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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, 2020
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 |

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

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

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

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

Indicate by check mark whether the registrant is a shell company (as defined in Rule 12b-2 of the Act.). Yes ☐ No x
Number of shares outstanding of the registrant’s Common Stock as of October 30, 2020: 11,203,512.

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 | 49
Item 3. | Quantitative and Qualitative Disclosures About Market Risk | 73
Item 4. | Controls and Procedures | 74
PART II – OTHER INFORMATION |
Item 1. | Legal Proceedings | 75
Item 1A. | Risk Factors | 75
Item 2. | Unregistered Sales of Equity Securities and Use of Proceeds | 75
Item 3. | Defaults upon Senior Securities | 75
Item 4. | Mine Safety Disclosures | 75
Item 5. | Other Information | 75
Item 6. | Exhibits | 76
SIGNATURES | 77

2

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

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

(Dollars in thousands, except per share amounts) | September 30, 2020 |  | December 31, 2019
Assets |  |  |
Cash and due from banks | $ | 26,854 |  |  | $ | 25,969 |
Interest-bearing deposits with banks | 60,453 |  |  | 29,994 |
Cash and cash equivalents | 87,307 |  |  | 55,963 |
Restricted investments in bank stocks | 12,646 |  |  | 16,184 |
Securities available for sale (amortized cost of $478,476 and $491,492 at September 30, 2020 and December 31, 2019, respectively) | 478,288 |  |  | 490,885 |
Loans held for sale, at fair value | 12,804 |  |  | 9,364 |
Loans | 2,029,870 |  |  | 1,644,330 |
Less: Allowance for loan losses | (19,725) |  |  | (14,655) |
Net loans | 2,010,145 |  |  | 1,629,675 |
Premises and equipment, net | 35,476 |  |  | 37,524 |
Cash surrender value of life insurance | 68,446 |  |  | 63,613 |
Goodwill | 18,724 |  |  | 19,925 |
Other intangible assets, net | 5,803 |  |  | 7,180 |
Accrued interest receivable | 8,812 |  |  | 6,040 |
Other assets | 43,216 |  |  | 46,921 |
Total assets | $ | 2,781,667 |  |  | $ | 2,383,274 |
Liabilities |  |  |
Deposits: |  |  |
Noninterest-bearing | $ | 409,051 |  |  | $ | 249,450 |
Interest-bearing | 1,870,432 |  |  | 1,626,072 |
Total deposits | 2,279,483 |  |  | 1,875,522 |
Securities sold under agreements to repurchase | 17,445 |  |  | 8,269 |
FHLB advances and other | 183,373 |  |  | 209,667 |
Subordinated notes | 31,889 |  |  | 31,847 |
Other liabilities | 36,630 |  |  | 34,720 |
Total liabilities | 2,548,820 |  |  | 2,160,025 |
Commitments and contingencies |  |  |
Shareholders’ Equity |  |  |
Preferred stock, $1.25 par value per share; 500,000 shares authorized; no shares issued or outstanding | — |  |  | — |
Common stock, no par value—$0.05205 stated value per share 50,000,000 shares authorized; 11,257,046 shares issued and 11,203,512 outstanding at September 30, 2020; 11,220,604 shares issued and 11,199,874 outstanding at December 31, 2019 | 586 |  |  | 584 |
Additional paid - in capital | 188,588 |  |  | 188,365 |
Retained earnings | 45,938 |  |  | 35,246 |
Accumulated other comprehensive loss | (1,455) |  |  | (480) |
Treasury stock— 53,534 and 20,730 shares, at cost at September 30, 2020 and December 31, 2019, respectively | (810) |  |  | (466) |
Total shareholders’ equity | 232,847 |  |  | 223,249 |
Total liabilities and shareholders’ equity | $ | 2,781,667 |  |  | $ | 2,383,274 |

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

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

| Three Months Ended |  | Nine Months Ended
(Dollars in thousands, except per share amounts) | September 30, 2020 |  | September 30, 2019 |  | September 30, 2020 |  | September 30, 2019
Interest income |  |  |  |  |  |  |
Loans | $ | 21,645 |  |  | $ | 20,178 |  |  | $ | 63,605 |  |  | $ | 54,987 |
Investment securities - taxable | 2,145 |  |  | 3,790 |  |  | 8,378 |  |  | 10,963 |
Investment securities - tax-exempt | 417 |  |  | 309 |  |  | 1,121 |  |  | 1,783 |
Short-term investments | 9 |  |  | 558 |  |  | 101 |  |  | 1,232 |
Total interest income | 24,216 |  |  | 24,835 |  |  | 73,205 |  |  | 68,965 |
Interest expense |  |  |  |  |  |  |
Deposits | 2,483 |  |  | 5,795 |  |  | 10,147 |  |  | 14,402 |
Securities sold under agreements to repurchase | 20 |  |  | 29 |  |  | 72 |  |  | 84 |
FHLB advances and other | 394 |  |  | 443 |  |  | 1,604 |  |  | 1,640 |
Subordinated notes | 501 |  |  | 490 |  |  | 1,504 |  |  | 1,486 |
Total interest expense | 3,398 |  |  | 6,757 |  |  | 13,327 |  |  | 17,612 |
Net interest income | 20,818 |  |  | 18,078 |  |  | 59,878 |  |  | 51,353 |
Provision for loan losses | 2,200 |  |  | 300 |  |  | 5,025 |  |  | 900 |
Net interest income after provision for loan losses | 18,618 |  |  | 17,778 |  |  | 54,853 |  |  | 50,453 |
Noninterest income |  |  |  |  |  |  |
Service charges on deposit accounts | 684 |  |  | 918 |  |  | 2,085 |  |  | 2,508 |
Interchange income | 900 |  |  | 843 |  |  | 2,507 |  |  | 2,422 |
Other service charges, commissions and fees | 168 |  |  | 193 |  |  | 473 |  |  | 583 |
Swap fees | 95 |  |  | 629 |  |  | 527 |  |  | 629 |
Trust and investment management income | 1,713 |  |  | 1,892 |  |  | 5,049 |  |  | 5,399 |
Brokerage income | 751 |  |  | 654 |  |  | 2,069 |  |  | 1,804 |
Mortgage banking activities | 1,985 |  |  | 623 |  |  | 3,926 |  |  | 1,743 |
Gain on sale of portfolio loans | — |  |  | — |  |  | 2,803 |  |  | — |
Income from life insurance | 543 |  |  | 479 |  |  | 1,615 |  |  | 1,505 |
Investment securities (losses) gains | (13) |  |  | 2,328 |  |  | (44) |  |  | 4,731 |
Other income | 35 |  |  | 44 |  |  | 118 |  |  | 188 |
Total noninterest income | 6,861 |  |  | 8,603 |  |  | 21,128 |  |  | 21,512 |
Noninterest expenses |  |  |  |  |  |  |
Salaries and employee benefits | 10,695 |  |  | 10,489 |  |  | 32,352 |  |  | 28,088 |
Occupancy | 1,231 |  |  | 1,133 |  |  | 3,480 |  |  | 3,200 |
Furniture and equipment | 1,203 |  |  | 1,252 |  |  | 3,569 |  |  | 3,415 |
Data processing | 958 |  |  | 830 |  |  | 2,620 |  |  | 2,658 |
Automated teller and interchange fees | 278 |  |  | 270 |  |  | 778 |  |  | 744 |
Advertising and bank promotions | 197 |  |  | 279 |  |  | 1,153 |  |  | 1,348 |
FDIC insurance | 230 |  |  | (9) |  |  | 491 |  |  | 397 |
Other professional services | 603 |  |  | 814 |  |  | 2,340 |  |  | 2,078 |
Directors' compensation | 214 |  |  | 228 |  |  | 679 |  |  | 725 |
Taxes other than income | 453 |  |  | 306 |  |  | 904 |  |  | 926 |
Intangible asset amortization | 357 |  |  | 486 |  |  | 1,224 |  |  | 1,096 |
Merger related and branch consolidation expenses | 1,310 |  |  | 471 |  |  | 1,310 |  |  | 7,976 |
Insurance claim receivable (recovery) write-off | — |  |  | — |  |  | (486) |  |  | 615 |
Other operating expenses | 1,536 |  |  | 1,591 |  |  | 5,586 |  |  | 4,327 |
Total noninterest expenses | 19,265 |  |  | 18,140 |  |  | 56,000 |  |  | 57,593 |
Income before income tax expense | 6,214 |  |  | 8,241 |  |  | 19,981 |  |  | 14,372 |
Income tax expense | 1,237 |  |  | 1,340 |  |  | 3,577 |  |  | 1,682 |
Net income | $ | 4,977 |  |  | $ | 6,901 |  |  | $ | 16,404 |  |  | $ | 12,690 |
Per share information: |  |  |  |  |  |  |
Basic earnings per share | $ | 0.45 |  |  | $ | 0.63 |  |  | $ | 1.50 |  |  | $ | 1.25 |
Diluted earnings per share | 0.45 |  |  | 0.62 |  |  | 1.49 |  |  | 1.23 |
Dividends paid per share | 0.17 |  |  | 0.15 |  |  | 0.51 |  |  | 0.45 |

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

| Three Months Ended |  | Nine Months Ended
(Dollars in thousands) | September 30, 2020 |  | September 30, 2019 |  | September 30, 2020 |  | September 30, 2019
Net income | $ | 4,977 |  |  | $ | 6,901 |  |  | $ | 16,404 |  |  | $ | 12,690 |
Other comprehensive income, net of tax: |  |  |  |  |  |  |
Unrealized gains on securities available for sale arising during the period | 4,296 |  |  | 1,400 |  |  | 375 |  |  | 11,880 |
Reclassification adjustment for losses (gains) realized in net income | 13 |  |  | (2,328) |  |  | 44 |  |  | (4,731) |
Net unrealized gains (losses) on securities available for sale | 4,309 |  |  | (928) |  |  | 419 |  |  | 7,149 |
Tax effect | (904) |  |  | 195 |  |  | (87) |  |  | (1,502) |
Total other comprehensive income (loss), net of tax and reclassification adjustments on securities available for sale | 3,405 |  |  | (733) |  |  | 332 |  |  | 5,647 |
Unrealized gain (loss) on interest rate swaps used in cash flow hedges | 208 |  |  | — |  |  | (1,893) |  |  | — |
Reclassification adjustment for losses realized in net income | 114 |  |  | — |  |  | 239 |  |  | — |
Net unrealized gain (loss) on interest rate swaps used in cash flow hedges | 322 |  |  | — |  |  | (1,654) |  |  | — |
Tax effect | (68) |  |  | — |  |  | 347 |  |  | — |
Total other comprehensive gain (loss), net of tax and reclassification adjustments on interest rate swaps | 254 |  |  | — |  |  | (1,307) |  |  | — |
Total other comprehensive income (loss), net of tax and reclassification adjustments | 3,659 |  |  | (733) |  |  | (975) |  |  | 5,647 |
Total comprehensive income | $ | 8,636 |  |  | $ | 6,168 |  |  | $ | 15,429 |  |  | $ | 18,337 |

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

| Three Months Ended September 30, 2020
(Dollars in thousands, except per share amounts) | Common Stock |  | Additional Paid-In Capital |  | Retained Earnings |  | Accumulated Other Comprehensive Loss |  | Treasury Stock |  | Total Shareholders’ Equity
Balance, July 1, 2020 | $ | 586 |  |  | $ | 188,226 |  |  | $ | 42,862 |  |  | $ | (5,114) |  |  | $ | (922) |  |  | $ | 225,638 |
Net income | — |  |  | — |  |  | 4,977 |  |  | — |  |  | — |  |  | 4,977 |
Total other comprehensive income, net of taxes | — |  |  | — |  |  | — |  |  | 3,659 |  |  | — |  |  | 3,659 |
Cash dividends ($0.17 per share) | — |  |  | — |  |  | (1,901) |  |  | — |  |  | — |  |  | (1,901) |
Share-based compensation plans: |  |  |  |  |  |  |  |  |  |  |
11,383 net common shares forfeited and 5,634 net treasury shares issued, including compensation expense totaling $437 | — |  |  | 362 |  |  | — |  |  | — |  |  | 112 |  |  | 474 |
Balance, September 30, 2020 | $ | 586 |  |  | $ | 188,588 |  |  | $ | 45,938 |  |  | $ | (1,455) |  |  | $ | (810) |  |  | $ | 232,847 |
| Nine Months Ended September 30, 2020
(Dollars in thousands, except per share amounts) | Common Stock |  | Additional Paid-In Capital |  | Retained Earnings |  | Accumulated Other Comprehensive Loss |  | Treasury Stock |  | Total Shareholders’ Equity
Balance, January 1, 2020 | $ | 584 |  |  | $ | 188,365 |  |  | $ | 35,246 |  |  | $ | (480) |  |  | $ | (466) |  |  | $ | 223,249 |
Net income | — |  |  | — |  |  | 16,404 |  |  | — |  |  | — |  |  | 16,404 |
Total other comprehensive loss, net of taxes | — |  |  | — |  |  | — |  |  | (975) |  |  | — |  |  | (975) |
Cash dividends ($0.51 per share) | — |  |  | — |  |  | (5,712) |  |  | — |  |  | — |  |  | (5,712) |
Share-based compensation plans: |  |  |  |  |  |  |  |  |  |  |
36,442 net common shares issued and 32,804 net treasury shares acquired, including compensation expense totaling $1,613 | 2 |  |  | 223 |  |  | — |  |  | — |  |  | (344) |  |  | (119) |
Balance, September 30, 2020 | $ | 586 |  |  | $ | 188,588 |  |  | $ | 45,938 |  |  | $ | (1,455) |  |  | $ | (810) |  |  | $ | 232,847 |

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

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

| Nine Months Ended
(Dollars in thousands) | September 30, 2020 |  | September 30, 2019
Cash flows from operating activities |  |  |
Net income | $ | 16,404 |  |  | $ | 12,690 |
Adjustments to reconcile net income to net cash provided by operating activities: |  |  |
Net discount accretion | (2,898) |  |  | (1,594) |
Depreciation and amortization expense | 4,980 |  |  | 3,970 |
Impairment of intangibles | 153 |  |  | — |
Provision for loan losses | 5,025 |  |  | 900 |
Share-based compensation | 1,613 |  |  | 1,154 |
Gain on sales of loans originated for sale | (4,028) |  |  | (1,653) |
Mortgage loans originated for sale | (147,647) |  |  | (78,242) |
Proceeds from sales of loans originated for sale | 146,890 |  |  | 75,276 |
Gain on sale of portfolio loans | (2,803) |  |  | — |
Net loss (gain) on disposal of OREO | 164 |  |  | (8) |
Writedown of OREO | 544 |  |  | — |
Net loss on disposal of premises and equipment | 1 |  |  | 137 |
Deferred income taxes | (672) |  |  | 1,348 |
Investment securities losses (gains) | 44 |  |  | (4,731) |
Income from life insurance | (1,615) |  |  | (1,505) |
(Increase) decrease in accrued interest receivable | (2,772) |  |  | 742 |
Decrease in accrued interest payable and other liabilities | (504) |  |  | (5,618) |
Other, net | 3,459 |  |  | 589 |
Net cash provided by operating activities | 16,338 |  |  | 3,455 |
Cash flows from investing activities |  |  |
Proceeds from sales of AFS securities | — |  |  | 199,411 |
Maturities, repayments and calls of AFS securities | 38,970 |  |  | 22,934 |
Purchases of AFS securities | (26,691) |  |  | (166,694) |
Net cash and cash equivalents received from acquisitions | — |  |  | 29,442 |
Net redemptions of restricted investments in bank stocks | 3,538 |  |  | 2,101 |
Net decrease in loans | 65,605 |  |  | 4,023 |
Proceeds from sales of portfolio loans | 22,665 |  |  | — |
Purchases of bank premises and equipment | (914) |  |  | (3,226) |
Proceeds from disposal of OREO | 3,734 |  |  | 724 |
Proceeds from disposal of bank premises and equipment | 59 |  |  | — |
Purchases of bank owned life insurance | (3,636) |  |  | (2,280) |
Death benefit proceeds from life insurance contracts | — |  |  | 571 |
Net cash provided by investing activities | 103,330 |  |  | 87,006 |
Cash flows from financing activities |  |  |
Net decrease in deposits | (63,761) |  |  | (23,598) |
Net decrease in borrowings with original maturities less than 90 days | (137,424) |  |  | (2,464) |
Proceeds from FHLB advances and other borrowings | 180,955 |  |  | 20,000 |
Payments on FHLB advances and other borrowings | (60,649) |  |  | (116,678) |
Subordinated note issuance costs | — |  |  | (59) |
Dividends paid | (5,712) |  |  | (4,472) |
Acquisition of treasury stock | (1,170) |  |  | — |
Treasury shares repurchased for employee taxes associated with restricted stock vesting | (679) |  |  | (1,694) |
Proceeds from issuance of employee stock purchase plan shares | 116 |  |  | 113 |
Net cash used in financing activities | (88,324) |  |  | (128,852) |
Net increase (decrease) in cash and cash equivalents | 31,344 |  |  | (38,391) |
Cash and cash equivalents at beginning of period | 55,963 |  |  | 88,815 |
Cash and cash equivalents at end of period | $ | 87,307 |  |  | $ | 50,424 |

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Supplemental disclosures of cash flow information: |  |  |
Cash paid during the period for: |  |  |
Interest | $ | 13,387 |  |  | $ | 17,573 |
Supplemental schedule of noncash investing activities: |  |  |
OREO acquired in settlement of loans | — |  |  | 161 |
Lease liabilities arising from obtaining ROU assets | 400 |  |  | 8,115 |
SBA PPP loans originated | 467,654 |  |  | — |

The Notes to Unaudited Condensed Consolidated Financial Statements are an integral part of these statements.
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Notes to Condensed Consolidated Financial Statements (Unaudited)
(All dollar amounts presented in the tables, except per share amounts, are in thousands)
NOTE 1. SUMMARY OF SIGNIFICANT ACCOUNTING POLICIES
See the Glossary of Defined Terms at the beginning of this Report for terms used throughout the unaudited condensed consolidated financial statements and related notes of this Form 10-Q.
Nature of Operations – Orrstown Financial Services, Inc. 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. 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. Effective July 31, 2020, Wheatland Advisors, Inc., a registered investment advisor non-bank subsidiary, headquartered in Lancaster County, Pennsylvania was discontinued. The Company and the Bank are subject to regulation by certain federal and state agencies and undergo periodic examinations by such regulatory authorities.
Basis of Presentation – The accompanying unaudited condensed consolidated financial statements include the accounts of Orrstown Financial Services, Inc. and its wholly owned subsidiary, the Bank. 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, 2019 consolidated balance sheet information contained in this Quarterly Report on Form 10-Q was derived from the Company's 2019 audited consolidated financial statements. 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, 2019. Operating results for the three and nine months ended September 30, 2020 are not necessarily indicative of the results that may be expected for the year ending December 31, 2020. All significant intercompany transactions and accounts have been eliminated. Certain reclassifications may have been made to prior year amounts to conform with current year classifications.
The Company's management has evaluated all activity of the Company and concluded that subsequent events are properly reflected in the Company's unaudited condensed consolidated financial statements and notes as required by GAAP.
The preparation of financial statements in conformity with GAAP requires management to make estimates and assumptions that affect the reported amounts of assets and liabilities and disclosure of contingent assets and liabilities as of the date of the financial statements and the reported amounts of revenues and expenses during the reporting periods. Actual results could differ from those estimates. The effects of the COVID-19 pandemic may negatively impact material estimates. Material estimates that are particularly susceptible to significant change include the determination of the ALL and those used in valuation methodologies in areas with no observable market, such as loans, deposits, borrowings, goodwill, core deposit and other intangible assets, mortgage servicing rights, other assets and liabilities obtained or assumed in business combinations.
Derivatives - FASB ASC 815, Derivatives and Hedging (“ASC 815”), provides the disclosure requirements for derivatives and hedging activities with the intent to provide users of financial statements with an enhanced understanding of: (a) how and why an entity uses derivative instruments, (b) how the entity accounts for derivative instruments and related hedged items, and (c) how derivative instruments and related hedged items affect an entity’s financial position, financial performance, and cash flows. Further, qualitative disclosures are required that explain the Company’s objectives and strategies for using derivatives, as well as quantitative disclosures about the fair value of and gains and losses on derivative instruments, and disclosures about credit-risk-related contingent features in derivative instruments.
As required by ASC 815, the Company records all derivatives on the balance sheet at fair value. The accounting for changes in the fair value of derivatives depends on the intended use of the derivative, whether the Company has elected to designate a derivative in a hedging relationship and apply hedge accounting and whether the hedging relationship has satisfied the criteria necessary to apply hedge accounting. Derivatives designated and qualifying as a hedge of the exposure to changes in the fair value of an asset, liability, or firm commitment attributable to a particular risk, such as interest rate risk, are considered fair value hedges. Derivatives designated and qualifying as a hedge of the exposure to variability in expected future cash flows, or other types of forecasted transactions, are considered cash flow hedges. Hedge accounting generally provides for the matching of the timing of gain or loss recognition on the hedging instrument with the recognition of the changes in the fair value of the hedged asset or liability that are attributable to the hedged risk in a fair value hedge or the earnings effect of the hedged forecasted transactions in a cash flow hedge.
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The Company may enter into derivative contracts that are intended to economically hedge certain of its risk, even though hedge accounting does not apply or the Company elects not to apply hedge accounting. The Company's objectives in using interest rate derivatives are to add stability to interest income and to manage its exposure to interest rate movements. To accomplish this objective, the Company primarily uses interest rate swaps as part of its interest rate risk management strategy. Interest rate swaps designated as cash flow hedges involve the receipt of fixed amounts from a counterparty in exchange for the Company making variable-rate payments over the life of the agreements without exchange of the underlying notional amount. The Company may enter into derivative contracts that are intended to economically hedge certain of its risk, even though hedge accounting does not apply or the Company elects not to apply hedge accounting.
Changes to the fair value of derivatives designated and that qualify as cash flow hedges are recorded in accumulated other comprehensive income and are subsequently reclassified into earnings in the period that the hedged transaction affects earnings. During the nine months ended September 30, 2020, such derivatives were used to hedge the variable cash flows associated with overnight borrowings.
Derivatives not designated as hedges are not speculative and result from a service the Company provides to certain customers. The Company executes interest rate swaps with commercial banking customers to facilitate their respective risk management strategies. Those interest rate swaps are simultaneously hedged by offsetting derivatives that the Company executes with a third party, such that the Company minimizes its net risk exposure resulting from such transactions. As the interest rate derivatives associated with this program do not meet the strict hedge accounting requirements, changes in the fair value of both the customer derivatives and the offsetting derivatives are recognized directly in earnings.
Leases - The Company evaluates its contracts at inception to determine if an arrangement either is a lease or contains one. Operating lease ROU assets are included in other assets and operating lease liabilities in accrued interest payable and other liabilities in the unaudited condensed consolidated balance sheets. The Company had no finance leases at September 30, 2020.
ROU assets represent the right to use an underlying asset for the lease term, and lease liabilities represent an obligation to make lease payments arising from the lease. Operating lease ROU assets and liabilities are recognized at commencement date based on the present value of lease payments over the lease term. The Company's leases do not provide an implicit rate, so the Company's incremental borrowing rate is used, which approximates its fully collateralized borrowing rate, based on the information available at commencement date in determining the present value of lease payments. The incremental borrowing rate is reevaluated upon lease modification. The operating lease ROU asset also includes any initial direct costs and prepaid lease payments made less any lease incentives. In calculating the present value of lease payments, the Company may include options to extend the lease when it is reasonably certain that it will exercise that option.
In accordance with ASU 2016-02, “Leases (Topic 842)” (“ASU 2016-02”), the Company keeps leases with an initial term of 12 months or less off of the balance sheet. The Company recognizes these lease payments in the unaudited condensed consolidated statements of income on a straight-line basis over the lease term. The Company has lease agreements with lease and non-lease components and has elected the practical expedient to account for them as a single lease component.
The Company's operating leases relate primarily to bank branches and office space. Upon the adoption of ASU 2016-02 on January 1, 2019, operating lease liabilities of $10.5 million and related lease assets of $7.5 million were recognized on the unaudited condensed consolidated balance sheets. The difference between the lease assets and lease liabilities primarily consists of deferred rent liabilities reclassified upon adoption to reduce the measurement of the lease assets.
Recent Accounting Pronouncements - ASU No. 2016-13, Financial Instruments - Credit Losses (Topic 326): Measurement of Credit Losses on Financial Instruments ("ASU 2016-13"). 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 was effective for interim and annual periods beginning after December 15, 2019. The Company delayed the adoption of ASU 2016-13 as noted below.
ASU No. 2019-10, Financial Instruments—Credit Losses (Topic 326), Derivatives and Hedging (Topic 815), and Leases (Topic 842): Effective Dates ("ASU 2019-10"), extended the implementation deadline of ASU 2016-13 for smaller reporting and other companies until the fiscal year and interim periods beginning after December 15, 2022. The Company meets the requirements to be considered a smaller reporting company under SEC Regulation S-K and SEC Rule 405, and did not adopt ASU 2016-13 on January 1, 2020. The Company is evaluating the impact of the delay for adoption of ASU 2016-13, and is working with a third-party vendor solution to assist with the application of ASU 2016-13 and finalizing the loss estimation
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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 the Company anticipates the allowance for loan losses will increase under its current assumptions, it expects the impact of adopting ASU 2016-13 will be influenced by the composition, characteristics and quality of its loan and securities portfolios, as well as general economic conditions and forecasts at the adoption date. The other provisions of ASU 2019-10 were not applicable to the Company.
In March 2020, the FASB issued ASU No. 2020-04, Reference Rate Reform (Topic 848): Facilitation of the Effects of Reference Rate Reform on Financial Reporting ("ASU 2020-04"). ASU 2020-04 contains optional expedients and exceptions for applying generally accepted accounting principles to contract modifications and hedging relationships, subject to meeting certain criteria, that reference LIBOR or another reference rate expected to be discontinued. The optional expedients apply consistently to all contracts or transactions within the scope of this topic, while the optional expedients for hedging relationships can be elected on an individual basis. The Company has formed a cross-functional working group to lead the transition from LIBOR to a planned adoption of an alternate index. The Company has not yet determined what index will replace LIBOR in its loan agreements. The Company is in the process of implementing fallback language for loans that will mature after 2021. The Company expects to adopt the LIBOR transition relief allowed under this standard, and is currently evaluating the potential impact of this guidance on its financial statements.
NOTE 2. MERGERS AND ACQUISITIONS
Hamilton Bancorp, Inc.
On May 1, 2019, the Company acquired 100% of the outstanding common shares of Hamilton Bancorp, Inc., and its wholly-owned subsidiary, Hamilton Bank, based in Towson, Maryland. The Company acquired Hamilton to introduce our banking and financial services into the Greater Baltimore area of Maryland.
Pursuant to the merger agreement, the Company issued 1,765,704 shares of its common stock and paid $14.2 million in cash for all outstanding shares of Hamilton stock and options vesting upon acquisition. Based on the Company's closing stock price of $20.74 on April 30, 2019, the consideration paid to acquire Hamilton totaled approximately $50.8 million.
The fair value of assets acquired, excluding goodwill, totaled $494.0 million, including loans totaling $347.1 million. The fair value of liabilities assumed totaled $449.4 million, including deposits totaling $388.2 million. Goodwill represents consideration transferred in excess of the fair value of the net assets acquired. At May 1, 2019, the Company recognized $6.1 million 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 becomes available. The Company finalized the fair values of loans, intangible assets, other assets, income taxes and liabilities associated with Hamilton as of May 1, 2020. Measurement period adjustments made from the date of acquisition through May 1, 2020 are summarized in Note 6 - Goodwill and Other Intangible Assets.
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The following table summarizes the consideration paid for Hamilton and the estimated fair values of the assets acquired and liabilities assumed recognized at the acquisition date:

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 |  | 347,143 |
Premises and equipment |  | 3,749 |
Core deposit intangible |  | 4,550 |
Goodwill |  | 6,132 |
Cash surrender value of life insurance |  | 17,948 |
Deferred tax asset, net |  | 7,257 |
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) |

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 the Company considered to be level 3 fair value measurements. Deposit liabilities assumed in the Hamilton acquisition were segregated into two categories: time-deposits (i.e., deposit accounts with a stated maturity) and demand deposits, both using level 2 fair value measurements. In determining fair value of time deposits, the Company discounted the contractual cash flows of the deposit accounts using prevailing market interest rates for time deposit accounts of similar type and duration. For demand deposits, the acquisition date outstanding balance of the assumed demand deposit accounts approximates fair value. Acquisition date fair values for securities available for sale were determined using Level 1 or Level 2 inputs consistent with the methods discussed further in Note 13 - 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).
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.
The Company recognized a core deposit intangible of $4.6 million, which is being amortized using an accelerated method over a 10-year amortization period, consistent with expected future cash flows.
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Loans acquired with Hamilton were measured at fair value at the acquisition date with no carryover of any ALL. Loans were segregated into those loans considered to be performing and those considered PCI. The following table presents performing and PCI loans acquired, by loan class, at May 1, 2019:

| Performing |  | PCI |  | Total
Commercial real estate: |  |  |  |  |
Owner-occupied | $ | 42,148 |  |  | $ | 5,894 |  |  | $ | 48,042 |
Non-owner occupied | 45,401 |  |  | 770 |  |  | 46,171 |
Multi-family | 10,773 |  |  | — |  |  | 10,773 |
Acquisition and development: |  |  |  |  |
1-4 family residential construction | 7,450 |  |  | — |  |  | 7,450 |
Commercial and land development | 4,528 |  |  | — |  |  | 4,528 |
Commercial and industrial | 32,316 |  |  | 1,914 |  |  | 34,230 |
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 |  |  | — |  |  | 13,657 |
Installment and other loans | 14,467 |  |  | 195 |  |  | 14,662 |
Total loans acquired | $ | 327,875 |  |  | $ | 19,268 |  |  | $ | 347,143 |

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

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 | (5,726) |
Estimated fair value of acquired loans | $ | 347,143 |

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

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

Unaudited pro forma net income for the Company for the three and nine months ended September 30, 2019, would have totaled $7.6 million and $13.4 million, respectively, and revenues would have totaled $38.7 million and $95.7 million for the same periods had the Hamilton acquisition occurred on January 1, 2019.
In connection with the Mercersburg and Hamilton acquisitions, the Company incurred merger related expenses totaling $0.5 million and $8.0 million for the three and nine months ending September 30, 2019, which are included in noninterest
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expenses on the unaudited condensed statements of income. The Company did not incur any merger related expenses for the three and nine months ended September 30, 2020.
NOTE 3. INVESTMENT SECURITIES
At September 30, 2020 and December 31, 2019, all investment securities were classified as AFS. The following table summarizes amortized cost and fair value of investment securities, and the corresponding amounts of gross unrealized gains and losses recognized in AOCI, at September 30, 2020 and December 31, 2019:

| Amortized Cost |  | Gross Unrealized Gains |  | Gross Unrealized Losses |  | Fair Value
September 30, 2020 |  |  |  |  |  |  |
States and political subdivisions | $ | 104,900 |  |  | $ | 8,042 |  |  | $ | 235 |  |  | $ | 112,707 |
GSE residential MBSs | 4,488 |  |  | 90 |  |  | — |  |  | 4,578 |
GSE residential CMOs | 60,254 |  |  | 2,682 |  |  | 797 |  |  | 62,139 |
Non-agency CMOs | 17,071 |  |  | 91 |  |  | — |  |  | 17,162 |
Private label commercial CMOs | 72,372 |  |  | 23 |  |  | 3,186 |  |  | 69,209 |
Asset-backed | 219,048 |  |  | 148 |  |  | 7,046 |  |  | 212,150 |
Other | 343 |  |  | — |  |  | — |  |  | 343 |
Totals | $ | 478,476 |  |  | $ | 11,076 |  |  | $ | 11,264 |  |  | $ | 478,288 |
December 31, 2019 |  |  |  |  |  |  |
States and political subdivisions | $ | 83,607 |  |  | $ | 4,288 |  |  | $ | 32 |  |  | $ | 87,863 |
GSE residential CMOs | 67,928 |  |  | 1,000 |  |  | 774 |  |  | 68,154 |
Non-agency CMOs | 17,210 |  |  | — |  |  | 123 |  |  | 17,087 |
Private label commercial CMOs | 86,704 |  |  | 156 |  |  | 231 |  |  | 86,629 |
Asset-backed | 235,406 |  |  | 138 |  |  | 5,029 |  |  | 230,515 |
Other | 637 |  |  | — |  |  | — |  |  | 637 |
Totals | $ | 491,492 |  |  | $ | 5,582 |  |  | $ | 6,189 |  |  | $ | 490,885 |

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

| Less Than 12 Months |  | 12 Months or More |  | Total
| # of Securities |  | Fair Value |  | Unrealized Losses |  | # of Securities |  | Fair Value |  | Unrealized Losses |  | # of Securities |  | Fair Value |  | Unrealized Losses
September 30, 2020 |  |  |  |  |  |  |  |  |  |  |  |  |  |  |  |  |
States and political subdivisions | 1 |  |  | $ | 9,975 |  |  | $ | 235 |  |  | — |  |  | $ | — |  |  | $ | — |  |  | 1 |  |  | $ | 9,975 |  |  | $ | 235 |
GSE residential CMOs | 3 |  |  | 25,296 |  |  | 797 |  |  | — |  |  | — |  |  | — |  |  | 3 |  |  | 25,296 |  |  | 797 |
Private label commercial CMOs | 4 |  |  | 24,768 |  |  | 1,285 |  |  | 9 |  |  | 38,469 |  |  | 1,901 |  |  | 13 |  |  | 63,237 |  |  | 3,186 |
Asset-backed | 6 |  |  | 45,289 |  |  | 419 |  |  | 13 |  |  | 158,129 |  |  | 6,627 |  |  | 19 |  |  | 203,418 |  |  | 7,046 |
Totals | 14 |  |  | $ | 105,328 |  |  | $ | 2,736 |  |  | 22 |  |  | $ | 196,598 |  |  | $ | 8,528 |  |  | 36 |  |  | $ | 301,926 |  |  | $ | 11,264 |
December 31, 2019 |  |  |  |  |  |  |  |  |  |  |  |  |  |  |  |  |
States and political subdivisions | 1 |  |  | $ | 6,173 |  |  | $ | 32 |  |  | — |  |  | $ | — |  |  | $ | — |  |  | 1 |  |  | $ | 6,173 |  |  | $ | 32 |
GSE residential CMOs | 5 |  |  | 37,158 |  |  | 309 |  |  | 1 |  |  | 11,602 |  |  | 465 |  |  | 6 |  |  | 48,760 |  |  | 774 |
Non-agency CMOs | 1 |  |  | 17,087 |  |  | 123 |  |  | — |  |  | — |  |  | — |  |  | 1 |  |  | 17,087 |  |  | 123 |
Private label commercial CMOs | 6 |  |  | 26,079 |  |  | 67 |  |  | 8 |  |  | 39,726 |  |  | 164 |  |  | 14 |  |  | 65,805 |  |  | 231 |
Asset-backed | 9 |  |  | 92,189 |  |  | 1,145 |  |  | 9 |  |  | 121,399 |  |  | 3,884 |  |  | 18 |  |  | 213,588 |  |  | 5,029 |
Totals | 22 |  |  | $ | 178,686 |  |  | $ | 1,676 |  |  | 18 |  |  | $ | 172,727 |  |  | $ | 4,513 |  |  | 40 |  |  | $ | 351,413 |  |  | $ | 6,189 |

The Company determines whether unrealized losses are temporary in nature in accordance with FASB ASC 320-10, Investments - Overall, (“FASB ASC 320-10”) and FASB ASC 325-40, Investments – Beneficial Interests in Securitized Financial Assets, when applicable. The evaluation is based upon factors such as the creditworthiness of the underlying
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borrowers, performance of the underlying collateral, if applicable, and the level of credit support in the security structure. Management also evaluates other factors and circumstances that may be indicative of an OTTI condition. This includes, but is not limited to, an evaluation of the type of security, length of time and extent to which the fair value has been less than cost and near-term prospects of the issuer.
FASB ASC 320-10 requires the Company to assess if an OTTI exists by considering whether the Company has the intent to sell the security or it is more likely than not that it will be required to sell the security before recovery. If either of these situations applies, the guidance requires the Company to record an OTTI charge to earnings on debt securities for the difference between the amortized cost basis of the security and the fair value of the security. If neither of these situations applies, the Company is required to assess whether it is expected to recover the entire amortized cost basis of the security. If the Company is not expected to recover the entire amortized cost basis of the security, the guidance requires the Company to bifurcate the identified OTTI into a credit loss component and a component representing loss related to other factors. A discount rate is applied which equals the effective yield of the security. The difference between the present value of the expected flows and the amortized book value is considered a credit loss, which would be recorded through earnings as an OTTI charge. When a market price is not readily available, the market value of the security is determined using the same expected cash flows; the discount rate is a rate the Company determines from the open market and other sources as appropriate for the security. The difference between the market value and the present value of cash flows expected to be collected is recognized in accumulated other comprehensive loss on the consolidated statements of financial condition.
As of September 30, 2020, the Company had no cumulative OTTI. There were no OTTI charges recognized in earnings as a result of credit losses on investments in the three and nine months ended September 30, 2020 and 2019. During the nine months ended September 30, 2020, unrealized losses were substantially higher due to market uncertainty brought about by the COVID-19 pandemic. The sudden and desperate need for liquidity from many institutional pools of capital combined with the global economic implications of the COVID-19 pandemic caused significant widening of spreads.
States and Political Subdivisions. The unrealized losses presented in the table above have been caused by a widening of spreads 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 September 30, 2020 or December 31, 2019.
GSE Residential CMOs. The unrealized losses presented in the table above have been caused by a widening of spreads 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, 2020 or December 31, 2019.
Non-agency CMOs. The unrealized losses presented in the table above have been caused by a widening of spreads from the time the securities were purchased. Management considers the investment rating and other credit support in determining whether a security is other-than-temporarily impaired. As of September 30, 2020, management concluded that an OTTI did not exist on any of the aforementioned securities based upon its assessment. Management also concluded that it does not intend to sell nor will it be required to sell the securities before their recovery, which may be maturity, and management expects to recover the entire amortized cost basis of these securities.
Private Label Commercial CMOs and Asset-backed. The unrealized losses presented in the table above have been caused by a widening of spreads from the time the securities were purchased. Management considers the investment rating and other credit support in determining whether a security is other-than-temporarily impaired. 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, 2020 or December 31, 2019.
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The following table summarizes the credit ratings and collateral associated with the Company's investment portfolio, excluding equity securities, at September 30, 2020:

Sector | Portfolio Mix | Amortized Book | Fair Value | Credit Enhancement | AAA | AA | A | BBB | NR | Collateral Type
Unsecured ABS | 2 | % | $ | 8,239 |  | $ | 8,291 |  | 43 | % | 5 | % | — | % | — | % | — | % | 95 | % | Unsecured Consumer Debt
Student Loan ABS | 2 | % | $ | 11,868 |  | $ | 11,636 |  | 26 | % | — | % | — | % | — | % | — | % | 100 | % | Seasoned Student Loans
Federal Family Education Loan ABS | 38 | % | $ | 181,639 |  | $ | 174,916 |  | 6 | % | 4 | % | 73 | % | 23 | % | — | % | — | % | Federal Family Education Loan (1)
PACE Loan ABS | 1 | % | $ | 5,472 |  | $ | 5,551 |  | 6 | % | 100 | % | — | % | — | % | — | % | — | % | PACE Loans
Non-Agency CMBS | 15 | % | $ | 72,372 |  | $ | 69,209 |  | 55 | % | 87 | % | — | % | 3 | % | 10 | % | — | % | Commercial Real Estate
Non-Agency RMBS | 4 | % | $ | 17,071 |  | $ | 17,162 |  | 33 | % | 100 | % | — | % | — | % | — | % | — | % | Reverse Mortgages (2)
Municipal - General Obligation | 11 | % | $ | 53,886 |  | $ | 58,640 |  |  | 3 | % | 85 | % | 12 | % | — | % | — | % |
Municipal - Revenue | 11 | % | $ | 51,014 |  | $ | 54,067 |  |  | — | % | 61 | % | 19 | % | — | % | 20 | % |
SBA ReRemic | 2 | % | $ | 11,830 |  | $ | 11,756 |  |  | — | % | 100 | % | — | % | — | % | — | % | SBA Guarantee (3)
Agency MBS | 14 | % | $ | 64,743 |  | $ | 66,717 |  |  | — | % | 100 | % | — | % | — | % | — | % | Residential Mortgages (3)
Bank CDs | — | % | $ | 249 |  | $ | 249 |  |  | — | % | — | % | — | % | — | % | 100 | % | FDIC Insured CD
| 100 | % | $ | 478,383 |  | $ | 478,194 |  |  | 20 | % | 60 | % | 13 | % | 1 | % | 6 | % |
(1) Minimum of 97% guaranteed by U.S. government
(2) Reverse mortgages, expected credit enhancement is provided above
(3) 100% guaranteed by U.S. government agencies
Note : Ratings in table are the lowest of the six rating agencies (Standard & Poors, Moody's, Morningstar, DBRS, KBRA and Fitch). Standard & Poors rates U.S. government obligations at AA+

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

| Amortized Cost |  | Fair Value
Due in one year or less | $ | — |  |  | $ | — |
Due after one year through five years | 249 |  |  | 249 |
Due after five years through ten years | 27,068 |  |  | 29,078 |
Due after ten years | 77,926 |  |  | 83,723 |
CMOs and MBSs | 154,185 |  |  | 153,088 |
Asset-backed | 219,048 |  |  | 212,150 |
| $ | 478,476 |  |  | $ | 478,288 |

The following table summarizes proceeds from sales of investment securities and gross gains and gross losses for the three and nine months ended September 30, 2020 and 2019:

| Three months ended September 30, |  | Nine months ended September 30,
| 2020 |  | 2019 |  | 2020 |  | 2019
Proceeds from sale of investment securities | $ | — |  |  | $ | 25,575 |  |  | $ | — |  |  | $ | 199,411 |
Gross gains | — |  |  | 2,328 |  |  | — |  |  | 4,956 |
Gross losses | 13 |  |  | — |  |  | 44 |  |  | 225 |

During the three and nine months ended September 30, 2020, a loss of $13 thousand and $44 thousand, respectively, was recorded to adjust an equity security to market value, compared to net investment security gains of $2.3 million and $4.7 million, respectively, for the three and nine months ended September 30, 2019 from security sales. There were no sales of investment securities during the three and nine months ended September 30, 2020. Investment securities with a fair value of $426.1 million and $158.7 million at September 30, 2020 and December 31, 2019, respectively, were pledged to secure public funds and for other purposes as required or permitted by law.
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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. At September 30, 2020 and December 31, 2019, commercial and industrial loans include $458.1 million and $0, respectively, of loans, net of deferred fees and costs, originated through the U.S. Small Business Administration Paycheck Protection Program ("SBA PPP").
Municipal loans consist of extensions of credit to municipalities and school districts within the Company’s market area. These loans generally present a lower risk than commercial and industrial loans, as they are generally secured by the municipality’s full taxing authority, by revenue obligations, or by its ability to raise assessments on its customers for a specific utility.
The Company originates loans to its retail customers, including fixed-rate and adjustable first lien mortgage loans with the underlying 1-4 family owner occupied residential property securing the loan. The Company’s risk exposure is minimized in these types of loans through the evaluation of the creditworthiness of the borrower, including credit scores and debt-to-income ratios, and underwriting standards which limit the loan-to-value ratio to generally no more than 80% upon loan origination, unless the borrower obtains private mortgage insurance.
Home equity loans, including term loans and lines of credit, present a slightly higher risk to the Company than 1-4 family first liens, as these loans can be first or second liens on 1-4 family owner occupied residential property, but can have loan-to-
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value ratios of no greater than 90% of the value of the real estate taken as collateral. The creditworthiness of the borrower is also considered, including credit scores and debt-to-income ratios.
Installment and other loans’ credit risk are mitigated through prudent underwriting standards, including evaluation of the creditworthiness of the borrower through credit scores and debt-to-income ratios and, if secured, the collateral value of the assets. These loans can be unsecured or secured by assets the value of which may depreciate quickly or may fluctuate, and may present a greater risk to the Company than 1-4 family residential loans.
On March 27, 2020, the Coronavirus Aid, Relief and Economic Security (“CARES”) Act was enacted. The CARES Act established the SBA PPP. The SBA PPP is intended to provide economic relief to small businesses nationwide adversely impacted under the COVID-19 Emergency Declaration issued on March 13, 2020. The SBA PPP, which began on April 3, 2020, provides small businesses with funds to cover up to 24 weeks of payroll costs and other expenses, including benefits. It also provides for forgiveness of up to the full principal amount of qualifying loans. The Bank closed and funded almost 3,200 PPP loans for a total loan amount of $467.7 million in the nine months ended September 30, 2020. As these loans are 100% guaranteed by the SBA, there is no associated allowance for loan losses at September 30, 2020. These loans resulted in net fee income of $13.5 million to be recognized through net interest income over the life of the loans, which is between two and five years. During the three and nine months ended September 30, 2020, the Company recognized $2.2 million and $4.0 million, respectively, of net deferred SBA PPP fees, included in interest income on loans on the condensed consolidated statements of income. At September 30, 2020, the Bank had $9.5 million of unrecognized SBA PPP net deferred fees. The timing of the recognition of these fees is dependent upon the forgiveness process established by the SBA. The Bank continues to closely monitor the SBA guidance regarding this process. The Bank is working on implementing the SBA's recently announced, streamlined forgiveness approval process, which is anticipated to make the forgiveness process easier for both borrowers and lenders.
In an effort to assist clients which were negatively impacted by the COVID-19 pandemic, the Bank offered various mitigation options, including a loan payment deferral program. Under this program, most commercial deferrals were for a 90-day period, while most consumer deferrals were for a 180-day period. Commercial and consumer deferrals totaled $61.6 million and $16.8 million, respectively, at September 30, 2020. In accordance with the revised Interagency Statement on Loan Modifications by Financial Institutions Working with Customers Affected by the Coronavirus issued on April 7, 2020, these deferrals are exempt from TDR status as they meet the specified requirements.
The following table presents the loan portfolio by segment and class, excluding residential mortgage LHFS, at September 30, 2020 and December 31, 2019:

| September 30, 2020 |  | December 31, 2019
Commercial real estate: |  |  |
Owner occupied | $ | 166,623 |  |  | $ | 170,884 |
Non-owner occupied | 403,138 |  |  | 361,050 |
Multi-family | 110,153 |  |  | 106,893 |
Non-owner occupied residential | 111,958 |  |  | 120,038 |
Acquisition and development: |  |  |
1-4 family residential construction | 9,627 |  |  | 15,865 |
Commercial and land development | 37,850 |  |  | 41,538 |
Commercial and industrial (1) | 690,330 |  |  | 214,554 |
Municipal | 28,867 |  |  | 47,057 |
Residential mortgage: |  |  |
First lien | 273,149 |  |  | 336,372 |
Home equity - term | 11,108 |  |  | 14,030 |
Home equity - lines of credit | 158,106 |  |  | 165,314 |
Installment and other loans | 28,961 |  |  | 50,735 |
Total loans | $ | 2,029,870 |  |  | $ | 1,644,330 |

(1) This balance includes $458.1 million and $0 of SBA PPP loans, net of deferred fees and costs, at September 30, 2020 and December 31, 2019, respectively.
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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 Management ERM Committee, comprised of executive officers and loan department personnel, is charged with the oversight of overall credit quality and risk exposure of the Company's loan portfolio. This includes the monitoring of the lending activities of all Company personnel with respect to underwriting and processing new loans and the timely follow-up and corrective action for loans showing signs of deterioration in quality. A loan review program provides the Company with an independent review of the commercial loan portfolio on an ongoing basis. Generally, consumer and residential mortgage loans are included in the Pass categories unless a specific action, such as extended delinquencies, bankruptcy, repossession or death of the borrower occurs, which heightens awareness as to a possible credit event.
Internal loan reviews are completed annually on all commercial relationships with a committed loan balance in excess of $1.0 million, which includes confirmation of risk rating by an independent credit officer. In addition, all commercial relationships greater than $500 thousand rated Substandard, Doubtful or Loss are reviewed quarterly and corresponding risk ratings are reaffirmed by the Company's Problem Loan Committee, with subsequent reporting to the Management ERM Committee and the Board of Directors.
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The following table summarizes the Company’s loan portfolio ratings based on its internal risk rating system at September 30, 2020 and December 31, 2019:

| Pass |  | Special Mention |  | Non-Impaired Substandard |  | Impaired - Substandard |  | Doubtful |  | PCI Loans |  | Total
September 30, 2020 |  |  |  |  |  |  |  |  |  |  |  |  |
Commercial real estate: |  |  |  |  |  |  |  |  |  |  |  |  |
Owner occupied | $ | 142,294 |  |  | $ | 8,654 |  |  | $ | 7,750 |  |  | $ | 3,341 |  |  | $ | — |  |  | $ | 4,584 |  |  | $ | 166,623 |
Non-owner occupied | 347,253 |  |  | 55,552 |  |  | — |  |  | — |  |  | — |  |  | 333 |  |  | 403,138 |
Multi-family | 88,896 |  |  | 20,530 |  |  | 653 |  |  | 74 |  |  | — |  |  | — |  |  | 110,153 |
Non-owner occupied residential | 105,159 |  |  | 3,678 |  |  | 1,455 |  |  | 275 |  |  | — |  |  | 1,391 |  |  | 111,958 |
Acquisition and development: |  |  |  |  |  |  |  |  |  |  |  |  |
1-4 family residential construction | 9,341 |  |  | 286 |  |  | — |  |  | — |  |  | — |  |  | — |  |  | 9,627 |
Commercial and land development | 35,818 |  |  | 662 |  |  | 533 |  |  | 837 |  |  | — |  |  | — |  |  | 37,850 |
Commercial and industrial | 660,538 |  |  | 16,724 |  |  | 9,439 |  |  | 755 |  |  | — |  |  | 2,874 |  |  | 690,330 |
Municipal | 28,867 |  |  | — |  |  | — |  |  | — |  |  | — |  |  | — |  |  | 28,867 |
Residential mortgage: |  |  |  |  |  |  |  |  |  |  |  |  |
First lien | 264,761 |  |  | — |  |  | — |  |  | 2,835 |  |  | — |  |  | 5,553 |  |  | 273,149 |
Home equity - term | 11,009 |  |  | — |  |  | 70 |  |  | 11 |  |  | — |  |  | 18 |  |  | 11,108 |
Home equity - lines of credit | 157,206 |  |  | 170 |  |  | 34 |  |  | 696 |  |  | — |  |  | — |  |  | 158,106 |
Installment and other loans | 28,868 |  |  | — |  |  | — |  |  | 20 |  |  | — |  |  | 73 |  |  | 28,961 |
| $ | 1,880,010 |  |  | $ | 106,256 |  |  | $ | 19,934 |  |  | $ | 8,844 |  |  | $ | — |  |  | $ | 14,826 |  |  | $ | 2,029,870 |
December 31, 2019 |  |  |  |  |  |  |  |  |  |  |  |  |
Commercial real estate: |  |  |  |  |  |  |  |  |  |  |  |  |
Owner occupied | $ | 151,161 |  |  | $ | 4,513 |  |  | $ | 3,163 |  |  | $ | 5,872 |  |  | $ | — |  |  | $ | 6,175 |  |  | $ | 170,884 |
Non-owner occupied | 342,753 |  |  | 17,152 |  |  | — |  |  | — |  |  | — |  |  | 1,145 |  |  | 361,050 |
Multi-family | 100,361 |  |  | 4,822 |  |  | 682 |  |  | 345 |  |  | — |  |  | 683 |  |  | 106,893 |
Non-owner occupied residential | 111,697 |  |  | 4,534 |  |  | 1,115 |  |  | 235 |  |  | — |  |  | 2,457 |  |  | 120,038 |
Acquisition and development: |  |  |  |  |  |  |  |  |  |  |  |  |
1-4 family residential construction | 15,865 |  |  | — |  |  | — |  |  | — |  |  | — |  |  | — |  |  | 15,865 |
Commercial and land development | 39,939 |  |  | 206 |  |  | 1,393 |  |  | — |  |  | — |  |  | — |  |  | 41,538 |
Commercial and industrial | 198,951 |  |  | 1,133 |  |  | 8,899 |  |  | 1,763 |  |  | — |  |  | 3,808 |  |  | 214,554 |
Municipal | 42,649 |  |  | 4,408 |  |  | — |  |  | — |  |  | — |  |  | — |  |  | 47,057 |
Residential mortgage: |  |  |  |  |  |  |  |  |  |  |  |  |
First lien | 323,040 |  |  | 978 |  |  | — |  |  | 2,590 |  |  | — |  |  | 9,764 |  |  | 336,372 |
Home equity - term | 13,774 |  |  | 74 |  |  | 149 |  |  | 13 |  |  | — |  |  | 20 |  |  | 14,030 |
Home equity - lines of credit | 164,469 |  |  | 74 |  |  | 38 |  |  | 733 |  |  | — |  |  | — |  |  | 165,314 |
Installment and other loans | 50,497 |  |  | — |  |  | — |  |  | 85 |  |  | — |  |  | 153 |  |  | 50,735 |
| $ | 1,555,156 |  |  | $ | 37,894 |  |  | $ | 15,439 |  |  | $ | 11,636 |  |  | $ | — |  |  | $ | 24,205 |  |  | $ | 1,644,330 |

For commercial real estate, acquisition and development and commercial and industrial loans, a loan is considered impaired when, based on current information and events, it is probable that the Company will be unable to collect the scheduled payments of principal or interest when due according to the contractual terms of the loan agreement. Factors considered by
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management in determining impairment include payment status, collateral value, and the probability of collecting scheduled principal and interest payments when due. Loans that experience insignificant payment delays and payment shortfalls generally are not classified as impaired. Generally, loans that are more than 90 days past due are deemed impaired. Management determines the significance of payment delays and payment shortfalls on a case-by-case basis, taking into consideration all of the circumstances surrounding the loan and the borrower, including the length of the delay, the reasons for the delay, the borrower’s prior payment record, and the amount of the shortfall in relation to the principal and interest owed to determine if the loan should be placed on nonaccrual status. Nonaccrual loans in the commercial and commercial real estate portfolios and any TDRs are, by definition, deemed to be impaired. Impairment is measured on a loan-by-loan basis for commercial, construction and restructured loans by either the present value of the expected future cash flows discounted at the loan’s effective interest rate, the loan’s obtainable market price, or the fair value of the collateral if the loan is collateral dependent. A loan is collateral dependent if the repayment of the loan is expected to be provided solely by the underlying collateral. For loans that are deemed to be impaired for extended periods of time, periodic updates on fair values are obtained, which may include updated appraisals. Updated fair values are incorporated into the impairment analysis in the next reporting period.
Loan charge-offs, which may include partial charge-offs, are taken on an impaired loan that is collateral dependent if the loan’s carrying balance exceeds its collateral’s appraised value, the loan has been identified as uncollectible, and it is deemed to be a confirmed loss. Typically, impaired loans with a charge-off or partial charge-off will continue to be considered impaired, unless the note is split into two, 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, 2020 and December 31, 2019, nearly all of the Company’s loan impairments were measured based on the estimated fair value of the collateral securing the loan, except for TDRs. By definition, TDRs are considered impaired. All TDR impairment analyses are initially based on discounted cash flows for those loans. For real estate loans, collateral generally consists of commercial real estate, but in the case of commercial and industrial loans, it could also consist of accounts receivable, inventory, equipment or other business assets. Commercial and industrial loans may also have real estate collateral.
Updated appraisals are generally required every 18 months for classified commercial loans in excess of $250 thousand. The “as is" value provided in the appraisal is often used as the fair value of the collateral in determining impairment, unless circumstances, such as subsequent improvements, approvals, or other circumstances, dictate that another value than that provided by the appraiser is more appropriate.
Generally, impaired commercial loans secured by real estate, other than performing TDRs, are measured at fair value using certified real estate appraisals that had been completed within the last 18 months. Appraised values are discounted for estimated costs to sell the property and other selling considerations to arrive at the property’s fair value. In those situations in which it is determined an updated appraisal is not required for loans individually evaluated for impairment, fair values are based on either an existing appraisal or a discounted cash flow analysis as determined by management. The approaches are discussed below:
•Existing appraisal – if the existing appraisal provides a strong loan-to-value ratio (generally 70% or lower) and, after consideration of market conditions and knowledge of the property and area, it is determined by the Credit Administration staff that there has not been a significant deterioration in the collateral value, the existing certified appraised value may be used. Discounts to the appraised value, as deemed appropriate for selling costs, are factored into the 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 aging or appraisals from individuals with knowledge in the business. Stated balances are generally discounted for the age of the financial information or the quality of the assets. In determining fair value, liquidation discounts are applied to this collateral based on existing loan evaluation policies.
The Company distinguishes substandard loans on both an impaired and non-impaired basis, as it places less emphasis on a loan’s classification, and increased reliance on whether the loan was performing in accordance with the contractual terms. A substandard 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 as substandard. As a result, the Company’s methodology includes an evaluation of certain accruing commercial real estate, acquisition and development, and commercial and industrial loans rated substandard to be collectively evaluated for impairment. Although the Company believes
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these loans meet the definition of substandard, they are generally performing and management has concluded that it is likely the Company will be able to collect the scheduled payments of principal and interest when due according to the contractual terms of the loan agreement.
Larger groups of smaller balance homogeneous loans are collectively evaluated for impairment. Generally, the Company does not separately identify individual consumer and residential loans for impairment disclosures, unless such loans are the subject of a restructuring agreement due to financial difficulties of the borrower.
The following table, which excludes PCI loans, summarizes impaired loans by segment and class, segregated by those for which a specific allowance was required and those for which a specific allowance was not required at September 30, 2020 and December 31, 2019. The recorded investment in loans excludes accrued interest receivable due to insignificance. Related allowances established generally pertain to those loans in which loan forbearance agreements were in the process of being negotiated or updated appraisals were pending, and any partial charge-off will be recorded when final information is received.

| Impaired Loans with a Specific Allowance |  | Impaired Loans with No Specific Allowance
| Recorded Investment (Book Balance) |  | Unpaid Principal Balance (Legal Balance) |  | Related Allowance |  | Recorded Investment (Book Balance) |  | Unpaid Principal Balance (Legal Balance)
September 30, 2020 |  |  |  |  |  |  |  |  |
Commercial real estate: |  |  |  |  |  |  |  |  |
Owner-occupied | $ | — |  |  | $ | — |  |  | $ | — |  |  | $ | 3,341 |  |  | $ | 4,112 |
Non-owner occupied | — |  |  | — |  |  | — |  |  | — |  |  | 457 |
Multi-family | — |  |  | — |  |  | — |  |  | 74 |  |  | 309 |
Non-owner occupied residential | — |  |  | — |  |  | — |  |  | 275 |  |  | 396 |
Acquisition and development: |  |  |  |  |  |  |  |  |
Commercial and land development | — |  |  | — |  |  | — |  |  | 837 |  |  | 875 |
Commercial and industrial | — |  |  | — |  |  | — |  |  | 755 |  |  | 1,668 |
Residential mortgage: |  |  |  |  |  |  |  |  |
First lien | 452 |  |  | 452 |  |  | 35 |  |  | 2,383 |  |  | 3,450 |
Home equity—term | — |  |  | — |  |  | — |  |  | 11 |  |  | 14 |
Home equity—lines of credit | — |  |  | — |  |  | — |  |  | 696 |  |  | 939 |
Installment and other loans | — |  |  | — |  |  | — |  |  | 20 |  |  | 20 |
| $ | 452 |  |  | $ | 452 |  |  | $ | 35 |  |  | $ | 8,392 |  |  | $ | 12,240 |
December 31, 2019 |  |  |  |  |  |  |  |  |
Commercial real estate: |  |  |  |  |  |  |  |  |
Owner-occupied | $ | — |  |  | $ | — |  |  | $ | — |  |  | $ | 5,872 |  |  | $ | 8,086 |
Multi-family | — |  |  | — |  |  | — |  |  | 345 |  |  | 569 |
Non-owner occupied residential | — |  |  | — |  |  | — |  |  | 235 |  |  | 422 |
Commercial and industrial | — |  |  | — |  |  | — |  |  | 1,763 |  |  | 3,361 |
Residential mortgage: |  |  |  |  |  |  |  |  |
First lien | 425 |  |  | 425 |  |  | 36 |  |  | 2,165 |  |  | 3,164 |
Home equity—term | — |  |  | — |  |  | — |  |  | 13 |  |  | 15 |
Home equity—lines of credit | — |  |  | — |  |  | — |  |  | 733 |  |  | 1,077 |
Installment and other loans | — |  |  | — |  |  | — |  |  | 85 |  |  | 97 |
| $ | 425 |  |  | $ | 425 |  |  | $ | 36 |  |  | $ | 11,211 |  |  | $ | 16,791 |

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

| 2020 |  | 2019
| Average Impaired Balance |  | Interest Income Recognized |  | Average Impaired Balance |  | Interest Income Recognized
Three Months Ended September 30, |  |  |  |  |  |  |
Commercial real estate: |  |  |  |  |  |  |
Owner-occupied | $ | 4,424 |  |  | $ | — |  |  | $ | 2,126 |  |  | $ | — |
Non-owner occupied | 102 |  |  | — |  |  | 150 |  |  | — |
Multi-family | 141 |  |  | — |  |  | 110 |  |  | — |
Non-owner occupied residential | 433 |  |  | — |  |  | 173 |  |  | — |
Acquisition and development: |  |  |  |  |  |  |
Commercial and land development | 837 |  |  | — |  |  | — |  |  | — |
Commercial and industrial | 1,044 |  |  | — |  |  | 765 |  |  | — |
Residential mortgage: |  |  |  |  |  |  |
First lien | 3,209 |  |  | 12 |  |  | 2,392 |  |  | 12 |
Home equity – term | 12 |  |  | — |  |  | 12 |  |  | — |
Home equity - lines of credit | 645 |  |  | — |  |  | 768 |  |  | — |
Installment and other loans | 17 |  |  | — |  |  | 8 |  |  | — |
| $ | 10,864 |  |  | $ | 12 |  |  | $ | 6,504 |  |  | $ | 12 |
Nine Months Ended September 30, |  |  |  |  |  |  |
Commercial real estate: |  |  |  |  |  |  |
Owner occupied | $ | 5,033 |  |  | $ | 1 |  |  | $ | 1,950 |  |  | $ | 1 |
Non-owner occupied | 108 |  |  | — |  |  | 60 |  |  | — |
Multi-family | 259 |  |  | — |  |  | 118 |  |  | — |
Non-owner occupied residential | 422 |  |  | — |  |  | 246 |  |  | — |
Acquisition and development: |  |  |  |  |  |  |
Commercial and land development | 586 |  |  | — |  |  | — |  |  | — |
Commercial and industrial | 1,316 |  |  | — |  |  | 469 |  |  | — |
Residential mortgage: |  |  |  |  |  |  |
First lien | 3,050 |  |  | 36 |  |  | 2,574 |  |  | 41 |
Home equity - term | 12 |  |  | — |  |  | 13 |  |  | — |
Home equity - lines of credit | 699 |  |  | 1 |  |  | 752 |  |  | 1 |
Installment and other loans | 29 |  |  | — |  |  | 8 |  |  | — |
| $ | 11,514 |  |  | $ | 38 |  |  | $ | 6,190 |  |  | $ | 43 |

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

| September 30, 2020 |  | December 31, 2019
| Number of Contracts |  | Recorded Investment |  | Number of Contracts |  | Recorded Investment
Accruing: |  |  |  |  |  |  |
Commercial real estate: |  |  |  |  |  |  |
Owner occupied | 1 |  |  | $ | 28 |  |  | 1 |  |  | $ | 30 |
Residential mortgage: |  |  |  |  |  |  |
First lien | 9 |  |  | 908 |  |  | 9 |  |  | 931 |
Home equity - lines of credit | 1 |  |  | 9 |  |  | 1 |  |  | 18 |
| 11 |  |  | 945 |  |  | 11 |  |  | 979 |
Nonaccruing: |  |  |  |  |  |  |
Commercial real estate: |  |  |  |  |  |  |
Owner occupied | — |  |  | — |  |  | 4 |  |  | 1,909 |
Residential mortgage: |  |  |  |  |  |  |
First lien | 5 |  |  | 329 |  |  | 5 |  |  | 359 |
| 5 |  |  | 329 |  |  | 9 |  |  | 2,268 |
| 16 |  |  | $ | 1,274 |  |  | 20 |  |  | $ | 3,247 |

There were no new TDR's for the three and nine months ended September 30, 2020 or 2019.
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Management further monitors the performance and credit quality of the loan portfolio by analyzing the length of time a portfolio is past due, by aggregating loans based on its delinquencies. The following table presents the classes of loan portfolio summarized by aging categories of performing loans and nonaccrual loans at September 30, 2020 and December 31, 2019:

|  |  | Days Past Due |  |  |  |  |  |
| Current |  | 30-59 |  | 60-89 |  | 90+ (still accruing) |  | Total Past Due |  | Non- Accrual |  | Total Loans
September 30, 2020 |  |  |  |  |  |  |  |  |  |  |  |  |
Commercial real estate: |  |  |  |  |  |  |  |  |  |  |  |  |
Owner occupied | $ | 157,456 |  |  | $ | 1,090 |  |  | $ | 180 |  |  | $ | — |  |  | $ | 1,270 |  |  | $ | 3,313 |  |  | $ | 162,039 |
Non-owner occupied | 402,805 |  |  | — |  |  | — |  |  | — |  |  | — |  |  | — |  |  | 402,805 |
Multi-family | 110,079 |  |  | — |  |  | — |  |  | — |  |  | — |  |  | 74 |  |  | 110,153 |
Non-owner occupied residential | 110,292 |  |  | — |  |  | — |  |  | — |  |  | — |  |  | 275 |  |  | 110,567 |
Acquisition and development: |  |  |  |  |  |  |  |  |  |  |  |  |
1-4 family residential construction | 9,627 |  |  | — |  |  | — |  |  | — |  |  | — |  |  | — |  |  | 9,627 |
Commercial and land development | 36,940 |  |  | 73 |  |  | — |  |  | — |  |  | 73 |  |  | 837 |  |  | 37,850 |
Commercial and industrial | 686,537 |  |  | 107 |  |  | 57 |  |  | — |  |  | 164 |  |  | 755 |  |  | 687,456 |
Municipal | 28,867 |  |  | — |  |  | — |  |  | — |  |  | — |  |  | — |  |  | 28,867 |
Residential mortgage: |  |  |  |  |  |  |  |  |  |  |  |  |
First lien | 264,989 |  |  | 646 |  |  | 34 |  |  | — |  |  | 680 |  |  | 1,927 |  |  | 267,596 |
Home equity - term | 11,067 |  |  | 1 |  |  | 11 |  |  | — |  |  | 12 |  |  | 11 |  |  | 11,090 |
Home equity - lines of credit | 157,143 |  |  | 276 |  |  | — |  |  | — |  |  | 276 |  |  | 687 |  |  | 158,106 |
Installment and other loans | 28,758 |  |  | 99 |  |  | 11 |  |  | — |  |  | 110 |  |  | 20 |  |  | 28,888 |
Subtotal | 2,004,560 |  |  | 2,292 |  |  | 293 |  |  | — |  |  | 2,585 |  |  | 7,899 |  |  | 2,015,044 |
Loans acquired with credit deterioration: |  |  |  |  |  |  |  |  |  |  |  |
Commercial real estate: |  |  |  |  |  |  |  |  |  |  |  |  |
Owner occupied | 4,584 |  |  | — |  |  | — |  |  | — |  |  | — |  |  | — |  |  | 4,584 |
Non-owner occupied | 333 |  |  | — |  |  | — |  |  | — |  |  | — |  |  | — |  |  | 333 |
Non-owner occupied residential | 1,234 |  |  | — |  |  | — |  |  | 157 |  |  | 157 |  |  | — |  |  | 1,391 |
Commercial and industrial | 2,857 |  |  | — |  |  | — |  |  | 17 |  |  | 17 |  |  | — |  |  | 2,874 |
Residential mortgage: |  |  |  |  |  |  |  |  |  |  |  |  |
First lien | 4,868 |  |  | 298 |  |  | 40 |  |  | 347 |  |  | 685 |  |  | — |  |  | 5,553 |
Home equity - term | 18 |  |  | — |  |  | — |  |  | — |  |  | — |  |  | — |  |  | 18 |
Installment and other loans | 72 |  |  | — |  |  | 1 |  |  | — |  |  | 1 |  |  | — |  |  | 73 |
Subtotal | 13,966 |  |  | 298 |  |  | 41 |  |  | 521 |  |  | 860 |  |  | — |  |  | 14,826 |
| $ | 2,018,526 |  |  | $ | 2,590 |  |  | $ | 334 |  |  | $ | 521 |  |  | $ | 3,445 |  |  | $ | 7,899 |  |  | $ | 2,029,870 |

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|  |  | Days Past Due |  |  |  |  |  |
| Current |  | 30-59 |  | 60-89 |  | 90+ (still accruing) |  | Total Past Due |  | Non- Accrual |  | Total Loans
December 31, 2019 |  |  |  |  |  |  |  |  |  |  |  |  |
Commercial real estate: |  |  |  |  |  |  |  |  |  |  |  |  |
Owner occupied | $ | 158,723 |  |  | $ | 144 |  |  | $ | — |  |  | $ | — |  |  | $ | 144 |  |  | $ | 5,842 |  |  | $ | 164,709 |
Non-owner occupied | 359,425 |  |  | 480 |  |  | — |  |  | — |  |  | 480 |  |  | — |  |  | 359,905 |
Multi-family | 105,865 |  |  | — |  |  | — |  |  | — |  |  | — |  |  | 345 |  |  | 106,210 |
Non-owner occupied residential | 116,370 |  |  | 841 |  |  | 66 |  |  | 69 |  |  | 976 |  |  | 235 |  |  | 117,581 |
Acquisition and development: |  |  |  |  |  |  |  |  |  |  |  |  |
1-4 family residential construction | 15,587 |  |  | 278 |  |  | — |  |  | — |  |  | 278 |  |  | — |  |  | 15,865 |
Commercial and land development | 40,403 |  |  | 1,135 |  |  | — |  |  | — |  |  | 1,135 |  |  | — |  |  | 41,538 |
Commercial and industrial | 208,668 |  |  | 315 |  |  | — |  |  | — |  |  | 315 |  |  | 1,763 |  |  | 210,746 |
Municipal | 47,057 |  |  | — |  |  | — |  |  | — |  |  | — |  |  | — |  |  | 47,057 |
Residential mortgage: |  |  |  |  |  |  |  |  |  |  |  |  |
First lien | 314,473 |  |  | 9,092 |  |  | 1,234 |  |  | 150 |  |  | 10,476 |  |  | 1,659 |  |  | 326,608 |
Home equity - term | 13,993 |  |  | — |  |  | 4 |  |  | — |  |  | 4 |  |  | 13 |  |  | 14,010 |
Home equity - lines of credit | 163,907 |  |  | 417 |  |  | 275 |  |  | — |  |  | 692 |  |  | 715 |  |  | 165,314 |
Installment and other loans | 50,224 |  |  | 236 |  |  | 37 |  |  | — |  |  | 273 |  |  | 85 |  |  | 50,582 |
Subtotal | 1,594,695 |  |  | 12,938 |  |  | 1,616 |  |  | 219 |  |  | 14,773 |  |  | 10,657 |  |  | 1,620,125 |
Loans acquired with credit deterioration: |  |  |  |  |  |  |  |  |  |  |  |
Commercial real estate: |  |  |  |  |  |  |  |  |  |  |  |  |
Owner occupied | 6,015 |  |  | — |  |  | 129 |  |  | 31 |  |  | 160 |  |  | — |  |  | 6,175 |
Non-owner occupied | 564 |  |  | — |  |  | — |  |  | 581 |  |  | 581 |  |  | — |  |  | 1,145 |
Multi-family | 683 |  |  | — |  |  | — |  |  | — |  |  | — |  |  | — |  |  | 683 |
Non-owner occupied residential | 1,710 |  |  | 105 |  |  | 111 |  |  | 531 |  |  | 747 |  |  | — |  |  | 2,457 |
Commercial and industrial | 3,792 |  |  | — |  |  | — |  |  | 16 |  |  | 16 |  |  | — |  |  | 3,808 |
Residential mortgage: |  |  |  |  |  |  |  |  |  |  |  |  |
First lien | 6,308 |  |  | 1,857 |  |  | 745 |  |  | 854 |  |  | 3,456 |  |  | — |  |  | 9,764 |
Home equity - term | 16 |  |  | 4 |  |  | — |  |  | — |  |  | 4 |  |  | — |  |  | 20 |
Installment and other loans | 131 |  |  | 22 |  |  | — |  |  | — |  |  | 22 |  |  | — |  |  | 153 |
Subtotal | 19,219 |  |  | 1,988 |  |  | 985 |  |  | 2,013 |  |  | 4,986 |  |  | — |  |  | 24,205 |
| $ | 1,613,914 |  |  | $ | 14,926 |  |  | $ | 2,601 |  |  | $ | 2,232 |  |  | $ | 19,759 |  |  | $ | 10,657 |  |  | $ | 1,644,330 |

The Company maintains its ALL at a level management believes adequate for probable incurred credit losses. The ALL is established and maintained through a provision for loan losses charged to earnings. Quarterly, management assesses the adequacy of the ALL utilizing a defined methodology which considers specific credit evaluation of impaired loans as discussed above, past loan loss historical experience, and qualitative factors. Management believes its approach properly addresses relevant accounting guidance for loans individually identified as impaired and for loans collectively evaluated for impairment, and other bank regulatory guidance.
In connection with its quarterly evaluation of the adequacy of the ALL, management reviews its methodology to determine if it properly addresses the current risk in the loan portfolio. For each loan class, general allowances based on quantitative factors, principally historical loss trends, are provided for loans that are collectively evaluated for impairment. An
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adjustment to historical loss factors may be incorporated for delinquency and other potential risk not elsewhere defined within the ALL methodology.
In addition to this quantitative analysis, adjustments to the ALL requirements are allocated on loans collectively evaluated for impairment based on additional qualitative factors, including:
Nature and Volume of Loans – including loan growth in the current and subsequent quarters based on the Company’s targeted growth and strategic plan, coupled with the types of loans booked based on risk management and credit culture; the number of exceptions to loan policy; and supervisory loan to value exceptions.
Concentrations of Credit and Changes within Credit Concentrations – including the composition of the Company’s overall portfolio makeup and management's evaluation related to concentration risk management and the inherent risk associated with the concentrations identified.
Underwriting Standards and Recovery Practices – including changes to underwriting standards and perceived impact on anticipated losses; trends in the number of exceptions to loan policy; supervisory loan to value exceptions; and administration of loan recovery practices.
Delinquency Trends – including delinquency percentages noted in the portfolio relative to economic conditions; severity of the delinquencies; and whether the ratios are trending upwards or downwards.
Classified Loans Trends – including internal loan ratings of the portfolio; severity of the ratings; whether the loan segment’s ratings show a more favorable or less favorable trend; and underlying market conditions and impact on the collateral values securing the loans.
Experience, Ability and Depth of Management/Lending staff – including the years’ experience of senior and middle management and the lending staff; turnover of the staff; and instances of repeat criticisms of ratings.
Quality of Loan Review – including the years of experience of the loan review staff; in-house versus outsourced provider of review; turnover of staff and the perceived quality of their work in relation to other external information.
National and Local Economic Conditions – including trends in the consumer price index, unemployment rates, the housing price index, housing statistics compared to the prior year, bankruptcy rates, regulatory and legal environment risks and competition. During the nine months ended September 30, 2020, this factor was increased for the commercial and consumer portfolios to account for the negative economic impact of the COVID-19 pandemic.
COVID-19 – during the nine months ended September 30, 2020, a qualitative allocation was implemented associated with the potential impact of the COVID-19 pandemic on the Company's commercial loan portfolio. The factor assumes downgrades of loans with identified hardships resulting from the shutdown driven by the pandemic.
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The following table presents the activity in the ALL for the three and nine months ended September 30, 2020 and 2019:

| Commercial |  | Consumer |  |  |  |
| Commercial Real Estate |  | Acquisition and Development |  | Commercial and Industrial |  | Municipal |  | Total |  | Residential Mortgage |  | Installment and Other |  | Total |  | Unallocated |  | Total
Three Months Ended |  |  |  |  |  |  |  |  |  |  |  |  |  |  |  |  |  |  |
September 30, 2020 |  |  |  |  |  |  |  |  |  |  |  |  |  |  |  |  |  |  |
Balance, beginning of period | $ | 9,347 |  |  | $ | 1,069 |  |  | $ | 2,916 |  |  | $ | 75 |  |  | $ | 13,407 |  |  | $ | 3,552 |  |  | $ | 386 |  |  | $ | 3,938 |  |  | $ | 172 |  |  | $ | 17,517 |
Provision for loan losses | 1,520 |  |  | (219) |  |  | 963 |  |  | (19) |  |  | 2,245 |  |  | (71) |  |  | 18 |  |  | (53) |  |  | 8 |  |  | 2,200 |
Charge-offs | (3) |  |  | — |  |  | (193) |  |  | — |  |  | (196) |  |  | — |  |  | (31) |  |  | (31) |  |  | — |  |  | (227) |
Recoveries | 171 |  |  | — |  |  | 45 |  |  | — |  |  | 216 |  |  | 6 |  |  | 13 |  |  | 19 |  |  | — |  |  | 235 |
Balance, end of period | $ | 11,035 |  |  | $ | 850 |  |  | $ | 3,731 |  |  | $ | 56 |  |  | $ | 15,672 |  |  | $ | 3,487 |  |  | $ | 386 |  |  | $ | 3,873 |  |  | $ | 180 |  |  | $ | 19,725 |
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 | — |  |  | — |  |  | (50) |  |  | — |  |  | (50) |  |  | (24) |  |  | (49) |  |  | (73) |  |  | — |  |  | (123) |
Recoveries | 111 |  |  | — |  |  | 33 |  |  | — |  |  | 144 |  |  | 5 |  |  | 23 |  |  | 28 |  |  | — |  |  | 172 |
Balance, end of period | $ | 7,423 |  |  | $ | 820 |  |  | $ | 2,372 |  |  | $ | 93 |  |  | $ | 10,708 |  |  | $ | 3,742 |  |  | $ | 233 |  |  | $ | 3,975 |  |  | $ | 126 |  |  | $ | 14,809 |
Nine Months Ended |  |  |  |  |  |  |  |  |  |  |  |  |  |  |  |  |  |  |
September 30, 2020 |  |  |  |  |  |  |  |  |  |  |  |  |  |  |  |  |  |  |
Balance, beginning of period | $ | 7,634 |  |  | $ | 959 |  |  | $ | 2,356 |  |  | $ | 100 |  |  | $ | 11,049 |  |  | $ | 3,147 |  |  | $ | 319 |  |  | $ | 3,466 |  |  | $ | 140 |  |  | $ | 14,655 |
Provision for loan losses | 2,780 |  |  | (117) |  |  | 1,875 |  |  | (44) |  |  | 4,494 |  |  | 329 |  |  | 162 |  |  | 491 |  |  | 40 |  |  | 5,025 |
Charge-offs | (3) |  |  | — |  |  | (689) |  |  | — |  |  | (692) |  |  | (109) |  |  | (117) |  |  | (226) |  |  | — |  |  | (918) |
Recoveries | 624 |  |  | 8 |  |  | 189 |  |  | — |  |  | 821 |  |  | 120 |  |  | 22 |  |  | 142 |  |  | — |  |  | 963 |
Balance, end of period | $ | 11,035 |  |  | $ | 850 |  |  | $ | 3,731 |  |  | $ | 56 |  |  | $ | 15,672 |  |  | $ | 3,487 |  |  | $ | 386 |  |  | $ | 3,873 |  |  | $ | 180 |  |  | $ | 19,725 |
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) |  |  | — |  |  | (140) |  |  | — |  |  | (165) |  |  | (295) |  |  | (121) |  |  | (416) |  |  | — |  |  | (581) |
Recoveries | 225 |  |  | 2 |  |  | 103 |  |  | — |  |  | 330 |  |  | 100 |  |  | 46 |  |  | 146 |  |  | — |  |  | 476 |
Balance, end of period | $ | 7,423 |  |  | $ | 820 |  |  | $ | 2,372 |  |  | $ | 93 |  |  | $ | 10,708 |  |  | $ | 3,742 |  |  | $ | 233 |  |  | $ | 3,975 |  |  | $ | 126 |  |  | $ | 14,809 |

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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, 2020 and December 31, 2019. PCI loans are excluded from loans individually evaluated for impairment.

| Commercial |  | Consumer |  |  |  |
| Commercial Real Estate |  | Acquisition and Development |  | Commercial and Industrial |  | Municipal |  | Total |  | Residential Mortgage |  | Installment and Other |  | Total |  | Unallocated |  | Total
September 30, 2020 |  |  |  |  |  |  |  |  |  |  |  |  |  |  |  |  |  |  |
Loans allocated by: |  |  |  |  |  |  |  |  |  |  |  |  |  |  |  |  |  |  |
Individually evaluated for impairment | $ | 3,690 |  |  | $ | 837 |  |  | $ | 755 |  |  | $ | — |  |  | $ | 5,282 |  |  | $ | 3,542 |  |  | $ | 20 |  |  | $ | 3,562 |  |  | $ | — |  |  | $ | 8,844 |
Collectively evaluated for impairment | 788,182 |  |  | 46,640 |  |  | 689,575 |  |  | 28,867 |  |  | 1,553,264 |  |  | 438,821 |  |  | 28,941 |  |  | 467,762 |  |  | — |  |  | 2,021,026 |
| $ | 791,872 |  |  | $ | 47,477 |  |  | $ | 690,330 |  |  | $ | 28,867 |  |  | $ | 1,558,546 |  |  | $ | 442,363 |  |  | $ | 28,961 |  |  | $ | 471,324 |  |  | $ | — |  |  | $ | 2,029,870 |
ALL allocated by: |  |  |  |  |  |  |  |  |  |  |  |  |  |  |  |  |  |  |
Individually evaluated for impairment | $ | — |  |  | $ | — |  |  | $ | — |  |  | $ | — |  |  | $ | — |  |  | $ | 35 |  |  | $ | — |  |  | $ | 35 |  |  | $ | — |  |  | $ | 35 |
Collectively evaluated for impairment | 11,035 |  |  | 850 |  |  | 3,731 |  |  | 56 |  |  | 15,672 |  |  | 3,452 |  |  | 386 |  |  | 3,838 |  |  | 180 |  |  | 19,690 |
| $ | 11,035 |  |  | $ | 850 |  |  | $ | 3,731 |  |  | $ | 56 |  |  | $ | 15,672 |  |  | $ | 3,487 |  |  | $ | 386 |  |  | $ | 3,873 |  |  | $ | 180 |  |  | $ | 19,725 |
December 31, 2019 |  |  |  |  |  |  |  |  |  |  |  |  |  |  |  |  |  |  |
Loans allocated by: |  |  |  |  |  |  |  |  |  |  |  |  |  |  |  |  |  |  |
Individually evaluated for impairment | $ | 6,452 |  |  | $ | — |  |  | $ | 1,763 |  |  | $ | — |  |  | $ | 8,215 |  |  | $ | 3,336 |  |  | $ | 85 |  |  | $ | 3,421 |  |  | $ | — |  |  | $ | 11,636 |
Collectively evaluated for impairment | 752,413 |  |  | 57,403 |  |  | 212,791 |  |  | 47,057 |  |  | 1,069,664 |  |  | 512,380 |  |  | 50,650 |  |  | 563,030 |  |  | — |  |  | 1,632,694 |
| $ | 758,865 |  |  | $ | 57,403 |  |  | $ | 214,554 |  |  | $ | 47,057 |  |  | $ | 1,077,879 |  |  | $ | 515,716 |  |  | $ | 50,735 |  |  | $ | 566,451 |  |  | $ | — |  |  | $ | 1,644,330 |
ALL allocated by: |  |  |  |  |  |  |  |  |  |  |  |  |  |  |  |  |  |  |
Individually evaluated for impairment | $ | — |  |  | $ | — |  |  | $ | — |  |  | $ | — |  |  | $ | — |  |  | $ | 36 |  |  | $ | — |  |  | $ | 36 |  |  | $ | — |  |  | $ | 36 |
Collectively evaluated for impairment | 7,634 |  |  | 959 |  |  | 2,356 |  |  | 100 |  |  | 11,049 |  |  | 3,111 |  |  | 319 |  |  | 3,430 |  |  | 140 |  |  | 14,619 |
| $ | 7,634 |  |  | $ | 959 |  |  | $ | 2,356 |  |  | $ | 100 |  |  | $ | 11,049 |  |  | $ | 3,147 |  |  | $ | 319 |  |  | $ | 3,466 |  |  | $ | 140 |  |  | $ | 14,655 |

The following table provides activity for the accretable yield of PCI loans for the three and nine months ended September 30, 2020 and 2019:

| Three Months Ended |  | Nine Months Ended
| September 30, 2020 |  | September 30, 2019 |  | September 30, 2020 |  | September 30, 2019
Accretable yield, beginning of period | $ | 4,182 |  |  | $ | 4,988 |  |  | $ | 6,950 |  |  | $ | 2,065 |
Additions (1) | — |  |  | — |  |  | 570 |  |  | 3,497 |
Accretion of income | (546) |  |  | (422) |  |  | (2,459) |  |  | (1,814) |
Reclassifications from nonaccretable difference due to improvement in expected cash flows | 139 |  |  | 825 |  |  | 1,260 |  |  | 1,441 |
Other changes, net (2) | (231) |  |  | 319 |  |  | (2,777) |  |  | 521 |
Accretable yield, end of period | $ | 3,544 |  |  | $ | 5,710 |  |  | $ | 3,544 |  |  | $ | 5,710 |

(1) The amount for the nine months ended September 30, 2020 reflects a measurement period adjustment for Hamilton loans that should have been in the PCI pool at the acquisition date.
(2) The amount for the nine months ended September 30, 2020 represents the impact of purchased credit impaired loans sold during that period.
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NOTE 5. LEASES
A lease provides the lessee the right to control the use of an identified asset for a period of time in exchange for consideration. The Company has primarily entered into operating leases for branches and office space. Most of the Company's leases contain renewal options, which the Company is reasonably certain to exercise. Including renewal options, the Company's leases range from three years to 50 years. Operating lease right-of-use assets and lease liabilities are included in other assets and accrued interest and other liabilities on the Company's unaudited condensed consolidated balance sheets.
The Company uses its incremental borrowing rate to determine the present value of the lease payments, as the rate implicit in the Company's leases is not readily determinable. Lease agreements that contain non-lease components are generally accounted for as a single lease component, while variable costs, such as common area maintenance expenses and property taxes, are expensed as incurred.
The following table presents information related to the Company's operating leases at September 30, 2020 and December 31, 2019:

| September 30, 2020 |  | December 31, 2019
Operating lease ROU assets | $ | 8,949 |  |  | $ | 9,222 |
Operating lease ROU liabilities | 9,398 |  |  | 9,688 |
Weighted-average remaining lease term (in years) | 16.8 |  | 17.6
Weighted-average discount rate | 4.3 | % |  | 4.5 | %

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

| Three Months Ended |  | Nine Months Ended
| September 30, 2020 |  | September 30, 2019 |  | September 30, 2020 |  | September 30, 2019
Cash paid for operating lease liabilities | $ | 210 |  |  | $ | 330 |  |  | $ | 847 |  |  | $ | 791 |
Operating lease expense | 421 |  |  | 507 |  |  | 1,171 |  |  | 1,016 |

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

Remainder of 2020 | $ | 354 |
2021 | 1,208 |
2022 | 785 |
2023 | 807 |
2024 | 827 |
Thereafter | 10,288 |
| 14,269 |
Less: imputed interest | 4,871 |
Total lease liabilities | $ | 9,398 |

NOTE 6. GOODWILL AND OTHER INTANGIBLE ASSETS
The following table presents changes in goodwill at September 30, 2020 and December 31, 2019:

| September 30, 2020 |  | December 31, 2019
Balance, beginning of year | $ | 19,925 |  |  | $ | 12,592 |
Acquired goodwill | — |  |  | 7,029 |
Adjustments to acquired goodwill (1) | (1,201) |  |  | 304 |
Balance, end of period | $ | 18,724 |  |  | $ | 19,925 |

(1) The Company finalized its purchase accounting adjustments associated with Hamilton as of May 1, 2020.
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Goodwill is not amortized but is reviewed for potential impairment on at least an annual basis, with testing between annual tests if an event occurs or circumstances change that could potentially reduce the fair value of a reporting unit.
Due to the severe economic impact of COVID-19 and a resulting sustained decline in the Company's market value below book value, management performed a quantitative Step 1 impairment analysis of its goodwill to determine whether the Company's goodwill was impaired as of August 31, 2020. This analysis, which was performed in accordance with ASU 2017-04, Intangibles-Goodwill and Other, considered several factors, such as future cash flow projections and estimated market acquisition premiums in its analysis. In performing the analysis, management made several assumptions with respect to future operating performance, economic and market conditions and various others, many of which require significant judgment. The analysis performed and the related assumptions reflect the best currently available estimates and judgements regarding future performance of the Company. It was concluded that no impairment existed at August 31, 2020 as the calculated fair value of the reporting unit exceeded its book value. No changes occurred that would impact the results of that analysis through September 30, 2020.
The following table presents changes in other intangible assets for the three and nine months ended September 30, 2020 and 2019:

| Three Months Ended September 30, |  | Nine Months Ended September 30,
| 2020 |  | 2019 |  | 2020 |  | 2019
Beginning of period | $ | 6,160 |  |  | $ | 8,140 |  |  | $ | 7,180 |  |  | $ | 3,910 |
Acquired CDI | — |  |  | — |  |  | — |  |  | 4,550 |
Non-compete agreement | — |  |  | — |  |  | — |  |  | 290 |
Amortization Expense | (357) |  |  | (486) |  |  | (1,224) |  |  | (1,096) |
Impairment | — |  |  | — |  |  | (153) |  |  | — |
Balance, end of period | $ | 5,803 |  |  | $ | 7,654 |  |  | $ | 5,803 |  |  | $ | 7,654 |

During the nine months ended September 30, 2020, the Company recorded an impairment charge of $153 thousand for the full remaining balance attributable to a customer list intangible asset due to the dissolution of Wheatland Advisors, Inc. in the three months ended September 30, 2020. No impairment charges were recorded in the nine months ended September 30, 2019.
The following table presents the components of other identifiable intangible assets at September 30, 2020 and December 31, 2019:

| September 30, 2020 |  | December 31, 2019
| Gross Amount |  | Accumulated Amortization |  | Gross Amount |  | Accumulated Amortization
Amortized intangible assets: |  |  |  |  |  |  |
Core deposit intangibles | $ | 8,390 |  |  | $ | 2,590 |  |  | $ | 8,390 |  |  | $ | 1,493 |
Other customer relationship intangibles | 25 |  |  | 22 |  |  | 524 |  |  | 338 |
Non-compete agreement | — |  |  | — |  |  | 290 |  |  | 193 |
Total | $ | 8,415 |  |  | $ | 2,612 |  |  | $ | 9,204 |  |  | $ | 2,024 |

The following table presents future estimated aggregate amortization expense for intangible assets remaining at September 30, 2020:

Remainder of 2020 | $ | 345 |
2021 | 1,275 |
2022 | 1,105 |
2023 | 935 |
2024 | 766 |
Thereafter | 1,377 |
| $ | 5,803 |

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NOTE 7. INCOME TAXES
The Company files income tax returns in the U.S. federal jurisdiction, the Commonwealth of Pennsylvania and the State of Maryland. The Company is no longer subject to tax examination by tax authorities for years before 2016.
The following table summarizes income tax expense for the three and nine months ended September 30, 2020 and 2019:

| Three months ended September 30, |  | Nine months ended September 30,
| 2020 |  | 2019 |  | 2020 |  | 2019
Current expense | $ | 2,040 |  |  | $ | 244 |  |  | $ | 2,495 |  |  | $ | 334 |
Deferred expense | (803) |  |  | 1,096 |  |  | 1,082 |  |  | 1,348 |
Income tax expense | $ | 1,237 |  |  | $ | 1,340 |  |  | $ | 3,577 |  |  | $ | 1,682 |

The following table summarizes deferred tax assets and liabilities at September 30, 2020 and December 31, 2019:

(Dollars in thousands) | September 30, 2020 |  | December 31, 2019
Deferred tax assets: |  |  |
Allowance for loan losses | $ | 4,549 |  |  | $ | 3,418 |
Deferred compensation | 507 |  |  | 415 |
Retirement and salary continuation plans | 2,467 |  |  | 2,357 |
Share-based compensation | 630 |  |  | 631 |
Off-balance sheet reserves | 270 |  |  | 234 |
Nonaccrual loan interest | 760 |  |  | 697 |
Net unrealized losses on AFS securities | 40 |  |  | 127 |
Purchase accounting adjustments | 2,318 |  |  | 4,081 |
Bonus accrual | 471 |  |  | 493 |
Interest Rate Swaps | 449 |  |  | — |
Low-income housing credit carryforward | 345 |  |  | — |
Net operating loss carryovers | 1,645 |  |  | 1,872 |
Other | 724 |  |  | 672 |
Total deferred tax assets | 15,175 |  |  | 14,997 |
Deferred tax liabilities: |  |  |
Depreciation | 465 |  |  | 452 |
Mortgage servicing rights | 593 |  |  | 694 |
Purchase accounting adjustments | 1,280 |  |  | 1,599 |
Other | 275 |  |  | 275 |
Total deferred tax liabilities | 2,613 |  |  | 3,020 |
Net deferred tax asset, included in other assets | $ | 12,562 |  |  | $ | 11,977 |

At September 30, 2020, the Company had acquired federal and state net operating loss carryforwards of $11.1 million and $6.7 million, respectively, subject to annual loss limitation limits, that expire through 2037. A deferred tax asset is recognized for these carryforwards because the benefit is more likely than not to be realized.
FASB ASC 740, Income Taxes, (“ASC 740”) clarifies the accounting for income taxes by prescribing a minimum probability threshold that a tax position must meet before a financial statement benefit is recognized. The minimum threshold is defined in ASC 740 as a tax position that is more likely than not to be sustained upon examination by the applicable taxing authority, including resolution of any related appeals or litigation processes, based on the technical merits of the position. The tax benefit to be recognized is measured as the largest amount of benefit that has a greater than 50% likelihood of being realized upon ultimate settlement. ASC 740 was applied to all existing tax positions upon initial adoption. There was no liability for uncertain tax positions and no known unrecognized tax benefits at September 30, 2020 or December 31, 2019.
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NOTE 8. SHARE-BASED COMPENSATION PLANS
The Company maintains share-based compensation plans under the shareholder-approved 2011 Plan. The purpose of the share-based compensation plans is to provide officers, employees, and non-employee members of the Board of Directors of the Company with additional incentive to further the success of the Company. At September 30, 2020, 881,920 shares of the common stock of the Company were reserved to be issued and 354,729 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 and members of the Board of Directors of the Company and its subsidiaries, are eligible to participate in the 2011 Plan. The 2011 Plan allows for the Compensation Committee of the Board of Directors to determine the type of incentive to be awarded, its term, manner of exercise, vesting and restrictions on shares. Generally, awards are nonqualified under the IRC, unless the awards are deemed to be incentive awards to employees at the Compensation Committee’s discretion.
The table below presents a summary of nonvested restricted shares activity for the nine months ended September 30, 2020:

| Shares |  | Weighted Average Grant Date Fair Value
Nonvested shares, beginning of year | 228,758 |  |  | $ | 21.90 |
Granted | 114,182 |  |  | 20.09 |
Forfeited | (13,883) |  |  | 21.35 |
Vested | (77,731) |  |  | 20.68 |
Nonvested shares, at period end | 251,326 |  |  | $ | 21.52 |

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, 2020 and 2019:

| Three months ended September 30, |  | Nine months ended September 30,
| 2020 |  | 2019 |  | 2020 |  | 2019
Restricted share award expense | $ | 434 |  |  | $ | 470 |  |  | $ | 1,607 |  |  | $ | 1,146 |
Restricted share award tax benefit | 91 |  |  | 212 |  |  | 337 |  |  | 361 |
Fair value of shares vested | 225 |  |  | 2,056 |  |  | 1,314 |  |  | 2,500 |

The unrecognized compensation expense related to the share awards totaled $2.5 million at September 30, 2020 and $2.2 million at December 31, 2019. The unrecognized compensation expense at September 30, 2020 is expected to be recognized over a weighted-average period of 1.9 years.
The following table presents a summary of outstanding stock options activity for the nine months ended September 30, 2020:

| Shares |  | Weighted Average Exercise Price
Outstanding, beginning of year | 30,559 |  |  | $ | 21.56 |
Forfeited | (1,000) |  |  | 21.14 |
Expired | (29,559) |  |  | 25.76 |
Options outstanding and exercisable | — |  |  | $ | 0.00 |

The Company maintains an employee stock purchase plan to provide its employees with 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 purchases occur in March and September of each year. The Company reserved 350,000 shares of its common stock to be issued under the employee stock purchase plan. At September 30, 2020, 160,235 shares were available to be issued.
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The following table presents information for the employee stock purchase plan for the three and nine months ended September 30, 2020 and 2019:

| Three months ended September 30, |  | Nine months ended September 30,
| 2020 |  | 2019 |  | 2020 |  | 2019
Shares purchased | 4,218 |  |  | 2,395 |  |  | 7,831 |  |  | 5,399 |
Weighted average price of shares purchased | $ | 13.08 |  |  | $ | 22.87 |  |  | $ | 14.85 |  |  | $ | 20.69 |

The Company issues either new shares or treasury shares, depending on market conditions, for award through its share-based compensation plans.
NOTE 9. DERIVATIVE FINANCIAL INSTRUMENTS
The Company is exposed to certain risk arising from both its business operations and economic conditions. The Company principally manages its exposures to a wide variety of business and operational risks through management of its core business activities. The Company manages economic risks, including interest rate, liquidity, and credit risk primarily by managing the amount, sources, and duration of its assets and liabilities and the use of derivative financial instruments. Specifically, the Company enters into derivative financial instruments to manage exposures that arise from business activities that result in the receipt or payment of future known and uncertain cash amounts, the value of which are determined by interest rates. The Company’s derivative financial instruments are used as risk management tools by the Company to manage differences in the amount, timing, and duration of the Company’s known or expected cash receipts and its known or expected cash payments principally related to the Company’s borrowings and are not used for trading or speculative purposes.
The Company’s objectives in using interest rate derivatives are to add stability to interest expense and to manage its exposure to interest rate movements. To accomplish this objective, the Company primarily uses interest rate swaps as part of its interest rate risk management strategy. Interest rate swaps designated as cash flow hedges involve the receipt of variable amounts from a counterparty in exchange for the Company making fixed-rate payments over the life of the agreements without exchange of the underlying notional amount. At September 30, 2020, the Company had two interest rate derivatives designated as hedging instruments with an aggregate notional amount of $100.0 million. The Company had no derivative instruments at December 31, 2019. Such derivatives were used to hedge the variable cash flows associated with the Company's borrowings. At September 30, 2020, the Company had cash collateral of $2.4 million held with the counterparty for these derivatives.
The Company enters into interest rate swaps that allow its commercial loan customers to effectively convert a variable-rate commercial loan agreement to a fixed-rate commercial loan agreement. Under these agreements, the Company enters into a variable-rate loan agreement with a customer in addition to an interest rate swap agreement, which serves to effectively swap the customer’s variable-rate loan into a fixed-rate loan. The Company then enters into a corresponding swap agreement with a third party in order to economically hedge its exposure through the customer agreement. The interest rate swaps with both the customers and third parties are not designated as hedges and are marked through earnings. At September 30, 2020, the Company had three customer and three corresponding third-party broker interest rate derivatives not designated as a hedging instrument with an aggregate notional amount of $23.8 million. The Company had no such derivative instruments at December 31, 2019.
As a part of its normal residential mortgage operations, the Company will enter into an interest rate lock commitment with a potential borrower. The Company enters into a corresponding commitment to an investor to sell that loan at a specific price
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shortly after origination. In accordance with FASB ASC 820, adjustments are recorded through earnings to account for the net change in fair value of these transactions for the held for sale pipeline.
The following table summarizes the fair value of the Company's derivative instruments at September 30, 2020 and December 31, 2019:

| September 30, 2020 |  | December 31, 2019
| Notional Amount |  | Balance Sheet Location |  | Fair Value |  | Notional Amount |  | Balance Sheet Location |  | Fair Value
Derivatives designated as hedging instruments: |  |  |  |  |  |  |  |  |  |  |
Interest rate swaps - balance sheet hedge | $ | 100,000 |  |  | Other liabilities |  | $ | (1,657) |  |  | $ | — |  |  |  |  | $ | — |
Total derivatives designated as hedging instruments |  |  |  |  | $ | (1,657) |  |  |  |  |  |  | $ | — |
Derivatives not designated as hedging instruments: |  |  |  |  |  |  |  |  |  |  |
Interest rate swap - commercial borrower | $ | 11,901 |  |  | Other assets |  | $ | 347 |  |  | $ | — |  |  |  |  | $ | — |
Interest rate swap - counterparty | 11,901 |  |  | Other liabilities |  | (368) |  |  | — |  |  |  |  | — |
Interest Rate lock commitments with customers | 33,560 |  |  | Other assets |  | 1,143 |  |  | 4,408 |  |  | Other assets |  | 103 |
Forward sale commitment | 11,699 |  |  | Other assets |  | 17 |  |  | 8,969 |  |  | Other assets |  | 1 |
Total derivatives not designated as hedging instruments |  |  |  |  | $ | 1,139 |  |  |  |  |  |  | $ | 104 |

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

| Amount of Gain Recognized in OCI on Derivative |  | Amount of Loss Recognized in OCI on Derivative
| Three Months Ended September 30, |  | Nine Months Ended September 30,
| 2020 |  | 2019 |  | 2020 |  | 2019
Derivatives in cash flow hedging relationships: |  |  |  |  |  |
Interest rate products | $ | 208 |  |  | $ | — |  |  | $ | (1,893) |  |  | $ | — |
Total | $ | 208 |  |  | $ | — |  |  | $ | (1,893) |  |  | $ | — |

| Amount of Loss Reclassified from Accumulated OCI into Income |  | Amount of Loss Reclassified from AOCI into Income |  | Location of Loss Recognized from AOCI into Income
| Three Months Ended September 30, |  | Nine Months Ended September 30, |  |
| 2020 |  | 2019 |  | 2020 |  | 2019 |  |
Derivatives in cash flow hedging relationships: |  |  |  |  |  |  |  |
Interest rate products | $ | (114) |  |  | $ | — |  |  | $ | (239) |  |  | $ | — |  |  | Interest expense
Total | $ | (114) |  |  | $ | — |  |  | $ | (239) |  |  | $ | — |  |  |

| Amount of Gain (Loss) Recognized in Income |  | Amount of Gain (Loss) Recognized in Income |  | Location of Gain (Loss) Recognized in Income
| Three Months Ended September 30, |  | Nine Months Ended September 30, |  |
| 2020 |  | 2019 |  | 2020 |  | 2019 |  |
Derivatives not designated as hedging instruments: |  |  |  |  |  |  |  |
Interest rate products | $ | (4) |  |  | $ | — |  |  | $ | (21) |  |  | $ | — |  |  | Other operating expenses
Interest rate lock commitments with customers | 157 |  |  | — |  |  | 1,040 |  |  | — |  |  | Mortgage banking activities
Forward sale commitment | 71 |  |  | — |  |  | (126) |  |  | — |  |  | Mortgage banking activities
Total | $ | 224 |  |  | $ | — |  |  | $ | 893 |  |  | $ | — |  |  |

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

| September 30, 2020 |  | December 31, 2019
Weighted average pay rate | 0.54 | % |  | — | %
Weighted average receive rate | 0.80 | % |  | — | %
Weighted average maturity in years | 5.5 |  | —

NOTE 10. SHAREHOLDERS’ EQUITY AND REGULATORY CAPITAL
Banks and bank holding companies are subject to regulatory capital requirements administered by federal banking agencies. Capital adequacy guidelines and, additionally for banks, prompt corrective action regulations, involve quantitative measures of assets, liabilities and certain off-balance sheet items calculated under regulatory accounting practices. Capital amounts and classifications are also subject to qualitative judgments by regulators. Failure to meet capital requirements can initiate regulatory action. Under the Basel Committee on Banking Supervision's capital guidelines for U.S. Banks ("Basel III rules"), an entity must hold a capital conservation buffer above the adequately capitalized risk-based capital ratios. The Company and the Bank have elected not to include net unrealized gain or loss on available for sale securities in computing regulatory capital.
The consolidated asset limit on small bank holding companies is $3.0 billion and a company with assets under that limit is not subject to the FRB consolidated capital rules, but may file reports that include capital amounts and ratios. The Company has elected to file those reports.
Management believes that the Company and the Bank met all capital adequacy requirements to which they are subject at September 30, 2020 and December 31, 2019.
Prompt corrective action regulations provide five classifications: well capitalized, adequately capitalized, undercapitalized, significantly undercapitalized and critically undercapitalized, although these terms are not used to represent overall financial condition. If adequately capitalized, regulatory approval is required to accept brokered deposits. If undercapitalized, capital distributions are limited, as is asset growth and expansion, and capital restoration plans are required. At September 30, 2020, the most recent regulatory notifications categorized the Bank as well capitalized under the regulatory framework for prompt corrective action. There are no conditions or events since that notification that management believes have changed the Bank's classification.
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The following table presents capital amounts and ratios at September 30, 2020 and December 31, 2019:

| Actual |  | For Capital Adequacy Purposes (includes applicable capital conservation buffer) |  | To Be Well Capitalized Under Prompt Corrective Action Provisions
| Amount |  | Ratio |  | Amount |  | Ratio |  | Amount |  | Ratio
September 30, 2020 |  |  |  |  |  |  |  |  |  |  |
Total risk-based capital: |  |  |  |  |  |  |  |  |  |  |
Orrstown Financial Services, Inc. | $ | 261,779 |  |  | 15.0 | % |  | $ | 182,912 |  |  | 10.5 | % |  | n/a |  | n/a
Orrstown Bank | 248,781 |  |  | 14.3 | % |  | 182,848 |  |  | 10.5 | % |  | $ | 174,141 |  |  | 10.0 | %
Tier 1 risk-based capital: |  |  |  |  |  |  |  |  |  |  |
Orrstown Financial Services, Inc. | 208,970 |  |  | 12.0 | % |  | 148,071 |  |  | 8.5 | % |  | n/a |  | n/a
Orrstown Bank | 227,847 |  |  | 13.1 | % |  | 148,019 |  |  | 8.5 | % |  | 139,312 |  |  | 8.0 | %
Tier 1 common equity risk-based capital: |  |  |  |  |  |  |  |  |  |  |
Orrstown Financial Services, Inc. | 208,970 |  |  | 12.0 | % |  | 121,941 |  |  | 7.0 | % |  | n/a |  | n/a
Orrstown Bank | 227,847 |  |  | 13.1 | % |  | 121,898 |  |  | 7.0 | % |  | 113,191 |  |  | 6.5 | %
Tier 1 leverage capital: |  |  |  |  |  |  |  |  |  |  |
Orrstown Financial Services, Inc. | 208,970 |  |  | 7.8 | % |  | 107,186 |  |  | 4.0 | % |  | n/a |  | n/a
Orrstown Bank | 227,847 |  |  | 8.5 | % |  | 107,216 |  |  | 4.0 | % |  | 134,020 |  |  | 5.0 | %
December 31, 2019 |  |  |  |  |  |  |  |  |  |  |
Total risk-based capital: |  |  |  |  |  |  |  |  |  |  |
Orrstown Financial Services, Inc. | $ | 244,003 |  |  | 14.1 | % |  | $ | 182,028 |  |  | 10.5 | % |  | n/a |  | n/a
Orrstown Bank | 231,805 |  |  | 13.4 | % |  | 181,948 |  |  | 10.5 | % |  | $ | 173,284 |  |  | 10.0 | %
Tier 1 risk-based capital: |  |  |  |  |  |  |  |  |  |  |
Orrstown Financial Services, Inc. | 196,451 |  |  | 11.3 | % |  | 147,356 |  |  | 8.5 | % |  | n/a |  | n/a
Orrstown Bank | 216,100 |  |  | 12.5 | % |  | 147,291 |  |  | 8.5 | % |  | 138,627 |  |  | 8.0 | %
Tier 1 common equity risk-based capital: |  |  |  |  |  |  |  |  |  |  |
Orrstown Financial Services, Inc. | 196,451 |  |  | 11.3 | % |  | 121,352 |  |  | 7.0 | % |  | n/a |  | n/a
Orrstown Bank | 216,100 |  |  | 12.5 | % |  | 121,299 |  |  | 7.0 | % |  | 112,635 |  |  | 6.5 | %
Tier 1 leverage capital: |  |  |  |  |  |  |  |  |  |  |
Orrstown Financial Services, Inc. | 196,451 |  |  | 8.6 | % |  | 91,782 |  |  | 4.0 | % |  | n/a |  | n/a
Orrstown Bank | 216,100 |  |  | 9.4 | % |  | 91,798 |  |  | 4.0 | % |  | 114,747 |  |  | 5.0 | %

In September 2015, the Board of Directors of the Company authorized a share repurchase program under which the Company may repurchase up to 5% of the Company's outstanding shares of common stock, or approximately 416,000 shares, in accordance with all applicable securities laws and regulations, including Rule 10b-18 of the Exchange Act of 1934, as amended. When and if appropriate, repurchases may be made in open market or privately negotiated transactions, depending on market conditions, regulatory requirements and other corporate considerations, as determined by management. Share repurchases may not occur and may be discontinued at any time. At September 30, 2020, 154,680 shares had been repurchased under the program at a total cost of $2.6 million, or $16.88 per share.
On October 20, 2020, the Board declared a cash dividend of $0.17 per common share, which will be paid on November 9, 2020 to shareholders of record at November 2, 2020.
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NOTE 11. EARNINGS PER SHARE
The following table presents earnings per share for the three and nine months ended September 30, 2020 and 2019:

| Three Months Ended September 30, |  | Nine Months Ended September 30,
| 2020 |  | 2019 |  | 2020 |  | 2019
Net income | $ | 4,977 |  |  | $ | 6,901 |  |  | $ | 16,404 |  |  | $ | 12,690 |
Weighted average shares outstanding - basic | 10,941 |  |  | 10,949 |  |  | 10,939 |  |  | 10,159 |
Dilutive effect of share-based compensation | 84 |  |  | 145 |  |  | 88 |  |  | 159 |
Weighted average shares outstanding - diluted | 11,025 |  |  | 11,094 |  |  | 11,027 |  |  | 10,318 |
Per share information: |  |  |  |  |  |  |
Basic earnings per share | $ | 0.45 |  |  | $ | 0.63 |  |  | $ | 1.50 |  |  | $ | 1.25 |
Diluted earnings per share | 0.45 |  |  | 0.62 |  |  | 1.49 |  |  | 1.23 |

Average outstanding stock options totaling 6,110 and 7,882 for the three months ended September 30, 2020 and 2019, respectively, and of 21,479 and 28,699 for the nine months ended September 30, 2020 and 2019, respectively, were not included in the computation of earnings per share because the effect was antidilutive, due to the exercise price exceeding the average market price. The dilutive effect of share-based compensation in each period above relates principally to restricted stock awards.
NOTE 12. FINANCIAL INSTRUMENTS WITH OFF-BALANCE SHEET RISK
The Company is a party to financial instruments with off-balance sheet risk in the normal course of business to meet the financing needs of its customers. These financial instruments include commitments to extend credit and standby letters of credit. Those instruments involve, to varying degrees, elements of credit and interest rate risk in excess of the amount recognized in the consolidated balance sheets. The contract amounts of those instruments reflect the extent of involvement the Company has in particular classes of financial instruments.
The Company’s exposure to credit loss in the event of nonperformance by the other party to the financial instrument for commitments to extend credit and standby letters of credit and financial guarantees written is represented by the contractual amount of those instruments. The Company uses the same credit policies in making commitments and conditional obligations as it does for on-balance sheet instruments. The following table presents these contractual, or notional, amounts:

| Contractual or Notional Amount
| September 30, 2020 |  | December 31, 2019
Commitments to fund: |  |  |
Home equity lines of credit | $ | 218,961 |  |  | $ | 205,502 |
1-4 family residential construction loans | 23,546 |  |  | 19,812 |
Commercial real estate, construction and land development loans | 24,738 |  |  | 19,018 |
Commercial, industrial and other loans | 245,722 |  |  | 222,288 |
Standby letters of credit | 16,376 |  |  | 10,588 |

Commitments to extend credit are agreements to lend to a customer as long as there is no violation of any condition established in the contract. Commitments generally have fixed expiration dates or other termination clauses and may require payment of a fee. Since many of the commitments are expected to expire without being drawn upon, the total commitment amounts do not necessarily represent future cash requirements. The Company evaluates each customer’s credit-worthiness on a case-by-case basis. The amount of collateral obtained, if deemed necessary by the Company upon extension of credit, is based on management’s credit evaluation of the customer. Collateral varies but may include accounts receivable, inventory, equipment, residential real estate, and income-producing commercial properties.
Standby letters of credit and financial guarantees written are conditional commitments issued by the Company to guarantee the performance of a customer to a third party. Those guarantees are primarily issued to support public and private borrowing arrangements. The credit risk involved in issuing letters of credit is essentially the same as that involved in extending
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loans to customers. The Company holds collateral supporting those commitments when deemed necessary by management. The liability, at September 30, 2020 and December 31, 2019, for guarantees under standby letters of credit issued was not material.
The Company maintains a reserve, based on historical loss experience of the related loan class, for off-balance sheet credit exposures that currently are not funded, in other liabilities on the unaudited condensed consolidated balance sheets. This reserve totaled $1.2 million at September 30, 2020 and $1.0 million at December 31, 2019.
NOTE 13. FAIR VALUE
Fair value is the exchange price that would be received for an asset or paid to transfer a liability (exit price) in the principal or most advantageous market for the asset or liability in an orderly transaction between market participants on the measurement date. Certain financial instruments and all non-financial instruments are excluded from disclosure requirements. Accordingly, the aggregate fair value amounts presented do not represent the underlying value of the Company.
The fair value hierarchy distinguishes between (1) market participant assumptions developed based on market data obtained from independent sources (observable inputs) and (2) an entity's own assumptions about market participant assumptions based on the best information available in the circumstances (unobservable inputs). The fair value hierarchy consists of three broad levels, which gives the highest priority to unadjusted quoted prices in active markets for identical assets or liabilities (Level 1) and the lowest priority to unobservable inputs (Level 3). The three levels of the fair value hierarchy are:
Level 1 – quoted prices (unadjusted) for identical assets or liabilities in active markets that the entity has the ability to access at the measurement date.
Level 2 – significant other observable inputs other than Level 1 prices such as prices for similar assets and liabilities in active markets; quoted prices for identical or similar instruments in markets that are not active; or other inputs that are observable or can be corroborated by observable market data.
Level 3 – at least one significant unobservable input that reflects a company's own assumptions about the assumptions that market participants would use in pricing an asset or liability.
In instances in which multiple levels of inputs are used to measure fair value, hierarchy classification is based on the lowest level input that is significant to the fair value measurement in its entirety. The Company's assessment of the significance of a particular input to the fair value measurement in its entirety requires judgment, and considers factors specific to the asset or liability.
The Company used the following methods and significant assumptions to estimate fair value for instruments measured on a recurring basis:
Where quoted prices are available in an active market, securities are classified within Level 1 of the valuation hierarchy. Level 1 securities include highly liquid government bonds, mortgage products and exchange traded equities. If quoted market prices are not available, securities are classified within Level 2 and fair values are estimated by using pricing models, quoted prices of securities with similar characteristics or discounted cash flow. Level 2 securities include U.S. agency securities, mortgage-backed securities, obligations of states and political subdivisions and certain corporate, asset backed and other securities. In certain cases where there is limited activity or less transparency around inputs to the valuation, securities are classified within Level 3 of the valuation hierarchy. All of the Company’s securities are classified as available for sale.
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The Company had no liabilities measured at fair value on a recurring basis at September 30, 2020 and December 31, 2019.
The following table summarizes assets measured at fair value on a recurring basis at September 30, 2020 and December 31, 2019:

| Level 1 |  | Level 2 |  | Level 3 |  | Total Fair Value Measurements
September 30, 2020 |  |  |  |  |  |  |
Investment securities: |  |  |  |  |  |  |
States and political subdivisions | $ | — |  |  | $ | 112,707 |  |  | $ | — |  |  | $ | 112,707 |
GSE residential MBSs | — |  |  | 4,578 |  |  | — |  |  | 4,578 |
GSE residential CMOs | — |  |  | 62,139 |  |  | — |  |  | 62,139 |
Nonagency CMOs | — |  |  | — |  |  | 17,162 |  |  | 17,162 |
Private label commercial CMOs | — |  |  | 62,479 |  |  | 6,730 |  |  | 69,209 |
Asset-backed | — |  |  | 212,150 |  |  | — |  |  | 212,150 |
Other | 343 |  |  | — |  |  | — |  |  | 343 |
Loans held for sale | — |  |  | 12,804 |  |  | — |  |  | 12,804 |
Interest rate swaps | — |  |  | 339 |  |  | — |  |  | 339 |
Interest rate lock commitments on residential mortgages | — |  |  | — |  |  | 1,143 |  |  | 1,143 |
Totals | $ | 343 |  |  | $ | 467,196 |  |  | $ | 25,035 |  |  | $ | 492,574 |
December 31, 2019 |  |  |  |  |  |  |
Investment securities: |  |  |  |  |  |  |
States and political subdivisions | $ | — |  |  | $ | 87,863 |  |  | $ | — |  |  | $ | 87,863 |
GSE residential CMOs | — |  |  | 68,154 |  |  | — |  |  | 68,154 |
Nonagency CMOs | — |  |  | — |  |  | 17,087 |  |  | 17,087 |
Private label commercial CMOs | — |  |  | 79,437 |  |  | 7,192 |  |  | 86,629 |
Asset-backed | — |  |  | 230,515 |  |  | — |  |  | 230,515 |
Other | 637 |  |  | — |  |  | — |  |  | 637 |
Loans held for sale | — |  |  | 9,364 |  |  | — |  |  | 9,364 |
Interest rate lock commitments on residential mortgages | — |  |  | — |  |  | 103 |  |  | 103 |
Totals | $ | 637 |  |  | $ | 475,333 |  |  | $ | 24,382 |  |  | $ | 500,352 |

The Company has CMOs measured at fair value on a recurring basis using significant unobservable inputs (Level 3) at September 30, 2020 and December 31, 2019. The Level 3 valuation is based on a non-executable broker quote, which is considered a significant unobservable input. Such quotes are updated as available and may remain constant for a period of time for certain broker-quoted securities that do not move with the market or that are not interest rate sensitive as a result of their structure or overall attributes.
Effective October 1, 2019, the Company’s residential mortgage loans held for sale were recorded at fair value utilizing Level 2 measurements. This fair value measurement is determined based upon third party quotes obtained on similar loans. For loans held for sale for which the fair value option has been elected, the aggregate fair value exceeded the aggregate principal balance by $424 thousand as of September 30, 2020.
The determination of the fair value of interest rate lock commitments on residential mortgages is based on agreed upon pricing with the respective investor on each loan and includes a pull through percentage. The pull through percentage represents an estimate of loans in the pipeline to be delivered to an investor versus the total loans committed for delivery. Significant changes in this input could result in a significantly higher or lower fair value measurement. As the pull through percentage is a significant unobservable input, this is deemed a Level 3 valuation input. The average pull through percentage, which is based upon historical experience, was 89% as of September 30, 2020. An increase or decrease of 5% in the pull through assumption would result in a positive or negative change of $62 thousand in the fair value of interest rate lock commitments at September 30, 2020.
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The following provides details of the Level 3 fair value measurement activity for the periods ended September 30, 2020 and 2019:
CMOs:

| Three Months Ended September 30, |  | Nine Months Ended September 30,
| 2020 |  | 2019 |  | 2020 |  | 2019
Balance, beginning of period | $ | 23,834 |  |  | $ | — |  |  | $ | 24,279 |  |  | $ | — |
Unrealized gain (loss) included in OCI | 200 |  |  | — |  |  | (229) |  |  | — |
Principal payments and other | (142) |  |  | — |  |  | (158) |  |  | — |
Balance, end of period | $ | 23,892 |  |  | $ | — |  |  | $ | 23,892 |  |  | $ | — |

Interest rate lock commitments on residential mortgages:

| Three Months Ended September 30, |  | Nine Months Ended September 30,
| 2020 |  | 2019 |  | 2020 |  | 2019
Balance, beginning of period | $ | 986 |  |  | $ | — |  |  | $ | 103 |  |  | $ | — |
Total gains |  |  |  |  |  |  |
Included in earnings | 157 |  |  | — |  |  | 1,040 |  |  | — |
Balance, end of period | $ | 1,143 |  |  | $ | — |  |  | $ | 1,143 |  |  | $ | — |

Certain financial assets are measured at fair value on a nonrecurring basis. Adjustments to the fair value of these assets usually results 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 using a market rate of interest for performing TDRs. For collateral-dependent loans, fair value is measured based on the value of the collateral securing the loan, less estimated costs to sell. Collateral may be in the form of real estate or business assets including equipment, inventory, and accounts receivable. The value of the real estate collateral is determined utilizing an income or market valuation approach based on an appraisal conducted by an independent, licensed appraiser outside of the Company using observable market data (Level 2). However, if the collateral is a house or building in the process of construction, or if management adjusts the appraisal value, then the fair value is considered Level 3. The value of business equipment is based upon an outside appraisal, if deemed significant, or the net book value on the applicable business’ financial statements if not considered significant using observable market data. Likewise, values for inventory and accounts receivable collateral are based on financial statement balances or aging reports (Level 3). Impaired loans with an allocation to the ALL are measured at fair value on a nonrecurring basis. Any fair value adjustments are recorded in the period incurred as provision for loan losses on the unaudited condensed consolidated statements of income.
Any changes in the fair value of impaired loans still held were not material for the three and nine months ended September 30, 2020 and 2019:
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. There were no charges recorded to the value of OREO at the lower of cost or fair value on properties held during the three and nine months ended September 30, 2020 and 2019. There were no changes in the fair value of OREO for properties still held at September 30, 2020 that were charged to real estate expenses for the three and nine months ended September 30, 2020 and 2019.
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Mortgage Servicing Rights
The MSR fair value is estimated to be equal to its carrying value, unless the quarterly valuation model calculates the present value of the estimated net servicing income is less than its carrying value, in which case an impairment charge is taken. At September 30, 2020 and December 31, 2019, an impairment reserve of $1.1 million and $70 thousand, respectively, existed on the mortgage servicing right portfolio. For the three months ended September 30, 2020 and 2019, impairment charges of $166 thousand and $221 thousand were included, respectively, in mortgage banking activities on the unaudited condensed consolidated statements of income. For the nine months ended September 30, 2020 and 2019, impairment charges of $986 thousand and $240 thousand were included, respectively, in mortgage banking activities on the unaudited condensed consolidated statements of income. The impairment charges resulted from rapidly declining market rates caused by the COVID-19 pandemic.
The following table summarizes assets measured at fair value on a nonrecurring basis at September 30, 2020 and December 31, 2019:

| Level 1 |  | Level 2 |  | Level 3 |  | Total Fair Value Measurements
September 30, 2020 |  |  |  |  |  |  |
Impaired Loans |  |  |  |  |  |  |
Commercial real estate: |  |  |  |  |  |  |
Owner occupied | $ | — |  |  | $ | — |  |  | $ | 875 |  |  | $ | 875 |
Multi-family | — |  |  | — |  |  | 74 |  |  | 74 |
Non-owner occupied residential | — |  |  | — |  |  | 39 |  |  | 39 |
Commercial and industrial | — |  |  | — |  |  | 195 |  |  | 195 |
Residential mortgage: |  |  |  |  |  |  |
First lien | — |  |  | — |  |  | 684 |  |  | 684 |
Home equity - lines of credit | — |  |  | — |  |  | 174 |  |  | 174 |
Total impaired loans | $ | — |  |  | $ | — |  |  | $ | 2,041 |  |  | $ | 2,041 |
Mortgage servicing rights | $ | — |  |  | $ | — |  |  | $ | 2,661 |  |  | $ | 2,661 |
December 31, 2019 |  |  |  |  |  |  |
Impaired Loans |  |  |  |  |  |  |
Commercial real estate: |  |  |  |  |  |  |
Owner occupied | $ | — |  |  | $ | — |  |  | $ | 938 |  |  | $ | 938 |
Multi-family | — |  |  | — |  |  | 96 |  |  | 96 |
Non-owner occupied residential | — |  |  | — |  |  | 103 |  |  | 103 |
Commercial and industrial | — |  |  | — |  |  | 11 |  |  | 11 |
Residential mortgage: |  |  |  |  |  |  |
First lien | — |  |  | — |  |  | 641 |  |  | 641 |
Home equity - lines of credit | — |  |  | — |  |  | 400 |  |  | 400 |
Installment and other loans | — |  |  | — |  |  | 7 |  |  | 7 |
Total impaired loans | $ | — |  |  | $ | — |  |  | $ | 2,196 |  |  | $ | 2,196 |
Mortgage servicing rights | $ | — |  |  | $ | — |  |  | $ | 3,119 |  |  | $ | 3,119 |

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

| Fair Value Estimate |  | Valuation Techniques |  | Unobservable Input |  | Range
September 30, 2020 |  |  |  |  |  |  |
Impaired loans | $ | 2,041 |  |  | Appraisal of collateral |  | Management adjustments on appraisals for property type and recent activity |  | 0% - 25% discount
|  |  |  |  | - Management adjustments for liquidation expenses |  | 6%- 19% discount
Mortgage servicing rights | $ | 2,661 |  |  | Discounted cash flows |  | Weighted average CPR |  | 16.96%
|  |  |  |  | - Weighted average discount rate |  | 9.57%
December 31, 2019 |  |  |  |  |  |  |
Impaired loans | $ | 2,196 |  |  | Appraisal of collateral |  | Management adjustments on appraisals for property type and recent activity |  | 0% - 20% discount
|  |  |  |  | - Management adjustments for liquidation expenses |  | 6% - 33% discount
Mortgage servicing rights | $ | 3,119 |  |  | Discounted cash flows |  | Weighted average CPR |  | 11.63%
|  |  |  |  | - Weighted average discount rate |  | 9.54%

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

| Carrying Amount |  | Fair Value |  | Level 1 |  | Level 2 |  | Level 3
September 30, 2020 |  |  |  |  |  |  |  |  |
Financial Assets |  |  |  |  |  |  |  |  |
Cash and due from banks | $ | 26,854 |  |  | $ | 26,854 |  |  | $ | 26,854 |  |  | $ | — |  |  | $ | — |
Interest-bearing deposits with banks | 60,453 |  |  | 60,453 |  |  | 60,453 |  |  | — |  |  | — |
Restricted investments in bank stocks | 12,646 |  |  | n/a |  | n/a |  | n/a |  | n/a
Investment securities | 478,288 |  |  | 478,288 |  |  | — |  |  | 454,396 |  |  | 23,892 |
Loans held for sale | 12,804 |  |  | 12,804 |  |  | — |  |  | 12,804 |  |  | — |
Loans, net of allowance for loan losses | 2,010,145 |  |  | 2,003,349 |  |  | — |  |  | — |  |  | 2,003,349 |
Interest rate lock commitments on residential mortgages | 1,143 |  |  | 1,143 |  |  | — |  |  | — |  |  | 1,143 |
Interest rate swaps | 339 |  |  | 339 |  |  | — |  |  | 339 |  |  | — |
Accrued interest receivable | 8,812 |  |  | 8,812 |  |  | — |  |  | 1,810 |  |  | 7,002 |
Financial Liabilities |  |  |  |  |  |  |  |  |
Deposits | 2,279,483 |  |  | 2,282,669 |  |  | — |  |  | 2,282,669 |  |  | — |
Securities sold under agreements to repurchase | 17,445 |  |  | 17,445 |  |  | — |  |  | 17,445 |  |  | — |
FHLB advances and other | 183,373 |  |  | 183,650 |  |  | — |  |  | 183,650 |  |  | — |
Subordinated notes | 31,889 |  |  | 32,009 |  |  | — |  |  | 32,009 |  |  | — |
Interest rate swaps | 2,014 |  |  | 2,014 |  |  | — |  |  | 2,014 |  |  | — |
Accrued interest payable | 819 |  |  | 819 |  |  | — |  |  | 819 |  |  | — |
December 31, 2019 |  |  |  |  |  |  |  |  |
Financial Assets |  |  |  |  |  |  |  |  |
Cash and due from banks | $ | 25,969 |  |  | $ | 25,969 |  |  | $ | 25,969 |  |  | $ | — |  |  | $ | — |
Interest-bearing deposits with banks | 30,493 |  |  | 30,493 |  |  | 30,493 |  |  | — |  |  | — |
Restricted investments in bank stocks | 16,184 |  |  | n/a |  | n/a |  | n/a |  | n/a
Investment securities | 490,386 |  |  | 490,386 |  |  | — |  |  | 466,107 |  |  | 24,279 |
Loans held for sale | 9,364 |  |  | 9,364 |  |  | — |  |  | 9,364 |  |  | — |
Loans, net of allowance for loan losses | 1,629,675 |  |  | 1,652,788 |  |  | — |  |  | — |  |  | 1,652,788 |
Interest rate lock commitments on residential mortgages | 103 |  |  | 103 |  |  | — |  |  | — |  |  | 103 |
Accrued interest receivable | 6,040 |  |  | 6,040 |  |  | — |  |  | 1,863 |  |  | 4,177 |
Financial Liabilities |  |  |  |  |  |  |  |  |
Deposits | 1,875,522 |  |  | 1,876,555 |  |  | — |  |  | 1,876,555 |  |  | — |
Securities sold under agreements to repurchase | 8,269 |  |  | 8,269 |  |  | — |  |  | 8,269 |  |  | — |
FHLB advances and other | 209,667 |  |  | 210,005 |  |  | — |  |  | 210,005 |  |  | — |
Subordinated notes | 31,847 |  |  | 33,953 |  |  | — |  |  | 33,953 |  |  | — |
Accrued interest payable | 879 |  |  | 879 |  |  | — |  |  | 879 |  |  | — |

The methods used to estimate the fair value of financial instruments at September 30, 2020 did not necessarily represent an exit price. In accordance with the Company's adoption of ASU 2016-01, Financial Instruments – Overall (Subtopic 825-10): Recognition and Measurement of Financial Assets and Financial Liabilities, the methods utilized to measure the fair value of financial instruments at September 30, 2020 represents an approximation of exit price; however, an actual exit price may differ.
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 March 5, 2019, Paul Parshall, a purported individual stockholder of Hamilton, filed, on behalf of himself and all of Hamilton’s stockholders other than the named defendants and their affiliates (the “Purported Class”), a derivative and putative class action complaint in the Circuit Court for Baltimore City, Maryland, captioned Paul Parshall v. Carol Coughlin et. al., naming each Hamilton director, Orrstown, and Hamilton as defendants (the “Action”). The Action alleged, among other things, that Hamilton’s directors breached their fiduciary duties to the Purported Class in connection with the merger, and that the
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Proxy Statement/Prospectus omitted certain material information regarding the merger. Orrstown was alleged to have aided and abetted the Hamilton directors’ alleged breaches of their fiduciary duties. The Action sought, among other remedies, to enjoin the merger or, in the event the merger was completed, rescission of the merger or rescissory damages; unspecified damages; and costs of the lawsuit, including attorneys’ and experts’ fees. A settlement was reached on the Action in March 2020 which resulted in a payment by the Company of $135 thousand in mootness fees to the defendants in April 2020.
On May 25, 2012, SEPTA filed a putative class action complaint in the U.S. District Court for the Middle District of Pennsylvania against the Company, the Bank and certain current and former directors and officers (collectively, the “Orrstown Defendants”). The complaint alleged, 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 asserted 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 sought class certification, unspecified money damages, interest, costs, fees and equitable or injunctive relief. Under the Private Securities Litigation Reform Act of 1995 (“PSLRA”), the Court appointed SEPTA Lead Plaintiff on August 20, 2012.
On March 4, 2013, SEPTA filed an amended complaint. The amended complaint expanded the list of defendants in the action to include the Company’s former independent registered public accounting firm, Smith Elliott Kearns & Company, LLC (“SEK”), and the underwriters of the Company’s March 2010 public offering of common stock. In addition, among other things, the amended complaint extended the purported 1934 Exchange Act class period from March 15, 2010 through April 5, 2012.
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. On February 8, 2016, the Court granted SEPTA’s motion for leave to amend again and SEPTA filed its second amended complaint that same day.
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 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 has not yet filed a motion for class certification.
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 30, 2018, the FRB filed an unopposed motion to intervene in the Action for the purpose of opposing SEPTA’s 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.
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 July 17, 2019, the Court entered an Order partially granting Orrstown’s motion for protective order, ruling that all deposition discovery in the case was stayed pending a decision on SEPTA’s motion for leave to file a third amended complaint. Party and non-party document discovery in the case has largely been completed.
On February 14, 2020, the Court issued an Order and Memorandum granting SEPTA’s motion for leave to file a third amended complaint. The third amended complaint is now the operative complaint. It reinstates the Orrstown Defendants, as well as SEK and the underwriter defendants, previously dismissed from the case on December 7, 2016. The third amended complaint also revives the previously-dismissed 1933 Securities Act claim against the Orrstown Defendants, SEK, and the
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underwriter defendants. Defendants filed their motions to dismiss the third amended complaint on April 24, 2020. SEPTA’s opposition was filed on July 8, 2020, and Orrstown’s reply brief was filed on August 12, 2020. The motions to dismiss the third amended complaint are currently pending.
Additionally, on February 24, 2020, the Orrstown Defendants, and the underwriter defendants and SEK, separately filed motions under 28 U.S.C. § 1292(b) asking the District Court to certify its February 14, 2020 Order granting leave to file the third amended complaint for interlocutory appeal to the Third Circuit Court of Appeals. The District Court granted those motions on July 17, 2020, and defendants filed their Petition for Permission to Appeal with the Third Circuit on July 27, 2020. The Third Circuit granted permission to appeal the Order pursuant to 28 U.S.C. § 1292(b) on August 13, 2020. Defendants filed their joint Opening Brief in the Third Circuit on November 2, 2020, asking the Court to reverse the district court’s Order. SEPTA’s brief is due December 2, and defendants’ reply brief must be filed by December 23, 2020.
The Company believes that the allegations of SEPTA’s third amended complaint are without merit and intends to defend itself vigorously against those claims. It is not possible at this time to reasonably estimate possible losses, or even a range of reasonably possible losses, in connection with the litigation.
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Item 2. Management’s Discussion and Analysis of Financial Condition and Results of Operations
The following discussion and analysis is intended to assist readers in understanding the consolidated financial condition and results of operations of Orrstown and should be read in conjunction with the preceding unaudited condensed consolidated financial statements and notes thereto included in this Quarterly Report on Form 10-Q, as well as with the audited consolidated financial statements and notes thereto for the year ended December 31, 2019, included in our Annual Report on Form 10-K. Throughout this discussion, the yield on earning assets is stated on a fully taxable-equivalent basis and balances represent average daily balances unless otherwise stated. Certain prior period amounts presented in this discussion and analysis have been reclassified to conform to current period classifications.
Overview
The Company, headquartered in Shippensburg, Pennsylvania, is a one-bank holding company that has elected status as a financial holding company. The consolidated financial information presented herein reflects the Company and its wholly-owned subsidiary, the Bank. At September 30, 2020, the Company had total assets of $2.8 billion, total liabilities of $2.5 billion and total shareholders’ equity of $232.8 million.
During the three months ended September 30, 2020, the Company recognized charges associated with the consolidation of six branch locations, the exit from three loan production offices, reduction in back-office real estate and staffing model adjustments. These actions were initiated due to evolving client preferences for the digital delivery of products and services. In addition, the anticipated future cost reductions resulting from these actions will prepare the Company for a challenging operating environment in 2021. A charge of $1.6 million was recorded in the three months ended September 30, 2020, which included $1.3 million related to branch consolidations.
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. In addition to risks and uncertainties related to the COVID-19 pandemic and resulting governmental and societal responses, factors that could cause actual results to differ from those expressed or implied by the forward-looking statements include, but are not limited to, the following: ineffectiveness of the Company’s business strategy due to changes in current or future market conditions; the effects of competition, including industry consolidation and development of competing financial products and services; difficulty integrating the Company's strategic acquisitions; the inability to fully achieve expected savings, efficiencies or synergies from mergers and acquisitions, or taking longer than estimated for such savings, efficiencies and synergies to be realized; changes in laws and regulations; interest rate movements; changes in credit quality; inability to raise capital, if necessary, under favorable conditions; volatility in the securities markets; deteriorating economic conditions; expenses associated with pending litigation and legal proceedings; the failure of the SBA to honor its guarantee of loans issued under the SBA PPP; and other risks and uncertainties, including those detailed in our Annual Report on Form 10-K for the year ended December 31, 2019, and our Quarterly Reports on Form 10-Q under the sections titled “Risk Factors” and “Management’s Discussion and Analysis of Financial Condition and Results of Operations” and in other filings made with the SEC. The statements are valid only as of the date hereof and we disclaim any obligation to update this information.
Economic Climate and Market Conditions
Preliminary real GDP for the third quarter of 2020 resulted in a record annualized increase of 33.1%. This is a substantial increase from negative 31.4% for the second quarter of 2020. The increase was driven by increased consumer spending as well as increased exports and rising inventories. Concern remains heading into the fourth quarter. While certain industries such as real estate, home improvement and grocery stores have performed well, the leisure, travel and entertainment industries continue to struggle. Weekly jobless claims remain high but have been declining recently. Also, the prospects for new government stimulus packages remain uncertain.
The pace of U.S. economic growth weakened substantially late in the first quarter of 2020 and into the second quarter of 2020 as over 30 million people in the U.S filed for unemployment since mid-March 2020. Early in 2020, a novel coronavirus (“COVID-19”) emerged and spread, first in China and then around the globe. The fast spread of the virus and the fear that
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resulted combined to create a high level of uncertainty about the near and intermediate future economic outlook. Because of this uncertainty, markets were pricing in a wide range of potential outcomes by buying sovereign government bonds, especially U.S. Treasuries, and selling stocks and bonds not issued by sovereign governments. The COVID-19 pandemic has adversely affected, and is likely to continue to adversely affect, economic activity globally, nationally and locally. Actions taken around the world to help mitigate the spread of COVID-19 include restrictions on travel, quarantines in certain areas, and forced closures for certain types of public places and businesses, as well as shelter-in-place orders by many states.
The decline in second quarter GDP reflected the response to COVID-19, as shelter-in-place orders issued in March and April were partially lifted in some areas of the country in May and June, and government pandemic assistance payments were distributed to households and businesses. This led to shifts in economic activity, as businesses remained closed or operated remotely and consumers and businesses significantly reduced or redirected their spending. Actions taken to mitigate the spread of COVID-19 have had and are expected to continue to have an adverse impact on the economies and financial markets of many countries, including the geographical area in which the Company operates.
D ue to the COVID-19 pandemic, market interest rates have declined significantly, with the 10-year Treasury bond falling for the first time below 1.00% on March 3, 2020; it was at 0.69% on September 30, 2020. On March 3, 2020, in reaction to the increase in uncertainty, the Federal Reserve cut the Fed Funds rates by 50 basis points between regularly scheduled meetings to a target range of 1.00% to 1.25%. On March 11, 2020, the World Health Organization declared COVID-19 a global pandemic. On March 13, 2020, a national emergency was declared by President Trump under the National Emergencies Act. On March 15, 2020, the Federal Reserve responded by again reducing the Fed Funds rate, this time by 100 basis points, to 0% to 0.25%. The Fed Funds rate was left unchanged in future meetings with rates expected to remain at this level for an extended period of time. These reductions in interest rates and other effects of the COVID-19 pandemic may adversely affect the Company's financial condition and results of operations in future periods. It is unknown how long the adverse conditions associated with the COVID-19 pandemic will last and what the complete financial effect will be to the Company. It is reasonably foreseeable that estimates made in the financial statements could be materially and adversely impacted in the near term as a result of these conditions, including expected credit losses on loans and the fair value of financial instruments that are carried at fair value.
Critical Accounting Estimates
The Company’s accounting and reporting policies are in accordance with GAAP and follow accounting and reporting guidelines prescribed by bank regulatory authorities and general practices within the financial services industry in which it operates. Our financial position and results of operations are affected by management's application of accounting policies, including estimates, and assumptions and judgments that affect the amounts reported in the consolidated financial statements and accompanying notes. These estimates, assumptions, and judgments are based on information available as of the balance sheet date and through the date the financial statements are filed with the SEC. Different assumptions in the application of these policies could result in material changes in the consolidated financial position and/or consolidated results of operations and related disclosures. The more critical accounting estimates include accounting for credit losses and valuation methodologies. Accordingly, these critical accounting estimates are discussed in detail in "Management's Discussion and Analysis of Financial Condition and Results of Operations" in our Annual Report on Form 10-K for the year ended December 31, 2019. Significant accounting policies and any changes in accounting principles and effects of new accounting pronouncements are discussed in Note 1, Summary of Significant Accounting Policies, to the Consolidated Financial Statements under Part II, Item 8, "Financial Statements and Supplementary Data," in our Annual Report on Form 10-K for the year ended December 31, 2019. Additional disclosures regarding the effects of new accounting pronouncements are included in this report in Note 1, Summary of Significant Accounting Policies, to the unaudited condensed consolidated financial statements under Part I, Item 1, "Financial Information."
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RESULTS OF OPERATIONS
Three months ended September 30, 2020 compared with three months ended September 30, 2019
Summary
Net income totaled $5.0 million for the three months ended September 30, 2020 compared with net income of $6.9 million for the same period in 2019. Diluted EPS for the three months ended September 30, 2020 totaled $0.45, compared with $0.62 for the three months ended September 30, 2019. Net interest income positively influenced results of operations, and totaled $20.8 million for the three months ended September 30, 2020, a $2.7 million increase compared with 2019. Noninterest income, excluding investment securities gains, totaled $6.9 million for the three months ended September 30, 2020 compared with $6.3 million in 2019. Investment securities losses totaled $13 thousand in the three months ended September 30, 2020, compared with net gains of $2.3 million for the same period in 2019. Noninterest expenses totaled $19.3 million and $18.1 million for the three months ended September 30, 2020 and 2019, respectively.
The comparability of operating results for 2020 with 2019 has generally been impacted by the SBA PPP loans originated in 2020.
Net Interest Income
Net interest income increased by $2.7 million, from $18.1 million to $20.8 million, for the three months ended September 30, 2020 compared with the three months ended September 30, 2019. Interest income on loans increased by $1.5 million, from $20.2 million to $21.6 million, securities interest income decreased by $1.5 million, from $4.1 million to $2.6 million, and total interest expense decreased by $3.4 million from $6.8 million to $3.4 million, in comparing the three months ended September 30, 2020 with the three months ended September 30, 2019.
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The following table presents net interest income, net interest spread and net interest margin for the three months ended September 30, 2020 and 2019 on a taxable-equivalent basis:

| Three Months Ended September 30, 2020 |  | Three Months Ended September 30, 2019
| Average Balance |  | Taxable- Equivalent Interest |  | Taxable- Equivalent Rate |  | Average Balance |  | Taxable- Equivalent Interest |  | Taxable- Equivalent Rate
Assets |  |  |  |  |  |  |  |  |  |  |
Federal funds sold & interest-bearing bank balances | $ | 31,087 |  |  | $ | 9 |  |  | 0.12 | % |  | $ | 95,713 |  |  | $ | 558 |  |  | 2.31 | %
Securities (1) | 496,107 |  |  | 2,673 |  |  | 2.14 |  |  | 496,981 |  |  | 4,180 |  |  | 3.34 |
Loans (1)(2)(3) | 2,054,193 |  |  | 21,741 |  |  | 4.21 |  |  | 1,604,491 |  |  | 20,305 |  |  | 5.02 |
Total interest-earning assets | 2,581,387 |  |  | 24,423 |  |  | 3.76 |  |  | 2,197,185 |  |  | 25,043 |  |  | 4.52 |
Other assets | 190,119 |  |  |  |  |  |  | 193,946 |  |  |  |  |
Total | $ | 2,771,506 |  |  |  |  |  |  | $ | 2,391,131 |  |  |  |  |
Liabilities and Shareholders’ Equity |  |  |  |  |  |  |  |  |  |  |
Interest-bearing demand deposits | $ | 1,213,208 |  |  | 939 |  |  | 0.31 |  |  | $ | 954,824 |  |  | 2,206 |  |  | 0.92 |
Savings deposits | 168,377 |  |  | 67 |  |  | 0.16 |  |  | 159,029 |  |  | 90 |  |  | 0.22 |
Time deposits (4) | 432,438 |  |  | 1,477 |  |  | 1.36 |  |  | 651,250 |  |  | 3,499 |  |  | 2.13 |
Securities sold under agreements to repurchase | 21,145 |  |  | 20 |  |  | 0.38 |  |  | 8,617 |  |  | 29 |  |  | 1.29 |
FHLB Advances and other | 219,567 |  |  | 394 |  |  | 0.71 |  |  | 76,404 |  |  | 443 |  |  | 2.31 |
Subordinated notes | 31,881 |  |  | 501 |  |  | 6.28 |  |  | 31,826 |  |  | 490 |  |  | 6.10 |
Total interest-bearing liabilities | 2,086,616 |  |  | 3,398 |  |  | 0.65 |  |  | 1,881,950 |  |  | 6,757 |  |  | 1.42 |
Noninterest-bearing demand deposits | 417,939 |  |  |  |  |  |  | 252,211 |  |  |  |  |
Other | 37,330 |  |  |  |  |  |  | 35,720 |  |  |  |  |
Total Liabilities | 2,541,885 |  |  |  |  |  |  | 2,169,881 |  |  |  |  |
Shareholders’ Equity | 229,621 |  |  |  |  |  |  | 221,250 |  |  |  |  |
Total | $ | 2,771,506 |  |  |  |  |  |  | $ | 2,391,131 |  |  |  |  |
Taxable-equivalent net interest income /net interest spread |  |  | 21,025 |  |  | 3.12 | % |  |  |  | 18,286 |  |  | 3.10 | %
Taxable-equivalent net interest margin |  |  |  |  | 3.24 | % |  |  |  |  |  | 3.30 | %
Taxable-equivalent adjustment |  |  | (207) |  |  |  |  |  |  | (208) |  |  |
Net interest income |  |  | $ | 20,818 |  |  |  |  |  |  | $ | 18,078 |  |  |

NOTES TO ANALYSIS OF NET INTEREST INCOME:
(1) | Yields and interest income on tax-exempt assets have been computed on a taxable-equivalent basis assuming a 21% tax rate.
(2) | Average balances include nonaccrual loans.
(3) | Interest income on loans includes prepayment and late fees.
(4) | For the three months ended September 30, 2019, expenses associated with the early redemption of brokered time deposits totaled $0.2 million and increased the cost of funds by 13 basis points.

For the three months ended September 30, 2020, taxable-equivalent basis net interest income increased by $2.7 million compared with the three months ended September 30, 2019. The increase reflected an increase of $384.2 million in average interest-earning assets partially offset by an increase of $204.7 million in average interest-bearing liabilities from the three months ended September 30, 2019 to the three months ended September 30, 2020. These balances increased due to the SBA PPP loans originated in the nine months ended September 30, 2020, which also generated an increase in deposits.
Taxable-equivalent interest income earned on lo ans increased by $1.4 million year-over-year. The $449.7 million increase in average loan balance year-over-year primarily reflects average loans originated through the SBA PPP of $466.9 million during the three months ended September 30, 2020. For the three months ended September 30, 2020, interest income on loans
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includes $2.2 million of deferred fees recognized associated with the SBA PPP loans. A total of $13.5 million in net deferred fees were recorded for these loans in the second quarter of 2020 to be recognized over the life of the loans, which is between two and five years. The yield on loans was 4.21% for the three months ended September 30, 2020 as compared to 5.02% for the three months ended September 30, 2019. This decline reflects a reduction in market interest rates on variable rate loans in the portfolio as well as a lower yield on the SBA PPP loans, which contributed to 13 basis points of the decline. Accretion of purchase accounting adjustments was $546 thousand for the three months ended September 30, 2020 as compared to $422 thousand for the three months ended September 30, 2019. The three months ended September 30, 2020 and 2019 included $650 thousand and $415 thousand, respectively, of accelerated accretion related to the payoff of purchased credit impaired loans.
Taxable-equivalent securities interest income decreased by $1.5 million year-over-year, with the taxable equivalent yield decreasing from 3.34% for the three months ended September 30, 2019 to 2.14% for the three months ended September 30, 2020. The 120 basis point decrease in taxable-equivalent yield on securities reflected the decreased interest rate environment between years and certain repositioning w ithin the portfolio under the Company's asset/liability management strategies. The impact of the interest rate decline was partially offset by a decrease of $874 thousand in the average balance of securities from the three months ended September 30, 2019 to the three months ended September 30, 2020. As the Bank continues to execute its plan to grow relationship loans, it will work to reduce its investment portfolio to fund some of this loan growth through investment repayments.
Interest expense on interest-bearing liabilities decreased by $3.4 million year-over-year due to a decline of 77 basis points in the cost of interest-bearing liabilities. The impact of a significant decline in market interest rates was partially offset by the average balance of interest-bearing deposits increasing by $48.9 million and the average balance of total borrowings increasing by $155.7 million. The increase in these balances was due primarily to the SBA PPP loans originated during the nine months ended September 30, 2020. During the second quarter of June 30, 2020, the Company obtained funding through the Federal Reserve’s Paycheck Protection Program Liquidity Facility ("PPPLF"), which had an average balance of $68.5 million during the three months ended September 30, 2020. The balance of deposits and borrowings associated with the SBA PPP loans are expected to decline significantly into the first half of 2021 as the funds are drawn by the borrowers and the loans are forgiven by the SBA.
Provision for Loan Losses
Asset quality trends continue to be solid with a low level of charge-offs and nonperforming loans. The provision for loan losses totaled $2.2 million for the three months ended September 30, 2020 compared with $300 thousand for the same period in 2019. The provision recorded in the three months ended September 30, 2020 w as driven by an increase in qualitative factor assumptions as a result of the COVID-19 pandemic. Due to continuing uncertainty in the external environment, management increased the qualitative factors for certain commercial loan segments in the Bank’s allowance for loan loss analysis in the three months ended September 30, 2020. Net recoveries in the three months ended September 30, 2020 totaled $8 thousand, as compared to $49 thousand of net recoveries in the comparable prior year period. Nonperforming loans were 0.39% of gross loans at September 30, 2020, compared with 0.65% of gross loans at December 31, 2019. Nonperforming loans decreased by $2.8 million f rom December 31, 2019 to September 30, 2020 due primarily to a measurement period adjustment for the transfer of a $2.6 million loan from the Hamilton acquisition into the PCI pool during the three months ended March 31, 2020.
Additional information is included in the "Credit Risk Management" section herein.
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Noninterest Income
The following table compares noninterest income for the three months ended September 30, 2020 and 2019:

| Three Months Ended September 30, |  | $ Change |  | % Change
| 2020 |  | 2019 |  | 2020-2019 |  | 2020-2019
Service charges on deposit accounts | $ | 684 |  |  | $ | 918 |  |  | $ | (234) |  |  | (25) | %
Interchange income | 900 |  |  | 843 |  |  | 57 |  |  | 7 | %
Other service charges, commissions and fees | 168 |  |  | 193 |  |  | (25) |  |  | (13) | %
Swap fees | 95 |  |  | 629 |  |  | (534) |  |  | — | %
Trust and investment management income | 1,713 |  |  | 1,892 |  |  | (179) |  |  | (9) | %
Brokerage income | 751 |  |  | 654 |  |  | 97 |  |  | 15 | %
Mortgage banking activities | 1,985 |  |  | 623 |  |  | 1,362 |  |  | 219 | %
Income from life insurance | 543 |  |  | 479 |  |  | 64 |  |  | 13 | %
Other income | 35 |  |  | 44 |  |  | (9) |  |  | (20) | %
Subtotal before securities (losses) gains | 6,874 |  |  | 6,275 |  |  | 599 |  |  | 10 | %
Investment securities (losses) gains | (13) |  |  | 2,328 |  |  | (2,341) |  |  | (101) | %
Total noninterest income | $ | 6,861 |  |  | $ | 8,603 |  |  | $ | (1,742) |  |  | (20) | %

The following factors contributed to the more significant changes in noninterest income between the three months ended September 30, 2020 and 2019:
•Service charges on deposit accounts decreased by $234 thousand due primarily to waivers of ATM fees in response to the COVID-19 pandemic and reductions in overdraft charges from lower deposit account usage during the three months ended September 30, 2020 due to the pandemic.
•In the three months ended September 30, 2020, the Company recognized $534 thousand less of swap fee income than in the three months ended September 30, 2019. Swap fee income fluctuates based on the number of transactions entered into in a period.
•Mortgage banking income increased by $1.4 million. Refinance activity remained strong in the three months ended September 30, 2020 due to the decrease in interest rates, and the gain on sale margin increased. Mortgage loans sold in the three months ended September 30, 2020 totaled $72.8 million compared with $34.4 million in the three months ended September 30, 2019. In addition, there was an increase of $157 thousand in the fair value of interest rate lock commitments in the three months ended September 30, 2020 as compared to the three months ended September 30, 2019. During the three months ended September 30, 2020, the Company recorded an MSR impairment charge of $166 thousand driven by significant market interest rate reductions caused by the COVID-19 pandemic, partially offsetting the mortgage gains.
•Trust and investment management income declined by $179 thousand from the three months ended September 30, 2019 to the three months ended September 30, 2020 due primarily to the overall market decline caused by the COVID-19 pandemic.
•During the three months ended September 30, 2020, the Company recorded net investment securities losses of $13 thousand due to the change in the value of an equity security. There were no investment sales during this period. The Company recognized net investment securities gains of $2.3 million in 2019 as opportunities became available to reposition part of the investment portfolio under asset/liability management strategies or to improve responsiveness of the portfolio to interest rate conditions, while also considering funding requirements of anticipated lending activity.
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Noninterest Expenses
The following table compares noninterest expenses for the three months ended September 30, 2020 and 2019:

| Three Months Ended September 30, |  | $ Change |  | % Change
| 2020 |  | 2019 |  | 2020-2019 |  | 2020-2019
Salaries and employee benefits | $ | 10,695 |  |  | $ | 10,489 |  |  | $ | 206 |  |  | 2.0 | %
Occupancy | 1,231 |  |  | 1,133 |  |  | 98 |  |  | 8.6 | %
Furniture and equipment | 1,203 |  |  | 1,252 |  |  | (49) |  |  | (3.9) | %
Data processing | 958 |  |  | 830 |  |  | 128 |  |  | 15.4 | %
Automated teller machine and interchange fees | 278 |  |  | 270 |  |  | 8 |  |  | 3.0 | %
Advertising and bank promotions | 197 |  |  | 279 |  |  | (82) |  |  | (29.4) | %
FDIC insurance | 230 |  |  | (9) |  |  | 239 |  |  | (2655.6) | %
Other professional services | 603 |  |  | 814 |  |  | (211) |  |  | (25.9) | %
Directors' compensation | 214 |  |  | 228 |  |  | (14) |  |  | (6.1) | %
Taxes other than income | 453 |  |  | 306 |  |  | 147 |  |  | 48.0 | %
Intangible asset amortization | 357 |  |  | 486 |  |  | (129) |  |  | (26.5) | %
Merger related and branch consolidation expenses | 1,310 |  |  | 471 |  |  | 839 |  |  | 178.1 | %
Other operating expenses | 1,536 |  |  | 1,591 |  |  | (55) |  |  | (3.5) | %
Total noninterest expenses | $ | 19,265 |  |  | $ | 18,140 |  |  | $ | 1,125 |  |  | 6.2 | %

The following factors contributed to the more significant changes in noninterest expenses between the three months ended September 30, 2020 and 2019:
•The increase in salaries and employee benefits partially reflected $115 thousand of severance costs recorded in the three months ended September 30, 2020. In addition, the increase included the impact of our overall expansion efforts and incremental expense for additional share-based compensation awards granted in 2020, net of the benefit of forfeitures.
•Advertising and bank promotions decreased by $82 thousand due primarily to targeted campaigns in the prior year which did not recur in 2020, as well as reduced marketing efforts in 2020 due to the COVID-19 pandemic.
•FDIC insurance expense increased by $239 thousand. This 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 bill ion, after the reserve ratio reaches 1.38% (and provided that it remains at least 1.38%), the FDIC will automatically apply credits to reduce regular deposit insurance assessments up to the full amount of their assessments or the full amount of their credits, whichever is less. The reserve ratio reached 1.40% on June 30, 2019. Therefore, credits were first applied during the third quarter of 2019. The final credit was applied as of the March 31, 2020 payment as the reserve ratio was sufficiently maintained.
•Other professional services decreased by $211 thousand due to non-recurring consulting expenses incurred in the prior year period.
•The Company incurred $1.3 million in costs related to the consolidation of six branches and three loan production offices announced in the third quarter of 2020. The three months ended September 30, 2019 includes $471 thousand of costs associated with the Hamilton merger.
•Other line items within noninterest expenses showed fluctuations between 2020 and 2019 attributable to normal business operations and the impact of acquisitions.
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Income Tax Expense
Income tax expense totaled $1.2 million, an effective tax rate of 19.9%, for the three months ended September 30, 2020, compared with $1.3 million, an effective tax rate of 16.3%, for the three months ended September 30, 2019. The Company’s effective tax rate is less than the 21% federal statutory rate, principally due to tax-free income, which includes interest income on tax-free loans and securities and income from life insurance policies, federal income tax credits, and the impact of non-tax deductible expenses, including merger related expenses. The difference in the effective tax rate from the three months ended September 30, 2019 to the three months ended September 30, 2020 was primarily due to an increase in estimated earnings before income taxes.
Nine months ended September 30, 2020 compared with nine months ended September 30, 2019
Summary
Net income totaled $16.4 million for the nine months ended September 30, 2020 compared with net income of $12.7 million for the same period in 2019. Diluted earnings per share for the nine months ended September 30, 2020 totaled $1.49, compared with $1.23 for the nine months ended September 30, 2019. Net interest income positively influenced results of operations, and totaled $59.9 million for the nine months ended September 30, 2020, a $8.5 million increase compared with 2019. Noninterest income, excluding investment securities gains, totaled $21.2 million for the nine months ended September 30, 2020 compared with $16.8 million in 2019. Investment securities losses totaled $44 thousand in the nine months ended September 30, 2020, compared with net gains of $4.7 million for the same period in 2019. Noninterest expenses totaled $56.0 million and $57.6 million for the nine months ended September 30, 2020 and 2019, respectively.
The comparability of operating results for 2020 with 2019 have generally been impacted by the Hamilton acquisition completed on May 1, 2019 and the SBA PPP loans originated in the nine months ended September 30, 2020.
Net Interest Income
Net interest income increased by $8.5 million, from $51.4 million to $59.9 million, for the nine months ended September 30, 2020 compared with the nine months ended September 30, 2019. Interest income on loans increased by $8.6 million, from $55.0 million to $63.6 million, securities interest income decreased $3.2 million, from $12.7 million to $9.5 million, and total interest expense decreased $4.3 million from $17.6 million to $13.3 million, in comparing the nine months ended September 30, 2020 with the nine months ended September 30, 2019.
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The following table presents net interest income, net interest spread and net interest margin for the nine months ended September 30, 2020 and 2019 on a taxable-equivalent basis:

| Nine Months Ended September 30, 2020 |  | Nine Months Ended September 30, 2019
| Average Balance |  | Taxable- Equivalent Interest |  | Taxable- Equivalent Rate |  | Average Balance |  | Taxable- Equivalent Interest |  | Taxable- Equivalent Rate
Assets |  |  |  |  |  |  |  |  |  |  |
Federal funds sold & interest-bearing bank balances | $ | 27,315 |  |  | $ | 101 |  |  | 0.49 | % |  | $ | 70,020 |  |  | $ | 1,232 |  |  | 2.35 | %
Securities (1) | 496,977 |  |  | 9,797 |  |  | 2.63 |  |  | 497,949 |  |  | 13,219 |  |  | 3.55 |
Loans (1)(2)(3) | 1,899,186 |  |  | 63,940 |  |  | 4.50 |  |  | 1,454,468 |  |  | 55,360 |  |  | 5.09 |
Total interest-earning assets | 2,423,478 |  |  | 73,838 |  |  | 4.07 |  |  | 2,022,437 |  |  | 69,811 |  |  | 4.62 |
Other assets | 193,057 |  |  |  |  |  |  | 169,308 |  |  |  |  |
Total | $ | 2,616,535 |  |  |  |  |  |  | $ | 2,191,745 |  |  |  |  |
Liabilities and Shareholders’ Equity |  |  |  |  |  |  |  |  |  |  |
Interest-bearing demand deposits | $ | 1,113,740 |  |  | 4,100 |  |  | 0.49 |  |  | $ | 907,911 |  |  | 6,117 |  |  | 0.90 |
Savings deposits | 160,133 |  |  | 194 |  |  | 0.16 |  |  | 144,825 |  |  | 232 |  |  | 0.21 |
Time deposits (4) | 466,032 |  |  | 5,853 |  |  | 1.68 |  |  | 539,385 |  |  | 8,053 |  |  | 2.00 |
Securities sold under agreements to repurchase | 17,395 |  |  | 72 |  |  | 0.55 |  |  | 8,708 |  |  | 85 |  |  | 1.31 |
FHLB Advances and other | 194,197 |  |  | 1,604 |  |  | 1.10 |  |  | 98,451 |  |  | 1,640 |  |  | 2.23 |
Subordinated notes | 31,867 |  |  | 1,504 |  |  | 6.29 |  |  | 31,843 |  |  | 1,486 |  |  | 6.24 |
Total interest-bearing liabilities | 1,983,364 |  |  | 13,327 |  |  | 0.90 |  |  | 1,731,123 |  |  | 17,613 |  |  | 1.36 |
Noninterest-bearing demand deposits | 373,614 |  |  |  |  |  |  | 230,056 |  |  |  |  |
Other | 35,874 |  |  |  |  |  |  | 30,286 |  |  |  |  |
Total Liabilities | 2,392,852 |  |  |  |  |  |  | 1,991,465 |  |  |  |  |
Shareholders’ Equity | 223,683 |  |  |  |  |  |  | 200,280 |  |  |  |  |
Total | $ | 2,616,535 |  |  |  |  |  |  | $ | 2,191,745 |  |  |  |  |
Taxable-equivalent net interest income /net interest spread |  |  | 60,511 |  |  | 3.17 | % |  |  |  | 52,198 |  |  | 3.25 | %
Taxable-equivalent net interest margin |  |  |  |  | 3.34 | % |  |  |  |  |  | 3.45 | %
Taxable-equivalent adjustment |  |  | (633) |  |  |  |  |  |  | (845) |  |  |
Net interest income |  |  | $ | 59,878 |  |  |  |  |  |  | $ | 51,353 |  |  |

NOTES TO ANALYSIS OF NET INTEREST INCOME:
(1) | Yields and interest income on tax-exempt assets have been computed on a taxable-equivalent basis assuming a 21% tax rate.
(2) | Average balances include nonaccrual loans.
(3) | Interest income on loans includes prepayment and late fees.
(4) | For the nine months ended September 30, 2019, expenses associated with the early redemption of brokered time deposits totaled $0.2 million, and increased the cost of funds by five basis points.

For the nine months ended September 30, 2020, taxable-equivalent basis net interest income increased by $8.3 million compared with the nine months ended September 30, 2019. The increase reflected an increase of $401.0 million in average interest-earning assets partially offset by an increase of $252.2 million in average interest-bearing liabilities from the nine months ended September 30, 2019 to the nine months ended September 30, 2020. These balances increased primarily due to the SBA PPP loans originated in the nine months ended September 30, 2020, as well as loans acquired from Hamilton on May 1, 2019.
Taxable-equivalent interest income earned on lo ans increased by $8.6 million year-over-year. The $444.7 million increase in average loan balance year-over-year reflects four extra months of Hamilton loans in the nine months ended September 30, 2020 as compared to the same prior year period. In addition, SBA PPP loans averaged $274.4 million during the nine months ended September 30, 2020 as compared to $0 in the nine months ended September 30, 2019. There was an offsetting decrease
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in residential mortgage loans during the period due to significant refinance activity resulting from the low interest rate environment. For the nine months ended September 30, 2020, interest income on loans includes $4.0 m illion of net deferred fees recognized associated with the SBA PPP loans. A total of $13.5 million in net deferred fees were recorded for these loans to be recognized over the life of the loans, which is between two and five years. The yield on loans w as 4.50% for the nine months ended September 30, 2020 as compared to 5.09% for the nine months ended September 30, 2019. This decline reflects a reduction in market interest rates on variable rate loans in the portfolio, as well as a lower yield on the SBA PPP loans, which contributed to 13 basis points of the decline. Accretion of purchase accounting adjustments was $2.5 million for the nine months ended September 30, 2020 as compared to $1.8 million for the nine months ended September 30, 2019. The nine months ended September 30, 2020 and 2019 include d $1.4 million and $1.1 million, respectively, of accelerated accretion related to the payoff of purchased credit impaired loans.
Taxable-equivalent securities interest income decreased by $3.4 million year-over-year, with the taxable equivalent yield decreasing from 3.55% for the nine months ended September 30, 2019 to 2.63% for the nine months ended September 30, 2020. The 92 basis point decrease i n taxable-equivalent yield on securities reflected the decreased interest rate environment between years and certain repositioning within the portfolio under the Company's asset/liability management strategies. The impact of the interest rate decline was partially offset by a decrease of $1.0 million in the average balance of securities from the nine months ended September 30, 2019 to the nine months ended September 30, 2020. As the Bank continues to execute its plan to grow relationship loans, it will work to reduce its investment portfolio to fund some of this loan growth through investment repayments.
Interest expense on deposits and borrowings decreased by $4.3 million year-over-year, with the average balance of interest-bearing deposits increasing by $147.8 million and the average balance of total borrowings increasing by $104.5 million. The increase in these balances was due primarily to the SBA PPP loans originated during the nine months ended September 30, 2020. During the nine months ended September 30, 2020, the Company obtained funding through the PPPLF with an average balance of $23.9 million during the nine months ended September 30, 2019. The balance of deposits and borrowings associated with the SBA PPP loans are expected to decline significantly into the first half of 2021 as the funds are drawn by the borrowers and the loans are forgiven by the SBA.
Provision for Loan Losses
Asset quality trends continue to be solid with a low level of charge-offs and nonperforming loans. The provision for loan losses totaled $5.0 million for the nine months ended September 30, 2020 compared with $900 thousand for the same period in 2019. The provision recorded in the nine months ended September 30, 2020 was driven by an increase in qualitative factor assumptions as a result of the COVID-19 pandemic. Net recoveries in the nine mo nths ended September 30, 2020 totaled $45 thousand, as compared to net charge-offs of $105 thousand in the comparable prior year period. Nonperforming loans were 0.39% of gross loans at September 30, 2020, compared with 0.65% of gross loans at December 31, 2019. Nonperforming loans decreased by $2.8 million from December 31, 2019 to September 30, 2020 due primarily to a measurement period adjustment for the transfer of a $2.6 million loan from the Hamilton acquisition into the PCI pool during the nine months ended September 30, 2020.
Additional information is included in the "Credit Risk Management" section herein.
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Noninterest Income
The following table compares noninterest income for the nine months ended September 30, 2020 and 2019:

| Nine Months Ended September 30, |  | $ Change |  | % Change |
| 2020 |  | 2019 |  | 2020-2019 |  | 2020-2019 |
Service charges on deposit accounts | $ | 2,085 |  |  | $ | 2,508 |  |  | $ | (423) |  |  | (17) | % |
Interchange income | 2,507 |  |  | 2,422 |  |  | 85 |  |  | 4 | % |
Other service charges, commissions and fees | 473 |  |  | 583 |  |  | (110) |  |  | (19) | % |
Swap fees | 527 |  |  | 629 |  |  | (102) |  |  | — | % |
Trust and investment management income | 5,049 |  |  | 5,399 |  |  | (350) |  |  | (6) | % |
Brokerage income | 2,069 |  |  | 1,804 |  |  | 265 |  |  | 15 | % |
Mortgage banking activities | 3,926 |  |  | 1,743 |  |  | 2,183 |  |  | 125 | % |
Gain on sale of portfolio loans | 2,803 |  |  | — |  |  | 2,803 |  |  | — | % |
Income from life insurance | 1,615 |  |  | 1,505 |  |  | 110 |  |  | 7 | % |
Other income | 118 |  |  | 188 |  |  | (70) |  |  | (37) | % |
Subtotal before securities (losses) gains | 21,172 |  |  | 16,781 |  |  | 4,391 |  |  | 26 | % |
Investment securities (losses) gains | (44) |  |  | 4,731 |  |  | (4,775) |  |  | (101) | % |
Total noninterest income | $ | 21,128 |  |  | $ | 21,512 |  |  | $ | (384) |  |  | (2) | % |

The following factors contributed to the more significant changes in noninterest income between the nine months ended September 30, 2020 and 2019:
•Service charges on deposit accounts decreased due primarily to waivers of ATM fees in response to the COVID-19 pandemic and reductions in overdraft charges from lower deposit account usage during the nine months ended September 30, 2020 due to the pandemic.
•Mortgage banking income increased by $2.2 million. Refinance activity was strong in the second and third quarters of 2020 due to the decrease in interest rates, and the gain on sale margin increased. Loans sold in the nine months ended September 30, 2020 totaled $144.5 million compared with $109.1 million in the nine months ended September 30, 2019. In addition, there was an increase of $1.0 million in the fair value of interest rate lock commitments in the nine months ended September 30, 2020. The Company began recognizing this income in the fourth quarter of 2019. During the nine months ended September 30, 2020, the Company recorded MSR impairment charges totaling $986 thousand driven by significant market interest rate reductions caused by the COVID-19 pandemic, partially offsetting the mortgage gains.
•During the nine months ended September 30, 2020, the Bank recorded $2.8 million in gains due to the sale of $10.9 m illion of classified loans for net gains of $2.5 million, and the sale of an $11.0 million portfolio of recreational vehicle loans for a gain of $314 thousand.
•During the nine months ended September 30, 2020, the Company recorded net investment securities losses of $44 thousand due to the decrease in the value of an equity security. The Company recognized net investment securities gains of $4.7 million in 2019 as opportunities became available to reposition part of the investment portfolio under asset/liability management strategies or to improve responsiveness of the portfolio to interest rate conditions, while also considering funding requirements of anticipated lending activity.
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Noninterest Expenses
The following table compares noninterest expenses for the nine months ended September 30, 2020 and 2019:

| Nine Months Ended September 30, |  | $ Change |  | % Change
| 2020 |  | 2019 |  | 2020-2019 |  | 2020-2019
Salaries and employee benefits | $ | 32,352 |  |  | $ | 28,088 |  |  | $ | 4,264 |  |  | 15.2 | %
Occupancy | 3,480 |  |  | 3,200 |  |  | 280 |  |  | 8.8 | %
Furniture and equipment | 3,569 |  |  | 3,415 |  |  | 154 |  |  | 4.5 | %
Data processing | 2,620 |  |  | 2,658 |  |  | (38) |  |  | (1.4) | %
Automated teller machine and interchange fees | 778 |  |  | 744 |  |  | 34 |  |  | 4.6 | %
Advertising and bank promotions | 1,153 |  |  | 1,348 |  |  | (195) |  |  | (14.5) | %
FDIC insurance | 491 |  |  | 397 |  |  | 94 |  |  | 23.7 | %
Other professional services | 2,340 |  |  | 2,078 |  |  | 262 |  |  | 12.6 | %
Directors' compensation | 679 |  |  | 725 |  |  | (46) |  |  | (6.3) | %
Taxes other than income | 904 |  |  | 926 |  |  | (22) |  |  | (2.4) | %
Intangible asset amortization | 1,224 |  |  | 1,096 |  |  | 128 |  |  | 11.7 | %
Merger related and branch consolidation expenses | 1,310 |  |  | 7,976 |  |  | (6,666) |  |  | (83.6) | %
Insurance claim receivable (recovery) write off | (486) |  |  | 615 |  |  | (1,101) |  |  | (179.0) | %
Other operating expenses | 5,586 |  |  | 4,327 |  |  | 1,259 |  |  | 29.1 | %
Total noninterest expenses | $ | 56,000 |  |  | $ | 57,593 |  |  | $ | (1,593) |  |  | (2.8) | %

The following factors contributed to the more significant changes in noninterest expenses between the nine months ended September 30, 2020 and 2019:
•Expanded operations with the addition of employees and branches from the Hamilton acquisition in May 2019.
•The increase in salaries and employee benefits principally reflected employees added in the Hamilton acquisition and prior year additions to the Bank’s commercial lending team. In addition, the increase included the impact of annual merit increases, and incremental expense for additional share-based compensation awards granted in 2020, net of the benefit of forfeitures.
•Occupancy and furniture and equipment costs reflected the Hamilton branches acquired.
•Advertising and bank promotions decreased by $195 thousand due primarily to due primarily to targeted campaigns in the prior year which did not recur in 2020, as well as reduced marketing efforts in 2020 due to the COVID-19 pandemic.
•Other professional services increased by $262 thousand due to legal costs incurred in the nine months ended September 30, 2020 in connection with the SEPTA litigation.
•Intangible asset amortization increased principally due to amortization of core deposit intangibles recorded in the Hamilton acquisition.
•The Company recorded $1.3 million of expenses in the three months ended September 30, 2020 associated with the announced consolidation of six branch locations and three loan production offices. The Company incurred merger related expenses in the nine months ended September 30, 2019 for data processing contract termination costs, employee contract termination costs and legal and consulting fees for the Hamilton acquisition. System conversion expenses were also recorded for the Mercersburg acquisition in the first quarter of 2019.
•In the nine months ended September 30, 2019, the Company incurred a $615 thousand expense to write off an insurance claim receivable from a 2018 cyber security incident. During the nine months ended September 30, 2020, $486 thousand of this expense was recovered through refunds received from the insurance company.
•Other operating expenses increased by $1.3 million due primarily to $724 tho usand in expenses associated with the sale of a property in the third quarter of 2020, an increase of $172 thousand in the reserve for unfunded commitments due to increased qualitative factors and an impairment charge of $152 thousand o n a customer list intangible asset due to the discontinuance of Wheatland Advisors, Inc., effective July 31, 2020, during the nine months ended September 30, 2020.
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•Other line items within noninterest expenses showed fluctuations between 2020 and 2019 attributable to normal business operations and the impact of acquisitions.
Income Tax Expense
Income tax expense totaled $3.6 million, an effective tax rate of 17.9%, for the nine months ended September 30, 2020, compared with $1.7 million, an effective tax rate of 11.7%, for the nine months ended September 30, 2019. The Company’s effective tax rate is less than the 21% federal statutory rate, principally due to tax-free income, which includes interest income on tax-free loans and securities and income from life insurance policies, federal income tax credits, and the impact of non-tax deductible expenses, including merger related expenses. The Company recorded a tax benefit of $185 thousand during the nine months ended September 30, 2019, related to a favorable tax law clarification concerning the treatment of life insurance assets of an acquired entity. In the prior year period, the Company also recorded a tax benefit of $334 thousand 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. These tax benefits had the effect of lowering the effective tax rate for the six months ended June 30, 2019 by approximately 3.6%. The remaining difference in the effective tax rate from the nine months ended September 30, 2019 to the nine months ended September 30, 2020 was due to an increase in estimated earnings before income taxes.
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FINANCIAL CONDITION
Management devotes substantial time to overseeing the investment of funds in loans and securities and the formulation of policies directed toward the profitability and management of the risks associated with these investments.
Investment Securities
The Company utilizes investment securities 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, 2020, investment securities totaled $478.3 million, a decrease of $12.6 million, from the $490.9 million balance at December 31, 2019. The balance of investment securities included net unrealized losses of $188 thousand at September 30, 2020 as c ompared to net unrealized losses of $607 thousand at December 31, 2019. This increase reflects market improvement throughout 2020 despite the significant reduction in market rates in the nine months ended September 30, 2020, resulting from market uncertainty related to the COVID-19 pandemic.
In the nine months ended September 30, 2020, the Company realized net losses totaling $44 thousand due to a market value adjustment to an equity security, compared to net investment security gains of $4.7 million for the nine months ended September 30, 2019.
Loan Portfolio
The Company offers a variety of products to meet the credit needs of its borrowers, principally commercial real estate loans, commercial and industrial loans, and retail loans consisting of loans secured by residential properties, and to a lesser extent, installment loans. No loans are extended to non-domestic borrowers or governments.
The risks associated with lending activities differ among loan classes and are subject to the impact of changes in interest rates, market conditions of collateral securing the loans and general economic conditions. Any of these factors may adversely impact a borrower’s ability to repay loans, and also impact the associated collateral. See Note 4, Loans and Allowance for Loan Losses, to the unaudited condensed consolidated financial statements under Part I, Item 1, "Financial Information," for a description of the Company’s loan classes and differing levels of associated credit risk.
The following table presents the loan portfolio, excluding residential LHFS, by segment and class at September 30, 2020 and December 31, 2019:

| September 30, 2020 |  | December 31, 2019
Commercial real estate: |  |  |
Owner occupied | $ | 166,623 |  |  | $ | 170,884 |
Non-owner occupied | 403,138 |  |  | 361,050 |
Multi-family | 110,153 |  |  | 106,893 |
Non-owner occupied residential | 111,958 |  |  | 120,038 |
Acquisition and development: |  |  |
1-4 family residential construction | 9,627 |  |  | 15,865 |
Commercial and land development | 37,850 |  |  | 41,538 |
Commercial and industrial (1) | 690,330 |  |  | 214,554 |
Municipal | 28,867 |  |  | 47,057 |
Residential mortgage: |  |  |
First lien | 273,149 |  |  | 336,372 |
Home equity - term | 11,108 |  |  | 14,030 |
Home equity - lines of credit | 158,106 |  |  | 165,314 |
Installment and other loans | 28,961 |  |  | 50,735 |
| $ | 2,029,870 |  |  | $ | 1,644,330 |

(1) This balance includes $458.1 million and $0 of SBA PPP loans at September 30, 2020 and December 31, 2019, respectively.
Total loans grew by $385.5 million from December 31, 2019 to September 30, 2020. This increase is due primarily to the origination of SBA PPP loans during the nine months ended September 30, 2020. These loans, net of deferred fees, totaled $458.1 million at September 30, 2020. This increase was partially offset by a reduction in residential mortgage loans due to
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significant refinancing activity. In addition, the Company sold $10.9 million in classified loans and $11.0 million of acquired recreational vehicle loans during the nine months ended September 30, 2020.
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.
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The following table presents the Company’s risk elements, including the aggregate balances of nonaccrual loans, restructured loans still accruing, loans past due 90 days or more, and OREO as of September 30, 2020 and December 31, 2019. Relevant asset quality ratios are also presented.

| September 30, 2020 |  | December 31, 2019 |  |
Nonaccrual loans | $ | 7,899 |  |  | $ | 10,657 |  |  |
OREO | — |  |  | 197 |  |  |
Total nonperforming assets | 7,899 |  |  | 10,854 |  |  |
Restructured loans still accruing | 945 |  |  | 979 |  |  |
Loans past due 90 days or more and still accruing | 520 |  |  | 2,232 |  |  |
Total nonperforming and other risk assets | $ | 9,364 |  |  | $ | 14,065 |  |  |
Loans 30-89 days past due | $ | 2,924 |  |  | $ | 17,527 |  |  |
Asset quality ratios: |  |  |  |  |
Total nonperforming loans to total loans | 0.39 | % |  | 0.65 | % |  |
Total nonperforming assets to total assets | 0.28 | % |  | 0.46 | % |  |
Total nonperforming assets to total loans and OREO | 0.39 | % |  | 0.66 | % |  |
Total risk assets to total loans and OREO | 0.46 | % |  | 0.86 | % |  |
Total risk assets to total assets | 0.34 | % |  | 0.59 | % |  |
ALL to total loans | 0.97 | % |  | 0.89 | % |  |
ALL to nonperforming loans | 249.72 | % |  | 137.52 | % |  |
ALL to nonperforming loans and restructured loans still accruing | 223.03 | % |  | 125.95 | % |  |

Total nonperforming and other risk assets decreased by $4.7 million, or 33.4%, from December 31, 2019 to September 30, 2020. The principal driver for this decrease is a measurement period adjustment for the transfer of a $2.6 million loan from the Hamilton acquisition into the PCI pool during the nine months ended September 30, 2020. In addition, loans past due 90 days and still accruing decreased by $1.7 million due primarily to loans sold from the portfolio in the nine months ended September 30, 2020.
The following table presents detail of impaired loans at September 30, 2020 and December 31, 2019:

| September 30, 2020 |  | December 31, 2019
| Nonaccrual Loans |  | Restructured Loans Still Accruing |  | Total |  | Nonaccrual Loans |  | Restructured Loans Still Accruing |  | Total
Commercial real estate: |  |  |  |  |  |  |  |  |  |  |
Owner occupied | $ | 3,313 |  |  | $ | 28 |  |  | $ | 3,341 |  |  | $ | 5,842 |  |  | $ | 30 |  |  | $ | 5,872 |
Multi-family | 74 |  |  | — |  |  | 74 |  |  | 345 |  |  | — |  |  | 345 |
Non-owner occupied residential | 275 |  |  | — |  |  | 275 |  |  | 235 |  |  | — |  |  | 235 |
Acquisition and development: |  |  |  |  |  |  |  |  |  |  |
Commercial and land development | 837 |  |  | — |  |  | 837 |  |  | — |  |  | — |  |  | — |
Commercial and industrial | 755 |  |  | — |  |  | 755 |  |  | 1,763 |  |  | — |  |  | 1,763 |
Residential mortgage: |  |  |  |  |  |  |  |  |  |  |
First lien | 1,927 |  |  | 908 |  |  | 2,835 |  |  | 1,659 |  |  | 931 |  |  | 2,590 |
Home equity - term | 11 |  |  | — |  |  | 11 |  |  | 13 |  |  | — |  |  | 13 |
Home equity - lines of credit | 687 |  |  | 9 |  |  | 696 |  |  | 715 |  |  | 18 |  |  | 733 |
Installment and other loans | 20 |  |  | — |  |  | 20 |  |  | 85 |  |  | — |  |  | 85 |
| $ | 7,899 |  |  | $ | 945 |  |  | $ | 8,844 |  |  | $ | 10,657 |  |  | $ | 979 |  |  | $ | 11,636 |

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The following table presents our exposure to borrowers with impaired loans, partial charge-offs taken to date and specific reserves established on the borrowing relationships at September 30, 2020 and December 31, 2019. Of the relationships deemed to be impaired at September 30, 2020, one had a recorded balance in excess of $1.0 million, and 67, or 42.9%, of total impaired loans, had recorded balances of less than $250 thousand.

| # of Relationships |  | Recorded Investment |  | Partial Charge-offs to Date |  | Specific Reserves
September 30, 2020 |  |  |  |  |  |  |
Relationships greater than $1,000,000 | 1 |  |  | $ | 2,764 |  |  | $ | — |  |  | $ | — |
Relationships greater than $500,000 but less than $1,000,000 | 1 |  |  | 689 |  |  | 17 |  |  | — |
Relationships greater than $250,000 but less than $500,000 | 5 |  |  | 1,595 |  |  | 242 |  |  | — |
Relationships less than $250,000 | 67 |  |  | 3,796 |  |  | 459 |  |  | 35 |
| 74 |  |  | $ | 8,844 |  |  | $ | 718 |  |  | $ | 35 |
December 31, 2019 |  |  |  |  |  |  |
Relationships greater than $1,000,000 | 2 |  |  | $ | 5,218 |  |  | $ | — |  |  | $ | — |
Relationships greater than $500,000 but less than $1,000,000 | 2 |  |  | 1,516 |  |  | 17 |  |  | — |
Relationships greater than $250,000 but less than $500,000 | 3 |  |  | 980 |  |  | — |  |  | — |
Relationships less than $250,000 | 68 |  |  | 3,922 |  |  | 781 |  |  | 36 |
| 75 |  |  | $ | 11,636 |  |  | $ | 798 |  |  | $ | 36 |

The Company takes partial charge-offs on collateral-dependent loans when carrying value exceeds estimated fair value, as determined by the most recent appraisal adjusted for current (within the quarter) conditions, less costs to dispose. Impairment reserves remain in place if updated appraisals are pending, and represent management’s estimate of potential loss.
Internal loan reviews are completed annually on all commercial relationships with a committed loan balance in excess of $1.0 million, which includes confirmation of risk rating by an independent credit officer. In addition, all relationships greater than $500 thousand rated Substandard, Doubtful or Loss are reviewed and corresponding risk ratings are reaffirmed by the Bank's Problem Loan Committee, with subsequent reporting to the Management ERM Committee.
In its individual loan impairment analysis, the Company determines the extent of any full or partial charge-offs that may be required, or any reserves that may be needed. The determination of the Company’s charge-offs or impairment reserve include an evaluation of the outstanding loan balance and the related collateral securing the credit. Through a combination of collateral securing the loans and partial charge-offs taken to date, the Company believes that it has adequately provided for the potential losses that it may incur on these relationships at September 30, 2020. However, over time, additional information may result in increased reserve allocations or, alternatively, it may be deemed that the reserve allocations exceed those that are needed.
In an effort to assist clients which were negatively impacted by the COVID-19 pandemic, the Bank offered various mitigation options, including a loan payment deferral program. Under this program, most commercial deferrals were for a 90-day period, while most consumer deferrals were for a 180-day period. As of September 30, 2020, the Company had loan deferrals under this program for commercial and consumer clients with a total loan balance of $61.6 million and $16.8 million, respectively. In accordance with the revised Interagency Statement on Loan Modifications by Financial Institutions Working with Customers Affected by the Coronavirus issued on April 7, 2020, these deferrals are exempt from TDR status as they meet the specified requirements. Below is a summary of select loan concentrations and the deferrals within those categories at September 30, 2020.
The following table summarizes COVID-19 related modifications, including deferrals and forbearances:

Loan Type |  | Amount of Loans |  | Percent of Non-PPP Loans
| September 30, 2020 |  | June 30, 2020 |  | September 30, 2020 |  | June 30, 2020
Commercial |  | $ | 61,597 |  |  | $ | 218,060 |  |  | 5.6 | % |  | 20.0 | %
Consumer Portfolio Loans |  | 16,845 |  |  | 21,209 |  |  | 3.6 |  |  | 4.2 |
Total Loans |  | $ | 78,442 |  |  | $ | 239,269 |  |  | 5.0 | % |  | 15.1 | %

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The following table summarizes COVID-19 related deferral balances within certain industry segments at September 30, 2020:

Industry Segment |  | Balance |  | % of Total non-PPP Loans |  | $ Non-PPP Segment Total |  | % of non-PPP Segment
Hotel/Motel |  | $ | 22,288 |  |  | 1.4 | % |  | $ | 48,559 |  |  | 45.9 | %
Restaurant/Bar |  | 7,229 |  |  | 0.5 |  |  | 31,817 |  |  | 22.7 |
Multi-Family CRE |  | 16,613 |  |  | 1.1 |  |  | 110,417 |  |  | 15.1 |
Strip Center/Retail |  | — |  |  | — |  |  | 51,402 |  |  | — |
Senior Housing |  | — |  |  | — |  |  | 42,508 |  |  | — |

The Company’s OREO balance was $0 at September 30, 2020. The balance of $197 thousand at December 31, 2019 consisted of two commercial and one residential properties. All OREO properties are carried at the lower of cost or fair value, less costs to dispose.
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 unaudited condensed consolidated financial statements under Part I, Item 1, "Financial Information."
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The following table summarizes the Company’s internal risk ratings at September 30, 2020 and December 31, 2019:

| Pass |  | Special Mention |  | Non-Impaired Substandard |  | Impaired - Substandard |  | Doubtful |  | PCI Loans |  | Total
September 30, 2020 |  |  |  |  |  |  |  |  |  |  |  |  |
Commercial real estate: |  |  |  |  |  |  |  |  |  |  |  |  |
Owner occupied | $ | 142,294 |  |  | $ | 8,654 |  |  | $ | 7,750 |  |  | $ | 3,341 |  |  | $ | — |  |  | $ | 4,584 |  |  | $ | 166,623 |
Non-owner occupied | 347,253 |  |  | 55,552 |  |  | — |  |  | — |  |  | — |  |  | 333 |  |  | 403,138 |
Multi-family | 88,896 |  |  | 20,530 |  |  | 653 |  |  | 74 |  |  | — |  |  | — |  |  | 110,153 |
Non-owner occupied residential | 105,159 |  |  | 3,678 |  |  | 1,455 |  |  | 275 |  |  | — |  |  | 1,391 |  |  | 111,958 |
Acquisition and development: |  |  |  |  |  |  |  |  |  |  |  |  |
1-4 family residential construction | 9,341 |  |  | 286 |  |  | — |  |  | — |  |  | — |  |  | — |  |  | 9,627 |
Commercial and land development | 35,818 |  |  | 662 |  |  | 533 |  |  | 837 |  |  | — |  |  | — |  |  | 37,850 |
Commercial and industrial | 660,538 |  |  | 16,724 |  |  | 9,439 |  |  | 755 |  |  | — |  |  | 2,874 |  |  | 690,330 |
Municipal | 28,867 |  |  | — |  |  | — |  |  | — |  |  | — |  |  | — |  |  | 28,867 |
Residential mortgage: |  |  |  |  |  |  |  |  |  |  |  |  |
First lien | 264,761 |  |  | — |  |  | — |  |  | 2,835 |  |  | — |  |  | 5,553 |  |  | 273,149 |
Home equity - term | 11,009 |  |  | — |  |  | 70 |  |  | 11 |  |  | — |  |  | 18 |  |  | 11,108 |
Home equity - lines of credit | 157,206 |  |  | 170 |  |  | 34 |  |  | 696 |  |  | — |  |  | — |  |  | 158,106 |
Installment and other loans | 28,868 |  |  | — |  |  | — |  |  | 20 |  |  | — |  |  | 73 |  |  | 28,961 |
| $ | 1,880,010 |  |  | $ | 106,256 |  |  | $ | 19,934 |  |  | $ | 8,844 |  |  | $ | — |  |  | $ | 14,826 |  |  | $ | 2,029,870 |
December 31, 2019 |  |  |  |  |  |  |  |  |  |  |  |  |
Commercial real estate: |  |  |  |  |  |  |  |  |  |  |  |  |
Owner occupied | $ | 151,161 |  |  | $ | 4,513 |  |  | $ | 3,163 |  |  | $ | 5,872 |  |  | $ | — |  |  | $ | 6,175 |  |  | $ | 170,884 |
Non-owner occupied | 342,753 |  |  | 17,152 |  |  | — |  |  | — |  |  | — |  |  | 1,145 |  |  | 361,050 |
Multi-family | 100,361 |  |  | 4,822 |  |  | 682 |  |  | 345 |  |  | — |  |  | 683 |  |  | 106,893 |
Non-owner occupied residential | 111,697 |  |  | 4,534 |  |  | 1,115 |  |  | 235 |  |  | — |  |  | 2,457 |  |  | 120,038 |
Acquisition and development: |  |  |  |  |  |  |  |  |  |  |  |  |
1-4 family residential construction | 15,865 |  |  | — |  |  | — |  |  | — |  |  | — |  |  | — |  |  | 15,865 |
Commercial and land development | 39,939 |  |  | 206 |  |  | 1,393 |  |  | — |  |  | — |  |  | — |  |  | 41,538 |
Commercial and industrial | 198,951 |  |  | 1,133 |  |  | 8,899 |  |  | 1,763 |  |  | — |  |  | 3,808 |  |  | 214,554 |
Municipal | 42,649 |  |  | 4,408 |  |  | — |  |  | — |  |  | — |  |  | — |  |  | 47,057 |
Residential mortgage: |  |  |  |  |  |  |  |  |  |  |  |  |
First lien | 323,040 |  |  | 978 |  |  | — |  |  | 2,590 |  |  | — |  |  | 9,764 |  |  | 336,372 |
Home equity - term | 13,774 |  |  | 74 |  |  | 149 |  |  | 13 |  |  | — |  |  | 20 |  |  | 14,030 |
Home equity - lines of credit | 164,469 |  |  | 74 |  |  | 38 |  |  | 733 |  |  | — |  |  | — |  |  | 165,314 |
Installment and other loans | 50,497 |  |  | — |  |  | — |  |  | 85 |  |  | — |  |  | 153 |  |  | 50,735 |
| $ | 1,555,156 |  |  | $ | 37,894 |  |  | $ | 15,439 |  |  | $ | 11,636 |  |  | $ | — |  |  | $ | 24,205 |  |  | $ | 1,644,330 |

Potential problem loans are defined as performing loans which have characteristics that cause management concern over the ability of the borrower to perform under present loan repayment terms and which may result in the reporting of these loans as nonperforming loans in the future. Generally, management feels that Substandard loans that are currently performing and not considered impaired result in some doubt as to the borrower’s ability to continue to perform under the terms of the loan, and
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represent potential problem loans. Additionally, the Special Mention classification is intended to be a temporary classification reflective of loans that have potential weaknesses that may, if not monitored or corrected, weaken the asset or inadequately protect the Company’s position at some future date. Special Mention loans represent an elevated risk, but their weakness does not yet justify a more severe, or classified, rating. These loans require inquiry by lenders on the cause of the potential weakness and, once analyzed, the loan classification may be downgraded to Substandard or, alternatively, could be upgraded to Pass. Special Mention loans increased by $68.4 million f rom December 31, 2019 to September 30, 2020 due to commercial loan downgrades, primarily in the hospitality industry, as a result of the significant economic impact of the COVID-19 pandemic.
The following table summarizes activity in the ALL for the nine months ended September 30, 2020 and 2019:

| Commercial |  | Consumer |  |  |  |
| Commercial Real Estate |  | Acquisition and Development |  | Commercial and Industrial |  | Municipal |  | Total |  | Residential Mortgage |  | Installment and Other |  | Total |  | Unallocated |  | Total
Three Months Ended |  |  |  |  |  |  |  |  |  |  |  |  |  |  |  |  |  |  |
September 30, 2020 |  |  |  |  |  |  |  |  |  |  |  |  |  |  |  |  |  |  |
Balance, beginning of period | $ | 9,347 |  |  | $ | 1,069 |  |  | $ | 2,916 |  |  | $ | 75 |  |  | $ | 13,407 |  |  | $ | 3,552 |  |  | $ | 386 |  |  | $ | 3,938 |  |  | $ | 172 |  |  | $ | 17,517 |
Provision for loan losses | 1,520 |  |  | (219) |  |  | 963 |  |  | (19) |  |  | 2,245 |  |  | (71) |  |  | 18 |  |  | (53) |  |  | 8 |  |  | 2,200 |
Charge-offs | (3) |  |  | — |  |  | (193) |  |  | — |  |  | (196) |  |  | — |  |  | (31) |  |  | (31) |  |  | — |  |  | (227) |
Recoveries | 171 |  |  | — |  |  | 45 |  |  | — |  |  | 216 |  |  | 6 |  |  | 13 |  |  | 19 |  |  | — |  |  | 235 |
Balance, end of period | $ | 11,035 |  |  | $ | 850 |  |  | $ | 3,731 |  |  | $ | 56 |  |  | $ | 15,672 |  |  | $ | 3,487 |  |  | $ | 386 |  |  | $ | 3,873 |  |  | $ | 180 |  |  | $ | 19,725 |
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 | — |  |  | — |  |  | (50) |  |  | — |  |  | (50) |  |  | (24) |  |  | (49) |  |  | (73) |  |  | — |  |  | (123) |
Recoveries | 111 |  |  | — |  |  | 33 |  |  | — |  |  | 144 |  |  | 5 |  |  | 23 |  |  | 28 |  |  | — |  |  | 172 |
Balance, end of period | $ | 7,423 |  |  | $ | 820 |  |  | $ | 2,372 |  |  | $ | 93 |  |  | $ | 10,708 |  |  | $ | 3,742 |  |  | $ | 233 |  |  | $ | 3,975 |  |  | $ | 126 |  |  | $ | 14,809 |
Nine Months Ended |  |  |  |  |  |  |  |  |  |  |  |  |  |  |  |  |  |  |
September 30, 2020 |  |  |  |  |  |  |  |  |  |  |  |  |  |  |  |  |  |  |
Balance, beginning of period | $ | 7,634 |  |  | $ | 959 |  |  | $ | 2,356 |  |  | $ | 100 |  |  | $ | 11,049 |  |  | $ | 3,147 |  |  | $ | 319 |  |  | $ | 3,466 |  |  | $ | 140 |  |  | $ | 14,655 |
Provision for loan losses | 2,780 |  |  | (117) |  |  | 1,875 |  |  | (44) |  |  | 4,494 |  |  | 329 |  |  | 162 |  |  | 491 |  |  | 40 |  |  | 5,025 |
Charge-offs | (3) |  |  | — |  |  | (689) |  |  | — |  |  | (692) |  |  | (109) |  |  | (117) |  |  | (226) |  |  | — |  |  | (918) |
Recoveries | 624 |  |  | 8 |  |  | 189 |  |  | — |  |  | 821 |  |  | 120 |  |  | 22 |  |  | 142 |  |  | — |  |  | 963 |
Balance, end of period | $ | 11,035 |  |  | $ | 850 |  |  | $ | 3,731 |  |  | $ | 56 |  |  | $ | 15,672 |  |  | $ | 3,487 |  |  | $ | 386 |  |  | $ | 3,873 |  |  | $ | 180 |  |  | $ | 19,725 |
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) |  |  | — |  |  | (140) |  |  | — |  |  | (165) |  |  | (295) |  |  | (121) |  |  | (416) |  |  | — |  |  | (581) |
Recoveries | 225 |  |  | 2 |  |  | 103 |  |  | — |  |  | 330 |  |  | 100 |  |  | 46 |  |  | 146 |  |  | — |  |  | 476 |
Balance, end of period | $ | 7,423 |  |  | $ | 820 |  |  | $ | 2,372 |  |  | $ | 93 |  |  | $ | 10,708 |  |  | $ | 3,742 |  |  | $ | 233 |  |  | $ | 3,975 |  |  | $ | 126 |  |  | $ | 14,809 |

The ALL at September 30, 2020, increased by $5.1 million from December 31, 2019, reflecting the $5.0 million provision for loan losses during the nine months ended September 30, 2020. The provision for loan losses increased in the nine months ended September 30, 2020 as a result of qualitative factor adjustments for the impact of the COVID-19 pandemic on the Bank’s loan portfolio and commercial loan downgrades. Net recoveries totaled $8 thousand and $45 thousand for the three and nine mont hs ended September 30, 2020, respectively, compared with net charge-offs of $49 thousand and $105 thousand, respectively, for the same periods in 2019. Classified loans totaled $28.8 million at September 30, 2020, or 1.4% of total loans outstanding, and increased from $27.1 million at December 31, 2019, or 1.6% of loans outstanding. The asset quality ratios previously noted are indicative of the continued benefit the Company has received from favorable historical charge-off statistics and generally stable economic and market conditions for the last few years, even while the loan portfolio has been growing. Recent loan growth trends, as well as concerns regarding the COVID-19 pandemic, contributed to management's determination that an increased provision for loan losses was required to maintain an adequate ALL, with an ALL to total loans ratio of 0.97% at September 30, 2020 as compared to 0.89% at December 31, 2019. Excluding SBA loans, which are 100% guaranteed, the ALL to total loans was 1.3% at September 30, 2020. The ALL plus purchase accounting marks to unguaranteed loans was 1.9% at September 30, 2020 and 2.0% a t December 31, 2019.
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Despite generally favorable historical charge-off data, the impact of the COVID-19 pandemic on economic conditions may result in the need for additional provisions for loan losses in future quarters.
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, 2020 and December 31, 2019, including PCI loans:

| Commercial |  | Consumer |  |  |  |
| Commercial Real Estate |  | Acquisition and Development |  | Commercial and Industrial |  | Municipal |  | Total |  | Residential Mortgage |  | Installment and Other |  | Total |  | Unallocated |  | Total
September 30, 2020 |  |  |  |  |  |  |  |  |  |  |  |  |  |  |  |  |  |  |
Loans allocated by: |  |  |  |  |  |  |  |  |  |  |  |  |  |  |  |  |  |  |
Individually evaluated for impairment | $ | 3,690 |  |  | $ | 837 |  |  | $ | 755 |  |  | $ | — |  |  | $ | 5,282 |  |  | $ | 3,542 |  |  | $ | 20 |  |  | $ | 3,562 |  |  | $ | — |  |  | $ | 8,844 |
Collectively evaluated for impairment | 788,182 |  |  | 46,640 |  |  | 689,575 |  |  | 28,867 |  |  | 1,553,264 |  |  | 438,821 |  |  | 28,941 |  |  | 467,762 |  |  | — |  |  | 2,021,026 |
| $ | 791,872 |  |  | $ | 47,477 |  |  | $ | 690,330 |  |  | $ | 28,867 |  |  | $ | 1,558,546 |  |  | $ | 442,363 |  |  | $ | 28,961 |  |  | $ | 471,324 |  |  | $ | — |  |  | $ | 2,029,870 |
ALL allocated by: |  |  |  |  |  |  |  |  |  |  |  |  |  |  |  |  |  |  |
Individually evaluated for impairment | $ | — |  |  | $ | — |  |  | $ | — |  |  | $ | — |  |  | $ | — |  |  | $ | 35 |  |  | $ | — |  |  | $ | 35 |  |  | $ | — |  |  | $ | 35 |
Collectively evaluated for impairment | 11,035 |  |  | 850 |  |  | 3,731 |  |  | 56 |  |  | 15,672 |  |  | 3,452 |  |  | 386 |  |  | 3,838 |  |  | 180 |  |  | 19,690 |
| $ | 11,035 |  |  | $ | 850 |  |  | $ | 3,731 |  |  | $ | 56 |  |  | $ | 15,672 |  |  | $ | 3,487 |  |  | $ | 386 |  |  | $ | 3,873 |  |  | $ | 180 |  |  | $ | 19,725 |
December 31, 2019 |  |  |  |  |  |  |  |  |  |  |  |  |  |  |  |  |  |  |
Loans allocated by: |  |  |  |  |  |  |  |  |  |  |  |  |  |  |  |  |  |  |
Individually evaluated for impairment | $ | 6,452 |  |  | $ | — |  |  | $ | 1,763 |  |  | $ | — |  |  | $ | 8,215 |  |  | $ | 3,336 |  |  | $ | 85 |  |  | $ | 3,421 |  |  | $ | — |  |  | $ | 11,636 |
Collectively evaluated for impairment | 752,413 |  |  | 57,403 |  |  | 212,791 |  |  | 47,057 |  |  | 1,069,664 |  |  | 512,380 |  |  | 50,650 |  |  | 563,030 |  |  | — |  |  | 1,632,694 |
| $ | 758,865 |  |  | $ | 57,403 |  |  | $ | 214,554 |  |  | $ | 47,057 |  |  | $ | 1,077,879 |  |  | $ | 515,716 |  |  | $ | 50,735 |  |  | $ | 566,451 |  |  | $ | — |  |  | $ | 1,644,330 |
ALL allocated by: |  |  |  |  |  |  |  |  |  |  |  |  |  |  |  |  |  |  |
Individually evaluated for impairment | $ | — |  |  | $ | — |  |  | $ | — |  |  | $ | — |  |  | $ | — |  |  | $ | 36 |  |  | $ | — |  |  | $ | 36 |  |  | $ | — |  |  | $ | 36 |
Collectively evaluated for impairment | 7,634 |  |  | 959 |  |  | 2,356 |  |  | 100 |  |  | 11,049 |  |  | 3,111 |  |  | 319 |  |  | 3,430 |  |  | 140 |  |  | 14,619 |
| $ | 7,634 |  |  | $ | 959 |  |  | $ | 2,356 |  |  | $ | 100 |  |  | $ | 11,049 |  |  | $ | 3,147 |  |  | $ | 319 |  |  | $ | 3,466 |  |  | $ | 140 |  |  | $ | 14,655 |

In addition to the specific reserve allocations on impaired loans noted previously, 15 loans, with aggregate outstanding principal balances of $1.6 million, have had cumulative partial charge-offs to the ALL totaling $718 thousand at September 30, 2020. 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 $180 thousand, or 0.9% of the ALL balance, at September 30, 2020 compared with $140 thousand, or 1.0% of the ALL balance at December 31, 2019. The Company monitors the unallocated portion of the
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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.
Management believes the Company’s ALL is adequate based on currently available information. Future adjustments to the ALL and enhancements to the methodology may be necessary due to changes in economic conditions, regulatory guidance, or management’s assumptions as to future delinquencies or loss rates.
Deposits
Deposits totaled $2.3 billion at September 30, 2020, an increase of $404.0 million, or 21.5%, from $1.9 billion at December 31, 2019.
Noninterest-bearing deposits increased by $159.6 million, or 64.0%, from December 31, 2019 to September 30, 2020. Interest-bearing deposits totaled $1.9 billion at September 30, 2020, an increase of $244.4 million, or 15.0% from the $1.6 billion balance at December 31, 2019.
The Company continues to increase both noninterest-bearing and interest-bearing deposit relationships from its enhanced treasury management offerings as it increases its commercial relationships. Deposit growth in the first nine months of 2020 was principally due to clients seeking a safe haven for their deposits during the COVID-19 pandemic and the high usage of checking accounts for SBA PPP loan funds. As the SBA PPP clients utilize their borrowings to fund operations, the associated deposits are expected to decline.
Shareholders' Equity, Capital Adequacy and Regulatory Matters
Capital management in a regulated financial services industry must properly balance return on equity to its shareholders while maintaining sufficient levels of capital and related risk-based regulatory capital ratios to satisfy statutory regulatory requirements. The Company’s capital management strategies have been developed to provide attractive rates of returns to its shareholders, while maintaining a “well capitalized” position of regulatory strength.
Shareholders’ equity totaled $232.8 million at September 30, 2020, an increase of $9.6 million, or 4.3%, from $223.2 million at December 31, 2019. The increase was primarily attributable to net income totaling $16.4 million for the nine months ended September 30, 2020. This increase was partially offset by an increase in accumulated other comprehensive loss from changes in net unrealized gains and losses in securities available for sale, net of tax, whic h increased by $332 thousand from December 31, 2019 to September 30, 2020 due to declining interest rates and market uncertainty resulting from the COVID-19 pandemic. Accumulated other comprehensive loss also included $1.3 million in losses on cash flow hedges, net of tax, during the nine months ended September 30, 2020. In add ition, there were dividends paid on common stock totaling $5.7 million during the nine months ended September 30, 2020.
The Company routinely evaluates its capital levels in light of its risk profile to assess its capital needs. The Company and the Bank are subject to various regulatory capital requirements administered by federal and state banking agencies. The consolidated asset limit on small bank holding companies is $3.0 billion and a company with assets under that limit is not subject to the FRB consolidated capital rules, but may file reports that include capital amounts and ratios. The Company has elected to file those reports.
At September 30, 2020 and December 31, 2019, the Bank was considered well capitalized under applicable banking regulations. Under capital adequacy guidelines and the regulatory framework for prompt corrective action, the Bank must meet specific guidelines that involve quantitative measures of assets, liabilities and certain off-balance sheet items as calculated under regulatory accounting practices. Prompt corrective action provisions are not applicable to bank holding companies, including financial holding companies.
Note 10, Shareholders' Equity and Regulatory Capital, to the Notes to Unaudited Condensed Consolidated Financial Statements under Part I, Item 1, "Financial Information," includes a table presenting capital amounts and ratios for the Company and the Bank at September 30, 2020 and December 31, 2019.
In addition to the minimum capital ratio requirement and minimum capital ratio to be well capitalized presented in the referenced table in Note 10, the Bank must maintain a capital conservation buffer as more fully described in the Company's Annual Report on Form 10-K for the year ended December 31, 2019, Item 1 - Business, under the topic Basel III Capital Rules. At September 30, 2020, the Bank's capital conservation buffer, based on the most restrictive Total Capital to risk weighted assets capital ratio, was 6.3%, which is greater than the 2.5% requirement.
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Liquidity
The primary function of asset/liability management is to ensure adequate liquidity and manage the Company’s sensitivity to changing interest rates. Liquidity management involves the ability to meet the cash flow requirements of customers who may be either depositors wanting to withdraw funds or borrowers needing assurance that sufficient funds will be available to meet their credit needs. Our primary sources of funds consist of deposit inflows, loan repayments, maturities and sales of investment securities, the sale of mortgage loans and borrowings from the FHLB of Pittsburgh. While maturities and scheduled amortization of loans and securities are predictable sources of funds, deposit flows and mortgage prepayments are greatly influenced by general interest rates, economic conditions and competition. The maximum borrowing capacity from the FHLB is $841.0 million at September 30, 2020.
We regularly adjust our investments in liquid assets based upon our assessment of expected loan demand, expected deposit flows, yields available on interest-earning deposits and securities and the objectives of our asset/liability management policy. Unencumbered investment securities totaled $52.1 million at September 30, 2020. At September 30, 2020, the Company had $153.6 million of i nvestment securities pledged at the FRB Discount Window, with no associated borrowings outstanding.
The Company applied for and received access to the PPPLF, a liquidity facility created by the Federal Reserve for the pledging of PPP loans, to further expand its already robust access to off balance sheet liquidity. Borrowings through the PPPLF facility totaled $70.9 million at September 30, 2020, with SBA PPP loans of the same amount pledged as collateral. The remaining availability to the Company under this facility is $396.8 million at September 30, 2020.
Mergers and Acquisitions
See Note 2, Mergers and Acquisitions, to the Consolidated Financial Statements under Part I, Item 1, "Financial Statements" in this Form 10-Q.
Supplemental Reporting of Non-GAAP Measures
As a result of acquisitions, the Company had intangible assets consisting of goodwill and core deposit and other intangible assets totaling $24.5 million and $27.1 million at September 30, 2020 and December 31, 2019, respectively.
Management believes providing certain “non-GAAP” financial information will assist investors in their understanding of the effect of acquisition activity on reported results, particularly to overcome comparability issues related to the influence of intangibles (principally goodwill) created in acquisitions.
Tangible book value per share and net interest margin excluding the impact of purchase accounting, as used by the Company in this supplemental reporting presentation, are determined by methods other than in accordance with 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.

|  | September 30, 2020 |  | December 31, 2019
Tangible Book Value per Common Share |  |  |  |
Shareholders' equity |  | $ | 232,847 |  |  | $ | 223,249 |
Less: Goodwill |  | 18,724 |  |  | 19,925 |
Other intangible assets |  | 5,803 |  |  | 7,180 |
Related tax effect |  | (1,219) |  |  | (1,508) |
Tangible common equity (non-GAAP) |  | $ | 209,539 |  |  | $ | 197,652 |
Common shares outstanding |  | 11,204 |  |  | 11,200 |
Book value per share (most directly comparable GAAP based measure) |  | $ | 20.78 |  |  | $ | 19.93 |
Intangible assets per share |  | 2.08 |  |  | 2.28 |
Tangible book value per share (non-GAAP) |  | $ | 18.70 |  |  | $ | 17.65 |

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| Three Months Ended September 30,
|  |  | 2020 |  | 2019
Taxable-Equivalent Net Interest Margin (excluding the effect of purchase accounting) |  |  |  |  |  |  |  |
Taxable-equivalent net interest income/margin, as reported |  |  | $ | 21,025 |  |  | 3.24 | % |  | $ | 18,287 |  |  | 3.30 | %
Effect of purchase accounting: |  |  |  |  |  |  |  |  |
Loans | Income |  | (1,199) |  |  | (0.20) | % |  | (879) |  |  | (0.17) | %
Time deposits | Expenses |  | 16 |  |  | 0.00 | % |  | 35 |  |  | (0.01) | %
Purchase accounting effect on taxable-equivalent income/ margin |  |  | (1,215) |  |  | (0.20) | % |  | (914) |  |  | (0.18) | %
Taxable-equivalent net interest income/margin (excluding the effect of purchase accounting) (non-GAAP) |  |  | $ | 19,810 |  |  | 3.04 | % |  | $ | 17,373 |  |  | 3.12 | %
| Nine Months Ended September 30,
|  |  | 2020 |  | 2019
Taxable-Equivalent Net Interest Margin (excluding the effect of purchase accounting) |  |  |  |  |  |  |  |
Taxable-equivalent net interest income/margin, as reported |  |  | $ | 60,511 |  |  | 3.34 | % |  | $ | 52,198 |  |  | 3.45 | %
Effect of purchase accounting: |  |  |  |  |  |  |  |  |
Loans | Income |  | (3,701) |  |  | (0.22) | % |  | (2,517) |  |  | (0.19) | %
Time deposits | Expenses |  | 68 |  |  | (0.01) | % |  | 50 |  |  | 0.00 | %
Purchase accounting effect on taxable-equivalent income/ margin |  |  | (3,769) |  |  | (0.23) | % |  | (2,567) |  |  | (0.19) | %
Taxable-equivalent net interest income/margin (excluding the effect of purchase accounting) (non-GAAP) |  |  | $ | 56,742 |  |  | 3.11 | % |  | $ | 49,631 |  |  | 3.26 | %

| September 30, 2020
Allowance to unguaranteed loans |
Allowance for loan losses | $ | 19,725 |
Gross loans | $ | 2,029,870 |
less: SBA guaranteed loans | (459,662) |
Unguaranteed loans | $ | 1,570,208 |
Allowance to unguaranteed loans | 1.3 | %

| September 30, 2020 |  | December 31, 2019
Allowance plus purchase accounting marks to unguaranteed loans: |  |  |
Allowance for loan losses | $ | 19,725 |  |  | $ | 14,655 |
Purchase accounting marks | 9,607 |  |  | 18,160 |
Allowance plus purchase accounting marks | 29,332 |  |  | 32,815 |
Gross loans | 2,029,870 |  |  | 1,644,330 |
less: SBA guaranteed loans | (459,662) |  |  | (1,559) |
Unguaranteed loans | $ | 1,570,208 |  |  | $ | 1,642,771 |
Allowance plus purchase accounting marks to unguaranteed loans: | 1.9 | % |  | 2.0 | %

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Item 3. Quantitative and Qualitative Disclosures about Market Risk
Market risk comprises exposure to interest rate risk, foreign currency exchange rate risk, commodity price risk, and other relevant market rate or price risks. In the banking industry, a major risk exposure is changing interest rates. The primary objective of monitoring our interest rate sensitivity, or risk, is to provide management the tools necessary to manage the balance sheet to minimize adverse changes in net interest income as a result of changes in the direction and level of interest rates. Federal Reserve Board monetary control efforts, the effects of deregulation, economic uncertainty and legislative changes have been significant factors affecting the task of managing interest rate sensitivity positions in recent years.
Interest Rate Risk
Interest rate risk is the exposure to fluctuations in the Company’s future earnings (earnings at risk) and value (value at risk) resulting from changes in interest rates. This exposure results from differences between the amounts of interest-earning assets and interest-bearing liabilities that reprice within a specified time period as a result of scheduled maturities, scheduled and unscheduled repayments, the propensity of borrowers and depositors to react to changes in their economic interests, and loan contractual interest rate changes.
We attempt to manage the level of repricing and maturity mismatch through our asset/liability management process so that fluctuations in net interest income are maintained within policy limits across a range of market conditions, while satisfying liquidity and capital requirements. Management recognizes that a certain amount of interest rate risk is inherent, appropriate and necessary to ensure the Company’s profitability. Thus, the goal of interest rate risk management is to evaluate the amount of reward for taking risk and adjusting both the size and composition of the balance sheet relative to the level of reward available for taking risk.
Management endeavors to control the exposure to changes in interest rates by understanding, reviewing and making decisions based on its risk position. The Company primarily uses its securities portfolio, FHLB advances, interest rate swaps and brokered deposits to manage its interest rate risk position. Additionally, pricing, promotion and product development activities are directed in an effort to emphasize the loan and deposit term or repricing characteristics that best meet current interest rate risk objectives.
We use simulation analysis to assess earnings at risk and net present value analysis to assess value at risk. These methods allow management to regularly monitor both the direction and magnitude of our interest rate risk exposure. These analyses require numerous assumptions including, but not limited to, changes in balance sheet mix, prepayment rates on loans and securities, cash flows and repricing of all financial instruments, changes in volumes and pricing, future shapes of the yield curve, relationship of market interest rates to each other (basis risk), credit spread and deposit sensitivity. Assumptions are based on management’s best estimates but may not accurately reflect actual results under certain changes in interest rate due to the timing, magnitude and frequency of rate changes and changes in market conditions and management strategies, among other factors. However, the analyses are useful in quantifying risk and providing a relative gauge of our interest rate risk position over time.
Our asset/liability committee operates under management policies, approved by the Board of Directors, which define guidelines and limits on the level of risk. The committee meets regularly and reviews our interest rate risk position and monitors various liquidity ratios to ensure a satisfactory liquidity position. By utilizing our analyses, we can determine changes that may need to be made to the asset and liability mixes to mitigate the change in net interest income under various interest rate scenarios. Management continually evaluates the condition of the economy, the pattern of market interest rates and other economic data to inform the committee on the selection of investment securities. Regulatory authorities also monitor our interest rate risk position along with other liquidity ratios.
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Net Interest Income Sensitivity
Simulation analysis evaluates the effect of upward and downward changes in market interest rates on future net interest income. The analysis involves changing the interest rates used in determining net interest income over the next twelve months. The resulting percentage change in net interest income in various rate scenarios is an indication of our short-term interest rate risk. The analysis assumes recent pricing trends in new loan and deposit volumes will continue while balances remain constant. Additional assumptions are applied to modify pricing under the various rate scenarios.
The simulation analysis results are presented in the Net Interest Income table below. At September 30, 2020 and December 31, 2019, results indicated the Company would be better positioned over the subsequent 12 months in a moderately declining rate environment than it would be if interest rates increased. This is due to a shift in the mix of assets to more floating rate loans, a shift in the mix of liabilities to fewer certificates of deposit, and the steep decline in interest rates.
Economic Value
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. 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, 2020, similar to at December 31, 2019, these results indicated the Company would be better positioned in a rising interest rate environment than it would be if interest rates decreased. As a result of the low interest rates at September 30, 2020, the impact of increased rates on the economic value of the balance sheet would be substantial. To improve the comparability across periods, the Company follows best practices and maintains the size and mix of the period end balance sheet; thus, the results do not reflect actions management may take to improve results.

Net Interest Income |  | Economic Value
|  | % Change in Net Interest Income |  |  |  | % Change in Market Value
Change in Market Interest Rates (basis points) |  | September 30, 2020 |  | December 31, 2019 |  | Change in Market Interest Rates (basis points) |  | September 30, 2020 |  | December 31, 2019
(100) |  |  | 0.3 | % |  | (0.5) | % |  | (100) |  |  | (98.8) | % |  | (21.7) | %
100 |  |  | (1.8) | % |  | (1.3) | % |  | 100 |  |  | 76.5 | % |  | 10.9 | %
200 |  |  | (3.8) | % |  | (3.8) | % |  | 200 |  |  | 122.3 | % |  | 15.1 | %
300 |  |  | (8.1) | % |  | (8.1) | % |  | 300 |  |  | 148.2 | % |  | 15.0 | %

Item 4. Controls and Procedures
Based on the evaluation required by Securities Exchange Act Rules 13a-15(b) and 15d-15(b), the Company's management, including the Chief Executive Officer and Chief Financial Officer, conducted an evaluation of the effectiveness of our disclosure controls and procedures, as defined in Securities Exchange Act Rules 13a-15(e) and 15d-15(e), at September 30, 2020. Based on that evaluation, our Chief Executive Officer and Chief Financial Officer concluded that our disclosure controls and procedures were effective at September 30, 2020. There have been no changes in internal control over financial reporting that have materially affected, or are reasonably likely to materially affect, our internal control over financial reporting during the nine months ended September 30, 2020.
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PART II – OTHER INFORMATION
Item 1 – Legal Proceedings
Information regarding legal proceedings is included in Note 14, Contingencies, to the Consolidated Financial Statements under Part I, Item 1, "Financial Statements" and incorporated herein by reference.
Item 1A – Risk Factors
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, 2019 and our Quarterly Report on Form 10-Q for the quarterly periods ended March 31, 2020 and June 30, 2020.
Item 2 – Unregistered Sales of Equity Securities and Use of Proceeds
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, 2020, 154,680 shares had been repurchased under the program at a total cost of $2.6 million, or $16.88 per share. The maximum number of shares that may yet be purchased under the plan is 261,320 at September 30, 2020. No repurchases occurred during the three months ended September 30, 2020.
Item 3 – Defaults Upon Senior Securities
Not applicable.
Item 4 – Mine Safety Disclosures
Not applicable.
Item 5 – Other Information
None.
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Item 6 – Exhibits

2.1(a) |  | Agreement and Plan of Merger, dated May 31, 2018, by and between Orrstown Financial Services, Inc. and Mercersburg Financial Corporation, incorporated by reference to Exhibit 2.1 of the Registrant's Form 8-K filed June 1, 2018.
2.1(b) |  | Agreement and Plan of Merger, dated October 23, 2018, by and between Orrstown Financial Services, Inc. and Hamilton Bancorp, Inc., incorporated by reference to Exhibit 2.1 of the Registrant's Form 8-K filed October 24, 2018.
3.1 |  |  | Articles of Incorporation as amended, incorporated by reference to Exhibit 3.1 of the Registrant’s Report on Form 8-K filed on January 29, 2010.
3.2 |  |  | By-laws as amended, incorporated by reference to Exhibit 3.2 to the Registrant’s Report on Form 8-K filed January 30, 2018.
4.1 |  |  | Specimen Common Stock Certificate, incorporated by reference to the Registrant’s Registration Statement on Form S-3 filed February 8, 2010 (File No. 333-164780).
10.1 |  |  | Salary Continuation Agreement by and between Orrstown Bank and Robert Coradi dated March 26, 2018.
10.2 |  |  | D eferred Compensation Agreement by and b etween Orrstown Bank and Thomas R. Brugger, incorporated by reference to Exhibit 10.1 to the Registrant's Form 8-K filed September 18, 2020.
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 5, 2020

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