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Table of Contents

UNITED STATES
SECURITIES AND EXCHANGE COMMISSION
WASHINGTON, D.C. 20549

FORM 10-Q

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

For the quarterly period ended September 30, 2019
or

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

For the transition period from to
Commission file number: 001-34292

ORRSTOWN FINANCIAL SERVICES, INC.
(Exact Name of Registrant as Specified in its Charter)

Pennsylvania |  |  |  | 23-2530374 |
(State or Other Jurisdiction of Incorporation or Organization) |  |  |  | (I.R.S. Employer Identification No.) |
| 77 East King Street, | P. O. Box 250 | Shippensburg, | Pennsylvania | 17257
| (Address of Principal Executive Offices) |  |  |  | (Zip Code)
| Registrant’s Telephone Number, Including Area Code: |  | (717) | 532-6114 |

Indicate by check mark whether the registrant (1) has filed all reports required to be filed by Section 13 or 15(d) of the Securities Exchange Act of 1934 during the preceding 12 months (or for such shorter period that the registrant was required to file such reports), and (2) has been subject to such filing requirements for the past 90 days. Yes x No ¨
Indicate by check mark whether the registrant has submitted electronically every Interactive Data File required to be submitted pursuant to Rule 405 of Regulation S-T (§232.405 of this chapter) during the preceding 12 months (or for such shorter period that the registrant was required to submit such files). Yes x No ¨
Indicate by check mark whether the registrant is a large accelerated filer, an accelerated filer, a non-accelerated filer, a smaller reporting company, or an emerging growth company. See the definitions of “large accelerated filer,” “accelerated filer,” “smaller reporting company,” and "emerging growth company" in Rule 12b-2 of the Exchange Act.

Large accelerated filer |  | ¨ |  | Accelerated filer |  | ☒
Non-accelerated filer |  | ¨ |  | Smaller reporting company |  | ☒
|  |  |  | Emerging growth company |  | ☐
If an emerging growth company, indicate by check mark if the registrant has elected not to use the extended transition period for complying with any new or revised financial accounting standards provided pursuant to Section 13(a) of the Exchange Act. |  |  |  |  |  | o

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

Title of each class |  | Trading symbol(s) |  | Name of each exchange on which registered
Common Stock, no par value |  | ORRF |  | Nasdaq Capital Market

Number of shares outstanding of the registrant’s Common Stock as of October 31, 2019: 11,190,199.

Table of Contents
ORRSTOWN FINANCIAL SERVICES, INC.
INDEX

|  | Page
Part I – FINANCIAL INFORMATION |  |
| Glossary | 3
Item 1. | Financial Statements | 4
| Consolidated Balance Sheets (Unaudited) | 4
| Consolidated Statements of Income (Unaudited) | 5
| Consolidated Statements of Comprehensive Income (Unaudited) | 6
| Consolidated Statements of Changes in Shareholders’ Equity (Unaudited) | 7
| Consolidated Statements of Cash Flows (Unaudited) | 9
| Notes to Consolidated Financial Statements (Unaudited) | 11
Item 2 | Management’s Discussion and Analysis of Financial Condition and Results of Operations | 45
Item 3. | Quantitative and Qualitative Disclosures About Market Risk | 64
Item 4. | Controls and Procedures | 65
PART II – OTHER INFORMATION |  |
Item 1. | Legal Proceedings | 66
Item 1A. | Risk Factors | 66
Item 2. | Unregistered Sales of Equity Securities and Use of Proceeds | 66
Item 3. | Defaults upon Senior Securities | 66
Item 4. | Mine Safety Disclosures | 66
Item 5. | Other Information | 66
Item 6. | Exhibits | 67
SIGNATURES |  | 68

2

Table of Contents
Glossary of Defined Terms
The following terms may be used throughout this Report, including the consolidated financial statements and related notes.

Term | Definition
ALL | Allowance for loan losses
AFS | Available for sale
AOCI | Accumulated other comprehensive income (loss)
ASC | Accounting Standards Codification
ASU | Accounting Standards Update
Bank | Orrstown Bank, the commercial banking subsidiary of Orrstown Financial Services, Inc.
CDI | Core deposit intangible
CET1 | Common Equity Tier 1
CMO | Collateralized mortgage obligation
Company | Orrstown Financial Services, Inc. and subsidiaries (interchangeable with "Orrstown” below)
EPS | Earnings per common share
ERM | Enterprise risk management
Exchange Act | Securities Exchange Act of 1934, as amended
FASB | Financial Accounting Standards Board
FDIC | Federal Deposit Insurance Corporation
FHLB | Federal Home Loan Bank
FRB | Board of Governors of the Federal Reserve System
GAAP | Accounting principles generally accepted in the United States of America
GSE | U.S. government-sponsored enterprise
Hamilton | Hamilton Bancorp, Inc., and its wholly-owned banking subsidiary, Hamilton Bank
IRC | Internal Revenue Code of 1986, as amended
LHFS | Loans held for sale
MBS | Mortgage-backed securities
Mercersburg | Mercersburg Financial Corporation and its wholly-owned banking subsidiary, First Community Bank of Mercersburg (acquired October 1, 2018)
MPF Program | Mortgage Partnership Finance Program
MSR | Mortgage servicing right
NIM | Net interest margin
OCI | Other comprehensive income (loss)
OREO | Other real estate owned (foreclosed real estate)
Orrstown | Orrstown Financial Services, Inc. and subsidiaries
OTTI | Other-than-temporary impairment
Parent Company | Orrstown Financial Services, Inc., the parent company of Orrstown Bank and Wheatland Advisors, Inc.
2011 Plan | 2011 Orrstown Financial Services, Inc. Incentive Stock Plan
PCI loans | Purchased credit impaired loans
Repurchase Agreements | Securities sold under agreements to repurchase
ROU | Right of use (leases)
SEC | Securities and Exchange Commission
Securities Act | Securities Act of 1933, as amended
TDR | Troubled debt restructuring
Wheatland | Wheatland Advisors, Inc., the Registered Investment Advisor subsidiary of Orrstown Financial Services, Inc.
Unless the context otherwise requires, the terms “Orrstown,” “we,” “us,” “our,” and “Company” refer to Orrstown Financial Services, Inc. and its subsidiaries. |

3

Table of Contents
PART I – FINANCIAL INFORMATION
Item 1. Financial Statements
Consolidated Balance Sheets (Unaudited)
ORRSTOWN FINANCIAL SERVICES, INC.

(Dollars in thousands, except per share information) | September 30, 2019 |  | December 31, 2018
Assets |  |  |
Cash and due from banks | $ | 31,872 |  |  | $ | 26,156 |
Interest-bearing deposits with banks | 19,051 |  |  | 45,664 |
Federal funds sold | 0 |  |  | 16,995 |
Cash and cash equivalents | 50,923 |  |  | 88,815 |
Restricted investments in bank stocks | 11,399 |  |  | 10,842 |
Securities available for sale | 481,120 |  |  | 465,844 |
Loans held for sale | 7,610 |  |  | 3,340 |
Loans | 1,593,105 |  |  | 1,247,657 |
Less: Allowance for loan losses | (14,809) |  |  | (14,014) |
Net loans | 1,578,296 |  |  | 1,233,643 |
Premises and equipment, net | 43,031 |  |  | 38,201 |
Cash surrender value of life insurance | 62,207 |  |  | 41,327 |
Goodwill | 19,925 |  |  | 12,592 |
Other intangible assets, net | 7,654 |  |  | 3,910 |
Accrued interest receivable | 6,546 |  |  | 5,927 |
Other assets | 44,966 |  |  | 29,947 |
Total assets | $ | 2,313,677 |  |  | $ | 1,934,388 |
Liabilities |  |  |
Deposits: |  |  |
Noninterest-bearing | $ | 246,773 |  |  | $ | 204,843 |
Interest-bearing | 1,676,681 |  |  | 1,353,913 |
Total deposits | 1,923,454 |  |  | 1,558,756 |
Short-term borrowings | 36,605 |  |  | 64,069 |
Long-term debt | 63,165 |  |  | 83,450 |
Subordinated notes | 31,834 |  |  | 31,859 |
Accrued interest and other liabilities | 35,126 |  |  | 22,821 |
Total liabilities | 2,090,184 |  |  | 1,760,955 |
Shareholders’ Equity |  |  |
Preferred stock, $1.25 par value per share; 500,000 shares authorized; no shares issued or outstanding | 0 |  |  | 0 |
Common stock, no par value—$0.05205 stated value per share 50,000,000 shares authorized; 11,220,804 and 9,439,255 shares issued; 11,175,299 and 9,430,224 shares outstanding | 584 |  |  | 491 |
Additional paid - in capital | 188,582 |  |  | 151,678 |
Retained earnings | 32,690 |  |  | 24,472 |
Accumulated other comprehensive income (loss) | 2,675 |  |  | (2,972) |
Treasury stock—common, 45,505 and 9,031 shares, at cost | (1,038) |  |  | (236) |
Total shareholders’ equity | 223,493 |  |  | 173,433 |
Total liabilities and shareholders’ equity | $ | 2,313,677 |  |  | $ | 1,934,388 |

The Notes to Consolidated Financial Statements are an integral part of these statements.
4

Table of Contents
Consolidated Statements of Income (Unaudited)
ORRSTOWN FINANCIAL SERVICES, INC.

| Three Months Ended |  |  |  | Nine Months Ended |  |
(Dollars in thousands, except per share information) | September 30, 2019 |  | September 30, 2018 |  | September 30, 2019 |  | September 30, 2018
Interest income |  |  |  |  |  |  |
Loans | $ | 19,999 |  |  | $ | 12,281 |  |  | $ | 54,611 |  |  | $ | 35,068 |
Investment securities - taxable | 3,787 |  |  | 2,922 |  |  | 10,958 |  |  | 7,754 |
Investment securities - tax-exempt | 309 |  |  | 955 |  |  | 1,783 |  |  | 2,834 |
Short-term investments | 561 |  |  | 68 |  |  | 1,237 |  |  | 169 |
Total interest income | 24,656 |  |  | 16,226 |  |  | 68,589 |  |  | 45,825 |
Interest expense |  |  |  |  |  |  |
Deposits | 5,774 |  |  | 2,780 |  |  | 14,338 |  |  | 6,765 |
Short-term borrowings | 39 |  |  | 332 |  |  | 316 |  |  | 1,097 |
Long-term debt | 433 |  |  | 410 |  |  | 1,408 |  |  | 1,222 |
Subordinated notes | 490 |  |  | 0 |  |  | 1,486 |  |  | 0 |
Total interest expense | 6,736 |  |  | 3,522 |  |  | 17,548 |  |  | 9,084 |
Net interest income | 17,920 |  |  | 12,704 |  |  | 51,041 |  |  | 36,741 |
Provision for loan losses | 300 |  |  | 200 |  |  | 900 |  |  | 600 |
Net interest income after provision for loan losses | 17,620 |  |  | 12,504 |  |  | 50,141 |  |  | 36,141 |
Noninterest income |  |  |  |  |  |  |
Service charges on deposit accounts | 1,761 |  |  | 1,524 |  |  | 4,930 |  |  | 4,405 |
Other service charges, commissions and fees | 372 |  |  | 492 |  |  | 959 |  |  | 1,430 |
Loan swap referral fees | 629 |  |  |  | 0 |  |  |  | 629 |  |  |  | 0 |
Trust and investment management income | 1,892 |  |  | 1,668 |  |  | 5,399 |  |  | 5,037 |
Brokerage income | 654 |  |  | 455 |  |  | 1,804 |  |  | 1,514 |
Mortgage banking activities | 623 |  |  | 735 |  |  | 1,743 |  |  | 2,049 |
Income from life insurance | 479 |  |  | 533 |  |  | 1,505 |  |  | 1,101 |
Other income | 44 |  |  | 56 |  |  | 188 |  |  | 272 |
Investment securities gains | 2,328 |  |  | 29 |  |  | 4,731 |  |  | 891 |
Total noninterest income | 8,782 |  |  | 5,492 |  |  | 21,888 |  |  | 16,699 |
Noninterest expenses |  |  |  |  |  |  |
Salaries and employee benefits | 10,489 |  |  | 7,610 |  |  | 28,088 |  |  | 23,487 |
Occupancy | 1,133 |  |  | 775 |  |  | 3,200 |  |  | 2,252 |
Furniture and equipment | 1,252 |  |  | 990 |  |  | 3,415 |  |  | 2,977 |
Data processing | 830 |  |  | 661 |  |  | 2,658 |  |  | 1,875 |
Telephone and communication | 198 |  |  | 181 |  |  | 612 |  |  | 542 |
Automated teller and interchange fees | 270 |  |  | 187 |  |  | 744 |  |  | 548 |
Advertising and bank promotions | 279 |  |  | 279 |  |  | 1,348 |  |  | 898 |
FDIC insurance | (9) |  |  | 169 |  |  | 397 |  |  | 507 |
Legal fees | 189 |  |  | 215 |  |  | 362 |  |  | 364 |
Other professional services | 625 |  |  | 361 |  |  | 1,716 |  |  | 1,140 |
Directors' compensation | 228 |  |  | 207 |  |  | 725 |  |  | 663 |
Real estate owned | 22 |  |  | 18 |  |  | 36 |  |  | 96 |
Taxes other than income | 306 |  |  | 259 |  |  | 926 |  |  | 761 |
Intangible asset amortization | 486 |  |  | 24 |  |  | 1,096 |  |  | 72 |
Merger related | 471 |  |  | 319 |  |  | 7,976 |  |  | 473 |
Insurance claim receivable write off | 0 |  |  | 0 |  |  | 615 |  |  | 0 |
Other operating expenses | 1,392 |  |  | 1,081 |  |  | 3,743 |  |  | 3,022 |
Total noninterest expenses | 18,161 |  |  | 13,336 |  |  | 57,657 |  |  | 39,677 |
Income before income tax expense | 8,241 |  |  | 4,660 |  |  | 14,372 |  |  | 13,163 |
Income tax expense | 1,340 |  |  | 644 |  |  | 1,682 |  |  | 1,510 |
Net income | $ | 6,901 |  |  | $ | 4,016 |  |  | $ | 12,690 |  |  | $ | 11,653 |
Per share information: |  |  |  |  |  |  |
Basic earnings per share | $ | 0.63 |  |  | $ | 0.50 |  |  | $ | 1.25 |  |  | $ | 1.44 |
Diluted earnings per share | 0.62 |  |  | 0.49 |  |  | 1.23 |  |  | 1.41 |

The Notes to Consolidated Financial Statements are an integral part of these statements.
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Consolidated Statements of Comprehensive Income (Unaudited)
ORRSTOWN FINANCIAL SERVICES, INC.

| Three Months Ended |  |  |  | Nine Months Ended |  |
(Dollars in thousands) | September 30, 2019 |  | September 30, 2018 |  | September 30, 2019 |  | September 30, 2018
Net income | $ | 6,901 |  |  | $ | 4,016 |  |  | $ | 12,690 |  |  | $ | 11,653 |
Other comprehensive income (loss), net of tax: |  |  |  |  |  |  |
Unrealized gains (losses) on securities available for sale arising during the period | 1,400 |  |  | (3,488) |  |  | 11,880 |  |  | (9,637) |
Reclassification adjustment for gains realized in net income | (2,328) |  |  | (29) |  |  | (4,731) |  |  | (891) |
Net unrealized gains (losses) | (928) |  |  | (3,517) |  |  | 7,149 |  |  | (10,528) |
Tax effect | 195 |  |  | 738 |  |  | (1,502) |  |  | 2,211 |
Total other comprehensive income (loss), net of tax and reclassification adjustments | (733) |  |  | (2,779) |  |  | 5,647 |  |  | (8,317) |
Total comprehensive income | $ | 6,168 |  |  | $ | 1,237 |  |  | $ | 18,337 |  |  | $ | 3,336 |

The Notes to Consolidated Financial Statements are an integral part of these statements.
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Consolidated Statements of Changes in Shareholders’ Equity (Unaudited)
ORRSTOWN FINANCIAL SERVICES, INC.

| Three Months Ended September 30, 2018 |  |  |  |  |  |  |  |  |  |
(Dollars in thousands, except per share information) | Common Stock |  | Additional Paid-In Capital |  | Retained Earnings |  | Accumulated Other Comprehensive Income (Loss) |  | Treasury Stock |  | Total Shareholders’ Equity
Balance, June 30, 2018 | $ | 438 |  |  | $ | 126,402 |  |  | $ | 21,584 |  |  | $ | (2,693) |  |  | $ | (594) |  |  | $ | 145,137 |
Net income | 0 |  |  | 0 |  |  | 4,016 |  |  | 0 |  |  | 0 |  |  | 4,016 |
Total other comprehensive loss, net of taxes | 0 |  |  | 0 |  |  | 0 |  |  | (2,779) |  |  | 0 |  |  | (2,779) |
Cash dividends ($0.13 per share) | 0 |  |  | 0 |  |  | (1,071) |  |  | 0 |  |  | 0 |  |  | (1,071) |
Share-based compensation plans: |  |  |  |  |  |  |  |  |  |  |
30,321 net common shares forfeited and 15,251 net treasury shares issued, including compensation expense totaling $188 | (1) |  |  | (142) |  |  | 0 |  |  | 0 |  |  | 397 |  |  | 254 |
Balance, September 30, 2018 | $ | 437 |  |  | $ | 126,260 |  |  | $ | 24,529 |  |  | $ | (5,472) |  |  | $ | (197) |  |  | $ | 145,557 |
| Nine Months Ended September 30, 2018 |  |  |  |  |  |  |  |  |  |
(Dollars in thousands, except per share information) | Common Stock |  | Additional Paid-In Capital |  | Retained Earnings |  | Accumulated Other Comprehensive Income (Loss) |  | Treasury Stock |  | Total Shareholders’ Equity
Balance, January 1, 2018 | $ | 435 |  |  | $ | 125,458 |  |  | $ | 16,042 |  |  | $ | 2,845 |  |  | $ | (15) |  |  | $ | 144,765 |
Net income | 0 |  |  | 0 |  |  | 11,653 |  |  | 0 |  |  | 0 |  |  | 11,653 |
Total other comprehensive loss, net of taxes | 0 |  |  | 0 |  |  | 0 |  |  | (8,317) |  |  | 0 |  |  | (8,317) |
Cash dividends ($0.38 per share) | 0 |  |  | 0 |  |  | (3,166) |  |  | 0 |  |  | 0 |  |  | (3,166) |
Share-based compensation plans: |  |  |  |  |  |  |  |  |  |  |
45,302 net common shares issued and 6,714 net treasury shares acquired, including compensation expense totaling $1,112 | 2 |  |  | 802 |  |  | 0 |  |  | 0 |  |  | (182) |  |  | 622 |
Balance, September 30, 2018 | $ | 437 |  |  | $ | 126,260 |  |  | $ | 24,529 |  |  | $ | (5,472) |  |  | $ | (197) |  |  | $ | 145,557 |

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| Three Months Ended September 30, 2019 |  |  |  |  |  |  |  |  |  |
(Dollars in thousands, except per share information) | Common Stock |  | Additional Paid-In Capital |  | Retained Earnings |  | Accumulated Other Comprehensive Income (Loss) |  | Treasury Stock |  | Total Shareholders’ Equity
Balance, June 30, 2019 | $ | 584 |  |  | $ | 188,414 |  |  | $ | 27,462 |  |  | $ | 3,408 |  |  | $ | 0 |  |  | $ | 219,868 |
Net income | 0 |  |  | 0 |  |  | 6,901 |  |  | 0 |  |  | 0 |  |  | 6,901 |
Total other comprehensive loss, net of taxes | 0 |  |  | 0 |  |  | 0 |  |  | (733) |  |  | 0 |  |  | (733) |
Cash dividends ($0.15 per share) | 0 |  |  | 0 |  |  | (1,673) |  |  | 0 |  |  | 0 |  |  | (1,673) |
Share-based compensation plans: |  |  |  |  |  |  |  |  |  |  |
48,694 net common shares vested/repurchased and 45,505 net treasury shares acquired, including compensation expense totaling $475 | 0 |  |  | 168 |  |  | 0 |  |  | 0 |  |  | (1,038) |  |  | (870) |
Balance, September 30, 2019 | $ | 584 |  |  | $ | 188,582 |  |  | $ | 32,690 |  |  | $ | 2,675 |  |  | $ | (1,038) |  |  | $ | 223,493 |
| Nine Months Ended September 30, 2019 |  |  |  |  |  |  |  |  |  |
(Dollars in thousands, except per share information) | Common Stock |  | Additional Paid-In Capital |  | Retained Earnings |  | Accumulated Other Comprehensive Income (Loss) |  | Treasury Stock |  | Total Shareholders’ Equity
Balance, January 1, 2019 | $ | 491 |  |  | $ | 151,678 |  |  | $ | 24,472 |  |  | $ | (2,972) |  |  | $ | (236) |  |  | $ | 173,433 |
Net income | 0 |  |  | 0 |  |  | 12,690 |  |  | 0 |  |  | 0 |  |  | 12,690 |
Total other comprehensive loss, net of taxes | 0 |  |  | 0 |  |  | 0 |  |  | 5,647 |  |  | 0 |  |  | 5,647 |
Cash dividends ($0.45 per share) | 0 |  |  | 0 |  |  | (4,472) |  |  | 0 |  |  | 0 |  |  | (4,472) |
Issuance of stock (1,765,704 common shares) to acquire Hamilton Bancorp, Inc. | 92 |  |  | 36,530 |  |  | 0 |  |  | 0 |  |  | 0 |  |  | 36,622 |
Share-based compensation plans: |  |  |  |  |  |  |  |  |  |  |
15,845 net common shares issued and 36,474 net treasury shares acquired, including compensation expense of $1,154 | 1 |  |  | 374 |  |  | 0 |  |  | 0 |  |  | (802) |  |  | (427) |
Balance, September 30, 2019 | $ | 584 |  |  | $ | 188,582 |  |  | $ | 32,690 |  |  | $ | 2,675 |  |  | $ | (1,038) |  |  | $ | 223,493 |

The Notes to Consolidated Financial Statements are an integral part of these statements.
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Consolidated Statements of Cash Flows (Unaudited)
ORRSTOWN FINANCIAL SERVICES, INC.

| Nine Months Ended |  |
(Dollars in thousands) | September 30, 2019 |  | September 30, 2018
Cash flows from operating activities |  |  |
Net income | $ | 12,690 |  |  | $ | 11,653 |
Adjustments to reconcile net income to net cash provided by operating activities: |  |  |
Net premium amortization (discount accretion) | (1,594) |  |  | 1,356 |
Depreciation and amortization (including amortization of ROU assets) | 3,970 |  |  | 2,572 |
Provision for loan losses | 900 |  |  | 600 |
Share-based compensation | 1,154 |  |  | 1,112 |
Net gain on sales of loans originated for sale | (1,653) |  |  | (1,687) |
Mortgage loans originated for sale | (78,242) |  |  | (71,008) |
Proceeds from sales of loans originated for sale | 75,276 |  |  | 73,679 |
Gain on sale of portfolio loans | 0 |  |  | (291) |
Net gain on disposal of OREO | (8) |  |  | (111) |
Writedown of OREO | 0 |  |  | 24 |
Net loss on disposal of premises and equipment | 137 |  |  | 16 |
Deferred income taxes | 1,348 |  |  | 756 |
Investment securities gains | (4,731) |  |  | (891) |
Income from life insurance | (1,505) |  |  | (1,101) |
(Increase) decrease in accrued interest receivable | 742 |  |  | (345) |
Increase in accrued interest payable and other liabilities | (5,618) |  |  | (46) |
Other, net | 589 |  |  | (1,158) |
Net cash provided by operating activities | 3,455 |  |  | 15,130 |
Cash flows from investing activities |  |  |
Proceeds from sales of AFS securities | 199,910 |  |  | 113,180 |
Maturities, repayments and calls of AFS securities | 22,934 |  |  | 12,793 |
Purchases of AFS securities | (166,694) |  |  | (211,014) |
Net cash and cash equivalents received from acquisitions | 29,442 |  |  | 0 |
Net redemptions of restricted investments in bank stocks | 2,101 |  |  | 660 |
Net (increase) decrease in loans | 4,023 |  |  | (78,497) |
Proceeds from sales of portfolio loans | 0 |  |  | 3,589 |
Purchases of bank premises and equipment | (3,226) |  |  | (3,078) |
Proceeds from disposal of OREO | 724 |  |  | 1,260 |
Proceeds from disposal of bank premises and equipment | 0 |  |  | 7 |
Purchases of bank owned life insurance | (2,280) |  |  | (900) |
Proceeds from settlement of life insurance contracts | 571 |  |  | 576 |
Net cash provided by (used in) investing activities | 87,505 |  |  | (161,424) |
Cash flows from financing activities |  |  |
Net increase (decrease) in deposits | (23,598) |  |  | 209,655 |
Net decrease in borrowings with original maturities less than 90 days | (2,464) |  |  | (8,223) |
Payments on other short-term borrowings | (25,000) |  |  | (40,000) |
Proceeds from long-term debt | 20,000 |  |  | 0 |
Payments on long-term debt | (91,678) |  |  | (272) |
Subordinated note issuance costs | (59) |  |  | 0 |
Dividends paid | (4,472) |  |  | (3,166) |
Treasury shares repurchased for employee taxes associated with restricted stock vesting | (1,694) |  |  | (651) |
Proceeds from issuance of stock for option exercises and employee stock purchase plan | 113 |  |  | 161 |
Net cash provided by (used in) financing activities | (128,852) |  |  | 157,504 |
Net increase (decrease) in cash and cash equivalents | (37,892) |  |  | 11,210 |
Cash and cash equivalents at beginning of period | 88,815 |  |  | 29,807 |
Cash and cash equivalents at end of period | $ | 50,923 |  |  | $ | 41,017 |

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Supplemental disclosures of cash flow information: |  |  |
Cash paid during the period for: |  |  |
Interest | $ | 17,573 |  |  | $ | 8,991 |
Income taxes | 0 |  |  | 60 |
Supplemental schedule of noncash investing activities: |  |  |
OREO acquired in settlement of loans | 161 |  |  | 538 |
ROU assets obtained in exchange for lease obligations | 8,115 |  |  | 0 |

The Notes to Consolidated Financial Statements are an integral part of these statements.
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Notes to Consolidated Financial Statements (Unaudited)
NOTE 1. SUMMARY OF SIGNIFICANT ACCOUNTING POLICIES
See the Glossary of Defined Terms at the beginning of this Report for terms used throughout the consolidated financial statements and related notes of this Form 10-Q.
Nature of Operations – Orrstown Financial Services, Inc. and subsidiaries is a financial holding company that operates Orrstown Bank, a commercial bank with banking and financial advisory offices in Berks, Cumberland, Dauphin, Franklin, Lancaster, Perry and York Counties, Pennsylvania, and in Anne Arundel, Baltimore, Howard and Washington Counties, Maryland, as well as Baltimore City, Maryland and Wheatland Advisors, Inc., a registered investment advisor non-bank subsidiary, headquartered in Lancaster County, Pennsylvania. The Company operates in the community banking segment and engages in lending activities, including commercial, residential, commercial mortgages, construction, municipal, and various forms of consumer lending, and deposit services, including checking, savings, time, and money market deposits. The Company also provides fiduciary services, investment advisory, insurance and brokerage services. The Company and the Bank are subject to regulation by certain federal and state agencies and undergo periodic examinations by such regulatory authorities.
Basis of Presentation – The accompanying condensed consolidated financial statements include the accounts of Orrstown Financial Services, Inc. and its wholly owned subsidiaries, the Bank and Wheatland. The Company has prepared these unaudited condensed consolidated financial statements in accordance with GAAP for interim financial information, SEC rules that permit reduced disclosure for interim periods, and Article 10 of Regulation S-X. In the opinion of management, all adjustments (all of which are of a normal recurring nature) that are necessary for a fair statement are reflected in the unaudited condensed consolidated financial statements. The December 31, 2018 consolidated balance sheet information contained in this Quarterly Report on Form 10-Q was derived from the 2018 audited consolidated financial statements. Interim results are not necessarily indicative of results for a full year. The unaudited condensed consolidated financial statements should be read in conjunction with the audited consolidated financial statements, including the notes thereto, included in the Company’s Annual Report on Form 10-K for the year ended December 31, 2018. Operating results for the three and nine months ended September 30, 2019 are not necessarily indicative of the results that may be expected for the year ending December 31, 2019. All significant intercompany transactions and accounts have been eliminated. Certain reclassifications may have been made to prior year amounts to conform with current year classifications.
The Company's management has evaluated all activity of the Company and concluded that subsequent events are properly reflected in the Company's consolidated financial statements and notes as required by GAAP.
The preparation of financial statements in conformity with GAAP requires management to make estimates and assumptions that affect the reported amounts of assets and liabilities and disclosure of contingent assets and liabilities as of the date of the financial statements and the reported amounts of revenues and expenses during the reporting periods. Actual results could differ from those estimates. Material estimates that are particularly susceptible to significant change include the determination of the ALL and those used in valuation methodologies in areas with no observable market, such as loans, deposits, borrowings, goodwill, core deposit and other intangible assets, other assets and liabilities obtained or assumed in business combinations.
Leases - We evaluate our contracts at inception to determine if an arrangement is or contains a lease. Operating leases are included in operating lease ROU assets in Other assets and operating lease liabilities in Accrued interest payable and other liabilities in our consolidated balance sheets. The Company has no finance leases.
ROU assets represent our right to use an underlying asset for the lease term, and lease liabilities represent our obligation to make lease payments arising from the lease. Operating lease ROU assets and liabilities are recognized at commencement date based on the present value of lease payments over the lease term. Our leases do not provide an implicit rate, so we use our incremental borrowing rate, which approximates our fully collateralized borrowing rate, based on the information available at commencement date in determining the present value of lease payments. The incremental borrowing rate is reevaluated upon lease modification. The operating lease ROU asset also includes any initial direct costs and prepaid lease payments made less any lease incentives. Our lease terms may include options to extend or terminate the lease when it is reasonably certain that we will exercise that option.
We adopted ASU 2016-02, “Leases (Topic 842),” on January 1, 2019, the effective date of the guidance, using the practical expedient transition method whereby we did not revise comparative period information or disclosure. The new standard requires lessees to record assets and liabilities on the balance sheet for all leases with terms longer than 12 months. We elected the package of practical expedients permitted under the transition guidance within the new standard, which among other things, allows us to carryforward the historical lease classification. We also elected certain optional practical expedients,
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including the hindsight practical expedient under which we considered the actual outcomes of lease renewals and terminations when measuring the lease term at adoption, and we made an accounting policy election to keep leases with an initial term of 12 months or less off of the balance sheet. We recognize these lease payments in the consolidated statements of income on a straight-line basis over the lease term. We have lease agreements with lease and non-lease components, and we have elected the practical expedient to account for these as a single lease component.
Our operating leases relate primarily to bank branches and office space. In conjunction with the adoption on January 1, 2019, we recognized operating lease liabilities of $7,971,000 and related lease assets of $7,494,000 on our balance sheet. The difference between the lease assets and lease liabilities primarily consists of deferred rent liabilities reclassified upon adoption to reduce the measurement of the lease assets. The standard did not materially impact our consolidated net income and had no impact on cash flows.
Recent Accounting Pronouncements - ASU No. 2016-13, Financial Instruments - Credit Losses (Topic 326): Measurement of Credit Losses on Financial Instruments. The amendments in this update require an organization to measure 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 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. Organizations will continue to use judgment to determine which loss estimation method is appropriate for their circumstances. Additionally, the amendments in this update amend the accounting for credit losses on available-for-sale debt securities and purchased financial assets with credit deterioration. For certain public companies, this update will be effective for interim and annual periods beginning after December 15, 2019. On October 16, 2019, the FASB extended the implementation deadline for smaller reporting and other companies until the fiscal year and interim periods beginning after December 15, 2022. The Company currently meets the requirements to be considered a smaller reporting company under SEC Regulation S-K and SEC Rule 405, and, pending the issuance of a final pronouncement, is evaluating the impact of the delay for adoption of the update.
We are working with a third party vendor solution to assist with the application of ASU 2016-13 and finalizing the loss estimation models to be used. Once management determines which methods will be utilized, a third party will be contracted to perform a model validation prior to adoption. While we anticipate the allowance for loan losses will increase under our current assumptions, we expect the impact of adopting ASU 2016-13 will be influenced by the composition, characteristics and quality of our loan and securities portfolios, as well as general economic conditions and forecasts at the adoption date.
ASU 2017-04, Intangibles - Goodwill and Other (Topic 350): Simplifying the Test for Goodwill Impairment. The update simplifies how all entities assess goodwill for impairment by eliminating Step 2 from the goodwill impairment test. As amended, the goodwill impairment test will consist of one step comparing the fair value of a reporting unit with its carrying amount. An entity should recognize a goodwill impairment charge for the amount by which the carrying amount exceeds the reporting unit’s fair value. ASU 2017-04 will be effective for the Company on January 1, 2020, with earlier adoption permitted, and is not expected to have a material impact on the Company's consolidated financial statements.
ASU 2017-08, Receivables - Nonrefundable Fees and Other Costs (Subtopic 310-20). The update shortens the amortization period of certain callable debt securities held at a premium to the earliest call date unless applicable guidance related to certain pools of securities is applied to consider estimated prepayments. Under prior guidance, entities were generally required to amortize premiums on individual, non-pooled callable debt securities as a yield adjustment over the contractual life of the security. ASU 2017-08 does not change the accounting for callable debt securities held at a discount. On January 1, 2019, we adopted ASU 2016-18 with no material impact on our consolidated financial condition or results of operations.
In August 2018, the SEC adopted the final rule under SEC Release No. 33-10532, Disclosure Update and Simplification, amending certain disclosure requirements. In addition, the amendments expanded the disclosure requirements on the analysis of stockholders' equity for interim financial statements. Under the amendments, an analysis of changes in each caption of stockholders' equity presented in the balance sheet must be provided in a note or separate statement and should present a reconciliation of the beginning balance to the ending balance for each period for which a statement of comprehensive income is presented. The Company implemented the additional disclosure requirements effective with the filing of its March 31, 2019 Form 10-Q.
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NOTE 2. MERGERS AND ACQUISITIONS
Mercersburg Financial Corporation
On October 1, 2018, we acquired 100% of the outstanding common shares of Mercersburg Financial Corporation and its wholly-owned subsidiary, First Community Bank of Mercersburg, headquartered in Mercersburg, Pennsylvania. We issued 1,052,635 shares of our common stock and paid $4,866,000 in cash for all outstanding shares of Mercersburg stock. Based on our $23.80 closing stock price on Friday, September 28, 2018, the consideration paid to acquire Mercersburg totaled $29,919,000.
The fair value of assets acquired, excluding goodwill, totaled $181,430,000, including loans totaling $141,103,000 and investment securities available for sale totaling $7,352,000. The fair value of liabilities assumed totaled $163,384,000, including deposits totaling $160,433,000. The Company recognized $11,873,000 in initial goodwill, representing consideration transferred in excess of the fair value of the net assets acquired in the Mercersburg acquisition. The goodwill resulting from the acquisition represents the value expected from the expansion of our market in south central Pennsylvania and the enhancement of our operations through customer synergies and efficiencies, thereby providing enhanced customer service.
The Mercersburg acquisition was accounted for using the acquisition method of accounting and, accordingly, purchased assets, including identifiable intangible assets, and assumed liabilities were recorded at their respective acquisition date fair values. The fair value measurements of assets acquired and liabilities assumed were subject to refinement for up to one year after the closing date of the acquisition as additional information relative to closing date fair values became available. No material measurement period adjustments were made in the nine months ended September 30, 2019. The results of operations for the Company include Mercersburg's results from and after October 1, 2018.
Hamilton Bancorp, Inc.
On May 1, 2019, we acquired 100% of the outstanding common shares of Hamilton Bancorp, Inc., and its wholly-owned subsidiary, Hamilton Bank, based in Towson, Maryland. We acquired Hamilton to introduce our banking and financial services into the Greater Baltimore area of Maryland.
Pursuant to the merger agreement, we issued 1,765,704 shares of our common stock and paid $14,197,000 in cash for all outstanding shares of Hamilton stock and options vesting upon acquisition. Based on our closing stock price of $20.74 on Tuesday, April 30, 2019, the consideration paid to acquire Hamilton totaled approximately $50,819,000.
The fair value of assets acquired, excluding goodwill, totaled $492,844,000, including loans totaling $347,361,000. The fair value of liabilities assumed totaled $449,358,000, including deposits totaling $388,246,000. Goodwill represents consideration transferred in excess of the fair value of the net assets acquired. At May 1, 2019, the Company recognized $7,333,000 in goodwill associated with the Hamilton acquisition. The goodwill resulting from the acquisition represents the value expected from the expansion of our market in the Greater Baltimore area and the enhancement of our operations through customer synergies and efficiencies, thereby providing enhanced customer service. Goodwill acquired in the Hamilton acquisition is not deductible for tax purposes.
The Hamilton acquisition was accounted for using the acquisition method of accounting and, accordingly, purchased assets, including identifiable intangible assets, and assumed liabilities were recorded at their respective acquisition date fair values. The fair value measurements of assets acquired and liabilities assumed are subject to refinement for up to one year after the closing date of the acquisition as additional information relative to closing date fair values become available. The Company continues to finalize the fair values of loans, intangible assets, other assets, income taxes and liabilities. As a result, the fair value adjustments are preliminary and may change as information becomes available. Fair value adjustments will be finalized no later than May 2020. No material measurement period adjustments were made from the date of acquisition through
September 30, 2019. The results of operations for the Company include Hamilton's results from and after May 1, 2019.
The following table summarizes the consideration paid for Hamilton and the estimated fair values of the assets acquired and liabilities assumed recognized at the acquisition date:
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(Dollars in thousands) |  |
Fair value of consideration transferred: |  |
Cash |  | $ | 14,197 |
Common stock issued |  | 36,622 |
Total consideration transferred |  | $ | 50,819 |
Estimated fair values of assets acquired and (liabilities) assumed: |  |
Cash and cash equivalents |  | $ | 43,140 |
Securities available for sale |  | 60,882 |
Restricted investments in bank stocks |  | 2,658 |
Loans |  | 347,361 |
Premises and equipment |  | 3,749 |
Core deposit intangible |  | 4,550 |
Goodwill |  | 7,333 |
Cash surrender value of life insurance |  | 17,948 |
Deferred tax asset, net |  | 5,838 |
ROU lease asset |  | 2,793 |
Other assets |  | 3,925 |
Total assets acquired |  | 500,177 |
Deposits |  | (388,246) |
Borrowings |  | (51,393) |
Other liabilities |  | (9,719) |
Total liabilities assumed |  | (449,358) |
|  | $ | 50,819 |

The determination of estimated fair values of the acquired loans required the Company to make certain estimates about discount rates, future expected cash flows, market conditions and other future events that are highly subjective in nature. Based on such factors as past due status, nonaccrual status, bankruptcy status, and credit risk ratings, the acquired loans were divided into loans with evidence of credit quality deterioration, which are accounted for under ASC 310-30 (purchased credit impaired), and loans that do not meet this criteria, which are accounted for under ASC 310-20 (purchased non-impaired). Expected cash flows, both principal and interest, were estimated based on key assumptions covering such factors as prepayments, default rates and severity of loss given default. These assumptions were developed using both Hamilton's historical experience and the portfolio characteristics as of the acquisition date as well as available market research. The fair value estimates for acquired loans were based on the amount and timing of expected principal, interest and other cash flows, including expected prepayments, discounted at prevailing market interest rates applicable to the types of acquired loans, which we considered to be level 3 fair value measurements. Deposit liabilities assumed in the Hamilton acquisition were segregated into two categories: time-deposits (i.e., deposit accounts with a stated maturity) and demand deposits, both using level 2 fair value measurements. In determining fair value of time deposits, the Company discounted the contractual cash flows of the deposit accounts using prevailing market interest rates for time deposit accounts of similar type and duration. For demand deposits, the acquisition date outstanding balance of the assumed demand deposit accounts approximates fair value. Acquisition date fair values for securities available for sale were determined using Level 1 or Level 2 inputs consistent with the methods discussed further in “Note 12 - Fair Value.” The remaining acquisition date fair values represent either Level 2 fair value measurements or Level 3 fair value measurements (premises and equipment and core deposit intangible).
We recognized a core deposit intangible of $4,550,000, which will be amortized using an accelerated method over a 10-year amortization period, consistent with expected future cash flows.
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Loans acquired with Hamilton were measured at fair value at the acquisition date with no carryover of any ALL. Loans were segregated into those loans considered to be performing and those considered PCI. The following table presents performing and PCI loans acquired, by loan class, at May 1, 2019.
Upon completion of the acquisition, the Company sold the acquired investment portfolio and paid off acquired borrowings at the indicated fair value amounts in conjunction with its asset/liability management strategies.

(in thousands) | Performing |  | PCI |  | Total
Commercial real estate: |  |  |  |  |
Owner-occupied | $ | 42,148 |  |  | $ | 6,324 |  |  | $ | 48,472 |
Non-owner occupied | 45,401 |  |  | 770 |  |  | 46,171 |
Multi-family | 10,773 |  |  | 0 |  |  | 10,773 |
Acquisition and development: |  |  |  |  |
1-4 family residential construction | 7,450 |  |  | 0 |  |  | 7,450 |
Commercial and land development | 4,528 |  |  | 0 |  |  | 4,528 |
Commercial and industrial | 32,316 |  |  | 1,702 |  |  | 34,018 |
Residential mortgage: |  |  |  |  |
First lien | 152,657 |  |  | 10,494 |  |  | 163,151 |
Home-equity - term | 4,478 |  |  | 1 |  |  | 4,479 |
Home equity - lines of credit | 13,657 |  |  | 0 |  |  | 13,657 |
Installment and other loans | 14,467 |  |  | 195 |  |  | 14,662 |
Total loans acquired | $ | 327,875 |  |  | $ | 19,486 |  |  | $ | 347,361 |

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

(in thousands) |
Gross amortized cost basis at acquisition | $ | 362,125 |
Market rate adjustment | (5,309) |
Credit fair value adjustment on non-credit impaired loans | (3,947) |
Credit fair value adjustment on PCI loans | (5,508) |
Estimated fair value of acquired loans | $ | 347,361 |

The market rate adjustment represents the movement in market interest rates, irrespective of credit adjustments, compared to the contractual rates of the acquired loans. The credit fair value adjustment made on non-credit impaired loans represents the changes in credit quality of the underlying borrowers from loan inception to the acquisition date. The credit fair value adjustment on PCI loans is derived in accordance with ASC 310-30 and represents the portion of the loan balance that has been deemed uncollectible based on our expectations of future cash flows for each respective loan.
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The following table provides information about acquired PCI loans at May 1, 2019.

(in thousands) |
Contractually required principal and interest at acquisition | $ | 31,599 |
Nonaccretable difference | (8,616) |
Expected cash flows at acquisition | 22,983 |
Accretable yield | (3,497) |
Estimated fair value of acquired PCI loans | $ | 19,486 |

Unaudited pro forma net income for the three and nine months ended September 30, 2018, would have totaled $4,353,000 and $6,869,000, and revenues would have totaled $28,862,000 and $87,557,000 for the same periods had the Mercersburg and Hamilton acquisitions occurred January 1, 2018. Unaudited pro forma net income for the three and nine months ended September 30, 2019, would have totaled $7,566,000 and $13,355,000, and revenues would have totaled $38,675,000 and $95,714,000 for the same periods had the Hamilton acquisition occurred January 1, 2019.
In connection with the Mercersburg and Hamilton acquisitions, we incurred merger related expenses totaling $471,000 and $7,976,000 for the three and nine months ended September 30, 2019, which are included in noninterest expenses. The expenses consisted primarily of $0 and $1,967,000 of investment banking, legal and consulting fees; $236,000 and $3,855,000 of information systems expense, including canceling of contracts; and $235,000 and $2,154,000 of other expenses, including payout of employee termination contracts.
NOTE 3. SECURITIES AVAILABLE FOR SALE
At September 30, 2019 and December 31, 2018, all investment securities were classified as AFS. The following table summarizes amortized cost and fair value of AFS securities, and the corresponding amounts of gross unrealized gains and losses recognized in AOCI, at September 30, 2019 and December 31, 2018.

(Dollars in thousands) | Amortized Cost |  | Gross Unrealized Gains |  | Gross Unrealized Losses |  | Fair Value
September 30, 2019 |  |  |  |  |  |  |
States and political subdivisions | $ | 77,553 |  |  | $ | 5,159 |  |  | $ | 0 |  |  | $ | 82,712 |
GSE residential CMOs | 70,214 |  |  | 1,142 |  |  | 355 |  |  | 71,001 |
Private label commercial CMOs | 87,848 |  |  | 146 |  |  | 227 |  |  | 87,767 |
Asset-backed and other | 242,119 |  |  | 153 |  |  | 2,632 |  |  | 239,640 |
Totals | $ | 477,734 |  |  | $ | 6,600 |  |  | $ | 3,214 |  |  | $ | 481,120 |
December 31, 2018 |  |  |  |  |  |  |
States and political subdivisions | $ | 144,596 |  |  | $ | 1,919 |  |  | $ | 1,511 |  |  | $ | 145,004 |
GSE residential CMOs | 110,421 |  |  | 332 |  |  | 2,689 |  |  | 108,064 |
Private label residential CMOs | 144 |  |  | 0 |  |  | 1 |  |  | 143 |
Private label commercial CMOs | 75,911 |  |  | 55 |  |  | 921 |  |  | 75,045 |
Asset-backed and other | 138,535 |  |  | 126 |  |  | 1,073 |  |  | 137,588 |
Totals | $ | 469,607 |  |  | $ | 2,432 |  |  | $ | 6,195 |  |  | $ | 465,844 |

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

| Less Than 12 Months |  |  |  |  |  | 12 Months or More |  |  |  |  |  | Total |  |  |  |
(Dollars in thousands) | # of Securities |  | Fair Value |  | Unrealized Losses |  | # of Securities |  | Fair Value |  | Unrealized Losses |  | # of Securities |  | Fair Value |  | Unrealized Losses
September 30, 2019 |  |  |  |  |  |  |  |  |  |  |  |  |  |  |  |  |
GSE residential CMOs | 3 |  | 27,100 |  |  | 45 |  |  | 1 |  | 12,147 |  |  | 310 |  |  | 4 |  | 39,247 |  |  | 355 |
Private label commercial CMOs | 7 |  | 33,093 |  |  | 71 |  |  | 6 |  | 34,644 |  |  | 156 |  |  | 13 |  | 67,737 |  |  | 227 |
Asset-backed and other | 15 |  | 176,324 |  |  | 2,258 |  |  | 2 |  | 18,324 |  |  | 374 |  |  | 17 |  | 194,648 |  |  | 2,632 |
Totals | 25 |  | $ | 236,517 |  |  | $ | 2,374 |  |  | 9 |  | $ | 65,115 |  |  | $ | 840 |  |  | 34 |  | $ | 301,632 |  |  | $ | 3,214 |
December 31, 2018 |  |  |  |  |  |  |  |  |  |  |  |  |  |  |  |  |
States and political subdivisions | 27 |  | $ | 46,585 |  |  | $ | 662 |  |  | 6 |  | $ | 23,036 |  |  | $ | 849 |  |  | 33 |  | $ | 69,621 |  |  | $ | 1,511 |
GSE residential CMOs | 1 |  | 18,037 |  |  | 122 |  |  | 7 |  | 46,168 |  |  | 2,567 |  |  | 8 |  | 64,205 |  |  | 2,689 |
Private label residential CMOs | 1 |  | 143 |  |  | 1 |  |  | 0 |  | 0 |  |  | 0 |  |  | 1 |  | 143 |  |  | 1 |
Private label commercial CMOs | 11 |  | 56,499 |  |  | 712 |  |  | 2 |  | 6,349 |  |  | 209 |  |  | 13 |  | 62,848 |  |  | 921 |
Asset-backed and other | 6 |  | 78,900 |  |  | 859 |  |  | 3 |  | 10,808 |  |  | 214 |  |  | 9 |  | 89,708 |  |  | 1,073 |
Totals | 46 |  | $ | 200,164 |  |  | $ | 2,356 |  |  | 18 |  | $ | 86,361 |  |  | $ | 3,839 |  |  | 64 |  | $ | 286,525 |  |  | $ | 6,195 |

States and Political Subdivisions. The unrealized losses presented in the table above have been caused by a widening of spreads and/or a rise in interest rates from the time these securities were purchased. Management considers the investment rating, the state of the issuer of the security and other credit support in determining whether the security is OTTI. Because the Company does not intend to sell these securities and it is not more likely than not that the Company will be required to sell them before recovery of their amortized cost basis, which may be maturity, the Company does not consider these securities to be OTTI at December 31, 2018.
GSE Residential CMOs. The unrealized losses presented in the table above have been caused by a widening of spreads and/or a rise in interest rates from the time these securities were purchased. The contractual terms of these securities do not permit the issuer to settle the securities at a price less than its par value basis. Because the Company does not intend to sell these securities and it is not more likely than not that the Company will be required to sell them before recovery of their amortized cost basis, which may be maturity, the Company does not consider these securities to be OTTI at September 30, 2019 or at December 31, 2018.
Private Label Residential CMOs, Private Label Commercial CMOs and Asset-backed and Other. The unrealized losses presented in the table above have been caused by a widening of spreads and/or a rise in interest rates from the time the securities were purchased. Because the Company does not intend to sell these securities and it is not more likely than not that the Company will be required to sell them before recovery of their amortized cost basis, which may be maturity, the Company does not consider these securities to be OTTI at September 30, 2019 or at December 31, 2018.
The following table summarizes amortized cost and fair value of AFS securities by contractual maturity at September 30, 2019. Expected maturities may differ from contractual maturities if borrowers have the right to call or prepay obligations with or without call or prepayment penalties. Securities not due at a single maturity date are shown separately.

| Available for Sale |  |
(Dollars in thousands) | Amortized Cost |  | Fair Value
Due in one year or less | $ | 230 |  |  | $ | 230 |
Due after one year through five years | 0 |  |  | 0 |
Due after five years through ten years | 26,456 |  |  | 27,952 |
Due after ten years | 50,867 |  |  | 54,530 |
CMOs | 158,062 |  |  | 158,768 |
Asset-backed and other | 242,119 |  |  | 239,640 |
| $ | 477,734 |  |  | $ | 481,120 |

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The following table summarizes proceeds from sales of AFS securities and gross gains and gross losses for the three and nine months ended September 30, 2019 and 2018.

| Three months ended September 30, |  |  |  | Nine months ended September 30, |  |
(Dollars in thousands) | 2019 |  | 2018 |  | 2019 |  | 2018
Proceeds from sale of AFS securities | $ | 25,575 |  |  | $ | 25,070 |  |  | $ | 199,910 |  |  | $ | 113,180 |
Gross gains | 2,328 |  |  | 185 |  |  | 4,956 |  |  | 1,237 |
Gross losses | 0 |  |  | 156 |  |  | 225 |  |  | 346 |

AFS securities with a fair value of $161,627,000 and $164,233,000 at September 30, 2019 and December 31, 2018 were pledged to secure public funds and for other purposes as required or permitted by law.
NOTE 4. LOANS AND ALLOWANCE FOR LOAN LOSSES
The Company’s loan portfolio is grouped into classes to allow management to monitor the performance by the borrower and to monitor the yield on the portfolio. Consistent with ASU 2010-20, Disclosures about the Credit Quality of Financing Receivables and the Allowance for Loan Losses, the segments are further broken down into classes to allow for differing risk characteristics within a segment.
The risks associated with lending activities differ among the various loan classes and are subject to the impact of changes in interest rates, market conditions of collateral securing the loans, and general economic conditions. All of these factors may adversely impact both the borrower’s ability to repay its loans and associated collateral.
The Company has various types of commercial real estate loans, which have differing levels of credit risk. Owner occupied commercial real estate loans are generally dependent upon the successful operation of the borrower’s business, with the cash flows generated from the business being the primary source of repayment of the loan. If the business suffers a downturn in sales or profitability, the borrower’s ability to repay the loan could be in jeopardy.
Non-owner occupied and multi-family commercial real estate loans and non-owner occupied residential loans present a different credit risk to the Company than owner occupied commercial real estate loans, as the repayment of the loan is dependent upon the borrower’s ability to generate a sufficient level of occupancy to produce rental income that exceeds debt service requirements and operating expenses. Lower occupancy or lease rates may result in a reduction in cash flows, which hinders the ability of the borrower to meet debt service requirements, and may result in lower collateral values. The Company generally recognizes that greater risk is inherent in these credit relationships as compared to owner occupied loans mentioned above.
Acquisition and development loans consist of 1-4 family residential construction and commercial and land development loans. The risk of loss on these loans is largely dependent on the Company’s ability to assess the property’s value at the completion of the project, which should exceed the property’s construction costs. During the construction phase, a number of factors could potentially negatively impact the collateral value, including cost overruns, delays in completing the project, competition, and real estate market conditions which may change based on the supply of similar properties in the area. In the event the collateral value at the completion of the project is not sufficient to cover the outstanding loan balance, the Company must rely upon other repayment sources, including, if any, the guarantors of the project or other collateral securing the loan.
Commercial and industrial loans include advances to local and regional businesses for general commercial purposes and include permanent and short-term working capital, machinery and equipment financing, and may be either in the form of lines of credit or term loans. Although commercial and industrial loans may be unsecured to our highest-rated borrowers, the majority of these loans are secured by the borrower’s accounts receivable, inventory and machinery and equipment. In a significant number of these loans, the collateral also includes the business real estate or the business owner’s personal real estate or assets. Commercial and industrial loans present credit exposure to the Company, as they are more susceptible to risk of loss during a downturn in the economy as borrowers may have greater difficulty in meeting their debt service requirements and the value of the collateral may decline. The Company attempts to mitigate this risk through its underwriting standards, including evaluating the creditworthiness of the borrower and, to the extent available, credit ratings on the business. Additionally, monitoring of the loans through annual renewals and meetings with the borrowers are typical. However, these procedures cannot eliminate the risk of loss associated with commercial and industrial lending.
Municipal loans consist of extensions of credit to municipalities and school districts within the Company’s market area. These loans generally present a lower risk than commercial and industrial loans, as they are generally secured by the municipality’s full taxing authority, by revenue obligations, or by its ability to raise assessments on its customers for a specific utility.
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The Company originates loans to its retail customers, including fixed-rate and adjustable first lien mortgage loans with the underlying 1-4 family owner occupied residential property securing the loan. The Company’s risk exposure is minimized in these types of loans through the evaluation of the creditworthiness of the borrower, including credit scores and debt-to-income ratios, and underwriting standards which limit the loan-to-value ratio to generally no more than 80% upon loan origination, unless the borrower obtains private mortgage insurance.
Home equity loans, including term loans and lines of credit, present a slightly higher risk to the Company than 1-4 family first liens, as these loans can be first or second liens on 1-4 family owner occupied residential property, but can have loan-to-value ratios of no greater than 90% of the value of the real estate taken as collateral. The creditworthiness of the borrower is considered including credit scores and debt-to-income ratios.
Installment and other loans’ credit risk are mitigated through prudent underwriting standards, including evaluation of the creditworthiness of the borrower through credit scores and debt-to-income ratios and, if secured, the collateral value of the assets. These loans can be unsecured or secured by assets the value of which may depreciate quickly or may fluctuate, and may present a greater risk to the Company than 1-4 family residential loans.
The following table presents the loan portfolio by segment and class, excluding residential LHFS, at September 30, 2019 and December 31, 2018.

(Dollars in thousands) | September 30, 2019 |  | December 31, 2018
Commercial real estate: |  |  |
Owner occupied | $ | 171,327 |  |  | $ | 129,650 |
Non-owner occupied | 310,334 |  |  | 252,794 |
Multi-family | 108,751 |  |  | 78,933 |
Non-owner occupied residential | 120,395 |  |  | 100,367 |
Acquisition and development: |  |  |
1-4 family residential construction | 12,257 |  |  | 7,385 |
Commercial and land development | 38,494 |  |  | 42,051 |
Commercial and industrial | 215,734 |  |  | 160,964 |
Municipal | 47,920 |  |  | 50,982 |
Residential mortgage: |  |  |
First lien | 353,811 |  |  | 235,296 |
Home equity - term | 15,175 |  |  | 12,208 |
Home equity - lines of credit | 159,930 |  |  | 143,616 |
Installment and other loans | 38,977 |  |  | 33,411 |
Total Loans (1) | $ | 1,593,105 |  |  | $ | 1,247,657 |

(1) Includes $425,940,000 and $135,009,000 of acquired loans at September 30, 2019 and December 31, 2018.
In order to monitor ongoing risk associated with its loan portfolio and specific loans within the segments, management uses an internal grading system. The first several rating categories, representing the lowest risk to the Bank, are combined and given a “Pass” rating. Management generally follows regulatory definitions in assigning criticized ratings to loans, including "Special Mention," "Substandard," "Doubtful" or "Loss." The Special Mention category includes loans that have potential weaknesses that may, if not monitored or corrected, weaken the asset or inadequately protect the Bank's position at some future date. These assets pose elevated risk, but their weakness does not yet justify a more severe, or classified rating. Substandard loans are classified as they have a well-defined weakness, or weaknesses that jeopardize liquidation of the debt. These loans are characterized by the distinct possibility that the Bank will sustain some loss if the deficiencies are not corrected. Substandard loans include loans that management has determined not to be impaired, as well as loans considered to be impaired. A Doubtful loan has a high probability of total or substantial loss, but because of specific pending events that may strengthen the asset, its classification as Loss is deferred. Loss loans are considered uncollectible, as the borrowers are often in bankruptcy, have suspended debt repayments, or have ceased business operations. Once a loan is classified as Loss, there is little prospect of collecting the loan’s principal or interest and it is charged-off.
The Company has a loan review policy and program which is designed to identify and monitor risk in the lending function. The ERM Committee, comprised of executive officers and loan department personnel, is charged with the oversight of overall credit quality and risk exposure of the Company's loan portfolio. This includes the monitoring of the lending activities of all Company personnel with respect to underwriting and processing new loans and the timely follow-up and corrective action for loans showing signs of deterioration in quality. A loan review program provides the Company with an independent review
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of the commercial loan portfolio on an ongoing basis. Generally, consumer and residential mortgage loans are included in the Pass categories unless a specific action, such as extended delinquencies, bankruptcy, repossession or death of the borrower occurs, which heightens awareness as to a possible credit event.
Internal loan reviews are completed annually on all commercial relationships with a committed loan balance in excess of $500,000, which includes confirmation of risk rating by an independent credit officer. Credit Administration also reviews loans in excess of $1,000,000. In addition, all commercial relationships greater than $250,000 rated Substandard, Doubtful or Loss are reviewed quarterly and corresponding risk ratings are reaffirmed by the Company's Problem Loan Committee, with subsequent reporting to the ERM Committee.
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The following table summarizes the Company’s loan portfolio ratings based on its internal risk rating system at September 30, 2019 and December 31, 2018.

(Dollars in thousands) | Pass |  | Special Mention |  | Non-Impaired Substandard |  | Impaired - Substandard |  | Doubtful |  | PCI Loans |  | Total
September 30, 2019 |  |  |  |  |  |  |  |  |  |  |  |  |
Commercial real estate: |  |  |  |  |  |  |  |  |  |  |  |  |
Owner occupied | $ | 153,327 |  |  | $ | 5,750 |  |  | $ | 2,664 |  |  | $ | 3,324 |  |  | $ | 0 |  |  | $ | 6,262 |  |  | $ | 171,327 |
Non-owner occupied | 298,268 |  |  | 10,685 |  |  | 0 |  |  | 0 |  |  | 0 |  |  | 1,381 |  |  | 310,334 |
Multi-family | 101,479 |  |  | 5,537 |  |  | 940 |  |  | 105 |  |  | 0 |  |  | 690 |  |  | 108,751 |
Non-owner occupied residential | 113,248 |  |  | 3,139 |  |  | 1,246 |  |  | 137 |  |  | 0 |  |  | 2,625 |  |  | 120,395 |
Acquisition and development: |  |  |  |  |  |  |  |  |  |  |  |  |
1-4 family residential construction | 12,004 |  |  | 253 |  |  | 0 |  |  | 0 |  |  | 0 |  |  | 0 |  |  | 12,257 |
Commercial and land development | 37,582 |  |  | 348 |  |  | 564 |  |  | 0 |  |  | 0 |  |  | 0 |  |  | 38,494 |
Commercial and industrial | 198,348 |  |  | 2,316 |  |  | 10,101 |  |  | 1,089 |  |  | 0 |  |  | 3,880 |  |  | 215,734 |
Municipal | 47,920 |  |  | 0 |  |  | 0 |  |  | 0 |  |  | 0 |  |  | 0 |  |  | 47,920 |
Residential mortgage: |  |  |  |  |  |  |  |  |  |  |  |  |
First lien | 340,619 |  |  | 713 |  |  | 0 |  |  | 2,547 |  |  | 0 |  |  | 9,932 |  |  | 353,811 |
Home equity - term | 15,068 |  |  | 76 |  |  | 0 |  |  | 11 |  |  | 0 |  |  | 20 |  |  | 15,175 |
Home equity - lines of credit | 159,063 |  |  | 75 |  |  | 39 |  |  | 753 |  |  | 0 |  |  | 0 |  |  | 159,930 |
Installment and other loans | 38,715 |  |  | 0 |  |  | 0 |  |  | 7 |  |  | 0 |  |  | 255 |  |  | 38,977 |
| $ | 1,515,641 |  |  | $ | 28,892 |  |  | $ | 15,554 |  |  | $ | 7,973 |  |  | $ | 0 |  |  | $ | 25,045 |  |  | $ | 1,593,105 |
December 31, 2018 |  |  |  |  |  |  |  |  |  |  |  |  |
Commercial real estate: |  |  |  |  |  |  |  |  |  |  |  |  |
Owner occupied | $ | 121,903 |  |  | $ | 3,024 |  |  | $ | 987 |  |  | $ | 1,880 |  |  | $ | 0 |  |  | $ | 1,856 |  |  | $ | 129,650 |
Non-owner occupied | 242,136 |  |  | 10,008 |  |  | 0 |  |  | 0 |  |  | 0 |  |  | 650 |  |  | 252,794 |
Multi-family | 71,482 |  |  | 5,886 |  |  | 717 |  |  | 131 |  |  | 0 |  |  | 717 |  |  | 78,933 |
Non-owner occupied residential | 97,590 |  |  | 736 |  |  | 1,197 |  |  | 309 |  |  | 0 |  |  | 535 |  |  | 100,367 |
Acquisition and development: |  |  |  |  |  |  |  |  |  |  |  |  |
1-4 family residential construction | 7,385 |  |  | 0 |  |  | 0 |  |  | 0 |  |  | 0 |  |  | 0 |  |  | 7,385 |
Commercial and land development | 41,251 |  |  | 25 |  |  | 583 |  |  | 0 |  |  | 0 |  |  | 192 |  |  | 42,051 |
Commercial and industrial | 150,286 |  |  | 2,278 |  |  | 2,940 |  |  | 286 |  |  | 0 |  |  | 5,174 |  |  | 160,964 |
Municipal | 50,982 |  |  | 0 |  |  | 0 |  |  | 0 |  |  | 0 |  |  | 0 |  |  | 50,982 |
Residential mortgage: |  |  |  |  |  |  |  |  |  |  |  |  |
First lien | 229,971 |  |  | 0 |  |  | 0 |  |  | 2,877 |  |  | 0 |  |  | 2,448 |  |  | 235,296 |
Home equity - term | 12,170 |  |  | 0 |  |  | 0 |  |  | 16 |  |  | 0 |  |  | 22 |  |  | 12,208 |
Home equity - lines of credit | 142,638 |  |  | 165 |  |  | 15 |  |  | 798 |  |  | 0 |  |  | 0 |  |  | 143,616 |
Installment and other loans | 33,229 |  |  | 15 |  |  | 1 |  |  | 0 |  |  | 0 |  |  | 166 |  |  | 33,411 |
| $ | 1,201,023 |  |  | $ | 22,137 |  |  | $ | 6,440 |  |  | $ | 6,297 |  |  | $ | 0 |  |  | $ | 11,760 |  |  | $ | 1,247,657 |

For commercial real estate, acquisition and development and commercial and industrial loans, a loan is considered impaired when, based on current information and events, it is probable that the Company will be unable to collect the scheduled payments of principal or interest when due according to the contractual terms of the loan agreement. Factors considered by
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management in determining impairment include payment status, collateral value, and the probability of collecting scheduled principal and interest payments when due. Loans that experience insignificant payment delays and payment shortfalls generally are not classified as impaired. Generally, loans that are more than 90 days past due are deemed impaired. Management determines the significance of payment delays and payment shortfalls on a case-by-case basis, taking into consideration all of the circumstances surrounding the loan and the borrower, including the length of the delay, the reasons for the delay, the borrower’s prior payment record, and the amount of the shortfall in relation to the principal and interest owed to determine if the loan should be placed on nonaccrual status. Nonaccrual loans in the commercial and commercial real estate portfolios and any TDRs are, by definition, deemed to be impaired. Impairment is measured on a loan-by-loan basis for commercial, construction and restructured loans by either the present value of the expected future cash flows discounted at the loan’s effective interest rate, the loan’s obtainable market price, or the fair value of the collateral if the loan is collateral dependent. A loan is collateral dependent if the repayment of the loan is expected to be provided solely by the underlying collateral. For loans that are deemed to be impaired for extended periods of time, periodic updates on fair values are obtained, which may include updated appraisals. Updated fair values are incorporated into the impairment analysis in the next reporting period.
Loan charge-offs, which may include partial charge-offs, are taken on an impaired loan that is collateral dependent if the loan’s carrying balance exceeds its collateral’s appraised value, the loan has been identified as uncollectible, and it is deemed to be a confirmed loss. Typically, impaired loans with a charge-off or partial charge-off will continue to be considered impaired, unless the note is split into two, and management expects the performing note to continue to perform and is adequately secured. The second, or non-performing note, would be charged-off. Generally, an impaired loan with a partial charge-off may continue to have an impairment reserve on it after the partial charge-off, if factors warrant.
At September 30, 2019 and December 31, 2018, nearly all of the Company’s impaired loans’ extent of impairment were measured based on the estimated fair value of the collateral securing the loan, except for TDRs. By definition, TDRs are considered impaired. All restructured loans’ impairment was determined based on discounted cash flows for those loans classified as TDRs and still accruing interest. For real estate loans, collateral generally consists of commercial real estate, but in the case of commercial and industrial loans, it could also consist of accounts receivable, inventory, equipment or other business assets. Commercial and industrial loans may also have real estate collateral.
Updated appraisals are generally required every 18 months for classified commercial loans in excess of $250,000. The “as is" value provided in the appraisal is often used as the fair value of the collateral in determining impairment, unless circumstances, such as subsequent improvements, approvals, or other circumstances, dictate that another value than that provided by the appraiser is more appropriate.
Generally, impaired commercial loans secured by real estate, other than performing TDRs, are measured at fair value using certified real estate appraisals that had been completed within the last 18 months. Appraised values are discounted for estimated costs to sell the property and other selling considerations to arrive at the property’s fair value. In those situations in which it is determined an updated appraisal is not required for loans individually evaluated for impairment, fair values are based on one or a combination of approaches. In those situations in which a combination of approaches is considered, the factor that carries the most consideration will be the one management believes is warranted. The approaches are:
•Original appraisal – if the original appraisal provides a strong loan-to-value ratio (generally 70% or lower) and, after consideration of market conditions and knowledge of the property and area, it is determined by the Credit Administration staff that there has not been a significant deterioration in the collateral value, the original certified appraised value may be used. Discounts as deemed appropriate for selling costs are factored into the appraised value in arriving at fair value.
•Discounted cash flows – in limited cases, discounted cash flows may be used on projects in which the collateral is liquidated to reduce the borrowings outstanding, and is used to validate collateral values derived from other approaches.
Collateral on certain impaired loans is not limited to real estate, and may consist of accounts receivable, inventory, equipment or other business assets. Estimated fair values are determined based on borrowers’ financial statements, inventory ledgers, accounts receivable agings or appraisals from individuals with knowledge in the business. Stated balances are generally discounted for the age of the financial information or the quality of the assets. In determining fair value, liquidation discounts are applied to this collateral based on existing loan evaluation policies.
The Company distinguishes Substandard loans on both an impaired and nonimpaired basis, as it places less emphasis on a loan’s classification, and increased reliance on whether the loan was performing in accordance with the contractual terms. A Substandard classification does not automatically meet the definition of impaired. Loss potential, while existing in the aggregate amount of Substandard loans, does not have to exist in individual extensions of credit classified Substandard. As a result, the Company’s methodology includes an evaluation of certain accruing commercial real estate, acquisition and
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development and commercial and industrial loans rated Substandard to be collectively, as opposed to individually, evaluated for impairment. Although the Company believes these loans meet the definition of Substandard, they are generally performing and management has concluded that it is likely we will be able to collect the scheduled payments of principal and interest when due according to the contractual terms of the loan agreement.
Larger groups of smaller balance homogeneous loans are collectively evaluated for impairment. Generally, the Company does not separately identify individual consumer and residential loans for impairment disclosures, unless such loans are the subject of a restructuring agreement due to financial difficulties of the borrower.
The following table, which excludes PCI loans, summarizes impaired loans by segment and class, segregated by those for which a specific allowance was required and those for which a specific allowance was not required at September 30, 2019 and December 31, 2018. The recorded investment in loans excludes accrued interest receivable due to insignificance. Related allowances established generally pertain to those loans in which loan forbearance agreements were in the process of being negotiated or updated appraisals were pending, and any partial charge-off will be recorded when final information is received.

| Impaired Loans with a Specific Allowance |  |  |  |  |  | Impaired Loans with No Specific Allowance |  |
(Dollars in thousands) | Recorded Investment (Book Balance) |  | Unpaid Principal Balance (Legal Balance) |  | Related Allowance |  | Recorded Investment (Book Balance) |  | Unpaid Principal Balance (Legal Balance)
September 30, 2019 |  |  |  |  |  |  |  |  |
Commercial real estate: |  |  |  |  |  |  |  |  |
Owner occupied | $ | 0 |  |  | $ | 0 |  |  | $ | 0 |  |  | $ | 3,324 |  |  | $ | 5,490 |
Multi-family | 0 |  |  | 0 |  |  | 0 |  |  | 105 |  |  | 325 |
Non-owner occupied residential | 26 |  |  | 48 |  |  | 0 |  |  | 111 |  |  | 319 |
Commercial and industrial | 0 |  |  | 0 |  |  | 0 |  |  | 1,089 |  |  | 2,769 |
Residential mortgage: |  |  |  |  |  |  |  |  |
First lien | 498 |  |  | 498 |  |  | 36 |  |  | 2,049 |  |  | 3,098 |
Home equity - term | 0 |  |  | 0 |  |  | 0 |  |  | 11 |  |  | 19 |
Home equity - lines of credit | 0 |  |  | 0 |  |  | 0 |  |  | 753 |  |  | 1,081 |
Installment and other loans | 0 |  |  | 0 |  |  | 0 |  |  | 7 |  |  | 17 |
| $ | 524 |  |  | $ | 546 |  |  | $ | 36 |  |  | $ | 7,449 |  |  | $ | 13,118 |
December 31, 2018 |  |  |  |  |  |  |  |  |
Commercial real estate: |  |  |  |  |  |  |  |  |
Owner occupied | $ | 0 |  |  | $ | 0 |  |  | $ | 0 |  |  | $ | 1,880 |  |  | $ | 2,576 |
Multi-family | 0 |  |  | 0 |  |  | 0 |  |  | 131 |  |  | 336 |
Non-owner occupied residential | 0 |  |  | 0 |  |  | 0 |  |  | 309 |  |  | 632 |
Commercial and industrial | 0 |  |  | 0 |  |  | 0 |  |  | 286 |  |  | 457 |
Residential mortgage: |  |  |  |  |  |  |  |  |
First lien | 743 |  |  | 743 |  |  | 38 |  |  | 2,134 |  |  | 2,727 |
Home equity - term | 0 |  |  | 0 |  |  | 0 |  |  | 16 |  |  | 23 |
Home equity - lines of credit | 0 |  |  | 0 |  |  | 0 |  |  | 798 |  |  | 1,081 |
| $ | 743 |  |  | $ | 743 |  |  | $ | 38 |  |  | $ | 5,554 |  |  | $ | 7,832 |

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The following table, which excludes PCI loans, summarizes the average recorded investment in impaired loans and related recognized interest income for the three and nine months ended September 30, 2019 and 2018.

| 2019 |  |  |  | 2018 |  |
(Dollars in thousands) | Average Impaired Balance |  | Interest Income Recognized |  | Average Impaired Balance |  | Interest Income Recognized
Three Months Ended September 30, |  |  |  |  |  |  |
Commercial real estate: |  |  |  |  |  |  |
Owner-occupied | $ | 2,126 |  |  | $ | 0 |  |  | $ | 1,569 |  |  | $ | 1 |
Non-owner occupied | 150 |  |  | 0 |  |  | 0 |  |  | 0 |
Multi-family | 110 |  |  | 0 |  |  | 144 |  |  | 0 |
Non-owner occupied residential | 173 |  |  | 0 |  |  | 336 |  |  | 0 |
Acquisition and development: |  |  |  |  |  |  |
1-4 family residential construction | 0 |  |  | 0 |  |  | 201 |  |  | 0 |
Commercial and industrial | 765 |  |  | 0 |  |  | 316 |  |  | 0 |
Residential mortgage: |  |  |  |  |  |  |
First lien | 2,392 |  |  | 12 |  |  | 2,900 |  |  | 15 |
Home equity – term | 12 |  |  | 0 |  |  | 18 |  |  | 0 |
Home equity - lines of credit | 768 |  |  | 0 |  |  | 692 |  |  | 0 |
Installment and other loans | 8 |  |  | 0 |  |  | 1 |  |  | 0 |
| $ | 6,504 |  |  | $ | 12 |  |  | $ | 6,177 |  |  | $ | 16 |
Nine Months Ended September 30, |  |  |  |  |  |  |
Commercial real estate: |  |  |  |  |  |  |
Owner occupied | $ | 1,950 |  |  | $ | 1 |  |  | $ | 1,372 |  |  | $ | 2 |
Non-owner occupied | 60 |  |  | 0 |  |  | 2,395 |  |  | 0 |
Multi-family | 118 |  |  | 0 |  |  | 152 |  |  | 0 |
Non-owner occupied residential | 246 |  |  | 0 |  |  | 355 |  |  | 0 |
Acquisition and development: |  |  |  |  |  |  |
1-4 family residential construction | 0 |  |  | 0 |  |  | 235 |  |  | 0 |
Commercial and industrial | 469 |  |  | 0 |  |  | 330 |  |  | 0 |
Residential mortgage: |  |  |  |  |  |  |
First lien | 2,574 |  |  | 41 |  |  | 3,312 |  |  | 44 |
Home equity - term | 13 |  |  | 0 |  |  | 20 |  |  | 0 |
Home equity - lines of credit | 752 |  |  | 1 |  |  | 621 |  |  | 1 |
Installment and other loans | 8 |  |  | 0 |  |  | 6 |  |  | 0 |
| $ | 6,190 |  |  | $ | 43 |  |  | $ | 8,798 |  |  | $ | 47 |

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

| September 30, 2019 |  |  |  | December 31, 2018 |  |
(Dollars in thousands) | Number of Contracts |  | Recorded Investment |  | Number of Contracts |  | Recorded Investment
Accruing: |  |  |  |  |  |  |
Commercial real estate: |  |  |  |  |  |  |
Owner occupied | 1 |  |  | $ | 30 |  |  | 1 |  |  | $ | 39 |
Residential mortgage: |  |  |  |  |  |  |
First lien | 10 |  |  | 992 |  |  | 11 |  |  | 1,069 |
Home equity - lines of credit | 1 |  |  | 20 |  |  | 1 |  |  | 24 |
| 12 |  |  | 1,042 |  |  | 13 |  |  | 1,132 |
Nonaccruing: |  |  |  |  |  |  |
Commercial real estate: |  |  |  |  |  |  |
Owner occupied | 4 |  |  | 1,898 |  |  | 1 |  |  | 37 |
Residential mortgage: |  |  |  |  |  |  |
First lien | 5 |  |  | 368 |  |  | 8 |  |  | 658 |
| 9 |  |  | 2,266 |  |  | 9 |  |  | 695 |
| 21 |  |  | $ | 3,308 |  |  | 22 |  |  | $ | 1,827 |

There were three new commercial real estate owner occupied TDR's, totaling $1,867,000, for the quarter ended September 30, 2019. There were no modified restructured loans in 2018. No additional commitments have been made to borrowers whose loans are considered TDRs.
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Management further monitors the performance and credit quality of the loan portfolio by analyzing the length of time a portfolio is past due, by aggregating loans based on its delinquencies. The following table presents the classes of loan portfolio summarized by aging categories of performing loans and nonaccrual loans at September 30, 2019 and December 31, 2018.

|  |  | Days Past Due |  |  |  |  |  |  |  |  |  |
(Dollars in thousands) | Current |  | 30-59 |  | 60-89 |  | 90+ (still accruing) |  | Total Past Due |  | Non- Accrual |  | Total Loans
September 30, 2019 |  |  |  |  |  |  |  |  |  |  |  |  |
Commercial real estate: |  |  |  |  |  |  |  |  |  |  |  |  |
Owner occupied | $ | 161,771 |  |  | $ | 0 |  |  | $ | 0 |  |  | $ | 0 |  |  | $ | 0 |  |  | $ | 3,294 |  |  | $ | 165,065 |
Non-owner occupied | 308,823 |  |  | 0 |  |  | 0 |  |  | 130 |  |  | 130 |  |  | 0 |  |  | 308,953 |
Multi-family | 107,707 |  |  | 0 |  |  | 0 |  |  | 249 |  |  | 249 |  |  | 105 |  |  | 108,061 |
Non-owner occupied residential | 117,301 |  |  | 225 |  |  | 69 |  |  | 38 |  |  | 332 |  |  | 137 |  |  | 117,770 |
Acquisition and development: |  |  |  |  |  |  |  |  |  |  |  |  |
1-4 family residential construction | 12,257 |  |  | 0 |  |  | 0 |  |  | 0 |  |  | 0 |  |  | 0 |  |  | 12,257 |
Commercial and land development | 38,358 |  |  | 0 |  |  | 0 |  |  | 136 |  |  | 136 |  |  | 0 |  |  | 38,494 |
Commercial and industrial | 210,112 |  |  | 320 |  |  | 333 |  |  | 0 |  |  | 653 |  |  | 1,089 |  |  | 211,854 |
Municipal | 47,920 |  |  | 0 |  |  | 0 |  |  | 0 |  |  | 0 |  |  | 0 |  |  | 47,920 |
Residential mortgage: |  |  |  |  |  |  |  |  |  |  |  |  |
First lien | 339,460 |  |  | 1,101 |  |  | 1696 |  |  | 67 |  |  | 2,864 |  |  | 1,555 |  |  | 343,879 |
Home equity - term | 15,122 |  |  | 17 |  |  | 0 |  |  | 5 |  |  | 22 |  |  | 11 |  |  | 15,155 |
Home equity - lines of credit | 158,601 |  |  | 475 |  |  | 121 |  |  | 0 |  |  | 596 |  |  | 733 |  |  | 159,930 |
Installment and other loans | 38,556 |  |  | 122 |  |  | 37 |  |  | 0 |  |  | 159 |  |  | 7 |  |  | 38,722 |
Subtotal | 1,555,988 |  |  | 2,260 |  |  | 2,256 |  |  | 625 |  |  | 5,141 |  |  | 6,931 |  |  | 1,568,060 |
Loans acquired with credit deterioration: |  |  |  |  |  |  |  |  |  |  |  |  |
Commercial real estate: |  |  |  |  |  |  |  |  |  |  |  |  |
Owner occupied | 6,089 |  |  | 131 |  |  | 0 |  |  | 42 |  |  | 173 |  |  | 0 |  |  | 6,262 |
Non-owner occupied | 585 |  |  | 0 |  |  | 0 |  |  | 796 |  |  | 796 |  |  | 0 |  |  | 1,381 |
Multi-family | 690 |  |  | 0 |  |  | 0 |  |  | 0 |  |  | 0 |  |  | 0 |  |  | 690 |
Non-owner occupied residential | 2,025 |  |  | 0 |  |  | 188 |  |  | 412 |  |  | 600 |  |  | 0 |  |  | 2,625 |
Commercial and industrial | 3,863 |  |  | 0 |  |  | 0 |  |  | 17 |  |  | 17 |  |  | 0 |  |  | 3,880 |
Residential mortgage: |  |  |  |  |  |  |  |  |  |  |  |  |
First lien | 8,459 |  |  | 74 |  |  | 357 |  |  | 1,042 |  |  | 1,473 |  |  | 0 |  |  | 9,932 |
Home equity - term | 16 |  |  | 4 |  |  | 0 |  |  | 0 |  |  | 4 |  |  | 0 |  |  | 20 |
Installment and other loans | 190 |  |  | 17 |  |  | 0 |  |  | 48 |  |  | 65 |  |  | 0 |  |  | 255 |
Subtotal | 21,917 |  |  | 226 |  |  | 545 |  |  | 2,357 |  |  | 3,128 |  |  | 0 |  |  | 25,045 |
| $ | 1,577,905 |  |  | $ | 2,486 |  |  | $ | 2,801 |  |  | $ | 2,982 |  |  | $ | 8,269 |  |  | $ | 6,931 |  |  | $ | 1,593,105 |

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|  |  | Days Past Due |  |  |  |  |  |  |  |  |  |
(Dollars in thousands) | Current |  | 30-59 |  | 60-89 |  | 90+ (still accruing) |  | Total Past Due |  | Non- Accrual |  | Total Loans
December 31, 2018 |  |  |  |  |  |  |  |  |  |  |  |  |
Commercial real estate: |  |  |  |  |  |  |  |  |  |  |  |  |
Owner occupied | $ | 125,887 |  |  | $ | 66 |  |  | $ | 0 |  |  | $ | 0 |  |  | $ | 66 |  |  | $ | 1,841 |  |  | $ | 127,794 |
Non-owner occupied | 252,144 |  |  | 0 |  |  | 0 |  |  | 0 |  |  | 0 |  |  | 0 |  |  | 252,144 |
Multi-family | 78,085 |  |  | 0 |  |  | 0 |  |  | 0 |  |  | 0 |  |  | 131 |  |  | 78,216 |
Non-owner occupied residential | 99,268 |  |  | 226 |  |  | 29 |  |  | 0 |  |  | 255 |  |  | 309 |  |  | 99,832 |
Acquisition and development: |  |  |  |  |  |  |  |  |  |  |  |  |
1-4 family residential construction | 7,385 |  |  | 0 |  |  | 0 |  |  | 0 |  |  | 0 |  |  | 0 |  |  | 7,385 |
Commercial and land development | 41,822 |  |  | 37 |  |  | 0 |  |  | 0 |  |  | 37 |  |  | 0 |  |  | 41,859 |
Commercial and industrial | 154,988 |  |  | 411 |  |  | 105 |  |  | 0 |  |  | 516 |  |  | 286 |  |  | 155,790 |
Municipal | 50,982 |  |  | 0 |  |  | 0 |  |  | 0 |  |  | 0 |  |  | 0 |  |  | 50,982 |
Residential mortgage: |  |  |  |  |  |  |  |  |  |  |  |  |
First lien | 228,714 |  |  | 1,592 |  |  | 734 |  |  | 0 |  |  | 2,326 |  |  | 1,808 |  |  | 232,848 |
Home equity - term | 11,487 |  |  | 678 |  |  | 5 |  |  | 0 |  |  | 683 |  |  | 16 |  |  | 12,186 |
Home equity - lines of credit | 142,394 |  |  | 420 |  |  | 28 |  |  | 0 |  |  | 448 |  |  | 774 |  |  | 143,616 |
Installment and other loans | 33,135 |  |  | 66 |  |  | 44 |  |  | 0 |  |  | 110 |  |  | 0 |  |  | 33,245 |
Subtotal | 1,226,291 |  |  | 3,496 |  |  | 945 |  |  | 0 |  |  | 4,441 |  |  | 5,165 |  |  | 1,235,897 |
Loans acquired with credit deterioration: |  |  |  |  |  |  |  |  |  |  |  |  |
Commercial real estate: |  |  |  |  |  |  |  |  |  |  |  |  |
Owner occupied | 1,784 |  |  | 0 |  |  | 72 |  |  | 0 |  |  | 72 |  |  | 0 |  |  | 1,856 |
Non-owner occupied | 650 |  |  | 0 |  |  | 0 |  |  | 0 |  |  | 0 |  |  | 0 |  |  | 650 |
Multi-family | 717 |  |  | 0 |  |  | 0 |  |  | 0 |  |  | 0 |  |  | 0 |  |  | 717 |
Non-owner occupied residential | 535 |  |  | 0 |  |  | 0 |  |  | 0 |  |  | 0 |  |  | 0 |  |  | 535 |
Acquisition and development: |  |  |  |  |  |  |  |  |  |  |  |  |
Commercial and land development | 192 |  |  | 0 |  |  | 0 |  |  | 0 |  |  | 0 |  |  | 0 |  |  | 192 |
Commercial and industrial | 4,943 |  |  | 231 |  |  | 0 |  |  | 0 |  |  | 231 |  |  | 0 |  |  | 5,174 |
Residential mortgage: |  |  |  |  |  |  |  |  |  |  |  |  |
First lien | 1,971 |  |  | 382 |  |  | 42 |  |  | 53 |  |  | 477 |  |  | 0 |  |  | 2,448 |
Home equity - term | 17 |  |  | 5 |  |  | 0 |  |  | 0 |  |  | 5 |  |  | 0 |  |  | 22 |
Installment and other loans | 149 |  |  | 13 |  |  | 0 |  |  | 4 |  |  | 17 |  |  | 0 |  |  | 166 |
Subtotal | 10,958 |  |  | 631 |  |  | 114 |  |  | 57 |  |  | 802 |  |  | 0 |  |  | 11,760 |
| $ | 1,237,249 |  |  | $ | 4,127 |  |  | $ | 1,059 |  |  | $ | 57 |  |  | $ | 5,243 |  |  | $ | 5,165 |  |  | $ | 1,247,657 |

The Company maintains its ALL at a level management believes adequate for probable incurred credit losses. The ALL is established and maintained through a provision for loan losses charged to earnings. Quarterly, management assesses the adequacy of the ALL utilizing a defined methodology which considers specific credit evaluation of impaired loans as discussed above, past loan loss historical experience, and qualitative factors. Management believes its approach properly addresses relevant accounting guidance for loans individually identified as impaired and for loans collectively evaluated for impairment, and other bank regulatory guidance.
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In connection with its quarterly evaluation of the adequacy of the ALL, management reviews its methodology to determine if it properly addresses the current risk in the loan portfolio. For each loan class, general allowances based on quantitative factors, principally historical loss trends, are provided for loans that are collectively evaluated for impairment. An adjustment to historical loss factors may be incorporated for delinquency and other potential risk not elsewhere defined within the ALL methodology.
In addition to this quantitative analysis, adjustments to the ALL requirements are allocated on loans collectively evaluated for impairment based on additional qualitative factors, including:
Nature and Volume of Loans – including loan growth in the current and subsequent quarters based on the Company’s targeted growth and strategic plan, coupled with the types of loans booked based on risk management and credit culture; the number of exceptions to loan policy; and supervisory loan to value exceptions.
Concentrations of Credit and Changes within Credit Concentrations – including the composition of the Company’s overall portfolio makeup and management's evaluation related to concentration risk management and the inherent risk associated with the concentrations identified.
Underwriting Standards and Recovery Practices – including changes to underwriting standards and perceived impact on anticipated losses; trends in the number of exceptions to loan policy; supervisory loan to value exceptions; and administration of loan recovery practices.
Delinquency Trends – including delinquency percentages noted in the portfolio relative to economic conditions; severity of the delinquencies; and whether the ratios are trending upwards or downwards.
Classified Loans Trends – including internal loan ratings of the portfolio; severity of the ratings; whether the loan segment’s ratings show a more favorable or less favorable trend; and underlying market conditions and impact on the collateral values securing the loans.
Experience, Ability and Depth of Management/Lending staff – including the years’ experience of senior and middle management and the lending staff; turnover of the staff; and instances of repeat criticisms of ratings.
Quality of Loan Review – including the years of experience of the loan review staff; in-house versus outsourced provider of review; turnover of staff and the perceived quality of their work in relation to other external information.
National and Local Economic Conditions – including trends in the consumer price index, unemployment rates, the housing price index, housing statistics compared to the prior year, bankruptcy rates, regulatory and legal environment risks and competition.
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The following table presents the activity in the ALL for the three and nine months ended September 30, 2019 and 2018.

| Commercial |  |  |  |  |  |  |  |  |  | Consumer |  |  |  |  |  |  |  |
(Dollars in thousands) | Commercial Real Estate |  | Acquisition and Development |  | Commercial and Industrial |  | Municipal |  | Total |  | Residential Mortgage |  | Installment and Other |  | Total |  | Unallocated |  | Total
Three Months Ended |  |  |  |  |  |  |  |  |  |  |  |  |  |  |  |  |  |  |
September 30, 2019 |  |  |  |  |  |  |  |  |  |  |  |  |  |  |  |  |  |  |
Balance, beginning of period | $ | 6,847 |  |  | $ | 1,008 |  |  | $ | 2,120 |  |  | $ | 94 |  |  | $ | 10,069 |  |  | $ | 3,734 |  |  | $ | 209 |  |  | $ | 3,943 |  |  | $ | 448 |  |  | $ | 14,460 |
Provision for loan losses | 465 |  |  | (188) |  |  | 269 |  |  | (1) |  |  | 545 |  |  | 27 |  |  | 50 |  |  | 77 |  |  | (322) |  |  | 300 |
Charge-offs | 0 |  |  | 0 |  |  | (50) |  |  | 0 |  |  | (50) |  |  | (24) |  |  | (49) |  |  | (73) |  |  | 0 |  |  | (123) |
Recoveries | 111 |  |  | 0 |  |  | 33 |  |  | 0 |  |  | 144 |  |  | 5 |  |  | 23 |  |  | 28 |  |  | 0 |  |  | 172 |
Balance, end of period | $ | 7,423 |  |  | $ | 820 |  |  | $ | 2,372 |  |  | $ | 93 |  |  | $ | 10,708 |  |  | $ | 3,742 |  |  | $ | 233 |  |  | $ | 3,975 |  |  | $ | 126 |  |  | $ | 14,809 |
September 30, 2018 |  |  |  |  |  |  |  |  |  |  |  |  |  |  |  |  |  |  |
Balance, beginning of period | $ | 6,680 |  |  | $ | 720 |  |  | $ | 1,598 |  |  | $ | 80 |  |  | $ | 9,078 |  |  | $ | 3,544 |  |  | $ | 230 |  |  | $ | 3,774 |  |  | $ | 585 |  |  | $ | 13,437 |
Provision for loan losses | 194 |  |  | 19 |  |  | (38) |  |  | (1) |  |  | 174 |  |  | (45) |  |  | 146 |  |  | 101 |  |  | (75) |  |  | 200 |
Charge-offs | (17) |  |  | 0 |  |  | 0 |  |  | 0 |  |  | (17) |  |  | (62) |  |  | (80) |  |  | (142) |  |  | 0 |  |  | (159) |
Recoveries | 200 |  |  | 0 |  |  | 1 |  |  | 0 |  |  | 201 |  |  | 102 |  |  | 31 |  |  | 133 |  |  | 0 |  |  | 334 |
Balance, end of period | $ | 7,057 |  |  | $ | 739 |  |  | $ | 1,561 |  |  | $ | 79 |  |  | $ | 9,436 |  |  | $ | 3,539 |  |  | $ | 327 |  |  | $ | 3,866 |  |  | $ | 510 |  |  | $ | 13,812 |
Nine Months Ended |  |  |  |  |  |  |  |  |  |  |  |  |  |  |  |  |  |  |
September 30, 2019 |  |  |  |  |  |  |  |  |  |  |  |  |  |  |  |  |  |  |
Balance, beginning of period | $ | 6,876 |  |  | $ | 817 |  |  | $ | 1,656 |  |  | $ | 98 |  |  | $ | 9,447 |  |  | $ | 3,753 |  |  | $ | 244 |  |  | $ | 3,997 |  |  | $ | 570 |  |  | $ | 14,014 |
Provision for loan losses | 347 |  |  | 1 |  |  | 753 |  |  | (5) |  |  | 1,096 |  |  | 184 |  |  | 64 |  |  | 248 |  |  | (444) |  |  | 900 |
Charge-offs | (25) |  |  | 0 |  |  | (140) |  |  | 0 |  |  | (165) |  |  | (295) |  |  | (121) |  |  | (416) |  |  | 0 |  |  | (581) |
Recoveries | 225 |  |  | 2 |  |  | 103 |  |  | 0 |  |  | 330 |  |  | 100 |  |  | 46 |  |  | 146 |  |  | 0 |  |  | 476 |
Balance, end of period | $ | 7,423 |  |  | $ | 820 |  |  | $ | 2,372 |  |  | $ | 93 |  |  | $ | 10,708 |  |  | $ | 3,742 |  |  | $ | 233 |  |  | $ | 3,975 |  |  | $ | 126 |  |  | $ | 14,809 |
September 30, 2018 |  |  |  |  |  |  |  |  |  |  |  |  |  |  |  |  |  |  |
Balance, beginning of period | $ | 6,763 |  |  | $ | 417 |  |  | $ | 1,446 |  |  | $ | 84 |  |  | $ | 8,710 |  |  | $ | 3,400 |  |  | $ | 211 |  |  | $ | 3,611 |  |  | $ | 475 |  |  | $ | 12,796 |
Provision for loan losses | (217) |  |  | 319 |  |  | 114 |  |  | (5) |  |  | 211 |  |  | 157 |  |  | 197 |  |  | 354 |  |  | 35 |  |  | 600 |
Charge-offs | (17) |  |  | 0 |  |  | 0 |  |  | 0 |  |  | (17) |  |  | (148) |  |  | (198) |  |  | (346) |  |  | 0 |  |  | (363) |
Recoveries | 528 |  |  | 3 |  |  | 1 |  |  | 0 |  |  | 532 |  |  | 130 |  |  | 117 |  |  | 247 |  |  | 0 |  |  | 779 |
Balance, end of period | $ | 7,057 |  |  | $ | 739 |  |  | $ | 1,561 |  |  | $ | 79 |  |  | $ | 9,436 |  |  | $ | 3,539 |  |  | $ | 327 |  |  | $ | 3,866 |  |  | $ | 510 |  |  | $ | 13,812 |

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The following table summarizes the ending loan balance individually evaluated for impairment based upon loan segment, as well as the related ALL loss allocation for each at September 30, 2019 and December 31, 2018, including PCI loans.

| Commercial |  |  |  |  |  |  |  |  |  | Consumer |  |  |  |  |  |  |  |
(Dollars in thousands) | Commercial Real Estate |  | Acquisition and Development |  | Commercial and Industrial |  | Municipal |  | Total |  | Residential Mortgage |  | Installment and Other |  | Total |  | Unallocated |  | Total
September 30, 2019 |  |  |  |  |  |  |  |  |  |  |  |  |  |  |  |  |  |  |
Loans allocated by: |  |  |  |  |  |  |  |  |  |  |  |  |  |  |  |  |  |  |
Individually evaluated for impairment | $ | 3,566 |  |  | $ | 0 |  |  | $ | 1,089 |  |  | $ | 0 |  |  | $ | 4,655 |  |  | $ | 3,311 |  |  | $ | 7 |  |  | $ | 3,318 |  |  | $ | 0 |  |  | $ | 7,973 |
Collectively evaluated for impairment | 707,241 |  |  | 50,751 |  |  | 214,645 |  |  | 47,920 |  |  | 1,020,557 |  |  | 525,605 |  |  | 38,970 |  |  | 564,575 |  |  | 0 |  |  | 1,585,132 |
| $ | 710,807 |  |  | $ | 50,751 |  |  | $ | 215,734 |  |  | $ | 47,920 |  |  | $ | 1,025,212 |  |  | $ | 528,916 |  |  | $ | 38,977 |  |  | $ | 567,893 |  |  | $ | 0 |  |  | $ | 1,593,105 |
ALL allocated by: |  |  |  |  |  |  |  |  |  |  |  |  |  |  |  |  |  |  |
Individually evaluated for impairment | $ | 0 |  |  | $ | 0 |  |  | $ | 0 |  |  | $ | 0 |  |  | $ | 0 |  |  | $ | 36 |  |  | $ | 0 |  |  | $ | 36 |  |  | $ | 0 |  |  | $ | 36 |
Collectively evaluated for impairment | 7,423 |  |  | 820 |  |  | 2,372 |  |  | 93 |  |  | 10,708 |  |  | 3,706 |  |  | 233 |  |  | 3,939 |  |  | 126 |  |  | 14,773 |
| $ | 7,423 |  |  | $ | 820 |  |  | $ | 2,372 |  |  | $ | 93 |  |  | $ | 10,708 |  |  | $ | 3,742 |  |  | $ | 233 |  |  | $ | 3,975 |  |  | $ | 126 |  |  | $ | 14,809 |
December 31, 2018 |  |  |  |  |  |  |  |  |  |  |  |  |  |  |  |  |  |  |
Loans allocated by: |  |  |  |  |  |  |  |  |  |  |  |  |  |  |  |  |  |  |
Individually evaluated for impairment | $ | 2,320 |  |  | $ | 0 |  |  | $ | 286 |  |  | $ | 0 |  |  | $ | 2,606 |  |  | $ | 3,691 |  |  | $ | 0 |  |  | $ | 3,691 |  |  | $ | 0 |  |  | $ | 6,297 |
Collectively evaluated for impairment | 559,424 |  |  | 49,436 |  |  | 160,678 |  |  | 50,982 |  |  | 820,520 |  |  | 387,429 |  |  | 33,411 |  |  | 420,840 |  |  | 0 |  |  | 1,241,360 |
| $ | 561,744 |  |  | $ | 49,436 |  |  | $ | 160,964 |  |  | $ | 50,982 |  |  | $ | 823,126 |  |  | $ | 391,120 |  |  | $ | 33,411 |  |  | $ | 424,531 |  |  | $ | 0 |  |  | $ | 1,247,657 |
ALL allocated by: |  |  |  |  |  |  |  |  |  |  |  |  |  |  |  |  |  |  |
Individually evaluated for impairment | $ | 0 |  |  | $ | 0 |  |  | $ | 0 |  |  | $ | 0 |  |  | $ | 0 |  |  | $ | 38 |  |  | $ | 0 |  |  | $ | 38 |  |  | $ | 0 |  |  | $ | 38 |
Collectively evaluated for impairment | 6,876 |  |  | 817 |  |  | 1,656 |  |  | 98 |  |  | 9,447 |  |  | 3,715 |  |  | 244 |  |  | 3,959 |  |  | 570 |  |  | 13,976 |
| $ | 6,876 |  |  | $ | 817 |  |  | $ | 1,656 |  |  | $ | 98 |  |  | $ | 9,447 |  |  | $ | 3,753 |  |  | $ | 244 |  |  | $ | 3,997 |  |  | $ | 570 |  |  | $ | 14,014 |

The following table provides activity for the accretable yield of purchased credit impaired loans for the three and nine months ended September 30, 2019.

| Three Months Ended |  |  |  | Nine Months Ended |  |
(Dollars in thousands) | September 30, 2019 |  |  |  | September 30, 2019 |  |
Accretable yield, beginning of period | $ | 4,988 |  |  |  |  | $ | 2,065 |  |  |
New loans purchased | 0 |  |  |  |  | 3,497 |  |  |
Accretion of income | (422) |  |  |  |  | (1,814) |  |  |
Reclassifications from nonaccretable difference due to improvement in expected cash flows | 825 |  |  |  |  | 1,441 |  |  |
Other changes, net | 319 |  |  |  |  | 521 |  |  |
Accretable yield, end of period | $ | 5,710 |  |  |  |  | $ | 5,710 |  |  |

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NOTE 5. GOODWILL AND OTHER INTANGIBLE ASSETS
The following table presents changes in goodwill at September 30, 2019 and December 31, 2018.

(Dollars in thousands) | September 30, 2019 |  | December 31, 2018
Balance, beginning of year | $ | 12,592 |  |  | $ | 719 |
Acquired goodwill | 7,029 |  |  | 11,873 |
Adjustments to acquired goodwill | 304 |  |  | 0 |
Balance, end of period | $ | 19,925 |  |  | $ | 12,592 |

The following table presents changes in other intangible assets for the three and nine months ended September 30, 2019 and 2018.

| Three Months Ended |  |  |  | Nine Months Ended |  |
(Dollars in thousands) | September 30, 2019 |  | September 30, 2018 |  | September 30, 2019 |  | September 30, 2018
Beginning of period | $ | 8,140 |  |  | $ | 308 |  |  | $ | 3,910 |  |  | $ | 356 |
Acquired CDI | 0 |  |  | 0 |  |  | 4,550 |  |  | 0 |
Non-compete agreement | 0 |  |  | 0 |  |  | 290 |  |  | 0 |
Amortization Expense | (486) |  |  | (24) |  |  | (1,096) |  |  | (72) |
Balance, end of period | $ | 7,654 |  |  | $ | 284 |  |  | $ | 7,654 |  |  | $ | 284 |

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

| September 30, 2019 |  |  |  | December 31, 2018 |  |
(Dollars in thousands) | Gross Amount |  | Accumulated Amortization |  | Gross Amount |  | Accumulated Amortization
Amortized intangible assets: |  |  |  |  |  |  |
Core deposit intangibles | $ | 8,390 |  |  | $ | 1,106 |  |  | $ | 3,840 |  |  | $ | 190 |
Other customer relationship intangibles | 931 |  |  | 730 |  |  | 931 |  |  | 671 |
Non-compete agreement | 290 |  |  | 121 |  |  | 0 |  |  | 0 |
Total | $ | 9,611 |  |  | $ | 1,957 |  |  | $ | 4,771 |  |  | $ | 861 |

The following table presents estimated aggregate amortization expense for intangible assets remaining at September 30, 2019.

(Dollars in thousands) |
Remainder of 2019 | $ | 474 |
2020 | 1,591 |
2021 | 1,313 |
2022 | 1,137 |
2023 | 960 |
Thereafter | 2,179 |
| $ | 7,654 |

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NOTE 6. LEASES
A lease provides the lessee the right to control the use of an identified asset for a period of time in exchange for consideration. The Company has primarily entered into operating leases for branches and office space. Most of our leases contain renewal options, which we are reasonably certain to exercise. Including renewal options, our leases range from 3 years to 50 years Operating lease right-of-use assets and lease liabilities are included in Other assets and Accrued interest and other liabilities on the Company's Consolidated Balance Sheet.
The Company uses its incremental borrowing rate to determine the present value of the lease payments, as the rate implicit in the Company's leases is not readily determinable. Lease agreements that contain non-lease components are generally accounted for as a single lease component, while variable costs, such as common area maintenance expenses and property taxes, are expensed as incurred.
The following table summarizes the Company's ROU assets and related lease liabilities for the three and nine months at September 30, 2019.

| Three Months Ended |  |  |  | Nine Months Ended |  |
(Dollars in thousands) | September 30, 2019 |  |  |  | September 30, 2019 |  |
Cash paid for operating lease liabilities | 330 |  |  |  |  | $ | 791 |  |  |
Right-of-use assets obtained in exchange for operating lease obligations (1) | 0 |  |  |  |  | $ | 10,908 |  |  |
Weighted-average remaining lease term (in years) | 17.6 |  |  |  | 17.6 |  |
Weighted-average discount rate | 4.5 | % |  |  |  | 4.5 | % |  |

(1) Includes $7,971,000 for operating leases existing on January 1, 2019, $144,000 for operating leases that commenced in the first quarter of 2019, and $2,793,000 for operating leases that were acquired in the second quarter of 2019.
The following table presents maturities of the Company's lease liabilities.

(Dollars in thousands) |
Remainder of 2019 | $ | 332 |
2020 | 1,336 |
2021 | 1,207 |
2022 | 788 |
2023 | 810 |
2024 | 801 |
Thereafter | 10,976 |
| 16,250 |
Less imputed interest | 5,810 |
Total lease liabilities | $ | 10,440 |

NOTE 7. INCOME TAXES
The Company files income tax returns in the U.S. federal jurisdiction, the Commonwealth of Pennsylvania and the State of Maryland. The Company is no longer subject to tax examination by tax authorities for years before 2015.
The following table summarizes income tax expense for the three and nine months ended September 30, 2019 and 2018.

| Three months ended September 30, |  |  |  | Nine months ended September 30, |  |
(Dollars in thousands) | 2019 |  | 2018 |  | 2019 |  | 2018
Current expense | $ | 244 |  |  | $ | 406 |  |  | $ | 334 |  |  | $ | 754 |
Deferred expense | 1,096 |  |  | 238 |  |  | 1,348 |  |  | 756 |
Income tax expense | $ | 1,340 |  |  | $ | 644 |  |  | $ | 1,682 |  |  | $ | 1,510 |

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Income tax expense includes $489,000 and $6,000 related to net securities gains for the three months ended September 30, 2019 and 2018, and $994,000 and $187,000 related to net security gains for the nine months ended September 30, 2019 and 2018.
The following table summarizes deferred tax assets and liabilities at September 30, 2019 and December 31, 2018.

(Dollars in thousands) | September 30, 2019 |  | December 31, 2018
Deferred tax assets: |  |  |
Allowance for loan losses | $ | 3,465 |  |  | $ | 3,143 |
Deferred compensation | 396 |  |  | 723 |
Retirement and salary continuation plans | 2,326 |  |  | 1,416 |
Share-based compensation | 592 |  |  | 742 |
Off-balance sheet reserves | 270 |  |  | 219 |
Nonaccrual loan interest | 843 |  |  | 537 |
Net unrealized losses on AFS securities | 0 |  |  | 791 |
Purchase accounting adjustments | 4,349 |  |  | 1,795 |
Bonus accrual | 366 |  |  | 470 |
Low-income housing credit carryforward | 341 |  |  | 641 |
Net operating loss carryovers | 1,872 |  |  | 0 |
Other | 473 |  |  | 321 |
Total deferred tax assets | 15,293 |  |  | 10,798 |
Deferred tax liabilities: |  |  |
Depreciation | 440 |  |  | 458 |
Net unrealized gains on AFS securities | 711 |  |  | 0 |
Mortgage servicing rights | 644 |  |  | 590 |
Purchase accounting adjustments | 1,682 |  |  | 1,021 |
Other | 250 |  |  | 150 |
Total deferred tax liabilities | 3,727 |  |  | 2,219 |
Net deferred tax asset, included in Other Assets | $ | 11,566 |  |  | $ | 8,579 |

The provision for income taxes differs from that computed by applying statutory rates to income before income taxes, primarily due to the effects of tax-exempt income, non-deductible expenses and tax credits. In the first quarter of 2019, the Company recorded a tax benefit of $185,000, related to a favorable tax law clarification concerning the treatment of life insurance assets of an acquired entity. In the second quarter of 2019, the Company recorded a tax benefit of $334,000, related to an increase in its deferred state income tax asset for the effect of the state tax rate change resulting from the Hamilton acquisition.
At September 30, 2019, the Company had low-income housing credit carryforwards that expire through 2038 and acquired federal and state net operating loss carryforwards, that are subject to annual loss limitation limits, that expire through 2037.
NOTE 8. SHARE-BASED COMPENSATION PLANS
The Company maintains share-based compensation plans under the shareholder-approved 2011 Plan. The purpose of the share-based compensation plans is to provide officers, employees, and non-employee members of the Board of Directors of the Company with additional incentive to further the success of the Company. At September 30, 2019, 881,920 shares of the common stock of the Company were reserved to be issued and 483,178 shares were available to be issued.
The 2011 Plan incentive awards may consist of grants of incentive stock options, nonqualified stock options, stock appreciation rights, restricted stock, deferred stock units and performance shares. All employees of the Company and its present or future subsidiaries, and members of the Board of Directors of the Company or any subsidiary of the Company, are eligible to participate in the 2011 Plan. The 2011 Plan allows for the Compensation Committee of the Board of Directors to determine the type of incentive to be awarded, its term, manner of exercise, vesting of awards and restrictions on shares. Generally, awards are nonqualified under the IRC, unless the awards are deemed to be incentive awards to employees at the Compensation Committee’s discretion.
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The table below presents a summary of nonvested restricted shares activity for the nine months ended September 30, 2019.

| Shares |  | Weighted Average Grant Date Fair Value
Nonvested shares, beginning of year | 275,412 |  |  | $ | 20.33 |
Granted | 86,543 |  |  | 19.71
Forfeited | (35,869) |  |  | 19.42 |
Vested | (114,405) |  |  | 17.22 |
Nonvested shares, at period end | 211,681 |  |  | $ | 21.91 |

The following table presents restricted shares compensation expense, with tax benefit information, and fair value of shares vested, for the three and nine months ended September 30, 2019 and 2018.

| Three months ended September 30, |  |  |  | Nine months ended September 30, |  |
(Dollars in thousands) | 2019 |  | 2018 |  | 2019 |  | 2018
Restricted share award expense | $ | 470 |  |  | $ | 179 |  |  | $ | 1,146 |  |  | $ | 1,099 |
Restricted share award tax benefit | 212 |  |  | 38 |  |  | 361 |  |  | 231 |
Fair value of shares vested | 2,056 |  |  | 0 |  |  | 2,500 |  |  | 1,056 |

The unrecognized compensation expense related to the share awards totaled $1,993,000 at September 30, 2019 and $2,115,000 at December 31, 2018. The unrecognized compensation expense at September 30, 2019 is expected to be recognized over a weighted-average period of 1.7 years.
The following table presents a summary of outstanding stock options activity for the nine months ended September 30, 2019.

| Shares |  | Weighted Average Exercise Price
Outstanding, beginning of year | 40,984 |  |  | $ | 24.34 |
Expired | (10,425) |  |  | 32.47 |
Options outstanding and exercisable | 30,559 |  |  | $ | 21.56 |

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

Range of Exercise Prices |  | Number Outstanding |  | Weighted Average Remaining Contractual Life (Years) |  | Weighted Average Exercise Price
$21.14 - $25.76 |  | 30,559 |  |  | 0.78 |  | $ | 21.56 |

Outstanding and exercisable options had an intrinsic value of $21,000 at September 30, 2019 and $0 at December 31, 2018.
The Company maintains an employee stock purchase plan to provide employees of the Company an opportunity to purchase Company common stock. Eligible employees may purchase shares in an amount that does not exceed 10% of their annual salary, at the lower of 95% of the fair market value of the shares on the semi-annual offering date or related purchase date. The Company reserved 350,000 shares of its common stock to be issued under the employee stock purchase plan. At September 30, 2019, 168,066 shares were available to be issued.
The following table presents information for the employee stock purchase plan for the three and nine months ended September 30, 2019 and 2018.

| Three months ended September 30, |  |  |  | Nine months ended September 30, |  |
(Dollars in thousands except share information) | 2019 |  | 2018 |  | 2019 |  | 2018
Shares purchased | 2,395 |  |  | 2,951 |  |  | 5,399 |  |  | 5,907 |
Weighted average price of shares purchased | $ | 22.87 |  |  | $ | 22.61 |  |  | $ | 20.69 |  |  | $ | 23.04 |
Compensation expense recognized | 5 |  |  | 10 |  |  | 8 |  |  | 14 |
Tax benefits | 1 |  |  | 2 |  |  | 2 |  |  | 3 |

The Company issues new shares or treasury shares, depending on market conditions, in its share-based compensation plans.
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NOTE 9. SHAREHOLDERS’ EQUITY AND REGULATORY CAPITAL
Banks and bank holding companies are subject to regulatory capital requirements administered by federal banking agencies. Capital adequacy guidelines and, additionally for banks, prompt corrective action regulations, involve quantitative measures of assets, liabilities and certain off-balance sheet items calculated under regulatory accounting practices. Capital amounts and classifications are also subject to qualitative judgments by regulators. Failure to meet capital requirements can initiate regulatory action. Under the Basel Committee on Banking Supervision's capital guidelines for U.S. Banks ("Basel III rules"), an entity must hold a capital conservation buffer above the adequately capitalized risk-based capital ratios. The required capital conservation buffer was 1.875% for 2018 and is 2.50% for 2019 under phase-in rules which were completed in 2019.
The consolidated asset limit on small bank holding companies is $3,000,000,000 and a company with assets under that limit is not subject to the FRB consolidated capital rules, but may file reports that include capital amounts and ratios. The Company has elected to file those reports.
Management believes that the Company and the Bank met all capital adequacy requirements to which they are subject at September 30, 2019 and December 31, 2018.
At September 30, 2019, the most recent regulatory notifications categorized the Bank as well capitalized under the regulatory framework for prompt corrective action. There are no conditions or events since that notification that management believes have changed the Bank's classification. Prompt corrective action regulations provide five classifications: well capitalized, adequately capitalized, undercapitalized, significantly undercapitalized and critically undercapitalized, although these terms are not used to represent overall financial condition. If adequately capitalized, regulatory approval is required to accept brokered deposits. If undercapitalized, capital distributions are limited, as is asset growth and expansion, and capital restoration plans are required.
The following table presents capital amounts and ratios at September 30, 2019 and December 31, 2018.

| Actual |  |  |  | For Capital Adequacy Purposes (includes applicable capital conservation buffer) |  |  |  | To Be Well Capitalized Under Prompt Corrective Action Provisions |  |
(Dollars in thousands) | Amount |  | Ratio |  | Amount |  | Ratio |  | Amount |  | Ratio
September 30, 2019 |  |  |  |  |  |  |  |  |  |  |
Total Capital to risk weighted assets |  |  |  |  |  |  |  |  |  |  |
Consolidated | $ | 240,674 |  |  | 14.5 | % |  | $ | 174,255 |  |  | 10.5 | % |  | n/a |  | n/a
Bank | 226,296 |  |  | 13.6 | % |  | 174,112 |  |  | 10.5 | % |  | $ | 165,821 |  |  | 10.0 | %
Tier 1 Capital to risk weighted assets |  |  |  |  |  |  |  |  |  |  |
Consolidated | 192,818 |  |  | 11.6 | % |  | 141,064 |  |  | 8.5 | % |  | n/a |  | n/a
Bank | 210,274 |  |  | 12.7 | % |  | 140,948 |  |  | 8.5 | % |  | 132,656 |  |  | 8.0 | %
Common Tier 1 (CET1) to risk weighted assets |  |  |  |  |  |  |  |  |  |  |  |
Consolidated | 192,818 |  |  | 11.6 | % |  | 116,170 |  |  | 7.0 | % |  | n/a |  | n/a
Bank | 210,274 |  |  | 12.7 | % |  | 116,074 |  |  | 7.0 | % |  | 107,783 |  |  | 6.5 | %
Tier 1 Capital to average assets |  |  |  |  |  |  |  |  |  |  |
Consolidated | 192,818 |  |  | 8.2 | % |  | 94,360 |  |  | 4.0 | % |  | n/a |  | n/a
Bank | 210,274 |  |  | 8.9 | % |  | 94,413 |  |  | 4.0 | % |  | 118,016 |  |  | 5.0 | %
December 31, 2018 |  |  |  |  |  |  |  |  |  |  |
Total Capital to risk weighted assets |  |  |  |  |  |  |  |  |  |  |
Consolidated | $ | 206,988 |  |  | 15.6 | % |  | $ | 131,393 |  |  | 9.875 | % |  | n/a |  | n/a
Bank | 177,892 |  |  | 13.4 | % |  | 131,286 |  |  | 9.875 | % |  | $ | 132,948 |  |  | 10.0 | %
Tier 1 Capital to risk weighted assets |  |  |  |  |  |  |  |  |  |  |
Consolidated | 160,117 |  |  | 12.0 | % |  | 104,782 |  |  | 7.875 | % |  | n/a |  | n/a
Bank | 162,880 |  |  | 12.3 | % |  | 104,696 |  |  | 7.875 | % |  | 106,358 |  |  | 8.0 | %
Common Tier 1 (CET1) to risk weighted assets |  |  |  |  |  |  |  |  |  |  |  |
Consolidated | 160,117 |  |  | 12.0 | % |  | 84,823 |  |  | 6.375 | % |  | n/a |  |  | n/a |
Bank | 162,880 |  |  | 12.3 | % |  | 84,754 |  |  | 6.375 | % |  | 86,416 |  |  | 6.5 | %
Tier 1 Capital to average assets |  |  |  |  |  |  |  |  |  |  |
Consolidated | 160,117 |  |  | 8.4 | % |  | 76,089 |  |  | 4.0 | % |  | n/a |  | n/a
Bank | 162,880 |  |  | 8.6 | % |  | 76,113 |  |  | 4.0 | % |  | 95,142 |  |  | 5.0 | %

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In September 2015, the Board of Directors of the Company authorized a share repurchase program under which the Company may repurchase up to 5% of the Company's outstanding shares of common stock, or approximately 416,000 shares, in accordance with all applicable securities laws and regulations, including Rule 10b-18 of the Exchange Act of 1934, as amended. When and if appropriate, repurchases may be made in open market or privately negotiated transactions, depending on market conditions, regulatory requirements and other corporate considerations, as determined by management. Share repurchases may not occur and may be discontinued at any time. At September 30, 2019, 82,725 shares had been repurchased under the program at a total cost of $1,438,000, or $17.38 per share.
On October 23, 2019, the Board declared a cash dividend of $0.15 per common share, which will be paid on November 12, 2019 to shareholders of record at November 4, 2019.
NOTE 10. EARNINGS PER SHARE
The following table presents earnings per share for the three and nine months ended September 30, 2019 and 2018.

| Three Months Ended September 30, |  |  |  | Nine Months Ended September 30, |  |
(In thousands, except per share information) | 2019 |  | 2018 |  | 2019 |  | 2018
Net income | $ | 6,901 |  |  | $ | 4,016 |  |  | $ | 12,690 |  |  | $ | 11,653 |
Weighted average shares outstanding - basic | 10,949 |  |  | 8,099 |  |  | 10,159 |  |  | 8,092 |
Dilutive effect of share-based compensation | 145 |  |  | 172 |  |  | 159 |  |  | 182 |
Weighted average shares outstanding - diluted | 11,094 |  |  | 8,271 |  |  | 10,318 |  |  | 8,274 |
Per share information: |  |  |  |  |  |  |
Basic earnings per share | $ | 0.63 |  |  | $ | 0.50 |  |  | $ | 1.25 |  |  | $ | 1.44 |
Diluted earnings per share | 0.62 |  |  | 0.49 |  |  | 1.23 |  |  | 1.41 |

Average outstanding stock options and restricted shares totaling 21,000 and 21,000 for the three months ended September 30, 2019 and 2018, and totaling 36,000 and 23,000 for the nine months ended September 30, 2019 and 2018, were not included in the computation of earnings per share because the effect was antidilutive, due to the exercise price exceeding the average market price. The dilutive effect of share-based compensation in each period above relates principally to restricted stock awards.
NOTE 11. FINANCIAL INSTRUMENTS WITH OFF-BALANCE SHEET RISK
The Company is a party to financial instruments with off-balance sheet risk in the normal course of business to meet the financing needs of its customers. These financial instruments include commitments to extend credit and standby letters of credit. Those instruments involve, to varying degrees, elements of credit and interest rate risk in excess of the amount recognized in the consolidated balance sheets. The contract amounts of those instruments reflect the extent of involvement the Company has in particular classes of financial instruments.
The Company’s exposure to credit loss in the event of nonperformance by the other party to the financial instrument for commitments to extend credit and standby letters of credit and financial guarantees written is represented by the contractual amount of those instruments. The Company uses the same credit policies in making commitments and conditional obligations as it does for on-balance sheet instruments. The following table presents these contract, or notional, amounts.

| Contract or Notional Amount |  |
(Dollars in thousands) | September 30, 2019 |  | December 31, 2018
Commitments to fund: |  |  |
Home equity lines of credit | $ | 201,353 |  |  | $ | 160,971 |
1-4 family residential construction loans | 26,630 |  |  | 13,002 |
Commercial real estate, construction and land development loans | 15,742 |  |  | 31,133 |
Commercial, industrial and other loans | 173,780 |  |  | 147,518 |
Standby letters of credit | 14,604 |  |  | 13,909 |

Commitments to extend credit are agreements to lend to a customer as long as there is no violation of any condition established in the contract. Commitments generally have fixed expiration dates or other termination clauses and may require payment of a fee. Since many of the commitments are expected to expire without being drawn upon, the total commitment amounts do not necessarily represent future cash requirements. The Company evaluates each customer’s credit-worthiness on a
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case-by-case basis. The amount of collateral obtained, if deemed necessary by the Company upon extension of credit, is based on management’s credit evaluation of the customer. Collateral varies but may include accounts receivable, inventory, equipment, residential real estate, and income-producing commercial properties.
Standby letters of credit and financial guarantees written are conditional commitments issued by the Company to guarantee the performance of a customer to a third party. Those guarantees are primarily issued to support public and private borrowing arrangements. The credit risk involved in issuing letters of credit is essentially the same as that involved in extending loans to customers. The Company holds collateral supporting those commitments when deemed necessary by management. The liability, at September 30, 2019 and December 31, 2018, for guarantees under standby letters of credit issued was not material.
NOTE 12. FAIR VALUE
Fair value is the exchange price that would be received for an asset or paid to transfer a liability (exit price) in the principal or most advantageous market for the asset or liability in an orderly transaction between market participants on the measurement date. Certain financial instruments and all non-financial instruments are excluded from disclosure requirements. Accordingly, the aggregate fair value amounts presented do not represent the underlying value of the Company.
The fair value hierarchy distinguishes between (1) market participant assumptions developed based on market data obtained from independent sources (observable inputs) and (2) an entity's own assumptions about market participant assumptions based on the best information available in the circumstances (unobservable inputs). The fair value hierarchy consists of three broad levels, which gives the highest priority to unadjusted quoted prices in active markets for identical assets or liabilities (Level 1) and the lowest priority to unobservable inputs (Level 3). The three levels of the fair value hierarchy are:
Level 1 – quoted prices (unadjusted) for identical assets or liabilities in active markets that the entity has the ability to access at the measurement date.
Level 2 – significant other observable inputs other than Level 1 prices such as prices for similar assets and liabilities in active markets; quoted prices for identical or similar instruments in markets that are not active; or other inputs that are observable or can be corroborated by observable market data.
Level 3 – at least one significant unobservable input that reflects a company's own assumptions about the assumptions that market participants would use in pricing an asset or liability.
In instances in which multiple levels of inputs are used to measure fair value, hierarchy classification is based on the lowest level input that is significant to the fair value measurement in its entirety. The Company's assessment of the significance of a particular input to the fair value measurement in its entirety requires judgment, and considers factors specific to the asset or liability.
The Company used the following methods and significant assumptions to estimate fair value for instruments measured on a recurring basis:
Where quoted prices are available in an active market, securities are classified within Level 1 of the valuation hierarchy. Level 1 securities include highly liquid government bonds, mortgage products and exchange traded equities. If quoted market prices are not available, securities are classified within Level 2 and fair values are estimated by using pricing models, quoted prices of securities with similar characteristics or discounted cash flow. Level 2 securities include U.S. agency securities, mortgage-backed securities, obligations of states and political subdivisions and certain corporate, asset backed and other securities. In certain cases where there is limited activity or less transparency around inputs to the valuation, securities are classified within Level 3 of the valuation hierarchy. All of the Company’s securities are classified as available for sale.
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The Company had no fair value liabilities measured on a recurring basis at September 30, 2019 and December 31, 2018.
The following table summarizes assets measured at fair value on a recurring basis at September 30, 2019 and December 31, 2018.

(Dollars in Thousands) | Level 1 |  | Level 2 |  | Level 3 |  | Total Fair Value Measurements
September 30, 2019 |  |  |  |  |  |  |
AFS Securities: |  |  |  |  |  |  |
States and political subdivisions | $ | 0 |  |  | $ | 82,712 |  |  | $ | 0 |  |  | $ | 82,712 |
GSE residential CMOs | 0 |  |  | 71,001 |  |  | 0 |  |  | 71,001 |
Private label commercial CMOs | 0 |  |  | 80,554 |  |  | 7,213 |  |  | 87,767 |
Asset-backed and other | 0 |  |  | 239,640 |  |  | 0 |  |  | 239,640 |
Totals | $ | 0 |  |  | $ | 473,907 |  |  | $ | 7,213 |  |  | $ | 481,120 |
December 31, 2018 |  |  |  |  |  |  |
AFS Securities: |  |  |  |  |  |  |
States and political subdivisions | $ | 0 |  |  | $ | 145,004 |  |  | $ | 0 |  |  | $ | 145,004 |
GSE residential CMOs | 0 |  |  | 108,064 |  |  | 0 |  |  | 108,064 |
Private label residential CMOs | 0 |  |  | 143 |  |  | 0 |  |  | 143 |
Private label commercial CMOs | 0 |  |  | 67,836 |  |  | 7,209 |  |  | 75,045 |
Asset-backed and other | 0 |  |  | 137,588 |  |  | 0 |  |  | 137,588 |
Totals | $ | 0 |  |  | $ | 458,635 |  |  | $ | 7,209 |  |  | $ | 465,844 |

One private label commercial CMO was measured at fair value on a recurring basis using significant unobservable inputs (Level 3) at September 30, 2019 and December 31, 2018. Fair value for this investment totaled $7,213,000 at September 30, 2019 and $7,209,000 at December 31, 2018. The investment was purchased at $7,213,000. Premium amortization expense totaling $31,000 and $72,000 was included in earnings for the three and nine months ended September 30, 2019, and an unrealized gain (loss) totaling $(87,000) and $76,000 was recognized in other comprehensive income for the three and nine months ended September 30, 2019. The Level 3 valuation is based on a non-executable broker quote, which is considered a significant unobservable input. Such quotes are updated as available and may remain constant for a period of time for certain broker-quoted securities that do not move with the market or that are not interest rate sensitive as a result of their structure or overall attributes.
Certain financial assets are measured at fair value on a nonrecurring basis. 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. The Company used the following methods and significant assumptions to estimate fair value for these financial assets.
Impaired Loans
Loans are designated as impaired when, in the judgment of management and based on current information and events, it is probable that all amounts due, according to the contractual terms of the loan agreement, will not be collected. The measurement of loss associated with impaired loans for all loan classes can be based on either the observable market price of the loan, the fair value of the collateral, or discounted cash flows based on a market rate of interest for performing TDRs. For collateral-dependent loans, fair value is measured based on the value of the collateral securing the loan, less estimated costs to sell. Collateral may be in the form of real estate or business assets including equipment, inventory, and accounts receivable. The value of the real estate collateral is determined utilizing an income or market valuation approach based on an appraisal conducted by an independent, licensed appraiser outside of the Company using observable market data (Level 2). However, if the collateral is a house or building in the process of construction, or if management adjusts the appraisal value, then the fair value is considered Level 3. The value of business equipment is based upon an outside appraisal, if deemed significant, or the net book value on the applicable business’ financial statements if not considered significant using observable market data. Likewise, values for inventory and accounts receivable collateral are based on financial statement balances or aging reports (Level 3). Impaired loans with an allocation to the ALL are measured at fair value on a nonrecurring basis. Any fair value adjustments are recorded in the period incurred as provision for loan losses on the consolidated statements of income. Specific allocations to the ALL or partial charge-offs totaled $863,000 and $928,000 at September 30, 2019 and December 31, 2018.
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The following table presents changes in the fair value for impaired loans still held at September 30, considered in the determination of the provision for loan losses, for the three and nine months ended September 30, 2019 and 2018.

| Three months ended September 30, |  |  |  | Nine months ended September 30, |  |
(Dollars in thousands) | 2019 |  | 2018 |  | 2019 |  | 2018
Changes in fair value of impaired loans still held | $ | 21 |  |  | $ | 63 |  |  | $ | 49 |  |  | $ | 147 |

Foreclosed Real Estate
OREO property acquired through foreclosure is initially recorded at the fair value of the property at the transfer date less estimated selling cost. Subsequently, OREO is carried at the lower of its carrying value or the fair value less estimated selling cost. Fair value is usually determined based upon an independent third-party appraisal of the property or occasionally upon a recent sales offer. Specific charges to value OREO at the lower of cost or fair value on properties held at September 30, 2019 and December 31, 2018 both totaled $0. There were no changes in the fair value of OREO for properties, still held at September 30, that were charged to real estate expenses for the three and nine months ended September 30, 2019. The fair value of OREO properties changed $11,000 for the three and nine months ended September 30, 2018.
Mortgage Servicing Rights
The fair value of mortgage servicing rights is estimated to be equal to its carrying value, unless the quarterly valuation model calculates the present value of the estimated net servicing income is less than its carrying value, in which case a lower of cost or fair value charge is taken. At September 30, 2019, a $240,000 lower of cost or fair value reserve existed on the mortgage servicing right portfolio. For the three and nine months ended September 30, 2019, impairment charges of $221,000 and $240,000 were recorded. No reserve existed at December 31, 2018, and no impairment charges were recorded in 2018.
The following table summarizes assets measured at fair value on a nonrecurring basis at September 30, 2019 and December 31, 2018.

(Dollars in thousands) | Level 1 |  | Level 2 |  | Level 3 |  | Total Fair Value Measurements
September 30, 2019 |  |  |  |  |  |  |
Impaired Loans |  |  |  |  |  |  |
Commercial real estate: |  |  |  |  |  |  |
Owner occupied | $ | 0 |  |  | $ | 0 |  |  | $ | 971 |  |  | $ | 971 |
Multi-family | 0 |  |  | 0 |  |  | 105 |  |  | 105 |
Non-owner occupied residential | 0 |  |  | 0 |  |  | 136 |  |  | 136 |
Commercial and industrial | 0 |  |  | 0 |  |  | 6 |  |  | 6 |
Residential mortgage: |  |  |  |  |  |  |
First lien | 0 |  |  | 0 |  |  | 722 |  |  | 722 |
Home equity - lines of credit | 0 |  |  | 0 |  |  | 407 |  |  | 407 |
Installment and other loans | 0 |  |  | 0 |  |  | 7 |  |  | 7 |
Total impaired loans | $ | 0 |  |  | $ | 0 |  |  | $ | 2,354 |  |  | $ | 2,354 |
Mortgage servicing rights | $ | 0 |  |  | $ | 3,116 |  |  | $ | 0 |  |  | $ | 3,116 |
December 31, 2018 |  |  |  |  |  |  |
Impaired Loans |  |  |  |  |  |  |
Commercial real estate: |  |  |  |  |  |  |
Owner occupied | $ | 0 |  |  | $ | 0 |  |  | $ | 1,087 |  |  | $ | 1,087 |
Multi-family | 0 |  |  | 0 |  |  | 131 |  |  | 131 |
Non-owner occupied residential | 0 |  |  | 0 |  |  | 278 |  |  | 278 |
Commercial and industrial | 0 |  |  | 0 |  |  | 25 |  |  | 25 |
Residential mortgage: |  |  |  |  |  |  |
First lien | 0 |  |  | 0 |  |  | 1,121 |  |  | 1,121 |
Home equity - lines of credit | 0 |  |  | 0 |  |  | 409 |  |  | 409 |
Total impaired loans | $ | 0 |  |  | $ | 0 |  |  | $ | 3,051 |  |  | $ | 3,051 |

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

(Dollars in thousands) | Fair Value Estimate |  | Valuation Techniques |  | Unobservable Input |  | Range
September 30, 2019 |  |  |  |  |  |  |
Impaired loans | $ | 2,354 |  |  | Appraisal of collateral |  | Management adjustments on appraisals for property type and recent activity |  | 5% - 30% discount
|  |  |  |  | - Management adjustments for liquidation expenses |  | 6%- 33% discount
Mortgage servicing rights | 3,116 |  |  | Discounted cash flows |  | Weighted average CPR |  | 12.7% |
|  |  |  |  | - Weighted average discount rate |  | 9.5% |
December 31, 2018 |  |  |  |  |  |  |
Impaired loans | $ | 3,051 |  |  | Appraisal of collateral |  | Management adjustments on appraisals for property type and recent activity |  | 5% - 75% discount
|  |  |  |  | - Management adjustments for liquidation expenses |  | 6% - 20% discount

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

(Dollars in thousands) | Carrying Amount |  | Fair Value |  | Level 1 |  | Level 2 |  | Level 3
September 30, 2019 |  |  |  |  |  |  |  |  |
Financial Assets |  |  |  |  |  |  |  |  |
Cash and due from banks | $ | 31,872 |  |  | $ | 31,872 |  |  | $ | 31,872 |  |  | $ | 0 |  |  | $ | 0 |
Interest-bearing deposits with banks | 19,051 |  |  | 19,051 |  |  | 19,051 |  |  | 0 |  |  | 0 |
Restricted investments in bank stocks | 11,399 |  |  | n/a |  |  | n/a |  |  | n/a |  |  | n/a |
AFS securities | 481,120 |  |  | 481,120 |  |  | 0 |  |  | 473,907 |  |  | 7,213 |
Loans held for sale | 7,610 |  |  | 7,819 |  |  | 0 |  |  | 7,819 |  |  | 0 |
Loans (carrying amount net of allowance for loan losses) | 1,578,296 |  |  | 1,605,129 |  |  | 0 |  |  | 0 |  |  | 1,605,129 |
Accrued interest receivable | 6,546 |  |  | 6,546 |  |  | 0 |  |  | 2,371 |  |  | 4,175 |
Financial Liabilities |  |  |  |  |  |  |  |  |
Deposits | 1,923,454 |  |  | 1,923,901 |  |  | 0 |  |  | 1,923,901 |  |  | 0 |
Short-term borrowings | 36,605 |  |  | 36,605 |  |  | 0 |  |  | 36,605 |  |  | 0 |
Long-term debt | 63,165 |  |  | 63,497 |  |  | 0 |  |  | 63,497 |  |  | 0 |
Subordinated notes | 31,834 |  |  | 32,474 |  |  | 0 |  |  | 32,474 |  |  | 0 |
Accrued interest payable | 1,468 |  |  | 1,468 |  |  | 0 |  |  | 1,468 |  |  | 0 |
Off-balance sheet instruments | 0 |  |  | 0 |  |  | 0 |  |  | 0 |  |  | 0 |
December 31, 2018 |  |  |  |  |  |  |  |  |
Financial Assets |  |  |  |  |  |  |  |  |
Cash and due from banks | $ | 26,156 |  |  | $ | 26,156 |  |  | $ | 26,156 |  |  | $ | 0 |  |  | $ | 0 |
Interest-bearing deposits with banks | 45,664 |  |  | 45,664 |  |  | 45,664 |  |  | 0 |  |  | 0 |
Federal Funds Sold | 16,995 |  |  | 16,995 |  |  | 16,995 |  |  | 0 |  |  | 0 |
Restricted investments in bank stocks | 10,842 |  |  | n/a |  |  | n/a |  |  | n/a |  |  | n/a |
AFS securities | 465,844 |  |  | 465,844 |  |  | 0 |  |  | 458,635 |  |  | 7,209 |
Loans held for sale | 3,340 |  |  | 3,413 |  |  | 0 |  |  | 3,413 |  |  | 0 |
Loans, net of allowance for loan losses | 1,233,643 |  |  | 1,229,645 |  |  | 0 |  |  | 0 |  |  | 1,229,645 |
Accrued interest receivable | 5,927 |  |  | 5,927 |  |  | 0 |  |  | 2,853 |  |  | 3,074 |
Financial Liabilities |  |  |  |  |  |  |  |  |
Deposits | 1,558,756 |  |  | 1,555,912 |  |  | 0 |  |  | 1,555,912 |  |  | 0 |
Short-term borrowings | 64,069 |  |  | 64,069 |  |  | 0 |  |  | 64,069 |  |  | 0 |
Long-term debt | 83,450 |  |  | 82,951 |  |  | 0 |  |  | 82,951 |  |  | 0 |
Subordinated notes | 31,859 |  |  | 31,256 |  |  | 0 |  |  | 31,256 |  |  | 0 |
Accrued interest payable | 1,301 |  |  | 1,301 |  |  | 0 |  |  | 1,301 |  |  | 0 |
Off-balance sheet instruments | 0 |  |  | 0 |  |  | 0 |  |  | 0 |  |  | 0 |

The methods utilized to measure the fair value of financial instruments at September 30, 2019 and December 31, 2018 represent an approximation of exit price; however, an actual exit price may differ.
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NOTE 13. REVENUE FROM CONTRACTS WITH CUSTOMERS
All of the Company's revenue from contracts with customers within the scope of ASC 606 is recognized within noninterest income on the consolidated statements of income. Consistent with ASC 606, noninterest income covered by this guidance is recognized as services are transferred to our customers in an amount that reflects the consideration we expect to be entitled to in exchange for those services.
Service Charges on Deposit Accounts - The Company earns fees from its deposit customers for transaction-based, account maintenance, and overdraft services. Transaction-based fees, which include services such as ATM use fees, stop payment charges, statement rendering, and ACH fees, are recognized at the time the transaction is executed, as that is the point in time the Company fulfills the customer's request. Account maintenance fees, which relate primarily to monthly maintenance, are earned over the course of a month, representing the period over which the Company satisfies the performance obligation. Overdraft fees are recognized at the point in time that the overdraft occurs. Service charges on deposits are withdrawn from the customer's account balance.
Interchange Income - The Company earns interchange fees from debit/credit cardholder transactions conducted through the MasterCard payment network. Interchange fees from cardholder transactions represent a percentage of the underlying transaction value and are recognized daily, concurrently with the transaction processing services provided to the cardholder. Interchange income is presented net of cardholder rewards.
Loan swap referral fees - The Company earns fees from a third-party service provider for loan hedging referrals provided to lending clients. The Company acts as an agent in arranging the relationship between our client and the third-party service provider. The company is paid and recognizes income upon completion of the loan hedge between our client and the third-party service provider.
Wealth Management and Investment Advisory Income (Gross) - The Company earns wealth management and investment brokerage fees from its contracts with trust and wealth management customers to manage assets for investment, and/or to transact on their accounts. Asset management fees are primarily earned over time as the Company provides the contracted services and are generally assessed based on a tiered scale of the market value of assets under management. Fees that are transaction based, including trade execution services, are recognized at the point in time that the transaction is executed, i.e., the trade date. Other related services provided included financial planning services, and the fees the Company earns for such services, which are based on a fixed fee schedule, are recognized when the services are rendered. Services are generally billed in arrears and a receivable is recorded until fees are paid.
Investment Brokerage Income (Net) - The Company earns fees from investment management and brokerage services provided to its customers through a third-party service provider. The Company receives commissions from the third-party service provider and recognizes income on a weekly basis based upon customer activity. Because the Company acts as an agent in arranging the relationship between the customer and the third-party service provider and does not control the services rendered to the customers, investment brokerage income is presented net of related costs.
Gains/Losses on Sales of OREO - The Company records a gain or loss on the sale of OREO when control of the property transfers to the buyer, which generally occurs at the time of an executed deed. If the Company finances the sale of OREO to the buyer, the Company assesses whether the buyer is committed to perform their obligations under the contract and whether collectability of the transaction price is probable. Once these criteria are met, the OREO asset is derecognized and the gain or loss on sale is recorded upon the transfer of control of the property to the buyer. In determining the gain or loss on the sale, the Company adjusts the transaction price and related gain (loss) on sale if a significant financing component is present.
At September 30, 2019 and December 31, 2018, the Company had receivables from customers totaling $737,000 and $640,000.
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The following table presents our noninterest income disaggregated by revenue source for the three and nine months ended September 30, 2019 and 2018.

| Three Months Ended |  |  |  | Nine Months Ended |  |
(Dollars in thousands) | September 30, 2019 |  | September 30, 2018 |  | September 30, 2019 |  | September 30, 2018
Noninterest income |  |  |  |  |  |  |
Service charges on deposits | $ | 1,025 |  |  | $ | 926 |  |  | $ | 2,802 |  |  | $ | 2,599 |
Loan swap referral fees | 629 |  |  |  | 0 |  |  |  | 629 |  |  |  | 0 |
Trust and investment management income | 1,892 |  |  | 1,668 |  |  | 5,399 |  |  | 5,037 |
Brokerage income | 654 |  |  | 455 |  |  | 1,804 |  |  | 1,514 |
Merchant and bankcard fees (interchange income) | 843 |  |  | 681 |  |  | 2,422 |  |  | 2,047 |
Revenue from contracts with customers | 5,043 |  |  | 3,730 |  |  | 13,056 |  |  | 11,197 |
Other service charges | 265 |  |  | 409 |  |  | 665 |  |  | 1,189 |
Mortgage banking activities | 623 |  |  | 735 |  |  | 1,743 |  |  | 2,049 |
Income from life insurance | 479 |  |  | 533 |  |  | 1,505 |  |  | 1,101 |
Other income | 44 |  |  | 56 |  |  | 188 |  |  | 272 |
Investment securities gains | 2,328 |  |  | 29 |  |  | 4,731 |  |  | 891 |
Total noninterest income | $ | 8,782 |  |  | $ | 5,492 |  |  | $ | 21,888 |  |  | $ | 16,699 |

NOTE 14. CONTINGENCIES
The nature of the Company’s business generates a certain amount of litigation involving matters arising out of the ordinary course of business. Except as described below, in the opinion of management, there are no legal proceedings that might have a material effect on the results of operations, liquidity, or the financial position of the Company at this time.
On May 25, 2012, SEPTA filed a putative class action complaint in the U.S. District Court for the Middle District of Pennsylvania against the Company, the Bank and certain current and former directors and executive officers (collectively, the “Defendants”). The complaint alleges, among other things, that (i) in connection with the Company’s Registration Statement on Form S-3 dated February 23, 2010 and its Prospectus Supplement dated March 23, 2010, and (ii) during the purported class period of March 24, 2010 through October 27, 2011, the Company issued materially false and misleading statements regarding the Company’s lending practices and financial results, including misleading statements concerning the stringent nature of the Bank’s credit practices and underwriting standards, the quality of its loan portfolio, and the intended use of the proceeds from the Company’s March 2010 public offering of common stock. The complaint asserts claims under Sections 11, 12(a) and 15 of the Securities Act of 1933, Sections 10(b) and 20(a) of the Securities Exchange Act of 1934 and Rule 10b-5 promulgated thereunder, and seeks class certification, unspecified money damages, interest, costs, fees and equitable or injunctive relief. Under the Private Securities Litigation Reform Act of 1995 (“PSLRA”), motions for appointment of Lead Plaintiff in this case were due by July 24, 2012. SEPTA was the sole movant and the Court appointed SEPTA Lead Plaintiff on August 20, 2012.
Pursuant to the PSLRA and the Court’s September 27, 2012 Order, SEPTA was given until October 26, 2012 to file an amended complaint and the Defendants until December 7, 2012 to file a motion to dismiss the amended complaint. SEPTA’s opposition to the Defendant’s motion to dismiss was originally due January 11, 2013. Under the PSLRA, discovery and all other proceedings in the case were stayed pending the Court’s ruling on the motion to dismiss. The September 27, 2012 Order specified that if the motion to dismiss were denied, the Court would schedule a conference to address discovery and the filing of a motion for class certification. On October 26, 2012, SEPTA filed an unopposed motion for enlargement of time to file its amended complaint in order to permit the parties and new defendants to be named in the amended complaint time to discuss plaintiff’s claims and defendants’ defenses. On October 26, 2012, the Court granted SEPTA’s motion, mooting its September 27, 2012 scheduling Order, and requiring SEPTA to file its amended complaint on or before January 16, 2013 or otherwise advise the Court of circumstances that require a further enlargement of time. On January 14, 2013, the Court granted SEPTA’s second unopposed motion for enlargement of time to file an amended complaint on or before March 22, 2013.
On March 4, 2013, SEPTA filed an amended complaint. The amended complaint expands the list of defendants in the action to include the Company’s independent registered public accounting firm and the underwriters of the Company’s March 2010 public offering of common stock. In addition, among other things, the amended complaint extends the purported 1934 Exchange Act class period from March 15, 2010 through April 5, 2012. Pursuant to the Court’s March 28, 2013 Second
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Scheduling Order, on May 28, 2013, all defendants filed their motions to dismiss the amended complaint, and on July 22, 2013, SEPTA filed its “omnibus” opposition to all of the defendants’ motions to dismiss. On August 23, 2013, all defendants filed reply briefs in further support of their motions to dismiss. On December 5, 2013, the Court ordered oral argument on the Orrstown Defendants’ motion to dismiss the amended complaint to be heard on February 7, 2014. Oral argument on the pending motions to dismiss SEPTA’s amended complaint was held on April 29, 2014.
The Second Scheduling Order stayed all discovery in the case pending the outcome of the motions to dismiss, and informed the parties that, if required, a telephonic conference to address discovery and the filing of SEPTA’s motion for class certification would be scheduled after the Court’s ruling on the motions to dismiss.
On April 10, 2015, pursuant to Court order, all parties filed supplemental briefs addressing the impact of the U.S. Supreme Court’s March 24, 2015 decision in Omnicare, Inc. v. Laborers District Council Construction Industry Pension Fund on defendants’ motions to dismiss the amended complaint.
On June 22, 2015, in a 96-page Memorandum, the Court dismissed without prejudice SEPTA’s amended complaint against all defendants, finding that SEPTA failed to state a claim under either the Securities Act of 1933, as amended, or the Securities Exchange Act of 1934, as amended. The Court ordered that, within 30 days, SEPTA either seek leave to amend its amended complaint, accompanied by the proposed amendment, or file a notice of its intention to stand on the amended complaint.
On July 22, 2015, SEPTA filed a motion for leave to amend under Local Rule 15.1, and attached a copy of its proposed second amended complaint to its motion. Many of the allegations of the proposed second amended complaint are essentially the same or similar to the allegations of the dismissed amended complaint. The proposed second amended complaint also alleges that the Orrstown Defendants did not publicly disclose certain alleged failures of internal controls over loan underwriting, risk management, and financial reporting during the period 2009 to 2012, in violation of the federal securities laws. On February 8, 2016, the Court granted SEPTA’s motion for leave to amend and SEPTA filed its second amended complaint that same day.
On February 25, 2016, the Court issued a scheduling Order directing: all defendants to file any motions to dismiss by March 18, 2016; SEPTA to file an omnibus opposition to defendants’ motions to dismiss by April 8, 2016; and all defendants to file reply briefs in support of their motions to dismiss by April 22, 2016. Defendants timely filed their motions to dismiss the second amended complaint and the parties filed their briefs in accordance with the Court-ordered schedule, above. The February 25, 2016 Order stays all discovery and other deadlines in the case (including the filing of SEPTA’s motion for class certification) pending the outcome of the motions to dismiss.
The allegations of SEPTA’s second amended complaint disclosed the existence of a confidential, non-public, fact-finding inquiry regarding the Company being conducted by the SEC. As disclosed in the Company’s Form 8-K filed on September 27, 2016, on that date the Company entered into a settlement agreement with the SEC resolving the investigation of accounting and related matters at the Company for the periods ended June 30, 2010, to December 31, 2011. As part of the settlement of the SEC’s administrative proceedings and pursuant to the cease-and-desist order, without admitting or denying the SEC’s findings, the Company, its Chief Executive Officer, its former Chief Financial Officer, its former Executive Vice President and Chief Credit Officer, and its Chief Accounting Officer, agreed to pay civil money penalties to the SEC. The Company agreed to pay a civil money penalty of $1,000,000. The Company had previously established a reserve for that amount which was expensed in the second fiscal quarter of 2016. In the settlement agreement with the SEC, the Company also agreed to cease and desist from committing or causing any violations and any future violations of Securities Act Sections 17(a)(2) and 17(a)(3) and Exchange Act Sections 13(a), 13(b)(2)(A) and 13(b)(2)(B), and Rules 12b-20, 13a-1 and 13a-13 promulgated thereunder.
On September 27, 2016, the Orrstown Defendants filed with the Court a Notice of Subsequent Event in Further Support of their Motion to Dismiss the Second Amended Complaint, regarding the settlement with the SEC. The Notice attached a copy of the SEC’s cease-and-desist order and briefly described what the Company believed were the most salient terms of the neither-admit-nor-deny settlement. On September 29, 2016, SEPTA filed a Response to the Notice, in which SEPTA argued that the settlement with the SEC did not support dismissal of the second amended complaint.
On December 7, 2016, the Court issued an Order and Memorandum granting in part and denying in part defendants’ motions to dismiss SEPTA’s second amended complaint. The Court granted the motions to dismiss the Securities Act claims against all defendants, and granted the motions to dismiss the Exchange Act Section 10(b) and Rule 10b-5 claims against all defendants except Orrstown Financial Services, Inc., Orrstown Bank, Thomas R. Quinn, Jr., Bradley S. Everly, and Jeffrey W. Embly. The Court also denied the motions to dismiss the Exchange Act Section 20(a) claims against Quinn, Everly, and Embly.
On January 31, 2017, the Court entered a Case Management Order establishing the schedule for the litigation and, on August 15, 2017, it entered a revised Order that, among other things, set the following deadlines: all fact discovery closes on March 1, 2018, and SEPTA’s motion for class certification is due the same day; expert merits discovery closes May 30, 2018;
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summary judgment motions are due by June 26, 2018; the mandatory pretrial and settlement conference is set for December 11, 2018; and trial is scheduled to begin on January 7, 2019.
On December 15, 2017, the Orrstown Defendants and SEPTA exchanged expert reports in opposition to and in support of class certification, respectively. On January 15, 2018, the parties exchanged expert rebuttal reports. SEPTA’s motion for class certification was due March 1, 2018, with the Orrstown Defendants’ opposition due April 2, 2018, and SEPTA’s reply due April 23, 2018.
On February 9, 2018, SEPTA filed a Status Report and Request for a Telephonic Status Conference asking the Court to convene a conference to discuss the status of discovery in the case and possible revisions to the case schedule. On February 12, 2018, the Orrstown Defendants filed their status report to provide the Court with a summary of document discovery in the case to date. On February 27, 2018, SEPTA filed an unopposed motion for a continuance of the existing case deadlines pending a status conference with the Court or the issuance of a revised case schedule. On February 28, 2018, the Court issued an Order continuing all case management deadlines until further order of the Court.
On March 27, 2018, the Court held a telephonic status conference with the parties to discuss outstanding discovery issues and case deadlines. On May 2, 2018, the parties filed a joint status report. On May 10, 2018, the Court held a follow-up telephonic status conference at which the parties reported on the progress of discovery to date. Party and non-party document discovery in the case has continued. To date, SEPTA has taken a few non-party depositions.
On August 9, 2018, SEPTA filed a motion to compel the production of Confidential Supervisory Information (CSI) of non-parties the Board of Governors of the Federal Reserve System (FRB) and the Pennsylvania Department of Banking and Securities, in the possession of Orrstown and third parties. On August 23, 2018, the Orrstown Defendants filed a response to the motion to compel. On August 30, 2018, the FRB filed an unopposed motion to intervene in the Action for the purpose of opposing SEPTA’s motion to compel, and on September 27, 2018, the FRB filed its brief in opposition to SEPTA’s motion. On October 11, 2018, SEPTA filed its reply brief in support of its motion to compel. On February 12, 2019, the Court denied SEPTA’s motion to compel the production of CSI on the ground that SEPTA had failed to exhaust its administrative remedies.
On April 11, 2019, SEPTA filed a motion for leave to file a third amended complaint. The proposed third amended complaint seeks to reassert the Securities Act claims that the Court dismissed as to all defendants on December 7, 2016, when the Court granted in part and denied in part defendants’ motions to dismiss SEPTA’s second amended complaint. The proposed third amended complaint also seeks to reassert the Exchange Act claims against those defendants that the Court dismissed from the case on December 7, 2016. Defendants’ briefs in opposition to SEPTA’s motion for leave to file a third amended complaint were filed on April 25, 2019. SEPTA filed a reply brief in further support of its motion for leave to file a third amended complaint on May 9, 2019. That motion is pending.
On June 13, 2019, Orrstown filed a motion for protective order to stay discovery pending resolution of SEPTA’s motion for leave to file a third amended complaint. On June 19, 2019, former defendants Smith Elliott Kearns & Company, LLC and the underwriters joined in Orrstown’s motion for protective order. On June 25, 2019, SEPTA filed its opposition to Orrstown’s motion. On July 9, 2019, Orrstown filed a reply brief in further support of its motion. On July 17, 2019, the Court entered an Order partially granting Orrstown’s motion for protective order, ruling that all deposition discovery in the case is stayed pending a decision on SEPTA’s motion for leave to file a third amended complaint.
The Company believes that the allegations of SEPTA’s second amended complaint, and the allegations of the proposed third amended complaint, are without merit and intends to defend itself vigorously against those claims. It is not possible at this time to estimate reasonably possible losses, or even a range of reasonably possible losses, in connection with the litigation.
NOTE 15. SUBSEQUENT EVENT
In October, 2019, the Board of Directors approved a plan to consolidate five Pennsylvania branch locations and to sell an operations center. The plan is part of the Company's ongoing efforts to target serving local communities, to invest in new technologies to support changes in client preferences, to grow the Bank, and to optimize returns for shareholders. Subject to regulatory approval, the five Pennsylvania branches will be consolidated into other, larger, Orrstown Bank branches.
One time charges associated with the branch consolidations and operations center sale are estimated to be in the range of $800,000 to $1,200,000 in the fourth quarter of 2019 and thereafter cost savings are estimated to be in the range of $1,500,000 to $2,000,000 annually, beginning in the second quarter of 2020. It is anticipated that the consolidations and operations center sale will be completed in the first quarter of 2020. Approximately one third of the operations center space will be leased back to the Bank, eliminating approximately 50,000 square feet of excess back office space. The sale is not expected to result in a material gain or loss or materially impact future earnings.
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See the Glossary of Defined Terms at the beginning of this Report for terms used throughout this Form 10-Q.
Item 2. Management’s Discussion and Analysis of Financial Condition and Results of Operations
Overview
The Company, headquartered in Shippensburg, Pennsylvania, is a one-bank holding company that has elected status as a financial holding company. The consolidated financial information presented herein reflects the Company and its wholly-owned subsidiaries, the Bank and Wheatland. At September 30, 2019, the Company had total assets of $2,313,677,000, total liabilities of $2,090,184,000 and total shareholders’ equity of $223,493,000.
Caution About Forward-Looking Statements
Certain statements appearing herein, which are not historical in nature, are forward-looking statements within the meaning of the Private Securities Litigation Reform Act of 1995. In addition, we may make other written and oral communications, from time to time, that contain such statements. Such forward-looking statements refer to a future period or periods, reflecting our current beliefs as to likely future developments, and use words like “may,” “will,” “expect,” “estimate,” “anticipate” or similar terms. Forward-looking statements are statements that include projections, predictions, expectations, or beliefs about events or results or otherwise are not statements of historical facts, including, but not limited to, statements related to new business development, new loan opportunities, growth in the balance sheet and fee based revenue lines of business, merger and acquisition activity, reducing risk assets, and mitigating losses in the future. Actual results and trends could differ materially from those set forth in such statements and there can be no assurances that we will achieve the desired level of new business development and new loans, growth in the balance sheet and fee based revenue lines of business, successful merger and acquisition activity, continue to reduce risk assets or mitigate losses in the future. Factors that could cause actual results to differ from those expressed or implied by the forward-looking statements include, but are not limited to, the following: ineffectiveness of the Company’s business strategy due to changes in current or future market conditions; the effects of competition, including industry consolidation and development of competing financial products and services; difficulty integrating the Company's strategic acquisitions; the inability to fully achieve expected savings, efficiencies or synergies from mergers and acquisitions, or taking longer than estimated for such savings, efficiencies and synergies to be realized; changes in laws and regulations; interest rate movements; changes in credit quality; inability to raise capital, if necessary, under favorable conditions; volatilities in the securities markets; deteriorating economic conditions; expenses associated with pending litigation and legal proceedings; and other risks and uncertainties, including those detailed in our Annual Report on Form 10-K for the year ended December 31, 2018, and our Quarterly Reports on Form 10-Q under the sections titled “Risk Factors” and “Management’s Discussion and Analysis of Financial Condition and Results of Operations” and in other filings made with the SEC. The statements are valid only as of the date hereof and we disclaim any obligation to update this information.
The following is a discussion of our consolidated financial condition at September 30, 2019 and results of operations for the nine months ended September 30, 2019 and 2018. Throughout this discussion, the yield on earning assets is stated on a fully taxable-equivalent basis and balances represent average daily balances unless otherwise stated. The discussion and analysis should be read in conjunction with our unaudited consolidated financial statements and accompanying notes presented elsewhere in this report. Certain prior period amounts, presented in this discussion and analysis, may have been reclassified to conform to current period classifications.
Critical Accounting Estimates
The Company’s accounting and reporting policies are in accordance with GAAP and follow accounting and reporting guidelines prescribed by bank regulatory authorities and general practices within the financial services industry in which it operates. Our financial position and results of operations are affected by management's application of accounting policies, including estimates, and assumptions and judgments that affect the amounts reported in the consolidated financial statements and accompanying notes. These estimates, assumptions, and judgments are based on information available as of the balance sheet date and through the date the financial statements are filed with the SEC. Different assumptions in the application of these policies could result in material changes in the consolidated financial position and/or consolidated results of operations and related disclosures. The more critical accounting estimates include accounting for credit losses and valuation methodologies. Accordingly, these critical accounting estimates are discussed in detail in "Management's Discussion and Analysis of Financial Condition and Results of Operations" in our Annual Report on Form 10-K for the year ended December 31, 2018. Significant accounting policies and any changes in accounting principles and effects of new accounting pronouncements are discussed in Note 1, Summary of Significant Accounting Policies, to the Consolidated Financial Statements under Part II, Item 8, "Financial Statements and Supplementary Data," in our Annual Report on Form 10-K for the year ended December 31, 2018. Additional disclosures regarding the effects of new accounting pronouncements are included in this report in Note 1, Summary of Significant Accounting Policies, to the Consolidated Financial Statements under Part I, Item 1, "Financial Information."
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RESULTS OF OPERATIONS
Quarter ended September 30, 2019 compared with quarter ended September 30, 2018
Summary
Net income totaled $6,901,000 for the three months ended September 30, 2019 compared with net income totaling $4,016,000 for the same period in 2018. Diluted EPS for the three months ended September 30, 2019 totaled $0.62, compared with $0.49 for the three months ended September 30, 2018. Net interest income positively influenced results of operations, and totaled $17,920,000 for the three months ended September 30, 2019, a 41.06% increase compared with 2018. Noninterest income, excluding investment securities gains, totaled $6,454,000 for the three months ended September 30, 2019 and $5,463,000 for 2018. Investment securities gains totaled $2,328,000 in the three months ended September 30, 2019, compared with $29,000 for the same period in 2018. Noninterest expenses totaled $18,161,000 and $13,336,000 for the three months ended September 30, 2019 and 2018. Noninterest expenses in 2019 included merger related expenses totaling $471,000 associated with the Company's ongoing growth strategy.
The comparability of operating results for 2019 with 2018 have generally been impacted by the Mercersburg acquisition, completed on October 1, 2018, and the Hamilton acquisition, completed on May 1, 2019.
Net Interest Income
Net interest income increased $5,216,000, from $12,704,000 to $17,920,000, for the three months ended September 30, 2019 compared with the same period in 2018. Interest and fees income on loans increased $7,718,000, from $12,281,000 to $19,999,000, securities interest income increased $219,000, from $3,877,000 to $4,096,000, and total interest expense increased $3,214,000 from $3,522,000 to $6,736,000, in comparing the three months ended September 30, 2019 with 2018.
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The following table presents net interest income, net interest spread and net interest margin for the three months ended September 30, 2019 and 2018 on a taxable-equivalent basis.

| Three Months Ended September 30, 2019 |  |  |  |  |  | Three Months Ended September 30, 2018 |  |  |  |
(Dollars in thousands) | Average Balance |  | Taxable- Equivalent Interest |  | Taxable- Equivalent Rate |  | Average Balance |  | Taxable- Equivalent Interest |  | Taxable- Equivalent Rate
Assets |  |  |  |  |  |  |  |  |  |  |
Federal funds sold & interest-bearing bank balances | $ | 96,212 |  |  | $ | 561 |  |  | 2.31 | % |  | $ | 13,058 |  |  | $ | 68 |  |  | 2.07 | %
Securities (1) | 496,482 |  |  | 4,177 |  |  | 3.34 |  |  | 490,750 |  |  | 4,131 |  |  | 3.34 |
Loans (1)(2) | 1,604,491 |  |  | 20,126 |  |  | 4.98 |  |  | 1,074,106 |  |  | 12,376 |  |  | 4.57 |
Total interest-earning assets | 2,197,185 |  |  | 24,864 |  |  | 4.49 |  |  | 1,577,914 |  |  | 16,575 |  |  | 4.17 |
Other assets | 193,946 |  |  |  |  |  |  | 108,976 |  |  |  |  |
Total | $ | 2,391,131 |  |  |  |  |  |  | $ | 1,686,890 |  |  |  |  |
Liabilities and Shareholders’ Equity |  |  |  |  |  |  |  |  |  |  |
Interest-bearing demand deposits | $ | 954,824 |  |  | 2,185 |  |  | 0.91 |  |  | $ | 759,789 |  |  | $ | 1,377 |  |  | 0.72 |
Savings deposits | 151,692 |  |  | 81 |  |  | 0.21 |  |  | 97,527 |  |  | 38 |  |  | 0.15 |
Time deposits (3) | 658,587 |  |  | 3,508 |  |  | 2.11 |  |  | 328,321 |  |  | 1,365 |  |  | 1.65 |
Short-term borrowings | 10,497 |  |  | 39 |  |  | 1.48 |  |  | 63,617 |  |  | 332 |  |  | 2.07 |
Long-term debt | 74,524 |  |  | 433 |  |  | 2.30 |  |  | 83,596 |  |  | 410 |  |  | 1.95 |
Subordinated notes | 31,826 |  |  | 490 |  |  | 6.10 |  |  | 0 |  |  | 0 |  |  | 0.00 |
Total interest-bearing liabilities | 1,881,950 |  |  | 6,736 |  |  | 1.42 |  |  | 1,332,850 |  |  | 3,522 |  |  | 1.05 |
Noninterest-bearing demand deposits | 252,211 |  |  |  |  |  |  | 191,533 |  |  |  |  |
Other | 35,720 |  |  |  |  |  |  | 17,323 |  |  |  |  |
Total Liabilities | 2,169,881 |  |  |  |  |  |  | 1,541,706 |  |  |  |  |
Shareholders’ Equity | 221,250 |  |  |  |  |  |  | 145,184 |  |  |  |  |
Total | $ | 2,391,131 |  |  |  |  |  |  | $ | 1,686,890 |  |  |  |  |
Taxable-equivalent net interest income /net interest spread |  |  | 18,128 |  |  | 3.07 | % |  |  |  | 13,053 |  |  | 3.12 | %
Taxable-equivalent net interest margin |  |  |  |  | 3.27 | % |  |  |  |  |  | 3.28 | %
Taxable-equivalent adjustment |  |  | (208) |  |  |  |  |  |  | (349) |  |  |
Net interest income |  |  | $ | 17,920 |  |  |  |  |  |  | $ | 12,704 |  |  |

Table notes: (1) Yields and interest income on tax-exempt assets have been computed on a taxable-equivalent basis assuming a 21% tax rate.
(2) For yield calculation purposes, nonaccruing loans are included in the average loan balance.
(3) For the three months ended September 30, 2019, expenses associated with the early redemption of brokered time deposits totaled $215,000, and increased the cost of funds by 13 basis points.
For the quarter ended September 30, 2019, taxable-equivalent basis net interest income increased $5,075,000 from 2018. The increase reflected a changing interest rate environment with increased average interest-earning assets balances partially offset by a higher average balance of interest-bearing liabilities. The FOMC increased the Fed Funds target rate 25 basis points in both September and December, 2018, and decreased it 25 basis points in both July and September, 2019.
Taxable-equivalent interest income earned on loans increased $7,750,000 year-over-year. The $530,385,000 increase in average loan balance year-over-year reflects loans acquired in the Mercersburg and Hamilton transactions, which totaled approximately $425,900,000 at September 30, 2019. During the third quarter of 2019, the Company experienced a net $9,000,000 reduction in loans outstanding due to repayments totaling $16,000,000 from the acquired Hamilton loan portfolio. The focus on the successful Hamilton system conversion in the third quarter while simultaneously recruiting and onboarding a team of experienced lenders in the Maryland Region resulted in a slowdown in loan origination activity in Maryland. The noted rate increases in 2018 contributed to the 41 basis point increase in yield, but a flattened yield curve and the rate reductions in July and September, 2019, partially offset the benefit of the 2018 rate increases. Accretion of purchase accounting adjustments in connection with the Mercersburg and Hamilton acquisitions increased third quarter 2019 interest income by $880,000. Interest income included $21,000 related to the payoff of purchased credit impaired loans.
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Taxable-equivalent securities interest income increased $46,000 year-over-year, with the average balance of securities increasing $5,732,000 from September 30, 2018 to September 30, 2019. The taxable equivalent yield was 3.34% year-over-year and reflected the changing interest rate environment and certain repositioning within the portfolio under the Company's asset/liability management strategies.
Interest expense on deposits and borrowings increased $3,214,000 year-over-year, with the average balance of interest-bearing deposits increasing $579,466,000 and the average balance of total borrowings decreasing $30,366,000. In addition to the impact of the noted changing interest rate environment on interest expense, the Company issued $32,500,000 of 6.0% subordinated notes in December 2018. A seasonal increase in government deposits contributed to an increase in average cash on the balance sheet in the quarter in 2019. Due to the short-term increase in cash, the Company took steps to reduce brokered deposits in an effort to reduce cash to a normal target range of $25,000,000 or less. The excess cash held on the balance sheet, totaling approximately $70,000,000 during the third quarter, negatively impacted the interest margin by 11 basis points.
Provision for Loan Losses
Asset quality trends continue to be solid with a low level of charge-offs and low nonperforming loans. The provision for loan losses totaled $300,000 in the third quarter of 2019, compared with $200,000 for the same period in 2018.
Net recoveries in the quarter ended September 30, 2019 totaled $49,000, equating to (0.01)% annualized as compared with net charge-offs totaling $23,000, or 0.01% annualized, in the previous quarter. Nonperforming loans to loans totaled 0.44% of loans at September 30, 2019, compared with 0.27% of loans at June 30, 2019. Loans outstanding decreased in the quarter with net recoveries, however, the Company experienced a $2,500,000 increase in nonperforming loans during the third quarter of 2019, which required additional reserves.
Additional information is included in the "Credit Risk Management" section herein.
Noninterest Income
The following table compares noninterest income for the three months ended September 30, 2019 and 2018.

| Three Months Ended September 30, |  |  |  |  | $ Change |  |  | % Change
(Dollars in thousands) | 2019 |  | 2018 |  | 2019-2018 |  | 2019-2018
Service charges on deposit accounts | $ | 1,761 |  |  | $ | 1,524 |  |  | $ | 237 |  |  | 15.6 | %
Other service charges, commissions and fees | 372 |  |  | 492 |  |  | (120) |  |  | (24.4) | %
Loan swap referral fees | 629 |  |  | 0 |  |  | 629 |  |  | nm* |
Trust and investment management income | 1,892 |  |  | 1,668 |  |  | 224 |  |  | 13.4 | %
Brokerage income | 654 |  |  | 455 |  |  | 199 |  |  | 43.7 | %
Mortgage banking activities | 623 |  |  | 735 |  |  | (112) |  |  | (15.2) | %
Income from life insurance | 479 |  |  | 533 |  |  | (54) |  |  | (10.1) | %
Other income | 44 |  |  | 56 |  |  | (12) |  |  | (21.4) | %
Subtotal before securities gains | 6,454 |  |  | 5,463 |  |  | 991 |  |  | 18.1 | %
Investment securities gains | 2,328 |  |  | 29 |  |  | 2,299 |  |  | nm* |
Total noninterest income | $ | 8,782 |  |  | $ | 5,492 |  |  | $ | 3,290 |  |  | 59.9 | %
nm*: not meaningful |  |  |  |  |  |  |

The following factors contributed to the more significant changes in noninterest income between the three months ended September 30, 2019 and 2018.
•Income for trust and investment management income and brokerage income included the effect of increased revenue from additional advisors and increased estate fees in 2019.
•In the third quarter of 2019, the Company recognized $629,000 for loan swap referral fees under a program in which it refers qualified commercial borrowers to a third party, which enters into an interest rate swap agreement with the borrower. The rate swap provides the borrower with the economic equivalent of a fixed-rate loan while allowing the Company to receive a variable rate of interest. Income from this program will vary from quarter to quarter depending on demand from qualified borrowers with a preference to enter into swap agreements with the third party.
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•Mortgage banking income decreased in the year-over-year comparison. In the third quarter of 2019, a $221,000 impairment charge due to decreasing interest rates was recognized on mortgage servicing rights. Loans sold in the quarter totaled $34.4 million compared with $27.6 million in the previous year.
•Income from bank owned life insurance included death benefit proceeds totaling $242,000 in 2018, with the remainder of the change in 2019 attributable to additional life insurance policies acquired in the Mercersburg and Hamilton acquisitions.
•Other line items within noninterest income showed fluctuations between 2019 and 2018 attributable to normal business operations and the effect of the acquisitions.
The Company recognized net investment securities gains in 2019 and 2018 as opportunities became available to reposition part of the investment portfolio under asset/liability management strategies or to improve responsiveness of the portfolio to interest rate conditions, while also considering funding requirements of anticipated lending activity.
Noninterest Expenses
The following table compares noninterest expenses for the three months ended September 30, 2019 and 2018.

| Three Months Ended September 30, |  |  |  |  | $ Change |  | % Change
(Dollars in thousands) | 2019 |  | 2018 |  | 2019-2018 |  | 2019-2018
Salaries and employee benefits | $ | 10,489 |  |  | $ | 7,610 |  |  | $ | 2,879 |  |  | 37.8 | %
Occupancy | 1,133 |  |  | 775 |  |  | 358 |  |  | 46.2 | %
Furniture and equipment | 1,252 |  |  | 990 |  |  | 262 |  |  | 26.5 | %
Data processing | 830 |  |  | 661 |  |  | 169 |  |  | 25.6 | %
Telephone and communication | 198 |  |  | 181 |  |  | 17 |  |  | 9.4 | %
Automated teller machine and interchange fees | 270 |  |  | 187 |  |  | 83 |  |  | 44.4 | %
Advertising and bank promotions | 279 |  |  | 279 |  |  | 0 |  |  | 0.0 | %
FDIC insurance | (9) |  |  | 169 |  |  | (178) |  |  | (105.3) | %
Legal | 189 |  |  | 215 |  |  | (26) |  |  | (12.1) | %
Other professional services | 625 |  |  | 361 |  |  | 264 |  |  | 73.1 | %
Directors' compensation | 228 |  |  | 207 |  |  | 21 |  |  | 10.1 | %
Real estate owned | 22 |  |  | 18 |  |  | 4 |  |  | 22.2 | %
Taxes other than income | 306 |  |  | 259 |  |  | 47 |  |  | 18.1 | %
Intangible asset amortization | 486 |  |  | 24 |  |  | 462 |  |  | nm* |
Merger related | 471 |  |  | 319 |  |  | 152 |  |  | 47.6 | %
Other operating expenses | 1,392 |  |  | 1,081 |  |  | 311 |  |  | 28.8 | %
Total noninterest expenses | $ | 18,161 |  |  | $ | 13,336 |  |  | $ | 4,825 |  |  | 36.2 | %
nm*: not meaningful |  |  |  |  |  |  |

The following factors contributed to the more significant changes in noninterest expenses between the three months ended September 30, 2019 and 2018.
•Expanded operations with the addition of employees and branches from the Mercersburg acquisition in October 2018 and the Hamilton acquisition in May 2019; two branches opened in the fourth quarter of 2018 and two opened in the first quarter of 2019 in Lancaster County, Pennsylvania; and additional support personnel for the Company's ongoing expansion efforts all contributed to increases in salaries and employee benefits, occupancy costs, furniture and equipment, and data processing costs year-over-year, as well as the timing of advertising and bank promotions expenses incurred.
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•Salaries and employee benefits principally reflected employees added in the acquisitions and for additional employees for the Company's new branches. In addition, the net increase included the impact of our overall expansion efforts, annual merit increases, and incremental expense for additional share-based compensation awards granted in 2019, net of the benefit of forfeitures. In 2019, overall costs associated with the Company's self-insured group health plan were higher than in 2018 due to an increased number of employees and fluctuations in claims experience.
•Occupancy, furniture and equipment costs reflected Mercersburg and Hamilton branches acquired, and the Company's expanded presence in Lancaster County, Pennsylvania.
•The decrease in FDIC insurance expense reflects credits received in the third quarter that offset the Bank's second quarter 2019 FDIC assessment. The FDIC's assessment regulations provide that, for banks with consolidated total assets under $10 billion, after the reserve ratio reaches 1.38 percent (and provided that it remains at least 1.38%), the FDIC will automatically apply credits to reduce regular deposit insurance assessments up to the full amount of their assessments or the full amount of their credits, whichever is less. The reserve ratio reached 1.40% on June 30, 2019. Therefore, credits were first applied during the third quarter of 2019. If the reserve ratio remains at least 1.38%, the Company estimates it will receive credits that will offset its third quarter 2019 assessment and partially offset its fourth quarter 2019 assessment.
•Intangible asset amortization increased principally due to amortization of core deposit intangibles recorded in the Mercersburg and Hamilton acquisitions.
•The Company incurred merger related expenses in the second quarter of 2019, principally employee termination costs and system conversion related fees for the Hamilton acquisition.
•Other line items within noninterest expenses showed fluctuations between 2019 and 2018 attributable to normal business operations and the impact of the acquisitions.
Income Tax Expense
Income tax expense totaled $1,340,000, an effective tax rate of 16.3%, for the three months ended September 30, 2019, compared with $644,000, an effective tax rate of 13.8%, for the three months ended September 30, 2018. The Company’s effective tax rate is significantly less than the 21% federal statutory rate, principally due to tax-free income, which includes interest income on tax-free loans and securities and income from life insurance policies, federal income tax credits, and the impact of non-tax deductible expenses, including certain merger related expenses.
Nine months ended September 30, 2019 compared with nine months ended September 30, 2018
Summary
Net income totaled $12,690,000 for the nine months ended September 30, 2019 compared with net income of $11,653,000 for the same period in 2018. Diluted EPS for the nine months ended September 30, 2019 totaled $1.23, compared with $1.41 for the nine months ended September 30, 2018. Net interest income positively influenced results of operations, and totaled $51,041,000 for the nine months ended September 30, 2019, a $14,300,000 increase compared with 2018. Noninterest income, excluding investment securities gains, totaled $17,157,000 for the nine months ended September 30, 2019 compared with $15,808,000 in 2018. Investment securities gains totaled $4,731,000 in the nine months ended September 30, 2019, compared with $891,000 for the same period in 2018. Noninterest expenses totaled $57,657,000 and $39,677,000 for the nine months ended September 30, 2019 and 2018. Noninterest expenses in 2019 included merger related expenses totaling $7,976,000 associated with the Company's ongoing growth strategy, increased salaries and occupancy expenses, and the write-off of an insurance claim receivable totaling $615,000 resulting from an insurer's denial of a claim from a cyber security incident reported in 2018.
The comparability of operating results for 2019 with 2018 have generally been impacted by the Mercersburg acquisition, completed on October 1, 2018, and the Hamilton acquisition, completed on May 1, 2019.
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Net Interest Income
Net interest income increased $14,300,000, from $36,741,000 to $51,041,000, for the nine months ended September 30, 2019 compared with the same period in 2018. Interest and fees income on loans increased $19,543,000, from $35,068,000 to $54,611,000, securities interest income increased $2,153,000, from $10,588,000 to $12,741,000, and total interest expense increased $8,464,000 from $9,084,000 to $17,548,000, in comparing the nine months ended September 30, 2019 with 2018.
The following table presents net interest income, net interest spread and net interest margin for the nine months ended September 30, 2019 and 2018 on a taxable-equivalent basis.

| Nine Months Ended September 30, 2019 |  |  |  |  |  | Nine Months Ended September 30, 2018 |  |  |  |
(Dollars in thousands) | Average Balance |  | Taxable- Equivalent Interest |  | Taxable- Equivalent Rate |  | Average Balance |  | Taxable- Equivalent Interest |  | Taxable- Equivalent Rate
Assets |  |  |  |  |  |  |  |  |  |  |
Federal funds sold & interest-bearing bank balances | $ | 70,300 |  |  | $ | 1237 |  |  | 2.35 | % |  | $ | 12,169 |  |  | $ | 169 |  |  | 1.86 | %
Securities (1) | 497,669 |  |  | 13,214 |  |  | 3.55 |  |  | 470,290 |  |  | 11,341 |  |  | 3.22 |
Loans (1)(2) | 1,454,468 |  |  | 54,983 |  |  | 5.05 |  |  | 1,053,654 |  |  | 35,343 |  |  | 4.48 |
Total interest-earning assets | 2,022,437 |  |  | 69,434 |  |  | 4.59 |  |  | 1,536,113 |  |  | 46,853 |  |  | 4.08 |
Other assets | 169,308 |  |  |  |  |  |  | 106,979 |  |  |  |  |
Total | $ | 2,191,745 |  |  |  |  |  |  | $ | 1,643,092 |  |  |  |  |
Liabilities and Shareholders’ Equity |  |  |  |  |  |  |  |  |  |  |
Interest-bearing demand deposits | $ | 907,911 |  |  | 6,053 |  |  | 0.89 |  |  | $ | 739,616 |  |  | 3,191 |  |  | 0.58 |
Savings deposits | 137,493 |  |  | 206 |  |  | 0.20 |  |  | 98,105 |  |  | 115 |  |  | 0.16 |
Time deposits (3) | 546,717 |  |  | 8,079 |  |  | 1.98 |  |  | 303,749 |  |  | 3,459 |  |  | 1.52 |
Short-term borrowings | 20,622 |  |  | 316 |  |  | 2.05 |  |  | 83,485 |  |  | 1,097 |  |  | 1.76 |
Long-term debt | 86,537 |  |  | 1,408 |  |  | 2.18 |  |  | 83,686 |  |  | 1,222 |  |  | 1.95 |
Subordinated notes | 31,843 |  |  | 1,486 |  |  | 6.24 |  |  | 0 |  |  | 0 |  |  | 0.00 |
Total interest-bearing liabilities | 1,731,123 |  |  | 17,548 |  |  | 1.36 |  |  | 1,308,641 |  |  | 9,084 |  |  | 0.93 |
Noninterest-bearing demand deposits | 230,056 |  |  |  |  |  |  | 174,896 |  |  |  |  |
Other | 30,286 |  |  |  |  |  |  | 16,480 |  |  |  |  |
Total Liabilities | 1,991,465 |  |  |  |  |  |  | 1,500,017 |  |  |  |  |
Shareholders’ Equity | 200,280 |  |  |  |  |  |  | 143,075 |  |  |  |  |
Total | $ | 2,191,745 |  |  |  |  |  |  | $ | 1,643,092 |  |  |  |  |
Taxable-equivalent net interest income /net interest spread |  |  | 51,886 |  |  | 3.23 | % |  |  |  | 37,769 |  |  | 3.15 | %
Taxable-equivalent net interest margin |  |  |  |  | 3.43 | % |  |  |  |  |  | 3.29 | %
Taxable-equivalent adjustment |  |  | (845) |  |  |  |  |  |  | (1,028) |  |  |
Net interest income |  |  | $ | 51,041 |  |  |  |  |  |  | $ | 36,741 |  |  |

Table notes: (1) Yields and interest income on tax-exempt assets have been computed on a taxable-equivalent basis assuming a 21% tax rate.
(2) For yield calculation purposes, nonaccruing loans are included in the average loan balance.
(3) For the nine months ended September 30, 2019, expenses associated with the early redemption of brokered time deposits totaled $215,000, and increased the cost of funds by 5 basis points.
For the nine months ended September 30, 2019, taxable-equivalent basis net interest income increased $14,117,000 compared with 2018. The increase reflected a changing interest rate environment with increased average interest-earning assets balances partially offset by a higher average balance of interest-bearing liabilities. The FOMC increased the Fed Funds target rate 25 basis points in March, June, September and December, 2018, and decreased it 25 basis points in both July and September, 2019.
Taxable-equivalent interest income earned on loans increased $19,640,000 year-over-year. The $400,814,000 increase in average loan balance year-over-year reflects loans acquired in the Mercersburg and Hamilton transactions, which totaled approximately $425,900,000 at September 30, 2019. Growth in legacy and newer markets through sales efforts with additional loan officers in the first half of 2019 was partially offset by repayments within the acquired Hamilton loan portfolio in the third quarter, as previously described. The interest rate increases in 2018 contributed to the 57 basis point increase in yield, but a flattened yield curve and the rate reduction in July and September, 2019, partially offset the benefit of the 2018 rate increases.
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Accretion of purchase accounting adjustments in connection with the Mercersburg and Hamilton acquisitions increased interest income in the first nine months of 2019 by $2,500,000, including $736,000 related to the payoff of purchased credit impaired loans.
Taxable-equivalent securities interest income increased $1,873,000 year-over-year, with the average balance of securities increasing $27,379,000 from September 30, 2018 to September 30, 2019, and the taxable equivalent yield increasing from 3.22% to 3.55%. The 33 basis point increase in taxable-equivalent yield on securities reflected the increased interest rate environment between years and certain repositioning within the portfolio under the Company's asset/liability management strategies.
Interest expense on deposits and borrowings increased $8,464,000 year-over-year, with the average balance of interest-bearing deposits increasing $450,651,000 and the average balance of total borrowings decreasing $28,169,000. In addition to the impact of the noted increased interest rate environment on interest expense, the Company issued $32,500,000 of 6.0% subordinated notes in December 2018. As described in the 2019 to 2018 quarter over quarter comparison, the Company utilized a short-term cash increase to reduce brokered deposits in the third quarter of 2019.
Provision for Loan Losses
Asset quality trends continue to be solid with a low level of charge-offs and low nonperforming loans. The provision for loan losses totaled $900,000 for the nine months ended September 30, 2019 compared with $600,000 for the same period in 2018. Net charge-offs in the nine months ended September 30, 2019 totaled $105,000, equating to 0.01% annualized, as compared with net recoveries totaling $416,000, or (0.05)% annualized, in the prior year. Nonperforming loans to loans totaled 0.44% of loans at September 30, 2019, compared with 0.41% of loans at December 31, 2018. Loans outstanding increased in 2019 with net charge-offs, and there was a $1,800,000 increase in nonperforming loans, which required additional reserves.
Additional information is included in the "Credit Risk Management" section herein.
Noninterest Income
The following table compares noninterest income for the nine months ended September 30, 2019 and 2018.

| Nine Months Ended September 30, |  |  |  |  | $ Change |  |  | % Change
(Dollars in thousands) | 2019 |  | 2018 |  | 2019-2018 |  | 2019-2018
Service charges on deposit accounts | $ | 4,930 |  |  | $ | 4,405 |  |  | $ | 525 |  |  | 11.9 | %
Other service charges, commissions and fees | 959 |  |  | 1,430 |  |  | (471) |  |  | (32.9) | %
Loan swap referral fees | 629 |  |  |  | 0 |  |  | 629 |  |  | 0.0 | %
Trust and investment management income | 5,399 |  |  | 5,037 |  |  | 362 |  |  | 7.2 | %
Brokerage income | 1,804 |  |  | 1,514 |  |  | 290 |  |  | 19.2 | %
Mortgage banking activities | 1,743 |  |  | 2,049 |  |  | (306) |  |  | (14.9) | %
Income from life insurance | 1,505 |  |  | 1,101 |  |  | 404 |  |  | 36.7 | %
Other income | 188 |  |  | 272 |  |  | (84) |  |  | (30.9) | %
Subtotal before securities gains | 17,157 |  |  | 15,808 |  |  | 1,349 |  |  | 8.5 | %
Investment securities gains | 4,731 |  |  | 891 |  |  | 3,840 |  |  | 431.0 | %
Total noninterest income | $ | 21,888 |  |  | $ | 16,699 |  |  | $ | 5,189 |  |  | 31.1 | %
nm*: not meaningful |  |  |  |  |  |  |

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The following factors contributed to the more significant changes in noninterest income between the nine months ended September 30, 2019 and 2018.
•Other service charges, commissions and fees included increased loan transaction fees in 2018.
•In 2019, the Company recognized $629,000 for loan swap referral fees under a program in which it refers qualified commercial borrowers to a third party, which enters into an interest rate swap agreement with the borrower. The rate swap provides the borrower with the economic equivalent of a fixed-rate loan while allowing the Company to receive a variable rate of interest. Income from this program will vary from quarter to quarter depending on demand from qualified borrowers with a preference to enter into swap agreements with the third party.
•Income for trust and investment management income and brokerage income reflected fluctuations in customer volumes and market conditions, as well as the effect of increased revenue from additional advisors and increased estate fees in 2019.
•Mortgage banking income decreased and included a $240,000 impairment charge on mortgage servicing rights due to decreasing interest rates. Loans sold in the first nine months of 2019 totaled $74,000,000 compared with $73,200,000 in 2018.
•Other line items within noninterest income showed fluctuations between 2019 and 2018 attributable to normal business operations and the effect of the acquisitions.
The Company recognized net investment securities gains in 2019 and 2018 as opportunities became available to reposition part of the investment portfolio under asset/liability management strategies or to improve responsiveness of the portfolio to interest rate conditions, while also considering funding requirements of anticipated lending activity.
Noninterest Expenses
The following table compares noninterest expenses for the nine months ended September 30, 2019 and 2018.

| Nine Months Ended September 30, |  |  |  |  | $ Change |  | % Change
(Dollars in thousands) | 2019 |  | 2018 |  | 2019-2018 |  | 2019-2018
Salaries and employee benefits | $ | 28,088 |  |  | $ | 23,487 |  |  | $ | 4,601 |  |  | 19.6 | %
Occupancy | 3,200 |  |  | 2,252 |  |  | 948 |  |  | 42.1 | %
Furniture and equipment | 3,415 |  |  | 2,977 |  |  | 438 |  |  | 14.7 | %
Data processing | 2,658 |  |  | 1,875 |  |  | 783 |  |  | 41.8 | %
Telephone and communication | 612 |  |  | 542 |  |  | 70 |  |  | 12.9 | %
Automated teller machine and interchange fees | 744 |  |  | 548 |  |  | 196 |  |  | 35.8 | %
Advertising and bank promotions | 1,348 |  |  | 898 |  |  | 450 |  |  | 50.1 | %
FDIC insurance | 397 |  |  | 507 |  |  | (110) |  |  | (21.7) | %
Legal | 362 |  |  | 364 |  |  | (2) |  |  | (0.5) | %
Other professional services | 1,716 |  |  | 1,140 |  |  | 576 |  |  | 50.5 | %
Directors' compensation | 725 |  |  | 663 |  |  | 62 |  |  | 9.4 | %
Real estate owned | 36 |  |  | 96 |  |  | (60) |  |  | (62.5) | %
Taxes other than income | 926 |  |  | 761 |  |  | 165 |  |  | 21.7 | %
Intangible asset amortization | 1,096 |  |  | 72 |  |  | 1,024 |  |  | nm* |
Merger related | 7,976 |  |  | 473 |  |  | 7,503 |  |  | nm* |
Insurance claim receivable write off | 615 |  |  | 0 |  |  | 615 |  |  | nm* |
Other operating expenses | 3,743 |  |  | 3,022 |  |  | 721 |  |  | 23.9 | %
Total noninterest expenses | $ | 57,657 |  |  | $ | 39,677 |  |  | $ | 17,980 |  |  | 45.3 | %
nm*: not meaningful |  |  |  |  |  |  |

The following factors contributed to the more significant changes in noninterest expenses between the nine months ended September 30, 2019 and 2018.
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•Expanded operations with the addition of employees and branches from the Mercersburg acquisition in October, 2018, and the Hamilton merger in May, 2019; two branches opened in the fourth quarter of 2018 and two opened in the first quarter of 2019 in Lancaster County, Pennsylvania; and additional support personnel for the Company's ongoing expansion efforts all contributed to increases in salaries and employee benefits, occupancy costs, furniture and equipment, and data processing costs year-over-year, as well as the timing of advertising and bank promotions expenses incurred.
•Salaries and employee benefits principally reflected employees added in the acquisitions and for additional employees for the Company's new branches. In addition, the increase included the impact of our overall expansion efforts, annual merit increases, and incremental expense for additional share-based compensation awards granted in 2019, net of the benefit of forfeitures. In 2019, overall costs associated with the Company's self-insured group health plan were higher than in 2018 due to an increased number of employees and fluctuations in claims experience.
•Occupancy, furniture and equipment costs reflected Mercersburg and Hamilton branches acquired, and the Company's expanded presence in Lancaster County, Pennsylvania.
•The decrease in FDIC insurance expense reflects credits received in the third quarter of 2019 that offset the Bank's second quarter 2019 FDIC assessment. The FDIC's assessment regulations provide that, for banks with consolidated total assets under $10 billion, after the reserve ratio reaches 1.38 percent (and provided that it remains at least 1.38%), the FDIC will automatically apply credits to reduce regular deposit insurance assessments up to the full amount of their assessments or the full amount of their credits, whichever is less. The reserve ratio reached 1.40% on June 30, 2019. Therefore, credits were first applied during the third quarter of 2019. If the reserve ratio remains at least 1.38%, the Company estimates it will receive credits that will offset its third quarter 2019 assessment and partially offset its fourth quarter 2019 assessment.
•Intangible asset amortization increased principally due to amortization of core deposit intangibles recorded in the Mercersburg and Hamilton acquisitions.
•The Company incurred merger related expenses, principally in the second quarter of 2019, for data processing contract termination costs, employee contract termination costs and legal and consulting fees for the Hamilton acquisition. We also incurred system conversion expenses for the Mercersburg acquisition in the first quarter of 2019 and the Hamilton acquisition in the third quarter of 2019.
•As previously reported, in the first quarter of 2019, we incurred a $615,000 expense to write off an insurance claim receivable from a 2018 cyber security incident.
•Other line items within noninterest expenses showed fluctuations between 2019 and 2018 attributable to normal business operations and the impact of acquisitions.
Income Tax Expense
Income tax expense totaled $1,682,000, an effective tax rate of 11.7%, for the nine months ended September 30, 2019, compared with $1,510,000, an effective tax rate of 11.5%, for the nine months ended September 30, 2018. The Company’s effective tax rate is significantly less than the 21% federal statutory rate, principally due to tax-free income, which includes interest income on tax-free loans and securities and income from life insurance policies, federal income tax credits, and the impact of non-tax deductible expenses, including merger related expenses. The Company recorded a tax benefit of $185,000 in the first quarter of 2019, related to a favorable tax law clarification concerning the treatment of life insurance assets of an acquired entity. In the second quarter of 2019, we recorded a tax benefit of $334,000, related to an increase in our deferred state income tax asset for the effect of the state tax rate change resulting from the Hamilton acquisition. These tax benefit items had the effect of lowering the effective tax rate for the nine months ended September 30, 2019, from approximately 15.3% to 11.7%.
FINANCIAL CONDITION
Management devotes substantial time to overseeing the investment of funds in loans and securities and the formulation of policies directed toward the profitability and management of the risks associated with these investments.
AFS Securities
The Company utilizes securities available for sale to manage interest rate risk, to enhance income through interest and dividend income, to provide liquidity and to provide collateral for certain deposits and borrowings. At September 30, 2019, AFS securities totaled $481,120,000, an increase of $15,276,000, from the $465,844,000 balance at December 31, 2018.
In the nine months ended September 30, 2019, the Company realized net gains totaling $4,731,000 from sales of investments, as it repositioned parts of its portfolio in response to market and interest rate opportunities under its asset/liability management strategies. Sales of investments in states and political subdivisions were the principal driver of the realized net
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gains. Sale proceeds totaling $199,910,000 were principally redeployed in investments in asset-backed securities.
Loan Portfolio
The Company offers a variety of products to meet the credit needs of its borrowers, principally commercial real estate loans, commercial and industrial loans, and retail loans consisting of loans secured by residential properties, and to a lesser extent, installment loans. No loans are extended to non-domestic borrowers or governments.
The risks associated with lending activities differ among loan classes and are subject to the impact of changes in interest rates, market conditions of collateral securing the loans and general economic conditions. Any of these factors may adversely impact a borrower’s ability to repay loans, and also impact the associated collateral. See Note 4, Loans Receivable and Allowance for Loan Losses, to the Consolidated Financial Statements under Part I, Item 1, "Financial Information," for a description of the Company’s loan classes and differing levels of associated credit risk.
The following table presents the loan portfolio, excluding residential LHFS, by segment and class at September 30, 2019 and December 31, 2018.

(Dollars in thousands) | September 30, 2019 |  | December 31, 2018
Commercial real estate: |  |  |
Owner occupied | $ | 171,327 |  |  | $ | 129,650 |
Non-owner occupied | 310,334 |  |  | 252,794 |
Multi-family | 108,751 |  |  | 78,933 |
Non-owner occupied residential | 120,395 |  |  | 100,367 |
Acquisition and development: |  |  |
1-4 family residential construction | 12,257 |  |  | 7,385 |
Commercial and land development | 38,494 |  |  | 42,051 |
Commercial and industrial | 215,734 |  |  | 160,964 |
Municipal | 47,920 |  |  | 50,982 |
Residential mortgage: |  |  |
First lien | 353,811 |  |  | 235,296 |
Home equity - term | 15,175 |  |  | 12,208 |
Home equity - lines of credit | 159,930 |  |  | 143,616 |
Installment and other loans | 38,977 |  |  | 33,411 |
| $ | 1,593,105 |  |  | $ | 1,247,657 |

The above totals include $425,940,000 and $135,009,000 of acquired loans at September 30, 2019 and December 31, 2018.
Total loans grew $345,448,000 from December 31, 2018 to September 30, 2019. Balances at September 30, 2019, include approximately $335,000,000 acquired from Hamilton. The Hamilton acquisition increased the Company's loan portfolio principally in the residential mortgage - first lien, commercial real estate - owner occupied and non-owner occupied, and commercial and industrial classes.
Competition for new business opportunities remains strong, which has contributed to a reduced rate of organic loan growth in 2019 compared with prior years and may temper loan growth in future quarters. As previously described, during the third quarter of 2019, the Company experienced a net $9,000,000 reduction in loans outstanding due to repayments totaling $16,000,000 from the acquired Hamilton loan portfolio. The focus on the successful Hamilton system conversion in the third quarter while simultaneously recruiting and onboarding a team of experienced lenders in the Maryland Region resulted in a slowdown in loan origination activity in Maryland.
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Asset Quality
Risk Elements
The Company’s loan portfolio is subject to varying degrees of credit risk. Credit risk is managed through our underwriting standards, on-going credit reviews, and monitoring of asset quality measures. Additionally, loan portfolio diversification, which limits exposure to a single industry or borrower, and collateral requirements also mitigate our risk of credit loss.
The loan portfolio consists principally of loans to borrowers in south central Pennsylvania and the greater Baltimore, Maryland region. As the majority of loans are concentrated in these geographic regions, a substantial portion of the borrowers' ability to honor their obligations may be affected by the level of economic activity in the market areas.
Nonperforming assets include nonaccrual loans and foreclosed real estate. In addition, restructured loans still accruing and loans past due 90 days or more and still accruing are also deemed to be risk assets. For all loan classes, generally the accrual of interest income ceases when principal or interest is past due 90 days or more and collateral is inadequate to cover principal and interest or immediately if, in the opinion of management, full collection is unlikely. Interest will continue to accrue on loans past due 90 days or more if the collateral is adequate to cover principal and interest, and the loan is in the process of collection. Interest accrued, but not collected, as of the date of placement on nonaccrual status, is generally reversed and charged against interest income, unless fully collateralized. Subsequent payments received are either applied to the outstanding principal balance or recorded as interest income, depending on management’s assessment of the ultimate collectability of principal. Loans are returned to accrual status, for all loan classes, when all the principal and interest amounts contractually due are brought current, the loans have performed in accordance with the contractual terms of the note for a reasonable period of time, generally six months, and the ultimate collectability of the total contractual principal and interest is reasonably assured. Past due status is based on contract terms of the loan.
Loans, the terms of which are modified, are classified as TDRs if a concession was granted for legal or economic reasons related to a borrower’s financial difficulties. Concessions granted under a TDR typically involve a temporary deferral of scheduled loan payments, an extension of a loan’s stated maturity date, temporary reduction in interest rates, or below market rates. If a modification occurs while the loan is on accruing status, it will continue to accrue interest under the modified terms. Nonaccrual TDRs are restored to accrual status if scheduled principal and interest payments, under the modified terms, are current for six months after modification, and the borrower continues to demonstrate its ability to meet the modified terms. TDRs are evaluated individually for impairment if they have been restructured during the most recent calendar year, or if they are not performing according to their modified terms.
The following table presents the Company’s risk elements, including the aggregate balances of nonaccrual loans, restructured loans still accruing, loans past due 90 days or more, and OREO as of September 30, 2019, December 31, 2018 and September 30, 2018. Relevant asset quality ratios are also presented.

(Dollars in thousands) | September 30, 2019 |  | December 31, 2018 |  | September 30, 2018
Nonaccrual loans (cash basis) | $ | 6,931 |  |  | $ | 5,165 |  |  | $ | 5,458 |
OREO | 642 |  |  | 130 |  |  | 286 |
Total nonperforming assets | 7,573 |  |  | 5,295 |  |  | 5,744 |
Restructured loans still accruing | 1,042 |  |  | 1,132 |  |  | 1,143 |
Loans past due 90 days or more and still accruing | 2,982 |  |  | 57 |  |  | 0 |
Total nonperforming and other risk assets | $ | 11,597 |  |  | $ | 6,484 |  |  | $ | 6,887 |
Loans 30-89 days past due | $ | 5,287 |  |  | $ | 5,186 |  |  | $ | 1,681 |
Asset quality ratios: |  |  |  |  |
Total nonperforming loans to total loans | 0.44 | % |  | 0.41 | % |  | 0.50 | %
Total nonperforming assets to total assets | 0.33 | % |  | 0.27 | % |  | 0.33 | %
Total nonperforming assets to total loans and OREO | 0.48 | % |  | 0.42 | % |  | 0.53 | %
Total risk assets to total loans and OREO | 0.73 | % |  | 0.52 | % |  | 0.63 | %
Total risk assets to total assets | 0.50 | % |  | 0.34 | % |  | 0.40 | %
ALL to total loans | 0.93 | % |  | 1.12 | % |  | 1.27 | %
ALL to nonperforming loans | 213.66 | % |  | 271.33 | % |  | 253.06 | %
ALL to nonperforming loans and restructured loans still accruing | 185.74 | % |  | 222.55 | % |  | 209.24 | %

Total nonperforming and other risk assets increased $5,113,000, or 78.9%, from December 31, 2018 to September 30, 2019 and increased $4,710,000, or 68.4%, from September 30, 2018. The principal driver for the increase in nonperforming
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and risk assets is the increase in loans past due 90 days or more and still accruing, all of which were acquired in the mergers with Mercersburg and Hamilton.
The following table presents detail of impaired loans at September 30, 2019 and December 31, 2018.

| September 30, 2019 |  |  |  |  |  | December 31, 2018 |  |  |  |
(Dollars in thousands) | Nonaccrual Loans |  | Restructured Loans Still Accruing |  | Total |  | Nonaccrual Loans |  | Restructured Loans Still Accruing |  | Total
Commercial real estate: |  |  |  |  |  |  |  |  |  |  |
Owner occupied | $ | 3,294 |  |  | $ | 30 |  |  | $ | 3,324 |  |  | $ | 1,841 |  |  | $ | 39 |  |  | $ | 1,880 |
Multi-family | 105 |  |  | 0 |  |  | 105 |  |  | 131 |  |  | 0 |  |  | 131 |
Non-owner occupied residential | 137 |  |  | 0 |  |  | 137 |  |  | 309 |  |  | 0 |  |  | 309 |
Commercial and industrial | 1,089 |  |  | 0 |  |  | 1,089 |  |  | 286 |  |  | 0 |  |  | 286 |
Residential mortgage: |  |  |  |  |  |  |  |  |  |  |
First lien | 1,555 |  |  | 992 |  |  | 2,547 |  |  | 1,808 |  |  | 1,069 |  |  | 2,877 |
Home equity - term | 11 |  |  | 0 |  |  | 11 |  |  | 16 |  |  | 0 |  |  | 16 |
Home equity - lines of credit | 733 |  |  | 20 |  |  | 753 |  |  | 774 |  |  | 24 |  |  | 798 |
Installment and other loans | 7 |  |  | 0 |  |  | 7 |  |  | 0 |  |  | 0 |  |  | 0 |
| $ | 6,931 |  |  | $ | 1,042 |  |  | $ | 7,973 |  |  | $ | 5,165 |  |  | $ | 1,132 |  |  | $ | 6,297 |

The following table presents our exposure to borrowers with impaired loans, partial charge-offs taken to date and specific reserves established on the borrowing relationships at September 30, 2019 and December 31, 2018. Of the relationships deemed to be impaired at September 30, 2019, one had a recorded balance in excess of $1,000,000 and 62, or 46.5%, of total impaired loans, had recorded balances of less than $250,000.

(Dollars in thousands) | # of Relationships |  | Recorded Investment |  | Partial Charge-offs to Date |  | Specific Reserves
September 30, 2019 |  |  |  |  |  |  |
Relationships greater than $1,000,000 | 1 |  |  | $ | 1,641 |  |  | $ | 0 |  |  | $ | 0 |
Relationships greater than $500,000 but less than $1,000,000 | 2 |  |  | 1,533 |  |  | 17 |  |  | 0 |
Relationships greater than $250,000 but less than $500,000 | 3 |  |  | 1,088 |  |  | 0 |  |  | 0 |
Relationships less than $250,000 | 62 |  |  | 3,711 |  |  | 810 |  |  | 37 |
| 68 |  |  | $ | 7,973 |  |  | $ | 827 |  |  | $ | 37 |
December 31, 2018 |  |  |  |  |  |  |
Relationships greater than $500,000 but less than $1,000,000 | 1 |  |  | 810 |  |  | 17 |  |  | 0 |
Relationships greater than $250,000 but less than $500,000 | 2 |  |  | 673 |  |  | 0 |  |  | 0 |
Relationships less than $250,000 | 64 |  |  | 4,814 |  |  | 873 |  |  | 38 |
| 67 |  |  | $ | 6,297 |  |  | $ | 890 |  |  | $ | 38 |

The Company takes partial charge-offs on collateral-dependent loans when carrying value exceeds estimated fair value, as determined by the most recent appraisal adjusted for current (within the quarter) conditions, less costs to dispose. Impairment reserves remain in place if updated appraisals are pending, and represent management’s estimate of potential loss.
Internal loan reviews are completed annually on all commercial relationships with a committed loan balance in excess of $500,000, which includes confirmation of risk rating by an independent credit officer. Credit Administration also reviews loans in excess of $1,000,000. In addition, all relationships greater than $250,000 rated Substandard, Doubtful or Loss are reviewed and corresponding risk ratings are reaffirmed by the Bank's Problem Loan Committee, with subsequent reporting to the ERM Committee.
In its individual loan impairment analysis, the Company determines the extent of any full or partial charge-offs that may be required, or any reserves that may be needed. The determination of the Company’s charge-offs or impairment reserve include an evaluation of the outstanding loan balance and the related collateral securing the credit. Through a combination of collateral securing the loans and partial charge-offs taken to date, the Company believes that it has adequately provided for the potential losses that it may incur on these relationships at September 30, 2019. However, over time, additional information may result in increased reserve allocations or, alternatively, it may be deemed that the reserve allocations exceed those that are needed.
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The Company’s OREO totaled $642,000 at September 30, 2019 and consisted of two commercial and one residential properties. The increase in OREO from $130,000 at December 31, 2018 was the result of the addition of one commercial and one residential property. All properties are carried at the lower of cost or fair value, less costs to dispose.
At September 30, 2019, the Company believes the value of OREO represents the properties' fair values, but if the real estate market changes, additional expense may be recorded.
Credit Risk Management
Allowance for Loan Losses
The Company maintains the ALL at a level deemed adequate by management for probable incurred credit losses. The ALL is established and maintained through a provision for loan losses charged to earnings. Quarterly, management assesses the adequacy of the ALL using a defined methodology which considers specific credit evaluation of impaired loans, past loan loss historical experience and qualitative factors. Management addresses the requirements for loans individually identified as impaired, loans collectively evaluated for impairment, and other bank regulatory guidance in its assessment.
The ALL is evaluated based on review of the collectability of loans in light of historical experience; the nature and volume of the loan portfolio; adverse situations that may affect a borrower’s ability to repay; estimated value of any underlying collateral; and prevailing economic conditions. This evaluation is inherently subjective as it requires estimates that are susceptible to significant revision as more information becomes available. A description of the methodology for establishing the allowance and provision for loan losses and related procedures in establishing the appropriate level of reserve is included in Note 4, Loans and Allowance for Loan Losses, to the Consolidated Financial Statements under Part I, Item 1, "Financial Information."
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The following table summarizes the Company’s internal risk ratings at September 30, 2019 and December 31, 2018:

(Dollars in thousands) | Pass |  | Special Mention |  | Non-Impaired Substandard |  | Impaired - Substandard |  | Doubtful |  | PCI Loans |  | Total
September 30, 2019 |  |  |  |  |  |  |  |  |  |  |  |  |
Commercial real estate: |  |  |  |  |  |  |  |  |  |  |  |  |
Owner occupied | $ | 153,327 |  |  | $ | 5,750 |  |  | $ | 2,664 |  |  | $ | 3,324 |  |  | $ | 0 |  |  | $ | 6,262 |  |  | $ | 171,327 |
Non-owner occupied | 298,268 |  |  | 10,685 |  |  | 0 |  |  | 0 |  |  | 0 |  |  | 1,381 |  |  | 310,334 |
Multi-family | 101,479 |  |  | 5,537 |  |  | 940 |  |  | 105 |  |  | 0 |  |  | 690 |  |  | 108,751 |
Non-owner occupied residential | 113,248 |  |  | 3,139 |  |  | 1,246 |  |  | 137 |  |  | 0 |  |  | 2,625 |  |  | 120,395 |
Acquisition and development: |  |  |  |  |  |  |  |  |  |  |  |  |
1-4 family residential construction | 12,004 |  |  | 253 |  |  | 0 |  |  | 0 |  |  | 0 |  |  | 0 |  |  | 12,257 |
Commercial and land development | 37,582 |  |  | 348 |  |  | 564 |  |  | 0 |  |  | 0 |  |  | 0 |  |  | 38,494 |
Commercial and industrial | 198,348 |  |  | 2,316 |  |  | 10,101 |  |  | 1089 |  |  | 0 |  |  | 3,880 |  |  | 215,734 |
Municipal | 47,920 |  |  | 0 |  |  | 0 |  |  | 0 |  |  | 0 |  |  | 0 |  |  | 47,920 |
Residential mortgage: |  |  |  |  |  |  |  |  |  |  |  |  |
First lien | 340,619 |  |  | 713 |  |  | 0 |  |  | 2,547 |  |  | 0 |  |  | 9,932 |  |  | 353,811 |
Home equity - term | 15,068 |  |  | 76 |  |  | 0 |  |  | 11 |  |  | 0 |  |  | 20 |  |  | 15,175 |
Home equity - lines of credit | 159,063 |  |  | 75 |  |  | 39 |  |  | 753 |  |  | 0 |  |  | 0 |  |  | 159,930 |
Installment and other loans | 38,715 |  |  | 0 |  |  | 0 |  |  | 7 |  |  | 0 |  |  | 255 |  |  | 38,977 |
| $ | 1,515,641 |  |  | $ | 28,892 |  |  | $ | 15,554 |  |  | $ | 7,973 |  |  | $ | 0 |  |  | $ | 25,045 |  |  | $ | 1,593,105 |
December 31, 2018 |  |  |  |  |  |  |  |  |  |  |  |  |
Commercial real estate: |  |  |  |  |  |  |  |  |  |  |  |  |
Owner occupied | $ | 121,903 |  |  | $ | 3,024 |  |  | $ | 987 |  |  | $ | 1,880 |  |  | $ | 0 |  |  | $ | 1,856 |  |  | $ | 129,650 |
Non-owner occupied | 242,136 |  |  | 10,008 |  |  | 0 |  |  | 0 |  |  | 0 |  |  | 650 |  |  | 252,794 |
Multi-family | 71,482 |  |  | 5,886 |  |  | 717 |  |  | 131 |  |  | 0 |  |  | 717 |  |  | 78,933 |
Non-owner occupied residential | 97,590 |  |  | 736 |  |  | 1,197 |  |  | 309 |  |  | 0 |  |  | 535 |  |  | 100,367 |
Acquisition and development: |  |  |  |  |  |  |  |  |  |  |  |  |
1-4 family residential construction | 7,385 |  |  | 0 |  |  | 0 |  |  | 0 |  |  | 0 |  |  | 0 |  |  | 7,385 |
Commercial and land development | 41,251 |  |  | 25 |  |  | 583 |  |  | 0 |  |  | 0 |  |  | 192 |  |  | 42,051 |
Commercial and industrial | 150,286 |  |  | 2,278 |  |  | 2,940 |  |  | 286 |  |  | 0 |  |  | 5,174 |  |  | 160,964 |
Municipal | 50,982 |  |  | 0 |  |  | 0 |  |  | 0 |  |  | 0 |  |  | 0 |  |  | 50,982 |
Residential mortgage: |  |  |  |  |  |  |  |  |  |  |  |  |
First lien | 229,971 |  |  | 0 |  |  | 0 |  |  | 2,877 |  |  | 0 |  |  | 2,448 |  |  | 235,296 |
Home equity - term | 12,170 |  |  | 0 |  |  | 0 |  |  | 16 |  |  | 0 |  |  | 22 |  |  | 12,208 |
Home equity - lines of credit | 142,638 |  |  | 165 |  |  | 15 |  |  | 798 |  |  | 0 |  |  | 0 |  |  | 143,616 |
Installment and other loans | 33,229 |  |  | 15 |  |  | 1 |  |  | 0 |  |  | 0 |  |  | 166 |  |  | 33,411 |
| $ | 1,201,023 |  |  | $ | 22,137 |  |  | $ | 6,440 |  |  | $ | 6,297 |  |  | $ | 0 |  |  | $ | 11,760 |  |  | $ | 1,247,657 |

Potential problem loans are defined as performing loans which have characteristics that cause management concern over the ability of the borrower to perform under present loan repayment terms and which may result in the reporting of these loans as nonperforming loans in the future. Generally, management feels that Substandard loans that are currently performing and not considered impaired result in some doubt as to the borrower’s ability to continue to perform under the terms of the loan, and
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represent potential problem loans. Additionally, the Special Mention classification is intended to be a temporary classification reflective of loans that have potential weaknesses that may, if not monitored or corrected, weaken the asset or inadequately protect the Company’s position at some future date. Special Mention loans represent an elevated risk, but their weakness does not yet justify a more severe, or classified, rating. These loans require inquiry by lenders on the cause of the potential weakness and, once analyzed, the loan classification may be downgraded to Substandard or, alternatively, could be upgraded to Pass.
The following table summarizes activity in the ALL for the three and nine months ended September 30, 2019 and 2018.

| Commercial |  |  |  |  |  |  |  |  |  | Consumer |  |  |  |  |  |  |  |
(Dollars in thousands) | Commercial Real Estate |  | Acquisition and Development |  | Commercial and Industrial |  | Municipal |  | Total |  | Residential Mortgage |  | Installment and Other |  | Total |  | Unallocated |  | Total
Three Months Ended |  |  |  |  |  |  |  |  |  |  |  |  |  |  |  |  |  |  |
September 30, 2019 |  |  |  |  |  |  |  |  |  |  |  |  |  |  |  |  |  |  |
Balance, beginning of period | $ | 6,847 |  |  | $ | 1,008 |  |  | $ | 2,120 |  |  | $ | 94 |  |  | $ | 10,069 |  |  | $ | 3,734 |  |  | $ | 209 |  |  | $ | 3,943 |  |  | $ | 448 |  |  | $ | 14,460 |
Provision for loan losses | 465 |  |  | (188) |  |  | 269 |  |  | (1) |  |  | 545 |  |  | 27 |  |  | 50 |  |  | 77 |  |  | (322) |  |  | 300 |
Charge-offs | 0 |  |  | 0 |  |  | (50) |  |  | 0 |  |  | (50) |  |  | (24) |  |  | (49) |  |  | (73) |  |  | 0 |  |  | (123) |
Recoveries | 111 |  |  | 0 |  |  | 33 |  |  | 0 |  |  | 144 |  |  | 5 |  |  | 23 |  |  | 28 |  |  | 0 |  |  | 172 |
Balance, end of period | $ | 7,423 |  |  | $ | 820 |  |  | $ | 2,372 |  |  | $ | 93 |  |  | $ | 10,708 |  |  | $ | 3,742 |  |  | $ | 233 |  |  | $ | 3,975 |  |  | $ | 126 |  |  | $ | 14,809 |
September 30, 2018 |  |  |  |  |  |  |  |  |  |  |  |  |  |  |  |  |  |  |
Balance, beginning of period | $ | 6,680 |  |  | $ | 720 |  |  | $ | 1,598 |  |  | $ | 80 |  |  | $ | 9,078 |  |  | $ | 3,544 |  |  | $ | 230 |  |  | $ | 3,774 |  |  | $ | 585 |  |  | $ | 13,437 |
Provision for loan losses | 194 |  |  | 19 |  |  | (38) |  |  | (1) |  |  | 174 |  |  | (45) |  |  | 146 |  |  | 101 |  |  | (75) |  |  | 200 |
Charge-offs | (17) |  |  | 0 |  |  | 0 |  |  | 0 |  |  | (17) |  |  | (62) |  |  | (80) |  |  | (142) |  |  | 0 |  |  | (159) |
Recoveries | 200 |  |  | 0 |  |  | 1 |  |  | 0 |  |  | 201 |  |  | 102 |  |  | 31 |  |  | 133 |  |  | 0 |  |  | 334 |
Balance, end of period | $ | 7,057 |  |  | $ | 739 |  |  | $ | 1,561 |  |  | $ | 79 |  |  | $ | 9,436 |  |  | $ | 3,539 |  |  | $ | 327 |  |  | $ | 3,866 |  |  | $ | 510 |  |  | $ | 13,812 |
Nine Months Ended |  |  |  |  |  |  |  |  |  |  |  |  |  |  |  |  |  |  |
September 30, 2019 |  |  |  |  |  |  |  |  |  |  |  |  |  |  |  |  |  |  |
Balance, beginning of period | $ | 6,876 |  |  | $ | 817 |  |  | $ | 1,656 |  |  | $ | 98 |  |  | $ | 9,447 |  |  | $ | 3,753 |  |  | $ | 244 |  |  | $ | 3,997 |  |  | $ | 570 |  |  | $ | 14,014 |
Provision for loan losses | 347 |  |  | 1 |  |  | 753 |  |  | (5) |  |  | 1,096 |  |  | 184 |  |  | 64 |  |  | 248 |  |  | (444) |  |  | 900 |
Charge-offs | (25) |  |  | 0 |  |  | (140) |  |  | 0 |  |  | (165) |  |  | (295) |  |  | (121) |  |  | (416) |  |  | 0 |  |  | (581) |
Recoveries | 225 |  |  | 2 |  |  | 103 |  |  | 0 |  |  | 330 |  |  | 100 |  |  | 46 |  |  | 146 |  |  | 0 |  |  | 476 |
Balance, end of period | $ | 7,423 |  |  | $ | 820 |  |  | $ | 2,372 |  |  | $ | 93 |  |  | $ | 10,708 |  |  | $ | 3,742 |  |  | $ | 233 |  |  | $ | 3,975 |  |  | $ | 126 |  |  | $ | 14,809 |
September 30, 2018 |  |  |  |  |  |  |  |  |  |  |  |  |  |  |  |  |  |  |
Balance, beginning of period | $ | 6,763 |  |  | $ | 417 |  |  | $ | 1,446 |  |  | $ | 84 |  |  | $ | 8,710 |  |  | $ | 3,400 |  |  | $ | 211 |  |  | $ | 3,611 |  |  | $ | 475 |  |  | $ | 12,796 |
Provision for loan losses | (217) |  |  | 319 |  |  | 114 |  |  | (5) |  |  | 211 |  |  | 157 |  |  | 197 |  |  | 354 |  |  | 35 |  |  | 600 |
Charge-offs | (17) |  |  | 0 |  |  | 0 |  |  | 0 |  |  | (17) |  |  | (148) |  |  | (198) |  |  | (346) |  |  | 0 |  |  | (363) |
Recoveries | 528 |  |  | 3 |  |  | 1 |  |  | 0 |  |  | 532 |  |  | 130 |  |  | 117 |  |  | 247 |  |  | 0 |  |  | 779 |
Balance, end of period | $ | 7,057 |  |  | $ | 739 |  |  | $ | 1,561 |  |  | $ | 79 |  |  | $ | 9,436 |  |  | $ | 3,539 |  |  | $ | 327 |  |  | $ | 3,866 |  |  | $ | 510 |  |  | $ | 13,812 |

The ALL at September 30, 2019, increased $795,000 from December 31, 2018, reflecting the $900,000 provision for loan losses and net charge-offs during the quarter. Net recoveries totaled $49,000 and $(105,000) for the three and nine months ended September 30, 2019, compared with net recoveries of $175,000 and $416,000 for the same periods in 2018. The ratio of annualized net charge-offs (recoveries) to average loans outstanding was (0.01)% and 0.01% for the three and nine months ended September 30, 2019, compared with (0.06)% and (0.05)% for 2018. Classified loans totaled $23,527,000 at September 30, 2019, or 1.5% of total loans outstanding, and increased from $12,737,000 at December 31, 2018, or 1.0% of loans outstanding. The asset quality ratios previously noted are indicative of the continued benefit the Company has received from favorable historical charge-off statistics and generally stable economic and market conditions for the last few years, even while the loan portfolio has been growing. Recent loan growth trends contributed to management's determination that a provision for loan losses was required to maintain an adequate ALL, with an ALL to total loans ratio of 0.93% at September 30, 2019. A principal factor impacting a comparison with the ALL to total loans ratio of 1.27% at September 30, 2018, was loans acquired in the Mercersburg and Hamilton transactions that were recorded at fair value, which incorporated a credit factor, and did not require an increase in the Company's ALL.
Despite generally favorable historical charge-off data and stable economic and market conditions, the growth the Company has experienced in its loan portfolio may result in the need for additional provisions for loan losses in future quarters.
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The following table summarizes the ending loan balances individually or collectively evaluated for impairment based on loan type, as well as the ALL allocation for each, at September 30, 2019 and December 31, 2018, including PCI loans.

| Commercial |  |  |  |  |  |  |  |  |  | Consumer |  |  |  |  |  |  |  |
(Dollars in thousands) | Commercial Real Estate |  | Acquisition and Development |  | Commercial and Industrial |  | Municipal |  | Total |  | Residential Mortgage |  | Installment and Other |  | Total |  | Unallocated |  | Total
September 30, 2019 |  |  |  |  |  |  |  |  |  |  |  |  |  |  |  |  |  |  |
Loans allocated by: |  |  |  |  |  |  |  |  |  |  |  |  |  |  |  |  |  |  |
Individually evaluated for impairment | $ | 3,566 |  |  | $ | 0 |  |  | $ | 1,089 |  |  | $ | 0 |  |  | $ | 4,655 |  |  | $ | 3,311 |  |  | $ | 7 |  |  | $ | 3,318 |  |  | $ | 0 |  |  | $ | 7,973 |
Collectively evaluated for impairment | 707,241 |  |  | 50,751 |  |  | 214,645 |  |  | 47,920 |  |  | 1,020,557 |  |  | 525,605 |  |  | 38,970 |  |  | 564,575 |  |  | 0 |  |  | 1,585,132 |
| $ | 710,807 |  |  | $ | 50,751 |  |  | $ | 215,734 |  |  | $ | 47,920 |  |  | $ | 1,025,212 |  |  | $ | 528,916 |  |  | $ | 38,977 |  |  | $ | 567,893 |  |  | $ | 0 |  |  | $ | 1,593,105 |
ALL allocated by: |  |  |  |  |  |  |  |  |  |  |  |  |  |  |  |  |  |  |
Individually evaluated for impairment | $ | 0 |  |  | $ | 0 |  |  | $ | 0 |  |  | $ | 0 |  |  | $ | 0 |  |  | $ | 36 |  |  | $ | 0 |  |  | $ | 36 |  |  | $ | 0 |  |  | $ | 36 |
Collectively evaluated for impairment | 7,423 |  |  | 820 |  |  | 2,372 |  |  | 93 |  |  | 10,708 |  |  | 3,706 |  |  | 233 |  |  | 3,939 |  |  | 126 |  |  | 14,773 |
| $ | 7,423 |  |  | $ | 820 |  |  | $ | 2,372 |  |  | $ | 93 |  |  | $ | 10,708 |  |  | $ | 3,742 |  |  | $ | 233 |  |  | $ | 3,975 |  |  | $ | 126 |  |  | $ | 14,809 |
December 31, 2018 |  |  |  |  |  |  |  |  |  |  |  |  |  |  |  |  |  |  |
Loans allocated by: |  |  |  |  |  |  |  |  |  |  |  |  |  |  |  |  |  |  |
Individually evaluated for impairment | $ | 2,320 |  |  | $ | 0 |  |  | $ | 286 |  |  | $ | 0 |  |  | $ | 2,606 |  |  | $ | 3,691 |  |  | $ | 0 |  |  | $ | 3,691 |  |  | $ | 0 |  |  | $ | 6,297 |
Collectively evaluated for impairment | 559,424 |  |  | 49,436 |  |  | 160,678 |  |  | 50,982 |  |  | 820,520 |  |  | 387,429 |  |  | 33,411 |  |  | 420,840 |  |  | 0 |  |  | 1,241,360 |
| $ | 561,744 |  |  | $ | 49,436 |  |  | $ | 160,964 |  |  | $ | 50,982 |  |  | $ | 823,126 |  |  | $ | 391,120 |  |  | $ | 33,411 |  |  | $ | 424,531 |  |  | $ | 0 |  |  | $ | 1,247,657 |
ALL allocated by: |  |  |  |  |  |  |  |  |  |  |  |  |  |  |  |  |  |  |
Individually evaluated for impairment | $ | 0 |  |  | $ | 0 |  |  | $ | 0 |  |  | $ | 0 |  |  | $ | 0 |  |  | $ | 38 |  |  | $ | 0 |  |  | $ | 38 |  |  | $ | 0 |  |  | $ | 38 |
Collectively evaluated for impairment | 6,876 |  |  | 817 |  |  | 1,656 |  |  | 98 |  |  | 9,447 |  |  | 3,715 |  |  | 244 |  |  | 3,959 |  |  | 570 |  |  | 13,976 |
| $ | 6,876 |  |  | $ | 817 |  |  | $ | 1,656 |  |  | $ | 98 |  |  | $ | 9,447 |  |  | $ | 3,753 |  |  | $ | 244 |  |  | $ | 3,997 |  |  | $ | 570 |  |  | $ | 14,014 |

In addition to the specific reserve allocations on impaired loans noted previously, 17 loans, with aggregate outstanding principal balances of $3,470,000, have had cumulative partial charge-offs to the ALL totaling $827,000 at September 30, 2019. As updated appraisals are received on collateral-dependent loans, partial charge-offs are taken to the extent the loans’ principal balance exceeds their fair value.
Management believes the allocation of the ALL between the various loan classes adequately reflects the probable incurred credit losses in each portfolio and is based on the methodology outlined in Note 4, Loans and Allowance for Loan Losses, to the Consolidated Financial Statements under Part I, Item 1, "Financial Information." Management re-evaluates and makes enhancements to its reserve methodology to better reflect the risks inherent in the different segments of the portfolio, particularly in light of increased charge-offs, with noticeable differences between the different loan classes. Management believes these enhancements to the ALL methodology improve the accuracy of quantifying probable incurred credit losses inherent in the portfolio. Management charges actual loan losses to the reserve and bases the provision for loan losses on its overall analysis.
The unallocated portion of the ALL reflects estimated inherent losses within the portfolio that have not been detected, as well as the risk of error in the specific and general reserve allocation, other potential exposure in the loan portfolio, variances in management’s assessment of national and local economic conditions and other factors management believes appropriate at the time. The unallocated portion of the ALL totaled $126,000, or 0.9% of the ALL balance, at September 30, 2019 compared with $570,000, or 4.1% of the ALL balance at December 31, 2018. The Company monitors the unallocated portion of the ALL and, by policy, has determined it should not exceed 6% of the total reserve. Future negative provisions for loan losses may result if the unallocated portion was to increase, and management determined the reserves were not required for the anticipated risk in the portfolio.
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Management believes the Company’s ALL is adequate based on currently available information. Future adjustments to the ALL and enhancements to the methodology may be necessary due to changes in economic conditions, regulatory guidance, or management’s assumptions as to future delinquencies or loss rates.
Deposits
Deposits totaled $1,923,454,000 at September 30, 2019, an increase of $364,698,000, or 23.4%, from $1,558,756,000 at December 31, 2018.
Noninterest-bearing deposits increased $41,930,000, or 20.5%, from December 31, 2018 to September 30, 2019. Interest-bearing deposits totaled $1,676,681,000 at September 30, 2019, an increase of $322,768,000, or 23.8% from the $1,353,913,000 balance at December 31, 2018. The Hamilton acquisition contributed approximately 80% of the increase in total deposits.
The Company continues to increase both noninterest-bearing and interest-bearing deposit relationships from its enhanced cash management offerings as it increases its commercial relationships. Deposit growth in the first nine months of 2019 was principally used to reduce total borrowings, to fund growth in the loan and investment portfolios, and to reduce brokered deposits by approximately $91,000,000.
Shareholders' Equity, Capital Adequacy and Regulatory Matters
Capital management in a regulated financial services industry must properly balance return on equity to its shareholders while maintaining sufficient levels of capital and related risk-based regulatory capital ratios to satisfy statutory regulatory requirements. The Company’s capital management strategies have been developed to provide attractive rates of returns to its shareholders, while maintaining a “well capitalized” position of regulatory strength.
Shareholders’ equity totaled $223,493,000 at September 30, 2019, and increased $50,060,000 or 28.9%, from $173,433,000 at December 31, 2018. The increase was attributable to growth in retained earnings totaling $12,690,000 for the nine months ended September 30, 2019, net of dividends paid on common stock totaling $4,472,000, and improvement in net unrealized gains/losses in AOCI, net of taxes, totaling $5,647,000, and the issuance of the Company's common stock in connection with the acquisition of Hamilton totaling $36,622,000.
The Company routinely evaluates its capital levels in light of its risk profile to assess its capital needs. The Company and the Bank are subject to various regulatory capital requirements administered by federal and state banking agencies. The consolidated asset limit on small bank holding companies is $3,000,000,000 and a company with assets under that limit is not subject to the FRB consolidated capital rules, but may file reports that include capital amounts and ratios. The Company has elected to file those reports.
At September 30, 2019 and December 31, 2018, the Bank was considered well capitalized under applicable banking regulations. Under capital adequacy guidelines and the regulatory framework for prompt corrective action, the Bank must meet specific guidelines that involve quantitative measures of assets, liabilities and certain off-balance sheet items as calculated under regulatory accounting practices. Prompt corrective action provisions are not applicable to bank holding companies, including financial holding companies.
Note 9, Shareholders' Equity and Regulatory Capital, to the Notes to Consolidated Financial Statements under Part I, Item 1, "Financial Information," includes a table presenting capital amounts and ratios for the Company and the Bank at September 30, 2019 and December 31, 2018.
In addition to the minimum capital ratio requirement and minimum capital ratio to be well capitalized presented in the referenced table in Note 9, the Bank must maintain a capital conservation buffer as more fully described in the Company's Annual Report on Form 10-K for the year ended December 31, 2018, Item 1 - Business, under the topic Basel III Capital Rules. At September 30, 2019, the Bank's capital conservation buffer, based on the most restrictive Total Capital to risk weighted assets capital ratio, was 5.6%, which is greater than the 2.50% requirement for 2019.
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Liquidity
The primary function of asset/liability management is to ensure adequate liquidity and manage the Company’s sensitivity to changing interest rates. Liquidity management involves the ability to meet the cash flow requirements of customers who may be either depositors wanting to withdraw funds or borrowers needing assurance that sufficient funds will be available to meet their credit needs. Our primary sources of funds consist of deposit inflows, loan repayments, maturities and sales of investment securities, the sale of mortgage loans and borrowings from the FHLB of Pittsburgh. While maturities and scheduled amortization of loans and securities are predictable sources of funds, deposit flows and mortgage prepayments are greatly influenced by general interest rates, economic conditions and competition.
We regularly adjust our investments in liquid assets based upon our assessment of expected loan demand, expected deposit flows, yields available on interest-earning deposits and securities and the objectives of our asset/liability management policy.
Mergers and Acquisitions
See Note 2, Mergers and Acquisitions, to the Consolidated Financial Statements under Part I, Item 1, "Financial Statements" in this Form 10-Q.
Supplemental Reporting of Non-GAAP Measures
As a result of acquisitions, the Company has intangible assets consisting of goodwill and core deposit and other intangible assets totaling $27,579,000 and $16,502,000 at September 30, 2019 and December 31, 2018.
Management believes providing certain “non-GAAP” financial information will assist investors in their understanding of the effect of acquisition activity on reported results, particularly to overcome comparability issues related to the influence of intangibles (principally goodwill) created in acquisitions.
Tangible book value per share and net interest margin excluding the impact of purchase accounting, as used by the Company in this supplemental reporting presentation, are determined by methods other than in accordance with U.S. Generally Accepted Accounting Principles ("GAAP"). While we believe this information is a useful supplement to GAAP based measures presented in this Form 10-Q, readers are cautioned that this non-GAAP disclosure has limitations as an analytical tool, should not be viewed as a substitute for financial measures determined in accordance with GAAP, and should not be considered in isolation or as a substitute for analysis of our results and financial condition as reported under GAAP, nor are such measures necessarily comparable to non-GAAP performance measures that may be presented by other companies. This supplemental presentation should not be construed as an inference that our future results will be unaffected by similar adjustments to be determined in accordance with GAAP.
The following table presents the computation of each non-GAAP based measure shown together with its most directly comparable GAAP based measure.

(in thousands, except per share information) |  |  |  |  | September 30, 2019 |  | December 31, 2018
Tangible Book Value per Common Share |  |  |  |  |  |  |
Shareholders' equity |  |  |  |  | $ | 223,493 |  |  | $ | 173,433 |
Goodwill and other intangible assets, net of related tax effect |  |  |  |  | 25,972 |  |  | 15,698 |
Tangible common equity (non-GAAP) |  |  |  |  | $ | 197,521 |  |  | $ | 157,735 |
Common shares outstanding |  |  |  |  | 11,175 |  |  | 9,430 |
Book value per share (most directly comparable GAAP based measure) |  |  |  |  | $ | 20.00 |  |  | $ | 18.39 |
Intangible assets per share |  |  |  |  | 2.33 |  |  | 1.66 |
Tangible book value per share (non-GAAP) |  |  |  |  | $ | 17.67 |  |  | $ | 16.73 |

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| At or For The Three Months Ended |  |  |  |  | At or For The Nine Months Ended |  |  |
| September 30, 2019 |  | September 30, 2018 |  | September 30, 2019 |  | September 30, 2018
Net Interest Margin (excluding the impact of purchase accounting) |  |  |  |  |  |  |
Net interest margin as reported | 3.27 | % |  | 3.28 | % |  | 3.43 | % |  | 3.29 | %
Adjustment for purchase accounting: |  |  |  |  |  |  |
Total interest-earning assets (loans) | 0.19 | % |  | 0.00 | % |  | 0.19 | % |  | 0.00 | %
Net Interest Margin (excluding the impact of purchase accounting) (non-GAAP) | 3.08 | % |  | 3.28 | % |  | 3.24 | % |  | 3.29 | %

Item 3. Quantitative and Qualitative Disclosures about Market Risk
Market risk comprises exposure to interest rate risk, foreign currency exchange rate risk, commodity price risk, and other relevant market rate or price risks. In the banking industry, a major risk exposure is changing interest rates. The primary objective of monitoring our interest rate sensitivity, or risk, is to provide management the tools necessary to manage the balance sheet to minimize adverse changes in net interest income as a result of changes in the direction and level of interest rates. Federal Reserve Board monetary control efforts, the effects of deregulation, economic uncertainty and legislative changes have been significant factors affecting the task of managing interest rate sensitivity positions in recent years.
Interest Rate Risk
Interest rate risk is the exposure to fluctuations in the Company’s future earnings (earnings at risk) and value (value at risk) resulting from changes in interest rates. This exposure results from differences between the amounts of interest-earning assets and interest-bearing liabilities that reprice within a specified time period as a result of scheduled maturities, scheduled and unscheduled repayments, the propensity of borrowers and depositors to react to changes in their economic interests, and loan contractual interest rate changes.
We attempt to manage the level of repricing and maturity mismatch through our asset/liability management process so that fluctuations in net interest income are maintained within policy limits across a range of market conditions, while satisfying liquidity and capital requirements. Management recognizes that a certain amount of interest rate risk is inherent, appropriate and necessary to ensure the Company’s profitability. Thus, the goal of interest rate risk management is to evaluate the amount of reward for taking risk and adjusting both the size and composition of the balance sheet relative to the level of reward available for taking risk.
Management endeavors to control the exposure to changes in interest rates by understanding, reviewing and making decisions based on its risk position. The Company primarily uses its securities portfolio, FHLB advances and brokered deposits to manage its interest rate risk position. Additionally, pricing, promotion and product development activities are directed in an effort to emphasize the loan and deposit term or repricing characteristics that best meet current interest rate risk objectives. At present, we do not use hedging instruments for risk management, but we do evaluate them and may use them in the future.
We use simulation analysis to assess earnings at risk and net present value analysis to assess value at risk. These methods allow management to regularly monitor both the direction and magnitude of our interest rate risk exposure. These analyses require numerous assumptions including, but not limited to, changes in balance sheet mix, prepayment rates on loans and securities, cash flows and repricing of all financial instruments, changes in volumes and pricing, future shapes of the yield curve, relationship of market interest rates to each other (basis risk), credit spread and deposit sensitivity. Assumptions are based on management’s best estimates but may not accurately reflect actual results under certain changes in interest rate due to the timing, magnitude and frequency of rate changes, changes in market conditions and strategies management may undertake to reduce the impact of any changes, particularly in a low interest rate environment, among other factors. However, the analyses are useful in quantifying risk and providing a relative gauge of our interest rate risk position over time.
Our asset/liability committee operates under management policies, approved by the Board of Directors, which define guidelines and limits on the level of risk. The committee meets regularly and reviews our interest rate risk position and monitors various liquidity ratios to ensure a satisfactory liquidity position. By utilizing our analyses, we can determine changes that may need to be made to the asset and liability mixes to mitigate the change in net interest income under various interest rate scenarios. Management continually evaluates the condition of the economy, the pattern of market interest rates and other
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economic data to inform the committee on the selection of investment securities. Regulatory authorities also monitor our interest rate risk position along with other liquidity ratios.
Earnings at Risk
Simulation analysis evaluates the effect of upward and downward changes in market interest rates on future net interest income. The analysis involves changing the interest rates used in determining net interest income over the next twelve months. The resulting percentage change in net interest income in various rate scenarios is an indication of our short-term interest rate risk. The analysis assumes recent trends in new loan and deposit volumes will continue while the amount of investment securities remains constant. Additional assumptions are applied to modify volumes and pricing under the various rate scenarios.
The simulation analysis results are presented in the Earnings at Risk table below. At September 30, 2019, similar to at December 31, 2018, these results indicate the Company would be better positioned in a moderately rising rate environment than it would be if interest rates increased more substantially or decreased.
Value at Risk
Net present value analysis provides information on the risk inherent in the balance sheet that might not be taken into account in the simulation analysis due to the short time horizon used in that analysis. The net present value of the balance sheet incorporates the discounted present value of expected asset cash flows minus the discounted present value of expected liability cash flows. The analysis involves changing the interest rates used in determining the expected cash flows and in discounting the cash flows, assuming a point in time balance sheet with no management actions to actively manage the balance sheet for improved results. The resulting percentage change in net present value in various rate scenarios is an indication of the longer term repricing risk and options embedded in the balance sheet.
At September 30, 2019, similar to at December 31, 2018, these results indicate the Company would be better positioned in a rising interest rate environment than it would be if interest rates decreased.

Earnings at Risk |  |  |  |  |  | Value at Risk |  |  |  |
|  | % Change in Net Interest Income |  |  |  |  |  | % Change in Market Value |  |
Change in Market Interest Rates (basis points) |  | September 30, 2019 |  | December 31, 2018 |  | Change in Market Interest Rates (basis points) |  | September 30, 2019 |  | December 31, 2018
(100) |  |  | (1.6) | % |  | (2.1) | % |  | (100) |  |  | (30.0) | % |  | (14.1) | %
100 |  |  | (0.5) | % |  | (0.6) | % |  | 100 |  |  | 17.0 | % |  | 6.1 | %
200 |  |  | (2.7) | % |  | (2.2) | % |  | 200 |  |  | 25.0 | % |  | 7.1 | %

Item 4. Controls and Procedures
Based on the evaluation required by Securities Exchange Act Rules 13a-15(b) and 15d-15(b), the Company’s management, including the Principal Executive Officer and Principal Financial Officer, conducted an evaluation of the effectiveness of disclosure controls and procedures, as defined in Securities Exchange Act Rules 13a-15(e) and 15d-15(e), at September 30, 2019. Based on that evaluation, the Principal Executive Officer and Principal Financial Officer concluded that the disclosure controls and procedures were effective at September 30, 2019. There have been no changes in internal control over financial reporting that have materially affected, or are reasonably likely to materially affect, internal control over financial reporting during the third quarter of 2019.
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PART II – OTHER INFORMATION
Item 1 – Legal Proceedings
Information regarding legal proceedings is included in Note 13, Contingencies, to the Consolidated Financial Statements under Part I, Item 1, "Financial Statements" and incorporated herein by reference.
Item 1A – Risk Factors
Except as described below, there have been no material changes from the risk factors as disclosed in our Annual Report on Form 10-K for the year ended December 31, 2018.
Certain risk factors related to mergers and acquisitions in our Annual Report on Form 10-K for the year ended December 31, 2018 referenced risks associated with the completion of the Company's merger with Hamilton. As noted elsewhere in this Form 10-Q, the merger with Hamilton was completed on May 1, 2019 and our market area now includes Anne Arundel, Baltimore, and Howard Counties, Maryland, as well as Baltimore City, Maryland.
The risk factor related to changes in our accounting policies or in accounting standards appearing in our Annual Report on Form 10-K for the year ended December 31, 2018 referenced an adoption date in 2020 for ASU 2016-13, for changes in measurement of credit losses. As noted elsewhere in this Form 10-Q, the FASB has approved a delay in the effective date of this ASU for smaller reporting companies until fiscal years beginning after December 15, 2022, with earlier adoption permitted. Pending issuance of the final pronouncement, the Company is evaluating the impact of the delay for adoption of the update.
Item 2 – Unregistered Sales of Equity Securities and Use of Proceeds
No shares of the Company were repurchased from July 1, 2019 to September 30, 2019.
In September 2015, the Board of Directors of the Company authorized a share repurchase program under which the Company may repurchase up to 5% of the Company's outstanding shares of common stock, or approximately 416,000 shares, in accordance with all applicable securities laws and regulations, including Rule 10b-18 of the Exchange Act. When and if appropriate, repurchases may be made in open market or privately negotiated transactions, depending on market conditions, regulatory requirements and other corporate considerations, as determined by management. Share repurchases may not occur and may be discontinued at any time. At September 30, 2019, 82,725 shares had been repurchased under the program at a total cost of $1,438,000, or 17.38 per share. The maximum number of shares that may yet be purchased under the plan is 333,275 at September 30, 2019.
Item 3 – Defaults Upon Senior Securities
Not applicable.
Item 4 – Mine Safety Disclosures
Not applicable.
Item 5 – Other Information
None.
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Item 6 – Exhibits

2.1(a) |  |  | Agreement and Plan of Merger, dated May 31, 2018, by and between Orrstown Financial Services, Inc. and Mercersburg Financial Corporation, incorporated by reference to Exhibit 2.1 of the Registrant's Form 8-K filed June 1, 2018.
2.1(b) |  |  | Agreement and Plan of Merger, dated October 23, 2018, by and between Orrstown Financial Services, Inc. and Hamilton Bancorp, Inc., incorporated by reference to Exhibit 2.1 of the Registrant's Form 8-K filed October 24, 2018.
3.1 |  |  | Articles of Incorporation as amended, incorporated by reference to Exhibit 3.1 of the Registrant’s Report on Form 8-K filed on January 29, 2010.
3.2 |  |  | By-laws as amended, incorporated by reference to Exhibit 3.2 to the Registrant’s Report on Form 8-K filed January 30, 2018.
4.1 |  |  | Specimen Common Stock Certificate, incorporated by reference to the Registrant’s Registration Statement on Form S-3 filed February 8, 2010 (File No. 333-164780).
10.1 |  |  | Deferred Compensation Agreement between Orrstown Bank and Thomas R. Quinn, Jr., incorporated by reference to Exhibit 10.1 to the Registrant's Report on Form 8-K filed September 27, 2019.
10.2 |  |  | Amendment No. 1 to Change in Control Agreement between Orrstown Financial Services, Inc., Orrstown Bank and Thomas R. Quinn, Jr., incorporated by reference to Exhibit 10.2 to the Registrant's Report on Form 8-K filed September 27, 2019.
10.3 |  |  | First Amendment to Salary Continuation Agreement between Orrstown Bank and Thomas R. Quinn, Jr., incorporated by reference to Exhibit 10.3 to the Registrant's Report on Form 8-K filed September 27, 2019.
31.1 |  |  | Rule 13a – 14(a)/15d-14(a) Certification (Principal Executive Officer)
31.2 |  |  | Rule 13a – 14(a)/15d-14(a) Certifications (Principal Financial Officer)
32.1 |  |  | Section 1350 Certifications (Principal Executive Officer)
32.2 |  |  | Section 1350 Certifications (Principal Financial Officer)
101.LAB |  | XBRL Taxonomy Extension Label Linkbase
101.PRE |  | XBRL Taxonomy Extension Presentation Linkbase
101.INS |  | XBRL Instance Document
101.SCH |  | XBRL Taxonomy Extension Schema
101.CAL |  | XBRL Taxonomy Extension Calculation Linkbase
101.DEF |  | XBRL Taxonomy Extension Definition Linkbase

All other exhibits for which provision is made in the applicable accounting regulations of the Securities and Exchange Commission are not required under the related instructions or are inapplicable and therefore have been omitted.
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SIGNATURES
Pursuant to the requirements of the Securities Exchange Act of 1934, the registrant has duly caused this report to be signed on its behalf by the undersigned thereunto duly authorized.

| /s/ Thomas R. Quinn, Jr.
| Thomas R. Quinn, Jr.
| President and Chief Executive Officer
| (Principal Executive Officer)
| /s/ Thomas R. Brugger
| Thomas R. Brugger
| Executive Vice President and Chief Financial Officer
| (Principal Financial Officer)
| Date: November 8, 2019

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