EX-13 8 ex_174251.htm EXHIBIT 13

Exhibit 13

REPORT OF INDEPENDENT REGISTERED PUBLIC ACCOUNTING FIRM

To the Stockholders and the Board of Directors of Middlefield Banc Corp.

Opinion on the Financial Statements

We have audited the accompanying consolidated balance sheets of Middlefield Banc Corp. and subsidiaries (the “Company”) as of December 31, 2019 and 2018; the related consolidated statements of income, comprehensive income, changes in stockholders’ equity, and cash flows for each of the years then ended; and the related notes to the consolidated financial statements (collectively, the financial statements). In our opinion, the financial statements present fairly, in all material respects, the financial position of the Company as of December 31, 2019 and 2018, and the results of its operations and its cash flows for the years then ended, in conformity with accounting principles generally accepted in the United States of America.

We have also audited, in accordance with the standards of the Public Company Accounting Oversight Board (United States) (PCAOB), the Company’s internal control over financial reporting as of December 31, 2019, based on criteria established in Internal Control – Integrated Framework, issued by the Committee of Sponsoring Organizations of the Treadway Commission in 2013, and our report dated March 4, 2020, expressed an unqualified opinion on the effectiveness of the Company’s internal control over financial reporting.

Basis for Opinion

These financial statements are the responsibility of the Company’s management. Our responsibility is to express an opinion on the Company’s financial statements based on our audits. We are a public accounting firm registered with the PCAOB and are required to be independent, with respect to the Company, in accordance with U.S. federal securities laws and the applicable rules and regulations of the Securities and Exchange Commission and the PCAOB.

We conducted our audits in accordance with the standards of the PCAOB. Those standards require that we plan and perform the audit to obtain reasonable assurance about whether the financial statements are free of material misstatement, whether due to error or fraud. Our audits included performing procedures to assess the risks of material misstatement of the financial statements, whether due to error or fraud, and performing procedures that respond to those risks.

S.R. Snodgrass, P.C. ● 2009 Mackenzle Way, Suite 340 ● Cranberry Township, Pennsylvania 16066 ● Phone: 724-934-0344 ● Fax: 724-934-0345

1

Basis for Opinion (Continued)

Such procedures included examining, on a test basis, evidence regarding the amounts and disclosures in the financial statements. Our audits also included evaluating the accounting principles used and significant estimates made by management, as well as evaluating the overall presentation of the financial statements. We believe that our audits provide a reasonable basis for our opinion.

We have served as the Company’s auditor since 1986.

/s/S.R. Snodgrass, P.C.

Cranberry Township, Pennsylvania

March 4, 2020

2

REPORT OF INDEPENDENT REGISTERED PUBLIC ACCOUNTING FIRM

To the Stockholders and the Board of Directors of Middlefield Banc Corp.

Opinion on Internal Control over Financial Reporting

We have audited Middlefield Banc Corp. and subsidiaries’ (the “Company”) internal control over financial reporting as of December 31, 2019, based on criteria established in Internal Control – Integrated Framework, issued by the Committee of Sponsoring Organizations of the Treadway Commission in 2013. In our opinion, the Company maintained, in all material respects, effective internal control over financial reporting as of December 31, 2019, based on criteria established in Internal Control – Integrated Framework, issued by the Committee of Sponsoring Organizations of the Treadway Commission in 2013.

We have also audited, in accordance with the standards of the Public Company Accounting Oversight Board (United States) (PCAOB), the consolidated balance sheets of the Company as of December 31, 2019 and 2018; the related consolidated statements of income, comprehensive income, changes in stockholders’ equity, and cash flows for each of the two years in the period ended December 31, 2019, of the Company; and our report dated March 4, 2020, expressed an unqualified opinion.

Basis for Opinion

The Company’s management is responsible for maintaining effective internal control over financial reporting and for its assessment of the effectiveness of internal control over financial reporting in the accompanying Management’s Annual Report on Internal Control over Financial Reporting. Our responsibility is to express an opinion on the Company’s internal control over financial reporting based on our audit. We are a public accounting firm registered with the PCAOB and are required to be independent, with respect to the Company, in accordance with U.S. federal securities laws and the applicable rules and regulations of the Securities and Exchange Commission and the PCAOB.

We conducted our audit in accordance with the standards of the PCAOB. Those standards require that we plan and perform the audit to obtain reasonable assurance about whether effective internal control over financial reporting was maintained in all material respects. Our audit included obtaining an understanding of internal control over financial reporting, assessing the risk that a material weakness exists, and testing and evaluating the design and operating effectiveness of internal control based on the assessed risk. Our audit also included performing such other procedures as we considered necessary in the circumstances. We believe that our audit provides a reasonable basis for our opinion.

S.R. Snodgrass, P.C. ● 2009 Mackenzle Way, Suite 340 ● Cranberry Township, Pennsylvania 16066 ● Phone: 724-934-0344 ● Fax: 724-934-0345

3

Definition and Limitations of Internal Control over Financial Reporting

A company’s internal control over financial reporting is a process designed to provide reasonable assurance regarding the reliability of financial reporting and the preparation of financial statements for external purposes in accordance with generally accepted accounting principles. A company’s internal control over financial reporting includes those policies and procedures that (1) pertain to the maintenance of records that, in reasonable detail, accurately and fairly reflect the transactions and dispositions of the assets of the company; (2) provide reasonable assurance that transactions are recorded as necessary to permit preparation of financial statements in accordance with generally accepted accounting principles, and that receipts and expenditures of the company are being made only in accordance with authorizations of management and directors of the company; and (3) provide reasonable assurance regarding prevention or timely detection of unauthorized acquisition, use, or disposition of the company’s assets that could have a material effect on the financial statements.

Because of its inherent limitations, internal control over financial reporting may not prevent or detect misstatements. Also, projections of any evaluation of effectiveness to future periods are subject to the risk that controls may become inadequate because of changes in conditions or that the degree of compliance with the policies or procedures may deteriorate.

/s/S.R. Snodgrass, P.C.

Cranberry Township, Pennsylvania

March 4, 2020

4

MIDDLEFIELD BANC CORP.
CONSOLIDATED BALANCE SHEET
(Dollar amounts in thousands, except shares)

|  | December 31, |
|  | 2019 |  |  | 2018 |
ASSETS |  |  |  |  |  |  |  |
Cash and cash equivalents |  | $ | 35,113 |  |  | $ | 107,933 |
Equity securities, at fair value |  |  | 710 |  |  |  | 616 |
Investment securities available for sale, at fair value |  |  | 105,733 |  |  |  | 98,322 |
Loans held for sale |  |  | 1,220 |  |  |  | 597 |
Loans: |  |  |  |  |  |  |  |
Commercial and industrial |  |  | 89,527 |  |  |  | 83,857 |
Real estate - construction |  |  | 63,246 |  |  |  | 56,731 |
Real estate - mortgage: |  |  |  |  |  |  |  |
Residential |  |  | 347,047 |  |  |  | 336,487 |
Commercial |  |  | 470,027 |  |  |  | 498,247 |
Consumer installment |  |  | 14,411 |  |  |  | 16,787 |
Total loans |  |  | 984,258 |  |  |  | 992,109 |
Less allowance for loan and lease losses |  |  | 6,768 |  |  |  | 7,428 |
Net loans |  |  | 977,490 |  |  |  | 984,681 |
Premises and equipment, net |  |  | 17,874 |  |  |  | 13,003 |
Goodwill |  |  | 15,071 |  |  |  | 15,071 |
Core deposit intangibles |  |  | 2,056 |  |  |  | 2,397 |
Bank-owned life insurance |  |  | 16,511 |  |  |  | 16,080 |
Accrued interest receivable and other assets |  |  | 10,697 |  |  |  | 9,698 |
TOTAL ASSETS |  | $ | 1,182,475 |  |  | $ | 1,248,398 |
LIABILITIES |  |  |  |  |  |  |  |
Deposits: |  |  |  |  |  |  |  |
Noninterest-bearing demand |  | $ | 191,370 |  |  | $ | 203,410 |
Interest-bearing demand |  |  | 107,844 |  |  |  | 92,104 |
Money market |  |  | 160,826 |  |  |  | 196,685 |
Savings |  |  | 192,003 |  |  |  | 222,954 |
Time |  |  | 368,800 |  |  |  | 300,914 |
Total deposits |  |  | 1,020,843 |  |  |  | 1,016,067 |
Short-term borrowings: |  |  |  |  |  |  |  |
Federal funds purchased |  |  | 75 |  |  |  | 398 |
Federal Home Loan Bank advances |  |  | 5,000 |  |  |  | 90,000 |
Total short-term borrowings |  |  | 5,075 |  |  |  | 90,398 |
Other borrowings |  |  | 12,750 |  |  |  | 8,803 |
Accrued interest payable and other liabilities |  |  | 6,032 |  |  |  | 4,840 |
TOTAL LIABILITIES |  |  | 1,044,700 |  |  |  | 1,120,108 |
STOCKHOLDERS' EQUITY |  |  |  |  |  |  |  |
Common stock, no par value; 10,000,000 shares authorized, 7,294,792 and 7,260,994 shares issued; 6,423,630 and 6,488,664 shares outstanding |  |  | 86,617 |  |  |  | 85,925 |
Retained earnings |  |  | 65,063 |  |  |  | 56,037 |
Accumulated other comprehensive income (loss) |  |  | 1,842 |  |  |  | (154 | )
Treasury stock, at cost; 871,162 and 772,330 shares |  |  | (15,747 | ) |  |  | (13,518 | )
TOTAL STOCKHOLDERS' EQUITY |  |  | 137,775 |  |  |  | 128,290 |
TOTAL LIABILITIES AND STOCKHOLDERS' EQUITY |  | $ | 1,182,475 |  |  | $ | 1,248,398 |

See accompanying notes to the consolidated financial statements.

5

MIDDLEFIELD BANC CORP.
CONSOLIDATED STATEMENT OF INCOME
(Dollar amounts in thousands, except per share data)

|  | Year Ended December 31, |
|  | 2019 |  |  | 2018 |
INTEREST AND DIVIDEND INCOME |  |  |  |  |  |  |  |
Interest and fees on loans |  | $ | 50,390 |  |  | $ | 46,576 |
Interest-earning deposits in other institutions |  |  | 673 |  |  |  | 558 |
Federal funds sold |  |  | 78 |  |  |  | 46 |
Investment securities: |  |  |  |  |  |  |  |
Taxable interest |  |  | 796 |  |  |  | 688 |
Tax-exempt interest |  |  | 2,392 |  |  |  | 2,262 |
Dividends on stock |  |  | 196 |  |  |  | 227 |
Total interest and dividend income |  |  | 54,525 |  |  |  | 50,357 |
INTEREST EXPENSE |  |  |  |  |  |  |  |
Deposits |  |  | 12,409 |  |  |  | 8,631 |
Short-term borrowings |  |  | 368 |  |  |  | 842 |
Other borrowings |  |  | 363 |  |  |  | 436 |
Total interest expense |  |  | 13,140 |  |  |  | 9,909 |
NET INTEREST INCOME |  |  | 41,385 |  |  |  | 40,448 |
Provision for loan losses |  |  | 890 |  |  |  | 840 |
NET INTEREST INCOME AFTER PROVISION FOR LOAN LOSSES |  |  | 40,495 |  |  |  | 39,608 |
NONINTEREST INCOME |  |  |  |  |  |  |  |
Service charges on deposit accounts |  |  | 2,186 |  |  |  | 1,914 |
Investment securities gains on sale, net |  |  | 194 |  |  |  | - |
Gain (loss) on equity securities |  |  | 94 |  |  |  | (9 | )
Earnings on bank-owned life insurance |  |  | 431 |  |  |  | 428 |
Gain on sale of loans |  |  | 433 |  |  |  | 231 |
Other income |  |  | 1,503 |  |  |  | 1,164 |
Total noninterest income |  |  | 4,841 |  |  |  | 3,728 |
NONINTEREST EXPENSE |  |  |  |  |  |  |  |
Salaries and employee benefits |  |  | 16,523 |  |  |  | 15,749 |
Occupancy expense |  |  | 2,164 |  |  |  | 1,933 |
Equipment expense |  |  | 1,040 |  |  |  | 969 |
Data processing costs |  |  | 2,208 |  |  |  | 1,806 |
Ohio state franchise tax |  |  | 1,044 |  |  |  | 823 |
Federal deposit insurance expense |  |  | 230 |  |  |  | 550 |
Professional fees |  |  | 1,683 |  |  |  | 1,482 |
Advertising expense |  |  | 733 |  |  |  | 921 |
Software amortization expense |  |  | 638 |  |  |  | 605 |
Core deposit intangible amortization |  |  | 341 |  |  |  | 352 |
Other expense |  |  | 3,429 |  |  |  | 3,553 |
Total noninterest expense |  |  | 30,033 |  |  |  | 28,743 |
Income before income taxes |  |  | 15,303 |  |  |  | 14,593 |
Income taxes |  |  | 2,592 |  |  |  | 2,162 |
NET INCOME |  | $ | 12,711 |  |  | $ | 12,431 |
EARNINGS PER SHARE |  |  |  |  |  |  |  |
Basic |  | $ | 1.96 |  |  | $ | 1.92 |
Diluted |  |  | 1.95 |  |  |  | 1.91 |

See accompanying notes to the consolidated financial statements.

6

MIDDLEFIELD BANC CORP.
CONSOLIDATED STATEMENT OF COMPREHENSIVE INCOME
(Dollar amounts in thousands)

|  | Year Ended December 31, |
|  | 2019 |  |  | 2018 |
Net income |  | $ | 12,711 |  |  | $ | 12,431 |
Other comprehensive income (loss): |  |  |  |  |  |  |  |
Net unrealized holding gain (loss) on available- for-sale investment securities |  |  | 2,720 |  |  |  | (1,636 | )
Tax effect |  |  | (571 | ) |  |  | 345 |
Reclassification adjustment for investment securities gains included in net income |  |  | (194 | ) |  |  | - |
Tax effect |  |  | 41 |  |  |  | - |
Total other comprehensive income (loss) |  |  | 1,996 |  |  |  | (1,291 | )
Comprehensive income |  | $ | 14,707 |  |  | $ | 11,140 |

See accompanying notes to the consolidated financial statements.

7

MIDDLEFIELD BANC CORP.
CONSOLIDATED STATEMENT OF CHANGES IN STOCKHOLDERS' EQUITY
(Dollar amounts in thousands, except shares and dividend per share amount)

|  |  |  |  |  |  |  |  |  |  |  |  |  | Accumulated |  |  |  |  |  |  |  |  |
|  |  |  |  |  |  |  |  |  |  |  |  |  | Other |  |  |  |  |  |  | Total |
|  | Common Stock |  |  | Retained |  |  | Comprehensive |  |  | Treasury |  |  | Stockholders' |
|  | Shares |  |  | Amount |  |  | Earnings |  |  | Income (Loss) |  |  | Stock |  |  | Equity |
Balance, December 31, 2017 |  |  | 7,207,762 |  |  | $ | 84,859 |  |  | $ | 47,431 |  |  | $ | 1,091 |  |  | $ | (13,518 | ) |  | $ | 119,863 |
Change in accounting principle for adoption of ASU 2016-01 |  |  |  |  |  |  |  |  |  |  | 141 |  |  |  | (141 | ) |  |  |  |  |  |  | - |
Change in accounting principle for adoption of ASU 2018-02 |  |  |  |  |  |  |  |  |  |  | (187 | ) |  |  | 187 |  |  |  |  |  |  |  | - |
Net income |  |  |  |  |  |  |  |  |  |  | 12,431 |  |  |  |  |  |  |  |  |  |  |  | 12,431 |
Other comprehensive loss |  |  |  |  |  |  |  |  |  |  |  |  |  |  | (1,291 | ) |  |  |  |  |  |  | (1,291 | )
Dividend reinvestment and purchase plan |  |  | 24,512 |  |  |  | 618 |  |  |  |  |  |  |  |  |  |  |  |  |  |  |  | 618 |
Stock options exercised |  |  | 17,600 |  |  |  | 168 |  |  |  |  |  |  |  |  |  |  |  |  |  |  |  | 168 |
Stock-based compensation |  |  | 11,120 |  |  |  | 280 |  |  |  |  |  |  |  |  |  |  |  |  |  |  |  | 280 |
Cash dividends ($0.59 per share) |  |  |  |  |  |  |  |  |  |  | (3,779 | ) |  |  |  |  |  |  |  |  |  |  | (3,779 | )
Balance, December 31, 2018 |  |  | 7,260,994 |  |  | $ | 85,925 |  |  | $ | 56,037 |  |  | $ | (154 | ) |  | $ | (13,518 | ) |  | $ | 128,290 |
Net income |  |  |  |  |  |  |  |  |  |  | 12,711 |  |  |  |  |  |  |  |  |  |  |  | 12,711 |
Other comprehensive income |  |  |  |  |  |  |  |  |  |  |  |  |  |  | 1,996 |  |  |  |  |  |  |  | 1,996 |
Dividend reinvestment and purchase plan |  |  | 17,866 |  |  |  | 372 |  |  |  |  |  |  |  |  |  |  |  |  |  |  |  | 372 |
Stock options exercised |  |  | 400 |  |  |  | 4 |  |  |  |  |  |  |  |  |  |  |  |  |  |  |  | 4 |
Stock-based compensation, net |  |  | 15,532 |  |  |  | 316 |  |  |  |  |  |  |  |  |  |  |  |  |  |  |  | 316 |
Treasury shares acquired (98,832 shares) |  |  |  |  |  |  |  |  |  |  |  |  |  |  |  |  |  |  | (2,229 | ) |  |  | (2,229 | )
Cash dividends ($0.57 per share) |  |  |  |  |  |  |  |  |  |  | (3,685 | ) |  |  |  |  |  |  |  |  |  |  | (3,685 | )
Balance, December 31, 2019 |  |  | 7,294,792 |  |  | $ | 86,617 |  |  | $ | 65,063 |  |  | $ | 1,842 |  |  | $ | (15,747 | ) |  | $ | 137,775 |

See accompanying notes to the consolidated financial statements.

8

MIDDLEFIELD BANC CORP.
CONSOLIDATED STATEMENT OF CASH FLOWS
(Dollar amounts in thousands)

|  | Year Ended December 31, |
|  | 2019 |  |  | 2018 |
OPERATING ACTIVITIES |  |  |  |  |  |  |  |
Net income |  | $ | 12,711 |  |  | $ | 12,431 |
Adjustments to reconcile net income to net cash provided by operating activities: |  |  |  |  |  |  |  |
Provision for loan losses |  |  | 890 |  |  |  | 840 |
Investment securities gains on sale, net |  |  | (194 | ) |  |  | - |
(Gain) loss on equity securities |  |  | (94 | ) |  |  | 9 |
Depreciation and amortization of premises and equipment, net |  |  | 1,039 |  |  |  | 951 |
Software amortization expense |  |  | 638 |  |  |  | 605 |
Financing lease amortization expense |  |  | 360 |  |  |  | - |
Amortization of premium and discount on investment securities, net |  |  | 259 |  |  |  | 419 |
Accretion of deferred loan fees, net |  |  | (753 | ) |  |  | (868 | )
Amortization of core deposit intangibles |  |  | 341 |  |  |  | 352 |
Stock-based compensation expense |  |  | 644 |  |  |  | 467 |
Origination of loans held for sale |  |  | (19,845 | ) |  |  | (13,196 | )
Proceeds from sale of loans |  |  | 19,655 |  |  |  | 13,293 |
Gain on sale of loans |  |  | (433 | ) |  |  | (231 | )
Earnings on bank-owned life insurance |  |  | (431 | ) |  |  | (428 | )
Deferred income tax |  |  | 327 |  |  |  | (241 | )
Net gain on other real estate owned |  |  | (123 | ) |  |  | (55 | )
Decrease (increase) in accrued interest receivable |  |  | 162 |  |  |  | (345 | )
Increase in accrued interest payable |  |  | 173 |  |  |  | 166 |
Other, net |  |  | (1,867 | ) |  |  | 112 |
Net cash provided by operating activities |  |  | 13,459 |  |  |  | 14,281 |
INVESTING ACTIVITIES |  |  |  |  |  |  |  |
Investment securities available for sale: |  |  |  |  |  |  |  |
Proceeds from repayments and maturities |  |  | 17,687 |  |  |  | 7,280 |
Proceeds from sale of securities |  |  | 12,324 |  |  |  | - |
Purchases |  |  | (34,961 | ) |  |  | (12,999 | )
Decrease (increase) in loans, net |  |  | 6,932 |  |  |  | (68,796 | )
Proceeds from the sale of other real estate owned |  |  | 360 |  |  |  | 163 |
Purchase of premises and equipment |  |  | (1,897 | ) |  |  | (2,101 | )
Purchase of restricted stock |  |  | (169 | ) |  |  | (90 | )
Net cash provided by (used in) investing activities |  |  | 276 |  |  |  | (76,543 | )
FINANCING ACTIVITIES |  |  |  |  |  |  |  |
Net increase in deposits |  |  | 4,776 |  |  |  | 137,873 |
(Decrease) increase in short-term borrowings, net |  |  | (85,323 | ) |  |  | 15,691 |
Net repayment of other borrowings |  |  | (426 | ) |  |  | (20,262 | )
Restricted stock cash portion |  |  | (44 | ) |  |  | - |
Stock options exercised |  |  | 4 |  |  |  | 168 |
Proceeds from dividend reinvestment and purchase plan |  |  | 372 |  |  |  | 618 |
Repurchase of treasury shares |  |  | (2,229 | ) |  |  | - |
Cash dividends |  |  | (3,685 | ) |  |  | (3,779 | )
Net cash (used in) provided by financing activities |  |  | (86,555 | ) |  |  | 130,309 |
(Decrease) increase in cash and cash equivalents |  |  | (72,820 | ) |  |  | 68,047 |
CASH AND CASH EQUIVALENTS AT BEGINNING OF YEAR |  |  | 107,933 |  |  |  | 39,886 |
CASH AND CASH EQUIVALENTS AT END OF YEAR |  | $ | 35,113 |  |  | $ | 107,933 |

See accompanying notes to the consolidated financial statements.

9

|  | Year Ended December 31, |
|  | 2019 |  |  | 2018 |
SUPPLEMENTAL INFORMATION |  |  |  |  |  |  |  |
Cash paid during the year for: |  |  |  |  |  |  |  |
Interest on deposits and borrowings |  | $ | 12,967 |  |  | $ | 9,743 |
Income taxes |  |  | 2,705 |  |  |  | 2,125 |
Noncash operating transactions: |  |  |  |  |  |  |  |
Operating lease assets added to other, net |  | $ | (1,071 | ) |  | $ | - |
Operating lease liabilities added to other, net |  |  | 1,071 |  |  |  | - |
Noncash investing transactions: |  |  |  |  |  |  |  |
Transfers from loans to other real estate owned |  | $ | 122 |  |  | $ | 166 |
Transfer of equity securities from investment securities available for sale, at fair value |  |  | - |  |  |  | (625 | )
Finance lease assets added to premises and equipment |  |  | (4,373 | ) |  |  | - |
Noncash financing transactions: |  |  |  |  |  |  |  |
Finance lease liabilities added to borrowed funds |  | $ | 4,373 |  |  | $ | - |

See accompanying notes to the consolidated financial statements.

10

MIDDLEFIELD BANC CORP.

NOTES TO CONSOLIDATED FINANCIAL STATEMENTS

1. | SUMMARY OF SIGNIFICANT ACCOUNTING POLICIES

A summary of the significant accounting and reporting policies applied in the presentation of the accompanying financial statements follows:

Nature of Operations and Basis of Presenta tion

Middlefield Banc Corp. (the “Company”) is an Ohio corporation organized to become the holding company of The Middlefield Banking Company (“MBC”). MBC is a state-chartered bank located in Ohio, whose consolidated financial statements also include the accounts of MBC’s subsidiary, Middlefield Investments, Inc. (MI), established March 13, 2019. Significant intercompany items have been eliminated in preparing MBC’s consolidated financial statements. On October 23, 2009, the Company established an asset resolution subsidiary named EMORECO, Inc. The Company and its subsidiaries derive substantially all of their income from banking and bank-related services, which includes interest earnings on residential real estate, commercial mortgage, commercial and consumer financings as well as interest earnings on investment securities and deposit services to its customers through sixteen full-service locations. The Company is supervised by the Board of Governors of the Federal Reserve System, while MBC is subject to regulation and supervision by the Federal Deposit Insurance Corporation and the Ohio Division of Financial Institutions.

The consolidated financial statements of the Company include its wholly owned subsidiaries, MBC and EMORECO, Inc. Significant intercompany items have been eliminated in preparing the consolidated financial statements.

The financial statements have been prepared in conformity with U.S. Generally Accepted Accounting Principles. In preparing the financial statements, management is required to make estimates and assumptions that affect the reported amounts of assets and liabilities as of the balance sheet date and revenues and expenses for the period. Actual results could differ from those estimates.

Investment and Equity Securities

Investment securities are classified at the time of purchase, based on management’s intention and ability, as securities held to maturity or securities available for sale. Debt securities acquired with the intent and ability to hold to maturity are stated at cost adjusted for amortization of premium and accretion of discount, which are computed using a level yield method and recognized as adjustments of interest income. Certain other debt securities have been classified as available for sale to serve principally as a source of liquidity. Unrealized holding gains and losses for available-for-sale securities are reported as a separate component of stockholders’ equity, net of tax, until realized. Realized security gains and losses are computed using the specific identification method. Interest and dividends on investment securities are recognized as income when earned. For 2019 and 2018, this category includes common stocks of public companies that the Company has the positive intent and ability to hold for an indeterminate amount of time. Such securities are reported at fair value with unrealized holding gains and losses included in earnings.

Securities are evaluated on at least a quarterly basis and more frequently when economic or market conditions warrant such an evaluation to determine whether a decline in their value is other than temporary. For debt securities, management considers whether the present value of cash flows expected to be collected is less than the security’s amortized cost basis (the difference defined as the credit loss), the magnitude and duration of the decline, the reasons underlying the decline and the Bank’s intent to sell the security or whether it is more likely than not that the Bank would be required to sell the security before its anticipated recovery in market value, to determine whether the loss in value is other than temporary. Once a decline in value is determined to be other than temporary, if the Bank does not intend to sell the security, and it is more likely than not that it will not be required to sell the security, before recovery of the security’s amortized cost basis, the charge to earnings is limited to the amount of credit loss. Any remaining difference between fair value and amortized cost (the difference defined as the non-credit portion) is recognized in other comprehensive income, net of applicable taxes. Otherwise, the entire difference between fair value and amortized cost is charged to earnings. For equity securities where the fair value has been significantly below cost for one year, the Bank’s policy is to recognize an impairment loss unless sufficient evidence is available that the decline is not other than temporary and a recovery period can be predicted.

Restricted Stock

Common stock of the Federal Home Loan Bank (“FHLB”) represents ownership in an institution that is wholly owned by other financial institutions. This equity security is accounted for at cost and classified with other assets. The FHLB of Cincinnati has reported profits for 2019 and 2018, remains in compliance with regulatory capital and liquidity requirements, and continues to pay dividends on the stock and make redemptions at the par value. With consideration given to these factors, management concluded that the stock was not impaired at December 31, 2019 or 2018.

11

Mortgage Banking Activities

Mortgage loans originated and intended for sale in the secondary market are carried at fair value. The Bank sells the loans on a servicing retained basis. Servicing rights are initially recorded at fair value with the income statement effect recorded in gains on sales of loans. The Bank measures servicing assets using the amortization method. Fair value is based on market prices for comparable mortgage servicing contracts, when available, or alternatively, is based on a valuation model that calculates the present value of estimated future net servicing income. Loan servicing rights are amortized in proportion to and over the period of estimated net future servicing revenue. The expected period of the estimated net servicing income is based in part on the expected prepayment of the underlying mortgages. The unamortized balance of mortgage servicing rights is included in accrued interest and other assets on the Consolidated Balance Sheet.

Mortgage servicing rights are periodically evaluated for impairment. Impairment represents the excess of amortized cost over its estimated fair value. Impairment is determined by stratifying rights into tranches based on predominant risk characteristics, such as interest rate and original time to maturity. Any impairment is reported as a valuation allowance for an individual tranche. If the Company later determines that all or a portion of the impairment no longer exists for a particular grouping, a reduction of the allowance will be recorded as an increase to income.

Servicing fee income is recorded for fees earned for servicing loans. The fees are based on a contractual percentage of outstanding principal and are recorded as income when earned. The amortization of mortgage servicing rights is netted against loan servicing fee income. Late fees and ancillary fees related to loan servicing are not material. The Bank is servicing loans for others in the amount of $70.8 million and $59.4 million at December 31, 2019 and 2018, respectively.

Loans

Loans that management has the intent and ability to hold for the foreseeable future or until maturity or payoff generally are reported at their outstanding unpaid principal balances net of the allowance for loan and lease losses. Interest income is recognized as income when earned on the accrual method. The accrual of interest is discontinued on a loan when management believes, after considering economic and business conditions, the borrower’s financial condition is such that collection of interest is doubtful. Interest received on nonaccrual loans is recorded as income or applied against principal according to management’s judgment as to the collectability of such principal.

Loan origination fees and certain direct loan origination costs are being deferred and the net amount amortized as an adjustment of the related loan’s yield. Management is amortizing these amounts over the contractual life of the related loans.

Allowance for Loan and Lease Losses

The allowance for loan and lease losses represents the amount which management estimates is adequate to provide for probable loan losses inherent in the loan portfolio. The allowance method is used in providing for loan losses. Accordingly, all loan losses are charged to the allowance, and all recoveries are credited to it. The allowance for loan and lease losses is established through a provision for loan losses which is charged to operations. The provision is based on management’s periodic evaluation of the adequacy of the allowance for loan and lease losses, which encompasses the overall risk characteristics of the various portfolio segments, past experience with losses, the impact of economic conditions on borrowers, and other relevant factors. The estimates used in determining the adequacy of the allowance for loan and lease losses, including the amounts and timing of future cash flows expected on impaired loans, are particularly susceptible to significant change in the near term.

A loan is considered impaired when it is probable the borrower will not repay the loan according to the original contractual terms of the loan agreement. Loans that experience insignificant payment delays, which are defined as 89 days or less, generally are not classified as impaired. A loan is not impaired during a period of delay in payment if the Company expects to collect all amounts due, including interest accrued, at the contractual interest rate for the period of delay. All loans identified as impaired are evaluated independently by management. The Company estimates credit losses on impaired loans based on the present value of expected cash flows or the fair value of the underlying collateral if the loan repayment is expected to come from the sale or operation of such collateral. Impaired loans, or portions thereof, are charged off when it is determined a realized loss has occurred. Until such time, an allowance for loan and lease losses is maintained for estimated losses. Cash receipts on impaired loans are applied first to accrued interest receivable unless otherwise required by the loan terms, except when an impaired loan is also a nonaccrual loan, in which case the portion of the payment related to interest is used to reduce principal.

Mortgage loans secured by one-to-four family properties and all consumer loans are large groups of smaller-balance homogeneous loans and are measured for impairment collectively. Management determines the significance of payment delays on a case-by-case basis, taking into consideration all circumstances concerning the loan, the creditworthiness and payment history of the borrower, the length of the payment delay, and the amount of shortfall in relation to the principal and interest owed.

12

Loans Acquired

Loans acquired, including loans that have evidence of deterioration of credit quality since origination and for which it is probable, at acquisition, that the Company will be unable to collect all contractually required payments receivable, are initially recorded at fair value (as determined by the present value of expected future cash flows) with no valuation allowance. Loans are evaluated individually to determine if there is evidence of deterioration of credit quality since origination. The difference between the undiscounted cash flows expected at acquisition and the investment in the loan, or the “accretable yield,” is recognized as interest income on a level-yield method over the life of the loan. Contractually required payments for interest and principal that exceed the undiscounted cash flows expected at acquisition, or the “non-accretable difference,” are not recognized as a yield adjustment or as a loss accrual or a valuation allowance. Increases in expected cash flows subsequent to the initial investment are recognized prospectively through adjustment of the yield on the loan over its remaining estimated life. Decreases in expected cash flows are recognized immediately as impairment. Any valuation allowances on these impaired loans reflect only losses incurred after acquisition.

For purchased loans acquired that are not deemed impaired at acquisition, credit discounts representing the principal losses expected over the life of the loan are a component of the initial fair value. Loans are aggregated and accounted for as a pool of loans if the loans being aggregated have common risk characteristics. Subsequent to the purchase date, the methods utilized to estimate the required allowance for credit losses for these loans is similar to originated loans; however, the Company records a provision for loan losses only when the required allowance exceeds any remaining credit discounts. The remaining differences between the purchase price and the unpaid principal balance at the date of acquisition are recorded in interest income over the life of the loans.

Premises and Equipment

Land is carried at cost. Premises and equipment are stated at cost net of accumulated depreciation. Depreciation is computed on the straight-line method over the estimated useful lives of the assets, which range from 3 to 20 years for furniture, fixtures, and equipment and 3 to 40 years for buildings and leasehold improvements. Expenditures for maintenance and repairs are charged against income as incurred. Costs of major additions and improvements are capitalized.

Leases

The Company has operating and financing leases for several branch locations and office space. Generally, the underlying lease agreements do not contain any material residual value guarantees or material restrictive covenants. The Company may also lease certain office equipment under operating leases. Many of our leases include both lease (e.g., minimum rent payments) and non-lease components (e.g., common-area or other maintenance costs). The Company accounts for each component separately based on the standalone price of each component. In addition, there may be operating and financing leases with lease terms of less than one year and therefore, we have elected the practical expedient to exclude these short-term leases from our right-of-use assets and lease liabilities.

Most leases include one or more options to renew. The exercise of lease renewal options is typically at the sole discretion of management and is based on whether the extension options are reasonably certain to be exercised after giving proper consideration to all facts and circumstances of the lease. If management determines that the Company is reasonably certain to exercise the extension option(s), the additional term is included in the calculation of the right-of-use asset and lease liability.

As most of our leases do not provide an implicit rate, we use the fully collateralized FHLB borrowing rate, commensurate with the lease terms based on the information available at the lease commencement date in determining the present value of the lease payments.

Goodwill

The Company accounts for goodwill using a two-step process for testing the impairment of goodwill on at least an annual basis. This approach could cause more volatility in the Company’s reported net income because impairment losses, if any, could occur irregularly and in varying amounts. No impairment of goodwill was recognized in any of the periods presented.

Intangible Assets

Intangible assets include core deposit intangibles, which are a measure of the value of consumer demand and savings deposits acquired in business combinations accounted for as purchases. The core deposit intangibles are being amortized to their estimated residual values over their expected useful lives, commonly of ten years. The recoverability of the carrying value of intangible assets is evaluated on an ongoing basis, and permanent declines in value, if any, are charged to expense.

13

Bank-Owned Life Insurance (“BOLI”)

The Company owns insurance on the lives of a certain group of key employees. The policies were purchased to help offset the increase in the costs of various fringe benefit plans including healthcare. The cash surrender value of these policies is included as an asset on the Consolidated Balance Sheet and any increases in the cash surrender value are recorded as noninterest income on the Consolidated Statement of Income. In the event of the death of an insured individual under these policies, the Company would receive a death benefit, which would be recorded as tax-free noninterest income.

Other Real Estate Owned

Real estate properties acquired through foreclosure are initially recorded at fair value at the date of foreclosure, establishing a new cost basis. After foreclosure, management periodically performs valuations and the real estate is carried at the lower of cost or fair value less estimated cost to sell. Revenue and expenses from operations of the properties, gains or losses on sales and additions to the valuation allowance are included in operating results.

Income Taxes

The Company and its subsidiaries file a consolidated federal income tax return. Deferred tax assets and liabilities are reflected at currently enacted income tax rates applicable to the period in which the deferred tax assets or liabilities are expected to be realized or settled. As changes in tax laws or rates are enacted, deferred tax assets and liabilities are adjusted through the provision for income taxes.

Earnings Per Share

The Company provides dual presentation of basic and diluted earnings per share. Basic earnings per share is calculated utilizing net income as reported in the numerator and average shares outstanding in the denominator. The computation of diluted earnings per share differs in that the dilutive effects of any stock options, warrants, and convertible securities are adjusted in the denominator. Earnings and dividends per share are restated for all stock splits and stock dividends through the date of issuance of the financial statements. (See Note 20 – Stock Split Disclosure.)

Stock-Based Compensation

The Company accounts for stock compensation based on the grant date fair value of all share-based payment awards that are expected to vest, including employee share options to be recognized as employee compensation expense over the requisite service period.

Compensation cost is recognized for restricted stock issued to employees based on the fair value of these awards at the date of grant. The market price of the Company’s common shares at the date of grant is used to estimate the fair value of restricted stock and stock awards. Compensation cost is recognized over the required service period, generally defined as the vesting period, and is recorded in "Salaries and employee benefits" expense. (See Note 14-Employee Benefits) The Company’s restricted stock plan allows for a portion of the value to be received in cash by the participant upon vesting, and therefore, the Company records the expense as a liability until the shares vest and the split of the payment between shares and cash can be determined.

Cash Flow Information

The Company has defined cash and cash equivalents as those amounts included in the Consolidated Balance Sheet captions as “Cash and due from banks” and “Federal funds sold” with original maturities of less than 90 days.

Advertising Costs

Advertising costs are expensed as incurred.

Reclassification of Comparative Amounts

Certain comparative amounts for prior years have been reclassified to conform to current-year presentations. Such reclassifications did not affect net income or retained earnings.

Recently Adopted Accounting Pronouncements -

In May 2014, the FASB issued ASU 2014-09, Revenue from Contracts with Customers (a new revenue recognition standard). The Update’s core principle is that a company will recognize revenue to depict the transfer of goods or services to customers in an amount that reflects the consideration to which the entity expects to be entitled in exchange for those goods or services. In addition, this Update specifies the accounting for certain costs to obtain or fulfill a contract with a customer and expands disclosure requirements for revenue recognition. Since the guidance scopes out revenue associated with financial instruments, including loan receivables and investment securities, the adoption of the standard and its related amendments did not result in a material change from our current accounting for revenue because the majority of the Company’s revenue is not within the scope of Topic 606. Upon adoption on January 1, 2018, we have included the related new disclosure requirements in Note 2.

14

In January 2016, the FASB issued ASU 2016-01, Financial Instruments – Overall (Subtopic 825-10): Recognition and Measurement of Financial Assets and Financial Liabilities. This Update applies to all entities that hold financial assets or owe financial liabilities and is intended to provide more useful information on the recognition, measurement, presentation, and disclosure of financial instruments. Among other things, this Update (a) requires equity investments (except those accounted for under the equity method of accounting or those that result in consolidation of the investee) to be measured at fair value with changes in fair value recognized in net income; (b) simplifies the impairment assessment of equity investments without readily determinable fair values by requiring a qualitative assessment to identify impairment; (c) eliminates the requirement to disclose the fair value of financial instruments measured at amortized cost for entities that are not public business entities; (d) eliminates the requirement for public business entities to disclose the method(s) and significant assumptions used to estimate the fair value that is required to be disclosed for financial instruments measured at amortized cost on the balance sheet; (e) requires public business entities to use the exit price notion when measuring the fair value of financial instruments for disclosure purposes; (f) requires separate presentation of financial assets and financial liabilities by measurement category and form of financial asset (that is, securities or loans and receivables) on the balance sheet or the accompanying notes to the financial statements; and (g) clarifies that an entity should evaluate the need for a valuation allowance on a deferred tax asset related to available-for-sale securities in combination with the entity’s other deferred tax assets. On January 1, 2018, the Company adopted ASU 2016-01 which resulted in a reclassification of $141,000 between accumulated other comprehensive income and retained earnings on the Consolidated Balance Sheet and Consolidated Statement of Changes in Stockholders’ Equity. Additionally, the methods used to calculate the fair value of financial instruments in Note 18 were based on exit pricing assumptions as of December 31, 2019 and 2018.

In February 2016, the FASB issued ASU 2016-02, Leases (Topic 842). The standard requires lessees to recognize the assets and liabilities that arise from leases on the balance sheet. A lessee should recognize in the statement of financial position a liability to make lease payments (the lease liability) and a right-of-use asset representing its right to use the underlying asset for the lease term. A short-term lease is defined as one in which (a) the lease term is 12 months or less and (b) there is not an option to purchase the underlying asset that the lessee is reasonably certain to exercise. For short-term leases, lessees may elect to recognize lease payments over the lease term on a straight-line basis. On January 1, 2019, the Company adopted ASU 2016-02 which resulted in the recording of finance lease assets and liabilities of $3.8 million and operating lease assets and liabilities of $1.1 million on the Consolidated Balance Sheet. See Note 15 of the financial statements.

In March 2017, the FASB issued ASU 2017-08, Receivables – Nonrefundable Fees and Other Costs (Subtopic 310-20). The amendments in this Update shorten the amortization period for certain callable debt securities held at a premium. Specifically, the amendments require the premium to be amortized to the earliest call date. The amendments do not require an accounting change for securities held at a discount; the discount continues to be amortized to maturity. This Update has not had a significant impact on the Company’s financial position or results of operations.

In February 2018, the FASB issued ASU 2018-02, Income Statement – Reporting Comprehensive Income (Topic 220), to allow a reclassification from accumulated other comprehensive income to retained earnings for stranded tax effects resulting from the Tax Cuts and Jobs Act. Consequently, the amendments eliminate the stranded tax effects resulting from the Tax Cuts and Jobs Act and will improve the usefulness of information reported to financial statement users. On January 1, 2018, the Company adopted this standard which resulted in a reclassification of $187,000 between accumulated other comprehensive income and retained earnings on the Consolidated Balance Sheet and Consolidated Statement of Changes in Stockholders’ Equity.

In June 2018, the FASB issued ASU 2018-07, Compensation – Stock Compensation (Topic 718), which simplified the accounting for nonemployee share-based payment transactions. The amendments in this update expand the scope of Topic 718 to include share-based payment transactions for acquiring goods and services from nonemployees. The amendments in this Update improve the following areas of nonemployee share-based payment accounting: (a) the overall measurement objective, (b) the measurement date, (c) awards with performance conditions, (d) classification reassessment of certain equity-classified awards, (e) calculated value (nonpublic entities only), and (f) intrinsic value (nonpublic entities only). The adoption of this standard and its related amendments did not result in a material impact on the Company’s financial position or results of operations.

Recently Issued Accounting Pronouncements -

In June 2016, the FASB issued ASU 2016-13, Financial Instruments – Credit Losses: Measurement of Credit Losses on Financial Instruments (“CECL”), which changes the impairment model for most financial assets. This Update is intended to improve financial reporting by requiring timelier recording of credit losses on loans and other financial instruments held by financial institutions and other organizations. The underlying premise of the Update is that financial assets measured at amortized cost should be presented at the net amount expected to be collected, through an allowance for credit losses that is deducted from the amortized cost basis. The allowance for credit losses should reflect management’s current estimate of credit losses that are expected to occur over the remaining life of a financial asset. The income statement will be effected for the measurement of credit losses for newly recognized financial assets, as well as the expected increases or decreases of expected credit losses that have taken place during the period. ASU 2016-13 is effective for annual and interim periods beginning after December 15, 2019, and early adoption is permitted for annual and interim periods beginning after December 15, 2018. With certain exceptions, transition to the new requirements will be through a cumulative effect adjustment to opening retained earnings as of the beginning of the first reporting period in which the guidance is adopted. In November 2019, the FASB issued ASU 2019-10, Financial Instruments ‒ Credit Losses (Topic 326), Derivatives and Hedging (Topic 815), and Leases (Topic 842). This Update defers the effective date of ASU 2016-13 for SEC filers that are eligible to be smaller reporting companies, non-SEC filers, and all other companies to fiscal years beginning after December 15, 2022, including interim periods within those fiscal years. The CECL model has been completed and runs concurrently with the existing incurred loss model each month. Management will continue to monitor model output throughout the deferral period.

15

In January 2017, the FASB issued ASU 2017-04, Simplifying the Test for Goodwill Impairment. To simplify the subsequent measurement of goodwill, the FASB eliminated Step 2 from the goodwill impairment test. In computing the implied fair value of goodwill under Step 2, an entity had to perform procedures to determine the fair value at the impairment testing date of its assets and liabilities (including unrecognized assets and liabilities) following the procedure that would be required in determining the fair value of assets acquired and liabilities assumed in a business combination. Instead, under the amendments in this Update, an entity should perform its annual, or interim, goodwill impairment test by comparing the fair value of a reporting unit with its carrying amount. An entity should recognize an impairment charge for the amount by which the carrying amount exceeds the reporting units fair value; however, the loss recognized should not exceed the total amount of goodwill allocated to that reporting unit. A public business entity that is a U.S. Securities and Exchange Commission (SEC) filer should adopt the amendments in this Update for its annual or any interim goodwill impairment tests in fiscal years beginning after December 15, 2019. A public business entity that is not an SEC filer should adopt the amendments in this Update for its annual or any interim goodwill impairment tests in fiscal years beginning after December 15, 2020. All other entities, including not-for-profit entities, that are adopting the amendments in this Update should do so for their annual or any interim goodwill impairment tests in fiscal years beginning after December 15, 2021. In November 2019, the FASB issued ASU 2019-10, Financial Instruments ‒ Credit Losses (Topic 326), Derivatives and Hedging (Topic 815), and Leases (Topic 842), which deferred the effective date for ASC 350, Intangibles – Goodwill and Other, for smaller reporting companies to fiscal years beginning after December 15, 2022, and interim periods within those fiscal years. This Update is not expected to have a significant impact on the Company’s financial statements, OR the Company is currently evaluating the impact the adoption of the standard will have on the Company’s financial position or results of operations.

In August 2018, the FASB issued ASU 2018-13, Fair Value Measurement (Topic 820): Disclosure Framework – Changes the Disclosure Requirements for Fair Value Measurements. The Update removes the requirement to disclose the amount of and reasons for transfers between Level I and Level II of the fair value hierarchy; the policy for timing of transfers between levels; and the valuation processes for Level III fair value measurements. The Update requires disclosure of changes in unrealized gains and losses for the period included in other comprehensive income (loss) for recurring Level III fair value measurements held at the end of the reporting period and the range and weighted average of significant unobservable inputs used to develop Level III fair value measurements. This Update is effective for all entities for fiscal years, and interim periods within those fiscal years, beginning after December 15, 2019. The Company is currently evaluating the impact the adoption of the standard will have on the Company’s financial position or results of operations.

In November 2019, the FASB issued ASU 2019-11, Codification Improvements to Topic 326, Financial Instruments – Credit Losses, to clarify its new credit impairment guidance in ASC 326, based on implementation issues raised by stakeholders. This Update clarified, among other things, that expected recoveries are to be included in the allowance for credit losses for these financial assets; an accounting policy election can be made to adjust the effective interest rate for existing troubled debt restructurings based on the prepayment assumptions instead of the prepayment assumptions applicable immediately prior to the restructuring event; and extends the practical expedient to exclude accrued interest receivable from all additional relevant disclosures involving amortized cost basis. The effective dates in this Update are the same as those applicable for ASU 2019-10. The Company is currently evaluating the impact the adoption of the standard will have on the Company’s financial position or results of operations.

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

16

2. | REVENUE RECOGNITION

In accordance with ASC Topic 606, management determined that the primary sources of revenue, which emanate from interest income on loans and investments, along with noninterest revenue resulting from investment security gains, gains on the sale of loans, and BOLI income, are not within the scope of ASC 606. These revenue sources cumulatively comprise 92.2% of the total revenue of the Company.

The main types of noninterest income within the scope of the standard are as follows:

Service charges on deposit accounts – The Company has contracts with its deposit customers where fees are charged if the account balance falls below predetermined levels defined as compensating balances. The agreements can be cancelled at any time by either the Company or the deposit customer. Revenue from these transactions is recognized on a monthly basis as the Company has an unconditional right to the fee consideration. The Company also has transaction fees related to specific customer requests or activities that include overdraft fees, online banking fees, and other transaction fees. All of these fees are attributable to specific performance obligations of the Company where the revenue is recognized at a defined point in time, which is completion of the requested service/transaction.

Gains (losses) on sale of other real estate owned (“OREO”) - Gains and losses are recognized at the completion of the property sale when the buyer obtains control of the real estate and all of the performance obligations of the Company have been satisfied. Evidence of the buyer obtaining control of the asset includes transfer of the property title, physical possession of the asset, and the buyer obtaining control of the risks and rewards related to the asset. In situations where the Company agrees to provide financing to facilitate the sale, additional analysis is performed to ensure that the contract for sale identifies the buyer and seller, the asset to be transferred and the payment terms, that the contract has a true commercial substance and that amounts due from the buyer are reasonable. In situations where financing terms are not reflective of current market terms, the transaction price is discounted impacting the gain/loss and the carrying value of the asset. Gain and losses on sale of OREO is reported within other expense in the Consolidated Statement of Income.

The following table depicts the disaggregation of revenue derived from contracts with customers to depict the nature, amount, timing, and uncertainty of revenue and cash flows for the years ended December 31,

Noninterest Income |  | 2019 |  |  | 2018 |
(Dollar amounts in thousands) |  |  |  |  |  |  |  |
Service charges on deposit accounts: |  |  |  |  |  |  |  |
Overdraft fees |  | $ | 841 |  |  | $ | 798 |
ATM banking fees |  |  | 932 |  |  |  | 867 |
Service charges and other fees |  |  | 413 |  |  |  | 249 |
Investment securities gains on sale, net (a) |  |  | 194 |  |  |  | - |
Gain (loss) on equity securities (a) |  |  | 94 |  |  |  | (9 | )
Earnings on bank-owned life insurance (a) |  |  | 431 |  |  |  | 428 |
Gain on sale of loans (a) |  |  | 433 |  |  |  | 231 |
Revenue from investment services |  |  | 528 |  |  |  | 385 |
Other income |  |  | 975 |  |  |  | 779 |
Total noninterest income |  | $ | 4,841 |  |  | $ | 3,728 |
Net gain (loss) on other real estate owned |  | $ | (123 | ) |  | $ | (55 | )

(a) Not within scope of ASC 606

17

3. | EARNINGS PER SHARE

There are no convertible securities that would affect the numerator in calculating basic and diluted earnings per share; therefore, net income as presented on the Consolidated Statement of Income will be used as the numerator. The following table sets forth the composition of the weighted-average common shares (denominator) used in the basic and diluted earnings per share computation for the year ended December 31:

|  | 2019 |  |  | 2018 |
Weighted-average common shares issued |  |  | 7,286,554 |  |  |  | 7,232,238 |
Average treasury stock shares |  |  | (816,146 | ) |  |  | (772,330 | )
Weighted-average common shares and common stock equivalents used to calculate basic earnings per share |  |  | 6,470,408 |  |  |  | 6,459,908 |
Additional common stock equivalents (stock options and restricted stock) used to calculate diluted earnings per share |  |  | 32,398 |  |  |  | 27,906 |
Weighted-average common shares and common stock equivalents used to calculate diluted earnings per share |  |  | 6,502,806 |  |  |  | 6,487,814 |

Options to purchase 14,500 shares of common stock at $8.78 a share were outstanding during the year ended December 31, 2019. Also outstanding were 61,040 shares of restricted stock. None of the outstanding options or restricted stock were anti-dilutive.

Options to purchase 14,900 shares of common stock at $8.78 a share were outstanding during the year ended December 31, 2018. Also outstanding were 42,350 shares of restricted stock. None of the outstanding options or restricted stock were anti-dilutive.

When shares recognized as equity are repurchased, the amount of the consideration paid, which includes directly attributable costs, is recognized as a deduction from equity. Repurchased shares are classified as treasury shares and are presented in the treasury share reserve. The reserve for the Company’s treasury shares comprises the cost of the Company’s shares held by the Company. As of December 31, 2019, the Company held 871,162 of the Company’s shares, which is an increase of 98,832 shares for the twelve months ended December 31, 2019, from the 772,330 shares held as of December 31, 2018.

4. | INVESTME NT AND EQUITY SECURITIES

The amortized cost, gross gains and losses and fair values of securities available for sale are as follows:

|  | December 31, 2019 |
|  |  |  |  |  | Gross |  |  | Gross |  |  |  |  |
|  | Amortized |  |  | Unrealized |  |  | Unrealized |  |  | Fair |
(Dollar amounts in thousands) |  | Cost |  |  | Gains |  |  | Losses |  |  | Value |
Subordinated debt |  | $ | 4,000 |  |  | $ | 126 |  |  | $ | - |  |  | $ | 4,126 |
Obligations of states and political subdivisions: |  |  |  |  |  |  |  |  |  |  |  |  |  |  |  |
Taxable |  |  | 500 |  |  |  | 1 |  |  |  | - |  |  |  | 501 |
Tax-exempt |  |  | 80,436 |  |  |  | 2,065 |  |  |  | (25 | ) |  |  | 82,476 |
Mortgage-backed securities in government-sponsored entities |  |  | 18,465 |  |  |  | 274 |  |  |  | (109 | ) |  |  | 18,630 |
Total |  | $ | 103,401 |  |  | $ | 2,466 |  |  | $ | (134 | ) |  | $ | 105,733 |

18

|  | December 31, 2018 |
|  |  |  |  |  | Gross |  |  | Gross |  |  |  |  |
|  | Amortized |  |  | Unrealized |  |  | Unrealized |  |  | Fair |
(Dollar amounts in thousands) |  | Cost |  |  | Gains |  |  | Losses |  |  | Value |
U.S. government agency securities |  | $ | 7,442 |  |  | $ | 90 |  |  | $ | (61 | ) |  | $ | 7,471 |
Obligations of states and political subdivisions: |  |  |  |  |  |  |  |  |  |  |  |  |  |  |  |
Taxable |  |  | 502 |  |  |  | 10 |  |  |  | - |  |  |  | 512 |
Tax-exempt |  |  | 72,387 |  |  |  | 667 |  |  |  | (473 | ) |  |  | 72,581 |
Mortgage-backed securities in government-sponsored entities |  |  | 18,185 |  |  |  | 88 |  |  |  | (515 | ) |  |  | 17,758 |
Total |  | $ | 98,516 |  |  | $ | 855 |  |  | $ | (1,049 | ) |  | $ | 98,322 |

On January 1, 2018, the Company reclassified $625,000 from investment securities available for sale to equity securities in accordance with the adoption of ASU 2016-01. Equity securities totaled $710,000 and $616,000 at December 31, 2019 and 2018, respectively, which incorporates a recognized net gain (loss) on equity investments of $94,000 and ($9,000) for the year ended December 31, 2019 and 2018, respectively. No net gains on sold equity securities were realized from sales during these periods.

The amortized cost and fair value of debt securities at December 31, 2019, by contractual maturity, are shown below. Expected maturities will differ from contractual maturities because borrowers may have the right to call or prepay obligations with or without call or prepayment penalties.

|  | Amortized |  |  | Fair |
(Dollar amounts in thousands) |  | Cost |  |  | Value |
Due in one year or less |  | $ | 148 |  |  | $ | 149 |
Due after one year through five years |  |  | 1,324 |  |  |  | 1,345 |
Due after five years through ten years |  |  | 16,613 |  |  |  | 16,908 |
Due after ten years |  |  | 85,316 |  |  |  | 87,331 |
Total |  | $ | 103,401 |  |  | $ | 105,733 |

Investment securities with an approximate carrying value of $55.6 million and $63.5 million at December 31, 2019 and 2018, respectively, were pledged to secure deposits and other purposes as required by law.

There were no securities sold during the year ended December 31, 2018. Proceeds from the sales of investment securities and the gross realized gains and losses for the year ended December 31, 2019, are as follows (in thousands):

|  | 2019 |  |  | 2018 |
Proceeds from sales |  | $ | 12,324 |  |  | $ | - |
Gross realized gains |  |  | 227 |  |  |  | - |
Gross realized losses |  |  | (33 | ) |  |  | - |

The tax expense related to the net realized gains above was $41,000, and $0 for the year ended December 31, 2019 and 2018, respectively.

19

The following tables show the Company’s gross unrealized losses and fair value, aggregated by investment category and length of time that the individual securities have been in a continuous unrealized loss position.

|  | December 31, 2019 |
|  | Less than Twelve Months |  |  | Twelve Months or Greater |  |  | Total |
|  |  |  |  |  | Gross |  |  |  |  |  |  | Gross |  |  |  |  |  |  | Gross |
|  | Fair |  |  | Unrealized |  |  | Fair |  |  | Unrealized |  |  | Fair |  |  | Unrealized |
(Dollar amounts in thousands) |  | Value |  |  | Losses |  |  | Value |  |  | Losses |  |  | Value |  |  | Losses |
Obligations of states and political subdivisions |  |  |  |  |  |  |  |  |  |  |  |  |  |  |  |  |  |  |  |  |  |  |  |
Tax-exempt |  | $ | 4,324 |  |  | $ | (25 | ) |  | $ | - |  |  | $ | - |  |  | $ | 4,324 |  |  | $ | (25 | )
Mortgage-backed securities in government-sponsored entities |  |  | 1,409 |  |  |  | (2 | ) |  |  | 8,223 |  |  |  | (107 | ) |  |  | 9,632 |  |  |  | (109 | )
Total |  | $ | 5,733 |  |  | $ | (27 | ) |  | $ | 8,223 |  |  | $ | (107 | ) |  | $ | 13,956 |  |  | $ | (134 | )

|  | December 31, 2018 |
|  | Less than Twelve Months |  |  | Twelve Months or Greater |  |  | Total |
|  |  |  |  |  | Gross |  |  |  |  |  |  | Gross |  |  |  |  |  |  | Gross |
|  | Fair |  |  | Unrealized |  |  | Fair |  |  | Unrealized |  |  | Fair |  |  | Unrealized |
(Dollar amounts in thousands) |  | Value |  |  | Losses |  |  | Value |  |  | Losses |  |  | Value |  |  | Losses |
U.S. government agency securities |  | $ | - |  |  | $ | - |  |  | $ | 4,105 |  |  | $ | (61 | ) |  | $ | 4,105 |  |  | $ | (61 | )
Obligations of states and political subdivisions |  |  |  |  |  |  |  |  |  |  |  |  |  |  |  |  |  |  |  |  |  |  |  |
Tax-exempt |  |  | 20,451 |  |  |  | (286 | ) |  |  | 11,053 |  |  |  | (187 | ) |  |  | 31,504 |  |  |  | (473 | )
Mortgage-backed securities in government-sponsored entities |  |  | 2,068 |  |  |  | (9 | ) |  |  | 12,257 |  |  |  | (506 | ) |  |  | 14,325 |  |  |  | (515 | )
Total |  | $ | 22,519 |  |  | $ | (295 | ) |  | $ | 27,415 |  |  | $ | (754 | ) |  | $ | 49,934 |  |  | $ | (1,049 | )

There were 17 securities that were considered temporarily impaired at December 31, 2019.

On a quarterly basis, the Company performs an assessment to determine whether there have been any events or economic circumstances indicating that a security with an unrealized loss has suffered other-than-temporary impairment (“OTTI”). A debt security is considered impaired if the fair value is less than its amortized cost basis at the reporting date. The accounting literature requires the Company to assess whether the unrealized loss is other than temporary. For equity securities where the fair value has been significantly below cost for one year, the Company’s policy is to recognize an impairment loss unless sufficient evidence is available that the decline is not other than temporary and a recovery period can be predicted.

The Company has asserted that at December 31, 2019 and 2018, the declines outlined in the above table represent temporary declines and the Company does not intend to sell and does not believe it will be required to sell these securities before recovery of their cost basis, which may be at maturity. The Company has concluded that any impairment of its investment securities portfolio outlined in the above table is not other than temporary and is the result of interest rate changes, sector credit rating changes, or company-specific rating changes that are not expected to result in the non-collection of principal and interest during the period.

Debt securities issued by U.S. government agencies, U.S. government-sponsored enterprises, and state and political subdivisions accounted for 96.1% of the total available-for-sale portfolio as of December 31, 2019, and no credit losses are expected, given the explicit and implicit guarantees provided by the U.S. federal government and the lack of significant unrealized loss positions within the obligations of state and political subdivisions security portfolio. The Company evaluates credit losses on a quarterly basis. The Company considered the following factors in determining whether a credit loss exists and the period over which the debt security is expected to recover:

| ● | The length of time and the extent to which the fair value has been less than the amortized cost basis.

| ● | Changes in the near term prospects of the underlying collateral of a security such as changes in default rates, loss severity given default and significant changes in prepayment assumptions.

| ● | The level of cash flows generated from the underlying collateral supporting the principal and interest payments of the debt securities.

20

| ● | Any adverse change to the credit conditions and liquidity of the issuer, taking into consideration the latest information available about the overall financial condition of the issuer, credit ratings, recent legislation, and government actions affecting the issuer’s industry and actions taken by the issuer to deal with the present economic climate.

5. | LOANS AND RELATED ALL OWANCE FOR LOAN AND LEASE LOSSES

The Company’s primary business activity is with loan customers located within its local Northeastern Ohio trade area, eastern Geauga County, and contiguous counties to the north, east, and south. The Company also serves the central Ohio market with offices in Dublin, Sunbury, Powell, Plain City and Westerville, Ohio. The Northeastern Ohio trade area includes locations in Beachwood, Twinsburg, and Solon, Ohio. Commercial, residential, consumer, and agricultural loans are granted. Although the Company has a diversified loan portfolio at December 31, 2019 and 2018, loans outstanding to individuals and businesses are dependent upon the local economic conditions in the Company’s immediate trade area.

The following tables summarize the primary segments of the loan portfolio and the allowance for loan and lease losses (in thousands):

|  |  |  |  |  |  |  |  |  | Real Estate-Mortgage |  |  |  |  |  |  |  |  |
December 31, 2019 |  | Commercial and industrial |  |  | Real estate- construction |  |  | Residential |  |  | Commercial |  |  | Consumer installment |  |  | Total |
Loans: |  |  |  |  |  |  |  |  |  |  |  |  |  |  |  |  |  |  |  |  |  |  |  |
Individually evaluated for impairment |  | $ | 882 |  |  | $ | - |  |  | $ | 1,628 |  |  | $ | 10,559 |  |  | $ | 1 |  |  | $ | 13,070 |
Collectively evaluated for impairment |  |  | 88,645 |  |  |  | 63,246 |  |  |  | 345,419 |  |  |  | 459,468 |  |  |  | 14,410 |  |  |  | 971,188 |
Total loans |  | $ | 89,527 |  |  | $ | 63,246 |  |  | $ | 347,047 |  |  | $ | 470,027 |  |  | $ | 14,411 |  |  | $ | 984,258 |

|  |  |  |  |  |  |  |  |  | Real estate-Mortgage |  |  |  |  |  |  |  |  |
December 31, 2018 |  | Commercial and industrial |  |  | Real estate- construction |  |  | Residential |  |  | Commercial |  |  | Consumer installment |  |  | Total |
Loans: |  |  |  |  |  |  |  |  |  |  |  |  |  |  |  |  |  |  |  |  |  |  |  |
Individually evaluated for impairment |  | $ | 2,570 |  |  | $ | - |  |  | $ | 1,970 |  |  | $ | 9,533 |  |  | $ | 2 |  |  | $ | 14,075 |
Collectively evaluated for impairment |  |  | 81,287 |  |  |  | 56,731 |  |  |  | 334,517 |  |  |  | 488,714 |  |  |  | 16,785 |  |  |  | 978,034 |
Total loans |  | $ | 83,857 |  |  | $ | 56,731 |  |  | $ | 336,487 |  |  | $ | 498,247 |  |  | $ | 16,787 |  |  | $ | 992,109 |

The amounts above include net deferred loan origination costs of $1.3 million and $1.6 million at December 31, 2019 and December 31, 2018, respectively.

|  |  |  |  |  |  |  |  |  | Real Estate-Mortgage |  |  |  |  |  |  |  |  |
December 31, 2019 |  | Commercial and industrial |  |  | Real estate- construction |  |  | Residential |  |  | Commercial |  |  | Consumer installment |  |  | Total |
Allowance for loan and lease losses: |  |  |  |  |  |  |  |  |  |  |  |  |  |  |  |  |  |  |  |  |  |  |  |
Ending allowance balance attributable to loans: |  |  |  |  |  |  |  |  |  |  |  |  |  |  |  |  |  |  |  |  |  |  |  |
Individually evaluated for impairment |  | $ | 3 |  |  | $ | - |  |  | $ | 30 |  |  | $ | 627 |  |  | $ | - |  |  | $ | 660 |
Collectively evaluated for impairment |  |  | 453 |  |  |  | 97 |  |  |  | 1,628 |  |  |  | 3,902 |  |  |  | 28 |  |  |  | 6,108 |
Total ending allowance balance |  | $ | 456 |  |  | $ | 97 |  |  | $ | 1,658 |  |  | $ | 4,529 |  |  | $ | 28 |  |  | $ | 6,768 |

|  |  |  |  |  |  |  |  |  | Real Estate-Mortgage |  |  |  |  |  |  |  |  |
December 31, 2018 |  | Commercial and industrial |  |  | Real estate- construction |  |  | Residential |  |  | Commercial |  |  | Consumer installment |  |  | Total |
Allowance for loan and lease losses: |  |  |  |  |  |  |  |  |  |  |  |  |  |  |  |  |  |  |  |  |  |  |  |
Ending allowance balance attributable to loans: |  |  |  |  |  |  |  |  |  |  |  |  |  |  |  |  |  |  |  |  |  |  |  |
Individually evaluated for impairment |  | $ | 667 |  |  | $ | - |  |  | $ | 43 |  |  | $ | 643 |  |  | $ | 1 |  |  | $ | 1,354 |
Collectively evaluated for impairment |  |  | 302 |  |  |  | 100 |  |  |  | 1,538 |  |  |  | 4,008 |  |  |  | 126 |  |  |  | 6,074 |
Total ending allowance balance |  | $ | 969 |  |  | $ | 100 |  |  | $ | 1,581 |  |  | $ | 4,651 |  |  | $ | 127 |  |  | $ | 7,428 |

The Company’s loan portfolio is segmented to a level that allows management to monitor risk and performance. The portfolio is segmented into Commercial and Industrial (“C&I”), Real Estate Construction, Real Estate - Mortgage which is further segmented into Residential and Commercial real estate, and Consumer Installment Loans. The C&I loan segment consists of loans made for the purpose of financing the activities of commercial customers. The residential mortgage loan segment consists of loans made for the purpose of financing the activities of residential homeowners. The commercial mortgage loan segment consists of loans made for the purpose of financing the activities of commercial real estate owners and operators. The consumer loan segment consists primarily of installment loans and overdraft lines of credit connected with customer deposit accounts.

21

Management evaluates individual loans in all of the commercial segments for possible impairment based on guidance established by the Board of Directors. Loans are considered to be 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 management in evaluating impairment include payment status, collateral value, and the probability of collecting scheduled principal and interest payments when due. 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. The Company does not separately evaluate individual consumer and residential mortgage loans for impairment, unless such loans are part of a larger relationship that is impaired, or the loan was modified in a troubled debt restructuring.

Once the determination has been made that a loan is impaired, the determination of whether a specific allocation of the allowance is necessary is measured by comparing the recorded investment in the loan to the fair value of the loan using one of three methods: (a) the present value of expected future cash flows discounted at the loan’s effective interest rate; (b) the loan’s observable market price; or (c) the fair value of the collateral less selling costs. The method is selected on a loan-by-loan basis. The evaluation of the need and amount of a specific allocation of the allowance and whether a loan can be removed from impairment status is made on a quarterly basis. The Company’s policy for recognizing interest income on impaired loans does not differ from its overall policy for interest recognition.

The following tables present impaired loans by class, segregated by those for which a specific allowance was required and those for which a specific allowance was not necessary (in thousands):

December 31, 2019 |
Impaired Loans |
|  | Recorded |  |  | Unpaid Principal |  |  | Related |
|  | Investment |  |  | Balance |  |  | Allowance |
With no related allowance recorded: |  |  |  |  |  |  |  |  |  |  |  |
Commercial and industrial |  | $ | 747 |  |  | $ | 1,524 |  |  | $ | - |
Real estate - mortgage: |  |  |  |  |  |  |  |  |  |  |  |
Residential |  |  | 979 |  |  |  | 1,057 |  |  |  | - |
Commercial |  |  | 5,617 |  |  |  | 5,617 |  |  |  | - |
Consumer installment |  |  | 1 |  |  |  | 1 |  |  |  | - |
Total |  | $ | 7,344 |  |  | $ | 8,199 |  |  | $ | - |
With an allowance recorded: |  |  |  |  |  |  |  |  |  |  |  |
Commercial and industrial |  | $ | 135 |  |  | $ | 135 |  |  | $ | 3 |
Real estate - mortgage: |  |  |  |  |  |  |  |  |  |  |  |
Residential |  |  | 649 |  |  |  | 700 |  |  |  | 30 |
Commercial |  |  | 4,942 |  |  |  | 4,952 |  |  |  | 627 |
Total |  | $ | 5,726 |  |  | $ | 5,787 |  |  | $ | 660 |
Total: |  |  |  |  |  |  |  |  |  |  |  |
Commercial and industrial |  | $ | 882 |  |  | $ | 1,659 |  |  | $ | 3 |
Real estate - mortgage: |  |  |  |  |  |  |  |  |  |  |  |
Residential |  |  | 1,628 |  |  |  | 1,757 |  |  |  | 30 |
Commercial |  |  | 10,559 |  |  |  | 10,569 |  |  |  | 627 |
Consumer installment |  |  | 1 |  |  |  | 1 |  |  |  | - |
Total |  | $ | 13,070 |  |  | $ | 13,986 |  |  | $ | 660 |

22

December 31, 2018 |
Impaired Loans |
|  | Recorded |  |  | Unpaid Principal |  |  | Related |
|  | Investment |  |  | Balance |  |  | Allowance |
With no related allowance recorded: |  |  |  |  |  |  |  |  |  |  |  |
Commercial and industrial |  | $ | 207 |  |  | $ | 413 |  |  | $ | - |
Real estate - mortgage: |  |  |  |  |  |  |  |  |  |  |  |
Residential |  |  | 1,306 |  |  |  | 1,462 |  |  |  | - |
Commercial |  |  | 1,867 |  |  |  | 2,186 |  |  |  | - |
Total |  | $ | 3,380 |  |  | $ | 4,061 |  |  | $ | - |
With an allowance recorded: |  |  |  |  |  |  |  |  |  |  |  |
Commercial and industrial |  | $ | 2,363 |  |  | $ | 3,013 |  |  | $ | 667 |
Real estate - mortgage: |  |  |  |  |  |  |  |  |  |  |  |
Residential |  |  | 664 |  |  |  | 715 |  |  |  | 43 |
Commercial |  |  | 7,666 |  |  |  | 7,676 |  |  |  | 643 |
Consumer installment |  |  | 2 |  |  |  | 2 |  |  |  | 1 |
Total |  | $ | 10,695 |  |  | $ | 11,406 |  |  | $ | 1,354 |
Total: |  |  |  |  |  |  |  |  |  |  |  |
Commercial and industrial |  | $ | 2,570 |  |  | $ | 3,426 |  |  | $ | 667 |
Real estate - mortgage: |  |  |  |  |  |  |  |  |  |  |  |
Residential |  |  | 1,970 |  |  |  | 2,177 |  |  |  | 43 |
Commercial |  |  | 9,533 |  |  |  | 9,862 |  |  |  | 643 |
Consumer installment |  |  | 2 |  |  |  | 2 |  |  |  | 1 |
Total |  | $ | 14,075 |  |  | $ | 15,467 |  |  | $ | 1,354 |

The tables above include troubled debt restructuring totaling $3.6 million and $4.4 million as of December 31, 2019 and 2018, respectively.

The following table presents interest income by class, recognized on impaired loans (in thousands):

|  | As of December 31, 2019 |  |  | As of December 31, 2018 |
|  | Average Recorded Investment |  |  | Interest Income Recognized |  |  | Average Recorded Investment |  |  | Interest Income Recognized |
Commercial and industrial |  | $ | 1,770 |  |  | $ | 141 |  |  | $ | 4,210 |  |  | $ | 172 |
Real estate - construction |  |  | 648 |  |  |  | - |  |  |  | 9 |  |  |  | - |
Real estate - mortgage: |  |  |  |  |  |  |  |  |  |  |  |  |  |  |  |
Residential |  |  | 1,803 |  |  |  | 51 |  |  |  | 2,531 |  |  |  | 57 |
Commercial |  |  | 10,366 |  |  |  | 375 |  |  |  | 6,805 |  |  |  | 377 |
Consumer installment |  |  | 2 |  |  |  | - |  |  |  | 3 |  |  |  | - |
Total |  | $ | 14,589 |  |  | $ | 567 |  |  | $ | 13,558 |  |  | $ | 606 |

Troubled Debt Restructuring (TDR) describes loans on which the bank has granted concessions for reasons related to the customer’s financial difficulties. Such concessions may include one or more of the following:

| ● | reduction in the interest rate to below market rates

| ● | extension of repayment requirements beyond normal terms

| ● | reduction of the principal amount owed

| ● | reduction of accrued interest due

| ● | acceptance of other assets in full or partial payment of a debt

23

In each case the concession is made due to deterioration in the borrower’s financial condition, and the new terms are less stringent than those required on a new loan with similar risk. The total impact on the ALLL for 2019 and 2018 related to TDRs was $33,000 and $459,000, respectively.

The following tables present the number of loan modifications by class, the corresponding recorded investment, and the subsequently defaulted modifications (in thousands) for the years ended:

|  | December 31, 2019 |
|  | Number of Contracts |  |  | Pre-Modification |  |  | Post-Modification |
Troubled Debt Restructurings |  | Term Modification |  |  | Other |  |  | Total |  |  | Outstanding Recorded Investment |  |  | Outstanding Recorded Investment |
Commercial and industrial |  |  | 3 |  |  |  | - |  |  |  | 3 |  |  | $ | 488 |  |  | $ | 490 |
Residential real estate |  |  | 4 |  |  |  | 2 |  |  |  | 6 |  |  |  | 294 |  |  |  | 354 |
|  |  |  |  |  |  |  |  |  |  |  |  |  | $ | 782 |  |  | $ | 844 |

|  | December 31, 2018 |
|  | Number of Contracts |  |  | Pre-Modification |  |  | Post-Modification |
Troubled Debt Restructurings |  | Term Modification |  |  | Other |  |  | Total |  |  | Outstanding Recorded Investment |  |  | Outstanding Recorded Investment |
Commercial and industrial |  |  | 1 |  |  |  | - |  |  |  | 1 |  |  | $ | 44 |  |  | $ | 44 |
Residential real estate |  |  | 3 |  |  |  | 2 |  |  |  | 5 |  |  |  | 286 |  |  |  | 286 |
Commercial real estate |  |  | 1 |  |  |  | - |  |  |  | 1 |  |  |  | 94 |  |  |  | 94 |
|  |  |  |  |  |  |  |  |  |  |  |  |  | $ | 424 |  |  | $ | 424 |

|  | December 31, 2018 |
Troubled Debt Restructurings |  | Number of |  |  | Recorded |
subsequently defaulted |  | Contracts |  |  | Investment |
Residential real estate |  |  | 1 |  |  | $ | 19 |

One loan with a book balance of $36,000 was restructured in 2019 and defaulted by December 31, 2019. There were no subsequent defaults of troubled debt restructurings for the year ended December 31, 2019.

Management uses a nine-point internal risk-rating system to monitor the credit quality of the overall loan portfolio. The first five categories are considered not criticized and are aggregated as Pass rated. The criticized rating categories utilized by management generally follow bank regulatory definitions. The Special Mention category includes assets that are currently protected but are potentially weak, resulting in an undue and unwarranted credit risk, but not to the point of justifying a Substandard classification. Loans in the Substandard category have well-defined weaknesses that jeopardize the liquidation of the debt and have a distinct possibility that some loss will be sustained if the weaknesses are not corrected. All loans greater than 90 days past due are considered Substandard or Doubtful. Loans classified as doubtful have all the weaknesses inherent in those classified as substandard, with the added characteristic that the weaknesses make collection or liquidation in full, on the basis of currently existing facts, conditions, and values, highly questionable and improbable. Any portion of a loan that has been charged off is placed in the Loss category.

To help ensure that risk ratings are accurate and reflect the present and future capacity of borrowers to repay a loan as agreed, the Company has a structured loan-rating process with several layers of internal and external oversight. Generally, consumer and residential mortgage loans are included in the Pass categories unless a specific action, such as bankruptcy, repossession, or death, occurs to raise awareness of a possible credit event. The Company’s Commercial Loan Officers are responsible for the timely and accurate risk rating of the loans in their portfolios at origination and on an ongoing basis. The Credit Department performs an annual review of all commercial relationships with loan balances of $500,000 or greater. Confirmation of the appropriate risk grade is included in the review on an ongoing basis. The Company engages an external consultant to conduct loan reviews on a semiannual basis. Generally, the external consultant reviews commercial relationships greater than $250,000 and/or criticized relationships greater than $125,000. Detailed reviews, including plans for resolution, are performed on loans classified as Substandard on a quarterly basis. Loans in the Special Mention and Substandard categories that are collectively evaluated for impairment are given separate consideration in the determination of the allowance.

24

The following tables present the classes of the loan portfolio summarized by the aggregate Pass rating and the criticized categories of Special Mention, Substandard, and Doubtful within the internal risk rating system (in thousands):

|  |  |  |  |  | Special |  |  |  |  |  |  |  |  |  |  | Total |
December 31, 2019 |  | Pass |  |  | Mention |  |  | Substandard |  |  | Doubtful |  |  | Loans |
Commercial and industrial |  | $ | 84,136 |  |  | $ | 3,619 |  |  | $ | 1,772 |  |  | $ | - |  |  | $ | 89,527 |
Real estate - construction |  |  | 63,246 |  |  |  | - |  |  |  | - |  |  |  | - |  |  |  | 63,246 |
Real estate - mortgage: |  |  |  |  |  |  |  |  |  |  |  |  |  |  |  |  |  |  |  |
Residential |  |  | 342,988 |  |  |  | 420 |  |  |  | 3,639 |  |  |  | - |  |  |  | 347,047 |
Commercial |  |  | 453,170 |  |  |  | 6,989 |  |  |  | 9,868 |  |  |  | - |  |  |  | 470,027 |
Consumer installment |  |  | 14,399 |  |  |  | - |  |  |  | 12 |  |  |  | - |  |  |  | 14,411 |
Total |  | $ | 957,939 |  |  | $ | 11,028 |  |  | $ | 15,291 |  |  | $ | - |  |  | $ | 984,258 |

|  |  |  |  |  | Special |  |  |  |  |  |  |  |  |  |  | Total |
December 31, 2018 |  | Pass |  |  | Mention |  |  | Substandard |  |  | Doubtful |  |  | Loans |
Commercial and industrial |  | $ | 77,002 |  |  | $ | 4,572 |  |  | $ | 2,283 |  |  | $ | - |  |  | $ | 83,857 |
Real estate - construction |  |  | 55,397 |  |  |  | 1,334 |  |  |  | - |  |  |  | - |  |  |  | 56,731 |
Real estate - mortgage: |  |  |  |  |  |  |  |  |  |  |  |  |  |  |  |  |  |  |  |
Residential |  |  | 332,475 |  |  |  | 553 |  |  |  | 3,459 |  |  |  | - |  |  |  | 336,487 |
Commercial |  |  | 483,516 |  |  |  | 6,617 |  |  |  | 8,114 |  |  |  | - |  |  |  | 498,247 |
Consumer installment |  |  | 16,776 |  |  |  | - |  |  |  | 11 |  |  |  | - |  |  |  | 16,787 |
Total |  | $ | 965,166 |  |  | $ | 13,076 |  |  | $ | 13,867 |  |  | $ | - |  |  | $ | 992,109 |

Management further monitors the performance and credit quality of the loan portfolio by analyzing the age of the portfolio as determined by the length of time a recorded payment is past due. The following tables present the classes of the loan portfolio summarized by the aging categories of loans and nonaccrual loans (in thousands):

|  |  |  |  |  | 30-59 Days |  |  | 60-89 Days |  |  | 90 Days+ |  |  | Total |  |  | Total |
December 31, 2019 |  | Current |  |  | Past Due |  |  | Past Due |  |  | Past Due |  |  | Past Due |  |  | Loans |
Commercial and industrial |  | $ | 88,965 |  |  | $ | 190 |  |  | $ | 66 |  |  | $ | 306 |  |  | $ | 562 |  |  |  | 89,527 |
Real estate - construction |  |  | 63,246 |  |  |  | - |  |  |  | - |  |  |  | - |  |  |  | - |  |  |  | 63,246 |
Real estate - mortgage: |  |  |  |  |  |  |  |  |  |  |  |  |  |  |  |  |  |  |  |  |  |  |  |
Residential |  |  | 344,311 |  |  |  | 1,713 |  |  |  | 63 |  |  |  | 960 |  |  |  | 2,736 |  |  |  | 347,047 |
Commercial |  |  | 465,666 |  |  |  | 63 |  |  |  | - |  |  |  | 4,298 |  |  |  | 4,361 |  |  |  | 470,027 |
Consumer installment |  |  | 13,378 |  |  |  | 623 |  |  |  | 216 |  |  |  | 194 |  |  |  | 1,033 |  |  |  | 14,411 |
Total |  | $ | 975,566 |  |  | $ | 2,589 |  |  | $ | 345 |  |  | $ | 5,758 |  |  | $ | 8,692 |  |  | $ | 984,258 |

|  |  |  |  |  | 30-59 Days |  |  | 60-89 Days |  |  | 90 Days+ |  |  | Total |  |  | Total |
December 31, 2018 |  | Current |  |  | Past Due |  |  | Past Due |  |  | Past Due |  |  | Past Due |  |  | Loans |
Commercial and industrial |  | $ | 82,770 |  |  | $ | 288 |  |  | $ | 213 |  |  | $ | 586 |  |  | $ | 1,087 |  |  |  | 83,857 |
Real estate - construction |  |  | 56,731 |  |  |  | - |  |  |  | - |  |  |  | - |  |  |  | - |  |  |  | 56,731 |
Real estate - mortgage: |  |  |  |  |  |  |  |  |  |  |  |  |  |  |  |  |  |  |  |  |  |  |  |
Residential |  |  | 331,379 |  |  |  | 2,612 |  |  |  | 1,083 |  |  |  | 1,413 |  |  |  | 5,108 |  |  |  | 336,487 |
Commercial |  |  | 496,597 |  |  |  | 664 |  |  |  | - |  |  |  | 986 |  |  |  | 1,650 |  |  |  | 498,247 |
Consumer installment |  |  | 16,768 |  |  |  | 19 |  |  |  | - |  |  |  | - |  |  |  | 19 |  |  |  | 16,787 |
Total |  | $ | 984,245 |  |  | $ | 3,583 |  |  | $ | 1,296 |  |  | $ | 2,985 |  |  | $ | 7,864 |  |  |  | 992,109 |

25

The following tables present the classes of the loan portfolio summarized by nonaccrual loans and loans 90 days or more past due and still accruing (in thousands):

December 31, 2019 |  | Nonaccrual |  |  | 90+ Days Past Due and Accruing |
Commercial and industrial |  | $ | 946 |  |  | $ | - |
Real estate - mortgage: |  |  |  |  |  |  |  |
Residential |  |  | 3,285 |  |  |  | - |
Commercial |  |  | 4,451 |  |  |  | - |
Consumer installment |  |  | 197 |  |  |  | - |
Total |  | $ | 8,879 |  |  | $ | - |

December 31, 2018 |  | Nonaccrual |  |  | 90+ Days Past Due and Accruing |
Commercial and industrial |  | $ | 996 |  |  | $ | 91 |
Real estate - mortgage: |  |  |  |  |  |  |  |
Residential |  |  | 2,731 |  |  |  | 754 |
Commercial |  |  | 2,864 |  |  |  | 100 |
Consumer installment |  |  | 4 |  |  |  | - |
Total |  | $ | 6,595 |  |  | $ | 945 |

Interest income that would have been recorded had these loans not been placed on nonaccrual status was $342,000 in 2019 and $456,000 in 2018.

An allowance for loan and lease losses (“ALLL”) is maintained to absorb losses from the loan portfolio. The ALLL is based on management’s continuing evaluation of the risk characteristics and credit quality of the loan portfolio, assessment of current economic conditions, diversification and size of the portfolio, adequacy of collateral, past and anticipated loss experience, and the amount of nonperforming loans.

The Company’s methodology for determining the ALLL is based on the requirements of ASC Section 310-10-35 for loans individually evaluated for impairment (discussed above) and ASC Subtopic 450-20 for loans collectively evaluated for impairment, as well as the Interagency Policy Statement on the Allowance for Loan and Lease Losses and other bank regulatory guidance. The total of the two components represents the Company’s ALLL. Management also performs impairment analysis on TDRs, which may result in specific reserves.

Loans that are collectively evaluated for impairment are analyzed, with general allowances being made as appropriate. For general allowances, historical loss trends are used in the estimation of losses in the current portfolio. These historical loss amounts are modified by other qualitative factors.

The classes described above, which are based on the purpose code assigned to each loan, provide the starting point for the ALLL analysis. Management tracks the historical net charge-off activity at the purpose code level. A historical charge-off factor is calculated utilizing the last twelve consecutive historical quarters.

Management has identified a number of additional qualitative factors which it uses to supplement the historical charge-off factor, because these factors are likely to cause estimated credit losses associated with the existing loan pools to differ from historical loss experience. The additional factors that are evaluated quarterly and updated using information obtained from internal, regulatory, and governmental sources are: national and local economic trends and conditions; levels of and trends in delinquency rates and nonaccrual loans; trends in volumes and terms of loans; effects of changes in lending policies; experience, ability, and depth of lending staff; value of underlying collateral; and concentrations of credit from a loan type, industry, and/or geographic standpoint.

Management reviews the loan portfolio on a quarterly basis using a defined, consistently applied process in order to make appropriate and timely adjustments to the ALLL. When information confirms all or part of specific loans to be uncollectible, these amounts are promptly charged off against the ALLL.

26

The following tables summarize the primary segments of the loan portfolio (in thousands):

|  | Commercial and industrial |  |  | Real estate- construction |  |  | Real estate- residential mortgage |  |  | Real estate- commercial mortgage |  |  | Consumer installment |  |  | Total |
ALLL balance at December 31, 2018 |  | $ | 969 |  |  | $ | 100 |  |  | $ | 1,581 |  |  | $ | 4,651 |  |  | $ | 127 |  |  | $ | 7,428 |
Charge-offs |  |  | (519 | ) |  |  | - |  |  |  | (523 | ) |  |  | (32 | ) |  |  | (735 | ) |  |  | (1,809 | )
Recoveries |  |  | 82 |  |  |  | 74 |  |  |  | 78 |  |  |  | 17 |  |  |  | 8 |  |  |  | 259 |
Provision |  |  | (76 | ) |  |  | (77 | ) |  |  | 522 |  |  |  | (107 | ) |  |  | 628 |  |  |  | 890 |
ALLL balance at December 31, 2019 |  | $ | 456 |  |  | $ | 97 |  |  | $ | 1,658 |  |  | $ | 4,529 |  |  | $ | 28 |  |  | $ | 6,768 |

|  | Commercial and industrial |  |  | Real estate- construction |  |  | Real estate- residential mortgage |  |  | Real estate- commercial mortgage |  |  | Consumer installment |  |  | Total |
ALLL balance at December 31, 2017 |  | $ | 999 |  |  | $ | 313 |  |  | $ | 1,760 |  |  | $ | 4,036 |  |  | $ | 82 |  |  | $ | 7,190 |
Charge-offs |  |  | (610 | ) |  |  | - |  |  |  | (177 | ) |  |  | (111 | ) |  |  | (220 | ) |  |  | (1,118 | )
Recoveries |  |  | 287 |  |  |  | 63 |  |  |  | 128 |  |  |  | - |  |  |  | 38 |  |  |  | 516 |
Provision |  |  | 293 |  |  |  | (276 | ) |  |  | (130 | ) |  |  | 726 |  |  |  | 227 |  |  |  | 840 |
ALLL balance at December 31, 2018 |  | $ | 969 |  |  | $ | 100 |  |  | $ | 1,581 |  |  | $ | 4,651 |  |  | $ | 127 |  |  | $ | 7,428 |

The provision fluctions during the the year ended December 31, 2019 allocated to:

| ● | commercial and industrial loans are due to the charge-offs of two large relationships totaling $438,000, which had specific reserves allocated at the end of 2018.

| ● | residential portfolio are due to the charge-off of two relationships totalling $360,000 and portfolio growth.

| ● | commercial real estate loans are due to a small charge-off and a declining portfolio balance.

| ● | consumer installments are due to charge-offs in the student loan portfolio totaling $566,000.

The provision fluctions during the the year ended December 31, 2018 allocated to:

| ● | real estate construction loans are due to the historical loss rate for the real estate construction pool changing to -0.127% from 0.775% in the first quarter of 2018 as well as no charge-offs for the year.

| ● | residential real estate are due to a continued decline in historical losses and consistent decreases in the ratio of nonperforming loans to toal loans in this segment over the past few years resulting in a decrease in the reserves required.

| ● | consumer installment loans are primarily due to increases in historical losses for this segment over the prior year.

6. | PREMISES AND EQUIPMENT

Major classifications of premises and equipment at December 31:

(Dollar amounts in thousands) |  | 2019 |  |  | 2018 |
Land and land improvements |  | $ | 2,920 |  |  | $ | 2,920 |
Building and leasehold improvements |  |  | 15,836 |  |  |  | 15,377 |
Furniture, fixtures, and equipment |  |  | 9,357 |  |  |  | 8,011 |
Financing right-of-use assets |  |  | 4,012 |  |  |  | - |
Total premises and equipment |  |  | 32,125 |  |  |  | 26,308 |
Less accumulated depreciation and amortization |  |  | 14,251 |  |  |  | 13,305 |
Total premises and equipment, net |  | $ | 17,874 |  |  | $ | 13,003 |

Depreciation expense charged to operations was $1.0 million in 2019 and $951,000 in 2018.

27

7. | GOODWILL AND INTANGIBLE ASSETS

Goodwill totaled $15.1 million for both years ended December 31, 2019, and 2018. Core deposit intangible carrying amount was $2.1 million and $2.4 million for the years ended December 31, 2019, and 2018, respectively. Core deposit accumulated amortization was $1.4 million and $1.0 million for the years ended December 31, 2019, and 2018. Amortization expense totaled $341,000 and $352,000 in 2019 and 2018, respectively.

Core deposit intangible assets are amortized to their estimated residual values over their expected useful lives, commonly of ten years. The estimated aggregate future amortization expense for core deposit intangible assets as of December 31, 2019 is as follows:

2020 |  | $ | 332 |
2021 |  |  | 321 |
2022 |  |  | 309 |
2023 |  |  | 296 |
2024 |  |  | 281 |
Thereafter |  |  | 517 |
Total |  | $ | 2,056 |

8. | ACCRUED INTEREST RECEIVABLE AND OTHER ASSETS

The components of accrued interest receivable and other assets at the years ended December 31:

(Dollar amounts in thousands) |  | 2019 |  |  | 2018 |
Restricted stock |  | $ | 3,848 |  |  | $ | 3,679 |
Accrued interest receivable on investment securities |  |  | 753 |  |  |  | 794 |
Accrued interest receivable on loans |  |  | 2,718 |  |  |  | 2,839 |
Deferred tax asset, net |  |  | 374 |  |  |  | 1,232 |
Other real estate owned |  |  | 155 |  |  |  | 270 |
Operating right-of-use assets |  |  | 903 |  |  |  | - |
Other |  |  | 1,946 |  |  |  | 884 |
Total |  | $ | 10,697 |  |  | $ | 9,698 |

9. | DEPOSITS

Time deposits that meet or exceed the FDIC Insurance limit of $250,000 as of December 31, 2019 and 2018, were $126.6 million and $75.8 million, respectively.

Scheduled maturities of time deposits as of December 31, 2019 are as follows:

(Dollar amounts in thousands) |  |  |  |
2020 |  | $ | 251,291 |
2021 |  |  | 62,523 |
2022 |  |  | 25,195 |
2023 |  |  | 16,868 |
2024 |  |  | 12,923 |
Total |  | $ | 368,800 |

28

10. | SHORT-TERM BORROWINGS

For the year ended December 31, outstanding balances and related information of short-term borrowings, which includes securities sold under agreements to repurchase and short-term borrowings from other banks, are summarized as follows:

(Dollar amounts in thousands) |  | 2019 |  |  | 2018 |  |  | 2017 |
Balance at year-end |  | $ | 5,075 |  |  | $ | 90,398 |  |  | $ | 74,707 |
Average balance outstanding |  |  | 14,808 |  |  |  | 42,231 |  |  |  | 63,910 |
Maximum month-end balance |  |  | 92,000 |  |  |  | 101,857 |  |  |  | 114,025 |
Weighted-average rate at year-end |  |  | 1.66 | % |  |  | 2.53 | % |  |  | 1.36 | %
Weighted-average rate during the year |  |  | 2.49 | % |  |  | 1.99 | % |  |  | 1.18 | %

Average balances outstanding during the year represent daily average balances, and average interest rates represent interest expense divided by the related average balance.

The Company maintains a $6.0 million line of credit at an adjustable rate, currently 5.00%, a $10.0 million line of credit at an adjustable rate, currently at 4.93%, and a $4.0 million line of credit at an adjustable rate, currently 5.51%. At December 31, 2019, and 2018, there were no outstanding borrowings under these lines of credit. The additional borrowing capacity on FHLB advances was $87.0 million and $27.0 million at December 31, 2019 and 2018, respectively.

11. | OTHER BORROWINGS

Other borrowings consist of advances from the FHLB and subordinated debt as follows:

|  |  |  |  |  |  |  | Weighted- |  |  | Stated interest |  |  |  |  |  |  |  |  |
(Dollar amounts in thousands) |  | Maturity range |  |  | average |  |  | rate range |  |  |  |  |  |  |  |  |
Description |  | from |  |  | to |  |  | interest rate |  |  | from |  |  |  | to |  |  |  | 2019 |  |  |  | 2018 |
Fixed-rate amortizing |  | 07/01/25 |  | 10/01/28 |  |  |  | 4.06 | % |  |  | 4.02 | % |  |  | 4.47 | % |  | $ | 404 |  |  | $ | 555 |
Finance lease liabilities |  | 12/31/21 |  | 06/01/40 |  |  |  | 3.29 | % |  |  | 2.70 | % |  |  | 3.51 | % |  |  | 4,098 |  |  |  | - |
Junior subordinated debt |  | 12/21/37 |  | 12/21/37 |  |  |  | 4.10 | % |  |  | 3.61 | % |  |  | 4.42 | % |  |  | 8,248 |  |  |  | 8,248 |
Total |  |  |  |  |  |  |  |  |  |  |  |  |  |  |  |  |  | $ | 12,750 |  |  | $ | 8,803 |

The scheduled maturities of other borrowings are as follows:

(Dollar amounts in thousands) |  |  |  |  |  |  |  |
|  |  |  |  |  | Weighted- |
Year Ending December 31, |  | Amount |  |  | Average Rate |
2020 |  | $ | 445 |  |  |  | 3.36 | %
2021 |  |  | 442 |  |  |  | 3.36 | %
2022 |  |  | 434 |  |  |  | 3.36 | %
2023 |  |  | 433 |  |  |  | 3.36 | %
2024 |  |  | 430 |  |  |  | 3.36 | %
Beyond 2024 |  |  | 10,566 |  |  |  | 3.87 | %
Total |  | $ | 12,750 |  |  |  | 3.84 | %

Fixed-rate amortizing advances from the FHLB require monthly principal and interest payments and an annual 20 percent pay-down of outstanding principal. Monthly principal and interest payments are adjusted after each 20 percent pay-down. Under the terms of a blanket agreement, FHLB borrowings are secured by certain qualifying assets of the Company which consist principally of first mortgage loans or mortgage-backed securities. Under this credit arrangement, the Company has a remaining borrowing capacity of approximately $273.4 million at December 31, 2019. At December 31, 2019, the Company also had available a $10.0 million letter of credit with FHLB, which expired January 23, 2020. At December 31, 2019, there was no outstanding borrowings on this letter of credit.

The Company formed a special purpose entity (“Entity”) to issue $8.0 million of floating rate, obligated mandatorily redeemable securities, and $248,000 in common securities as part of a pooled offering. The rate adjusts quarterly, equal to LIBOR plus 1.67%. The Entity may redeem them, in whole or in part, at face value. The Company borrowed the proceeds of the issuance from the Entity in December 2006 in the form of an $8.3 million note payable, which matures in December 2037, and is included in the other borrowings on the Company’s Consolidated Balance Sheet.

29

On January 1, 2019, the Company adopted ASU 2016-02 which resulted in the recording of finance lease liabilities of $3.8 million on the Consolidated Balance Sheet. See Note 15 of the financial statements.

12. | ACCRUED INTEREST PAYABLE AND OTHER LIABILITIES

The components of accrued interest payable and other liabilities are as follows at December 31:

|  | 2019 |  |  | 2018 |
(Dollar amounts in thousands) |  |  |  |  |  |  |  |
Accrued interest payable |  | $ | 917 |  |  | $ | 744 |
Accrued directors' benefits |  |  | 1,470 |  |  |  | 1,346 |
Accrued salary and benefits expense |  |  | 1,451 |  |  |  | 1,058 |
Operating lease liabilities |  |  | 906 |  |  |  | - |
Other |  |  | 1,288 |  |  |  | 1,692 |
Total |  | $ | 6,032 |  |  | $ | 4,840 |

30

13. | INCOME TAXES

The provision for federal income taxes for the years ended December 31, consists of:

(Dollar amounts in thousands) |  | 2019 |  |  | 2018 |
Current payable |  | $ | 2,265 |  |  | $ | 2,403 |
Deferred |  |  | 327 |  |  |  | (241 | )
Total provision |  | $ | 2,592 |  |  | $ | 2,162 |

The tax effects of deductible and taxable temporary differences that give rise to significant portions of the deferred tax assets and deferred tax liabilities are as follows at December 31:

(Dollar amounts in thousands) |  | 2019 |  |  | 2018 |
Deferred tax assets: |  |  |  |  |  |  |  |
Allowance for loan and lease losses |  | $ | 1,288 |  |  | $ | 1,327 |
Supplemental retirement plan |  |  | 469 |  |  |  | 454 |
Investment security basis adjustment |  |  | 18 |  |  |  | 18 |
Nonaccrual interest income |  |  | 297 |  |  |  | 389 |
Accrued compensation |  |  | 244 |  |  |  | 222 |
Deferred origination fees, net |  |  | 30 |  |  |  | - |
Net unrealized loss on AFS securities |  |  | - |  |  |  | 41 |
Lease liability |  |  | 1,051 |  |  |  | - |
Gross deferred tax assets |  |  | 3,397 |  |  |  | 2,451 |
Deferred tax liabilities: |  |  |  |  |  |  |  |
Premises and equipment |  |  | 583 |  |  |  | 328 |
Net unrealized gain on AFS securities |  |  | 490 |  |  |  | - |
Net unrealized gain on equity securities |  |  | 62 |  |  |  | 1 |
FHLB stock dividends |  |  | 139 |  |  |  | 139 |
Intangibles |  |  | 378 |  |  |  | 342 |
Mortgage servicing rights |  |  | 82 |  |  |  | 75 |
Deferred origination fees, net |  |  | - |  |  |  | 13 |
Acquisition fair value adjustments |  |  | 253 |  |  |  | 275 |
Right of use assets |  |  | 1,032 |  |  |  | - |
Other |  |  | 4 |  |  |  | 5 |
Gross deferred tax liabilities |  |  | 3,023 |  |  |  | 1,178 |
Net deferred tax assets |  | $ | 374 |  |  | $ | 1,273 |

No valuation allowance was established at December 31, 2019 and 2018, in view of the Company’s tax strategies, coupled with the anticipated future taxable income as evidenced by the Company’s earnings potential.

31

The reconciliation between the federal statutory rate and the Company’s effective consolidated income tax rate for the years ended December 31, is as follows:

(Dollar amounts in thousands) |  | 2019 |  |  | 2018 |
|  |  |  |  |  | % of |  |  |  |  |  |  | % of |
|  |  |  |  |  | Pretax |  |  |  |  |  |  | Pretax |
|  | Amount |  |  | Income |  |  | Amount |  |  | Income |
Provision at statutory rate |  | $ | 3,214 |  |  |  | 21.0 | % |  | $ | 3,065 |  |  |  | 21.0 | %
Tax-exempt income |  |  | (647 | ) |  |  | (4.2 | )% |  |  | (622 | ) |  |  | (4.3 | )%
Nondeductible interest expense |  |  | 32 |  |  |  | 0.2 | % |  |  | 27 |  |  |  | 0.2 | %
Stock-based compensation |  |  | - |  |  |  | - | % |  |  | (37 | ) |  |  | (0.3 | )%
Other |  |  | (7 | ) |  |  | (0.1 | )% |  |  | (271 | ) |  |  | (1.8 | )%
Actual tax expense and effective rate |  | $ | 2,592 |  |  |  | 16.9 | % |  | $ | 2,162 |  |  |  | 14.8 | %

ASC 740-10 prescribes a recognition threshold and a measurement attribute for the financial statement recognition and measurement of a tax position taken or expected to be taken in a tax return. Benefits from tax positions should be recognized in the financial statements only when it is more likely than not that the tax position will be sustained upon examination by the appropriate taxing authority that would have full knowledge of all relevant information. A tax position that meets the more-likely-than-not recognition threshold is measured at the largest amount of benefit that is greater than 50 percent likely of being realized upon ultimate settlement. Tax positions that previously failed to meet the more-likely-than-not recognition threshold should be recognized in the first subsequent financial reporting period in which that threshold is met. Previously recognized tax positions that no longer meet the more-likely-than-not recognition threshold should be derecognized in the first subsequent financial reporting period in which that threshold is no longer met.

At December 31, 2019 and December 31, 2018, the Company had no ASC 740-10 unrecognized tax benefits. The Company does not expect the total amount of unrecognized tax benefits to significantly increase within the next 12 months. The Company recognizes interest and penalties on unrecognized tax benefits as a component of income tax expense.

The Company and the Bank are subject to U.S. federal income tax as well as an income tax in the states of Ohio and Florida, and the Bank is subject to a capital-based franchise tax in the state of Ohio. The Company and the Bank are no longer subject to examination by taxing authorities for years before December 31, 2016.

14. | EMPLOYEE BENEFITS

Employee Retirement Plan

The Bank maintains section 401(k) employee savings and investment plans for all full-time employees and officers of the Bank who are at least 21 years of age. The Bank’s contributions to the plans are discretionary, and were based on 50% matching of voluntary contributions up to 6% of compensation for the years ended December 31, 2019 and 2018. Employee contributions are vested at all times, and MBC contributions are fully vested after six years beginning at the second year in 20% increments. Special vesting provisions are in place for legacy Liberty employees with 3 or more years of service. Contributions for 2019 and 2018 to these plans amounted to $319,000 and $306,000, respectively.

Executive Deferred Compensation Plan s

The Company maintains executive deferred compensation plans to provide post-retirement payments to members of senior management. The plan agreements are noncontributory, defined contribution arrangements that provide supplemental retirement income benefits to several officers, with contributions made solely by the Bank. Accrued executive deferred compensation amounted to $615,000 and $504,000 as of December 31, 2019 and 2018, respectively. During 2019 and 2018, the Company recognized nonqualified deferred compensation expense of $85,000 and $98,000, respectively, to the plans.

Stock Option and Restricted Stock Plan

In 2007, the Company adopted the 2007 Omnibus Equity Plan (the “2007 Plan”) for granting incentive stock options, nonqualified stock options, and restricted stock to key officers and employees and nonemployee directors of the Company. A total of 320,000 shares of authorized and unissued or issued common stock were reserved for issuance under the 2007 Plan, which expired ten years from the date of board approval of the plan. Although the 2007 Plan expired in 2017, there remain outstanding 14,500 shares in incentive stock options awards granted under the 2007 Plan. The per share exercise price of an option granted is not less than the fair value of a share of common stock on the date the option was granted.

32

In 2017, the Company adopted the 2017 Omnibus Equity Plan (the “2017 Plan”) for granting incentive stock options, nonqualified stock options, restricted stock and other equity awards to key officers and employees and nonemployee directors of the Company. The Company’s stockholders approved the 2017 Plan at the annual meeting of the stockholders held on May 10, 2017. A total of 448,000 shares of authorized and unissued or issued common stock are reserved for issuance under the 2017 Plan, which expires ten years from the date of board approval of the plan. The per share exercise price of an option granted will not be less than the fair value of a share of common stock on the date the option is granted. Remaining available shares that can be issued under the Plan were 386,188 at December 31, 2019.

The following table presents share data related to the outstanding options:

|  | Shares |  |  | Weighted- average Exercise Price Per Share |
Outstanding, January 1, 2019 |  |  | 14,900 |  |  | $ | 8.78 |
Exercised |  |  | (400 | ) |  |  | 8.78 |
Outstanding, December 31, 2019 |  |  | 14,500 |  |  | $ | 8.78 |
Exercisable, December 31, 2019 |  |  | 14,500 |  |  | $ | 8.78 |

The total intrinsic value of outstanding in-the-money exercisable stock options was $251,068 and $185,356 at December 31, 2019 and 2018, respectively.

No options were granted for the years ended December 31, 2019 and 2018. The Company recognizes compensation expense in the amount of fair value of the options at the grant date and as an addition to stockholders’ equity.

For the years ended December 31, 2019 and 2018, the Company recorded $265,000 and $215,000, respectively, of compensation cost related to vested stock options. As of December 31, 2019, there was no unrecognized compensation cost related to vested stock options.

For the years ended December 31, 2019 and 2018, 400 and 24,600 options were exercised resulting in net proceeds to the participant of $0 and $85,000, respectively.

During 2019 and 2018, the Compensation Committee of the Board of Directors of the Company granted awards of restricted stock for an aggregate amount of 29,130 and 22,702 shares, respectively, to certain employees of the Bank. The expense recognized as a result of these awards was $184,000 and $191,000 for the years ended 2019 and 2018, respectively. The number of restricted stock shares earned or settled will depend on certain conditions and are also subject to service period-based vesting. The award recipient must maintain service with Middlefield Banc Corp. and affiliates until the third anniversary of the award to satisfy the service condition. The performance condition will be satisfied if the average total shareholder annual return on Middlefield Banc Corp. stock for the three subsequent years is at least 10.00% for 2019 and 8.00% for 2018.

The Company recognized restricted stock forfeitures in the period they occur.

The following table presents the activity during 2019 related to awards of restricted stock:

|  | Units |  |  | Weighted- average Grant Date Fair Value Per Unit |
Nonvested at January 1, 2019 |  |  | 42,350 |  |  | $ | 20.98 |
Granted |  |  | 29,130 |  |  |  | 20.95 |
Vested |  |  | (10,440 | ) |  |  | 16.56 |
Nonvested at December 31, 2019 |  |  | 61,040 |  |  | $ | 21.72 |
Expected to vest at December 31, 2019 |  |  | 41,136 |  |  | $ | 20.57 |

33

As of December 31, 2019, there was $715,000 of total unrecognized compensation cost related to nonvested restricted shares granted under the Plan. The cost is expected to be recognized over a weighted-average period of 1.83 years. The total fair value of shares vested during the years ended December 31, 2019 and 2018 was $265,000, and $205,000, respectively.

15. | C OMMITMENTS

In the normal course of business, there are various outstanding commitments and certain contingent liabilities which are not reflected in the accompanying consolidated financial statements. These commitments and contingent liabilities represent financial instruments with off-balance sheet risk. The contract or notional amounts of those instruments reflect the extent of involvement in particular types of financial instruments which were composed of the following at December 31:

(Dollar amounts in thousands) |  | 2019 |  |  | 2018 |
Commitments to extend credit |  | $ | 260,579 |  |  | $ | 228,427 |
Standby letters of credit |  |  | 1,616 |  |  |  | 1,656 |
Total |  | $ | 262,195 |  |  | $ | 230,083 |

These instruments involve, to varying degrees, elements of credit and interest rate risk in excess of the amount recognized in the Consolidated Balance Sheet. The Company’s exposure to credit loss, in the event of nonperformance by the other parties to the financial instruments, is represented by the contractual amounts as disclosed. The Company minimizes its exposure to credit loss under these commitments by subjecting them to credit approval and review procedures and collateral requirements as deemed necessary. Commitments generally have fixed expiration dates within one year of their origination.

Standby letters of credit are conditional commitments issued by the Company to guarantee the performance of a customer to a third party. These instruments are issued primarily to support bid or performance-related contracts. The coverage period for these instruments is typically a one-year period with an annual renewal option subject to prior approval by management. Fees earned from the issuance of these letters are recognized over the coverage period. For secured letters of credit, the collateral is typically bank deposit instruments or customer business assets.

Leasing Commitments

The Company leases seven of its branch locations and one loan production office. As of December 31, 2019, net assets recorded under leases amounted to $4.9 million and have remaining lease terms of 1 year to 20 years. As of December 31, 2019, finance lease assets included in premises and equipment, net, totaled $4.0 million and operating lease assets included in accrued interest receivable and other assets on the Consolidated Balance Sheet totaled $903,000. As of December 31, 2019, finance lease obligations included in other borrowings totaled $4.1 million and operating lease obligations included in accrued interest payable and other liabilities on the Consolidated Balance Sheet totaled $906,000.

On April 17, 2019, the Company purchased a building to relocate the Mantua branch which is and has been at a leased location as of December 31, 2019. The relocation is planned for 2020, and the Company entered into an amended lease agreement with the Mantua lessor which does not exceed 12 months. As such, the lease for the Mantua location is not considered a capitalized lease as of December 31, 2019.

Lease costs incurred are as follows:

|  | For the Twelve |
|  | Months Ended |
|  | December 31, 2019 |
Lease Costs: |  |  |  |
Finance lease cost: |  |  |  |
Amortization of right-of-use asset |  | $ | 360 |
Interest Expense |  |  | 132 |
Other |  |  | 57 |
Operating lease cost |  |  | 245 |
Total lease cost |  | $ | 794 |

34

The following table displays the weighted-average term and discount rates for both operating and finance leases outstanding as of December 31, 2019:

|  | Operating |  |  | Finance |
Weighted-average term (years) |  |  | 6.5 |  |  |  | 13.7 |
Weighted-average discount rate |  |  | 2.9 | % |  |  | 3.3 | %

The following table displays the undiscounted cash flows due related to operating and finance leases as of December 31, 2019, along with a reconciliation to the discounted amount recorded on the December 31, 2019 balance sheet:

|  | Operating |  |  | Finance |
Undiscounted cash flows due within: |  |  |  |  |  |  |  |
2020 |  | $ | 185 |  |  | $ | 458 |
2021 |  |  | 169 |  |  |  | 476 |
2022 |  |  | 169 |  |  |  | 478 |
2023 |  |  | 169 |  |  |  | 478 |
2024 |  |  | 133 |  |  |  | 478 |
2025 and thereafter |  |  | 174 |  |  |  | 2,749 |
Total undiscounted cash flows |  |  | 999 |  |  |  | 5,117 |
Impact of present value discount |  |  | (93 | ) |  |  | (1,019 | )
Amount reported on balance sheet |  | $ | 906 |  |  | $ | 4,098 |

16. | REGULATORY RESTRICTIONS

The Company is subject to the regulatory requirements of the Federal Reserve System as a bank holding company. The bank is subject to regulations of the Federal Deposit Insurance Corporation (“FDIC”) and the State of Ohio, Division of Financial Institutions.

Cash Requirements

The Federal Reserve Bank of Cleveland requires the Company to maintain certain average reserve balances. As of December 31, 2019 and 2018, the Bank had required reserves of $16.5 million and $17.3 million comprised of vault cash and a depository amount held with the Federal Reserve Bank.

Loans

Federal law prevents the Company from borrowing from the Bank unless the loans are secured by specific obligations. Further, such secured loans are limited in amount of 10% of the Bank’s common stock and capital surplus.

Dividends

MBC is subject to dividend restrictions that generally limit the amount of dividends that can be paid by an Ohio state-chartered bank. Under the Ohio Banking Code, cash dividends may not exceed net profits as defined for that year combined with retained net profits for the two preceding years less any required transfers to surplus. Under this formula the amount available for payment of dividends for 2019 approximates $20.5 million plus 2020 profits retained up to the date of the dividend declaration.

17. | REGULATORY CAPITAL

The Bank and Company are subject to regulatory capital requirements administered by banking agencies. Capital adequacy guidelines and prompt corrective action regulations involve quantitative measures of assets, liabilities, and certain off-balance-sheet items calculated under regulatory accounting practices. Capital amounts and classifications are also subject to qualitative judgments by regulators about components, risk weightings, and other factors and the regulators can lower classifications in certain cases. Failure to meet various capital requirements can initiate regulatory action that could have a direct material effect on the financial statements. As of December 31, 2019, the Bank and Company have met all capital adequacy requirements to which they are subject.

The prompt corrective action regulations provide five classifications, including well capitalized, adequately capitalized, under-capitalized, significantly undercapitalized, and critically undercapitalized, although these terms are not used to represent overall financial condition. If an institution is adequately capitalized, regulatory approval is required before the institution may accept brokered deposits. If an institution is undercapitalized, capital distributions are limited, as is asset growth and expansion, and plans for capital restoration are required.

35

The capital conservation buffer is designed to absorb losses during periods of economic stress. Banking institutions with a ratio of Common Equity Tier 1 capital to risk-weighted assets above the minimum but below the conservation buffer (or below the combined capital conservation buffer and countercyclical capital buffer, when the latter is applied) will face constraints on dividends, equity repurchases and compensation based on the amount of the shortfall.

The following tables present actual and required capital ratios as of December 31, 2019 and 2018, under the Basel III Capital Rules. Capital levels required to be considered well capitalized are based upon prompt corrective action regulations, as amended to reflect the changes under the Basel III Capital Rules.

|  | As of December 31, 2019 |
|  | Leverage |  |  | Tier 1 Risk Based |  |  | Common Equity Tier 1 |  |  | Total Risk Based |
The Middlefield Banking Company |  |  | 10.35 | % |  |  | 12.12 | % |  |  | 12.12 | % |  |  | 12.79 | %
Middlefield Banc Corp. |  |  | 10.23 | % |  |  | 12.56 | % |  |  | 11.77 | % |  |  | 13.23 | %
Adequately capitalized ratio |  |  | 4.00 | % |  |  | 6.00 | % |  |  | 4.50 | % |  |  | 8.00 | %
Adequately capitalized ratio plus fully phased-in capital conservation buffer |  |  | 4.00 | % |  |  | 8.50 | % |  |  | 7.00 | % |  |  | 10.50 | %
Well-capitalized ratio (Bank only) |  |  | 5.00 | % |  |  | 8.00 | % |  |  | 6.50 | % |  |  | 10.00 | %

|  | As of December 31, 2018 |
|  | Leverage |  |  | Tier 1 Risk Based |  |  | Common Equity Tier 1 |  |  | Total Risk Based |
The Middlefield Banking Company |  |  | 9.60 | % |  |  | 11.09 | % |  |  | 11.09 | % |  |  | 11.83 | %
Middlefield Banc Corp. |  |  | 10.35 | % |  |  | 11.83 | % |  |  | 11.04 | % |  |  | 12.57 | %
Adequately capitalized ratio |  |  | 4.00 | % |  |  | 6.00 | % |  |  | 4.50 | % |  |  | 8.00 | %
Adequately capitalized ratio plus fully phased-in capital conservation buffer |  |  | 4.00 | % |  |  | 8.50 | % |  |  | 7.00 | % |  |  | 10.50 | %
Well-capitalized ratio (Bank only) |  |  | 5.00 | % |  |  | 8.00 | % |  |  | 6.50 | % |  |  | 10.00 | %

18. | FAIR VALUE DISCLOSURE MEASUREMENTS

The following disclosures show the hierarchal disclosure framework associated with the level of pricing observations utilized in measuring assets and liabilities at fair value. The three broad levels defined by U.S. generally accepted accounting principles are as follows:

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

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

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

This hierarchy requires the use of observable market data when available.

36

The following tables present the assets measured on a recurring basis on the Consolidated Balance Sheet at their fair value by level within the fair value hierarchy. Financial assets and liabilities are classified in their entirety based on the lowest level of input that is significant to the fair value measurement.

|  |  |  |  |  | December 31, 2019 |  |  |  |  |
(Dollar amounts in thousands) |  | Level I |  |  | Level II |  |  | Level III |  |  | Total |
Assets measured on a recurring basis: |  |  |  |  |  |  |  |  |  |  |  |  |  |  |  |
Subordinated debt |  | $ | - |  |  | $ | 4,126 |  |  | $ | - |  |  | $ | 4,126 |
Obligations of states and political subdivisions |  |  | - |  |  |  | 82,977 |  |  |  | - |  |  |  | 82,977 |
Mortgage-backed securities in government- sponsored entities |  |  | - |  |  |  | 18,630 |  |  |  | - |  |  |  | 18,630 |
Total debt securities |  |  | - |  |  |  | 105,733 |  |  |  | - |  |  |  | 105,733 |
Equity securities in financial institutions |  |  | 710 |  |  |  | - |  |  |  | - |  |  |  | 710 |
Total |  | $ | 710 |  |  | $ | 105,733 |  |  | $ | - |  |  | $ | 106,443 |

|  |  |  |  |  | December 31, 2018 |  |  |  |  |
(Dollar amounts in thousands) |  | Level I |  |  | Level II |  |  | Level III |  |  | Total |
Assets measured on a recurring basis: |  |  |  |  |  |  |  |  |  |  |  |  |  |  |  |
U.S. government agency securities |  | $ | - |  |  | $ | 7,471 |  |  | $ | - |  |  | $ | 7,471 |
Obligations of states and political subdivisions |  |  | - |  |  |  | 73,093 |  |  |  | - |  |  |  | 73,093 |
Mortgage-backed securities in government- sponsored entities |  |  | - |  |  |  | 17,758 |  |  |  | - |  |  |  | 17,758 |
Total debt securities |  |  | - |  |  |  | 98,322 |  |  |  | - |  |  |  | 98,322 |
Equity securities in financial institutions |  |  | 616 |  |  |  | - |  |  |  | - |  |  |  | 616 |
Total |  | $ | 616 |  |  | $ | 98,322 |  |  | $ | - |  |  | $ | 98,938 |

Investment Securities Available for Sale – The Company obtains fair values from an independent pricing service which represent quoted prices for similar assets, fair values determined by pricing models using a market approach that considers observable market data, such as interest rate volatilities, LIBOR yield curve, credit spreads and prices from market makers and live trading systems (Level II).

Equity Securities - Equity securities that are traded on a national securities exchange are valued at their last reported sales price as of the measurement date. Equity securities traded in the over-the-counter (“OTC”) markets and listed securities for which no sale was reported on that date are generally valued at their last reported “bid” price if held long, and last reported “ask” price if sold short. To the extent equity securities are actively traded and valuation adjustments are not applied, they are categorized in Level I of the fair value hierarchy.

37

The following tables present the assets measured on a non-recurring basis on the Consolidated Balance Sheet at their fair value by level within the fair value hierarchy. Collateral-dependent impaired loans are carried at fair value if they have been charged down to fair value or if a specific valuation allowance has been established. A new cost basis is established at the time a property is initially recorded in OREO. OREO properties are carried at fair value if a devaluation has been taken to the property’s value subsequent to the initial measurement. No such devaluation occurred during the year ended December 31, 2019.

|  |  |  |  |  | December 31, 2019 |  |  |  |  |
(Dollar amounts in thousands) |  | Level I |  |  | Level II |  |  | Level III |  |  | Total |
Assets measured on a non-recurring basis: |  |  |  |  |  |  |  |  |  |  |  |  |  |  |  |
Impaired loans |  | $ | - |  |  | $ | - |  |  | $ | 5,166 |  |  | $ | 5,166 |

|  |  |  |  |  | December 31, 2018 |  |  |  |  |
(Dollar amounts in thousands) |  | Level I |  |  | Level II |  |  | Level III |  |  | Total |
Assets measured on a non-recurring basis: |  |  |  |  |  |  |  |  |  |  |  |  |  |  |  |
Impaired loans |  | $ | - |  |  | $ | - |  |  | $ | 1,075 |  |  | $ | 1,075 |

Impaired Loans – The Company has measured impairment on collateral-dependent impaired loans generally based on the fair value of the loan’s collateral. Fair value is generally determined based upon independent third-party appraisals of the properties. In some cases, management may adjust the appraised value due to the age of the appraisal, changes in market conditions, or observable deterioration of the property since the appraisal was completed. Additionally, management makes estimates about expected costs to sell the property which are also included in the net realizable value. If the fair value of the collateral-dependent loan is less than the carrying amount of the loan, a specific reserve for the loan is made in the allowance for loan losses or a charge-off is taken to reduce the loan to the fair value of the collateral (less estimated selling costs) and the loan is included in the above table as a Level III measurement. If the fair value of the collateral exceeds the carrying amount of the loan, then the loan is not included in the above table as it is not currently being carried at its fair value. The fair values in the above tables include estimated selling costs of $2.1 million and $492,000 at December 31, 2019 and 2018, respectively.

The following tables present additional quantitative information about assets measured at fair value on a non-recurring basis and for which the Company uses Level III inputs to determine fair value:

|  | Quantitative Information about Level III Fair Value Measurements |
(Dollar amounts in thousands) |  |  |  |  |  |  |  |  |  |  |  |
|  | Fair Value Estimate |  | Valuation Techniques | Unobservable Input |  | Range (Weighted Average) |
December 31, 2019 |  |  |  |  |  |  |  |  |  |  |  |
Impaired loans |  | $ | 5,166 |  | Appraisal of collateral (1) | Appraisal adjustments (2) |  | 40.3% | to | 47.4% | (41.8%) |

|  | Quantitative Information about Level III Fair Value Measurements |
(Dollar amounts in thousands) |  |  |  |  |  |  |  |  |  |  |  |
|  | Fair Value Estimate |  | Valuation Techniques | Unobservable Input |  | Range (Weighted Average) |
December 31, 2018 |  |  |  |  |  |  |  |  |  |  |  |
Impaired loans |  | $ | 1,075 |  | Appraisal of collateral (1) | Appraisal adjustment (2) |  | 0.0% | to | 100.0% | (40.6%) |

| (1) | Fair value is generally determined through independent appraisals of the underlying collateral, which generally include various level III inputs which are not identifiable, less any associated allowance.

| (2) | Appraisals may be adjusted by management for qualitative factors such as economic conditions and estimated liquidation expenses. The range and weighted average of liquidation expenses and other appraisal adjustments are presented as a percent of the appraisal.

38

The estimated fair value of the Company’s financial instruments not measured at fair value on a recurring basis is as follows:

|  | December 31, 2019 |
|  | Carrying |  |  |  |  |  |  |  |  |  |  |  |  |  |  | Total |
|  | Value |  |  | Level I |  |  | Level II |  |  | Level III |  |  | Fair Value |
|  | (in thousands) |
Financial assets: |  |  |  |  |  |  |  |  |  |  |  |  |  |  |  |  |  |  |  |
Cash and cash equivalents |  | $ | 35,113 |  |  | $ | 35,113 |  |  | $ | - |  |  | $ | - |  |  | $ | 35,113 |
Loans held for sale |  |  | 1,220 |  |  |  | - |  |  |  | 1,220 |  |  |  | - |  |  |  | 1,220 |
Net loans |  |  | 977,490 |  |  |  | - |  |  |  | - |  |  |  | 974,213 |  |  |  | 974,213 |
Bank-owned life insurance |  |  | 16,511 |  |  |  | 16,511 |  |  |  | - |  |  |  | - |  |  |  | 16,511 |
Federal Home Loan Bank stock |  |  | 3,848 |  |  |  | 3,848 |  |  |  | - |  |  |  | - |  |  |  | 3,848 |
Accrued interest receivable |  |  | 3,471 |  |  |  | 3,471 |  |  |  | - |  |  |  | - |  |  |  | 3,471 |
Financial liabilities: |  |  |  |  |  |  |  |  |  |  |  |  |  |  |  |  |  |  |  |
Deposits |  | $ | 1,020,843 |  |  | $ | 652,043 |  |  | $ | - |  |  | $ | 371,193 |  |  | $ | 1,023,236 |
Short-term borrowings |  |  | 5,075 |  |  |  | 5,075 |  |  |  | - |  |  |  | - |  |  |  | 5,075 |
Other borrowings |  |  | 12,750 |  |  |  | - |  |  |  | - |  |  |  | 12,783 |  |  |  | 12,783 |
Accrued interest payable |  |  | 917 |  |  |  | 917 |  |  |  | - |  |  |  | - |  |  |  | 917 |

|  | December 31, 2018 |
|  | Carrying |  |  |  |  |  |  |  |  |  |  |  |  |  |  | Total |
|  | Value |  |  | Level I |  |  | Level II |  |  | Level III |  |  | Fair Value |
|  | (in thousands) |
Financial assets: |  |  |  |  |  |  |  |  |  |  |  |  |  |  |  |  |  |  |  |
Cash and cash equivalents |  | $ | 107,933 |  |  | $ | 107,933 |  |  | $ | - |  |  | $ | - |  |  | $ | 107,933 |
Loans held for sale |  |  | 597 |  |  |  | - |  |  |  | 597 |  |  |  | - |  |  |  | 597 |
Net loans |  |  | 984,681 |  |  |  | - |  |  |  | - |  |  |  | 973,124 |  |  |  | 973,124 |
Bank-owned life insurance |  |  | 16,080 |  |  |  | 16,080 |  |  |  | - |  |  |  | - |  |  |  | 16,080 |
Federal Home Loan Bank stock |  |  | 3,679 |  |  |  | 3,679 |  |  |  | - |  |  |  | - |  |  |  | 3,679 |
Accrued interest receivable |  |  | 3,633 |  |  |  | 3,633 |  |  |  | - |  |  |  | - |  |  |  | 3,633 |
Financial liabilities: |  |  |  |  |  |  |  |  |  |  |  |  |  |  |  |  |  |  |  |
Deposits |  | $ | 1,016,067 |  |  | $ | 715,153 |  |  | $ | - |  |  | $ | 298,891 |  |  | $ | 1,014,044 |
Short-term borrowings |  |  | 90,398 |  |  |  | 90,398 |  |  |  | - |  |  |  | - |  |  |  | 90,398 |
Other borrowings |  |  | 8,803 |  |  |  | - |  |  |  | - |  |  |  | 8,827 |  |  |  | 8,827 |
Accrued interest payable |  |  | 744 |  |  |  | 744 |  |  |  | - |  |  |  | - |  |  |  | 744 |

All financial instruments included in the above tables, with the exception of net loans, deposits, and other borrowings, are carried at cost, which approximates the fair value of the instruments.

39

19. | ACCUMULATED OTHER COMPREHENSIVE INCOME (LOSS)

The following table presents the changes in accumulated other comprehensive income (loss) by component net of tax:

|  | Unrealized gains/(losses) on |
|  | available-for-sale |
(Dollars in thousands) |  | securities (a) |
Balance as of December 31, 2017 |  | $ | 1,091 |
Other comprehensive loss |  |  | (1,291 | )
Change in accounting principle, ASC 2016-01 (b) |  |  | (141 | )
Change in accounting principle, ASC 2018-02 (b) |  |  | 187 |
Period change |  |  | (1,245 | )
Balance at December 31, 2018 |  | $ | (154 | )
Balance as of December 31, 2018 |  | $ | (154 | )
Other comprehensive income |  |  | 2,149 |
Amount reclassified from accumulated other comprehensive income |  |  | (153 | )
Period change |  |  | 1,996 |
Balance at December 31, 2019 |  | $ | 1,842 |

| (a) | All amounts are net of tax. Amounts in parentheses indicate debits to accumulated other comprehensive income.

| (b) | Reclassifications are the result of the adoption of ASUs 2016-01 and 2018-02 effective for the Company beginning January 1, 2018. The reclassifications are presented within the Consolidated Statement of Changes in Stockholders’ Equity for the affected transitional periods.

The following table presents significant amounts reclassified out of each component of accumulated other comprehensive income for the year ended December 31, 2019:

|  | Amount Reclassified from |  | Affected Line Item in
|  | Accumulated Other |  | the Statement Where
(Dollars in thousands) |  | Comprehensive Income |  | Net Income is
Details about other comprehensive income |  | December 31, 2019 |  | Presented
Unrealized gains on available-for-sale securities (a) |  |  |  |  |
|  | $ | 194 |  | Investment securities gains on sale, net
|  |  | (41 | ) | Income taxes
|  | $ | 153 |  |

| (a) | Amounts in parentheses indicate expenses and other amounts indicate income.

There were no other reclassifications of amounts from accumulated other comprehensive income for the year ended December 31, 2018.

40

20. | STOCK SPLIT DISCLOSURE

On October 9, 2019, the Board of Directors of Middlefield Banc Corp. authorized a two-for-one stock split. Each shareholder of record at the close of business on October 25, 2019, received one additional share for every outstanding share held on the record date. The additional shares were paid on November 8, 2019. As a result, all share and earnings per share information have been retroactively adjusted to reflect the stock split.

With respect to the December 31, 2019 and 2018 financial statements, the effect of the stock split on December 31, 2018 amounts was recognized retroactively in the stockholders’ equity accounts in the Consolidated Balance Sheets, and in all share data in the Consolidated Financial Statements and Management’s Discussion and Analysis of Financial Condition and Results of Operations. The effect of the stock split on per share amounts and weighted average common shares outstanding for the year ended December 31, 2018 is as follows:

|  | For the year ended |
|  | December 31, 2018 |
Restated net income per common share - basic |  | $ | 1.92 |
Restated net income per common share - diluted |  | $ | 1.91 |
Restated weighted-average common shares issued |  |  | 7,232,238 |
Restated average treasury stock shares |  |  | (772,330 | )
Restated average shares outstanding - basic |  |  | 6,459,908 |
Restated stock options and restricted stock |  |  | 27,906 |
Restated average shares outstanding - diluted |  |  | 6,487,814 |
Restated period ending shares oustanding |  |  | 6,488,664 |
Restated treasury shares outstanding |  |  | 772,330 |

41

21. | PARENT COMPANY

Following are condensed financial statements for the Company.

CONDENSED BALANCE SHEET

(Dollar amounts in thousands) |  | December 31, |
|  | 2019 |  |  | 2018 |
ASSETS |  |  |  |  |  |  |  |
Cash and due from banks |  | $ | 2,577 |  |  | $ | 1,582 |
Equity securities, at fair value |  |  | 710 |  |  |  | 616 |
Investment in nonbank subsidiary |  |  | 1,400 |  |  |  | 2,364 |
Investment in subsidiary bank |  |  | 141,104 |  |  |  | 128,366 |
Other assets |  |  | 977 |  |  |  | 4,080 |
TOTAL ASSETS |  | $ | 146,768 |  |  | $ | 137,008 |
LIABILITIES |  |  |  |  |  |  |  |
Trust preferred debt |  | $ | 8,248 |  |  | $ | 8,248 |
Other liabilities |  |  | 745 |  |  |  | 470 |
TOTAL LIABILITIES |  |  | 8,993 |  |  |  | 8,718 |
STOCKHOLDERS' EQUITY |  |  | 137,775 |  |  |  | 128,290 |
TOTAL LIABILITIES AND STOCKHOLDERS' EQUITY |  | $ | 146,768 |  |  | $ | 137,008 |

CONDENSED STATEMENT OF COMPREHENSIVE INCOME

|  | Year Ended December 31, |
(Dollar amounts in thousands) |  | 2019 |  |  | 2018 |
INCOME |  |  |  |  |  |  |  |
Dividends from subsidiary bank |  | $ | 4,450 |  |  | $ | 4,650 |
Dividends from nonbank subsidiary |  |  | 1,000 |  |  |  | - |
Gain (loss) on equity securities |  |  | 94 |  |  |  | (9 | )
Other |  |  | 12 |  |  |  | 9 |
Total income |  |  | 5,556 |  |  |  | 4,650 |
EXPENSES |  |  |  |  |  |  |  |
Interest expense |  |  | 343 |  |  |  | 325 |
Other |  |  | 2,949 |  |  |  | 2,119 |
Total expenses |  |  | 3,292 |  |  |  | 2,444 |
Income before income tax benefit |  |  | 2,264 |  |  |  | 2,206 |
Income tax benefit |  |  | (669 | ) |  |  | (513 | )
Income before equity in undistributed net income of subsidiaries |  |  | 2,933 |  |  |  | 2,719 |
Equity in undistributed net income of subsidiaries |  |  | 9,778 |  |  |  | 9,712 |
NET INCOME |  | $ | 12,711 |  |  | $ | 12,431 |
Comprehensive Income |  | $ | 14,707 |  |  | $ | 11,140 |

42

CONDENSED STATEMENT OF CASH FLOWS

|  | Year Ended December 31, |
(Dollar amounts in thousands) |  | 2019 |  |  | 2018 |
OPERATING ACTIVITIES |  |  |  |  |  |  |  |
Net income |  | $ | 12,711 |  |  | $ | 12,431 |
Adjustments to reconcile net income to net cash provided by operating activities: |  |  |  |  |  |  |  |
Equity in undistributed net income of Middlefield Banking Company |  |  | (10,742 | ) |  |  | (9,711 | )
Equity in undistributed net loss of EMORECO |  |  | 964 |  |  |  | (1 | )
Stock-based compensation |  |  | 548 |  |  |  | 371 |
(Gain) loss on equity securities |  |  | (94 | ) |  |  | 9 |
Other, net |  |  | 3,095 |  |  |  | (382 | )
Net cash provided by operating activities |  |  | 6,482 |  |  |  | 2,717 |
FINANCING ACTIVITIES |  |  |  |  |  |  |  |
Proceeds from issuance of common stock |  |  | 95 |  |  |  | 92 |
Restricted stock cash portion |  |  | (44 | ) |  |  | - |
Stock options exercised |  |  | 4 |  |  |  | 168 |
Proceeds from dividend reinvestment plan |  |  | 372 |  |  |  | 618 |
Repurchase of treasury shares |  |  | (2,229 | ) |  |  | - |
Cash dividends |  |  | (3,685 | ) |  |  | (3,779 | )
Net cash (used in) financing activities |  |  | (5,487 | ) |  |  | (2,901 | )
Increase (decrease) in cash |  |  | 995 |  |  |  | (184 | )
CASH AT BEGINNING OF YEAR |  |  | 1,582 |  |  |  | 1,766 |
CASH AT END OF YEAR |  | $ | 2,577 |  |  | $ | 1,582 |
SUPPLEMENTAL INFORMATION |  |  |  |  |  |  |  |
Increase in common stock through increase in other, net |  | $ | 265 |  |  | $ | 183 |

43

22. | SELECTED QUARTERLY FINANCIAL DATA (Unaudited)

(Dollar amounts in thousands) |  | Three Months Ended |
|  | March 31, |  |  | June 30, |  |  | September 30, |  |  | December 31, |
|  | 2019 |  |  | 2019 |  |  | 2019 |  |  | 2019 |
Total interest and dividend income |  | $ | 13,484 |  |  | $ | 13,720 |  |  | $ | 13,885 |  |  | $ | 13,436 |
Total interest expense |  |  | 3,254 |  |  |  | 3,451 |  |  |  | 3,307 |  |  |  | 3,128 |
Net interest income |  |  | 10,230 |  |  |  | 10,269 |  |  |  | 10,578 |  |  |  | 10,308 |
Provision for loan losses |  |  | 240 |  |  |  | 110 |  |  |  | 80 |  |  |  | 460 |
Net interest income after provision for loan losses |  |  | 9,990 |  |  |  | 10,159 |  |  |  | 10,498 |  |  |  | 9,848 |
Total noninterest income |  |  | 1,132 |  |  |  | 1,299 |  |  |  | 1,105 |  |  |  | 1,305 |
Total noninterest expense |  |  | 7,500 |  |  |  | 7,482 |  |  |  | 7,673 |  |  |  | 7,378 |
Income before income taxes |  |  | 3,622 |  |  |  | 3,976 |  |  |  | 3,930 |  |  |  | 3,775 |
Income taxes |  |  | 611 |  |  |  | 686 |  |  |  | 661 |  |  |  | 634 |
Net income |  | $ | 3,011 |  |  | $ | 3,290 |  |  | $ | 3,269 |  |  | $ | 3,141 |
Per share data: |  |  |  |  |  |  |  |  |  |  |  |  |  |  |  |
Net income |  |  |  |  |  |  |  |  |  |  |  |  |  |  |  |
Basic |  | $ | 0.46 |  |  | $ | 0.51 |  |  | $ | 0.51 |  |  | $ | 0.48 |
Diluted |  |  | 0.46 |  |  |  | 0.50 |  |  |  | 0.50 |  |  |  | 0.49 |
Average shares outstanding: |  |  |  |  |  |  |  |  |  |  |  |  |  |  |  |
Basic |  |  | 6,498,278 |  |  |  | 6,502,508 |  |  |  | 6,458,258 |  |  |  | 6,423,543 |
Diluted |  |  | 6,510,568 |  |  |  | 6,514,946 |  |  |  | 6,479,066 |  |  |  | 6,455,387 |

44

(Dollar amounts in thousands) |  | Three Months Ended |
|  | March 31, |  |  | June 30, |  |  | September 30, |  |  | December 31, |
|  | 2018 |  |  | 2018 |  |  | 2018 |  |  | 2018 |
Total interest and dividend income |  | $ | 11,940 |  |  | $ | 12,129 |  |  | $ | 12,829 |  |  | $ | 13,459 |
Total interest expense |  |  | 2,040 |  |  |  | 2,287 |  |  |  | 2,584 |  |  |  | 2,998 |
Net interest income |  |  | 9,900 |  |  |  | 9,842 |  |  |  | 10,245 |  |  |  | 10,461 |
Provision for loan losses |  |  | 210 |  |  |  | 210 |  |  |  | 210 |  |  |  | 210 |
Net interest income after provision for loan losses |  |  | 9,690 |  |  |  | 9,632 |  |  |  | 10,035 |  |  |  | 10,251 |
Total noninterest income |  |  | 788 |  |  |  | 1,009 |  |  |  | 954 |  |  |  | 977 |
Total noninterest expense |  |  | 7,345 |  |  |  | 7,063 |  |  |  | 7,092 |  |  |  | 7,243 |
Income before income taxes |  |  | 3,133 |  |  |  | 3,578 |  |  |  | 3,897 |  |  |  | 3,985 |
Income taxes |  |  | 528 |  |  |  | 481 |  |  |  | 593 |  |  |  | 560 |
Net income |  | $ | 2,605 |  |  | $ | 3,097 |  |  | $ | 3,304 |  |  | $ | 3,425 |
Per share data: |  |  |  |  |  |  |  |  |  |  |  |  |  |  |  |
Net income |  |  |  |  |  |  |  |  |  |  |  |  |  |  |  |
Basic |  | $ | 0.41 |  |  | $ | 0.48 |  |  | $ | 0.51 |  |  | $ | 0.53 |
Diluted |  |  | 0.40 |  |  |  | 0.48 |  |  |  | 0.51 |  |  |  | 0.53 |
Average shares outstanding: |  |  |  |  |  |  |  |  |  |  |  |  |  |  |  |
Basic |  |  | 6,440,524 |  |  |  | 6,451,452 |  |  |  | 6,468,786 |  |  |  | 6,478,360 |
Diluted |  |  | 6,476,138 |  |  |  | 6,480,658 |  |  |  | 6,496,652 |  |  |  | 6,500,298 |

45

Management’s Discussion and Analysis of Financial Condition and Results of Operations

This information should be read in conjunction with the consolidated financial statements and accompanying notes to the financial statements.

This Management’s Discussion and Analysis section of the Annual Report contains forward-looking statements. Forward-looking statements are based upon a variety of estimates and assumptions. The estimates and assumptions involve judgments about a number of things, including future economic, competitive, and financial market conditions and future business decisions. These matters are inherently subject to significant business, economic, and competitive uncertainties, all of which are difficult to predict and many of which are beyond the Company's control. Although the Company believes its estimates and assumptions are reasonable, actual results could vary materially from those shown. Inclusion of forward-looking information does not constitute a representation by the Company or any other person that the indicated results will be achieved. Investors are cautioned not to place undue reliance on forward-looking information.

These forward-looking statements may involve significant risks and uncertainties. Although the Company believes that the expectations reflected in such forward-looking statements are reasonable, actual results may differ materially from the results in these forward-looking statements.

Overview

During 2019, the Company reported net income of $12.7 million, or $1.95 per diluted share, compared with $12.4 million, or $1.91 per diluted share, in 2018. The Company’s net income as a percentage of average assets for 2019 and 2018 was 1.05% and 1.09%, respectively, while the Company’s net income as a percentage of average shareholders’ equity was 9.35% and 9.94%, respectively.

Highlights of the Company’s performance in 2019 (on a year-over-year basis unless noted) include the following(4):

| ● | Net income increased 2.3% to a record $12.7 million

| ● | Earnings per diluted share increased 2.1% to a record $1.95 per share

| ● | Return on average common equity was 9.35%, compared to 9.94%

| ● | Return on average tangible common equity(1)(2) was 10.72%, compared to 11.57%

| ● | Book value per share was up 8.5% to a record $21.45 per share

| ● | Tangible book value(1)(3) per share was up 10.0% to a record $18.78 per share

| ● | Total net loans decreased 0.7% to $977.5 million

| ● | Net interest income improved 2.3% to $41.4 million

| ● | Total noninterest income was up 29.9% to $4.8 million

| ● | Noninterest expense was up only 4.5%

| ● | Equity to assets strengthened to 11.65%, compared to 10.28%

(1) A reconciliation of Non-GAAP financial measures can be found in the following tables.

(2) Calculated by dividing net income by average tangible common equity

(3) Calculated by dividing tangible common equity by shares outstanding

(4) All per share data has been adjusted to reflect the November 8, 2019 two-for-one stock split

Reconciliation of Common Stockholders' Equity to Tangible Common Equity * |  | For the Twelve Months Ended |
(Dollar amounts in thousands) |  | December 31, |  |  | December 31, |
|  | 2019 |  |  | 2018 |
Stockholders' Equity |  | $ | 137,775 |  |  | $ | 128,290 |
Less Goodwill and other intangibles |  |  | 17,127 |  |  |  | 17,468 |
Tangible Common Equity |  | $ | 120,648 |  |  | $ | 110,822 |
Shares outstanding |  |  | 6,423,630 |  |  |  | 6,488,664 |
Tangible book value per share |  | $ | 18.78 |  |  | $ | 17.08 |

46

Reconciliation of Average Equity to Return on Average Tangible Common Equity |  | For the Twelve Months Ended |
|  | December 31, |  |  | December 31, |
|  | 2019 |  |  | 2018 |
Average Stockholders' Equity |  | $ | 135,900 |  |  | $ | 125,074 |
Less Average Goodwill and other intangibles |  |  | 17,296 |  |  |  | 17,641 |
Average Tangible Common Equity |  | $ | 118,604 |  |  | $ | 107,433 |
Net income |  | $ | 12,711 |  |  |  | 12,431 |
Return on average tangible common equity (annualized) |  |  | 10.72 | % |  |  | 11.57 | %

*All share and per share information has been adjusted for a two-for-one stock split completed on November 8, 2019.

Significant Factors Affecting Financial Results

Nonperforming and classified assets held by the banking industry have decreased from previous elevated levels. Because of uncertainty about economic sustainability and the potential for other factors to have an adverse impact on the prospects for the banking industry, such as national and global economic and political factors, the bank regulatory agencies have insisted that banks increase the size of the buffer that protects a bank from unknown potential adverse events and circumstances: regulatory capital.

The total number of banks and savings associations as of the end of 2019 is less than half the number at the end of 1990. Nevertheless, a large percentage of the institutions that remain are small, community-oriented institutions, although the share of total banking assets that they control continues to decline. We believe a strong incentive exists for growth through industry consolidation as a defense to pressure from competitors. We therefore believe that industry consolidation is likely to continue.

The trend toward consolidation would be most advantageous for financial institution organizations that have a surplus of capital, a strategy for growth, a strong financial profile, and few if any regulatory supervisory concerns. Our goal is to maintain that advantage, although we give no assurance that our efforts to do so will succeed. We continue to commit significant resources to increase operational effectiveness in The Middlefield Banking Company.

Critical Accounting Policies

Allowance for loan and lease losses. Arriving at an appropriate level of allowance for loan and lease losses involves a high degree of judgment. The Company’s allowance for loan and lease losses provides for probable losses based upon evaluations of known and inherent risks in the loan portfolio.

Management uses historical information to assess the adequacy of the allowance for loan and lease losses as well as the prevailing business environment, which is affected by changing economic conditions and various external factors and which may impact the portfolio in ways currently unforeseen. The allowance is increased by provisions for loan losses and by recoveries of loans previously charged-off and reduced by loans charged-off. For a full discussion of the Company’s methodology of assessing the adequacy of the reserve for loan losses, refer to Note 1 of “Notes to Consolidated Financial Statements” of this Annual Report.

Valuation of Securities. Investment securities are classified as held to maturity or available for sale on the date of purchase. Only those securities classified as held to maturity are reported at amortized cost. Available-for-sale securities are reported at fair value with unrealized gains and losses included in accumulated other comprehensive income, net of related deferred income taxes, on the Consolidated Balance Sheet. The majority of all of the Company’s securities are valued based on prices compiled by third party vendors using observable market data. However, certain securities are less actively traded and do not always have quoted market prices. The determination of fair value for less actively traded securities, therefore, requires judgment, with such determination requiring benchmarking to similar instruments or analyzing default and recovery rates. Examples include certain collateralized mortgage and debt obligations and high-yield debt securities. Realized securities gains or losses are reported within noninterest income in the Consolidated Statement of Income. The cost of securities sold is based on the specific identification method.

Management evaluates securities for other-than-temporary impairment (“OTTI”) at least on a quarterly basis, and more frequently when economic or market conditions warrant such an evaluation Investments in debt securities are generally evaluated for OTTI under Financial Accounting Standards Board (“FASB”) Accounting Standards Codification (“ASC”) 320, Investments — Debt and Equity Securities. Consideration is given to the length of time and the extent to which the fair value has been less than cost, the financial condition and near-term prospects of the issuer, whether the market decline was affected by macroeconomic conditions and whether the Company has the intent to sell the debt security or more likely than not will be required to sell the debt security before its anticipated recovery. In analyzing an issuer’s financial condition, the Company may consider whether the securities are issued by the federal government or its agencies, or U.S. government-sponsored enterprises, whether downgrades by bond rating agencies have occurred, and the results of reviews of the issuer’s financial condition. The assessment of whether an other-than-temporary decline exists involves a high degree of subjectivity and judgment and is based on the information available to management at a point in time.

47

When OTTI occurs, the amount of the OTTI recognized in earnings depends on whether an entity intends to sell the security or it is more likely than not it will be required to sell the security before recovery of its amortized cost basis. If an entity intends to sell or it is more likely than not it will be required to sell the security before recovery of its amortized cost basis, the OTTI shall be recognized in earnings equal to the entire difference between the investment’s amortized cost basis and its fair value at the balance sheet date. The previous amortized cost basis less the OTTI recognized in earnings becomes the new amortized cost basis of the investment. For debt securities that do not meet the aforementioned criteria, the amount of impairment is split into two components as follows: 1) OTTI related to credit loss, which must be recognized in the income statement and 2) OTTI related to other factors, which is recognized in other comprehensive income or loss. The credit loss is defined as the difference between the present value of the cash flows expected to be collected and the amortized cost basis. For equity securities, the entire amount of impairment is recognized through earnings.

Debt securities issued by U.S. government agencies, U.S. government-sponsored enterprises, and state and political subdivisions accounted for 96.1% of the total available-for-sale portfolio as of December 31, 2019, and no credit losses are expected, given the explicit and implicit guarantees provided by the U.S. federal government and the lack of significant unrealized loss positions within the obligations of state and political subdivisions security portfolio. The Company considered the following factors in determining whether a credit loss exists and the period over which the debt security is expected to recover:

| ● | The length of time and the extent to which the fair value has been less than the amortized cost basis.

| ● | Changes in the near-term prospects of the underlying collateral of a security such as changes in default rates, loss severity given default and significant changes in prepayment assumptions.

| ● | The level of cash flows generated from the underlying collateral supporting the principal and interest payments of the debt securities; and,

| ● | Any adverse change to the credit conditions and liquidity of the issuer, taking into consideration the latest information available about the overall financial condition of the issuer, credit ratings, recent legislation and government actions affecting the issuer’s industry and actions taken by the issuer to deal with the present economic climate.

Refer to Note 4 in the consolidated financial statements.

Income Taxes

The Company estimates income tax expense based on amounts expected to be owed to the various tax jurisdictions in which the Company conducts business. On a quarterly basis, management assesses the reasonableness of the Company’s effective tax rate based upon management’s current estimate of the amount and components of net income, tax credits and the applicable statutory tax rates expected for the full year. The estimated income tax expense is recorded in the Consolidated Statement of Income.

Deferred income tax assets and liabilities are determined using the balance sheet method and are reported in accrued taxes, interest and expenses in the Consolidated Balance Sheet. Under this method, the net deferred tax asset or liability is based on the tax effects of the differences between the book and tax basis of assets and liabilities and recognizes enacted changes in tax rates and laws. Deferred tax assets are recognized to the extent they exist and are subject to a valuation allowance based on management’s judgment that realization is more likely than not.

Accrued taxes represent the net estimated amount due to taxing jurisdictions and are reported in accrued taxes, interest and expenses in the Consolidated Balance Sheet. The Company evaluates and assesses the relative risks and appropriate tax treatment of transactions and filing positions after considering statutes, regulations, judicial precedent and other information and maintains tax accruals consistent with management’s evaluation of these relative risks and merits. Changes to the estimate of accrued taxes occur periodically due to changes in tax rates, interpretations of tax laws, the status of examinations being conducted by taxing authorities and changes to statutory, judicial and regulatory guidance that impact the relative risks of tax positions. These changes, when they occur, can affect deferred taxes and accrued taxes as well as the current period’s income tax expense and can be significant to the operating results of the Company.

Goodwill and Other Intangible Assets

Goodwill is the excess of the purchase price over the fair value of the assets acquired in connection with business acquisitions accounted for as purchases. Other intangible assets consist of branch acquisition core deposit premiums. Initially, an assessment of qualitative factors is performed to determine whether the existence of events or circumstances leads to a determination that it is more likely than not that the fair value of a reporting unit is less than its carrying amount. If, after assessing the totality of events or circumstances, we determine it is not more likely than not that the fair value of a reporting unit is less than its carrying value, then performing the two-step impairment test is unnecessary. However, if we conclude otherwise, then we are required to perform the impairment test by calculating the fair value of the reporting unit and comparing against the carrying amount of the reporting unit. If the fair value is less than the carrying value, an expense may be required to write down the goodwill to the proper carrying value.

48

The Company must assess goodwill and other intangible assets each year for impairment. The Company evaluates goodwill using financial data as of September 30. Based on the analysis performed as of September 30, 2019, the Company determined that goodwill was not impaired.

Changes in Financial Condition

General The Company’s total assets decreased $65.9 million or 5.3% to $1.18 billion at December 31, 2019 from $1.25 billion at December 31, 2018. This decrease was mostly due to a decrease in cash and cash equivalents and net loans of $72.8 million and $7.2 million, respectively.

The decrease in the Company’s total assets reflects a related decrease in total liabilities of $75.4 million or 6.7% to a total balance of $1.04 billion at December 31, 2019 from $1.12 billion at December 31, 2018. The Company experienced an increase in total stockholders’ equity of $9.5 million. The decrease in total liabilities was due to a decrease in short-term borrowings for the year of $85.3 million.

Total deposits increased $4.8 million or 0.5% to $1.02 billion at December 31, 2019 from $1.02 billion as of December 31, 2018. Short-term borrowings decreased $85.3 million or 94.4% to $5.1 million at December 31, 2019 from $90.4 million as of December 31, 2018. The net increase in total stockholders’ equity can be attributed to an increase in common stock, retained earnings, and accumulated other comprehensive income (loss) of $692,000, $9.0 million, and $2.0 million, respectively, partially offset by an increase in treasury stock of $2.2 million or 16.5%, which is due to the Company repurchasing 98,832 of its outstanding shares during the year ended December 31, 2019.

On October 9, 2019, the Board of Directors of Middlefield Bank Corp. authorized a two-for-one stock split. Each shareholder of record at the close of business on October 25, 2019, received one additional share for every outstanding share held on the record date. The additional shares were paid on November 8, 2019.

Cash and cash equivalents Cash and due from banks and federal funds sold represent cash and cash equivalents which decreased $72.8 million or 67.5% to $35.1 million at December 31, 2019 from $107.9 million at December 31, 2018. This decrease resulted from the repayment of short-term borrowings. The Company tested a line of credit as of December 31, 2018 by borrowing $70.0 from the FHLB and repaying the following business day. This testing was not done as of December 31, 2019, resulting in the large variance. Deposits from customers into savings and checking accounts, loan and security repayments and proceeds from borrowed funds typically increase these accounts. Decreases result from customer withdrawals, new loan originations, security purchases and repayments of borrowed funds.

Investment securities Management's objective in structuring the portfolio is to maintain a prudent level of liquidity while providing an acceptable rate of return without sacrificing asset quality. The balance of investment securities available for sale increased $7.4 million, or 7.5%, as compared to 2018. This increase includes purchases of investment securities available for sale of $35.0 million during the year ended December 31, 2019. The ratio of securities to total assets increased to 8.9% at December 31, 2019, compared to 7.9% at December 31, 2018.

The Company benefits from owning municipal bonds, which totaled $83.0 million or 78.5% of the Company's total investment portfolio at December 31, 2019. The weighted-average federal tax equivalent (FTE) yield on all debt securities at year-end 2019 increased to 3.77% from 3.67% at year-end 2018. While the Company's focus is to generate interest revenue primarily through loan growth, management will continue to invest excess funds in securities when opportunities arise.

Loans receivable The loans receivable category consists primarily of single-family mortgage loans used to purchase or refinance personal residences located within the Company’s market area and commercial real estate loans used to finance properties that are used in the borrowers’ businesses or to finance investor-owned rental properties and commercial loans to finance the business operations and to a lesser extent construction and consumer loans. The portfolio is well disbursed, geographically, with the five branches in the central Ohio market comprising 24.6% of the Company’s total loans. Since December 31, 2018, the central OH footprint’s total loans increased by 1.9%, compared to the Company’s total loan decrease of 0.8%. Net loans receivable decreased $7.2 million or 0.7% to $977.5 million at December 31, 2019 from $984.7 million at December 31, 2018. Included in the total decrease of loans receivable were decreases in the commercial real estate and consumer installment portfolios of $28.2 million and $2.4 million, respectively. Also included in the total decrease of loans receivable were increases in the residential real estate, real estate-construction, and commercial and industrial portfolios of $10.6 million, $6.5 million, and $5.7 million, respectively.

The product mix in the loan portfolio consists of commercial real estate loans equaling 47.8% of total loans, residential real estate loans, 35.3%, commercial and industrial loans, 9.1%, construction loans, 6.4%, and consumer loans, 1.5% at December 31, 2019 compared with 50.2%, 33.9%, 8.5%, 5.7%, and 1.7%, respectively, at December 31, 2018.

49

Loans contributed 92.4% of total interest income in 2019 and 92.5% in 2018. The loan portfolio yield of 5.06% in 2019 was 23 basis points higher than the average yield for total interest-earning assets. Management recognizes that while the loan portfolio holds some of the Company’s highest yielding assets, it is inherently the riskiest portfolio. Accordingly, management attempts to balance credit risk versus return with conservative credit standards. Management has developed and maintains comprehensive underwriting guidelines and a loan review function that monitors credits during and after the approval process. Management follows additional procedures to obtain current borrower financial information annually throughout the life of the loan obligation.

To minimize risks associated with changes in the borrower’s future repayment capacity, the Company generally requires scheduled periodic principal and interest payments on all types of loans and normally requires collateral.

The Company will continue to monitor the size of its loan portfolio growth. The Company expects loan growth to be minimal, while steadfastly adhering to sound underwriting standards. The Company remains committed to sound underwriting practices without sacrificing asset quality and avoiding exposure to unnecessary risk that could weaken the credit quality of the portfolio.

Restricted stock. The Company’s investment in restricted stock increased $168,000, or 4.6%, to $3.8 million as of December 31, 2019, compared to $3.7 million as of December 31, 2018.

Premises and equipment, net. The Company’s investment in premises and equipment, net increased $4.9 million, or 37.5%, to $17.9 million as of December 31, 2019, compared to $13.0 million as of December 31, 2018. This increase was mostly due to the recording of finance lease right of use assets, totaling $4.0 million as of December 31, 2019, due to the adoption of ASU 2016-02, Leases (Topic 84), effective January 1, 2019 (see Note 15). Other increases include an increase in equipment from new ATMs purchased for all locations, an increase in buildings and related furniture and fixtures representing the new Plain City branch opened in the fourth quarter of 2019, and the relocation of the Mantua branch to be in operation in the first quarter 2020.

Goodwill and other intangible s. Goodwill results from prior business acquisitions and represents the excess of the purchase price over the fair value of acquired tangible assets and liabilities and identifiable intangible assets. Goodwill is assessed annually for impairment and any such impairment is recognized in the period identified by a charge to earnings.

The process of evaluating goodwill for impairment requires management to make significant estimates and judgments. The use of different estimates, judgments or approaches to estimate fair value could result in a different conclusion regarding impairment of goodwill. Based on the analysis, management has determined that there is no goodwill impairment.

The Company monitors the ongoing value of core deposit intangibles and goodwill on an annual basis. As of December 31, 2019, the Company recorded a decrease in core deposit intangibles of $341,000, and no change in the goodwill asset.

Bank-owned life insurance. Bank-owned life insurance (BOLI) is universal life insurance, purchased by the Company, on the lives of the Company’s officers. The beneficial aspects of these universal life insurance policies are tax-free earnings and a tax-free death benefit, which are realized by the Company as the owner of the policies. BOLI increased by $431,000 to $16.5 million as of December 31, 2019 from $16.1 million at the end of 2018 as a result of increases in cash surrender value.

Deposits. Interest-earning assets are funded generally by both interest-bearing and noninterest-bearing core deposits. Deposits are influenced by changes in interest rates, economic conditions and competition from other banks. The Company considers various sources when evaluating funding needs, including but not limited to deposits, which represented 98.3% of the Company’s total funding sources at December 31, 2019. The deposit base consists of demand deposits, savings, money market accounts and time deposits. Total deposits increased $4.8 million or 0.5% to $1.02 billion at December 31, 2019 from $1.02 billion at December 31, 2018.

Savings and time deposits are the largest sources of funding for the Company's earning assets, making up a combined 54.9% of total deposits. The total increase in deposits is the result of increases in time deposits and interest-bearing demand deposits of $67.9 million or 22.6%, and $15.7 million or 17.1%, respectively. This increase is net of decreases in noninterest-bearing demand, savings, and money market deposits of $12.0 million or 5.9%, $31.0 million or 13.9%, and $35.9 million or 18.2%, respectively, at December 31, 2019.

The Company avails itself of certain deposit brokers and listing services in an effort to facilitate growth. Although they are often priced favorably relative to FHLB advances, these deposits typically cost more than core deposits. Therefore, an effort is made to minimize them when prudent. Brokered and listing service deposits decreased $31.7 million from $148.8 million at December 31, 2018 to $117.1 million at December 31, 2019.

The Company will continue to experience increased competition for deposits in its market areas, which could challenge net growth in its deposit balances. The Company will continue to evaluate its deposit portfolio mix to properly employ both retail and wholesale funds to support earning assets and minimize interest costs.

50

Borrowed funds. The Company uses short and long-term borrowings as another source of funding to benefit asset growth and liquidity needs. These borrowings primarily include FHLB advances, junior subordinated debt, and lines of credit from other banks. Borrowed funds decreased $81.4 million or 82.0% to $17.8 million at December 31, 2019 from $99.2 million at December 31, 2018. The net decrease is a result of a partial shift of funding from FHLB to brokered deposits as well as the repayment of overnight short-term borrowings. The Company tested a line of credit as of December 31, 2018 by borrowing $70.0 million from the FHLB and repaying the following business day. This testing was not done as of December 31, 2019, resulting in the large variance.

On July 27, 2017, the Chief Executive of the United Kingdom Financial Conduct Authority, which regulates LIBOR, announced that it intends to stop persuading or compelling banks to submit rates for the calculation of LIBOR to the administrator of LIBOR after 2021. The announcement indicates that the continuation of LIBOR on the current basis will not be guaranteed after 2021. The Company formed a special purpose entity to issue $8.0 million of floating rate mandatorily redeemable trust preferred securities (“TruPS”). The rate on the TruPS adjusts quarterly, equal to LIBOR plus 1.67%. The cessation of LIBOR quotes in 2021 and the uncertainty over possible replacement rates for LIBOR will affect our TruPS. The Company expects a consensus as to what rate or rates may become accepted alternatives to LIBOR in 2020.

Stockholders’ equity. The Company maintains a capital level that exceeds regulatory requirements as a margin of safety for its depositors and shareholders. All of the capital ratios exceeded the regulatory well-capitalized guidelines.

Stockholders’ equity totaled $137.8 million at December 31, 2019, compared to $128.3 million at December 31, 2018, which represents an increase of $9.5 million or 7.4%. Retained earnings increased $9.0 million resulting from net income of $12.7 million, less cash dividends paid of $3.7 million, or $0.57 per share, year-to-date. Common stock increased $692,000, or 0.8%, to $86.6 million at December 31, 2019 from $85.9 million at December 31, 2018. The Company maintains a dividend reinvestment and stock purchase plan. The plan allows shareholders to purchase additional shares of Company stock. A benefit of the plan is to permit the shareholders to reinvest cash dividends as well as make supplemental purchases without the usual payment of brokerage commissions. During 2019, shareholders invested $372,000 through the dividend reinvestment and stock purchase plan. These proceeds resulted in the issuance of 17,866 new shares at a weighted average price of $20.80. Accumulated other comprehensive income (loss) increased by $2.0 million during 2019 primarily due to an increase in the value of the Company’s available for sale securities. Treasury stock increased by $2.2 million due to the Company repurchasing 98,832 of its outstanding shares during the year ended December 31, 2019 at a weighted average price of $22.55 per share.

51

Average Balance Sheet and Yield/Rate Analysis. The following table sets forth, for the periods indicated, information concerning the total dollar amounts of interest income from interest-earning assets and the resultant average yields, the total dollar amounts of interest expense on interest-bearing liabilities and the resultant average costs, net interest income, interest rate spread and the net interest margin earned on average interest-earning assets. For purposes of this table, average balances are calculated using monthly averages and the average loan balances include nonaccrual loans and exclude the allowance for loan and lease losses, and interest income includes accretion of net deferred loan fees. Yields on tax-exempt securities and loans (tax-exempt for federal income tax purposes) are shown on a fully tax-equivalent basis utilizing a federal tax rate of 21% for the years ended December 31, 2019 and 2018, and 34% for the year ended December 31, 2017, respectively. Yields and rates have been calculated on an annualized basis utilizing monthly interest amounts.

|  | For the Twelve Months Ended December 31, |
|  | 2019 |  |  | 2018 |  |  | 2017 |
|  | Average |  |  |  |  |  |  | Average |  |  | Average |  |  |  |  |  |  | Average |  |  | Average |  |  |  |  |  |  | Average |
(Dollar amounts in thousands) |  | Balance |  |  | Interest |  |  | Yield/Cost |  |  | Balance |  |  | Interest |  |  | Yield/Cost |  |  | Balance |  |  | Interest |  |  | Yield/Cost |
Interest-earning assets: |  |  |  |  |  |  |  |  |  |  |  |  |  |  |  |  |  |  |  |  |  |  |  |  |  |  |  |  |  |  |  |  |  |  |  |
Loans receivable (3) |  | $ | 997,744 |  |  | $ | 50,390 |  |  |  | 5.06 | % |  | $ | 950,455 |  |  | $ | 46,576 |  |  |  | 4.91 | % |  | $ | 857,361 |  |  | $ | 40,235 |  |  |  | 4.69 | %
Investment securities (3) |  |  | 101,381 |  |  |  | 3,188 |  |  |  | 3.77 | % |  |  | 96,856 |  |  |  | 2,950 |  |  |  | 3.67 | % |  |  | 104,444 |  |  |  | 3,168 |  |  |  | 4.22 | %
Interest-earning deposits with other banks (4) |  |  | 44,943 |  |  |  | 947 |  |  |  | 2.11 | % |  |  | 43,701 |  |  |  | 831 |  |  |  | 1.90 | % |  |  | 47,168 |  |  |  | 592 |  |  |  | 1.26 | %
Total interest-earning assets |  |  | 1,144,068 |  |  |  | 54,525 |  |  |  | 4.83 | % |  |  | 1,091,012 |  |  |  | 50,357 |  |  |  | 4.68 | % |  |  | 1,008,973 |  |  |  | 43,995 |  |  |  | 4.48 | %
Noninterest-earning assets |  |  | 61,596 |  |  |  |  |  |  |  |  |  |  |  | 53,964 |  |  |  |  |  |  |  |  |  |  |  | 60,683 |  |  |  |  |  |  |  |  |
Total assets |  | $ | 1,205,664 |  |  |  |  |  |  |  |  |  |  | $ | 1,144,976 |  |  |  |  |  |  |  |  |  |  | $ | 1,069,656 |  |  |  |  |  |  |  |  |
Interest-bearing liabilities: |  |  |  |  |  |  |  |  |  |  |  |  |  |  |  |  |  |  |  |  |  |  |  |  |  |  |  |  |  |  |  |  |  |  |  |
Interest-bearing demand deposits |  | $ | 102,550 |  |  |  | 374 |  |  |  | 0.36 | % |  | $ | 120,191 |  |  |  | 280 |  |  |  | 0.23 | % |  | $ | 113,054 |  |  |  | 236 |  |  |  | 0.21 | %
Money market deposits |  |  | 167,187 |  |  |  | 2,438 |  |  |  | 1.46 | % |  |  | 158,364 |  |  |  | 1,754 |  |  |  | 1.11 | % |  |  | 158,159 |  |  |  | 980 |  |  |  | 0.62 | %
Savings deposits |  |  | 199,515 |  |  |  | 1,399 |  |  |  | 0.70 | % |  |  | 217,270 |  |  |  | 1,421 |  |  |  | 0.65 | % |  |  | 193,003 |  |  |  | 608 |  |  |  | 0.32 | %
Certificates of deposit |  |  | 369,006 |  |  |  | 8,198 |  |  |  | 2.22 | % |  |  | 282,602 |  |  |  | 5,176 |  |  |  | 1.83 | % |  |  | 241,195 |  |  |  | 3,526 |  |  |  | 1.46 | %
Short-term borrowings |  |  | 14,808 |  |  |  | 368 |  |  |  | 2.49 | % |  |  | 42,231 |  |  |  | 842 |  |  |  | 1.99 | % |  |  | 63,910 |  |  |  | 753 |  |  |  | 1.18 | %
Other borrowings |  |  | 12,986 |  |  |  | 363 |  |  |  | 2.80 | % |  |  | 15,914 |  |  |  | 436 |  |  |  | 2.74 | % |  |  | 32,244 |  |  |  | 544 |  |  |  | 1.69 | %
Total interest-bearing liabilities |  |  | 866,052 |  |  |  | 13,140 |  |  |  | 1.52 | % |  |  | 836,572 |  |  |  | 9,909 |  |  |  | 1.18 | % |  |  | 801,565 |  |  |  | 6,647 |  |  |  | 0.83 | %
Noninterest-bearing liabilities: |  |  |  |  |  |  |  |  |  |  |  |  |  |  |  |  |  |  |  |  |  |  |  |  |  |  |  |  |  |  |  |  |  |  |  |
Noninterest-bearing demand deposits |  |  | 199,672 |  |  |  |  |  |  |  |  |  |  |  | 181,067 |  |  |  |  |  |  |  |  |  |  |  | 153,300 |  |  |  |  |  |  |  |  |
Other liabilities |  |  | 4,040 |  |  |  |  |  |  |  |  |  |  |  | 2,263 |  |  |  |  |  |  |  |  |  |  |  | 3,825 |  |  |  |  |  |  |  |  |
Stockholders' equity |  |  | 135,900 |  |  |  |  |  |  |  |  |  |  |  | 125,074 |  |  |  |  |  |  |  |  |  |  |  | 110,966 |  |  |  |  |  |  |  |  |
Total liabilities and stockholders' equity |  | $ | 1,205,664 |  |  |  |  |  |  |  |  |  |  | $ | 1,144,976 |  |  |  |  |  |  |  |  |  |  | $ | 1,069,656 |  |  |  |  |  |  |  |  |
Net interest income |  |  |  |  |  | $ | 41,385 |  |  |  |  |  |  |  |  |  |  | $ | 40,448 |  |  |  |  |  |  |  |  |  |  | $ | 37,348 |  |  |  |  |
Interest rate spread (1) |  |  |  |  |  |  |  |  |  |  | 3.31 | % |  |  |  |  |  |  |  |  |  |  | 3.49 | % |  |  |  |  |  |  |  |  |  |  | 3.65 | %
Net interest margin (2) |  |  |  |  |  |  |  |  |  |  | 3.68 | % |  |  |  |  |  |  |  |  |  |  | 3.77 | % |  |  |  |  |  |  |  |  |  |  | 3.82 | %
Ratio of average interest-earning assets to average interest-bearing liabilities |  |  |  |  |  |  |  |  |  |  | 132.10 | % |  |  |  |  |  |  |  |  |  |  | 130.41 | % |  |  |  |  |  |  |  |  |  |  | 125.88 | %

(1) Interest rate spread represents the difference between the average yield on interest-earning assets and the average cost of interest-bearing liabilities.
(2) Net interest margin represents net interest income as a percentage of average interest-earning assets.
(3) Tax-equivalent adjustments to calculate the yield on tax-exempt securities and loans were $720, $682, and $1,239, for 2019, 2018, and 2017, respectively.
(4) Includes dividends received on restriced stock.

52

I nterest R ates and I nterest D ifferential

|  | 2019 versus 2018 |  |  | 2018 versus 2017 |
|  | Increase (decrease) due to |  |  | Increase (decrease) due to |
(Dollars in thousands) |  | Volume |  |  | Rate |  |  | Total |  |  | Volume |  |  | Rate |  |  | Total |
Interest-earning assets: |  |  |  |  |  |  |  |  |  |  |  |  |  |  |  |  |  |  |  |  |  |  |  |
Loans receivable |  | $ | 2,357 |  |  | $ | 1,457 |  |  | $ | 3,814 |  |  | $ | 4,469 |  |  | $ | 1,872 |  |  | $ | 6,341 |
Investment securities |  |  | 168 |  |  |  | 70 |  |  |  | 238 |  |  |  | (299 | ) |  |  | 81 |  |  |  | (218 | )
Interest-bearing deposits with other banks |  |  | 25 |  |  |  | 91 |  |  |  | 116 |  |  |  | (55 | ) |  |  | 294 |  |  |  | 239 |
Total interest-earning assets |  |  | 2,550 |  |  |  | 1,618 |  |  |  | 4,168 |  |  |  | 4,115 |  |  |  | 2,247 |  |  |  | 6,362 |
Interest-bearing liabilities: |  |  |  |  |  |  |  |  |  |  |  |  |  |  |  |  |  |  |  |  |  |  |  |
Interest-bearing demand deposits |  |  | (52 | ) |  |  | 146 |  |  |  | 94 |  |  |  | 16 |  |  |  | 28 |  |  |  | 44 |
Money market deposits |  |  | 113 |  |  |  | 571 |  |  |  | 684 |  |  |  | 2 |  |  |  | 772 |  |  |  | 774 |
Savings deposits |  |  | (120 | ) |  |  | 98 |  |  |  | (22 | ) |  |  | 118 |  |  |  | 695 |  |  |  | 813 |
Certificates of deposit |  |  | 1,750 |  |  |  | 1,272 |  |  |  | 3,022 |  |  |  | 682 |  |  |  | 968 |  |  |  | 1,650 |
Short-term borrowings |  |  | (615 | ) |  |  | 141 |  |  |  | (474 | ) |  |  | (344 | ) |  |  | 433 |  |  |  | 89 |
Other borrowings |  |  | (81 | ) |  |  | 8 |  |  |  | (73 | ) |  |  | (361 | ) |  |  | 253 |  |  |  | (108 | )
Total interest-bearing liabilities |  |  | 995 |  |  |  | 2,236 |  |  |  | 3,231 |  |  |  | 113 |  |  |  | 3,149 |  |  |  | 3,262 |
Net interest income |  | $ | 1,555 |  |  | $ | (618 | ) |  | $ | 937 |  |  | $ | 4,002 |  |  | $ | (902 | ) |  | $ | 3,100 |

53

The ratio of net income to average shareholders’ equity and average total assets and certain other ratios are as follows for periods ended December 31:

(Dollars in thousands) |  | 2019 |  |  | 2018 |  |  | 2017 |
Average total assets |  | $ | 1,205,664 |  |  | $ | 1,144,976 |  |  | $ | 1,069,656 |
Average shareholders' equity |  | $ | 135,900 |  |  | $ | 125,074 |  |  | $ | 110,966 |
Net income |  | $ | 12,711 |  |  | $ | 12,431 |  |  | $ | 9,455 |
Cash dividends declared per share |  | $ | 0.57 |  |  | $ | 0.59 |  |  | $ | 0.54 |
Return on average total assets |  |  | 1.05 | % |  |  | 1.09 | % |  |  | 0.88 | %
Return on average shareholders' equity |  |  | 9.35 | % |  |  | 9.94 | % |  |  | 8.52 | %
Dividend payout ratio (1) |  |  | 28.99 | % |  |  | 30.40 | % |  |  | 35.52 | %
Average shareholders' equity to average assets |  |  | 11.27 | % |  |  | 10.92 | % |  |  | 10.37 | %

(1) Cash dividends declared on common shares divided by net income

54

Allowance for Loan and Lease Losses. The allowance for loan and lease losses (“ALLL”) represents the amount management estimates is adequate to provide for probable losses inherent in the loan portfolio as of the balance sheet date. Accordingly, all loan losses are charged to the allowance, and all recoveries credited to it. The ALLL is established through a provision for loan losses, which is charged to operations. The provision is based on management's periodic evaluation of the adequacy of the ALLL, taking into account the overall risk characteristics of the various portfolio segments, the Company's loan loss experience, the impact of economic conditions on borrowers, and other relevant factors. The estimates used to determine the adequacy of the ALLL, including the amounts and timing of future cash flows expected on impaired loans, are particularly susceptible to significant change in the near term. The total ALLL is a combination of a specific allowance for identified problem loans and a general allowance for homogeneous loan pools.

The allowance for loan and lease loss balance as of December 31, 2019 totaled $6.8 million representing a $660,000 decrease from the end of 2018. For the year of 2019, the provision for loan losses was $890,000 which represented an increase of $50,000 from the $840,000 provided during 2018. Asset quality is a high priority in our overall business plan as it relates to long-term asset growth projections. During 2019, net charge-offs increased by $948,000 to $1.6 million compared to $602,000 in 2018. Two key ratios to monitor asset quality performance are net charge-offs to average loans and the allowance for loan and lease losses to nonperforming loans. At year-end 2019, these ratios were 0.16% and 76.22%, respectively, compared to 0.06% and 98.51% in 2018. During the 2019 fourth quarter, charge-offs were higher as a result of charging off $566,000 of acquired student loans during the quarter. The Company believes this was a one-time issue, and, as the nonperforming assets at December 31, 2019 indicate, the Company expects charge-offs will return to more historical levels during the 2020 first quarter.

The specific allowance incorporates the results of measuring impaired loans. The formula allowance is calculated by applying loss factors to outstanding loans by type, excluding loans for which a specific allowance has been determined. Loss factors are based on management's determination of the amounts necessary for concentrations and changes in mix and volume of the loan portfolio, and consideration of historical loss experience.

The non-specific allowance is determined based upon management's evaluation of existing economic and business conditions affecting the key lending areas of the Company and other conditions, such as new loan products, credit quality trends, collateral values, unique industry conditions within portfolio segments that existed as of the balance sheet date, and the impact of those conditions on the collectability of the loan portfolio. Management reviews these conditions quarterly. The non-specific allowance is subject to a higher degree of uncertainty because it considers risk factors that may not be reflected in the historical loss factors.

Although management uses the best information available to make the determination of the adequacy of the ALLL at December 31, 2019, future adjustments could be necessary if circumstances or economic conditions differ substantially from the assumptions used in making the initial determinations. A downturn in the local economy could result in increased levels of nonperforming assets and charge-offs, increased loan loss provisions, and reductions in income. Additionally, as an integral part of the examination process, bank regulatory agencies periodically review a bank’s ALLL. The banking agencies could require the recognition of additions to the loan loss allowance based on their judgment of information available to them at the time of their examination.

55

The following table sets forth information concerning the Company's ALLL at the dates and for the periods presented:

|  | For the Years Ended |
|  | December 31, |
(Dollars in thousands) |  | 2019 |  |  | 2018 |  |  | 2017 |  |  | 2016 |  |  | 2015 |
Allowance balance at beginning of period |  | $ | 7,428 |  |  | $ | 7,190 |  |  | $ | 6,598 |  |  | $ | 6,385 |  |  | $ | 6,846 |
Loans charged off: |  |  |  |  |  |  |  |  |  |  |  |  |  |  |  |  |  |  |  |
Commercial and industrial |  |  | (519 | ) |  |  | (610 | ) |  |  | (536 | ) |  |  | (237 | ) |  |  | (280 | )
Real estate-construction |  |  | - |  |  |  | - |  |  |  | - |  |  |  | - |  |  |  | (385 | )
Real estate-mortgage: |  |  |  |  |  |  |  |  |  |  |  |  |  |  |  |  |  |  |  |
Residential |  |  | (523 | ) |  |  | (177 | ) |  |  | (117 | ) |  |  | (414 | ) |  |  | (425 | )
Commercial |  |  | (32 | ) |  |  | (111 | ) |  |  | (39 | ) |  |  | (70 | ) |  |  | (92 | )
Consumer installment |  |  | (735 | ) |  |  | (220 | ) |  |  | (462 | ) |  |  | (22 | ) |  |  | (15 | )
Total loans charged off |  |  | (1,809 | ) |  |  | (1,118 | ) |  |  | (1,154 | ) |  |  | (743 | ) |  |  | (1,197 | )
Recoveries of loans previously charged-off: |  |  |  |  |  |  |  |  |  |  |  |  |  |  |  |  |  |  |  |
Commercial and industrial |  |  | 82 |  |  |  | 287 |  |  |  | 234 |  |  |  | 90 |  |  |  | 207 |
Real estate-construction |  |  | 74 |  |  |  | 63 |  |  |  | 34 |  |  |  | - |  |  |  | - |
Real estate-mortgage: |  |  |  |  |  |  |  |  |  |  |  |  |  |  |  |  |  |  |  |
Residential |  |  | 78 |  |  |  | 128 |  |  |  | 241 |  |  |  | 141 |  |  |  | 186 |
Commercial |  |  | 17 |  |  |  | - |  |  |  | 111 |  |  |  | 140 |  |  |  | 5 |
Consumer installment |  |  | 8 |  |  |  | 38 |  |  |  | 81 |  |  |  | 15 |  |  |  | 23 |
Total recoveries |  |  | 259 |  |  |  | 516 |  |  |  | 701 |  |  |  | 386 |  |  |  | 421 |
Net loans charged off |  |  | (1,550 | ) |  |  | (602 | ) |  |  | (453 | ) |  |  | (357 | ) |  |  | (776 | )
Provision for loan losses |  |  | 890 |  |  |  | 840 |  |  |  | 1,045 |  |  |  | 570 |  |  |  | 315 |
Allowance balance at end of period |  | $ | 6,768 |  |  | $ | 7,428 |  |  | $ | 7,190 |  |  | $ | 6,598 |  |  | $ | 6,385 |
Loans outstanding: |  |  |  |  |  |  |  |  |  |  |  |  |  |  |  |  |  |  |  |
Average |  | $ | 997,744 |  |  | $ | 950,455 |  |  | $ | 857,361 |  |  | $ | 565,223 |  |  | $ | 494,931 |
End of period |  | $ | 984,258 |  |  | $ | 992,109 |  |  | $ | 923,213 |  |  | $ | 609,140 |  |  | $ | 533,710 |
Ratio of allowance for loan and lease losses to loans outstanding at end of period |  |  | 0.69 | % |  |  | 0.75 | % |  |  | 0.78 | % |  |  | 1.08 | % |  |  | 1.20 | %
Net charge-offs to average loans |  |  | 0.16 | % |  |  | 0.06 | % |  |  | 0.05 | % |  |  | 0.06 | % |  |  | 0.16 | %

56

The following table illustrates the allocation of the Company's allowance for loan losses for each category of loan for each reported period. The allocation of the allowance to each category is not necessarily indicative of future loss in a particular category and does not restrict our use of the allowance to absorb losses in other loan categories.

|  | At December 31, |
|  | 2019 |  |  | 2018 |  |  | 2017 |  |  | 2016 |  |  | 2015 |
|  |  |  |  |  | Percent of |  |  |  |  |  |  | Percent of |  |  |  |  |  |  | Percent of |  |  |  |  |  |  | Percent of |  |  |  |  |  |  | Percent of |
|  |  |  |  |  | Loans in Each |  |  |  |  |  |  | Loans in Each |  |  |  |  |  |  | Loans in Each |  |  |  |  |  |  | Loans in Each |  |  |  |  |  |  | Loans in Each |
|  |  |  |  |  | Category to |  |  |  |  |  |  | Category to |  |  |  |  |  |  | Category to |  |  |  |  |  |  | Category to |  |  |  |  |  |  | Category to |
|  | Amount |  |  | Total Loans |  |  | Amount |  |  | Total Loans |  |  | Amount |  |  | Total Loans |  |  | Amount |  |  | Total Loans |  |  | Amount |  |  | Total Loans |
(Dollars in Thousands) |  |  |  |  |  |  |  |  |  |  |  |  |  |  |  |  |  |  |  |  |  |  |  |  |  |  |  |  |  |  |  |  |  |  |  |  |  |  |  |
Type of Loans: |  |  |  |  |  |  |  |  |  |  |  |  |  |  |  |  |  |  |  |  |  |  |  |  |  |  |  |  |  |  |  |  |  |  |  |  |  |  |  |
Commercial and industrial |  | $ | 456 |  |  |  | 9.10 | % |  | $ | 969 |  |  |  | 8.45 | % |  | $ | 999 |  |  |  | 10.98 | % |  | $ | 448 |  |  |  | 9.95 | % |  | $ | 448 |  |  |  | 7.97 | %
Real estate construction |  |  | 97 |  |  |  | 6.43 |  |  |  | 100 |  |  |  | 5.72 |  |  |  | 313 |  |  |  | 5.09 |  |  |  | 172 |  |  |  | 3.89 |  |  |  | 172 |  |  |  | 4.15 |
Mortgage: |  |  |  |  |  |  |  |  |  |  |  |  |  |  |  |  |  |  |  |  |  |  |  |  |  |  |  |  |  |  |  |  |  |  |  |  |  |  |  |
Residential |  |  | 1,658 |  |  |  | 35.26 |  |  |  | 1,581 |  |  |  | 33.92 |  |  |  | 1,760 |  |  |  | 34.46 |  |  |  | 2,818 |  |  |  | 44.46 |  |  |  | 2,818 |  |  |  | 43.56 |
Commercial |  |  | 4,529 |  |  |  | 47.75 |  |  |  | 4,651 |  |  |  | 50.22 |  |  |  | 4,036 |  |  |  | 47.44 |  |  |  | 3,135 |  |  |  | 40.96 |  |  |  | 3,135 |  |  |  | 43.41 |
Consumer installment |  |  | 28 |  |  |  | 1.46 |  |  |  | 127 |  |  |  | 1.69 |  |  |  | 82 |  |  |  | 2.03 |  |  |  | 25 |  |  |  | 0.74 |  |  |  | 25 |  |  |  | 0.91 |
Total |  | $ | 6,768 |  |  |  | 100.0 | % |  | $ | 7,428 |  |  |  | 100.0 | % |  | $ | 7,190 |  |  |  | 100.0 | % |  | $ | 6,598 |  |  |  | 100.0 | % |  | $ | 6,598 |  |  |  | 100.0 | %

Nonperforming assets. Nonperforming assets include nonaccrual loans, loans 90 days or more past due, OREO, and repossessed assets. Real estate owned is written down to fair value at its initial recording and continually monitored for changes in fair value. A loan is classified as nonaccrual when, in the opinion of management, there are serious doubts about collectability of interest and principal. Accrual of interest is discontinued on a loan when management believes, after considering economic and business conditions, the borrower’s financial condition is such that collection of principal and interest is doubtful. Payments received on nonaccrual loans are applied against principal until doubt about collectability ceases.

Nonperforming loans exclude TDRs that are perfoming in accordance with their terms over a prescribed period of time. TDRs are those loans which the Company, for economic or legal reasons related to a borrower’s financial difficulties, grants a concession to the borrower that the Company would not otherwise consider. The Company has 37 TDRs accruing interest with a balance of $3.6 million as of December 31, 2019, compared to 43 TDRs with a balance of $4.4 million as of December 31, 2018. Non-performing loans amounted to $8.9 million or 0.9% of total loans and $7.5 million or 0.8% of total loans at December 31, 2019 and December 31, 2018, respectively.

A major factor in determining the appropriateness of the ALLL is the type of collateral which secures the loans. Although this does not insure against all losses, real estate collateral provides substantial recovery, even in a distressed-sale and declining-value environment. The Bank’s objective is to work with the borrower to minimize the burden of the debt service and to minimize the future loss exposure to the Company.

The following table summarizes nonperforming loans by category:

|  | At December 31, |
|  | 2019 |  |  | 2018 |  |  | 2017 |  |  | 2016 |  |  | 2015 |
|  | (Dollars in Thousands) |
Loans accounted for on a nonaccrual basis |  |  |  |  |  |  |  |  |  |  |  |  |  |  |  |  |  |  |  |
Commercial and industrial |  | $ | 946 |  |  | $ | 996 |  |  | $ | 1,120 |  |  | $ | 454 |  |  | $ | 1,450 |
Real estate - construction |  |  | - |  |  |  | - |  |  |  | - |  |  |  | - |  |  |  | 130 |
Real estate-mortgage: |  |  |  |  |  |  |  |  |  |  |  |  |  |  |  |  |  |  |  |
Residential |  |  | 3,285 |  |  |  | 2,731 |  |  |  | 4,002 |  |  |  | 4,034 |  |  |  | 4,122 |
Commercial |  |  | 4,451 |  |  |  | 2,864 |  |  |  | 3,311 |  |  |  | 1,409 |  |  |  | 1,842 |
Consumer installment |  |  | 197 |  |  |  | 4 |  |  |  | - |  |  |  | 6 |  |  |  | 1 |
Total nonaccrual loans |  | $ | 8,879 |  |  | $ | 6,595 |  |  | $ | 8,433 |  |  | $ | 5,903 |  |  | $ | 7,545 |
Accruing loans which are contractually past due ninety days or more |  | $ | - |  |  | $ | 945 |  |  | $ | - |  |  | $ | - |  |  | $ | 2 |

Accrual of interest is discontinued on a loan when management believes, after considering economic and business conditions, the borrower's financial condition is such that collection of interest is doubtful. Payments received on nonaccrual loans are recorded as income or applied against principal according to management's judgment as to the collectability of principal.

A loan is considered impaired when it is probable the borrower will not repay the loan according to the original contractual terms of the loan agreement, including all troubled debt restructurings. Management has determined that first mortgage loans on one-to-four family properties and all consumer loans represent large groups of smaller-balance homogeneous loans that are to be collectively evaluated. Loans that experience insignificant payment delays, which are defined as 90 days or less, generally are not classified as impaired. A loan is not impaired during a period of delay in payment if the Company expects to collect all amounts due, including interest accrued at the contractual interest rate for the period of delay. Management evaluates all loans identified as impaired individually. The Company estimates credit losses on impaired loans based on the present value of expected cash flows, or the fair value of the underlying collateral if loan repayment is expected to come from the sale or operation of the collateral. Impaired loans, or portions thereof, are charged off when it is determined a realized loss has occurred. Until that time, an allowance for loan and lease loss is maintained for estimated losses.

57

Interest income that would have been recorded had these loans not been placed on nonaccrual status was $257,000 in 2019, and $456,000 in 2018. Management is not aware of any trends or uncertainties related to any loans classified as doubtful or substandard that might have a material effect on earnings, liquidity, or capital resources.

Changes in Results of Operations

2019 Results Compared to 2018 Results

General The Company posted net income of $12.7 million, compared to $12.4 million for the year ended December 31, 2018. On a per share basis, 2019 earnings were $1.95 per diluted share, representing an increase from the $1.92 per diluted share for the year ended December 31, 2018. The return on average equity for the year ended December 31, 2019, was 9.35% and the Company’s return on average assets was 1.05%, compared to 9.94% and 1.09%, respectively, for the year ended December 31, 2018.

Net interest income Net interest income, which is the Company’s largest revenue source, is the difference between interest income on earning assets and interest expense paid on liabilities. Net interest income is affected by the changes in interest rates and the composition of interest-earning assets and interest-bearing liabilities. Net interest income increased by $937,000 in 2019 to $41.4 million compared to $40.5 million for 2018. This increase is the result of a $4.2 million increase in interest and dividend income with only a $3.2 million increase in interest expense. Interest-earning assets averaged $1.14 billion during 2019, a year-over-year increase of $53.1 million from $1.09 billion for 2018. The Company’s average interest-bearing liabilities increased from $836.6 million in 2018 to $866.1 million in 2019.

Net interest margin, a key performance indicator, is net interest income as a percentage of total interest-earning assets. For 2019 the net interest margin, measured on a fully taxable equivalent basis, decreased to 3.68%, compared to 3.77% in 2018. The decline in the net interest margin is attributable to a 34 basis points increase in the yield on total interest-bearing liabilities partially offset by an increase of 15 basis points in the yield on total interest-earning assets for the year ended December 31, 2019.

Interest and dividend income Interest and dividend income increased $4.2 million to $54.5 million for 2019 which is attributable to a $3.8 million increase in interest and fees on loans. This change was the result of an increase in the average balance of loans receivable, accompanied by a higher yield on the portfolio. The average balance of loans receivable increased by $47.3 million or 4.98% to $997.7 million for the year ended December 31, 2019 as compared to $950.5 million for the year ended December 31, 2018. The loans receivable yield increased to 5.06% for 2019, from 4.91% in 2018.

Interest on investment securities increased $238,000 to $3.2 million for 2019, compared to $3.0 million for 2018. The average balance of investment securities increased $4.5 million to $101.4 million for the year ended December 31, 2019 as compared to $96.9 million for the year ended December 31, 2018. The investment securities yield increased 10 basis points to 3.77% for 2019, compared to 3.67% for 2018.

Interest expense Interest expense increased $3.2 million or 32.6% to $13.1 million for 2019, compared with $9.9 million for 2018. This change in interest expense can be partially attributed to an increase in the average balance of interest-bearing liabilities. For the year ended December 31, 2019 the average balance of interest-bearing liabilities increased by $29.5 million to $866.1 million as compared to $836.6 million for the year ended December 31, 2018. Interest incurred on deposits increased by $3.8 million for the year from $8.6 million in 2018 to $12.4 million for year-end 2019. The change in deposit expense was due to an increase in the average balance as well as a 30 basis point increase in the cost of deposits during the year. Interest expense incurred on FHLB advances, junior subordinated debt and other borrowings decreased 42.8% from 2018. The decrease was due to a $30.4 million decrease in the average balance, partially offset by 43 basis points increase in the cost to borrow.

Provi sion for loan losses The provision for loan losses is an operating expense recorded to maintain the related balance sheet allowance for loan and lease losses at an amount considered adequate to cover probable losses incurred in the normal course of lending. The provision for loan losses for the year ended December 31, 2019 was $890,000 compared to $840,000 in 2018. The loan loss provision is based upon management's assessment of a variety of factors, including types and amounts of nonperforming loans, historical loss experience, collectability of collateral values and guaranties, pending legal action for collection of loans and related guaranties, and current economic conditions. The loan loss provision reflects management's judgment of the current period cost-of-credit risk inherent in the loan portfolio. Although management believes the loan loss provision has been sufficient to maintain an adequate allowance for loan and lease losses, actual loan losses could exceed the amounts that have been charged to operations.

The ratio of nonperforming loans to total loans was 0.90% at December 31, 2019, an increase from 0.76% at December 31, 2018. The ratio of the allowance for loan and lease losses to total loans decreased to 0.69% of total loans at December 31, 2019 compared to 0.75% at December 31, 2018. Generally, historical loss rates have decreased during 2019 and the pooled reserve is 93.6% qualitative. In addition, the specific reserves are about half as much as year-end 2018. One nonperforming loan relationship of $3.2 million fell into a nonpayment status during the first quarter of 2019. This loan is a one-time event unrelated to any trend in the portfolio and has a specific reserve that accounts for the risk of this credit.

58

Noninterest income Noninterest income increased $1.1 million or 29.9% to $4.8 million for 2019 compared to $3.7 million for 2018. This increase was largely the result of increases in service charges on deposit accounts of $272,000, gain on sale of loans of $202,000, and other income of $339,000, which includes an increase in revenue from investment services of $143,000 from the prior year.

Noninterest expense Operating expenses increased $1.3 million, or 4.5% to $30.0 million for 2019 compared to $28.7 million for 2018. The increase was largely the result of increases in salaries and employee benefits expense and data processing costs of $774,000 and $402,000, respectively. The salary increase is mostly due to annual pay adjustments and an increase in employees. The increase in data processing costs is due to new and increased costs of processing agreements. This increase was partially offset by a decrease in federal deposit insurance expense of $320,000, which is due to the Company being determined to be eligible for small bank assessment credits.

Provision for income taxes The provision for income taxes increased by $430,000, or 19.9%, to $2.6 million for 2019 from $2.2 million for 2018. The Company’s effective federal income tax rate in 2019 was 16.9% compared to 14.8% in 2018.

Asset and Liability Management

The primary objective of the Company’s asset and liability management function is to maximize net interest income while maintaining an acceptable level of interest rate risk given the Company’s operating environment, capital and liquidity requirements, performance objectives and overall business focus. The principal determinant of the exposure of the Company’s earnings to interest rate risk is the timing difference between the re-pricing or maturity of interest-earning assets and the re-pricing or maturity of its interest-bearing liabilities. The Company’s asset and liability management policies are designed to decrease interest rate sensitivity primarily by shortening the maturities of interest-earning assets while at the same time extending the maturities of interest-bearing liabilities. The Board of Directors of the Company continues to believe in a strong asset/liability management process in order to insulate the Company from material and prolonged increases in interest rates.

The Company’s Board of Directors has established an Asset and Liability Management Committee consisting of outside directors and senior management. This committee, which meets quarterly, generally monitors asset and liability management policies and strategies.

Liquidity and Capital Resources

Liquidity. Liquidity management involves monitoring the ability to meet the cash flow needs of bank customers, such as borrowings or deposit withdrawals, as well as the Company’s own financial commitments. The principal sources of liquidity are net income, loan payments, maturing and principal reductions on securities and sales of securities available for sale, federal funds sold and cash and deposits with banks. Along with its liquid assets, the Company has additional sources of liquidity available to ensure adequate funds are available as needed. These include, but are not limited to, the purchase of federal funds, the ability to borrow funds under line of credit agreements with correspondent banks, a borrowing agreement with the Federal Home Loan Bank of Cincinnati, brokered deposits, and the adjustment of interest rates to obtain deposits. Management believes the Company has the capital adequacy, profitability and reputation to meet the current and projected needs of its customers.

Liquidity is managed based on factors including core deposits as a percentage of total deposits, the degree of funding source diversification, the allocation and amount of deposits among deposit types, the short-term funding sources used to fund assets, the amount of non-deposit funding used to fund assets, the availability of unused funding sources, off-balance sheet obligations, the availability of assets readily converted to cash without undue loss, the amount of cash and liquid securities we hold, and the re-pricing characteristics and maturities of our assets when compared to the re-pricing characteristics of our liabilities and other factors.

The Company's liquid assets consist of cash and cash equivalents, which include investments in very short-term investments (i.e., federal funds sold), equity securities, and investment securities classified as available for sale. The level of these assets is dependent on the Company's operating, investing, and financing activities during any given period. At December 31, 2019, cash and cash equivalents totaled $35.1 million or 3.0% of total assets, equity securities totaled $710,000 or 0.1% of total assets, and investment securities classified as available for sale totaled $105.7 million or 8.9% of total assets. Management believes that the liquidity needs of the Company are satisfied by the current balance of cash and cash equivalents, readily available access to traditional funding sources, FHLB advances, junior subordinated debt, brokered deposits, and the portion of the investment and loan portfolios that mature within one year. These sources of funds will enable the Company to meet cash obligations and off-balance sheet commitments as they come due.

Operating activities provided net cash of $13.5 million and $14.3 million for 2019 and 2018, respectively, generated principally from net income of $12.7 million and $12.4 million in these respective periods.

59

Investing activities provided net cash of $276,000 which consisted primarily of investment activity. The cash provided primarily consisted of proceeds from repayments and maturities of investments and the sale of securities of $17.7 million, and $12.3 million, respectively. Partially offsetting the proceeds is the usage from investment purchases of $35.0 million. For the same period ended 2018, investing activities used $76.5 million which consisted primarily of loan originations and investment activity. The cash usages primarily consisted of loan increases of $68.8 million and investment purchases of $13.0 million. Partially offsetting the usage are proceeds from repayments and maturities of $7.3 million.

Financing activities consist of the solicitation and repayment of customer deposits, borrowings and repayments and the payment of dividends. During 2019, net cash used in financing activities totaled $86.6 million, principally derived from a decrease in short-term borrowings, net, of $85.3 million. Partially offsetting the usage are proceeds from the net increase in deposits of $4.8 million. During 2018, net cash provided by financing activities totaled $130.3 million, principally derived from increases in deposit accounts, and increase in short-term borrowings, net, of $137.9 million, and $15.7 million, respectively. Partially offsetting the proceeds are repayments of other borrowings and the payment of cash dividends of $20.3 million and $3.8 million, respectively.

Liquidity may be adversely affected by many circumstances, including unexpected deposit outflows and increased draws on lines of credit. Management monitors projected liquidity needs and determines the desirable level based in part on the Company's commitment to make loans and management's assessment of the Company's ability to generate funds. The Company anticipates having sufficient liquidity to satisfy estimated short and long-term funding needs.

Capital Resources. The Company's primary source of capital is retained earnings. Historically, the Company has generated net retained income to support normal growth and expansion. Management has developed a capital planning policy to not only ensure regulatory compliance but capital adequacy for future expansion.

Registrant's Common Equity and Related Stockholder Matters

The Company had approximately 1,002 stockholders of record as of December 31, 2019. The Company’s common stock is traded and authorized for quotation on NASDAQ under the symbol “MBCN.” The Company currently expects consistency in the payout of future cash dividends.

60

MANAGEMENT’S ANNUAL REPORT ON INTERNAL CONTROL OVER FINANCIAL REPORTING

Management of the Company is responsible for establishing and maintaining adequate internal control over financial reporting as defined in Rules 13a-15(f) and 15d-15(f) under the Exchange Act. The Company’s internal control over financial reporting is designed to provide reasonable assurance regarding the reliability of financial reporting and the preparation of financial statements for external purposes in accordance with generally accepted accounting principles.

Because of its inherent limitations, internal control over financial reporting may not prevent or detect misstatements. Also, projections of any evaluation of effectiveness to future periods are subject to the risk that controls may become inadequate because of changes in conditions, or that the degree of compliance with the policies or procedures may deteriorate.

A material weakness is a significant deficiency (as defined in Public Company Accounting Oversight Board Auditing Standard No. 5), or a combination of significant deficiencies, that results in there being more than a remote likelihood that a material misstatement of the annual or interim financial statements will not be prevented or detected on a timely basis by management or employees in the normal course by management or employees in the normal course of performing their assigned functions.

Management assessed the effectiveness of the Company’s internal control over financial reporting as of December 31, 2019. In making this assessment, management used the criteria set forth by the Committee of Sponsoring Organizations of the Treadway Commission (COSO) in Internal Control-Integrated Framework (2013). Based on this assessment, management believes that, as of December 31, 2019, the Company’s internal control over financial reporting was effective.

The Company’s independent registered public accounting firm, S.R. Snodgrass, P.C., that audited the consolidated financial statements has issued an audit report on the effective operation of the Company’s internal control over financial reporting as of December 31, 2019.

/s/ Thomas G. Caldwell

By: Thomas G. Caldwell

President and Chief Executive Officer

(Principal Executive Officer)

Date: March 4, 2020

/s/ Donald L. Stacy

By: Donald L. Stacy

Treasurer

(Principal Financial & Accounting Officer)

Date: March 4, 2020

61