Eagle Financial Services (EFSI) 10-Q 2021 Q2 Quarterly report

UNITED STATES

SECURITIES AND EXCHANGE COMMISSION

WASHINGTON, D.C. 20549

FORM 10-Q

(Mark One)

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

For the quarterly period ended June 30, 2021

or

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

For the transition period from             to

Commission File Number: 0-20146

EAGLE FINANCIAL SERVICES, INC.

(Exact name of registrant as specified in its charter)

Virginia		54-1601306
(State or other jurisdiction of incorporation or organization)		(I.R.S. Employer Identification No.)
2 East Main Street	P.O. Box 391
Berryville, VA		22611
(Address of principal executive offices)		(Zip Code)

(540) 955-2510

(Registrant’s telephone number, including area code)

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

Title of each class	Trading Symbol(s)	Name of each exchange on which registered
None

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 Date 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  ☒

The number of shares of the registrant’s Common Stock ($2.50 par value) outstanding as of August 5, 2021 was 3,447,473.

TABLE OF CONTENTS

PART I - FINANCIAL INFORMATION
Item 1.	Financial Statements:
	Consolidated Balance Sheets at June 30, 2021 and December 31, 2020	1
	Consolidated Statements of Income for the Three and Six Months Ended June 30, 2021 and 2020	2
	Consolidated Statements of Comprehensive Income for the Three and Six Months Ended June 30, 2021 and 2020	3
	Consolidated Statements of Changes in Shareholders’ Equity for the Three and Six Months Ended June 30, 2021 and 2020	4
	Consolidated Statements of Cash Flows for the Six Months Ended June 30, 2021 and 2020	5
	Notes to Consolidated Financial Statements	6
Item 2.	Management’s Discussion and Analysis of Financial Condition and Results of Operations	28
Item 3.	Quantitative and Qualitative Disclosures about Market Risk	46
Item 4.	Controls and Procedures	46
PART II - OTHER INFORMATION
Item 1.	Legal Proceedings	47
Item 1A.	Risk Factors	47
Item 2.	Unregistered Sales of Equity Securities and Use of Proceeds	47
Item 3.	Defaults Upon Senior Securities	47
Item 4.	Mine Safety Disclosures	47
Item 5.	Other Information	47
Item 6.	Exhibits	48

2

PART I - FINANCIAL INFORMATION

Item 1. Financial Statements

EAGLE FINANCIAL SERVICES, INC.

Consolidated Balance Sheets

(dollars in thousands, except per share amounts)

	June 30, 2021			December 31, 2020
	(Unaudited)
Assets
Cash and due from banks	$	15,284		$	12,644
Interest-bearing deposits with other institutions		88,945			67,054
Federal funds sold		234			222
Total cash and cash equivalents	$	104,463		$	79,920
Securities available for sale, at fair value		176,491			164,955
Restricted investments		1,045			1,267
Loans held for sale		1,073			—
Loans		877,369			836,334
Allowance for loan losses		(8,098	)		(7,096	)
Net Loans	$	869,271		$	829,238
Bank premises and equipment, net		18,627			18,725
Other real estate owned, net of allowance		423			607
Other assets		47,751			35,440
Total assets	$	1,219,144		$	1,130,152
Liabilities and Shareholders’ Equity
Liabilities
Deposits:
Noninterest bearing demand deposits	$	441,051		$	407,576
Savings and interest bearing demand deposits		532,269			476,864
Time deposits		126,078			128,658
Total deposits	$	1,099,398		$	1,013,098
Other liabilities		12,144			11,980
Total liabilities	$	1,111,542		$	1,025,078
Commitments and contingencies
Shareholders’ Equity
Preferred stock, $10 par value; 500,000 shares authorized and unissued	$	—		$	—
Common stock, $2.50 par value; authorized 10,000,000 shares; issued and outstanding 2021, 3,442,782 including 36,875 shares of unvested restricted stock; issued and outstanding 2020, 3,405,035 including 20,928 shares of unvested restricted stock		8,515			8,460
Surplus		11,426			10,811
Retained earnings		86,539			82,524
Accumulated other comprehensive income		1,122			3,279
Total shareholders’ equity	$	107,602		$	105,074
Total liabilities and shareholders’ equity	$	1,219,144		$	1,130,152

See Notes to Consolidated Financial Statements

1

EAGLE FINANCIAL SERVICES, INC.

Consolidated Statements of Income (Unaudited)

(dollars in thousands, except per share amounts)

	Three Months Ended						Six Months Ended
	June 30,						June 30,
	2021			2020			2021		2020
Interest and Dividend Income
Interest and fees on loans	$	9,749		$	8,773		$	19,157	$	16,712
Interest and dividends on securities available for sale:
Taxable interest income		530			715			996		1,610
Interest income exempt from federal income taxes		107			152			225		319
Dividends		12			15			24		34
Interest on deposits in banks		15			6			27		92
Interest on federal funds sold		—			—			—		1
Total interest and dividend income	$	10,413		$	9,661		$	20,429	$	18,768
Interest Expense
Interest on deposits		434			879		$	921	$	1,981
Interest on Federal Home Loan Bank advances		—			25			—		25
Total interest expense	$	434		$	904		$	921	$	2,006
Net interest income	$	9,979		$	8,757		$	19,508	$	16,762
Provision for Loan Losses		284			752			883		655
Net interest income after provision for loan losses	$	9,695		$	8,005		$	18,625	$	16,107
Noninterest Income
Income from fiduciary activities	$	399		$	403		$	740	$	700
Service charges on deposit accounts		241			170			458		454
Other service charges and fees		1,354			1,147			2,663		2,251
(Loss) gain on sale of securities		(52	)		529			24		529
Gain on sale of loans		359			—			359		—
Bank owned life insurance income		118			143			223		143
Other operating income		231			30			610		35
Total noninterest income	$	2,650		$	2,422		$	5,077	$	4,112
Noninterest Expenses
Salaries and employee benefits	$	5,310		$	4,373		$	10,026	$	8,461
Occupancy expenses		413			403			869		798
Equipment expenses		238			252			462		484
Advertising and marketing expenses		198			152			306		357
Stationery and supplies		60			34			98		66
ATM network fees		312			243			562		485
Other real estate owned expense		6			(3	)		5		(1	)
Loss (gain) on other real estate owned		92			—			102		(132	)
FDIC assessment		133			41			240		41
Computer software expense		281			161			470		281
Bank franchise tax		195			176			384		350
Professional fees		369			317			829		671
Data processing fees		373			382			775		863
Other operating expenses		747			483			1,515		1,165
Total noninterest expenses	$	8,727		$	7,014		$	16,643	$	13,889
Income before income taxes	$	3,618		$	3,413		$	7,059	$	6,330
Income Tax Expense		615			594			1,194		1,070
Net income	$	3,003		$	2,819		$	5,865	$	5,260
Earnings Per Share
Net income per common share, basic	$	0.87		$	0.83		$	1.71	$	1.54
Net income per common share, diluted	$	0.87		$	0.83		$	1.71	$	1.54

See Notes to Consolidated Financial Statements

2

EAGLE FINANCIAL SERVICES, INC.

Consolidated Statements of Comprehensive Income

(Unaudited)

(dollars in thousands)

	Three Months Ended					Six Months Ended
	June 30,					June 30,
	2021		2020			2021			2020
Net income	$	3,003	$	2,819		$	5,865		$	5,260
Other comprehensive (loss) income:
Unrealized (loss) gain on available for sale securities net of reclassification adjustments, and net of deferred income tax of $9 and ($96) for the three months ended, respectively and ($573) and $653 for the six months ended, respectively		36		(361	)		(2,157	)		2,455
Total other comprehensive (loss) income		36		(361	)		(2,157	)		2,455
Total comprehensive income	$	3,039	$	2,458		$	3,708		$	7,715

See Notes to Consolidated Financial Statements

3

EAGLE FINANCIAL SERVICES, INC.

Consolidated Statements of Changes in Shareholders’ Equity (Unaudited)

(dollars in thousands, except per share amounts)

	Common Stock			Surplus			Retained Earnings			Accumulated Other Comprehensive Income			Total
December 31, 2019	$	8,529		$	11,406		$	74,909		$	1,482		$	96,326
Net income								2,441						2,441
Other comprehensive income											2,816			2,816
Vesting of restricted stock awards, stock incentive plan (10,000 shares)		25			(25	)								—
Stock-based compensation expense					114									114
Issuance of common stock, dividend investment plan (3,685 shares)		9			102									111
Repurchase and retirement of common stock (1,500 shares)		(97	)		(1,019	)								(1,116	)
Dividends declared ($0.26 per share)								(893	)					(893	)
March 31, 2020	$	8,466		$	10,578		$	76,457		$	4,298		$	99,799
Net income								2,819						2,819
Other comprehensive (loss)											(361	)		(361	)
Stock-based compensation expense					114									114
Issuance of common stock, employee benefit plan (2,761 shares)		7			79									86
Dividends declared ($0.26 per share)								(888	)					(888	)
June 30, 2020	$	8,473		$	10,771		$	78,388		$	3,937		$	101,569
December 31, 2020	$	8,460		$	10,811		$	82,524		$	3,279		$	105,074
Net income								2,862						2,862
Other comprehensive (loss)											(2,193	)		(2,193	)
Vesting of restricted stock awards, stock incentive plan (10,258 shares)		26			(26	)								—
Stock-based compensation expense					147									147
Issuance of common stock, dividend investment plan (6,260 shares)		16			165									181
Repurchase and retirement of common stock (2,814 shares)		(7	)		(76	)								(83	)
Dividends declared ($0.27 per share)								(924	)					(924	)
March 31, 2021	$	8,495		$	11,021		$	84,462		$	1,086		$	105,064
Net income								3,003						3,003
Other comprehensive income											36			36
Stock-based compensation expense					159									159
Issuance of common stock, dividend investment plan (4,702 shares)		12			146									158
Issuance of common stock, employee benefit plan (4,154 shares)		10			123									133
Repurchase and retirement of common stock (760 shares)		(2	)		(23	)								(25	)
Dividends declared ($0.27 per share)								(926	)					(926	)
June 30, 2021	$	8,515		$	11,426		$	86,539		$	1,122		$	107,602

See Notes to Consolidated Financial Statements

4

EAGLE FINANCIAL SERVICES, INC.

Consolidated Statements of Cash Flows (Unaudited)

(dollars in thousands)

	Six Months Ended
	June 30,
	2021			2020
Cash Flows from Operating Activities
Net income	$	5,865		$	5,260
Adjustments to reconcile net income to net cash provided by operating activities:
Depreciation		502			516
Amortization of other assets		218			216
Origination of loans held for sale		(5,655	)		—
Proceeds from sale of loans held for sale		4,734			—
Net gains on sales of loans		(359	)		—
Provision for loan losses		883			655
Loss (gain) on other real estate owned		102			(132	)
Loss on the sale of repossessed assets		—			2
(Gain) on the sale of securities		(24	)		(529	)
Stock-based compensation expense		306			228
Premium amortization on securities, net		726			371
Changes in assets and liabilities:
(Increase) in other assets		(1,956	)		(2,650	)
Increase (decrease) in other liabilities		164			(148	)
Net cash provided by operating activities	$	5,506		$	3,789
Cash Flows from Investing Activities
Proceeds from maturities, calls, and principal payments of securities available for sale	$	31,404		$	23,895
Proceeds from the sale of securities available for sale		15,885			24,893
Purchases of securities available for sale		(62,257	)		(25,636	)
Proceeds from the sale of restricted investments		222			2,125
Purchases of restricted investments		—			(2,196	)
Purchases of bank-owned life insurance		(10,000	)		(12,000	)
Purchases of bank premises and equipment		(404	)		(266	)
Proceeds from the sale of other real estate owned		155			183
Proceeds from the sale of repossessed assets		—			13
Proceeds from sales of loans		18,182			—
Origination of loans net of principal collected		(58,964	)		(143,762	)
Net cash (used in) investing activities	$	(65,777	)	$	(132,751	)
Cash Flows from Financing Activities
Net increase in noninterest bearing demand deposits, savings, and interest bearing demand deposits	$	88,880		$	135,659
Net (decrease) increase in time deposits		(2,580	)		707
Issuance of common stock, employee benefit plan		133			86
Repurchase and retirement of common stock		(108	)		(1,116	)
Cash dividends paid		(1,511	)		(1,670	)
Net cash provided by financing activities	$	84,814		$	133,666
Increase in cash and cash equivalents	$	24,543		$	4,704
Cash and Cash Equivalents
Beginning		79,920			33,659
Ending	$	104,463		$	38,363
Supplemental Disclosures of Cash Flow Information
Cash payments for:
Interest	$	960		$	2,048
Income taxes	$	1,164		$	168
Supplemental Schedule of Noncash Investing and Financing Activities:
Unrealized (loss) gain on securities available for sale	$	(2,730	)	$	3,108
Other real estate and repossessed assets acquired in settlement of loans	$	73		$	325
Issuance of common stock, dividend investment plan	$	339		$	111
Lease liabilities arising from right-of-use assets	$	—		$	549

See Notes to Consolidated Financial Statements

5

EAGLE FINANCIAL SERVICES, INC.

Notes to Consolidated Financial Statements (Unaudited)

June 30, 2021

NOTE 1. General

The accompanying unaudited financial statements have been prepared in accordance with accounting principles generally accepted in the United States of America (“GAAP”) for interim financial information and with the instructions to Form 10-Q and Rule 8-03 of Regulation S-X. Accordingly, they do not include all of the information and footnotes required by GAAP.

In the opinion of management, the accompanying financial statements contain all adjustments (consisting of only normal recurring accruals) necessary to present fairly the financial position at June 30, 2021 and December 31, 2020, the results of operations and the changes in stockholders' equity for the three and six months ended June 30, 2021 and 2020, and cash flows for the six months ended June 30, 2021 and 2020. The results of operations for the three and six months ended June 30, 2021 are not necessarily indicative of the results to be expected for the full year. These financial statements should be read in conjunction with the Consolidated Financial Statements and related Notes included in the Company’s Annual Report on Form 10-K for the year ended December 31, 2020 (the “2020 Form 10-K”).

Eagle Financial Services, Inc. (the "Company") owns 100% of Bank of Clarke County (the “Bank”). The consolidated financial statements include the accounts of the Company and its wholly-owned subsidiary. All significant intercompany accounts and transactions between the Company and the Bank have been eliminated.

Certain amounts in the consolidated financial statements have been reclassified to conform to current year presentations.  None of the reclassifications were of a material nature and they had no effect on prior year net income or shareholders' equity.

Risks and Uncertainties

Since the novel coronavirus ("COVID-19") was declared a pandemic in March 2020, COVID-19 has significantly affected the Company’s communities, customers, and operations.  COVID-19 continues to have a significant impact in 2021; however, the extent of its effects are dependent upon multiple factors, such as the extent of distribution and efficacy of vaccines, COVID-19 variants, additional government economic intervention/stimulus, and pandemic-related restrictions, among others.  As a result, the ultimate effects of COVID-19 over the longer term cannot be reasonably estimated at this time.  Risks and uncertainties arising from the pandemic remain and are primarily concerned with the ability of customers to fulfill their financial obligations to the Company as well as potential operational disruptions and the ability of the Company to generate demand for its products and services. Accordingly, estimates used in the preparation of our financial statements may be subject to significant adjustments in future periods.

NOTE 2. Stock-Based Compensation Plan

During 2014, the Company’s shareholders approved a stock incentive plan which allows key employees and directors to increase their personal financial interest in the Company. This plan permits the issuance of incentive stock options and non-qualified stock options and the award of stock appreciation rights, common stock, restricted stock, and phantom stock. The plan authorizes the issuance of up to 500,000 shares of common stock.

6

The Company periodically grants restricted stock to its directors, executive officers and certain non-executive officers. Restricted stock provides grantees with rights to shares of common stock upon completion of a service period or achievement of Company performance measures. During the restriction period, all shares are considered outstanding and dividends are paid to the grantee. In general, outside directors are periodically granted restricted shares which vest over a period of less than 9 months. Beginning during 2006, executive officers were granted restricted shares which vest over a 3 year service period and restricted shares which vest based on meeting annual performance measures over a 1 year period. Beginning in 2018, certain non-executive officers also were granted restricted shares which vest over a 3 year service period. The Company recognizes compensation expense over the restricted period based on the fair value of the Company's stock on the grant date.  The Company's policy is to recognize forfeitures as they occur.  As of June 30, 2021, there was $673 thousand of unrecognized compensation cost related to nonvested restricted stock.

The following table presents restricted stock activity for the six months ended June 30, 2021 and 2020:

	Six Months Ended
	June 30,
	2021					2020
	Shares			Weighted Average Grant Date Fair Value		Shares			Weighted Average Grant Date Fair Value
Nonvested, beginning of period		20,928		$	29.98		18,488		$	30.39
Granted		26,630			30.52		11,925			31.05
Vested		(10,258	)		31.11		(9,933	)		31.13
Forfeited		(425	)		31.05		—			—
Nonvested, end of period		36,875		$	30.04		20,480		$	30.90

NOTE 3. Earnings Per Common Share

Basic earnings per share represents income available to common shareholders divided by the weighted average number of common shares outstanding during the period.  Nonvested restricted shares are included in the weighted average number of common shares used to compute basic earnings per share because of dividend participation and voting rights.  Diluted earnings per share reflects additional common shares that would have been outstanding if dilutive potential common shares had been issued, as well as any adjustment to income that would result from the assumed issuance. The number of potential common shares is determined using the treasury method.

The following table shows the weighted average number of shares used in computing earnings per share for the three and six months ended June 30, 2021 and 2020. During 2021 and 2020, there were 0 potentially dilutive securities outstanding.

	Three Months Ended				Six Months Ended
	June 30,				June 30,
	2021		2020		2021		2020
Average number of common shares outstanding used to calculate basic and diluted earnings per share		3,433,387		3,409,689		3,430,131		3,423,387

7

NOTE 4. Securities

Amortized costs and fair values of securities available for sale at June 30, 2021 and December 31, 2020 were as follows:

	Amortized Cost		Gross Unrealized Gains		Gross Unrealized (Losses)			Fair Value
	June 30, 2021
	(in thousands)
Obligations of U.S. government corporations and agencies	$	15,544	$	567	$	(55	)	$	16,056
Mortgage-backed securities		134,919		1,067		(1,203	)		134,783
Obligations of states and political subdivisions		23,130		1,022		—			24,152
Subordinated debt		1,500		—		—			1,500
	$	175,093	$	2,656	$	(1,258	)	$	176,491

	December 31, 2020
	(in thousands)
Obligations of U.S. government corporations and agencies	$	16,576	$	907	$	—		$	17,483
Mortgage-backed securities		117,161		1,894		(46	)		119,009
Obligations of states and political subdivisions		25,840		1,373		—			27,213
Subordinated debt		1,250		—		—			1,250
	$	160,827	$	4,174	$	(46	)	$	164,955

During the six months ended June 30, 2021, the Company sold $15.9 million of available for sale securities recognizing $143 thousand in gross gains and $119 in gross losses. During the six months ended June 30, 2020, the Company sold $24.9 million of available for sale securities recognizing $529 in gross gains and 0 gross losses.

The fair value and gross unrealized losses for securities available for sale, totaled by the length of time that individual securities have been in a continuous gross unrealized loss position, at June 30, 2021 and December 31, 2020 were as follows:

	Less than 12 months				12 months or more				Total
	Fair Value		Gross Unrealized Losses		Fair Value		Gross Unrealized Losses		Fair Value		Gross Unrealized Losses
	June 30, 2021
	(in thousands)
Obligations of U.S. government corporations and agencies	$	3,159	$	55	$	—	$	—	$	3,159	$	55
Mortgage-backed securities		87,723		1,203		—		—		87,723		1,203
	$	90,882	$	1,258	$	—	$	—	$	90,882	$	1,258

	Less than 12 months				12 months or more				Total
	Fair Value		Gross Unrealized Losses		Fair Value		Gross Unrealized Losses		Fair Value		Gross Unrealized Losses
	December 31, 2020
	(in thousands)
Mortgage-backed securities	$	12,014	$	46	$	—	$	—	$	12,014	$	46
	$	12,014	$	46	$	—	$	—	$	12,014	$	46

8

Gross unrealized losses on available for sale securities included NaN (27) and 3 (3) debt securities at June 30, 2021 and December 31, 2020, respectively. The Company evaluates securities for other-than-temporary impairment on at least a quarterly basis, and more frequently when economic or market concerns warrant such evaluation.  Consideration is given to the length of time and the amount of an unrealized loss, the financial condition of the issuer, and the intent and ability of the Company to retain its investment in the issuer long enough to allow for an anticipated recovery in fair value. The fair value of a security reflects its liquidity as compared to similar instruments, current market rates on similar instruments, and the creditworthiness of the issuer. Absent any change in the liquidity of a security or the creditworthiness of the issuer, prices will decline as market rates rise and vice-versa. The primary cause of the unrealized losses at June 30, 2021 and December 31, 2020 was changes in market interest rates and other market conditions and not credit concerns of the issuers. Since the losses can be primarily attributed to changes in market interest rates and conditions and not expected cash flows or an issuer’s financial condition and management does not intend to sell and it is likely that management will not be required to sell the securities prior to their anticipated recovery, the unrealized losses were deemed to be temporary. The Company’s mortgage-backed securities are issued by U.S. government agencies, which guarantee payments to investors regardless of the status of the underlying mortgages.  The Company monitors the financial condition of these issuers continuously and will record other-than-temporary impairment if the recovery of value is unlikely.

The Company’s securities are exposed to various risks, such as interest rate, market, currency and credit risks. Due to the level of risk associated with certain securities and the level of uncertainty related to changes in the value of securities, it is at least reasonably possible that changes in risks in the near term would materially affect the securities balance reported in the financial statements.

Securities having a carrying value of $3.1 million at June 30, 2021 were pledged as security for public deposits.

The composition of restricted investments at June 30, 2021 and December 31, 2020 was as follows:

	June 30, 2021		December 31, 2020
	(in thousands)
Federal Reserve Bank Stock	$	344	$	344
Federal Home Loan Bank Stock		561		783
Community Bankers’ Bank Stock		140		140
	$	1,045	$	1,267

NOTE 5. Loans and Allowance for Loan Losses

The composition of loans at June 30, 2021 and December 31, 2020 was as follows:

	June 30,			December 31,
	2021			2020
	(in thousands)
Mortgage loans on real estate:
Construction and land development	$	59,288		$	42,544
Secured by farmland		15,334			15,846
Secured by 1-4 family residential properties		249,517			248,246
Multifamily		19,523			21,496
Commercial		343,873			334,661
Commercial and industrial loans		135,849			140,762
Consumer installment loans		42,287			21,321
All other loans		10,896			10,773
Total loans	$	876,567		$	835,649
Net deferred loan costs		802			685
Allowance for loan losses		(8,098	)		(7,096	)
	$	869,271		$	829,238

9

Changes in the allowance for loan losses for the six months ended June 30, 2021 and 2020 and the year ended December 31, 2020 were as follows:

	Six Months Ended			Year Ended			Six Months Ended
	June 30,			December 31,			June 30,
	2021			2020			2020
				(in thousands)
Balance, beginning	$	7,096		$	4,973		$	4,973
Provision for loan losses		883			1,457			655
Recoveries added to the allowance		143			1,131			880
Loan losses charged to the allowance		(24	)		(465	)		(143	)
Balance, ending	$	8,098		$	7,096		$	6,365

Nonaccrual and past due loans by class at June 30, 2021 and December 31, 2020 were as follows:

	June 30, 2021
	(in thousands)
	30 - 59 Days Past Due		60 - 89 Days Past Due		90 or More Days Past Due		Total Past Due		Current		Total Loans		90 or More Days Past Due Still Accruing		Nonaccrual Loans
Commercial - Non Real Estate:
Commercial & Industrial	$	—	$	—	$	—	$	—	$	135,849	$	135,849	$	—	$	—
Commercial Real Estate:
Owner Occupied		—		—		—		—		167,493		167,493		—		1,004
Non-owner occupied		131		—		500		631		175,749		176,380		500		2,229
Construction and Farmland:
Residential		—		—		—		—		12,599		12,599		—		—
Commercial		108		—		—		108		61,915		62,023		—		108
Consumer:
Installment		6		—		—		6		42,281		42,287		—		4
Residential:
Equity Lines		—		—		—		—		32,800		32,800		—		33
Single family		393		419		193		1,005		215,712		216,717		—		1,054
Multifamily		—		—		—		—		19,523		19,523		—		—
All Other Loans		—		—		—		—		10,896		10,896		—		—
Total	$	638	$	419	$	693	$	1,750	$	874,817	$	876,567	$	500	$	4,432

10

	December 31, 2020
	(in thousands)
	30 - 59 Days Past Due		60 - 89 Days Past Due		90 or More Days Past Due		Total Past Due		Current		Total Loans		90 or More Past Due Still Accruing		Nonaccrual Loans
Commercial - Non Real Estate:
Commercial & Industrial	$	43	$	—	$	—	$	43	$	140,719	$	140,762	$	—	$	—
Commercial Real Estate:
Owner Occupied		—		—		157		157		165,764		165,921		—		1,227
Non-owner occupied		500		—		122		622		168,118		168,740		—		2,405
Construction and Farmland:
Residential		—		—		—		—		10,644		10,644		—		—
Commercial		—		—		69		69		47,677		47,746		—		69
Consumer:
Installment		5		—		—		5		21,316		21,321		—		5
Residential:
Equity Lines		13		—		—		13		31,239		31,252		—		42
Single family		249		123		581		953		216,041		216,994		—		1,006
Multifamily		—		—		—		—		21,496		21,496		—		—
All Other Loans		—		—		—		—		10,773		10,773		—		—
Total	$	810	$	123	$	929	$	1,862	$	833,787	$	835,649	$	—	$	4,754

Allowance for loan losses by segment at June 30, 2021 and December 31, 2020 were as follows:

	As of and For the Three Months Ended
	June 30, 2021
	(in thousands)
	Construction and Farmland		Residential Real Estate		Commercial Real Estate		Commercial		Consumer			All Other Loans			Unallocated		Total
Allowance for credit losses:
Beginning Balance	$	1,604	$	1,929	$	1,645	$	1,374	$	198		$	346		$	—	$	7,096
Charge-Offs		—		—		—		—		(10	)		(14	)		—		(24	)
Recoveries		9		109		—		4		15			6			—		143
Provision		669		96		40		159		(92	)		11			—		883
Ending balance	$	2,282	$	2,134	$	1,685	$	1,537	$	111		$	349		$	—	$	8,098
Ending balance: Individually evaluated for impairment	$	—	$	58	$	—	$	—	$	—		$	—		$	—	$	58
Ending balance: collectively evaluated for impairment	$	2,282	$	2,076	$	1,685	$	1,537	$	111		$	349		$	—	$	8,040
Loans:
Ending balance	$	74,622	$	269,040	$	343,873	$	135,849	$	42,287		$	10,896		$	—	$	876,567
Ending balance individually evaluated for impairment	$	140	$	3,228	$	3,233	$	128	$	19		$	—		$	—	$	6,748
Ending balance collectively evaluated for impairment	$	74,482	$	265,812	$	340,640	$	135,721	$	42,268		$	10,896		$	—	$	869,819

11

	December 31, 2020
	(in thousands)
	Construction and Farmland			Residential Real Estate			Commercial Real Estate			Commercial			Consumer			All Other Loans			Unallocated			Total
Allowance for credit losses:
Beginning Balance	$	446		$	1,601		$	1,991		$	565		$	54		$	120		$	196		$	4,973
Charge-Offs		(119	)		(20	)		(155	)		(49	)		(83	)		(39	)		—			(465	)
Recoveries		7			275			302			498			41			8			—			1,131
Provision		1,270			73			(493	)		360			186			257			(196	)		1,457
Ending balance	$	1,604		$	1,929		$	1,645		$	1,374		$	198		$	346		$	—		$	7,096
Ending balance: Individually evaluated for impairment	$	—		$	72		$	—		$	—		$	—		$	—		$	—		$	72
Ending balance: collectively evaluated for impairment	$	1,604		$	1,857		$	1,645		$	1,374		$	198		$	346		$	—		$	7,024
Loans:
Ending balance	$	58,390		$	269,742		$	334,661		$	140,762		$	21,321		$	10,773		$	—		$	835,649
Ending balance individually evaluated for impairment	$	105		$	3,869		$	3,632		$	147		$	15		$	—		$	—		$	7,768
Ending balance collectively evaluated for impairment	$	58,285		$	265,873		$	331,029		$	140,615		$	21,306		$	10,773		$	—		$	827,881

12

Impaired loans by class as of and for the periods ended June 30, 2021 and December 31, 2020 were as follows:

	As of
	June 30, 2021
	(in thousands)
	Unpaid Principal Balance		Recorded Investment		Related Allowance		Average Recorded Investment		Interest Income Recognized
With no related allowance:
Commercial - Non Real Estate:
Commercial & Industrial	$	203	$	128	$	—	$	151	$	6
Commercial Real Estate:
Owner Occupied		1,086		1,004		—		1,022		—
Non-owner occupied		2,548		2,229		—		2,234		—
Construction and Farmland:
Residential		—		—		—		—		—
Commercial		149		140		—		144		3
Consumer:
Installment		20		19		—		21		—
Residential
Equity lines		38		33		—		34		—
Single family		2,389		2,210		—		2,233		38
Multifamily		—		—		—		—		—
Other Loans		—		—		—		—		—
	$	6,433	$	5,763	$	—	$	5,839	$	47
With an allowance recorded:
Commercial - Non Real Estate:
Commercial & Industrial	$	—	$	—	$	—	$	—	$	—
Commercial Real Estate:
Owner Occupied		—		—		—		—		—
Non-owner occupied		—		—		—		—		—
Construction and Farmland:
Residential		—		—		—		—		—
Commercial		—		—		—		—		—
Consumer:
Installment		—		—		—		—		—
Residential
Equity lines		—		—		—		—		—
Single family		1,019		999		58		1,006		14
Multifamily		—		—		—		—		—
Other Loans		—		—		—		—		—
	$	1,019	$	999	$	58	$	1,006	$	14
Total:
Commercial	$	203	$	128	$	—	$	151	$	6
Commercial Real Estate		3,634		3,233		—		3,256		—
Construction and Farmland		149		140		—		144		3
Consumer		20		19		—		21		—
Residential		3,446		3,242		58		3,273		52
Other		—		—		—		—		—
Total	$	7,452	$	6,762	$	58	$	6,845	$	61

(1) Recorded investment is defined as the summation of the outstanding principal balance, accrued interest, net deferred loan fees or costs, and any partial charge-offs. Accrued interest and net deferred loan fees or costs totaled $14 thousand at June 30, 2021.

13

	As of
	December 31, 2020
	(in thousands)
	Unpaid Principal Balance		Recorded Investment		Related Allowance		Average Recorded Investment		Interest Income Recognized
With no related allowance:
Commercial - Non Real Estate:
Commercial & Industrial	$	246	$	147	$	—	$	186	$	16
Commercial Real Estate:
Owner Occupied		1,282		1,227		—		1,258		18
Non-owner occupied		2,682		2,405		—		2,444		34
Construction and Farmland:
Residential		—		—		—		—		—
Commercial		233		105		—		109		3
Consumer:
Installment		16		15		—		22		1
Residential:
Equity lines		272		42		—		44		—
Single family		2,655		2,413		—		2,514		76
Multifamily		—		—		—		—		—
Other Loans		—		—		—		—		—
	$	7,386	$	6,354	$	—	$	6,577	$	148
With an allowance recorded:
Commercial - Non Real Estate:
Commercial & Industrial	$	—	$	—	$	—	$	—	$	—
Commercial Real Estate:
Owner Occupied		—		—		—		—		—
Non-owner occupied		—		—		—		—		—
Construction and Farmland:
Residential		—		—		—		—		—
Commercial		—		—		—		—		—
Consumer:
Installment		—		—		—		—		—
Residential:
Equity lines		—		—		—		—		—
Single family		1,449		1,431		72		1,448		38
Multifamily		—		—		—		—		—
Other Loans		—		—		—		—		—
	$	1,449	$	1,431	$	72	$	1,448	$	38
Total:
Commercial	$	246	$	147	$	—	$	186	$	16
Commercial Real Estate		3,964		3,632		—		3,702		52
Construction and Farmland		233		105		—		109		3
Consumer		16		15		—		22		1
Residential		4,376		3,886		72		4,006		114
Other		—		—		—		—		—
Total	$	8,835	$	7,785	$	72	$	8,025	$	186

(1) Recorded investment is defined as the summation of the outstanding principal balance, accrued interest, net deferred loan fees or costs, and any partial charge-offs. Accrued interest and net deferred loan fees or costs totaled $17 thousand at December 31, 2020.

14

When the ultimate collectability of the total principal of an impaired loan is in doubt and the loan is in nonaccrual status, all payments are applied to principal under the cost-recovery method. For financial statement purposes, the recorded investment in nonaccrual loans is the actual principal balance reduced by payments that would otherwise have been applied to interest. When reporting information on these loans to the applicable customers, the unpaid principal balance is reported as if payments were applied to principal and interest under the original terms of the loan agreements. Therefore, the unpaid principal balance reported to the customer would be higher than the recorded investment in the loan for financial statement purposes. When the ultimate collectability of the total principal of the impaired loan is not in doubt and the loan is in nonaccrual status, contractual interest is credited to interest income when received under the cash-basis method.

The Company uses a rating system for evaluating the risks associated with non-consumer loans. Consumer loans are not evaluated for risk unless the characteristics of the loan fall within classified categories. Consumer loans are evaluated for collection based on payment performance. Descriptions of these ratings are as follows:

Pass	Pass loans exhibit acceptable history of profits, cash flow ability and liquidity. Sufficient cash flow exists to service the loan. All obligations have been paid by the borrower in an as agreed manner.
Pass Monitored	Pass monitored loans may be experiencing income and cash volatility, inconsistent operating trends, nominal liquidity and/or a leveraged balance sheet. A higher level of supervision is required for these loans as the potential for a negative event could impact the borrower’s ability to repay the loan.
Special Mention	Special mention loans exhibit negative trends and potential weakness that, if left uncorrected, may negatively affect the borrower’s ability to repay its obligations. The risk of default is not imminent and the borrower still demonstrates sufficient financial strength to service debt.
Substandard	Substandard loans exhibit well defined weaknesses resulting in a higher probability of default. The borrowers exhibit adverse financial trends and a diminishing ability or willingness to service debt.
Doubtful	Doubtful loans exhibit all of the characteristics inherent in substandard loans; however given the severity of weaknesses, the collection of 100% of the principal is unlikely under current conditions.
Loss	Loss loans are considered uncollectible over a reasonable period of time and of such little value that its continuance as a bankable asset is not warranted.

15

Credit quality information by class at June 30, 2021 and December 31, 2020 was as follows:

	As of
	June 30, 2021
	(in thousands)
INTERNAL RISK RATING GRADES	Pass		Pass Monitored		Special Mention		Substandard		Doubtful		Loss		Total
Commercial - Non Real Estate:
Commercial & Industrial	$	129,046	$	4,664	$	2,133	$	6	$	—	$	—	$	135,849
Commercial Real Estate:
Owner Occupied		110,771		48,055		7,662		1,005		—		—		167,493
Non-owner occupied		128,333		33,108		12,306		2,633		—		—		176,380
Construction and Farmland:
Residential		7,310		5,289		—		—		—		—		12,599
Commercial		24,476		29,777		7,577		193		—		—		62,023
Residential:
Equity Lines		32,001		719		47		33		—		—		32,800
Single family		197,619		13,518		3,453		2,007		120		—		216,717
Multifamily		12,689		5,665		1,169		—		—		—		19,523
All other loans		10,764		132		—		—		—		—		10,896
Total	$	653,009	$	140,927	$	34,347	$	5,877	$	120	$	—	$	834,280

	Performing		Nonperforming
Consumer Credit Exposure by Payment Activity	$	42,281	$	6

	As of
	December 31, 2020
	(in thousands)
INTERNAL RISK RATING GRADES	Pass		Pass Monitored		Special Mention		Substandard		Doubtful		Loss		Total
Commercial - Non Real Estate:
Commercial & Industrial	$	137,566	$	2,750	$	439	$	7	$	—	$	—	$	140,762
Commercial Real Estate:
Owner Occupied		126,839		31,927		5,929		1,226		—		—		165,921
Non-owner occupied		101,026		42,338		22,555		2,821		—		—		168,740
Construction and Farm land:
Residential		8,131		2,513		—		—		—		—		10,644
Commercial		19,599		24,982		3,004		161		—		—		47,746
Residential:
Equity Lines		31,087		124		—		36		5		—		31,252
Single family		193,579		16,639		3,594		3,053		129		—		216,994
Multifamily		10,923		8,700		1,873		—		—		—		21,496
All other loans		8,438		—		2,335		—		—		—		10,773
Total	$	637,188	$	129,973	$	39,729	$	7,304	$	134	$	—	$	814,328

	Performing		Nonperforming
Consumer Credit Exposure by Payment Activity	$	21,316	$	5

16

NOTE 6. Troubled Debt Restructurings

All loans deemed a troubled debt restructuring (“TDR"), are considered impaired, and are evaluated for collateral and cash-flow sufficiency. A loan is considered a TDR when the Company, for economic or legal reasons related to a borrower’s financial difficulties, grants a concession to the borrower that the Company would not otherwise consider. All of the following factors are indicators that the Company has granted a concession (one or multiple items may be present):

• The borrower receives a reduction of the stated interest rate to a rate less than the institution is willing to accept at the time of the restructure for a new loan with comparable risk.

• The borrower receives an extension of the maturity date or dates at a stated interest rate lower than the current market interest rate for new debt with similar risk characteristics.

• The borrower receives a reduction of the face amount or maturity amount of the debt as stated in the instrument or other agreement.

• The borrower receives a deferral of required payments (principal and/or interest) which causes more than an insignificant change in cash flow.

• The borrower receives a reduction of the accrued interest.

There were seventeen (17) TDR loans totaling $2.8 million at June 30, 2021.  At December 31, 2020, there were seventeen (17) TDR loans totaling $3.3 million. NaN TDR loans, totaling $809 thousand, were in nonaccrual status at June 30, 2021.  NaN TDR loans, totaling $796 thousand, were in nonaccrual status at December 31, 2020. There were no outstanding commitments to lend additional amounts to troubled debt restructured borrowers at June 30, 2021 or December 31, 2020.

During the year ended December 31, 2020, the Company approved 255 deferrals of interest and/or principal payments with respect to loan balances totaling $130.5 million at December 31, 2020 for its customers experiencing hardships related to COVID-19. During the six months ended June 30, 2021, the Company approved 2 additional deferrals of interest and/or principal with respect to loan balances totaling $41 thousand at June 30, 2021. These deferrals were no more than six months in duration and were for loans not more than 30 days past due as of December 31, 2019.  As such, they were not considered troubled debt restructurings based on the relief provisions of the Coronavirus Aid, Relief and Economic Security ("CARES") Act (extended by the Consolidated Appropriations Act) and recent interagency regulatory guidance.  As of June 30, 2021, 254 of these loans with current loan balances totaling approximately $107.0 million had begun making payments on their loans or have been paid off after the end of the deferral period.

17

The following tables set forth information on the Company’s troubled debt restructurings by class of loans occurring during the three and six months ended June 30, 2021. During the three and six months ended June 30, 2020, the Company classified no additional loans as troubled debt restructurings.

	Three Months Ended
	June 30, 2021
	(in thousands)
	Number of Contracts		Pre-Modification Outstanding Recorded Investment		Post-Modification Outstanding Recorded Investment
Consumer:
Installment		1	$	4	$	4
Total		1	$	4	$	4
	Six Months Ended
	June 30, 2021
	(in thousands)
	Number of Contracts		Pre-Modification Outstanding Recorded Investment		Post-Modification Outstanding Recorded Investment
Consumer:
Installment		2	$	15	$	15
Residential:
Equity
Single family		1		98		98
Total		3	$	113	$	113

During the three and six months ended June 30, 2021, the Company restructured 1 and 3 loans, respectively, by granting a concession to borrowers experiencing financial difficulty. These loans were restructured by reducing the loan payments and extending the term.

There were 0 payment defaults during the three and six months ended June 30, 2021 for TDRs that were restructured within the preceding twelve-month period.  There were also 0 payment defaults during the three and six months ended June 30, 2020.  

Management defines default as over 30 days contractually past due under the modified terms, the foreclosure and/or repossession of the collateral, or the charge-off of the loan during the twelve-month period subsequent to the modification.

18

NOTE  7. Deposits

The composition of deposits at June 30, 2021 and December 31, 2020 was as follows:

	June 30, 2021		December 31, 2020
	(in thousands)
Noninterest bearing demand deposits	$	441,051	$	407,576
Savings and interest bearing demand deposits:
NOW accounts	$	151,275	$	132,249
Money market accounts		221,727		207,837
Regular savings accounts		159,267		136,778
	$	532,269	$	476,864
Time deposits:
Balances of less than $250,000	$	58,420	$	59,621
Balances of $250,000 and more		67,658		69,037
	$	126,078	$	128,658
	$	1,099,398	$	1,013,098

NOTE 8. Leases

Lease liabilities represent the Company’s obligation to make lease payments and are presented at each reporting date as the net present value of the remaining contractual cash flows.  Cash flows are discounted at the Company’s incremental borrowing rate in effect at the commencement date of the lease.  Right-of-use assets represent the Company’s right to use the underlying asset for the lease term and are calculated as the sum of the lease liability and if applicable, prepaid rent, initial direct costs and any incentives received from the lessor.

The Company’s two long-term lease agreements are classified as operating leases.  These leases offer the option to extend the lease term and the Company has included such extensions in its calculation of the lease liability to the extent the options are reasonably certain of being exercised.  The lease agreements do not provide for a residual value guarantee and have no restrictions or covenants that would impact dividends or require incurring additional financial obligations.

The following tables present information about the Company’s leases:

(dollars in thousands)
					June 30, 2021			December 31, 2020
Lease liabilities					$	4,053		$	4,113
Right-of-use assets					$	3,932		$	4,014
Weighted average remaining lease term					17 years			17 years
Weighted average discount rate						3.35	%		3.34	%
	Three Months Ended				Six Months Ended
Lease Cost	June 30, 2021		June 30, 2020		June 30, 2021			June 30, 2020
Operating lease cost	$	86	$	82	$	151		$	156
Short-term lease cost		4		4		8			8
Total lease cost	$	90	$	86	$	159		$	164
Cash paid for amounts included in the measurement of lease liabilities	$	71	$	80	$	126		$	138

19

A maturity analysis of operating lease liabilities and reconciliation of the undiscounted cash flows to the total operating lease liabilities is as follows:

	As of
Lease payments due	June 30, 2021
Twelve months ending June 30, 2022	$	318
Twelve months ending June 30, 2023		321
Twelve months ending June 30, 2024		324
Twelve months ending June 30, 2025		332
Twelve months ending June 30, 2026		352
Thereafter		3,927
Total undiscounted cash flows	$	5,574
Discount		(1,521	)
Lease liabilities	$	4,053

NOTE 9. Fair Value Measurements

GAAP requires the Company to record fair value adjustments to certain assets and liabilities and to determine fair value disclosures. The fair value of assets and liabilities is an exit price, representing the amount that would be received to sell an asset or paid to transfer a liability in the principal or most advantageous market for the asset or liability in an orderly transaction between market participants on the measurement date.

“Fair Value Measurements” defines fair value, establishes a framework for measuring fair value, establishes a three-level valuation hierarchy for disclosure of fair value measurement and enhances disclosure requirements for fair value measurements. The valuation hierarchy is based upon the transparency of inputs to the valuation of an asset or liability as of the measurement date. The three levels are defined as follows:

•	Level 1	Inputs to the valuation methodology are quoted prices (unadjusted) for identical assets or liabilities in active markets.
•	Level 2	Inputs to the valuation methodology include quoted prices for similar assets and liabilities in active markets, and inputs that are observable for the asset or liability, either directly or indirectly, for substantially the full term of the financial instrument.
•	Level 3	Inputs to the valuation methodology are unobservable and significant to the fair value measurement.

20

The following section provides a description of the valuation methodologies used for instruments measured at fair value on a recurring basis, as well as the general classification of such instruments pursuant to the valuation hierarchy:

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

The following table presents balances of financial assets and liabilities measured at fair value on a recurring basis at June 30, 2021 and December 31, 2020:

			Fair Value Measurements at
			June 30, 2021
			Using
	Balance as of		Quoted Prices in  Active Markets for Identical Assets		Significant Other Observable Inputs		Significant Unobservable Inputs
	June 30, 2021		(Level 1)		(Level 2)		(Level 3)
	(in thousands)
Assets:
Securities available for sale
Obligations of U.S. government corporations and agencies	$	16,056	$	—	$	16,056	$	—
Mortgage-backed securities		134,783		—		134,783		—
Obligations of states and political subdivisions		24,152		—		24,152		—
Subordinated debt		1,500		—		1,500		—
Total assets at fair value	$	176,491	$	—	$	176,491	$	—
			Fair Value Measurements at
			December 31, 2020
			Using
	Balance as of		Quoted Prices in Active Markets for Identical Assets		Significant Other Observable Inputs		Significant Unobservable Inputs
	December 31, 2020		(Level 1)		(Level 2)		(Level 3)
	(in thousands)
Assets:
Securities available for sale
Obligations of U.S. government corporations and agencies	$	17,483	$	—	$	17,483	$	—
Mortgage-backed securities		119,009		—		119,009		—
Obligations of states and political subdivisions		27,213		—		27,213		—
Subordinated debt		1,250		—		1,250		—
Total assets at fair value	$	164,955	$	—	$	164,955	$	—

Certain financial assets are measured at fair value on a nonrecurring basis in accordance with GAAP. Adjustments to the fair value of these assets usually result from the application of lower of cost or market accounting or write downs of individual assets.

21

The following describes the valuation techniques used by the Company to measure certain financial and nonfinancial assets recorded at fair value on a nonrecurring basis in the financial statements:

Loans Held for Sale: Loans held for sale are carried at the lower of cost or market value. These loans currently consist of one-to-four family residential loans originated for sale in the secondary market. Fair value is based on the price secondary markets are currently offering for similar loans using observable market data which is not materially different than cost due to the short duration between origination and sale (Level 2). As such. The Company records any fair value adjustments on a nonrecurring basis. NaN nonrecurring fair value adjustments were recorded on loans held for sale during the three and six months ended June 30, 2021 and the year ended December 31, 2020.

Impaired Loans: Loans are designated as impaired when, in the judgment of management based on current information and events, it is probable that all amounts due according to the contractual terms of the loan agreement will not be collected when due. The measurement of loss associated with impaired loans can be based on the present value of its expected future cash flows discounted at the loan's coupon rate, or at the loans' observable market price or the fair value of the collateral securing the loans, if they are collateral dependent. Collateral may be in the form of real estate or business assets including equipment, inventory, and accounts receivable. The vast majority of the collateral is real estate. The value of real estate collateral is determined utilizing a market valuation approach based on an appraisal conducted by an independent, licensed appraiser using observable market data within the last twelve months (Level 2). However, if the collateral is a house or building in the process of construction or if an appraisal of the property is more than one year old and not solely based on observable market comparables or management determines the fair value of the collateral is further impaired below the appraised value, then a Level 3 valuation is considered to measure the fair value. The value of business equipment is based upon an outside appraisal, of one year or less, if deemed significant, or the net book value on the applicable business’s financial statements if not considered significant using observable market data. Likewise, values for inventory and accounts receivables collateral are based on financial statement balances or aging reports (Level 3). Impaired loans allocated to the allowance for loan losses are measured at fair value on a nonrecurring basis. Any fair value adjustments are recorded in the period incurred as provision for loan losses on the Consolidated Statements of Income.

Other Real Estate Owned: Assets acquired through, or in lieu of, loan foreclosure are held for sale and are initially recorded at the  fair value of the property, less estimated selling costs, establishing a new costs basis. Any write-downs based on the asset’s fair value at the date of acquisition are charged to the allowance for loan losses.  Costs of significant property improvements are capitalized, whereas costs relating to holding property are expensed. The portion of interest costs relating to development of real estate is capitalized. Valuations are periodically obtained by management, and any subsequent write-downs are recorded as a charge to operations, if necessary, to reduce the carrying value of a property to fair value less cost to sell.  The fair value measurement of real estate held in other real estate owned is assessed in the same manner as impaired loans described above.  We believe that the fair value follows the provisions of GAAP.

The following table displays quantitative information about Level 3 Fair Value Measurements for certain financial assets measured at fair value on a nonrecurring basis at June 30, 2021 and December 31, 2020:

	Quantitative information about Level 3 Fair Value Measurements
	June 30, 2021
	Valuation Technique(s)	Unobservable Input	Range	Weighted Average
Assets:
Impaired loans	Discounted appraised value	Selling cost	12%	12%
Impaired loans	Present value of cash flows	Discount rate	4% - 6%	5%
Other real estate owned	Discounted appraised value	Selling cost	6%	6%
	Quantitative information about Level 3 Fair Value Measurements
	December 31, 2020
	Valuation Technique(s)	Unobservable Input	Range	Weighted Average
Assets:
Impaired loans	Present value of cash flows	Discount rate	4% - 6%	4%
Other real estate owned	Discounted appraised value	Selling cost	6%	6%

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(1) Unobservable inputs were weighted by the relative fair values of the instruments.

The following table summarizes the Company’s financial and nonfinancial assets that were measured at fair value on a nonrecurring basis at June 30, 2021 and December 31, 2020:

			Carrying value at
			June 30, 2021
	Balance as of		Identical Assets		Observable Inputs		Unobservable Inputs
	June 30, 2021		(Level 1)		(Level 2)		(Level 3)
	(in thousands)
Financial Assets:
Impaired loans	$	937	$	—	$	—	$	937
Nonfinancial Assets:
Other real estate owned		423		—		47		376
			Carrying value at
			December 31, 2020
	Balance as of		Quoted Prices in Active Markets for Identical Assets		Significant Other Observable Inputs		Significant Unobservable Inputs
	December 31, 2020		(Level 1)		(Level 2)		(Level 3)
	(in thousands)
Financial Assets:
Impaired loans	$	1,355	$	—	$	—	$	1,355
Nonfinancial Assets:
Other real estate owned		607		—		165		442

The carrying value and fair value of the Company’s financial instruments at June 30, 2021 and December 31, 2020 were as follows:

	Fair Value Measurements at
	June 30, 2021
	Using
	Carrying Value as of		Quoted Prices in Active Markets for Identical Assets		Significant Other Observable Inputs		Significant Unobservable Inputs		Fair Value as of
	June 30, 2021		(Level 1)		(Level 2)		(Level 3)		June 30, 2021
	(in thousands)
Financial Assets:
Cash and short-term investments	$	104,463	$	104,463	$	—	$	—	$	104,463
Securities		176,491		—		176,491		—		176,491
Restricted Investments		1,045		—		1,045		—		1,045
Loans held for sale		1,073		—		1,073		—		1,073
Loans, net		869,271		—		—		860,961		860,961
Accrued interest receivable		2,724		—		2,724		—		2,724
Bank owned life insurance		22,931		—		22,931		—		22,931
Financial Liabilities:
Deposits	$	1,099,398	$	—	$	1,099,889	$	—	$	1,099,889
Accrued interest payable		33		—		33		—		33

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	Fair Value Measurements at
	December 31, 2020
	Using
	Carrying Value as of		Quoted Prices in Active Markets for Identical Assets		Significant Other Observable Inputs		Significant Unobservable Inputs		Fair Value as of
	December 31, 2020		(Level 1)		(Level 2)		(Level 3)		December 31, 2020
	(in thousands)
Financial assets:
Cash and short-term investments	$	79,920	$	79,920	$	—	$	—	$	79,920
Securities		164,955		—		164,955		—		164,955
Restricted Investments		1,267		—		1,267		—		1,267
Loans, net		829,238		—		—		819,691		819,691
Bank owned life insurance		12,709		—		12,709		—		12,709
Accrued interest receivable		3,441		—		3,441		—		3,441
Financial liabilities:
Deposits	$	1,013,098	$	—	$	1,013,600	$	—	$	1,013,600
Accrued interest payable		72		—		72		—		72

NOTE 10. Change in Accumulated Other Comprehensive Income

Accumulated other comprehensive income includes unrealized gains and losses on available for sale securities and changes in benefit obligations and plan assets for the post retirement benefit plan.  Changes to accumulated other comprehensive income are presented net of their tax effect as a component of equity.  Reclassifications out of accumulated other comprehensive income are recorded in the Consolidated Statements of Income either as a gain or loss.

Changes to accumulated other comprehensive income by component are shown in the following tables for the periods indicated:

	Three Months Ended
	June 30,
	2021								2020
	Unrealized Gains and Losses on Available for Sale Securities			Change in Benefit Obligations and Plan Assets for the Post Retirement Benefit Plan		Total			Unrealized Gains and Losses on Available for Sale Securities			Change in Benefit Obligations and Plan Assets for the Post Retirement Benefit Plan		Total
	(dollars in thousands)								(dollars in thousands)
April 1	$	1,067		$	19	$	1,086		$	4,254		$	44	$	4,298
Other comprehensive (loss) income before reclassifications		(7	)		—		(7	)		72			—		72
Reclassifications		52			—		52			(529	)		—		(529	)
Tax effect of current period changes		(9	)		—		(9	)		96			—		96
Current period changes net of taxes		36			—		36			(361	)		—		(361	)
June 30	$	1,103		$	19	$	1,122		$	3,893		$	44	$	3,937

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	Six Months Ended
	June 30,
	2021								2020
	Unrealized Gains and Losses on Available for Sale Securities			Change in Benefit Obligations and Plan Assets for the Post Retirement Benefit Plan		Total			Unrealized Gains and Losses on Available for Sale Securities			Change in Benefit Obligations and Plan Assets for the Post Retirement Benefit Plan		Total
	(dollars in thousands)								(dollars in thousands)
January 1	$	3,260		$	19	$	3,279		$	1,438		$	44	$	1,482
Other comprehensive (loss) income before reclassifications		(2,706	)		—		(2,706	)		3,637			—		3,637
Reclassifications		(24	)		—		(24	)		(529	)		—		(529	)
Tax effect of current period changes		573			—		573			(653	)		—		(653	)
Current period changes net of taxes		(2,157	)		—		(2,157	)		2,455			—		2,455
June 30	$	1,103		$	19	$	1,122		$	3,893		$	44	$	3,937

For the three and six months ended June 30, 2021, $(52) thousand and $24 thousand, respectively, was reclassified out of accumulated other comprehensive income and appeared as (loss) gain on sale of securities in the Consolidated Statements of Income. The tax related to these reclassifications was $(11) thousand and $5 thousand, respectively, which is included in income tax expense in the Consolidated Statements of Income. For the three and six months ended June 30, 2020, $529 thousand was reclassified out of accumulated other comprehensive income and appeared as (loss) gain on sale of securities in the Consolidated Statements of Income. The tax related to these reclassifications was $111 thousand, which is included in income tax expense in the Consolidated Statements of Income.  

NOTE 11. Other Real Estate Owned

The following table is a summary of other real estate owned ("OREO") activity for the six months ended June 30, 2021 and 2020 and the year ended December 31, 2020:

	Six Months Ended			Year Ended			Six Months Ended
	June 30,			December 31,			June 30,
	2021			2020			2020
	(in thousands)
Balance, beginning	$	607		$	183		$	183
Transfer from loans		73			441			310
Gain on foreclosures		—			166			132
Sales		(165	)		(183	)		(183	)
Valuation adjustments		(92	)		—			—
Balance, ending	$	423		$	607		$	442

The major classifications of other real estate owned in the consolidated balance sheets at June 30, 2021 and December 31, 2020 were as follows:

	June 30, 2021		December 31, 2020
	(in thousands)
Construction and Farmland	$	73	$	—
Residential Real Estate		—		165
Commercial Real Estate		442		442
Subtotal	$	515	$	607
Less valuation allowance		92		—
Total	$	423	$	607

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There was 1 consumer mortgage loan totaling $193 thousand collateralized by residential real estate in the process of foreclosure at June 30, 2021.  There was 1 consumer mortgage loan totaling $68 thousand collateralized by residential real estate in the process of foreclosure at December 31, 2020.

NOTE 12. Qualified Affordable Housing Project Investments

The Company invests in qualified affordable housing projects. The general purpose of these investments is to encourage and assist participants in investing in low-income residential rental properties located in the Commonwealth of Virginia, develop and implement strategies to maintain projects as low-income housing, provide tax credits and other tax benefits to investors, and to preserve and protect project assets.

At June 30, 2021 and December 31, 2020, the balance of the investment for qualified affordable housing projects was $2.7 million and $2.8 million, respectively. These balances are reflected in Other assets on the Consolidated Balance Sheets.  Total unfunded commitments related to the investments in qualified affordable housing projects totaled $23 thousand and $446 thousand at June 30, 2021 and December 31, 2020, respectively. These balances are reflected in Other liabilities on the Consolidated Balance Sheets.  The Company expects to fulfill these commitments by December 31, 2023, in accordance with the terms of the individual agreements.

During the three months ended June 30, 2021 and June 30, 2020, the Company recognized amortization expense of $57 thousand. During the six months ended June 30, 2021 and 2020, the Company recognized amortization expense of $115 thousand.  The amortization expense was included in Other operating expenses on the Consolidated Statements of Income.

Total estimated credits to be received during 2021 are $363 thousand based on the most recent quarterly estimates received from the funds. Total tax credits and other tax benefits recognized during the six months ended June 30, 2021 and 2020, were $182 thousand and $173 thousand, respectively.

NOTE 13. Recent Accounting Pronouncements and Other Authoritative Guidance

In June 2016, the Financial Accounting Standards Board ("FASB") issued Accounting Standards Update (“ASU”) No. 2016-13, “Financial Instruments - Credit Losses (Topic 326): Measurement of Credit Losses on Financial Instruments.”  The amendments in this ASU, among other things, require the measurement of all expected credit losses for financial assets held at the reporting date based on historical experience, current conditions, and reasonable and supportable forecasts. Financial institutions and other organizations will now use forward-looking information to better inform their credit loss estimates. Many of the loss estimation techniques applied today will still be permitted, although the inputs to those techniques will change to reflect the full amount of expected credit losses. In addition, the ASU amends the accounting for credit losses on available-for-sale debt securities and purchased financial assets with credit deterioration. At the FASB’s October 16, 2019 meeting, the Board affirmed its decision to amend the effective date of this ASU for many companies.  Smaller reporting companies who file with the U.S. Securities and Exchange Commission (SEC) and all other entities who do not file with the SEC are required to apply the guidance for fiscal years, and interim periods within those years, beginning after December 15, 2022. The Company is currently assessing the impact that ASU 2016-13 will have on its consolidated financial statements. The Company formed a CECL committee during 2016 which continues to meet weekly to address the compliance requirements.  Historic loan data has been gathered and reviewed for completeness and accuracy.  In addition, the committee has selected a third-party that is assisting in calculating the financial impact of ASU 2016-13 and anticipates running parallel allowance models under the current and new standard in advance of the required implementation date.

Effective November 25, 2019, the SEC adopted Staff Accounting Bulletin (“SAB”) 119.  SAB 119 updated portions of SEC interpretative guidance to align with FASB ASC 326, “Financial Instruments - Credit Losses.”  It covers topics including (1) measuring current expected credit losses; (2) development, governance, and documentation of a systematic methodology; (3) documenting the results of a systematic methodology; and (4) validating a systematic methodology.

26

In March 2020, the FASB issued ASU No. 2020-04 “Reference Rate Reform (Topic 848): Facilitation of the Effects of Reference Rate Reform on Financial Reporting.” These amendments provide temporary optional guidance to ease the potential burden in accounting for reference rate reform. The ASU provides optional expedients and exceptions for applying generally accepted accounting principles to contract modifications and hedging relationships, subject to meeting certain criteria, that reference LIBOR or another reference rate expected to be discontinued. It is intended to help stakeholders during the global market-wide reference rate transition period. The guidance is effective for all entities as of March 12, 2020 through December 31, 2022. Subsequently, in January 2021, the FASB issued ASU No. 2021-01 “Reference Rate Reform (Topic 848): Scope.” This ASU clarifies that certain optional expedients and exceptions in Topic 848 for contract modifications and hedge accounting apply to derivatives that are affected by the discounting transition. The ASU also amends the expedients and exceptions in Topic 848 to capture the incremental consequences of the scope clarification and to tailor the existing guidance to derivative instruments affected by the discounting transition. An entity may elect to apply ASU No. 2021-01 on contract modifications that change the interest rate used for margining, discounting, or contract price alignment retrospectively as of any date from the beginning of the interim period that includes March 12, 2020, or prospectively to new modifications from any date within the interim period that includes or is subsequent to January 7, 2021, up to the date that financial statements are available to be issued. An entity may elect to apply ASU No. 2021-01 to eligible hedging relationships existing as of the beginning of the interim period that includes March 12, 2020, and to new eligible hedging relationships entered into after the beginning of the interim period that includes March 12, 2020.The Company is assessing ASU 2020-04 and its impact on the Company’s transition away from LIBOR for its loans.

Recent Accounting Developments

In December 2020, the Consolidated Appropriates Act of 2021 (“CAA”) was passed.  Under Section 541 of the CAA, Congress extended or modified many of the relief programs first created by the CARES Act, including the PPP loan program and treatment of certain loan modifications related to the COVID-19 pandemic. Refer to Note 6. Troubled Debt Restructurings for further discussion regarding details of loan modifications.

27

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

The purpose of this discussion is to focus on the important factors affecting the Company’s financial condition, results of operations, liquidity and capital resources. This discussion should be read in conjunction with the Company’s Consolidated Financial Statements and the Notes to the Consolidated Financial Statements presented in Part I, Item 1, Financial Statements, of this Form 10-Q and Item 8, Financial Statements and Supplementary Data, of the 2020 Form 10-K.

GENERAL

Eagle Financial Services, Inc. is a bank holding company which owns 100% of the stock of Bank of Clarke County (the “Bank” and, collectively with Eagle Financial Services, Inc., the “Company”, “we”, “us” or “our”). Accordingly, the results of operations for the Company are dependent upon the operations of the Bank. The Bank conducts a commercial banking business which consists of attracting deposits from the general public and investing those funds in commercial, consumer and real estate loans and municipal and U.S. government agency securities. The Bank’s deposits are insured by the Federal Deposit Insurance Corporation to the maximum extent permitted by law. At June 30, 2021, the Company had total assets of $1.22 billion, net loans of $869.3 million, total deposits of $1.10 billion, and shareholders’ equity of $107.6 million. The Company’s net income was $5.9 million for the six months ended June 30, 2021.

COVID-19 and Related Response

The COVID-19 crisis has changed our communities, both in the way we live and the way we do business. While circumstances continue to change at a rapid pace, the Company is steadfastly working to meet and exceed the needs of its customers, employees and the communities in which it does business. The Company, while considered an essential business, has implemented procedures to protect its employees, customers and the community and still serve their banking needs. Branch lobbies are open, but with enhanced safety features for employees and customers. Our customers also continue to conduct their business via automated teller machines, online banking and our call center. Approximately 45% of our workforce is working either remotely or hybrid with the remaining essential workers showing up every day at our branches and operations centers. In efforts to assist local businesses during this pandemic, the Company approved 1,372 Small Business Association Paycheck Protection Program ("SBA PPP") loans, totaling $132.1 million during the first and second rounds of the SBA PPP. The outstanding balance of SBA PPP loans as of June 30, 2021 was $48.2 million. The Company has also worked with local small businesses, consumers and other commercial customers through its loan deferral program whereby customers experiencing hardships due to COVID-19 may be granted a deferral in loan payments for up to six months. During 2020 and the first half of 2021, the Company approved 256 deferrals with outstanding loan balances totaling $107.1 million at June 30, 2021 for its customers experiencing hardships related to COVID-19. As of June 30, 2021, 254 loans with loan balances totaling approximately $107.0 million had begun making payments on their loans after the deferral date had passed.

MANAGEMENT’S STRATEGY

The Company strives to be an outstanding financial institution in its market by building solid sustainable relationships with: (1) its customers, by providing highly personalized customer service, a network of conveniently placed branches and ATMs, a competitive variety of products/services and courteous, professional employees, (2) its employees, by providing generous benefits, a positive work environment, advancement opportunities and incentives to exceed expectations, (3) its communities, by participating in local concerns, providing monetary support, supporting employee volunteerism and providing employment opportunities, and (4) its shareholders, by providing sound profits and returns, sustainable growth, regular dividends and committing to its local, independent status.

28

OPERATING STRATEGY

The Bank is a locally owned and managed financial institution. This allows the Bank to be flexible and responsive in the products and services it offers. The Bank grows primarily by lending funds to local residents and businesses at a competitive price that reflects the inherent risk of lending. The Bank attempts to fund these loans through deposits gathered from local residents and businesses. The Bank prices its deposits by comparing alternative sources of funds and selecting the lowest cost available. When deposits are not adequate to fund asset growth, the Bank relies on borrowings, both short and long term. The Bank’s primary source of borrowed funds is the Federal Home Loan Bank of Atlanta which offers numerous terms and rate structures to the Bank.

As interest rates change, the Bank attempts to maintain its net interest margin. This is accomplished by changing the price, terms, and mix of its financial assets and liabilities. The Bank also earns fees on services provided through its trust department, sales of investments through Eagle Investment Services, secondary market mortgage activities, and deposit operations. The Bank also incurs noninterest expenses such as compensating employees, maintaining and acquiring fixed assets, and purchasing goods and services necessary to support its daily operations.

The Bank has a marketing department which seeks to develop new business. This is accomplished through an ongoing calling program whereby account officers visit with existing and potential customers to discuss the products and services offered. The Bank also utilizes traditional advertising such as television commercials, radio ads, newspaper ads, and billboards.

LENDING POLICIES

Administration and supervision over the lending process is provided by the Bank’s Credit Administration Department. The principal risk associated with the Bank’s loan portfolio is the creditworthiness of its borrowers. In an effort to manage this risk, the Bank’s policy gives loan amount approval limits to individual loan officers based on their position and level of experience. Credit risk is increased or decreased, depending on the type of loan and prevailing economic conditions. In consideration of the different types of loans in the portfolio, the risk associated with real estate mortgage loans, commercial loans and consumer loans varies based on employment levels, consumer confidence, fluctuations in the value of real estate and other conditions that affect the ability of borrowers to repay debt.

The Company has written policies and procedures to help manage credit risk. The Company utilizes a loan review process that includes formulation of portfolio management strategy, guidelines for underwriting standards and risk assessment, procedures for ongoing identification and management of credit deterioration, and regular portfolio reviews to establish loss exposure and to ascertain compliance with the Company’s policies.

The Bank uses a tiered approach to approve credit requests consisting of individual lending authorities, joint approval of Category I officers, and a director loan committee. Lending limits for individuals are set by the Board of Directors and are determined by loan purpose, collateral type, and internal risk rating of the borrower. The highest individual authority (Category I) is assigned to the Bank’s President / Chief Executive Officer, Chief Revenue Officer and Chief Credit Officer (approval authority only). Two officers in Category I may combine their authority to approve loan requests to borrowers with credit exposure up to $10.0 million on a secured basis and $6.0 million unsecured; and the three Category I Officers can combine to approve loan requests to borrowers with credit exposure up to $15.0 million on a secured basis and $9.0 million unsecured. Officers in Category II, III, IV, V, VI and VII have lesser authorities and with approval of a Category I officer may extend loans to borrowers with exposure of $5.0 million on a secured basis and $3.0 million unsecured.  Loans exceeding $15.0 million and up to the Bank’s legal lending limit can be approved by the Director Loan Committee consisting of four directors (three directors constituting a quorum). The Director’s Loan Committee also reviews and approves changes to the Bank’s Loan Policy as presented by management.

29

The following sections discuss the major loan categories within the total loan portfolio:

One-to-Four-Family Residential Real Estate Lending

Residential lending activity may be generated by the Bank’s loan officer solicitations, referrals by real estate professionals, and existing or new bank customers. Loan applications are taken by a Bank loan officer. As part of the application process, information is gathered concerning income, employment and credit history of the applicant. The valuation of residential collateral is provided by independent fee appraisers who have been approved by the Bank’s Directors Loan Committee. In connection with residential real estate loans, the Bank requires title insurance, hazard insurance and, if applicable, flood insurance. In addition to traditional residential mortgage loans secured by a first or junior lien on the property, the Bank offers home equity lines of credit.

Commercial Real Estate Lending

Commercial real estate loans are secured by various types of commercial real estate in the Bank’s market area, including multi-family residential buildings, commercial buildings and offices, small shopping centers and churches. Commercial real estate loan originations are obtained through broker referrals, direct solicitation of developers and continued business from customers. In its underwriting of commercial real estate, the Bank’s loan to original appraised value ratio is generally 80% or less. Commercial real estate lending entails significant additional risk as compared with residential mortgage lending. Commercial real estate loans typically involve larger loan balances concentrated with single borrowers or groups of related borrowers. Additionally, the repayment of loans secured by income producing properties is typically dependent on the successful operation of a business or a real estate project and thus may be subject, to a greater extent, to adverse conditions in the real estate market or the economy, in general. The Bank’s commercial real estate loan underwriting criteria require an examination of debt service coverage ratios, the borrower’s creditworthiness, prior credit history and reputation, and the Bank typically requires personal guarantees or endorsements of the borrowers’ principal owners.

Construction and Land Development Lending

The Bank makes local construction loans, primarily residential, and land acquisition and development loans. The construction loans are secured by residential houses under construction and the underlying land for which the loan was obtained. The average life of most construction loans is less than one year and the Bank offers both fixed and variable rate interest structures. The interest rate structure offered to customers depends on the total amount of these loans outstanding and the impact of the interest rate structure on the Bank’s overall interest rate risk. There are two characteristics of construction lending which impact its overall risk as compared to residential mortgage lending. First, there is more concentration risk due to the extension of a large loan balance through several lines of credit to a single developer or contractor. Second, there is more collateral risk due to the fact that loan funds are provided to the borrower based upon the estimated value of the collateral after completion. This could cause an inaccurate estimate of the amount needed to complete construction or an excessive loan-to-value ratio. To mitigate the risks associated with construction lending, the Bank generally limits loan amounts to 80% of the estimated appraised value of the finished construction project. The Bank also obtains a first lien on the property as security for its construction loans and typically requires personal guarantees from the borrower’s principal owners. Finally, the Bank performs inspections of the construction projects to ensure that the percentage of construction completed correlates with the amount of draws on the construction line of credit.

30

Commercial and Industrial Lending

Commercial business loans generally have more risk than residential mortgage loans, but have higher yields. To manage these risks, the Bank generally obtains appropriate collateral and personal guarantees from the borrower’s principal owners and monitors the financial condition of its business borrowers. Residential mortgage loans generally are made on the basis of the borrower’s ability to make repayment from employment and other income and are secured by real estate whose value tends to be readily ascertainable. In contrast, commercial business loans typically are made on the basis of the borrower’s ability to make repayment from cash flow from its business and are secured by business assets, such as commercial real estate, accounts receivable, equipment and inventory. As a result, the availability of funds for the repayment of commercial business loans is substantially dependent on the success of the business itself. Furthermore, the collateral for commercial business loans may depreciate over time and generally cannot be appraised with as much precision as residential real estate.

Consumer Lending

The Bank offers various secured and unsecured consumer loans, which include personal installment loans, personal lines of credit, automobile loans, and credit card loans. The Bank originates its consumer loans within its geographic market area and these loans are generally made to customers with whom the Bank has an existing relationship. Consumer loans generally entail greater risk than residential mortgage loans, particularly in the case of consumer loans which are unsecured or secured by rapidly depreciable assets such as automobiles. In such cases, any repossessed collateral on a defaulted consumer loan may not provide an adequate source of repayment of the outstanding loan balance as a result of the greater likelihood of damage, loss or depreciation. Consumer loan collections are dependent on the borrower’s continuing financial stability, and thus are more likely to be adversely affected by job loss, divorce, illness or personal bankruptcy. Furthermore, the application of various federal and state laws, including federal and state bankruptcy and insolvency laws, may limit the amount which can be recovered on such loans.

The underwriting standards employed by the Bank for consumer loans include a determination of the applicant’s payment history on other debts and an assessment of ability to meet existing obligations and payments on the proposed loan. The stability of the applicant’s monthly income may be determined by verification of gross monthly income from primary employment, and from any verifiable secondary income. Although creditworthiness of the applicant is the primary consideration, the underwriting process also includes an analysis of the value of the security in relation to the proposed loan amount.

31

CRITICAL ACCOUNTING POLICIES

The financial statements of the Company are prepared in accordance with accounting principles generally accepted in the United States of America ("GAAP"). The financial information contained within these statements is, to a significant extent, based on measurements of the financial effects of transactions and events that have already occurred. A variety of factors could affect the ultimate value that is obtained when earning income, recognizing an expense, recovering an asset or relieving a liability. In addition, GAAP itself may change from one previously acceptable method to another method. Although the economics of the transactions would be the same, the timing of events that would impact the transactions could change.

Allowance for Loan Losses

The allowance for loan losses is an estimate of the probable losses inherent in the Company’s loan portfolio. As required by GAAP, the allowance for loan losses is accrued when their occurrence is probable and they can be estimated.  Impairment losses are accrued based on the differences between the loan balance and the value of its collateral, the present value of future cash flows, or the price established in the secondary market. The Company’s allowance for loan losses has three basic components: the general allowance, the specific allowance and the unallocated allowance. Each of these components is determined based upon estimates that can and do change when actual events occur. The general allowance uses historical experience and other qualitative factors to estimate future losses and, as a result, the estimated amount of losses can differ significantly from the actual amount of losses which would be incurred in the future. However, the potential for significant differences is mitigated by continuously updating the loss history of the Company. The specific allowance is based upon the evaluation of specific impaired loans on which a loss may be realized. Factors such as past due history, ability to pay, and collateral value are used to identify those loans on which a loss may be realized. Each of these loans is then evaluated to determine how much loss is estimated to be realized on its disposition. The sum of the losses on the individual loans becomes the Company’s specific allowance. This process is inherently subjective and actual losses may be greater than or less than the estimated specific allowance. The unallocated allowance is due to imprecision in the model and for losses that are not directly allocable to a specific loan type within the portfolio. As the loans, which are affected by these events, are identified or losses are experienced on the loans which are affected by these events, they will be reflected within the specific or general allowances. Note 1 to the Consolidated Financial Statements presented in Item 8, Financial Statements and Supplementary Data, of the 2020 Form 10-K, provides additional information related to the allowance for loan losses.

32

FORWARD LOOKING STATEMENTS

The Company makes forward looking statements in this report that are subject to risks and uncertainties. These forward looking statements include statements regarding our expectations, intentions or objectives concerning our profitability, liquidity, allowance for loan losses, interest rate sensitivity, market risk, growth strategy, and financial and other goals. The words “believes,” “expects,” “may,” “will,” “should,” “projects,” “contemplates,” “anticipates,” “forecasts,” “intends,” or other similar words or terms are intended to identify forward looking statements. These forward looking statements are subject to significant uncertainties because they are based upon or are affected by factors including:

• the effects of the COVID-19 pandemic, including on the Company's credit quality and business operations, as well as its impact on general economic and financial market conditions;

• the ability to successfully manage growth or implement growth strategies if the Bank is unable to identify attractive markets, locations or opportunities to expand in the future or if the Bank is unable to successfully integrate new branches, business lines or other growth opportunities into its existing operations;

• competition with other banks and financial institutions, and companies outside of the banking industry, including those companies that have substantially greater access to capital and other resources;

• the successful management of interest rate risk;

• risks inherent in making loans such as repayment risks and fluctuating collateral values;

• changes in general economic and business conditions in the Bank’s market area;

• reliance on the Bank’s management team, including the ability to attract and retain key personnel;

• changes in interest rates and interest rate policies;

• maintaining capital levels adequate to support growth;

• maintaining cost controls and asset qualities as new branches are opened or acquired;

• demand, development and acceptance of new products and services;

• problems with technology utilized by the Bank;

• changing trends in customer profiles and behavior;

• changes in banking, tax and other laws and regulations and interpretations or guidance thereunder; and

• other factors described in Item 1A., “Risk Factors,” in the Company’s 2020 Form10-K.

Because of these uncertainties, actual future results may be materially different from the results indicated by these forward looking statements. In addition, past results of operations do not necessarily indicate future results.

33

RESULTS OF OPERATIONS

Net Income

Net income for the six months ended June 30, 2021 was $5.9 million, an increase of 11.5% or $605 thousand when compared to the same period in 2020.  Net income for the three months ended June 30, 2021 was $3.0 million, an increase of 6.53% or $184 thousand when compared to the same period in 2020. Earnings per share, basic and diluted were $1.71 and $1.54 for the six months ended June 30, 2021 and 2020, respectively. Earnings per share, basic and diluted were $0.87 and $0.83 for the three months ended June 30, 2021 and 2020, respectively.

Return on average assets ("ROA") measures how efficiently the Company uses its assets to produce net income. Some issues reflected within this efficiency include the Company’s asset mix, funding sources, pricing, fee generation, and cost control. The ROA of the Company, on an annualized basis, for the six months ended June 30, 2021 and 2020 was 1.01% and 1.11%, respectively.

Return on average equity ("ROE") measures the utilization of shareholders’ equity in generating net income. This measurement is affected by the same factors as ROA with consideration to how much of the Company’s assets are funded by shareholders. The ROE of the Company, on an annualized basis, for the six months ended June 30, 2021 and 2020 was 11.19% and 10.65%, respectively.

Net Interest Income

Net interest income is our primary source of revenue, representing the difference between interest and fees earned on interest-earning assets and the interest paid on deposits and other interest-bearing liabilities. The level of net interest income is impacted primarily by variations in the volume and mix of these assets and liabilities, as well as changes in interest rates. Net interest income was $19.5 million and $16.8 million for the six months ended June 30, 2021 and 2020, respectively, which represents an increase of $2.75 million or 16.4%. Net interest income was $10.0 million and $8.8 million for the three months ended June 30, 2021 and 2020, respectively, which represents an increase of $1.2 million or 14.0%. Despite the decline in the interest rate environment, net interest income increased due to the increase in the average balance of the loan portfolio. Average interest earning assets increased $172.8 million when comparing the six months ended June 30, 2020 to the six months ended June 30, 2021 while the average yield on earning assets decreased by 47 basis points over that same period.  This decrease in yield can be mostly attributed to the production of SBA PPP loans. Between March 31, 2020 and June 30, 2021, the Company originated $132.1 million in these loans at an interest rate of 1.00%. This decrease in yield is partially offset by fee income on these loans.  Fees are recognized through the net interest margin as loans are forgiven or repaid.

Total interest income was $20.4 million and $18.8 million for the six months ended June 30, 2021 and 2020, respectively, which represents an increase of $1.66 million or 8.9%. Total interest income was $10.4 million and $9.7 million for the three months ended June 30, 2021 and 2020, respectively, which represents an increase of $752 thousand or 7.8%. The increase in interest income was driven by an increase in the average balance of the loan portfolio partially offset by the overall decrease in the interest rate environment during the reported time periods. As stated in the paragraph above, SBA PPP loans originated at a lower yield than the existing portfolio have contributed to this decrease in yield. Total interest expense was $921 thousand and $2.0 million for the six months ended June 30, 2021 and 2020, respectively, which represents a decrease of $1.1 million or 54.1%. Total interest expense was $434 thousand and $904 thousand for the three months ended June 30, 2021 and 2020, respectively, which represents a decrease of $470 thousand or 52.0%. The decrease in interest expense resulted from the reduction in interest rates paid on deposit accounts.

The net interest margin was 3.59% and 3.78% for the six months ended June 30, 2021 and 2020, respectively. The net interest margin was 3.56% and 3.70% for the three months ended June 30, 2021 and 2020, respectively. Tax-equivalent net interest income is calculated by adding the tax benefit on certain securities and loans, whose interest is tax-exempt, to total interest income then subtracting total interest expense. The tax rate used to calculate the tax benefit was 21% for 2021 and 2020.

34

Given the expectation of continued low interest rates and a flat yield curve, net interest income and net interest margin could experience continued pressure.

The following table shows interest income on earning assets and related average yields as well as interest expense on interest-bearing liabilities and related average rates paid for the three months ended June 30, 2021 and 2020 (dollars in thousands):

	June 30, 2021								June 30, 2020
				Interest		Average						Interest		Average
	Average			Income/		Yield/			Average			Income/		Yield/
Assets:	Balance			Expense		Rate (3)			Balance			Expense		Rate (3)
Securities:
Taxable	$	159,246		$	542		1.36	%	$	131,702		$	730		2.23	%
Tax-Exempt (1)		16,237			135		3.35	%		22,716			192		3.40	%
Total Securities	$	175,483		$	677		1.55	%	$	154,418		$	922		2.40	%
Loans:
Taxable	$	862,078		$	9,667		4.50	%	$	736,584		$	8,685		4.74	%
Non-accrual		4,280			—		—	%		3,263			—		—	%
Tax-Exempt (1)		9,473			104		4.39	%		10,166			112		4.43	%
Total Loans	$	875,831		$	9,771		4.47	%	$	750,013		$	8,797		4.72	%
Federal funds sold		234			—		0.08	%		710			—		0.02	%
Interest-bearing deposits in other banks		83,366			15		0.08	%		55,958			6		0.04	%
Total earning assets (2)	$	1,130,634		$	10,463		3.71	%	$	957,836		$	9,725		4.08	%
Allowance for loan losses		(7,862	)							(5,532	)
Total non-earning assets		78,573								68,401
Total assets	$	1,201,345							$	1,020,705
Liabilities and Shareholders' Equity:
Interest-bearing deposits:
NOW accounts	$	144,914		$	79		0.22	%	$	102,651		$	76		0.30	%
Money market accounts		213,311			148		0.28	%		175,199			220		0.51	%
Savings accounts		155,065			22		0.06	%		119,045			34		0.11	%
Time deposits:
$250,000 and more		67,706			114		0.67	%		80,099			372		1.87	%
Less than $250,000		58,520			71		0.49	%		59,714			177		1.19	%
Total interest-bearing deposits	$	639,516		$	434		0.27	%	$	536,708		$	879		0.66	%
Federal Home Loan Bank advances		—			—		—	%		30,769			25		0.33	%
Total interest-bearing liabilities	$	639,516		$	434		0.27	%	$	567,477		$	904		0.64	%
Noninterest-bearing liabilities:
Demand deposits		443,397								341,020
Other Liabilities		12,265								11,437
Total liabilities	$	1,095,178							$	919,934
Shareholders' equity		106,167								100,771
Total liabilities and shareholders' equity	$	1,201,345							$	1,020,705
Net interest income				$	10,029							$	8,821
Net interest spread							3.44	%							3.44	%
Interest expense as a percent of
average earning assets							0.15	%							0.38	%
Net interest margin							3.56	%							3.70	%

(1) Income and yields are reported on a tax-equivalent basis using a federal tax rate of 21%.

(2) Non-accrual loans are not included in this total since they are not considered earning assets.

(3) Annualized.

35

The following table shows interest income on earning assets and related average yields as well as interest expense on interest-bearing liabilities and related average rates paid for the six months ended June 30, 2021 and 2020 (dollars in thousands):

	June 30, 2021								June 30, 2020
				Interest		Average						Interest		Average
	Average			Income/		Yield/			Average			Income/		Yield/
Assets:	Balance			Expense		Rate (3)			Balance			Expense		Rate (3)
Securities:
Taxable	$	151,753		$	1,020		1.36	%	$	134,780		$	1,644		2.45	%
Tax-Exempt (1)		17,063			284		3.36	%		23,310			404		3.48	%
Total Securities	$	168,816		$	1,304		1.56	%	$	158,090		$	2,048		2.60	%
Loans:
Taxable		851,134			18,993		4.50	%		690,983			16,534		4.81	%
Non-accrual		4,430			—		—	%		2,656			—		—	%
Tax-Exempt (1)		9,516			208		4.41	%		10,206			225		4.43	%
Total Loans	$	865,080		$	19,201		4.48	%	$	703,845		$	16,759	��	4.79	%
Federal funds sold		222			—		0.08	%		475			1		0.33	%
Interest-bearing deposits in other banks		71,983			27		0.08	%		39,739			92		0.46	%
Total earning assets (2)	$	1,101,671		$	20,532		3.76	%	$	899,493		$	18,900		4.23	%
Allowance for loan losses		(7,562	)							(5,477	)
Total non-earning assets		75,917								61,041
Total assets	$	1,170,026							$	955,057
Liabilities and Shareholders' Equity:
Interest-bearing deposits:
NOW accounts	$	137,921		$	153		0.22	%	$	101,595		$	199		0.39	%
Money market accounts		211,590			303		0.29	%		169,839			562		0.66	%
Savings accounts		149,792			44		0.06	%		114,080			78		0.14	%
Time deposits:
$250,000 and more		68,090			266		0.79	%		78,640			743		1.90	%
Less than $250,000		59,016			155		0.53	%		60,966			399		1.31	%
Total interest-bearing deposits	$	626,409		$	921		0.30	%	$	525,120		$	1,981		0.76	%
Federal  funds purchased		—			—		—	%		1			—		0.40	%
Federal Home Loan Bank advances		—			—		—	%		15,385			25		0.33	%
Total interest-bearing liabilities	$	626,409		$	921		0.30	%	$	540,506		$	2,006		0.75	%
Noninterest-bearing liabilities:
Demand deposits		425,701								304,306
Other Liabilities		12,203								10,968
Total liabilities	$	1,064,313							$	855,780
Shareholders' equity		105,713								99,277
Total liabilities and shareholders' equity	$	1,170,026							$	955,057
Net interest income				$	19,611							$	16,894
Net interest spread							3.46	%							3.48	%
Interest expense as a percent of
average earning assets							0.17	%							0.45	%
Net interest margin							3.59	%							3.78	%

(1) Income and yields are reported on a tax-equivalent basis using a federal tax rate of 21%.

(2) Non-accrual loans are not included in this total since they are not considered earning assets.

(3) Annualized.

36

The following table reconciles tax-equivalent net interest income, which is not a measurement under GAAP, to net interest income.

	Three Months Ended				Six Months Ended
	June 30,				June 30,
	2021		2020		2021		2020
	(in thousands)				(in thousands)
GAAP Financial Measurements:
Interest Income - Loans	$	9,749	$	8,773	$	19,157	$	16,712
Interest Income - Securities and Other Interest-Earnings Assets		664		888		1,272		2,056
Interest Expense - Deposits		434		879		921		1,981
Interest Expense - Other Borrowings		—		25		—		25
Total Net Interest Income	$	9,979	$	8,757	$	19,508	$	16,762
Non-GAAP Financial Measurements:
Add: Tax Benefit on Tax-Exempt Interest Income - Loans (1)	$	22	$	24	$	44	$	47
Add: Tax Benefit on Tax-Exempt Interest Income - Securities (1)		28		40		59		85
Total Tax Benefit on Tax-Exempt Interest Income	$	50	$	64	$	103	$	132
Tax-Equivalent Net Interest Income	$	10,029	$	8,821	$	19,611	$	16,894

(1) Tax benefit was calculated using the federal statutory tax rate of 21%.

The tax-equivalent yield on earning assets decreased from 4.23% to 3.76% for the six months ended June 30, 2020 and 2021, respectively. For those same time periods, the tax-equivalent yield on securities decreased 104 basis points.  The tax equivalent yield on loans decreased 31 basis points from 4.79% for the six months ended June 30, 2020 to 4.48% for the same time period in 2021. The decrease in the tax-equivalent yield on earning assets for the six months ended June 30, 2021 resulted mostly from the decrease in the tax-equivalent yield on loans. The decrease in the yield on loans as compared to the corresponding period in the prior year was primarily due to SBA PPP loans originating at a lower yield than the existing portfolio as well as rate decreases during early 2020.  Additionally, as securities are maturing and being called or sold, they are being replaced with securities at lower rates.

The average rate on interest bearing liabilities decreased 45 basis points from 0.75% for the six months ended June 30, 2020 to 0.30% for the same time period in 2021.  Federal Reserve Bank interest rate decreases during early 2020 drove a reduction in interest rates paid on deposit accounts, which resulted in a lower rate paid on interest bearing liabilities.

Provision for Loan Losses

The provision for loan losses is based upon management’s estimate of the amount required to maintain an adequate allowance for loan losses as discussed within the Critical Accounting Policies section above. The allowance represents an amount that, in management’s judgment, will be adequate to absorb probable losses inherent in the loan portfolio. Management’s judgment in determining the level of the allowance is based on evaluations of the collectability of loans while taking into consideration such factors as trends in delinquencies and charge-offs, changes in the nature and volume of the loan portfolio, current economic conditions that may affect a borrower’s ability to repay and the value of collateral, overall portfolio quality and review of specific potential losses. This evaluation is inherently subjective because it requires estimates that are susceptible to significant revision as more information becomes available. The amount of provision for loan losses is affected by several factors including the growth rate of loans, net charge-offs (recoveries), and the estimated amount of inherent losses within the loan portfolio. The provision for loan losses for the six months ended June 30, 2021 and 2020 was $883 thousand and $655 thousand, respectively. The provision for loan losses for the three months ended June 30, 2021 and 2020 was $284 thousand and $752 thousand, respectively. The provision for the three and six months ended June 30, 2021 resulted mostly from loan growth, which was concentrated mainly in the first quarter of 2021. The provision during the three and six months ended June 30, 2020 resulted mostly from decline in the current state of the economy, by an increase in the qualitative factors within our allowance for loan losses, primarily associated with the current COVID-19 pandemic.

37

Noninterest Income

Total noninterest income for the six months ended June 30, 2021 and 2020 was $5.1 million and $4.1 million, respectively. Total noninterest income for the three months ended June 30, 2021 and 2020 was $2.7 million and $2.4 million, respectively. Management reviews the activities which generate noninterest income on an ongoing basis. The following table provides the components of noninterest income for the three and six months ended June 30, 2021 and 2020, which are included within the respective Consolidated Statements of Income headings.  Variances that the Company believes require explanation are discussed below the table.

	Three Months Ended											Six Months Ended
	June 30,											June 30,
(dollars in thousands)	2021			2020		$ Change			% Change			2021		2020		$ Change			% Change
Income from fiduciary activities	$	399		$	403	$	(4	)		(1	)%	$	740	$	700	$	40			6	%
Service charges on deposit accounts		241			170		71			42	%		458		454		4			1	%
Other service charges and fees		1,354			1,147		207			18	%		2,663		2,251		412			18	%
(Loss) gain on sale of securities		(52	)		529		(581	)	NM				24		529		(505	)	NM
Gain on sale of loans held for sale		359			—		359		NM				359		—		359		NM
Bank owned life insurance income		118			143		(25	)		(17	)%		223		143		80			56	%
Other operating income		231			30		201			670	%		610		35		575			1643	%
Total noninterest income	$	2,650		$	2,422	$	228			9	%	$	5,077	$	4,112	$	965			23	%

NM - Not Meaningful

Services charges on deposit accounts increased during the three and six months ended June 30, 2021 when compared to the same periods in 2020. This increase is mainly due to increases in overdraft charges.  Overdraft charges can fluctuate based on changes in customer activity.

The amount of other services charges and fees is comprised primarily of commissions from the sale of non-deposit investment products, fees received from the Bank’s credit card program, fees generated from the Bank’s ATM/debit card programs, and fees generated from procuring applications for secondary market loans. Other service charges and fees increased during the three and six months ended June 30, 2021 when compared to the same periods in 2020. This increase can be attributed to an increase in ATM fees, which fluctuates due to ATM usage.  

Beginning in the second quarter of 2021, the Company sold $4.6 million in mortgage loans on the secondary market and $18.0 million of loans from the commercial and consumer loan portfolios. These loan sales resulted in gains of $359 thousand during the three and six months ended June 30, 2021.

BOLI income was $223 thousand and $143 thousand for the six months ended June 30, 2021 and 2020, respectively. During the first quarter of 2020, the Company purchased $12 million of BOLI.  The Company made an additional investment of $10 million in June of 2021.

Other operating income increased during the three and six months ended June 30, 2021 when compared to the same periods in 2020.  This increase can be attributed to adjustments to the investment in Banker’s Insurance as well as cash distributions received from investments in Small Business Investment Companies (SBICs).

38

Noninterest Expenses

Total noninterest expenses increased $2.8 million or 19.8% for the six months ended June 30, 2021 compared to the same period in 2020. Total noninterest expenses increased $1.7 million and 24.4% for the three months ended June 30, 2021 and 2020. The following table presents the components of noninterest expense for the three and six months ended June 30, 2021 and 2020, which are included within the respective Consolidated Statements of Income headings. Variances that the Company believes require explanation are discussed below the table.

	Three Months Ended											Six Months Ended
	June 30,											June 30,
(dollars in thousands)	2021		2020			$ Change			% Change			2021		2020			$ Change			% Change
Salaries and employee benefits	$	5,310	$	4,373		$	937			21	%	$	10,026	$	8,461		$	1,565			18	%
Occupancy expenses		413		403			10			2	%		869		798			71			9	%
Equipment expenses		238		252			(14	)		(6	)%		462		484			(22	)		(5	)%
Advertising and marketing expenses		198		152			46			30	%		306		357			(51	)		(14	)%
Stationary and supplies		60		34			26			76	%		98		66			32			48	%
ATM network fees		312		243			69			28	%		562		485			77			16	%
Other real estate owned expense		6		(3	)		9		NM				5		(1	)		6		NM
Loss (gain) on other real estate owned		92		—			92		NM				102		(132	)		234		NM
FDIC assessment		133		41			92			224	%		240		41			199			485	%
Computer software expense		281		161			120			75	%		470		281			189			67	%
Bank franchise tax		195		176			19			11	%		384		350			34			10	%
Professional fees		369		317			52			16	%		829		671			158			24	%
Data processing fees		373		382			(9	)		(2	)%		775		863			(88	)		(10	)%
Other operating expenses		747		483			264			55	%		1,515		1,165			350			30	%
Total noninterest expenses	$	8,727	$	7,014		$	1,713			24	%	$	16,643	$	13,889		$	2,754			20	%

NM - Not Meaningful

The COVID-19 pandemic has had and continues to have an impact on noninterest expenses. Decreases in year-to-date expenses compared to the prior year were noted in advertising and marketing expenses. The decrease was due to adjustments in the timing of marketing promotions. Increases in computer software expenses in comparison to the prior year were largely due to software purchases to allow for remote work during the COVID-19 pandemic.      

Salaries and employee benefits increased during the three and six months ended June 30, 2021 over 2020.  Annual pay increases, newly hired employees, increasing insurance costs and enhanced employee incentive plans have attributed to these increases. The number of full-time equivalent employees (FTEs) has increased from 189 at June 30, 2020 to 213 at June 30, 2021.

Occupancy expenses increased year over year due mostly to $27 thousand of snow removal costs incurred during the six months ended June 30, 2021 that were not incurred during the same period in 2020.

ATM network fees increased during the three and six months ended June 30, 2021 over 2020 due to increased ATM
usage. During the height of the COVID-19 pandemic in 2020, customer activity and usage decreased.  During 2021, increases in customer activity have been observed.

FDIC assessment increased during the three and six months ended June 30, 2021 over 2020. The Company received notification of a Small Bank Credit Assessment for approximately $178 thousand during the second quarter of 2019.  This credit was received because the Deposit Insurance Fund reserve ratio exceeded the established level as of June 30, 2019. Credits were applied to the successive invoices in 2019 and 2020. There was no credit balance to apply to the assessment starting with the quarter ended September 30, 2020.

Bank franchise tax increased during the three and six months ended June 30, 2021 over 2020. This expense increases as
capital levels increase.

39

Professional fees increased during the three and six months ended June 30, 2021 over 2020 due mainly to the increase in recruiting fees paid during those two periods.  

Other operating expenses increased during the three and six months ended June 30, 2021 over 2020. This increase is due primarily to increased loan related expenses due to a higher volume in the three and six months ended June 30, 2021 over 2020.

The efficiency ratio of the Company was 67.07% and 68.47% for the six months ended June 30, 2021 and 2020, respectively. The efficiency ratio of the Company was 67.83% and 65.45% for the three months ended June 30, 2021 and 2020, respectively. The efficiency ratio is not a measurement under accounting principles generally accepted in the United States. It is calculated by dividing noninterest expense by the sum of tax equivalent net interest income and noninterest income excluding gains and losses on the investment portfolio and other gains/losses from OREO, repossessed vehicles, disposals of bank premises and equipment, etc. The tax rate utilized is 21%. The Company calculates and reviews this ratio as a means of evaluating operational efficiency.

The calculation of the efficiency ratio for the three and six months ended June 30, 2021 and 2020 are as follows:

	Three Months Ended						Six Months Ended
	June 30,						June 30,
	2021			2020			2021			2020
	(in thousands)						(in thousands)
Summary of Operating Results:
Noninterest expenses	$	8,727		$	7,014		$	16,643		$	13,889
Less: Loss (gain) on other real estate owned		92			—			102			(132	)
Adjusted noninterest expenses	$	8,635		$	7,014		$	16,541		$	14,021
Net interest income		9,979			8,757			19,508			16,762
Noninterest income		2,650			2,422			5,077			4,112
Less: (Loss) gain on sales of securities		(52	)		529			24			529
Less: (Loss) on sale of repossessed assets		—			(2	)		—			(2	)
Adjusted noninterest income	$	2,702		$	1,895		$	5,053		$	3,585
Tax equivalent adjustment (1)		50			64			103			132
Total net interest income and noninterest income, adjusted	$	12,731		$	10,716		$	24,664		$	20,479
Efficiency ratio		67.83	%		65.45	%		67.07	%		68.47	%

(1) Includes tax-equivalent adjustments on loans and securities using the federal statutory tax rate of 21%.

Income Taxes

Income tax expense was $1.2 million and $1.1 million during the six months ended June 30, 2021 and 2020, respectively. Income tax expense was $615 thousand and $594 thousand during the three months ended June 30, 2021 and 2020, respectively. The effective tax rate was 16.91% and 16.90% for the six months ended June 30, 2021 and 2020, respectively. The effective tax rate was 17.00% and 17.40% for the three months ended June 30, 2021 and 2020, respectively. The effective tax rate is below the statutory rate of 21% due to tax-exempt income on investment securities and loans. The effective tax rate is also impacted by BOLI as well as income tax credits on qualified affordable housing project investments as discussed in Note 12 to the Consolidated Financial Statements as well as qualified rehabilitation credits.

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FINANCIAL CONDITION

Securities

Total securities available for sale were $176.5 million at June 30, 2021, compared to $165.0 million at December 31, 2020. This represents an increase of $11.5 million or 6.96%. The Company purchased $62.3 million securities during the six months ended June 30, 2021. The Company had total maturities, calls, and principal repayments of $31.4 million.  There were $15.9 million sales during the six months ended June 30, 2021. The Company did not have any securities from a single issuer, other than U.S. government agencies, whose amount exceeded 10% of shareholders’ equity at June 30, 2021. Note 4 to the Consolidated Financial Statements provides additional details about the Company’s securities portfolio at June 30, 2021 and December 31, 2020. The Company had a net unrealized gain on available for sale securities of $1.4 million at June 30, 2021 as compared to a net unrealized gain of $4.1 million at December 31, 2020.  Unrealized gains or losses on available for sale securities are reported within shareholders’ equity, net of the related deferred tax effect, as accumulated other comprehensive income.

Loan Portfolio

The Company’s primary use of funds is supporting lending activities from which it derives the greatest amount of interest income. Gross loans were $877.4 million and $836.3 million at June 30, 2021 and December 31, 2020, respectively. This represents an increase of $41.1 million or 4.91% during the six months ended June 30, 2021. The ratio of gross loans to deposits decreased during the six months ended June 30, 2021 from 81.85% at December 31, 2020 to 79.80% at June 30, 2021. Loan growth excluding changes in SBA PPP loans during the six months ended June 30, 2021 was $74.1 million or 9.82%. SBA PPP loans originated during 2020 and 2021 and outstanding as of June 30, 2021 were $48.2 million.

The loan portfolio consists primarily of loans for owner-occupied single-family dwellings and loans secured by commercial real estate. Note 5 to the Consolidated Financial Statements provides the composition of the loan portfolio at June 30, 2021 and December 31, 2020.

Residential real estate loans were $269.0 million or 30.66% and $269.7 million or 32.25% of total loans at June 30, 2021 and December 31, 2020, respectively. Commercial real estate loans were $343.9 million or 39.19% and $334.7 million or 40.02% of total loans at June 30, 2021 and December 31, 2020, respectively. Construction, land development, and farmland loans were $74.6 million or 8.51% and $58.4 million or 6.98% of total loans at June 30, 2021 and December 31, 2020, respectively. Consumer installment loans were $42.3 million or 4.82% and $21.3 million or 2.55% of total loans at June 30, 2021 and December 31, 2020, respectively, representing an increase of $21.0 million or 98.33% during the six months ended June 30, 2021. Commercial and industrial loans were $135.8 million or 15.48% and $140.8 million or 16.83% of total loans at June 30, 2021 and December 31, 2020, respectively, representing a decrease of $4.9 million or 3.49% during the six months ended June 30, 2021.  During the six months ended June 30, 2021, loan growth was mainly concentrated in growth of our marine lending portfolio which falls into both the consumer installment loan and commercial and industrial loan portfolios.  Commercial and industrial loans experienced a decrease during the six months ended June 30, 2021 due largely to the forgiveness of SBA PPP loans of approximately $38.1 million.

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Allowance for Loan Losses

The purpose of, and the methods for, measuring the allowance for loan losses are discussed in the Critical Accounting Policies section above. Note 5 to the Consolidated Financial Statements shows the activity within the allowance for loan losses during the six months ended June 30, 2021 and 2020 and the year ended December 31, 2020. Charged-off loans were $24 thousand and $143 thousand for the six months ended June 30, 2021 and 2020, respectively. Recoveries were $143 thousand and $880 thousand for the six months ended June 30, 2021 and 2020, respectively. This resulted in net recoveries of $119 thousand and $737 thousand for the six months ended June 30, 2021 and 2020, respectively. The Company collected a $459 thousand recovery during the first quarter of 2020 related to an $850 thousand commercial and industrial loan charge-off in 2019. The allowance for loan losses as a percentage of loans was 0.92% at June 30, 2021 and 0.85% at December 31, 2020.  Excluding outstanding PPP loans, the allowance for loan losses as a percentage of total loans was 0.98% and 0.94% as of June 30, 2021 and December 31, 2020, respectively. During the six months ended June 30, 2021, loan growth was concentrated in mostly commercial and industrial loans as well as consumer loans.  These two loan pools have a higher general allocation than certain other loan pools due to the inherent risk of the portfolios. This was the main cause of the increase in the allowance for loan losses as a percentage of loans. The allowance for loan losses was 182.71% of nonperforming loans at June 30, 2021 and 146.85% of nonperforming loans at December 31, 2020. Refer to the Nonperforming Assets and Other Assets section on the following page for further discussion on nonperforming loans.

All nonaccrual and other impaired loans were evaluated for impairment and any specific allocations were provided for as necessary. Based on management's evaluation and update of the Company's historical loss experience adjusted for qualitative factors assessed, the general reserve as a percentage of non-impaired loans increased from 0.85% at December 31, 2020 to 0.92% at June 30, 2021. Management believes that the allowance for loan losses is currently adequate to absorb probable losses inherent in the loan portfolio. Management will continue to evaluate the adequacy of the allowance for loan losses as more economic data becomes available and as changes within the Company’s portfolio are known. The effects of the pandemic may require the Company to fund increases in the allowance for loan losses in future periods.

Nonperforming Assets and Other Assets

Nonperforming assets consist of nonaccrual loans, repossessed assets, OREO (foreclosed properties), and loans past due 90 days or more and still accruing. Nonperforming assets decreased by $6 thousand during the six months ended June 30, 2021. Nonaccrual loans were $4.4 million and $4.8 million at June 30, 2021 and December 31, 2020. OREO was $423 thousand and $607 thousand at June 30, 2021 and December 31, 2020, respectively.  The Company held two properties in OREO with an average balance of $212 thousand at June 30, 2021. The Company held three properties in OREO with an average balance of $202 thousand at December 31, 2020.  The percentage of nonperforming assets to loans and OREO was 0.61% at June 30, 2021 and 0.64% at December 31, 2020, respectively. There were $500 thousand and zero in loans past due 90 days or more and still accruing interest at June 30, 2021 and December 31, 2020, respectively.

Total past due loans, as disclosed in note 5 to the Consolidated Financial Statements, decreased to $1.8 million at June 30, 2021 compared to $1.9 million at December 31, 2020.

During the six months ended June 30, 2021, the Bank placed four loans with an outstanding balance of $618 thousand on nonaccrual status. During the same period, ten loans with an outstanding balance of $775 thousand were paid off. Management evaluates the financial condition of borrowers and the value of any collateral on nonaccrual loans. The results of these evaluations are used to estimate the amount of losses which may be realized on the disposition of these nonaccrual loans and are reflected in the allowance for loan losses.

Loans are placed on nonaccrual status when collection of principal and interest is doubtful, generally when a loan becomes 90 days past due. There are three negative implications for earnings when a loan is placed on non-accrual status. First, all interest accrued but unpaid at the date that the loan is placed on non-accrual status is either deducted from interest income or written off as a loss. Second, accruals of interest are discontinued until it becomes certain that both principal and interest can be repaid. Finally, there may be actual losses to principal that require additional provisions for loan losses to be charged against earnings.

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For real estate loans, upon foreclosure, the balance of the loan is transferred to OREO and carried at the fair value of the property based on current appraisals and other current market trends, less estimated selling costs. If a write down of the OREO property is necessary at the time of foreclosure, the amount is charged-off to the allowance for loan losses. A review of the recorded property value is performed in conjunction with normal loan reviews, and if market conditions indicate that the recorded value exceeds the fair value, additional write downs of the property value are charged directly to operations.

In addition, the Company may, under certain circumstances, restructure loans in troubled debt restructurings as a concession to a borrower when the borrower is experiencing financial distress. Formal, standardized loan restructuring programs are not utilized by the Company. Each loan considered for restructuring is evaluated based on customer circumstances and may include modifications to one or more loan provisions. Such restructured loans are included in impaired loans. However, restructured loans are not necessarily considered nonperforming assets. At June 30, 2021, the Company had $2.8 million in restructured loans with specific allowances totaling $45 thousand.  At December 31, 2020, the Company had $3.3 million in restructured loans with specific allowances totaling $72 thousand.  At June 30, 2021 and December 31, 2020, total restructured loans performing under the restructured terms and accruing interest were $2.0 million and $2.6 million, respectively. Three loans, totaling $809 thousand, were in nonaccrual status at June 30, 2021.  Three loans, totaling $796 thousand, were in nonaccrual status at December 31, 2020.  As noted in Note 6 to the consolidated financial statements the Bank modified a significant number of loans during 2020 to allow for short-term payment deferrals. These loans were not considered TDRs based on the provisions of the CARES Act and interagency guidance issued.

Deposits

Total deposits were $1.10 billion and $1.01 billion at June 30, 2021 and December 31, 2020, respectively. This represents an increase of $86.3 million or 8.52% during the six months ended June 30, 2021. Note 7 to the Consolidated Financial Statements provides the composition of total deposits at June 30, 2021 and December 31, 2020. The growth in deposits was mainly organic growth as we expand and grow into newer market areas.

Noninterest-bearing demand deposits, which are comprised of checking accounts, increased $33.5 million or 8.21% from $407.6 million at December 31, 2020 to $441.1 million at June 30, 2021. Savings and interest-bearing demand deposits, which include NOW accounts, money market accounts and regular savings accounts increased $55.4 million or 11.62% from $476.9 million at December 31, 2020 to $532.3 million at June 30, 2021. Savings and interest-bearing demand deposits included $39.8 million and $34.6 million in reciprocal ICS deposits at June 30, 2021 and December 31, 2020, respectively. Time deposits decreased $2.6 million or 2.01% from $128.7 million at December 31, 2020 to $126.1 million at June 30, 2021.

CAPITAL RESOURCES

The Bank continues to be a well capitalized financial institution. Total shareholders’ equity at June 30, 2021 was $107.6 million, reflecting a percentage of total assets of 8.83%, as compared to $105.1 million and 9.08% at December 31, 2020. During the six months ended June 30, 2021 and 2020, the Company declared dividends of $0.54 and $0.52 per share, respectively.  The Company has a Dividend Investment Plan that allows shareholders to reinvest dividends in Company stock.

At June 30, 2021, the Bank met all capital adequacy requirements and had regulatory capital ratios in excess of the levels established for well-capitalized institutions. The Bank monitors these ratios on a quarterly basis and has several strategies, including without limitation the issuance of common stock, to ensure that these ratios remain above regulatory minimums. Federal regulatory risk-based capital guidelines require percentages to be applied to various assets, including off-balance sheet assets, based on their perceived risk in order to calculate risk-weighted assets. Tier 1 capital consists of total shareholders’ equity less net unrealized gains and losses on available for sale securities and changes in the benefit obligations and plan assets for the post retirement benefit plan. Total capital is comprised of Tier 1 capital plus the allowable portion of the allowance for loan losses.

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For capital adequacy purposes financial institutions must maintain a Tier 1 common equity risk-based capital ratio of 4.50%, a Tier 1 risk-based capital ratio of at least 6.00%, a Total risk-based capital ratio of at least 8.00% and a minimum Tier 1 leverage ratio of 4.00%. The rules require the Bank to maintain (i) a minimum ratio of common equity Tier 1 to risk-weighted assets of at least 4.5%, plus a 2.5% “capital conservation buffer”, (ii) a minimum ratio of Tier 1 capital to risk-weighted assets of at least 6.0%, plus the 2.5% capital conservation buffer, (iii) a minimum ratio of total capital to risk-weighted assets of at least 8.0%, plus the 2.5% capital conservation buffer, and (iv) a minimum leverage ratio of 4.0%, calculated as the ratio of Tier 1 capital to average assets. The Bank's institution specific capital conservation buffer at June 30, 2021 and December 31, 2020 was 4.35% and 5.29%, respectively. The capital conservation buffer is designed to absorb losses during periods of economic stress. Banking institutions with any ratio (excluding the leverage ratio) above the minimum but below the conservation buffer will face constraints on dividends, equity repurchases, and compensation based on the amount of the shortfall.

The Bank's Tier 1 common risk-based capital ratio was 11.44% at June 30, 2021 as compared to 12.39% at December 31, 2020.  The Bank’s Tier 1 risk-based capital ratio was 11.44% at June 30, 2021 as compared to 12.39% at December 31, 2020. The Bank’s total risk-based capital ratio was 12.35% at June 30, 2021 as compared to 13.29% at December 31, 2020. The Bank’s Tier 1 capital to average total assets ratio was 8.58% at June 30, 2021 as compared to 9.06% at December 31, 2020.  Through July 31, 2021, the Bank's capital ratios continued to exceed the regulatory minimums for well-capitalized institutions.  We are closely monitoring our capital position and are taking appropriate steps to ensure our level of capital remains strong. Our capital, while significant, may fluctuate in future periods due to the effects of the pandemic and limit our ability to pay dividends.

On September 17, 2019, the Federal Deposit Insurance Corporation finalized a rule that introduces an optional simplified measure of capital adequacy for qualifying community banking organizations (i.e., the community bank leverage ratio or “CBLR” framework), as required by the Economic Growth, Regulatory Relief and Consumer Protection Act. The CBLR framework is designed to reduce burden by removing the requirements for calculating and reporting risk-based capital ratios for qualifying community banking organizations that opt into the framework. In order to qualify for the CBLR framework, a community banking organization must have a tier 1 leverage ratio of greater than 9 percent, less than $10 billion in total consolidated assets, and limited amounts of off-balance-sheet exposures and trading assets and liabilities. On April 6, 2020, in a joint statement, the FDIC, Federal Reserve and the Office of Comptroller of the Currency (“OCC”), issued two interim final rules regarding temporary changes to the CBLR framework to implement provisions of the CARES Act. Under the interim final rules, the community bank leverage ratio will be reduced to 8 percent beginning in the second quarter and for the remainder of calendar year 2020, 8.5 percent for calendar year 2021, and 9 percent thereafter. A qualifying community banking organization that opts into the CBLR framework and meets all requirements under the framework will be considered to have met the well-capitalized ratio requirements under the Prompt Corrective Action regulations and will not be required to report or calculate risk-based capital. The CBLR framework was first available for banks to use beginning in their March 31, 2020, Call Report.  The Bank did not opt into the CBLR framework as of June 30, 2021.

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LIQUIDITY

Liquidity management involves meeting the present and future financial obligations of the Company with the sale or maturity of assets or with the occurrence of additional liabilities. Liquidity needs are met with cash on hand, deposits in banks, federal funds sold, securities classified as available for sale and loans maturing within one year. At June 30, 2021, liquid assets totaled $395.9 million as compared to $320.4 million at December 31, 2020. These amounts represent 35.62% and 31.26% of total liabilities at June 30, 2021 and December 31, 2020, respectively.  The Company minimizes liquidity demand by utilizing core deposits to fund asset growth. Securities provide a constant source of liquidity through paydowns and maturities. Also, the Company maintains short-term borrowing arrangements, namely federal funds lines of credit, with larger financial institutions as an additional source of liquidity. The Bank’s membership with the Federal Home Loan Bank of Atlanta provides a source of borrowings with numerous rate and term structures. The Company’s senior management monitors the liquidity position regularly and attempts to maintain a position which utilizes available funds most efficiently. Our liquidity, while significant, may fluctuate in future periods due to the effects of the pandemic, funding of SBA PPP loans and deferral of loan payments.

OFF-BALANCE SHEET ARRANGEMENTS AND CONTRACTUAL OBLIGATIONS

There have been no material changes in off-balance sheet arrangements and contractual obligations as reported in the 2020 Form 10-K.

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Item 3. Quantitative and Qualitative Disclosures about Market Risk

There have been no material changes in Quantitative and Qualitative Disclosures about Market Risk as reported in the 2020 Form 10-K.

Item 4. Controls and Procedures

Disclosure Controls and Procedures

The Company, under the supervision and with the participation of management, including the Company’s Chief Executive Officer and Chief Financial Officer, has evaluated the effectiveness of the design and operation of its disclosure controls and procedures as of the end of the period covered by this Quarterly Report on Form 10-Q. Based on that evaluation, the Chief Executive Officer and Chief Financial Officer have concluded that the Company’s disclosure controls and procedures were effective as of June 30, 2021 to ensure that information required to be disclosed by the Company in reports that it files or submits under the Securities Exchange Act of 1934 is recorded, processed, summarized and reported within the time periods specified in Securities and Exchange Commission rules and forms and that such information is accumulated and communicated to the Company’s management, including the Chief Executive Officer and Chief Financial Officer, as appropriate to allow timely decisions regarding required disclosure.

Internal Control over Financial Reporting

Management is also responsible for establishing and maintaining adequate internal control over the Company’s financial reporting (as defined in Rule 13a-15(f) promulgated under the Securities Exchange Act of 1934, as amended).  The Company is currently using the 2013 COSO Framework.

There were no changes in the Company’s internal control over financial reporting during the Company’s three months ended June 30, 2021 that have materially affected, or are reasonably likely to materially affect, the Company’s internal control over financial reporting.

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PART II - OTHER INFORMATION

Item 1. Legal Proceedings

There are no material pending legal proceedings to which the Company is a party or of which the property of the Company is subject.

Item 1A. Risk Factors

There were no material changes to the Company’s risk factors as disclosed in its Annual Report on Form 10-K for the year ended December 31, 2020.

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

The following table details the Company's purchases of its common stock during the second quarter of 2021 pursuant to the Stock Repurchase Program.  The Company authorized 150,000 shares for repurchase under the Stock Repurchase program which was renewed on June 16, 2021.  The Program has an expiration date of June 30, 2022.

	Issuer Purchases of Equity Securities
	Total Number of Shares Purchased		Average Price Paid Per Share		Total Number of Shares Purchased as Part of Publicly Announced Plan		Maximum Number of Shares that may Yet Be Purchased Under the Plan
								118,611
April 1 - April 30, 2021		—	$	—		—		118,611
May 1 - May 31, 2021		760		33.00		760		117,851
June 1 - June 30, 2021		—		—		760		117,851
		760	$	33.00		760		117,851

Item 3. Defaults Upon Senior Securities

None.

Item 4. Mine Safety Disclosures

None.

Item 5. Other Information

None.

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Item 6. Exhibits

The following exhibits are filed with this Form 10-Q and this list includes the exhibit index:

Exhibit No.	Description
3.1	Bylaws of Eagle Financial Services, Inc. (attached as Exhibit 3.1 to the Current Report on Form 8-K filed May 20, 2021 and incorporated here-in by reference).
31.1	Certification by Chief Executive Officer pursuant to Rule 13a-14(a) under the Securities Exchange Act of 1934, as adopted pursuant to Section 302 of the Sarbanes-Oxley Act of 2002.
31.2	Certification by Chief Financial Officer pursuant to Rule 13a-14(a) under the Securities Exchange Act of 1934, as adopted pursuant to Section 302 of the Sarbanes-Oxley Act of 2002.
32.1	Certification by Chief Executive Officer and Chief Financial Officer pursuant to 18 U.S.C. Section 1350, as adopted pursuant to Section 906 of the Sarbanes-Oxley Act of 2002.
101	The following materials from the Eagle Financial Services, Inc. Quarterly Report on Form 10-Q for the quarter ended June 30, 2021 formatted in Inline Extensible Business Reporting Language (XBRL): (i) Consolidated Balance Sheets, (ii) Consolidated Statements of Income, (iii) Consolidated Statements of Comprehensive Income (iv) Consolidated Statements of Changes in Shareholders' Equity, (v) Consolidated Statements of Cash Flows and (vi) notes to Consolidated Financial Statements.
104	The cover page from the Eagle Financial Services, Inc. Quarterly Report on Form 10-Q for the quarter ended June 30, 2021 formatted in Inline XBRL (included with Exhibit 101).

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SIGNATURES

Pursuant to the requirements of the Securities Exchange Act of 1934, the Registrant has duly caused this report to be signed on its behalf by the undersigned thereunto duly authorized, this 13th day of August 2021.

Eagle Financial Services, Inc.

By:	/S/ BRANDON C. LOREY
	Brandon C. Lorey President and Chief Executive Officer
By:	/S/ KATHLEEN J. CHAPPELL
	Kathleen J. Chappell Executive Vice President, Chief Financial Officer

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