after the date of adoption. This Update did not have a significant impact on the Company’s financial statements.

7

 

NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (UNAUDITED)

In March 2019, the FASB issued ASU 2019-01, Leases (Topic 842): Codification Improvements, which addressed issues lessors sometimes encounter. Specifically addressed in this Update were issues related to 1) determining the fair value of the underlying asset by the lessor that are not manufacturers or dealers (generally financial institutions and captive finance companies), and 2) lessors that are depository and lending institutions should classify principal and payments received under sales-type and direct financing leases within investing activities in the cash flow statement. The ASU also exempts both lessees and lessors from having to provide the interim disclosures required by ASC 250-10-50-3 in the fiscal year in which a company adopts the new leases standard. The amendments addressing the two lessor accounting issues are effective for public business entities for fiscal years beginning after December 15, 2019, and interim periods within those fiscal years. For all other entities, the effective date is for fiscal years beginning after December 15, 2019, and interim periods within fiscal years beginning after December 15, 2020. This Update did not impact the Company’s financial statements.

In May 2019, the FASB issued ASU 2019-05, Financial Instruments – Credit Losses (Topic 326), which allows entities to irrevocably elect the fair value option for certain financial assets previously measured at amortized cost upon adoption of the new credit losses standard. To be eligible for the transition election, the existing financial asset must otherwise be both within the scope of the new credit losses standard and eligible for applying the fair value option in ASC 825-10.3. The election must be applied on an instrument-by-instrument basis and is not available for either available-for-sale or held-to-maturity debt securities. For entities that elect the fair value option, the difference between the carrying amount and the fair value of the financial asset would be recognized through a cumulative-effect adjustment to opening retained earnings as of the date an entity adopted ASU 2016-13. Changes in fair value of that financial asset would subsequently be reported in current earnings. For entities that have not yet adopted ASU 2016-13, the effective dates and transition requirements are the same as those in ASU 2016-13. For entities that have adopted ASU 2016-13, ASU 2019-05 is effective for fiscal years beginning after December 15, 2019, including interim periods within those fiscal years. Early adoption is permitted once ASU 2016-13 has been adopted. In November 2019, the FASB issued ASU 2019-10, Financial Instruments ‒ Credit Losses (Topic 326), Derivatives and Hedging (Topic 815), and Leases (Topic 842). The Update defers the effective date of ASU 2016-13 for SEC filers that are eligible to be smaller reporting companies, non-SEC filers, and all other companies, to fiscal years beginning after December 15, 2022, including interim periods within those fiscal years. The Company qualifies as a smaller reporting company and does not expect to early adopt ASU 2016-13.

In November 2019, the FASB issued ASU 2019-08, Compensation ‒ Stock Compensation (Topic 718) and Revenue from Contracts with Customers (Topic 606), which requires entities to measure and classify sharebased payments to a customer, in accordance with the guidance in ASC 718, Compensation ‒ Stock Compensation. The amendments in that Update expanded the scope of Topic 718 to include share-based payment transactions for acquiring goods and services from nonemployees and, in doing so, superseded guidance in Subtopic 505-50, Equity ‒ Equity-Based Payments to Non-Employees. The amount that would be recorded as a reduction in revenue would be measured based on the grant date fair value of the sharebased payment, in accordance with Topic 718. The grant date is the date at which a supplier and customer reach a mutual understanding of the award’s key terms and conditions. The award’s classification and subsequent measurement would be subject to ASC 718 unless the award is modified or the grantee is no longer a customer. For entities that have not yet adopted the amendments in Update 2018-07, the amendments in this Update are effective for (1) public business entities in fiscal years beginning after December 15, 2019, and interim periods within those fiscal years, and (2) other than public business entities in fiscal years beginning after December 15, 2019, and interim periods within fiscal years beginning after December 15, 2020. For entities that have adopted the amendments in Update 2018-07, the amendments in this Update are effective in fiscal years beginning after December 15, 2019, and interim periods within those fiscal years. An entity may early adopt the amendments in this Update, but not before it adopts the amendments in Update 2018-07. This Update did not have a significant impact on the Company’s financial statements.

In November 2019, the FASB issued ASU 2019-10, Financial Instruments ‒ Credit Losses (Topic 326), Derivatives and Hedging (Topic 815), and Leases (Topic 842). The Update defers the effective dates of ASU 2016-13 for SEC filers that are eligible to be smaller reporting companies, non-SEC filers, and all other companies to fiscal years beginning after December 15, 2022, including interim periods within those fiscal years. This Update also amends the mandatory effective date for the elimination of Step 2 from the goodwill impairment test under ASU No. 2017-04, Intangibles ‒ Goodwill and Other (Topic 350): Simplifying the Test for Goodwill Impairment (Goodwill), to align with those used for credit losses. Furthermore, the ASU provides a one-year deferral of the effective dates of the ASUs on derivatives and hedging and leases for companies that are not public business entities. We have elected to apply ASU 2016-02 and its related amendments as of the beginning of the period of adoption ( January 1, 2019) and have not restated comparative periods. The Company elected to adopt the transition relief provisions from ASU 2018-11. The Company qualifies as a smaller reporting company and does not expect to early adopt ASUs 2016-13 and 2017-04.

8

 

NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (UNAUDITED)

In November 2019, the FASB issued ASU 2019-11, Codification Improvements to Topic 326, Financial Instruments – Credit Losses, to clarify its new credit impairment guidance in ASC 326, based on implementation issues raised by stakeholders. This Update clarified, among other things, that expected recoveries are to be included in the allowance for credit losses for these financial assets; an accounting policy election can be made to adjust the effective interest rate for existing troubled debt restructurings based on the prepayment assumptions instead of the prepayment assumptions applicable immediately prior to the restructuring event; and extends the practical expedient to exclude accrued interest receivable from all additional relevant disclosures involving amortized cost basis. The effective dates in this Update are the same as those applicable for ASU 2019-10. This Update is not expected to have a significant impact on the Company’s financial statements.

In December 2019, the FASB issued ASU 2019-12, Income Taxes (Topic 740), to simplify the accounting for income taxes, change the accounting for certain tax transactions, and make minor improvements to the codification. This Update provides a policy election to not allocate consolidated income taxes when a member of a consolidated tax return is not subject to income tax and provides guidance to evaluate whether a step-up in tax basis of goodwill relates to a business combination in which book goodwill was recognized or a separate transaction. The Update also changes current guidance for making an intraperiod allocation, if there is a loss in continuing operations and gains outside of continuing operations; determining when a deferred tax liability is recognized after an investor in a foreign entity transitions to or from the equity method of accounting; accounting for tax law changes and year-to-date losses in interim periods; and determining how to apply the income tax guidance to franchise taxes that are partially based on income. For public business entities, the amendments in this Update are effective for fiscal years and interim periods within those fiscal years, beginning after December 15, 2020. For all other entities, the amendments are effective for fiscal years beginning after December 15, 2021, and interim periods within fiscal years beginning after December 15, 2022. This Update is not expected to have a significant impact on the Company’s financial statements.

In January 2020, the FASB issued ASU 2020-1, Investments – Equity Securities (Topic 321), Investments– Equity Method and Joint Ventures (Topic 323), and Derivatives and Hedging (Topic 815), to clarify that an entity should consider observable transactions that require it to either apply or discontinue the equity method of accounting for the purposes of applying the measurement alternative in accordance with Topic 321 immediately before applying or upon discontinuing the equity method. The amendments also clarify that, for the purpose of applying paragraph 815-10-15-141(a) an entity should not consider whether, upon the settlement of the forward contract or exercise of the purchased option, individually or with existing investments, the underlying securities would be accounted for under the equity method in Topic 323 or the fair value option, in accordance with the financial instruments guidance in Topic 825. An entity also would evaluate the remaining characteristics in paragraph 815-10-15-141 to determine the accounting for those forward contracts and purchased options. For public business entities, the amendments in this Update are effective for fiscal years beginning after December 15, 2020, and interim periods within those fiscal years. For all other entities, the amendments are effective for fiscal years beginning after December 15, 2021, and interim periods within those fiscal years. This Update is not expected to have a significant impact on the Company’s financial statements.

In January 2020, the FASB issued ASU 2020-2, Financial Instruments – Credit Losses (Topic 326) and Leases (Topic 842): Amendments to SEC Paragraphs Pursuant to SEC Staff Accounting Bulletin No. 119 and Update to SEC Section on Effective Date Related to Accounting Standards Update No. 2016-02, Leases (Topic 842), February 2020, to add and amend SEC paragraphs in the Accounting Standards Codification to reflect the issuance of SEC Staff Accounting Bulletin No. 119, related to the new credit losses standard, and comments by the SEC staff related to the revised effective date of the new leases standard. This ASU is effective upon issuance. This did not have a significant impact on the Company’s financial statements.

In March 2020, the FASB issued ASU 2020-3, Codification Improvements to Financial Instruments. This ASU was issued to improve and clarify various financial instruments topics, including the current expected credit losses (CECL) standard issued in 2016. The ASU includes seven issues that describe the areas of improvement and the related amendments to GAAP; they are intended to make the standards easier to understand and apply and to eliminate inconsistencies, and they are narrow in scope and are not expected to significantly change practice for most entities. Among its provisions, the ASU clarifies that all entities, other than public business entities that elected the fair value option, are required to provide certain fair value disclosures under ASC 825, Financial Instruments, in both interim and annual financial statements. It also clarifies that the contractual term of a net investment in a lease under Topic 842 should be the contractual term used to measure expected credit losses under Topic 326. Amendments related to ASU 2019-04 are effective for fiscal years beginning after December 15, 2019, including interim periods within those fiscal years. Early adoption is not permitted before an entity’s adoption of ASU 2016-01. Amendments related to ASU 2016-13 for entities that have not yet adopted that guidance are effective upon adoption of the amendments in ASU 2016-13. Early adoption is not permitted before an entity’s adoption of ASU 2016-13. Amendments related to ASU 2016-13 for entities that have adopted that guidance are effective for fiscal years beginning after December 15, 2019, including interim periods within those years. Other amendments are effective upon issuance of this ASU. This Update is not expected to have a significant impact on the Company’s financial statements.

In January 2020, the FASB issued ASU 2020-4, Reference Rate Reform (Topic 848): Facilitation of the Effects of Reference Rate Reform on Financial Reporting, March 2020, to provide temporary optional expedients and exceptions to the U.S. GAAP guidance on contract modifications and hedge accounting to ease the financial reporting burdens of the expected market transition from LIBOR and other interbank offered rates to alternative reference rates, such as Secured Overnight Financing Rate. Entities can elect not to apply certain modification accounting requirements to contracts affected by what the guidance calls reference rate reform, if certain criteria are met. An entity that makes this election would not have to remeasure the contracts at the modification date or reassess a previous accounting determination. Also, entities can elect various optional expedients that would allow them to continue applying hedge accounting for hedging relationships affected by reference rate reform, if certain criteria are met, and can make a one-time election to sell and/or reclassify held-to-maturity debt securities that reference an interest rate affected by reference rate reform. The amendments in this ASU are effective for all entities upon issuance through December 31, 2022. It is too early to predict whether a new rate index replacement and the adoption of the ASU will have a material impact on the Company's financial statements.

9

NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (UNAUDITED)

3.) Investment Securities:

Investments in debt securities are classified as held-to-maturity, available-for-sale or trading. Securities classified as held-to-maturity are those that management has the positive intent and ability to hold to maturity. Securities classified as available-for-sale are those that could be sold for liquidity, investment management, or similar reasons, even though management has no present intentions to do so. Securities classified as trading are those that management has bought principally for the purpose of selling in the near term. The Company currently has no securities classified as held-to-maturity or trading.

Available-for-sale securities are carried at fair value with unrealized gains and losses recorded as a separate component of shareholders’ equity, net of tax. Realized gains or losses on dispositions are based on net proceeds and the adjusted carrying amount of securities sold, using the specific identification method. Interest income includes amortization of purchase premium or discount and is amortized on the level-yield method without anticipating payments, except for U.S. Government mortgage-backed and related securities where twelve months of historical prepayments are taken into consideration.

The regulatory stock is carried at cost (its redeemable value) and the Company is required to hold such investments as a condition of membership in order to transact business with the Federal Home Loan Bank (FHLB) of Cincinnati and the Federal Reserve Bank (FRB). The stock is bought from and sold to the correspondent institutions based upon its par value. The stock cannot be traded or sold in any market and as such is classified as restricted stock, carried at cost (its redeemable value) and evaluated by management. The stock’s value is determined by the ultimate recoverability of the par value rather than by recognizing temporary declines. The determination of whether the par value will ultimately be recovered is influenced by criteria such as the following: (a) the significance of the decline in net assets of the FHLB and FRB as compared to the capital stock amount and the length of time this situation has persisted, (b) commitments by the FHLB and FRB to make payments required by law or regulation and the level of such payments in relation to the operating performance, (c) the impact of legislative and regulatory changes on the customer base of the FHLB and FRB and (d) the liquidity position of the FHLB and FRB. The Company does not consider these investments to be other-than-temporarily impaired at September 30, 2020.

Securities are evaluated periodically to determine whether a decline in value is other-than-temporary. Management utilizes criteria such as the magnitude and duration of the decline, along with the reasons underlying the decline, to determine whether the loss in value is other-than-temporary. The term “other-than-temporary” is not intended to indicate that the decline in value is permanent but indicates that the prospect for a near-term recovery of value is not necessarily favorable and that there is a lack of evidence to support a realizable value equal to or greater than the carrying value of the investment. Unrealized losses on available-for-sale investments have not been recognized into income. However, once a decline in value is determined to be other-than-temporary, the credit related other-than-temporary impairment (OTTI) is recognized in earnings while the non-credit related OTTI on securities not expected to be sold is recognized in other comprehensive income (loss).

10

NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (UNAUDITED)

The following table is a summary of investment securities available-for-sale and regulatory stock: 

	(Amounts in thousands)
			Gross		Gross
			Unrealized		Unrealized
September 30, 2020	Amortized Cost		Gains		Losses		Fair Value
U.S. Government agencies and corporations	$	—	$	—	$	—	$	—
Obligations of states and political subdivisions		84,264		4,174		27		88,411
U.S. Government-sponsored mortgage-backed securities		66,929		1,014		28		67,915
U.S. Government-sponsored collateralized mortgage obligations		5,507		112		3		5,616
U.S. Government-guaranteed small business administration pools		5,474		161		—		5,635
Total investment securities available-for-sale	$	162,174	$	5,461	$	58	$	167,577
Federal Home Loan Bank (FHLB) stock	$	2,805	$	—	$	—	$	2,805
Federal Reserve Bank (FRB) stock		226		—		—		226
Total regulatory stock	$	3,031	$	—	$	—	$	3,031

	(Amounts in thousands)
			Gross		Gross
			Unrealized		Unrealized
December 31, 2019	Amortized Cost		Gains		Losses		Fair Value
U.S. Government agencies and corporations	$	3,348	$	1	$	39	$	3,310
Obligations of states and political subdivisions		67,794		1,853		21		69,626
U.S. Government-sponsored mortgage-backed securities		48,566		75		404		48,237
U.S. Government-sponsored collateralized mortgage obligations		8,447		78		44		8,481
U.S. Government-guaranteed small business administration pools		6,576		—		99		6,477
Total investment securities available-for-sale	$	134,731	$	2,007	$	607	$	136,131
Federal Home Loan Bank (FHLB) stock	$	2,609	$	—	$	—	$	2,609
Federal Reserve Bank (FRB) stock		226		—		—		226
Total regulatory stock	$	2,835	$	—	$	—	$	2,835

The amortized cost and fair value of debt securities at September 30, 2020, by contractual maturity, are shown below. Actual maturities will differ from contractual maturities because issuers may have the right to call or prepay obligations with or without call or prepayment penalties. 

	(Amounts in thousands)
	Amortized Cost		Fair Value
Due in one year or less	$	69	$	70
Due after one year through five years		5,176		5,298
Due after five years through ten years		2,146		2,295
Due after ten years		82,347		86,383
Total		89,738		94,046
U.S. Government-sponsored mortgage-backed and related securities		72,436		73,531
Total investment securities available-for-sale	$	162,174	$	167,577

The table below sets forth the proceeds, gains and losses realized on available for sale securities sold or called for the periods ended September 30, 2020 and September 30, 2019.

	(Amounts in thousands)				(Amounts in thousands)
	Three Months Ended				Nine Months Ended
	2020		2019		2020		2019
Proceeds on securities sold	$	—	$	—	$	2,610	$	13,622
Gross realized gain		—		—		27		82
Gross realized losses		—		—		9		126

Investment securities with a carrying value of approximately $87.3 million at  September 30, 2020 and $59.0 million at December 31, 2019 were pledged to secure deposits and for other purposes. The remaining securities provide an adequate level of liquidity.

11

 

NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (UNAUDITED)

The following is a summary of the fair value of available-for-sale securities with unrealized losses and an aging of those unrealized losses at September 30, 2020:  

	(Amounts in thousands)
	Less than 12 Months				12 Months or More				Total
			Unrealized				Unrealized				Unrealized
	Fair Value		Losses		Fair Value		Losses		Fair Value		Losses
U.S. Government agencies and corporations	$	—	$	—	$	—	$	—	$	—	$	—
Obligations of states and political subdivisions		3,532		27		—		—		3,532		27
U.S. Government-sponsored mortgage-backed securities		6,873		28		—		—		6,873		28
U.S. Government-sponsored collateralized mortgage obligations		992		3		—		—		992		3
U.S. Government-guaranteed small business administration pools		—		—		—		—		—		—
Total	$	11,397	$	58	$	—	$	—	$	11,397	$	58

The above table comprises 6 investment securities where the fair value is less than the related amortized cost.

The following is a summary of the fair value of available-for-sale securities with unrealized losses and an aging of those unrealized losses at December 31, 2019:

	(Amounts in thousands)
	Less than 12 Months				12 Months or More				Total
			Unrealized				Unrealized				Unrealized
	Fair Value		Losses		Fair Value		Losses		Fair Value		Losses
U.S. Government agencies and corporations	$	2,961	$	39	$	—	$	—	$	2,961	$	39
Obligations of states and political subdivisions		263		1		1,332		20		1,595		21
U.S. Government-sponsored mortgage-backed securities		—		—		34,124		404		34,124		404
U.S. Government-sponsored collateralized mortgage obligations		931		7		3,944		37		4,875		44
U.S. Government-guaranteed small business administration pools		5,600		78		877		21		6,477		99
Total	$	9,755	$	125	$	40,277	$	482	$	50,032	$	607

The above table comprises 32 investment securities where the fair value is less than the related amortized cost.

The unrealized losses at September 30, 2020 on the Company’s investments were caused by changes in market rates and related spreads. It is expected that the securities would not be settled at less than the amortized cost of the Company’s investment because the decline in fair value is attributable to changes in interest rates and relative spreads and not credit quality. Also, the Company does not intend to sell those investments and it is not more-likely-than-not that the Company will be required to sell the investments before recovery of its amortized cost basis less any current period credit loss. The Company does not consider these investments to be other-than-temporarily impaired at September 30, 2020.

12

NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (UNAUDITED)

4.) Loans and Allowance for Loan Losses:

The Company, through the Bank, grants residential, consumer and commercial loans to customers located primarily in Northeastern Ohio and Western Pennsylvania.

The following represents the composition of the loan portfolio for the period ending:

	(Amounts in thousands)
	September 30, 2020				December 31, 2019
	Balance			%	Balance			%
Commercial	$	123,403	23.1		$	99,864	19.3
Commercial real estate		303,404	56.8			302,084	58.2
Residential real estate		79,808	14.9			87,172	16.8
Consumer - home equity		23,749	4.5			25,856	5.0
Consumer - other		3,782	0.7			3,740	0.7
Total loans	$	534,146	100.0		$	518,716	100.0

During 2020 the Company participated in the Paycheck Protection Program (“PPP”), administered directly by the U.S. SBA. The PPP provides loans to small businesses who were affected by economic conditions as a result of COVID-19 to provide cash-flow assistance to employers who maintain their payroll (including healthcare and certain related expenses), mortgage interest, rent, leases, utilities and interest on existing debt during the COVID-19 emergency. As of September 30, 2020, the Company had outstanding principal balances of $56.4 million. The PPP loans are fully guaranteed by the SBA and may be eligible for forgiveness by the SBA to the extent that the proceeds are used to cover eligible payroll costs, interest costs, rent, and utility costs over a period of up to 24 weeks after the loan is made as long as certain conditions are met regarding employee retention and compensation levels. PPP loans deemed eligible for forgiveness by the SBA will be repaid by the SBA to the Company. PPP loans are included in the Commercial loan category.

In accordance with the SBA terms and conditions on these PPP loans, the Company received approximately $2.2 million in fees associated with the processing of these loans. Upon funding of the loan, these fees were deferred and will be amortized over the life of the loan as an adjustment to yield in accordance with FASB ASC 310-20-25-2.

Management has an established methodology to determine the adequacy of the allowance for loan losses that assesses the risks and losses inherent in the loan portfolio. For purposes of determining the allowance for loan losses, the Company has segmented loans in the portfolio by product type. Loans are segmented into the following pools: commercial loans, commercial real estate loans, residential real estate loans and consumer loans. The pools of commercial real estate loans and commercial loans are also broken down further by industry sectors when analyzing the related pools. Using the largest concentrations as the qualifier, these industry sectors include non-residential buildings; skilled nursing and nursing care; residential real estate lessors, agents and managers; hotel and motels, and trucking. The Company also sub-segments the consumer loan portfolio into the following two classes: home equity loans and other consumer loans. Historical loss percentages for each risk category are calculated and used as the basis for calculating allowance allocations. These historical loss percentages are calculated over multiple periods for all portfolio segments. Management evaluates these results and utilizes the most reflective period in the calculation. Certain qualitative factors are then added to the historical allocation percentage to get the adjusted factor.

These factors include, but are not limited to, the following:

Factor Considered:	Risk Trend:
Levels of and trends in charge-offs, classifications and non-accruals	Stable
Trends in volume and terms	Stable
Changes in lending policies and procedures	Stable
Experience, depth and ability of management, including loan review function	Stable
Economic trends, including valuation of underlying collateral	Increasing
Concentrations of credit	Increasing
Effect of COVID-19 pandemic	Increasing

The following factors are analyzed and applied to loans internally graded with higher credit risk in addition to the above factors for non-classified loans:

Factor Considered:	Risk Trend:
Levels and trends in classification	Stable
Declining trends in financial performance	Increasing
Structure and lack of performance measures	Stable
Migration between risk categories	Stable

13

NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (UNAUDITED)

The provision charged to operations can be allocated to a loan classification either as a positive or negative value as a result of any material changes to: net charge-offs or recovery which influence the historical allocation percentage, qualitative risk factors or loan balances.

The following is an analysis of changes in the allowance for loan losses for the periods ended:

Three Months Ended

	(Amounts in thousands)
				Commercial		Residential			Consumer -			Consumer -
September 30, 2020	Commercial			real estate		real estate			home equity			other			Total
Balance at beginning of period	$	1,832		$	3,045	$	401		$	101		$	141		$	5,520
Loan charge-offs		(1	)		—		—			—			(59	)		(60	)
Recoveries		8			—		—			—			52			60
Net loan recoveries (charge-offs)		7			—		—			—			(7	)		—
Provision charged to operations		10			548		(21	)		(1	)		(11	)		525
Balance at end of period	$	1,849		$	3,593	$	380		$	100		$	123		$	6,045

	(Amounts in thousands)
			Commercial		Residential			Consumer -		Consumer -
September 30, 2019	Commercial		real estate		real estate			home equity		other			Total
Balance at beginning of period	$	1,717	$	2,165	$	368		$	98	$	137		$	4,485
Loan charge-offs		—		—		—			—		(37	)		(37	)
Recoveries		—		—		—			1		12			13
Net loan recoveries (charge-offs)		—		—		—			1		(25	)		(24	)
Provision charged to operations		84		94		(23	)		2		23			180
Balance at end of period	$	1,801	$	2,259	$	345		$	101	$	135		$	4,641

Nine Months Ended

	(Amounts in thousands)
				Commercial		Residential		Consumer -			Consumer -
September 30, 2020	Commercial			real estate		real estate		home equity			other			Total
Balance at beginning of period	$	1,756		$	2,130	$	334	$	104		$	141		$	4,465
Loan charge-offs		(2	)		—		—		—			(154	)		(156	)
Recoveries		8			19		25		1			108			161
Net loan recoveries (charge-offs)		6			19		25		1			(46	)		5
Provision charged to operations		87			1,444		21		(5	)		28			1,575
Balance at end of period	$	1,849		$	3,593	$	380	$	100		$	123		$	6,045

	(Amounts in thousands)
			Commercial			Residential			Consumer -			Consumer -
September 30, 2019	Commercial		real estate			real estate			home equity			other			Total
Balance at beginning of period	$	1,232	$	2,414		$	314		$	115		$	123		$	4,198
Loan charge-offs		—		—			(29	)		—			(146	)		(175	)
Recoveries		28		—			—			2			53			83
Net loan recoveries (charge-offs)		28		—			(29	)		2			(93	)		(92	)
Provision charged to operations		541		(155	)		60			(16	)		105			535
Balance at end of period	$	1,801	$	2,259		$	345		$	101		$	135		$	4,641

The total allowance reflects management’s estimate of loan losses inherent in the loan portfolio at the consolidated balance sheet date.

The following tables present a full breakdown by portfolio classification of the allowance for loan losses and the recorded investment in loans at  September 30, 2020 and December 31, 2019:

	(Amounts in thousands)
			Commercial		Residential		Consumer -		Consumer -
September 30, 2020	Commercial		real estate		real estate		home equity		other		Total
Allowance for loan losses:
Ending allowance balance attributable to loans:
Individually evaluated for impairment	$	579	$	—	$	—	$	—	$	—	$	579
Collectively evaluated for impairment		1,270		3,593		380		100		123		5,466
Total ending allowance balance	$	1,849	$	3,593	$	380	$	100	$	123	$	6,045
Loan Portfolio:
Individually evaluated for impairment	$	4,645	$	2,473	$	—	$	—	$	—	$	7,118
Collectively evaluated for impairment		118,758		300,931		79,808		23,749		3,782		527,028
Total ending loans balance	$	123,403	$	303,404	$	79,808	$	23,749	$	3,782	$	534,146

14

NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (UNAUDITED)

	(Amounts in thousands)
			Commercial		Residential		Consumer -		Consumer -
December 31, 2019	Commercial		real estate		real estate		home equity		other		Total
Allowance for loan losses:
Ending allowance balance attributable to loans:
Individually evaluated for impairment	$	579	$	—	$	—	$	—	$	—	$	579
Collectively evaluated for impairment		1,177		2,130		334		104		141		3,886
Total ending allowance balance	$	1,756	$	2,130	$	334	$	104	$	141	$	4,465
Loan Portfolio:
Individually evaluated for impairment	$	4,909	$	2,940	$	—	$	—	$	—	$	7,849
Collectively evaluated for impairment		94,955		299,144		87,172		25,856		3,740		510,867
Total ending loans balance	$	99,864	$	302,084	$	87,172	$	25,856	$	3,740	$	518,716

The change in commercial loan balances from year-end was affected by two sets of transactions in opposing directions. Decreasing the balances in 2020 were 60-day or less term commercial loans for a total of $25.2 million that closed in December 2019 and were fully secured by segregated deposit accounts with the Bank. The loans matured in the first quarter of 2020. Increasing the commercial loans by $56.4 million were loans granted under the PPP as indicated previously.

The increase in the allowance is a result of stress on our loan portfolio from the increase in unemployment and other negative effects of the coronavirus pandemic. Based on current economic indicators, the Company increased the economic qualitative factors within the allowance for loan losses evaluation. Relative to the number of requests for modifications and deferrals from commercial borrowers, additional COVID-19 factors were applied to these loans after segmenting into industry classifications.  Such requests from consumers were insignificant. The amount of net charge-offs also impacts the provision charged to operations for any category of loans. Charge-offs affect the historical rate applied to each category, and the amount needed to replenish the amount charged-off, which primarily impacted consumer loans.

The following tables represent credit exposures by internally assigned grades for September 30, 2020 and December 31, 2019. The grading analysis estimates the capability of the borrower to repay the contractual obligations of the loan agreements as scheduled or at all. The Company’s internal credit risk grading system is based on experiences with similarly graded loans.

The Company’s internally assigned grades are as follows:

• Pass – loans which are protected by the current net worth and paying capacity of the obligor or by the value of the underlying collateral. Within this category, there are grades of exceptional, quality, acceptable and pass monitor.

• Special Mention – loans where a potential weakness or risk exists, which could cause a more serious problem if not corrected.

• Substandard – loans that have a well-defined weakness based on objective evidence and are characterized by the distinct possibility that the Bank will sustain some loss if the deficiencies are not corrected.

• Doubtful – loans classified as doubtful have all the weaknesses inherent in a substandard asset but with the severity which makes collection in full highly questionable and improbable, based on existing circumstances.

• Loss – loans classified as a loss are considered uncollectible, or of such value that continuance as an asset is not warranted. This rating does not mean that the assets have no recovery or salvage value but rather that the assets should be charged off now, even though partial or full recovery may be possible in the future.

15

NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (UNAUDITED)

The following table is a summary of credit quality indicators by internally assigned grades as of September 30, 2020 and December 31, 2019:

	(Amounts in thousands)
	Commercial		Commercial real estate
September 30, 2020
Pass	$	110,811	$	266,770
Special Mention		2,570		22,000
Substandard		10,022		14,634
Ending Balance	$	123,403	$	303,404

	(Amounts in thousands)
	Commercial		Commercial real estate
December 31, 2019
Pass	$	83,114	$	275,763
Special Mention		6,273		21,995
Substandard		10,477		4,326
Ending Balance	$	99,864	$	302,084

The Company evaluates the classification of consumer, home equity and residential loans primarily on a pooled basis. If the Company becomes aware that adverse or distressed conditions exist that may affect a particular loan, the loan is downgraded following the above definitions of special mention and substandard. Nonaccrual loans in these categories are evaluated for charge off or charge down, and the remaining balance has the same allowance factor as pooled loans.

The following table is a summary of consumer credit exposure as of September 30, 2020 and December 31, 2019:

	(Amounts in thousands)
	Residential real estate		Consumer - home equity		Consumer - other
September 30, 2020
Performing	$	79,316	$	23,614	$	3,782
Nonperforming		492		135		—
Total	$	79,808	$	23,749	$	3,782

	(Amounts in thousands)
	Residential real estate		Consumer - home equity		Consumer - other
December 31, 2019
Performing	$	86,703	$	25,709	$	3,740
Nonperforming		469		147		—
Total	$	87,172	$	25,856	$	3,740

Loans are considered to be nonperforming when they become 90 days past due or on nonaccrual status, though the Company may be receiving partial payments of interest and partial repayments of principal on such loans. When a loan is placed in non-accrual status, previously accrued but unpaid interest is deducted from interest income.

16

NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (UNAUDITED)

The following table is a summary of classes of loans on non-accrual status as of September 30, 2020 and December 31, 2019:

	(Amounts in thousands)
	September 30,		December 31,
	2020		2019
Commercial	$	890	$	1,152
Commercial real estate		418		566
Residential real estate		492		469
Consumer:
Consumer - home equity		135		147
Consumer - other		—		—
Total	$	1,935	$	2,334

Troubled Debt Restructuring

Nonperforming loans also include certain loans that have been modified in troubled debt restructurings (TDRs) where economic concessions have been granted to borrowers who have experienced or are expected to experience financial difficulties. These concessions typically result from the Company’s loss mitigation activities and could include reductions in the interest rate, payment extensions, forgiveness of principal, forbearance or other actions. Certain TDRs are classified as nonperforming at the time of restructure and may only be returned to performing status after considering the borrower’s sustained repayment performance for a reasonable period, generally six months.

On March 22, 2020, federal banking regulators issued an interagency statement that included guidance on their approach for the accounting of loan modifications in light of the economic impact of the Coronavirus Disease 2019 (COVID-19) pandemic. The guidance interprets current accounting standards and indicates that a lender can conclude that a borrower is not experiencing financial difficulty if short-term modifications are made in response to COVID-19, such as payment deferrals, fee waivers, extensions of repayment terms, or other delays in payment that are insignificant related to the loans in which the borrower is less than 30 days past due on its contractual payments as of December 31, 2019. The agencies confirmed in working with the staff of the FASB that short-term modifications made on a good faith basis in response to COVID-19 to borrowers who were current prior to any relief are not TDRs.

There were no loans modified as TDR’s during the three and nine month periods ended September 30, 2020 and September 30, 2019.

As of September 30, 2020, we had 40 commercial loans aggregating $61 million, deferring principal and/or interest for periods ranging from 90 to 180 days.  All of these loans were performing in accordance with their terms prior to modification, are currently performing, and are in conformance with the guidelines of the CARES Act. Since June 30, 2020, 90 prior modifications aggregating $49 million have returned to full payment status. For further discussion, see Significant Developments Impact of COVID-19 section of Item 2. Management's Discussion and Analysis of Financial Condition and Results of Operation. 

The following table is an aging analysis of the recorded investment of past due loans as of September 30, 2020 and December 31, 2019:

	(Amounts in thousands)
													Recorded
													Investment >
	30-59 Days		60-89 Days		90 Days Or								90 Days and
	Past Due		Past Due		Greater		Total Past Due		Current		Total Loans		Accruing
September 30, 2020
Commercial	$	—	$	—	$	890	$	890	$	122,513	$	123,403	$	—
Commercial real estate		—		276		121		397		303,007		303,404		—
Residential real estate		—		52		403		455		79,353		79,808		—
Consumer:
Consumer - home equity		—		108		55		163		23,586		23,749		—
Consumer - other		8		—		—		8		3,774		3,782		—
Total	$	8	$	436	$	1,469	$	1,913	$	532,233	$	534,146	$	—

17

 

NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (UNAUDITED)

	(Amounts in thousands)
													Recorded
													Investment >
	30-59 Days		60-89 Days		90 Days Or								90 Days and
	Past Due		Past Due		Greater		Total Past Due		Current		Total Loans		Accruing
December 31, 2019
Commercial	$	1	$	—	$	1,152	$	1,153	$	98,711	$	99,864	$	—
Commercial real estate		—		—		253		253		301,831		302,084		—
Residential real estate		5		214		454		673		86,499		87,172		—
Consumer:
Consumer - home equity		24		25		123		172		25,684		25,856		—
Consumer - other		14		—		—		14		3,726		3,740		—
Total	$	44	$	239	$	1,982	$	2,265	$	516,451	$	518,716	$	—

An impaired loan is a loan on which, based on current information and events, it is probable that a creditor will be unable to collect all amounts due (including both interest and principal) according to the contractual terms of the loan agreement. However, an insignificant delay or insignificant shortfall in amount of payments on a loan does not indicate that the loan is impaired.

When a loan is determined to be impaired, impairment should be measured based on the present value of expected future cash flows discounted at the loan’s effective interest rate. However, as a practical expedient, the Company will measure impairment based on a loan’s observable market price, or the fair value of the collateral if the loan is collateral dependent.

The following are the criteria for selecting individual loans / relationships for impairment analysis. Non-homogenous loans which meet the criteria below are evaluated quarterly.

• All borrowers whose loans are classified doubtful by examiners and internal loan review

• All loans on non-accrual status

• Any loan in foreclosure

• Any loan with a specific allowance

• Any loan determined to be collateral dependent for repayment

• Loans classified as troubled debt restructuring

Commercial loans and commercial real estate loans evaluated for impairment are excluded from the general pool of loans in the ALLL calculation regardless if a specific reserve was determined. If management determines that the value of the impaired loan is less than the recorded investment in the loan (net of previous charge-offs, deferred loan fees or costs and unamortized premium or discount), impairment is recognized through an allowance estimate or a charge-off to the allowance.

18

 

NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (UNAUDITED)

The following table presents the recorded investment and unpaid principal balances for impaired loans, excluding homogenous loans for which impaired analyses are not necessarily performed, with the associated allowance amount, if applicable, at September 30, 2020 and December 31, 2019. Also presented are the average recorded investments in the impaired balances and interest income recognized after impairment for the three and nine months ended September 30, 2020 and 2019.

	(Amounts in thousands)
	Recorded Investment		Unpaid Principal Balance		Related Allowance
September 30, 2020
With no related allowance recorded:
Commercial	$	3,833	$	4,759	$	—
Commercial real estate		2,473		2,473		—
With an allowance recorded:
Commercial		812		812		579
Commercial real estate		—		—		—
Total:
Commercial	$	4,645	$	5,571	$	579
Commercial real estate	$	2,473	$	2,473	$	—

	(Amounts in thousands)
	Recorded Investment		Unpaid Principal Balance		Related Allowance
December 31, 2019
With no related allowance recorded:
Commercial	$	3,925	$	4,946	$	—
Commercial real estate		2,940		2,940		—
With an allowance recorded:
Commercial		984		984		579
Commercial real estate		—		—		—
Total:
Commercial	$	4,909	$	5,930	$	579
Commercial real estate	$	2,940	$	2,940	$	—

	(Amounts in thousands)				(Amounts in thousands)
	Three Months Ended				Nine Months Ended
	Average Recorded		Interest Income		Average Recorded		Interest Income
	Investment		Recognized		Investment		Recognized
September 30, 2020
With no related allowance recorded:
Commercial	$	3,826	$	39	$	3,853	$	117
Commercial real estate		2,723		37		2,720		119
With an allowance recorded:
Commercial		812		—		850		—
Commercial real estate		—		—		—		—
Total:
Commercial	$	4,638	$	39	$	4,703	$	117
Commercial real estate	$	2,723	$	37	$	2,720	$	119

19

NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (UNAUDITED)

	(Amounts in thousands)				(Amounts in thousands)
	Three Months Ended				Nine Months Ended
	Average Recorded		Interest Income		Average Recorded		Interest Income
	Investment		Recognized		Investment		Recognized
September 30, 2019
With no related allowance recorded:
Commercial	$	4,074	$	39	$	4,395	$	258
Commercial real estate		3,049		45		3,157		156
With an allowance recorded:
Commercial		984		—		769		—
Commercial real estate		—		—		—		—
Total:
Commercial	$	5,058	$	39	$	5,164	$	258
Commercial real estate	$	3,049	$	45	$	3,157	$	156

5.) Legal Proceedings:

The Company is involved in legal actions arising in the ordinary course of business. In the opinion of management, the outcomes from these matters, either individually or in the aggregate, are not expected to have any material effect on the Company.

6.) Earnings Per Share and Capital Transactions:

Earnings per share is computed by dividing net income available to common shareholders by the weighted average number of shares of common outstanding stock, net of any treasury shares, during the period. Diluted earnings per share is calculated by dividing net income available to common shareholders by the weighted average number of shares of common stock outstanding, net of any treasury shares, after consideration of the potential dilutive effect of common stock equivalents, based upon the treasury stock method using an average market price for the period. The common stock equivalents are comprised of unvested restricted share awards.

	Three Months Ended				Nine Months Ended
	September 30,				September 30,
	2020		2019		2020		2019
Net income (amounts in thousands)	$	2,162	$	1,945	$	5,465	$	5,378
Weighted average common shares outstanding		4,171,697		4,351,801		4,190,385		4,341,858
Net effect of dilutive common share equivalents		4,326		7,894		10,348		7,279
Adjusted average shares outstanding-dilutive		4,176,023		4,359,695		4,200,733		4,349,137
Basic earnings per share	$	0.51	$	0.45	$	1.30	$	1.24
Diluted earnings per share	$	0.51	$	0.45	$	1.30	$	1.24

7.) Subordinated Debt:

In July 2007, a trust formed by the Company issued $5.0 million of floating rate trust preferred securities as part of a pooled offering of such securities due December 2037. The Company owns all $155,000 of the common securities issued by the trust. The securities bear interest at the 3-month LIBOR rate plus 1.45%. The rates at September 30, 2020 and December 31, 2019 were 1.70% and 3.34%, respectively. The Company issued subordinated debentures to the trust in exchange for the proceeds of the trust preferred offering. The debentures represent the sole assets of this trust. The Company may redeem the subordinated debentures, in whole or in part, at par.

The trust is not consolidated with the Company’s financial statements. Accordingly, the Company does not report the securities issued by the trust as liabilities, but instead reports as liabilities the subordinated debentures issued by the Company and held by the trust. The subordinated debentures qualify as Tier 1 capital for regulatory purposes in determining and evaluating the Company’s capital adequacy.

20

NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (UNAUDITED)

8.) Commitments:

The Bank 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, standby letters of credit and financial guarantees. Such instruments involve, to varying degrees, elements of credit risk in excess of the amount recognized on the Consolidated Balance Sheets. The contract or notional amounts on those instruments reflect the extent of involvement the Company has in particular classes of financial instruments.

In the event of nonperformance by the other party, the Company’s exposure to credit loss on these financial instruments is represented by the contract or notional amount of the instrument. The Company uses the same credit policies in making commitments and conditional obligations as it does for instruments recorded on the balance sheet. The amount and nature of collateral obtained, if any, is based on management’s credit evaluation.

The following table is a summary of such contractual commitments:

	(Amounts in thousands)
	September 30,		December 31,
	2020		2019
Commitments to extend credit:
Fixed rate	$	45,921	$	19,755
Variable rate		89,153		75,147
Standby letters of credit		3,920		3,905

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. Generally, these financial arrangements have fixed expiration dates or other termination clauses and may require payment of a fee. Standby letters of credit are conditional commitments issued by the Company to guarantee the performance of a customer to a third party. 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 creditworthiness 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 counterparty. Collateral held varies but may include accounts receivable, inventory, property, plant and equipment and income-producing commercial properties. The increase in commitments is in line with the Company’s increased focus on commercial and industrial lending, and specifically construction loans requiring future draws.

The Company also offers limited overdraft protection as a non-contractual courtesy which is available to businesses as well as individually/jointly owned accounts in good standing for personal or household use. The Company reserves the right to discontinue this service without prior notice.

The following table is a summary of overdraft protection for the periods indicated:

	(Amounts in thousands)
	September 30,			December 31,
	2020			2019
Overdraft protection available on depositors' accounts	$	8,125		$	8,070
Balance of overdrafts included in loans		83			130
Average daily balance of overdrafts		463			112
Average daily balance of overdrafts as a percentage of available		5.70	%		1.39	%

Customer Derivatives - Interest Rate Swaps/Floors – The Company enters into interest rate swaps that allow our 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 into a fixed-rate. 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 party are not designated as hedges under FASB ASC 815 and are marked to market through earnings. As the interest rate swaps are structured to offset each other, changes to the underlying benchmark interest rates considered in the valuation of these instruments do not result in an impact to earnings; however, there may be fair value adjustments related to credit quality variations between counterparties, which may impact earnings as required by FASB ASC 820. There was no effect on earnings in any periods presented. At September 30, 2020, based on the contract values, the Company had four U.S. Government-sponsored mortgage-backed securities pledged for collateral on its interest rate swaps with the third party financial institution at a fair value of $5.0 million. At December 31, 2019 based upon the swap contract values, the Company had two U.S. Government-sponsored mortgage-backed securities pledged for collateral on its interest rate swaps with a third-party financial institution with a fair value of $2.8 million.

21

NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (UNAUDITED)

Summary information regarding these derivatives is presented below:

	(Amounts in thousands)
	Notional Amount						Fair Value
	September 30,		December 31,				September 30,			December 31,
	2020		2019		Interest Rate Paid	Interest Rate Received	2020			2019
Customer interest rate swap
Maturing in 2020	$	2,236	$	2,312	1 Mo. Libor + Margin	Fixed	$	6		$	4
Maturing in 2025		4,267		4,557	1 Mo. Libor + Margin	Fixed		321			134
Maturing in 2026		1,726		1,822	1 Mo. Libor + Margin	Fixed		118			19
Maturing in 2027		13,032		13,363	1 Mo. Libor + Margin	Fixed		1,567			636
Maturing in 2028		6,040		6,068	1 Mo. Libor + Margin	Fixed		1,055			548
Maturing in 2029		3,659		3,721	1 Mo. Libor + Margin	Fixed		338			(19	)
Maturing in 2030		5,983		3,649	1 Mo. Libor + Margin	Fixed		443			44
Maturing in 2032		2,551		—	1 Mo. Libor + Margin	Fixed		204			—
Maturing in 2033		1,102		1,121	1 Mo. Libor + Margin	Fixed		187			56
Total	$	40,596	$	36,613			$	4,239		$	1,422
Third party interest rate swap
Maturing in 2020	$	2,236	$	2,312	Fixed	1 Mo. Libor + Margin	$	(6	)	$	(4	)
Maturing in 2025		4,267		4,557	Fixed	1 Mo. Libor + Margin		(321	)		(134	)
Maturing in 2026		1,726		1,822	Fixed	1 Mo. Libor + Margin		(118	)		(19	)
Maturing in 2027		13,032		13,363	Fixed	1 Mo. Libor + Margin		(1,567	)		(636	)
Maturing in 2028		6,040		6,068	Fixed	1 Mo. Libor + Margin		(1,055	)		(548	)
Maturing in 2029		3,659		3,721	Fixed	1 Mo. Libor + Margin		(338	)		19
Maturing in 2030		5,983		3,649	Fixed	1 Mo. Libor + Margin		(443	)		(44	)
Maturing in 2032		2,551		—	Fixed	1 Mo. Libor + Margin		(204	)		—
Maturing in 2033		1,102		1,121	Fixed	1 Mo. Libor + Margin		(187	)		(56	)
Total	$	40,596	$	36,613			$	(4,239	)	$	(1,422	)

The following table presents the fair values of derivative instruments in the balance sheet:

	(Amounts in thousands)
	Assets			Liabilities
	Balance Sheet Location	Fair Value		Balance Sheet Location	Fair Value
September 30, 2020
Interest rate derivatives	Other assets	$	4,239	Other liabilities	$	4,239
December 31, 2019
Interest rate derivatives	Other assets	$	1,422	Other liabilities	$	1,422

22

NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (UNAUDITED)

9.) Fair Value of Assets and Liabilities:

Measurements

The Company groups assets and liabilities recorded at fair value into three levels based on the markets in which the assets and liabilities are traded and the reliability of the assumptions used to determine fair value. A financial instrument’s level within the fair value hierarchy is based on the lowest level of input that is significant to the fair value measurement (with level 1 considered highest and level 3 considered lowest). A brief description of each level follows:

Level 1: Quoted prices are available in active markets for identical assets or liabilities as of the reported date.

Level 2: Pricing inputs are other than quoted prices in active markets, which are either directly or indirectly observable as of the reported date. The nature of these assets and liabilities include items for which quoted prices are available but which trade less frequently, and items that are fair valued using other financial instruments, the parameters of which can be directly observed.

Level 3: Assets and liabilities that have little to no pricing observability as of the reported date. These items do not have two-way markets and are measured using management’s best estimate of fair value, where inputs into the determination of fair value require significant management judgment or estimation.

Such techniques and assumptions, as they apply to individual categories of the financial instruments, are as follows:

Investment securities available-for-sale– Fair values of securities are based on quoted market prices, where available. If quoted market prices are not available, fair values are based on quoted market prices of comparable securities.

Loans held for sale – Loans held for sale consist of residential mortgage loans originated for sale. Loans held for sale are recorded at fair value based on what the secondary markets have offered on best efforts commitments.

Interest rate derivatives – The fair value is based on settlement values adjusted for credit risks associated with the counter parties and the Company and observable market interest rate curves.

The following table presents the assets reported on the Consolidated Balance Sheets, on a recurring basis, at their fair value as of September 30, 2020 and December 31, 2019 by level within the fair value hierarchy. Financial assets and liabilities are classified in their entirety based on the lowest level of input that is significant to the fair value measurement.

	(Amounts in thousands)
			Fair Value Measurements at September 30, 2020 Using
	September 30,
Description	2020		Level 1		Level 2		Level 3
ASSETS
U.S. Government agencies and corporations	$	—	$	—	$	—	$	—
Obligations of states and political subdivisions		88,411		—		88,411		—
U.S. Government-sponsored mortgage-backed securities		67,915		—		67,915		—
U.S. Government-sponsored collateralized mortgage obligations		5,616		—		5,616		—
U.S. Government-guaranteed small business administration pools		5,635		—		5,635		—
Loans held for sale		6,564		6,564		—		—
Interest rate derivatives		4,239		—		4,239		—
LIABILITIES
Interest rate derivatives	$	4,239	$	—	$	4,239	$	—

23

NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (UNAUDITED)

	(Amounts in thousands)
			Fair Value Measurements at December 31, 2019 Using
	December 31,
Description	2019		Level 1		Level 2		Level 3
ASSETS
U.S. Government agencies and corporations	$	3,310	$	—	$	3,310	$	—
Obligations of states and political subdivisions		69,626		—		69,626		—
U.S. Government-sponsored mortgage-backed securities		48,237		—		48,237		—
U.S. Government-sponsored collateralized mortgage obligations		8,481		—		8,481		—
U.S. Government-guaranteed small business administration pools		6,477		—		6,477		—
Loans held for sale		4,890		4,890		—		—
Interest rate derivatives		1,422		—		1,422		—
LIABILITIES
Interest rate derivatives	$	1,422	$	—	$	1,422	$	—

The following table presents quantitative information about the Level 3 significant inputs for assets and liabilities measured at fair value on a recurring and nonrecurring basis at September 30, 2020 and December 31, 2019.

	(Amounts in thousands)
	Fair value at September 30,		Valuation	Significant Unobservable
	2020		Technique	Input	Range of Inputs
Impaired loans	$	233	Appraisal of Collateral	Appraisal Adjustments		(76	)%
				Liquidation Expenses		(10	)%

	(Amounts in thousands)
	Fair value at December 31,		Valuation	Significant Unobservable
	2019		Technique	Input	Range of Inputs
Impaired loans	$	405	Appraisal of Collateral	Appraisal Adjustments		(76	)%
				Liquidation Expenses		(10	)%

Financial Instruments

The Company discloses fair value information about financial instruments, whether or not recognized in the Consolidated Balance Sheets, for which it is practicable to estimate the value. In cases where quoted market prices are not available, fair values are based on estimates using present value or other estimation techniques. Those techniques are significantly affected by the assumptions used, including the discount rate and estimates of future cash flows.

In addition, other assets and liabilities of the Company that are not defined as financial instruments are not included in the disclosures, such as property and equipment. Also, non-financial instruments typically not recognized in financial statements nevertheless may have value but are not included in the above disclosures. These include, among other items, the estimated earning power of core deposit accounts, the trained work force, customer goodwill and similar items. Accordingly, the aggregate fair value amounts presented do not represent the underlying value of the Company.

24

NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (UNAUDITED)

The carrying amounts and fair values of the Company’s financial instruments carried at amortized cost are as follows:

	(Amounts in thousands)
	September 30, 2020
	Carrying
	Amount		Level 1		Level 2		Level 3		Fair Value
ASSETS:
Cash and cash equivalents	$	48,633	$	48,633	$	—	$	—	$	48,633
Net loans		528,101		—		—		530,052		530,052
Bank-owned life insurance		21,046		21,046		—		—		21,046
Accrued interest receivable		2,471		2,471		—		—		2,471
LIABILITIES:
Demand, savings and money market deposits	$	571,060	$	571,060	$	—	$	—	$	571,060
Time deposits		109,580		—		—		110,833		110,833
Securities sold under agreements to repurchase		1,088		1,088		—		—		1,088
Federal Home Loan Bank advances - short term		7,000		—		—		7,002		7,002
Federal Home Loan Bank advances - long term		24,000		—		—		24,472		24,472
Subordinated debt		5,155		—		—		4,537		4,537
Accrued interest payable		411		411		—		—		411

	(Amounts in thousands)
	December 31, 2019
	Carrying
	Amount		Level 1		Level 2		Level 3		Fair Value
ASSETS:
Cash and cash equivalents	$	27,815	$	27,815	$	—	$	—	$	27,815
Net loans		514,251		—		—		517,787		517,787
Bank-owned life insurance		17,768		17,768		—		—		17,768
Accrued interest receivable		2,336		2,336		—		—		2,336
LIABILITIES:
Demand, savings and money market deposits	$	476,358	$	476,358	$	—	$	—	$	476,358
Time deposits		142,023		—		—		143,485		143,485
Securities sold under agreements to repurchase		1,922		1,922		—		—		1,922
Federal Home Loan Bank advances - short term		—		—		—		—		—
Federal Home Loan Bank advances - long term		24,000		—		—		24,005		24,005
Subordinated debt		5,155		—		—		4,835		4,835
Accrued interest payable		510		510		—		—		510

25

NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (UNAUDITED)

10.) Accumulated Other Comprehensive Income (Loss):

The following table presents the changes in accumulated other comprehensive income (loss) by component net of tax for the three and nine months ended September 30, 2020 and 2019:

	(Amounts in thousands)
	Three Months Ended										Nine Months Ended
	September 30,										September 30,
	2020					2019					2020						2019
	Unrealized					Unrealized					Unrealized						Unrealized
	gains					gains					gains						gains
	(losses) on		Change in			(losses) on			Change in		(losses) on			Change in			(losses) on			Change in
	available-		pension and			available-			pension and		available-			pension and			available-			pension and
	for-sale		postretirement			for-sale			postretirement		for-sale			postretirement			for-sale			postretirement
	securities (a)		obligations (a)			securities (a)			obligations (a)		securities (a)			obligations (a)			securities (a)			obligations (a)
Beginning balance	$	3,531	$	50		$	(183	)	$	44	$	1,107		$	61		$	(3,686	)	$	30
Other comprehensive income (loss) before reclassification		738		(18	)		1,393			7		3,176			(29	)		4,861			21
Amount reclassified from accumulated other comprehensive income or loss		—		—			—			—		(14	)		—			35			—
Total other comprehensive income (loss)		738		(18	)		1,393			7		3,162			(29	)		4,896			21
Ending balance	$	4,269	$	32		$	1,210		$	51	$	4,269		$	32		$	1,210		$	51

(a) All amounts are net of tax. Amounts in parentheses indicate debits.

There following table presents significant amounts reclassified out of each component of accumulated other comprehensive income (loss) for the three and nine months ended September 30, 2020 and 2019.

	(Amounts in thousands)
	Three Months Ended				Nine Months Ended
	September 30,				September 30,
	2020		2019		2020			2019
	Amount		Amount		Amount			Amount
	reclassified		reclassified		reclassified			reclassified			Affected line
	from		from		from			from			item in the
	accumulated		accumulated		accumulated			accumulated			statement
	other		other		other			other			where
	comprehensive		comprehensive		comprehensive			comprehensive			net income
	income or loss (a)		income or loss (a)		income or loss (a)			income or loss (a)			is presented
Details about other comprehensive income or loss:
Unrealized gains (losses) on available-for-sale securities	$	—	$	—	$	18		$	(44	)	Investment securities available-for-sale gains (losses), net
		—		—		(4	)		9		Federal income tax expense
	$	—	$	—	$	14		$	(35	)

11.) Post-Retirement Obligations:

The Company accrues for the monthly benefit expense of post-retirement cost of insurance for split dollar life insurance coverage. The following table presents the changes in the accumulated liability:

	(Amounts in thousands)
	Three Months Ended					Nine Months Ended
	September 30,					September 30,
	2020		2019			2020		2019
Beginning balance	$	774	$	815		$	745	$	831
Expense recorded		9		(13	)		27		(15	)
Other comprehensive loss (income) recorded		18		(7	)		29		(21	)
Ending balance	$	801	$	795		$	801	$	795

12.) Stock Repurchase Program:

On December 18, 2018, the Company’s Board of Directors approved a program which allowed the Company to repurchase up to 300,000 shares, or approximately 6.9% of the 4,349,624 outstanding shares of common stock effective December 18, 2018. This program terminated on December 31, 2019. The company purchased 54,000 shares under this program. On December 17, 2019, the Company’s Board of Directors approved a new program which allows the Company to purchase up to 200,000 shares, or approximately 4.6% of the 4,323,822 outstanding shares of common stock at December 17, 2019. On March 17, 2020 the Company’s Board of Directors approved an increase in the number of shares authorized for repurchase under the December 17, 2019 plan by 100,000 shares bringing the total to 300,000 shares authorized. This program will terminate on December 31, 2020, or upon purchase of 300,000 shares if earlier or at any time without prior notice. As of September 30, 2020, the Company purchased 146,318 shares under this program. Repurchased shares are designated as treasury shares, available for general corporate purposes, including possible use in connection with the Company’s dividend reinvestment program, employee benefit plans, acquisitions or other distributions. Based on the value of the Company’s stock on September 30, 2020, the remaining authorization to repurchase the stock for the program is approximately $2.3 million.

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NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (UNAUDITED)

13.) Securities Sold Under Agreements to Repurchase:

The following table provides additional detail regarding repurchase agreements:

	(Amounts in thousands)
	Repurchase Agreements (Sweep)
	Accounted for as Secured Borrowings
	At September 30,		At December 31,
	2020		2019
	Remaining Contractual Maturity
	of the Agreements
	Overnight and		Overnight and
	Continuous		Continuous
Repurchase agreements:
U.S. Government-sponsored mortgage-backed securities	$	4,236	$	2,750
Total collateral carrying value	$	4,236	$	2,750
Total repurchase agreements	$	1,088	$	1,922

14.) Equity Compensation:

The Omnibus Equity Plan permits the award of up to 340,000 shares to the Company’s employees to promote the long-term financial success of the Company, increasing shareholder value by providing employees the opportunity to acquire an ownership interest in the Company and enabling the Company and its related entities to attract and retain the services of those upon whom the successful conduct of business depends. In the first nine months of 2020, 47,567 shares were granted to employees under the plan, compared to 30,156 shares being granted under the plan in the first nine months of 2019. The Company is expensing the grant date fair value of all share-based compensation over the requisite vesting periods on a prorated straight-line basis.  In the first nine months of 2020 and 2019, compensation expense of $318,000 and $626,000, respectively, was recorded in the Consolidated Statements of Income. As of September 30, 2020, there was $643,000 of total unrecognized compensation expense related to the non-vested shares granted under the Plan. Shares awarded under this plan can vest immediately and/or on the anniversary of the award date from one to three years out if the employee remains employed with Cortland Bancorp. The remaining cost is expected to be recognized over a weighted average period of 11.8 months.

Granted shares are awarded upon a combination of service and achievement of performance objectives derived from one or more of the performance criteria. The main performance metrics used for the periods presented were three-year earnings per share growth and three-year return on equity ranked versus a peer group.

The following is the activity under the Omnibus Equity Plan during the nine months ended September 30, 2020:

				Weighted Average
				Grant Date Fair
	Shares			Value
Nonvested at January 1, 2020		26,025		$	21.78
Granted		47,567			15.82
Vested		(22,136	)		21.74
Forfeited		—			—
Nonvested at September 30, 2020		51,456		$	16.29

The Director Equity Plan permits the award of up to 113,000 shares to nonemployee directors to promote the long-term financial success of the Company, increasing shareholder value by enabling the Company and its related entities to attract and retain the services of those directors upon whom the successful conduct of business depends.  There were 2,684 Board approved shares granted in the first nine months of 2020, and there were 1,525 Board approved shares granted under the plan in the first nine months of 2019. In the first nine months of 2020, there was $43,000 of expense recorded in the Consolidated Statements of Income, and $34,000 of expense recorded in the first nine months of 2019.

Note 15.) Subsequent Events:

On October 1, 2020, the Company paid off $8 million of advances from the FHLB of Cincinnati due to the current low interest rate environment and excess cash held on the Company’s Statement of Financial Condition.  Management has reviewed events occurring through November 5, 2020, the date the financial statements were issued, and no additional subsequent events occurred requiring accrual or disclosure.

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ITEM 2. MANAGEMENT’S DISCUSSION AND ANALYSIS OF FINANCIAL

CONDITION AND RESULTS OF OPERATIONS

CONSOLIDATED AVERAGE BALANCE SHEETS, YIELDS AND RATES (UNAUDITED)

	(Fully taxable equivalent basis in thousands of dollars)
	YEAR-TO-DATE AS OF
	September 30, 2020							September 30, 2019
	Average				Average			Average				Average
	Balance		Interest		Rate			Balance		Interest		Rate
ASSETS
Interest earning deposits	$	37,519	$	84		0.30	%	$	13,170	$	235		2.38	%
Investment securities (1) (2) (3)		147,078		2,901		2.63	%		140,688		3,000		2.85	%
Loans (1) (2) (3)		522,504		17,598		4.49	%		489,816		19,254		5.25	%
Total interest-earning assets		707,101	$	20,583		3.88	%		643,674	$	22,489		4.67	%
Cash and due from banks		7,533							7,490
Bank premises and equipment		11,920							10,342
Other assets		39,754							30,563
Total non-interest-earning assets		59,207							48,395
Total assets	$	766,308						$	692,069
LIABILITIES AND SHAREHOLDERS' EQUITY
Interest-bearing demand deposits	$	227,810	$	1,033		0.60	%	$	194,953	$	1,386		0.95	%
Savings		116,396		83		0.09	%		110,505		75		0.09	%
Time		127,542		1,615		1.69	%		140,056		2,146		2.05	%
Total interest-bearing deposits		471,748		2,731		0.77	%		445,514		3,607		1.08	%
Other borrowings		28,160		275		1.30	%		24,473		403		2.20	%
Subordinated debt		5,155		91		2.36	%		5,155		157		4.01	%
Total interest-bearing liabilities		505,063	$	3,097		0.82	%		475,142	$	4,167		1.17	%
Demand deposits		168,190							135,033
Other liabilities		16,188							12,593
Shareholders' equity		76,867							69,301
Total liabilities and shareholders' equity	$	766,308						$	692,069
Net interest income			$	17,486						$	18,322
Net interest rate spread (4)						3.06	%						3.50	%
Net interest margin (5)						3.30	%						3.80	%
Ratio of interest-earning assets to interest-bearing liabilities						1.40							1.35

(1) Includes both taxable and tax-exempt loans and investment securities.

(2) The amounts are presented on a fully taxable equivalent basis using the statutory rate of 21% in 2020 and 2019 and have been adjusted to reflect the effect of disallowed interest expenses related to carrying tax-exempt assets. The tax equivalent income adjustment for loans and investment securities was $5,000 and $359,000, respectively, for September 30, 2020, and $4,000 and $270,000, respectively, for September 30, 2019.

(3) Average balance outstanding includes the average amount outstanding of all non-accrual investment securities and loans. Investment securities consist of average total principal adjusted for amortization of premium and accretion of discount and includes both taxable and tax-exempt securities. Loans consist of average total loans, including loans held for sale, less average unearned income.

(4) Interest rate spread represents the difference between the yield on earning assets and the rate paid on interest-bearing liabilities.

(5) Net interest margin is calculated by dividing net interest income by total interest-earning assets.

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CONSOLIDATED AVERAGE BALANCE SHEETS, YIELDS AND RATES (UNAUDITED)

	(Fully taxable equivalent basis in thousands of dollars)
	QUARTER-TO-DATE AS OF
	September 30, 2020							June 30, 2020							September 30, 2019
	Average				Average			Average				Average			Average				Average
	Balance		Interest		Rate			Balance		Interest		Rate			Balance		Interest		Rate
ASSETS
Interest earning deposits	$	50,548	$	14		0.12	%	$	45,708	$	14		0.12	%	$	13,690	$	90		2.62	%
Investment securities (1) (2) (3)		161,975		1,019		2.52	%		144,125		955		2.64	%		139,476		981		2.84	%
Loans (1) (2) (3)		535,591		5,774		4.30	%		525,913		5,768		4.39	%		487,793		6,258		5.11	%
Total interest-earning assets		748,114	$	6,807		3.64	%		715,746	$	6,737		3.77	%		640,959	$	7,329		4.56	%
Cash and due from banks		7,581							7,466							7,607
Bank premises and equipment		11,987							12,161							10,519
Other assets		42,152							39,431							35,336
Total non-interest-earning assets		61,720							59,058							53,462
Total assets	$	809,834						$	774,804						$	694,421
LIABILITIES AND SHAREHOLDERS' EQUITY
Interest-bearing demand deposits	$	248,952	$	272		0.43	%	$	218,889	$	331		0.61	%	$	187,623	$	457		0.97	%
Savings		120,493		26		0.09	%		116,666		29		0.10	%		110,504		26		0.09	%
Time		113,196		454		1.59	%		135,677		523		1.54	%		145,123		755		2.06	%
Total interest-bearing deposits		482,641		752		0.62	%		471,232		883		0.75	%		443,250		1,238		1.11	%
Other borrowings		32,687		93		1.14	%		29,723		94		1.26	%		21,536		114		2.10	%
Subordinated debt		5,155		23		1.75	%		5,155		27		2.12	%		5,155		50		3.81	%
Total interest-bearing liabilities		520,483	$	868		0.66	%		506,110	$	1,004		0.80	%		469,941	$	1,402		1.18	%
Demand deposits		195,307							177,055							137,721
Other liabilities		16,996							17,679							14,092
Shareholders' equity		77,048							73,960							72,667
Total liabilities and shareholders' equity	$	809,834						$	774,804						$	694,421
Net interest income			$	5,939						$	5,733						$	5,927
Net interest rate spread (4)						2.98	%						2.97	%						3.38	%
Net interest margin (5)						3.17	%						3.21	%						3.70	%
Ratio of interest-earning assets to interest-bearing liabilities						1.44							1.41							1.36

(1) Includes both taxable and tax-exempt loans and investment securities.

(2) The amounts are presented on a fully taxable equivalent basis using the statutory rate of 21% in 2020 and 2019 and have been adjusted to reflect the effect of disallowed interest expenses related to carrying tax-exempt assets. The tax equivalent income adjustment for loans and investment securities was $2,000 and $134,000, respectively, for September 30, 2020, $1,000 and $118,000, respectively, for June 30, 2020; and $1,000 and $104,000, respectively, for September 30, 2019.

(3) Average balance outstanding includes the average amount outstanding of all non-accrual investment securities and loans. Investment securities consist of average total principal adjusted for amortization of premium and accretion of discount and includes both taxable and tax-exempt securities. Loans consist of average total loans, including loans held for sale, less average unearned income.

(4) Interest rate spread represents the difference between the yield on earning assets and the rate paid on interest-bearing liabilities.

(5) Net interest margin is calculated by dividing net interest income by total interest-earning assets.

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SELECTED FINANCIAL DATA FOR THE QUARTER ENDED

(In thousands of dollars, except for ratios and per share amounts)

	September 30,			June 30,			March 31,			December 31,			September 30,
Unaudited	2020			2020			2020			2019			2019
SUMMARY OF OPERATIONS
Total interest income	$	6,671		$	6,618		$	6,930		$	7,428		$	7,224
Total interest expense		(868	)		(1,004	)		(1,225	)		(1,387	)		(1,402	)
NET INTEREST INCOME (NII)		5,803			5,614			5,705			6,041			5,822
Provision for loan losses		(525	)		(450	)		(600	)		(180	)		(180	)
NII after loss provision		5,278			5,164			5,105			5,861			5,642
Investment securities gains (losses)		—			18			—			—			—
Mortgage banking gains		1,281			900			596			381			492
Other income		684			797			856			958			935
Total non-interest expense		(4,721	)		(4,578	)		(4,980	)		(4,903	)		(4,761	)
Income before tax expense		2,522			2,301			1,577			2,297			2,308
Federal income tax expense		360			369			206			393			363
Net income	$	2,162		$	1,932		$	1,371		$	1,904		$	1,945
PER COMMON SHARE DATA (1)
Earnings per share, basic and diluted	$	0.51		$	0.47		$	0.32		$	0.44		$	0.45
Book value		18.51			17.94			17.32			17.19			16.93
Cash dividends declared per share		0.14			0.14			0.19			0.12			0.11
BALANCE SHEET DATA
Assets	$	811,625		$	780,017		$	712,650		$	737,162		$	700,621
Investments		170,608			165,957			133,638			138,966			139,291
Loans		534,146			528,097			482,239			518,716			488,435
Allowance for loan losses		6,045			5,520			5,087			4,465			4,641
Deposits		680,640			648,417			593,256			618,381			587,128
Borrowings		37,243			39,483			30,830			31,077			25,462
Shareholders' equity		78,148			75,772			73,209			74,338			74,153
AVERAGE BALANCES
Assets	$	809,834		$	774,804		$	713,808		$	712,629		$	694,421
Investments		161,975			144,125			134,969			137,260			139,476
Loans		530,704			521,447			502,398			497,387			483,590
Deposits		677,948			648,287			593,163			594,794			580,971
Borrowings		37,842			34,878			27,176			28,857			26,691
Shareholders' equity		77,048			73,960			79,593			74,483			72,667
ASSET QUALITY RATIOS
Net (charge-offs) recoveries	$	—		$	(17	)	$	22		$	(356	)	$	(24	)
Net (charge-offs) recoveries as a percentage of average total loans		0.00	%		(0.01	)%		0.02	%		(0.29	)%		(0.02	)%
Loans 30 days or more beyond their contractual due date as a percent of total loans		0.36	%		0.38	%		0.59	%		0.44	%		0.55	%
Nonperforming loans	$	7,746		$	7,918		$	8,230		$	8,545		$	9,118
Total nonperforming assets	$	7,746		$	7,918		$	8,230		$	8,545		$	9,118
Nonperforming assets as a percentage of:
Total assets		0.95	%		1.02	%		1.15	%		1.16	%		1.30	%
Equity plus allowance for loan losses		9.20			9.74			10.51			10.84			11.57
Tier I capital		9.82			10.26			10.86			10.94			11.71
FINANCIAL RATIOS
Return on average equity		11.22	%		10.45	%		6.89	%		10.23	%		10.71	%
Return on average assets		1.07			1.00			0.77			1.07			1.12
Efficiency ratio		59.72			61.62			68.54			65.50			64.74
Effective tax rate		14.27			16.04			13.06			17.11			15.73
Net interest margin		3.17			3.21			3.56			3.74			3.70

(1) Basic earnings per common share are based on weighted average shares outstanding. Diluted earnings per share is after consideration of common stock equivalents. Cash dividends per common share are based on actual dividends declared. Book value per common share is based on shares outstanding at each period end.

30

Financial Review

The following is management’s discussion and analysis of the financial condition and results of operations of Cortland Bancorp (the Company). The discussion should be read in conjunction with the Consolidated Financial Statements and related notes and summary financial information included elsewhere in this quarterly report.

Note Regarding Forward-looking Statements

The Private Securities Litigation Reform Act of 1995 provides a “safe harbor” for forward-looking statements. In addition to historical information, certain information included in this discussion and other material filed or to be filed by the Company with the Securities and Exchange Commission (as well as information included in oral statements or other written statements made or to be made by the Company) may contain forward-looking statements that involve risks and uncertainties. The words “believes,” “expects,” “may,” “will,” “should,” “projects,” “contemplates,” “anticipates,” “forecasts,” “intends,” or similar terminology identify forward-looking statements. These statements reflect management’s beliefs and assumptions, and are based on information currently available to management.

Economic circumstances, the Company’s operations and actual results could differ significantly from those discussed in any forward-looking statements. Some of the factors that could cause or contribute to such differences are changes in the economy and interest rates either nationally or in the Company’s market area, including the impact of the impairment of securities; political actions, including failure of the United States Congress to raise the federal debt ceiling or the imposition of changes in the federal budget; changes in customer preferences and consumer behavior; increased competitive pressures or changes in either the nature or composition of competitors; changes in the legal and regulatory environment; changes in factors influencing liquidity, such as expectations regarding the rate of inflation or deflation, currency exchange rates, and other factors influencing market volatility; changes in assumptions underlying the establishment of reserves for possible loan losses, reserves for repurchase of mortgage loans sold and other estimates; and risks associated with other global economic activity caused by infectious disease outbreaks, including the recent outbreak of coronavirus, or COVID-19, and the significant impact that such outbreak has had and may have on our growth, operations, earnings and asset quality along with global political and financial factors.

While actual results may differ significantly from the results discussed in the forward-looking statements, the Company undertakes no obligation to update publicly any forward-looking statement for any reason, even if new information becomes available.

Significant Developments

Each item listed below materially affects the comparability of our results of operations for the three and nine months ended September 30, 2020 and 2019, and our financial condition as of September 30, 2020 and December 31, 2019, and may affect the comparability of financial information we report in future fiscal periods.

Impact of COVID-19

The progression of the COVID-19 pandemic in the United States has had an adverse impact on our financial condition and results of operations as of and for the nine months ended September 30, 2020, and can be expected to have a complex and significant adverse impact on the economy, the banking industry and our Company in future fiscal periods, all subject to a high degree of uncertainty.

Effects on Our Market Areas.  Our commercial and consumer banking products and services are offered primarily in Ohio, where individual and governmental responses to the COVID-19 pandemic led to a broad curtailment of economic activity beginning in March 2020.  In Ohio, the Governor ordered schools to close through the remainder of the school year and ordered many retail establishments to close and imposed limitations on gathering sizes through May 31, 2020.  The Bank remained open during these orders because banks have been identified as essential services, but serving its customers through its drive-ups and Video Teller Machines and in all of its branch offices by appointment only. Beginning in June, the Governor began opening up business in various phases in order to improve economic conditions. The Bank opened six of its thirteen branches but continued to operate only drive-up services at the others. Since June, the Bank has opened its remaining branches. 

Each state has experienced an increase in unemployment levels as a result of the curtailment of business activities, rising from an average of 4.1 percent in Ohio in January 2020 to an average of 17.6 percent in April 2020, according to the Bureau of Labor Statistics. The Ohio unemployment rate in September was down to 8.9%.   

To date, many of the public health and economic effects of COVID-19 have been concentrated in large cities, such as New York City and Miami, but, as suspected, similar effects have occurred on a more delayed basis in smaller cities and communities, where our banking operations are primarily focused.

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Policy and Regulatory Developments.  Federal, state and local governments and regulatory authorities have enacted and issued a range of policy responses to the COVID-19 pandemic, including the following:

• The Federal Reserve decreased the range for the federal funds target rate by 0.50% on March 3, 2020, and by another 1.0% on March 16, 2020, reaching a range of 0.0 – 0.25%.

• On March 27, 2020, President Trump signed the Coronavirus Aid, Relief and Economic Security Act (“CARES Act”) which established a $2.0 trillion economic stimulus package, including cash payments to individuals, supplemental unemployment insurance benefits and a $349 billion loan program administered through the SBA, referred to as the paycheck protection program (“PPP”). Under the PPP, small businesses, sole proprietorships, independent contractors and self-employed individuals may apply for loans from existing SBA lenders and other approved regulated lenders that enroll in the program, subject to numerous limitations and eligibility criteria. The Bank is participating as a lender in the PPP. On or about April 16, 2020, the SBA notified lenders that the $349 billion earmarked for the PPP was exhausted. On April 24, 2020, an additional $310 billion in funding for PPP loans was authorized, with such funds available for PPP loans beginning on April 27, 2020. In addition, the CARES Act provides financial institutions the option to temporarily suspend certain requirements under GAAP related to TDRs for a limited period of time to account for the effects of COVID-19.

• On April 7, 2020, federal banking regulators issued a revised Interagency Statement on Loan Modifications and Reporting for Financial Institutions, which, among other things, encouraged financial institutions to work prudently with borrowers who are or may be unable to meet their contractual payment obligations because of the effects of COVID-19, and stated that institutions generally do not need to categorize COVID-19-related modifications as TDRs and that the agencies will not direct supervised institutions to automatically categorize all COVID-19 related loan modifications as TDRs.

• On April 9, 2020, the Federal Reserve announced additional measures aimed at supporting small and midsized business, as well as state and local governments impacted by COVID-19.  The Federal Reserve announced the Main Street Business Lending Program, which establishes two new loan facilities intended to facilitate lending to small and midsized businesses: (1) the Main Street New Loan Facility (MSNLF), and (2) the Main Street Expanded Loan Facility (MSELF). MSNLF loans are unsecured term loans originated on or after April 8, 2020, while MSELF loans are provided as upsized tranches of existing loans originated before April 8, 2020.  The combined size of the program will be up to $600 billion.  The program is designed for businesses with up to 10,000 employees or $2.5 billion in 2019 revenues.  To obtain a loan, borrowers must confirm that they are seeking financial support because of COVID-19 and that they will not use proceeds from the loan to pay off debt.  The Federal Reserve also stated that it would provide additional funding to banks offering PPP loans to struggling small businesses.  Lenders participating in the PPP will be able to exclude loans financed by the facility from their leverage ratio.  In addition, the Federal Reserve created a Municipal Liquidity Facility to support state and local governments with up to $500 billion in lending, with the Treasury Department backing $35 billion for the facility using funds appropriated by the CARES Act.  The facility will make short-term financing available to cities with a population of more than one million or counties with a population of greater than two million.  The Federal Reserve expanded both the size and scope its Primary and Secondary Market Corporate Credit Facilities to support up to $750 billion in credit to corporate debt issuers.  This will allow companies that were investment grade before the onset of COVID-19 but then subsequently downgraded after March 22, 2020 to gain access to the facility.  Finally, the Federal Reserve announced that its Term Asset-Backed Securities Loan Facility will be scaled up in scope to include the triple A-rated tranche of commercial mortgage-backed securities and newly issued collateralized loan obligations.  The size of the facility is $100 billion.

Effects on Our Business. We currently expect that the COVID-19 pandemic and the specific developments referred to above could have a significant impact on our business. In particular, we anticipate that a significant portion of the Bank’s borrowers in the hotel industry will continue to endure significant economic distress, which has caused, and may continue to cause, them to draw on their existing lines of credit and adversely affect their ability to repay existing indebtedness, and is expected to adversely impact the value of collateral. These developments, together with economic conditions generally, are also expected to impact our commercial real estate portfolio, particularly with respect to real estate with exposure to this industry and the value of certain collateral securing our loans. As a result, we anticipate that our financial condition, capital levels and results of operations could be adversely affected, as described in further detail below.

Our Response. We have taken numerous steps in response to the COVID-19 pandemic, including the following:

• We are actively working with loan customers to monitor loan modification terms. (See below)

• We continue to promote our digital banking options through our website. Customers are encouraged to utilize online and mobile banking tools, and our customer service and retail departments are fully staffed and available to assist customers remotely.

32

• We are a participating lender in the PPP. We believe it is our responsibility as a community bank to assist the SBA in the distribution of funds authorized under the CARES Act to our customers and communities, which we are carrying out in a prudent and responsible manner.  As of September 30, 2020, we had 419 PPP loans authorized totaling $56.4 million, an average of $135,000 per loan.

• No employees have been furloughed. Employees whose job responsibilities can be effectively carried out remotely worked from home through August, but have now phased in on-site. Employees whose critical duties require their continued presence on-site are observing social distancing and cleaning protocols.  We are also utilizing staggered shifts and/or work days to create more workspace in those operational areas conducive to that type of scheduling.

Loan Modifications.  As of September 30, 2020, we had 40 commercial loans aggregating $61 million, deferring principal and/or interest for periods ranging from 90 to 180 days.  All of these loans were performing in accordance with their terms prior to modification, are currently performing, and are in conformance with the guidelines of the CARES Act. Since June 30, 2020, 90 prior modifications aggregating $49 million have returned to full payment status. Details with respect to modifications are as follows:

	As of September 30, 2020										As of June 30, 2020
			(Amounts in thousands)										(Amounts in thousands)
Type of Loan	Number of Loans		Balance		% of Total Loans			% of Segment			Number of Loans		Balance		% of Total Loans			% of Segment
One-to-four family residential		—	$	—		—	%		—	%		28	$	5,995		1	%		8	%
Consumer		—		—		—	%		—	%		2		149		—	%		1	%
Commercial and Industrial
Trucking		—		—		—	%		—	%		17		5,961		1	%		33	%
Other		6		7,669		1	%		8	%		20		14,213		3	%		14	%
Commercial Real Estate
Multi-family		2		5,591		1	%		14	%		5		6,648		1	%		18	%
Nonresidential		11		18,131		3	%		18	%		15		27,319		5	%		28	%
Hotels		7		21,831		4	%		78	%		8		25,510		5	%		95	%
Skilled nursing/ personal care		2		2,211		—	%		3	%		4		9,908		2	%		18	%
Other		12		5,849		1	%		8	%		31		15,058		3	%		16	%
Total		40	$	61,282		11	%					130	$	110,761		21	%

The effect of these modifications was captured in the evaluation of the Allowance for Loan Losses.  All of these loans are performing as of quarter end and through this reporting; however, the future performance, specifically beyond the term of the deferral, is uncertain.  To recognize a credit allowance commensurate with the existing risk, the Company assigned qualitative factors onto each of the above segmented balances for allowance purposes.  Among the data used to assign qualitative factors were the stress tests performed on each of the five largest concentrations presented above, the nature and length of the modifications, and observations of the overall COVID impact to the specific industry including:

• Whether the business experienced closure or just a curtailment

• Any impact of existing or potential government aid to the business/industry

• The adaptability to alternative revenue production

• Support of underlying collateral

These qualitative factors were based on current observations and could be materially different in future quarters.  The longer the economy is operating in its current reduced capacity, the more severe the ultimate outcome is expected.

Liquidity and Capital Resources.  As the stay-at-home orders played out in March, the company began a liquidity preservation mode.  With the growing pandemic and all of the uncertainty of its affect on the economy, availability of future liquidity came into question. In late March and early April, the Company accessed several of its wholesale funding sources in the aggregate of $8 million to begin building liquidity for cautionary purposes.  Also during this time period, the Federal Reserve announced the relaxation of the discount window standards, encouraging member banks to utilize this borrowing resource at any time.  Additionally, the Federal Reserve created the Payroll Protection Program Liquidity Facility (“PPPLF”) designed to directly fund the PPP loans made available to small businesses, essentially availing $56.4 million in funding to the Company.  In addition to these federally sponsored programs, the State of Ohio also made funds available through various programs.  As of quarter-end, the Company has available all of these untapped specially formed liquidity programs, in addition to its unused wholesale capacity by policy of $157 million.

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Analysis of Assets, Liabilities and Shareholders’ Equity

Due to the seasonality of the loan and deposit balances in the year-end balance sheet, a comparison of September 30, 2019 is included in the analysis of assets and liabilities, in addition to the usual comparison to December 31, 2019. The following table contains the loan and deposit balances referenced in the discussions:

	(Amounts in thousands)
	September 30,		December 31,		September 30,
	2020		2019		2019
Loans:
Commercial	$	123,403	$	99,864	$	77,071
Commercial real estate		303,404		302,084		292,150
Residential real estate		79,808		87,172		89,709
Consumer - home equity		23,749		25,856		25,578
Consumer - other		3,782		3,740		3,927
Total loans	$	534,146	$	518,716	$	488,435
Total earning assets	$	752,143	$	681,939	$	644,739
Total assets	$	811,625	$	737,162	$	700,621
Deposits:
Noninterest-bearing deposits	$	194,174	$	133,340	$	138,537
Interest-bearing demand deposits		376,886		343,018		301,567
Time deposits		109,580		142,023		147,024
Total deposits	$	680,640	$	618,381	$	587,128
Total interest bearing liabilities	$	523,709	$	516,118	$	474,053

Earning assets are comprised of deposits at financial institutions, including the Federal Reserve Bank, investment securities and loans. Earning assets were $752.1 million at September 30, 2020, an increase of 10.3% from the December 31, 2019 balance of $681.9 million. The increase from December 31, 2019 was mainly due to an increase in loans of $15.4 million, an increase of $31.4 million in investment securities available-for-sale and an increase in interest-earning deposits of $21.5 million.  Earning assets increased 16.7% from the September 30, 2019 balance of $644.7 million, which was due mainly to an increase in interest-earning deposits of $28.8 million, an increase in investment securities available-for-sale of $31.1 million, and an increase in loans of $45.7 million. Total assets of $811.6 million at September 30, 2020 increased by $74.5 million, or 10.1%, from the asset total of $737.2 million at December 31, 2019, and increased $111.0 million, or 15.8%, from the asset total of $700.6 million at September 30, 2019. See below for further analysis of changes in loans.

At September 30, 2020, the investment securities available-for-sale portfolio was $167.6 million compared to $136.1 million at December 31, 2019, an increase of $31.4 million, or 23.1%. Investment securities available-for-sale represented 22.3% of earning assets at September 30, 2020, compared to 20.0% at December 31, 2019. The Company deployed $30 million of excess liquidity in the May-June time frame generated by customer COVID-related deposit increases. As the Company manages its balance sheet for loan growth, asset mix, liquidity and current interest rates and interest rate forecasts, the investment portfolio is a primary source of liquidity and therefore reflects variation in balances accordingly. The investment securities available-for-sale portfolio represented 24.6% and 22.0% of each deposit dollar at September 30, 2020 and December 31, 2019, respectively.

The investment securities available-for-sale portfolio had net unrealized gains, net of tax, of $4.3 million at September 30, 2020 and net unrealized gains, net of tax of $1.1 million at December 31, 2019. The increase in unrealized gains is reflective of the decline in interest rates during 2020 and its effect on securities valuation.

Loans held for sale increased by $1.7 million to $6.6 million at September 30, 2020 from $4.9 million at December 31, 2019, reflecting variation of the mortgage loan processing and origination activity.

Total loans at September 30, 2020 were $534.1 million compared to $518.7 million at December 31, 2019, a 3.0% increase, and $488.4 million at September 30, 2019, a 9.4% increase. Year-end loan balances included 60-day or less term commercial loans totaling $25.2 million that closed in December 2019 and were fully secured by segregated deposit accounts with the Bank, and matured in the first quarter of 2020. Excluding these seasonal loans at December 31, 2019, total loans actually increased $40.6 million, or 8.2% through September 30, 2020. All of this increase was driven by the PPP loans issued during this second quarter relative to government pandemic aid. Loan balances otherwise declined 3.2%, reflecting significant payoffs. With falling interest rates, numerous commercial customers paid off loan balances to take advantage of capital markets. In the current and previous quarter, commercial loan payoffs totaled $9.3 million and $5.7 million, respectively. Additionally, efforts from the lending staff have shifted focus on servicing existing borrowers impacted by COVID-19 versus prospecting for new loans. Total gross loans as a percentage of earning assets stood at 71.0% as of September 30, 2020, 76.1% as of December 31, 2019, and 75.8% as of September 30, 2019. The total loan-to-deposit ratio was 78.5% at September 30, 2020, 83.9% at December 31, 2019 and 83.2% September 30, 2019.

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The allowance for loan losses of $6.0 million, $4.5 million and $4.6 million, respectively, represented approximately 1.13% of outstanding loans at September 30, 2020, 0.86% at December 31, 2019 and 0.95% at September 30, 2019. Excluding the fully guaranteed PPP loans, the allowance was 1.27% of loans this quarter end. The elevated level of the allowance is a reflection of the effect of the COVID-19 pandemic on the borrowers of the Company. See Analysis of Provision for Loan Losses.

During the first nine months, loan charge-offs were $156,000 in 2020 compared to $175,000 for the same period in 2019, while the recovery of previously charged-off loans amounted to $161,000 in 2020 and $83,000 in 2019. There were net recoveries of $5,000 in  2020 and net charge-offs of $92,000 in 2019, which represented 3 basis points. Charge-offs of specific problem loans, as well as for smaller balance homogeneous loans, are recorded periodically during the year. The number of loan accounts and the amount of charge-offs associated with account balances vary from period to period as loans are deemed uncollectible by management. Nonaccrual loans were $1.9 million at September 30, 2020 and September 30, 2019, $2.3 million at December 31, 2019, and $2.8 million at September 30, 2019 or 0.4%, 0.5% and 0.6%, respectively, of total loans.

Bank-owned life insurance had a cash surrender value of $21.0 million at September 30, 2020 and $17.8 million at December 31, 2019 reflecting the $3 million purchased during the quarter. Comprising approximately 24.8% and 22.1% of Tier 1 capital plus the allowance for loan losses for September 30, 2020 and December 31, 2019, respectively, management may consider additional insurance purchases not to exceed a 25% ratio.

Other assets increased to $24.8 million at September 30, 2020 from $21.5 million at December 31, 2019. As of September 30, 2020, a $5.2 million investment in partnership funds is included in other assets compared to $5.7 million at December 31, 2019, with an offsetting $2.5 million at September 30, 2020 and $3.1 million at December 31, 2019 in other liabilities, which is the commitment to fund these affordable housing investments. A partnership investment of $8.1 million and $7.7 million into a privately managed pooled fund of small business administration loans is included in other assets at September 30, 2020 and at December 31, 2019., respectively. Both of these investments are intended to satisfy Community Reinvestment Act requirements. Also included in other assets is $4.2 million in fair value of commercial loan swaps at September 30, 2020 and $1.4 million at December 31, 2019 with a equal amount in other liabilities.

Noninterest-bearing deposits measured $194.2 million at September 30, 2020 compared to $133.3 million at December 31, 2019 and $138.5 million at September 30, 2019. Much of the $60.8 million, or 45.6%, increase from year-end relates to government aid to our customers in the form of PPP loans to commercial customers and stimulus checks to consumers. Interest-bearing deposits increased $1.5 million to $486.5 million at September 30, 2020 from $485.0 million at December 31, 2019 and increased $37.9 million from $448.6 million at September 30, 2019. The small increase in interest-bearing deposits from year end reflects segregated money market deposit accounts with the Bank which fully collateralized $25.2 million in 60-day or less term commercial loans that closed in December 2019. The loans matured and the deposits withdrew in the first quarter of 2020. Absent the collateral deposits, interest-bearing deposits increased $26.6 million, or 5.8%, during the first nine months of 2020.

Federal Home Loan Bank advances and short-term borrowings increased by $6.2 million to $32.1 million at September 30, 2020 from $25.9 million at December 31, 2019, reflecting the Company's initial reaction at the outset of the pandemic. Management continues to use short-term borrowings to bridge its current cash flow needs resulting in variations from period to period. Wholesale deposits, when cheaper than FHLB funds, are sometimes used in lieu of borrowings as had been the case throughout 2019. In early October 2020, the Company utilized a portion of its excess liquidity to pay off $8 million of FHLB advances. Other liabilities measured $15.6 million at September 30, 2020 and $13.4 million at December 31, 2019. Included is the operating lease liability, the commitment to fund the affordable housing investments and fair value of swaps described above.

The Company’s total shareholders’ equity measured $78.1 million at September 30, 2020 and $74.3 million on December 31, 2019. The Company’s capital continues to meet the requirements to be deemed well-capitalized under all regulatory measures.

Cash dividends of $0.47 per share were paid to shareholders in the first nine months of 2020, with $0.38 in cash dividends paid in the first nine months of 2019 (including a special dividend of $.05 in both periods). Cash dividends of $0.14 per share and $0.11 per share were paid to shareholders in the third quarters of 2020 and 2019.

Capital Resources

The Company and the Bank are subject to regulatory capital requirements administered by federal banking agencies. Capital adequacy guidelines and 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 about components, risk weightings, and other factors, and the regulators can lower classifications in certain cases. Failure to meet various capital requirements can initiate regulatory action that could have a direct material effect on the financial statements.

The prompt corrective action regulations provide five categories, including well capitalized, adequately capitalized, undercapitalized, significantly undercapitalized, and critically undercapitalized, although these terms are not used to represent overall financial condition. If a bank is only adequately capitalized, regulatory approval is required to, among other things, accept, renew or roll-over brokered deposits. If a bank is undercapitalized, capital distributions and growth and expansion are limited, and plans for capital restoration are required.

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The Board of Governors of the Federal Reserve Board and the FDIC approved the final rules implementing the Basel Committee on Banking Supervision's capital guidelines for U.S. banks (commonly known as Basel III). Under the final rules, which began for the Company and the Bank on January 1, 2015 and were subject to a phase-in period through January 1, 2019, minimum requirements increased for both the quantity and quality of capital held by the Company and the Bank. The rules include a new common equity Tier 1 capital to risk-weighted assets ratio (CET1 ratio) of 4.5% and a capital conservation buffer of 2.5% of risk-weighted assets, which when fully phased-in, effectively results in a minimum CET1 ratio of 7.0%. Basel III raises the minimum ratio of Tier 1 capital to risk-weighted assets from 4.0% to 6.0% (which, with the capital conservation buffer, effectively results in a minimum Tier 1 capital ratio of 8.5% when fully phased-in), effectively results in a minimum total capital to risk-weighted assets ratio of 10.5% (with the capital conservation buffer fully phased-in), and requires a minimum leverage ratio of 4.0%. Basel III also makes changes to risk weights for certain assets and off-balance-sheet exposures. Management expects that the capital ratios for the Company and the Bank under Basel III will continue to exceed the well capitalized minimum capital requirements, as they currently exceed the fully phased in 2019 requirements.

In September 2019, consistent with Section 201 of the Regulatory Relief Act, the Federal Reserve Board, along with the other federal bank regulatory agencies, issued a final rule, effective January 1, 2020, that gives community banks, including the Company, the option to calculate a simple leverage ratio to measure capital adequacy, if the community banks meet certain requirements.  Under the rule, a community bank is eligible to elect the Community Bank Leverage Ratio (CBLR) framework if it has less than $10 billion in total consolidated assets, limited amounts of certain trading assets and liabilities, limited amounts of off-balance sheet exposures and a leverage ratio greater than 9.0%.  The final rule adopts tier 1 capital and the existing leverage ratio into the CBLR framework.  The tier 1 numerator takes into account the modifications made in relation to the capital simplifications and current expected credit loss (CECL) methodology transitions rules as of the compliance dates of those rules.  Qualifying institutions that elect to use the CBLR framework (each, a CBLR Bank) and that maintain a leverage ratio of greater than 9.0% will be considered to have satisfied the risk based and leverage capital requirements in the regulatory agencies’ generally applicable capital rules and to have met the well capitalized ratio requirements.  Each CBLR Bank will not be required to calculate or report risk based capital.  A CBLR Bank may opt out of the framework at any time, without restriction, by reverting to the generally applicable risk based capital rule. The Company did not elect the option of using the CBLR framework to measure capital adequacy as of September 30, 2020.

At September 30, 2020 and December 31, 2019, actual capital levels and minimum required levels were:

	(Dollars in thousands)
						Minimum required					To be well-capitalized under
						for capital adequacy					prompt corrective action
	Actual					purposes					regulations
September 30, 2020	Amount		Ratio			Amount		Ratio			Amount		Ratio
CET1 capital (to risk-weighted assets)
Company	$	73,847		12.50	%	$	30,271		4.5	%		N/A		N/A
Bank		70,369		11.98	%		30,108		4.5	%	$	38,186		6.5	%
Tier 1 capital (to risk-weighted assets)
Company		78,847		13.35	%		39,131		6.0	%		N/A		N/A
Bank		70,369		11.98	%		38,920		6.0	%		46,998		8.0	%
Total capital (to risk-weighted assets)
Company		84,976		14.39	%		50,944		8.0	%		N/A		N/A
Bank		82,499		14.04	%		50,670		8.0	%		58,748		10.0	%
Tier 1 capital (to average assets)
Company		78,847		9.81	%		32,139		4.0	%		N/A		N/A
Bank		70,369		8.80	%		32,004		4.0	%		40,005		5.0	%

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	(Dollars in thousands)
						Minimum required					To be well-capitalized under
						for capital adequacy					prompt corrective action
	Actual					purposes					regulations
December 31, 2019	Amount		Ratio			Amount		Ratio			Amount		Ratio
CET1 capital (to risk-weighted assets)
Company	$	73,091		12.76	%	$	25,775		4.5	%		N/A		N/A
Bank		69,768		12.25	%		25,633		4.5	%	$	37,026		6.5	%
Tier 1 capital (to risk-weighted assets)
Company		78,091		13.63	%		34,367		6.0	%		N/A		N/A
Bank		69,768		12.25	%		34,178		6.0	%		45,570		8.0	%
Total capital (to risk-weighted assets)
Company		82,640		14.43	%		45,823		8.0	%		N/A		N/A
Bank		80,317		14.10	%		45,570		8.0	%		56,963		10.0	%
Tier 1 capital (to average assets)
Company		78,091		10.98	%		28,461		4.0	%		N/A		N/A
Bank		69,768		9.85	%		28,321		4.0	%		35,401		5.0	%

The Company had $5.0 million of trust preferred securities at both September 30, 2020 and December 31, 2019 that qualified as Tier 1 capital. Refer to Note 7, “Subordinated Debt.”

The Bank was categorized as "well capitalized" at September 30, 2020 and December 31, 2019.

Certain Non-GAAP Measures

Certain financial information can be determined by methods other than Generally Accepted Accounting Principles (GAAP). Specifically, certain financial measures are based on core earnings rather than net income. Core earnings exclude income, expense, gains and losses that either are not reflective of ongoing operations or that are not expected to reoccur with any regularity or reoccur with a high degree of uncertainty and volatility. Included in the volatile category is the loan loss provision and Federal income tax expense, while gains on Bank-owned life insurance are considered nonrecurring. Such information may be useful to both investors and management and can aid them in understanding the Company’s current performance trends and financial condition. Core earnings are a supplemental tool for analysis and not a substitute for GAAP net income. Reconciliation from GAAP net income to the non-GAAP measure of core earnings can be referenced as part of management’s discussion and analysis of financial condition and results of operations.

Core earnings of $3 million for the three months ended September 30, 2020 was 22% higher than the same period in 2019, and 11% higher on a linked quarter basis. Likewise, core earnings for the nine months ended September 30, 2020 of $8 million exceeded the previous nine months by 16%. The improvement stemmed primarily from the boom in mortgage banking activity in the historically low interest rate environment. 

	(Amounts in thousands)
	Three Months Ended						Nine Months Ended
	Sept. 30, 2020		Sept. 30, 2019		June 30, 2020		Sept. 30, 2020		Sept. 30, 2020
GAAP net income	$	2,162	$	1,945	$	1,932	$	5,465	$	5,378
Provision for loan losses		525		180		450		1,575		535
Federal income tax expense		360		363		369		935		966
Pre-tax, pre-provision income	$	3,047	$	2,488	$	2,751	$	7,975	$	6,879

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Analysis of Net Interest Income

	(Amounts in thousands)
	Three months ended				Nine Months Ended
	September 30,				September 30,
	2020		2019		2020		2019
Net interest income	$	5,803	$	5,822	$	17,122	$	18,048
Tax equivalent income adjustment for investment securities		134		104		359		270
Tax equivalent income adjustment for loans		2		1		5		4
Net interest income on a fully taxable equivalent basis	$	5,939	$	5,927	$	17,486	$	18,322
Interest and dividends on investment securities	$	751	$	877	$	2,183	$	2,730
Tax equivalent income adjustment for investment securities		134		104		359		270
Investment securities income on a fully taxable equivalent basis	$	885	$	981	$	2,542	$	3,000
Interest and fees on loans	$	5,770	$	6,527	$	17,588	$	19,250
Tax equivalent income adjustment for loans		2		1		5		4
Loan income on a fully taxable equivalent basis	$	5,772	$	6,528	$	17,593	$	19,254

Nine Months Ended September 30, 2020 and 2019

Net interest income, the principal source of the Company’s earnings, is the amount by which interest and fees generated by interest-earning assets, primarily loans and investment securities, exceed the interest cost of deposits and borrowed funds. On a fully taxable equivalent basis, net interest income measured $17.5 million for the nine months ended September 30, 2020 and $18.3 million for the nine months ended September 30, 2019. The resulting net interest margin was 3.30% for September 30, 2020 and 3.80% for September 30, 2019.

The decrease in interest income, on a fully taxable equivalent basis, of $1.9 million is the product of a 9.9% year-over-year increase in average earning assets and a 79 basis point decrease in yield. The decrease in interest expense of $1.1 million was a product of a 35 basis point decrease in rates paid and a 6.3% increase in average interest-bearing liabilities. The net result was a 6.5% decrease in net interest income on a fully taxable equivalent basis, and a 50 basis point decrease in the Company’s net interest margin on a modestly growing asset base with a different mix.

On a fully taxable equivalent basis, income on investment securities decreased by $99,000, or 3.3%. The average invested balances in these securities increased by $6.4 million, or 4.5%, from the levels of a year ago. The increase in the average balance of investment securities was accompanied by a 22 basis point decrease in the tax equivalent yield of the portfolio. The Company will continue attempting to redeploy liquidity into loans which generate greater yields than securities, thus sacrificing securities balances when beneficial.

On a fully taxable equivalent basis, income on loans decreased by $1.7 million, or 8.6%, for year to date September 30, 2020 compared to the same period in 2019. A $32.7 million increase in the average balance of the loan portfolio, or 6.7%, was accompanied by a 76 basis point decrease in the portfolio’s tax equivalent yield. The three rate decreases in the latter half of 2019 by the Federal Open Market Committee (FOMC) aggregating to 75 basis points has now been amplified with two rate reductions in the first quarter of 2020 for another 150 basis points. Coupled with strong competition for good credits, there is continued downward pressure on offering rates. The commercial loan portfolio housed the majority of the net increase in balances mainly consisting of PPP loans.

Other interest income decreased by $151,000, or 64.3%, from the same period a year ago. The average balance of interest-earning deposits increased by $24.3 million, or 184.9%, reflecting the increased liquidity driven by pandemic aid. The yield decreased by 208 basis points from 2019 to 2020, reflecting the aggregate net decreases in the federal funds rate. Management intends to remain fully invested, minimizing on-balance sheet liquidity.

Average interest-bearing demand deposits and money market accounts increased by $32.9 million, or 16.9%, for the nine months ended September 30, 2020 compared to the same period of 2019, and average savings balances increased by $5.9 million, or 5.3%. The average rate paid on interest-bearing demand deposits and money market accounts decreased 35 basis points from 2019 to 2020 to 0.60%, reflecting the expiration of promotional specials offered during 2019. The average rate paid on savings accounts was 0.09% for both September 30, 2020 and 2019. The average balance of time deposit products decreased by $12.5 million, or 8.9%, as the average rate paid decreased by 36 basis points, from 2.05% to 1.69%. The current low-rate environment offers little opportunity for time deposit customers, except for periodic special rates offered on a limited basis. Time deposits also include wholesale funds, generally brokered deposits, obtained at generally higher rates than in-market accounts. Brokered deposits are one of several borrowing sources, primarily used when rates therein are beneficial versus other sources.

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Average borrowings and subordinated debt increased by $3.7 million while the average rate paid decreased by 158 basis points. As higher cost borrowings matured, the remaining borrowings were at lower rates. Management continues to utilize short-term borrowings to bridge liquidity gaps, along with wholesale deposit alternatives. In the current low rate environment, wholesale and borrowing rates can reprice lower, while deposit rates may show modest decline. In early October 2020, the Company utilized a portion of its excess liquidity to pay off $8 million of advances from the FHLB. The average rate on the advances was 2.62%, which will result in a reduction in the average cost of borrowings prospectively.

Three Months Ended September 30, 2020 and 2019

Net interest income, the principal source of the Company’s earnings, is the amount by which interest and fees generated by interest-earning assets, primarily loans and investment securities, exceed the interest cost of deposits and borrowed funds. On a fully taxable equivalent basis, net interest income measured $5.9 million for the quarter ended September 30, 2020 and September 30, 2019. The resulting net interest margin was 3.17% for September 30, 2020 and 3.70% for September 30, 2019.

The decrease in interest income, on a fully taxable equivalent basis, of $522,000 is the product of a 16.7% year-over-year increase in average earning assets and a 92 basis point decrease in yield. The decrease in interest expense of $534,000 was a product of a 52 basis point decrease in rates paid and a 10.8% increase in average interest-bearing liabilities. The net result was a 2.1% decrease in net interest income on a fully taxable equivalent basis, and a 53 basis point decrease in the Company’s net interest margin on a modestly growing asset base with a different mix.

On a fully taxable equivalent basis, income on investment securities increased by $38,000, or 3.9%. The average invested balances in these securities increased by $22.5 million, or 16.1%, from the levels of a year ago. The increase in the average balance of investment securities was accompanied by a 32 basis point decrease in the tax equivalent yield of the portfolio. The Company will continue attempting to redeploy liquidity into loans which generate greater yields than securities, thus sacrificing securities balances when beneficial. Deployment of $30 million of excess liquidity relating to pandemic aid occurred late in the second quarter of 2020, thus driving the higher invested balances. 

On a fully taxable equivalent basis, income on loans decreased by $484,000, or 7.7%, for the September 30, 2020 period compared to the same period in 2019. A $47.8 million increase in the average balance of the loan portfolio, or 9.8%, was accompanied by a 81 basis point decrease in the portfolio’s tax equivalent yield. The three rate decreases in the latter half of 2019 by the Federal Open Market Committee (FOMC) aggregating to 75 basis points has now been amplified with two rate reductions in the first quarter of 2020 for another 150 basis points. Coupled with strong competition for good credits, there is continued downward pressure on offering rates. The commercial loan portfolio housed the majority of the net increase in balances mainly consisting of PPP loans. Excluding PPP loans, the portfolio declined $8.6 million, or 1.2%, year-over-year.

Other interest income decreased by $76,000, or 84.4%, from the same period a year ago. The average balance of interest-earning deposits increased by $36.9 million, or 269.2%. The yield decreased by 250 basis points from 2019 to 2020, reflecting the aggregate net decreases in the federal funds rate. Management intends to remain fully invested, minimizing on-balance sheet liquidity.

Average interest-bearing demand deposits and money market accounts increased by $61.3 million, or 32.7%, for the quarter ended September 30, 2020 compared to the same period of 2019, while average savings balances increased by $10.0 million, or 9.0%. The average rate paid on interest-bearing demand deposits and money market accounts decreased 54 basis points from 2019 to 2020 to 0.43%, reflecting the expiration of promotional specials offered during 2019. The average rate paid on savings accounts was 0.09% for both September 30, 2020 and 2019. The average balance of time deposit products decreased by $31.9 million, or 22.0%, as the average rate paid decreased by 47 basis points, from 2.06% to 1.59%. The current low-rate environment offers little opportunity for time deposit customers, except for periodic special rates offered on a limited basis. Time deposits also include wholesale funds, generally brokered deposits, obtained at generally higher rates than in-market accounts. Brokered deposits are one of several borrowing sources, primarily used when rates therein are beneficial versus other sources.

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Average borrowings and subordinated debt increased by $11.1 million or 41.8% while the average rate paid decreased by 62 basis points. As higher cost borrowings matured, the borrowings that remained were at lower rates, and the new borrowings were obtained at lower rates as well . Management continues to utilize short-term borrowings to bridge liquidity gaps, along with wholesale deposit alternatives. In the current low rate environment, wholesale and borrowing rates can reprice lower, while deposit rates may show modest decline. In early October 2020, the Company utilized a portion of its excess liquidity to pay off $8 million of advances from the FHLB. The average rate on the advances was 2.62%, which will result in a reduction in the average cost of borrowings prospectively.

Analysis of Provision for Loan Losses, Non-Interest Income, Non-Interest Expense and Federal Income Tax - Nine Months Ended September 30, 2020 and September 30, 2019

During the first nine months of both 2020 and 2019, the amount charged to operations as a provision for loan losses was adjusted to account for charge-offs against the allowance, as well as an increase in loan balances recorded in the portfolio, expected losses on specific problem loans and several qualitative factors, including factors specific to the local economy and to industries operating in the local market. The Company had allocated a portion of the allowance for a select few specific problem loans in 2020 and 2019, and has not experienced significant deterioration in any loan type other than the hotel industry, including the residential real estate portfolios or the commercial loan portfolio, and accordingly has not added any special provision for these loan types. All other past due loans, potential problem loans, as well as loans on non-accrual have all been stable. As illustrated previously in "Significant Developments," 78% of the hotel portfolio is currently deferring principle and/or interest payments under COVID-19 modifications. During this third quarter, the Company classified two of these credits totaling $10.4 million as substandard. With loan to values of 22% and 47%, the loans are not considered impaired, but have been allocated qualitative factors commensurate with the associated risk. The provision for loan losses was $1.6 million for the nine months ended September 30, 2020, compared to $535,000 provision for loan losses for the nine months ended September 30, 2019. The increased provision for the nine months ended September 30, 2020, compared to the same time period in 2019, was due to uncertainty in the economy as a result of the COVID-19 pandemic. As presented in the Significant Developments section, the Company received requests for the loan modifications as a result of business closures/curtailments from the COVID-19 pandemic. As the ultimate outcome of the performance of these credits is uncertain, qualitative factors were developed based upon industry segmentation, and the evaluation of various criteria. We believe the provision for loan losses could increase in future periods based on our belief that the credit quality of our loan portfolio may decline and loan defaults could increase as a result of the COVID-19 pandemic.

Total non-interest income increased by $1.4 million, or 39.3%, for the nine months ended  September 30, 2020 compared to September 30, 2019.

For the first nine months of 2020, fees for customer services decreased by $138,000, or 8.1%, from the same period a year ago, driven by fewer customer transactions on deposit accounts.  Mortgage banking gains increased by $1.6 million in 2020 compared to 2019, reflective of the increase in margin on loan sales and the increase in refinances of existing loans resulting from the decline in interest rates. Earnings on bank-owned life insurance decreased by $18,000, the difference being the proceeds received on a policy upon the death of a former executive exceeding the cash value of the policy by $51,000 in 2019. Other sources of non-interest income increased by $1,000 from the same period a year ago. This latter income category is subject to fluctuation due to the non-recurring nature of some of the items.  

Total non-interest expenses in the first nine months were $14.3 million in 2020 compared to $14.9 million in 2019, a decrease of $573,000 or 3.9%. During the first nine months of 2020, expenditures for salaries and employee benefits decreased by $609,000, or 7.2%, from the similar period a year ago. In lieu of layoffs and/or furloughs during the pandemic, the Company lowered headcount through attrition. 

Occupancy and equipment increased by $148,000 mainly due to moving from a leased branch facility to a bank owned property in the first quarter of 2020. Professional fees increased by $55,000. This is due in part to an increase in legal fees attributable mainly to loan collection efforts. All other expense categories decreased by $167,000 or 4.4%, in the aggregate. This is due in part to the opening of a new branch in the first quarter of 2019, and expenses related to moving the Company’s stock listing to NASDAQ.

The effective tax rate for the first nine months was 14.6% in 2020 and 15.2% in 2019, resulting in income tax expense of $935,000 in 2020 and $966,000 in 2019. The effective rate is affected by the current rate of profitability and tax-free components of the revenue stream.

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The provision for income taxes differs from the amount of income tax determined applying the applicable U.S. statutory federal income tax rate (21%) to pre-tax income as a result of the following differences:

	(Amounts in thousands)
	September 30,
	2020						2019
	Balance			%			Balance			%
Provision at statutory rate	$	1,344			21.0		$	1,332			21.0
Add (Deduct) tax effects of:
Earnings on bank-owned life insurance-net		(20	)		(0.3	)		(73	)		(1.2	)
Non-taxable interest income		(325	)		(5.1	)		(253	)		(4.0	)
Low income housing tax credits		(131	)		(2.0	)		(115	)		(1.8	)
Non-deductible expenses		67			1.0			75			1.2
Federal income tax expense	$	935			14.6		$	966			15.2

Analysis of Provision for Loan Losses, Non-Interest Income, Non-Interest Expense and Federal Income Tax  - Three Months Ended September 30, 2020 and September 30, 2019

For the third quarter ended September 30, 2020, charge offs and recoveries netted to zero, and for the similar period of 2019 there were net charge-offs of $24,000. Other than hotel loans, past due loans, potential problem loans, as well as loans on nonaccrual have all been stable. With the loan modifications granted relative to the CARES Act, additional qualitative factors were applied due to the uncertain outcome of these modified credits (see hotel discussion on previous page). The resulting provision for loan losses was $525,000 for the third quarter of 2020, versus $180,000 in 2019. We believe the provision for loan losses could increase in future periods based on our belief that the credit quality of our loan portfolio may decline and loan defaults could increase as a result of the COVID-19 pandemic.

Total non-interest income increased by $538,000, or 37.7%, for the quarter ending September 30, 2020 compared to the same quarter of 2019 Mortgage banking gains increased to $1.3 million in the third quarter of 2020 from $492,000 the same quarter of 2019, an increase of $789,000 reflective of the increase in volume and margin on loan sales. Mortgage loan originations nearly doubled to $35.8 million in the quarter ended September 30, 2020 versus $16.6 million in 2019. Earnings on bank-owned life insurance increased by $4,000. Other sources of non-interest income decreased by $255,000 from the same period a year ago. This latter income category is subject to fluctuation due to the non-recurring nature of some of the items.  

Total non-interest expenses in the third quarter were $4.7 million in 2020 and $4.8 million in 2019, a decrease of 0.8%. During the third quarter of 2020, expenditures for salaries and employee benefits decreased by $24,000, or 0.9%, from the similar period a year ago. Full time equivalent employment averaged 152 during the third quarter of 2020 and 162 during the third quarter of 2019. The Company reduced headcount via attrition to date in 2020 in an effort to gain efficiency during the pandemic. All other expense categories decreased by $16,000, or 0.8%, in the aggregate. This latter category is subject to fluctuation due to the non-recurring nature of some of the items.

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Liquidity

The central role of the Company’s liquidity management is to (1) ensure sufficient liquid funds to meet the normal transaction requirements of its customers, (2) take advantage of market opportunities requiring flexibility and speed, and (3) provide a cushion against unforeseen liquidity needs.

Liquidity risk arises from the possibility that the Company may not be able to satisfy current or future financial commitments or may become unduly reliant on alternative funding sources. The objective of liquidity management is to ensure the Company has the ability to fund balance sheet growth and meet deposit and debt obligations in a timely and cost-effective manner. Management monitors liquidity through a regular review of asset and liability maturities, funding sources, and loan and deposit forecasts. The Company maintains strategic and contingency liquidity plans to ensure sufficient available funding to satisfy requirements for balance sheet growth, proper management of capital markets funding sources and addressing unexpected liquidity requirements.

Principal sources of liquidity available to the Company include assets considered relatively liquid, such as interest-bearing deposits in other banks, federal funds sold and, cash and due from banks, as well as cash flows from maturities and repayments of loans, investment securities and mortgage-backed securities.

Principal repayments on mortgage-backed securities, collateralized mortgage obligations and small business administration pools, along with investment securities maturing or called amounted to $16.3 million in the first nine months of 2020, which annualized represents 12.8% of the total combined portfolio, compared to $8.5 million, or 8.1%, of the portfolio a year ago. The current low interest rate environment generally increases prepayment speeds on mortgage-backed securities. A large portion of the investment portfolio is allocated to amortizing debt in order to provide cash flows to supplement loan growth.

In order to address the concern of FDIC insurance of larger depositors, the Bank is a member of the Certificate of Deposit Account Registry Service (CDARS^®) program and the Insured Cash Sweep (ICS) program. Through CDARS^®, the Bank’s customers can increase their FDIC insurance by up to $50 million through reciprocal certificate of deposit accounts and likewise through ICS, they can accomplish the same through money market savings accounts. This is accomplished by the Bank entering into reciprocal depository relationships with other member banks. The individual customer’s large deposit is broken into amounts below $250,000 and placed with other banks that are members of the network. The reciprocal member bank issues certificates of deposit or money market savings accounts in amounts that ensure that the entire deposit is eligible for FDIC insurance. The Bank can also execute “one-way buy” transactions wherein deposits are taken in on a non-reciprocal basis through a weekly bidding process. At September 30, 2020, the Bank had $ 5.5 million of deposits in the CDARS^® program, of which none was executed as one-way buy transactions and the Bank had $15.9 million of deposits in the ICS money market program, of which none was executed as one-way buy transactions. Prospectively, for regulatory purposes, reciprocal CDARS^® and ICS are no longer considered a brokered deposit.

Along with its liquid assets, the Bank has other sources of liquidity available to it which help to ensure that adequate funds are available as needed. These other sources include, but are not limited to, the ability to obtain deposits through the adjustment of interest rates, the purchasing of federal funds, correspondent bank lines of credit and access to the Federal Reserve Discount Window. The Bank is also a member of the Federal Home Loan Bank of Cincinnati, which provides its largest source of liquidity. At September 30, 2020, the Bank had approximately $8.6 million available of collateral-based borrowing capacity at FHLB of Cincinnati, supplementing the $4.5 million of availability with the Federal Reserve Discount window. Additionally, the FHLB has committed a $38.8 million cash management line, of which nothing has been disbursed, subject to posting additional collateral. The Bank, by policy, has access to approximately 25% of total deposits in various forms of wholesale deposits that could be used as an additional source of liquidity. At September 30, 2020, there was $13.2 million in outstanding balances in wholesale deposits including internet-based deposits and the above-mentioned one-way buy funds, with access to an additional $156.9 million. The Company was also granted a total of $13.5 million in unsecured, discretionary Federal Funds lines of credit with correspondent banks with no funds drawn upon as of September 30, 2020. Unpledged securities of $80.3 million are also available for borrowing under repurchase agreements or as additional collateral for FHLB lines of credit or to sell to generate liquidity. In early October 2020, the Company utilized a portion of its excess liquidity to pay off $8 million of advances from the FHLB. This increases availability of collateral based borrowing to $16.6 million. 

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At the outset of the Pandemic, in response to the uncertainty surrounding the stay-at-home orders, business closures, and the potential negative effects to the economy, the Bank opted to begin increasing on-balance sheet liquidity in the event funds may be unavailable in the future.  Simultaneously, in response to the COVID-19 pandemic, governmental agencies took several measures to avail liquidity to the banking industry.  Among the key provisions are the following:

Federal Reserve Bank Actions

• Lowered the primary borrowing rate through the discount window by 150 basis points to 0.25% to enhance the role of the discount window for banks facing potential funding pressures.

• Encouraged banks to utilize intraday credit extended by Reserve Banks on both a collateralized and uncollateralized basis.

• Supports firms that choose to use their capital and liquidity buffers to lend and undertake other supportive actions.

• Reduced the reserve requirement ratios to 0.0% effective March 26, 2020.

• Established the Paycheck Protection Program Liquidity Facility (PPPLF) to extend credit to eligible financial institutions that originate Small Business PPP loans, taking the loans as collateral at face value; established the rate at 0.35%.

In addition to the Federal Reserve Bank’s actions, the FHLB offered interest free six-month advances for COVID-19 related liquidity needs, with normal collateral posted up to $5 million per institution.  The Treasurer of the State of Ohio offered to open interest-bearing deposit accounts in Ohio banks at a rate of .02% (currently), fully collateralized up to a six-month term.  The Company qualified for $17 million under this program and entered into the program in the third quarter of 2020.

Based upon the accommodations described above, the Bank has substantial liquidity available, over and above normal channels, to address any future needs emanating from the current pandemic.

The Company has other more limited sources of liquidity. In addition to its existing liquid assets, it can raise funds in the securities market through debt or equity offerings or it can receive dividends from its bank subsidiary. Generally, the Bank may pay dividends without prior approval as long as the dividend is not more than the total of the current calendar year-to-date earnings plus any earnings from the previous two years not already paid out in dividends, as long as the Bank remains well-capitalized after the dividend payment. The amount available for dividends at September 30, 2020 is $10.5 million. Future dividend payments by the Bank to the Company are based upon future earnings. The Holding Company had cash of $136,000 at September 30, 2020 available to meet cash needs. It also held a $6.0 million note receivable, the cash flow from which approximates the debt service on the Junior Subordinated Debentures. Cash is generally used by the Holding Company to pay quarterly interest payments on the debentures, pay dividends to common shareholders, repurchase shares, and to fund operating expenses.

Cash and cash equivalents totaled $48.6 million at September 30, 2020 compared to $20.5 million at September 30, 2019 and $27.8 million at December 31, 2019 The Company strives to be fully invested, minimizing on balance sheet liquidity, however, higher liquidity levels have been maintained during the Pandemic as a precautionary measure. 

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The following table details the cash flow from operating activities for the nine months ended:

	(Amounts in thousands)
	September 30,
	2020			2019
Net income	$	5,465		$	5,378
Adjustments to reconcile net income to net cash flow from operating activities:
Depreciation, amortization and accretion		1,946			1,656
Provision for loan losses		1,575			535
Investment securities available-for-sale (gains) losses, net		(18	)		44
Originations of mortgage banking loans held for sale		(85,612	)		(45,448	)
Proceeds from the sale of mortgage banking loans		86,715			42,673
Mortgage banking gains, net		(2,777	)		(1,173	)
Earnings on bank-owned life insurance		(278	)		(296	)
Equity compensation		361			661
Changes in:
Deferred taxes		(584	)		156
Other assets and liabilities		(305	)		7
Net cash flow from operating activities	$	6,488		$	4,193

Key variations stem from: 1) In the nine months ended September 30, 2020 net income was $87,000 higher than the same period in 2019 with provision for loan losses $1.0 million higher than the same period in 2019. 2) Mortgage banking activity increased substantially due to historic low interest rates. 3) Equity compensation decreased $300,000 primarily due to lower awards in 2020 versus 2019. 4) Deferred tax change primarily due to larger provision for loan losses. Refer to the Consolidated Statements of Cash Flows for a summary of the sources and uses of cash for 2020 and 2019.

Critical Accounting Policies and Estimates

The discussion and analysis of the Company’s financial condition and results of operation are based upon the Consolidated Financial Statements, which have been prepared in accordance with U.S. Generally Accepted Accounting Principles (GAAP). The preparation of these consolidated financial statements requires management to make estimates and judgments that affect the reported amounts of assets and liabilities, revenues and expenses, and related disclosures of contingent assets and liabilities at the date of the Company’s consolidated financial statements. Actual results may differ from these estimates under different assumptions or conditions.

Certain accounting policies involve significant judgments and assumptions by management which has a material impact on the carrying value of certain assets and liabilities; management considers such accounting policies to be critical accounting policies. The judgments and assumptions used by management are based on historical experience and other factors, which are believed to be reasonable under the circumstances. Management has discussed the development and selection of these accounting estimates with the Audit Committee.

Management believes the following are critical accounting policies that require the most significant judgments and estimates used in the preparation of the Company’s consolidated financial statements.

Accounting for the Allowance for Loan Losses

The determination of the allowance for loan losses and the resulting amount of the provision for loan losses charged to operations reflects management’s current judgment about the credit quality of the loan portfolio and takes into consideration changes in lending policies and procedures, changes in economic and business conditions, changes in the nature and volume of the portfolio and, in the terms of loans, changes in the experience, ability and depth of lending management, changes in the volume and severity of past due, non-accrual and adversely classified or graded loans, changes in the quality of the loan review system, changes in the value of underlying collateral for collateral-dependent loans, the existence and effect of any concentrations of credit and the effect of competition, legal and regulatory requirements and other external factors. The nature of the process by which we determine the appropriate allowance for loan losses requires the exercise of considerable judgment. While management utilizes its best judgment and information available, the ultimate adequacy of the allowance is dependent upon a variety of factors beyond our control, including the performance of the loan portfolio, the economy, changes in interest rates and the view of the regulatory authorities toward loan classifications. The allowance is increased by the provision for loan losses and decreased by charge-offs when management believes the uncollectibility of a loan is confirmed. Subsequent recoveries, if any, are credited to the allowance. A weakening of the economy or other factors that adversely affect asset quality could result in an increase in the number of delinquencies, bankruptcies or defaults and a higher level of non-performing assets, net charge offs, and provision for loan losses in future periods.

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The Company’s allowance for loan losses methodology consists of three elements: specific valuation allowances based on probable losses on specific loans; valuation allowances based on historical loan loss experience for similar loans with similar characteristics and trends; and general valuation allowances based on general economic conditions and other qualitative risk factors both internal and external to the Company. These elements support the basis for determining allocations between the various loan categories and the overall adequacy of our allowance to provide for probable losses inherent in the loan portfolio.

With these methodologies, a general allowance is established for each loan type based on historical losses for each loan type in the portfolio. Additionally, management allocates a specific allowance for “Impaired Credits,” which is based on current information and events; it is probable the Company will not collect all amounts due according to the original contractual terms of the loan agreement. The level of the general allowance is established to provide coverage for management’s estimate of the credit risk in the loan portfolio by various loan segments not covered by the specific allowance. Additional information regarding allowance for credit losses can be found in the Notes to the Consolidated Financial Statements (Note 4) and elsewhere in this Management’s Discussion and Analysis.

Investment Securities and Impairment

The classification and accounting for investment securities is discussed in detail in Note 3 of the Consolidated Financial Statements. Investment securities must be classified as held-to-maturity, available-for-sale, or trading. The appropriate classification is based partially on our ability to hold the securities to maturity and largely on management’s intentions, if any, with respect to either holding or selling the securities. The classification of investment securities is significant since it directly impacts the accounting for unrealized gains and losses on securities. Unrealized gains and losses on trading securities, if any, flow directly through earnings during the periods in which they arise, whereas available-for-sale securities are recorded as a separate component of shareholders’ equity (accumulated other comprehensive income or loss) and do not affect earnings until realized. The fair values of our investment securities are generally determined by reference to quoted market prices and reliable independent sources. At each reporting date, the Company assesses whether there is an “other-than-temporary” impairment to the Company’s investment securities. Such impairment must be recognized in current earnings rather than in other comprehensive income (loss).

The Company reviews investment debt securities on an ongoing basis for the presence of other-than-temporary impairment (OTTI) with formal reviews performed quarterly. OTTI losses on individual investment securities are recognized in accordance with FASB ASC topic 320, Investments – Debt and Equity Securities. The purpose of this ASC is to provide greater clarity to investors about the credit and noncredit component of an OTTI event and to communicate more effectively when an OTTI event has occurred. This ASC amends the OTTI guidance in GAAP for debt securities, improves the presentation and disclosure of OTTI on investment securities and changes the calculation of the OTTI recognized in earnings in the financial statements. This ASC does not amend existing recognition and measurement guidance related to OTTI of equity securities.

For debt securities, ASC topic 320 requires an entity to assess whether it has the intent to sell the debt security or it is more-likely-than-not that it will be required to sell the debt security before its anticipated recovery. If either of these conditions is met, an OTTI on the security must be recognized.

In instances in which a determination is made that a credit loss (defined as the difference between the present value of the cash flows expected to be collected and the amortized cost basis) exists but the entity does not intend to sell the debt security and it is not more-likely-than-not that the entity will be required to sell the debt security before the anticipated recovery of its remaining amortized cost basis (i.e., the amortized cost basis less any current-period credit loss), ASC topic 320 changes the presentation and amount of the OTTI recognized in the income statement.

In these instances, the impairment is separated into the amount of the total impairment related to the credit loss and the amount of the total impairment related to all other factors. The amount of the total other-than-temporary impairment related to the credit loss is recognized in earnings. The amount of the total impairment related to all other factors is recognized in other comprehensive income (loss). The total OTTI is presented in the income statement with an offset for the amount of the total OTTI that is recognized in other comprehensive income (loss). In determining the amount of impairment related to credit loss, the Company uses a third party discounted cash flow model, several inputs for which require estimation and judgment. Among these inputs are projected deferral and default rates and estimated recovery rates. Realization of events different than that projected could result in a large variance in the values of the securities.

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Income Taxes

The provision for income taxes is based on income reported for financial statement purposes and differs from the amount of taxes currently payable, since certain income and expense items are reported for financial statement purposes in different periods than those for tax reporting purposes. Accrued taxes represent the net estimated amount due or to be received from taxing authorities. In estimating accrued taxes, the Company assesses the relative merits and risks of the appropriate tax treatment of transactions taking into account statutory, judicial and regulatory guidance in the context of the Company’s tax position.

The Company accounts for income taxes using the asset and liability approach, the objective of which is to establish deferred tax assets and liabilities for the temporary differences between the financial reporting basis and tax basis of our assets and liabilities at enacted tax rates expected to be in effect when such amounts are realized or settled. The Company conducts periodic assessments of deferred tax assets, including net operating loss carryforwards, to determine if it is more-likely-than-not that they will be realized. In making these assessments, the Company considers taxable income in prior periods, projected future taxable income, potential tax planning strategies and projected future reversals of deferred tax items. These assessments involve a certain degree of subjectivity which may change significantly depending on the related circumstances.

Available Information

The Company files an annual report on Form 10-K, quarterly reports on Form 10-Q, current reports on Form 8-K and amendments to those reports with the Securities and Exchange Commission (SEC) pursuant to Section 13(a) or 15(d) of the Exchange Act of 1934 Amended (the Exchange Act). The Company’s website is www.cortlandbank.com. The Company makes available through its website, free of charge, the reports filed with the SEC, as soon as reasonably practicable after such material is electronically filed, or furnished to, the SEC. The SEC also maintains a website that contains reports, proxy and information statements, and other information regarding issuers that file electronically with the SEC at www.sec.gov. The public may read and copy any materials filed with the Commission at the SEC’s Public Reference Room at 100 F Street, NE, Washington, DC 20549, on official business days during the hours of 10:00 am to 3:00 pm. The public may obtain information on the operation of the Public Reference Room by calling the Commission at 1-800-SEC-0330.

ITEM 3. QUANTITATIVE AND QUALITATIVE DISCLOSURES ABOUT MARKET RISK

There have been no material changes in the quantitative and qualitative information about market risk from the information provided in the Company’s Form 10-K for the year ended December 31, 2019.

ITEM 4. CONTROLS AND PROCEDURES

Evaluation of Disclosure Controls and Procedures. With the supervision and participation by management, including the Company’s principal executive officer and principal financial officer, the effectiveness of disclosure controls and procedures (as defined in Rules 13a-15(e) and 15d-15(e) under the Securities Exchange Act of 1934 (the “Exchange Act”)) has been evaluated as of the end of the period covered by this report. Based upon that evaluation, the Company’s principal executive officer and principal financial officer have concluded that these controls and procedures were effective.

Changes in Internal Control Over Financial Reporting. Our Chief Executive Officer and Chief Financial Officer have concluded that there have been no significant changes during the period covered by this report in the Company’s internal control over financial reporting (as defined in Rules 13a-13 and 15d-15 of the Exchange Act) that have materially affected, or are reasonably likely to materially affect, internal control over financial reporting.

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PART II—OTHER INFORMATION

Item 1. Legal Proceedings

See Note (5) of the financial statements.

Item 1A. Risk Factors

In addition to the risk factors previously disclosed in the “Risk Factors” section included in our Annual Report on Form 10-K for the fiscal year ended December 31, 2019, the Company has made the following updates:

The current COVID-19 pandemic could adversely affect our business operations, asset valuations, financial condition, and results of operations.

The COVID-19 pandemic has caused significant economic dislocation in the United States as many state and local governments have ordered non-essential businesses to close and mandated "stay-at-home" restrictions for residents. This has resulted in an unprecedented slow-down in economic activity and a related increase in unemployment. Since the COVID-19 outbreak, tens of millions of people have filed claims for unemployment, and stock markets have declined in value and, in particular, bank stocks have significantly declined in value. In response to the COVID-19 outbreak, the Federal Reserve Board has reduced the benchmark fed funds rate to a target range of 0% to 0.25%, and the yields on 10 and 30-year treasury notes have declined to historic lows. Various state governments and federal agencies are requiring lenders to provide forbearance and other relief to borrowers (e.g., waiving late payment and other fees). The federal banking agencies have encouraged financial institutions to prudently work with affected borrowers and recently passed legislation has provided relief from reporting loan classifications due to modifications related to the COVID-19 outbreak. Certain industries have been particularly hard-hit, including the travel and hospitality industry, the restaurant industry and the retail industry. Finally, the spread of the coronavirus has caused the Company to modify its business practices, including employee travel, employee work locations, and cancellation of physical participation in meetings, events and conferences. The Company may take further actions as may be required by government authorities or that it determines are in the best interests of the Company’s employees, customers and business partners.

We are unable to estimate the near-term and ultimate impacts of the COVID-19 pandemic on our business and operations at this time. It is unknown how long the COVID-19 pandemic will last, or when restrictions on individuals and businesses will be lifted and businesses and their employees will be able to resume normal activities. Additional information may emerge regarding the severity of COVID-19 and additional actions may be taken by federal, state, and local governments to contain COVID-19 or treat its impact.

Our efforts in assisting our borrowers with loan modifications has caused us, and could continue to cause us, to recognize increases in our allowance for loan losses. Sustained adverse effects may also increase our cost of capital, prevent us from satisfying our minimum regulatory capital ratios and other supervisory requirements, or result in downgrades in our credit ratings.  Furthermore, the U.S. economy is likely to experience a recession as a result of the pandemic, and our business could be materially and adversely affected by a prolonged recession.  To the extent the pandemic adversely affects our business, financial condition, liquidity, or results of operations, it may also have the effect of heightening many of the other risks described in the section entitled “Risk Factors” in our 2019 Annual Report on Form 10-K and any subsequent Quarterly Reports on Form 10-Q.

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Item 2. Unregistered Sales of Equity Securities and Use of Proceeds—Not applicable

Company’s Common Stock.

The following table shows information relating to the repurchase of shares of the Company’s common stock during the quarter ended September 30, 2020.

	Total Number of Shares Purchased		Average Price Paid Per Share		Total Number of Shares Purchased as Part of Publicly Announced Plans or Programs		Maximum Number of Shares That May Yet Be Purchased Under the Plans or Programs*
July		—	$	—		—		153,682
August		—		—		—		153,682
September		—		—		—		153,682
Total		—	$	—		—		153,682

* On December 17, 2019, the Company’s Board of Directors approved a new program which allows the Company to purchase up to 200,000 shares, or approximately 4.6% of the 4,323,822 outstanding shares of common stock at December 17, 2019. On March 17, 2020 the Company’s Board of Directors approved an increase in the number of shares authorized for repurchase under the December 17, 2019 plan by 100,000 shares bringing the total to 300,000 shares authorized. This program will terminate on December 31, 2020, or upon purchase of 300,000 shares if earlier or at any time without prior notice (See footnote 12).

Item 3. Defaults upon Senior Securities—Not applicable

Item 4. Mine Safety Disclosures—Not applicable

Item 5. Other Information—Not applicable

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CORTLAND BANCORP AND SUBSIDIARIES

INDEX TO EXHIBITS

Item 6. Exhibits—The following exhibits are filed or incorporated by reference as part of this report:

		Incorporated by Reference
Exhibit No.	Exhibit Description	Form**	Exhibit	Filing Date	Filed Herewith
3.1	Restated Amended Articles of Cortland Bancorp reflecting amendment dated June 25, 1999. Note: filed for purposes of SEC reporting compliance only. This restated document has not been filed with the State of Ohio.	10-K(1)	3.1	03/16/06
3.2	Code of Regulations, as amended.	8-K	3.2	05/30/17
4.1	The rights of holders of equity securities are defined in portions of the Articles of Incorporation as referenced in Exhibit 3.1	10-K(1)	4.1	03/16/06
	and the Code of Regulations as referenced in Exhibit 3.2	8-K	4.1	05/30/17
4.2	Agreement to furnish instruments and agreements defining rights of holders of long-term debt				✓
*10.1	Group Term Carve Out Plan dated February 23, 2001, by The Cortland Savings and Banking Company with each executive officer other than Rodger W. Platt and with selected other officers, as amended by the August 2002 letter amendment	10-K(1)	10.1	03/16/06
*10.1.1	Amendment of Group Term Carve Out Plan, dated October 28, 2014	8-K	10.1.1	11/03/14
10.2	[Reserved]
10.3	[Reserved]
*10.4	Amended Director Retirement Agreement between Cortland Bancorp and David C. Cole, dated as of December 18, 2007	10-K	10.4	03/17/08
10.5	[Reserved]
10.6	[Reserved]
*10.7	Amended Director Retirement Agreement between Cortland Bancorp and James E. Hoffman III, dated as of December 18, 2007	10-K	10.7	03/17/08
*10.8	Amended Director Retirement Agreement between Cortland Bancorp and Neil J. Kaback, dated as of December 18, 2007	10-K	10.8	03/17/08
10.9	[Reserved]
*10.10	Amended Director Retirement Agreement between Cortland Bancorp and Richard B. Thompson, dated as of December 18, 2007	10-K	10.10	03/17/08
*10.11	Amended Director Retirement Agreement between Cortland Bancorp and Timothy K. Woofter, dated as of December 18, 2007	10-K	10.11	03/17/08
*10.12	Form of Split Dollar Agreement entered into by Cortland Bancorp and each of Directors David C. Cole, James E. Hoffman III, and Timothy K. Woofter as of February 23, 2001, as of March 1, 2004, with Director Neil J. Kaback, and as of October 1, 2001, with Director Richard B. Thompson;	10-K(1)	10.12	03/16/06
	as amended on December 26, 2006, for Directors Cole, Hoffman, Thompson, and Woofter;	10-K	10.12	03/15/07
*10.13	Director’s Retirement Agreement between Cortland Bancorp and Director Joseph E. Koch, dated as of April 19, 2011	8-K	10.13	04/22/11

49

		Incorporated by Reference
Exhibit No.	Exhibit Description	Form**	Exhibit	Filing Date	Filed Herewith
*10.14	Split Dollar Agreement and Endorsement between Cortland Bancorp and Director Joseph E. Koch, dated as of April 19, 2011	8-K	10.14	04/22/11
*10.15	Form of Indemnification Agreement entered into by Cortland Bancorp with each of its directors	10-K(1)	10.15	03/16/06
*10.16	Endorsement Split Dollar Agreement between The Cortland Savings and Banking Company and David J. Lucido, dated as of March 27, 2012	10-K	10.16	03/29/12
*10.17	Eighth Amended Salary Continuation Agreement between The Cortland Savings and Banking Company and Timothy Carney, dated as of December 28, 2018	8-K	10.17	12/28/18
*10.18	Third Amended Salary Continuation Agreement between The Cortland Savings and Banking Company and Lawrence A. Fantauzzi, dated as of December 3, 2008	8-K	10.18	12/12/08
*10.19	Eighth Amended Salary Continuation Agreement between The Cortland Savings and Banking Company and James M. Gasior, dated as of December 28, 2018	8-K	10.19	12/28/18
10.20	[Reserved]
10.21	[Reserved]
10.22	[Reserved]
*10.23	Second Amended Salary Continuation Agreement between The Cortland Savings and Banking Company and David J. Lucido, dated as of December 28, 2018	8-K	10.23	12/28/18
*10.24	Fifth Amended Split Dollar Agreement and Endorsement between The Cortland Savings and Banking Company and Timothy Carney, dated as of December 28, 2018	8-K	10.24	12/28/18
*10.25	Amended Salary Continuation Agreement between The Cortland Savings and Banking Company and Stanley P. Feret, dated as of December 28, 2018	8-K	10.25	12/28/18
*10.26	Fifth Amended Split Dollar Agreement and Endorsement between The Cortland Savings and Banking Company and James M. Gasior, dated as of December 28, 2018	8-K	10.26	12/28/18
10.27	[Reserved]
10.28	[Reserved]
10.29	[Reserved]
*10.30	Endorsement Split Dollar Agreement between The Cortland Savings and Banking Company and Stanley P. Feret, dated as of July 23, 2013	10-Q	10.30	08/13/13
*10.31.1	Severance Agreement between Cortland Bancorp and Tim Carney, dated as of September 28, 2012, as amended November 24, 2015	10-K	10.31.1	12/01/15
*10.31.2	Severance Agreement between Cortland Bancorp and James Gasior, dated as of September 28, 2012, as amended November 24, 2015	8-K	10.31.2	12/01/15
*10.31.3	Amended Severance Agreement between Cortland Bancorp and David J. Lucido, dated as of December 28, 2018	8-K	10.31.3	12/28/18
10.32	[Reserved]
10.33	[Reserved]

50

		Incorporated by Reference
Exhibit No.	Exhibit Description	Form**	Exhibit	Filing Date	Filed Herewith
*10.34	Amended Severance Agreement between Cortland Bancorp and Stanley P. Feret, dated as of December 28, 2018	8-K	10.34	12/28/18
*10.35	Annual Incentive Plan for Executive Officers	8-K	10.35	09/18/20
*10.36	2015 Omnibus Equity Plan	10-Q	10.36	08/11/15
*10.36.1	Form of incentive stock option award under the 2015 Omnibus Equity Plan	10-Q	10.36.1	08/11/15
*10.36.2	Form of nonqualified stock option award under the 2015 Omnibus Equity Plan	10-Q	10.36.2	08/11/15
*10.36.3	Form of restricted stock award under the 2015 Omnibus Equity Plan	8-K	10.36.3	03/19/20
*10.36.4	Form of restricted stock award under the 2015 Omnibus Equity Plan	8-K	10.36.4	03/23/20
*10.37	2015 Director Equity Plan	10-Q	10.37	08/11/15
*10.37.1	Form of nonqualified stock option award under the 2015 Director Equity Plan	10-Q	10.37.1	08/11/15
*10.37.2	2015 Director Equity Plan Restricted Stock Award Agreement	10-Q	10.37.2	08/11/15
11	Statement of re-computation of per share earnings	See Note 6 of Financial Statements
31.1	Certification of the Chief Executive Officer under Rule 13a-14(a)				✓
31.2	Certification of Chief Financial Officer under Rule 13a-14(a)				✓
32	Section 1350 Certification of Chief Executive Officer and Chief Financial Officer required under section 906 of the Sarbanes-Oxley Act of 2002				✓
101	The following materials from Cortland Bancorp’s Quarterly Report on Form 10-Q for the quarter ended September 30, 2020, formatted in Extensible Business Reporting Language (XBRL): (a) Consolidated Balance Sheets; (b) Consolidated Statements of Income; (c) Consolidated Statements of Comprehensive Income; (d) Consolidated Statements of Changes in Shareholders’ Equity; (e) Consolidated Statements of Cash Flows; and (f) the Notes to Consolidated Financial Statements tagged as blocks of text and in detail (included with this filing)				✓
101.INS	Inline XBRL Instance Document (the Instance Document does not appear in the Interactive Data File because its XBRL tags are embedded within the Inline XBRL document)				✓
101.SCH	Inline XBRL Taxonomy Extension Schema Document				✓
101.CAL	Inline XBRL Taxonomy Extension Calculation Linkbase Document				✓
101.DEF	Inline XBRL Taxonomy Extension Definition Linkbase Document				✓
101.LAB	Inline XBRL Taxonomy Extension Label Linkbase Document				✓
101.PRE	Inline XBRL Taxonomy Extension Presentation Linkbase Document				✓
104	Cover Page Interactive Data File (formatted as Inline XBRL and contained in Exhibit 101)				✓

(1) Film number 06691632

* Management contract or compensatory plan or arrangement

** SEC File No. 000-13814 through March 2019, SEC File No. 001-38827 thereafter.

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CORTLAND BANCORP AND SUBSIDIARIES

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.

CORTLAND BANCORP

(Registrant)

/s/ James M. Gasior	Date: November 5, 2020
James M. Gasior President and Chief Executive Officer (Principal Executive Officer)

/s/ David J. Lucido	Date: November 5, 2020
David J. Lucido Senior Vice President and Chief Financial Officer (Principal Financial and Accounting Officer)

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